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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2004

OR

For the transition period from______to_______

Commission file number 0-12992

SYNTHETECH, INC.
(Exact name of registrant as specified in its charter)

1290 Industrial Way
PO Box 646
Albany, Oregon 97321
(Address of Principal Executive Offices)

(541) 967-6575
(Registrant’s Telephone Number, Including Area Code)

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.

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

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

Class: Common Stock, $0.001 par value
Shares outstanding as of October 29, 2004: 14,463,093

SYNTHETECH, INC

INDEX

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

SYNTHETECH, INC.

Condensed Balance Sheets
(unaudited)

The accompanying notes are an integral part of these condensed financial statements.

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SYNTHETECH, INC.

Condensed Balance Sheets
(continued)
(unaudited)

The accompanying notes are an integral part of these condensed financial statements.

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SYNTHETECH, INC.

Condensed Statements of Operations
(unaudited)

The accompanying notes are an integral part of these condensed financial statements.

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SYNTHETECH, INC.

Condensed Statements of Cash Flows
(unaudited)

The accompanying notes are an integral part of these condensed financial statements.

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SYNTHETECH, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
(Information as of September 30, 2004 and for the three and six-month
periods ended September 30, 2004 is unaudited)

        Synthetech, Inc., an Oregon corporation, is a fine chemicals company specializing in organic synthesis, biocatalysis and chiral technologies. Synthetech develops and manufactures amino acid derivatives, specialty amino acids, peptide fragments, and proprietary custom chiral intermediates primarily for the pharmaceutical and cosmeceutical industries. Synthetech’s products support the development and manufacture of therapeutic peptides and peptidomimetic small molecule drugs at every stage of a customer’s clinical development pipeline, and are used as ingredients in drugs for the treatment of AIDS, cancer, cardiovascular and other diseases, and in cosmeceuticals.

The summary financial statements included herein have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although Synthetech management believes that the disclosures are adequate to make the information presented not misleading. Synthetech’s management suggests that these summary financial statements be read in conjunction with the financial statements and the notes thereto included in the Synthetech’s Annual Report on Form 10-K for the year ended March 31, 2004.

The interim period information included in this Form 10-Q reflects all adjustments, consisting of normal recurring adjustments, that are, in the opinion of Synthetech’s management, necessary for a fair statement of the results of the respective interim periods. Results of operations for interim periods are not necessarily indicative of results to be expected for an entire year.

        Use of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Significant items subject to such estimates and assumptions include the valuation of inventory, accounts receivable, deferred tax assets and the carrying amount of property, plant and equipment.

        Cash and Cash Equivalents: Cash and cash equivalents include demand cash and highly liquid debt instruments with maturities of three months or less when purchased.

Cash and cash equivalents consist of the following:

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        Accounts receivable: Accounts receivable are recorded at the invoiced amount and do not bear interest. Synthetech does not finance its trade receivables by factoring the balances to a third party. The allowance for doubtful accounts is established by a review of aged accounts receivables and a review for collectibility of specific accounts. The allowance for doubtful accounts as of September 30, 2004 and March 31, 2004 was $15,000.

        Inventories: Inventories are stated at the lower of cost or market, determined on the first-in, first-out basis. Costs include direct material, direct labor, applicable manufacturing overhead, and other direct costs.

Management evaluates Synthetech’s inventory for impairment whenever it becomes aware that indicators of impairment exist. It is Synthetech’s policy to write-down inventories to reflect an estimate for impairment in an amount equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. Write-downs of inventory are reported as a component of cost of revenue in the relevant period.

        Property, Plant and Equipment: Property, plant and equipment are recorded at cost. Expenditures for maintenance and repairs are expensed as incurred. Expenditures that materially increase values, change capacities or extend useful lives are capitalized. When assets are retired, sold, or otherwise disposed of, the applicable costs and accumulated depreciation are removed from the accounts and the resulting gain or loss is recognized. Depreciation and amortization are provided on the straight-line method over the estimated useful lives of the individual assets which range from three to 40 years. Assets to be disposed of by sale are stated at the lower of their fair values or carrying amounts and depreciation is no longer recognized.

Synthetech monitors the recoverability of the carrying value of its long-lived assets such as property, plant and equipment. An impairment charge is recognized when the expected net undiscounted cash flows from an asset’s use (including any proceeds from disposition) are less than the asset’s carrying value and the asset’s carrying value exceeds its fair value.

        Revenue Recognition: Synthetech recognizes revenue, including shipping and handling charges billed to customers, upon shipment of product when title and risk of loss pass to customers. Shipping and handling costs are classified as part of cost of revenue.

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        Stock Based Compensation: In accordance with Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure – an Amendment of Financial Accounting Standards Board (FASB) Statement No. 123" (SFAS 148) and Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (SFAS 123), Synthetech’s pro forma option expense is computed using the Black-Scholes option pricing model.

As permitted by SFAS No. 123, as amended by SFAS No. 148, Synthetech has elected to continue to apply the provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in accounting for its employee stock option plan and employee stock purchase plan (ESPP). Synthetech is generally not required under APB Opinion No. 25 and related interpretations to recognize compensation expense in connection with its stock based compensation plans. Synthetech is required by SFAS No. 123 to present, in the Notes to Financial Statements, the pro forma effects on reported net income and earnings per share as if compensation expense had been recognized based on the fair value method of accounting prescribed by SFAS No. 123. Compensation expense is recorded only if, on the date of grant, the current market price of the underlying stock exceeds the exercise price. Resulting compensation expense is recognized over the vesting period.

Synthetech is presenting the following table to illustrate the effect on the net loss and net loss per share if it had applied the fair value recognition provisions of SFAS 123, as amended, to options granted under the stock based employee compensation plans. For purposes of this pro forma disclosure, the estimated value of the options is recognized over the options’ vesting periods.

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In calculating pro forma compensation, the fair value of each stock option grant and stock purchase right is estimated on the date of grant using the Black-Scholes option pricing model and the following weighted average assumptions. No stock options were granted by Synthetech during the three months ended September 30, 2004.

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Synthetech has no material components of comprehensive income or loss other than net income or loss. Accordingly, comprehensive net income or loss was equal to net income or loss for all periods presented.

Basic loss per share (EPS) is computed by dividing net loss by the weighted average number of shares of common stock outstanding during the period. Diluted loss per share is computed by dividing net loss by the weighted average number of shares of common stock and common stock equivalents outstanding during the period, calculated using the treasury stock method as defined in SFAS No. 128. For the three month and six month periods ended September 30, 2004, the weighted average shares used to compute diluted loss per share did not differ from the weighted average shares used to compute basic loss per share.

The following common stock equivalents were excluded from the earnings per share computation because their effect would have been anti-dilutive:

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        During the third quarter of fiscal 2004, Synthetech entered into a line of credit facility with a bank that provides for borrowings of up to $1 million. Interest is payable at prime with an annual facility fee of 0.5 percent. The agreement is collateralized by cash and cash equivalents, accounts receivable, inventories and equipment. The agreement requires Synthetech to maintain various financial and other covenants. The line of credit has a one-year term and expires in December 2004. As of September 30, 2004, Synthetech had no borrowings outstanding under the credit agreement.

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

The following discussion of the results of Synthetech’s operations and financial condition should be read in conjunction with the accompanying financial statements and the notes thereto included within this report.

FORWARD LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. This Act provides a “safe harbor” for forward-looking statements to encourage companies to provide prospective information about themselves so long as they identify these statements as forward-looking and provide meaningful cautionary statements identifying important factors that could cause actual results to differ from the projected results. All statements, other than statements of historical fact, including statements regarding industry prospects and future results of operations or financial position, made in this Quarterly Report are forward looking. Words such as “anticipates,” “believes,” “expects,” “future” and “intends” and similar expressions may identify forward-looking statements. In particular, forward-looking statements in this report include statements regarding: our future operating results, including margins in future periods and our expected results for the third and fourth quarters of fiscal 2005; customer completion of a New Drug Application, obtaining regulatory approval for new drugs and other matters relating to drug development progress; results of cost cutting measures; expected shipping dates; projected revenue from large-scale customer projects; increasing competition from developing countries; financing our current and future capital expenditures; management statements regarding market conditions including the status of the new product development sector of the pharmaceutical industry; the financial effect on us of successful commercialization of customer drug development projects; the effect any change in foreign currency exchange rates would have on our operating results; adequacy of our cash and cash equivalents, borrowing capacity including our ability to renew our credit facility and internally generated funds to operate our business for the next twelve months; and our ability to recognize deferred tax assets. Forward-looking statements reflect management’s current expectations, plans or projections and are inherently uncertain. Actual results could differ materially from management’s expectations, plans or projections. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. The risks and uncertainties include, but are not limited to, the following: the uncertain market for our products, potential loss of a significant customer, customer concentration, potential termination or suspension by customers of significant projects, potential period-to-period revenue or expense fluctuations, higher than expected cash use, or ability to borrow funds under our line of credit, production factors, industry cost factors, competition, government regulation, labor disputes, technological change, and international business risks. Investors are directed to our filings with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the fiscal year ended March 31, 2004, as amended, for a further description of risks and uncertainties related to forward-looking statements made by us as well as to other aspects of our business. Synthetech will not release any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Readers are urged, however, to review the factors set forth in reports that Synthetech files from time to time with the Securities and Exchange Commission.

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OVERVIEW

Synthetech is a fine chemicals company specializing in organic synthesis, biocatalysis and chiral technologies. Synthetech develops and manufactures amino acid derivatives, specialty amino acids, peptide fragments, and proprietary custom chiral intermediates primarily for the pharmaceutical and cosmeceutical industries. Synthetech’s products support the development and manufacture of therapeutic peptides and peptidomimetic small molecule drugs at every stage of a customer’s clinical development pipeline. Synthetech’s domestic and international customer base includes major pharmaceutical and emerging biopharmaceutical companies, as well as contract drug synthesis firms. Synthetech also supplies catalog quantities of specialty amino acids to research institutions, universities and drug discovery firms. Our integrated “grams to tons” production capabilities allow us to be involved with our customers from the early phases of pharmaceutical discovery and clinical development through approval, market launch and commercialization.

Synthetech continued to face difficult market conditions in the second quarter of fiscal 2005. The pharmaceutical industry remains subject to significant overcapacity at a time when low cost suppliers from emerging economies are developing positions in the pharmaceutical supply chain resulting in downward pressure on pricing. We expect that revenue will be substantially lower than usual for the third quarter of fiscal 2005 before improving in the fourth quarter.

During the second quarter of fiscal 2005, Synthetech entered into a manufacturing agreement to prepare three validation batches and submit a Drug Master File (DMF) to the Food and Drug Administration for an advanced cGMP intermediate. This will support a customer’s New Drug Application (NDA) in calendar 2005. Synthetech also received an order for validation batches to supply a key starting material for another customer’s drug under development which is expected to be filed for regulatory approval in calendar 2005. Combined, these orders represent $1.1 million of revenue expected to ship during the second half of fiscal 2005, with shipments predominantly weighted towards our fiscal fourth quarter ending March 31, 2005.

Management anticipates that Synthetech’s revenue will continue to be volatile from period to period. Variability in Synthetech’s level of revenue is primarily based on our participation in large-scale customer projects and the timing of shipments arising from these projects. Synthetech operates in a challenging business environment, characterized by the unpredictable dynamics and life cycle of pharmaceutical projects, which can lead to rapid fluctuations in the mix of projects and revenues. As the uncertainties inherent in drug development projects remain outside of Synthetech’s control, it is difficult to predict the progress, timing and revenue potential of these projects.

Management believes that the new product development sector of the pharmaceutical industry remains active. Synthetech is participating in a variety of early-stage projects, which have traditionally been the source for our future large-scale projects. In addition, we continue to supply products for marketed pharmaceuticals and a marketed cosmeceutical. The progress and timing of development projects and continued success of marketed products remain outside our control.

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RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, the percentage of revenues represented by each item included in the Statements of Operations.

Revenue

Revenue of $2.5 million in the second quarter of fiscal 2005 increased by $688,000, or 37%, from revenue of $1.8 million in the second quarter of fiscal 2004. Revenue of $5.3 million in the first half of fiscal 2005 increased by $1.7 million, or 46%, from revenue of $3.6 million in the first half of fiscal 2004.

Revenue from large-scale customer projects was $1.1 million and $3.2 million in the second quarter and first half of fiscal 2005, respectively, compared to $1.1 million and $2.1 million in the same periods of fiscal 2004. Large-scale project revenue during the first half of fiscal 2005 included revenue from four ongoing customer projects compared to two large-scale projects in the comparable period of fiscal 2004. Revenue in the second quarter and first half of fiscal 2005 and 2004 included a large-scale customer project in support of an established product in the cosmeceutical sector. A cosmeceutical is a product that makes no therapeutic claims but is intended for topical use by humans.

In addition to large-scale projects, a significant number of other customer projects contributed to revenue during the second quarter and first half of fiscal 2005 and 2004. While individually smaller in dollar value, these projects support a wide variety of programs for our major pharmaceutical, emerging biopharmaceutical and contract drug synthesis customers.

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International sales, mainly to Europe, were $620,000 and $818,000 for the second quarter and first half of fiscal 2005, respectively, compared to $585,000 and $971,000 for the second quarter and first half of fiscal 2004, respectively. International sales, like all of our revenues, are subject to significant quarterly fluctuations.

To the extent successful customer projects develop into larger volumes, either during late stage clinical trials, pre-launch or as a marketed product, our per unit pricing may decline. There is a risk that the impact on future sales and profitability from declines in pricing may not be offset by an increase in volume.

The level of Synthetech’s business from period to period is largely unpredictable. Although revenue associated with marketed products is more likely to provide a longer term, on-going revenue stream than revenue associated with drugs at the clinical or discovery stages, continuation of customer demand for our products from customers with marketed products remains subject to various market conditions, including potential use of alternative manufacturing methods, continued market demand for drugs or cosmeceuticals that we support, and competition from other suppliers. Accordingly, while significant orders related to marketed products provide increased and more predictable revenue, we expect revenue related to marketed products and other projects to continue to fluctuate significantly from period to period.

Gross income (loss)

Gross income for the second quarter of fiscal 2005 was $575,000, or 23% of revenue, compared to a gross loss of $653,000, or 35% of revenue, for the second quarter of fiscal 2004. Gross income for the first half of fiscal 2005 was $845,000 or 16% of revenue, compared to a gross loss of $1.1 million, or 30% of revenue, for the comparable period of fiscal 2004.

Compared to the second quarter and first half of fiscal 2004, the comparable periods of fiscal 2005 benefited from a higher level of sales, a favorable mix of projects with above average margins and from cost controls. However, for the level of revenue reported in the second quarter, we typically would not expect gross income to be this high.

In the second quarter and first half of fiscal 2005, costs incurred by Synthetech’s manufacturing departments decreased by approximately $420,000 and $480,000, respectively, compared to the comparable periods of fiscal 2004, largely due to a decrease in labor and maintenance costs. In response to difficult business conditions, Synthetech reduced its workforce during the second quarter of fiscal 2004 and has implemented other cost reduction measures. Cost reductions achieved in the second quarter of fiscal 2005 are not expected to continue at this level in future quarters.

Gross income for the second quarter and first half of fiscal 2005 reflects charges for impaired inventory of $184,000 and $397,000, respectively. This compares to charges for impaired inventory of $389,000 and $583,000 in the comparable periods of 2004. Synthetech routinely develops manufacturing processes to produce new products or to refine procedures for existing products. It is not unusual for manufacturing costs associated with new processes to exceed the selling price for the initial batches of product, which results in an inventory write-off. The international fine chemicals industry has been marked by overcapacity and a resulting downward pressure on pricing. It remains difficult to rework certain materials on a cost effective basis.

Cost of revenue includes raw materials, direct labor, manufacturing overhead, other direct costs, and adjustments to inventory.

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Operating Expenses

R&D Expense. Research and development (R&D) expense in the second quarter of fiscal 2005 was $158,000, or 6% of revenue, compared to $176,000, or 10% of revenue, in the second quarter of fiscal 2004. R&D expense in the first half of fiscal 2005 was $284,000, or 5% of revenue, compared to $372,000, or 10% of revenue, for the comparable period of fiscal 2004.

The decrease in R&D expense for the second quarter and first half of fiscal 2005, compared to the comparable periods of fiscal 2004 is primarily associated with a decrease in labor costs between the periods. The decrease in labor costs is composed of salary reductions that were implemented late in the second quarter of fiscal 2004 and changes in staffing levels that reduced both labor and related expenses. The first quarter and first half of fiscal 2004 include approximately $30,000 of employee relocation costs.

Synthetech’s R&D department primarily develops processes to produce and optimize the production of our products and their related scale-up to manufacturing quantities.

SG&A Expense. Selling, general and administrative (SG&A) expense in the second quarter of fiscal 2005 was $528,000, or 21% of revenue, compared to $403,000, or 22% of revenue, in the second quarter of fiscal 2004. SG&A expense in the first half of fiscal 2005 was $1.1 million or 21% of revenue, compared to $884,000, or 24% of revenue, for the comparable period of fiscal 2004.

The increase in SG&A expense in the second quarter and first half of fiscal 2005, compared to the same periods in fiscal 2004 is primarily due to an increase in Synthetech’s marketing activities including the additions of a Director of Business Development in August 2003 and a Director of business Development for Europe in February 2004. In addition, Board of Director fees and related costs, and fees for legal services have increased $54,000 for the six month period ended September 30, 2004 compared to the comparable period of the prior year.

SG&A expense consists of compensation and related fringe benefits for sales and administrative employees, cost of professional services, marketing costs, costs associated with being a public company and costs related to administrative facilities and information services.

Interest Income

Interest income in the second quarter and first half of fiscal 2005 was $10,000 and $19,000, respectively, compared to $8,000 and $20,000, respectively, in the comparable periods of fiscal 2004. Synthetech’s interest income is primarily derived from earnings on our cash equivalents. The changes in interest income for the periods presented were due to the amount of cash equivalents and the interest rates in effect during the periods. Average rates of interest earned on Synthetech’s cash equivalents during the first six months of fiscal 2005 were 1.01%, compared to 0.88% during the comparable period of fiscal 2004.

Interest expense

Interest expense was $2,000 and $4,000, respectively, for the second quarter and first half of both fiscal 2005 and 2004.

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Benefit for Income Taxes

Based on Synthetech’s recent history of losses, our near-term outlook and management’s evaluation of available tax planning strategies, we have concluded that it is more likely than not that Synthetech will be unable to recognize its net deferred tax assets as a benefit for income taxes, continuing for an uncertain period of time.

Net Loss

Net loss for the second quarter of fiscal 2005 was $103,000, or 4% of revenue, compared to a net loss of $1.2 million, or 67% of revenue, for the second quarter of fiscal 2004. Net loss for the first half of fiscal 2005 was $515,000, or 10% of revenue, compared to a net loss of $2.3 million, or 64% of revenue, for the comparable period of fiscal 2004.

INDUSTRY FACTORS

Market Factors

The market for Synthetech’s products is driven by the market for the drugs into which they are incorporated. The drug development process is dictated by the marketplace, drug companies and the regulatory environment. Synthetech has no control over the pace of these drug development efforts, which drugs get selected for clinical trials, which drugs are approved by the FDA or, even if approved, the ultimate market potential of the drugs. Synthetech also manufactures products for use in a cosmeceutical, and faces similar factors in that market.

The three stages of the drug development process include: R&D or discovery stage, clinical trial stage and marketed drug stage. Synthetech’s customers can spend years researching and developing new drugs, and take only a small percentage to clinical trials and fewer yet to commercial market. A substantial amount of activity continues to occur at the earlier stages of R&D and clinical trials. The market for peptide and peptidomimetic small molecule drugs is still developing.

Recurring sales of our products for development programs are sporadic. Because of the high cancellation rate for drug development programs, there is a significant likelihood that there will be no subsequent or “follow-on” sales for any particular drug development program. Accordingly, the level and timing of customer orders relating to specific drug development programs vary substantially from period to period and we cannot rely on any one customer as a constant source of revenue.

The size of customer orders for marketed drugs can be substantially larger than those for the discovery or clinical trial stages. Sales of Synthetech’s products for marketed drugs may provide an opportunity for continuing, longer-term sales. While not subject to the same high cancellation rate faced by discovery and clinical trial-stage drug development programs, the demand for approved drugs remains subject to many uncertainties, including price, side effects, the existence of competing drugs and other factors affecting market acceptance. These factors, which are outside of Synthetech’s control, affect the level of demand for the drug itself and, therefore, the demand for Synthetech’s products. With longer-term, significant or large-scale orders, we expect increased competition to supply these products, which may result in canceled orders or downward price pressure. Also, industry cost pressures can cause pharmaceutical companies to explore and ultimately adopt alternative manufacturing processes that may not include Synthetech’s products as an intermediate. The

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international fine chemicals industry, where Synthetech is a niche participant, has been marked by significant overcapacity and a resulting downward pressure on pricing.

Similar dynamics affect the cosmeceutical development process and market, except that the regulatory oversight and, consequently, the typical length of a product’s “time to market” are reduced.

Due to the foregoing industry factors Synthetech cannot predict future demand beyond its current order base, and existing orders may be subject to cancellation or delay by customers. Until there is stable demand for our products, we are likely to continue to experience significant fluctuations in our periodic results.

Production Factors

Synthetech has a full cycle “grams to tons” production capability and has made over 400 products. With over 15 years of experience, Synthetech has developed extensive process technology and is recognized as one of the leaders in our area of expertise. Nevertheless, initial batches of new products and scaling up production processes for existing products may result in significantly lower than expected yields and extended processing time, and may require substantial rework to meet the required customer specifications. These factors could cause increased costs and delayed shipments, either of which could negatively affect periodic operating results.

LIQUIDITY AND CAPITAL RESOURCES

Synthetech’s cash and cash equivalents totaled $5.0 million at September 30, 2004, compared to $4.3 million at March 31, 2004. At September 30, 2004 and March 31, 2004, Synthetech had working capital of $9.2 million. Synthetech has a $1 million bank line of credit. Interest is payable at the prime rate with an annual facility fee of 0.5 percent. The facility is collateralized by cash and cash equivalents, accounts receivable, inventories and equipment. Financial covenants contained in the agreement require Synthetech to maintain a quick ratio of 1.5 to 1 and a tangible net worth of $19 million. Synthetech had no borrowings outstanding under the credit facility as of September 30, 2004. The credit facility expires in December 2004. Management expects to renew the credit facility.

Synthetech generated cash from operating activities of $736,000 during the first half of fiscal 2005, compared to cash used in operating activities of $1.9 million in the first half of fiscal 2004. In the first half of fiscal 2005, the primary use of cash from operating activities was the net loss of $515,000 which was offset by non-cash charges for depreciation of $535,000 and amortization of deferred compensation of $8,000. Reductions in prepaid expenses, inventories and accounts receivable were the primary sources of cash flow derived from operating activities. Accounts receivable decreased $153,000 to $1.1 million at September 30, 2004 from $1.3 million at March 31, 2004. The change in accounts receivable between the two periods is primarily due to differences in the timing of shipments. Inventory decreased $304,000 to $3.9 million at September 30, 2004 from $4.2 million at March 31, 2004. The change in inventory between the two periods is consistent with normal levels of inventory fluctuations based on the timing of raw material purchases and customer shipments. Accounts payable of $530,000 at September 30, 2004 decreased slightly from the March 31, 2004 balance of $559,000.

Synthetech used $59,000 of cash for capital expenditures during the first half of fiscal 2005, compared to $285,000 in the first half of fiscal 2004. Synthetech has completed its existing long-term capital plan for its sole facility in Albany, Oregon. Synthetech’s revised capital plan for fiscal 2005 includes

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various projects totaling approximately $350,000. Based upon Synthetech’s future financial results management may defer some of these projects to conserve cash. Synthetech expects to finance all capital expenditures from cash on hand and any internal cash flow and does not anticipate the need for any new debt or equity financing to fund these projects.

Cash used in financing activities for the first half of fiscal 2005 totaled $4,000 compared to cash provided by financing activities of $4,000 in the first half of fiscal 2004.

Synthetech incurred significant negative cash flow in fiscal 2004. Although we are unable to predict with certainty future demand (as discussed above), based on the existing state of the fine chemicals industry, our first half operating results and our existing order base, we expect to incur negative cash flow for fiscal 2005, which would adversely affect our cash position.

Notwithstanding the foregoing, Synthetech believes that its existing cash and cash equivalents, its bank line of credit and any funds generated from operations will be sufficient to support its operations for the next twelve months. However, any projections of future cash needs and cash flows are subject to substantial uncertainty. There can be no assurance that current cash and cash equivalent balances and proceeds from the bank line of credit, together with cash anticipated to be generated from operations, will be sufficient to satisfy our liquidity requirements. Synthetech may not be able to draw under or renew its line of credit or obtain a replacement line of credit on acceptable terms. If sources of liquidity are insufficient, Synthetech may have to seek additional debt or equity financing to satisfy its liquidity requirements, may not be able to obtain adequate or favorable financing and any financing Synthetech obtains may dilute the ownership interests of its shareholders prior to the financing.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The discussion and analysis of Synthetech’s financial condition and results of operations are based upon its financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires Synthetech to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities. On an on-going basis, Synthetech evaluates its estimates, including those related to deferred tax asset realization, inventory realization, allowance for doubtful accounts and long-lived asset impairments. Synthetech bases its estimates on historical experience and on various other assumptions. Actual results may differ from these estimates under different assumptions or conditions. Synthetech believes the following are among the critical accounting policies and the related judgments and estimates that affect the preparation of its financial statements.

Allowance for Doubtful Accounts

A customer’s creditworthiness is analyzed by a review of a customer’s payment history and financial stability. The allowance for doubtful accounts is established by a review of aged accounts receivables and a review for collectibility of specific accounts. The allowance for doubtful accounts as of September 30, 2004 and March 31, 2004 was $15,000. If circumstances related to a specific customer change, Synthetech’s estimate of the recoverability of receivables could materially change.

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Inventories

Inventories are valued at the lower of cost or market, determined on the first-in first-out (FIFO) basis. Costs include direct material, direct labor, applicable manufacturing overhead, and other direct costs.

Management evaluates Synthetech’s inventory for impairment whenever it becomes aware that indicators of impairment exist. Factors contributing to inventory impairment include, but are not limited to: decreases in selling price; changes in customer specifications; project terminations or holds; variations in material produced by Synthetech from customer specifications; and production costs materially in excess of current market price. It is our policy to write-down inventories to reflect an estimate for impairment in an amount equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, an additional inventory write-down may be required in the future. Write-downs of inventory are reported as a component of cost of revenue in the relevant period.

Long-Lived Asset Impairment

Synthetech monitors the recoverability of the carrying value of its long-lived assets such as property, plant and equipment. An impairment charge is recognized when the expected net undiscounted cash flows from an asset’s use (including any proceeds from disposition) are less than the asset’s carrying value and the asset’s carrying value exceeds its fair value. Changes in the expected use of a long-lived asset, and the financial performance of the long-lived asset, are evaluated as indicators of possible impairment. Future cash flow value may be based upon appraisals for property, plant and equipment, future cash flow estimates from operating the long-lived assets and other operating considerations.

Revenue Recognition

Synthetech recognizes revenue, including shipping and handling charges billed to customers, when the following criteria are met:

• Persuasive evidence of an arrangement exists,
• Delivery has occurred or services have been rendered,
• Synthetech’s price to our customer is fixed or determinable, and
• Collectibility is reasonably assured.

Shipping and handling costs are classified as part of cost of revenue.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Synthetech’s primary market risk exposure is the impact of interest rate fluctuations on interest income earned on our cash equivalents. The risks associated with market, liquidity and principal are mitigated by investing in high-credit quality securities and limiting concentrations of issuers and maturity dates. Synthetech does not invest in derivative financial instruments.

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Substantially all of Synthetech’s purchases and sales are denominated in U.S. dollars and, as a result, it has relatively little exposure to foreign currency exchange risk with respect to any of its purchases and sales. Should Synthetech enter into a significant transaction denominated in a foreign currency, we may enter into a forward exchange contract at that time.  Synthetech was not a party to any forward exchange contracts as of September 30, 2004.  For existing company transactions denominated in a foreign currency, the effect of an immediate 10% change in relevant exchange rates would not have a material impact on Synthetech’s operating results or cash flows.

Item 4. Controls and Procedures

Synthetech maintains a system of disclosure controls and procedures designed to provide reasonable assurance as to the reliability of our published financial statements and other disclosures included in our reports under the Securities Exchange Act of 1934. In accordance with Rule 13a-15(b) of the Securities and Exchange Act of 1934, our management evaluated, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of the design and operation of Synthetech’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities and Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and the Chief Financial Officer concluded that Synthetech’s disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that material information relating to Synthetech was made known to them by others within Synthetech, particularly during the period in which this Quarterly Report on Form 10-Q was being prepared.

There has been no change in our internal control over financial reporting during the fiscal quarter ended September 30, 2004 that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.

Synthetech’s Chief Executive Officer and Chief Financial Officer do not expect that our disclosure controls and internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Synthetech have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple mistake or error. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based partly on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

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PART II. OTHER INFORMATION

Item 2. Changes in Securities and Use of Proceeds

The following table provides information as of September 30, 2004 with respect to the shares of common stock repurchased by Synthetech during the second quarter of fiscal 2005:

(1)  Synthetech has no repurchase plans or programs.

Item 6. Exhibits and Reports on Form 8-K

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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.

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