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

FORM 10-Q

(Mark One)

For the quarterly period ended December 31, 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.

Yes      X                 No            

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

Yes                        No      X     

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

SYNTHETECH, INC

INDEX

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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 December 31, 2004 and for the three and nine-month
periods ended December 31, 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. A cosmeceutical is a product that makes no therapeutic claims, but is intended for topical use by humans.

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 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.

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        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:

        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 December 31, 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 employee 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.

The following table illustrates the effect on the net loss and net loss per share if Synthetech 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 during the three months ended December 31, 2003. No ESPP shares were granted during the three months ended December 31, 2004, or 2003.

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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 nine month periods ended December 31, 2004 and 2003, 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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Synthetech’s bank line of credit 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, inventory 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 2005. As of December 31, 2004, Synthetech had no borrowings outstanding under the credit agreement and was in compliance with all covenants.

Synthetech has engaged Mr. Paul Ahrens, Chairman of the Board, and Mr. David Clarke, Director, to assist with Synthetech’s marketing and strategic development efforts. Fees incurred by Synthetech under these arrangements during the first nine months of fiscal 2005 were $40,000.

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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 our large-scale project revenue for the fourth quarter of fiscal 2005; customer completion of a New Drug Application; obtaining regulatory approval for new drugs and other matters relating to drug development progress; expected shipping dates; financing our current and future capital expenditures; 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; the adequacy of our cash and cash equivalents, borrowing capacity including our ability to draw on our credit facility and internally generated funds to operate our business for the next twelve months; and our inability 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 that may cause actual results to vary materially from any forward-looking statements 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 inability 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 urged to read 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 does not intend to 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.

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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 continues to face difficult market conditions. 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 that are resulting in downward pressure on pricing.

Revenue in the third quarter of fiscal 2005 was $1.2 million. Our quarterly results fluctuate significantly, primarily as a result of the progress on and timing of customer orders relating to large-scale projects. The level of revenue for the current quarter is near the lower end of our range of quarterly revenues since fiscal year 2001.

Management expects that, compared to the third quarter of fiscal 2005, revenue will improve significantly in the fourth quarter of fiscal 2005. As of February 10, 2005, our revenues relating to large-scale project shipments already made during the fourth quarter of fiscal 2005 and our backlog relating to large-scale projects scheduled for shipment during the fourth quarter, totaled approximately $2.3 million. In addition, we continue to be active in supplying smaller orders of key intermediates for several early stage drug development projects. Management is currently unable to forecast with reasonable certainty Synthetech’s revenues relating to large-scale projects beyond the fourth quarter of fiscal 2005.

During the second quarter of fiscal 2005, Synthetech entered into a manufacturing agreement to prepare three validation batches and submit a Drug Master File to the Food and Drug Administration for an advanced cGMP intermediate. This agreement will support a customer’s New Drug Application expected to be filed in calendar 2005. We shipped the first validation batch during the third quarter of fiscal 2005. Synthetech has also received orders 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. Synthetech has supported both of these projects for numerous years as they have progressed through the pharmaceutical development cycle.

Management anticipates that Synthetech’s revenue will continue to be volatile from period to period, primarily due to the level of revenue from, and the timing of shipments relating to, large-scale 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.

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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. The progress and timing of development projects and continued success of marketed products remain outside our control.

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 $1.2 million in the third quarter of fiscal 2005 decreased by $1.7 million, or 59%, from revenue of $2.9 million in the third quarter of fiscal 2004. Revenue for the first nine months of fiscal 2005 and 2004 was $6.5 million.

The size and timing of large-scale customer projects can cause significant fluctuations in quarter to quarter revenue. Revenue from large-scale customer projects was $563,000 and $3.7 million in the third quarter and first nine months of fiscal 2005, respectively, compared to $2.1 million and $4.2 million in the same periods of fiscal 2004. Revenue in the third quarter of fiscal 2005 was comprised of two large-scale projects and numerous smaller projects. Large-scale project revenue during the first nine months of fiscal 2005 included revenue from five customer projects compared to three large-scale projects in the comparable period of fiscal 2004. Revenue in the first nine months of fiscal 2005 and 2004 and the third quarter of fiscal 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

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therapeutic claims but is intended for topical use by humans. Synthetech is uncertain if future sales in support of this particular cosmeceutical will continue.

In addition to large-scale projects, a significant number of other customer projects contributed to revenue during the third quarter and first nine months 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. Synthetech’s large-scale projects typically originate from the company’s portfolio of successful small-scale early stage drug development projects.

International sales, mainly to Europe, were $520,000 and $1.3 million in the third quarter and first nine months of fiscal 2005, respectively, compared to $399,000 and $1.4 million in the third quarter and first nine months 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)

The gross loss in the third quarter of fiscal 2005 was $494,000, or 42% of revenue, compared to gross income of $302,000, or 10% of revenue, in the third quarter of fiscal 2004. Gross income for the first nine months of fiscal 2005 was $351,000, or 5% of revenue, compared to a gross loss of $779,000, or 12% of revenue, in the first nine months of fiscal 2004.

Manufacturing department costs incurred during the third quarter of fiscal 2005 were comparable to costs incurred during the third quarter of fiscal 2004. The low amount of revenue in the third quarter of fiscal 2005 was inadequate to generate sufficient margins to offset manufacturing costs directly charged to cost of revenue. The gross loss in the third quarter of fiscal 2005 reflects charges for impaired inventory of $393,000 compared to charges for impaired inventory of $224,000 in the third quarter of fiscal 2004.

The first nine months of fiscal 2005 benefited from both a favorable mix of projects and reduced manufacturing costs, compared to the first nine months of fiscal 2004. In the first nine months of fiscal 2005, costs incurred by Synthetech’s manufacturing departments decreased by approximately $480,000, compared to the first nine months 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.

Gross income for the first nine months of fiscal 2005 reflects charges for impaired inventory of $790,000, compared to charges for impaired inventory of $807,000 in the first nine months of fiscal 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

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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.

Operating Expenses

R&D Expense. Research and development (R&D) expense in the third quarter of fiscal 2005 was $190,000, or 16% of revenue, compared to $167,000, or 6% of revenue, in the third quarter of fiscal 2004. R&D expense in the first nine months of fiscal 2005 was $474,000, or 7% of revenue, compared to $539,000, or 8% of revenue, in the first nine months of fiscal 2004.

The increase in R&D expense in the third quarter of fiscal 2005, compared to the third quarter of fiscal 2004 is primarily due to an increase in expenditures for laboratory supplies. The decrease in R&D expense for the first nine months of fiscal 2005, compared to the first nine months of fiscal 2004 is primarily due to a decrease in labor costs. The decrease in labor costs is due to 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 partially offset by $30,000 of employee relocation costs.

Synthetech’s R&D department primarily develops processes to manufacture 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 third quarter of fiscal 2005 was $599,000, or 51% of revenue, compared to $489,000, or 17% of revenue, in the third quarter of fiscal 2004. SG&A expense in the first nine months of fiscal 2005 was $1.7 million or 26% of revenue, compared to $1.4 million, or 21% of revenue, in the first nine months of fiscal 2004.

The increase in SG&A expense in the third quarter and first nine months 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, in response to the more demanding corporate governance environment our Board of Director fees and related costs, and fees for legal services have increased approximately $80,000 in the first nine month of fiscal 2005, compared to the first nine months of fiscal 2004.

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 third quarter and first nine months of fiscal 2005 was $17,000 and $36,000, respectively, compared to $6,000 and $26,000, respectively, in the same periods in 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. The average rate of interest earned on Synthetech’s cash equivalents during the first nine months of fiscal 2005 was 1.16%, compared to 0.87% during the first nine months of fiscal 2004.

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Interest expense

Interest expense in the third quarter and first nine months of fiscal 2005 was $1,000 and $5,000, respectively, compared to $2,000 and $6,000, respectively, in the same periods in fiscal 2004.

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 in the third quarter of fiscal 2005 was $1.3 million, or 107% of revenue, compared to a net loss of $350,000, or 12% of revenue, in the third quarter of fiscal 2004. Net loss for the first nine months of fiscal 2005 was $1.8 million, or 28% of revenue, compared to a net loss of $2.7 million, or 41% of revenue, in the first nine months 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

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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 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 $3.5 million at December 31, 2004, compared to $4.3 million at March 31, 2004. At December 31, 2004 and March 31, 2004, Synthetech had working capital of $8.2 million and $9.2 million, respectively. 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, inventory 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 $18 million. The terms of the credit agreement call for the required amount of tangible net worth to increase by 50% of positive quarterly net income and 50% of all equity or capital contributed. Synthetech had no borrowings outstanding under the credit facility and was in compliance with all covenants as of December 31, 2004. The credit facility expires in December 2005.

Synthetech used cash in operating activities of $736,000 during the first nine months of fiscal 2005, compared to cash used in operating activities of $1.7 million in the first nine months of fiscal 2004. In the first nine months of fiscal 2005, the primary use of cash from operating activities was the net loss of $1.8 million, which was partially offset by non-cash charges for depreciation of $806,000 and amortization of deferred compensation of $12,000. A reduction in accounts receivable was the primary source of cash flow derived from operating activities. Accounts receivable decreased $470,000 to $812,000 at December 31, 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 and amount

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of shipments. Inventory remained substantially unchanged between March 31, 2004 and December 31, 2004. Prepaid expenses increased $93,000 to $514,000 at December 31, 2004 from $421,000 at March 31, 2004. The change in prepaid expenses between the two periods is primarily due to the renewal of Synthetech’s various insurance policies during the third quarter less amortization of prepaid expenses over the periods which they benefit. Accounts payable decreased $83,000 to $476,000 at December 31, 2004 from $559,000 at March 31, 2004.

Synthetech used $65,000 of cash for capital expenditures during the first nine months of fiscal 2005, compared to $356,000 in the first nine months 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 various projects totaling approximately $100,000. 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 nine months of fiscal 2005 totaled $10,000 compared to cash provided by financing activities of $1,000 in the first nine months of fiscal 2004.

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

Synthetech believes that its existing cash and cash equivalents, any available funds under 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 any 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 its line of credit. If sources of liquidity are insufficient, Synthetech may have to seek 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 or increase its leverage and interest expense.

NEW ACCOUNTING PRONOUNCEMENTS

In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment”. SFAS No. 123R is a revision of SFAS No. 123, “Accounting for Stock Based Compensation”, and supersedes APB 25. Among other items, SFAS 123R eliminates the use of APB 25 and the intrinsic value method of accounting, and requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, based on the grant date fair value of those awards, in the financial statements. The effective date of SFAS 123R is the first reporting period beginning after June 15, 2005, although early adoption is allowed. SFAS 123R permits companies to adopt its requirements using either a “modified prospective” method, or a “modified retrospective” method. Under the “modified prospective” method, compensation cost is recognized in the financial statements beginning with the effective date, based on the requirements of SFAS 123R for all share-based payments granted after that date, and based on the requirements of SFAS 123 for all unvested awards granted prior to the effective date of SFAS 123R. Under the “modified retrospective” method, the requirements are the

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same as under the “modified prospective” method, but also permits entities to restate financial statements of previous periods based on proforma disclosures made in accordance with SFAS 123.

Synthetech currently utilizes a standard option pricing model (i.e., Black-Scholes) to measure the fair value of stock options granted to employees. While SFAS 123R permits entities to continue to use such a model, the standard also permits the use of a “lattice” model. Synthetech has not yet determined which model it will use to measure the fair value of employee stock options upon the adoption of SFAS 123R.

Synthetech expects to adopt SFAS 123R effective July 1, 2005. Synthetech is currently in the process of evaluating the impact of adoption on our results of operations.

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 December 31, 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.

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

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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.

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 December 31, 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.

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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 December 31, 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.

PART II. OTHER INFORMATION

Item 5. Other Information

On March 1, 2004, Synthetech entered into an oral compensation agreement with Paul C. Ahrens, Synthetech’s Chairman. Pursuant to this agreement, Mr. Ahrens has provided certain marketing services to Synthetech during the first nine months of fiscal 2005. Synthetech paid Mr. Ahrens $10,000 for these services.

On September 15, 2004, David R. Clarke, a member of Synthetech’s Board of Directors, began providing certain strategic planning services to Synthetech in his capacity as a director. Synthetech paid Mr. Clarke $6,000 for these services. On November 8, 2004, Synthetech entered into an oral compensation agreement with Mr. Clarke under which Mr. Clarke agreed to provide full-time strategic planning services to Synthetech. Synthetech paid $45,500 to Mr. Clarke for these services through January 31, 2005. On February 1, 2005, Synthetech and Mr. Clark entered into a written agreement pursuant to which Mr. Clarke will provide full-time strategic planning services to Synthetech from February 1, 2005 through May 31, 2005. Synthetech will pay Mr. Clarke a total of $13,000 per month for these services and his temporary living expenses. In addition, Synthetech has agreed to grant to Mr. Clarke at the next meeting of the Compensation Committee an option to purchase 30,000 shares of Synthetech’s common stock under Synthetech’s 2000 Stock Incentive Plan at an exercise price equal to the closing price reported by Nasdaq on the date the option is granted.

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Item 6. Exhibits

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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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