Albany Molecular Research
ALBANY MOLECULAR RESEARCH INC (Form: 10-Q, Received: 08/09/2011 16:15:28)



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2011

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from               to
 
Commission file number:  0-25323
 
ALBANY MOLECULAR RESEARCH, INC.
(Exact name of registrant as specified in its charter)
 
DELAWARE
 
14-1742717
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
21 Corporate Circle
PO Box 15098
Albany, New York  12212-5098
(Address of principal executive offices)
 
(518) 512-2000
(Registrant’s telephone number, including area code)
 
N/A
(Former name, former address and former fiscal year, if changed since last report)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes    x
 
No    o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
Yes    x
 
No    ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer o
 
Accelerated filer x
 
Non-accelerated filer o
 
Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes    o
 
No    x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
Class
 
Outstanding at July 31, 2011
 
Common Stock, $.01 par value
 
30,658,902 excluding treasury shares of 5,411,372
 
 


 
 

 
 
ALBANY MOLECULAR RESEARCH, INC.
INDEX
 
Part I.
 
Financial Information
 
3
           
   
Item 1.
Condensed Consolidated Financial Statements (Unaudited)
 
3
           
     
Condensed Consolidated Statements of Operations
 
3
     
Condensed Consolidated Balance Sheets
 
4
     
Condensed Consolidated Statements of Cash Flows
 
5
     
Notes to Condensed Consolidated Financial Statements
 
6
           
   
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
17
           
   
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
24
           
   
Item 4.
Controls and Procedures
 
24
           
Part II.
 
Other Information
 
25
           
   
Item 1.
Legal Proceedings
 
25
           
   
Item 1A.     
Risk Factors
 
25
           
   
Item 6.
Exhibits
 
25
           
Signatures
   
26
           
Exhibit Index
     
 
 
2

 

PART I — FINANCIAL INFORMATION
 
Item 1.    Condensed Consolidated Financial Statements (Unaudited)
 
Albany Molecular Research, Inc.
Condensed Consolidated Statements of Operations
(unaudited)
 
   
Three Months Ended
   
Six Months Ended
 
(Dollars in thousands, except for per share data)
 
June 30, 2011
   
June 30, 2010
   
June 30, 2011
   
June 30, 2010
 
                         
Contract revenue
  $ 43,497     $ 40,732     $ 86,428     $ 79,624  
Recurring royalties
    7,380       8,743       21,396       19,182  
Milestone revenue
    3,000             3,000        
Total revenue
    53,877       49,475       110,824       98,806  
                                 
Cost of contract revenue
    41,186       34,516       82,728       69,277  
Technology incentive award
    791       875       2,193       1,918  
Research and development
    1,910       2,813       4,514       5,576  
Selling, general and administrative
    10,030       9,243       21,491       19,882  
Restructuring charges
 
      5,687       951       5,687  
Impairment charges
 
      2,306    
      2,306  
Arbitration charge
 
   
      127    
 
Total operating expenses
    53,917       55,440       112,004       104,646  
                                 
Loss from operations
    (40 )     (5,965 )     (1,180 )     (5,840 )
                                 
Interest income, net
    4       66       1       109  
Other (expense) income, net
    (296 )     126       (244 )     38  
                                 
Loss before income taxes
    (332 )     (5,773 )     (1,423 )     (5,693 )
                                 
Income tax expense (benefit)
    236       (1,847 )     612       (1,833 )
                                 
Net loss
  $ (568 )   $ (3,926 )   $ (2,035 )   $ (3,860 )
                                 
Basic loss per share
  $ (0.02 )   $ (0.13 )   $ (0.07 )   $ (0.12 )
                                 
Diluted loss per share
  $ (0.02 )   $ (0.13 )   $ (0.07 )   $ (0.12 )
 
See notes to unaudited condensed consolidated financial statements.

 
3

 

Albany Molecular Research, Inc.
Condensed Consolidated Balance Sheets
(unaudited)
(Dollars and shares in thousands, except for per share data)
 
June 30,
 2011
   
December 31,
2010
 
Assets
           
Current assets:
           
Cash and cash equivalents
  $ 23,506     $ 25,747  
Marketable securities
    5,205       15,734  
Accounts receivable, net
    30,099       32,766  
Royalty income receivable
    7,848       7,416  
Income taxes receivable
    9,997       7,638  
Inventory
    29,725       27,102  
Prepaid expenses and other current assets
    13,616       10,110  
Deferred income taxes
    3,148       7,533  
Total current assets
    123,144       134,046  
                 
Property and equipment, net
    162,189       163,212  
                 
Goodwill
    18,146       16,698  
Intangible assets and patents, net
    3,886       3,942  
Equity investment in unconsolidated affiliates
    956       956  
Deferred income taxes
    1,875       596  
Other assets
    1,092       5,656  
Total assets
  $ 311,288     $ 325,106  
                 
Liabilities and Stockholders’ Equity
               
Current liabilities:
               
Accounts payable and accrued expenses
  $ 26,917     $ 28,397  
Arbitration reserve
    4,765       9,798  
Deferred revenue and licensing fees
    9,109       14,083  
Accrued pension benefits
    811       884  
Current installments of long-term debt
    6,639       1,475  
Total current liabilities
    48,241       54,637  
                 
Long-term liabilities:
               
Long-term debt, excluding current installments
    3,005       11,737  
Accrued long-term restructuring
    1,171       1,413  
Deferred licensing fees
    5,000       5,714  
Deferred rent
    1,184       1,263  
Pension and postretirement benefits
    6,259       6,408  
Environmental liabilities
    191       191  
Total liabilities
    65,051       81,363  
                 
Commitments and contingencies
               
                 
Stockholders’ equity:
               
Common stock, $0.01 par value, 100,000 shares authorized, 36,007 shares issued as of  June 30, 2011, and 35,667 shares issued as of December 31, 2010
    360       357  
Additional paid-in capital
    204,943       203,964  
Retained earnings
    109,215       111,250  
Accumulated other comprehensive loss, net
    (1,393 )     (4,940 )
      313,125       310,631  
Less, treasury shares at cost, 5,411 shares as of June 30, 2011 and December 31, 2010
    (66,888 )     (66,888 )
Total stockholders’ equity
    246,237       243,743  
Total liabilities and stockholders’ equity
  $ 311,288     $ 325,106  
 
See notes to unaudited condensed consolidated financial statements.

 
4

 

Albany Molecular Research, Inc.
Condensed Consolidated Statements of Cash Flows
(unaudited)
 
   
Six Months Ended
 
(Dollars in thousands)
 
June 30, 2011
   
June 30, 2010
 
             
Operating activities
           
Net loss
  $ (2,035 )   $ (3,860 )
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
               
Depreciation and amortization
    8,827       8,293  
Deferred income taxes
    3,041       (2,012 )
Impairment and loss on disposal of property, plant and equipment
    3       4,848  
Stock-based compensation expense
    745       780  
Recoveries of bad debt
    (89 )     (46 )
Write down for obsolete inventories
    964       123  
Changes in assets and liabilities, net of effects of acquisitions:
               
Accounts receivable
    2,756       (5,907 )
Royalty income receivable
    (432 )     (1,134 )
Inventory, prepaid expenses and other assets
    (2,665 )     (3,285 )
Income taxes receivable
    (2,359 )     (7 )
Accounts payable and accrued expenses
    (6,755 )     3,886  
Deferred revenue and licensing fees
    (5,688 )     (781 )
Pension and postretirement benefits
    4       57  
Other long-term liabilities
    (79 )     (78 )
Net cash (used in) provided by operating activities
    (3,762 )     877  
                 
Investing activities
               
Purchases of investment securities
    (1,347 )     (4,906 )
Proceeds from sales and maturities of investment securities
    11,772       13,472  
Purchase of business, net of cash acquired
          (45,386 )
Purchase of property, plant and equipment
    (5,840 )     (5,279 )
Payments for patent applications and other costs
    (194 )     (296 )
Net cash provided by (used in) investing activities
    4,391       (42,395 )
                 
Financing activities
               
Principal payments on long-term debt
    (3,568 )     (270 )
Purchase of treasury stock
          (159 )
Proceeds from sale of common stock
    383       341  
Tax benefit of stock based compensation
    (147 )      
Net cash used in financing activities
    (3,332 )     (88 )
                 
Effect of exchange rate changes on cash flows
    462       (263 )
                 
Decrease in cash and cash equivalents
    (2,241 )     (41,869 )
                 
Cash and cash equivalents at beginning of period
    25,747       80,953  
                 
Cash and cash equivalents at end of period
  $ 23,506     $ 39,084  
 
See notes to unaudited condensed consolidated financial statements.
 
 
5

 

(All amounts in thousands, except per share amounts, unless otherwise noted)
 
Note 1 — Summary of Operations and Significant Accounting Policies
 
Nature of Business and Operations
 
Albany Molecular Research, Inc. (the “Company”) provides scientific services, technologies and products focused on improving the quality of life. The Company’s core business consists of a fee-for-service contract services platform encompassing drug discovery, development and manufacturing and a separate, stand-alone research and development division consisting of proprietary technology investments, internal drug discovery and niche generic active pharmaceutical ingredient product development.  With locations in the U.S., Europe, and Asia, the Company provides customers with a range of services and cost models.
 
Basis of Presentation
 
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. In accordance with Rule 10-01, the unaudited condensed consolidated financial statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete consolidated financial statements. The year-end condensed consolidated balance sheet data was derived from audited financial statements but does not include all disclosures required by U.S. generally accepted accounting principles. In the opinion of management, all adjustments (consisting of normal recurring accruals and adjustments) considered necessary for a fair statement of the results for the interim period have been included. Operating results for the three and six months ended June 30, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2010.
 
The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated during consolidation. Assets and liabilities of non-U.S. operations are translated at period-end rates of exchange, and the statements of operations are translated at the average rates of exchange for the period. Unrealized gains or losses resulting from translating non-U.S. currency financial statements are recorded in accumulated other comprehensive (loss) income in the accompanying unaudited condensed consolidated balance sheets.
 
Use of Management Estimates
 
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent assets and liabilities, at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.  The most significant estimates included in the accompanying consolidated financial statements include assumptions regarding the collectibility of receivables, the valuation of inventory, the fair value of goodwill, intangible assets, and long-lived assets, and the estimated fair values of net assets acquired in business combinations. Other significant estimates include assumptions utilized in determining the amount and realizabilty of deferred tax assets, assumptions utilized in determining actuarial obligations in conjunction with the Company’s pension and postretirement health plans, the estimation of restructuring charges, assumptions utilized in determining stock-based compensation, and assumptions associated with legal contingencies. Actual results can vary from these estimates.
 
Contract Revenue Recognition
 
The Company’s contract revenue consists primarily of fees earned under contracts with third-party customers and reimbursed expenses under such contracts. The Company also seeks to include provisions in certain contracts that contain a combination of up-front licensing fees, milestone and royalty payments should the Company’s proprietary technology and expertise lead to the discovery of new products that become commercial. Reimbursed expenses consist of chemicals and other project specific costs. Generally, the Company’s contracts may be terminated by the customer upon 30 days’ to one year’s prior notice, depending on the terms and/or size of the contract. The Company analyzes its agreements to determine whether the elements can be separated and accounted for individually or as a single unit of accounting in accordance with the FASB’s Accounting Standards Codification (“ASC”) 605-25, “Revenue Arrangements with Multiple Deliverables,” and Staff Accounting Bulletin (“SAB”) 104, “Revenue Recognition”. Allocation of revenue to individual elements that qualify for separate accounting is based on the estimated selling price or fair value of the respective elements.

 
6

 

The Company generates contract revenue on the following basis:
 
Full-time Equivalent (“FTE”). An FTE agreement establishes the number of Company employees contracted for a project or a series of projects, the duration of the contract period, the price per FTE, plus an allowance for chemicals and other project specific costs, which may or may not be incorporated in the FTE rate. FTE contracts can run in one month increments, but typically have terms of six months or longer. FTE contracts typically provide for annual adjustments in billing rates for the scientists assigned to the contract.
 
These contracts involve the Company’s scientists providing services on a “best efforts” basis on a project that may involve a research component with a timeframe or outcome that has some level of unpredictability. There are no fixed deliverables that must be met for payment as part of these services. As such, the Company recognizes revenue under FTE contracts on a monthly basis as services are performed according to the terms of the contract.
 
Time and Materials .   Under a time and materials contract the Company charges customers an hourly rate plus reimbursement for chemicals and other project specific costs. The Company recognizes revenue for time and material contracts based on the number of hours devoted to the project multiplied by the customer’s billing rate plus other project specific costs incurred.
 
Fixed-Fee . Under a fixed-fee contract the Company charges a fixed agreed upon amount for a deliverable. Fixed-fee contracts have fixed deliverables upon completion of the project. Typically, the Company recognizes revenue for fixed-fee contracts after projects are completed, delivery is made and title transfers to the customer, and collection is reasonably assured. In certain instances, the Company’s customers request that the Company retain materials produced upon completion of the project due to the fact that the customer does not have a qualified facility to store those materials or for other reasons.  In these instances, the revenue recognition process is considered complete when project documents (batch records, Certificates of Analysis, etc.) have been delivered to the customer and payment has been collected.
 
Up-Front License Fees, Milestone, and Royalty Revenue . The Company recognizes revenue from up-front non-refundable licensing fees on a straight-line basis over the period of the underlying project. The Company will recognize revenue arising from a substantive milestone payment upon the successful achievement of the event, and the resolution of any uncertainties or contingencies regarding potential collection of the related payment, or if appropriate over the remaining term of the agreement.
 
Recurring Royalties Revenue Recognition.   Recurring royalties consist of royalties under a license agreement with sanofi-aventis based on the worldwide sales of fexofenadine HCl, marketed as Allegra in the Americas and Telfast elsewhere, as well as on sales of sanofi-aventis’ authorized generics. The Company records royalty revenue in the period in which the sales of Allegra/Telfast occur, because we can reasonably estimate such royalties. Royalty payments from sanofi-aventis are due within 45 days after each calendar quarter and are determined based on sales of Allegra/Telfast in that quarter, with the exception of Allegra D-12 which had a fixed royalty amount through July 2010.  Thereafter, the royalty rate has reverted to the rate in effect prior to the signing of the sub-license amendment and the Company will also receive a royalty on Teva Pharmaceuticals’ sales of the generic D-12.
 
Long-Lived Assets:
 
The Company assesses the impairment of long-lived assets whenever events or changes in circumstances indicate that their carrying value may not be recoverable. Factors the Company considers important that could trigger an impairment review include, among others, the following:
 
 
·
a significant change in the extent or manner in which a long-lived asset is being used;
 
 
·
a significant change in the business climate that could affect the value of a long-lived asset; and
 
 
·
a significant decrease in the market value of assets.
 
If the Company determines that the carrying value of long-lived assets may not be recoverable, based upon the existence of one or more of the above indicators of impairment, the Company compares the carrying value of the asset group to the undiscounted cash flows expected to be generated by the asset group. If the carrying value exceeds the undiscounted cash flows, an impairment charge is recorded to the extent that the carrying amount of the asset group exceeds their fair value.

 
7

 

Goodwill:
 
The Company performs an annual   assessment of the carrying value of goodwill for potential impairment (or on an interim basis if certain triggering events occur). A determination of impairment is made based upon the fair value of the related reporting unit.  If goodwill is determined to be impaired, the Company would be required to record a charge to its results of operations. Factors the Company considers important which could result in an impairment include the following:
 
 
·
significant underperformance relative to historical or projected future operating results;
 
 
·
significant negative industry or economic trends; and
 
 
·
market capitalization relative to net book value
 
See Note 6 for further information on the Company’s goodwill balances.
 
Note 2 — Business Combinations
 
In conjunction with the acquisitions of AMRI UK in February 2010 and AMRI Burlington in June 2010, the Company has recorded the fair value of the assets and liabilities of these entities at the time of acquisition and has allocated the respective purchase price accordingly.  The Company has finalized the purchase price allocation for these acquisitions subject to the final resolution of certain limited contingencies.  The Company resolved the contingencies related to the AMRI UK acquisition in the first quarter of 2011.  During the quarter ended March 31, 2011, the Company recognized net gains related to purchase accounting adjustments of $292 in other income (loss) net in the statement of operations.
 
Note 3 — Earnings Per Share
 
The shares used in the computation of the Company’s basic and diluted earnings per share are as follows:
 
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
(in thousands)
 
2011
   
2010
   
2011
   
2010
 
Weighted average shares outstanding - basic
    29,941       31,269       29,888       31,227  
Dilutive effect of stock options
                       
Dilutive effect of restricted stock
                       
Weighted average shares outstanding - diluted
    29,941       31,269       29,888       31,227  

The Company has excluded all outstanding stock options and non-vested restricted shares from the calculation of diluted earnings per share for the three and six months ended June 30, 2011 because the net loss causes these outstanding stock options and non-vested restricted shares to be anti-dilutive.  The weighted average number of anti-dilutive options and restricted shares outstanding (before the effects of the treasury stock method) was 1,601 and 1,904 for the three months ended June 30, 2011 and 2010, respectively and 1,677 and 1,816 for the six months ended June 30, 2011 and 2010, respectively.
 
Note 4 — Inventory
 
Inventory consisted of the following at June 30, 2011 and December 31, 2010:
 
   
June 30,
2011
   
December 31,
2010
 
Raw materials
  $ 6,984     $ 4,575  
Work in process
    3,598       4,382  
Finished goods
    19,143       18,145  
Total
  $ 29,725     $ 27,102  
 
Note 5 — Restructuring
 
In May 2010, the Company initiated a restructuring of its AMRI U.S. locations.  As part of its strategy to increase global competitiveness and continue to be diligent in managing costs, the Company implemented cost reduction activities at its operations in the U.S.  These cost reduction activities included a reduction in the U.S. workforce, as well as the suspension of operations at one of its research laboratory facilities in Rensselaer, New York.  Employees and equipment from this facility were consolidated into other nearby Company operations.  The Company recorded a restructuring charge of $3,223 in 2010.  This charge includes lease termination charges of $2,182, (net of estimated sublease income), termination benefits and personnel realignment costs of $833 and facility and other costs of $208.

 
8

 

Additionally, in March 2011, the Company reduced its workforce to right-size its U.S. operations, primarily focused on discovery chemistry services due to the shift in demand for these types of services to the Company’s lower cost operations in Asia.  In connection with this reduction, the Company recorded a restructuring charge of $951 for termination benefits. These restructuring activities were recorded within the Company’s Discovery, Drug Development and Small Scale Manufacturing (“DDS”) operating segment.
 
The following table displays the restructuring activity and liability balances for the six months ended June 30, 2011:
 
   
Balance at
January 1,
2011
   
Charges/
(reversals)
   
Paid Amounts
   
Foreign
Currency
Translation
Adjustments
   
Balance at
June 30, 2011
 
Termination benefits and personnel realignment
  $ 141     $ 951     $ (567 )     19     $ 544  
Lease termination charges
    1,932             (276 )           1,656  
Other
    120                   16       136  
Total
  $ 2,193     $ 951     $ (843 )     35     $ 2,336  

Termination benefits and personnel realignment costs relate to severance packages, outplacement services, and career counseling for employees affected by the restructuring.  Lease termination charges relate to costs associated with exiting the facility, net of estimated sublease income.
 
Restructuring charges are included under the caption “Restructuring charges” in the consolidated statement of operations for the three and six months ended June 30, 2011 and 2010 and the restructuring liabilities are included in “Accounts payable and accrued expenses” and “Accrued long-term restructuring” on the consolidated balance sheet at June 30, 2011 and December 31, 2010.
 
Anticipated cash outflow related to the restructurings for the remainder of 2011 is approximately $920.

Note 6 — Goodwill and Intangible Assets
 
The carrying amounts of goodwill, all of which is associated with the Company’s DDS operating segment, at June 30, 2011 and December 31, 2010 were $18,146 and $16,698, respectively.  The increase in goodwill within the DDS segment from December 31, 2010 to June 30, 2011 is due to the impact of foreign currency translation.
 
The components of intangible assets are as follows:
 
   
Cost
   
Accumulated
Amortization
   
Net
 
Amortization
Period
 
June 30, 2011
                     
Patents and Licensing Rights
  $ 5,054     $ (1,812 )   $ 3,242  
2-16 years
 
Customer Relationships
    815       (171 )     644  
5 years
 
    $ 5,869     $ (1,983 )   $ 3,886      
                             
December 31, 2010
                           
Patents and Licensing Rights
  $ 4,786     $ (1,571 )   $ 3,215  
2-16 years
 
Customer Relationships
    815       (88 )     727  
5 years
 
Total
  $ 5,601     $ (1,659 )   $ 3,942      
 
Amortization expense related to intangible assets was $135 and $73 for the three months ended June 30, 2011 and 2010, respectively and $254 and $147 for the six months ended June 30, 2011 and 2010, respectively.

 
9

 
 
The following chart represents estimated future annual amortization expense related to intangible assets:

Year  ending December 31,
     
2011 (remaining)
  $ 270  
2012
    470  
2013
    451  
2014
    446  
2015
    356  
Thereafter
    1,893  
Total
  $ 3,886  
 
Note 7 — Share-Based Compensation
 
During the three and six months ended June 30, 2011, the Company recognized total share based compensation cost of $386 and $745, respectively as compared to total share based compensation cost for the three and six months ended June 30, 2010, of $231 and $780, respectively.
 
The Company grants share-based compensation, including restricted shares, under its 2008 Stock Option and Incentive Plan, as well as its 1998 Employee Stock Purchase Plan.

Restricted Stock
 
A summary of unvested restricted stock activity as of June 30, 2011 and changes during the six months then ended is presented below:
 
   
    Number of    
Shares
   
Weighted
Average Grant Date
Fair Value Per
Share
 
Outstanding, January 1, 2011
    483     $ 9.61  
Granted
    312     $ 5.22  
Vested
    (104 )   $ 10.82  
Forfeited
    (63 )   $ 9.62  
Outstanding, June 30, 2011
    628     $ 7.22  
 
The weighted average fair value of restricted shares per share granted during the six months ended June 30, 2011 and 2010 was $5.22 and $8.27, respectively.  As of June 30, 2011, there was $3,582 of total unrecognized compensation cost related to non-vested restricted shares. That cost is expected to be recognized over a weighted-average period of 2.9 years.
 
Stock Options
 
The fair value of each stock option award is estimated at the date of grant using the Black-Scholes valuation model based on the following assumptions:
 
   
For the Six Months Ended
 
   
June 30, 2011
   
June 30, 2010
 
Expected life in years
    5       5  
Risk free interest rate
    1.92 %     2.32 %
Volatility
    56 %     46 %
Dividend yield
           
 
 
10

 

A summary of stock option activity under the Company’s Stock Option and Incentive Plans as of June 30, 2011 and changes during the six month period then ended is presented below:
 
   
Number of
Shares
   
Weighted
Exercise
Price Per Share
   
Weighted Average
Remaining
Contractual Term
(Years)
   
Aggregate
Intrinsic
Value
 
Outstanding, January 1, 2011
    1,557     $ 17.43              
Granted
    415       5.16              
Exercised
                       
Forfeited
    (118 )     23.81              
Expired
    (126 )     42.63              
Outstanding, June 30, 2011
    1,728     $ 12.15       5.4     $ 10  
Options exercisable, June 30, 2011
    1,133     $ 15.17       3.3     $  
 
The weighted average fair value of stock options granted for the six months ended June 30, 2011 and 2010 was $2.54 and $3.05, respectively.   As of June 30, 2011, there was $1,458 of total unrecognized compensation cost related to non-vested stock options. That cost is expected to be recognized over a weighted-average period of 2.6 years.
 
Employee Stock Purchase Plan
 
During the six months ended June 30, 2011 and 2010, 67 and 34 shares, respectively, were issued under the Company’s 1998 Employee Stock Purchase Plan.
 
During the six months ended June 30, 2011 and 2010, cash received from stock option exercises and employee stock purchases was $383 and $341, respectively.  The actual tax benefit realized for the tax deductions from share based compensation was $147 and $0 for the six months ended June 30, 2011 and 2010, respectively.
 
Note 8 — Operating Segment Data
 
The Company has organized its sales, marketing and production activities into the DDS and Large Scale Manufacturing (“LSM”) segments based on the criteria set forth in ASC 280, “Disclosures about Segments of an Enterprise and Related Information”. The Company’s management relies on an internal management accounting system to report results of the segments. The system includes revenue and cost information by segment. The Company’s management makes financial decisions and allocates resources based on the information it receives from this internal system.
 
DDS includes activities such as drug lead discovery, optimization, drug development and small scale commercial manufacturing. LSM includes pilot to commercial scale manufacturing of active pharmaceutical ingredients and intermediates and high potency and controlled substance manufacturing.  Corporate activities include business development and administrative functions, as well as research and development costs that have not been allocated to the operating segments.
 
The following table contains earnings data by operating segment, reconciled to totals included in the unaudited condensed consolidated financial statements:
 
   
Contract
Revenue
   
Milestone &
Recurring
Royalty
Revenue
   
Income
(Loss) 
from Operations
   
Depreciation
and
Amortization
 
For the three months ended June 30, 2011
                       
DDS
  $ 18,029     $ 10,380     $ 7,961     $ 2,576  
LSM
    25,468             2,029       1,854  
Corporate
                (10,030 )      
Total
  $ 43,497     $ 10,380     $ (40 )   $ 4,430  
                                 
For the three months ended June 30, 2010
                               
DDS
  $ 19,680     $ 8,743     $ (609 )   $ 2,398  
LSM
    21,052             3,887       1,746  
Corporate
                (9,243 )      
Total
  $ 40,732     $ 8,743     $ (5,965 )   $ 4,144  
 
 
11

 
 
   
Contract
Revenue
   
Milestone &
Recurring
Royalty
Revenue
   
Income
(Loss) 
from Operations
   
Depreciation
and
Amortization
 
For the six months ended June 30, 2011
                       
DDS
  $ 39,144     $ 24,396     $ 18,660     $ 5,040  
LSM
    47,284             1,651       3,787  
Corporate
                (21,491 )      
Total
  $ 86,428     $ 24,396     $ (1,180 )   $ 8,827  
                                 
For the six months ended June 30, 2010
                               
DDS
  $ 40,720     $ 19,182     $ 9,217     $ 4,780  
LSM
    38,904             4,825       3,513  
Corporate
                (19,882 )      
Total
  $ 79,624     $ 19,182     $ (5,840 )   $ 8,293  
 
The following table summarizes other information by segment as of and for the six month period ended June 30, 2011:
 
   
DDS
   
LSM
   
Total
 
Total assets
  $ 186,080     $ 125,208     $ 311,288  
Goodwill included in total assets
    18,146             18,146  
Investments in unconsolidated affiliates
    956             956  
Capital expenditures
    3,986       1,854       5,840  
 
The following table summarizes other information by segment as of and for the year ended December 31, 2010:
   
DDS
   
LSM
   
Total
 
Total assets
  $ 193,386     $ 131,720     $ 325,106  
Goodwill included in total assets
    16,698             16,698  
Investments in unconsolidated affiliates
    956             956  
Capital expenditures
    6,516       5,112       11,628  
 
Note 9 — Financial Information by Customer Concentration and Geographic Area
 
Total contract revenue from DDS’s three largest customers represented approximately 11%, 9% and 8% of DDS’s total contract revenue for the three months ended June 30, 2011, and 20%, 8% and 6% of DDS’s total contract revenue for the three months ended June 30, 2010.  Total contract revenue from DDS’s three largest customers represented approximately 11%, 8% and 7% of DDS’s total contract revenue for the six months ended June 30, 2011 and 21%, 8% and 5% for the six months ended June 30, 2010.  Total contract revenue from LSM’s largest customer, GE Healthcare (“GE”), represented 20% and 25% of LSM’s total contract revenue for the three months ended June 30, 2011 and 2010, respectively.  Total contract revenue from GE represented 28% and 33% of LSM’s total contract revenue for the six months ended June 30, 2011 and 2010, respectively.   GE accounted for approximately 15% and 16% of the Company’s total contract revenue for the six months ended June 30, 2011 and 2010, respectively.  The DDS segment’s largest customer, a large pharmaceutical company, represented approximately 5% and 11% of the Company’s total contract revenue for the six months ended June 30, 2011 and 2010, respectively. 
 
The Company’s total contract revenue for the three and six months ended June 30, 2011 and 2010 was recognized from customers in the following geographic regions:
 
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2011
   
2010
   
2011
   
2010
 
                         
United States
    55 %     70 %     59 %     67 %
Europe
    25       19       18       21  
Asia
    17       8       21       10  
Other
    3       3       2       2  
                                 
Total
    100 %     100 %     100 %     100 %

 
12

 
 
Long-lived assets by geographic region are as follows:
 
   
June 30,
2011
   
December 31, 2010
 
United States
  $ 132,088     $ 135,542  
Europe
    12,665       11,738  
Asia
    21,322       19,874  
Total long-lived assets
  $ 166,075     $ 167,154  
 
Note 10 — Comprehensive Income (loss)
 
The following table presents the components of the Company’s comprehensive income (loss) for the three and six months June 30, 2011 and 2010:
 
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Net loss
  $ (568 )   $ (3,926 )   $ (2,035 )   $ (3,860 )
                                 
Other comprehensive (loss) income:
                               
Change in unrealized gain (loss) on available-for-sale securities, net of taxes
    (20 )     9       (19 )     (14 )
Foreign currency translation gain (loss)
    678       (4,188 )     3,420       (4,815 )
Net actuarial gain of pension and postretirement benefits
    74       14       146       75  
Total comprehensive income (loss)
  $ 164     $ (8,091 )   $ 1,512     $ (8,614 )
 
Note 11 — Legal Proceedings
 
The Company, from time to time, may be involved in various claims and legal proceedings arising in the ordinary course of business. Except as noted below, the Company is not currently a party to any such claims or proceedings which, if decided adversely to the Company, would either individually or in the aggregate have a material adverse effect on the Company’s business, financial condition, results of operations or cash flows.
 
Allegra
The Company, along with Aventis Pharmaceuticals Inc., the U.S. pharmaceutical business of sanofi-aventis S.A., has been involved in legal proceedings with several companies seeking to market or which are currently marketing generic versions of Allegra and Allegra-D. In accordance with the Company’s agreements with sanofi-aventis, sanofi-aventis bears the external legal fees and expenses for these legal proceedings, but in general, the Company must consent to any settlement or other arrangement with any third party. Under those same agreements, the Company will receive royalties from sanofi-aventis on U.S. Patent No. 5,578,610 until its expiration in 2013 and royalties on U.S. Patent No. 5,750,703 until its expiration in 2015, unless those patents are earlier determined to be invalid.  Similarly, the Company is entitled to receive royalties from sanofi-aventis on certain foreign patents through 2015, unless those patents are earlier determined to be invalid.
 
United States Litigations
Beginning in 2001, Barr Laboratories, Inc., Impax Laboratories, Inc., Mylan Pharmaceuticals, Inc., Teva Pharmaceuticals USA, Dr. Reddy’s Laboratories, Ltd./Dr. Reddy’s Laboratories, Inc., Ranbaxy Laboratories Ltd./Ranbaxy Pharmaceuticals Inc., Sandoz Inc., Sun Pharma Global, Inc., Wockhardt, and Actavis Mid Atlantic LLC, and Aurolife Pharma LLC and Aurobindo Pharma Ltd. filed Abbreviated New Drug Applications (“ANDAs”) with the Food and Drug Administration (“FDA”) to produce and market generic versions of Allegra products.

In response to the filings described above, beginning in 2001, Aventis Pharmaceuticals (now sanofi-aventis) filed patent infringement lawsuits against each of the above referenced companies.  Each of the lawsuits was filed in the U.S. District Court in New Jersey and alleges infringement of one or more patents owned by Aventis Pharmaceuticals. In addition, beginning on November 14, 2006, sanofi-aventis filed two patent infringement suits against Teva Pharmaceuticals USA, Barr Laboratories, Inc. and Barr Pharmaceuticals, Inc. in the Eastern District of Texas based on patents owned by Aventis.  Those lawsuits were transferred to the U.S. District Court in New Jersey.

 
13

 

Further, beginning on March 5, 2004, the Company, along with Aventis Pharmaceuticals, filed suit in the U.S. District Court in New Jersey against a number of defendants asserting infringement of U.S. Patent Nos. 5,581,011 and 5,750,703, which are exclusively licensed to Aventis Pharmaceuticals and relate to Allegra and Allegra-D products.  On September 9, 2009, the Company filed patent infringement lawsuits in the U.S. District Court in New Jersey against Dr. Reddy’s Laboratories, Ltd, Dr. Reddy’s Laboratories, Inc., and Sandoz, Inc. asserting infringement of U.S. Patent No. 7,390,906, seeking damages.  That patent is licensed to sanofi-aventis U.S. LLC and sanofi-aventis U.S. LLC joined that lawsuit as a co-plaintiff with the Company.

On November 18, 2008, the Company, Aventis Pharmaceuticals, sanofi-aventis, Teva Pharmaceuticals, and Barr Laboratories reached a settlement regarding the above-described patent infringement litigations relating to Teva Pharmaceuticals and Barr Laboratories (the “Teva Settlement”).  As part of the Teva Settlement, the Company entered into an amendment to its licensing agreement with sanofi-aventis to allow sanofi-aventis to sublicense patents related to ALLEGRA ® and ALLEGRA ® D-12 to Teva Pharmaceuticals and Barr Laboratories in the United States.  Subsequently, Teva Pharmaceuticals acquired Barr Laboratories.  The Company received an upfront sublicense fee from sanofi-aventis of $10 million, and sanofi-aventis will pay royalties to the Company on the sale of products in the United States containing fexofenadine hydrochloride (the generic name for the active ingredient in ALLEGRA ® ) and products containing fexofenadine hydrochloride and pseudoephedrine hydrochloride (generic ALLEGRA ® D-12) by Teva Pharmaceuticals through 2015, along with additional consideration.   The Company received quarterly royalties through July 2010 for the branded Allegra D-12 equal to the royalties paid for the quarter ended June 30, 2009.  Thereafter, the royalty rate has reverted to the rate in effect prior to the signing of the sub-license amendment and the Company will also receive a royalty on Teva’s sales of the generic Allegra D-12.  The Company and Aventis Pharmaceuticals have also dismissed their claims against Ranbaxy Laboratories Ltd./Ranbaxy Pharmaceuticals Inc. and Sandoz, Inc. without prejudice. 

On March 19, 2010, the Company and sanofi-aventis filed a motion for a preliminary injunction in the U.S. District Court in New Jersey seeking to enjoin Dr. Reddy’s Laboratories, Ltd. and Dr. Reddy’s Laboratories, Inc. from commercial distribution of a Allegra D-24 product based in that product infringing U.S. Patent No. 7,390,906.   On June 14, 2010, the Company and sanofi-aventis were granted a preliminary injunction restraining Dr. Reddy’s Laboratories, Ltd. and Dr. Reddy’s Laboratories, Inc. from commercial distribution of a D-24 product.  On January 13, 2011, the same court issued a decision interpreting the scope of the claims of U.S. Patent No. 7,390,906.  Based on the court’s January 13, 2011 interpretation of the scope of a claim term in U.S. Patent No. 7,390,906, the Company does not presently have evidence sufficient to obtain a favorable outcome on its infringement claim against Dr. Reddy’s Laboratories, Ltd. and Dr. Reddy’s Laboratories, Inc.   As a result, the Company, along with sanofi-aventis, Dr. Reddy’s Laboratories, Ltd., and Dr. Reddy’s Laboratories, Inc., agreed to the court’s entry of an order on January 28, 2011, finding that there was no infringement of U.S. Patent No. 7,390,906 based on the Court’s January 13, 2011 claim interpretation. The court’s January 28, 2011 order also dissolved the preliminary injunction that was entered on June 14, 2010.  The Company and sanofi-aventis U.S. LLC have proceeded directly to the U.S. Court of Appeals for the Federal Circuit to appeal the January 13, 2011 decision.

The January 13, 2011, decision also included an interpretation of the scope of the claims of U.S. Patent No. 5,750,703, and based on that interpretation, the Company does not presently have evidence sufficient to obtain a favorable outcome on its infringement claim against Dr. Reddy’s Laboratories, Ltd., Dr. Reddy’s Laboratories, Inc., Amino Chemicals Ltd., Dipharma S.P.A., and Dipharma Francis Sr.l  As a result, the Company, along with sanofi-aventis, Dr. Reddy’s Laboratories, Ltd., Dr. Reddy’s Laboratories, Inc. Amino Chemicals Ltd., Dipharma S.P.A., and Dipharma Francis Sr.l  agreed to the court’s entry of an order on March 28, 2011, finding that there was no infringement of U.S. Patent No. 5,750,703 based on the Court’s January 13, 2011 claim interpretation. The Company and sanofi-aventis U.S. LLC have proceeded directly to the U.S. Court of Appeals for the Federal Circuit to appeal the January 13, 2011 decision.

On June 22, 2011, the Company, sanofi-aventis and Impax Laboratories, Inc. reached a settlement agreement of the above patent infringement litigation relating to Impax (“Impax Settlement”).  In conjunction with the Impax Settlement, the Company and sanofi-aventis agreed to amend their license agreement to allow sanofi-aventis to sublicense patents related to ALLEGRA ® and ALLEGRA ® D-12 to Impax Laboratories, Inc. in the United States.  

On June 23, 2011, the Company, sanofi-aventis, Mylan Pharmaceuticals, Inc., and Alphapharm reached a settlement agreement of the above patent infringement litigation relating to Mylan and the below noted litigation in Australia against Mylan affiliate Alphapharm (“Mylan Settlement”).  In conjunction with the Mylan Settlement, the Company and sanofi-aventis agreed to amend their license agreement to allow sanofi-aventis to sublicense patents related to ALLEGRA ® and ALLEGRA ® D-12 to Mylan Pharmaceuticals, Inc. in the United States.

 
14

 

International Litigations

In 2007, the Company filed patent infringement lawsuits in Australia against Alphapharm Pty Ltd., Arrow Pharmaceuticals Pty Ltd, Chemists’ Own Pty Ltd, and Sigma Pharmaceuticals Limited based on Australian Patent No. 699,799.  These matters were heard in a consolidated trial in November and December 2010.  On February 17, 2011, the Court ruled that the defendants are not liable for infringement because the asserted claims of the Australian Patent No. 699,799 are invalid for lack of novelty and false suggestion.  An appeal has been filed with regard to the ruling in the case against Arrow. The action against Alphapharm was settled as part of the Mylan Settlement, with Alphapharm receiving a sublicense to sell its products in Australia and New Zealand.   Notwithstanding the court’s ruling of non-infringement, the Company continues to receive royalties on sales of the Allegra products in Australia, based on its rights under other patents.
   
At Risk Launches

Under applicable federal law, marketing of an FDA-approved generic version of Allegra may not commence until the earlier of a decision favorable to the generic challenger in the patent litigation or 30 months after the date the patent infringement lawsuit was filed. In general, the first generic filer is entitled to a 180-day marketing exclusivity period upon FDA approval.  The launch of a generic product is considered an “at-risk” launch if the launch occurs while there is still on-going litigation.  Of the remaining defendants in the pending United States litigation, Dr. Reddy’s Laboratories has engaged in an at-risk launch of a generic fexofenadine single-entity product.

Note 12 – Fair Value
 
The Company uses a framework for measuring fair value in generally accepted accounting principles and making disclosures about fair value measurements.  A three-tiered fair value hierarchy has been established, which prioritizes the inputs used in measuring fair value.  

These tiers include:  
Level 1 – defined as quoted prices in active markets for identical instruments;
Level 2 – defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3 – defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

The following table presents the fair value of marketable securities by type and their determined level based on the three-tiered fair value hierarchy as of June 30, 2011:

   
Fair Value Measurements as of June 30, 2011
 
Marketable Securities
 
Total
   
Level 1
   
Level 2
   
Level 3
 
Obligations of states and political subdivisions
  $ 3,105     $     $ 3,105     $  
Auction rate securities
    2,100             2,100        
Total
  $ 5,205     $     $ 5,205     $  
The Company’s marketable securities are fixed maturity securities and are valued using pricing for similar securities, recently executed transactions, cash flow models with yield curves, broker/dealer quotes and other pricing models utilizing observable inputs. The valuation for the Company’s fixed maturity securities is classified as Level 2.

The Company determines its fair value of financial instruments using the following methods and assumptions:

Cash and cash equivalents, receivables, and accounts payable: The carrying amounts reported in the consolidated balance sheets approximate their fair value because of the short maturities of these instruments.
 
Investment securities: Investment securities’ fair values are based on quoted market prices of comparable instruments.  When necessary, the Company utilizes matrix pricing from a third party pricing vendor to determine fair value pricing.  Matrix prices are based on quoted prices for securities with similar coupons, ratings, and maturities, rather than on specific bids and offers for the designated security.
 
Debt: The carrying value of long-term debt was approximately equal to fair value at June 30, 2011 and December 31, 2010 due to the resetting dates of the variable interest rates.

 
15

 
 
Note 13 –Debt

In June 2011, the Company finalized the renegotiation of its credit agreement, which included repayment of $2,662 of the outstanding line of credit.  The remaining $7,000 of the outstanding line of credit was converted into a term loan with a maturity date of June 2012 and quarterly repayments of $400.  The term loan bears interest at a variable rate based on LIBOR.  As of June 30, 2011, the balance outstanding on the term loan was $6,350, bearing interest at 6%.  Beginning on July 14, 2011 and extending through January 13, 2012, the remaining balance of the term loan will bear interest at a weighted average rate of 4.1%.  The interest rate will reset based upon current LIBOR rates at January 13, 2012.  Additionally, the Company negotiated a new line of credit in the amount of $12,000.  As of June 30, 2011, the Company had $8,192 of outstanding letters of credit secured by the line of credit.
 
The credit facility contains certain financial covenants, including minimum earnings before interest, taxes, depreciation and amortization and a minimum unrestricted cash and cash equivalents balance.  Other covenants include, but are not limited to limits on quarterly capital expenditures.   Additionally, in connection with the new debt agreement, the Company provided security to the bank group in the form of a security interest in substantially all of the Company’s assets located in the United States.
 
The Company maintains variable interest rate industrial development authority bonds due in increasing annual installments through 2021. Interest payments are due monthly with a current interest rate of 0.32% at June 30, 2011.  The full amount outstanding on these bonds is secured by a direct pay letter of credit.  The amount outstanding as of June 30, 2011 was $3,275.
 
The following table summarizes long-term debt:
 
   
June 30,
2011
   
December 31,
2010
 
Term Loan
  $ 6,350     $ 9,662  
Industrial development authority bonds
    3,275       3,550  
Miscellaneous loan
    19        
      9,644       13,212  
Less current portion
    (6,639 )     (1,475 )
Total long-term debt
  $ 3,005     $ 11,737  
 
The aggregate maturities of long-term debt at June 30, 2011 are as follows:
 
2011 (remainder)
  $ 802  
2012
    5,840  
2013
    299  
2014
    309  
2015
    314  
Thereafter
    2,080  
Total
  $ 9,644  

Restricted Cash:

On March 2, 2011, the Company and one of its suppliers entered into a Settlement and Supply agreement (“Agreement”) which served to settle proceedings related to an arbitral award that was pending.  The Agreement required the Company to pay $4,817 to the supplier and provide a cash-collateralized letter of credit to secure the remainder of the arbitral award plus accrued interest. The letter of credit will reduce quarterly based on certain volume purchase milestones.  The Agreement also re-establishes the supply relationship between the Company and its supplier through 2018.

The cash collateral pledged to support the letter of credit had been categorized as restricted cash on the Company’s statement of financial position at March 31, 2011.  As a result of the new credit agreement discussed above, the full amount of the cash collateral was released.  As of June 30, 2011, the Company had no restricted cash.

 
16

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Forward-Looking Statements
 
The following discussion of our results of operations and financial condition should be read in conjunction with the accompanying Condensed Consolidated Financial Statements and the Notes thereto included within this report. This quarterly report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements may be identified by forward-looking words such as “may,” “could,” “should,” “would,” “will,” “intend,” “expect,” “anticipate,” “believe,” and “continue” or similar words and include, but are not limited to, statements concerning pension and postretirement benefit costs, the Company’s relationship with its largest customers, the Company’s collaboration with Bristol-Myers Squibb (“BMS”), future acquisitions, earnings, contract revenues, costs and margins, royalty revenues, patent protection and the ongoing Allegra® patent infringement litigation, Allegra® royalty revenue, government regulation, retention and recruitment of employees, customer spending and business trends, foreign operations, including increasing options and solutions for customers, business growth and the expansion of the Company’s global market, clinical supply manufacturing, management’s strategic plans, drug discovery, product commercialization, license arrangements, research and development projects and expenses, revenue and expense expectations for future periods, goodwill and long-lived asset impairment, competition and tax rates. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Factors that could cause such differences include, but are not limited to, those discussed in Part I, Item 1A, “Risk Factors”, of the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, as filed with the Securities and Exchange Commission on March 16, 2011, as updated by Part II Item 1A, “Risk Factors,” in subsequent Forms 10-Q.  All forward-looking statements are made as of the date of this report, and we do not undertake to update any such forward-looking statements in the future, except as required by law. References to “AMRI”, the “Company,” “we,” “us,” and “our,” refer to Albany Molecular Research, Inc. and its subsidiaries, taken as a whole.
 
Strategy and Overview
 
We provide contract services to many of the world’s leading pharmaceutical and biotechnology companies. We derive our contract revenue from research and development expenditures and commercial manufacturing demands of the pharmaceutical and biotechnology industry.  We continue to execute our long-term strategy to develop and grow an integrated global platform from which we can provide these services.  We have research and/or manufacturing facilities in the United States, Hungary, Singapore, India and the United Kingdom.  In February 2010, we acquired Excelsyn Ltd. (“AMRI UK”), which we believe is a well recognized leader in providing chemical development and manufacturing services to the pharmaceutical industry in Europe.  In June 2010, we acquired Hyaluron, Inc. (“AMRI Burlington”), a formulation company whose capabilities include cGMP manufacturing and sterile filling of parenteral drugs.  AMRI Burlington provides high value-added contract manufacturing services in sterile syringe and vial filling using specialized technologies.  AMRI Burlington provides these services for both small molecule drug products and biologicals, from clinical phase to commercial scale.
 
We have organized our activities into two distinct segments: Large Scale Manufacturing (“LSM”) and Discovery, Drug Development and Small Scale Manufacturing (“DDS”).  Our LSM activities include pilot to commercial scale production of active pharmaceutical ingredients and intermediates, sterile syringe and vial filling, and high potency and controlled substance manufacturing and our remaining activities, including drug lead discovery, optimization, drug development, and small scale commercial manufacturing represent our DDS business segment. 

We continue to integrate our research and manufacturing facilities worldwide, increasing our access to key global markets and enabling us to provide our customers with a flexible combination of high quality services and competitive cost structures to meet their individual outsourcing needs.  We seek comprehensive research and/or supply agreements with our customers, incorporating several of our service offerings and spanning across the entire pharmaceutical research and development process.  Our research facilities provide discovery, chemical development, analytical, and small-scale current Good Manufacturing Practices (“cGMP”) manufacturing services.  Compounds discovered and/or developed in our research facilities can then be more easily transitioned to production at our large-scale manufacturing facilities for use in clinical trials and, ultimately, commercial sales if the product meets regulatory approval.  Additionally, the acquisition of AMRI Burlington provides our Company with entry into a new and strategically important product offering.  We offer customers a fully integrated manufacturing process for sterile injectable drugs including the development and manufacture of the active pharmaceutical ingredient (“API”), the design of the criteria to formulate the API into an injectable drug product, and the manufacture of the final drug product.

 
17

 

We believe that the ability to partner with a single provider of pharmaceutical research and development services from discovery through commercial production is of significant benefit to our customers.  Through our comprehensive service offerings, we are able to provide customers with a more efficient transition of experimental compounds through the research and development process, ultimately reducing the time and cost involved in bringing these compounds from concept to market.
 
In addition to our globalization, we continue to implement process efficiencies, including our continued efforts of process improvement and cost savings measures, along with efforts to strengthen our sourcing.  We believe these factors will lead to improved margins.
 
We conduct proprietary research and development to discover new therapeutically active lead compounds with commercial potential. We anticipate that we would then license these compounds and underlying technology to third parties in return for up-front and service fees and milestone payments, as well as recurring royalty payments if these compounds are developed into new commercial drugs.
 
Our total revenue for the quarter ended June 30, 2011 was $53.9 million, as compared to $49.5 million for the quarter ended June 30, 2010.
 
Contract services revenue for the second quarter of 2011 was $43.5 million, compared to $40.7 million for the second quarter of 2010.  Recurring royalty revenues, which are based on the worldwide sales of fexofenadine HCl, marketed as Allegra in the Americas and Telfast elsewhere, as well as on sales of sanofi-aventis’ over-the-counter product, authorized generics and estimates of sales of Teva’s authorized generics, decreased $1.4 million in the second quarter of 2011 from the second quarter of 2010.  Consolidated gross margin was 5.3% for the quarter ended June 30, 2011 as compared to 15.3% for the quarter ended June 30, 2010.
 
During the six months ended June 30, 2011, cash used by operations was $3.8 million compared to cash provided by operations of $0.9 million for the same period of 2010.  The decrease of $4.6 million in cash flow from operations from the six months ended June 30, 2010 resulted primarily from a payment of $4.8 million associated with the Company’s settlement of the 2010 arbitration matter with a supplier.  We spent $5.8 million in capital expenditures, primarily related to international expansion and domestic modernization of our lab and production equipment.  As of June 30, 2011, we had $28.7 million in cash, cash equivalents and investments and $9.6 million in bank and other related debt.

Results of Operations – Three and Six Months ended June 30, 2011 Compared to Three and Six Months Ended June 30, 2010
 
Revenues
 
Total contract revenue
 
Contract revenue consists primarily of fees earned under contracts with our third party customers.  Our contract revenues for each of our Discovery/Development/Small Scale Manufacturing (“ DDS”) and Large-Scale Manufacturing (“LSM”) segments were as follows:
 
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
(in thousands)
 
2010
   
2010
   
2011
   
2010
 
                         
DDS
  $ 18,029     $ 19,680     $ 39,144     $ 40,720  
LSM
    25,468       21,052       47,284       38,904  
Total
  $ 43,497     $ 40,732     $ 86,428     $ 79,624  

DDS contract revenues for the three and six months ended June 30, 2011 decreased from the same periods in 2010 primarily due to lower contract revenue for our discovery services of $3.0 million and $4.9 million, respectively.  These decreases were offset in part by increases in contract revenue from development and small-scale manufacturing services of $1.4 million and $3.4 million, respectively.  The decrease in discovery services contract revenue was primarily due to lower demand for our U.S. medicinal chemistry and European discovery services, partially offset by higher demand for our discovery services at our Asia locations, including an increased demand for our in vitro biology services worldwide.  The increases in contract revenue from development and small-scale manufacturing services were attributable to higher demand for our chemistry development services.

We currently expect DDS contract revenue for the full year of 2011 to remain flat or decrease slightly from amounts recognized in 2010 primarily due to an increase in demand for our global development services, offset by a continued decrease from our U.S. chemistry discovery services.

 
18

 

LSM revenue for the three and six months ended June 30, 2011 increased from the same periods in 2010 primarily due to an increase in clinical manufacturing services revenue of $1.7 million and $4.1 million, respectively, the majority of which is a result of higher demand of U.S. API development services.  Additionally, LSM contract revenue increased $3.2 million for both the three and six months ended June 30, 2011 as a result of higher commercial shipments as compared to the same periods in 2010.  Contract revenue also increased for the six months ended June 30, 2011 as compared to the same period in 2010 from incremental revenues from the AMRI Burlington acquisition which took place in June of 2010.

We expect LSM contract revenue for the full year of 2011 to significantly increase over amounts recognized in 2010 due to higher demand of U.S. API development and commercial shipments.
 
Recurring royalty revenue
 
We earn royalties under our licensing agreement with sanofi-aventis S.A. for the active ingredient in Allegra.  Royalties were as follows:
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
2011
   
2010
   
2011
   
2010
 
(in thousands)
 
                     
$ 7,380     $ 8,743     $ 21,396     $ 19,182  
 
Recurring royalties are based on the worldwide sales of Allegra®/Telfast, as well as on sales of sanofi-aventis’ over-the-counter (“OTC”) product and authorized generics.  Recurring royalties decreased during the quarter ended June 30, 2011 from the same period in 2010 due to the timing of the launch of the over-the-counter product line in the U.S.  Recurring royalties increased $2.2 million for the six months ended June 30, 2011 from the same period in 2010 primarily due to an increase in sales of prescription Allegra® in Japan, as well as the addition of royalties recognized from the strong launch of the over-the-counter product line in the U.S. in the first quarter of 2011, offset in part by a decrease in sales in the second quarter of 2011 due to the timing of the OTC product launch in the U.S.
 
The recurring royalties we receive on the sales of Allegra®/Telfast have historically provided a material portion of our revenues, earnings and operating cash flows.  We continue to develop our business in an effort to supplement the revenues, earnings and operating cash flows that have historically been provided by Allegra®/Telfast royalties.

Milestone revenue
 
Milestone revenue is earned for achieving certain milestones included in certain licensing and research agreements.  Milestone revenues were as follows:
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
2011
   
2010
   
2011
   
2010
 
(in thousands)
 
                     
$ 3,000     $     $ 3,000     $  
 
Milestone revenue of $3.0 million received during the three months ended June 30, 2011 was recognized in conjunction with the Company’s license and research agreement with BMS for initiating a Phase II clinical trial of an AMRI compound licensed exclusively to BMS.

Costs and Expenses
 
Cost of contract revenue
 
Cost of contract revenue consists primarily of compensation and associated fringe benefits for employees, as well as chemicals, depreciation and other indirect project related costs. Cost of contract revenue for our DDS and LSM segments were as follows:

 
19

 
 
Segment
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
(in thousands)
 
2011
   
2010
   
2011
   
2010
 
                         
DDS
  $ 17,927     $ 17,488     $ 37,662     $ 35,469  
LSM
    23,259       17,028     $ 45,066       33,808  
Total
  $ 41,186     $ 34,516     $ 82,728     $ 69,277  
                                 
DDS Gross Margin
    0.6 %     11.1 %     3.8 %     12.9 %
LSM Gross Margin
    8.7 %     19.1 %     4.7 %     13.1 %
Total Gross Margin
    5.3 %     15.3 %     4.3 %     13.0 %
 
DDS contract revenue gross margin percentages decreased for the three and six months ended June 30, 2011 compared to contract gross margin percentages for the same periods in 2010.  These decreases in gross margin percentages resulted from lower demand for our U.S. medicinal chemistry services and our European discovery services in relation to our fixed costs, partially offset by improved global development margins.
 
We currently expect DDS contract margins for the full year of 2011 to significantly decrease from percentages recognized for the full year of 2010 primarily due to a decrease in demand for discovery services.
 
LSM’s contract revenue gross margin decreased for the three and six months ended June 30, 2011 compared to the same periods in 2010.  These decreases are primarily due to lower revenues at our Burlington facility in relation to its fixed cost base due to the pending resolution of its FDA warning letter, along with unutilized capacity at our AMRI UK facility, partially offset by an increase in margins for our U.S. API manufacturing services.
 
We expect gross margins in the LSM segment for the full year of 2011 to significantly improve over percentages recognized for the full year of 2010 primarily due to improved U.S. API manufacturing margins.

Technology incentive award
 
We maintain a Technology Development Incentive Plan, the purpose of which is to stimulate and encourage novel innovative technology developments by our employees.  This plan allows eligible participants to share in a percentage of the net revenue earned by us relating to patented technology with respect to which the eligible participant is named as an inventor or made a significant intellectual contribution. To date, the royalties from Allegra® are the main driver of the awards.  Accordingly, as the creator of the technology, the award is currently payable primarily to Dr. Thomas D’Ambra, the Chief Executive Officer and President of the Company. The incentive awards were as follows:
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
2011
   
2010
   
2011
   
2010
 
(in thousands)
 
                     
$ 791     $ 875     $ 2,193     $ 1,918  
 
The changes in technology incentive award expense for the three and six months ended June 30, 2011 as compared to the same periods in 2010 are associated with the fluctuation in Allegra recurring royalty revenue as discussed above.
 
We expect technology incentive award expense to generally fluctuate directionally and proportionately with fluctuations in Allegra royalties in future periods.
 
Research and development
 
Research and development (“R&D”) expense consists of compensation and benefits for scientific personnel for work performed on proprietary technology R&D projects, costs of chemicals, materials, outsourced activities and other out of pocket costs and overhead costs. We utilize our expertise in integrated drug discovery to perform our internal R&D projects. The goal of these programs is to discover new compounds with commercial potential. We would then seek to license these compounds to a third party in return for a combination of up-front license fees, milestone payments and recurring royalty payments if these compounds are successfully developed into new drugs and reach the market. In addition, R&D is performed at our large-scale manufacturing facility related to the potential manufacture of new products, the development of processes for the manufacture of generic products with commercial potential, and the development of alternative manufacturing processes.  Research and development expenses were as follows:

 
20

 
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
2011
   
2010
   
2011
   
2010
 
(in thousands)
 
                     
$ 1,910     $ 2,813     $ 4,514     $ 5,576  
 
R&D expense for the three and six months ended June 30, 2011 decreased from the same periods in 2010.  These decreases are primarily due to an overall decrease in internal operating costs as we strategically manage our R&D investments and continue to narrow the focus of R&D spending on only the most advanced development programs, as well as a decrease in clinical trial costs related to our oncology and obesity programs.
 
We currently expect research and development expenses for the full year of 2011 to decrease from amounts recognized in 2010 as we strategically manage our R&D investments.
 
Projecting completion dates and anticipated revenue from our internal research programs is not practical at this time due to the early stages of the projects and the inherent risks related to the development of new drugs. Our proprietary amine neurotransmitter reuptake inhibitor program, which was our most advanced project at that time, was licensed to BMS in October 2005 in exchange for up-front license fees, contracted research services, and the rights to future milestone and royalty payments.  We also continue to utilize our proprietary technologies to further advance other early to middle-stage internal research programs in the fields of oncology, irritable bowel syndrome, obesity, and CNS, with a view to seeking a licensing partner for these programs at an appropriate research or developmental stage.
 
We budget and monitor our R&D expenses by type or category, rather than by project on a comprehensive or fully allocated basis. In addition, our R&D expenses are not tracked by project as they often benefit multiple projects in our technology platform. Consequently, fully loaded R&D expense summaries by project are not available.
 
Selling, general and administrative
 
Selling, general and administrative (“SG&A”) expenses consist of compensation and related fringe benefits for selling, marketing, operational and administrative employees, professional service fees, marketing costs and costs related to facilities and information services.  SG&A expenses were as follows:
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
2011
   
2010
   
2011
   
2010
 
(in thousands)
 
                     
$ 10,030     $ 9,243     $ 21,491     $ 19,882  
SG&A expenses for the three and six months ended June 30, 2011 increased from the same periods of 2010.  These increases are primarily attributable to incremental SG&A costs from AMRI Burlington which was acquired in June 2010.
 
SG&A expenses for 2011 are expected to decrease slightly from amounts recognized in 2010 as nonrecurring acquisition charges and AMRI Burlington remediation costs are reduced, offset by run rate impact from the 2010 acquisitions as well as some investment in global capabilities in the areas of sales and information technology. 
 
Restructuring.
 
In May 2010, we initiated a restructuring of our AMRI U.S. locations.  As part of our strategy to increase global competitiveness and continue to be diligent in managing costs, we implemented cost reduction activities at our operations in the U.S.  These cost reduction activities included a reduction in the U.S. workforce, as well as the suspension of operations at one of our research laboratory facilities in Rensselaer, New York.  Employees and equipment from this facility were consolidated into other nearby Company operations.  We recorded a restructuring charge of $3.2 million in 2010.  This charge includes lease termination charges of $2.2 million (net of estimated sublease income), termination benefits and personnel realignment costs of $0.8 million and facility and other costs of $0.2 million.  This restructuring activity was recorded within our DDS operating segment.

Additionally, in March 2011, we reduced our workforce to right-size our U.S. operations, primarily focused on discovery chemistry services due to the shift in demand for these types of services from our lower cost operations in Asia.  In connection with this reduction, we recorded a restructuring charge of $1.0 million for termination benefits. These restructuring activities were recorded within our DDS operating segment.

 
21

 
 
The following table displays the restructuring activity and liability balances for the six months ended June 30, 2011:
 
   
Balance at
January 1,
2011
   
Charges/
(reversals)
   
Paid Amounts
   
Foreign
Currency
Translation
Adjustments
   
Balance at
June 30, 2011
 
Termination benefits and personnel realignment
  $ 141     $ 951     $ (567 )     19     $ 544  
Lease termination charges
    1,932             (276 )           1,656  
Other
    120                   16       136  
Total
  $ 2,193     $ 951     $ (843 )     35     $ 2,336  

Termination benefits and personnel realignment costs relate to severance packages, outplacement services, and career counseling for employees affected by the restructuring.  Lease termination charges relate to costs associated with exiting the facility, net of estimated sublease income.

Anticipated cash outflow related to the restructurings for the remainder of 2011 is approximately $0.9 million.

Interest income, net
 
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
(in thousands)
 
2011
   
2010
   
2011
   
2010
 
                         
Interest expense
  $ (87 )   $ (38 )   $ (142 )   $ (74 )
Interest income
    91       104       143       183  
Interest income, net
  $ 4     $ 66     $ 1     $ 109  
 
Net interest income decreased for the three and six months ended June 30, 2011 from the same periods in 2010 due to increased interest rates on our interest bearing liabilities and a decrease in balances of interest bearing assets.

Other (expense) income, net

Three Months Ended June 30,
   
Six Months Ended June 30,
 
2011
   
2010
   
2011
   
2010
 
(in thousands)
 
                     
$ (296 )   $ 126     $ (244 )   $ 38  

 
Other expense for the three and six months ended June 30, 2011 was primarily due to changes in rates associated with foreign currency transactions.  Other expense for the six months ended June 30, 2011 was offset in part by income from purchase accounting adjustments in the first quarter of $0.3 million related to the 2010 AMRI UK and AMRI Burlington acquisitions.

Income tax expense (benefit)
Three Months Ended June 30,
   
Six Months Ended June 30,
 
2011
   
2010
   
2011
   
2010
 
(in thousands)
 
                     
$ 236     $ (1,847 )   $ 612     $ (1,833 )
 
Income tax expense increased for the three and six months ended June 30, 2011 due primarily to changes in the composition of taxable income in relation to the applicable tax rates at our various international locations, as well as the recognition of certain discrete tax expense items.

 
22

 

Liquidity and Capital Resources
 
We have historically funded our business through operating cash flows and proceeds from borrowings. During the first six months of 2011, we used cash of $3.8 million in operating activities. The use of cash from operating activities resulted primarily from a payment of $4.8 million associated with the Company’s settlement of the 2010 arbitration matter with a supplier.
 
During the first six months of 2011, cash provided by investing activities was $4.4 million, resulting primarily from net proceeds from the sale or maturities of marketable securities of $10.4 million, offset in part by the use of $5.8 million for the acquisition of property and equipment.  During the first six months of 2011, we used $3.3 million in financing activities, relating primarily to payments made on our credit facilities.

Working capital was $74.9 million at June 30, 2011 as compared to $79.4 million as of December 31, 2010.
 
In June 2011, we finalized the renegotiation of our credit agreement which included repayment of $2.7 million of the outstanding line of credit.  The remaining $7.0 million of the outstanding line of credit was converted into a term loan with a maturity date of June 2012 and quarterly repayments of $0.4 million.  The term loan bears interest at a variable rate based on LIBOR.  As of June 30, 2011, the balance outstanding on the term loan was $6.4 million, bearing interest at 6%.  Beginning on July 14, 2011 and extending through January 13, 2012, the remaining balance of the term loan will bear interest at a weighted average rate of 4.1%.  The interest rate will reset based upon current LIBOR rates at January 13, 2012.  Additionally, we received a new line of credit in the amount of $12.0 million.  As of June 30, 2011, we had $8.2 million of outstanding letters of credit against the line of credit.
 
The credit facility contains certain financial covenants, including minimum earnings before interest, taxes, depreciation and amortization and a minimum unrestricted cash and cash equivalents balance.  Other covenants include, but are not limited to limits on quarterly capital expenditures.
 
The disclosure of payments we have committed to make under our contractual obligations is set forth under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” under Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2010.  There have been no material changes to our contractual obligations since December 31, 2010, except for long term debt repayments as discussed above and in Note 13 to the condensed consolidated financial statements.  As of June 30, 2011, we had no off-balance sheet arrangements as defined in Item 303(a)(4) of the Securities and Exchange Commission’s Regulation S-K.
 
We continue to pursue the expansion of our operations through internal growth and strategic acquisitions.  We expect that additional expansion activities will be funded from existing cash and cash equivalents, cash flow from operations and/or the issuance of debt or equity securities and borrowings.  Future acquisitions, if any, could be funded with cash on hand, cash from operations, borrowings under our credit facility and/or the issuance of equity or debt securities.  There can be no assurance that attractive acquisition opportunities will be available to us or will be available at prices and upon such other terms that are attractive to us.  We regularly evaluate potential acquisitions of other businesses, products and product lines and may hold discussions regarding such potential acquisitions.  As a general rule, we will publicly announce such acquisitions only after a definitive agreement has been signed.  In addition, in order to meet our long-term liquidity needs or consummate future acquisitions, we may incur additional indebtedness or issue additional equity or debt securities, subject to market and other conditions.  There can be no assurance that such additional financing will be available on terms acceptable to us or at all.  The failure to raise the funds necessary to finance our future cash requirements or consummate future acquisitions could adversely affect our ability to pursue our strategy and could negatively affect our operations in future periods.
 
Critical Accounting Policies and Estimates
 
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to inventories, goodwill, long-lived assets, pension and postretirement benefit plans, income taxes and contingencies. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 
23

 

We refer to the policies and estimates set forth in the section “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Estimates” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2010.  There have been no material changes or modifications to the policies since December 31, 2010.
 
Item 3. Quantitative and Qualitative Disclosures about Market Risk
 
There have been no material changes with respect to the information on Quantitative and Qualitative Disclosures about Market Risk appearing in Part II, Item 7A to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010.
 
Item 4. Controls and Procedures
 
a)  Disclosure Controls and Procedures
 
As required by rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the Company’s last fiscal quarter our management conducted an evaluation with the participation of our Chief Executive Officer and Chief Financial Officer regarding the effectiveness of our disclosure controls and procedures. In designing and evaluating our disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management was required to apply its judgment in evaluating and implementing possible controls and procedures. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, the Company’s disclosure controls and procedures were not effective as of June 30, 2011 due to material weaknesses in financial reporting with respect to our accounting for income taxes as described in the Company’s Annual Report on Form 10-K for the period ended December 31, 2010.  We intend to review and document our disclosure controls and procedures, including our internal controls and procedures for financial reporting, on an ongoing basis, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that our systems evolve with our business.

b) Changes in Internal Control Over Financial Reporting
 
There were no changes, other than those in conjunction with certain remediation efforts described below, in the Company’s internal control over financial reporting during the quarterly period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

c)  Remediation Efforts
 
We have implemented, or plan to implement, certain measures to remediate the material weakness relating to the Company’s income tax accounting identified in the Company’s 2010 Annual Report on Form 10-K.  As of the date of the filing of this Quarterly Report on Form 10-Q, the Company has implemented or is in the process of implementing the following measures:

 
·
engaged external tax experts to support the Company’s financial closing and reporting process;
 
·
improved documentation and instituted more formalized review of tax positions, with senior management and external advisors, to ensure proper evaluation and accounting treatment of complex tax issues; and
 
·
continued to evaluate and, if necessary, supplement the resources provided by our external advisors.
 
We believe that these remediation actions represent ongoing improvement measures and we plan to enhance our plans in  the remaining quarters of 2011.  Furthermore, while we have taken steps to remediate the material weakness, these steps may not be adequate to fully remediate this weakness, and additional measures may be required.   The effectiveness of our remediation efforts will not be known until we can test those controls in connection with management’s evaluation of internal controls over financial reporting that we will perform as of December 31, 2011.

 
24

 

PART II - OTHER INFORMATION
 
Item 1. Legal Proceedings
 
The Company, along with Aventis Pharmaceuticals Inc., the U.S. pharmaceutical business of sanofi-aventis S.A., has been involved in legal proceedings with several companies seeking to market or which are currently marketing generic versions of Allegra and Allegra-D. In accordance with the Company’s agreements with sanofi-aventis, sanofi-aventis bears the external legal fees and expenses for these legal proceedings, but in general, the Company must consent to any settlement or other arrangement with any third party. Under those same agreements, the Company will receive royalties from sanofi-aventis on U.S. Patent No. 5,578,610 until its expiration in 2013 and royalties on U.S. Patent No. 5,750,703 until its expiration in 2015, unless those patents are earlier determined to be invalid.  Similarly, the Company is entitled to receive royalties from sanofi-aventis on certain foreign patents through 2015, unless those patents are earlier determined to be invalid.
 
Please refer to Part 1 – Note 11 to the condensed consolidated financial statements for further details and history on these litigations.
 
Item 1A. Risk Factors
 
If we fail to meet our credit facility’s financial covenants, our business and financial condition could be adversely affected.
 
In June 2011, we finalized the renegotiation of our credit agreement which included repayment of $2.7 million of the outstanding line of credit.  The remaining $7.0 million of the outstanding line of credit was converted into a term loan with a maturity date of June 2012 with quarterly repayments of $0.4 million.  As of June 30, 2011, we had $8.2 million of outstanding letters of credit secured by the line of credit.  Additionally, in connection with our new debt agreement, we provided security to the bank group in the form of a security interest in substantially all of our United States assets.
 
The credit facility contains certain financial covenants, including minimum earnings before interest, taxes, depreciation and amortization and a minimum unrestricted cash and cash equivalents balance.  Other covenants include, but are not limited to limits on quarterly capital expenditures.  As of June 30, 2011, we were in compliance with our financial covenant requirements; however, there is no assurance that we will receive waivers of covenant noncompliance from the lenders if we were to not meet our financial covenants in future periods.  If at any point, we fail to meet our credit facility’s financial covenants, the lenders can demand immediate repayment of our outstanding balance and deny future borrowings under the remaining line of credit.  This could have a negative impact on our liquidity, thereby reducing the availability of cash flow for other purposes.
 
Our Burlington, MA facility is subject to an FDA warning letter which has resulted in a significant disruption in our business operations and has had and may continue to have a material adverse effect on our business operations and cash flow.
 
On August 18, 2010, we received a warning letter from the FDA which pertained to its inspection of AMRI Burlington in March 2010 and which identified three significant observations.  According to the warning letter, these observations may have caused our drug product(s) to be adulterated in that the methods used in, or the facilities or controls used for, their manufacture, processing, packing or holding did not conform to, or were not operated or administered in conformity with cGMP.  A copy of the warning letter is available on the FDA website at www.fda.gov.  We acquired the facility on June 14, 2010. The warning letter did not restrict production or shipment of products from the facility, however we voluntarily suspended cGMP production for a period of time while we undertook remediation steps to address the FDA’s observations.  Although we resumed cGMP operations in May 2011, the suspension of production has had a material adverse effect on our business operations and cash flow.
 
We have been working to resolve the issues identified in the warning letter.  In May, 2011, the Company provided the FDA with its final update pertaining to the warning letter.  From June 8, 2011 through June 28, 2011, the FDA conducted a re-inspection of the Company's Burlington facility.  On June 28, 2011, the FDA issued a Form 483 report to the Company which included 7 inspectional observations.  The Company has provided a response to the FDA’s Form 483 report.   The Company will continue the manufacturing operations currently ongoing at the Burlington site, including GMP operations.  However, there can be no assurance that the FDA will be satisfied with the Company’s response. The failure to promptly correct any violations as required by the FDA may result in legal action without further notice. There can be no assurance that the FDA will be satisfied with our response or will not identify additional issues on re-inspection. Failure to promptly correct these violations as required by the FDA may result in legal action without further notice including, without limitation, seizure and injunction.  Other federal agencies may take the FDA warning letter into account when considering the award of contracts.  Additionally, the FDA may withhold approval of requests for export certificate, or approval of pending drug applications listing our Burlington facility until the above violations are corrected.  In addition, certain customers who claim to be adversely impacted by the FDA warning letter and our inability to fulfill our contractual commitments may bring legal action against us.  Any such actions could significantly disrupt our business and operations and have a material adverse impact on our financial position and operating results.

 
25

 

Item 6. 
Exhibits
 
Exhibit
  
 
Number
 
Description
     
4.1
 
Amendment to Rights Agreement, dated as of June 1, 2011, between Albany Molecular Research, Inc. and Mellon Investor Services LLC, as Rights Agent (incorporated herein by reference to Exhibit 4.2 to the Company’s Registration Statement on Form 8-A/A filed on June 1, 2011.  File no. 000-25323).
     
10.1
 
Amended and Restated Credit Agreement, dated as of June 3, 2011, among Albany Molecular Research, Inc., as the Borrower, AMRI Rensselaer Inc., AMRI Bothell Research Center, Inc., and AMRI Burlington, Inc., as Guarantors, Bank of America, N.A., as Administrative Agent and L/C Issuer and the other Lender party thereto (filed in redacted form since confidential treatment was requested pursuant to Rule 24b-2 for certain portions thereof).
     
31.1
 
Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.
     
31.2
 
Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.
     
32.1
 
Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
32.2
 
Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
101.INS
 
XBRL Instance Document*
     
101.SCH
 
XBRL Taxonomy Extension Schema Document*
     
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document*
     
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document*
     
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document*
     
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document*
 
* XBRL (Extensible Business Reporting Language) information is furnished and not deemed filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, as amended, or section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

 
26

 

SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
ALBANY MOLECULAR RESEARCH, INC.
     
Date: August 9, 2011
By:  
/s/ Mark T. Frost
 
   
Mark T. Frost
   
Senior Vice President, Administration, Chief Financial Officer and Treasurer
(Duly Authorized Officer and Principal Financial Officer)
 
 
27

 

[EXECUTION COPY]
 


AMENDED AND RESTATED CREDIT AGREEMENT
 
Dated as of June 3, 2011
 
among
 
ALBANY MOLECULAR RESEARCH, INC.,
 
as the Borrower
 
AMRI RENSSELAER, INC.,
 
AMRI BOTHELL RESEARCH CENTER, INC.,
 
and
 
AMRI BURLINGTON, INC.,
 
as Guarantors
 
BANK OF AMERICA, N.A. ,
as Administrative Agent and
L/C Issuer
 
and
 
THE OTHER LENDERS PARTY HERETO
 
MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED
as Lead Arranger and Book Manager
 


 
 

 

TABLE OF CONTENTS

       
Page
         
ARTICLE I.
 
DEFINITIONS AND ACCOUNTING TERMS
 
1
1.01.
 
Defined Terms
 
1
1.02.
 
Other Interpretive Provisions
 
33
1.03.
 
Accounting Terms
 
33
1.04.
 
Rounding
 
34
1.05.
 
Times of Day
 
34
1.06.
 
Letter of Credit Amounts
 
34
1.07.
 
Exchange Rates; Currency Equivalents
 
34
1.08.
 
Additional Alternative Currencies
 
35
1.09.
 
Change of Currency
 
36
ARTICLE II.
 
THE COMMITMENTS AND CREDIT EXTENSIONS
 
36
2.01.
 
The Loans
 
36
2.02.
 
Borrowings, Conversions and Continuations of Loans
 
37
2.03.
 
Letters of Credit
 
39
2.04.
 
[Intentionally Omitted]
 
48
2.05.
 
Prepayments
 
49
2.06.
 
Termination or Reduction of Commitments
 
51
2.07.
 
Repayment of Loans
 
52
2.08.
 
Interest
 
52
2.09.
 
Fees
 
53
2.10.
 
Computation of Interest and Fees
 
53
2.11.
 
Evidence of Debt
 
54
2.12.
 
Payments Generally; Administrative Agent’s Clawback
 
54
2.13.
 
Sharing of Payments by Lenders
 
57
2.14.
 
Cash Collateral
 
58
2.15.
 
Defaulting Lenders
 
60
ARTICLE III.
 
TAXES, YIELD PROTECTION AND ILLEGALITY
 
62
3.01.
 
Taxes
 
62
3.02.
 
Illegality
 
65
3.03.
 
Inability to Determine Rates
 
66

 
i

 

TABLE OF CONTENTS
(continued)
       
Page
         
3.04.
 
Increased Costs; Reserves on Eurodollar Rate Loans
 
66
3.05.
 
Compensation for Losses
 
68
3.06.
 
Mitigation Obligations; Replacement of Lenders
 
69
3.07.
 
Survival
 
69
ARTICLE IV.
 
CONDITIONS PRECEDENT TO CREDIT EXTENSIONS
 
69
4.01.
 
Conditions of Initial Credit Extension
 
69
4.02.
 
Conditions to all Credit Extensions
 
74
ARTICLE V.
 
REPRESENTATIONS AND WARRANTIES
 
75
5.01.
 
Existence, Qualification and Power
 
75
5.02.
 
Authorization; No Contravention
 
75
5.03.
 
Governmental Authorization; Other Consents
 
75
5.04.
 
Binding Effect
 
76
5.05.
 
Financial Statements; No Material Adverse Effect
 
76
5.06.
 
Litigation
 
77
5.07.
 
No Default
 
77
5.08.
 
Ownership of Property; Liens; Investments
 
77
5.09.
 
Environmental Compliance
 
78
5.10.
 
Insurance
 
78
5.11.
 
Taxes
 
79
5.12.
 
ERISA Compliance
 
79
5.13.
 
Subsidiaries; Equity Interests; Loan Parties
 
80
5.14.
 
Margin Regulations; Investment Company Act
 
81
5.15.
 
Disclosure
 
81
5.16.
 
Compliance with Laws
 
81
5.17.
 
Intellectual Property; Licenses, Etc
 
82
5.18.
 
Solvency
 
82
5.19.
 
Casualty, Etc
 
82
5.20.
 
Labor Matters
 
83
5.21.
 
Collateral Documents
 
83
5.22.
 
Warning Letters, Etc
 
83

 
ii

 

TABLE OF CONTENTS
(continued)
       
Page