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EX-32.1 - EXHIBIT 32.1 - ALBANY MOLECULAR RESEARCH INCv325792_ex32-1.htm
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EX-32.2 - EXHIBIT 32.2 - ALBANY MOLECULAR RESEARCH INCv325792_ex32-2.htm

 

 

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 September 30, 2012
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

  

For the transition period from               to

 

Commission file number: 0-25323

 

ALBANY MOLECULAR RESEARCH, INC. 

(Exact name of registrant as specified in its charter)

 

DELAWARE   14-1742717
(State or other jurisdiction of   (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 October 31, 2012  
Common Stock, $.01 par value   30,924,480 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 Statements of Comprehensive Loss   4
        Condensed Consolidated Balance Sheets   5
        Condensed Consolidated Statements of Cash Flows   6
        Notes to Condensed Consolidated Financial Statements   7
             
    Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations   17
             
    Item 3.   Quantitative and Qualitative Disclosures About Market Risk   25
             
    Item 4.   Controls and Procedures   25
             
Part II.   Other Information   26
             
    Item 1.   Legal Proceedings   26
             
    Item 1A.   Risk Factors   26
             
    Item 6.   Exhibits   26
             
Signatures   27
             
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   Nine Months Ended 
(Dollars in thousands, except for per share data)  September 30, 
2012
   September 30, 
2011
   September 30, 
2012
   September 30, 
2011
 
                 
Contract revenue  $45,627   $43,771   $130,727   $130,199 
Recurring royalties   9,393    6,458    27,907    27,854 
Milestone revenue   750        840    3,000 
Total revenue   55,770    50,229    159,474    161,053 
                     
Cost of contract revenue   43,660    45,388    119,581    128,116 
Technology incentive award   621    646    2,473    2,839 
Research and development   196    1,608    800    6,122 
Selling, general and administrative   10,774    10,504    30,461    31,702 
Restructuring charges   1,616        3,743    951 
Impairment charges           3,967     
Arbitration charge               127 
Total operating expenses   56,867    58,146    161,025    169,857 
                     
Loss from operations   (1,097)   (7,917)   (1,551)   (8,804)
                     
Interest expense, net   (109)   (205)   (364)   (327)
Other (expense) income, net   (445)   547    (1,101)   133 
                     
Loss before income taxes   (1,651)   (7,575)   (3,016)   (8,998)
                     
Income tax expense (benefit)   492    (1,723)   2,677    (1,111)
                     
Net loss  $(2,143)  $(5,852)  $(5,693)  $(7,887)
                     
Basic loss per share  $(0.07)  $(0.19)  $(0.19)  $(0.26)
                     
Diluted loss per share  $(0.07)  $(0.19)  $(0.19)  $(0.26)

 

See notes to unaudited condensed consolidated financial statements.

 

3
 

 

Albany Molecular Research, Inc.

Condensed Consolidated Statements of Comprehensive Loss

(unaudited)

 

   Three Months Ended 
September 30,
   Nine Months Ended 
September 30,
 
   2012   2011   2012   2011 
Net loss  $(2,143)  $(5,852)  $(5,693)  $(7,887)
Unrealized loss on marketable securities, net of taxes       (4)   (1)   (23)
Foreign currency translation gain (loss)   1,010    (5,517)   1,732    (2,097)
Net actuarial gain of pension and postretirement benefits   124    96    373    242 
Total comprehensive loss  $(1,009)  $(11,277)  $(3,589)  $(9,765)

 

See notes to unaudited condensed consolidated financial statements.

 

4
 

 

Albany Molecular Research, Inc.

Condensed Consolidated Balance Sheets

(unaudited)

 

(Dollars and shares in thousands, except for per share data)  September 30,
2012
   December 31,
2011
 
Assets          
Current assets:          
Cash and cash equivalents ─ unrestricted  $15,673   $19,984 
Accounts receivable, net   35,180    30,437 
Royalty income receivable   9,260    6,819 
Income taxes receivable       3,407 
Inventory   33,156    26,004 
Prepaid expenses and other current assets   10,885    10,130 
Deferred income taxes   3,233    3,779 
Total current assets   107,387    100,560 
           
Property and equipment, net   141,495    149,796 
           
Restricted cash   5,000     
Intangible assets and patents, net   3,119    2,976 
Equity investment in unconsolidated affiliates   956    956 
Deferred income taxes   5,117    7,373 
Other assets   1,393    1,406 
Total assets  $264,467   $263,067 
           
Liabilities and Stockholders’ Equity          
Current liabilities:          
Accounts payable and accrued expenses  $26,001   $23,175 
Arbitration reserve   3,058    4,082 
Income taxes payable   1,004     
Deferred revenue and licensing fees   7,205    6,464 
Accrued pension benefits   284    1,416 
Current installments of long-term debt   597    2,839 
Total current liabilities   38,149    37,976 
           
Long-term liabilities:          
Long-term debt, excluding current installments   7,407    3,003 
Deferred licensing fees   3,214    4,286 
Deferred income taxes   888    733 
Pension and postretirement benefits   8,909    9,047 
Other long-term liabilities   1,339    1,588 
Total liabilities   59,906    56,633 
           
Commitments and contingencies          
           
Stockholders’ equity:          
Common stock, $0.01 par value, 50,000 shares authorized, 36,336 shares issued as of  September 30, 2012, and 36,016 shares issued as of December 31, 2011   363    360 
Additional paid-in capital   207,787    206,074 
Retained earnings   73,261    78,954 
Accumulated other comprehensive loss, net   (9,962)   (12,066)
    271,449    273,322 
Less, treasury shares at cost, 5,411 shares as of September 30, 2012 and December 31, 2011   (66,888)   (66,888)
Total stockholders’ equity   204,561    206,434 
Total liabilities and stockholders’ equity  $264,467   $263,067 

 

See notes to unaudited condensed consolidated financial statements.

 

5
 

 

Albany Molecular Research, Inc.

Condensed Consolidated Statements of Cash Flows

(unaudited)

 

   Nine Months Ended 
(Dollars in thousands)  September 30, 2012   September 30, 2011 
         
Operating activities          
Net loss  $(5,693)  $(7,887)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:          
Depreciation and amortization   13,058    13,444 
Deferred income taxes   2,425    3,767 
Impairment and loss on disposal of property, plant and equipment   4,123    83 
Stock-based compensation expense   1,435    1,222 
Provision for bad debt   148    123 
Changes in assets and liabilities:          
Accounts receivable   (4,891)   (1,427)
Royalty income receivable   (2,441)   960 
Inventory   (7,152)   1,967 
Prepaid expenses and other assets   (1,525)   (504)
Accounts payable and accrued expenses   1,472    (7,845)
Income taxes payable   4,411    (4,194)
Deferred revenue and licensing fees   (331)   (8,397)
Pension and postretirement benefits   (695)   (334)
Other long-term liabilities   81    (119)
Net cash provided by (used in) operating activities   4,425    (9,141)
           
Investing activities          
Proceeds from sales and maturities of investment securities   213    14,448 
Purchase of property, plant and equipment   (7,125)   (7,892)
Payments for patent applications and other costs   (448)   (311)
Proceeds from disposal of property, plant and equipment   447     
Purchases of investment securities       (1,354)
Net cash (used in) provided by investing activities   (6,913)   4,891 
           
Financing activities          
Change in restricted cash   (5,000)    
Borrowings on long-term debt   5,000     
Principal payments on long-term debt   (2,838)   (3,969)
Proceeds from sale of common stock   531    524 
Net cash used in financing activities   (2,307)   (3,445)
           
Effect of exchange rate changes on cash flows   484    (554)
           
Decrease in cash and cash equivalents   (4,311)   (8,249)
           
Cash and cash equivalents at beginning of period   19,984    25,747 
           
Cash and cash equivalents at end of period  $15,673   $17,498 

 

See notes to unaudited condensed consolidated financial statements.

 

6
 

 

(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. With locations in the U.S., Europe, and Asia, the Company provides customers with a range of services and cost models. The Company’s core business consists of a fee-for-service contract services platform encompassing drug discovery, development and manufacturing. The Company also owns a portfolio of proprietary technologies which have resulted from its internal programs, including drug discovery and niche generic products and manufacturing process efficiencies, some of which are licensed to third parties, and some of which benefit the Company’s operations.

 

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 nine months ended September 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. 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, 2011.

 

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, net 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 collectability of receivables, the valuation of inventory, the fair value of intangible assets and long-lived assets, and the amount and realizability of deferred tax assets. Other significant estimates include 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 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 fair value of the respective elements.

 

7
 

 

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 collection is reasonably assured.

 

Up-Front License Fees, Milestone, and Royalty Revenue. The Company recognizes revenue from up-front non-refundable licensing fees on a straight-line basis over the period of the underlying project. The Company will recognize revenue arising from a 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

 

The Company receives a portion of its recurring royalties under a license agreement with Sanofi based on the worldwide net sales of fexofenadine HCl, marketed as Allegra in the Americas and Telfast elsewhere, as well as on sales of Sanofi’s authorized or licensed generics. The Company records royalty revenue in the period in which the net sales of Allegra/Telfast occur, because it can reasonably estimate such royalties. Royalty payments from Sanofi are due within 45 days after each calendar quarter and are determined based on net sales of Allegra/Telfast and Teva Pharmaceuticals’ sales of generic D-12 in that quarter.

 

The Company receives additional royalties in conjunction with a development and supply agreement at the Company’s Rensselaer, NY manufacturing facility. These royalties, which the Company began receiving in the third quarter of 2012, are earned on net sales of a generic product sold by a long standing customer, who recently received FDA approval for this generic product. The Company records royalty revenue in the period in which the net sales of this product occur. Royalty payments are due within 60 days after each calendar quarter and are determined based on sales of the qualifying product in that quarter.

 

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.

 

8
 

 

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 its fair value and will reduce only the carrying amount of the long-lived assets.

 

Note 2 — Earnings Per Share

 

Both basic and diluted weighted average shares outstanding were 30,414 and 30,273 for the three and nine months ended September 30, 2012 and 30,025 and 29,934 for the three and nine months ended September 30, 2011.

 

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 nine months ended September 30, 2012 and 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 2,983 and 1,710 for the three months ended September 30, 2012 and 2011, respectively, and 3,142 and 1,722 for the nine months ended September 30, 2012 and 2011, respectively.

 

Note 3 — Inventory

 

Inventory consisted of the following at September 30, 2012 and December 31, 2011:

 

   September 30,
2012
   December 31,
2011
 
Raw materials  $9,749   $6,030 
Work in process   5,453    3,050 
Finished goods   17,954    16,924 
Total  $33,156   $26,004 

 

Note 4 –Debt and restricted cash

 

Debt

In April 2012, the Company entered into a $20,000 credit facility consisting of a 4-year, $5,000 term loan and a $15,000 revolving line of credit. The Company used a portion of the initial proceeds to repay all amounts due under its prior credit agreement. As of September 30, 2012, the Company had no amounts outstanding and $8,876 of outstanding letters of credit secured under this line of credit.

 

Borrowings under this agreement will bear interest at a fluctuating rate equal to (i) in the case of the term loan, the sum of (a) an interest rate equal to daily three month LIBOR, plus (b) 3.25%; and (ii) in the case of advances under the revolving line of credit, the sum of (a) an interest rate equal to daily three month LIBOR, plus (b) 2.75%. As of September 30, 2012, the interest rate on the outstanding term loan was 3.75%.

 

The credit facility contains financial covenants, including certain net cash flow requirements for 2012, a minimum fixed charge coverage ratio commencing in 2013 and extending for the remaining term of the agreement, maximum quarterly year-to-date capital expenditures, minimum monthly domestic unrestricted cash and maximum average monthly cash reserves held at international locations. As of September 30, 2012, the Company was in compliance with its current financial covenants.

 

The Company maintains variable interest rate industrial development authority (“IDA”) bonds due in increasing annual installments through 2021. Interest payments are due monthly with a current interest rate of 0.29% at September 30, 2012. The amount outstanding as of September 30, 2012 was $2,990.

 

9
 

 

The following table summarizes long-term debt:

 

   September 30,
2012
   December 31,
2011
 
Term loan  $5,000   $2,550 
Industrial development authority bonds   2,990    3,275 
Miscellaneous loan   14    17 
    8,004    5,842 
Less current portion   (597)   (2,839)
Total long-term debt  $7,407   $3,003 

 

The aggregate maturities of long-term debt at September 30, 2012 are as follows:

 

2012 (remainder)   $ 1  
2013     775  
2014     1,024  
2015     1,029  
2016     1,034  
Thereafter     4,141  
Total   $ 8,004  

 

Restricted cash

 

Upon entering into the credit agreement in April 2012, the Company is required to maintain a $5,000 restricted cash balance to partially collateralize the revolving line of credit.

 

Note 5 — Restructuring and Impairment

 

In March 2012, the Company approved a restructuring plan that ceased all operations at its Budapest, Hungary facility effective March 30, 2012. The goal of the restructuring plan is to advance the Company’s continued strategy of increasing global competitiveness and remaining diligent in managing costs by improving efficiency and customer service and by realigning resources to meet shifting customer demand and market preferences. In connection with this closure, the Company recorded a restructuring charge in its DDS operating segment of $1,927 in the first half of 2012 and $1,503 in the third quarter of 2012.  These amounts included $1,330 for termination benefits and $2,100 for estimated costs associated with terminating the Budapest lease, preparing the facility for closure and other administrative costs.  The Company exited the facility in the third quarter of 2012 and is in the process of resolving the termination of the lease. 

 

In conjunction with the decision to cease operations at the Company’s Budapest, Hungary facility as discussed above, in the first quarter of 2012 the Company also recorded property and equipment impairment charges of $3,967 in the DDS segment. These charges are included under the caption “Impairment charges” on the consolidated statement of operations for the nine months ended September 30, 2012.

 

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 DDS operating segment.

 

In December 2011, the Company initiated a restructuring plan at one of its U.S. locations which included actions to further reduce the Company's workforce, right size capacity, and reduce operating costs. These actions were implemented to better align the business to current and expected market conditions and are expected to improve the Company's overall cost competitiveness and increase cash flow generation. The workforce reduction primarily affected certain positions associated with the Company’s elimination of internal R&D activities.  As a result of the workforce reduction, the Company will be terminating the lease of one of its U.S. facilities which will result in a reduction in annual operating expenses related to this facility.  As a result of this restructuring, the Company recorded restructuring charges in the DDS operating segment of $313 in the first nine months of 2012 and $320 in the fourth quarter of 2011.

 

10
 

 

The following table displays the restructuring activity and liability balances for the nine months ended September 30, 2012:

 

   Balance at
December 31, 2011
   Charges/
(reversals)
   Paid Amounts   Foreign
Currency
Translation
Adjustments
   Balance at
September 30, 2012
 
Termination benefits and personnel realignment  $456    942    (1,048)   5    355 
Lease termination and relocation charges   1,128    2,295    (1,804)   9    1,628 
Other   354    506    (774)   9    95 
Total  $1,938    3,743    (3,626)   23   $2,078 

 

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 a facility, net of estimated sublease income.

 

Restructuring charges are included under the caption “Restructuring charges” in the consolidated statements of operations for the three and nine months ended September 30, 2012 and 2011 and the restructuring liabilities are included in “Accounts payable and accrued expenses” and “other long-term liabilities” on the consolidated balance sheets at September 30, 2012 and December 31, 2011.

 

Anticipated cash outflow related to the restructurings for the remainder of 2012 is approximately $427.

 

Note 6 —Intangible Assets

 

The components of intangible assets are as follows:

 

   Cost   Accumulated
Amortization
   Net   Amortization
Period
 
September 30, 2012                    
Patents and Licensing Rights  $4,233   $(1,556)  $2,677    2-16 years 
Customer Relationships   815    (373)   442    5 years 
Total  $5,048   $(1,929)  $3,119      
                     
December 31, 2011                    
Patents and Licensing Rights  $3,756   $(1,343)  $2,413    2-16 years 
Customer Relationships   815    (252)   563    5 years 
Total  $4,571   $(1,595)  $2,976      

 

Amortization expense related to intangible assets was $82 and $131 for the three months ended September 30, 2012 and 2011, respectively, and $307 and $385 for the nine months ended September 30, 2012 and 2011, respectively.

 

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

 

Year  ending December 31,        
2012 (remaining)     $ 300  
2013       413  
2014       366  
2015       250  
2016       215  
Thereafter       1,575  
Total     $ 3,119  

 

Note 7 — Share-Based Compensation

 

During the three and nine months ended September 30, 2012, the Company recognized total share based compensation cost of $369 and $1,435, respectively, as compared to total share based compensation cost for the three and nine months ended September 30, 2011 of $477 and $1,222, 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.

 

11
 

 

Restricted Stock

 

A summary of unvested restricted stock activity as of September 30, 2012 and changes during the nine months then ended is presented below:

 

      Number of
Shares
    Weighted
Average Grant Date
Fair Value Per Share
 
Outstanding, January 1, 2012       561     $ 7.14  
Granted       140     $ 3.12  
Vested       (123 )   $ 8.63  
Forfeited       (64 )   $ 6.02  
Outstanding, September 30, 2012       514     $ 5.83  

 

The weighted average fair value of restricted shares per share granted during the nine months ended September 30, 2012 and 2011 was $3.12 and $5.22, respectively. As of September 30, 2012, there was $2,035 of total unrecognized compensation cost related to unvested restricted shares. That cost is expected to be recognized over a weighted-average period of 2.3 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 Nine Months Ended 
   September 30, 2012   September 30, 2011 
Expected life in years   5    5 
Risk free interest rate   0.85%   1.92%
Volatility   57%   56%
Dividend yield        

 

A summary of stock option activity under the Company’s Stock Option and Incentive Plans as of September 30, 2012 and changes during the nine month period then ended is presented below:

 

      Number of
Shares
    Weighted Average
Exercise
Price Per Share
    Weighted Average
Remaining
Contractual Term
(Years)
    Aggregate
Intrinsic
Value
 
Outstanding, January 1, 2012       2,762     $ 7.58                  
Granted       430       3.00                  
Exercised                              
Forfeited       (483 )     6.31                  
Expired       (127 )     24.93                  
Outstanding, September 30, 2012       2,582     $ 6.20       7.1     $ 1,333  
Options exercisable, September 30, 2012       917     $ 11.70       3.5     $  

 

The weighted average fair value of stock options granted for the nine months ended September 30, 2012 and 2011 was $1.46 and $2.54, respectively. As of September 30, 2012, there was $1,992 of total unrecognized compensation cost related to non-vested stock options. That cost is expected to be recognized over a weighted-average period of 2.3 years.

 

Employee Stock Purchase Plan

 

During the nine months ended September 30, 2012 and 2011, 182 and 137 shares, respectively, were issued under the Company’s 1998 Employee Stock Purchase Plan.

 

During the nine months ended September 30, 2012 and 2011, cash received from stock option exercises and employee stock purchases was $531 and $524, respectively. The actual tax benefit realized for the tax deductions from share based compensation was $0 for both the nine months ended September 30, 2012 and 2011.

 

Note 8 — Operating Segment Data

 

The Company has organized its sales, marketing and production activities into the DDS and 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.

 

12
 

 

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 September 30, 2012                                  
DDS     $ 16,293     $ 6,817     $ 4,673     $ 2,206  
LSM       29,334       3,326       5,004       1,952  
Corporate                   (10,774 )      
Total     $ 45,627     $ 10,143     $ (1,097 )   $ 4,158  
                                   
For the three months ended September 30, 2011                                  
DDS     $ 18,049     $ 6,458     $ 3,934     $ 2,705  
LSM       25,722             (1,347 )     1,912  
Corporate                   (10,504 )      
Total     $ 43,771     $ 6,458     $ (7,917 )   $ 4,617  
                                   
For the nine months ended September 30, 2012                                  
DDS     $ 52,410     $ 25,331     $ 15,682     $ 7,247  
LSM       78,317       3,416       13,228       5,811  
Corporate                   (30,461 )      
Total     $ 130,727     $ 28,747     $ (1,551 )   $ 13,058  
                                   
For the nine months ended September 30, 2011                                  
DDS     $ 57,193     $ 30,854     $ 22,594     $ 7,745  
LSM       73,006             304       5,699  
Corporate                   (31,702 )      
Total     $ 130,199     $ 30,854     $ (8,804 )   $ 13,444  

 

The following table summarizes other information by segment as of and for the nine month period ended September 30, 2012:

 

   DDS   LSM   Total 
Total assets  $134,126   $130,341   $264,467 
Investments in unconsolidated affiliates   956        956 
Capital expenditures   2,405    4,720    7,125 

 

The following table summarizes other information by segment as of and for the year ended December 31, 2011:

 

   DDS   LSM   Total 
Total assets  $146,017   $117,050   $263,067 
Investments in unconsolidated affiliates   956        956 
Capital expenditures   6,578    4,198    10,776 

 

Note 9 — Financial Information by Customer Concentration and Geographic Area

 

Total contract revenue from DDS’s three largest customers represented approximately 9%, 8% and 7% of DDS’s total contract revenue for the three months ended September 30, 2012, and 11%, 10% and 9% of DDS’s total contract revenue for the three months ended September 30, 2011. Total contract revenue from DDS’s three largest customers represented approximately 10%, 7% and 6% of DDS’s total contract revenue for the nine months ended September 30, 2012 and 11%, 8% and 4% for the nine months ended September 30, 2011.

 

13
 

 

Total contract revenue from LSM’s three largest customers represented approximately 29%, 15% and 11% of LSM’s total contract revenue for the three months ended September 30, 2012, and 31%, 20% and 8% of LSM’s total contract revenue for the three months ended September 30, 2011. Total contract revenue from LSM’s three largest customers represented approximately 27%, 15% and 13% of LSM’s total contract revenue for the nine months ended September 30, 2012, and 29%, 18% and 13% of LSM’s total contract revenue for the nine months ended September 30, 2011.

 

GE Healthcare (“GE”) is the Company and LSM’s largest customer. GE accounted for approximately 16% of the Company’s total contract revenue for both the nine months ended September 30, 2012 and 2011. Another customer of LSM which is a large pharmaceutical company represented 10% and 11% of total contract revenue for the nine months ended September 30, 2012 and 2011, respectively.

 

The Company’s total contract revenue for the three and nine months ended September 30, 2012 and 2011 was recognized from customers in the following geographic regions:

 

   Three Months Ended  
September 30,
   Nine Months Ended 
September 30,
 
   2012   2011   2012   2011 
                 
United States   55%   54%   57%   57%
Europe   25    25    22    23 
Asia   17    20    17    18 
Other   3    1    4    2 
                     
Total   100%   100%   100%   100%

 

Long-lived assets by geographic region are as follows:

 

   September 30,
2012
   December  31,
2011
 
United States  $118,472   $123,245 
Asia   19,231    19,015 
Europe   6,911    10,512 
Total long-lived assets  $144,614   $152,772 

 

Note 10 — 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, 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, Sanofi 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 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 on certain foreign patents through 2015, unless those patents are earlier determined to be invalid. The Company is also entitled to receive certain royalties from Sanofi in certain foreign countries through mid 2015, unless certain 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 AurolifePharma LLC and AurobindoPharma Ltd. filed Abbreviated New Drug Applications (“ANDAs”) with the Food and Drug Administration (“FDA”) to produce and market generic versions of Allegra products.

 

14
 

 

In response to the filings described above, beginning in 2001, Aventis Pharmaceuticals (now Sanofi) 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 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.

 

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. That patent is licensed to Sanofi U.S. LLC and Sanofi U.S. LLC joined that lawsuit as a co-plaintiff with the Company.

 

On November 18, 2008, the Company, Aventis Pharmaceuticals, Sanofi, 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 to allow Sanofi 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 of $10 million, and Sanofi 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 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 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, 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 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, 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 U.S. LLC have proceeded directly to the U.S. Court of Appeals for the Federal Circuit to appeal the January 13, 2011 decision.

 

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

 

15
 

 

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. 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. The Company has also settled its suit against Arrow Pharmaceuticals Pty Ltd, Chemists’ Own Pty Ltd, and Sigma Pharmaceuticals Limited, with those parties receiving a sublicense to sell their products in Australia and New Zealand. The Company is receiving royalties directly from Arrow with respect to their sales of royalty bearing products in Australia. The Company continues to receive royalties on sales of the Allegra products in Australia.

   

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 11 – 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 Company did not use any level 3 inputs in measuring the fair value of any of its financial instruments in the nine months ended September 30, 2012.

 

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

 

Cash and cash equivalents, restricted cash, 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.

 

Debt: The carrying value of long-term debt was approximately equal to fair value at September 30, 2012 and December 31, 2011 due to the resetting dates of the variable interest rates.

 

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, 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, 2011, as filed with the Securities and Exchange Commission on March 15, 2012, 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 are a global contract research and manufacturing organization that provides customers fully integrated drug discovery, development, and manufacturing services. We supply a broad range of services and technologies that support the discovery and development of pharmaceutical products and the manufacturing of active pharmaceutical ingredients (“API”) and drug product for existing and experimental new drugs. With locations in the United States, Europe, and Asia, we maintain geographic proximity and flexible cost models. We have also historically leveraged our drug-discovery expertise to execute on several internal drug discovery programs, which have progressed to the development candidate stage and in some cases into Phase I clinical development. We have successfully partnered certain programs and are actively seeking to out-license our remaining programs to strategic partners for further development.

 

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.  Our service offerings range from early stage discovery through manufacturing and formulation across U.S., Europe and Asia. We believe that the ability to partner with a single provider is of significant benefit to our customers as we are able to provide them 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. Compounds discovered and/or developed in our contract 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, we offer our customers a fully integrated manufacturing process for sterile injectable drugs. This includes the development and manufacture of the API, the design of the criteria to formulate the API into an injectable drug product, and the manufacture of the final drug product. We continue to make investments to build and recover our formulation business, as we believe this type of business has significant potential in the drug product world driven by the growth in biologically based compounds which are formulated/manufactured on an aseptic basis.

 

In addition to providing our customers our hybrid services model for outsourcing, we now offer the option of insourcing. With our world class expertise in managing high performing groups of scientists, this option allows us to embed our scientists into the customer’s facility allowing the customer to cost effectively leverage their unused laboratory space.

 

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As our customers continue to seek innovative new strategies for R&D efficiency and productivity, we are aggressively realigning our business and resources to address their needs. To that end, we have launched AMRI SMARTSOURCING™, a cross functional approach that maximizes the strengths of both insourcing and outsourcing, by leveraging AMRI’s people, know-how, facilities, expertise and global project management to provide exactly what is needed across the discovery or development process. We have also streamlined our sales and marketing organization to optimize cross-selling opportunities and enhanced our commitment to quality with the appointment of key personnel at our Burlington aseptic services facility, both underscoring our dedication to client service. Our improved organizational structure, combined with more focused marketing efforts, should enable us to continue to drive long term growth and profitability.

 

In 2011, we made a decision to cease activities related to our internal proprietary compound discovery R&D programs. Although we halted our proprietary R&D activities, we continue to believe there are additional opportunities to partner our proprietary compounds or programs to create value, as we have seen a renewed commitment by pharmaceutical companies for innovation both internally and through licensing. Our goal is to partner these compounds or programs in return for a combination of up-front license fees, milestone payments and recurring royalty payments if any compound based on our intellectual property is successfully developed into new drugs and reach the market.

 

In March 2012, we approved a restructuring plan that ceased all operations at our Budapest, Hungary facility effective March 30, 2012. The goal of the restructuring plan is to advance our continued strategy of increasing global competitiveness and remaining diligent in managing costs by improving efficiency and customer service and by realigning resources to meet shifting customer demand and market preferences.

 

Our total revenue for the quarter ended September 30, 2012 was $55.8 million, as compared to $50.2 million for the quarter ended September 30, 2011.

 

Contract services revenue for the third quarter of 2012 was $45.6 million, compared to $43.8 million for the same quarter in 2011. Recurring royalty revenues increased in the third quarter of 2012 as compared to the same quarter in 2011 due to the receipt of a new recurring royalty stream beginning in the quarter, offset in part by a decrease in Allegra royalties.

 

Consolidated gross margin was 4.3% for the quarter ended September 30, 2012 as compared to (3.7%) for the quarter ended September 30, 2011.

 

During the nine months ended September 30, 2012, cash provided by operations was $4.4 million compared to cash used in operations of $9.1 million for the same period of 2011. This change from the nine months ended September 30, 2011 resulted primarily from the receipt of an income tax refund in the third quarter of 2012 as well as a payment of $4.8 million in the first quarter of 2011 associated with the Company’s arbitration settlement with a supplier. During the nine months ended September 30, 2012, we spent $7.1 million in capital expenditures, primarily related to domestic modernization of our lab and production equipment. As of September 30, 2012, we had $15.7 million in unrestricted cash and cash equivalents and $8.0 million in bank and other related debt.

 

Results of Operations – Three and Nine Months ended September 30, 2012 Compared to Three and Nine Months Ended September 30, 2011

 

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 
September 30,
   Nine Months Ended 
September 30,
 
(in thousands)  2012   2011   2012   2011 
                 
DDS  $16,293   $18,049   $52,410   $57,193 
LSM   29,334    25,722    78,317    73,006 
Total  $45,627   $43,771   $130,727   $130,199 

 

The decrease in DDS contract revenue for the three and nine months ended September 30, 2012 from the same periods in 2011 is primarily due to lower contract revenue for our development and small-scale manufacturing services of $1.7 million and $3.4 million, respectively, as a result of lower demand for our U.S. chemistry development services. Additionally, contract revenue for our discovery services in the nine months ended September 30, 2012 decreased $1.3 million from the same period in 2011 resulting from lower demand for our U.S. biology services, along with decreased revenues due to the closure of our Hungarian operations. These decreases were offset in part by higher demand for our U.S. chemistry discovery services.

 

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We currently expect DDS contract revenue for full year 2012 to decrease slightly from amounts recognized in 2011 driven by the decrease in revenue resulting from the closure of our Hungarian operations along with lower demand for our U.S. development services partially offset by increased revenue from our U.S. chemistry discovery services.

 

LSM contract revenue increased for the three and nine months ended September 30, 2012 from the same periods in 2011. These increases were primarily due to an increase in commercial manufacturing services at our Rensselaer, NY facility, as well as continued improvement in clinical manufacturing services revenue at our Burlington, MA facility.

 

We currently expect LSM contract revenue for full year 2012 to significantly increase from amounts recognized in 2011 driven by robust U.S. commercial API demand, an increase in our Phase III portfolio, and improved revenues from our Burlington, MA and UK facilities.

 

Recurring royalty revenue

 

Three Months Ended September 30,   Nine Months Ended September 30, 
2012   2011   2012   2011 
(in thousands) 
              
$9,393   $6,458   $27,907   $27,854 

 

A portion of our recurring royalties are based on the worldwide sales of Allegra®/Telfast, as well as on sales of Sanofi over-the-counter (“OTC”) product and authorized generics. Additionally, beginning in the third quarter of 2012 we earned recurring royalty revenue in conjunction with a development and supply agreement at the Company’s Rensselaer, NY manufacturing facility.

 

Recurring royalties increased during the quarter ended September 30, 2012 from the same period in 2011 due to the receipt of a new recurring royalty stream from one of our Rensselaer facility’s long-standing customer’s product launch of $3.3 million, offset in part by a decrease in Allegra royalties of $0.4 million.

 

Recurring royalties remained flat for the nine months ended September 30, 2012 from the same period in 2011. Increases in recurring royalties due to the above mentioned new royalty stream were offset primarily by a decrease in royalties recognized from the sales of prescription Allegra® in Japan in the first quarter of 2012 as a result of a less severe allergy season.

 

We currently expect full year 2012 recurring royalties to approximate amounts recognized in 2011 reflecting the reduced revenues from Allegra, offset by the new royalty stream described above.

 

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

 

Three Months Ended September 30,   Nine Months Ended September 30, 
2012   2011   2012   2011 
(in thousands) 
              
$750   $-   $840   $3,000 

 

Milestone revenue for the three months ended September 30, 2012 was recognized in conjunction with the Company’s license and research agreement with BMS for advancing a fourth compound into preclinical development. Additionally, milestone revenue for the nine months ended September 30, 2012 includes $0.1 million recognized in the first half of 2012 in conjunction with a development and supply agreement at the Company’s Rensselaer, NY manufacturing facility.

 

Milestone revenue of $3.0 million received during the nine months ended September 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.

 

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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:

 

Segment  Three Months Ended 
September 30,
   Nine Months Ended 
September 30,
 
(in thousands)  2012   2011   2012   2011 
                 
DDS  $16,090   $18,427   $51,238   $56,089 
LSM   27,570    26,961    68,343    72,027 
Total  $43,660   $45,388   $119,581   $128,116 
                     
DDS Gross Margin   1.3%   (2.1)%   2.2%   1.9%
LSM Gross Margin   6.0%   (4.8))%   12.7%   1.3%
Total Gross Margin   4.3%   (3.7)%   8.5%   1.6%

 

DDS contract revenue gross margin percentage increased for the three and nine months ended September 30, 2012 compared to the same period in 2011. These increases are primarily due to cost savings initiatives taken in our U.S chemistry operations in 2011, as well as the impact of the closure of our Hungarian operations in 2012, offset in part by lower demand for our U.S. biology and development services in relation to our fixed costs.

 

As a result of the continued impact of the current trends in demand and the closure of our Hungarian operations, we currently expect DDS contract margins for the full year of 2012 to improve over amounts recognized in 2011.

 

LSM’s contract revenue gross margin percentages improved for the three and nine months ended September 30, 2012 compared to the same period in 2011 primarily due to an increase in sales of higher margin products for our U.S. manufacturing services, as well as an increase in capacity utilization at our large-scale manufacturing facilities worldwide.

 

We currently expect LSM contract margins for 2012 to significantly improve from amounts recognized in 2011 driven by improved capacity utilization, along with shift in revenues to higher margin commercial products.

 

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 September 30,   Nine Months Ended September 30, 
2012   2011   2012   2011 
(in thousands) 
              
$621   $646   $2,473   $2,839 

 

Technology incentive award expense for the three and nine months ended September 30, 2012 decreased from expense recognized for the same period in 2011 due to the decrease 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.

 

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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.

 

During the fourth quarter of 2011, the Company’s Board of Directors made a decision to cease activities related to its internal discovery research and development programs, excluding its generic program. Although we ceased our proprietary R&D activities, we continue to believe there are additional opportunities to partner our proprietary compounds 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 activities continue 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:

 

Three Months Ended September 30,   Nine Months Ended September 30, 
2012   2011   2012   2011 
(in thousands) 
              
$196   $1,608   $800   $6,122 

 

R&D expense for the three and nine months ended September 30, 2012 decreased from the same periods in 2011 as a result of our strategic decision during the fourth quarter of 2011 to cease R&D operations related to our internal discovery research and development programs, excluding our generics program. R&D expenditures incurred in the first nine months of 2012 related primarily to developing new niche generic products and improving process efficiencies in our manufacturing plants.

 

We currently expect full year 2012 R&D expense to reduce to approximately $1.0 million, with costs primarily related to developing new niche generic products and improving process efficiencies in our manufacturing plants.

 

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 September 30,   Nine Months Ended September 30, 
2012   2011   2012   2011 
(in thousands) 
              
$10,774   $10,504   $30,461   $31,702 

 

SG&A expenses increased for the three months ended September 30, 2012 when compared to the same period in 2011 due to $1.0 million of executive transition costs, offset in part by cost savings actions implemented in the U.S. along with the closure of our Hungarian operations.

 

The decrease in SG&A expenses for the nine months ended September 30, 2012 from the comparable prior year period is primarily attributable to the cost savings actions and closure of our Hungarian operations discussed above, offset in part by the executive transition costs. Additionally, in the first half of 2011 we incurred charges attributable to AMRI Burlington’s efforts to remediate certain issues identified during an inspection by the FDA in 2010.

 

We currently expect SG&A expenses for 2012 to be relatively consistent with 2011 due to the closure of our Hungarian operations, as well as other cost saving actions implemented in the U.S. in 2011, offset in part by executive transition costs.

 

Restructuring

 

Three Months Ended September 30,   Nine Months Ended September 30, 
2012   2011   2012   2011 
(in thousands) 
              
$1,616   $-   $3,743   $951 

 

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In March 2012, we approved a restructuring plan that ceased all operations at our Budapest, Hungary facility effective March 30, 2012. The goal of the restructuring plan is to advance our continued strategy of increasing global competitiveness and remaining diligent in managing costs by improving efficiency and customer service and by realigning resources to meet shifting customer demand and market preferences. In connection with this closure, we recorded a restructuring charge of $3.3 million in our DDS operating segment in the first nine months of 2012.  This amount included $1.3 million for termination benefits and $2.1 million for preparing the facility for closure, estimated costs associated with terminating the Budapest facility lease and other administrative costs.  We exited the facility in the third quarter of 2012 and are in the process of resolving the termination of the lease.  

 

In December 2011, we initiated a restructuring plan at one of our U.S. locations which included actions to further reduce our workforce, right size capacity, and reduce operating costs. These actions were implemented to better align the business to current and expected market conditions and are expected to improve our overall cost competitiveness and increase cash flow generation. The workforce reduction primarily affected certain positions associated with our elimination of internal R&D activities.  As a result of the workforce reduction, we will be terminating the lease of one of our U.S. facilities which will result in a reduction in annual operating expenses related to this facility.  As a result of this restructuring, we recorded a restructuring charge in the DDS operating segment of $0.3 million in the fourth quarter of 2011 and $0.4 million in the first nine months of 2012.

 

Anticipated cash outflow related to the restructurings for the remainder of 2012 is approximately $0.4 million.

 

Property and Equipment Impairment

 

Three Months Ended September 30,   Nine Months Ended September 30, 
2012   2011   2012   2011 
(in thousands) 
              
$   $   $3,967   $ 

 

In the first quarter of 2012, we recorded property and equipment impairment charges of $4.0 million in our DDS segment associated with the Company’s decision to cease operations at our Budapest, Hungary facility, as discussed above.

 

Interest expense, net

 

   Three Months Ended 
September 30,
   Nine Months Ended
September 30,
 
(in thousands)  2012   2011   2012   2011 
                 
Interest expense  $(111)  $(205)  $(373)  $(470)
Interest income   2        9    143 
Interest expense, net  $(109)  $(205)  $(364)  $(327)

 

Net interest expense decreased for the three months ended September 30, 2012 from the same period in 2011 due to decreased rates on lower balances of our interest bearing liabilities.

 

Net interest expense increased for the nine months ended September 30, 2012 from the same period in 2011 due to decreased balances of interest bearing assets, offset in part by decreased rates on lower balances of our interest bearing liabilities.

 

Other income (expense), net

 

Three Months Ended September 30,   Nine Months Ended September 30, 
2012   2011   2012   2011 
(in thousands) 
              
$(445)  $547   $(1,101)  $133 

 

Other expense for the three months ended September 30, 2012 was primarily due to changes in rates associated with foreign currency transactions.

 

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Other expense for the nine months ended September 30, 2012 was primarily related to deferred financing amortization expense related to our prior credit agreement that was amended in June 2011 with a one year term, as well as changes in rates associated with foreign currency transactions.

 

Other income for the three months ended September 30, 2011 was primarily related to changes in rates associated with foreign currency transactions. Other income for the nine months ended September 30, 2011 includes 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 September 30,   Nine Months Ended September 30, 
2012   2011   2012   2011 
(in thousands) 
              
$492   $(1,723)  $2,677   $(1,111)

 

Income tax expense increased for the three and nine months ended September 30, 2012 due primarily to the composition of pre-tax income or losses in relation to the applicable tax rates at our various locations worldwide.

 

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Liquidity and Capital Resources

 

We have historically funded our business through operating cash flows and proceeds from borrowings. During the first nine months of 2012, we generated cash of $4.4 million in operating activities primarily related to the receipt of a $4.7 million income tax refund.

 

During the first nine months of 2012, cash used in investing activities was $6.9 million, resulting primarily from the acquisition of property and equipment. During the first nine months of 2012, we used $2.3 million in financing activities, relating primarily to pledging $5.0 million of cash to collateralize our revolving line of credit issued in conjunction with our credit facility executed in April 2012 along with principal payments of long-term debt, partially offset by net proceeds from the term loan issued under this agreement.

 

Working capital was $69.2 million at September 30, 2012 as compared to $62.6 million as of December 31, 2011.

 

In April 2012, we entered into a $20.0 million credit facility consisting of a 4-year, $5.0 million term loan and a $15.0 million revolving line of credit. As of September 30, 2012, the Company had no amounts outstanding and $8.9 million of outstanding letters of credit secured under the new line of credit.

 

Borrowings under this agreement bear interest at a fluctuating rate equal to (i) in the case of the term loan, the sum of (a) an interest rate equal to daily three month LIBOR, plus (b) 3.25%; and (ii) in the case of advances under the revolving line of credit, the sum of (a) an interest rate equal to daily three month LIBOR, plus (b) 2.75%. As of September 30, 2012, the interest rate on the outstanding term loan was 3.75%.

 

The credit facility contains financial covenants, including certain net cash flow requirements for 2012, a minimum fixed charge coverage ratio commencing in 2013 and extending for the remaining term of the agreement, maximum quarterly year-to-date capital expenditures, minimum monthly domestic unrestricted cash and maximum average monthly cash reserves held at international locations. As of September 30, 2012, the Company was in compliance with its current financial covenants.

 

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, 2011. There have been no material changes to our contractual obligations since December 31, 2011, except for long term debt repayments and the April 2012 credit facility as discussed above and in Note 4 to the condensed consolidated financial statements. As of September 30, 2012, 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, 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.

 

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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, 2011. There have been no material changes or modifications to the policies since December 31, 2011.

 

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, 2011.

 

Item 4. Controls and Procedures

 

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 upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the Company’s last fiscal quarter, our disclosure controls and procedures were effective in that they provide reasonable assurance that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, including ensuring that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer as appropriate to allow timely decisions regarding required disclosure. 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.

 

Changes in Internal Control Over Financial Reporting

 

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

 

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PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings

 

Please refer to Part 1 – Note 10 to the condensed consolidated financial statements for further details and history on the Company’s material litigation.

 

Item 1A. Risk Factors

 

In addition to the other information set forth in this report, the risks and uncertainties that we believe are most important for you to consider are discussed in Part II, "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2011. These risk factors could materially affect our business, financial condition or future results.

 

Item 6. Exhibits

 

Exhibit    
Number   Description
     
10.1   Separation Agreement, dated September 10, 2012, between Albany Molecular Research, Inc. and Mark T. Frost. ***
     
10.2   Employment Agreement, dated September 17, 2012, between Albany Molecular Research, Inc. and Michael M. Nolan.***
     
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   XBRL (eXtensible Business Reporting Language).  The following materials from Albany Molecular Research, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2012, formatted in XBRL: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Equity and Comprehensive Income, (iv) the Consolidated Statements of Cash Flows and (v) notes to consolidated financial statements.**

 

* This certification is not “filed” for purposes of Section 18 of the Exchange Act or incorporated by reference into any filing under the Securities Act or the Securities Exchange Act.

 

** 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.

 

*** Denotes management contract or compensation plan or arrangement.

 

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SIGNATURES

 

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

 

  ALBANY MOLECULAR RESEARCH, INC.
     
Date: November 9, 2012 By: /s/ Michael M. Nolan  
    Michael M. Nolan
    Vice President, Chief Financial Officer and Treasurer
(Duly Authorized Officer and Principal Financial Officer)

 

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