10-K 1 v336030_10k.htm FORM 10-K

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

FORM 10-K

 

 

 

(Mark One)

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

 

For the fiscal year ended December 31, 2012

 

or

 

¨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 001-35622

 

 

 

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.)
     
26 Corporate Circle    
Albany, New York   12203
(Address of principal executive offices)   (zip code)

 

(518) 512-2000

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

Title of each class   Name of exchange on which registered
Common Stock, par value $.01 per share   The NASDAQ Stock Market LLC
Preferred Stock Purchase Rights    

 

Securities registered pursuant to Section 12(g) of the Act:

None

(Title of Each Class)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  o   No  x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes   o   No  x

 

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes   x    No  o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

 

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 12b-2 of the Exchange Act

o Large accelerated filer   x Accelerated filer   o Non-accelerated filer   o Smaller reporting company

  

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes  o    No  x

 

The aggregate market value of the Registrant’s Common Stock held by non-affiliates of the Registrant on June 30, 2012 was approximately $58 million based upon the closing price per share of the Registrant’s Common Stock as reported on the Nasdaq Global Market on June 30, 2012. Shares of Common Stock held by each officer and director and by each person who owns 10% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of February 28, 2013, there were 31,337,423 outstanding shares of the Registrant’s Common Stock, excluding treasury shares of 5,411,372.

 

 

 

DOCUMENTS INCORPORATED BY REFERENCE

 

The information required pursuant to Part III of this report is incorporated by reference from the Company’s definitive proxy statement, relating to the annual meeting of stockholders to be held on or around June 5, 2013, pursuant to Regulation 14A to be filed with the Securities and Exchange Commission.

 

 

 
 

 

ALBANY MOLECULAR RESEARCH, INC.
INDEX TO
ANNUAL REPORT ON FORM 10-K

        Page No.
       
    Cover page    
    Part I.    
Forward-Looking Statements   3
Item 1.   Business   4
Item 1A.   Risk Factors   18
Item 1B.   Unresolved Staff Comments   25
Item 2.   Properties   25
Item 3.   Legal Proceedings   25
Item 4.   Mine Safety Disclosures   25
    Part II.    
Item 5.   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities   26
Item 6.   Selected Financial Data   28
Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations   29
Item 7A.   Quantitative and Qualitative Disclosures about Market Risk   40
Item 8.   Financial Statements and Supplementary Data   40
Item 9.   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   41
Item 9A.   Controls and Procedures   41
Item 9B.   Other Information   41
    Part III.    
Item 10.   Directors, Executive Officers and Corporate Governance of the Registrant   42
Item 11.   Executive Compensation   42
Item 12.   Security Ownership of Certain Beneficial Owners and Management   42
Item 13.   Certain Relationships, Related Transactions and Director Independence   42
Item 14.   Principal Accountant Fees and Services   42
    Part IV.    
Item 15.   Exhibits and Financial Statement Schedules   43

 

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Forward-Looking Statements

 

References throughout this Form 10-K to the “Company”, “we,” “us,” and “our” refer to Albany Molecular Research, Inc. and its subsidiaries, taken as a whole. This Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act, 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, patent protection, Allegra® and Actavis 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. Readers should review carefully the risks and uncertainties identified below under the caption “Risk Factors” and elsewhere in this 10-K. All forward-looking statements are made as of the date of this report and we do not undertake any obligation to update our forward-looking statements, except as required by applicable law.

 

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PART I

 

ITEM 1. BUSINESS.

 

Overview

 

Albany Molecular Research, Inc. (the “Company,” “AMRI”, “we,” “us,” and “our”), a Delaware corporation incorporated on June 20, 1991, is a global contract research and manufacturing organization providing customers fully integrated drug discovery, development, and manufacturing services. AMRI supplies 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, AMRI maintains geographic proximity to our customers and flexible cost models. AMRI has also historically leveraged its 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. AMRI has successfully partnered certain programs and is actively seeking to out-license its remaining programs to strategic partners for further development.

 

Industry Overview and Trends

 

Pharmaceutical and biotechnology companies are under increasing pressure to deliver new drugs to market, lower the current high cost of new drug research and development and reduce the time required for drug development. This pressure has come about, in part, as a result of the significant number of current drug products on the market for which patent protection has or will soon expire, as well as a reported drop in productivity from pharmaceutical companies’ internal research pipelines. In addition, Federal government healthcare legislation is expected to put more pressure on pricing for new drugs. Large pharmaceutical companies are facing increased pressures to reduce their fixed cost base and turn to more flexible cost models to address these cost/pricing implications.

 

In recent years, many pharmaceutical and biotechnology companies responded to these pressures in part by augmenting their internal research and development capacity through outsourcing. However, the financial crisis coupled with the pending patent cliff caused many companies to reduce the overall number of their internal R&D programs. In addition to internal program rationalizations, we believe these companies also refocused their licensing efforts to seek programs that had reached the proof of concept stage in clinical trials in contrast to prior interest in forging licensing deals at much earlier stages. In addition, small biotech companies have experienced the squeeze of tightened credit policies by banks and other sources of capital, a lack of an IPO market and the need to take programs further through clinical trials in order to generate the data needed to make their intellectual property attractive in the current licensing environment. These circumstances have also had an effect on the number of R&D programs these small companies can work on simultaneously.

 

We believe a number of large pharmaceutical companies also have a robust late stage pipeline. Due to increased regulatory scrutiny requiring larger and longer studies, as well as an emphasis by payors focused on reimbursing only new products which offer significant benefit over existing alternatives, funding of several late stage clinical trials has squeezed investment in new programs that are required to replenish the pipeline. The combination of the above factors has led to a decrease in the growth of new R&D programs over the last couple of years resulting in softness in the market for new discovery and early development outsourcing. The net effect has led to an excess of capacity in the outsourcing industry and a more competitive environment during this period.

 

For a majority of large pharmaceutical companies, 2011 was a year of refocusing their R&D strategy which resulted in large cuts of staff, resources and facilities.  These efforts continued through 2012, resulting in a reduction in spending on R&D, which was once the growth engine of discovery contract research organizations (“CROs”), such as AMRI. Additionally, market forces continued to adversely affect the small startup and biotech companies that have been anchors for the growth of AMRI’s discovery, development and small scale manufacturing business.  Venture funding for new compounds and startups has not recovered to the pre-financial crisis levels, and the same factors affecting pharmaceutical companies’ internal R&D consolidations also led to a weak licensing environment for products coming out of the small and emerging pharmaceutical and biotech companies.  As a result, total funding for early stage companies and programs remained down, leading to softer demand for discovery and development services.  We believe this was in part a factor in the declining growth of AMRI’s early development and small scale business in 2011 and these trends continued to affect AMRI’s business throughout 2012.  At the same time, these companies focused on their later stage pipelines, which was the primary reason for our U.S. large-scale manufacturing plant reaching record levels of revenue during both 2011 and 2012. We expect to see strong demand continuing for this same reason in 2013. In addition, we entered into or extended multi-year commercial supply agreements for several active ingredients that we are making in our Rensselaer, NY facility.  We are optimistic that these agreements will lead to a period of stability and continuing growth for our large scale manufacturing business.

 

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As the industry emerges from this economic downturn and several new products recently approved achieve significant market share, we believe that market trends will exert an increasing emphasis towards outsourcing, as large pharmaceutical companies seek to maintain reduced internal resources in favor of a variable model that offers high quality and higher accountability alternatives to meet their drug discovery and development needs. We believe that announcements coming from several big pharmaceutical companies regarding their reorganization plans and strategy changes point to outsourcing as an increasingly important and strategic part of future R&D efforts as a way to boost productivity and efficiency, and better align cost structure of their R&D organizations. Overall, we believe that events of the last few years point to an acceptance that the research model of the past is broken in that productivity has not kept pace with patent expirations. As a result, the industry is more willing than ever before to explore different paradigms to deliver new sources of revenue, control costs and improve productivity.

 

In addition, we have recently observed an increased involvement by government research entities and non-profit organizations in undertaking drug discovery and development efforts. We believe that due to the lack of internal resources within these groups, outsourcing will be a key strategy in achieving their drug discovery and development objectives.

 

A new development in the industry is an increasing interest in insourcing models, whereby contract research organizations embed their employees in a client facility. The staff is managed by the contractor but the physical infrastructure is provided by the client. There are indications that this approach may become more widely adopted as pharmaceutical companies recognize the ability to cost-effectively leverage their unused laboratory space. Using an insourcing model allows a customer with excess physical laboratory or other capacity to create a variable and more accountable resource in which benefits and other long term obligations accrue to the provider.

 

Business Strategy

 

AMRI is uniquely positioned in the marketplace to provide a competitive advantage to a diverse group of customers. Our reputation of providing the highest quality service on a global basis with a variety of pricing options provides companies with the security of sourcing discovery, development, small and large scale manufacturing projects throughout our global network of research and manufacturing facilities. We believe we have a unique portfolio of service offerings ranging from early stage discovery through manufacturing and formulation across the U.S., Europe and Asia. We believe this product and geographic mix will allow us to increase multi-year strategic relationships and enhance our revenue growth with a variety of customers. With the market of competitors being highly fragmented, we have strategically focused our efforts to strengthen our global service offerings with the intent to improve profitability of these offerings and to drive the Company to be profitable independent of royalties from the sales of Allegra. Our strategy to accomplish this includes the following:

 

·Enhance revenue growth and mix

 

Market trends point to outsourcing as an increasingly important part of business strategies for pharmaceutical companies. We believe our ability to offer a full service model, which also allows customers to use a combination of our U.S., Europe and Asia based facilities, will result in an increase in demand for our services globally. We offer our customers the option of insourcing, a strategic relationship that embeds AMRI scientists into the customer’s facility, allowing them to cost-effectively leverage their unused laboratory space.

 

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 launched AMRI SMARTSOURCING™, a full range of value-added opportunities providing customers informed decision-making, enhanced efficiency and more successful outcomes at all stages of the pipeline. This approach maximizes the strengths of both insourcing and outsourcing by leveraging AMRI’s expertise, global facilities and project management to provide strategic relationships and flexible business models for customers. We have enhanced and integrated our sales and marketing organization into an international business development group to optimize selling opportunities and key account management. At our facilities we have strengthened our commitment to quality with the appointment of key personnel, again underscoring our dedication to client service. Our improved organizational structure, combined with more focused sales and marketing efforts, should enable us to drive long term growth and increased profitability.

 

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We are also continuing to focus our efforts on other important customer segments; small and large biotech companies, non-profit/government entities and related industries such as the agricultural, nutraceutical and food industries. We believe maintaining a balance within our customer portfolio between large pharmaceutical, non-profit/government, biotech and other companies will help ensure sustained sales and reduce risk. During 2011, we were awarded a five year government contract from National Institute of Health (“NIH”) to develop pre-clinical drug candidates for diseases of the central nervous system. We continue to pursue other contracts of this type.

 

We have made investments to build our formulation business at our Burlington, MA facility and continue to focus on enhancing quality in response to an FDA warning letter received in August 2010. 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 and manufactured on an aseptic basis. As a result of our investments, there are no current restrictions on the manufacture of clinical or commercial products at this facility.

 

·Streamline operations to improve margins

 

The cost base of our manufacturing and research facilities are largely fixed in nature. However, we continue to seek opportunities to minimize these fixed costs, with a focus on gaining flexibility and improving efficiency, cost structure and margin.

 

During 2012, we transitioned certain services from Hungary to India and initiated actions to transition certain services from Bothell, WA to Singapore and Albany, NY.  These actions were taken to better align the business to customer demand and current and expected market conditions due to shifting preferences related to the preferred co-localization of integrated drug discovery activities.

 

·Maximize licensing/partnering of proprietary compounds to enhance future cash flow

 

Although we suspended substantial investments and halted proprietary compound R&D activities in 2011, 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 programs in return for a combination of up-front license fees, milestone payments and recurring royalty payments if compounds resulting from our intellectual property are successfully developed into new drugs and reach the market. One compound was successfully partnered in early 2013. We are continuing to focus on partnering other programs.

 

Small Molecule Drug Discovery, Development and Manufacturing Process

 

Although many scientific disciplines are required for new drug discovery and development of small molecule drugs, chemistry and biology are core technologies. Chemists and biologists typically work together to develop laboratory models of disease, screen small molecule (low molecular weight) compounds to identify those that demonstrate desired activity and finally create a marketable drug.

 

The drug discovery and development process for small molecules includes the following steps:

 

Drug Discovery

 

§Lead Discovery. The first major hurdle in drug discovery is the identification of one or more lead compounds that interact with a biological target, such as an enzyme, receptor or other protein that may be associated with a disease. A biological test, or assay, based on the target is developed and used to test or “screen” chemical compounds. The objective of lead discovery is to identify a lead compound or screening ‘hit’. Validation of a screening hit is performed under the scrutiny of the discovery biologists and medicinal chemists in order to identify the ‘hits’ with the best chance to obtain a drug-like chemical series or lead compound. Early in vitro profiling for metabolic stability, potential unwanted drug-drug interactions and indications of toxic liability are also conducted. The objective of lead discovery is to identify a lead compound that has many of the properties needed in the eventual drug and a good prognosis for further optimization in order to produce a robust clinical development candidate.

 

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§Lead Optimization. Lead optimization typically involves improving the potency, selectivity, absorption/metabolism and pharmacokinetics of the lead compound, through targeted structural modifications, while maintaining, or generating, patentable intellectual property. Optimized lead compounds must demonstrate a scientifically proven benefit in controlled and well-defined biological tests and must exhibit this benefit at doses much lower than those at which side effects would occur. During the lead optimization and preclinical testing phases, scientists continue the synthesis of additional analogs of the lead compound using medicinal chemistry techniques. The compounds are tested in similar biochemical assays as those used during lead discovery but additional profiling of mechanism of action and more sophisticated analysis of metabolic and safety parameters are also introduced. Often a second compound, referred to as a backup compound or second generation analog, is synthesized and enters the drug development cycle. In addition, continued synthesis and testing is desirable in order to prepare compounds of significant diversity to broaden potential patent coverage. As a result, the advancement of a lead compound into preclinical testing is often a catalyst which increases, rather than decreases, the need for additional drug discovery services. During lead optimization most compounds are prepared in milligram to gram quantities.

 

Drug Development

 

§Preclinical Testing. Following the advancement of a lead compound to a development candidate, advanced preclinical testing is conducted in order to evaluate the efficacy and safety of the development candidate prior to initiating human clinical trials. During this phase, specialists in chemical development work to identify the preferred route to prepare the drug substance. In addition, efforts are required to determine the best physical form of the compound, selecting appropriate salts and controlling polymorphic form (properties of the crystal form of the active ingredient that are important for reproducible solubility and therefore absorption or bioavailability) and to begin to improve the process for preparing the candidate in larger quantities, often hundreds of grams. Working with analytical chemists, the development chemists will prepare material of sufficient quality and quantity to be used in IND-enabling toxicity studies. In the United States, prior to continuing on to the human clinical trials stage, an Investigational New Drug application (“IND”) must be filed with the FDA. Once the application is filed, the applicant must wait 30 days for comments from the FDA. If none are received, human clinical trials may commence.

 

§Clinical Trials. During clinical trials, several phases of studies are conducted to test the safety and efficacy of a drug candidate in humans. The human clinical trials phase is usually costly and time-consuming. As study populations increase and trial durations lengthen, larger quantities of the active ingredient are required. Clinical trials are normally done in three phases prior to submission for regulatory approval and overall generally take at least seven years to complete. During these phases, development work continues in order to provide suitable formulations for clinical testing and for the ultimate commercial product. The API and the formulated drug product must be prepared under cGMP guidelines. Formulations are selected that maximize bioavailability and optimize dosing regimen. Analytical chemistry services are critical to cGMP manufacturing. Additional preparations provide an opportunity to further refine the manufacturing process for the active ingredient, with the ultimate goal of maximizing the cost effectiveness, safety and reproducibility of the synthesis prior to commercialization.

 

§Product Commercialization. Before approving a drug, the FDA requires that manufacturing procedures and operations conform to cGMP guidelines, International Conference on Harmonization guidance and manufacturing guidelines and guidance published by the FDA. Manufacturing procedures and operations must be in compliance with all regulatory and quality regulations at all times during the manufacture of commercial products and APIs. Once a drug has received all necessary approvals, the manufacture, marketing and sale of commercial quantities of the approved drug may commence, following tightly defined batch record procedures. All commercial activities are subject to audit during an FDA or other country’s regulatory inspection and failure to strictly follow procedures or substantial deviations or abnormalities can result in regulatory observations such as a Form 483, a Warning Letter or a product recall or other sanction.

 

Our Capabilities

 

We perform services including drug discovery, pharmaceutical development, and manufacturing of active ingredients and pharmaceutical intermediates for many of the world’s leading healthcare companies. The problem-solving abilities of our scientists can provide added value throughout the drug discovery, development and manufacturing process. We also offer certain, limited formulation services, including early phase solid dosage capabilities at our Rensselaer, NY facility and aseptic fill finish for both clinical and commercial products at our Burlington, MA location. Our comprehensive suite of services allows our customers to contract with a single partner, eliminating the time and cost of transitioning projects among multiple vendors.

 

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Service Offerings

 

Drug Discovery Services

 

The competitive drug discovery industry continues to face many challenges, including a weakening product pipeline, increasing costs, more complex disease targets and regulatory hurdles.  These challenges have compelled many companies/research organizations to look outside their own R&D function for contract partners to support research and development from the earliest stages of the drug discovery process.

 

AMRI performs integrated drug discovery programs, harnessing the capabilities and expertise of specialist teams of scientists from individual disciplines under the coordination of experienced project leaders and key employees with decades of experience.  All of the capabilities described below are also offered individually to support customers who have their own capacity in certain areas.

 

Our Drug Discovery Services include:

 

Assay Development and Design

 

We offer custom assay design and development services to clients in the pharmaceutical, biopharmaceutical and agrochemical industries who are starting from a unique target or who are supporting ongoing lead discovery programs. This service can be delivered independently to a client, or integrated with our full range of drug discovery services.

 

Key features of our Assay Design and Development services include:

 

·Design of assays to meet client objectives, or transfer of customer developed assays

 

·Development of cell-lines and reagents

 

·Developing, optimizing and validating assays for screening

 

·Mechanism of action testing

 

·Extensive assay performance testing

 

Screening

 

Our diverse offering of screening capabilities, coupled with access to our range of sample collections, give customers the essential tools to efficiently identify and optimize lead compounds.

 

Key features of our screening capabilities include:

 

·Availability of high throughput screening for lead-finding, utilizing client or AMRI’s sample collections

 

·Conduct of absolute potency and selectivity screening for lead optimization

 

Screening Libraries

 

We have created a series of unique, high purity, cost effective, small molecule synthetic compound libraries and a complementary collection of natural product extracts from marine, plant and microbial sources designed for screening and hit-to-lead programs. We are uniquely positioned to fully support active hits from any of these libraries with lead optimization services, analytical services, custom synthesis and/or small or large scale manufacturing.

 

Our libraries include:

 

·Natural Products Libraries

 

·Target focused Discovery Libraries

 

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·Synthetic Sample Libraries

 

·Diverse Fragment Based Library

 

Natural Product Services

 

We have a longstanding, well established ability to deliver on natural products discovery programs.  Our natural product library and screening capabilities are supported by a team of experts with decades of experience in the field. We have substantial expertise in natural product isolation, structural identification, fermentation development and biotransformations giving us the ability to rapidly advance a natural product from hit to lead to qualified drug candidate.

 

Custom Synthesis and Library Synthesis

 

In the Hit-Lead phase of drug discovery it is common to require custom designed libraries of compounds relating to specific structural classes of interest. Our synthetic libraries group is equipped to design and execute the preparation of libraries typically containing hundreds of compounds. AMRI applies the same capabilities to create larger libraries, typically thousands of compounds, for use in the screening phase of drug discovery. AMRI’s custom synthesis capabilities support all stages of drug discovery.

 

Medicinal Chemistry

 

Lead optimization is the complex, iterative process of altering the chemical structure of a confirmed hit to identify an improved drug lead with the goal of progressing to a preclinical candidate. Well-trained, intuitive and knowledgeable, our medicinal chemists have years of experience working with drug-like compounds. Our medicinal chemistry capability is fully integrated with our other drug discovery services, allowing for a “one stop shop” approach towards outsourcing lead discovery and optimization efforts, if so desired.

 

Computer-Aided Drug Discovery (“CADD”)

 

Our CADD services use sophisticated computational software and techniques to help identify novel hits or leads against selected therapeutic targets, as well as to support medicinal chemistry lead optimization programs. CADD methods can increase the odds of identifying compounds with desirable characteristics, speed up the hit-to-lead process and improve the chances of getting a compound over the many hurdles of preclinical testing.

 

In vitro ADMET

 

We conduct in vitro ADMET assays to evaluate and improve metabolism, bioavailability, pharmacology and toxicology of compounds.

 

Early stage ADMET testing, integrated with Medicinal Chemistry programs, typically include:

 

·Aqueous solubility under physiological conditions

 

·Metabolic and chemical stability

 

·Membrane permeability

 

·Inhibition and induction of major metabolic enzymes

 

Bioanalytical Services

 

We develop and execute rapid, sensitive, and robust bioanalytical methods for extraction and quantitation of drug and metabolites in biological fluids and tissues to support preclinical and clinical studies. This service is provided stand-alone or can be coupled directly with services provided by our network of in vivo testing providers.

 

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Network of pharmacology service providers

 

We have worked in close collaboration with multiple in vivo pharmacology and preclinical safety assessment providers. The strong relationships we have developed with several of these providers allow AMRI to effectively coordinate these external services with our own internal capabilities to deliver a fully integrated drug discovery program.

 

Chemical Development

 

Chemical development involves the scale-up synthesis of a lead compound and intermediates. Processes developed for small scale production of a compound may not be suitable for larger scale production because they may be too expensive, environmentally unacceptable or present safety concerns. With chemical development locations around the globe, we have become a top choice for an ever increasing number of pharmaceutical and biotechnology companies seeking a partner for the rapid advancement of their drug candidates. Customers throughout the world rely on our proven technical expertise, commitment to the highest quality and regulatory standards, flexibility, and strong customer focus to advance their lead compounds through the drug development process, from bench scale to commercial production.

 

Our Chemical Development services include:

 

·Process Research and Development

 

·Custom Synthesis

 

·Process Safety Assessment

 

·Scale-up Capabilities

 

·High Potency and Controlled Substances

 

·Analytical Services

 

·Preformulation Services and Physical Characterization

 

·Preparative Chromatography

 

·IND Support Services

 

·Fermentation Development and Optimization

 

·Building Blocks Collection and Database

 

cGMP API Manufacturing

 

Our manufacturing facilities are strategically situated in various locations in the United States, Europe and Asia. These locations are globally positioned to provide tailored customer solutions and enable the efficient and cost-effective transfer of pre-clinical, clinical and commercial APIs from small-scale to large-scale production. Additionally, these locations easily integrate with our discovery and pharmaceutical development services.

 

We provide chemical synthesis and manufacturing services for our customers in accordance with cGMP regulations. All facilities and manufacturing techniques used for prescribed steps in the manufacture of products for clinical use or for sale in the United States must be operated in conformity with cGMP guidelines and regulations as established by the FDA. Our Albany, New York location has production facilities and quarantine and restricted access storage necessary to manufacture quantities of drug substances sufficient for conducting clinical trials from Phase I through Phase II, and later stages, including commercial API, for selected products, based on volume and other parameters. Our large scale manufacturing facility in Rensselaer, New York is equipped to provide a wide range of custom chemical development and manufacturing capabilities. We conduct commercial cGMP manufacturing of APIs and advanced intermediates. Our large-scale cGMP manufacturing facilities provide synergies with our small-scale development laboratories, offering our customers services at every scale, from bench to production. We have special capabilities in high value-added areas of pharmaceutical development and manufacturing, including high potency manufacturing. Cytotoxic and other highly potent compounds present a number of potential challenges in their production and handling. We have extensive experience in the cGMP production of these types of compounds, from grams to hundreds of kilograms per year. Our Rensselaer, NY facility is licensed by the U.S. Drug Enforcement Administration to produce Schedule I, II, III, IV and V controlled substances. For over 50 years, the facility has produced controlled substances such as analgesics, amphetamines, barbiturates, and anabolic steroids. In 2012, our focus on compliance was reinforced following successful DEA and FDA inspections at our Rensselaer facility.

 

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Our large-scale manufacturing facility in Aurangabad, India was issued a GMP certificate from the Therapeutic Goods Administration (“TGA”) following an inspection in February 2011. The TGA is the Australian Government regulatory agency and is recognized as one of the leading global authorities on GMP compliance. The certificate covers general GMP manufacturing operations, and laboratory controls designed for the production and release of APIs and intermediates. The successful audit confirms AMRI’s compliance with GMP regulations and further demonstrates the Company’s commitment to operational quality. Our Aurangabad facility is an approved facility by Indian FDA and WHO GMP certified with production facilities and quarantine and restricted access storage necessary to manufacture quantities of drug substances under cGMP regulations sufficient for conducting clinical trials and commercial API, for selected products, based on volume and other parameters. In addition our site was approved by various leading global pharmaceutical companies from Europe and Asia as their API vendor for their generics and drug development requirements.

 

Formulation Development & cGMP Formulation Manufacturing

 

We have added selected focused formulation capabilities to our portfolio. Our Burlington, MA facility provides contract manufacturing services in sterile syringe and vial filling using specialized technologies including lyophilization. AMRI Burlington provides these services for both small molecule drug products and biologicals, from clinical phase to commercial scale.

 

Working in close collaboration with our already established chemical synthesis, analytical development and preformulation groups, we also offer formulation development services for solid dosage, solution, suspension, topicals and injectables, cGMP early clinical phase capsules filling using Xcelodose technology and cGMP early clinical Powder in Bottle (“PIB”) for solution and suspension.

 

Formulation services include:

 

·Aseptic fill and finish (vials and syringes)

 

·Aseptic lyophilization

 

·Neat API or pharmaceutical blend in capsules

 

·PIB for solution and suspension

 

·Blending and sieving

 

·Milling

 

·Tableting

 

·Rheology

 

·Roller compaction

 

·Wet granulation

 

·Fluid bed processing, including Wurster coating

 

·All associated analytical testing for dosage formulation products

 

Analytical Chemistry Services

 

We provide broad analytical chemistry services for drug discovery, pharmaceutical development and manufacturing.  With years of industry experience, state-of-the-art technologies and instrumentation, along with close collaboration with synthesis chemists, our analytical services are designed to ensure that the right tools are used to solve even the most difficult problem.

 

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Analytical services that we provide include:

 

·Impurity identification & structure elucidation

 

·Method development, qualification and validation

 

·Preformulation and physical characterization

 

·Quality control

 

·Stability services

 

·Analytical and preparative Supercritical Fluid Chromatography

 

·Preparative chromatography

 

·Good Laboratory Practices (“GLP”) bioanalytical services

 

·Regulatory support/quality assurance

 

Proprietary Research and Development

 

Leveraging our wide array of drug discovery capabilities, we established several internal drug discovery programs with the goal to discover and develop promising drug candidates and license these candidates in return for upfront fees, milestones and downstream royalty payments for commercialized drug products. We identified lead series by utilizing our high throughput screening capabilities, coupled with our computer assisted drug design capabilities, to assess our diverse range of synthetic, virtual and natural product screening libraries. Applying the expertise of our separate R&D medicinal chemistry group, supported by our own in vitro biology and in vitro metabolism capabilities and a select range of in vivo service providers, we optimized these lead series to development candidate status, in some cases pursuing these into early clinical studies.

 

Our proprietary research and development efforts to date have contributed to the discovery and development of one product that has reached the market. We discovered a new process to prepare a metabolite known as terfenadine carboxylic acid, or TAM, in a purer form. The purer form of TAM is the active ingredient in the non-sedating antihistamine known as fexofenadine HCl, which is sold by Sanofi under the name Allegra in the Americas and as Telfast elsewhere. We have been issued several United States and foreign patents relating to TAM and the process chemistry by which TAM is produced. Subject to payment of government annuities and maintenance fees, our issued patents relating to TAM expire between 2013 and 2015.

 

Recent drug discovery and development projects have been focused on treatments for irritable bowel disease, central nervous system diseases and obesity. Our R&D efforts benefited from access to a broad array of our scientific services including capabilities in microbial fermentation, molecular biology, cell culture, gene expression and cloning, scale up synthesis of human metabolites, preformulation, chemical development and cGMP synthesis. Additionally, a portion of our R&D efforts focused on improving the manufacturing process for our generic API products. In late 2011, we announced that we would cease to invest in most of these internal drug discovery efforts but continue to seek partnership or investment for the advanced programs with the goal of returning value to AMRI. We continue to place some R&D focus on improving manufacturing processes. We spent $0.9 million, $7.9 million and $11.1 million on research and development activities in 2012, 2011 and 2010, respectively.

 

Licensing Agreements

 

AMRI Rensselaer, Inc., a wholly-owned subsidiary of AMRI, and Actavis, Inc. (“Actavis”) are parties to a long term Development and Supply Agreement (the “Supply Agreement”). Under the Supply Agreement, the Company supplies four amphetamine salts (“API”) to Actavis. In addition to compensation for the supply of API, the Company will receive royalties on Actavis’ sales of any finished drug product that incorporates the API, for a period of five years from the date of the first commercial sale of the last product approved for sale by the Federal Drug Administration.

 

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Actavis received FDA approval of its abbreviated new drug application (“ANDA”) for generic Adderall XR® on June 25, 2012. Actavis received FDA approval of its ANDA for extended release formulations of dextroamphetamine sulfate on November 30, 2012. Under the Agreement, the Company will receive royalty payments on sales of both finished drug products, which royalties are expected to continue through at least 2017.

 

In January 2011, we entered into a research and licensing agreement with Genentech. Under the terms of the agreement, Genentech received an exclusive license to develop and commercialize multiple potential products from our proprietary antibacterial program. Additionally, we have collaborated with Genentech in a research program with the objective of identifying novel antibacterial agents.   In addition to an upfront license fee and research funding of $1.5 million, we will be eligible to receive development and regulatory milestones of up to $40.0 million for each compound to achieve these events and will receive royalties from Genentech on worldwide sales of any resulting commercialized compounds.

 

In October 2005, we licensed the worldwide rights to develop and commercialize potential products from our amine neurotransmitter reuptake inhibitor technology and patents identified in one of our proprietary research programs to Bristol-Myers Squibb Company (“BMS”). In conjunction with the licensing agreement, we received a non-refundable, non-creditable up-front payment of $8.6 million, which included the cancellation of outstanding warrants, and a total of $10.8 million for research and development services in the first three years of the agreement. The agreement also set forth milestone events that, if achieved by these products, would entitle the Company to non-refundable, non-creditable milestone payments. For such potential products currently under development by BMS, the Company is entitled to milestone payments of up to $43.5 million for each of the first and second compounds to achieve these events, and up to $22.0 million for each subsequent product to achieve these events. These milestone events include candidate nomination, IND or equivalent regulatory filings, commencement of middle- and late-stage clinical trials, and regulatory approval of compounds for commercial sale. The agreement also provides for the Company to receive royalty payments on worldwide sales of any such product that is commercialized. From the entry into this agreement through December 31, 2012, we have recorded $15.5 million from achieving certain milestones with BMS.

 

In March 1995, we entered into a license agreement with Sanofi. Under the terms of the license agreement, we granted Sanofi an exclusive, worldwide license to any patents issued to us related to our original TAM patent applications. From the beginning of the agreement through December 31, 2012, we have had revenues of $7.4 million in milestone payments and approximately $524.2 million in royalties under this license agreement. Sanofi is obligated under the license agreement to pay ongoing royalties to us based upon its net sales of Allegra/Telfast and generic fexofenadine. Additionally during the fourth quarter of 2008, we entered into an amendment to our 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. As a result of this amendment, we received an upfront sublicense fee from Sanofi of $10.0 million and additionally we will receive royalties from Sanofi on the net sale of products in the United States containing fexofenadine hydrochloride and products containing fexofenadine hydrochloride (generic Allegra) and pseudoephedrine hydrochloride (generic Allegra D-12) by Teva Pharmaceuticals through 2015, along with additional consideration. We are not entitled, however, to receive any additional milestone payments under the license agreement. Sales of Allegra/Telfast and generic fexofenadine by Sanofi worldwide were approximately $1.0 billion, $1.2 billion and $1.1 billion for the years ended December 31, 2012, 2011 and 2010, respectively. See “Item 3—Legal Proceedings” for discussion of current legal proceedings related to Allegra/Telfast.

 

Business Segments

 

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, in vitro biology and DMPK, lead optimization, drug development, and small scale commercial manufacturing, represent our DDS business segment. See “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Notes to the Consolidated Financial Statements for financial information on the Company’s business segments.

 

Customers

 

Our customers include pharmaceutical companies and biotechnology companies, as well as government research entities and non-profit organizations, which are a growing segment of our customer base. We also sell, to a more limited extent, to companies who are in the businesses of agriculture, fine chemicals, contract chemical manufacturing, medical devices, and flavoring and cosmetics. For the year ended December 31, 2012, contract revenue from our three largest customers represented 15%, 12% and 7%, respectively, of our contract revenue. For the year ended December 31, 2011, contract revenue from our three largest customers represented 16%, 9% and 8%, respectively, of our contract revenue. For the year ended December 31, 2010, contract revenue from our three largest customers represented 17%, 10% and 7%, respectively, of our contract revenue. In 2012, the company’s largest customer was GE Healthcare. See Note 15 to the Consolidated Financial Statements for information on geographic and other customer concentrations.

 

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Our backlog of open manufacturing orders and accepted service contracts was $122.0 million at December 31, 2012, as compared to $97.3 million at December 31, 2011. Our manufacturing and services contracts are completed over varying durations, from short to extended periods of time, which may be as long as several years.

 

We believe our aggregate backlog as of any date is not necessarily a meaningful indicator of our future results for a variety of reasons. First, contracts vary in duration, and as such the timing and amount of revenues recognized from backlog can vary from period to period. Second, the Company’s manufacturing and services contracts are of a nature that a customer may, at its option, cancel or delay the timing of delivery, which would change our projections concerning the timing and extent to which revenue may be recognized. In addition, the value of the Company’s services contracts that are conducted on a time and materials or full-time equivalent basis are based on estimates, from which actual revenue generated could vary. Finally, there is no assurance that projects included in backlog will not be terminated or delayed at any time by customers or regulatory authorities. We cannot provide any assurance that we will be able to realize all or most of the net revenues included in backlog or estimate the portion to be filled in the current year.

 

Sales and Marketing

 

Our services are sold primarily by our dedicated sales and business development personnel and senior management. Because our customer contacts are often highly skilled scientists, we believe our use of technical experts in the sales effort has allowed us to establish strong customer relationships. In addition to our internal sales efforts, we also rely on the sales efforts of consultants, both in the United States and abroad. We market our services directly to customers through targeted mailings, meetings with senior management of pharmaceutical and biotechnology companies, maintenance of an extensive Internet web site, participation in trade conferences and shows, and advertisements in scientific and trade journals. We also receive a significant amount of business from customer referrals and through expansion of existing contracts.

 

Employees

 

As of January 31, 2013, we had 1,329 employees. Of these employees, 547 are at our international facilities. Our U.S. large-scale manufacturing hourly work force has 89 employees who are subject to a collective bargaining agreement with the International Chemical Workers Union. A 3-year collective bargaining agreement was signed in January 2011 with the union and expires in January 2014. Additionally, we have 79 union employees at our large-scale manufacturing facility at AMRI India that are covered by two collective bargaining agreements. One agreement expires in March 2013 and the other expires in December 2015. Negotiations on the collective bargaining agreement expiring in March 2013 are in progress. None of our other employees are subject to any collective bargaining agreement. We consider our relations with our employees and the unions to be good.

 

Competition

 

While a small number of larger outsourcing service providers have emerged as leaders within the industry, the outsourcing market for pharmaceutical and biotechnology contract chemistry and biology services remains fragmented. We face competition based on a number of factors, including size, relative expertise and sophistication, quality and costs of identifying and optimizing potential lead compounds and speed and costs of optimizing chemical processes. In many areas of our business we also face foreign competition from companies in regions with lower cost structures. We compete with contract research companies, contract drug manufacturing companies, research and academic institutions and with the internal research departments of biotechnology companies. We have also historically competed with internal research departments of large pharmaceutical companies; recently, however, competition in this area has been reduced as these companies have downsized their internal organizations.

 

We rely on many internal factors that allow us to stay competitive and differentiate us in the marketplace, including:

 

  § Our globalization of both research and manufacturing facilities, which allows us to increase our access to key global markets

 

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  § Our ability to offer a flexible combination of high quality, cost-effective services
     

  § Our comprehensive service offerings, which allow us to provide our customers 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.

 

Patents and Proprietary Rights

 

Our success will depend, in part, on our ability to obtain and enforce patents, protect trade secrets, obtain licenses to technology owned by third parties when necessary, and conduct our business without infringing the proprietary rights of others. The patent positions of pharmaceutical, medical products and biotechnology firms can be uncertain and involve complex legal and factual questions. We seek patent protection with respect to products and processes developed in the course of our activities when we believe such protection is in our best interest and when the cost of seeking such protection is not inordinate. We cannot be assured that any AMRI patent applications will result in the issuance of patents or, if any patents are issued, whether they will provide significant proprietary protection or commercial advantage, or will not be circumvented by others. In the event a third party has also filed one or more patent applications for inventions which conflict with one of ours, we may have to participate in interference proceedings declared by the United States Patent and Trademark Office to determine priority of invention, which could result in the loss of any opportunity to secure patent protection for the inventions and the loss of any right to use the inventions. Even if the eventual outcome is favorable to us, these proceedings could result in substantial cost to us. The filing and prosecution of patent applications, litigation to establish the validity and scope of patents, assertion of patent infringement claims against others and the defense of patent infringement claims by others can be expensive and time consuming. We cannot be certain that in the event that any claims with respect to any of our patents, if issued, are challenged by one or more third parties, a court or patent authority ruling on such challenge will determine that such patent claims are valid and enforceable. An adverse outcome in such litigation could cause us to lose exclusivity afforded by the disputed rights. If a third party is found to have rights covering products or processes used by us, we could be forced to cease using the technologies covered by such rights, could be subject to significant liability to the third party, and could be required to license technologies from the third party. Furthermore, even if our patents are determined to be valid, enforceable, and broad in scope, we cannot be certain that competitors will not be able to design around such patents and compete with us and our licensees using the resulting alternative technology.

 

We have been issued various United States and international patents covering fexofenadine HC1 and certain related manufacturing processes. These United States patents begin to expire in November 2013, and the international patents begin to expire in 2014 and most of these patents are covered by our license agreements with Sanofi, described herein. Additionally, our United States patents related to substituted biaryl purines as potent anticancer agents and a series of aryl and heteroaryl tetrahydroisoquinolines related to central nervous system indications begin to expire in 2020.

 

Many of our current contracts with our customers provide that ownership of proprietary technology developed by us in the course of work performed under the contract is vested in the customer, and we retain little or no ownership interest.

 

We also rely upon trade secrets and proprietary know-how for certain unpatented aspects of our technology. To protect such information, we require all employees, consultants and licensees to enter into confidentiality agreements limiting the disclosure and use of such information. We cannot provide assurance that these agreements provide meaningful protection or that they will not be breached, that we would have adequate remedies for any such breach, or that our trade secrets, proprietary know-how and technological advances will not otherwise become known to others. In addition, we cannot provide assurance that, despite precautions taken by us, others have not and will not obtain access to our proprietary technology. Further, we cannot be certain that third parties will not independently develop substantially equivalent or better technology.

 

Government Regulation

 

The manufacture, transportation and storage of our products are subject to certain international, Federal, state and local laws and regulations. Our future profitability is indirectly dependent on the sales of pharmaceuticals and other products developed by our customers. Regulation by governmental entities in the United States and other countries will be a significant factor in the production and marketing of any pharmaceutical products that may be developed by us or our customers. The nature and the extent to which such regulation may apply to us or our customers will vary depending on the nature of any such pharmaceutical products. Virtually all pharmaceutical products developed by us or our customers will require regulatory approval by governmental agencies prior to commercialization. Human pharmaceutical products are subject to rigorous preclinical and clinical testing and other approval procedures by the FDA and by foreign regulatory authorities. Various federal and, in some cases, state statutes and regulations also govern or influence the manufacturing, safety, labeling, storage, record keeping and marketing of such pharmaceutical products. The process of obtaining these approvals and the subsequent compliance with appropriate federal and foreign statutes and regulations are time consuming and require the expenditure of substantial resources.

 

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Generally, in order to gain U.S. FDA approval, a company first must conduct preclinical studies in the laboratory and in animal models to gain preliminary information on a compound’s efficacy and to identify any safety problems. The results of these studies are submitted as a part of an IND, that the FDA must review before human clinical trials of an investigational drug can start. In order to commercialize any products, we or our customer will be required to sponsor and file an IND and will be responsible for designing, initiating and overseeing the clinical studies to demonstrate the safety and efficacy that are necessary to obtain FDA approval of any such products. Clinical trials are normally done in three phases and generally take two to seven years, but may take longer, to complete. After completion of clinical trials of a new product, FDA and foreign regulatory authority marketing approval must be obtained. If the product is classified as a new drug, we or our customer will be required to file a new drug application, or NDA, and receive approval before commercial marketing of the drug. The testing and approval processes require substantial time, effort and expense, and we cannot be certain that any approval will be granted on a timely basis, if at all. NDAs submitted to the FDA can take several years to obtain approval. Even if FDA regulatory clearances are obtained, a marketed product is subject to continual review. Later discovery of previously unknown problems or failure to comply with the applicable regulatory requirements may result in restrictions on the marketing of a product or withdrawal of the product from the market as well as possible civil or criminal sanctions. For marketing outside the United States, we will also be subject to foreign regulatory requirements governing human clinical trials and marketing approval for pharmaceutical products. The requirements governing the conduct of clinical trials, product licensing, pricing and reimbursement vary widely from country to country.

 

All facilities and manufacturing techniques used for prescribed steps in the manufacture of API for clinical use or for sale in the United States must be operated in conformity with cGMP guidelines as established by the FDA and International Conference on Harmonization (“ICH”). Our facilities are subject to unscheduled periodic regulatory inspections to ensure compliance with cGMP regulations. Failure on our part to comply with applicable requirements could result in the termination of ongoing research or the disqualification of data for submission to regulatory authorities. A finding that we had materially violated cGMP requirements could result in additional regulatory sanctions and, in severe cases, could result in a mandated closing of our facilities or significant fines, which would materially and adversely affect our business, financial condition and results of operations. During 2012, an FDA inspection of our large scale cGMP manufacturing facility in Rensselaer was completed, resulting in no issuance of a Form FDA 483. Further during 2012, the Rensselaer facility was audited by representatives of the South Korean Food and Drug Administration (“KFDA”) as part of a pre-approval audit for a commercial product already manufactured on behalf of a customer and already approved in other markets. The audit resulted in several minor observations being cited, but concluded with an approvable rating. AMRI submitted responses to the observations consistent with the requirements and timeframe of the KFDA. Once AMRI’s responses have been accepted by the KFDA product approval will be provided.

 

Additionally during 2012, the Rensselaer facility was audited by the DEA to assess conformance with the controlled drug legislation for which the facility holds Schedule I, II, III, IV and V licenses. The audit was successful and no non conformances were noted.

 

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 warning letter, subsequent remediation efforts and suspension of production have had a material adverse effect on our business operations and cash flow.

 

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We have worked 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 and resumed operations following our voluntary shut down.  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 provided a response to the FDA’s Form 483 report on July 20, 2011. On September 13, 2011, the Company received a letter from the FDA regarding the Company’s response stating that corrective actions proposed by the Company, once fully implemented, should adequately address the observations made by the FDA investigators. The letter also indicated that the Company’s corrective actions will be verified by the FDA at the next facility inspection.  The Company believes that the corrective actions have now been fully implemented.  The Company will continue the manufacturing operations currently ongoing at the Burlington site, including GMP operations.  There is no timeline for re-inspection of the Burlington facility and 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.

 

During 2012 the U.S. Government passed new legislation termed the Generic Drug User Fee Amendments (“GDUFA”) which was effective beginning October 2012. AMRI has taken required actions, specifically, the self-identification of impacted facilities and the budgeting of required fees.

 

Our manufacturing and research and development processes involve the controlled use of hazardous or potentially hazardous materials and substances. We are subject to federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of such materials, including radioactive compounds and certain waste products. Additionally, we are subject to various laws and regulations relating to safe working conditions, laboratory and manufacturing practices and emissions and wastewater discharges. Although we believe that our activities currently comply with the standards prescribed by such laws and regulations, the risk of accidental contamination or injury from these materials cannot be eliminated. In the event of such an accident, we could be held liable for any damages that result and any such liability could exceed our resources. In addition, we cannot predict the extent of regulations that might result from any future legislative or administrative actions, therefore we could be required to incur significant costs to comply with environmental laws and regulations and these actions could restrict our operations in the future.

 

Concentration of Business and Geographic Information

 

For a description of revenue and long lived assets by geographic region, please see Note 15 to the Consolidated Financial Statements.

 

Internet Website

 

We maintain an internet website at www.amriglobal.com. The information contained on our website is not included as a part of, or incorporated by reference into, this Annual Report on Form 10-K. We make available on our website, free of charge, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the SEC. Our reports filed with, or furnished to, the SEC are also available at the SEC’s website at www.sec.gov.

 

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ITEM 1A. RISK FACTORS

 

The following factors should be considered carefully in addition to the other information in this Form 10-K. Except as mentioned under “Item 7A - Quantitative and Qualitative Disclosure About Market Risk” and except for the historical information contained herein, the discussion contained in this Form 10-K contains “forward-looking statements,” within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act, that involve risks and uncertainties. Our actual results could differ materially from those discussed in this Form 10-K. Important factors that could cause or contribute to such differences include those discussed below, as well as those discussed elsewhere herein.

 

Failure to manage the business to profitability without Allegra royalties will have a significant impact on operations and stock value.

 

The recurring royalties we receive on the sales of Allegra/Telfast have historically provided a material portion of our revenue, earnings and operating cash flows. We continue to develop our business and manage our operating costs in order to be in a position to maintain a business that can operate profitably as these royalties decrease significantly in 2014 then further in 2015. Recurring royalties have a significantly higher gross and operating margin than do our other business activities, resulting in the need to replace a significant amount of margin in order to achieve such profitability. The Company has taken certain cost cutting steps in order to right size the business operations to support the profitability that is achievable from our core contract research and manufacturing businesses. In the future, we may need to take additional cost cutting measures if our revenues do not increase or are not profitable enough to support our operations. In addition, if we are not able to increase operating revenue and decrease operating costs in order to replace the Allegra royalty income, there will be a material and adverse impact on our business, including negative impacts on our operating cash flow, access to capital and ability to implement required capital improvements to our facilities.

 

Our Burlington, MA facility is subject to an FDA warning letter which has resulted in a significant disruption in our business operations at this facility 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 worked 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 provided a response to the FDA’s Form 483 report on July 20, 2011. On September 13, 2011, the Company received a letter from the FDA regarding the Company’s response stating that corrective actions proposed by the Company, once fully implemented, should adequately address the observations made by the FDA investigators. The letter also indicated that the Company’s corrective actions will be verified by the FDA at the next facility inspection.   The Company believes the corrective actions have now been fully implemented. The Company will continue the manufacturing operations currently ongoing at the Burlington site, including GMP operations.  There is no timeline for re-inspection of the Burlington facility and 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.

 

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We may experience disruptions in or the inability to source raw materials to support our production processes or to deliver goods to our customers.

 

We rely on independent suppliers for key raw materials, consisting primarily of various chemicals. We generally use raw materials available from more than one source and do not enter into long-term contracts for such materials. We could experience inventory shortages if we were required to use an alternative manufacturer on short notice, which could lead to raw materials being purchased on less favorable terms than we have with our regular supplier. Additionally, we rely on various third-party delivery services to transport both goods from our vendors and finished products to our customers. A disruption in our ability to source or transport materials could delay or halt production and delivery of certain of our products thereby adversely impacting our ability to market and sell such products and our ability to compete.

 

Our sales forecast and/or revenue projections may not be accurate.

 

We use a backlog system, a common industry practice, to forecast sales and trends in our business. Our sales personnel monitor the status of proposals, including the date when they estimate a customer will make a purchase decision and the potential size of the order. We aggregate these estimates on a quarterly basis in order to generate a sales backlog. While this process provides us with some guidance in business planning and forecasting, it is based on estimates only and is therefore subject to risks and uncertainties. We believe our aggregate backlog as of any date is not necessarily a meaningful indicator of our future results for a variety of reasons. First, contracts vary in duration, and as such the timing and amount of revenues recognized from backlog can vary from period to period. Second, the Company’s manufacturing and services contracts are of a nature that a customer may, at its option, cancel or delay the timing of delivery, which would change our projections concerning the timing and extent to which revenue may be recognized. In addition, the value of the Company’s services contracts that are conducted on a time and materials or full-time equivalent basis are based on estimates, from which actual revenue generated could vary. Finally, there is no assurance that projects included in backlog will not be terminated or delayed at any time by customers or regulatory authorities. We cannot provide any assurance that we will be able to realize all or most of the net revenues included in backlog or estimate the portion to be filled in the current year. Any variation in the conversion of the backlog into revenue or the backlog itself could cause us to improperly plan or budget and thereby adversely affect our business, results of operations and financial condition.

 

We derive a significant percentage of our revenue from a small group of customers. We may lose one or more of our major customers.

 

During the year ended December 31, 2012, revenues from our largest customer represented approximately 15% of our contract revenue, or 13% of our total revenue. During the year ended December 31, 2011, revenues from our largest customer represented approximately 16% of our contract revenue, or 13% of our total revenue. Our existing agreement with this customer extends through 2016. In addition, during the year ended December 31, 2012 sales to another customer represented approximately 12% of our contract revenue, or 10% of our total revenue. In addition, during the year ended December 31, 2012, we provided services to two other major customers, who combined, represent approximately 11% of our contract revenues or 9% of our total revenue. In total, our four largest customers in 2012 represented approximately 38% of our contract revenue and 32% of our total revenue. These customers, along with most of our other customers, typically may cancel their contracts with 30 days’ to two-year’s prior notice, depending on the size of the contract, for a variety of reasons, some of which are beyond our control. If any one of our major customers cancels its contract with us, our contract revenues may materially decrease.

 

If we fail to meet our current credit facility’s financial covenants, our business and financial condition could be adversely affected.  

 

We currently have 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 December 31, 2012, the Company had $8.5 million of outstanding letters of credit secured by this line of credit.

 

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 December 31, 2012, the Company was in compliance with its current financial covenants.

 

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If we fail to comply with these obligations, and default under our credit facility, our business could be adversely affected by, among other things, limited flexibility in planning for, or reacting to, changes in our business and the industry in which we operate, thereby placing us at a competitive disadvantage compared to our competitors that may have more favorable credit facilities.

 

There is no assurance that we will continue to be in compliance with all of the covenants. 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.

 

If we fail to meet strict regulatory requirements, we could be required to pay fines or even close our facilities.

 

All facilities and manufacturing techniques used to manufacture drugs in the United States must conform to standards that are established by the FDA. The FDA conducts unscheduled periodic inspections of our facilities to monitor our compliance with regulatory standards. If the FDA finds that we fail to comply with the appropriate regulatory standards, it may impose fines on us or, if the FDA determines that our non-compliance is severe, it may close our facilities. Any adverse action by the FDA or other applicable regulatory bodies could have a material adverse effect on our operations.

 

Pharmaceutical and biotechnology companies may discontinue or decrease their usage of our services.

 

We depend on pharmaceutical and biotechnology companies that use our services for a large portion of our revenues. Although there has been a trend among pharmaceutical and biotechnology companies to outsource drug research and development functions, this trend may not continue. We have experienced increasing pressure on the part of our customers to reduce expenses, including the use of our services, as a result of negative economic trends generally and more specifically in the pharmaceutical industry.

 

We may be adversely affected in future periods as a result of general economic and/or pharmaceutical industry downturns which may result in a diminished availability of liquidity in the marketplace. If pharmaceutical and biotechnology companies discontinue or decrease their usage of our services, including as a result of a slowdown in the overall global economy, our revenues and earnings could be lower than we currently expect and our revenues may decrease or not grow at historical rates.

 

We face increased competition.

 

We compete directly with the in-house research departments of pharmaceutical companies and biotechnology companies, as well as contract research companies, and research and academic institutions. We also experience significant competition from foreign companies operating under lower cost structures, primarily those in China and other Asian countries. While we operate in certain lower relative cost jurisdictions, such as India and Singapore, we do not have operations in China. Many of our competitors have greater financial and other resources than we have. As new companies enter the market and as more advanced technologies become available, we currently expect to face increased competition. In the future, any one of our competitors may develop technological advances that render the services that we provide obsolete. While we plan to develop technologies, which will give us competitive advantages, our competitors plan to do the same. We may not be able to develop the technologies we need to successfully compete in the future, and our competitors may be able to develop such technologies before we do or provide those services at a lower cost. Consequently, we may not be able to successfully compete in the future.

 

We may be required to record additional long-lived asset impairment charges.

 

We review long-lived assets for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable based on the existence of certain triggering events.

 

Factors we consider important which could result in long-lived asset impairment include the following:

 

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

 

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

 

·a significant decrease in the market value of assets.

 

20
 

 

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. Additionally, during the fourth quarter of 2012, we recorded long-lived asset impairment charges of $4.4 million in the DDS segment primarily as a result of the Company’s decision to further optimize its location footprint and close its Bothell, Washington facility.  

 

In the fourth quarter of 2011, we recorded long-lived asset impairment charges of $4.7 million in our DDS segment associated with the Company’s decision to terminate its lease and exit one of its U.S. facilities as part of the overall initiative to reduce the Company's workforce, right size capacity, and reduce operating costs.

 

In 2010, we recorded long-lived asset impairment charges of $4.8 million in our DDS segment. As a result of realigning some of the AMRI U.S. operating activities, the Company evaluated the future economic benefit expected to be generated from the revised operating activities in one of its U.S. facilities against the carrying value of the facility’s property and equipment and determined that these assets were impaired. We also recorded a long-lived asset impairment charge of $6.0 million in our LSM segment upon determining that the carrying value of certain assets at our AMRI India location used in the manufacturing of generic products was not recoverable based on projections of future revenues and cash flows expected to be derived from the use of these assets.

 

If long-lived assets are determined to be impaired in the future, we would be required to record a charge to our results of operations.

 

Agreements we have with our employees, customers, consultants and other third parties may not afford adequate protection for our valuable intellectual property, confidential information and other proprietary information.

 

Some of our most valuable assets include patents. In addition to patent protection, we also rely on trade secrets, know-how, continuing technological innovation and licensing opportunities. In an effort to maintain the confidentiality and ownership of our customer’s information, such as trade secrets, proprietary information and other customer confidential information, as well as our own, we require our employees, consultants and advisors to execute confidentiality and proprietary information agreements. However, these agreements may not provide us with adequate protection against improper use or disclosure of confidential information and there may not be adequate remedies in the event of unauthorized use or disclosure. Furthermore, we may from time to time hire scientific personnel formerly employed by other companies involved in one or more areas similar to the activities we conduct. In some situations, our confidentiality and proprietary information agreements may conflict with, or be subject to, the rights of third parties with whom our employees, consultants or advisors have prior employment or consulting relationships. Although we require our employees and consultants to maintain the confidentiality of all proprietary information of their previous employers, these individuals, or we, may be subject to allegations of trade secret misappropriation or other similar claims as a result of their prior affiliations. Finally, others may independently develop substantially equivalent proprietary information and techniques causing some technologies that we develop to be patented by other companies. Our failure to protect our proprietary information and techniques may inhibit our ability to compete effectively and our investment in those technologies may not yield the benefits we expected. In addition, we may be subject to claims that we are infringing on the intellectual property of others. We could incur significant costs defending such claims and if we are unsuccessful in defending these claims, we may be subject to liability for infringement. To the extent that we are unable to protect confidential customer information, we may encounter material harm to our reputation and to our business.

 

We may not be able to effectively manage our international operations.

 

There are significant risks associated with the establishment of foreign operations, including, but not limited to: geopolitical risks, foreign currency exchange rates and the impact of shifts in the U.S. and local economies on those rates, compliance with local laws and regulations, the protection of our intellectual property and that of our customers, the ability to integrate our corporate culture with local customs and cultures, and the ability to effectively and efficiently supply our international facilities with the required equipment and materials. If we are unable to effectively manage these risks, these locations may not produce the revenues, earnings, or strategic benefits that we anticipate, or we may be subject to fines or other regulatory actions if we do not comply with local laws and regulations, which could have a material adverse effect on our business.

 

Delays in, or failure of, the approval of our customers’ regulatory submissions could impact our revenue and earnings.

 

The successful transition of clinical and preclinical candidates into long term commercial supply agreements is a key component of the LSM business strategy. If our customers do not receive approval of their FDA regulatory submissions, this could have a significant negative impact on our revenue and earnings. In addition, the manufacture of controlled substances requires timely approval by the DEA of sufficient controlled substance quota. If we do not receive sufficient DEA quota to meet our customers’ demands, and/or if our customers do not receive sufficient quota to take delivery of and/or formulate the product at their facilities, this could have a significant negative impact on our revenue and earnings.

 

21
 

 

We may not be able to recruit and retain the highly skilled employees we need.

 

Our future growth and profitability depends upon the research and efforts of our highly skilled employees, such as our scientists, and their ability to keep pace with changes in drug discovery and development technologies. We compete vigorously with pharmaceutical firms, biotechnology firms, contract research firms, and academic and research institutions to recruit scientists. If we cannot recruit and retain scientists and other highly skilled employees, we will not be able to continue our existing services and will not be able to expand the services we offer to our customers.

 

We may lose one or more of our key employees.

 

Our business is highly dependent on our senior management and scientific staff, including:

 

·Dr. Thomas E. D’Ambra, our Chairman, Chief Executive Officer and President;

 

·Michael M. Nolan, our Vice President, Chief Financial Officer and Treasurer;

 

·Dr. Steven R. Hagen, our Senior Vice President, Pharmaceutical Development and Manufacturing;

 

·Lori M. Henderson, our Vice President, General Counsel and Secretary;

 

·Brian D. Russell, our Vice President, Human Resources; and

 

·Dr. Bruce J. Sargent, our Senior Vice President, Drug Discovery.

 

The loss of any of our key employees, including our scientists, may have a material adverse effect on our business.

 

We may be held liable for harm caused by drugs that we develop and test.

 

We develop, test and manufacture drugs that are used by humans. If any of the drugs that we develop, test or manufacture harm people, we may be required to pay damages. Although we carry liability insurance, we may be required to pay damages in excess of the amounts of our insurance coverage. Damages awarded in a product liability action could be substantial and could have a material adverse effect on our financial condition.

 

We may be liable for contamination or other harm caused by hazardous materials that we use.

 

Our manufacturing and research and development processes involve the use of hazardous or potentially hazardous materials and substances. We are subject to Federal, state and local laws and regulation governing the use, manufacture, handling, storage and disposal of such materials, including but not limited to radioactive compounds and certain waste products. Additionally, we are subject to various laws and regulations relating to safe working conditions, laboratory and manufacturing practices and emissions and wastewater discharges. Although we believe that our activities currently comply with the standards prescribed by such laws and regulations, we cannot completely eliminate the risk of contamination or injury resulting from these materials. We may incur liability as a result of any contamination or injury. In addition, we cannot predict the extent of regulations that might result from any future legislative or administrative actions, therefore we could be required to incur significant costs to comply with environmental laws and regulations and these actions could restrict our operations in the future. Such expenses, liabilities or restrictions could have a material adverse effect on our operations and financial condition.

 

We completed an environmental remediation assessment associated with groundwater contamination at our Rensselaer, New York location. This contamination is associated with past practices at the facility prior to 1990, and prior to our investment or ownership of the facility. Ongoing costs associated with the remediation include biannual monitoring and reporting to the State of New York’s Department of Environmental Conservation. Under the remediation plan, we are expected to pay for monitoring and reporting until 2014. Under a 1999 agreement with the facility’s previous owner, our maximum liability under the remediation is $5.5 million. If the State of New York Department of Environmental Conservation finds that we fail to comply with the appropriate regulatory standards, it may impose fines on us which could have a material adverse effect on our operations.

 

22
 

 

Our operations may be interrupted by the occurrence of a natural disaster or other catastrophic event at our facilities.

 

We depend on our laboratories and equipment for the continued operation of our business. Our research and development, manufacturing and all administrative functions are primarily conducted at our facilities in Albany and Rensselaer, New York. Although we have contingency plans in effect for natural disasters or other catastrophic events, these events could still disrupt our operations. Even though we carry business interruption insurance policies, we may suffer losses as a result of business interruptions that exceed the coverage available under our insurance policies. Any natural disaster or catastrophic event at any of our facilities could have a significant negative impact on our operations.

 

Terrorist attacks or acts of war may seriously harm our business.

 

Terrorist attacks or acts of war may cause damage or disruption to our company, our employees, our facilities and our customers, which could significantly impact our revenues, costs and expenses and financial condition. The potential for terrorist attacks, the national and international responses to terrorist attacks, and other acts of war or hostility have created many economic and political uncertainties, which could materially adversely affect our business, results of operations, and financial condition in ways that we currently cannot predict.

 

Domestic governmental policy changes, including health care reform and budgetary policies could reduce the reimbursement rates pharmaceutical and biotechnology companies receive for drugs they sell, which incorporate some of our products, which in turn, could reduce the demand for or amounts that they have available to retain our services.

 

We depend on contracts with pharmaceutical and biotechnology companies for a majority of our revenues. We therefore depend upon the ability of pharmaceutical and biotechnology companies to earn enough profit on the drugs they market to devote substantial resources to the research and development of new drugs. Additionally, we rely on our collaborative partners to obtain acceptable prices or an adequate level of reimbursement for our current and potential future products. Continued efforts of government and third-party payors to contain or reduce the cost of health care through various means, could affect our levels of revenues and earnings. In certain foreign markets, pricing and/or profitability of pharmaceutical products are subject to governmental control. Domestically, there have been and may continue to be proposals to implement similar governmental control. Future legislation may limit the prices pharmaceutical and biotechnology companies can charge for the drugs they market and cost control initiatives could affect the amounts that third-party payors agree to reimburse for those drugs. There is no assurance that our collaborative partners will be able to obtain acceptable prices for our products which would allow us to sell these products on a competitive and profitable basis. As a result, such laws and initiatives may have the effect of reducing the resources that pharmaceutical and biotechnology companies can devote to the research and development of new drugs. If pharmaceutical and biotechnology companies decrease the resources they devote to the research and development of new drugs, the amount of services that we perform, and therefore our revenues, could be reduced.

 

The ability of our stockholders to control our policies and effect a change of control of our company is limited, which may not be in every shareholder’s best interests.

 

There are provisions in our certificate of incorporation and bylaws which may discourage a third party from making a proposal to acquire us, even if some of our stockholders might consider the proposal to be in their best interests. These provisions include the following:

 

·Our certificate of incorporation provides for three classes of directors with the term of office of one class expiring each year, commonly referred to as a “staggered board.” By preventing stockholders from voting on the election of more than one class of directors at any annual meeting of stockholders, this provision may have the effect of keeping the current members of our board of directors in control for a longer period of time than stockholders may desire.

 

·Our certificate of incorporation authorizes our board of directors to issue shares of preferred stock without stockholder approval and to establish the preferences and rights of any preferred stock issued, which would allow the board to issue one or more classes or series of preferred stock that could discourage or delay a tender offer or change in control.

 

Additionally, we are subject to Section 203 of the Delaware General Corporation Law, which, in general, imposes restrictions upon acquirers of 15% or more of our stock.

 

23
 

 

We have renewed a Shareholder Rights Plan, the purpose of which is, among other things, to enhance the Board’s ability to protect shareholder interests and to ensure that shareholders receive fair treatment in the event any coercive takeover attempt of us is made in the future. Under the terms of the Shareholder Rights Plan, the Board can in effect prevent a person or group from acquiring more than 15% of the outstanding shares of our Common Stock. Once a shareholder acquires more than 15% of our outstanding Common Stock without Board approval (the “acquiring person”), all other shareholders will have the right to purchase securities from us at a price less than their then fair market value. These subsequent purchases by other shareholders substantially reduce the value and influence of the shares of Common Stock owned by the acquiring person.

 

Our officers and directors have significant control over us and their interests as shareholders may differ from our other shareholders.

 

At February 28, 2013, our directors and officers beneficially owned or controlled approximately 10.1% of our outstanding common stock. Individually and in the aggregate, these stockholders significantly influence our management, affairs and all matters requiring stockholder approval. In particular, this concentration of ownership may have the effect of delaying, deferring or preventing an acquisition of us and may adversely affect the market price of our common stock.

 

Our stock price is volatile and could experience substantial change.

 

The market price of our common stock has historically experienced and may continue to experience volatility. Our quarterly operating results, changes in general conditions in the economy or the financial markets and other developments affecting us or our competitors could cause the market price of our common stock to fluctuate substantially.

 

Because we do not intend to pay dividends, our shareholders will benefit from an investment in our common stock only if it appreciates in value.

 

We have never declared or paid any cash dividends on our common stock. We currently intend to retain our future earnings, if any, to finance the expansion of our business and do not expect to pay any cash dividends in the foreseeable future. As a result, the success of our shareholders’ investment in our common stock will depend entirely upon any future appreciation. There is no guarantee that our common stock will appreciate in value or even maintain the price at which shareholders purchased their shares.

 

We may experience significant increases in operational costs beyond our control.

 

Costs for certain items which are needed to run our business, such as energy and certain materials, have the potential to fluctuate. As these cost increases are often dependent on market conditions, and although we do our best to manage these price increases, we may experience increases in our costs due to the volatility of prices and market conditions. Increases in these costs could negatively impact our results of operations to the extent that we are unable to incorporate these increases into the pricing of our goods and services.

 

Our business may be adversely affected if we encounter complications in connection with our information technology systems and infrastructure.

 

We rely to a large extent upon sophisticated information technology systems and infrastructure, with respect to enterprise resource planning, manufacturing, and the storage of business, financial, intellectual property, and other information essential to the effective operation and management of our business. While we have invested significantly in the operation and protection of data and information technology, there can be no assurance that our efforts will prevent service interruptions, or identify breaches in our systems. Prolonged interruptions or significant breaches could result in a material adverse effect on our operations.

 

We are subject to foreign currency risks.

 

Our global business operations give rise to market risk exposure related to changes in foreign exchange rates, interest rates, commodity prices and other market factors. If we fail to effectively manage such risks, it could have a negative impact on our consolidated financial statements. For a further discussion of our foreign currency risks, please see “Item 7A. Quantitative and Qualitative Disclosures About Market Risk”.

 

24
 

 

A reduction or delay in government funding of research and development may adversely affect our business.

 

A portion of our overall revenue is derived either from governmental sources directly, such as the U.S. National Institutes of Health (“NIH”) , or indirectly, from customers whose funding is partially dependent on both the level and timing of funding from government sources. A reduction in government funding for the NIH or other government research agencies could adversely affect our business and our financial results and there is no guarantee that NIH funding will be directed towards projects and studies that require use of our services.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS.

 

None.

 

ITEM 2. PROPERTIES.

 

The aggregate square footage of our operating facilities is approximately 1,099,000 square feet, of which 718,000 square feet are owned and 381,000 square feet are leased. Set forth below is information on our principal facilities:

 

Location   Square Feet   Primary Purpose
Rensselaer, New York   270,000   Contract Manufacturing 
Albany, New York   250,000   Contract Manufacturing, Contract Research and Administration
Aurangabad, India   208,000   Contract Manufacturing
Holywell, United Kingdom   68,000   Contract Manufacturing & Contract Research 
East Greenbush, New York   64,000   Contract Research 
Hyderabad, India   59,000   Contract Research
Burlington, Massachusetts   57,000   Contract Manufacturing
Singapore   51,000   Contract Research 
Bothell, Washington   44,000   Contract Research
Syracuse, New York   28,000   Contract Research 

 

Our Rensselaer, NY, Aurangabad, India, Holywell, United Kingdom and Burlington, MA facilities are used in our Large-Scale Manufacturing (“LSM”) segment as reported in the consolidated financial statements. All other facilities are used in our Discovery, Drug Development and Small Scale Manufacturing (“DDS”) segment, as reported in the consolidated financial statements.

 

We believe these facilities are generally in good condition and suitable for their purpose. We believe that the capacity associated with these facilities is adequate to meet our anticipated needs through 2013.

 

ITEM 3. 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 products. 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 and certain approved sub-licensees on U.S. Patent No. 5,578,610 until its expiration in November 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. The Company is also entitled to receive certain royalties from Sanofi and certain approved sub-licensees in certain foreign countries and with respect to certain foreign patents through mid-2015, unless certain patents are earlier determined to be invalid. As of early in the first quarter of 2013, the Company had settled all of the pending United States and foreign litigations surrounding the marketing of generic versions of Allegra and Allegra-D products, with the exception of certain proceedings pending in the United States related to two affiliated defendants’ production and sale of generic versions of Allegra and Allegra-D products. All of the other pending legal proceedings have been settled to the mutual satisfaction of the parties and the related litigations have been dismissed by the mutual consent of the parties.

 

ITEM 4. Mine Safety Disclosures

 

None.

 

25
 

 

PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES.

 

(a)     Market Information. The Common Stock of the Company is traded on the NASDAQ Global Market (“NASDAQ”) under the symbol “AMRI.” The following table sets forth the high and low closing prices for our Common Stock as reported by NASDAQ for the periods indicated:

 

Period  High   Low 
Year ending December 31, 2012          
First Quarter   $3.22   $2.58 
Second Quarter   $3.44   $2.25 
Third Quarter   $3.85   $2.57 
Fourth Quarter   $5.59   $3.36 
           
Year ending December 31, 2011          
First Quarter   $6.37   $4.02 
Second Quarter   $5.55   $3.87 
Third Quarter   $5.16   $2.80 
Fourth Quarter   $3.65   $2.08 

 

Stock Performance Graph

 

The following graph provides a comparison, from December 31, 2007 through December 31, 2012, of the cumulative total stockholder return (assuming reinvestment of any dividends) among the Company, the NASDAQ Stock Market (U.S. Companies) Index (the “NASDAQ Index”) and the NASDAQ Pharmaceuticals Index (the “Pharmaceuticals Index”). The historical information set forth below is not necessarily indicative of future performance. Data for the NASDAQ Index and the Pharmaceuticals Index were provided by NASDAQ.

 

             
   Albany Molecular
Research, Inc
   NASDAQ Stock
Market
(U.S. Companies)
Index
   NASDAQ
Pharmaceuticals
Index
 
December 31, 2007   100.000    100.000    100.000 
December 31, 2008   67.733    61.172    93.041 
December 31, 2009   63.143    87.928    104.545 
December 31, 2010   39.082    104.131    113.328 
December 31, 2011   20.376    104.686    121.306 
December 31, 2012   36.718    123.849    161.397 

 

26
 

 

(b)     Holders.

 

The number of record holders of our Common Stock as of February 28, 2013 was approximately 202. We believe that the number of beneficial owners of our Common Stock at that date was substantially greater than 202.

 

(c)     Dividends.

 

We have not declared any cash dividends on our Common Stock since our inception in 1991. We currently intend to retain our earnings for future growth and, therefore, do not anticipate paying cash dividends in the foreseeable future.

 

(d)     Equity Compensation Plan Information.

 

The following table provides information about the securities authorized for issuance under our equity compensation plans as of December 31, 2012:

 

Plan Category  (a)
Number of securities to be
issued upon exercise of
outstanding options,
warrants
and rights
   (b)
Weighted-average
exercise price of
outstanding options,
warrants and rights
   (c)
Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column (a))
 
Equity compensation plans approved by security holders(1)   2,388,766   $5.90    1,343,002(2)
Equity compensation plans not approved by security holders            
Total   2,388,766   $5.90    1,343,002 

 

(1)Consists of the Company’s 1998 Stock Option Plan, the Company’s 2008 Stock Option Plan and the Company’s Employee Stock Purchase Plan (“ESPP”). Does not include purchase rights accruing under the ESPP because the purchase price (and therefore the number of shares to be purchased) will not be determined until the end of the purchase period.

 

(2)Includes 1,106,443 shares available under the 2008 Stock Option Plan and 236,559 shares available under the ESPP.

 

27
 

 

ITEM 6. SELECTED FINANCIAL DATA.

 

The selected financial data shown below for the fiscal years ended December 31, 2012, 2011 and 2010, and as of December 31, 2012 and 2011, have been derived from our audited consolidated financial statements included in this Form 10-K. The selected financial data set forth below for the fiscal years ended December 31, 2009 and 2008 and as of December 31, 2010, 2009 and 2008 have been derived from our audited consolidated financial statements for those years, which are not included in this Form 10-K. The information should be read in conjunction with the Company’s audited Consolidated Financial Statements and related notes and other financial information included herein, including Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

 

   As of and for the Year Ending December 31, 
   2012   2011   2010   2009   2008 
   (in thousands, except per share data) 
Consolidated Statement of Operations Data:                         
Contract revenue  $189,858   $169,611   $163,228   $156,800   $195,455 
Recurring royalties   35,988    35,034    34,838    34,867    28,305 
Milestone revenue   840    3,000        4,750    5,500 
Total revenue   226,686    207,645    198,066    196,417    229,260 
Cost of contract revenue   168,064    168,470    152,673    138,739    146,075 
Technology incentive award   3,143    3,557    3,484    3,594    2,901 
Research and development   906    7,939    11,090    14,547    13,129 
Selling, general and administrative   40,904    41,071    42,234    38,036    39,229 
Goodwill impairment       15,812    36,844    22,900     
Property and equipment impairment   8,334    4,674    10,848         
Intangible asset impairment       856             
Restructuring charges   4,632    1,271    3,090    329    1,833 
Arbitration charge       127    9,798         
Total costs and expenses   225,983    243,777    270,061    218,145    203,167 
Income (loss) from operations   703    (36,132)   (71,995)   (21,728)   26,093 
Interest (expense) income, net   (454)   (583)   160    269    1,082 
Other (expense) income, net   (130)   77    (1,007)   (593)   715 
Income (loss) before income tax (benefit) expense   119    (36,638)   (72,842)   (22,052)   27,890 
Income tax (benefit) expense   3,896    (4,342)   (9,971)   (5,357)   7,330 
Net (loss) income  $(3,777)  $(32,296)  $(62,871)  $(16,695)  $20,560 
Basic (loss) earnings per share  $(0.12)  $(1.08)  $(2.05)  $(0.54)  $0.66 
Diluted (loss) earnings per share  $(0.12)  $(1.08)  $(2.05)  $(0.54)  $0.65 
Weighted average common shares outstanding, basic   30,318    29,961    30,657    31,062    31,389 
Weighted average common shares outstanding, diluted   30,318    29,961    30,657    31,062    31,612 
Consolidated Balance Sheet Data:                         
Cash, cash equivalents and investment securities - unrestricted  $23,293   $20,198   $41,481   $111,058   $87,470 
Property and equipment, net   135,519    149,729    163,212    166,746    167,502 
Working capital   77,438    62,584    79,409    149,730    140,693 
Total assets   262,862    263,067    325,106    373,692    390,684 
Long-term debt, excluding current installments   7,227    3,003    11,737    13,212    13,482 
Total stockholders’ equity   206,141    206,432    243,743    314,613    326,680 
Other Consolidated Data:                         
Capital expenditures  $9,890   $10,837   $11,628   $15,172   $23,938 

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

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.

 

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. In November 2012, we approved a restructuring plan to cease all operations at our Bothell, WA facility. The goal of these restructuring activities 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.

 

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Our total revenue for 2012 was $226.7 million, including $189.9 million from our contract service business and $36.0 million from royalties on sales of Allegra/Telfast and certain products sold by Actavis, Inc (“Actavis”). We generated $15.3 million in cash from operations, and we used $9.9 million for capital expenditures on our facilities and equipment, primarily related to maintaining and upgrading our U.S. facilities. We recorded a net loss of $3.8 million in 2012, largely the result of $8.3 million of long-lived asset impairment charges and $4.6 million of restructuring charges. As of December 31, 2012, we had $28.5 million in cash, cash equivalents and restricted cash and $8.0 million in bank and other related debt.

 

Results of Operations

 

Operating Segment Data

 

We have organized our sales, marketing and production activities into the Discovery, Drug Development and Small Scale Manufacturing (“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.’’ We rely on an internal management accounting system to report results of these segments. The accounting system includes revenue and cost information by segment. We make financial decisions and allocate resources based on the information we receive from this internal system. The DDS segment includes activities such as drug lead discovery, optimization, drug development and small scale commercial manufacturing. The LSM segment includes pilot to commercial scale manufacturing of active pharmaceutical ingredients and intermediates, sterile syringe and vial filling, and high potency and controlled substance manufacturing.

 

Contract Revenue

 

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

 

   Year Ended December 31, 
   2012   2011   2010 
   (in thousands) 
DDS  $73,458   $74,032   $83,308 
LSM   116,400    95,579    79,920 
Total  $189,858   $169,611   $163,228 

 

DDS contract revenues for the year ended December 31, 2012 remained consistent with amounts recognized in the same period in 2011 including lower contract revenue for our biology discovery services and development and small-scale manufacturing services, offset in part by an increase in our U.S. chemistry discovery services.

 

We currently expect DDS contract revenue for full year 2013 to increase from amounts recognized in 2012 primarily due to an increase in demand for our U.S. chemistry services, offset in part by a decrease in our biology services.

 

DDS contract revenues decreased for the year ended December 31, 2011 from the same period in 2010 primarily due to lower contract revenue from our discovery services of $10.7 million, offset in part by an increase in our development and small-scale manufacturing services of $1.5 million. The decrease in discovery services contract revenue was primarily due to lower demand for our U.S. medicinal chemistry services, partially offset by higher demand for our discovery services at our Asia locations. The increases in contract revenue from development and small-scale manufacturing services were attributable to higher demand for our chemistry development services.

 

LSM contract revenue significantly increased for the year ended December 31, 2012 from the same period in 2011 as a result of higher commercial manufacturing services at our Rensselaer, NY facility, as well as continued improvement at our UK facility.

 

We currently expect continued growth in LSM contract revenue for full year 2013 due to strong demand for our commercial manufacturing services.

 

LSM contract revenue increased for the year ended December 31, 2011 from the same period in 2010 as a result of higher commercial and API development manufacturing shipments from our Rensselaer, NY facility, as well as increased intermediate manufacturing in our Aurangabad, India facility as compared to the same period in 2010.

 

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Recurring royalty revenue

 

Year Ended December 31, 
2012   2011   2010 
(in thousands) 
$35,988   $35,034   $34,838 

 

The largest 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 with Actavis at the Company’s Rensselaer, NY manufacturing facility.

 

Recurring royalties increased during the year ended December 31, 2012 from the same period in 2011 due to the receipt of Actavis royalties of $4.7 million. This increase was offset in part by a $3.7 million decrease in royalties recognized from the sales of prescription Allegra which was primarily due to decreased sales in Japan in the first quarter of 2012 as a result of a less severe allergy season.

 

We currently expect full year 2013 recurring royalties to slightly increase over amounts recognized in 2012 primarily due to incremental royalties from Actavis, partially offset by lower Allegra royalties.

 

Recurring royalties slightly increased for the year ended December 31, 2011 as compared to the same period in 2010 primarily due to a significant increase in sales of prescription Allegra in Japan, partially offset by a decrease in royalties recognized from the sale of Allegra products 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 milestones included in licensing and research agreements with certain of our partners. Milestone revenues were as follows:

 

Year Ended December 31, 
2012   2011   2010 
    (in thousands)     
$840   $3,000   $ 

 

Milestone revenue received during the year ended December 31, 2012 was recognized primarily in conjunction with the Company’s license and research agreement with BMS for advancing a fourth compound into preclinical development.

 

Milestone revenue of $3.0 million received during the year ended December 31, 2011 was recognized in conjunction with the Company’s license and research agreement with BMS and was specifically based on meeting a Phase II clinical trial milestone of an AMRI compound licensed exclusively to BMS.

 

No milestone revenue was recorded during the year ended December 31, 2010.

 

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Cost of Contract Revenue

 

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

 

   Year Ended December 31, 
   2012   2011   2010 
   (in thousands) 
DDS  $70,366   $72,758   $72,903 
LSM   97,698    95,712    79,770 
Total  $168,064   $168,470   $152,673 
DDS Gross Contract Margin   4.2%   1.7%   12.5%
LSM Gross Contract Margin   16.0%   (0.1)%   0.2%
Total Gross Contract Margin   11.5%   0.7%   6.5%

 

DDS contract revenue gross margin percentages increased for the year ended December 31, 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.

 

We currently expect DDS contract margins for 2013 to improve over amounts recognized in 2012 due to cost savings initiatives in our global discovery services platform along with improved facility utilization.

 

LSM’s contract revenue gross margin percentages improved for the year ended December 31, 2012 compared to the same period in 2011. This increase is 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 continued improvement in LSM contract margins for 2013 driven by an increase in capacity utilization in relation to our fixed costs.

 

DDS contract revenue gross margin percentages decreased for the year ended December 31, 2011 compared to the same period in 2010. This resulted from lower demand for our discovery services in relation to our fixed costs.

 

LSM’s contract revenue gross margin slightly decreased for the year ended December 31, 2011 compared to the same period in 2010. This decrease was primarily due to levels of fixed cost base at our Burlington, MA facility as compared to its revenues due to the disruption at the facility resulting from the FDA warning letter received in August 2010, along with unutilized capacity at our AMRI UK facility. These decreases were partially offset by an increase in margins for our U.S. API manufacturing services.

 

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:

 

Year Ended December 31, 
2012   2011   2010 
(in thousands) 
$3,143   $3,557   $3,484 

 

We expect technology incentive award expense to generally fluctuate directionally and proportionately with fluctuations in Allegra royalties in future periods. Technology incentive award expense decreased for the year ended December 31, 2012 as compared to the same period in 2011 due to the decrease in Allegra recurring royalty revenue as discussed above.

 

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Technology incentive award expense for the year ended December 31, 2011 remained consistent as compared to 2010 which reflected the relative consistency in Allegra royalty revenue.

 

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 made a decision to cease activities related to its internal discovery research and development programs, excluding generic programs. Although we ceased our proprietary new compound R&D activities, we continue to believe there are additional opportunities to partner these programs in return for appropriate consideration if our technology results in compounds that 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:

 

Year Ended December 31, 
2012   2011   2010 
(in thousands) 
$906   $7,939   $11,090 

 

R&D expense for the year ended December 31, 2012 decreased to $0.9 million 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 during 2012 related primarily to developing new niche generic products and improving process efficiencies in our manufacturing plants.

 

Based on our strategic decision to cease R&D operations, we currently expect 2013 R&D expense to be consistent with amounts recognized in 2012.

 

Research and development expenses for the year ended December 31, 2011 decreased 28% from the year ended December 31, 2010. This decrease was primarily due to an overall decrease in internal operating costs as we strategically managed our R&D investments and continued to narrow the focus of R&D spending on those programs with the highest licensing potential, as well as a decrease in clinical trial costs related to our oncology and obesity programs.

 

Selling, General and Administrative

 

Selling, general and administrative (“SG&A”) expenses consist of compensation and related fringe benefits for sales, marketing, operational and administrative employees, professional service fees, marketing costs and costs related to facilities and information services. SG&A expenses were as follows:

 

Year Ended December 31, 
2012   2011   2010 
(in thousands) 
$40,904   $41,071   $42,234 

 

Selling, general and administrative expenses for the year ended December 31, 2012 remained relatively flat as compared to the same period in 2011. Decreases in SG&A resulting from ongoing actions related to cost savings were offset by non-recurring executive transition costs.

 

We currently expect SG&A expenses for 2013 to decrease from amounts recognized in 2012 due to on-going cost saving actions partially offset by inflation.

 

Selling, general and administrative expenses for the year ended December 31, 2011 decreased from the same period in 2010. This decrease was primarily attributable to nonrecurring acquisition costs and reductions in AMRI Burlington remediation costs compared to the levels incurred in 2010.

 

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Goodwill Impairment

 

Year Ended December 31, 
2012   2011   2010 
(in thousands) 
$   $15,812   $36,844 

 

During the fourth quarter of 2011, we recorded a goodwill impairment charge of $15.8 million in our DDS operating segment due to a change in the implied fair value of the segment’s goodwill to below its carrying value. The change in the fair value of the segment was primarily attributable to significantly lower than forecasted demand for contract services in 2011, which resulted in a decrease in management’s long-term estimates of operating results and cash flows for the segment.

 

During the fourth quarter of 2010, we recorded a goodwill impairment charge of $36.8 million in our LSM operating segment due to a change in the implied fair value of the segment’s goodwill to below its carrying value. The change in the fair value of the segment was primarily attributable to the fact that in the fourth quarter of 2010 several events occurred in the LSM segment that significantly impacted our expected future performance for this segment. Our AMRI UK facility was notified of an unplanned significant reduction in demand for a key commercial product, which had historically represented a significant amount of annual revenues at the site. In addition, the FDA warning letter issued to our AMRI Burlington facility was expected to have both continued negative short-term financial impact during the remediation process, as well as delaying the planned integration of the AMRI Burlington business into our overall LSM platform and the forecasted resulting growth in the long term.

 

Property and Equipment Impairment

 

Year Ended December 31, 
2012   2011   2010 
(in thousands) 
$8,334   $4,674   $10,848 

 

During 2012, we recorded long-lived asset impairment charges of $8.3 million in our DDS segment in order to further optimize the Company’s location footprint and cease operations at our Budapest, Hungary and Bothell, Washington facilities.

 

In the fourth quarter of 2011, we recorded long-lived asset impairment charges of $4.7 million in our DDS segment associated with the Company’s decision to terminate its lease and exit one of its U.S. facilities as part of the overall initiative to reduce the Company's workforce, right size capacity, and reduce operating costs.

 

In 2010, we recorded long-lived asset impairment charges of $4.8 million in our DDS segment. As a result of realigning some of the AMRI U.S. operating activities, the Company evaluated the future economic benefit expected to be generated from the revised operating activities in this facility against the carrying value of the facility’s property and equipment and determined that these assets were impaired. Additionally, we recorded a long-lived asset impairment charge of $6.0 million in our LSM segment upon determining that the carrying value of certain assets at our AMRI India location used in the manufacturing of generic products was not recoverable based on projections of future revenues and cash flows expected to be derived from the use of these assets.

 

Intangible Impairment

 

Year Ended December 31, 
2012   2011   2010 
(in thousands) 
$   $856   $ 

 

In the fourth quarter of 2011, we identified patent assets relating to technologies that we no longer expect to derive value from as a result of the Company’s decision to cease internal R&D activities. We recorded an intangible impairment charge of $0.9 million in our DDS segment in conjunction with this review of our patent portfolio.

 

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Restructuring Charges

 

Year Ended December 31, 
2012   2011   2010 
(in thousands) 
$4,632   $1,271   $3,090 

 

During 2012, we approved restructuring plans to cease all operations at our Budapest, Hungary, and Bothell, WA facilities. The goal of these restructuring activities is to advance our continued strategy of increasing global competitiveness and to remain diligent in managing costs by improving efficiency and customer service and by realigning resources to meet shifting customer demand and market preferences. Additionally, we intend to expand and better integrate our in vitro biology services with the total drug discovery service platform and to further optimize the Company’s location footprint. In connection with these actions, we recorded restructuring charges of $4.6 million in 2012.

 

We exited the Budapest, Hungary 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 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 have terminated 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 $0.3 million in 2012.

 

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 included 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.

 

Anticipated cash outflow related to the restructuring activities for 2013 is approximately $2.1 million.

 

Arbitration charge

 

Year Ended December 31, 
2012   2011   2010 
(in thousands) 
$   $127   $9,798 

 

On August 19, 2009, AMRI Rensselaer notified one of its suppliers that it was cancelling a purchase agreement between the parties pursuant to a hardship clause of the agreement.  Our supplier commenced arbitration in September 2009 with International Centre for Dispute Resolution ("ICDR") seeking damages for AMRI Rensselaer’s alleged wrongful repudiation of the agreement.

 

On October 13, 2010 the ICDR issued an arbitration award in favor of our supplier against AMRI Rensselaer and awarded damages of $8.7 million plus interest at the rate of 9% starting from August 19, 2009.   AMRI accrued $9.8 million for the award and related interest expense in the year ended December 31, 2010.

 

On March 2, 2011, AMRI Rensselaer and our supplier entered into a Settlement and Supply Agreement (“Agreement”) which served to settle the arbitral award and other legal proceedings related to the arbitral award that were pending. The Agreement required AMRI Rensselaer to pay $4.8 million to our supplier and provide a 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 AMRI and our supplier through 2018 with mutually beneficial terms.

 

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As the letter of credit is reduced, the Company reverses the allocated portion of the accrued charge through a reduction in the carrying cost of the associated inventory. The maximum amount to be reversed is $5.5 million through 2014. As of December 31, 2012, the remaining arbitration reserve is $2.7 million.

 

Arbitration charges of $0.1 million in 2011 represented accrued interest expense related to the award prior to the arbitration settlement.

 

Interest (expense) income, net

 

   Year Ended December 31, 
(in thousands)  2012   2011   2010 
Interest expense  $(463)  $(714)  $(292)
Interest income   9    131    452 
Interest (expense) income, net  $(454)  $(583)  $160 

 

Interest expense decreased for the year ended December 31, 2012 as compared with the same period in the prior year primarily due to lower borrowing costs under the Company’s April 2012 credit agreement. Interest expense increased for the year ended December 31, 2011 as compared with the same period in 2010 primarily due to borrowing costs associated with the renegotiation of the Company’s credit agreement entered into in 2011.

 

Interest income decreased for the year ended December 31, 2012 as compared with the same period in 2011 due to a decrease in the amount of interest bearing assets. Interest income decreased for the year ended December 31, 2011 as compared with the same period in 2010 primarily due to the decrease in the average balances of interest bearing cash and investments held during the year.

 

Other (expense) income, net

 

Year Ended December 31, 
2012   2011   2010 
(in thousands) 
$(130)  $77   $(1,007)

 

Other expense increased for the year ended December 31, 2012 from income for the same period in 2011 primarily due to rates associated with foreign currency transactions, as well as costs associated with transitioning our financing to a new creditor during 2012. These amounts were partially offset by income from the settlement of contingencies associated with our 2010 AMRI UK and AMRI Burlington acquisitions, along with income from insurance claims related to the remediation of the FDA warning letter at our Burlington facility.

 

Other income for the year ended December 31, 2011 included income of $0.3 million related to settlement of contingencies associated with the 2010 AMRI UK and AMRI Burlington acquisitions and income related to the fluctuation in exchange rates associated with foreign currency translations. These amounts were offset in part by deferred financing amortization expense.

 

Income tax expense (benefit)

 

Year Ended December 31, 
2012   2011   2010 
(in thousands) 
$3,896   $(4,342)  $(9,971)

 

Income tax expense for the year ended December 31, 2012 was $3.9 million as compared to income tax benefit of $4.3 million for the same period in 2011 due primarily to improved pre-tax income at the Company’s U.S. locations and the composition of pre-tax income or losses in relation to the applicable tax rates at our various locations worldwide.

 

Income tax benefit for the year ended December 31, 2011 was $4.3 million as compared to income tax benefit of $10.0 million for the same period in 2010. This decrease in income tax benefit is due to a decrease in pre-tax loss, as well as the composition of pre-tax 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 2012, we generated cash of $15.3 million from operating activities.

 

During 2012, cash used in investing activities was $9.8 million, primarily for the acquisition and installation of equipment. Additionally, we used $2.5 million for 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, defined as current assets less current liabilities, was $77.4 million as of December 31, 2012, compared to $62.6 million as of December 31, 2011. This is primarily due to an increase in both accounts receivable and inventories as a result of the growth in our business in 2012.

 

Total capital expenditures for the year ended December 31, 2012 were $9.9 million as compared to $10.8 million for the year ended December 31, 2011. Capital expenditures in 2012 were primarily related to growth, maintenance and upgrading our existing facilities.

 

For 2013, we expect to incur $12.0 to $14.0 million in capital expenditures primarily relating to the growth and maintenance of our existing facilities.

 

In April 2012, the Company 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. The Company used a portion of the initial proceeds from borrowings against the term loan to repay all amounts due under its prior credit agreement. As of December 31, 2012, the Company had no amounts outstanding under the line of credit and $8.5 million of outstanding letters of credit secured by this line of credit. The amount available to be borrowed under the revolving line of credit at December 31, 2012 was $6.5 million.

 

Upon entering into the credit agreement in April 2012, the Company is required to maintain a $5.0 million restricted cash balance to partially collateralize the revolving line of credit. In conjunction with an amendment to the credit agreement dated December 20, 2012, the restricted cash requirement will be directly reduced by the amount of principal payments made on the term loan beginning in May 2013.

 

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 December 31, 2012, the interest rate on the outstanding term loan was 3.625%.

 

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 and year-to-date capital expenditures, minimum monthly domestic unrestricted cash and maximum average monthly cash reserves held at international locations. As of December 31, 2012, the Company was in compliance with its current financial covenants.

 

Working capital, defined as current assets less current liabilities, was $62.6 million as of December 31, 2011, compared to $79.4 million as of December 31, 2010. This decrease includes a payment of $4.8 million associated with the Company’s settlement of the 2010 arbitration matter with a supplier and $10.8 million used for capital expenditures.

 

Total capital expenditures for the year ended December 31, 2011 were $10.8 million as compared to $11.6 million for the year ended December 31, 2010. Capital expenditures in 2011 were primarily related to maintenance and expansion of our existing facilities.

 

During 2011, we used cash of $1.5 million for operating activities and cash provided by investing activities was $4.0 million, resulting primarily from net proceeds from the sale or maturities of marketable securities of $15.2 million offset in part by the use of $10.8 million for the acquisition of property and equipment. During 2011, we used $7.0 million for financing activities, relating primarily to payments made on our credit facilities.

 

We expect that additional future capital expansion and acquisition activities, 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.

 

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Off Balance Sheet Arrangements

 

We do not use special purpose entities or other off-balance sheet financing techniques that we believe have or are reasonably likely to have a current or future material effect on our financial condition, revenues or expenses, results of operations, liquidity or capital resources.

 

Contractual Obligations

 

The following table sets forth our long-term contractual obligations and commitments as of December 31, 2012:

 

Payments Due by Period (in thousands)

 

 

   Total   Under 1 Year   1-3 Years   4-5 Years   After 5  Years 
Long-Term Debt (principal)   $8,003   $776   $2,053   $3,745   $1,429 
Operating Leases    18,291    4,837    7,424    1,495    3,435 
Purchase Commitments    3,099    3,099             
Restructuring liabilities   2,261    2,126    135         
Pension Plan Contributions (1)    1,712    414    649    649      

 

(1)Pension and other postretirement benefits include estimated payments made from Company assets. No estimate of payments after five years has been provided due to many uncertainties.

 

Critical Accounting Estimates

 

Accounting estimates and assumptions discussed in this section are those that we consider to be the most critical to an understanding of our financial statements because they inherently involve significant judgments and uncertainties. All of these estimates reflect our best judgment and are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Under different assumptions or conditions, it is reasonably possible that the judgments and estimates described below could change, which may result in future impairments of inventories, and long-lived assets, as well as increased pension liabilities, the establishment of valuation allowances on deferred tax assets and increased tax liabilities, among other effects. Also see Note 1, Summary of Significant Accounting Policies, in Part II, Item 8. “Financial Statements and Supplementary Data” of this report, which discusses the significant accounting policies that we have selected from acceptable alternatives.

 

Inventory

 

Inventory consists primarily of commercially available fine chemicals used as raw materials, work-in-process and finished goods in our large-scale manufacturing plants. Large-scale manufacturing inventories are valued on a first-in, first-out (“FIFO”) basis. Inventories are valued at the lower of cost or market. We regularly review inventories on hand and record a charge for slow-moving and obsolete inventory, inventory not meeting quality standards and inventory subject to expiration. The charge for slow-moving and obsolete inventory is based on current estimates of future product demand, market conditions and related management judgment. Any significant unanticipated changes in future product demand or market conditions that vary from current expectations could have an impact on the value of inventories. Total inventories recorded on our consolidated balance sheet at December 31, 2012 and 2011 were $28.2 million and $26.0 million, respectively. We recorded charges to reduce obsolete inventory balances of $0, $0.9 million and $1.4 million for the years ended December 31, 2012, 2011 and 2010, respectively.

 

Income Taxes

 

Our annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Tax laws are complex and subject to different interpretations by the taxpayer and respective governmental taxing authorities. Significant judgment is required in determining our tax expense and in evaluating our tax positions, including evaluating uncertainties and the need for valuation allowances. We review our tax positions quarterly and adjust the balances as new information becomes available. Our income tax rate is significantly affected by the tax rates on our international operations, each of which are subject to local country tax laws and regulations.

 

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Deferred income tax assets represent amounts available to reduce income taxes payable on taxable income in future years. Such assets arise because of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as from net operating loss and tax credit carry-forwards. We evaluate the recoverability of these future tax deductions and credits by assessing the adequacy of future expected taxable income from all sources, including reversal of taxable temporary differences, forecasted operating earnings with focus on our U.S. operations and available tax planning strategies. These sources of income inherently rely heavily on estimates. To the extent we do not consider it more likely than not that a deferred tax asset will be recovered, a valuation allowance is established. We use our historical experience and our short and long-range business forecasts to provide insight. Amounts recorded for deferred tax assets, net of valuation allowances, were $18.0 million and $22.1 million at December 31, 2012 and 2011, respectively. Such 2012 year-end amounts are expected to be fully recoverable within the applicable statutory expiration periods.

 

Long-Lived Assets

 

We review long-lived assets for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable. Factors we consider 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 group is being used;
·A significant change in the business climate that could affect the value of a long-lived asset group; and
·A significant decrease in the market value of assets.

 

Determining whether an impairment has occurred typically requires various estimates and assumptions, including determining which undiscounted cash flows are directly related to the potentially impaired asset group, the useful life over which cash flows will occur, their amount, and the asset group’s residual value, if any. In turn, measurement of an impairment loss requires a determination of fair value, which is based on the best information available. We derive the required undiscounted cash flow estimates from our historical experience, internal business plans and our understanding of current marketplace valuation estimates. To determine fair value, we use our internal cash flow estimates discounted at an appropriate interest rate, quoted market prices when available and independent appraisals, as appropriate.

 

During 2012, we recorded long-lived asset impairment charges of $8.3 million in our DDS segment in order to further optimize the Company’s location footprint and cease operations at our Budapest, Hungary and Bothell, Washington facilities.

 

Pension and Postretirement Benefit Plans

 

We utilize actuarial models to measure pension and postretirement benefit obligations and related effects on operations. Three assumptions – discount rate, expected return on assets, and trends in healthcare costs– are important elements of plan expense and asset/liability measurement. We evaluate these critical assumptions at least annually. We periodically evaluate other assumptions involving demographic factors, such as retirement age, mortality and turnover, and update them to reflect our experience and expectations for the future. Actual results in any given year will often differ from actuarial assumptions because of economic and other factors.

 

Accumulated and projected benefit obligations are expressed as the present value of future cash payments. We discount those cash payments using the weighted average of market-observed yields for high quality fixed income securities with maturities that correspond to the payment of benefits. Lower discount rates increase present values; higher discount rates decrease present values.

 

Our discount rates for our pension plan at December 31, 2012, 2011 and 2010 were 3.50%, 4.00% and 5.10%, respectively, reflecting market interest rates.

 

To determine the expected long-term rate of return on pension plan assets, we consider current and expected asset allocations, as well as historical and expected returns on various categories of plan assets. In developing future return expectations for our pension plan’s assets, we evaluate general market trends as well as key elements of asset class returns such as expected earnings growth, yields and spreads across a number of potential scenarios. In 2012 and 2011, assets in our pension plan earned 11.3% and 4.9%, respectively. Based on our analysis of future expectations of asset performance, past return results, and our current and expected asset allocations, we have assumed an 8.0% long-term expected return on those assets.

 

39
 

 

Healthcare cost trend rates have a significant effect on the amounts reported for our postretirement welfare plan. Due to the fact that no retirees are currently covered by the Postretirement Welfare Plan, survey data is reviewed for industry averages. Based on this review, a trend of a 7.25% annual cost increase grading to an ultimate rate of 5% is within industry norms.

 

Recent Accounting Pronouncements

 

In February 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-02, “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income”. This ASU adds new disclosure requirement for items reclassified out of accumulated other comprehensive income (“AOCI”). The ASU is effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2012 and must be applied prospectively. The Company is evaluating the impact of the standard on its consolidated financial statements and related disclosures.

 

In July 2012, the FASB issued ASU No. 2012-02, “Intangibles – Goodwill and Other (Topic 350): Testing Indefinite-Lived Assets for Impairment”. This ASU allows an entity to first assess qualitative factors to determine whether it is necessary to perform the quantitative impairment test for indefinite-lived intangible assets. An organization that elects to perform a qualitative assessment is required to perform the quantitative impairment test for an indefinite-lived intangible asset if it is more likely than not that the asset is impaired. This ASU is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. The Company does not expect a material impact on its financial statements and related disclosures as a result of adoption of this ASU.

 

In December 2011, the FASB issued ASU No. 2011-11, “Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities”. ASU 2011-11 requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. ASU No. 2011-11 is effective for interim and annual periods beginning on or after January 1, 2013 and will be applied retrospectively. The Company does not expect the adoption of ASU 2011-11 to have a material impact on its consolidated financial statements.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We have market risk with respect to foreign currency exchange rates and interest rates. The market risk is the potential loss arising from adverse changes in these rates as discussed below.

 

The Company has facilities and customers in foreign jurisdictions and therefore is subject to foreign currency risk. This risk is composed of both potential losses from the translation of foreign currency financial statements and the remeasurement of foreign currency transactions. The total net assets of non-U.S. operations denominated in non-functional currencies subject to potential loss amount to approximately $32.0 million. The potential loss in fair value resulting from a hypothetical 10% adverse change in quoted foreign currency exchange rates amounts to approximately $3.2 million. Furthermore, related to foreign currency transactions, the Company has exposure to non-functional currency balances totaling approximately $11.1 million. This amount includes, on an absolute basis, exposures to foreign currency assets and liabilities. On a net basis, the Company had approximately $10.9 million of foreign currency assets as of December 31, 2012. As currency rates change, these non-functional currency balances are revalued, and the corresponding adjustment is recorded in the consolidated statement of operations. A hypothetical change of 10% in currency rates could result in an adjustment to the consolidated statement of operations of approximately $1.1 million.

 

With respect to interest rates, the risk is composed of changes in future cash flows due to changes in interest rates on our $5.0 million term loan and $3.0 million industrial development authority bonds. The potential loss in 2013 cash flows from a 10% adverse change in quoted interest rates would approximate nineteen thousand dollars.

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

 

Financial statements and notes thereto appear on pages F-1 to F-38 of this Annual Report on Form 10-K.

 

40
 

 

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

 

None.

 

ITEM 9A. CONTROLS AND PROCEDURES

 

(a) Evaluation of 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 period covered by this Annual Report on Form 10-K, the Company’s management conducted an evaluation under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer regarding the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based upon that evaluation the Company’s management has concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2012.

 

(b) Management’s Annual Report on Internal Control over Financial Reporting

 

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles, and includes those policies and procedures that:

 

·pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;

 

·provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles and, that receipts and expenditures of the Company are being made only in accordance with authorization of management and directors of the Company; and

 

·provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

The Company’s management, including the Chief Executive Officer and Chief Financial Officer, assessed as of December 31, 2012 the effectiveness of the Company’s internal control over financial reporting. In making this assessment, management used the criteria set forth in the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on the results of this evaluation, management has concluded that the Company’s internal control over financial reporting as of December 31, 2012 was effective.

 

The Company’s independent registered public accounting firm has issued a report on the effectiveness of the Company’s internal control over financial reporting, as of December 31, 2012, which is included in Item 8 of this Annual Report on Form 10-K and incorporated herein by reference.

 

(c) 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 required by Rule 13a-15(d) or Rule 15d-15 under the Exchange Act that occurred during the Company’s fiscal quarter ended December 31, 2012 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

ITEM 9B. OTHER INFORMATION

 

None.

 

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PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

 

The information appearing under the captions “Directors and Executive Officers,” “Section 16(a) Beneficial Ownership Reporting Compliance” and “Code of Ethics and Business Conduct Guidelines” in the Company’s definitive proxy statement relating to the Annual Meeting of Stockholders to be held on or around June 5, 2013 is incorporated herein by reference.

 

ITEM 11. EXECUTIVE COMPENSATION.

 

The information appearing under the captions “Compensation of Directors”, “Compensation Committee Interlocks and Insider Participation”, and “Agreements with Named Executive Officers,” and “Corporate Governance and Board Matters” in the Company’s definitive proxy statement relating to the Annual Meeting of Stockholders to be held on or around June 5, 2013 is incorporated herein by reference.

 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

 

The information appearing under the caption “Principal and Management Stockholders” in the Company’s definitive proxy statement relating to the Annual Meeting of Stockholders to be held on or around June 5, 2013 is incorporated herein by reference.

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.

 

The information appearing under the caption “Related Party Transactions” in the Company’s definitive proxy statement relating to the Annual Meeting of Stockholders to be held on or around June 5, 2013 is incorporated herein by reference.

 

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

The information appearing under the caption “Independent Registered Public Accounting Firm” in the Company’s definitive proxy statement relating to the Annual Meeting of Stockholders to be held on or around June 5, 2013 is incorporated herein by reference.

 

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PART IV

 

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

(a) (1) Financial Statements.

 

The consolidated financial statements required by this item are submitted in a separate section beginning on page F-1 of this report.

 

    Page
Number
Report of Independent Registered Public Accounting Firm   F-2

Consolidated Statements of Operations for the Years Ended December 31, 2012, 2011 and 2010 

  F-3
Consolidated Statements of Comprehensive Loss for the Years Ended December 31, 2012, 2011 and 2010   F-4
Consolidated Balance Sheets at December 31, 2012 and 2011   F-5
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2012, 2011 and 2010   F-6
Consolidated Statements of Cash Flows for the Years Ended December 31, 2012, 2011 and 2010   F-7
Notes to Consolidated Financial Statements   F-9

 

(a) (2)      Financial Statement Schedules

 

The following financial schedule of Albany Molecular Research, Inc. is included in this annual report on Form 10-K.

 

Schedule II—Valuation and Qualifying Accounts   F-38

 

Schedules other than that which is listed above have been omitted since they are either not required, are not applicable, or the required information is shown in the consolidated financial statements or related notes.

 

(a) (3)      Exhibits

 

EXHIBIT INDEX

 

Exhibit
No.
  Description
2.1   Agreement, dated February 17, 2010, by and among the Company and the shareholders of Excelsyn Limited, for the sale and purchase of Excelsyn Limited and its subsidiary, Excelsyn Molecular Development Limited (incorporated herein by reference to Exhibit 2.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2010, File No. 000-25323).
2.2   Agreement, dated June 14, 2010, by and among the Company and the shareholders of Hyaluron, Inc. (incorporated by reference to Exhibit 2.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, File No. 000-25323).
3.1   Restated Certificate of Incorporation of the Company (incorporated herein by reference to Exhibit 3.2 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1998, File No. 000-25323).
3.2   Amended and Restated By-Laws of the Company (incorporated herein by reference to Exhibit 3.1 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1998, File No. 000-25323).
4.1   Specimen certificate for shares of Common Stock, $0.01 par value, of the Company (incorporated herein by reference to Exhibit 4.1 to Amendment No. 3 to the Company’s Registration Statement on Form S-1, File No. 333-58795).
4.2   Amended and Restated Certificate of Designations, Preferences and Rights of a Series of Preferred Stock of Albany Molecular Research, Inc. classifying and designating the Series A Junior Participating Cumulative Preferred Stock (incorporated herein by reference to Exhibit 3.1 to the Company’s Registration Statement on Form 8-A filed with the Securities and Exchange Commission on July 31, 2012, File No. 001-35622).

 

43
 

 

Exhibit
No.
  Description
4.3   Shareholder Rights Agreement, dated as of July 27, 2012, between the Company and Computershare Shareowner Services LLC, as Rights Agent (incorporated herein by reference to Exhibit 4.1 to the Company’s Registration Statement on Form 8-A filed with the Securities and Exchange Commission on July 31, 2012, File No. 001-35622).
4.4   Amendment to Shareholder 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).
4.5   Amendment No. 2 to Shareholder Rights Agreement, dated as of July 27, 2012, between Albany Molecular Research, Inc. and Computershare Shareowner Services LLC, as Rights Agent (as successor to Mellon Investor Services LLC) (incorporated herein by reference to Exhibit 4.2 to the Company’s Registration Statement on Form 8-A/A filed on July 31, 2012.  File no. 000-25323).
10.1 * 1998 Stock Option and Incentive Plan of the Company (incorporated herein by reference to Exhibit 10.2 to Amendment No. 3 to the Company’s Registration Statement on Form S-1,  File No. 333-58795).
10.2 * Amended 1998 Employee Stock Purchase Plan of the Company, approved on June 1, 2011 (incorporated herein by reference to Exhibit 10.3 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011, File No. 000-25323).
10.3 * Amended 2008 Stock Option and Incentive Plan, approved on June 1, 2011 (incorporated herein by reference to Exhibit 10.4 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011, File No. 000-25323).
10.4 * Amended and Restated Employment Agreement, dated as of April 5, 2012, by and between the Company and Bruce J. Sargent, Ph.D. (incorporated herein by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on April 5, 2012, File No. 000-25323).
10.5   Form of Indemnification Agreement between the Company and each of its directors (incorporated herein by reference to Exhibit 10.5 to Amendment No. 2 to the Company’s Registration Statement on Form S-1, File No. 333-58795).
10.6   License Agreement dated March 15, 1995 by and between the Company and Marion Merrell Dow Inc. (now Sanofi) (excluding certain portions which have been omitted as indicated based upon an order for confidential treatment, but which have been filed separately with the Commission) (incorporated herein by reference to Exhibit 10.7 to Amendment No. 3 to the Company’s Registration Statement on Form S-1, File No. 333-58795).
10.7 * Amendment to 1998 Stock Option and Incentive Plan of the Company (incorporated herein by reference to Exhibit 10.7 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004, File No. 000-25323).
10.8 * Technology Development Incentive Plan (incorporated herein by reference to Exhibit 10.10 to Amendment No. 2 to the Company’s Registration Statement on Form S-1, File No. 333-58795).
10.9   Form of Employee Innovation, Proprietary Information and Post-Employment Activity Agreement between the Company and each of its executive officers (incorporated herein by reference to Exhibit 10.14 to Amendment No. 3 to the Company’s Registration Statement on Form S-1, File No. 333-58795).
10.10 * Amended and Restated Employment Agreement, dated as of April 5, 2012, by and between the Company and Lori M. Henderson (incorporated herein by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on April 5, 2012, File No. 000-25323).
10.11 * Form of Restricted Stock Award Agreement under 1998 Stock Option and Incentive Plan (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on March 17, 2005, File No. 000-25323).
10.12 * Albany Molecular Research, Inc. Incentive Bonus Plan (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on May 3, 2005, File No. 000-25323).
10.13 * Form of Incentive Stock Option Agreement under 1998 Stock Option and Incentive Plan (incorporated herein by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2005 filed with the Securities and Exchange Commission on May 10, 2005, File No. 000-25323).

 

44
 

 

Exhibit
No.
  Description
10.14 * Form of Non-Qualified Stock Option Agreement under 1998 Stock Option and Incentive Plan (incorporated herein by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2005 filed with the Securities and Exchange Commission on May 10, 2005, File No. 000-25323).
10.15   Supply Agreement, effective as of January 1, 2012, between AMRI Rensselaer, Inc. and GE Healthcare AS (filed herein with certain information omitted pursuant to a request for confidential treatment and filed separately with the Securities and Exchange Commission).
10.16   License and Research Agreement, dated as of October 20, 2005, between Albany Molecular Research, Inc., AMR Technology, Inc. and Bristol-Myers Squibb Company (incorporated herein by reference to Exhibit 10.19 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005, File No. 000-25323).
10.17 * Amended and Revised Technology Development Incentive Plan, dated October 13, 2003 (incorporated herein by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2006, File No. 0-25323).
10.18 * Amended and Restated Employment Agreement, dated as of April 5, 2012, by and between the Company and Thomas E. D’Ambra, Ph.D. (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on April 5, 2012, File No. 000-25323).
10.19 * Amended and Restated Employment Agreement, dated as of April 5, 2012, by and between the Company and Mark T. Frost (incorporated herein by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on April 5, 2012, File No. 000-25323).
10.20   Amendment to License Agreement Regarding Sublicensing , dated November 19, 2008, by and between Albany Molecular Research, Inc., AMR Technology, Inc. (formerly a subsidiary of AMRI, which has subsequently been merged into AMRI) and Sanofi U.S. LLC (filed with certain information omitted pursuant to a request for confidential treatment and filed separately with the Securities and Exchange Commission) (incorporated herein by reference to Exhibit 10.25 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008, File No. 000-25323).
10.21 * Amended and Restated Employment Agreement, dated as of April 5, 2012, by and between the Company and Steven R. Hagen, Ph.D. (incorporated herein by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on April 5, 2012, File No. 000-25323).
10.22   Research/Manufacturing Agreement between Schering Corporation and Albany Molecular Research, Inc. dated January 13, 2006 (filed with certain information omitted pursuant to a request for confidential treatment and filed separately with the Securities and Exchange Commission) (incorporated herein by reference to Exhibit 10.1 to the Company’s Amended Quarterly Report on Form 10-Q/A for the quarter ended September 30, 2010, filed with the Securities and Exchange Commission on February 17, 2011, File No. 000-25323).
10.23   Seventh Amendment dated July 14, 2010 to the Research/Manufacturing Agreement between Schering Corporation and Albany Molecular Research, Inc. dated January 13, 2006 (filed with certain information omitted pursuant to a request for confidential treatment and filed separately with the Securities and Exchange Commission) (incorporated herein by reference to Exhibit 10.2 to the Company’s Amended Quarterly Report on Form 10-Q/A for the quarter ended September 30, 2010, filed with the Securities and Exchange Commission on February 17, 2011, File No. 000-25323).
10.24   Credit and Security Agreement dated April 11, 2012, by and among Albany Molecular Research, Inc., AMRI Rensselaer, Inc., AMRI Burlington, Inc., AMRI Bothell Research Center, Inc. and Wells Fargo Bank, National Association. (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on April 12, 2012, File No. 000-25323)
10.25   First Amendment, dated December 20, 2012, to Credit and Security Agreement dated April 11, 2012, by and among Albany Molecular Research, Inc., AMRI Rennselaer, Inc., AMRI Burlington, Inc., and AMRI Bothell Research Center, Inc., as the borrower and Wells Fargo Bank, National Association as the lender (filed herein)

 

45
 

 

Exhibit
No.
  Description
10.26   Development and Supply Agreement between Organichem Corporation (now AMRI Rensselaer, Inc., a wholly-owned subsidiary of the Company) and Purepac Pharmaceuticals Co. (now Actavis, Inc.) effective May 10, 2000 (filed herein with certain information omitted pursuant to a request for confidential treatment and filed separately with the Securities and Exchange Commission).
10.27 * Separation Agreement, dated September 10, 2012, between Albany Molecular Research, Inc. and Mark T. Frost (incorporated herein by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2012, filed with the Securities and Exchange Commission on November 9, 2012, File No. 001-35622).
10.28 * Amended Employment Agreement, effective September 17, 2012, as amended on December 27, 2012, between Albany Molecular Research, Inc. and Michael M. Nolan (filed herein).
10.29 * Amended Form of Restricted Stock Award Agreement under the 2008 Stock Option and Incentive Plan (filed herein).
10.30 * Amended Form of Non-Qualified Stock Option Agreement under the 2008 Stock Option and Incentive Plan (filed herein).
21.1   Subsidiaries of the Company (filed herein).
23.1   Consent of KPMG LLP (filed herein).
31.1   Rule 13a-14(a)/15d-14(a) certification (filed herein).
31.2   Rule 13a-14(a)/15d-14(a) certification (filed herein).
32.1   Section 1350 certification (furnished herein). (1)
32.2   Section 1350 certification (furnished herein). (1)
101.INS   XBRL Instance Document (furnished herein). (2)
101.SCH   XBRL Taxonomy Extension Schema Document (furnished herein). (2)
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document (furnished herein). (2)
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document (furnished herein). (2)
101.LAB   XBRL Taxonomy Extension Label Linkbase Document (furnished herein). (2)
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document (furnished herein). (2)

 

 

*Denotes management contract of compensation plan or arrangement

 

(1)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 Exchange Act.

 

(2)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.

 

46
 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) 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.

 

Dated: March 18, 2013 Albany Molecular Research, Inc.
   
  By: /s/ Thomas E. D’Ambra
    Thomas E. D’Ambra, Ph.D.
    President and Chief Executive Officer

  

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

 Signature   Title   Date
         
/s/ Thomas E. D’Ambra   Chairman of the Board, President, Chief Executive   March 18, 2013
Thomas E. D’Ambra, Ph.D.   Officer and Director (Principal Executive Officer)    
         
/s/ Michael M. Nolan   Vice President, Chief Financial Officer and Treasurer   March 18, 2013
Michael M. Nolan   (Principal Financial and Accounting Officer)    
         
/s/ Veronica G.H. Jordan   Director   March 18, 2013
Veronica G.H. Jordan, Ph.D.        
         
/s/ Gabriel Leung   Director   March 18, 2013
Gabriel Leung        
         
/s/ William Marth   Director   March 18, 2013
William Marth        
         
/s/ Kevin O’Connor   Director   March 18, 2013
Kevin O’Connor        
         
/s/ Arthur J. Roth   Director   March 18, 2013
Arthur J. Roth        
         
/s/ Una S. Ryan   Director   March 18, 2013
Una S. Ryan, Ph.D., O.B.E.        

 

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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

ALBANY MOLECULAR RESEARCH, INC.

 

    Page
Report of Independent Registered Public Accounting Firm   F-2
     
Consolidated Statements of Operations for the Years Ended December 31, 2012, 2011 and 2010   F-3
     
Consolidated Statements of Comprehensive Loss for the Years Ended December 31, 2012, 2011 and 2010   F-4
     
Consolidated Balance Sheets at December 31, 2012 and 2011   F-5
     
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2012, 2011 and 2010   F-6
     
Consolidated Statements of Cash Flows for the Years Ended December 31, 2012, 2011 and 2010   F-7
     
Notes to Consolidated Financial Statements   F-9

 

F-1
 

 

Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Stockholders

Albany Molecular Research, Inc.:

 

We have audited the accompanying consolidated balance sheets of Albany Molecular Research, Inc. and subsidiaries (the Company) as of December 31, 2012 and 2011, and the related consolidated statements of operations, comprehensive loss, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2012. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule of valuation and qualifying accounts. We also have audited the Company’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these consolidated financial statements and financial statement schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting (Item 9A(b)). Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule, and an opinion on the Company’s internal control over financial reporting based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Albany Molecular Research, Inc. and subsidiaries as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles. In our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. Also in our opinion, Albany Molecular Research, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

/s/ KPMG LLP

Albany, New York

March 18, 2013

 

F-2
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

Years Ended December 31, 2012, 2011 and 2010

 

(In thousands, except per share amounts)

 

   Year Ended December 31, 
   2012   2011   2010 
Contract revenue  $189,858   $169,611   $163,228 
Recurring royalties   35,988    35,034    34,838 
Milestone revenue   840    3,000     
Total revenue   226,686    207,645    198,066 
Cost of contract revenue   168,064    168,470    152,673 
Technology incentive award   3,143    3,557    3,484 
Research and development   906    7,939    11,090 
Selling, general and administrative   40,904    41,071    42,234 
Goodwill impairment       15,812    36,844 
Property and equipment impairment   8,334    4,674    10,848 
Intangible asset impairment       856     
Restructuring charges   4,632    1,271    3,090 
Arbitration charge       127    9,798 
Total costs and expenses   225,983    243,777    270,061 
Income (loss) from operations   703    (36,132)   (71,995)
Interest expense   (463)   (714)   (292)
Interest income   9    131    452 
Other (expense) income, net   (130)   77    (1,007)
Income (loss) before income tax expense (benefit)   119    (36,638)   (72,842)
Income tax expense (benefit)   3,896    (4,342)   (9,971)
Net loss  $(3,777)  $(32,296)  $(62,871)
                
Basic loss per share  $(0.12)  $(1.08)  $(2.05)
Diluted loss per share  $(0.12)  $(1.08)  $(2.05)

 

See Accompanying Notes to Consolidated Financial Statements.

 

F-3
 

 

Albany Molecular Research, Inc.

 

Consolidated Statements of Comprehensive Loss

 

Years Ended December 31, 2012, 2011 and 2010

 

(In thousands)

 

   Years Ended December 31, 
   2012   2011   2010 
Net loss  $(3,777)  $(32,296)  $(62,871)
Unrealized loss on marketable securities, net of taxes   1    (21)   (49)
Foreign currency translation gain (loss)   1,239    (4,813)   252 
Net actuarial gain (loss) of pension and postretirement benefits   531    (2,292)   (501)
Total comprehensive loss  $(2,006)  $(39,422)  $(63,169)

 

See Accompanying Notes to Consolidated Financial Statements.

 

F-4
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

CONSOLIDATED BALANCE SHEETS

 

December 31, 2012 and 2011

 

(In thousands, except per share amounts)

 

   December 31, 
   2012   2011 
Assets          
Current assets:          
Cash and cash equivalents  $23,293   $19,984 
Restricted cash   702     
Marketable securities       214 
Accounts receivable, net   42,496    30,437 
Royalty income receivable   8,180    6,819 
Income taxes receivable       3,407 
Inventory   28,216    26,004 
Prepaid expenses and other current assets   7,337    9,916 
Deferred income taxes   3,200    3,779 
Total current assets   113,424    100,560 
Property and equipment, net   135,519    149,796 
Restricted cash   4,524     
Intangible assets and patents, net   3,065    2,976 
Equity investment in unconsolidated affiliates   956    956 
Deferred income taxes   3,520    7,373 
Other assets   1,854    1,406 
Total assets  $262,862   $263,067 
Liabilities and Stockholders’ Equity          
Current liabilities:          
Accounts payable and accrued expenses  $18,194   $20,424 
Deferred revenue and licensing fees   7,365    6,464 
Accrued compensation   5,372    2,751 
Arbitration reserve   2,717    4,082 
Income taxes payable   1,148     
Accrued pension benefits   414    1,416 
Current installments of long-term debt   776    2,839 
Total current liabilities   35,986    37,976 
Long-term liabilities:          
Long-term debt, excluding current installments   7,227    3,003 
Deferred licensing fees   2,857    4,286 
Pension and postretirement benefits   8,691    9,047 
Deferred income taxes   753    733 
Other long-term liabilities   1,207    1,588 
Total liabilities   56,721    56,633 
Commitments and contingencies (Notes 12 and 14)          
Stockholders’ equity:          
Preferred stock, $0.01 par value, authorized 2,000 shares, none issued or outstanding        
Common stock, $0.01 par value, authorized 50,000 shares, 36,326 shares issued in 2012 and 36,016 shares issued in 2011   363    360 
Additional paid-in capital   207,784    206,074 
Retained earnings   75,177    78,954 
Accumulated other comprehensive loss, net   (10,295)   (12,066)
    273,029    273,322 
Less, treasury shares at cost, 5,411 shares in 2012 and 2011   (66,888)   (66,888)
Total stockholders’ equity   206,141    206,434 
Total liabilities and stockholders’ equity  $262,862   $263,067 

 

See Accompanying Notes to Consolidated Financial Statements.

 

F-5
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

 

Years Ended December 31, 2012, 2011 and 2010

 

(In thousands)

 

                       Accumulated             
       Common Stock   Additional       Other   Treasury Stock     
   Preferred   Number of   Par   Paid-in   Retained   Comprehensive   Number of         
   Stock   Shares   Value   Capital   Earnings   Income (Loss)   Shares   Amount   Total 
Balances at December January 1, 2010   $—    35,467   $355   $201,667   $174,121   $(4,642)   (3,825)  $(56,888)  $314,613 
Net loss                       (62,871)                  (62,871)
Unrealized loss on investment securities, available-for-sale, net of taxes                            (49)             (49)
Pension and other postretirement benefits:                                             
Amortization of actuarial loss, net of taxes                            144              144 
Current year actuarial loss, net of taxes                            (645)             (645)
Foreign currency translation gain                            252              252 
Treasury stock purchases                                 (1,586)   (10,000)   (10,000)
Share-based payment expense                  565                        565 
Issuance of restricted stock        174    2    (2)                        
Amortization of unearned compensation - restricted stock                  1,141                        1,141 
Forfeiture of unearned compensation - restricted stock        (78)   (1)   1                         
Issuance of common stock in connection with stock option  plan and ESPP        104    1    592                        593 
Balances at December 31, 2010       35,667    357    203,964    111,250    (4,940)   (5,411)   (66,888)   243,743 
Net loss                       (32,296)                  (32,296)
Unrealized loss on investment securities, available-for-sale, net of taxes                            (21)             (21)
Pension and other postretirement benefits:                                             
Amortization of actuarial loss, net of taxes                            323              323 
Current year actuarial loss, net of taxes                            (2,615)             (2,615)
Foreign currency translation loss                            (4,813)             (4,813)
Tax expense from share-based compensation                  (202)                       (202)
Share-based payment expense                  782                        782 
Issuance of restricted stock        318    3    (4)                       (1)
Amortization of unearned compensation - restricted stock                  861                        861 
Forfeiture of unearned compensation - restricted stock        (124)   (1)   2                        1 
Issuance of common stock in connection with stock option  plan and ESPP        155    1    671                        672 
Balances at December 31, 2011       36,016    360    206,074    78,954    (12,066)   (5,411)   (66,888)   206,434 
Net loss                       (3,777)                  (3,777)
Unrealized loss on investment securities, available-for-sale, net of taxes                            1              (1)
Pension and other postretirement benefits:                                             
Amortization of actuarial loss, net of taxes                            498              498 
Current year actuarial gain, net of taxes                            33              33 
Foreign currency translation gain                            1,239              1,241 
Tax shortfall from share-based compensation                  (747)                       (747)
Share-based payment expense                  964                        964 
Issuance of restricted stock        140    1    (2)                       (1)
Amortization of unearned compensation - restricted stock                  932                        932 
Forfeiture of unearned compensation - restricted stock        (56)   -    34                        34 
Issuance of common stock in connection with stock option  plan and ESPP        226    2    529                        531 
Balances at December 31, 2012  $    36,326   $363   $207,784   $75,177   $(10,295)   (5,411)  $(66,888)  $206,141 

 

See Accompanying Notes to Consolidated Financial Statements.

 

F-6
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

Years Ended December 31, 2012, 2011 and 2010

 

(In thousands)

 

   Year ended December 31, 
   2012   2011   2010 
Operating Activities               
Net loss  $(3,777)  $(32,296)  $(62,871)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:               
Depreciation and amortization   17,332    17,970    17,102 
Net amortization of premiums on marketable securities   (2)   185    359 
Noncash charge for obsolete inventories       883    1,398 
Provision for doubtful accounts   148    200    363 
Forgiven principal on notes receivable   43    39    54 
Deferred income tax benefit   3,368    (976)   (1,918)
Goodwill impairment       15,812    36,844 
Property and equipment impairment   8,334    4,674    10,848 
Intangible asset impairment       856     
Loss on disposal of property and equipment   176    83    331 
Stock-based compensation expense   1,896    1,643    1,706 
Changes in operating assets and liabilities that provide (use) cash, net of business combinations:               
Accounts receivable   (12,207)   2,129    (7,661)
Royalty income receivable   (1,361)   597    (315)
Inventory   (2,212)   215    (1,339)
Prepaid expenses and other assets   1,467    3,794    (1,795)
Accounts payable, accrued compensation and accrued expenses   196    (6,233)   5,713 
Arbitration reserve   (1,365)   (5,716)   9,798 
Income taxes receivable/payable   4,555    4,258    (8,739)
Deferred revenue and licensing fees   (528)   (9,047)   (909)
Pension and postretirement benefits   (540)   (355)   (133)
Other long-term liabilities   (186)   (196)   (157)
Net cash provided by (used in) operating activities   15,337    (1,481)   (1,321)
Investing Activities               
Purchases of marketable securities       (817)   (7,825)
Proceeds from sales and maturities of marketable securities   213    16,044    21,756 
Purchase of businesses, net of cash acquired           (46,340)
Purchases of property and equipment   (9,890)   (10,837)   (11,628)
Payments for patent applications and other costs   (552)   (423)   (1,020)
Proceeds from disposal of property and equipment   447         
Net cash (used in) provided by investing activities   (9,782)   3,967    (45,057)
Financing Activities               
Purchases of treasury stock           (10,000)
Changes in restricted cash   (5,226)        
Borrowings on long-term debt   5,000         
Principal payments on long-term debt   (2,839)   (7,370)   (270)
Tax expense of stock option exercises       (270)    
Proceeds from exercise of options and Employee Stock Purchase Plan   531    671    592 
Net cash used in financing activities   (2,534)   (6,969)   (9,678)
Effect of exchange rate changes on cash flows   288    (1,280)   850 
Increase (decrease) in cash and cash equivalents   3,309    (5,763)   (55,206)
Cash and cash equivalents at beginning of year   19,984    25,747    80,953 
Cash and cash equivalents at end of year  $23,293   $19,984   $25,747 
                
Supplemental disclosure of non-cash investing and financing activities:               
Unrealized loss on securities available-for-sale, net of tax  $(1)  $(21)  $(49)
Actuarial loss (gain) on pension and other postretirement liability, net of tax  $531   $(2,292)  $(501)
Issuance of restricted stock  $436   $1,647   $1,440 
Non-cash forgiveness of arbitration reserve  $1,365   $1,025   $ 
Supplemental disclosures of cash flow information:               
Cash paid during the period for:               
Interest  $463   $714   $292 
Income taxes  $759   $910   $554 

 

See Accompanying Notes to Consolidated Financial Statements.

 

F-7
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

 

Years Ended December 31, 2012, 2011 and 2010

 

(In thousands)

 

In June 2010, the Company completed the purchase of all of the outstanding shares of Hyaluron, Inc., a formulation facility located in Burlington, Massachusetts. The aggregate purchase price was $29,098.

 

Fair value of assets acquired  $32,548 
Cash paid for net assets, net of cash acquired   (28,358)
Liabilities assumed  $4,190 

 

In February 2010, the Company completed the purchase of all of the outstanding shares of Excelsyn Ltd., a chemical development and manufacturing facility located in Holywell, United Kingdom. The aggregate purchase price was $17,982.

 

Fair value of assets acquired  $22,373 
Cash paid for net assets   (17,982)
Liabilities assumed  $4,391 

 

See Accompanying Notes to Consolidated Financial Statements.

 

F-8
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

December 31, 2012 and 2011

 

(In thousands, except per share amounts)

 

1.Summary of Significant Accounting Policies

 

Nature of Business:

 

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 consolidated financial statements include the accounts of Albany Molecular Research, Inc. (“AMRI”) and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated during consolidation. When necessary, prior years’ consolidated financial statements have been reclassified to conform to the current year presentation. 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. Gains or losses resulting from translating non-U.S. currency financial statements are recorded in the consolidated statements of comprehensive loss and in accumulated other comprehensive loss in the accompanying 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, intangible assets, and long-lived assets, and the amount and realizabilty 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 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 two 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.

 

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.

 

F-9
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

December 31, 2012 and 2011

 

(In thousands, except per share amounts)

 

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 have been delivered to the customer and amounts due have been collected.

 

Recurring Royalty and Milestone Revenues

 

The Company has discovered and conducted the early development of several new drug candidates, with a view to out- licensing these candidates to partners for further development in return for a potential combination of up-front license fees, milestone payments and recurring royalty payments if compounds resulting from our intellectual property are successfully developed into new drugs and reach the market.

 

On October 20, 2005, the Company entered into a License and Research Agreement with Bristol-Myers Squibb (“BMS”) for a program of compounds that encompass biogenic amine reuptake inhibitors in development for the treatment of depression and other central nervous system disorders. As amended, the agreement is referred to herein as the “BMS Agreement”.

 

On December 20, 2010, the Company entered into a Research Collaboration and License Agreement with Genentech, Inc. (“Genentech”) (the “Genentech Agreement”, and collectively with the BMS Agreement, the “Agreements”) for a family of antibacterial compounds discovered from the Company’s proprietary research of its natural products sample collection.

 

Under the terms of the Agreements, the Company received upfront licensing fees and research funding to further develop the licensed compounds. In addition, the Company is eligible to receive development and regulatory milestones for each licensed compound, as well as royalties on sales of commercialized compounds if any.

 

Under the terms of the Agreements, the Company may receive milestone payments for each compound advanced by BMS and Genentech upon achievement of certain clinical and regulatory milestones as follows:

 

·Up to $14,000 in clinical development milestones; and

 

·Up to $30,000 in regulatory milestones, due upon acceptance and/or approval of new drug application filings with regulatory agencies in various jurisdictions.

 

F-10
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

December 31, 2012 and 2011

 

(In thousands, except per share amounts)

 

The Company has determined the milestones contained in these Agreements to be substantive milestones in accordance with ASC 605-28-25. In evaluating the milestones included in the Agreements, the Company considered the following:

 

·the Company considered each individual milestone to be commensurate with the enhanced value of the underlying licensed intellectual property as it is advanced from the development stage to a commercialized product, and considered them to be reasonable when evaluated in relation to the total agreement consideration, including other milestones.

 

·the milestones are deemed to relate solely to past performance, as each milestone is payable to the Company only after the achievement of the related event defined in the agreement, and is not refundable if additional future success events do not occur.

 

For the years ended December 31, 2012 and 2011, the Company recognized clinical development milestones of $800 and $3,000, respectively, under the BMS Agreement, and no additional amounts for each such period under the Genentech Agreement.

 

Recurring Royalties Revenue. Recurring royalties include 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 and sales by certain authorized sub-licensees. 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’ net sales of generic D-12 in that quarter. The Company receives additional royalties in conjunction with a Development and Supply Agreement with Actavis, Inc (“Actavis”). These royalties, which the Company began receiving in the third quarter of 2012, are earned on net sales of a generic product sold by its 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.

 

Up-Front License Fees and Milestone 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.

 

Cash, Cash Equivalents and Restricted Cash:

 

Cash equivalents consist of money market accounts and overnight deposits. For purposes of the consolidated statements of cash flows, the Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.

 

Upon entering into a new 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. In conjunction with an amendment to the credit agreement dated December 20, 2012, the restricted cash requirement will be directly reduced by the amount of principal payments made on the term loan beginning in May 2013.

 

Allowance for Doubtful Accounts:

 

The Company records an allowance for doubtful accounts for estimated receivable losses. Management reviews outstanding receivable balances on a regular basis in order to assess the collectibility of these balances, and adjusts the allowance for doubtful accounts accordingly. The allowance and related accounts receivable are reduced when the account is deemed uncollectible.

 

F-11
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

December 31, 2012 and 2011

 

(In thousands, except per share amounts)

 

Allowances for doubtful accounts were $487 and $545 as of December 31, 2012 and 2011, respectively.

 

Inventory:

 

Inventory consists primarily of commercially available fine chemicals used as raw materials, work-in-process and finished goods in the Company’s large-scale manufacturing plant. Large-scale manufacturing inventories are valued on a first-in, first-out (“FIFO”) basis. Inventories are stated at the lower of cost or market. The Company writes down inventories equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. Any such write-down, which represents a new cost basis for the inventory, results in a charge to operations.

 

Property and Equipment:

 

Property and equipment are initially recorded at cost or, if acquired as part of a business combination, at fair value. Expenditures for maintenance and repairs are expensed when incurred. When assets are sold, retired, or otherwise disposed of, the applicable costs and accumulated depreciation are removed from the accounts and the resulting gain or loss is recognized.

 

Depreciation is determined using the straight-line method over the estimated useful lives of the individual assets. Accelerated methods of depreciation have been used for income tax purposes.

 

The Company provides for depreciation of property and equipment over the following estimated useful lives:

 

Laboratory equipment and fixtures   7-18 years
Office equipment   3-7 years
Computer equipment   3-5 years
Buildings   39 years

 

Leasehold improvements are amortized over the lesser of the useful life of the asset or the lease term.

 

Equity Investments in Unconsolidated Subsidiaries:

 

The Company maintains an equity investment in a company that has operations in areas within the Company’s strategic focus. This investment is in a leveraged start-up company and was recorded at historical cost. The Company accounts for this investment using the cost method of accounting as the Company’s ownership interest in the investee is below 20% and the Company does not have the ability to exercise significant influence over the investee.

 

The Company records an impairment charge when an investment has experienced a decline in value that is other-than-temporary. Future adverse changes in market conditions or poor operating results of underlying investments could result in the Company’s inability to recover the carrying value of the investments thereby requiring an impairment charge in the future.

 

The carrying value of equity investments at December 31, 2012 and 2011 was $956.

 

Long-Lived Assets:

 

The Company assesses the impairment of a long-lived asset group 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:

 

F-12
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

December 31, 2012 and 2011

 

(In thousands, except per share amounts)

 

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

 

·a significant change in the business climate that could affect the value of a long-lived asset group; or

 

·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 indicated. An impairment charge is recognized to the extent that the carrying amount of the asset group exceeds its fair value and will reduce only the carrying amounts of the long-lived assets.

 

Patents, Patent Application Costs and Customer Relationships:

 

The costs of patents issued and acquired are being amortized on the straight-line basis over the estimated remaining lives of the issued patents. Patent application and processing costs are capitalized and will be amortized over the estimated life once a patent is acquired or expensed in the period the patent application is denied or the related appeal process has been exhausted.

 

Customer relationships acquired are being amortized on a straight-line basis over the estimated period of benefit from these relationships.

 

Pension and Postretirement Benefits:

 

The Company maintains pension and postretirement benefit costs and liabilities that are developed from actuarial valuations. Inherent in these valuations are key assumptions, including discount rates and expected return on plan assets, which are updated on an annual basis. The Company is required to consider current market conditions, including changes in interest rates, in making these assumptions. Changes in the related pension and postretirement benefit costs may occur in the future due to changes in the assumptions.

 

Loss Contingencies:

 

Loss contingencies are recorded as liabilities when it is probable that a liability has been incurred and the amount of the loss is reasonably estimable. Disclosure is required when there is a reasonable possibility that the ultimate loss will be material. Contingent liabilities are often resolved over long time periods. Estimating probable losses requires analyses that often depend on judgments about potential actions by third parties such as regulators. The Company enlists the technical expertise of its internal resources in evaluating current exposures and potential outcomes, and will utilize third party subject matter experts to supplement these assessments as circumstances dictate.

 

Research and Development:

 

Research and development costs are charged to operations when incurred and are included in operating expenses.

 

Income Taxes:

 

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the income tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided for when it is determined that deferred tax assets are not recoverable based on an assessment of estimated future taxable income that incorporates ongoing, prudent and feasible tax-planning strategies.

 

F-13
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

December 31, 2012 and 2011

 

(In thousands, except per share amounts)

 

Additionally, a tax position is a position in a previously filed tax return or a position expected to be taken in a future tax filing that is reflected in measuring current or deferred income tax assets and liabilities. Tax positions are recognized only when it is more likely than not (likelihood of greater than 50%), based on technical merits, that the position would be sustained upon examination by taxing authorities. Tax positions that meet the more likely than not threshold are measured using a probability-weighted approach.

  

Stock-Based Compensation:

 

The Company records compensation expense associated with stock options and other equity based compensation in accordance with ASC 718 “Compensation – Stock Compensation”. The Company establishes fair value as the measurement objective in accounting for share-based payment transactions with employees and recognizes expense on a straight-line basis over the applicable vesting period.

 

Earnings Per Share:

 

The Company computes net (loss) earnings per share in accordance with ASC 260-20 “Earnings per Share”. Basic (loss) earnings per share is computed by dividing net (loss) earnings available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share would reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company (such as stock options).

 

Because the Company has reported net losses, both basic and diluted weighted average shares outstanding were 30,318, 29,961 and 30,657 for the years ended December 31, 2012, 2011 and 2010, respectively. Both basic and diluted loss per share were $(0.12), $(1.08) and $(2.05) for the years ended December 31, 2012, 2011 and 2010, respectively.

 

The weighted average number of anti-dilutive options outstanding was 1,712, 1,852 and 1,872 for the years ended December 31, 2012, 2011 and 2010, respectively, and were excluded from the calculation of diluted loss per share.

 

Restructuring Charges:

 

The Company accounts for its restructuring costs as required by ASC 420-10, “Accounting for Costs Associated with Exit or Disposal Activities”, which requires that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at its fair value in the period in which the liability is incurred, except for one-time termination benefits that meet certain requirements.

 

Subsequent Events:

 

The Company evaluates subsequent events at the date of the balance sheet as well as conditions that arise after the balance sheet date but before the financial statements are issued. The effects of conditions that existed at the date of the balance sheet date are recognized in the financial statements. Events and conditions arising after the balance sheet date but before the financial statements are issued are evaluated to determine if disclosure is required to keep the financial statements from being misleading. To the extent such events and conditions exist, if any, disclosures are made regarding the nature of events and the estimated financial effects for those events and conditions. For purposes of preparing the accompanying consolidated financial statements and the notes to these financial statements, the Company evaluated subsequent events through the date the accompanying financial statements were issued.

 

2.Restructuring

 

During 2012, the Company announced its decisions to cease operations at its Budapest, Hungary, and Bothell, Washington facilities. The goal of these restructuring activities 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, while optimizing its location footprint. In connection with these activities, the Company recorded restructuring charges in its Discovery, Drug Development and Small Scale Manufacturing (“DDS”) operating segment of $4,355 during 2012.  This amount included $1,172 for termination benefits and $2,738 for estimated costs associated with terminating the Budapest lease, preparing the facilities for closure and other administrative costs and $445 for repayment of government incentive programs. The Company exited the Hungary facility in the third quarter of 2012 and is in the process of resolving the termination of the lease. 

 

F-14
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

December 31, 2012 and 2011

 

(In thousands, except per share amounts)

 

In conjunction with the Company’s actions to optimize its location footprint, the Company also recorded property and equipment impairment charges of $8,334 in the DDS segment in 2012. These charges are included under the caption “Property and equipment impairment” on the Consolidated Statement of Operations for the year ended December 31, 2012.

 

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 $277 in 2012 and $320 in the fourth quarter of 2011.

 

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.

 

The following table displays the restructuring activity and liability balances for the year ended and as of December 31, 2012:

 

   Balance at
January 1,
2012
   Charges/
(reversals)
   Amounts 
Paid
   Foreign
Currency
Translation
Adjustments
   Balance at
December 31,
2012
 
Termination benefits and personnel realignment  $456   $1,076   $(1,154)   8   $386 
Lease termination and relocation charges   1,128    2,713    (2,446)   10    1,405 
Other   354    843    (727)   -    470 
Total  $1,938   $4,632   $(4,327)   18   $2,261 

 

The following table displays the restructuring activity and liability balances for the year ended and as of December 31, 2011:

 

   Balance at
January 1,
2011
   Charges/
(reversals)
   Amounts 
Paid
   Foreign
Currency
Translation
Adjustments
   Balance at
December 31,
2011
 
Termination benefits and personnel realignment  $141   $1,282   $(949)  $(18)  $456 
Lease termination charges   1,932    (261)   (543)       1,128 
Other   120    250        (16)   354 
Total  $2,193   $1,271   $(1,492)  $(34)  $1,938 

 

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 estimated costs associated with exiting a facility, net of estimated sublease income.

 

F-15
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

December 31, 2012 and 2011

 

(In thousands, except per share amounts)

 

Restructuring charges are included under the caption “Restructuring charges” in the consolidated statements of operations for the year ended December 31, 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 December 31, 2012 and 2011.

 

Anticipated cash outflow related to the restructurings for 2013 is approximately $2,126, which includes the estimated settlement of the Hungary lease.

 

3.Inventory

 

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

 

   December 31, 
   2012   2011 
Raw materials  $8,575   $6,030 
Work in process   2,949    3,050 
Finished goods   16,692    16,924 
Total inventories, at cost  $28,216   $26,004 

 

4.Fair Value of Financial Instruments

 

The Company determines its 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.

 

Marketable securities: Marketable securities’ fair values are based on pricing for similar securities, recently executed transactions, cash flow models with yield curves, broker/dealer quotes and other pricing models utilizing observable inputs.

 

Long-term debt:The carrying value of long-term debt approximated fair value at December 31, 2012 and 2011 due to the resetting dates of the variable interest rates.

 

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 own any marketable securities or hold any other investments carried at fair value as of December 31, 2012.

 

F-16
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

December 31, 2012 and 2011

 

(In thousands, except per share amounts)

 

As of December 31, 2011, the Company owned marketable securities classified as available-for-sale with a fair value of $214 which included $212 of amortized cost and $2 of gross unrealized gains. All of the marketable securities at December 31, 2011 were obligations of states and political subdivisions. Additionally, they were all due in less than one year and included no temporarily impaired securities. These marketable securities were fixed maturity securities and were classified as Level 2.

 

The Company received proceeds from sales and maturities of $213 and $16,044 during the years ended December 31, 2012 and 2011, respectively. Additionally, the Company recorded realized a gain of $2 and losses of $185 from maturities and sales of available-for-sale securities during the years ended December 31, 2012 and 2011.

 

Nonrecurring Measurements:

 

The Company has assets, including intangible assets, property and equipment, and equity method investments which are not required to be carried at fair value on a recurring basis but are subject to fair value adjustments only in certain circumstances. If certain triggering events occur such that a non-financial instrument is required to be evaluated for impairment, a resulting asset impairment would require that the non-financial instrument be recorded at the lower of historical cost or its fair value.

 

The fair values of these assets are then determined by the application of a discounted cash flow model using Level 3 inputs. Cash flows are determined based on Company estimates of future operating results, and estimates of market participant weighted average costs of capital (“WACC”) are used as a basis for determining the discount rates to apply the future expected cash flows, adjusted for the risks and uncertainty inherent in the Company’s internally developed forecasts. 

 

Although the fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies, the estimates presented are not necessarily indicative of the amounts that the Company could realize in current market exchanges.

 

In 2012, the Company recorded long-lived asset impairment charges of $8,334 in our DDS segment primarily associated with the Company’s decision to cease operations at its Budapest, Hungary and Bothell, Washington facilities.

 

In the fourth quarter of 2011, the Company recorded long-lived asset impairment charges of $4,674 in its DDS segment associated with the Company’s decision to terminate its lease and exit one of its U.S. facilities as part of the overall initiative to reduce the Company's workforce, right size capacity, and reduce operating costs in 2012.

 

These long-lived asset impairment charges are included under the caption “Property and equipment impairment” in the consolidated statement of operations for the years ended December 31, 2012 and 2011.

 

Additionally in 2011, the Company recorded impairment charges associated with goodwill and other intangible assets. See Note 6 for further information related to these charges.

 

F-17
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

December 31, 2012 and 2011

 

(In thousands, except per share amounts)

 

5.Property and Equipment

 

Property and equipment consists of the following:

 

   December 31, 
   2012   2011 
Laboratory equipment and fixtures  $149,448   $147,215 
Office equipment   32,985    30,446 
Leasehold improvements   39,612    48,069 
Buildings   62,146    62,290 
Land   2,676    2,828 
    286,867    290,848 
Less accumulated depreciation and amortization   (158,972)   (146,834)
    127,895    144,014 
Construction-in-progress   7,624    5,782 
   $135,519   $149,796 

 

Depreciation and amortization expense of property and equipment was approximately $16,253, $16,754 and $16,643 for the years ended December 31, 2012, 2011 and 2010, respectively.

 

The Company recorded long-lived asset impairment charges of $8,334, $4,674 and $10,848 for the years ended December 31, 2012, 2011 and 2010, respectively.

 

6.Goodwill and Intangible Assets

 

Goodwill

 

Total goodwill recorded on the Company’s consolidated balance sheet at December 31, 2012 and 2011 was $0.

 

The Company assesses goodwill, if any, for impairment at the reporting unit level.    For the Company’s annual impairment assessment, it identified its reporting units to be two operating segments, the DDS segment and the Large Scale Manufacturing (“LSM”) segment. The selection of a valuation methodology is based on the facts and circumstances surrounding the valuation, including the segment being valued and the timing of the valuation.  In performing the Company’s annual impairment tests, the fair value of certain cash flow streams within the Company’s segments were determined using the income approach. For purposes of the income approach, fair value was determined based on the present value of estimated future cash flows, discounted at an appropriate risk-adjusted rate (“DCF analysis”).  The Company made assumptions about the amount and timing of future expected cash flows, terminal value growth rates and appropriate discount rates.  The amount and timing of future cash flows within the Company’s DCF analysis was based on its operational budgets, long range strategic plans and other estimates.  The terminal value growth rate was used to calculate the value of cash flows beyond the last projected period in the Company’s DCF analysis and reflected its best estimates for stable, perpetual growth of its reporting units.  The Company used estimates of market participant weighted average cost of capital (“WACC”) as a basis for determining the discount rates to apply to its reporting units’ future expected cash flows, adjusted for the risks and uncertainty inherent in its industry generally and in its internally developed forecasts.

 

For certain other cash flow streams within the segment, the fair value was determined, in part, by evaluating the valuation metrics of comparable publicly traded companies and evaluating enterprise values derived from recent arms-length transactions involving comparable companies. The Company also determined the fair value derived from the tangible book value of the assets associated with these cash flow streams and weighted this fair value equally with the fair values derived from the market-based methodologies noted above.

 

F-18
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

December 31, 2012 and 2011

 

(In thousands, except per share amounts)

 

2011 Impairment

 

Based upon the results of the valuation procedures performed, there was an indication of impairment, as the carrying value of the DDS segment exceeded its fair value. In the fourth quarter of 2011, the Company experienced significantly lower than forecasted demand for DDS contract services. As a result, the Company decreased the long-term estimates of operating results and cash flows utilized in performing the annual impairment test. In order to assess the estimated amount of impairment the Company performed the second step of the goodwill impairment test. The second step involved an analysis reflecting the allocation of the fair value of the DDS segment as calculated in the first step to its assets and liabilities, including an assessment of whether there were any previously unidentified intangible assets in connection with DDS. Based on the results of these procedures, the Company recorded a goodwill impairment charge of $15,812 for the year ended December 31, 2011 in the DDS segment.

 

2010 Impairment

 

The Company recorded a goodwill impairment charge in 2010 of $36,844 in the LSM segment. In the fourth quarter of 2010 several events occurred in the LSM segment that significantly impacted the Company’s long-term forecast for this segment. The UK facility was notified of an unplanned significant reduction in demand for a key commercial product, which has historically represented a significant portion of annual revenues at the site. In addition, the FDA warning letter issued to the AMRI Burlington facility was expected to have both negative short-term financial impact during the remediation process, as well as delaying the planned synergies expected to be derived from the AMRI Burlington business into the Company’s overall LSM platform and the forecasted resulting growth in the long-term. The impacts on cash flow from the current revenue, expense and capital expenditure forecasts, combined with an increase in discount rates used in the DCF analysis due to increases in the Company-specific risk premium included in the discount rate, resulted in a calculated fair value of the LSM segment being less than its carrying value.

 

The following table represents the activity in goodwill:

 

   DDS   LSM   Total 
Balance at January 1, 2010  $13,199   $4,352   $17,551 
Increases related to acquisitions   4,508    32,510    37,018 
Decreases related to impairment       (36,844)   (36,844)
Impact of foreign currency translation   (1,009)   (18)   (1,027)
Balance at December 31, 2010  $16,698   $   $16,698 
Decreases related to impairment   (15,812)       (15,812)
Impact of foreign currency translation   (886)       (886)
Balance at December 31, 2011  $   $   $ 

 

The accumulated goodwill impairment losses since the adoption of ASC Topic 350 are $90,050.

 

Intangible Assets

 

The components of intangible assets are as follows:

 

   Cost   Accumulated
Amortization
   Net   Amortization
Period
December 31, 2012                  
Patents and Licensing Rights  $4,333   $(1,669)  $2,664   2-16 years
Customer Relationships   815    (414)   401   5 years
Total  $5,148   $(2,083)  $3,065    
                   
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    

 

F-19
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

December 31, 2012 and 2011

 

(In thousands, except per share amounts)

 

Amortization expense related to intangible assets for the years ended December 31, 2012, 2011 and 2010 was $466, $529 and $396, respectively.

 

During the fourth quarter of 2011, the Company recorded a non-cash intangible asset impairment charge of $856 in the DDS segment as a result of the Company’s decision to cease its proprietary research and development activities.

 

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

 

Year ending December 31,     
2013  $423 
2014   419 
2015   316 
2016   240 
2017   240 
Thereafter   1,427 
Total  $3,065 

 

7.Business Combinations

 

On June 14, 2010 the Company completed the purchase of all of the outstanding shares of Hyaluron, Inc. (“AMRI Burlington”), a formulation facility located in Burlington, Massachusetts. The aggregate purchase price was $29,098. AMRI Burlington provides high value-added contract manufacturing services in sterile syringe and vial filling using specialized technologies including lyophilization. AMRI Burlington provides these services for both small molecule drug products and biologicals, from clinical phase to commercial scale. AMRI Burlington is part of the Company’s LSM segment.

 

On February 17, 2010, the Company completed the purchase of all of the outstanding shares of Excelsyn Ltd. (“AMRI UK”), a chemical development and manufacturing facility located in Holywell, United Kingdom. The aggregate purchase price was $17,982. AMRI UK provides development and large scale manufacturing services to large pharmaceutical, specialty pharmaceutical and biotechnology customers throughout Europe, Asia and North America. Manufacturing services include pre-clinical and Phase I – III product development as well as commercial manufacturing services for approved products. The acquisition of AMRI UK expanded AMRI’s portfolio of development and large scale manufacturing facilities as well as its customer portfolio, with little overlap of customers between the two companies. AMRI UK includes operations that are part of the Company’s LSM segment as well as operations that are part of the Company’s DDS segment.

 

In conjunction with the acquisitions of AMRI UK and AMRI Burlington, the Company has recorded the fair value of the assets acquired and liabilities assumed of these entities at the time of acquisition, has determined the consideration transferred to the former owners of the acquired companies, and has recognized goodwill, measured as the excess of the consideration transferred over the amount of acquisition-date net assets acquired.

 

Contingent consideration is recognized at its acquisition-date fair value as part of the consideration transferred in exchange for the acquired companies. Contingent consideration for these business combinations consisted of the Company’s right to the return of previously transferred consideration held in escrow. The fair value of the contingent consideration for claims made by the Company against the escrow accounts was estimated by considering the value of the escrow claim made by the Company, the amount of the counteroffer made by the former owners of the acquired companies to accept the claim and release the consideration from escrow, and evaluating the likelihood of potential outcomes between those two values.

 

F-20
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

December 31, 2012 and 2011

 

(In thousands, except per share amounts)

 

The Company resolved the contingencies related to these acquisitions in 2012 and recognized net gains of $707 within other (expense) income, net in the statement of operations.

 

Acquisition costs related to these transactions have been recognized as expenses in the periods in which the costs were incurred and the services were received.

 

As described in Note 6, the Company recorded goodwill impairment charges during 2011 and 2010 associated with these acquisitions.

 

8.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 borrowed under the term loan to repay all amounts due under its prior credit agreement. As of December 31, 2012, the Company had no amounts outstanding on the revolving line of credit and $8,536 of outstanding letters of credit secured by this line of credit. The amount available to be borrowed under the revolving line of credit at December 31, 2012 is $6,464.

 

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 December 31, 2012, the interest rate on the term loan was 3.625%.

 

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 December 31, 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 0.25% at December 31, 2012. The amount outstanding as of December 31, 2012 was $2,990.

 

The following table summarizes long-term debt:

 

   December 31,
 2012
   December 31,
2011
 
Term loan  $5,000   $2,550 
Industrial development authority bonds   2,990    3,275 
Miscellaneous loan   13    17 
    8,003    5,842 
Less current portion   (776)   (2,839)
Total long-term debt  $7,227   $3,003 

 

F-21
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

December 31, 2012 and 2011

 

(In thousands, except per share amounts)

 

The aggregate maturities of long-term debt at December 31, 2012 are as follows:

 

2013  $776 
2014   1,024 
2015   1,029 
2016   1,034 
2017   2,711 
Thereafter   1,429 
Total  $8,003 

 

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. In conjunction with an amendment to the credit agreement dated December 20, 2012, the restricted cash requirement will be directly reduced by the amount of principal payments made on the term loan beginning in May 2013.

 

9.Income Taxes

 

The components of income (loss) before taxes and income tax expense (benefit) are as follows:

 

   Year Ended December 31, 
   2012   2011   2010 
Income (loss) before taxes:               
U.S.  $9,990   $(19,498)  $(49,481)
Foreign   (9,871)   (17,140)   (23,361)
   $119   $(36,638)  $(72,842)
Income tax expense(benefit):               
Current:               
Federal  $188   $(5,099)  $(9,124)
State       157    (35)
Foreign   330    824    1,106 
    518    (4,118)   (8,053)
Deferred:               
Federal   3,399    (839)   (1,960)
State           (34)
Foreign   (21)   615    76 
    3,378    (224)   (1,918)
   $3,896   $(4,342)  $(9,971)

 

F-22
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

December 31, 2012 and 2011

 

(In thousands, except per share amounts)

 

The differences between income tax expense (benefit) and income taxes computed using a federal statutory rate of 35% for the years ended December 31, 2012, 2011 and 2010, were as follows:

 

   Year Ended December 31, 
   2012   2011   2010 
Pre-tax income (loss) at statutory rate  $42   $(12,807)  $(25,490)
Increase (reduction) in taxes resulting from:               
Tax-exempt interest income       (35)   (75)
State taxes, net of federal benefit and valued credits       102    1,109 
Rate differential on foreign operations   1,666    324    2,384 
Domestic production deduction   (79)        
Change in valuation allowance   671    1,642    1,406 
Research and development credits   10    (115)   (551)
Employee Stock Purchase Plan   56    96    84 
Goodwill impairment       4,594    12,443 
Increase (reduction) in uncertain tax position reserves       326    (529)
Other, net   1,530    1,531    (752)
   $3,896   $(4,342)  $(9,971)

 

The tax effects of temporary differences giving rise to significant portions of the deferred tax assets and liabilities are as follows:

 

   December 31, 
   2012   2011 
Deferred tax assets:          
Nondeductible accrued expenses  $1,181   $218 
Library amortization and impairment charges   1,922    2,172 
Inventories   1,676    2,265 
State tax credit carry forward   5,071    5,048 
Investment write-downs and losses   867    867 
Deferred income   1,781    2,978 
Stock based compensation   1,131    1,432 
Goodwill and intangibles   6,743    7,569 
Arbitration reserve   951    1,429 
Restructuring   1,655    773 
Net operating loss carry forwards   10,048    11,697 
Federal tax credit carry forwards   920    1,519 
Other, net   892    376 
    34,838    38,343 
Less valuation allowance   (16,885)   (16,214)
Deferred tax assets, net   17,953    22,129 
Deferred tax liabilities:          
Property and equipment depreciation differences   (15,027)   (15,019)
Prepaid real estate taxes   (229)   (241)
Net deferred tax asset  $2,697   $6,869 

 

F-23
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

December 31, 2012 and 2011

 

(In thousands, except per share amounts)

 

The preceding table does not include deferred tax assets of $3,270 and $3,551 at December 31, 2012 and 2011, respectively, associated with the Company’s pension liability as discussed in Note 11. The Company has tax-effected foreign net operating loss carryforwards (“NOLs”) of $4,058, which begin to expire in various years beginning in 2013, and tax-effected foreign NOLs of $5,246, which do not expire.  The Company has tax-effected U.S. state NOLs of $1,764 that begin to expire in 2030.

 

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and carry back opportunities in making this assessment. Based upon the level of projected future taxable income over the periods in which the deferred tax assets are deductible, a valuation allowance is included in deferred tax assets above as follows:

 

   December 31,
2012
   December 31,
2011
 
U.S.  $7,163   $7,471 
Foreign   9,722    8,743 
Total valuation allowance  $16,885   $16,214 

 

The Company has determined that the remaining net deferred tax assets are more likely than not to be realized, and therefore no additional valuation allowance is required. This determination was based on the evaluation of the recoverability of these future tax deductions and credits by assessing the adequacy of future expected taxable income from all sources, including reversal of taxable temporary differences and forecasted operating earnings with focus on the Company’s U.S. operations. The change in the valuation allowance during 2012 is related to increases in tax attributes in taxing jurisdictions where the Company does not project sufficient taxable income to utilize these attributes. The amount of the deferred tax asset considered realizable could be reduced if estimates of future taxable income during the carry forward period are reduced.

 

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

 

   2012   2011 
Balance at January 1  $326   $ 
Increases related to prior year tax positions       326 
Decreases related to prior year tax positions        
Balance at December 31  $326   $326 

 

The Company classifies interest expense and penalties related to unrecognized tax benefits as a component of income tax expense. As of December 31, 2012 the Company has not accrued any penalties related to its uncertain tax position as it believes that it is more likely than not that there will not be any assessment of penalties. Also as of December 31, 2012, the Company has not accrued any interest related to its uncertain tax positions as the amount is immaterial.

 

The Company files Federal income tax returns, as well as multiple state and foreign jurisdiction tax returns. The Company currently has a tax holiday in Singapore through the end of 2015, resulting in a zero tax rate on current income in Singapore. The Company’s federal income tax returns have been examined by the Internal Revenue Service through the year ended December 31, 2007.  All significant state matters have been concluded for years through 2007 and foreign matters have been concluded for years through 2005. Tax examinations that commenced during 2010 and 2011 remain in process. Management of the Company believes that the Company’s exposure associated with future tax examinations is not material.

 

F-24
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

December 31, 2012 and 2011

 

(In thousands, except per share amounts)

 

The Company has not provided for U.S. income taxes on undistributed earnings of its foreign subsidiaries totaling $13,279 because management considers such earnings to be reinvested indefinitely outside of the U.S. If the earnings are distributed in the future, the Company may be subject to both foreign withholding taxes and U.S. income taxes that may not be fully offset by foreign tax credits, however calculations of the potential tax liability is not practicable as of December 31, 2012.

 

10.Share-based Compensation

 

During the years ended December 31, 2012, 2011 and 2010, the Company recognized total share based compensation cost of $1,896, $1,639 and $1,706, respectively. During the years ended December 31, 2012 and 2011, cash received from stock option exercises and employee stock purchase plan purchases was $531 and $671, respectively.

 

The following are the shares of common stock reserved for issuance at December 31, 2012:

 

   Number of Shares 
Stock Option Plans   1,106 
Employee Stock Purchase Plan   237 
Shares reserved for issuance   1,343 

 

Employee Stock Purchase Plan

 

The Company’s 1998 Employee Stock Purchase Plan (the “Purchase Plan”) was adopted during August 1998 and amended in November 2010 and again in June 2011. Up to 1,000 shares of common stock may be issued under the Purchase Plan, which is administered by the Compensation Committee of the Board of Directors. The Purchase Plan establishes two stock offering periods per calendar year, the first beginning on January 1 and ending on June 30, and the second beginning on July 1 and ending December 31. All U.S. employees who work more than 20 hours per week are eligible for participation in the Purchase Plan. Employees who are deemed to own greater than 5% of the combined voting power of all classes of stock of the Company are not eligible for participation in the Purchase Plan.

 

During each offering, an employee may purchase shares under the Purchase Plan by authorizing payroll deductions up to 10% of their cash compensation during the offering period. The maximum number of shares to be issued to any single employee during an offering period is limited to two thousand shares. At the end of the offering period, the accumulated payroll deductions will be used to purchase common stock on the last business day of the offering period at a price equal to 85% of the closing price of the common stock on the first or last day of the offering period, whichever is lower.

 

The 15% discount and the look-back feature are considered compensatory items for which expense must be recognized. The Company values Purchase Plan shares as a combination position consisting of 15% of a share of nonvested stock and 85% of a six-month stock option. The value of the nonvested stock is estimated based on the fair market value of the Company’s common stock at the beginning of the offering period. The value of the stock option is calculated using the Black-Scholes valuation model using historical expected volatility percentages, a risk free interest rate equal to the six-month U.S. Treasury rate at the beginning of the offering period, and an expected life of six months. The resulting per-share value is multiplied by the shares estimated to be purchased during the offering period based on historical experience to arrive at a total estimated compensation cost for the offering period. The estimated compensation cost is recognized on a straight-line basis over the offering period.

 

During the years ended December 31, 2012, 2011 and 2010, 182, 137 and 88 shares, respectively, were issued under the Purchase Plan.

 

F-25
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

December 31, 2012 and 2011

 

(In thousands, except per share amounts)

 

Stock Option Plan

 

The Company has a Stock Option Plan, through which incentive stock options or non-qualified stock options, as well as other equity instruments such as restricted shares, may be issued. In addition, certain stock options are outstanding which were issued under stock option plans that have subsequently expired. Incentive stock options granted to employees may not be granted at prices less than 100% of the fair market value of the Company’s common stock at the date of option grant. Non-qualified stock options may be granted to employees, directors, advisors, consultants and other key persons of the Company at prices established at the date of grant, and may be less than the fair market value at the date of grant. All stock options may be exercised at any time, after vesting, over a ten-year period subsequent to the date of grant. The Company has a variety of vesting schedules for the stock options that have been granted to employees and non-employees directors. The Company has elected to record the compensation expense associated with these options on a straight-line basis over the vesting term. Non-qualified stock option vesting terms are established at the date of grant, but have a duration of not more than ten years.

 

The per share weighted-average fair value of stock options granted is determined using the Black-Scholes option pricing model with the following weighted-average assumptions:

 

   2012   2011   2010 
Expected life in years   5    5    5 
Interest rate   0.83%   1.20%   2.27%
Volatility   57%   57%   46%
Dividend yield            

 

Following is a summary of the status of stock option programs during 2012, 2011 and 2010:

 

           Weighted Average     
       Weighted   Remaining   Aggregate 
   Number of   Exercise   Contractual Term   Intrinsic 
   Shares   Price   (Years)   Value 
                 
Outstanding, January 1, 2010   1,864    19.66           
Granted   170    7.08           
Exercised                  
Forfeited   (218)   16.62           
Expired   (259)   27.00           
Outstanding, December 31, 2010   1,557    17.43           
Granted   1,615    3.03           
Exercised                  
Forfeited   (213)   18.34           
Expired   (197)   35.98           
Outstanding, December 31, 2011   2,762   $7.58           
Granted   430    3.00           
Exercised                  
Forfeited   (678)   7.34           
Expired   (125)   24.92           
Outstanding, December 31, 2012   2,389   $5.90    7.2   $3,782 
Options exercisable, December 31, 2012   1,081   $8.94    5.1   $984 

 

The weighted average fair value per share of stock options granted during the years ended December 31, 2012, 2011 and 2010 was $1.46, $1.49 and $3.02, respectively. The total intrinsic value of stock options exercised during the years ended December 31, 2012, 2011 and 2010 was $0 for each of the years. The actual tax expense realized for the tax deductions from stock option exercises was $0 and $270 during the years ended December 31, 2012 and 2011.

 

F-26
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

December 31, 2012 and 2011

 

(In thousands, except per share amounts)

 

As of December 31, 2012, there was $1,779 of total unrecognized compensation cost related to non-vested stock options. That cost is expected to be recognized over a weighted-average period of 2.0 years. The total fair value of shares vested during the years ended December 31, 2012, 2011 and 2010 was approximately $769, $527 and $563, respectively.

 

Restricted Stock

 

The Company also issues restricted shares of common stock of the Company under the 2008 Stock Option and Incentive Plan. The shares are issued as restricted stock and are held in the custody of the Company until all vesting restrictions are satisfied. If the vesting terms under which the award was granted are not satisfied, the shares are forfeited. Restricted stock is valued based on the fair value of the shares on the grant date, and is amortized to expense on a straight-line basis over the applicable vesting period. The Company reduces the straight-line compensation expense by an estimated forfeiture rate to account for the estimated impact of shares of restricted stock that are expected to be forfeited before becoming fully vested. This estimate is based on the Company’s historical forfeiture experience.

 

Following is a summary of the restricted stock activity during 2012, 2011 and 2010:

 

   Number of
Shares
   Weighted
Average Grant Date
Fair Value
 
Outstanding, January 1, 2010   516   $10.08 
Granted   174    8.27 
Vested   (129)   9.89 
Forfeited   (78)   9.27 
Outstanding, December 31, 2010   483   $9.61 
Granted   318    5.19 
Vested   (116)   11.06 
Forfeited   (124)   8.06 
Outstanding, December 31, 2011   561   $7.14 
Granted   140    3.12 
Vested   (177)   7.68 
Forfeited   (56)   6.16 
Outstanding, December 31, 2012   468   $5.85 

 

For the years ended December 31, 2012 and 2011, the fair value of restricted stock issued of $437 and $1,647, respectively, was based on the fair value of the shares on the grant date and amortized over the applicable vesting period. During the years ended December 31, 2012 and 2011, a total of 56 and 124 shares, respectively, with an unrecognized compensation expense of $447 and $996, respectively, were forfeited. The amount amortized to expense during years ended December 31, 2012, 2011 and 2010, net of the impact of forfeitures, was approximately $932, $861 and $1,141, respectively. As of December 31, 2012, there was $1,748 of total unrecognized compensation cost related to non-vested restricted shares. That cost is expected to be recognized over a weighted-average period of 2.0 years.

 

Shareholder Rights Plan

 

The Company has renewed a Shareholder Rights Plan, the purpose of which is, among other things, to enhance the Board of Directors’ ability to protect shareholder interests and to ensure that shareholders receive fair treatment in the event any coercive takeover attempt of the Company is made in the future. The Shareholder Rights Plan could make it more difficult for a third party to acquire, or could discourage a third party from acquiring, the Company or a large block of the Company’s Common Stock. The following summary description of the Shareholder Rights Plan does not purport to be complete and is qualified in its entirety by reference to the Company’s Shareholder Rights Plan, which has been previously filed with the Securities and Exchange Commission as an exhibit to a Registration Statement on Form 8-A.

 

F-27
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

December 31, 2012 and 2011

 

(In thousands, except per share amounts)

 

In connection with the renewal of the Shareholder Rights Plan, the Board of Directors of the Company declared a dividend distribution of one preferred stock purchase right (a “Right”) for each outstanding share of Common Stock to stockholders of record as of the close of business on July 30, 2012. The Rights currently are not exercisable and are attached to and trade with the outstanding shares of Common Stock. Under the Shareholder Rights Plan, the Rights become exercisable if a person becomes an “acquiring person” by acquiring 15% or more of the outstanding shares of Common Stock or if a person commences a tender offer that would result in that person owning 15% or more of the Common Stock. A stockholder owning 15% or more of the common stock of the Company as of July 27, 2012, is “grandfathered” under the Shareholder Rights Plan and will become an “acquiring person” upon acquiring an additional 1¤2% of the Common Stock. If a person becomes an “acquiring person,” each holder of a Right (other than the acquiring person) would be entitled to purchase, at the then-current exercise price, such number of shares of the Company’s preferred stock which are equivalent to shares of Common Stock having twice the exercise price of the Right. If the Company is acquired in a merger or other business combination transaction after any such event, each holder of a Right would then be entitled to purchase, at the then-current exercise price, shares of the acquiring company’s common stock having a value of twice the exercise price of the Right. The Shareholder Rights Plan was amended on March 23, 2011 in order to allow the Board of Directors to grant equity awards to Dr. Thomas D’Ambra, the Company’s CEO, without the granting, vesting or exercise of those awards resulting in an inadvertent triggering of the Shareholder Rights Plan. The Shareholder Rights Plan was renewed on July 27, 2012.

 

11.Employee Benefit Plans

 

Defined Contribution Plans

 

The Company maintains a savings and profit sharing plan under section 401(k) of the Internal Revenue Code covering all eligible U.S. non-union employees. Employees must complete one calendar month of service and be over 20.5 years of age as of the plan’s entry dates. Participants may contribute up to 100% of their compensation, subject to IRS limitations. The Company currently makes matching contributions equal to 50% of the participants’ contributions, up to a limit of 10% of the participants’ wages. In addition, the Company has reserved the right to make discretionary profit sharing contributions to employee accounts. The Company has made no discretionary profit sharing contributions. Employer matching contributions vest at a rate of 20% per year beginning after two years of participation in the plan. Employer matching contributions were approximately $1,688, $1,765 and $1,780 for the years ended December 31, 2012, 2011 and 2010, respectively.

 

The Company also sponsors a savings and profit sharing plan under section 401(k) of the Internal Revenue Code covering union employees. Employees must complete one calendar month of service and there is no age requirement as of the plan’s entry dates. Participants may contribute up to 100% of their regular wages, subject to IRS limitations, and the Company matches 50% of each dollar contributed by the employee up to 10% of their wages. In addition, the Company has reserved the right to make discretionary profit sharing contributions to employee accounts. The Company has made no discretionary profit sharing contributions. Employer matching contributions vest at a rate of 20% per year beginning after two years of participation in the plan, however the employer match under this plan does not begin until the employee completes one year of service. Employer matching contributions were $129, $127 and $129 for the years ended December 31, 2012, 2011 and 2010, respectively.

 

Defined Benefit and Postretirement Welfare Plan

 

AMRI Rensselaer maintains a non-contributory defined benefit plan (salaried and hourly) and a non-contributory, unfunded post-retirement welfare plan, covering substantially all employees. Benefits for the salaried defined benefit plan are based on salary and years of service. Benefits for the hourly defined benefit plan (for union employees) are based on negotiated benefits and years of service. The hourly defined benefit plan is covered under a collective bargaining agreement with the International Chemical Workers Union which represents the hourly workforce at AMRI Rensselaer.

 

Effective June 5, 2003, the Company eliminated the accumulation of additional future benefits under the non-contributory, unfunded post-retirement welfare plan for salaried employees. Effective August 1, 2003, the Company curtailed the salaried defined benefit pension plan and effective March 1, 2004, the Company curtailed the hourly defined benefit pension plan.

 

F-28
 

 

ALBANY MOLECULAR RESEARCH, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

December 31, 2012 and 2011

 

(In thousands, except per share amounts)

 

The Company recognizes the overfunded or underfunded status of its postretirement plans in its balance sheet and recognizes changes in that funded status in the year in which the changes occur. Additionally, the Company is required to measure the funded status of a plan as of the end of its fiscal year.

 

The following table provides a reconciliation of the changes in the plans’ benefit obligations and fair value of the plans’ assets during the years ended December 31, 2012 and 2011, and a reconciliation of the funded status to the net amount recognized in the consolidated balance sheets as of December 31 (the plans’ measurement dates) of both years:

 

   Pension Benefits   Postretirement 
Benefits