Albany Molecular Research (NASDAQ:AMRI) is acting quickly to shore up its core contract-service business. But as its latest earnings report reveals, the company seems destined for a tough 2006, even as it improves its cost structure. Declining royalties are a big part of the story.

The provider of chemistry services to drug developers reported on Monday that 2005 revenue rose 8.5% year over year to $183.9 million while earnings were $0.50 a share, a nice recovery considering 2004's $0.37 loss. But the fourth-quarter numbers are a troubling sign of things to come. Revenue declined 15.2% to $39.1 million, and earnings came in at a $0.03 loss per share, versus a gain of $0.11 in the fourth quarter of 2004.

The main culprit in the Q4 decline wasn't the core contract business. Revenue in that area did slip 3% to $32.9 million, but that decline was due in part to timing -- General Electric's (NYSE:GE) GE Healthcare requested accelerated delivery of a product, so Albany Molecular recorded revenues from that product in the first half of the year, rather than throughout the year as expected. But that acceleration also means that Albany Molecular can no longer count on revenue from the GE Healthcare product.

The real pain in the quarter came from royalty revenue from the company's rights to Sanofi-Aventis' (NYSE:SNY) Allegra. That revenue sank like a stone. With generic competition from Barr Pharmaceuticals (NYSE:BRL) and Teva Pharmaceutical (NASDAQ:TEVA) eating into Allegra sales, royalty revenue for the allergy drug plunged 49% to $6.2 million. Albany Molecular and Sanofi continue to litigate against the generic outfits, but it's probably best to bet on the conservative side and assume that Allegra sales will continue to suffer.

On a positive note, Albany Molecular has made progress in ensuring that its contract business will stay competitive. After suffering from low-cost competition, the company is now taking advantage of cheaper labor. It has begun operations in India and Singapore, and last month it reached an agreement to buy a chemistry-services company in Hungary.

As for future results, Albany Molecular expects its 2006 contract services revenue to grow 10% to 17%. But even so, as Allegra royalties shrink, 2006 certainly looks like a transition year.

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Fool contributor Brian Gorman is a freelance writer in Chicago. He does not own shares of any companies mentioned in this article.