Table
of Contents
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x
|
QUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|
|
|
|
For the
Quarterly Period Ended January 31, 2010
|
|
|
|
or
|
|
|
o
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
|
For the Transition Period From to
COMMISSION FILE NUMBER 0-22354
MARTEK
BIOSCIENCES CORPORATION
(Exact name of registrant
as specified in its charter)
Delaware
|
|
52-1399362
|
(State or other
jurisdiction of incorporation or organization)
|
|
(I.R.S. Employer
Identification Number)
|
6480 Dobbin Road, Columbia,
Maryland 21045
(Address of principal
executive offices)
Registrants telephone
number, including area code:
(410) 740-0081
None
(Former name, former
address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has
filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
x
Yes
o
No
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).
o
Yes
o
No
Indicate by check mark whether the registrant is a
large accelerated filer, an accelerated filer, or a non-accelerated filer, or a
smaller reporting company. See the
definitions of large accelerated filer, accelerated filer and smaller
reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
x
|
|
Accelerated filer
o
|
Non-accelerated filer
o
|
|
Smaller reporting
company
o
|
(Do not check if a
smaller reporting company)
|
|
|
Indicate by check mark whether the registrant is a
shell company (as defined in Rule 12b-2 of the Exchange Act).
o
Yes
x
No
The number of shares of
Common Stock outstanding as of March 8, 2010 was 33,309,034.
Table
of Contents
MARTEK
BIOSCIENCES CORPORATION
FORM 10-Q
For
The Quarterly Period Ended January 31, 2010
INDEX
2
Table
of Contents
PART I
- FINANCIAL INFORMATION
Item 1.
Financial Statements.
MARTEK BIOSCIENCES CORPORATION
CONSOLIDATED BALANCE SHEETS
|
|
January 31,
|
|
October 31,
|
|
In
thousands, except share and per share data
|
|
2010
|
|
2009
|
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
Current assets
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
150,072
|
|
$
|
141,063
|
|
Short-term
investments
|
|
7,278
|
|
7,301
|
|
Accounts
receivable, net
|
|
55,087
|
|
44,304
|
|
Inventories,
net
|
|
114,006
|
|
116,179
|
|
Deferred
tax asset
|
|
25,184
|
|
24,303
|
|
Other
current assets
|
|
4,638
|
|
5,240
|
|
Total
current assets
|
|
356,265
|
|
338,390
|
|
|
|
|
|
|
|
Property,
plant and equipment, net
|
|
250,231
|
|
252,279
|
|
Long-term
investments
|
|
4,556
|
|
4,495
|
|
Goodwill
|
|
51,592
|
|
51,592
|
|
Other
intangible assets, net
|
|
41,872
|
|
42,631
|
|
Other
assets, net
|
|
3,733
|
|
430
|
|
|
|
|
|
|
|
Total
assets
|
|
$
|
708,249
|
|
$
|
689,817
|
|
|
|
|
|
|
|
Liabilities and stockholders equity
|
|
|
|
|
|
Current liabilities
|
|
|
|
|
|
Accounts
payable
|
|
$
|
13,919
|
|
$
|
13,122
|
|
Accrued
liabilities
|
|
19,736
|
|
18,243
|
|
Current
portion of notes payable and other long-term obligations
|
|
389
|
|
410
|
|
Current
portion of deferred revenue
|
|
1,670
|
|
2,981
|
|
Total
current liabilities
|
|
35,714
|
|
34,756
|
|
|
|
|
|
|
|
Notes
payable and other long-term obligations
|
|
1,149
|
|
400
|
|
Long-term
portion of deferred revenue
|
|
8,290
|
|
8,426
|
|
Deferred
tax liability
|
|
15,898
|
|
10,091
|
|
|
|
|
|
|
|
Total
liabilities
|
|
61,051
|
|
53,673
|
|
|
|
|
|
|
|
Commitments
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders equity
|
|
|
|
|
|
Preferred
stock, $.01 par value, 4,700,000 shares authorized; none issued or
outstanding
|
|
|
|
|
|
Common
stock, $.10 par value; 100,000,000 shares authorized; 33,302,834 and
33,269,686 shares issued and outstanding, respectively
|
|
3,330
|
|
3,327
|
|
Additional
paid-in capital
|
|
558,889
|
|
557,519
|
|
Accumulated
other comprehensive loss
|
|
(636
|
)
|
(674
|
)
|
Retained
earnings
|
|
85,615
|
|
75,972
|
|
|
|
|
|
|
|
Total
stockholders equity
|
|
647,198
|
|
636,144
|
|
|
|
|
|
|
|
Total
liabilities and stockholders equity
|
|
$
|
708,249
|
|
$
|
689,817
|
|
See accompanying notes.
3
Table
of Contents
MARTEK BIOSCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
|
|
Three months ended January 31,
|
|
Unaudited - In thousands,
except per share data
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Revenues:
|
|
|
|
|
|
Product sales
|
|
$
|
84,086
|
|
$
|
84,022
|
|
Contract
manufacturing and services
|
|
5,670
|
|
3,341
|
|
|
|
|
|
|
|
Total revenues
|
|
89,756
|
|
87,363
|
|
|
|
|
|
|
|
Cost of
revenues:
|
|
|
|
|
|
Cost of product sales
|
|
45,937
|
|
46,909
|
|
Cost of contract
manufacturing and services
|
|
5,233
|
|
3,409
|
|
|
|
|
|
|
|
Total cost of
revenues
|
|
51,170
|
|
50,318
|
|
|
|
|
|
|
|
Gross margin
|
|
38,586
|
|
37,045
|
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
|
Research and
development
|
|
7,066
|
|
6,749
|
|
Selling, general
and administrative
|
|
13,289
|
|
13,097
|
|
Amortization of
intangible assets
|
|
1,445
|
|
1,781
|
|
Acquisition
costs
|
|
1,187
|
|
|
|
Other operating
expenses
|
|
34
|
|
153
|
|
|
|
|
|
|
|
Total operating
expenses
|
|
23,021
|
|
21,780
|
|
|
|
|
|
|
|
Income from
operations
|
|
15,565
|
|
15,265
|
|
|
|
|
|
|
|
Interest and
other income, net
|
|
(49
|
)
|
255
|
|
Interest expense
|
|
(88
|
)
|
(95
|
)
|
|
|
|
|
|
|
Income before
income tax provision
|
|
15,428
|
|
15,425
|
|
Income tax
provision
|
|
5,785
|
|
5,819
|
|
|
|
|
|
|
|
Net income
|
|
$
|
9,643
|
|
$
|
9,606
|
|
|
|
|
|
|
|
Net income per
share
|
|
|
|
|
|
Basic
|
|
$
|
0.29
|
|
$
|
0.29
|
|
Diluted
|
|
$
|
0.29
|
|
$
|
0.29
|
|
|
|
|
|
|
|
Weighted average
common shares outstanding
|
|
|
|
|
|
Basic
|
|
33,276
|
|
33,150
|
|
Diluted
|
|
33,454
|
|
33,399
|
|
See accompanying notes.
4
Table
of Contents
MARTEK BIOSCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
|
|
Three months ended
January 31,
|
|
Unaudited
In thousands
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Operating activities
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
9,643
|
|
$
|
9,606
|
|
Adjustments
to reconcile net income to net cash provided by operating activities:
|
|
|
|
|
|
Depreciation
and amortization
|
|
7,911
|
|
7,046
|
|
Deferred
tax provision
|
|
6,038
|
|
4,768
|
|
Equity-based
compensation expense
|
|
900
|
|
836
|
|
Incremental
tax benefit from exercise of non-qualified stock options and vesting of
restricted stock units
|
|
|
|
(30
|
)
|
Loss
on asset disposal and other, net
|
|
2
|
|
340
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
Accounts
receivable
|
|
(10,782
|
)
|
(9,155
|
)
|
Inventories
|
|
2,193
|
|
(3,895
|
)
|
Other
assets
|
|
626
|
|
57
|
|
Accounts
payable
|
|
1,115
|
|
6,175
|
|
Accrued
liabilities
|
|
(85
|
)
|
(7,110
|
)
|
Deferred
revenue and other liabilities
|
|
(1,136
|
)
|
(37
|
)
|
|
|
|
|
|
|
Net
cash provided by operating activities
|
|
16,425
|
|
8,601
|
|
|
|
|
|
|
|
Investing activities
|
|
|
|
|
|
|
|
|
|
|
|
Sales
and maturities of investments
|
|
50
|
|
|
|
Expenditures
for property, plant and equipment
|
|
(3,433
|
)
|
(2,531
|
)
|
Capitalization
of intangible and other assets
|
|
(1,138
|
)
|
(1,309
|
)
|
|
|
|
|
|
|
Net
cash used in investing activities
|
|
(4,521
|
)
|
(3,840
|
)
|
|
|
|
|
|
|
Financing activities
|
|
|
|
|
|
|
|
|
|
|
|
Repayments
of notes payable and other long-term obligations
|
|
(30
|
)
|
(29
|
)
|
Payment
of debt issuance costs
|
|
(3,328
|
)
|
|
|
Issuance
of common stock under employee stock plans
|
|
472
|
|
61
|
|
Tax
payments from shares withheld upon vesting of restricted stock units
|
|
(9
|
)
|
(9
|
)
|
Incremental
tax benefit from exercise of non-qualified stock options and vesting of
restricted stock units
|
|
|
|
30
|
|
|
|
|
|
|
|
Net
cash (used in) provided by financing activities
|
|
(2,895
|
)
|
53
|
|
|
|
|
|
|
|
Net
increase in cash and cash equivalents
|
|
9,009
|
|
4,814
|
|
Cash
and cash equivalents, beginning of period
|
|
141,063
|
|
102,495
|
|
|
|
|
|
|
|
Cash
and cash equivalents, end of period
|
|
$
|
150,072
|
|
$
|
107,309
|
|
|
|
|
|
|
|
Supplemental cash flow disclosures:
|
|
|
|
|
|
Interest paid
|
|
$
|
49
|
|
$
|
50
|
|
Income taxes paid
|
|
$
|
58
|
|
$
|
337
|
|
See accompanying notes.
5
Table
of Contents
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1.
BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited consolidated
financial statements of Martek Biosciences Corporation (the Company or Martek)
have been prepared in accordance with accounting principles generally accepted
in the United States for interim financial information and with the instructions
to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring adjustments) considered necessary for a fair
presentation have been included.
Operating results for the three months ended January 31, 2010 are
not necessarily indicative of the results that may be expected for the year
ending October 31, 2010. The
accompanying unaudited financial statements and these notes should be read in
conjunction with the consolidated financial statements and footnotes thereto
included in the Companys Annual Report on Form 10-K for the year ended October 31,
2009.
Consolidation
The
consolidated financial statements include the accounts of Martek and its
wholly-owned subsidiaries, Martek Biosciences Boulder Corporation and Martek
Biosciences Kingstree Corporation, after elimination of all significant
intercompany balances and transactions.
Use
of Estimates
The
preparation of consolidated financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the Companys
consolidated financial statements and accompanying notes. On an ongoing basis,
the Company evaluates its estimates and judgments, which are based on
historical and anticipated results and trends and on various other assumptions
that the Company believes to be reasonable under the circumstances. By their
nature, estimates are subject to an inherent degree of uncertainty and, as
such, actual results may differ from the Companys estimates.
Segment
Information
The Company currently operates in one material business
segment, the development and commercialization of high value nutritional
products from microbial sources, including algae, fungi and other microbes. The
Company is managed and operated as one business. The entire business is
comprehensively managed by a single management team that reports to the Chief
Executive Officer. The Company does not operate any material separate lines of
business or separate business entities with respect to its products or product
candidates. Accordingly, the Company does not have separately reportable
segments.
Revenue
Recognition
The Company derives
revenue from three sources: product sales, contract manufacturing and
collaborations. The Company recognizes product sales revenue when persuasive
evidence of an arrangement exists, the fee is fixed or determinable,
collectibility is probable,
the product is shipped and title and risk of
loss are transferred
.
A number of
infant formula
license contracts
include an upfront license fee, a prepayment of product sales and established
pricing on future product sales, which also may include discounts based on the
achievement of certain volume purchases. The consideration from these contracts
is allocated based on the relative fair values of the separate elements.
Revenue is recognized on product sales when goods are shipped and all other
conditions for revenue recognition are met. If volume pricing discounts are
deemed to be a separate element, revenue on related product shipments is
recognized using the estimated average price to the customer
over the term of
the discount period, which requires an estimation of total production shipments
over that time frame
.
Amounts billed in excess of
the estimated average price are recorded as deferred revenue.
Conversely, a receivable is
recorded for the excess of the estimated average price over amounts billed.
Estimates of average prices are reviewed and, if necessary, adjusted
periodically based on updated estimates of product shipments during each
contract year. The Companys historical
estimates of product shipments have approximated actual results. Amounts recorded as either deferred revenue
or a receivable are settled at the end of each contract year, which generally
is December 31.
Once the requisite volume thresholds have been satisfied, the
previously recorded deferred revenue is recognized over the remaining discount
period. Cash received as a prepayment on
future product purchases is deferred and recognized as revenue when product is
shipped. Revenue from product licenses is deferred and recognized on a
straight-line basis over the term of the agreement. The Companys terms of sale allow for limited
rights of return with such rights based solely on compliance with agreed-upon
customer product specifications. The
Company tests the product for compliance with customer product specifications
prior to shipment. Such returns have not been material.
Royalty income
is recorded when earned, based on information provided by the Companys
customers. Royalty income was not
material in the three months ended January 31, 2010 and 2009.
Contract
manufacturing revenue is recognized when goods are shipped to customers and all
other conditions for revenue recognition are met. Cash received that is related
to future performance under such contracts is deferred and recognized as
revenue when earned.
Revenue
earned from collaboration work may come from stand-alone arrangements for
certain discrete development work or multiple deliverable arrangements that
include such development work followed by larger-scale manufacturing efforts.
Revenue is recognized based on the nature of the arrangements, with each of the
multiple deliverables in a given arrangement having distinct and separate fair
values. Fair values are determined via consistent pricing between stand-alone
arrangements and multiple deliverable arrangements, as well as a competitive
bidding process. Collaborations may be performed on a time and materials basis
or fixed fee basis. For time and materials arrangements, revenue is recognized
as services are performed and billed. For fixed fee arrangements where customer
delivery and acceptance provisions are substantive, revenue is recognized upon
completion and acceptance by the customer.
6
Table
of Contents
Shipping
Income and Costs
Shipping
costs charged to customers are recorded as revenue in the period that the
related product sale revenue is recorded, and associated costs of shipping are
included in cost of revenues. Shipping
and handling costs were approximately $800,000 in the three months ended January 31,
2010 and $700,000 in the three months ended January 31, 2009.
Income
Taxes
Income tax provision
or benefit includes U.S. federal, state and local income taxes and is based on
pre-tax income or loss. The interim
period provision or benefit for income taxes is based upon the Companys
estimate of its annual effective income tax rate. In determining the estimated annual effective
income tax rate, the Company analyzes various factors, including projections of
the Companys annual earnings and taxing jurisdictions in which the earnings
will be generated, the impact of state and local income taxes and the ability
of the Company to use tax credits and net operating loss carryforwards.
The Company recognizes the benefits of tax
positions in the financial statements if such positions are more likely than
not to be sustained upon examination by the taxing authority and satisfy the
appropriate measurement criteria. If the
recognition threshold is met, the tax benefit is generally measured and
recognized as the tax benefit having the highest likelihood, in managements
judgment, of being realized upon ultimate settlement with the taxing authority,
assuming full knowledge of the position and all relevant facts.
The Company
also recognizes interest and penalties accrued related to unrecognized tax
benefits in the provision for income taxes.
The Company believes appropriate provisions for all outstanding issues
have been made for all jurisdictions and all open tax years. It is reasonably possible that the total
amount of unrecognized tax benefits as of January 31, 2010 will decrease within
the next 12 months as various uncertainties are resolved. The Company cannot reasonably estimate the
range of potential outcomes.
Foreign
Currency Transactions and Hedging Activities
Foreign currency
transactions are translated into U.S. dollars at prevailing rates. Gains or
losses resulting from foreign currency transactions are included in current
period income or loss as incurred. All material transactions of the Company are
denominated in U.S. dollars with the exception of a portion of purchases of
arachidonic acid (ARA)
from DSM Food Specialties
B.V. (DSM), which are denominated in Euros.
The Company periodically enters into foreign
currency forward contracts to reduce its transactional foreign currency
exposures associated with the purchases of ARA from DSM. The Company does not use derivative financial
instruments for speculative purposes.
These forward contracts are highly effective cash flow hedges and
qualify for hedge accounting. Consequently,
the resulting unrealized gains and losses are recorded as a component of other
comprehensive income until the related product is sold. As of January 31,
2010, there were no outstanding forward contracts. Amounts recorded due to hedge ineffectiveness
have not been material.
Advertising
Advertising costs are expensed as
incurred. Advertising costs, including
print, television and internet-based advertising, were approximately $500,000
in the three months ended January 31, 2010 and $300,000 in the three
months ended January 31, 2009.
Comprehensive Income
Comprehensive income is comprised of net earnings and other
comprehensive income, which includes certain changes in equity that are
excluded from net income. The Company includes unrealized holding gains and
losses on available-for-sale securities as well as changes in the market value
of exchange rate forward contracts designated as cash flow hedges in other
comprehensive income in the Consolidated Statement of Stockholders Equity.
Investments
The Company has classified investments
at January 31, 2010 and October 31, 2009 as either trading or
available-for-sale. Unrealized gains and losses on available-for-sale
securities are reported as accumulated other comprehensive income, which is a
separate component of stockholders equity. Unrealized gains and losses on
trading securities and realized gains and losses on both types of securities
are included in other income as incurred based on the specific identification
method.
The Company periodically evaluates whether any
declines in the fair value of its available-for-sale investments are other than
temporary. This evaluation consists of a
review of several factors, including, but not limited to: length of time and
extent that a security has been in an unrealized loss position; the existence
of an event that would impair the issuers future earnings potential; the near
term prospects for recovery of the market value of a security; the intent of
the Company to sell the impaired security; and whether the Company will be
required to sell the security prior to the anticipated recovery in market
value. Declines in value below cost for
debt securities where it is considered probable that all contractual terms of
the security will be satisfied, where the decline is due primarily to changes
in interest rates (and not because of increased credit risk), and where the
Company does not intend to sell the investment prior to a recovery of amortized
cost, are assumed to be temporary. If management determines that an
other-than-temporary impairment exists, the carrying value of the investment
will be reduced to the current fair value of the investment. An other-than-temporary impairment resulting
from credit-related matters is recognized as a charge in the consolidated
statements of income equal to the amount of the carrying value reduction.
Other-than-temporary impairment write-downs resulting from non-credit-related
matters are recognized in other comprehensive income.
The fair value option for financial assets and liabilities permits an
entity to elect to measure eligible items at fair value (fair value option),
including many financial instruments. The decision to elect the fair value
option is made individually for each instrument and is irrevocable once
made. Changes in fair value for the
selected instruments are recorded in earnings. The Company has elected the fair
value option for the auction rate securities rights agreement (the Put
Agreement), which is recorded within short-term investments at January 31,
2010. The Put Agreement is the only instrument of its nature or type held by
the Company and for which the Company has elected the fair value option. See
Note 3 for further discussion.
7
Table
of Contents
The Company classifies its investments as
either current or long-term based upon the investments contractual maturities
and the Companys ability and intent to convert such instruments to cash within
one year.
Fair
Value of Financial Instruments
The Company considers the carrying cost of its financial assets and
liabilities, which consist primarily of cash and cash equivalents, investments,
accounts receivable, accounts payable, notes payable and long-term debt, to
approximate the fair value of the respective assets and liabilities at January 31,
2010 and October 31, 2009. See Note
4 for further discussion of the Companys fair value measurements.
Patent
Costs
The
Company has filed a number of patent applications in the U.S. and in foreign
countries. Certain external legal and related costs are incurred in connection
with patent applications. If a future economic benefit is anticipated from the
resulting patent or an alternate future use is available to the Company, such
costs are capitalized and amortized over the expected life of the patent. The Company also capitalizes external legal
costs incurred in the defense of its patents when it is believed that the
future economic benefit of the patent will be maintained or increased and a
successful defense is probable. Capitalized patent defense costs are amortized
over the remaining life of the related patent.
Goodwill
and Other Intangible Assets
Goodwill is
tested for impairment annually, on August 1, or more frequently when
events occur or circumstances change that would more likely than not reduce the
fair value of the asset below its carrying amount. The Company operates as one reporting unit
and determines fair value of the reporting unit using the market approach.
Purchased
intangible assets other than goodwill are amortized over their useful lives
unless these lives are determined to be indefinite. The Companys intangible
assets are carried at cost less accumulated amortization. Amortization is
computed over the estimated useful lives of the respective assets, generally
ten to seventeen years.
Impairment
of Long-Lived Assets
The
Company reviews long-lived assets and certain identifiable intangibles for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset
to future undiscounted net cash flows expected to be generated by the asset.
Assets are grouped and evaluated for impairment at the lowest level for which
there is identified cash flows. The
Company deems an asset to be impaired if a forecast of undiscounted cash flows
is less than its carrying amount. The
impairment to be recognized is measured by the amount by which the carrying
amount of assets exceeds the fair value of the assets. The Company generally
measures fair value by discounting projected future cash flows. Assets to be disposed of are reported at the
lower of the carrying amount or fair value less costs to sell.
Recently
Issued Accounting Pronouncements
In December 2007,
the FASB issued Statement No. 141(R), Business Combinations, which has
principally been codified in FASB Accounting Standards Codification (ASC)
Topic 805, Business Combinations (ASC 805).
ASC 805 establishes principles and
requirements for how an acquirer recognizes and measures in its financial
statements the identifiable assets acquired, the liabilities assumed, any
noncontrolling interest in the acquiree and the goodwill acquired. ASC 805 also
establishes disclosure requirements to enable the evaluation of the nature and
financial effects of the business combination. ASC 805 was effective for the
Company beginning with the first quarter of fiscal 2010. As further described
in Note 13, the Company acquired Charter Amerifit LLC and all of its
subsidiaries (Amerifit) in February 2010. The adoption of ASC 805 did
not have a cumulative effect upon adoption; however, ASC 805 will be material
to the Companys financial condition and results of operations. Specifically, the adoption of ASC 805
required the immediate expensing of acquisition-related costs and additional
impacts of ASC 805 are anticipated as the total purchase price is allocated to
Amerifits net tangible and intangible assets based on their estimated fair
values on the date of acquisition.
2.
DSM SUPPLY AND LICENSE AGREEMENT
In July 2009, the
Company entered into the First Amended and Restated ARA Alliance, Purchase, and
Production Agreement (the Restated Agreement) with DSM. The Restated
Agreement, which extends the original supply term through December 31,
2023, amended, consolidated and restated
all existing agreements between the two parties governing the cross-licensing,
purchase, supply and production of ARA. While, subject to certain limited
exceptions, Martek is committed to purchasing all of its ARA requirements from
DSM through the term of the Restated Agreement, the Restated Agreement also set
minimum ARA purchase quantities for Martek in calendar years 2010 and
2011. As of January 31, 2010, the
value of the remaining calendar year 2010 and full calendar year 2011 minimum
purchase requirements are approximately $88.4 million and $87.1 million,
respectively. These minimum purchase quantities approximate the amounts
expected to be procured by Martek in the normal course of business. Under
certain circumstances, either Martek or DSM may terminate the Restated
Agreement after 2012. Upon early termination by Martek, Martek would be
required to make a payment to DSM with the value of such payment decreasing
over the remaining term of the Restated Agreement and being dependent upon
DSMs physical infrastructure at the early termination date. A termination
payment by Martek as of January 1, 2013 would currently range from $15 million
to $20 million and a termination payment as of January 1, 2016 would currently
range from less than $1 million to $7 million.
3. INVESTMENTS
At January 31, 2010 and October 31,
2009, the Company had investments consisting of auction rate securities (ARS),
the underlying assets of which are student loans originated under the Federal
Family Education Loan Program (FFELP).
FFELP student loans are guaranteed by state guarantors who have reinsurance
agreements with the U.S. Department of Education. These ARS are intended to provide liquidity
via an auction process that resets the applicable interest rate approximately
every 30 days and allows the Company to either roll over its holdings or gain
immediate liquidity by selling such investments at par. The underlying
maturities of these investments range from 17 to 38 years. Since February 2008,
as a result of negative conditions in the global credit markets, the large
majority of the auctions for the Companys investment in these securities have
failed to settle, resulting in Martek continuing to hold such securities.
Consequently, the investments are not currently liquid and the Company will not
be able to access these funds, except as noted below, until a future auction of
these investments is successful, a buyer is found outside of the auction
process or the investments reach their contractual maturity date.
While Martek continues to receive interest
payments on these investments involved in failed auctions, the Company believes
that the estimated fair value of these ARS no longer approximates par value.
Such fair value was estimated by the Company and considers, among other items,
the creditworthiness of the issuer, the collateralization underlying the
securities and the timing of expected future cash flows.
8
Table
of Contents
In November 2008, the Company
executed a Put Agreement with a financial institution that provides Martek the
ability to sell certain of its ARS to the financial institution and allows the
financial institution, at its sole discretion, to purchase such ARS at par
during the period June 30, 2010 through July 2, 2012. The Companys
ARS holdings to which this relates have a cost basis of approximately $7.3
million and a fair value at January 31, 2010 of approximately $6.1
million. Upon execution of the Put
Agreement, the Company no longer had the intent or unilateral ability to hold
the ARS covered by the Put Agreement to maturity. Therefore, the Company has classified such
investments as trading. Net gains
associated with these ARS during the three months ended January 31, 2010
were not material. In the three months
ended January 31, 2009, the Company recognized a $1.7 million impairment
charge on these ARS, which was recognized in interest and other income in the
consolidated statements of income. The
impairment charge consisted of $1.0 million of unrealized losses reclassified
from other comprehensive income and $700,000 of unrealized fair value declines
occurring after such reclassification.
The Company has recorded the Put
Agreement at its fair value, which as of January 31, 2010 is approximately
$1.2 million. The Company elected to adopt the fair value option for the Put
Agreement
so that future changes in the
fair value of this asset will largely offset the fair value movements of the
related ARS. The Company believes that the accounting for the Put Agreement
will then match its purpose as an economic hedge to the changes in the fair
value of the related ARS. The ability of the Put Agreement to act as an
economic hedge is
subject to the continued expected performance by the
financial institution of its obligations under the agreement. The fair value of
the Put Agreement considers, among other things, the creditworthiness of the
issuer and the liquidity of the financial instrument. Due to the Companys intent to sell its ARS
covered by the Put Agreement to the financial institution on June 30,
2010, the fair value of such ARS along with the fair value of the Put Agreement
are classified as short-term investments in the accompanying consolidated
balance sheet as of January 31, 2010.
Net losses associated with the Put Agreement during the three months
ended January 31, 2010 were not material.
In the three months ended January 31, 2009, the Company recognized
a gain of $1.6 million related to the Put Agreement, which was recognized in
interest and other income in the consolidated statements of income.
As of January 31, 2010, the
Companys ARS holdings not covered by the Put Agreement have a cost basis of
approximately $5.6 million and a fair value of approximately $4.6 million. The
total decline in fair value of $1.0 million has been recorded as a net
reduction to other comprehensive income. The Company believes that the
unrealized losses on these ARS are temporary.
In making this determination, Martek primarily considered the financial
condition of the issuers, collateralization underlying the securities, the
intent of the Company to sell the impaired security, and whether the Company
will be required to sell the security prior to the anticipated recovery in
market value. The Company continues to
monitor the market for ARS and consider its impact, if any, on the fair value
of these investments. If the Company determines that any valuation adjustment
is other than temporary, the Company would record an impairment charge to
earnings.
Due
to the underlying maturities of these investments and the Companys belief that
the market for the ARS not covered by the Put Agreement may take in excess of
twelve months to fully recover, the fair value of such ARS is classified as
long-term investments in the accompanying consolidated balance sheet as of January 31,
2010. Net unrealized gains associated
with these ARS during the three months ended January 31, 2010 were not
material. In the three months ended January 31,
2009, the Company recognized $900,000 as a reduction to other comprehensive
income related to the temporary unrealized losses for the Companys ARS not
covered by the Put Agreement.
4. FAIR VALUE MEASUREMENTS
The Company has adopted the provisions of
guidance codified as ASC Topic 820, Fair Value Measurements and Disclosures (ASC
820) for financial instruments. ASC 820 defines fair value, establishes a fair
value hierarchy for assets and liabilities measured at fair value and requires
expanded disclosures about fair value measurements. The ASC 820 hierarchy ranks the quality and
reliability of inputs, or assumptions, used in the determination of fair value
and requires assets and liabilities carried at fair value to be classified and
disclosed in one of the following three categories:
Level 1 quoted
prices in active markets for identical assets and liabilities;
Level 2 inputs
other than Level 1 quoted prices that are directly or indirectly observable;
and
Level 3 unobservable
inputs that are not corroborated by market data.
The Company
evaluates financial assets and liabilities subject to fair value measurements
on a recurring basis to determine the appropriate level at which to classify
them for each reporting period. This determination requires highly subjective
judgments as to the significance of inputs used in determining fair value and
where such inputs lie within the ASC 820 hierarchy.
9
Table
of Contents
As of January 31,
2010, the Company held certain assets that are required to be measured at fair
value on a recurring basis. These financial assets were as follows
(in thousands):
|
|
As of January 31, 2010
|
|
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Balance
|
|
|
|
|
|
|
|
|
|
|
|
Available-for-sale
securities (1)
|
|
$
|
|
|
$
|
|
|
$
|
4,556
|
|
$
|
4,556
|
|
Trading securities (2)
|
|
|
|
|
|
6,088
|
|
6,088
|
|
Put Agreement(2)
|
|
|
|
|
|
1,190
|
|
1,190
|
|
Investments in money
market funds (3)
|
|
109,173
|
|
|
|
|
|
109,173
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
109,173
|
|
$
|
|
|
$
|
11,834
|
|
$
|
121,007
|
|
(1) Included
in long-term investments in the accompanying consolidated balance sheets.
(2) Included
in short-term investments in the accompanying consolidated balance sheets.
(3) Included
in cash and cash equivalents in the accompanying consolidated balance sheets.
The table below
provides a reconciliation of the beginning and ending balances of the Companys
investments measured at fair value using significant unobservable inputs (Level
3) for the three months ended January 31, 2010 and 2009 (in thousands):
|
|
Auction Rate
Securities
|
|
Put Agreement
|
|
Total
|
|
|
|
|
|
|
|
|
|
Balance on November 1, 2009
|
|
$
|
10,575
|
|
$
|
1,221
|
|
$
|
11,796
|
|
|
|
|
|
|
|
|
|
Transfers to/(from)
Level 3
|
|
|
|
|
|
|
|
Total gains (losses)
(realized or unrealized): (1)
|
|
|
|
|
|
|
|
Included in earnings
|
|
58
|
|
(31
|
)
|
27
|
|
Included in other
comprehensive income
|
|
61
|
|
|
|
61
|
|
Purchases, sales,
issuances and settlements, net
|
|
(50
|
)
|
|
|
(50
|
)
|
|
|
|
|
|
|
|
|
Balance on
January 31, 2010
|
|
$
|
10,644
|
|
$
|
1,190
|
|
$
|
11,834
|
|
(1) See Note 3 for discussion of Auction Rate
Securities and related Put Agreement.
|
|
Auction Rate
Securities
|
|
Put Agreement
|
|
Total
|
|
|
|
|
|
|
|
|
|
Balance on November 1, 2008
|
|
$
|
11,336
|
|
$
|
|
|
$
|
11,336
|
|
|
|
|
|
|
|
|
|
Transfers to/(from)
Level 3
|
|
|
|
|
|
|
|
Total gains (losses)
(realized or unrealized): (1)
|
|
|
|
|
|
|
|
Included in earnings
|
|
(1,717
|
)
|
1,588
|
|
(129
|
)
|
Included in other
comprehensive income
|
|
103
|
|
|
|
103
|
|
Purchases, sales,
issuances and settlements, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance on
January 31, 2009
|
|
$
|
9,722
|
|
$
|
1,588
|
|
$
|
11,310
|
|
(1) See
Note 3 for discussion of Auction Rate Securities and related Put Agreement.
10
Table
of Contents
Some of the inputs into the discounted cash
flow models from which the Company bases its Level 3 valuations for the ARS and
Put Agreement are unobservable in the market and have a significant effect on
valuation. The assumptions used in preparing the models include, but are not
limited to, periodic coupon rates, market required rates of return, the
expected term of each security and the credit-adjusted rate of the counterparty
to the Put Agreement. The coupon rate was estimated using implied forward rate
data on interest rate swaps and U.S. Treasuries, and limited where necessary by
any contractual maximum rate paid under a scenario of continuing auction
failures. Assumptions regarding required rates of return were based on
risk-free interest rates and credit spreads for investments of similar credit
quality. The expected term for the ARS was based on a weighted
probability-based estimate of the time the principal will become available to
the Company. The expected term for the Put Agreement was based on the earliest
date on which the Company can exercise the Put Agreement rights.
5. INVENTORIES
Inventories
consist of the following (in thousands):
|
|
January 31,
|
|
October 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Finished goods
|
|
$
|
64,048
|
|
$
|
56,203
|
|
Work in process
|
|
46,832
|
|
56,501
|
|
Raw materials
|
|
3,126
|
|
3,475
|
|
|
|
|
|
|
|
Inventories, net
|
|
$
|
114,006
|
|
$
|
116,179
|
|
Inventory
levels are evaluated by management based upon anticipated product demand,
shelf-life, future marketing plans and other factors. Reserves for obsolete and slow-moving
inventories are recorded for amounts that may not be realizable.
6. PROPERTY, PLANT AND EQUIPMENT
Property,
plant and equipment consists of the following (in thousands):
|
|
January 31,
|
|
October 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Land
|
|
$
|
2,320
|
|
$
|
2,320
|
|
Building and improvements
|
|
68,057
|
|
67,094
|
|
Machinery and equipment
|
|
266,806
|
|
266,257
|
|
Furniture and fixtures
|
|
3,116
|
|
3,094
|
|
Computer hardware and software
|
|
17,332
|
|
17,220
|
|
|
|
357,631
|
|
355,985
|
|
Less: accumulated depreciation and amortization
|
|
(119,294
|
)
|
(113,437
|
)
|
|
|
238,337
|
|
242,548
|
|
Construction in progress
|
|
11,894
|
|
9,731
|
|
|
|
|
|
|
|
Property, plant and equipment, net
|
|
$
|
250,231
|
|
$
|
252,279
|
|
Assets
available for commercial use that were not in productive service had a net book
value of $32.9 million and $34.4 million at January 31, 2010 and October 31,
2009, respectively. Depreciation as well
as certain other fixed costs related to such idle assets is recorded as cost of
product sales in the accompanying consolidated statements of income.
11
Table
of Contents
7. GOODWILL AND OTHER INTANGIBLE ASSETS
Intangible
assets and related accumulated amortization consist of the following (in
thousands):
|
|
January 31, 2010
|
|
October 31, 2009
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
Accumulated
|
|
|
|
Intangible Asset
|
|
Gross
|
|
Amortization
|
|
Net
|
|
Gross
|
|
Amortization
|
|
Net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trademarks
|
|
$
|
2,219
|
|
$
|
(1,045
|
)
|
$
|
1,174
|
|
$
|
2,202
|
|
$
|
(1,004
|
)
|
$
|
1,198
|
|
Patents
|
|
26,875
|
|
(9,996
|
)
|
16,879
|
|
25,732
|
|
(9,046
|
)
|
16,686
|
|
Core technology
|
|
1,708
|
|
(826
|
)
|
882
|
|
1,708
|
|
(797
|
)
|
911
|
|
Current products
|
|
10,676
|
|
(5,541
|
)
|
5,135
|
|
10,676
|
|
(5,363
|
)
|
5,313
|
|
Licenses and other
|
|
23,191
|
|
(5,389
|
)
|
17,802
|
|
23,191
|
|
(4,668
|
)
|
18,523
|
|
|
|
64,669
|
|
(22,797
|
)
|
41,872
|
|
63,509
|
|
(20,878
|
)
|
42,631
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
51,592
|
|
|
|
51,592
|
|
51,592
|
|
|
|
51,592
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
116,261
|
|
$
|
(22,797
|
)
|
$
|
93,464
|
|
$
|
115,101
|
|
$
|
(20,878
|
)
|
$
|
94,223
|
|
In
February 2009, Martek entered into a license agreement with an international
food company for certain patented technology expected to be used in the
production of Marteks
lifesDHA
for
certain applications. Under the agreement, Martek was granted a perpetual and
generally exclusive license to the technology. As consideration for this
license, Martek paid an upfront license fee of $1.0 million and will pay,
subject to the successful completion by the licensor of certain development
goals related to the licensed technology, additional fees of up to
approximately $5.0 million. In addition, Martek will be required to pay
royalties of up to 4.5% of sales of products produced using the licensed
technology, including certain minimum royalty payments of approximately $2.0
million, the timing of which is also subject to the successful completion of
the development goals. The license fees
paid in connection with this arrangement are being amortized over 10
years.
Most of
the amortization associated with the Companys intangible assets is reflected
in amortization of intangible assets in the accompanying consolidated
statements of income. Included in
amortization of intangible assets is approximately $1.2 million in the three
months ended January 31, 2010 and approximately $1.6 million in the three
months ended January 31, 2009 related to assets supporting the Companys
commercial products and approximately $200,000 in the three months ended January 31,
2010 and January 31, 2009 related to assets supporting the Companys
research and development initiatives.
8. NOTES PAYABLE AND LONG-TERM DEBT
In January 2010, the Company entered into
a Credit Agreement (the Credit Agreement) that includes a $75 million term
loan (the Term Loan) and a $50 million secured revolving credit facility (the
Revolver). The Credit Agreement
replaced the existing $135 million credit facility (the Former Facility). The
proceeds from the Term Loan were received by, and the funds under the Revolver
became available to, Martek on February 12, 2010, coincident with the
closing of the Companys acquisition of Amerifit (see further discussion in
Note 13).
The Term Loan and the Revolver are
collateralized by certain of the Companys and its subsidiaries assets,
including accounts receivable, deposit accounts, inventory and certain
software, general intangibles and records pertaining to the foregoing as well
as a pledge of 100% of its domestic subsidiaries equity. The Revolver, which may be increased
during the term of the facility by up to an additional $50 million subject to
certain conditions, expires in February 2013. The Term Loan matures
in February 2013. Martek is required to make quarterly installment payments
on the Term Loan of $3,750,000 beginning April 2010 plus additional annual
repayments on January 31 of each year based on consolidated excess cash
flow, as defined in the Credit Agreement, of the preceding fiscal year.
The Term Loan will bear interest at the
election of Martek at either LIBOR plus up to 3.375% or a base rate plus up to
1.25% depending upon the consolidated leverage ratio during each preceding
fiscal quarter. The Revolver will bear interest at the election of Martek at
either LIBOR plus up to 3.00% or a base rate plus up to 1.00% depending upon
the consolidated leverage ratio during each preceding fiscal quarter. The
base rate is the higher of the lenders prime rate, the federal funds rate plus
0.50% or LIBOR plus 1.50%. LIBOR is the greater of 1.50% per annum or
LIBOR at the time of such determination
.
There were no amounts outstanding under the
Former Facility in the three months ended January 31, 2010. The
weighted average annual commitment fee rate on unused amounts was approximately
0.1% for the three months ended January 31, 2010 and 2009, all of which
was applicable to the Former Facility. The commitment fee rate under the
Credit Agreement of up to 0.50% on the Revolver is based on the Companys
consolidated leverage ratio during each preceding fiscal quarter. Among other
things, the Credit Agreement contains restrictions on future debt, the payment
of dividends and the further encumbrance of assets. In addition, the Credit
Agreement requires that the Company comply with specified financial ratios and
tests, including minimum coverage ratios and maximum leverage ratios.
In connection with the January 2010
financing, the Company incurred debt issuance costs totaling approximately $3.3
million. Such amounts were allocated to the Term Loan and the Revolver on a
pro-rata basis. Amounts allocated to the Term Loan are amortized using the
effective interest method and amounts allocated to the Revolver are amortized
using the straight-line method.
12
Table
of Contents
The
carrying amounts of notes payable at January 31, 2010 and October 31,
2009 approximate their fair values based on instruments of similar terms
available to the Company.
9. COMMITMENTS AND CONTINGENCIES
Scientific
Research Collaborations
The
Company has entered into various collaborative research and license agreements
for its algal technology. Under these agreements, the Company is required to
fund research or to collaborate on the development of potential products.
Certain of these agreements also commit the Company to pay royalties upon the
sale of certain products resulting from such collaborations.
In May 2008,
the Company entered into a collaboration agreement with a global biotechnology
company to jointly develop and commercialize a canola seed that produces
DHA. Martek and its co-collaborator
anticipate a multi-year effort to produce this oil. The Companys financial
commitments associated with this development initiative are subject to the
successful completion of identified milestones.
As of January 31, 2010, the Companys financial commitment,
primarily through internal research efforts, to the first projected milestone
date totals approximately $500,000. Commitments
thereafter, also primarily through internal research efforts, assuming
successful achievement of all identified milestones, total approximately $5.6
million.
In August 2009,
the Company entered into a collaboration agreement with BP for the joint
development of biofuels from microbial oils. Under the terms of the agreement,
Martek and BP will work together to establish proof of concept for large-scale,
cost-effective microbial biodiesel production through fermentation. In
connection with this agreement, BP has agreed to contribute up to $10 million
to the initial phases of the collaboration, which utilizes Marteks significant
expertise in microbial oil production and BPs production and commercialization
experience in biofuels as the platform for the joint development effort. Martek
will perform the biotechnology research and development associated with the
initial phases and receive fees from BP for such efforts. All intellectual property owned prior to the
execution of the collaboration agreement will be retained by each respective
company, and all intellectual property developed during the collaboration
period will be owned by BP, with an exclusive license to Martek for
commercialization in nutrition, cosmetic and pharmaceutical applications.
Additionally, each party is entitled to certain commercial payments from the
counterparty for commercialization of the technology in the other partys
fields of use.
Patent
Infringement Litigation
In September 2003, the Company filed a patent infringement lawsuit in the
U.S. District Court in Delaware against Nutrinova Nutrition Specialties &
Food Ingredients GmbH (Nutrinova) and others alleging infringement of certain
of our U.S. patents. In December 2005,
Nutrinovas DHA business was sold to Lonza Group LTD, a Swiss chemical and
biotechnology group, and the parties agreed to add Lonza to the U.S.
lawsuit. In October 2006, the
infringement action in the United States was tried, and a verdict favorable to
Martek was returned. The jury found that
the defendants infringed all the asserted claims of three Martek patents and
that these patents were valid. It also
found that the defendants willfully infringed one of these patents. In October 2007, the judge upheld the October 2006
jury verdict that the defendants infringed all of the asserted claims of U.S.
Patent Nos. 5,340,594 and 6,410,281 and that these patents were not invalid.
The judge has granted a permanent injunction against the defendants with
respect to those two patents. The judge
also upheld the jury verdict that the defendants had acted willfully in their
infringement of U.S. Patent No. 6,410,281. Regarding the third
patent involved in the case, U.S. Patent No. 6,451,567, the judge reversed
the jury verdict and found that the asserted claims of this patent were
invalid. Marteks request to the judge
to reconsider his ruling on the third patent was denied. Martek and the defendants appealed aspects of
the judges final decision and a hearing was held before the U.S. Court of
Appeals in April 2009. In September 2009,
the Court of Appeals ruled in Marteks favor on all of the patents that were
the subject of the appeal, which included U.S. Patent Nos. 5,340,594,
6,410,281, 6,451,567 noted above and 5,698,244, which was included in Marteks
appeal as a result of the trial courts decision at a pre-trial hearing on the
meaning and scope of the patent claims in dispute. With respect to U.S. Patent No. 5,698,244,
the Court of Appeals reversed the trial courts interpretation of certain claim
language and remanded this patent to the trial court for further
proceedings. U.S. Patent Nos. 5,340,594
and 6,454,567 have expired and U.S. Patent Nos. 6,410,281 and 5,698,244 are
scheduled to expire in August 2011 and December 2014,
respectively. The defendants requested a
rehearing with the Court of Appeals on the decision, but their request was
denied. Additionally, the defendants
have requested reexamination of U.S. Patent Nos. 6,410,281 and 5,698,244
in the U.S. Patent and Trademark Office.
In January 2004,
the Company filed a patent infringement lawsuit in Germany against Nutrinova
and Celanese Ventures GmbH. Lonza Ltd.
and a customer of Nutrinova have also been added to this lawsuit. The complaint alleges infringement of Marteks
European patent relating to DHA-containing oils. A hearing was held in a district court in
Dusseldorf in September 2007 and the court issued its decision in October 2007,
ruling that Marteks patent was infringed by the defendants. The defendants have appealed, and the appeal
is expected to be heard in 2010 or 2011.
This patent is scheduled to expire in February 2011.
In
connection with these patent lawsuits, the Company has incurred and capitalized
significant external legal costs. As of January 31, 2010, the patents
being defended in the Lonza matter had a net book value of approximately $4.1
million, including capitalized legal costs, which is being amortized over a
weighted average remaining period of approximately five years. This amount is subject to future impairment,
in whole or in part, pending the outcome of these patent lawsuits.
These lawsuits are further described in Item
1. Legal Proceedings of Part II of this Form 10-Q.
Other
The Company is
involved in various other legal actions.
Management believes that these actions, either individually or in the
aggregate, will not have a material adverse effect on the Companys results of
operations or financial condition.
13
Table
of Contents
10. STOCKHOLDERS EQUITY
The Company recognized approximately $900,000
in the three months ended January 31, 2010 and approximately $800,000 in
the three months ended January 31, 2009 in compensation cost related to
employee stock plans. Such costs were
recorded approximately 75%, 15% and 10% as selling, general and administrative
expenses, research and development expenses and cost of revenues, respectively,
in all periods.
The Company granted 384,926 restricted stock
units during the three months ended January 31, 2010, which generally vest
over 62 months from the date of grant.
The total fair value of the restricted stock units granted of $7.2
million was based on fair market value on the date of grant.
As of January 31, 2010, there was
approximately $18.1 million remaining in unrecognized compensation cost related
to restricted stock units. The cost is expected to be recognized through fiscal
2015 with a weighted average recognition period of approximately two years.
Unrecognized compensation cost related
to unvested stock options as of January 31, 2010 is not material.
11. NET INCOME PER SHARE
Basic
net income per share is computed using the weighted average number of common
shares outstanding. Diluted net income per share is computed using the weighted
average number of common shares outstanding, giving effect to stock options and
restricted stock units using the treasury stock method.
The
following table presents the calculation of basic and diluted net income per
share (in thousands, except per share amounts):
|
|
Three
months ended January 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Net income
|
|
$
|
9,643
|
|
$
|
9,606
|
|
|
|
|
|
|
|
Weighted average shares outstanding, basic
|
|
33,276
|
|
33,150
|
|
Effect of dilutive potential common shares:
|
|
|
|
|
|
Stock options
|
|
48
|
|
152
|
|
Restricted stock units
|
|
130
|
|
97
|
|
Total dilutive potential common shares
|
|
178
|
|
249
|
|
Weighted average shares outstanding, diluted
|
|
33,454
|
|
33,399
|
|
|
|
|
|
|
|
Net income per share, basic
|
|
$
|
0.29
|
|
$
|
0.29
|
|
Net income per share, diluted
|
|
$
|
0.29
|
|
$
|
0.29
|
|
Stock
options to purchase approximately 2.1 million shares were outstanding but were
not included in the computation of diluted net income per share for the three
months ended January 31, 2010, and stock options to purchase approximately
1.8 million shares were outstanding but were not included in the computation of
diluted net income per share for the three months ended January 31, 2009,
because the effects would have been antidilutive.
14
Table
of Contents
12. COMPREHENSIVE INCOME
Comprehensive
income and its components for the three months ended January 31, 2010 and
2009 were as follows (in thousands):
|
|
Three months ended January 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Net income, as reported
|
|
$
|
9,643
|
|
$
|
9,606
|
|
|
|
|
|
|
|
Other comprehensive income (loss):
|
|
|
|
|
|
Reclassification of available-for-sale securities,
net of tax of $ and $383, respectively
|
|
|
|
646
|
|
Unrealized gain (loss) on available-for-sale
securities, net of tax of $22 and $(344), respectively
|
|
38
|
|
(582
|
)
|
Realized loss on exchange rate forward contracts, net
of tax of $ and $436, respectively
|
|
|
|
735
|
|
Unrealized gain on exchange rate forward contracts,
net of tax of $ and $48, respectively
|
|
|
|
208
|
|
|
|
|
|
|
|
Comprehensive income
|
|
$
|
9,681
|
|
$
|
10,613
|
|
13. SUBSEQUENT EVENT ACQUISITION OF CHARTER
AMERIFIT LLC
On February 12, 2010, Martek completed
the acquisition of the Charter Amerifit LLC and all of its subsidiaries (Amerifit).
Amerifit develops, markets and distributes branded consumer health and wellness
products and holds leading brand positions in all of its key product
categories. Amerifit products are sold in most major mass, club, drug, grocery
and specialty stores and include: Culturelle®, a leading probiotic supplement;
AZO®, the leading OTC brand addressing symptom relief, detection and prevention
of urinary tract infections; and ESTROVEN®, the leading all-natural nutritional
supplement brand addressing the symptoms of menopause.
Upon the closing of the acquisition, Martek
paid for the benefit of Amerifits equity holders total cash consideration of
approximately $201 million, net of cash acquired, of which amount $27 million
was placed into an escrow that secures certain post-closing adjustment
obligations and certain indemnification obligations. The consideration
included approximately $1 million related to the effects of the preliminary
determinations of Amerifits net debt level and net working capital, both of
which are subject to adjustment based on the final determinations of Amerifits
net debt level and net working capital at closing. To finance the Amerifit acquisition, Martek
utilized existing cash of approximately $115 million along with the proceeds
from the $75 million Term Loan and $11 million drawn from the Revolver. See Note 8 for additional discussion of these
debt instruments.
In addition to the Companys expectation that
the Amerifit acquisition will be financially accretive, Martek expects to be
able to use Amerifits marketing platform to commercialize and distribute the
nutritional health and wellness products that Martek is currently developing.
Under the acquisition method of accounting,
the total purchase price will be allocated to Amerifits net tangible and
intangible assets based on their estimated fair values as of the February 12,
2010 closing date of the acquisition. The final purchase price will be
determined following completion of the closing balance sheet and post-closing
adjustments and valuation report of acquired intangible assets. Martek has made
a preliminary allocation of the estimated purchase price using estimates. We
are in the process of completing our assessment of the fair value of the assets
acquired and liabilities assumed and finalizing our calculation of the final
purchase price. The completion of the valuation report of acquired intangible
assets and final purchase price may result in material revisions to the fair
values noted below.
The table below summarizes the preliminary
estimated fair values of assets acquired and liabilities assumed based on
managements current best estimates.
15
Table
of Contents
(In thousands)
|
|
|
|
|
|
|
|
Assets
|
|
|
|
Current assets
|
|
$
|
20,800
|
|
Identifiable intangible assets
|
|
112,600
|
|
Property, equipment and other long-term assets
|
|
3,000
|
|
|
|
|
|
Total identifiable assets acquired
|
|
136,400
|
|
|
|
|
|
Liabilities
|
|
|
|
Current liabilities
|
|
(
10,400
|
)
|
Deferred tax liability
|
|
(34,200
|
)
|
Other liabilities
|
|
(3,400
|
)
|
|
|
|
|
Total liabilities assumed
|
|
(48,000
|
)
|
|
|
|
|
Net identifiable assets acquired
|
|
88,400
|
|
Goodwill
|
|
112,600
|
|
|
|
|
|
Net assets acquired
|
|
$
|
201,000
|
|
16
Table
of Contents
Item
2. Managements Discussion and Analysis
of Financial Condition and Results of Operations.
This Managements Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements concerning our
business and operations, including, among other things, statements concerning
the following:
·
expectations regarding future revenue,
revenue growth, gross margin, operating cash flow and profitability of Martek
and its newly-acquired subsidiary, Charter Amerifit LLC and all of its
subsidiaries (Amerifit);
·
expectations regarding product introductions
and growth in nutritional product sales;
·
expectations regarding Marteks
ability to use the marketing platform of Amerifit to commercialize products
under development;
·
expectations regarding potential
collaborations and acquisitions;
·
expectations regarding demand for products
with our nutritional oils;
·
expectations regarding sales to and by our
infant formula customers and supplemented infant formula market penetration
levels;
·
expectations regarding marketing of our oils
by our infant formula customers;
·
expectations regarding future agreements
with, and revenues from, companies in the food and beverage, pregnancy and
nursing, nutritional supplement and animal feed markets;
·
expectations regarding future revenues from
contract manufacturing customers;
·
expectations regarding future revenues from
collaborations;
·
expectations regarding growing consumer
recognition of the key health benefits of DHA and ARA;
·
expectations regarding competitive products;
·
expectations regarding future efficiencies
and improvements in manufacturing processes and the cost of production of our
nutritional oils;
·
expectations regarding future purchase
volumes and costs of third-party manufactured oils;
·
expectations regarding the amount of
production capacity and our ability to meet future demands for our nutritional
oils;
·
expectations regarding the amount of
inventory held by us or our customers;
·
expectations regarding production capacity
utilization and the effects of excess production capacity;
·
expectations regarding future selling, general
and administrative and research and development costs;
·
expectations regarding future capital
expenditures;
·
expectations regarding levels of consumption
through governmental programs of infant formula products containing our
nutritional oils; and
·
expectations regarding our ability to
maintain and protect our intellectual property.
Forward-looking statements include those statements containing words
such as the following:
·
will,
·
should,
·
could,
·
anticipate,
·
believe,
·
plan,
·
estimate,
·
expect,
·
intend, and other similar expressions.
All of these forward-looking statements involve risks and
uncertainties. They and other forward-looking statements in this Form 10-Q
are all made pursuant to the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. We wish to caution you that our actual results
may differ significantly from the results we discuss in our forward-looking
statements. We discuss some of the risks that could cause such differences in Part II,
Item 1A. Risk Factors in this report on Form 10-Q and in our various
other filings with the Securities and Exchange Commission. Our forward-looking statements speak only as
of the date of this document, and we do not intend to update these statements
to reflect events or circumstances that occur after that date.
GENERAL
Martek was founded in 1985. We are a leader in
the innovation, development, production and sale of high-value products from
microbial sources that promote health and wellness through nutrition. Our technology platform consists of our core
expertise, broad experience and proprietary technology in areas such as
microbial biology, algal genomics, fermentation and oil processing. This technology platform has resulted in our
development of a number of products including our flagship product,
lifesDHA
, a sustainable and vegetarian source of algal DHA
(docosahexaenoic acid) important for brain, heart and eye health throughout
life for use in infant formula, pregnancy and nursing products, foods and
beverages and dietary supplements. We also produce
lifesARA
(arachidonic acid), an omega-6 fatty acid, for use in infant formula and
growing-up milks. On February
17
Table
of Contents
12, 2010, we acquired Amerifit. Amerifit develops, markets and distributes
branded consumer health and wellness products and holds leading brand positions
in all of its key product categories. Amerifit products are sold in most major
mass, club, drug, grocery and specialty stores and include: Culturelle®, a
leading probiotic supplement; AZO®, the leading OTC brand addressing symptom
relief, detection and prevention of urinary tract infections; and ESTROVEN®,
the leading all-natural nutritional supplement brand addressing the symptoms of
menopause. We currently have a number of nutritional health and wellness
products under development that we plan to commercialize and distribute through
Amerifits marketing platform. See Recent Highlights below for further
discussion of Amerifit.
We sell
oils containing these fatty acids as
lifesDHA
,
DHASCO®, Neuromins®, ARASCO® and
lifesARA
. We
derive DHA from microalgae and ARA from fungi, using proprietary
processes. Cell membranes throughout the
body contain these fatty acids, and they are particularly concentrated in the
brain, central nervous system, retina and heart. Research has shown that DHA and ARA may
enhance mental and visual development in infants. In addition, research has shown that DHA may
play a pivotal role in brain function throughout life and may reduce the risk
of cardiovascular disease. Low levels of DHA in adults have been linked to a
variety of health risks, including Alzheimers disease, dementia,
cardiovascular problems and various other neurological and visual disorders.
Further research is underway to assess the role of supplementation with our DHA
on mitigating a variety of health risks.
We are
supplying over 35 infant formula customers with our nutritional oils. These companies collectively represent
approximately 75% of the estimated $15 billion worldwide retail market for
infant formula and nearly 100% of the estimated $4.5 billion U.S. retail market
for infant formula, including the retail value of Women, Infants and Children
program (WIC) rebates. WIC is a federal grant program administered by the
states for the benefit of low-income, nutritionally at-risk women, infants and
children. Our customers include infant
formula market leaders Mead Johnson Nutritionals, Nestle, Abbott Nutrition,
Pfizer and Danone, each of whom is selling infant formula supplemented with our
nutritional oils. Our customers are now
selling infant formula products containing our oils collectively in over 75
countries. Supplemented infant formulas
from Mead Johnson Nutritionals, Abbott Nutrition, PBM Products, Nestle, Hain
Celestial and Nutricia North America are currently being sold in the United
States. In addition, certain infant formula customers are selling products in
the United States and abroad that contain our nutritional oils and target the
markets for children ages nine months to seven years of age and older.
We are
currently marketing and selling
lifesDHA,
either
directly or through distributors, for food and beverage, supplement and animal
feed applications to both U.S. and international companies. To date, over 200
domestic and international companies have launched non-infant formula products
that contain
lifesDHA
, most of which remain
on the market. Certain of our DHA
license and supply agreements with major consumer food products companies
establish Martek, subject to certain exceptions, as their exclusive supplier of
DHA for minimum periods of time. Certain
of these agreements establish the customer as the exclusive customer of
lifesDHA
in a particular food or beverage category or
categories or geographic region. We,
along with our customers and certain third parties, are developing other DHA
delivery methods, including powders and emulsions, to facilitate further entry
into the non-infant formula markets.
Management believes that over the next few years, the non-infant formula
markets will continue to expand and could ultimately represent a larger
opportunity than infant formula.
Although
we anticipate future growth in annual sales of our nutritional oils, we are
likely to continue to experience quarter-to-quarter and year-to-year
fluctuations in our future operating results, some of which may be significant.
The timing and extent of future oils-related revenues are largely dependent
upon the following factors:
·
the timing of international infant formula market
introductions by our customers;
·
the timing of our customers ordering patterns;
·
the timing and extent of stocking and de-stocking of
inventory by our customers;
·
the timing and extent of our customers production campaigns
and plant maintenance shutdowns;
·
the timing and extent of introductions of DHA into various
child and/or adult applications and the marketplace success of such
applications;
·
the levels of inclusion of our oils in infant formula;
·
the continued acceptance, and extent thereof, of products
containing our oils under WIC and other regulatory programs in the U.S.;
·
the continued acceptance of these products by consumers and
continued demand by our customers;
·
the ability of our customers to incorporate our oils into
various foods and beverages;
·
our ability to protect against competitive products through
our patents;
·
competition from alternative sources of DHA and ARA; and
·
agreements with other future third-party collaborators to
market our products or develop new products.
As
such, the likelihood, timing and extent of future profitability are largely
dependent on factors such as those mentioned above, as well as others, over
which we have limited or no control.
RECENT HIGHLIGHTS
·
Acquisition
of Charter Amerifit LLC
On February 12, 2010, we completed the
acquisition of Amerifit. Amerifit develops, markets and distributes branded
consumer health and wellness products and holds leading brand positions in all
of its key product categories. Amerifit
18
Table
of Contents
products are sold in most major mass, club, drug, grocery and specialty
stores and include: Culturelle®, a leading probiotic supplement; AZO®, the
leading OTC brand addressing symptom relief, detection and prevention of
urinary tract infections; and ESTROVEN®, the leading all-natural nutritional
supplement brand addressing the symptoms of menopause.
Upon the closing of the
acquisition, we paid for the benefit of Amerifits equity holders total cash
consideration of approximately $201 million, net of cash acquired, of which
amount $27 million was placed into an escrow that secures certain post-closing
adjustment obligations and certain indemnification obligations. The
consideration included approximately $1 million related to the effects of the
preliminary determinations of Amerifits net debt level and net working
capital, both of which are subject to adjustment based on the final
determinations of Amerifits net debt level and net working capital at
closing. To finance the Amerifit
acquisition, we utilized existing cash of approximately $115 million along with
the proceeds from the $75 million Term Loan and $11 million drawn from the
Revolver. See Note 8 to the consolidated
financial statements for additional discussion of these debt instruments.
In addition to our
expectation that the Amerifit acquisition will be financially accretive, we
expect to be able to use Amerifits marketing platform to commercialize and
distribute the nutritional health and wellness products that we are currently
developing.
·
Non-Infant
Formula Product Launches
Products with Marteks
life
s
DHA
were recently launched in the United States including Natelle®One (Azur Pharma
Ltd) prescription prenatal vitamin with
250 mg
lifesDHA,
Algal-900 DHA Softgels
(CVS/Pharmacy®) with 900 mg
lifesDHA,
Spring Valley® Algal-900 DHA (Wal-Mart) with 900 mg
lifesDHA,
Horizon Organic Lowfat Chocolate Milk Plus DHA Omega-3 (WhiteWave Foods), Sara
Lee® Soft & Smooth Plus Bread (Sara Lee) and Francesco Rinaldi® ToBe
Healthy pasta sauces (LiDestri Foods).
·
Extension
of
Danone Multi-Year Sole-Source
License and Supply Agreement
In March 2010, Martek announced
that it has extended its multi-year sole-source license and supply agreement
with Danone, a leading worldwide producer of infant nutrition products. Under the terms of the amended agreement,
Martek will be Danones exclusive supplier of ARA for all of its infant formula
and growing-up milk products through at least December 31, 2014, which is
an extension of Marteks current exclusive ARA supply position with Danone by
three years. As with the current
agreement, Danone may continue to use non-microbial DHA sources. In most cases, Martek will continue to serve
as Danones global supplier for its microbially-derived DHA needs for infant
formula. This is an amendment to the 2007 agreement between Martek and Numico
and contains certain limited termination rights. Martek has supplied DHA and ARA to Numico,
which was acquired by Danone in 2008, for infant formula products since 1994.
·
New
Scientific Data Published on DHA and ARA
The benefits of DHA and ARA
supplementation were recently discussed in the following publications:
·
The
American Journal of Clinical Nutrition
(online, February 2010)
published results of a study investigating DHA supplementation on brain
function. Thirty-three healthy boys, 8-10 years of age, were supplemented
with 400 or 1200 mg/day DHA or placebo for 8 weeks and tested during an
activity of continuous performance. The results showed that the DHA level
in red blood cells was positively correlated with brain function and inversely
correlated with reaction time during the activity. These results demonstrate
the important role that DHA plays in regulation of brain activity. Martek
provided financial support and
lifesDHA
for
this study.
·
The
American Journal of Clinical Nutrition
(online, February 2010)
published the results of a study in which 343 term infants were fed
formula containing no long-chain polyunsaturated fats or formula supplemented
with 0.32% DHA, 0.64% DHA, or 0.96% DHA throughout the first year of
life. All DHA-supplemented formula also contained 0.64% ARA. Visual
evoked potential (VEP) was measured at 1.5, 4, 9, and 12 months. At 12
months, all DHA-supplemented infants scored significantly better in VEP visual
acuity than those given an unsupplemented formula. There were also no
significant differences in VEP visual acuity between the three DHA-supplemented
groups. The authors state that these subtle changes in vision are important
because they suggest diet-related modifications in the developmental course of
structure and function in the brain and/or retina and that dietary supply of
DHA during infancy may have long-lasting effects on brain function. Marteks
lifesDHA
and
lifesARA
were used in the study.
PRODUCTION
We
manufacture oils rich in DHA at our production facilities located in Kingstree,
South Carolina and Winchester, Kentucky.
The oils that we produce in these facilities are certified Kosher by the
Orthodox Union and are certified Halal by the Islamic Food and Nutrition
Council of America. Both manufacturing
facilities have received favorable ratings by the American Institute of Baking,
an independent auditor of food manufacturing facilities, and have achieved compliance
with the ISO 14001 Environmental Management System (EMS) International
Standard, the most recognized EMS standard in the world. Also, the National Oceanic and Atmospheric
Administration has granted Marteks Winchester plant, the Companys primary
shipping location, a health certificate, which is required for import of
products into many countries, including China and neighboring countries in the
Pacific Rim.
19
Table
of Contents
Over 90% of our ARA oils are purchased from
DSM. Because DSM is a third-party
manufacturer, we have only limited control over the timing and level of its
production volumes. The balance of our ARA requirements is produced at our
Kingstree facility.
In July 2009,
we entered into the First Amended and Restated ARA Alliance, Purchase, and
Production Agreement (the Restated Agreement) with DSM. The Restated
Agreement, which extends the original supply term through December 31,
2023, amended, consolidated and restated
all existing agreements between the two parties governing the cross-licensing,
purchase, supply and production of ARA. While, subject to certain limited
exceptions, Martek is committed to purchasing all of its ARA requirements from
DSM through the term of the Restated Agreement, the Restated Agreement also set
minimum ARA purchase quantities for Martek in calendar years 2010 and
2011. As of January 31, 2010, the
value of the remaining calendar year 2010 and full calendar year 2011 minimum
purchase requirements are approximately $88.4 million and $87.1 million,
respectively. These minimum purchase quantities approximate the amounts
expected to be procured by us in the normal course of business. Under certain circumstances, either we or DSM
may terminate the Restated Agreement after 2012. Upon early termination by us,
we would be required to make a payment to DSM with the value of such payment
decreasing over the remaining term of the Restated Agreement and being
dependent upon DSMs physical infrastructure at the early termination date. A
termination payment by us as of January 1, 2013 would currently range from $15
million to $20 million and a termination payment as of January 1, 2016 would currently
range from less than $1 million to $7 million.
We have attempted to reduce the risk inherent in
having a single supplier through certain elements of our supply agreement with
DSM. In connection with this agreement,
we have the ability to produce, either directly or through an approved third
party, an unlimited amount of ARA. The sale of such self-produced ARA is
limited annually, however, to the greater of (i) 100 tons of ARA oil or (ii) any
amounts ordered by us that DSM is unable to fulfill. Although we currently produce ARA ourselves,
our existing manufacturing capacity would not permit us to produce ARA
quantities sufficient to meet current demand without impacting our production
of DHA. To further improve our overall
ARA supply chain, we have directly engaged a U.S.-based provider of certain
post-fermentation ARA manufacturing services.
Along with our ARA downstream processing capabilities at Kingstree, this
third-party facility provides us with multiple U.S. sites for the full
downstream processing of ARA.
When combining our current DHA and ARA
production capabilities in Kingstree and Winchester with DSMs current ARA
production capabilities, we have production capacity for DHA and ARA products
in excess of $500 million in annualized sales, collectively, to the infant
formula and non-infant formula markets.
As such, our production capabilities exceed current demand; however, we
have the ability to manage production levels and, to a certain extent, control
our manufacturing costs. Nonetheless,
when experiencing excess capacity, we may be unable to produce the required
quantities of oil cost-effectively due to the existence of significant levels
of fixed production costs at our plants and the plants of our suppliers.
The commercial success of our nutritional oils
will depend, in part, on our ability to manufacture these oils or have them
manufactured at large scale on a routine basis and at a commercially acceptable
cost. Our success will also be somewhat
dependent on our ability to align our production with customer demand, which is
inherently uncertain. There can also be
no assurance that we will be able to continue to comply with applicable
regulatory requirements, including the Food and Drug Administrations good
manufacturing practice (GMP) requirements. Under the terms of several of our
agreements with infant formula customers, those customers may elect to
manufacture these oils themselves. While our customers are not required to
disclose to us that they have begun the process, we are currently unaware of
any of our customers producing our oils or preparing to produce our oils, and
estimate that it would take a customer a minimum of one year to implement a
process for making our oils.
CRITICAL ACCOUNTING POLICIES AND
THE USE OF ESTIMATES
The preparation of our consolidated financial
statements in conformity with U.S. generally accepted accounting principles
requires management to make estimates and assumptions that affect the amounts
reported in our consolidated financial statements and accompanying notes. On an
ongoing basis, we evaluate our estimates and judgments, which are based on
historical and anticipated results and trends and on various other assumptions
that we believe are reasonable under the circumstances, including assumptions
as to future events. By their nature, estimates are subject to an inherent
degree of uncertainty and, as such, actual results may differ from our
estimates. We discuss accounting policies and assumptions that involve a higher
degree of judgment and complexity than others in our Managements Discussion
and Analysis of Financial Condition and Results of Operations in our Annual
Report to shareholders on Form 10-K for the year ended October 31,
2009. There have been no significant
changes in the Companys critical accounting policies since October 31,
2009.
RESULTS OF OPERATIONS
Revenues
The following table presents revenues by
category (in thousands):
|
|
Three months ended January 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Product sales
|
|
$
|
84,086
|
|
$
|
84,022
|
|
Contract manufacturing and services
|
|
5,670
|
|
3,341
|
|
Total revenues
|
|
$
|
89,756
|
|
87,363
|
|
|
|
|
|
|
|
|
|
20
Table
of Contents
Product sales were essentially unchanged in
the three months ended January 31, 2010 as compared to the three months
ended January 31, 2009. Product
sales were comprised of the following (in thousands):
|
|
Three months ended January 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Infant formula market
|
|
$
|
71,541
|
|
$
|
74,591
|
|
Food and beverage market
|
|
4,193
|
|
2,618
|
|
Pregnancy and nursing, nutritional supplements and
animal feeds
|
|
7,370
|
|
5,664
|
|
Non-nutritional products
|
|
982
|
|
1,149
|
|
Total product sales
|
|
$
|
84,086
|
|
$
|
84,022
|
|
Sales to the infant formula market during the
three months ended January 31, 2010 decreased as compared to the three
months ended January 31, 2009 due primarily to normal fluctuations in
product ordering patterns and declines in the U.S. infant formula market.
Launches of new products and increased market penetration of existing products
containing
lifesDHA
, particularly in the food and
beverage, pregnancy and nursing and nutritional supplements markets,
resulted in higher sales to the non-infant formula
nutritional markets in the three months ended January 31, 2010 compared to
the same period of the prior fiscal year.
Approximately 70% of the increase in sales to the non-infant formula
nutritional markets was to customers outside of the U.S.
Approximately 73% of our product sales in the
three months ended January 31, 2010 were generated by sales to Mead
Johnson Nutritionals, Abbott Nutrition, Nestle, Pfizer and Danone. Although we
are not given precise information by our customers as to the countries in which
infant formula containing our oils is ultimately sold, we estimate that
approximately 46% and 52% of our sales to infant formula customers for the
three months ended January 31, 2010 and 2009, respectively, relate to
sales in the U.S. As of January 31,
2010, we estimate that formula supplemented with our oils had penetrated almost
all of the U.S. infant formula market.
Our
future nutritional oils sales are subject to quarter-to-quarter fluctuations
and are dependent to a significant degree upon the following factors: (i) the
expansions of current products containing our nutritional oils by our customers
in new and existing markets; (ii) the launches of new products containing
our nutritional oils by current or future customers and the success in the
marketplace of such launches; (iii) the timing and extent of stocking and
de-stocking of inventory by our customers; (iv) the levels of inclusion of
our oils in infant formula; (v) the timing and extent of our customers
production campaigns and plant maintenance shutdowns; and (vi) the
availability and use by our customers and others of competitive products.
Contract
manufacturing and services revenues totaled approximately $5.7 million in the
three months ended January 31, 2010 and $3.3 million in the three months
ended January 31, 2009. Of the $5.7
million in the first quarter of fiscal 2010, approximately $4.6 million relates
to contract manufacturing activities that we anticipate exiting, in large
measure, over the course of fiscal 2010.
The remaining $1.1 million relates to the revenues associated with
Marteks joint development agreement with BP for work on microbial oils for use
in biofuels, which began in late fiscal 2009 and is expected to continue
through at least 2011. The cessation of
contract manufacturing activities is not expected to have any material impact
on our financial condition or results of operations.
As a
result of the above, total revenues increased by $2.4 million or 2.7% in the
three months ended January 31, 2010 as compared to the three months ended January 31,
2009.
Cost
of Revenues
The following table presents our cost of
revenues (in thousands):
|
|
Three months ended January 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of product sales
|
|
$
|
45,937
|
|
$
|
46,909
|
|
Cost of contract manufacturing and services
|
|
5,233
|
|
3,409
|
|
Total cost of revenues
|
|
$
|
51,170
|
|
$
|
50,318
|
|
Cost of
product sales as a percentage of product sales improved to 55% in the three
months ended January 31, 2010 from 56% in the three months ended January 31,
2009. The decrease in the comparative three months was due to DHA productivity
improvements and decreases in our overall cost of ARA.
Cost of
contract manufacturing and services was $5.2 million in the three months ended January 31,
2010 and $3.4 million in the three months ended January 31, 2009. Our contract manufacturing and services
margins vary between periods primarily due to contract mix and volume.
See Management Outlook for discussion of
expected revenue and gross profit margin growth
for the second quarter of fiscal 2010.
21
Table
of Contents
Operating
Expenses
The following table presents our operating
expenses (in thousands):
|
|
Three months ended January 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Research and development
|
|
$
|
7,066
|
|
$
|
6,749
|
|
Selling, general and administrative
|
|
13,289
|
|
13,097
|
|
Amortization of intangible assets
|
|
1,445
|
|
1,781
|
|
Acquisition costs
|
|
1,187
|
|
|
|
Other operating expenses
|
|
34
|
|
153
|
|
Total operating expenses
|
|
$
|
23,021
|
|
$
|
21,780
|
|
Our research and development costs increased
by $300,000 or 5% in the three months ended January 31, 2010 as compared
to the three months ended January 31, 2009. The increase in the comparable three months
is primarily due to continued focus on clinical research and product
development. Our research and
development efforts continue to focus on: (i) broadening the scientific
evidence supporting our products; (ii) improving manufacturing processes; (iii) broadening
the market applications for the Companys
lifesDHA
; and
(iv) leveraging our microbial
technology platform to develop new high-value product offerings. We
continue to expect quarter-to-quarter fluctuations in research and development
expenses mainly due to the timing of outside services, including third-party
clinical trial services.
Our selling, general and administrative costs
were relatively unchanged, increasing by $200,000 or 1% in the three months
ended January 31, 2010 as compared to the three months ended January 31,
2009.
We capitalize patent application and patent
defense costs in addition to certain other external costs related to our
intellectual property portfolio to the extent that we anticipate a future
economic benefit or an alternate future use is available to us from such
expenditures. We amortize these costs over the expected life of the respective
assets. We recorded amortization expense related to our intangible assets of
$1.4 million in the three months ended January 31, 2010 and $1.8 million
in the three months ended January 31, 2009. The decrease in the three months ended January 31,
2010 resulted primarily from certain assets becoming fully amortized in the
prior period. See Item 1. Legal Proceedings of Part II of this Form 10-Q
for further discussion of certain patent matters.
We have incurred significant costs associated
with our acquisition of Amerifit (see Recent Highlights). In the three months ended January 31,
2010, these costs totaled $1.2 million.
We expect these acquisition costs to continue in the three months ended April 30,
2010, with such costs projected to total approximately $1.5 million in such
quarter. See Management Outlook for
further discussion.
Interest
and Other Income, Net
Interest
and other income, net, decreased by $300,000 in the three months ended January 31,
2010 as compared to the three months ended January 31, 2009, due primarily
to lower interest earned on cash balances
.
Interest
Expense
Interest
expense was relatively unchanged in the three months ended January 31,
2010 as compared to the three months ended January 31, 2009. Since October 31,
2007, there have been no amounts outstanding under the Former Facility. See
Note 8 to the consolidated financial statements for additional discussion of
the Former Facility and the Credit Agreement we entered in January 2010.
Income
Tax Provision
The
provision for income taxes reflected an effective tax rate of 37.5% in the
three months ended January 31, 2010 and 37.7% in the three months ended January 31,
2009.
As of October 31,
2009, we had net operating loss carryforwards for Federal income tax purposes
of approximately $82 million, which expire at various dates between 2021 and
2025. The timing and manner in which U.S. net operating loss carryforwards may
be utilized may be limited if we incur a change in ownership as defined under Section 382
of the Internal Revenue Code. Although
we have net operating losses available to offset future taxable income, we may
be subject to Federal alternative minimum taxes.
Net
Income
As a
result of the foregoing, net income was $9.6 million in the both the three
months ended January 31, 2010 and January 31, 2009.
22
Table
of Contents
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2007,
the FASB issued Statement No. 141(R), Business Combinations, which has
principally been codified in FASB Accounting Standards Codification (ASC)
Topic 805, Business Combinations (ASC 805).
ASC 805 establishes principles and
requirements for how an acquirer recognizes and measures in its financial
statements the identifiable assets acquired, the liabilities assumed, any
noncontrolling interest in the acquiree and the goodwill acquired. ASC 805 also
establishes disclosure requirements to enable the evaluation of the nature and
financial effects of the business combination. ASC 805 was effective for us
beginning with the first quarter of fiscal 2010. As further described in Note
13 to the consolidated financial statements, we acquired Charter Amerifit LLC
and all of its subsidiaries (Amerifit) in February 2010. The adoption of
ASC 805 did not have a cumulative effect upon adoption; however, ASC 805 will
be material to our financial condition and results of operations. Specifically, the adoption of ASC 805
required the immediate expensing of acquisition-related costs and additional
impacts of ASC 805 are anticipated as the total purchase price is allocated to
Amerifits net tangible and intangible assets based on their estimated fair
values on the date of acquisition.
LIQUIDITY AND CAPITAL RESOURCES
We have
financed our operations primarily from the following sources:
·
cash generated from operations;
·
cash received from the exercise of stock options; and
·
debt financing.
Our
cash flows for the three months ended January 31, 2010 and 2009 were as
follows (in thousands):
|
|
Three
months ended January 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Net cash
provided by operating activities
|
|
$
|
16,425
|
|
$
|
8,601
|
|
Net cash used in
investing activities
|
|
(4,521
|
)
|
(3,840
|
)
|
Net cash (used
in) provided by financing activities
|
|
(2,895
|
)
|
53
|
|
Total cash inflows
|
|
$
|
9,009
|
|
$
|
4,814
|
|
Cash and cash equivalents increased $9.0
million since October 31, 2009, largely due to net income of $9.6 million
in the quarter which contributed to the generation of $16.4 million in cash
from operating activities. Capital expenditures, including both property and
equipment as well as patent and other intangible asset costs, totaled $4.6
million during the three months ended January 31, 2010. In general, we believe that our current
production infrastructure can accommodate our short- and medium-term growth
objectives in all material respects. Our
financing activities in the quarter ended January 31, 2010 primarily
include payment of $3.3 million for costs related to debt incurred by us in January 2010
as described below.
In January 2010, we entered into a Credit
Agreement (the Credit Agreement) that includes a $75 million term loan (the Term
Loan) and a $50 million secured revolving credit facility (the Revolver). The Credit Agreement replaced our existing
$135 million credit facility. As of January 31, 2010, we had approximately
$150.1 million in cash and cash equivalents.
On February 12, 2010, we reduced our cash balances by $115 million in
connection with the acquisition of Amerifit and we received the $75 million in
proceeds from the Term Loan and drew down $11 million from the Revolver, both
of which were also utilized for the acquisition of Amerifit.
The Term Loan and the Revolver are
collateralized by certain of our and our subsidiaries assets, including
accounts receivable, deposit accounts, inventory and certain software, general
intangibles and records pertaining to the foregoing as well as a pledge of 100%
of our domestic subsidiaries equity.
The Revolver, which may be increased during the term of the
facility by up to an additional $50 million subject to certain conditions,
expires in February 2013. The Term Loan matures in February 2013.
We are required to make quarterly installment payments on the Term Loan of
$3,750,000 beginning April 2010 plus additional annual repayments on January 31
of each year based on consolidated excess cash flow, as defined in the Credit
Agreement, of the preceding fiscal year.
As a result of having entered the Credit Agreement and the subsequent
financing of our acquisition of Amerifit, our future minimum payments under
contractual obligations were amended.
Including the proceeds of the Term Loan and $11 million drawn from the
Revolver, minimum payments due in less than one year increase by $15 million,
minimum payments due in one to three years increase by $30 million and minimum
payments due in three to five years increase by $41 million.
The Term Loan will bear interest at the
election of Martek at either LIBOR plus up to 3.375% or a base rate plus up to
1.25% depending upon the consolidated leverage ratio during each preceding
fiscal quarter. The Revolver will bear interest at the election of Martek at
either LIBOR plus up to 3.00% or a base rate plus up to 1.00% depending upon
the consolidated leverage ratio during each preceding fiscal quarter. The
base rate is the higher of the lenders prime rate, the federal funds rate plus
0.50% or LIBOR plus 1.50%. LIBOR is the greater of 1.50% per annum or
LIBOR at the time of such determination
.
The
commitment fee rate under the Credit Agreement of up to 0.50% on the Revolver
is based on our consolidated leverage ratio during each preceding fiscal
quarter. Among other things, the Credit Agreement contains restrictions on
future debt, the payment of
23
Table
of Contents
dividends and the further encumbrance of
assets. In addition, the Credit Agreement requires that we comply with
specified financial ratios and tests, including minimum coverage ratios and
maximum leverage ratios.
At January 31, 2010, our investments had
a fair value of $10.6 million and consisted primarily of auction rate
securities (ARS), the underlying assets of which are student loans originated
under the Federal Family Education Loan Program (FFELP). FFELP student loans are guaranteed by state
guarantors who have reinsurance agreements with the U.S. Department of
Education. These ARS are intended to
provide liquidity via an auction process that resets the applicable interest
rate approximately every 30 days and allows investors to either roll over their
holdings or gain immediate liquidity by selling such investments at par. The
underlying maturities of these investments range from 17 to 38 years. Since February 2008, as a result of
negative conditions in the global credit markets, the large majority of the
auctions for our investment in these securities have failed to settle,
resulting in Martek continuing to hold such securities. Consequently, the investments are not currently
liquid and we will not be able to access these funds, except as noted below,
until a future auction of these investments is successful, a buyer is found
outside of the auction process or the investments reach their contractual
maturity date. To this end, in November 2008,
we executed an auction rate securities rights agreement (the Put Agreement)
with a financial institution that provides us the ability to sell certain of
our ARS to the financial institution and allows the financial institution, at its
sole discretion, to purchase such ARS at par during the period June 30,
2010 through July 2, 2012. Our ARS
holdings to which this relates have a cost basis of approximately $7.3 million
and a fair value at January 31, 2010 of approximately $6.1 million. The Put Agreement, which is deemed a discrete
short-term investment, has a recorded fair value at January 31, 2010 of
approximately $1.2 million. The time
period until the initial date on which the exercise of the Put Agreement is
permitted is currently less than 12 months; therefore, the investment values of
the Put Agreement and the ARS to which the Put Agreement relates are classified
as short-term investments in the accompanying consolidated balance sheet as of January 31,
2010. We based our valuation of these
ARS and the Put Agreement on discounted cash flow models that include various
unobservable inputs. Changes to the
inputs used as of January 31, 2010 would cause fluctuations to the fair
value of the affected instruments and such fair value changes could be
material.
We believe that the Revolver, when combined
with our cash and cash equivalents on-hand at January 31, 2010 (net of
amounts used in connection with the Amerifit acquisition), and anticipated
operating cash flows, will provide us with adequate capital to meet our
obligations for at least the next 12 to 18 months. The ultimate amount of
capital that we may require will depend, among other things, on one or more of
the following factors:
·
our ability to operate profitably and generate positive cash
flow;
·
growth in our infant formula, food and beverage and other
nutritional product sales;
·
the extent and progress of our research and development
programs;
·
the cost and progress of pre-clinical and clinical studies;
·
the time and costs of obtaining and maintaining regulatory
clearances for our products that are subject to such clearances;
·
the costs involved in filing, protecting and enforcing
patent claims;
·
competing technological and market developments;
·
the development or acquisition of new products;
·
the cost of acquiring additional and/or operating and
expanding existing manufacturing facilities for our various products and
potential products (depending on which products we decide to manufacture and
continue to manufacture ourselves);
·
the costs associated with our internal build-up of inventory
levels;
·
the costs associated with litigation to which we are a
party;
·
the costs associated with integrating Amerifit into our
operations;
·
the costs of, and any capital requirements related to,
future merger and acquisition activity; and
·
the costs of marketing and commercializing our products.
We can
offer no assurance that, if needed, any of our financing alternatives will be
available to us on terms that would be acceptable, if at all.
24
Table of Contents
MANAGEMENT OUTLOOK
Projected results for Martek (not including
Amerifit), Amerifit (stand-alone, post-acquisition) and on a consolidated basis
for the three months ended April 30, 2010 are as follows:
|
|
Three months ended April 30, 2010
|
|
(in millions, except per share
data)
|
|
Martek
|
|
Amerifit (a)
|
|
Consolidated
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
95.0 99.0
|
|
$
|
16.5 18.0
|
|
$
|
111.5 117.0
|
|
Earnings before interest and taxes
|
|
$
|
16.5 18.0
|
|
$
|
1.5 2.0 (b)
|
|
$
|
18.0 20.0
|
|
Net income
|
|
|
|
|
|
$
|
10.0 11.0 (c)
|
|
Diluted EPS
|
|
|
|
|
|
$
|
0.30 0.33 (c)
|
|
(a)
|
|
Projected
Amerifit results are included for the period from date of acquisition
(February 12, 2010) through April 30, 2010.
|
(b)
|
|
Includes
non-recurring cost of goods sold adjustment of $1.1 million associated with
the estimated effects of a write-up of inventory in connection with purchase
accounting.
|
(c)
|
|
Includes
estimated acquisition costs, net of tax of $1.4 million ($0.04 per diluted
share) and the non-recurring cost of goods sold adjustment noted in
(b) above, net of tax of $700,000 ($0.02 per diluted share).
|
For the second quarter of fiscal 2010, Martek
expects infant formula revenue to be between $78.0 million and $82.0 million,
non-infant formula nutritional revenue to be between $11.0 million and $12.5
million, and contract manufacturing and services revenue to be between $4.0
million and $4.5 million.
Consolidated gross margin is expected to be
between 46.5% and 47.5%, including the non-recurring cost of goods sold
adjustment noted above associated with the estimated effects of a write-up of
inventory in connection with purchase accounting of $1.1 million, which reduces
gross margin by approximately 1%.
25
Table
of Contents
Item 3. Quantitative and Qualitative
Disclosures about Market Risk.
We are subject to market risk associated with
changes in foreign currency exchange rates and interest rates.
In July 2009,
we entered into the First Amended and Restated ARA Alliance, Purchase, and
Production Agreement (the Restated Agreement) with DSM. As part of the agreement, it was established
that 25% of the ARA we buy from DSM will be denominated in Euros. As such, consistent with our payment
arrangements with DSM prior to the execution of the Restated Agreement, we are
exposed to risks related to changes in exchange rates between the U.S. dollar
and the Euro. We enter into foreign
currency cash flow hedges to reduce the related market risk on our payment
obligations. We do not enter into
foreign currency cash flow hedges for speculative purposes. While we had no foreign currency forward
contracts outstanding at January 31, 2010, we expect to enter into new
forward contracts in the future. We
estimate that a 5% change in the Euro-U.S. dollar exchange rate would impact
gross margins of our infant formula products by less than 0.5%.
We are
subject to risk from adverse changes in interest rates, primarily relating to
variable-rate borrowings under the Credit Agreement. The Term Loan and the
Revolver bear interest at rates that are determined by reference to, at the
election of the Company, LIBOR or a base rate that is equal to the higher of
the lenders prime rate, the federal funds rate plus 0.50 % or LIBOR plus
1.50%. Based on variable-rate borrowings
of $86 million used to fund the closing of the acquisition of Amerifit, we estimate
that a 1% increase in either LIBOR or the base rate would impact our net income
by approximately $600,000.
We have investments at January 31, 2010
with a fair value of $11.8 million, which consist primarily of auction rate
securities (ARS). These ARS are intended to provide liquidity via an auction
process that resets the applicable interest rate approximately every 30 days
and allows investors to either roll over their holdings or gain immediate
liquidity by selling such investments at par. Since February 2008, as a
result of negative conditions in the global credit markets, the large majority
of the auctions for our investment in these securities have failed to settle,
resulting in our continuing to hold such securities. Based on the estimated
fair value of the ARS, during fiscal 2008 through fiscal 2010, we recorded net
unrealized losses on these securities totaling approximately $2.2 million ($1.4
million, net of income tax benefit), reflecting the decline in the estimated
fair value of these securities. We
continue to monitor the market for auction rate securities and consider its
impact, if any, on the fair value of these investments. If current market
conditions deteriorate further, the Company may be required to record
additional write-downs. In November 2008, we executed an auction rate
securities rights agreement (the Put Agreement) with a financial institution
that provides us the ability to sell certain of our ARS to the financial
institution and allows the financial institution, at its sole discretion, to
purchase such ARS at par during the period June 30, 2010 through July 2,
2012. Our ARS holdings to which this relates have a cost basis of approximately
$7.3 million and a fair value at January 31, 2010 of approximately $6.1
million. The Put Agreement, which is
deemed a discrete short-term investment, has a recorded fair value of $1.2
million. The benefits of the Put
Agreement are subject to the continued expected performance by the financial
institution of its obligations under the agreement. We based our valuation of these ARS and the
Put Agreement on discounted cash flow models that include various unobservable
inputs. Changes to the inputs used as of
January 31, 2010 would cause fluctuations to the fair value of the
affected instruments and such fair value changes could be material.
Item 4.
Controls and Procedures.
a)
Evaluation
of Disclosure Controls and Procedures.
As of the end of the period
covered by this report, we, under the supervision and with the participation of
our management, including our Chief Executive Officer and Chief Financial
Officer, have evaluated the effectiveness of our disclosure controls and
procedures pursuant to Exchange Act rules 13a-15(e) and
15d-15(e). Based on this evaluation, our
Chief Executive Officer and Chief Financial Officer have concluded that, as of
the end of the period covered by this report, the disclosure controls and
procedures were effective.
b)
Internal
Control Over Financial Reporting.
There was no change in our
internal control over financial reporting in connection with the evaluation
required by paragraph (d) of Rules 13a-15 or 15d-15 under the
Exchange Act that occurred during Marteks quarter ended January 31, 2010
that materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.
26
Table
of Contents
PART II
- OTHER INFORMATION
Item
1. Legal Proceedings.
Information regarding reportable legal
proceedings is contained in
Item 3. Legal
Proceedings of Part I of our
Annual Report on Form 10-K
for the year ended October 31, 2009, as well as in the other reports we
file with the Securities and Exchange Commission (the SEC). The following is
provided to supplement and update the description of reportable legal
proceedings contained in those reports:
Aventis S.A. and Nagase &
Co. Ltd. are challenging our European patent covering our DHA-containing oils,
which expires in February 2011. At
a hearing in October 2000, the Opposition Division of the European Patent
Office (EPO) revoked our patent on the grounds that it was not novel. We
immediately appealed this ruling, and in July 2002 we received a positive
ruling from an Appeal Board of the EPO, setting aside the prior decision to
revoke this patent. The patent was returned to the Opposition Division for a
determination as to whether it has met the legal requirement of inventive step.
A hearing in August 2005 resulted in a ruling by the Opposition Division
that this requirement had been met and the validity of the patent was upheld.
Aventis appealed the decision to the Appeal Board of the EPO. Martek filed its answer to Aventis grounds
for appeal in July 2006. The appeal
hearing was scheduled for March 2009.
Martek submitted new evidence that the appeal was inadmissible because
Aventis was not the proper party.
Because the Appeal Board found that there are questions relating to the
admissibility of Aventis appeal, it postponed the hearing and directed the
parties to submit additional briefs on this issue. Aventis submitted its brief in May 2009
and Martek submitted its brief in August 2009. Aventis has filed a further brief, and Martek
has responded. The filing and
consideration of these briefs will likely delay the appeal hearing for about
one to two years from the original hearing date. Marteks patent will remain in full force and
effect during the pendency of these proceedings. Claim 1 of this patent is the basis of the
patent infringement suit against Nutrinova and Lonza in Germany and against
Lonza in France, discussed below. In the event Martek were to lose this appeal,
this DHA patent would be revoked. The revocation of this patent would result in
the dismissal of the patent infringement suit against Nutrinova and Lonza in
Germany and against Lonza in France, discussed below, and patent protection for
Marteks DHA-containing oils for use in infant formula would be compromised in
Europe. Currently, annual sales of Marteks DHA for use in infant formula in
Europe to companies other than those with whom Martek has an exclusive supply
agreement are less than $1 million. Such exclusive agreements generally run
through 2011. An adverse decision would
not impact Marteks ARA patent position in Europe. Moreover, the outcome
of this appeal will not affect the patent infringement lawsuit against
Lonza in the U.S., as the U.S. lawsuit is based on a different family of
patents.
Prior to our purchase of OmegaTech in fiscal
2002, Aventis Research and Technologies GmbH & Co. KG, and Nagase
Limited challenged OmegaTechs European patent covering its DHA-containing
oils. At a hearing in December 2000, the Opposition Division of the EPO
upheld some of the claims and revoked other claims. OmegaTech immediately
appealed this ruling, as did Aventis. At an appeal hearing in May 2005, we
received a favorable decision from the Appeal Board of the EPO, which
overturned the decision of the Opposition Division and returned the case to the
Opposition Division for review on the merits of the patent claims. In a November 2007 hearing, the
Opposition Division upheld claims that are narrower than the claims originally
granted but broader than the claims that were previously upheld in the December 2000
Opposition Division hearing. Martek and
Aventis have appealed. The patent, which
expires in November 2010, will remain in full force and effect during the
appeal process. This appeal suffers from the same admissibility problems that
Aventis has with the appeal of the DHA patent discussed above.
In October 2007, the EPO granted a patent
to Martek for fermentation processes for producing microbial lipids (e.g., DHA
oil) under low dissolved oxygen conditions. Lonza AG filed an opposition
against this process patent in July 2008, and Martek filed a written
response in April 2009. A hearing before the Opposition Division of
the EPO in Munich, Germany is scheduled for April 2010. This patent is scheduled to expire in January 2021.
In September 2003,
we filed a patent infringement lawsuit in the U.S. District Court in
Delaware against Nutrinova Inc., Nutrinova Nutrition Specialties &
Food Ingredients GmbH, Celanese Ventures GmbH, and Celanese AG. Celanese
Ventures GmbH and Celanese AG were dropped from the lawsuit. Lonza Ltd. was added to the lawsuit. In October 2006, after an almost two
week trial in Wilmington, Delaware, the jury returned a favorable verdict to
Martek, deciding that all three of the asserted Martek DHA patents were valid
and infringed, and that one was willfully infringed. In October 2007, the judge upheld the October 2006
jury verdict that the defendants infringed all of the asserted claims of U.S.
Patent Nos. 5,340,594 and 6,410,281 and that these patents were not
invalid. The judge has granted a
permanent injunction against the defendants with respect to those two
patents. The judge also upheld the jury
verdict that the defendants had acted willfully in their infringement of U.S.
Patent No. 6,410,281. Regarding the third patent involved in the
case, U.S. Patent No. 6,451,567, the judge reversed the jury verdict and
found that the asserted claims of this patent were invalid. Marteks request to the judge to reconsider
his ruling on the third patent was denied.
Martek and the defendants appealed aspects of the judges final decision
and a hearing was held before the U.S. Court of Appeals for the Federal Circuit
in April 2009. In September 2009, the Court of Appeals ruled in
Marteks favor on all of the patents that were the subject of the appeal, which
included U.S. Patent Nos. 5,340,594, 6,410,281, 6,451,567 noted above and
5,698,244, which was included in Marteks appeal as a result of the trial courts
decision at a pre-trial hearing on the meaning and scope of the patent claims
in dispute. With respect to U.S. Patent No. 5,698,244, the Court of
Appeals reversed the trial courts interpretation of certain claim language and
remanded this patent to the trial court for further proceedings. U.S. Patent
Nos. 5,340,594 and 6,454,567 have expired and U.S. Patent Nos. 6,410,281 and
5,698,244 are scheduled to expire in August 2011 and December 2014,
respectively. The defendants requested a
rehearing with the Court of Appeals on the decision, but their request was denied.
In November 2009,
Lonza filed with the U.S. Patent and Trademark Office a Request for Reexamination
(Request) of U.S. Patent No. 5,698,244.
This patent could impact competitors in
the food and beverage, dietary supplement and infant formula markets.
After multiple
resubmissions, the Office granted this Request in March 2010.
27
Table
of Contents
Also, in February 2010, Lonza
filed a Request seeking reexamination of Marteks U.S. Patent No.
6,410,281
, which is the only unexpired patent of
the three patents that Lonza was found to have infringed in the U.S., as
discussed above. The U.S. Patent and
Trademark Office has not ruled on this Request.
We also filed a patent
infringement suit involving Nutrinova Nutrition Specialties & Food
Ingredients GmbH and Celanese Ventures GmbH in Germany in January 2004. Lonza Ltd. and a customer of Nutrinova have
also been added to this lawsuit. The
complaint alleges infringement of our European patent relating to
DHA-containing oils. A hearing was held
in a district court in Dusseldorf in September 2007 and the court issued
its decision in October 2007, ruling that Marteks patent was infringed by
the defendants. The defendants have
appealed, and an appeal hearing was scheduled for February 2009. Martek and the defendants requested that the
appeal hearing be delayed until the Appeal Board of the EPO decides whether to
uphold Marteks European patent covering our DHA-containing oils. This EPO Appeal Board hearing was scheduled
for March 2009 and has been postponed.
In December 2008, Martek requested that the court expand the appeal
to include Lonzas production of DHA in Germany, based on evidence discovered
in October 2008.
We filed a patent
infringement suit involving Lonza Ltd AG and Capsugel France in France in November 2008. The complaint alleges infringement of our
European patent relating to DHA-containing oils. Lonza requested that the trial
be delayed until the Appeal Board of the EPO decides whether to uphold Marteks
European patent covering our DHA-containing oils. This EPO Appeal Board hearing was scheduled
for March 2009 and has been postponed.
We agreed to dismiss our claims against Capsugel France in November 2009
based on Capsugel and its affiliates agreeing to purchase all of their
microbial DHA exclusively from Martek for the life of the patent in question.
Martek is opposing two of Suntorys low sterol ARA oil patents in Europe
and one in Australia. The patents are
generally directed to processes for producing microbial ARA oil having a low
ratio of certain sterols, the resulting oil and its use in infant formula. Martek believes that the patents are invalid
for a number of reasons, including prior art that anticipates the claims
relevant to Martek. An Opposition
Division hearing on the first European patent was held in April 2008, and
the Opposition Division revoked the Suntory patent. Suntory has appealed, during which time the
patent will remain in full force and effect.
A hearing on the other European patent took place in December 2009,
resulting in the revocation of the Suntory patent. Suntory will likely appeal. A hearing on the Australian patent is
expected in 2010.
In 2008, third parties filed Requests seeking
reexamination of eleven of Marteks U.S. patents. Eight of these Requests
were filed by Lonza with respect to eight of Marteks DHA patents which are
generally not relevant to Marteks infant formula business. Four of these patents have now expired. Additionally, in 2008 an anonymous party
filed three other Requests with respect to two of Marteks blended oils patents
and one ARA patent, all of which relate to our infant formula business. The U.S. Patent and Trademark Office granted
all eleven of the Requests to initiate a Reexamination process (Reexamination(s)).
As a result of Reexaminations, the claims of the subject patents may be upheld
in their current form, narrowed, abandoned, or revoked, or the term of a patent
may be shortened. Not all of the claims
of the patents are subject to Reexamination. With respect to the ARA
patent, which is scheduled to expire in August 2014,
we received a Notice of Intent to Issue a Reexamination
Certificate
from the examiners in February 2010.
The ARA
patent will
emerge from this Reexamination with narrower claims, as the broader product
claims have been canceled. Specifically,
the reexamined patent will contain narrower product claims and process claims that,
among other things, provide patent protection for a production process that we
believe: i) results in higher quality oil and higher ARA potency and ii)
is cost efficient compared to other processes for producing ARA. When combined with our in-licensed patents
from our ARA production partner DSM, we believe that it will be technologically
difficult and less cost efficient for competitors to design around these
claims. Nonetheless, it is uncertain how much protection they will
provide.
In February 2010, an anonymous
party filed a new Request seeking reexamination of certain claims of Marteks
ARA patent, discussed above. Specifically, reexamination of certain
claims that were not reexamined during the initial Reexamination and
reexamination of other claims which have now been canceled was requested. The U.S. Patent and Trademark Office has not
ruled on this Request.
We received positive advisory actions from the
examiners regarding claims pending in the Reexaminations of two DHA patents
that have not expired and the two blended oils patents. The blended oils
patents expire in December 2011, which generally coincides with the
expiration of some of our infant formula customers sole source purchase
obligations. Three Reexamination Certificates have been received for
these two DHA patents and one of the two blended oils patents. We expect
the fourth Reeaxmination Certificate for the remaining blended oils patent will
issue in March 2010. The Reexaminations are continuing for the
remaining two unexpired DHA patents, and we have been conducting further
proceedings with the examiners on these two DHA patents. If we are unable
to obtain commercially meaningful claim coverage, we plan to appeal within the
U.S. Patent and Trademark Office, and in the event of a negative outcome, we
will have an opportunity to further appeal to the federal courts. These
patents will remain in full force and effect during the appeal process.
However, if the appeals are not successful or are not pursued, some or all of
the claims of these patents could be revoked.
There are additional intellectual
property proceedings pending against Martek or that Martek has pending against
third parties that are not considered material.
In addition, from time to time, Martek is a
party to additional litigation or administrative proceedings relating to claims
arising from its operations in the normal course of business or other
matters. Management believes that the
ultimate resolution of any such additional litigation or administrative
28
Table
of Contents
proceedings currently pending against Martek
is unlikely, either individually or in the aggregate, to have a material
adverse effect on Marteks results of operations or financial condition.
29
Table
of Contents
Item 1A.
Risk Factors.
Investing in our securities involves a high
degree of risk
. Before making an
investment decision, you should carefully consider the risks set forth in Item
1A. Risk Factors of Part I of our Annual Report on Form 10-K for
the year ended October 31, 2009 and all other information we include in
this report and the additional information in the other reports we file with
the Securities and Exchange Commission (the SEC). If any of the risks
contained in those reports, or described below, actually occur, our business
could be harmed. In such case, the trading price of our securities could
decline and you could lose all or part of your investment.
As described in Item 2 Managements
Discussion and Analysis of Financial Condition and Results of Operations, Recent
Highlights, on February 12, 2010, Martek acquired Charter Amerifit LLC
and all of its subsidiaries (Amerifit). Amerifit develops, markets and
distributes branded consumer health and wellness products and holds leading
brand positions in all of its key product categories. Amerifit products are
sold in most major mass, club, drug, grocery and specialty stores and include:
Culturelle®, a leading probiotic supplement; AZO®, the leading OTC brand
addressing symptom relief, detection and prevention of urinary tract
infections; and ESTROVEN®, the leading all-natural nutritional supplement brand
addressing the symptoms of menopause. Upon the closing of the acquisition, we
paid for the benefit of Amerifits equity holders total cash consideration of
approximately $201 million, net of cash acquired.
The risk
factors below are provided to supplement and update the risk factors contained
in the reports we file with the SEC, including the risk factors contained
in Item 1A. of Part I of our Annual Report on Form 10-K for the year
ended October 31, 2009. These
updates and supplements are intended to address the material risks associated
with the Amerifit acquisition and business, in general. Please note that certain risks associated
with Marteks nutritional oils business included in the Form 10-K for the
year ended October 31, 2009 are also risks which apply to the Amerifit
business.
These risks
include those which relate to:
·
the potential effects of the global economic
recession,
·
the potential effects of reliance on relatively few,
large customers,
·
the potential effects of allegedly unsubstantiated
product efficacy claims,
·
the potential effects of product liability claims and
recalls,
·
the potential effects of unfavorable future clinical
trials,
·
the potential effects of non-compliance with
regulatory requirements,
·
the potential effects of fluctuations in the
availability and cost of raw materials and energy,
·
the potential effects of failed product launches,
·
the potential effects of current and future
competitive products and
·
the potential effects of real or perceived product
safety and quality issues.
It should be
noted that certain of these previously-disclosed risk factors referred and
related specifically to our nutritional oils. While they have not been updated
and restated below, on a going forward basis, these general risks are intended
to include all products offered and businesses owned and operated by Martek.
Risk factors to
supplement and update those included in the Form 10-K for the year ended October 31,
2009 are as follows:
We may fail to realize the
anticipated strategic and sales synergies expected from the Amerifit
acquisition, which could adversely affect our operating results and the market
price of our common stock.
The success of the Amerifit acquisition will depend, in significant
part, on our ability to successfully integrate Amerifit into our operations,
and realize the anticipated benefits and synergies to be derived from the
combination of the two businesses. We believe that Amerifits product portfolio
and sales and marketing infrastructure will accelerate the execution of our
corporate and product development strategy and provide opportunities to significantly
improve our product development investment. However, an inability by us to
develop future products or to utilize the existing Amerifit sales and marketing
infrastructure for the commercialization of such future products may cause
actual operating, strategic and sales synergies to be lower than we expect or
to take longer to achieve than anticipated, if achieved at all. In addition, if
we are not able to adequately address the integration challenges above, we may
be unable to realize the anticipated benefits of the transaction. If we are not
able to achieve these objectives, the value of Marteks common stock may be
adversely affected.
In order to consummate the
Amerifit acquisition, we have taken on substantial additional indebtedness and
materially reduced our cash balance.
In accordance with the agreement and plan of merger, we agreed to pay
the former equity holders of Amerifit $201 million in cash, net of cash
acquired. We financed the acquisition though existing cash of approximately
$115 million along with the proceeds from the $75 million term loan and $11
million drawn down from a new revolving credit facility. The cash expenditure
significantly reduced our cash balance, and along with the debt incurred, could
adversely affect our business. In particular, we could be more vulnerable to
any sustained regional or global downtown or slow economic recovery and our
ability to obtain further financing and pursue certain operational and
strategic opportunities could be limited. Our indebtedness and lower cash
balance may also put us in a competitive disadvantage to competitors with
greater resources.
30
Table of Contents
The Amerifit acquisition may
expose us to significant unanticipated liabilities that could adversely affect
our business and results of operations.
Our purchase of the Amerifit may expose us to significant unanticipated
liabilities. We may incur unforeseen liabilities relating to the operation of
the newly-acquired business. The liabilities may include employment, retirement
or severance-related obligations under applicable law or other benefits
arrangements, legal claims, warranty or similar liabilities to customers or
vendors, and claims by or amounts owed to suppliers. We have placed $25 million
in an escrow to secure certain indemnification obligations of Amerifits
previous equity holders; however, the incurrence of unforeseen or unanticipated
liabilities, should they be significant and in excess of the amounts placed in
escrow, could have a material adverse affect on our business, results of
operations and financial condition.
The transaction may not be
accretive and may cause dilution to our earnings per share, which may harm the
market price of our common stock.
We currently anticipate that the transaction will be accretive to
earnings per share for fiscal 2010. This expectation is based on preliminary
estimates which may materially change. We could encounter unanticipated
integration-related costs or fail to realize all of the benefits of the
transaction that underlie our financial model and expectations as to
profitability. All of these factors could cause dilution to our earnings per
share or decrease or delay the expected accretive effect of the transaction and
cause a decrease in the price of our common stock.
We must be successful in the
retention, motivation and recruitment of key executives and employees.
We must continue to retain, motivate and recruit executives and other
key employees to realize the benefits of the Amerifit acquisition. Experienced
employees are in high demand and competition for their talents can be intense.
Employees of Martek and employees of Amerifit that are now part of the Martek
corporate organization may experience uncertainty, real or perceived, about
their future role at Martek. These potential distractions may adversely affect
the ability to retain, motivate and recruit executives and other key employees
and keep them focused on corporate strategies and objectives. The failure to
attract, retain and motivate executives and other key employees following
completion of the transaction could have a negative impact on our business.
The Amerifit business relies on
third- party manufacturers for the production of its product portfolio.
We use third- party manufacturers to produce Amerifit products. In most
cases, these third- party manufacturers are not bound by fixed term commitments
in our contracts with them, and they may discontinue production with little or
no advance notice. Manufacturers also may experience problems with product
quality or timeliness of product delivery. We rely on these manufacturers to
comply with applicable current good manufacturing practices (GMPs). The loss of
a contract manufacturer may force us to shift production to a different
supplier and possibly cause manufacturing delays, disrupt our ability to fill
orders or require us to suspend production until we find another third party
manufacturer, if one can be found at all. Should any of these manufacturers
fail to meet our standards, we may face regulatory sanctions, additional
product liability claims or customer complaints, any of which could harm our
reputation and our business. Disruption in supply by our third-party
manufacturers could have a material adverse effect on the future sales and
operations of the Amerifit business.
The Amerifit business could be
adversely affected if we are unable to successfully protect our intellectual
property or defend claims of infringement by others.
The Amerifit trademarks are of material importance to the Amerifit
business. Substantially all of Amerifits current revenues are from products
bearing proprietary brand names. Although our principal brand names are
registered trademarks in the United States and certain foreign countries, there
can be no assurance that the steps we take to protect our proprietary rights in
our brand names will be adequate to prevent the misappropriation of these
registered brand names in the United States or abroad. There can also be no
assurance that we will be able to successfully protect our trademarks from
infringement or otherwise. The loss or infringement of our trademarks could
impair our brands, harm our reputation and materially adversely affect our
financial results.
Changes to regulatory
requirements to which our business is subject could have a material effect on
our results of operations.
Our products
and our manufacturing and research activities are subject to varying degrees of
regulation and various regulatory authorities in the United States and
abroad. These regulatory authorities
include, but are not limited to, the Food and Drug Administration and Federal
Trade Commission in the United States as well as agencies and entities
providing similar functions throughout the rest of the world. The various regulatory requirements are
complex and constantly changing, sometimes quite unpredictably, due, in part, to
changes in agendas of political, business and environmental groups as well as
government priorities. We may be
required to incur substantial costs to comply with current or future laws and
regulations, or new interpretations of existing laws and regulations, and our
operations, business or financial condition could be adversely affected by such
future requirements or interpretations of existing requirements.
31
Table of Contents
Item
2. Unregistered Sales of Equity
Securities and Use of Proceeds.
None.
Item
3. Defaults Upon Senior Securities.
Not Applicable.
Item
4. Reserved.
Item
5. Other Information.
None.
Item
6. Exhibits.
2.01
|
Agreement and Plan of Merger, dated January 21,
2010, among Martek Biosciences Corporation, Pearl, LLC, Charter Amerifit LLC,
Charter Amerifit Holding Corporation, AB Merger Sub, Inc., Amerifit
Brands, Inc. and AB SR LLC. (1)
|
|
|
10.01
|
Credit Agreement, dated to be effective as of January 21,
2010, by and between Martek Biosciences Corporation, Manufacturers and
Traders Trust Company, and the lenders identified therein.(1)
|
|
|
31.01
|
Certification of Chief Executive Officer Pursuant to
Rule 13a-14(a)/15d-14(a).*
|
|
|
31.02
|
Certification of Chief Financial Officer Pursuant to
Rule 13a-14(a)/15d-14(a).*
|
|
|
32.01
|
Certification of Chief
Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *
|
|
|
32.02
|
Certification of Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.*
|
*
Filed or furnished herewith.
(1) Incorporated
by reference from our Current Report on Form 8-K (File No. 0-22354)
filed with the Securities and Exchange Commission on January 26, 2010.
32
Table of Contents
SIGNATURES
Pursuant to the requirements of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.
|
|
|
MARTEK BIOSCIENCES CORPORATION
|
|
|
|
(Registrant)
|
|
|
|
|
|
|
|
|
Date:
|
March 12, 2010
|
|
/s/ Peter L. Buzy
|
|
|
|
Peter L. Buzy
|
|
|
|
Chief Financial Officer, Treasurer and Executive Vice President for
Finance and Administration
|
|
|
|
(Principal Financial and Accounting Officer)
|
33
Table
of Contents
EXHIBIT
INDEX
Exhibit No.
|
|
Description
|
|
|
|
2.01
|
|
Agreement and Plan of Merger, dated January 21,
2010, among Martek Biosciences Corporation, Pearl, LLC, Charter Amerifit LLC,
Charter Amerifit Holding Corporation, AB Merger Sub, Inc., Amerifit
Brands, Inc. and AB SR LLC. (1)
|
|
|
|
10.01
|
|
Credit Agreement, dated to be effective as of
January 21, 2010, by and between Martek Biosciences Corporation,
Manufacturers and Traders Trust Company, and the lenders identified
therein.(1)
|
|
|
|
31.01
|
|
Certification of Chief Executive Officer Pursuant to
Rule 13a-14(a)/15d-14(a).*
|
|
|
|
31.02
|
|
Certification of Chief Financial Officer Pursuant to
Rule 13a-14(a)/15d-14(a).*
|
|
|
|
32.01
|
|
Certification of Chief
Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *
|
|
|
|
32.02
|
|
Certification of Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.*
|
*
Filed or furnished herewith.
(1) Incorporated
by reference from our Current Report on Form 8-K (File No. 0-22354)
filed with the Securities and Exchange Commission on January 26, 2010.
34
Martek (NASDAQ:MATK)
Historical Stock Chart
From Jun 2024 to Jul 2024
Martek (NASDAQ:MATK)
Historical Stock Chart
From Jul 2023 to Jul 2024