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 April 30,
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 June 1, 2010 was 33,460,268.
Table
of Contents
MARTEK
BIOSCIENCES CORPORATION
FORM 10-Q
For
The Quarterly Period Ended April 30, 2010
INDEX
2
Table
of Contents
PART I
- FINANCIAL INFORMATION
Item 1.
Financial Statements.
MARTEK BIOSCIENCES CORPORATION
CONSOLIDATED BALANCE SHEETS
|
|
April 30,
|
|
|
|
In
thousands, except share and per share data
|
|
2010
(unaudited)
|
|
October 31,
2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
Current assets
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
30,207
|
|
$
|
141,063
|
|
Short-term
investments
|
|
7,292
|
|
7,301
|
|
Accounts
receivable, net
|
|
68,234
|
|
44,304
|
|
Inventories,
net
|
|
119,456
|
|
116,179
|
|
Deferred
tax asset
|
|
25,071
|
|
24,303
|
|
Other
current assets
|
|
6,368
|
|
5,240
|
|
Total
current assets
|
|
256,628
|
|
338,390
|
|
|
|
|
|
|
|
Property,
plant and equipment, net
|
|
249,396
|
|
252,279
|
|
Long-term
investments
|
|
4,579
|
|
4,495
|
|
Goodwill
|
|
150,567
|
|
51,592
|
|
Customer
relationships, net
|
|
90,154
|
|
|
|
Other
intangible assets, net
|
|
89,541
|
|
42,631
|
|
Other
assets, net
|
|
3,834
|
|
430
|
|
|
|
|
|
|
|
Total
assets
|
|
$
|
844,699
|
|
$
|
689,817
|
|
|
|
|
|
|
|
Liabilities and stockholders equity
|
|
|
|
|
|
Current liabilities
|
|
|
|
|
|
Accounts
payable
|
|
$
|
20,031
|
|
$
|
13,122
|
|
Accrued
liabilities
|
|
38,410
|
|
18,243
|
|
Current
portion of notes payable and other long-term obligations
|
|
16,295
|
|
410
|
|
Current
portion of deferred revenue
|
|
970
|
|
2,981
|
|
Total
current liabilities
|
|
75,706
|
|
34,756
|
|
|
|
|
|
|
|
Notes
payable and other long-term obligations
|
|
28,110
|
|
400
|
|
Long-term
portion of deferred revenue
|
|
8,155
|
|
8,426
|
|
Deferred
tax liability
|
|
71,872
|
|
10,091
|
|
|
|
|
|
|
|
Total
liabilities
|
|
183,843
|
|
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; 33,460,268 and
33,269,686 shares issued and outstanding, respectively
|
|
3,346
|
|
3,327
|
|
Additional
paid-in capital
|
|
560,011
|
|
557,519
|
|
Accumulated
other comprehensive loss
|
|
(633
|
)
|
(674
|
)
|
Retained
earnings
|
|
98,132
|
|
75,972
|
|
|
|
|
|
|
|
Total
stockholders equity
|
|
660,856
|
|
636,144
|
|
|
|
|
|
|
|
Total
liabilities and stockholders equity
|
|
$
|
844,699
|
|
$
|
689,817
|
|
See accompanying notes.
3
Table
of Contents
MARTEK BIOSCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
|
|
Three months ended April 30,
|
|
Six months ended April 30,
|
|
Unaudited - In thousands,
except per share data
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
Product sales
|
|
$
|
119,082
|
|
$
|
88,152
|
|
$
|
203,168
|
|
$
|
172,174
|
|
Contract
manufacturing and collaborations
|
|
4,886
|
|
4,259
|
|
10,556
|
|
7,600
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
123,968
|
|
92,411
|
|
213,724
|
|
179,774
|
|
|
|
|
|
|
|
|
|
|
|
Cost of
revenues:
|
|
|
|
|
|
|
|
|
|
Cost of product sales
|
|
62,362
|
|
49,299
|
|
108,299
|
|
96,208
|
|
Cost of contract manufacturing and collaborations
|
|
4,097
|
|
4,017
|
|
9,330
|
|
7,426
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of
revenues
|
|
66,459
|
|
53,316
|
|
117,629
|
|
103,634
|
|
|
|
|
|
|
|
|
|
|
|
Gross margin
|
|
57,509
|
|
39,095
|
|
96,095
|
|
76,140
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
Research and
development
|
|
8,821
|
|
7,157
|
|
15,887
|
|
13,906
|
|
Selling, general
and administrative
|
|
17,926
|
|
12,280
|
|
30,706
|
|
25,031
|
|
Advertising and
promotion
|
|
3,965
|
|
595
|
|
4,474
|
|
941
|
|
Amortization of
intangible assets
|
|
2,594
|
|
1,595
|
|
4,039
|
|
3,376
|
|
Acquisition
costs
|
|
1,801
|
|
|
|
2,988
|
|
|
|
Other operating
expenses
|
|
171
|
|
569
|
|
205
|
|
722
|
|
|
|
|
|
|
|
|
|
|
|
Total operating
expenses
|
|
35,278
|
|
22,196
|
|
58,299
|
|
43,976
|
|
|
|
|
|
|
|
|
|
|
|
Income from
operations
|
|
22,231
|
|
16,899
|
|
37,796
|
|
32,164
|
|
|
|
|
|
|
|
|
|
|
|
Interest and
other income, net
|
|
(26
|
)
|
280
|
|
(75
|
)
|
535
|
|
Interest expense
|
|
(1,352
|
)
|
(94
|
)
|
(1,440
|
)
|
(189
|
)
|
|
|
|
|
|
|
|
|
|
|
Income before
income tax provision
|
|
20,853
|
|
17,085
|
|
36,281
|
|
32,510
|
|
Income tax
provision
|
|
8,336
|
|
6,068
|
|
14,121
|
|
11,887
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
12,517
|
|
$
|
11,017
|
|
$
|
22,160
|
|
$
|
20,623
|
|
|
|
|
|
|
|
|
|
|
|
Net income per
share
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.37
|
|
$
|
0.33
|
|
$
|
0.66
|
|
$
|
0.62
|
|
Diluted
|
|
$
|
0.37
|
|
$
|
0.33
|
|
$
|
0.66
|
|
$
|
0.62
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average
common shares outstanding
|
|
|
|
|
|
|
|
|
|
Basic
|
|
33,383
|
|
33,190
|
|
33,329
|
|
33,170
|
|
Diluted
|
|
33,578
|
|
33,310
|
|
33,514
|
|
33,349
|
|
See accompanying notes.
4
Table
of Contents
MARTEK BIOSCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
|
|
Six months ended April 30,
|
|
Unaudited
In thousands
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Operating activities
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
22,160
|
|
$
|
20,623
|
|
Adjustments
to reconcile net income to net cash provided by operating activities:
|
|
|
|
|
|
Depreciation
and amortization
|
|
17,021
|
|
14,115
|
|
Deferred
tax provision
|
|
13,795
|
|
11,244
|
|
Equity-based
compensation expense
|
|
2,305
|
|
1,924
|
|
Loss
on asset disposal and other, net
|
|
605
|
|
467
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
Accounts
receivable
|
|
(10,905
|
)
|
(12,460
|
)
|
Inventories
|
|
4,427
|
|
(10,016
|
)
|
Other
assets
|
|
1,145
|
|
1,119
|
|
Accounts
payable
|
|
2,942
|
|
4,687
|
|
Accrued
liabilities
|
|
11,417
|
|
(5,571
|
)
|
Deferred
revenue and other liabilities
|
|
(1,938
|
)
|
(501
|
)
|
|
|
|
|
|
|
Net
cash provided by operating activities
|
|
62,974
|
|
25,631
|
|
|
|
|
|
|
|
Investing activities
|
|
|
|
|
|
|
|
|
|
|
|
Cash
paid for acquisition of Amerifit, net of cash acquired
|
|
(200,743
|
)
|
|
|
Sales
of investments and marketable securities, net
|
|
50
|
|
|
|
Expenditures
for property, plant and equipment
|
|
(6,827
|
)
|
(5,263
|
)
|
Capitalization
of intangible assets
|
|
(2,458
|
)
|
(4,435
|
)
|
|
|
|
|
|
|
Net
cash used in investing activities
|
|
(209,978
|
)
|
(9,698
|
)
|
|
|
|
|
|
|
Financing activities
|
|
|
|
|
|
|
|
|
|
|
|
Repayments
of notes payable and other long-term obligations
|
|
(35,061
|
)
|
(59
|
)
|
Proceeds
of term loan
|
|
75,000
|
|
|
|
Borrowings
from revolving line of credit
|
|
11,000
|
|
|
|
Repayments
of borrowings from revolving line of credit
|
|
(11,000
|
)
|
|
|
Payment
of debt issuance costs
|
|
(3,944
|
)
|
|
|
Issuance
of common stock under employee stock plans
|
|
1,202
|
|
111
|
|
Tax
payments from shares withheld upon vesting of restricted stock units
|
|
(1,047
|
)
|
(536
|
)
|
|
|
|
|
|
|
Net
cash provided by (used in) financing activities
|
|
36,150
|
|
(484
|
)
|
|
|
|
|
|
|
Foreign
currency translation adjustment
|
|
(2
|
)
|
|
|
|
|
|
|
|
|
Net
(decrease) increase in cash and cash equivalents
|
|
(110,856
|
)
|
15,449
|
|
Cash
and cash equivalents, beginning of period
|
|
141,063
|
|
102,495
|
|
|
|
|
|
|
|
Cash
and cash equivalents, end of period
|
|
$
|
30,207
|
|
$
|
117,944
|
|
|
|
|
|
|
|
Supplemental cash flow disclosures:
|
|
|
|
|
|
Interest paid
|
|
$
|
742
|
|
$
|
101
|
|
Income taxes paid
|
|
$
|
550
|
|
$
|
734
|
|
Long-term license fee obligation
|
|
$
|
2,229
|
|
$
|
|
|
See accompanying notes.
5
Table
of Contents
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1.
ORGANIZATION AND DESCRIPTION OF BUSINESS
Martek
Biosciences Corporation (the Company or Martek), a Delaware corporation,
was founded in 1985. The Company is a leader in the innovation, development,
production and sale
of high-value
products from microbial sources that promote health and wellness through
nutrition. The Companys technology
platform consists of its core expertise, broad experience and proprietary
technology in areas such as microbial biology, algal genomics, fermentation and
downstream processing. This technology
platform has resulted in the Companys development of a number of products, including
its 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, dietary
supplements and animal feeds. Martek
also produces
lifesARA
(arachidonic acid), an
omega-6 fatty acid, for use in infant formula and growing-up milks.
The Companys DHA and
ARA are collectively referred to as nutritional ingredients.
On February 12, 2010, Martek completed
the acquisition of 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 include: Culturelle®, a leading
probiotic supplement; AZO, the leading over-the-counter 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. The products sold
through the Amerifit subsidiary are collectively referred to as branded
consumer health products. The Company
sells its branded consumer health products to retail outlets, including most
major mass, club, drug, food and specialty stores in the United States. The results of operations of Amerifit are
included in our consolidated financial statements as of the acquisition date
for the three and six months ended April 30, 2010.
Martek
also provides contract manufacturing and performs technical collaboration work
with corporate partners. The contract
manufacturing services are for both large and small companies and relate
primarily to the production of enzymes, specialty chemicals, vitamins, and
agricultural specialty products.
Collaboration work utilizes the Companys core expertise in microbial
biology, algal genomics, fermentation and downstream processing to collaborate
with these corporate partners in the development of new products and
technologies.
2.
BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited consolidated
financial statements of the Company 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 April 30,
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, Martek
Biosciences Kingstree Corporation and Martek Amerifit LLC (formerly called
Charter Amerifit LLC) along with its subsidiaries, Martek Amerifit Holding
Corporation, Amerifit Brands, Inc., Amerifit, Inc., Amerifit Pharma, Inc.
and Estroven Ltd., 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.
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 reasonably assured,
the product is shipped and
title and risk of loss are transferred
.
Sales are recorded net of allowances for returns, trade promotions, coupons and
other discounts. Additionally, with respect to its branded consumer health
products, the Company routinely commits to trade-promotion programs with its
retail customers that require the Company to estimate and accrue the expected
costs of such programs. Trade-promotion programs include cooperative marketing
programs, temporary price reductions, slotting and other trade-promotion
activities conducted by the retail customer. Trade-promotion costs are recorded
as a reduction of product sales.
A number of infant formula
license contracts for nutritional ingredients 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
6
Table of Contents
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 and included in product
sales in the consolidated statements of income.
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.
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 $1.1 million and $1.8 million in the three
and six months ended April 30, 2010, respectively, and $500,000 and $1.2
million in the three and six months ended April 30, 2009, respectively.
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 April 30, 2010 will change
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 Companys foreign subsidiary, Estroven
Ltd., maintains its accounts in its respective local currency, the Pound
Sterling. Assets and liabilities are
translated to U.S. dollars at period-end exchange rates. Income and expenses are translated at average
rates of exchange prevailing during the reporting period. Foreign currency translation adjustments are
accumulated and reported as other comprehensive income. The effects of changes in exchange rates on
foreign currency transactions included in net income are not material.
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 April 30, 2010, outstanding forward
contracts had notional values aggregating approximately 1.9 million Euros
(equivalent to $2.6 million at April 30, 2010), which mature by September 2010.
Amounts recorded due to hedge ineffectiveness have not been material.
Advertising
and Promotion
The Company
advertises and promotes its products primarily through national and regional print
and electronic media and expenses such activities when the promotion is run,
the electronic advertising is aired or the print media is released publicly.
7
Table
of Contents
Acquisition
Costs
Acquisition
costs are expensed as incurred. These
costs primarily include investment banking and professional service fees
directly attributable to the Companys acquisition of Amerifit in February 2010.
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, changes in the market value of
exchange rate forward contracts designated as cash flow hedges and foreign
currency translation adjustments in other comprehensive income.
Investments
The Company has classified
investments at April 30, 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 or would be required 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 April 30,
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 6 for further discussion.
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 April 30,
2010 and October 31, 2009. See Note
7 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.
Purchased
intangible assets other than goodwill are amortized over their useful lives
unless these lives are determined to be indefinite. The Companys amortizing
intangible assets, which consist primarily of patents, licenses, trademarks
unrelated to Amerifit and customer relationships resulting from the Amerifit
acquisition, are carried at cost less accumulated amortization. Amortization is
computed over the estimated useful lives of the respective assets, generally 10
to 18 years.
Trademarks
resulting from the Amerifit acquisition have been determined to have an
indefinite useful life. During the
period these assets are considered indefinite-lived, the trademarks will not be
amortized but will be tested for impairment on an annual basis and between
annual tests if management becomes aware of any events occurring or changes in
circumstances that would potentially indicate a reduction in the fair value of
the trademarks below their carrying amounts. Furthermore, during this
non-amortizing period, the trademarks will be evaluated for determining whether
events and circumstances continue to support an indefinite useful life. If a
trademark not being amortized is determined to have a finite useful life, the
asset will be amortized prospectively over the estimated remaining useful life
and accounted for in the same manner as intangible assets subject to
amortization.
See
Note 3 for further discussion of the goodwill and other intangible assets
associated with the Companys acquisition of Amerifit in February 2010.
8
Table
of Contents
Impairment
of Long-Lived Assets
The
Company reviews long-lived assets 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
comparing 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 3, 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.
In October 2009,
the FASB issued Accounting Standards Update No. 2009-13, Revenue
Recognition (Topic 605)Multiple-Deliverable Revenue Arrangements: a consensus
of the FASB Emerging Issues Task Force (ASU 2009-13). ASU 2009-13
establishes a selling-price hierarchy for determining the selling price of each
element within a multiple-deliverable arrangement. Specifically, the selling
price assigned to each deliverable is to be based on vendor-specific objective
evidence (VSOE), if available, third-party evidence, if VSOE is unavailable,
and estimated selling prices if neither VSOE or third-party evidence is
available. In addition, ASU 2009-13 eliminates the residual method of
allocating arrangement consideration and instead requires allocation using the
relative selling price method. ASU 2009-13 will be effective prospectively for
multiple-deliverable revenue arrangements entered into, or materially modified,
in fiscal years beginning on or after June 15, 2010. The Company is
assessing what impact, if any, the adoption of ASU 2009-13 may have on its
consolidated financial statements.
3.
ACQUISITION OF AMERIFIT
On February 12, 2010, Martek completed
the acquisition and obtained 100% of the voting interests of Amerifit. 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.
See Note 1 for an overall description of the Amerifit business.
The results of operations of Amerifit since February 12,
2010 have been included in the Companys consolidated statements of income.
This includes revenue of $18.0 million and income from operations of $1.9
million for the three and six months ended April 30, 2010.
Upon the closing of the acquisition, Martek
paid total cash consideration of approximately $218 million, 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 at the
closing, both of which are subject to adjustment based on the final
determinations of what Amerifits net debt level and net working capital
actually were at the closing. The
Company expects these final determinations to be made by October 31,
2010. To finance the Amerifit
acquisition, Martek utilized existing cash of approximately $115 million, proceeds
from the $75 million Term Loan (as defined below), $11 million drawn from the
Revolver (as defined below) and approximately $17 million of cash held by
Amerifit at closing. See Note 11 for
additional discussion of the debt instruments.
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 table below summarizes the preliminary
allocation of the purchase price based upon fair values of assets acquired and
liabilities assumed at February 12, 2010.
This preliminary allocation is based upon information that was available
to management at the time the financial statements were prepared. Accordingly, the allocation may change. The Company has no information that indicates
the final purchase price allocation could differ materially from the preliminary
estimates noted below other than potential changes associated with the final
determination of deferred tax assets acquired and certain accrued liabilities
assumed in connection with the acquisition of Amerifit.
9
Table
of Contents
(In thousands)
|
|
|
|
|
|
|
|
Assets
|
|
|
|
Cash
|
|
$
|
17,145
|
|
Accounts receivable
|
|
13,025
|
|
Inventories
|
|
7,634
|
|
Other current assets
|
|
2,243
|
|
Identifiable intangible assets
|
|
137,260
|
|
Property and equipment
|
|
1,813
|
|
|
|
|
|
Total identifiable assets acquired
|
|
179,120
|
|
|
|
|
|
Liabilities
|
|
|
|
Accounts payable and accrued expenses
|
|
(10,218
|
)
|
Deferred tax liability
|
|
(49,376
|
)
|
Other liabilities
|
|
(614
|
)
|
|
|
|
|
Total liabilities assumed
|
|
(60,208
|
)
|
|
|
|
|
Net identifiable assets acquired
|
|
118,912
|
|
Goodwill
|
|
98,975
|
|
|
|
|
|
Net assets acquired
|
|
$
|
217,887
|
|
The estimated fair value of the inventory acquired
resulted in a $1.9 million step-up from cost.
Of such step-up, $1.7 million was recorded as a cost of product sales in
the three and six months ended April 30, 2010 in the accompanying
consolidated statements of income. The
cost basis of all other current assets acquired, all current liabilities
assumed and of all acquired property and equipment approximated their fair
values.
Identified Intangible Assets
A
substantial portion of the assets acquired consisted of intangible assets
related to customer relationships, trademarks and the Culturelle® drug master
file (DMF). Management determined that the estimated acquisition-date fair
values of the intangible assets related to Amerifits customer relationships,
trademarks and the DMF were $91.4 million, $45.4 million and $500,000,
respectively.
The
Company used the income method to estimate the value of Amerifits customer
relationships. Through this approach, the fair value of these customer
relationships was determined by discounting to their present value the
estimated cash flows associated with the existing customers as of the date of
acquisition taking into consideration estimated attrition of the existing
customer base. The estimated cash flows were based on revenues for those
existing customers, net of operating expenses and other intangible assets that
contribute to the projected cash flow from those customers. The projected
revenues were based on assumed revenue growth rates and customer renewal rates.
Operating expenses were estimated based on the supporting infrastructure
expected to sustain the assumed revenue growth rates. A discount rate was based
on the risks associated with the respective cash flows taking into
consideration the Companys weighted average cost of capital. Martek expects to
amortize the value of Amerifits customer relationships using an accelerated
method over a period of 18 years, which is the period over which the acquired
customers are expected to contribute future cash flows to the Company. An
accelerated amortization method was considered the most appropriate means of
reflecting the consumption of the asset relative to the pattern of economic
benefits derived from the customer relationships.
The
Company used the relief-from-royalty method to estimate the fair value of
Amerifits trademarks. Through this method, the fair value of the trademarks
was determined based on the present value of the projected cost savings attributable
to the ownership of the asset. This approach is based on the theory that the
owner of the intangible asset is relieved of paying a royalty or license fee
for the use of the trademark. The method included assumptions related to
projected revenues attributable to the trademark and a reasonable market
royalty rate that would otherwise be charged by a licensor of the trademark to
a licensee of the trademark. A discount rate was based on the risks associated
with the respective cash flows taking into consideration the Companys weighted
average cost of capital. As there are believed to be no legal, regulatory,
contractual, competitive, economic or any other factors that may limit the
period over which the acquired trademarks are expected to contribute directly
or indirectly to our future cash flows, the trademarks are determined to have
an indefinite useful life.
The Company used the
cost approach to value the DMF. The cost
approach measures the value of an asset by the cost to replace it with another of
like utility.
Deferred Income Taxes
The
$2.4 million of deferred tax assets resulting from the acquisition was
primarily related to federal and state net operating loss carryforwards
acquired. The $51.8 million of deferred tax liabilities resulting from the
acquisition was primarily related to the difference between the book basis and
tax basis of the identifiable intangible assets.
10
Table
of Contents
Goodwill
The
excess of the consideration transferred over the fair values assigned to the
identifiable assets acquired and liabilities assumed was $99.0 million, which
represents the goodwill amount resulting from the acquisition. Management
believes that the goodwill mainly represents the future earnings potential of
Amerifit as well as the economic synergies to be gained from Martek using
Amerifits marketing platform to commercialize and distribute the nutritional
health and wellness products that Martek is currently developing. The Company
has recorded the goodwill as an intangible asset in our consolidated balance
sheet as of the acquisition date and has attributed the goodwill to Marteks
branded consumer health products segment.
The assignment of goodwill to reporting units has not been completed.
Goodwill is tested for impairment on an annual basis and between annual tests
if management becomes aware of any events occurring or changes in circumstances
that would potentially indicate a reduction in the fair value of the goodwill
below its carrying amount. None of the
goodwill generated from the Amerifit acquisition is expected to be deductible
for tax purposes.
Unaudited Pro Forma
Information
The
following unaudited pro forma information presents the combined results of
operations of Martek and Amerifit for the three and six months ended April 30,
2010 and 2009 as if the acquisition of Amerifit had been completed on November 1,
2009 and 2008, respectively, with adjustments to give effect to pro forma
events that are directly attributable to the acquisition. The unaudited pro
forma results do not reflect any operating efficiencies or potential cost
savings which may result from the consolidation of the operations of Martek and
Amerifit. Accordingly, these unaudited pro forma results are presented for
illustrative purposes and are not intended to represent or be indicative of the
actual results of operations of the combined company that would have been
achieved had the acquisition occurred at the beginning of each period
presented, nor are they intended to represent or be indicative of future
results of operations.
The
following table summarizes the unaudited pro forma results of operations (in
thousands, except per share amounts):
|
|
Three months
ended April 30,
|
|
Six
months ended April 30,
|
|
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
126,981
|
|
$
|
111,953
|
|
$
|
237,335
|
|
$
|
216,361
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
13,776
|
|
$
|
12,663
|
|
$
|
28,296
|
|
$
|
22,807
|
|
|
|
|
|
|
|
|
|
|
|
Net income per
share
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.41
|
|
$
|
0.38
|
|
0.85
|
|
0.69
|
|
Diluted
|
|
$
|
0.41
|
|
$
|
0.38
|
|
0.84
|
|
0.68
|
|
4.
SEGMENT INFORMATION
Martek
operates in two material business segments, the development and
commercialization of high-value nutritional ingredients products from microbial
sources
and, with the acquisition of Amerifit in February 2010,
the marketing and sale of branded consumer health products. Outside of these two segments, the Company
derives revenues primarily from contract manufacturing and collaborations,
which are included in other in the tables below.
Martek measures segment performance based on
income from operations. As follows are
segment revenues and overall segment operating performance (in thousands).
|
|
Three months ended April 30,
|
|
Six months ended April 30,
|
|
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
Segment Revenues
|
|
|
|
|
|
|
|
|
|
Branded consumer health products
|
|
$
|
18,009
|
|
$
|
|
|
$
|
18,009
|
|
$
|
|
|
Nutritional ingredients
|
|
99,668
|
|
87,163
|
|
182,772
|
|
170,036
|
|
Other
|
|
6,291
|
|
5,248
|
|
12,943
|
|
9,738
|
|
Total
|
|
$
|
123,968
|
|
$
|
92,411
|
|
$
|
213,724
|
|
$
|
179,774
|
|
|
|
|
|
|
|
|
|
|
|
Segment Income (Loss) From
Operations
|
|
|
|
|
|
|
|
|
|
Branded consumer health products
|
|
$
|
1,893
|
|
$
|
|
|
$
|
1,893
|
|
$
|
|
|
Nutritional ingredients
|
|
19,680
|
|
17,149
|
|
35,320
|
|
32,591
|
|
Other
|
|
658
|
|
(250
|
)
|
583
|
|
(427
|
)
|
Total
|
|
$
|
22,231
|
|
$
|
16,899
|
|
$
|
37,796
|
|
$
|
32,164
|
|
11
Table
of Contents
Included
in segment operating performance is depreciation and amortization attributed to
the branded consumer health products segment of $1.5 million in the three and
six months ended April 30, 2010 and depreciation and amortization
attributed to the nutritional ingredients segment of $6.0 million and $12.4
million in the three and six months ended April 30, 2010, respectively,
and $6.2 million and $12.5 million in the three and six months ended April 30,
2009, respectively.
Approximately 78% and 76%
of the Companys nutritional ingredients sales in the three and six months ended
April 30, 2010, respectively, were generated by sales to its top five nutritional
ingredients customers. In addition,
approximately 51% of the Companys branded consumer health products sales in
both the three and six months ended April 30, 2010 was generated by sales to
its top two branded consumer health products customers. Although the Company is
not given precise information by its customers as to the countries in which its
nutritional ingredients are sold, the Company estimates that approximately 50%
of its nutritional ingredients sales for the three and six months ended April
30, 2010 and the three and six months ended April 30, 2009 relate to sales in
the U.S. Virtually all sales of branded consumer health products are to
customers in the U.S.
Assets
of the branded consumer health products segment total $264.3 million at April 30,
2010. The remainder of the Companys
assets are almost entirely related to the operations of the nutritional
ingredients segment.
5.
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 April 30, 2010, the
value of the remaining calendar year 2010 and full calendar year 2011 minimum
purchase requirements are approximately $58.4 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.
6. INVESTMENTS
At April 30, 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 16 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.
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 (see further
discussion below). The Companys ARS holdings to which this relates have a cost
basis of approximately $7.3 million and a fair value at April 30, 2010 of
approximately $6.2 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 of approximately $100,000 during the
three and six months ended April 30, 2010 were recognized in interest and
other income in the consolidated statements of income. In the six months ended April 30,
2009, the Company recognized a $1.9 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 $900,000 of unrealized fair value declines occurring
after such reclassification, of which $170,000 was recognized during the three
months ended April 30, 2009.
The Company has recorded the Put
Agreement at its fair value, which as of April 30, 2010 is approximately
$1.1 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
12
Table
of Contents
creditworthiness of the issuer and the
liquidity of the financial instrument.
In May 2010, Martek alerted the financial institution of the
Companys intention to sell the ARS covered by the Put Agreement on June 30,
2010. 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 April 30, 2010.
Net losses associated with the Put Agreement of approximately $100,000
during the three and six months ended April 30, 2010 were recognized in interest
and other income in the consolidated statements of income. In the six months ended April 30, 2009,
the Company recognized a gain of $1.8 million related to the Put Agreement,
which was recognized in interest and other income in the consolidated statements
of income, of which $219,000 was recognized during the three months ended April 30,
2009.
As of April 30, 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 April 30,
2010. Net unrealized gains associated
with these ARS during the three and six months ended April 30, 2010 were
not material. In six months ended April 30,
2009, the Company recognized $600,000 as a reduction to other comprehensive
income related to the temporary unrealized losses for the Companys ARS not
covered by the Put Agreement, of which $300,000 was recorded as an increase to
other comprehensive income during the three months ended April 30, 2009.
7. 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.
As of April 30,
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 April 30, 2010
|
|
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Balance
|
|
Assets
|
|
|
|
|
|
|
|
|
|
Available-for-sale
securities (1)
|
|
$
|
|
|
$
|
|
|
$
|
4,579
|
|
$
|
4,579
|
|
Trading securities (2)
|
|
|
|
|
|
6,208
|
|
6,208
|
|
Put Agreement(2)
|
|
|
|
|
|
1,084
|
|
1,084
|
|
Investments in money
market funds (3)
|
|
5,110
|
|
|
|
|
|
5,110
|
|
Total assets
|
|
$
|
5,110
|
|
$
|
|
|
$
|
11,871
|
|
$
|
16,981
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
Exchange rate forward
contracts (4)
|
|
|
|
14
|
|
|
|
14
|
|
Total liabilities
|
|
$
|
|
|
$
|
14
|
|
$
|
|
|
$
|
14
|
|
(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.
(4)
Included
in accrued liabilities in the accompanying consolidated balance sheets.
13
Table
of Contents
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 April 30, 2010 (in thousands):
|
|
Auction Rate
Securities
|
|
Put Agreement
|
|
Total
|
|
|
|
|
|
|
|
|
|
Balance on January 31, 2010
|
|
$
|
10,644
|
|
$
|
1,190
|
|
$
|
11,834
|
|
|
|
|
|
|
|
|
|
Transfers to/(from)
Level 3
|
|
|
|
|
|
|
|
Total gains (losses)
(realized or unrealized): (1)
|
|
|
|
|
|
|
|
Included in earnings
|
|
120
|
|
(106
|
)
|
14
|
|
Included in other
comprehensive income
|
|
23
|
|
|
|
23
|
|
Purchases, sales,
issuances and settlements, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance on
April 30, 2010
|
|
$
|
10,787
|
|
$
|
1,084
|
|
$
|
11,871
|
|
(1) See
Note 6 for discussion of Auction Rate Securities and related Put Agreement.
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 six months ended April 30, 2010 (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
|
|
178
|
|
(137
|
)
|
41
|
|
Included in other
comprehensive income
|
|
84
|
|
|
|
84
|
|
Purchases, sales,
issuances and settlements, net
|
|
(50
|
)
|
|
|
(50
|
)
|
|
|
|
|
|
|
|
|
Balance on
April 30, 2010
|
|
$
|
10,787
|
|
$
|
1,084
|
|
$
|
11,871
|
|
(1) See
Note 6 for discussion of Auction Rate Securities and related Put Agreement.
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 April 30, 2009 (in thousands):
|
|
Auction Rate
Securities
|
|
Put Agreement
|
|
Total
|
|
|
|
|
|
|
|
|
|
Balance on January 31, 2009
|
|
$
|
9,722
|
|
$
|
1,588
|
|
$
|
11,310
|
|
|
|
|
|
|
|
|
|
Transfers to/(from)
Level 3
|
|
|
|
|
|
|
|
Total gains (losses)
(realized or unrealized): (1)
|
|
|
|
|
|
|
|
Included in earnings
|
|
(170
|
)
|
219
|
|
49
|
|
Included in other
comprehensive income
|
|
256
|
|
|
|
256
|
|
Purchases, sales,
issuances and settlements, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance on
April 30, 2009
|
|
$
|
9,808
|
|
$
|
1,807
|
|
$
|
11,615
|
|
(1) See
Note 6 for discussion of Auction Rate Securities and related Put Agreement.
14
Table
of Contents
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 six months ended April 30, 2009 (in thousands):
|
|
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
|
|
(1,887
|
)
|
1,807
|
|
(80
|
)
|
Included in other
comprehensive income
|
|
359
|
|
|
|
359
|
|
Purchases, sales,
issuances and settlements, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance on
April 30, 2009
|
|
$
|
9,808
|
|
$
|
1,807
|
|
$
|
11,615
|
|
(1) See
Note 6 for discussion of Auction Rate Securities and related Put Agreement.
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.
8. INVENTORIES
Inventories
consist of the following (in thousands):
|
|
April 30,
|
|
October 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Finished goods
|
|
$
|
66,709
|
|
$
|
56,203
|
|
Work in process
|
|
46,739
|
|
56,501
|
|
Raw materials
|
|
6,008
|
|
3,475
|
|
|
|
|
|
|
|
Inventories, net
|
|
$
|
119,456
|
|
$
|
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.
9. PROPERTY, PLANT AND EQUIPMENT
Property,
plant and equipment consists of the following (in thousands):
|
|
April 30,
|
|
October 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Land
|
|
$
|
2,320
|
|
$
|
2,320
|
|
Building and improvements
|
|
69,264
|
|
67,094
|
|
Machinery and equipment
|
|
270,106
|
|
266,257
|
|
Furniture and fixtures
|
|
3,309
|
|
3,094
|
|
Computer hardware and software
|
|
18,708
|
|
17,220
|
|
|
|
363,707
|
|
355,985
|
|
Less: accumulated depreciation and amortization
|
|
(125,124
|
)
|
(113,437
|
)
|
|
|
238,583
|
|
242,548
|
|
Construction in progress
|
|
10,813
|
|
9,731
|
|
|
|
|
|
|
|
Property, plant and equipment, net
|
|
$
|
249,396
|
|
$
|
252,279
|
|
15
Table
of Contents
Assets
available for commercial use that were not in productive service had a net book
value of $32.7 million and $34.4 million at April 30, 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.
10. INTANGIBLE ASSETS
Intangible
assets and related accumulated amortization consist of the following (in
thousands):
|
|
April 30, 2010
|
|
October 31, 2009
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
Accumulated
|
|
|
|
Intangible Asset
|
|
Gross
|
|
Amortization
|
|
Net
|
|
Gross
|
|
Amortization
|
|
Net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trademarks (amortizing)
|
|
$
|
2,242
|
|
$
|
(1,087
|
)
|
$
|
1,155
|
|
$
|
2,202
|
|
$
|
(1,004
|
)
|
$
|
1,198
|
|
Trademarks (indefinite-lived)
|
|
45,400
|
|
|
|
45,400
|
|
|
|
|
|
|
|
Patents
|
|
28,421
|
|
(10,986
|
)
|
17,435
|
|
25,732
|
|
(9,046
|
)
|
16,686
|
|
Current products
|
|
10,676
|
|
(5,719
|
)
|
4,957
|
|
10,676
|
|
(5,363
|
)
|
5,313
|
|
Licenses and other
|
|
27,603
|
|
(7,009
|
)
|
20,594
|
|
24,899
|
|
(5,465
|
)
|
19,434
|
|
|
|
114,342
|
|
(24,801
|
)
|
89,541
|
|
63,509
|
|
(20,878
|
)
|
42,631
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer relationships
|
|
91,400
|
|
(1,246
|
)
|
90,154
|
|
|
|
|
|
|
|
Goodwill
|
|
150,567
|
|
|
|
150,567
|
|
51,592
|
|
|
|
51,592
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
356,309
|
|
$
|
(26,047
|
)
|
$
|
330,262
|
|
$
|
115,101
|
|
$
|
(20,878
|
)
|
$
|
94,223
|
|
See
Note 3 for discussion of the additions to trademarks, customer relationships
and goodwill resulting from the Amerifit acquisition in February 2010.
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. In April 2010,
certain development goals were achieved by the licensor related to the licensed
technology which has resulted in future license payment obligations for Martek. During the three months ended April 30,
2010, the Company recorded the present value of such future payments, totaling
approximately $2.2 million, as an additional license fee asset as well as a
license fee obligation. 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, and may be required to pay additional
license fees of approximately $2.5 million if certain commercially beneficial
rights are exercised by the Company in the future. The license fees paid in connection with this
arrangement are being amortized over 10 years.
Included
in amortization of intangible assets is approximately $2.4 million and $3.6
million in the three and six months ended April 30, 2010, respectively,
and approximately $1.4 million and $3.0 million in the three and six months
ended April 30, 2009, respectively, related to assets supporting the
Companys commercial products.
Based
on the current amount of intangible assets subject to amortization, the
estimated total amortization expense for each year in fiscal 2010 through
fiscal 2014 will be approximately $12.4 million, $14.1 million, $12.9 million,
$12.6 million and $12.0 million, respectively.
11. NOTES PAYABLE AND LONG-TERM DEBT
In January 2010, the Company entered into
a Credit Agreement, subsequently amended in March 2010 (the Credit
Agreement), that includes a $75 million term loan (the Term Loan) and a $100
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 3).
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
16
Table
of Contents
Term Loan of $3,750,000, which began in 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. During the
three months ended April 30, 2010, the Company made the required quarterly
payment as well as an additional discretionary repayment of $31,250,000.
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%. For purposes of the Credit Agreement, LIBOR is
the greater of 1.25% per annum or LIBOR at the time of such determination.
There were no amounts outstanding under the
Former Facility from November 1, 2009 through its refinancing in January 2010.
The weighted average annual commitment fee rate on unused amounts under the
Revolver was approximately 0.3% for the three months ended April 30,
2010. The weighted average annual
commitment fee rate on unused amounts under the Former Facility in the first
quarter of fiscal 2010 was approximately 0.1%. 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.
During the three and six months ended April 30,
2010, the Company incurred interest on borrowings of approximately $800,000,
including $700,000 of interest on the Term Loan and $100,000 on the
Revolver. The weighted average annual
interest rate during the three and six months ended April 30, 2010 on the
Term Loan the Revolver was 4.9% and 4.5%, respectively.
In connection with the Credit Agreement
financing, the Company incurred debt issuance costs totaling approximately $3.9
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. Amortization of amounts allocated to the Term
Loan and Revolver totaled $300,000 and $200,000, respectively, from the date of
funding on February 12, 2010 through April 30, 2010. If repayment of the Term Loan is accelerated
by the Company, the amortization of debt issuance costs attributable to the
Term Loan would also accelerate.
The
carrying amounts of notes payable and long-term debt at April 30, 2010 and
October 31, 2009 approximate their fair values based on instruments of
similar terms available to the Company.
12. 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 April 30, 2010, the Companys financial commitment, primarily
through internal research efforts, to the first projected milestone date totals
approximately $300,000. 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
17
Table
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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.
The trial for US Patent No. 5,698,244
likely will not occur before 2011.
Discovery is expected to be completed before the end of 2010, and the
defendants will be permitted to file a summary judgment motion at the end of
2010.
Additionally, in early 2010 Lonza requested reexamination of U.S. Patent
Nos. 6,410,281 and 5,698,244 in the U.S. Patent and Trademark Office, and
these two requests have been granted.
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 April 30, 2010, the patents being
defended in the Lonza matter had a net book value of approximately $3.8
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. STOCKHOLDERS EQUITY
The Company recognized approximately $1.5
million and $2.4 million in the three and six months ended April 30, 2010,
respectively, and approximately $1.1 million and $1.9 million in the three and
six months ended April 30, 2009, respectively, 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 474,424 restricted stock
units during the six months ended April 30, 2010, which generally vest
over 62 months from the date of grant.
The total fair value of the restricted stock units granted of $9.1
million was based on fair market value on the date of grant.
As of April 30, 2010, there was
approximately $18.3 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 April 30, 2010 is not material.
18
Table
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14. 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 April 30,
|
|
Six
months ended April 30,
|
|
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
12,517
|
|
$
|
11,017
|
|
$
|
22,160
|
|
$
|
20,623
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding, basic
|
|
33,383
|
|
33,190
|
|
33,329
|
|
33,170
|
|
Effect of dilutive potential common shares:
|
|
|
|
|
|
|
|
|
|
Stock options
|
|
59
|
|
66
|
|
55
|
|
105
|
|
Restricted stock units
|
|
136
|
|
54
|
|
130
|
|
74
|
|
Total dilutive potential common shares
|
|
195
|
|
120
|
|
185
|
|
179
|
|
Weighted average shares outstanding, diluted
|
|
33,578
|
|
33,310
|
|
33,514
|
|
33,349
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share, basic
|
|
$
|
0.37
|
|
$
|
0.33
|
|
$
|
0.66
|
|
$
|
0.62
|
|
Net income per share, diluted
|
|
$
|
0.37
|
|
$
|
0.33
|
|
$
|
0.66
|
|
$
|
0.62
|
|
Stock
options to purchase approximately 2.0 million shares were outstanding but were
not included in the computation of diluted net income per share for both the
three and six months ended April 30, 2010, and stock options to purchase
approximately 2.2 million shares and 2.1 million shares were outstanding but
were not included in the computation of diluted net income per share for the
three and six months ended April 30, 2009, respectively, because the
effects would have been antidilutive.
15. COMPREHENSIVE INCOME
Comprehensive
income and its components for the three and six months ended April 30,
2010 and 2009 were as follows (in thousands):
|
|
Three months ended April 30,
|
|
Six months ended April 30,
|
|
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
Net income, as reported
|
|
$
|
12,517
|
|
$
|
11,017
|
|
$
|
22,160
|
|
$
|
20,623
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income (loss):
|
|
|
|
|
|
|
|
|
|
Foreign currency translation adjustment
|
|
(2
|
)
|
|
|
(2
|
)
|
|
|
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 $9, $95, $31 and $(249), respectively
|
|
14
|
|
162
|
|
52
|
|
(420
|
)
|
Realized loss on exchange rate forward contracts, net
of tax of $5, $484, $5 and $920, respectively
|
|
8
|
|
818
|
|
8
|
|
1,553
|
|
Unrealized (loss) gain on exchange rate forward
contracts, net of tax of $(10), $324, $(10) and $372, respectively
|
|
(17
|
)
|
466
|
|
(17
|
)
|
674
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
$
|
12,520
|
|
$
|
12,463
|
|
$
|
22,201
|
|
$
|
23,076
|
|
19
Table
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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, including its
newly-acquired subsidiary, Charter Amerifit LLC , now Martek 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 our
nutritional ingredients and branded consumer health products;
·
expectations regarding sales of our
nutritional ingredients to and by our infant formula customers and supplemented
infant formula market penetration levels;
·
expectations
regarding our ability to enter into new or extend existing sole source infant
formula supply agreements;
·
expectations regarding sales of our branded
consumer health products to retail and other customers;
·
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 ingredients;
·
expectations regarding future purchase
volumes and costs of third-party manufactured products;
·
expectations regarding the amount of
production capacity and our ability to meet future demands for our nutritional
ingredients;
·
expectations regarding the amount of
inventory held by us or our customers;
·
expectations regarding our production
capacity utilization and the effects of excess production capacity;
·
expectations regarding the amount of
production capacity and key raw materials we can procure and our ability to
meet future demands for our branded consumer health products;
·
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.
20
Table of Contents
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 downstream 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, dietary supplements and animal feeds. We also produce
lifesARA
(arachidonic acid), an omega-6 fatty acid, for
use in infant formula and growing-up milks.
Our DHA and ARA are collectively referred to as nutritional ingredients. On February 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
include: Culturelle®, a leading probiotic supplement; AZO, the leading
over-the-counter 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. The products sold through the Amerifit
subsidiary are collectively referred to as branded consumer health products. There are currently a number of nutritional
health and wellness products under development that we plan to commercialize
and distribute through Amerifits marketing platform.
We operate in two material business segments,
the development and commercialization of high-value nutritional ingredients
products from microbial sources
and, with the acquisition of Amerifit in February 2010,
the marketing and sale of branded consumer health products. The nutritional
ingredients segment sells to manufacturers of infant formula, foods and
beverages, animal feeds, supplements and pregnancy and nursing products. The branded consumer health products segment
sells to retail outlets, including most major mass, club, drug, food and
specialty stores in the United States.
In our
nutritional ingredients segment, we sell oils and powders containing
nutritional ingredients 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
ingredients. 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 ingredients. Our customers are now selling infant formula
products containing our nutritional ingredients collectively in over 75
countries. Supplemented infant formulas
from Mead Johnson Nutritionals, Abbott Nutrition, Perrigo Company (formerly 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
ingredients and target the markets for children ages nine months to seven years
and older.
RECENT HIGHLIGHTS
The
following highlights some recent positive developments in our business and the
literature around our nutritional ingredients. Please read our Risk Factors
carefully for certain factors that should be considered in evaluating these
developments and our business.
·
MIDAS Study
Published Which Shows Marteks Algal DHA Improved Memory and Learning In
Healthy Adults with Memory Complaints -
The
Memory Improvement with Docosahexaenoic Acid (DHA) Study (MIDAS) published in May 2010
in
Alzheimers & Dementia: The
Journal of the
Alzheimers
Association
showed that Marteks
algal DHA improved memory function in healthy aging adults.
MIDAS is the first large,
randomized, placebo-controlled study to demonstrate the benefits of DHA in
maintaining and improving brain health in older adults. MIDAS found that
healthy people with memory complaints who took 900mg of Marteks algal DHA
capsules for six months had almost double the reduction in errors on a test
that measures learning and memory performance versus those who took a placebo,
a benefit roughly equivalent to having the learning and memory skills of
someone three years younger. The DHA was well-tolerated and subjects taking the
DHA also experienced a lower heart rate, providing a significant cardiovascular
benefit. The study was funded by Martek.
·
Non-Infant
Formula Product Launches
·
Foods and Beverages - Fortune Natural Grains
Blended Cooking Oil (COFCO China), Future Star Kid Milk (Mengniu China),
Quiznos® salad dressings (U.S.) Milkana® Golden Baby Cheese (BSI (Tianjin)®
Food Company China), dha
21
Table
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Omega3 Eggs (M. Lasser Israel), Earths
Best® Organic Nutritional Mommy Bars (Hain Celestial U.S.), H-E-B® Reduced
Fat Milk (2%) with DHA Omega-3 and H-E-B® Whole Milk with DHA Omega-3
(Morningstar U.S.), Rice Milk with Omega3 DHA (Freedom Foods Australia)
·
Pregnancy and nursing and nutritional
supplements- Pharmaceutical LLC PreferaOB One (Alaven® U.S.), Algal-900 DHA Softgels (Walgreens
U.S.), Natural Omega-3 Vegetarian DHA
100 mg Softgels (Bluebonnet® U.S.), Natural Omega-3 Vegetarian DHA 200 mg Softgels (Bluebonnet®
U.S.) and Merck Kidabion DHA
Powder Drink for Children (China)
·
New
Scientific Data/Recommendations Published on DHA and ARA
In addition to
the MIDAS study noted above, the benefits of DHA and ARA supplementation were
recently discussed in the following publications:
·
The
Journal
of Nutrition
(April 2010) published the results of a study
examining the association between omega-3 fatty acids in serum and cognitive
function in mid-life adults. Levels of serum phospholipid ALA, EPA,
and DHA and performance in five major dimensions of cognitive function were determined
in 280 healthy volunteers, ages 35 to 54. Using regression analysis, higher
levels of DHA were associated with better performance on the tests of nonverbal
reasoning and mental flexibility, working memory and vocabulary. Neither
ALA nor EPA showed a significant relationship to cognitive function.
·
In the
EFSA Journal
(March 2010), the European Food Safety
Authoritys (EFSA) Panel on Dietetic Products, Nutrition, and Allergies (NDA)
officially adopted and published an Opinion on Dietary Reference Values for
fats, including polyunsaturated fatty acids. The NDA Panel concluded that
a daily intake of 250 mg of long-chain omega-3 fatty acids for adults may
reduce the risk of heart disease. The NDA Panel set an Adequate Intake (AI)
of 250 mg/day EPA+DHA for adults and an AI of 100 mg DHA/day for infants (>6
months) and young children <24 months.
For pregnant or lactating women, 100-200 mg preformed DHA is recommended
in addition to the 250 mg/day omega-3 DHA+EPA AI for adults.
·
The Joint FAO/WHO Expert Group Consultation on
Fats and Fatty Acids in Human Nutrition released their recommendations as an
interim report from the meeting which was held in Geneva in November 2008.
The report recommends an AI for DHA for ages 0-6 months of 0.1-0.18% energy
with no upper limit other than recognizing high maternal milk levels of 1.5%
total energy. The Committee refers to DHA during this period as a
conditionally essential nutrient. The recommended AI for ages 6-24 months
is 10-12 mg/kg. The Committee recognized the importance of DHA for
retinal and brain development during this period. A combination of
EPA+DHA was recommended for children ages 2-10 years ranging from 100-250
mg/day. For adults, daily consumption of 100-250 mg/day DHA+EPA is
recommended.
·
The
Journal
of Pediatrics
(June 2010) published a report on medical records
as reviewed by investigators unaware of treatment assignment for two cohorts of
infants looking at the incidence of respiratory infections and allergies at three
years of age. The original two cohorts included 147 infants who had received
either a DHA/ARA containing formula (0.32%-0.36% DHA/0.64%-0.73% ARA) or a
formula without supplementation for one year. Eighty-nine infants were
available for follow up evaluation at age three, 38 in the active and 51 in the
placebo group. The DHA/ARA-supplemented groups had significantly lower odds for
developing upper respiratory infections, wheezing, asthma, or symptoms of
allergy. Marteks
lifesDHA
and
lifesARA
were used in the study.
SALES AND MARKETING
In our
nutritional ingredients segment, we are currently marketing and selling
lifesDHA,
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.
The
products in our branded consumer health products segment are sold primarily
through a direct sales force, brokers, distributors and wholesalers. We are currently marketing and selling such
products to most major mass, club, drug, food and specialty stores in the
United States
.
We
expect that our future revenues and operating results will continue to
experience quarter-to-quarter and year-to-year fluctuations, some of which may
be significant. We currently have sole
source supply agreements, in most cases through 2011, with customers comprising
nearly 75% of our current infant formula revenues. Our success in entering into
new sole source agreements or in extending these existing sole source infant
formula supply agreements will be significant in determining the extent of such
revenue fluctuations. In order to extend
our sole source arrangements beyond 2011, reductions to our existing per-unit
pricing may be required, which is likely to result in declines to our future
infant formula revenues and may negatively impact related infant formula gross
profit margins. The Company has several
cost saving and product innovation strategies designed to mitigate a portion of
the possible negative gross profit margin impact of lower future infant formula
pricing. We anticipate continued growth in our nutritional ingredients segment
outside of infant formula and in our branded consumer health products segment,
which should also mitigate any decrease to infant formula revenues and
margins. In addition, any growth in the
overall market for DHA and ARA in infant formula would also help reduce the
impact of any such decreases.
In
addition to these aforementioned matters, the timing and extent of future
product sales 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;
22
Table
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·
the timing and effectiveness of promotional and advertising
campaigns for our branded consumer health products;
·
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 nutritional ingredients in
infant formula;
·
the continued acceptance, and extent thereof, of products
containing our nutritional ingredients under WIC and other regulatory programs
in the U.S.;
·
our continued ability to make product claims on our branded
consumer health products;
·
the continued acceptance of our products by consumers and
continued demand by our customers;
·
our ability to introduce new, internally-developed products
through Amerifits sales and marketing channels;
·
the ability of our customers to incorporate our nutritional
ingredients into various foods and beverages;
·
our ability to protect against competitive nutritional
ingredients products through our patents;
·
competition from alternative sources of our nutritional
ingredients and branded consumer health products; 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.
PRODUCTION AND SOURCES OF SUPPLY
Nutritional
Ingredients
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.
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 April 30, 2010, the
value of the remaining calendar year 2010 and full calendar year 2011 minimum
purchase requirements are approximately $58.4 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.
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.
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.
Our raw material suppliers for production of
our nutritional ingredients include major chemical companies and food and
beverage ingredient suppliers. We have identified and validated multiple
sources for most of our major ingredients and do not anticipate that the lack of
availability of raw materials will cause future production shortages.
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-
23
Table
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infant formula markets. As such, our production capacity exceeds
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.
Branded
Consumer Health Products
We
currently outsource the production and packaging of all of our branded consumer
health products with oversight by our internal managers. We expect to continue
to rely on third parties for these manufacturing requirements. Where possible,
we qualify more than one source for the manufacturing and packaging of our
products to manage the risk of supply disruptions. In such circumstances, if
one of our manufacturers or packagers were unable to supply our needs, we
believe we would have an alternative source available for those products. While one of our products does not have an
alternative manufacturer qualified, we have identified another manufacturer for
such product and have commenced the qualification process. However, qualifying
such replacement manufacturer, if successful, could take up to twelve months,
and, as a result, we would not be able to guarantee an uninterrupted supply of
the affected product to our customers.
When economically
advantageous, we directly procure key raw materials used by our manufacturers
that are contracted to produce our branded consumer health products. With the
exception of a key raw material for the production of
Culturelle®
,
we have identified multiple sources for the supply of key raw materials.
The commercial success of our
nutritional ingredients and branded consumer health products will depend, in
part, on our ability, or the ability of our contract manufacturers, to produce our products 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 or the production of our contract
manufacturers with customer demand, which is inherently uncertain. There can also be no assurance that we or our
contract manufacturers will be able to continue to comply with applicable regulatory
requirements, including the Food and Drug Administrations good manufacturing
practice (GMP) requirements.
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. Other than the changes and
additions noted below, which resulted from our acquisition of Amerifit in February 2010,
there have been no significant changes in the Companys critical accounting
policies since October 31, 2009.
Revenue
Recognition
We derive revenue from
three sources: product sales, contract manufacturing and collaborations. We
recognize product sales revenue when persuasive evidence of an arrangement
exists, the fee is fixed or determinable, collectibility is reasonably assured,
the product is shipped and title and risk of loss are transferred
. Sales are recorded net of allowances for returns, trade promotions,
coupons and other discounts. Additionally, with respect to our branded consumer
health products, we routinely commit to trade-promotion programs with our
retail customers that require the Company to estimate and accrue the expected
costs of such programs. Such cost estimates
generally utilize the historical results of similar trade-promotion programs
with additional allowances for any unique facts and circumstances. Trade-promotion programs include cooperative
marketing programs, temporary price reductions, slotting and other
trade-promotion activities conducted by the retail customer. Trade-promotion
costs are recorded as a reduction of product sales. If our actual costs of trade-promotion
programs differ from our historical results, actual product sales will differ
from those estimated and the differences could be material.
Identified
Intangible Assets
In conjunction with
the recent acquisition of Amerifit, we have recorded customer relationship and
trademark intangible assets as part of our recognition and measurement of assets
acquired and liabilities assumed. Identifiable intangible assets, such as
those, are measured at their respective fair values as of the acquisition date.
Discounted cash flow models have been used in valuing these intangible assets,
and these models require the use of significant estimates and assumptions in
such areas as growth rates, profitability and the discount rate applied to the
cash flows. While we believe the fair
values assigned to our acquired intangible assets are based on reasonable estimates
and assumptions given the available facts and circumstances as of the
acquisition dates, unanticipated market events may occur which could affect the
accuracy or validity of the estimates and assumptions.
We believe that
the acquired customer relationships have an estimated useful life of 18 years
based on estimates of value derived from these relationships and
attrition. The acquired trademarks have
an indefinite useful life due to the fact that
no legal, regulatory,
contractual, competitive, economic or any other factors that may limit the
period over which the acquired trademarks are expected to contribute directly
or indirectly to our
24
Table
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future cash flows
.
Due to their indefinite life, the trademarks will not be amortized. Different
conclusions with respect to the amortizability of the trademarks or the period
over which the customer relationships are amortized could have a material
effect on our results of operations.
The
non-amortizing trademarks will be tested annually for impairment, or more
frequently, if events or changes in circumstances indicate that the asset might
be impaired. In assessing the recoverability of the trademarks, we will make
assumptions about our estimated future cash flows and other factors to
determine the fair value of these assets. If the Company does not
achieve its growth targets as contemplated, the Company may need to record an
impairment charge in the future.
Impairment
of Goodwill
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. Judgments regarding the existence of
impairment indicators, including lower than expected cash flows from the
acquired Amerifit business, are based on variety of factors including market
conditions and operational performance. Future events could cause us to
conclude that impairment indicators exist. The Company estimates fair value
using valuation techniques such as discounted cash flows. This requires
management to make assumptions regarding future income, working capital and
discount rates. Different assumptions could affect the fair value determination
and ultimately the need to record an impairment charge in the future.
RESULTS OF OPERATIONS
Revenues
The following table presents revenues by
category (in thousands):
|
|
Three months ended April 30,
|
|
Six months ended April 30,
|
|
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
Product sales
|
|
$
|
119,082
|
|
$
|
88,152
|
|
$
|
203,168
|
|
$
|
172,174
|
|
Contract manufacturing and collaborations
|
|
4,886
|
|
4,259
|
|
10,556
|
|
7,600
|
|
Total revenues
|
|
$
|
123,968
|
|
$
|
92,411
|
|
$
|
213,724
|
|
$
|
179,774
|
|
Product sales increased $30.9 million or 35%
in the three months ended April 30, 2010 as compared to the three months
ended April 30, 2009 and increased $31.0 million or 18% in the six months
ended April 30, 2010 as compared to the six months ended April 30,
2009. This increase was partially
attributable to the branded consumer health product sales of our newly-acquired
Amerifit subsidiary, which totaled $18 million for the period from the
acquisition date (February 12, 2010) through April 30, 2010. The remainder of the increase, or $12.9
million, was the result of growth in demand for our nutritional ingredients in
both the infant formula and non-infant formula markets. Demand increases
outside the United States, particularly in Asia, were a key driver of this
growth. We believe that a portion of the nutritional ingredient revenue
increase, estimated to be in the range of $4 million to $8 million, was
associated with inventory stocking in the ordinary course by our customers
following depletion of inventories in 2009 as well as their production timing
and related product ordering patterns.
Product sales were comprised of the following
(in thousands):
|
|
Three months ended April 30,
|
|
Six months ended April 30,
|
|
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
Nutritional ingredients:
|
|
|
|
|
|
|
|
|
|
Infant formula
|
|
$
|
86,318
|
|
$
|
77,383
|
|
$
|
157,859
|
|
$
|
151,974
|
|
Food and beverage
|
|
4,519
|
|
2,979
|
|
8,712
|
|
5,597
|
|
Pregnancy and nursing, nutritional supplements and
animal nutrition
|
|
8,831
|
|
6,801
|
|
16,201
|
|
12,465
|
|
Total nutritional ingredients
|
|
99,668
|
|
87,163
|
|
182,772
|
|
170,036
|
|
|
|
|
|
|
|
|
|
|
|
Branded consumer health products
|
|
18,009
|
|
|
|
18,009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-nutritional products
|
|
1,405
|
|
989
|
|
2,387
|
|
2,138
|
|
Total product sales
|
|
$
|
119,082
|
|
$
|
88,152
|
|
$
|
203,168
|
|
$
|
172,174
|
|
Approximately 78% and 76% of our nutritional
ingredients sales in the three and six months ended April 30, 2010,
respectively, were generated by sales to our top five nutritional ingredients
customers. In addition, approximately
51% of our branded consumer health products sales in both the three and six
months ended April 30, 2010 was generated by sales to our top two branded
consumer health products customers. Although we are not given precise
information by our customers as to the countries in which our nutritional
ingredients are sold, we estimate that approximately 50% of our nutritional
ingredients sales for the three and six
25
Table
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months ended April 30, 2010 and the three
and six months ended April 30, 2009 relate to sales in the U.S. Virtually
all sales of our branded consumer health products are to customers in the U.S.
As of April 30, 2010, we estimate that
formula supplemented with our oils had penetrated almost all of the U.S. infant
formula market.
We
expect that our future nutritional ingredients sales will continue to be
subject to quarter-to-quarter fluctuations and will continue to be dependent to
a significant degree upon the following factors: (i) the expansions of
current products containing our nutritional ingredients by our customers in new
and existing markets; (ii) the launches of new products containing our
nutritional ingredients 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.
We
expect that our future branded consumer health product sales will also be
subject to quarter-to-quarter fluctuations and will be dependent to a
significant degree upon the following factors: (i) including the timing
and effectiveness of product promotions and advertising campaigns by us or our
competitors; (ii) new product launches by us or our competitors; and (iii) the
timing and extent of stocking and de-stocking of inventory by our customers.
Contract
manufacturing and collaborations revenues totaled approximately $4.9 million
and $10.6 million in the three and six months ended April 30, 2010, respectively,
and $4.3 million and $7.6 million in the three and six months ended April 30,
2009, respectively. Of the total
contract manufacturing and collaborations revenue in the three and six months
ended April 30, 2010, approximately $3.9 million and $8.5 million,
respectively, relates to contract manufacturing activities that we anticipate
exiting, in large measure, in the third quarter of fiscal 2010. The remaining $1.0 million and $2.1 million
in the three and six months ended April 30, 2010, respectively, 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 $31.6 million or 34.1% in the
three months ended April 30, 2010 as compared to the three months ended April 30,
2009, and total revenues increased by $34.0 million or 18.9% in the six months
ended April 30, 2010 as compared to the six months ended April 30,
2009.
Cost
of Revenues
The following table presents our cost of
revenues (in thousands):
|
|
Three months ended April 30,
|
|
Six months ended April 30,
|
|
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
Cost of product sales
|
|
$
|
62,362
|
|
$
|
49,299
|
|
$
|
108,299
|
|
$
|
96,208
|
|
Cost of contract manufacturing and collaborations
|
|
4,097
|
|
4,017
|
|
9,330
|
|
7,426
|
|
Total cost of revenues
|
|
$
|
66,459
|
|
$
|
53,316
|
|
$
|
117,629
|
|
$
|
103,634
|
|
Cost of
product sales as a percentage of product sales improved to 52% in the three
months ended April 30, 2010 from 56% in the three months ended April 30,
2009 and improved to 53% in the six months ended April 30, 2010 from 56%
in the six months ended April 30, 2009. The decrease in the comparative
three and six months was due to ARA cost reductions and the positive impact on
gross margins of branded consumer health product sales. Included in the gross margin for the second
quarter of fiscal 2010 is the negative effect of approximately $1.7 million of
one-time inventory step-up in fair value resulting from the Amerifit
acquisition.
Cost of
contract manufacturing and collaborations was $4.1 million and $9.3 million in
the three and six months ended April 30, 2010, respectively, and $4.0
million and $7.4 million in the three and six months ended April 30, 2009,
respectively. Our contract manufacturing
and services margins vary between periods primarily due to contract mix and
volume.
See Management Outlook for discussion of
expected operating results
for the second half of fiscal 2010.
26
Table
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Operating
Expenses
The following table presents our operating
expenses (in thousands):
|
|
Three months ended April 30,
|
|
Six months ended April 30,
|
|
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
Research and development
|
|
$
|
8,821
|
|
$
|
7,157
|
|
$
|
15,887
|
|
$
|
13,906
|
|
Selling, general and administrative
|
|
17,926
|
|
12,280
|
|
30,706
|
|
25,031
|
|
Advertising and promotion
|
|
3,965
|
|
595
|
|
4,474
|
|
941
|
|
Amortization of intangible assets
|
|
2,594
|
|
1,595
|
|
4,039
|
|
3,376
|
|
Acquisition costs
|
|
1,801
|
|
|
|
2,988
|
|
|
|
Other operating expenses
|
|
171
|
|
569
|
|
205
|
|
722
|
|
Total operating expenses
|
|
$
|
35,278,
|
|
$
|
22,196
|
|
$
|
58,299
|
|
$
|
43,976
|
|
Our research and development costs increased
by $1.7 million or 23% in the three months ended April 30, 2010 as
compared to the three months ended April 30, 2009 and increased by $2.0
million or 14% in the six months ended April 30, 2010 as compared to the
six months ended April 30, 2009.
The increases were due to our expanded clinical and pre-clinical
research activities along with higher personnel costs. 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
increased by $5.6 million or 46% in the three months ended April 30, 2010
as compared to the three months ended April 30, 2009 and increased by $5.7
million or 23% in the six months ended April 30, 2010 as compared to the
six months ended April 30, 2009.
These increases include expenses attributable to Amerifit, which totaled
$3.4 million for the period from the acquisition date through April 30,
2010, and increases to the estimate of annual incentive compensation payouts
based on the probable achievement of certain pre-established operational and
financial goals for the year.
Advertising and promotion increased from
approximately $600,000 in the three months ended April 30, 2009 to $4.0
million in the three months ended April 30, 2010 and increased from
approximately $900,000 in the six months ended April 30, 2009 to $4.5
million in the six months ended April 30, 2010. These increases resulted from advertising and
promotion attributable to Amerifit from the date of acquisition through April 30,
2010. We anticipate significant
advertising and promotion expenses each quarter; however, quarter-to-quarter
fluctuations will occur as a result of the timing of particular advertising and
promotion campaigns.
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
$2.6 million and $4.0 million in the three and six months ended April 30,
2010, respectively, and $1.6 million and $3.4 million in the three and six
months ended April 30, 2009, respectively.
The increase in the three and six months ended April 30, 2010
includes $1.3 million amortization associated with the intangible assets
acquired with Amerifit for the period from date of acquisition through April 30,
2010, partially offset by 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.
Acquisition costs relate primarily to
investment banking and professional service fees incurred during the six months
ended April 30, 2010 associated with the Amerifit acquisition, which under
ASC 805, Business Combinations, are required to be expensed as incurred. There were no acquisition-related costs
incurred in the 2009 periods.
Interest
and Other Income, Net
Interest
and other income, net, decreased by $300,000 in the three months ended April 30,
2010 as compared to the three months ended April 30, 2009 and decreased by
$600,000 in the six months ended April 30, 2010 as compared to the six
months ended April 30, 2009 due primarily to lower cash balances and interest
rates earned on those cash balances
.
Interest
Expense
Interest
expense increased by $1.3 million in the three and six months ended April 30,
2010 as compared to the three and six months ended April 30, 2009 due to
interest costs incurred on borrowings used to finance the Amerifit acquisition.
See Note 11 to the consolidated financial statements for additional discussion
of the Former Facility and the Credit Agreement we entered in January 2010,
as amended in March 2010.
Income
Tax Provision
The
provision for income taxes reflected an effective tax rate of 40.0% and
38.9% in the three and six months ended April 30,
2010, respectively, and 35.5% and 36.6% in the three and six months ended April 30,
2009, respectively. The higher effective
tax rate in the 2010 periods results from the non-deductibility of certain
expenses incurred related to the acquisition of Amerifit.
27
Table
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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 $12.5 million in the three months ended
April 30, 2010 as compared to net income of $11.0 million in the three
months ended April 30, 2009, and net income was $22.2 million in the six
months ended April 30, 2010 as compared to net income of $20.6 million in
the six months ended April 30, 2009.
Segment
Profitability
We
operate in two material business segments, the development and
commercialization of high-value nutritional ingredients products from microbial
sources and, with the acquisition of Amerifit in February 2010, the marketing
and sale of branded consumer health products.
Outside of these two segments, we derive revenues primarily from
contract manufacturing and collaborations, which are included in other in the
table below. Segment profitability is measured based on income from operations.
As follows is segment operating performance (in thousands).
|
|
Three months ended April 30,
|
|
Six months ended April 30,
|
|
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
Segment Income (Loss) From
Operations
|
|
|
|
|
|
|
|
|
|
Branded consumer health products
|
|
$
|
1,893
|
|
$
|
|
|
$
|
1,893
|
|
$
|
|
|
Nutritional ingredients
|
|
19,680
|
|
17,149
|
|
35,320
|
|
32,591
|
|
Other
|
|
658
|
|
(250
|
)
|
583
|
|
(427
|
)
|
Total
|
|
$
|
22,231
|
|
$
|
16,899
|
|
$
|
37,796
|
|
$
|
32,164
|
|
The
profitability of the nutritional ingredients segment increased in both the
three and six months ended April 30, 2010 as compared to the comparable prior
year periods due primarily to the revenue growth and gross margin improvements
noted above. Profitability of the combined contract manufacturing and
collaborations groups increased primarily as a result of our contract mix and
our joint development agreement with BP for work on microbial oils for use in
biofuels, which began in late fiscal 2009.
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 3
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.
In October 2009,
the FASB issued Accounting Standards Update No. 2009-13, Revenue
Recognition (Topic 605)Multiple-Deliverable Revenue Arrangements: a consensus
of the FASB Emerging Issues Task Force (ASU 2009-13). ASU 2009-13
establishes a selling-price hierarchy for determining the selling price of each
element within a multiple-deliverable arrangement. Specifically, the selling
price assigned to each deliverable is to be based on vendor-specific objective
evidence (VSOE), if available, third-party evidence, if VSOE is unavailable,
and estimated selling prices if neither VSOE or third-party evidence is
available. In addition, ASU 2009-13 eliminates the residual method of
allocating arrangement consideration and instead requires allocation using the
relative selling price method. ASU 2009-13 will be effective prospectively for
multiple-deliverable revenue arrangements entered into, or materially modified,
in fiscal years beginning on or after June 15, 2010. We are assessing what
impact, if any, the adoption of ASU 2009-13 may have on our consolidated
financial statements.
LIQUIDITY AND CAPITAL RESOURCES
We have
financed our operations primarily from the following sources:
·
cash generated from operations;
·
debt financing; and
·
cash received from the exercise of stock options.
Our
cash flows for the six months ended April 30, 2010 and 2009 were as
follows (in thousands):
|
|
Six
months ended April 30,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Net cash provided
by operating activities
|
|
$
|
62,974
|
|
$
|
25,631
|
|
Net cash used in
investing activities
|
|
(209,978
|
)
|
(9,698
|
)
|
Net cash
provided by (used in) financing activities
|
|
36,150
|
|
(484
|
)
|
Foreign currency
translation adjustment
|
|
(2
|
)
|
|
|
Total cash (outflows) inflows
|
|
$
|
(110,856
|
)
|
$
|
15,449
|
|
Cash and cash equivalents decreased $110.9
million since October 31, 2009 due to the acquisition of Amerifit in February 2010. To finance the Amerifit acquisition, we
utilized existing cash of approximately $115 million, the proceeds from a term
loan totaling $75 million and $11 million drawn from our revolving credit
facility (see below for further discussion) and approximately $17 million of
cash held by Amerifit at closing. Our
income excluding non-cash items of approximately $56 million in the six months
ended April 30, 2010 contributed to the generation of $63.0 million in cash
from operating activities. Capital expenditures, including both property and
equipment as well as patent and other intangible asset costs, totaled $9.3
million during the six months ended April 30, 2010. Our financing activities in the six months
ended April 30, 2010 primarily include borrowings described above to
finance the acquisition of Amerifit, of which the $11 million borrowed under
the revolving credit facility was repaid
28
Table
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in full and $35 million of borrowings under
the Term Loan were repaid by April 30, 2010. As of April 30, 2010, the Term Loan had
a remaining principal balance of $40 million.
The Company expects to repay the remaining balance on the Term Loan by October 31,
2010.
As of April 30, 2010, we had
approximately $30.2 million in cash and cash equivalents. In January 2010, we entered into a
Credit Agreement, subsequently amended in March 2010 (the Credit
Agreement), that includes a $75 million term loan (the Term Loan) and a $100
million secured revolving credit facility (the Revolver). The Credit Agreement replaced our existing $135 million credit
facility.
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, which began in 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 noted above, we made
additional discretionary repayments during the quarter ended April 30,
2010 and expect to be able to repay the Term Loan, in full, by October 31,
2010, in advance of the mandatory repayment schedule.
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%. For purposes of the Credit Agreement, LIBOR is
the greater of 1.25% 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 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.
As of April 30, 2010, we were in compliance with all loan
covenants.
At April 30, 2010, our investments had a
fair value of $10.8 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 16 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. In May 2010,
we alerted the financial institution of our intention to sell the ARS covered
by the Put Agreement on June 20, 2010.
Our ARS holdings to which this relates have a cost basis of
approximately $7.3 million and a fair value at April 30, 2010 of
approximately $6.2 million. The Put
Agreement, which is deemed a discrete short-term investment, has a recorded
fair value at April 30, 2010 of approximately $1.1 million. Due to the Companys intent to sell its ARS
covered by the Put Agreement to the financial institution on June 30,
2010, 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 April 30, 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
April 30, 2010 would cause fluctuations to the fair value of the affected
instruments and such fair value changes could be material.
The
following table sets forth our future minimum payments under contractual
obligations at April 30, 2010:
|
|
|
|
Less than
|
|
1-3
|
|
3-5
|
|
More than
|
|
In thousands
|
|
Total
|
|
1 year
|
|
years
|
|
years
|
|
5 years
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notes payable
(1)
|
|
$
|
520
|
|
$
|
66
|
|
$
|
77
|
|
$
|
77
|
|
$
|
300
|
|
Borrowings under
Term Loan (1)
|
|
41,930
|
|
16,308
|
|
25,622
|
|
|
|
|
|
Borrowings under
Revolver
|
|
|
|
|
|
|
|
|
|
|
|
Long-term license fee obligation (2)
|
|
2,450
|
|
792
|
|
1,533
|
|
125
|
|
|
|
Operating lease
obligations (3)
|
|
10,969
|
|
2,025
|
|
2,834
|
|
2,213
|
|
3,897
|
|
Unconditional
purchase obligations (4), (5)
|
|
145,523
|
|
87,447
|
|
58,076
|
|
|
|
|
|
Total
contractual cash obligations (6)
|
|
$
|
201,392
|
|
$
|
106,638
|
|
$
|
88,142
|
|
$
|
2,415
|
|
$
|
4,197
|
|
(1)
M
inimum payments above include interest and principal.
(2)
Excludes
$2.5 million of additional license fees due if we exercise certain commercially
beneficial rights in the future.
(3)
Includes
renewal and expansion of Columbia headquarters facility leases part of which
expire in 2015, with the remainder expiring in 2020.
29
Table
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(4)
Comprised
of future inventory purchases from DSM pursuant to minimum purchase
commitment. Excludes any additional future
inventory purchases from DSM pursuant to the Restated Agreement or the
potential payment by us associated with our rights to terminate the Restated
Agreement after 2012. 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 (see Note 5 to the
consolidated financial statements).
(5)
Excludes
$5.6 million of financial commitments associated with a research collaboration
that are contingent upon the successful completion of identified milestones
(see Note 12 to the consolidated financial statements).
(6)
The
table above excludes uncertain tax payments of $2.8 million, the timing of
which is uncertain.
We believe that the Revolver, when combined
with our cash and cash equivalents on-hand at April 30, 2010, 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;
·
our ability to enter into new or extend existing sole source
infant formula supply agreements;
·
the level of sales of our infant formula, food and beverage
and other nutritional products and of our branded consumer health products;
·
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.
MANAGEMENT
OUTLOOK
Mar
tek is providing
certain financial information for Amerifit on a stand-alone basis to provide
investors greater clarity through the integration process. Projected results
for Martek (not including Amerifit), Amerifit (stand-alone, post-acquisition)
and on a consolidated basis for the three months ended July 31, 2010 are
as follows:
|
|
Three months ended July 31, 2010
|
(in millions, except per share
data)
|
|
Martek
|
|
Amerifit
|
|
Consolidated
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
93.0 97.0
|
|
$
|
19.0 21.0
|
|
$
|
113.0 118.0
|
Income
from operations
|
|
$
|
17.0 18.0
|
|
$
|
2.0 3.0
|
|
$
|
19.0 21.0
|
Net
income
|
|
|
|
|
|
$
|
11.0 12.0
|
|
|
|
|
|
|
|
|
Diluted
EPS
|
|
|
|
|
|
$
|
0.33 0.36
|
For the third quarter of fiscal 2010, Martek
expects infant formula revenue to be between $76.0 million and $80.0 million,
non-infant formula nutritional revenue to be between $12.0 million and $14.0
million, and contract manufacturing and collaborations revenue to be between
$2.5 million and $3.0 million.
Consolidated gross margin in the third quarter
of fiscal 2010 is expected to be between 49% and 50%.
While our revenues
for the balance of 2010 are projected to be somewhat uneven on a
quarter-to-quarter basis due to customer plant shutdowns for maintenance and
other timing matters, Martek expects full fiscal year 2010 revenue to be
between $440 million and $445 million, including infant formula revenues of
between $307 million and $312 million. These forecasted revenues include
projected fourth quarter 2010 revenues similar to those projected for Marteks
third quarter. Such projected fourth quarter revenues would equate to
year-over-year growth of more than 25%. Furthermore, the projected 2010 annual
revenues would represent year-over-year growth in total revenues of 27% to 29%
(9% to 11% excluding Amerifit-related revenues) and contemplate meaningful
gains in all markets for our nutritional ingredients, including growth in
infant formula revenues of 7% to 9% and growth in non-infant formula
nutritional revenues of 27% to 35%.
30
Table
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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. At April 30, 2010, we had unrealized
losses on such hedge instruments totaling approximately $9,000, net of income
taxes. To the extent not covered by
these hedge instruments, fluctuations between the U.S. dollar and the Euro will
impact our cost of ARA oil and gross margins.
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 $40 million outstanding at April 30, 2010, we estimate that a 1%
increase in either LIBOR or the base rate would impact our net income by
approximately $300,000.
We have investments at April 30, 2010
with a fair value of $11.9 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 $2.1 million ($1.3
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. In May 2010, Martek alerted the financial institution of the Companys
intention to sell the ARS covered by the Put Agreement on June 30, 2010. Our ARS holdings to which this relates have a
cost basis of approximately $7.3 million and a fair value at April 30,
2010 of approximately $6.2 million. The
Put Agreement, which is deemed a discrete short-term investment, has a recorded
fair value of $1.1 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
April 30, 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 April 30, 2010
that materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.
31
Table
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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 and Item 1. Legal Proceedings of Part II
of our Quarterly Report on Form 10-Q
for the period ended January 31, 2010, 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, and both parties filed
further briefs. The Appeal Board hearing
has been scheduled for July 2010, and the Appeal Board will likely issue a
final, oral decision at the end of the hearing. 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 involves the same admissibility issues 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 was held in April 2010. We received a favorable
ruling in that all the claims were upheld with only minor amendments to some of
the claims. 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. The trial for US Patent No. 5,698,244
likely will not occur before 2011.
Discovery is expected to be completed before the end of 2010, and the
defendants will be permitted to file a summary judgment motion at the end of
2010.
32
Table
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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 granted this Request in March 2010.
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 until July 2010, as discussed
above. 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. Lonzas request that the trial
be delayed until the Appeal Board of the EPO decides whether to uphold Marteks
European patent covering our DHA-containing oils has been granted. This EPO Appeal Board hearing was scheduled
for March 2009 and has been postponed until July 2010, as discussed
above. 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. A hearing on the other European patent took
place in December 2009, resulting in the revocation of the Suntory
patent. Suntory has appealed both
European decisions, during which time the patents will remain in full force and
effect. A hearing on the Australian
patent is expected in late 2010 or 2011.
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 were subject to Reexamination.
With respect to the ARA patent, which
is scheduled to expire in August 2014,
the
Reexamination Certificate
issued in May 2010. The ARA
patent emerged from this Reexamination with narrower claims, as the broader
product claims were canceled. Specifically, the reexamined patent contains 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 granted this Request in May 2010.
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.
All four Reexamination Certificates have issued for these two DHA
patents and two blended oils patents. The
Reexaminations are continuing for the remaining two unexpired DHA patents,
which do not cover commercially material products or processes.
We received a second office action
rejection for one of these DHA patents in April 2010, and filed a Notice
of Appeal in May 2010, and have until July 2010 to determine whether
to file an appeal brief or allow the rejected claims to be revoked. We have not yet received a second office
action in the other, related DHA patent reexamination. If we are unable to obtain commercially
meaningful claim coverage, we may appeal within the U.S. Patent and Trademark
Office, and in the event that we do appeal and receive 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
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.
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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, Item 1A. Risk Factors of Part II
of our Quarterly Report on Form 10-Q for the quarter ended January 31,
2010 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.
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 and Item 1A. of Part II of our Quarterly
Report on Form 10-Q for the quarter ended January 31, 2010. It should be noted that certain of our
previously-disclosed risk factors referred and related specifically to our
nutritional ingredients business. 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, including the branded consumer health products business
of recently-acquired Amerifit.
Our opportunity in the U.S. infant formula
market, which represents approximately half of our total infant formula sales,
may be limited by the renewal rate of supplemented formulas into the Women,
Infants and Children program if the eligibility requirements for participating
in the program are made more restrictive, if the amount of infant formula
offered to participants is reduced, or if legislative changes result in the
reduction or elimination of ingredients added to infant formula currently
provided under the program.
We
estimate that of the total current annual U.S. market opportunity for sales of
supplemented infant formula, approximately half represents Women, Infants and
Children (WIC)-funded sales. WIC is a
federal grant program that is state-administered for the benefit of low-income
nutritionally at-risk women, infants and children. Most WIC state agencies provide only one
brand of term infant formula to its participants, depending on which company
has the infant formula contract in a particular state. Currently, WIC programs in 50 states and the
District of Columbia offer term and certain specialty infant formula products
supplemented with our oils. If supplemented formulas are removed from WIC
programs that previously adopted them, eligibility requirements for
participating in WIC become more restrictive and/or participation decreases, or
if any of our customers fail to renew, in a timely fashion, their contract
awards from WIC agencies for the adoption of a supplemented infant formula,
then our future revenues from supplemented infant formula sales in the U.S.
would be limited. Recently, certain
legislators have proposed draft amendments to the proposed 2010 Healthy,
Hunger-Free Kids Act that have the potential to seriously impact the addition
of certain ingredients, including DHA and ARA,
to infant formula supplied under the WIC program. If this draft legislation were to be enacted,
potential outcomes include, but are not limited to, the commissioning of
studies to assess the cost benefit justification and/or efficacy rationale for
the inclusion of DHA and ARA in infant formula sold under the program,
eliminating these ingredients from infant formula sold under the WIC program,
or maintenance of the status quo for
previously approved ingredients. If
certain of these possible outcomes were to occur, sales of our oils for use in
WIC program infant formula and potentially outside of the WIC program would be
adversely impacted. Further, in December 2007,
the USDA, the federal agency which governs WIC, issued an interim final rule which
included a reduction in the amount of infant formula to be offered through
WIC. State WIC agencies had until October 2009
to implement this change and the
interim rule comment period
ended in February 2010. USDA is currently reviewing and analyzing
comments and expects to promulgate a final rule in early 2011. If there is
a permanent reduction in the amount of infant formula offered through WIC, then
our future infant formula revenues could be materially adversely affected.
If our oils are
unable to be used in organic food and beverage products, the opportunity for
sales of our oils into the food and beverage market will be limited to
non-organic products.
The
Organic Foods Production Act of 1990 required the U.S. Department of
Agriculture (USDA) to develop national standards for organically produced
agricultural products to assure consumers that agricultural products marketed
as organic meet consistent, uniform standards. Accordingly, the USDA has put in
place a set of national standards (the National Organic Program or NOP)
that food labeled organic must meet, whether it is grown in the United States
or imported from other countries. Under the NOP regulations, only a
USDA-accredited certifying agent may make the determination that a food product
may be labeled as organic. Martek is not a USDA-accredited certifying agent.
Some
of our customers have obtained organic certification from USDA-accredited
certifying agents and have received authorization to use the USDAs organic
seal on certain products that contain our DHA and ARA-containing oils. In some instances, such products have been
further reviewed and the authorization to use Marteks oils has been explicitly
ratified by the USDA. Certain advocacy
groups, however, have challenged these authorizations and ratifications. In April 2010, the USDA elected to
revise its prior interpretations and ratifications of the specific
recommendations and standards which allowed for the use of nutrients (including
Marteks DHA and ARA-containing oils) in organic products. Under the USDAs revised interpretation, it
has asserted that the regulations do not permit the use of any nutrient
(including DHA and ARA) in certified organic products unless the nutrient is
considered either a vitamin or mineral, or the nutrient has been specifically
reviewed and recommended for inclusion by the National Organic Standards Board
(NOSB). The USDA has indicated that it
will issue draft guidance to formalize its revised interpretation later this
year. Following a public comment period,
it will likely take between three and six months for the USDAs new guidance to
be finalized. Thereafter, we anticipate
a period of transition for companies currently using previously approved
nutrients (including DHA and ARA) to petition the NOSB to have the nutrients
reviewed, recommended and listed as acceptable for use in certified organic
products, or to make appropriate label changes, or to remove the nutrients from
products previously certified organic.
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Because
the NOP regulations are subject to change and interpretation, there can be no
guarantee that our oils will continue to be acceptable for use in organic
products. Organic food sales accounted for approximately 3.5% of the total U.S.
food sales in 2008; sales of Marteks oils for use in organic food products
were less than $5 million during fiscal 2009.
However, we believe that interest from food manufacturers in producing
and selling organic products is expanding, and we have emphasized sales in this
market in our non-infant formula business.
If our oils are ineligible for inclusion in products that bear the USDA
organic seal, our sales opportunity in the food and beverage market may be
adversely impacted.
A
substantial
portion of our nutritional ingredients products sales is made to five of our
existing customers under agreements with no minimum purchase requirements. If
demand by these customers for our nutritional ingredients products decreases,
our revenues may materially decline.
We rely on a substantial portion of our nutritional ingredients sales to
five of our existing customers. Approximately 76% of our nutritional
ingredients sales in the six months ended April 30, 2010 was generated by
sales of DHA and ARA to five customers: Mead Johnson Nutritionals, Abbott
Nutrition, Nestle, Pfizer (formerly Wyeth) and Danone (formerly Numico). We
cannot guarantee that these customers will continue to demand our nutritional
products at current or predictable levels. None of our license agreements
requires our licensees to purchase any minimum amount of products from us now
or in the future, and certain of our license agreements can be terminated
within short periods and also allow our customers to manufacture our products themselves
or purchase nutritional oils from other sources. We have limited visibility
into our customers future actual level of demand, notwithstanding our view of
consumer demand.
We have sole source supply agreements (in most
cases through 2011) with customers comprising nearly 75% of our current infant
formula revenues. We are currently attempting to extend these sole source
agreements as well as enter into new such arrangements, but our ultimate
success in doing so is uncertain. If we are unable to successfully enter into
these new or extended arrangements, our future infant formula revenues may
materially decline.
Furthermore,
even if we are successful in the execution of these agreements, the resulting
arrangements may include price reductions which could yield material decreases
to our future infant formula revenues. In addition, if
demand by any of our significant
customers for our nutritional products decreases, either prior to or subsequent
to the expiration of such supply agreements, we may experience a material
decline in our revenues.
If purchasing patterns by our significant customers
continue to be uneven or inconsistent, we will likely experience fluctuations
in our quarter-to-quarter revenues and cash flows. In addition, if these
customers attempt to utilize their purchasing power in order to receive price
reductions on our products, we may be unable to maintain prices of our oils at
current levels, which could materially affect future revenues and product
margins.
Our major customers are part of either the pharmaceutical or food and
beverage industries. Mergers and acquisitions are prevalent in both industries.
If one of our major customers or divisions thereof are acquired, as there are
no minimum purchase requirements in our license agreements with them, there is
no guarantee that the acquirer will continue purchasing our oils at current
levels or continue selling infant formula at all. An acquisition of one of our
major customers could have a material effect on future revenues.
Our major customers also employ differing strategies with respect to the
timing of their inventory and raw material purchases. To the extent that these
strategies change (i.e., further advancements to a just-in-time
procurement process), our revenues in the quarter of such change could be
materially affected by this modification in customer ordering patterns. In
addition, our major customers use varying inclusion levels of DHA and ARA in
their infant formulas. If significant changes in their market shares occur, or,
in general, our customers reduce such inclusion levels, we could experience
material changes in our infant formula revenues.
The success of our branded
consumer health products business depends on our ability to maintain the value
of the brands.
The success of our branded consumer health products business depends, to
a significant degree, on the value of our Culturelle®, AZO, and ESTROVEN®
brands. These brand names are integral to the existing branded consumer health
products business and to the implementation of certain of our strategies for
expanding this business. Maintaining this brand value will depend largely on
the success of our marketing efforts and our ability to provide a consistent
and competitively differentiating health benefit to the end users of our
products. Our brands could be adversely affected if we fail to achieve these
objectives and our public image and reputation could be tarnished by negative
publicity. Any of these events could negatively impact sales.
A substantial portion of our
branded consumer health product sales is made to two of our existing customers
under agreements with no minimum purchase requirements. If demand by these
customers decreases, the revenues associated with this business may materially
decline.
Approximately 51% of our branded consumer health product sales revenue
during the quarter ended April 30, 2010 was generated by sales to two
customers. We cannot guarantee that
these customers will continue to demand our products at current levels. Our
supply arrangements with these customers do not require them to purchase any
minimum amount of products from us now or in the future. We have limited visibility into our customers
future actual level of demand, notwithstanding our view of consumer
demand. If demand by these significant
customers decreases, we may experience a material decline in our branded
consumer health products revenues. Furthermore,
if purchasing patterns by our significant customers are uneven or inconsistent,
we will likely experience fluctuations in the quarter-to-quarter revenues and
cash flows of the branded consumer health products business.
Our branded consumer health
products business has a material amount of value associated with customer
relationships, goodwill and trademarks, which, if they become impaired would
result in a reduction to our earnings.
For the acquisition
of Amerifit, we paid total cash consideration of approximately $218 million.
Under the acquisition method of accounting, the total purchase price was
allocated to Amerifits net tangible and intangible assets based on their
estimated fair values at the February 12, 2010 acquisition date. The
preliminary allocation of the purchase price resulted in value being assigned
to customer relationships, goodwill and trademarks of $91.4 million, $99.0
million and $46.4 million, respectively. We expect to amortize the value of
Amerifits customer relationships using an accelerated method over a period of
18 years. Both the goodwill and trademarks are intangibles with indefinite useful
lives and will not be amortized. Current accounting standards require that
intangible assets with indefinite lives be periodically evaluated for
impairment. Declines in the profitability or estimated cash flows of the
branded consumer health products business or potential changes in market
valuations for similar assets, may negatively impact the fair value of the
goodwill and trademarks as well as the customer relationships, which could
result in an impairment charge. These charges may have a material impact on our
operating results and financial position.
The Amerifit acquisition may
expose us to significant unanticipated liabilities that could adversely affect
our business and results of operations.
Our purchase of 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, subject to
annual reductions over the next three years, 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 Amerifit business relies on
third- party manufacturers and certain key raw material suppliers for the
production of its product portfolio.
We use third-party manufacturers
and
certain key raw material suppliers
to produce Amerifit products. These third-
party manufacturers and suppliers 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 and suppliers
to
35
Table
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comply with applicable current good manufacturing practices (GMPs).
The loss of a contract manufacturer or key raw material supplier may force us
to shift production to different vendors and possibly cause manufacturing
delays and disrupt our ability to fill orders until we find and qualify another
third party manufacturer or key raw material supplier, if one can be found at
all. Additionally, should any of these manufacturers or suppliers 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 and raw
material suppliers could have a material adverse effect on the future sales and
operations of the Amerifit business.
36
Table
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Item
2. Unregistered Sales of Equity
Securities and Use of Proceeds.
None.
Item
3. Defaults Upon Senior Securities.
Not Applicable.
Item
4. Removed and Reserved.
Item
5. Other Information.
None.
Item
6. Exhibits.
10.01
Amended and Restated Credit Agreement by and among
Martek Biosciences Corporation, a Delaware corporation, as Borrower (Martek),
and Manufacturers and Traders Trust Company, as Administrative Agent and
Issuing Lender, and Bank of America, NA, as Syndication Agent, and SunTrust
Bank, as Documentation Agent, and Capital One N.A., as Co-Agent, and
Manufacturers and Traders Trust Company and various other financial
institutions now or
hereafter
party hereto, as Lenders, dated to be effective March 19, 2010.
(1)
10.02
Amendment No. 1 by and among Martek; Martek
Biosciences Boulder Corporation, a Delaware corporation, Martek Biosciences
Kingstree Corporation, a Delaware corporation, Martek Amerifit Holding
Corporation, a Delaware corporation, Amerifit Pharma, Inc. a
Massachusetts
corporation, Amerifit Brands, Inc., a Delaware corporation, Martek
Amerifit LLC, a Delaware limited liability company, and Amerifit, Inc., a
Delaware corporation; Manufacturers and Traders Trust Company, as
administrative agent; and Manufacturers and Traders Trust Company.
(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 March 25, 2010.
37
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:
|
June 9, 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)
|
|
|
|
|
38
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