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 July 31,
2010
or
o
TRANSITION REPORT PURSUANT TO SECTION 13
OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period
From to
COMMISSION FILE NUMBER 0-22354
MARTEK BIOSCIENCES CORPORATION
(Exact name of registrant as specified in
its charter)
Delaware
|
|
52-1399362
|
(State or other jurisdiction of
incorporation or organization)
|
|
(I.R.S. Employer Identification Number)
|
6480 Dobbin Road, Columbia,
Maryland 21045
(Address of principal executive offices)
Registrants telephone number, including
area code:
(410)
740-0081
None
(Former name, former address and former
fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has
filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
x
Yes
o
No
Indicate by check mark whether the registrant has
submitted electronically and posted on its corporate Web site, if any, every
Interactive Data File required to be submitted and posted pursuant to Rule 405
of Regulation S-T during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files).
x
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 September 1, 2010 was 33,480,546.
Table of
Contents
MARTEK BIOSCIENCES CORPORATION
FORM 10-Q
For The Quarterly Period Ended July 31,
2010
INDEX
2
Table of Contents
PART I - FINANCIAL
INFORMATION
Item 1. Financial Statements.
MARTEK BIOSCIENCES CORPORATION
CONSOLIDATED BALANCE SHEETS
|
|
July 31,
|
|
|
|
|
|
2010
|
|
October 31,
|
|
In thousands, except share and
per share data
|
|
(unaudited)
|
|
2009
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
Current
assets
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
26,522
|
|
$
|
141,063
|
|
Short-term
investments
|
|
|
|
7,301
|
|
Accounts
receivable, net
|
|
66,415
|
|
44,304
|
|
Inventories,
net
|
|
110,751
|
|
116,179
|
|
Deferred
tax asset
|
|
25,761
|
|
24,303
|
|
Other
current assets
|
|
5,776
|
|
5,240
|
|
Total
current assets
|
|
235,225
|
|
338,390
|
|
|
|
|
|
|
|
Property,
plant and equipment, net
|
|
249,825
|
|
252,279
|
|
Long-term
investments
|
|
4,633
|
|
4,495
|
|
Goodwill
|
|
148,184
|
|
51,592
|
|
Customer
relationships, net
|
|
88,658
|
|
|
|
Other
intangible assets, net
|
|
89,295
|
|
42,631
|
|
Other
assets, net
|
|
2,267
|
|
430
|
|
|
|
|
|
|
|
Total
assets
|
|
$
|
818,087
|
|
$
|
689,817
|
|
|
|
|
|
|
|
Liabilities
and stockholders equity
|
|
|
|
|
|
Current
liabilities
|
|
|
|
|
|
Accounts
payable
|
|
$
|
15,451
|
|
$
|
13,122
|
|
Accrued
liabilities
|
|
38,353
|
|
18,243
|
|
Current
portion of notes payable and other long-term obligations
|
|
1,186
|
|
410
|
|
Current
portion of deferred revenue
|
|
830
|
|
2,981
|
|
Total
current liabilities
|
|
55,820
|
|
34,756
|
|
|
|
|
|
|
|
Notes
payable and other long-term obligations
|
|
3,079
|
|
400
|
|
Long-term
portion of deferred revenue
|
|
8,019
|
|
8,426
|
|
Deferred
tax liability
|
|
76,200
|
|
10,091
|
|
|
|
|
|
|
|
Total
liabilities
|
|
143,118
|
|
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; 33,480,468 and
33,269,686 shares issued and outstanding, respectively
|
|
3,348
|
|
3,327
|
|
Additional
paid-in capital
|
|
561,561
|
|
557,519
|
|
Accumulated
other comprehensive income (loss)
|
|
42
|
|
(674
|
)
|
Retained
earnings
|
|
110,018
|
|
75,972
|
|
|
|
|
|
|
|
Total
stockholders equity
|
|
674,969
|
|
636,144
|
|
|
|
|
|
|
|
Total
liabilities and stockholders equity
|
|
$
|
818,087
|
|
$
|
689,817
|
|
See accompanying notes.
3
Table
of Contents
MARTEK BIOSCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
|
|
Three months ended
July 31,
|
|
Nine months ended July 31,
|
|
Unaudited - In thousands, except per share data
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
Product sales
|
|
$
|
113,971
|
|
$
|
75,044
|
|
$
|
317,139
|
|
$
|
247,218
|
|
Contract manufacturing
and collaborations
|
|
3,192
|
|
2,790
|
|
13,748
|
|
10,390
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
117,163
|
|
77,834
|
|
330,887
|
|
257,608
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of revenues:
|
|
|
|
|
|
|
|
|
|
Cost of product sales
|
|
56,011
|
|
41,129
|
|
164,310
|
|
137,337
|
|
Cost of contract
manufacturing and collaborations
|
|
2,647
|
|
2,675
|
|
11,977
|
|
10,101
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenues
|
|
58,658
|
|
43,804
|
|
176,287
|
|
147,438
|
|
|
|
|
|
|
|
|
|
|
|
Gross margin
|
|
58,505
|
|
34,030
|
|
154,600
|
|
110,170
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
Research and
development
|
|
8,499
|
|
6,604
|
|
24,386
|
|
20,510
|
|
Selling, general and
administrative
|
|
18,892
|
|
11,027
|
|
49,598
|
|
36,058
|
|
Advertising and
promotion
|
|
5,598
|
|
412
|
|
10,072
|
|
1,353
|
|
Amortization of
intangible assets
|
|
2,983
|
|
1,534
|
|
7,022
|
|
4,910
|
|
Acquisition costs
|
|
484
|
|
|
|
3,472
|
|
|
|
Restructuring charge
|
|
607
|
|
|
|
607
|
|
|
|
Other operating
expenses
|
|
300
|
|
234
|
|
505
|
|
956
|
|
|
|
|
|
|
|
|
|
|
|
Total operating
expenses
|
|
37,363
|
|
19,811
|
|
95,662
|
|
63,787
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
21,142
|
|
14,219
|
|
58,938
|
|
46,383
|
|
|
|
|
|
|
|
|
|
|
|
Interest and other
income, net
|
|
73
|
|
175
|
|
(2
|
)
|
710
|
|
Interest expense
|
|
(1,850
|
)
|
(94
|
)
|
(3,290
|
)
|
(283
|
)
|
|
|
|
|
|
|
|
|
|
|
Income before income
tax provision
|
|
19,365
|
|
14,300
|
|
55,646
|
|
46,810
|
|
Income tax provision
|
|
7,479
|
|
5,372
|
|
21,600
|
|
17,259
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
11,886
|
|
$
|
8,928
|
|
$
|
34,046
|
|
$
|
29,551
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.36
|
|
$
|
0.27
|
|
$
|
1.02
|
|
$
|
0.89
|
|
Diluted
|
|
$
|
0.35
|
|
$
|
0.27
|
|
$
|
1.02
|
|
$
|
0.89
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average
common shares outstanding
|
|
|
|
|
|
|
|
|
|
Basic
|
|
33,468
|
|
33,234
|
|
33,376
|
|
33,191
|
|
Diluted
|
|
33,610
|
|
33,346
|
|
33,542
|
|
33,346
|
|
See
accompanying notes.
4
Table
of Contents
MARTEK BIOSCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
|
|
Nine
months ended July 31,
|
|
Unaudited In thousands
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Operating
activities
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
34,046
|
|
$
|
29,551
|
|
Adjustments
to reconcile net income to net cash provided by operating activities:
|
|
|
|
|
|
Depreciation
and amortization
|
|
26,538
|
|
21,275
|
|
Amortization
of debt issue costs
|
|
2,065
|
|
|
|
Deferred
tax provision
|
|
20,849
|
|
16,329
|
|
Equity-based
compensation expense
|
|
3,528
|
|
2,959
|
|
Loss
on asset disposal and other, net
|
|
466
|
|
382
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
Accounts
receivable
|
|
(9,085
|
)
|
3,119
|
|
Inventories
|
|
13,158
|
|
(25,734
|
)
|
Other
assets
|
|
2,644
|
|
(3,774
|
)
|
Accounts
payable
|
|
(1,934
|
)
|
1,280
|
|
Accrued
liabilities
|
|
9,710
|
|
(4,957
|
)
|
Deferred
revenue and other liabilities
|
|
(2,292
|
)
|
(428
|
)
|
|
|
|
|
|
|
Net
cash provided by operating activities
|
|
99,693
|
|
40,002
|
|
|
|
|
|
|
|
Investing
activities
|
|
|
|
|
|
|
|
|
|
|
|
Cash
paid for acquisition of Amerifit, net of cash acquired
|
|
(200,743
|
)
|
|
|
Sales
of investments and marketable securities, net
|
|
7,350
|
|
100
|
|
Expenditures
for property, plant and equipment
|
|
(13,171
|
)
|
(6,733
|
)
|
Capitalization
of intangible assets
|
|
(4,077
|
)
|
(6,129
|
)
|
|
|
|
|
|
|
Net
cash used in investing activities
|
|
(210,641
|
)
|
(12,762
|
)
|
|
|
|
|
|
|
Financing
activities
|
|
|
|
|
|
|
|
|
|
|
|
Repayments
of notes payable, term loan and other long-term obligations
|
|
(75,162
|
)
|
(88
|
)
|
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
|
|
1,569
|
|
234
|
|
Tax
payments from shares withheld upon vesting of restricted stock units
|
|
(1,057
|
)
|
(536
|
)
|
|
|
|
|
|
|
Net
cash used in financing activities
|
|
(3,594
|
)
|
(390
|
)
|
|
|
|
|
|
|
Foreign
currency translation adjustment
|
|
1
|
|
|
|
|
|
|
|
|
|
Net
(decrease) increase in cash and cash equivalents
|
|
(114,541
|
)
|
26,850
|
|
Cash
and cash equivalents, beginning of period
|
|
141,063
|
|
102,495
|
|
|
|
|
|
|
|
Cash
and cash equivalents, end of period
|
|
$
|
26,522
|
|
$
|
129,345
|
|
|
|
|
|
|
|
Supplemental
cash flow disclosures:
|
|
|
|
|
|
Interest
paid
|
|
$
|
1,157
|
|
$
|
150
|
|
Income
taxes paid
|
|
$
|
1,062
|
|
$
|
976
|
|
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 sales 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 are sold in most major mass, club, drug, grocery
and specialty stores and include: Culturelle®, a leading probiotic supplement;
AZO, the leading over-the-counter brand addressing symptom relief and detection
of urinary tract infections; and ESTROVEN®, the leading all-natural nutritional
supplement brand addressing the symptoms of menopause. The products sold through Amerifit are collectively
referred to as branded consumer health products. Martek currently has a number of nutritional
health and wellness products under development that it plans to commercialize
and distribute through Amerifits distribution channels. The results of operations of Amerifit are
included in Marteks consolidated financial statements since the acquisition
date.
Marteks technology platform has also made it a
sought-after partner on a range of groundbreaking projects in process,
including the development of microbially-derived biofuels and the development
of DHA-containing oilseeds.
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.
Martek also provides contract manufacturing
services. These 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. In fiscal 2009, the
Company began reducing the scope of its contract manufacturing services in
order to focus its resources on its higher margin products. As of July 31, 2010, such contract
manufacturing services have nearly ceased.
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 nine
months ended July 31, 2010 are not necessarily indicative of the results
that may be expected for the year ending October 31, 2010. The accompanying unaudited financial
statements and these notes should be read in conjunction with the consolidated financial
statements and footnotes thereto included in the Companys Annual Report on
Form 10-K for the year ended October 31, 2009.
Consolidation
The consolidated financial statements include the accounts of Martek
and its wholly-owned subsidiaries, Martek Biosciences Boulder Corporation,
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.
Effective August 31, 2010, Martek Amerifit LLC and Martek Amerifit
Holding Corporation have been eliminated through successive mergers into
Amerifit Brands, Inc., the surviving corporation.
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, collectability 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
6
Table of Contents
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 that may extend over several years
and also may include discounts, some of which are based on the achievement of
certain volume purchases. The consideration from these contracts is allocated
based on the relative fair values of the separate elements. Revenue is
recognized on product sales when goods are shipped and all other conditions for
revenue recognition are met. If volume pricing discounts are deemed to be a
separate element, revenue on related product shipments is recognized
using the estimated average price to the customer
over the term of the discount period, which requires an estimation of
total production shipments over that time frame
.
Amounts billed in excess of the estimated average price are recorded as
deferred revenue.
Conversely,
a receivable is recorded for the excess of the estimated average price over
amounts billed. Estimates of average prices are reviewed and, if necessary,
adjusted periodically based on updated estimates of product shipments during
each contract year. The Companys
historical estimates of product shipments have approximated actual
results. Amounts recorded as either
deferred revenue or a receivable are settled at the end of each contract year,
which generally is December 31.
Once the requisite volume thresholds have
been satisfied, the previously recorded deferred revenue is recognized over the
remaining discount period. Cash received
as a prepayment on future product purchases is deferred and recognized as
revenue when product is shipped. Revenue from product licenses is deferred and
recognized on a straight-line basis over the term of the agreement 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 $3.0 million in the three and nine months
ended July 31, 2010, respectively, and $600,000 and $1.7 million in the
three and nine months ended July 31, 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
July 31, 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 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 July 31, 2010, outstanding forward contracts had notional values
aggregating approximately 10.9 million euros (equivalent to $14.2 million at July 31,
2010), which mature by November 2011. Amounts recorded due to hedge
ineffectiveness have not been material.
7
Table
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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.
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.
Acquisition
Costs
Acquisition costs are expensed as incurred. These costs primarily include investment
banking fees, professional service expenses and employee severance costs
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 July 31, 2010 and October 31, 2009 as
either trading or available-for-sale. Unrealized gains and losses on
available-for-sale securities are reported as accumulated other comprehensive
income, which is a separate component of stockholders equity. Unrealized gains
and losses on trading securities and realized gains and losses on both types of
securities are included in other income as incurred based on the specific
identification method.
The Company periodically evaluates whether any
declines in the fair value of its available-for-sale investments are other than
temporary. This evaluation consists of a
review of several factors, including, but not limited to: length of time and extent that a security has
been in an unrealized loss position; the existence of an event that would
impair the issuers future earnings potential; the near term prospects for
recovery of the market value of a security; the intent of the Company to sell
the impaired security; and whether the
Company will be required to sell the security
prior to the anticipated recovery in market value. Declines in value below cost for debt
securities where it is considered probable that all contractual terms of the
security will be satisfied, where the decline is due primarily to changes in
interest rates (and not because of increased credit risk), and where the
Company does not intend to sell 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 elected the fair value option for
the auction rate securities rights agreement (the Put Agreement). 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 July 31, 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 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.
8
Table
of Contents
Trademarks
resulting from the Amerifit acquisition 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 to determine 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.
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. See Note 16 for discussion of
potential impairment charge to Winchesters production assets in the Companys
fourth quarter of fiscal 2010.
Recently
Issued Accounting Pronouncements
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 brand and distribute the
nutritional health and wellness products that Martek is currently developing
for Amerifits channels.
Upon the closing of the acquisition, Martek paid
total cash consideration of approximately $218 million, of which amount $27
million was placed in escrow to secure certain post-closing adjustment
obligations and certain indemnification obligations. During the three
months ended July 31, 2010 the parties resolved the post-closing
adjustments, which consisted of the final determinations of Amerifits net debt
level and net working capital at the closing.
Such resolution resulted in the release from escrow of $2 million to
Amerifits former equity holders.
Subject to claims being made associated with post-closing
indemnification obligations, the remaining $25 million will be released from
escrow, on defined dates, over the next 30 months to the former equity holders.
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 to 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
|
|
2,131
|
|
Identifiable intangible
assets
|
|
137,260
|
|
Property and equipment
|
|
1,813
|
|
|
|
|
|
Total identifiable
assets acquired
|
|
179,008
|
|
|
|
|
|
Liabilities
|
|
|
|
Accounts payable and
accrued expenses
|
|
(10,290
|
)
|
Deferred tax liability
|
|
(46,809
|
)
|
Other liabilities
|
|
(614
|
)
|
|
|
|
|
Total liabilities
assumed
|
|
(57,713
|
)
|
|
|
|
|
Net identifiable assets
acquired
|
|
121,295
|
|
Goodwill
|
|
96,593
|
|
|
|
|
|
Net assets acquired
|
|
$
|
217,888
|
|
The estimated fair value of the inventory acquired
resulted in a $1.9 million step-up from historical cost to fair value. Of such step-up, $200,000 and $1.9 million
was recorded as a cost of product sales in the three and nine months ended July 31,
2010, respectively, 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.
10
Table of Contents
Deferred Income Taxes
The $2.5
million of deferred tax assets resulting from the acquisition was primarily
related to federal and state net operating loss carryforwards acquired. The
$49.3 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.
Goodwill
The
excess of the consideration transferred over the fair values assigned to the
identifiable assets acquired and liabilities assumed was $96.6 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.
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.
Results
of Operations
The results of operations of Amerifit since February 12,
2010 have been included in the Companys consolidated statements of income.
This includes revenue of $20.3 million and $38.3 million and income from
operations of $1.9 million and $3.8 million for the three and nine months ended
July 31, 2010, respectively.
Unaudited Pro Forma Information
The
following unaudited pro forma information presents the combined results of
operations of Martek and Amerifit for the three months ended July 31, 2009
and nine months ended July 31, 2010 and 2009 as if the acquisition of
Amerifit had been completed on November 1, 2008 with adjustments to give
effect to pro forma events that are directly attributable to the acquisition.
For the quarter ended July 31, 2010, the results of operations for
Amerifit are reflected within the consolidated statements of income. 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 July 31,
|
|
Nine months ended July 31,
|
|
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
97,852
|
|
$
|
354,498
|
|
$
|
314,213
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
9,804
|
|
$
|
41,703
|
|
$
|
32,611
|
|
|
|
|
|
|
|
|
|
Net income per share
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.29
|
|
$
|
1.25
|
|
$
|
0.98
|
|
Diluted
|
|
$
|
0.29
|
|
$
|
1.24
|
|
$
|
0.98
|
|
11
Table
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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 July 31,
|
|
Nine months ended July 31,
|
|
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
Segment
Revenues
|
|
|
|
|
|
|
|
|
|
Branded
consumer health products
|
|
$
|
20,301
|
|
$
|
|
|
$
|
38,310
|
|
$
|
|
|
Nutritional
ingredients
|
|
93,361
|
|
74,402
|
|
277,392
|
|
245,466
|
|
Other
|
|
3,501
|
|
3,432
|
|
15,185
|
|
12,142
|
|
Total
|
|
$
|
117,163
|
|
$
|
77,834
|
|
$
|
330,887
|
|
$
|
257,608
|
|
|
|
|
|
|
|
|
|
|
|
Segment
Income From Operations
|
|
|
|
|
|
|
|
|
|
Branded
consumer health products
|
|
$
|
1,900
|
|
$
|
|
|
$
|
3,793
|
|
$
|
|
|
Nutritional
ingredients
|
|
18,921
|
|
13,949
|
|
54,123
|
|
46,042
|
|
Other
|
|
321
|
|
270
|
|
1,022
|
|
341
|
|
Total
|
|
$
|
21,142
|
|
$
|
14,219
|
|
$
|
58,938
|
|
$
|
46,383
|
|
Included
in segment operating performance is depreciation and amortization attributed to
the branded consumer health products segment of $1.7 million and $3.2 million
in the three and nine months ended July 31, 2010, respectively. Included in segment operating performance is
depreciation and amortization attributed to the nutritional ingredients segment
of $5.9 million and $18.3 million in the three and nine months ended July 31,
2010, respectively, and $6.4 million and $18.9 million in the three and nine
months ended July 31, 2009, respectively.
Approximately 73% and 75% of the Companys
nutritional ingredients sales in the three and nine months ended July 31,
2010, respectively, were generated by sales to its top five nutritional
ingredients customers. In addition,
approximately 50% of the Companys branded consumer health products sales in
the three and nine months ended July 31, 2010 were 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 nine months ended July 31,
2010 and the three and nine months ended July 31, 2009 relate to sales in
the United States. Virtually all sales of branded consumer health products are
to customers in the United States.
Assets
of the branded consumer health products segment total $254.7 million at July 31,
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 July 31, 2010, the
value of the remaining calendar year 2010 and full calendar year 2011 minimum
purchase requirements are approximately $35.0 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.
12
Table of Contents
6. INVESTMENTS
The Company has 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 37 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 held at July 31,
2010 are not currently liquid and the Company will not be able to access these
funds 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 provided Martek the ability
to sell certain of its ARS to the financial institution and allowed the
financial institution, at its sole discretion, to purchase such ARS at par
during the period June 30, 2010 through July 2, 2012. 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 classified such
investments as trading. On June 30,
2010, the Company exercised its rights under the Put Agreement which resulted
in the sale of the related ARS and the receipt by Martek of $7.3 million, the
par value of such ARS.
The Company had elected to adopt the fair
value option for the Put Agreement
so that changes in the fair value of this asset
would largely offset the fair value movements of the related ARS. As such, only
an immaterial net gain was recorded by the Company upon recognition of gain on
the sale of the ARS covered by the Put Agreement and loss upon settlement of
the Put Agreement. Total
net gains
associated with the ARS sold and Put Agreement exercised were also immaterial
during the full nine months ended July 31, 2010. In the nine months ended July 31,
2009, the Company recognized a
$1.8 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
approximately
$800,000
of unrealized fair value
declines occurring after such reclassification, which includes
$77,000
of unrealized gains recognized during the three months ended July 31,
2009. In the nine months ended July 31, 2009, the Company recognized a
gain of $1.7 million related to the Put Agreement, which was recognized in
interest and other income in the consolidated statements of income, and
includes $97,000 of fair value declines recognized during the three months
ended July 31, 2009.
As of July 31, 2010, the Companys ARS
holdings 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 will 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 July 31, 2010. Net unrealized gains associated with these
ARS during the three and nine months ended July 31, 2010 totaled
approximately $100,000. In the nine
months ended July 31, 2009, the Company recognized $600,000 as a reduction
to other comprehensive income related to the temporary unrealized losses
associated with these ARS, of which $52,000 was recorded as an increase to
other comprehensive income during the three months ended July 31, 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.
13
Table of
Contents
As of July 31, 2010, the Company held certain
assets that are required to be measured at fair value on a recurring
basis. These financial assets were as follows (in thousands):
|
|
As
of July 31, 2010
|
|
|
|
Level
1
|
|
Level
2
|
|
Level
3
|
|
Balance
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
Available-for-sale
securities (1)
|
|
$
|
|
|
$
|
|
|
$
|
4,633
|
|
$
|
4,633
|
|
Investments
in money market funds (2)
|
|
5,463
|
|
|
|
|
|
5,463
|
|
Exchange
rate forward contracts (3)
|
|
|
|
1,009
|
|
|
|
1,009
|
|
Total
assets
|
|
$
|
5,463
|
|
$
|
1,009
|
|
$
|
4,633
|
|
$
|
11,105
|
|
(1)
Included in long-term investments in the accompanying consolidated
balance sheets.
(2)
Included in cash and cash equivalents in the accompanying consolidated
balance sheets.
(3)
Included in other current assets in the accompanying consolidated
balance sheets.
The table below provides a reconciliation of the
beginning and ending balances of the Companys investments measured at fair
value using significant unobservable inputs (Level 3) for the three months
ended July 31, 2010 (in thousands):
|
|
Auction Rate
Securities
|
|
Put
Agreement
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
on April 30, 2010
|
|
$
|
10,787
|
|
$
|
1,084
|
|
$
|
11,871
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Transfers
to/(from) Level 3
|
|
|
|
|
|
|
|
|
|
Total
gains (losses) (realized or unrealized): (1)
|
|
|
|
|
|
|
|
|
|
Included
in earnings
|
|
1,092
|
|
(1,084
|
)
|
8
|
|
|
|
Included
in other comprehensive income
|
|
54
|
|
|
|
54
|
|
|
|
Purchases,
sales, issuances and settlements, net
|
|
(7,300
|
)
|
|
|
(7,300
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
on July 31, 2010
|
|
$
|
4,633
|
|
$
|
|
|
$
|
4,633
|
|
|
|
(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 nine months ended
July 31, 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
|
|
1,270
|
|
(1,221
|
)
|
49
|
|
|
|
Included
in other comprehensive income
|
|
138
|
|
|
|
138
|
|
|
|
Purchases,
sales, issuances and settlements, net
|
|
(7,350
|
)
|
|
|
(7,350
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
on July 31, 2010
|
|
$
|
4,633
|
|
$
|
|
|
$
|
4,633
|
|
|
|
(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 three months
ended July 31, 2009 (in thousands):
|
|
Auction Rate Securities
|
|
Put
Agreement
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
on April 30, 2009
|
|
$
|
9,808
|
|
$
|
1,807
|
|
$
|
11,615
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Transfers
to/(from) Level 3
|
|
|
|
|
|
|
|
|
|
Total
gains (losses) (realized or unrealized): (1)
|
|
|
|
|
|
|
|
|
|
Included
in earnings
|
|
110
|
|
(97
|
)
|
13
|
|
|
|
Included
in other comprehensive income
|
|
52
|
|
|
|
52
|
|
|
|
Purchases,
sales, issuances and settlements, net
|
|
(100
|
)
|
|
|
(100
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
on July 31, 2009
|
|
$
|
9,870
|
|
$
|
1,710
|
|
$
|
11,580
|
|
|
|
(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 nine months ended
July 31, 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
|
|
(1,777
|
)
|
1,710
|
|
(67
|
)
|
|
|
Included
in other comprehensive income
|
|
411
|
|
|
|
411
|
|
|
|
Purchases,
sales, issuances and settlements, net
|
|
(100
|
)
|
|
|
(100
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
on July 31, 2009
|
|
$
|
9,870
|
|
$
|
1,710
|
|
$
|
11,580
|
|
|
|
(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,
previously, the 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 could exercise the Put Agreement rights.
8. INVENTORIES
Inventories
consist of the following (in thousands):
|
|
July 31,
|
|
October 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Finished
goods
|
|
$
|
56,051
|
|
$
|
56,203
|
|
Work
in process
|
|
48,409
|
|
56,501
|
|
Raw
materials
|
|
6,291
|
|
3,475
|
|
|
|
|
|
|
|
Inventories,
net
|
|
$
|
110,751
|
|
$
|
116,179
|
|
15
Table
of Contents
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):
|
|
July 31,
|
|
October 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Land
|
|
$
|
2,320
|
|
$
|
2,320
|
|
Building
and improvements
|
|
69,571
|
|
67,094
|
|
Machinery
and equipment
|
|
270,683
|
|
266,257
|
|
Furniture
and fixtures
|
|
3,309
|
|
3,094
|
|
Computer
hardware and software
|
|
18,913
|
|
17,220
|
|
|
|
364,796
|
|
355,985
|
|
Less:
accumulated depreciation and amortization
|
|
(130,635
|
)
|
(113,437
|
)
|
|
|
234,161
|
|
242,548
|
|
Construction
in progress
|
|
15,664
|
|
9,731
|
|
|
|
|
|
|
|
Property,
plant and equipment, net
|
|
$
|
249,825
|
|
$
|
252,279
|
|
10. INTANGIBLE ASSETS
Intangible
assets and related accumulated amortization consist of the following (in
thousands):
|
|
July 31,
2010
|
|
October 31,
2009
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
Accumulated
|
|
|
|
Intangible Asset
|
|
Gross
|
|
Amortization
|
|
Net
|
|
Gross
|
|
Amortization
|
|
Net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trademarks
(amortizing)
|
|
$
|
2,305
|
|
$
|
(1,130
|
)
|
$
|
1,175
|
|
$
|
2,202
|
|
$
|
(1,004
|
)
|
$
|
1,198
|
|
Trademarks
(indefinite-lived)
|
|
45,400
|
|
|
|
45,400
|
|
|
|
|
|
|
|
Patents
|
|
30,263
|
|
(12,106
|
)
|
18,157
|
|
25,732
|
|
(9,046
|
)
|
16,686
|
|
Current
products
|
|
10,676
|
|
(5,897
|
)
|
4,779
|
|
10,676
|
|
(5,363
|
)
|
5,313
|
|
Licenses
and other
|
|
27,629
|
|
(7,845
|
)
|
19,784
|
|
24,899
|
|
(5,465
|
)
|
19,434
|
|
|
|
116,273
|
|
(26,978
|
)
|
89,295
|
|
63,509
|
|
(20,878
|
)
|
42,631
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer
relationships
|
|
91,400
|
|
(2,742
|
)
|
88,658
|
|
|
|
|
|
|
|
Goodwill
|
|
148,184
|
|
|
|
148,184
|
|
51,592
|
|
|
|
51,592
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
355,857
|
|
$
|
(29,720
|
)
|
$
|
326,137
|
|
$
|
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. Therefore, in April 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.
16
Table
of Contents
Included in
amortization of intangible assets is approximately $2.6 million and $6.3
million in the three and nine months ended July 31, 2010, respectively,
and approximately $1.3 million and $4.3 million in the three and nine months
ended July 31, 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 $12.6 million, $14.4 million, $13.2 million, $12.8
million and $12.2 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 had a maturity date of February 2013
and was fully repaid by the Company in July 2010 with available cash. During the months in which it was
outstanding, the Term Loan bore 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.
There have been no amounts outstanding on the Revolver since April 2010. The weighted average annual commitment fee
rate on unused amounts under the Revolver was approximately 0.2% for the three
months ended July 31, 2010 and approximately 0.3% since the
refinancing. 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 months ended July 31, 2010,
the Company incurred interest on borrowings of approximately $200,000 on the
Term Loan. During the nine months ended July 31,
2010, the Company incurred interest on borrowings of approximately $1.0
million, including $900,000 of interest on the Term Loan and $100,000 on the
Revolver. The weighted average annual
interest rate during the three and nine months ended July 31, 2010 on the
Term Loan was 4.4% and 4.8%, respectively. The weighted average annual interest
rate during the nine months ended July 31, 2010 on the Revolver was 4.5%.
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. Due to the full repayment of the Term Loan in July 2010,
the Company accelerated the amortization of the attributable debt issuance
costs resulting in amortization expense of $1.4 million and $1.7 million during
the three months ended July 31, 2010 and from the date of funding on February 12,
2010 through July 31, 2010, respectively. Amortization of amounts
allocated to the Revolver totaled $200,000 and $400,000 during the three months
ended July 31, 2010 and from the date of funding on February 12, 2010
through July 31, 2010, respectively.
The carrying
amounts of notes payable and long-term debt at July 31, 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.
17
Table of Contents
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 July 31, 2010, the Companys financial commitment, primarily
through internal research efforts, to the first projected milestone date totals
approximately $100,000. Commitments
thereafter, also primarily through internal research efforts, assuming
successful achievement of all identified milestones, total approximately $5.6
million.
In August 2009,
the Company entered into a collaboration agreement with BP for the joint
development of biofuels from microbial oils. Under the terms of the agreement,
Martek and BP will work together to establish proof of concept for large-scale,
cost-effective microbial biodiesel production through fermentation. In
connection with this agreement, BP has agreed to contribute up to $10 million
to the initial phases of the collaboration, which utilizes Marteks significant
expertise in microbial oil production and BPs production and commercialization
experience in biofuels as the platform for the joint development effort. Martek
will perform the biotechnology research and development associated with the
initial phases and receive fees from BP for such efforts. All intellectual property owned prior to the
execution of the collaboration agreement will be retained by each respective
company, and all intellectual property developed during the collaboration
period will be owned by BP, with an exclusive license to Martek for
commercialization in nutrition, cosmetic and pharmaceutical applications.
Additionally, each party is entitled to certain commercial payments from the
counterparty for commercialization of the technology in the other partys
fields of use.
Patent Infringement Litigation
In September 2003, the Company filed a patent infringement lawsuit
in the U.S. District Court in Delaware against Nutrinova Nutrition
Specialties & Food Ingredients GmbH (Nutrinova) and others alleging
infringement of certain of our U.S. patents. In December 2005, Nutrinovas DHA
business was sold to Lonza Group LTD, a Swiss chemical and biotechnology group,
and the parties agreed to add Lonza to the U.S. lawsuit. In October 2006, the infringement action
in the United States was tried, and a verdict favorable to Martek was
returned. The jury found that the
defendants infringed all the asserted claims of three Martek patents and that
these patents were valid. It also found
that the defendants willfully infringed one of these patents. In October 2007, the judge upheld the October 2006
jury verdict that the defendants infringed all of the asserted claims of U.S.
Patent Nos. 5,340,594 and 6,410,281 and that these patents were not invalid.
The judge has granted a permanent injunction against the defendants with
respect to those two patents. The judge
also upheld the jury verdict that the defendants had acted willfully in their
infringement of U.S. Patent No. 6,410,281. Regarding the third
patent involved in the case, U.S. Patent No. 6,451,567, the judge reversed
the jury verdict and found that the asserted claims of this patent were
invalid. Marteks request to the judge
to reconsider his ruling on the third patent was denied. Martek and the defendants appealed aspects of
the judges final decision and a hearing was held before the U.S. Court of
Appeals in April 2009. In September 2009,
the Court of Appeals ruled in Marteks favor on all of the patents that were
the subject of the appeal, which included U.S. Patent Nos. 5,340,594,
6,410,281, 6,451,567 noted above and 5,698,244, which was included in Marteks
appeal as a result of the trial courts decision at a pre-trial hearing on the
meaning and scope of the patent claims in dispute. With respect to U.S. Patent No. 5,698,244,
the Court of Appeals reversed the trial courts interpretation of certain claim
language and remanded this patent to the trial court for further
proceedings. U.S. Patent Nos. 5,340,594
and 6,454,567 have expired and U.S. Patent Nos. 6,410,281 and 5,698,244 are
scheduled to expire in August 2011 and December 2014,
respectively. The defendants requested a
rehearing with the Court of Appeals on the decision, but their request was
denied.
The trial for U.S. 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 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 July 31, 2010, the patents being
defended in the Lonza matter had a net book value of approximately $3.5
million, including capitalized legal costs, which is being amortized over a
weighted average remaining period of approximately four 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 $1.2 million
and $3.6 million in the three and nine months ended July 31, 2010,
respectively, and approximately $1.1 million and $3.0 million in the three and
nine months ended July 31, 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.
18
Table of
Contents
The Company granted 474,424 restricted stock units
during the nine months ended July 31, 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 July 31, 2010, there was approximately
$16.5 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 July 31, 2010 is not material.
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 July 31,
|
|
Nine months ended July 31,
|
|
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
11,886
|
|
$
|
8,928
|
|
$
|
34,046
|
|
$
|
29,551
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares
outstanding, basic
|
|
33,468
|
|
33,234
|
|
33,376
|
|
33,191
|
|
Effect of dilutive
potential common shares:
|
|
|
|
|
|
|
|
|
|
Stock options
|
|
48
|
|
76
|
|
53
|
|
94
|
|
Restricted stock units
|
|
94
|
|
36
|
|
113
|
|
61
|
|
Total dilutive
potential common shares
|
|
142
|
|
112
|
|
166
|
|
155
|
|
Weighted average shares
outstanding, diluted
|
|
33,610
|
|
33,346
|
|
33,542
|
|
33,346
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share,
basic
|
|
$
|
0.36
|
|
$
|
0.27
|
|
$
|
1.02
|
|
$
|
0.89
|
|
Net income per share,
diluted
|
|
$
|
0.35
|
|
$
|
0.27
|
|
$
|
1.02
|
|
$
|
0.89
|
|
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 nine
months ended July 31, 2010 and stock options to purchase approximately 2.1
million shares were outstanding but were not included in the computation of
diluted net income per share for both the three and nine months ended July 31,
2009, because the effects would have been antidilutive.
15. COMPREHENSIVE INCOME
Comprehensive income
and its components for the three and nine months ended July 31, 2010 and
2009 were as follows (in thousands):
|
|
Three months ended July 31,
|
|
Nine months ended July 31,
|
|
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
Net
income, as reported
|
|
$
|
11,886
|
|
$
|
8,928
|
|
$
|
34,046
|
|
$
|
29,551
|
|
|
|
|
|
|
|
|
|
|
|
Other
comprehensive income (loss):
|
|
|
|
|
|
|
|
|
|
Foreign
currency translation adjustment
|
|
3
|
|
|
|
1
|
|
|
|
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 $20, $19, $51 and
$(230), respectively
|
|
34
|
|
32
|
|
86
|
|
(388
|
)
|
Realized
loss on exchange rate forward contracts, net of tax of $92, $66, $97 and
$986, respectively
|
|
158
|
|
125
|
|
166
|
|
1,678
|
|
Unrealized
gain on exchange rate forward contracts, net of tax of $294, $372, $284 and
$744, respectively
|
|
480
|
|
544
|
|
463
|
|
1,218
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
income
|
|
$
|
12,561
|
|
$
|
9,629
|
|
$
|
34,762
|
|
$
|
32,705
|
|
19
Table of Contents
16. RESTRUCTURING
In June 2010, the Company commenced plans to
restructure its Winchester, Kentucky manufacturing facilities in an effort to
streamline operations, improve capacity utilization, and reduce manufacturing
costs and operating expenses. With an expected completion date of October 31,
2010, Martek plans to reduce its workforce and transfer certain manufacturing
and distribution processes currently being performed in Winchester to the
Companys Kingstree, South Carolina site. Remaining in Winchester after the
restructuring will be activities focused primarily on lab and pilot scale
development, innovation and production, as well as supply-chain management.
As a result of the restructuring plan, a charge and
accrued liability of approximately $600,000 was recorded in the third quarter
of fiscal 2010 related to employee separation costs in the nutritional
ingredients segment. Employee separation costs include severance, medical and
other benefits. The Company anticipates
incurring approximately $1.0 million of additional restructuring costs in the
fourth quarter of fiscal 2010 related to employee separation costs. In
addition, Martek is evaluating the potential sale or lease of a portion of its
Winchester operations. Any such sale or
lease would be contingent upon Marteks ability to maintain the necessary
production redundancies through continuing access to certain key processes at
the Winchester facility and/or arrangements with contract manufacturers. Either due to sale or a lack of plant
interdependency, the Company expects that the plant restructuring will result
in a non-cash charge of $30 million to $40 million in the fourth quarter of
fiscal 2010.
20
Table
of Contents
Item 2. Managements Discussion and Analysis of
Financial Condition and Results of Operations.
This
Managements Discussion and Analysis of Financial Condition and Results of
Operations contains forward-looking statements concerning our business and
operations, including, among other things, statements concerning the following:
·
expectations regarding
future revenue, revenue growth, gross margin, operating cash flow and profitability of Martek, including its Amerifit
subsidiaries;
·
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
future interest expense on borrowings;
·
expectations regarding
future charges associated with the Winchester restructuring;
·
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.
21
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 and detection of urinary tract
infections (UTI); and ESTROVEN®, the leading all-natural nutritional
supplement brand addressing the symptoms of menopause. The products sold through Amerifit are
collectively referred to as branded consumer health products.
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.
In our nutritional ingredients segment, we sell
nutritional oils and powders as
lifesDHA
,
DHASCO®, Neuromins®, ARASCO® and
lifesARA
. We
derive DHA from microalgae and ARA from fungi, using proprietary
processes. 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. We are supplying over 40 infant formula customers
with our nutritional ingredients, including market leaders Mead Johnson
Nutritionals, Nestle, Abbott Nutrition, Pfizer and Danone. Our customers are now selling infant formula
products containing our nutritional ingredients collectively in over 80
countries. We are also currently
marketing and selling our
lifesDHA
for
food and beverage, supplement and animal feed applications to both U.S. and
international companies. To date, over 300 domestic and international companies
have launched non-infant formula products that contain
lifesDHA
.
In our
branded consumer health products segment, we sell the Culturelle®, AZO, and
ESTROVEN® lines of products. Culturelle®
is a probiotic (good bacteria) supplement which promotes good digestion,
assists in maintaining regularity and supports the human immune system. The AZO
line includes over-the-counter products used for the diagnosis of UTI as well
as the treatment of pain associated with UTI. ESTROVEN® products are herbal
supplements made with all-natural ingredients to provide relief from menopause
symptoms such as hot flashes and night sweats. These branded consumer health
products are sold to most major mass, club, drug, food and specialty stores in
the United States.
There are
currently a number of nutritional health and wellness products under
development that we plan to brand and distribute through Amerifits marketing
and distribution platform.
RECENT HIGHLIGHTS
The following highlights some recent positive developments in our
business and the science supporting our nutritional ingredients. Please read
our Risk Factors carefully for certain factors that should be considered in
evaluating these developments and our business.
·
Extended Global Sole Source Supply Agreement with Mead
Johnson
In
June 2010,
Martek extended its sole
source supply agreement with Mead Johnson & Company, LLC, for DHA and
ARA for infant formula products. Under the terms of the amendment, Martek will
remain Mead Johnsons global sole source supplier of DHA and ARA for all of its
infant formula products through December 31, 2015, an extension of four
years beyond the earliest possible termination date of the current agreement.
The amendment also provides graduated price reductions to Mead Johnson over the
term of the extension, beginning in 2010.
·
Supply Agreements with Chinese
Dairies
Martek entered into nutritional ingredient
supply agreements with two leading Chinese dairies. A five-year agreement with
Chinese dairy Mengniu Dairy Company Limited was executed for the use of Marteks
lifesDHA
in Mengniu-brand UHT
milk and potentially other categories. In addition, the Company entered into a
multi-year DHA and ARA agreement with Feihe Dairy, a wholly-owned subsidiary of
American Dairy, Inc. Under the terms of the agreement, Feihe Dairy will
purchase its total requirements of DHA and ARA for its new premium infant
formula and growing-up milk products sold in China.
·
Non-Infant Formula Product
Launches with
lifesDHA
·
Foods and Beverages O
Sole Mio Vivi Bene® medaglioni with basil and O Sole Mio Vivi Bene®
medaglioni with sundried tomato (Les aliments OSole Mio Canada); Dairyland
Cool Ones yogurt (Saputo Inc.
Canada);
Little Bear® Kid Growing Milk (Uni-President China); Babyliqi Professor
Qiqi Drink (Hong Kong Babyliqi Biotechnology Co., Ltd. China); Yubao Goat-Goat Dairy Drink (Xian Yubao Goat
Dairy Industry Co., Ltd China).
22
Table
of Contents
·
Pregnancy and
nursing and nutritional supplements CitraNatal®Harmony with 250 mg
lifesDHA
(Mission Pharmacal® U.S.);
Prenexa® with 300 mg
lifesDHA
(Upsher-Smith Laboratories
U.S.);
Organic Nutritional Mommy Bars
(Earths Best Organic® U.S.); Opti3
(Chrysalis UK); Supradyn® Junior Gummies with 60 mg
lifesDHA
per daily dose (Bayer Spain); Stop Aging Now with 100 mg
lifesDHA
per day (Avema Pharma Solutions
U.S.); Neurofen (Laboratoria Natury Poland); Z.K. 200 Cereboost (Guarana,
DHA, Vitamins + Zinc) with 15 mg
lifesDHA
(Artisan Gida EU); Meydunig Mama and Maydunig Baby with 200 mg and 100 mg
lifesDHA
respectively (Shanghai
Baojialijia China).
·
New Scientific Data
Published on DHA and ARA
The journal
Acta Paediatrica
(online, July 2010)
published the results of the continuation of a study previously reported
from the University of Oslo, Norway. The study was a randomized,
double-blinded, placebo-controlled intervention in which additional DHA and ARA
or placebo oil were added to the human milk given to very low birth weight
infants (< 1500 g). The intervention and control group included 44 and 48
children, respectively. Supplementation began one week after birth until
discharge from hospital (9 weeks on average). The infants were tested at 2
years of age using various measures. The authors concluded that a positive
effect of early supplementation with DHA and ARA on 20 months attention
capacity was indicated. Martek supplied oils used in this study.
SALES AND MARKETING
Nutritional
Ingredients
Our
nutritional oils and powders are marketed and sold to the infant formula,
pregnancy and nursing, food and beverage, dietary supplement and animal feed
markets. These sales are both direct to customers through our direct sales
force as well as through distributors. Although we are not given precise
information by our customers as to the countries in which products containing
our nutritional ingredients are sold, we estimate that approximately 50% of our
nutritional ingredients sales are to customers in the U.S. Certain of our nutritional ingredient license
and supply agreements establish Martek, subject to certain exceptions, as their
exclusive supplier of such ingredients 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.
Consumer
marketing efforts are performed primarily by our customers although we play a
supportive role. Our infant formula customers market their DHA and ARA
supplemented formulas directly to consumers and healthcare professionals. Our dietary supplement, food and beverage and
animal feed customers also create and implement their own advertising
campaigns. We support these efforts through trade show participation and
targeted direct mail campaigns as well as limited advertising and public
relations campaigns.
Branded
Consumer Health Products
The products
in our branded consumer health products segment are sold primarily through a
direct sales force, but also through the use of third party sales 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 believe
that a focused and consistent marketing strategy is critical to the growth of
our brands. Our strategy includes the use of print, television and internet
advertising as well as point-of-sale merchandising. These programs are designed
to strengthen our brand equities, generate awareness of new items and stimulate
trial among our target customers. We also partner with our customers to develop
trade promotion programs which deliver merchandising and price promotions to
our consumers.
We expect
that our future revenues and operating results in both the nutritional
ingredients and branded consumer health products segments 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 with customers
comprising nearly 75% of our current infant formula revenues. These sole source arrangements include the
supply agreements recently extended with Mead Johnson and Danone, which are now
extended at least through calendar 2015 and 2014, respectively, and
collectively comprise approximately 43% of our current infant formula revenues
as well as others which, in most cases, extend through calendar 2011. Our
success in entering into new sole source agreements or in extending existing
sole source infant formula supply agreements will be significant in determining the extent of such
revenue fluctuations. Furthermore, in
order to extend the sole source arrangements which expire at the end of
calendar 2011, consistent with the pricing provisions in the recently extended
Mead Johnson and Danone arrangements, reductions to our existing per-unit
pricing may continue to 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, including the plant restructuring described below. 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.
23
Table
of Contents
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;
·
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 distribution 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;
·
the variability of birth rates;
·
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 currently
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.
In June 2010,
we commenced plans to restructure our Winchester, Kentucky manufacturing
facilities in an effort to streamline operations, improve capacity utilization,
and reduce manufacturing costs and operating expenses. With an expected
completion date of October 31, 2010, Martek plans to reduce its workforce
and transfer certain manufacturing and distribution processes currently being
performed in Winchester to our Kingstree, South Carolina site. Remaining in
Winchester after the restructuring will be activities focused primarily on lab
and pilot scale development, innovation and production, as well as supply-chain
management. As part of the restructuring, we are evaluating the potential sale
or lease of a portion of our Winchester facility. Any such sale or lease would
be contingent upon Marteks ability to maintain the necessary production
redundancies through continuing access to certain key processes at the
Winchester facility and/or arrangements with contract manufacturers.
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 July 31, 2010, the value of the
remaining calendar year 2010 and full calendar year 2011 minimum purchase
requirements are approximately $35.0 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
24
Table of Contents
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-infant formula markets. Furthermore,
despite
the plant
restructuring
described above
, when combined with DSMs current ARA
production capabilities, Marteks DHA and ARA production capacity will
continue to
be substantially in excess of current and forecasted requirements for
the next several years
even after such
restructuring. 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 current 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.
We have qualified alternatives suppliers for most of our products, and
where we do not, we are actively seeking to qualify an alternative supplier.
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 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,
collectability 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
25
Table
of Contents
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. Furthermore, with arrangements that involve
multiple deliverables or pricing variability, managements assessment of fair
value is a significant consideration of revenue recognition. Management evaluates future patent
expirations, market participants and competitive conditions in its assessment
of whether the identified deliverables or pricing variability represents fair
value.
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 there are
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
. 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
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 a 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 July 31,
|
|
Nine
months ended July 31,
|
|
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
Product
sales
|
|
$
|
113,971
|
|
$
|
75,044
|
|
$
|
317,139
|
|
$
|
247,218
|
|
Contract
manufacturing and collaborations
|
|
3,192
|
|
2,790
|
|
13,748
|
|
10,390
|
|
Total
revenues
|
|
$
|
117,163
|
|
$
|
77,834
|
|
$
|
330,887
|
|
$
|
257,608
|
|
Product sales increased $38.9 million or 52% in the
three months ended July 31, 2010 as compared to the three months ended July 31,
2009 and increased $69.9 million or 28% in the nine months ended July 31,
2010 as compared to the nine months ended July 31, 2009. This increase was partially attributable to
the branded consumer health product sales of Amerifit, which totaled $20.3 million
in the three months ended July 31, 2010 and $38.3 million for the period
from the acquisition date (February 12, 2010) through July 31,
2010. The remainder of the increase, or
$18.6 million and $31.6 million in the comparable three and nine months,
respectively, was primarily 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.
26
Table
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Product sales were comprised of the following (in
thousands):
|
|
Three
months ended July 31,
|
|
Nine
months ended July 31,
|
|
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
Nutritional
ingredients:
|
|
|
|
|
|
|
|
|
|
Infant
formula
|
|
$
|
79,169
|
|
$
|
63,320
|
|
$
|
237,028
|
|
$
|
215,294
|
|
Food
and beverage
|
|
4,553
|
|
2,681
|
|
13,265
|
|
8,278
|
|
Pregnancy
and nursing, nutritional supplements and animal nutrition
|
|
9,015
|
|
7,931
|
|
25,216
|
|
20,396
|
|
Shipping
charges
|
|
624
|
|
470
|
|
1,883
|
|
1,498
|
|
Total
nutritional ingredients
|
|
93,361
|
|
74,402
|
|
277,392
|
|
245,466
|
|
|
|
|
|
|
|
|
|
|
|
Branded
consumer health products
|
|
20,301
|
|
|
|
38,310
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-nutritional
products
|
|
309
|
|
642
|
|
1,437
|
|
1,752
|
|
Total
product sales
|
|
$
|
113,971
|
|
$
|
75,044
|
|
$
|
317,139
|
|
$
|
247,218
|
|
Approximately 73% and 75% of our nutritional
ingredients sales in the three and nine months ended July 31, 2010,
respectively, were generated by sales to our top five nutritional ingredients
customers. In addition, approximately
50% of our branded consumer health products sales in both the three and nine
months ended July 31, 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 nine months ended July 31, 2010 and
the three and nine months ended July 31, 2009 relate to sales in the United
States. Virtually all sales of our branded consumer health products are to
customers in the United States.
As of July 31, 2010, we estimate that formula
supplemented with our oils had penetrated almost all of the United States
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) 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 $3.2 million
and $13.7 million in the three and nine months ended July 31, 2010,
respectively, and $2.8 million and $10.4 million in the three and nine months
ended July 31, 2009, respectively.
Of the total contract manufacturing and collaborations revenue in the
three and nine months ended July 31, 2010, approximately $2.3 million and
$10.7 million, respectively, relates to contract manufacturing activities that
in large measure, we have now exited.
The remaining $900,000 and $3.0 million in the three and nine months
ended July 31, 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 $39.3 million or 51% in the three
months ended July 31, 2010 as compared to the three months ended July 31,
2009, and total revenues increased by $73.3 million or 28% in the nine months
ended July 31, 2010 as compared to the nine months ended July 31,
2009.
27
Table
of Contents
Cost
of Revenues
The following table presents our cost of revenues
(in thousands):
|
|
Three
months ended July 31,
|
|
Nine
months ended July 31,
|
|
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of product sales
|
|
$
|
56,011
|
|
$
|
41,129
|
|
$
|
164,310
|
|
$
|
137,337
|
|
Cost
of contract manufacturing and collaborations
|
|
2,647
|
|
2,675
|
|
11,977
|
|
10,101
|
|
Total
cost of revenues
|
|
$
|
58,658
|
|
$
|
43,804
|
|
$
|
176,287
|
|
$
|
147,438
|
|
Cost of
product sales as a percentage of product sales improved to 49% in the three
months ended July 31, 2010 from 55% in the three months ended July 31,
2009 and improved to 52% in the nine months ended July 31, 2010 from 56%
in the nine months ended July 31, 2009. The decrease in the comparative
three and nine months was due to both DHA and ARA cost reductions and the
positive impact on gross margins of branded consumer health product sales. Included in the gross margin for the third
quarter of and year-to-date fiscal 2010 is the negative effect of approximately
$200,000 and $1.9 million, respectively, of one-time inventory step-up in fair
value resulting from the Amerifit acquisition.
Cost of
contract manufacturing and collaborations was $2.6 million and $12.0 million in
the three and nine months ended July 31, 2010, respectively, and $2.7
million and $10.1 million in the three and nine months ended July 31,
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 fourth quarter and full fiscal year 2010.
Operating
Expenses
The following table presents our operating expenses
(in thousands):
|
|
Three
months ended July 31,
|
|
Nine
months ended July 31,
|
|
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
Research
and development
|
|
$
|
8,499
|
|
$
|
6,604
|
|
$
|
24,386
|
|
$
|
20,510
|
|
Selling,
general and administrative
|
|
18,892
|
|
11,027
|
|
49,598
|
|
36,058
|
|
Advertising
and promotion
|
|
5,598
|
|
412
|
|
10,072
|
|
1,353
|
|
Amortization
of intangible assets
|
|
2,983
|
|
1,534
|
|
7,022
|
|
4,910
|
|
Acquisition
costs
|
|
484
|
|
|
|
3,472
|
|
|
|
Restructuring
charge
|
|
607
|
|
|
|
607
|
|
|
|
Other
operating expenses
|
|
300
|
|
234
|
|
505
|
|
956
|
|
Total
operating expenses
|
|
$
|
37,363
|
|
$
|
19,811
|
|
$
|
95,662
|
|
$
|
63,787
|
|
Our research and development costs increased by
$1.9 million or 29% in the three months ended July 31, 2010 as compared to
the three months ended July 31, 2009 and increased by $3.9 million or 19%
in the nine months ended July 31, 2010 as compared to the nine months
ended July 31, 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 $7.9 million or 71% in the three months ended July 31, 2010
as compared to the three months ended July 31, 2009 and increased by $13.5
million or 38% in the nine months ended July 31, 2010 as compared to the
nine months ended July 31, 2009.
These increases resulted from expenses attributable to Amerifit, which
totaled approximately $4.1 million in the three months ended July 31, 2010
and $7.5 million in the period from the acquisition date through July 31,
2010, and from 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 $400,000 in the three months ended July 31, 2009 to $5.6
million in the three months ended July 31, 2010 and increased from
approximately $1.4 million in the nine months ended July 31, 2009 to $10.1
million in the nine months ended July 31, 2010. These increases resulted from advertising and
promotion attributable to Amerifit. 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.
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Table
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Our amortizing intangibles assets consist primarily
of patents, licenses, and trademarks unrelated to Amerifit and customer
relationships resulting from the Amerifit acquisition. We amortize these assets
over their expected life. We recorded amortization expense related to our
intangible assets of $3.0 million and $7.0 million in the three and nine months
ended July 31, 2010, respectively, and $1.5 million and $4.9 million in
the three and nine months ended July 31, 2009, respectively. The increase in the three and nine months
ended July 31, 2010 includes $1.5 million and $2.8 million, respectively,
of amortization associated with the intangible assets acquired with Amerifit,
partially offset by certain non-Amerifit patent 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 in 2010 relate primarily to
investment banking fees, professional service expenses and employee severance
costs incurred during the nine months ended July 31, 2010 associated with
the Amerifit acquisition. There were no
acquisition-related costs incurred in the 2009 periods.
In June 2010, we commenced plans to
restructure our Winchester, Kentucky manufacturing facilities in an effort to
streamline operations, improve capacity utilization, and reduce manufacturing
costs and operating expenses. With an expected completion date of October 31,
2010, we plan to reduce our workforce and transfer certain manufacturing and
distribution processes currently being performed in Winchester to the Companys
Kingstree, South Carolina site. Remaining in Winchester after the restructuring
will be activities focused primarily on lab and pilot scale development,
innovation and production, as well as supply-chain management.
As a result of the restructuring plan, a charge of
approximately $600,000 was recorded in the third quarter of fiscal 2010 related
to employee separation costs. Employee separation costs include severance,
medical and other benefits. We
anticipate incurring approximately $1.0 million of additional restructuring
costs in the fourth quarter of fiscal 2010 related to employee separation
costs. In addition, we are evaluating
the potential sale or lease of a portion of our Winchester operations. Any such sale or lease would be contingent
upon our ability to maintain the necessary production redundancies through
continuing access to certain key processes at the Winchester facility and/or
arrangements with contract manufacturers.
Either due to sale or a lack of plant interdependency, we expect that
the plant restructuring will result in a non-cash charge of $30 million to $40
million in the fourth quarter of fiscal 2010.
Interest
and Other Income, Net
Interest and
other income, net, decreased by $100,000 in the three months ended July 31,
2010 as compared to the three months ended July 31, 2009 and decreased by
$700,000 in the nine months ended July 31, 2010 as compared to the nine
months ended July 31, 2009 due primarily to lower cash balances and
interest rates earned on those cash balances
.
Interest
Expense
Interest
expense increased by $1.8 million and $3.0 million in the three and nine months
ended July 31, 2010, respectively, as compared to the three and nine
months ended July 31, 2009, respectively, due to interest costs incurred
on borrowings used to finance the Amerifit acquisition. Interest costs in the
three and nine month periods of 2010 include the effects of the accelerated
amortization of debt issue costs resulting from the early repayment of the Term
Debt in the third quarter of fiscal 2010.
With such early repayment, we expect interest expense to decline
significantly in the fourth quarter of fiscal 2010 as compared to the third
quarter of 2010. 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 38.6% and 38.8% in the three and nine months ended July 31,
2010, respectively, and 37.6% and 36.9%
in the three and nine months ended July 31, 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.
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 $11.9 million in the three months ended July 31,
2010 as compared to net income of $8.9 million in the three months ended July 31,
2009, and net income was $34.0 million in the nine months ended July 31,
2010 as compared to net income of $29.6 million in the nine months ended July 31,
2009.
29
Table
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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. Segment operating performance is as follows (in
thousands):
|
|
Three months ended July 31,
|
|
Nine months ended July 31,
|
|
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
Segment
Income From Operations
|
|
|
|
|
|
|
|
|
|
Branded
consumer health products
|
|
$
|
1,900
|
|
$
|
|
|
$
|
3,793
|
|
$
|
|
|
Nutritional
ingredients
|
|
18,921
|
|
13,949
|
|
54,123
|
|
46,042
|
|
Other
|
|
321
|
|
270
|
|
1,022
|
|
341
|
|
Total
|
|
$
|
21,142
|
|
$
|
14,219
|
|
$
|
58,938
|
|
$
|
46,383
|
|
The
profitability of the nutritional ingredients segment increased in both the
three and nine months ended July 31, 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 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
Over the last
five years, 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 nine months ended July 31, 2010 and 2009 were as follows (in
thousands):
|
|
Nine months ended July 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Net cash provided by
operating activities
|
|
$
|
99,693
|
|
$
|
40,002
|
|
Net cash used in
investing activities
|
|
(210,641
|
)
|
(12,762
|
)
|
Net cash used in
financing activities
|
|
(3,594
|
)
|
(390
|
)
|
Foreign currency
translation adjustment
|
|
1
|
|
|
|
Total cash (outflows)
inflows
|
|
$
|
(114,541
|
)
|
$
|
26,850
|
|
Cash and cash equivalents decreased $114.5 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 $87 million in the nine months
ended July 31, 2010 as well as reductions to inventories held contributed
to the generation of $99.7 million in cash from operating activities. Capital expenditures, including both property
and equipment as well as patent and other intangible asset costs, totaled $17.2
million during the nine months ended July 31, 2010. Our financing activities in the nine
30
Table of Contents
months ended July 31, 2010 primarily include
borrowings described above to finance the acquisition of Amerifit, of which the
$11 million borrowed under the revolving credit facility and the $75 million
borrowed under the Term Loan were repaid in full by July 31, 2010.
As of July 31, 2010, we had approximately
$26.5 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 had a maturity date of February 2013;
however we fully repaid the Term Loan in July 2010. During the months in which it was still
outstanding, the Term Loan bore 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 July 31, 2010, we were in compliance with all loan covenants.
At July 31, 2010, our investments had a fair
value of $4.6 million and consisted primarily of auction rate securities (ARS),
the underlying assets of which are student loans originated under the Federal
Family Education Loan Program (FFELP).
FFELP student loans are guaranteed by state guarantors who have
reinsurance agreements with the U.S. Department of Education. These ARS are intended to provide liquidity
via an auction process that resets the applicable interest rate approximately
every 30 days and allows investors to either roll over their holdings or gain
immediate liquidity by selling such investments at par. The underlying
maturities of these investments range from 16 to 37 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 a Put Agreement with a financial institution
that provided us the ability to sell certain of our ARS to the financial
institution and allowed the financial institution, at its sole discretion, to purchase
such ARS at par during the period June 30, 2010 through July 2, 2012.
On June 30, 2010, the Company exercised its rights under the Put Agreement
which resulted in the sale of the related ARS and the receipt by Martek of $7.3
million, the par value of such ARS.
The following
table sets forth our future minimum payments under contractual obligations at July 31,
2010:
|
|
|
|
Less than
|
|
1-3
|
|
3-5
|
|
More than
|
|
In thousands
|
|
Total
|
|
1 year
|
|
years
|
|
years
|
|
5 years
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notes payable (1)
|
|
$
|
484
|
|
$
|
38
|
|
$
|
77
|
|
$
|
77
|
|
$
|
292
|
|
Borrowings under
Revolver
|
|
|
|
|
|
|
|
|
|
|
|
Long-term license fee
obligation (2)
|
|
2,379
|
|
933
|
|
1,446
|
|
|
|
|
|
Operating lease
obligations (3)
|
|
10,495
|
|
1,955
|
|
2,663
|
|
2,198
|
|
3,679
|
|
Unconditional purchase
obligations (4), (5)
|
|
122,126
|
|
85,829
|
|
36,297
|
|
|
|
|
|
Total contractual cash
obligations (6)
|
|
$
|
135,484
|
|
$
|
88,755
|
|
$
|
40,483
|
|
$
|
2,275
|
|
$
|
3,971
|
|
(1)
Minimum 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.
(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 $3.1 million, the timing of which is uncertain.
31
Table of Contents
We believe that the Revolver, when combined with
our cash and cash equivalents on-hand at July 31, 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
The projected results are shown below for Martek
(not including Amerifit), Amerifit (stand-alone, post-acquisition) and on a
consolidated basis for the three months ending October 31, 2010. The
consolidated net income and earnings per share information is shown inclusive
of any charges resulting from the Winchester restructuring described above.
|
|
Three months ending October 31, 2010
|
|
(in millions, except per share
data)
|
|
Martek
|
|
Amerifit
|
|
Consolidated
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
87.0
91.0
|
|
$
|
21.0
22.0
|
|
$
|
108.0 113.0
|
|
Income
(loss) from operations before restructuring charge
|
|
$
|
16.1
18.3
|
|
$
|
3.0
3.5
|
|
$
|
19.6 21.8
|
|
Restructuring
charge
|
|
$
|
41.0
31.0
|
|
|
|
$
|
41.0 31.0
|
|
Income
(loss) from operations after restructuring charge
|
|
$
|
(24.9)
(12.7)
|
|
$
|
3.0
3.5
|
|
$
|
(21.4) (9.2)
|
|
Net
loss
|
|
|
|
|
|
$
|
(13.4) (5.9)
|
|
Diluted
EPS
|
|
|
|
|
|
$
|
(0.40) (0.18)
|
|
For the fourth quarter of fiscal 2010, Martek
expects infant formula revenue to be between $71 million and $75 million,
non-infant formula nutritional revenue to be between $13 million and $14
million, and contract manufacturing and collaborations revenue to be between
$1.0 million and $1.3 million. Such
projected fourth quarter revenues would equate to year-over-year growth of more
than 23%.
Consolidated gross margin in the fourth quarter of
fiscal 2010 is expected to be between 51% and 52%. Furthermore, due to the Companys early repayment of its term loan and
related debt issuance cost amortization acceleration in the third quarter, we
expect interest expense to decline significantly in the fourth quarter of
fiscal 2010 as compared to the third quarter of 2010.
Based on this fourth
quarter guidance, Martek expects full fiscal year 2010 revenue to be between
$439 million and $444 million, including infant formula revenues of between $308
million and $312 million. The projected 2010 annual revenues would represent
year-over-year growth in total revenues of 27% to 29% (10% to 11% excluding
Amerifit-related revenues) and reflects meaningful gains in nearly all markets
for our nutritional ingredients, including growth in infant formula revenues of
8% to 9% and growth in non-infant formula nutritional revenues of 31% to 34%.
32
Table
of Contents
With the
recently-extended infant formula supply agreements along with the pending
Winchester restructuring, the Company has greater visibility into its expected
results for fiscal 2011. As such, we are projecting revenue and net income
growth over fiscal 2010. Contributing to this anticipated earnings increase is
projected gross margin growth of at least 400 basis points over the expected
full year fiscal 2010 level. Gross margin for fiscal 2011 will be favorably
impacted by a full year of Amerifit operations, the discontinuation of the
Companys low margin contract manufacturing business, production cost
efficiencies and lower ARA pricing.
33
Table of
Contents
Item 3. Quantitative and Qualitative Disclosures
about Market Risk.
We are subject to market risk associated with
changes in foreign currency exchange rates and interest rates.
In July 2009,
we entered into the First Amended and Restated ARA Alliance, Purchase, and
Production Agreement (the Restated Agreement) with DSM. As part of the agreement, it was established
that 25% of the ARA we buy from DSM will be denominated in euros. As such, consistent with our payment
arrangements with DSM prior to the execution of the Restated Agreement, we are
exposed to risks related to changes in exchange rates between the U.S. dollar
and the euro. We enter into foreign currency
cash flow hedges to reduce the related market risk on our payment
obligations. We do not enter into
foreign currency cash flow hedges for speculative purposes. At July 31, 2010, we had unrealized
gains on such hedge instruments totaling approximately $600,000, 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 was repaid
in full in the quarter ended July 31, 2010. The Revolver bears 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%.
There were no variable-rate borrowings outstanding at July 31,
2010.
We have investments at July 31, 2010 with a
fair value of $4.6 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. 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 June 2010,
we exercised our rights under the Put Agreement and the ARS covered by the Put
Agreement were sold at par for total proceeds of $7.3 million. Our ARS holdings to which this relates had a
cost basis of approximately $7.3 million.
The Put Agreement was deemed a discrete short-term investment until its
exercise. The remaining ARS at July 31,
2010 are not currently liquid and we will not be able to access these funds
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. These remaining ARS have
a cost basis of approximately $5.6 million and a fair value of $4.6 million at July 31,
2010. We continue to monitor the market for auction rate securities and
consider its impact, if any, on the fair value of the remaining ARS investments
we hold. If current market conditions deteriorate further, the Company may be
required to record additional write-downs. We based our valuation of these
investments on discounted cash flow models that include various unobservable
inputs. Changes to the inputs used as of
July 31, 2010 would cause fluctuations to the fair value of the affected
instruments and such fair value changes could be material.
Item
4. Controls and Procedures.
a)
Evaluation of Disclosure Controls and Procedures.
As of the end of the period covered by this report, we, under the
supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, have evaluated the effectiveness
of our disclosure controls and procedures pursuant to Exchange Act rules 13a-15(e) and
15d-15(e). Based on this evaluation, our
Chief Executive Officer and Chief Financial Officer have concluded that, as of
the end of the period covered by this report, the disclosure controls and
procedures were effective.
b)
Internal Control Over Financial Reporting.
There was no change in our internal control over financial reporting in
connection with the evaluation required by paragraph (d) of Rules 13a-15
or 15d-15 under the Exchange Act that occurred during Marteks quarter ended July 31,
2010 that materially affected, or is reasonably likely to materially affect,
our internal control over financial reporting.
34
Table of Contents
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
Information regarding reportable legal proceedings
is contained in
Item 3. Legal Proceedings of Part I of our
Annual Report on Form 10-K for the year ended October 31, 2009
and Item 1. Legal Proceedings of Part II of our Quarterly Reports on Form 10-Q
for the periods ended January 31, 2010 and April 30, 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:
In November 2009,
Lonza filed with the U.S. Patent and Trademark Office a Request for
Reexamination (Request) of U.S. Patent No. 5,698,244.
This patent, which contains claims directed to raising animals,
including humans, by feeding them omega-3 highly unsaturated fatty acids from
Thraustochytriales, could impact competitors in the food and beverage, dietary
supplement and infant formula markets.
After multiple resubmissions, the Office granted this Request in March 2010. An adverse first Office Action issued in August 2010. We intend to respond to the Office Action and
defend this patent. The patent will
remain in full force and effect during the reexamination process.
Also, in February 2010, Lonza filed a
Request seeking reexamination of Marteks U.S. Patent No.
6,410,281
,
which contains claims directed to controlling corrosion in a fermentor by
providing a non-chloride sodium salt, rather than sodium chloride, as the
primary source of sodium. This 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. An adverse first Office Action issued in August 2010. We intend to respond to the Office Action and
defend this patent. The patent will
remain in full force and effect during the reexamination process.
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.
35
Table
of Contents
Item 1A. Risk Factors.
Investing in our securities involves a high degree
of risk
. Before
making an investment decision, you should carefully consider the risks set
forth in Item 1A. Risk Factors of Part I of our Annual Report on Form 10-K
for the year ended October 31, 2009, Item 1A. Risk Factors of Part II
of our Quarterly Reports on Form 10-Q for the quarters ended January 31,
2010 and April 30, 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
Reports on Form 10-Q for the quarters ended January 31, 2010 and April 30,
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.
We
maintain significant manufacturing capacity and have incurred substantial costs
in building it. If we are unable to increase our revenues from our nutritional
oils produced at these facilities, we may continue to experience excess
production capacity and we may be unable to recover these plant expansion
costs, which could result in a write-down of certain production assets.
In connection with
our efforts to alleviate supply constraints with our infant formula customers
and to prepare for other applications of our products, we expanded our internal
production capacity and incurred significant expansion costs in doing so. As of July 31, 2010, the Company had
$63.5 million of production assets that are currently idle. In June 2010, we commenced plans to
restructure our Winchester, Kentucky manufacturing facilities. These plans include the transfer of certain
manufacturing and distribution processes currently being performed in
Winchester to our Kingstree, South Carolina site and the potential sale or
lease of a portion of our Winchester operations. Either due to sale or a lack
of plant interdependency, we expect that the plant restructuring will result in
a non-cash asset charge of $30 million to $40 million in the fourth fiscal
quarter of fiscal 2010. Even following
the completion of this restructuring, our ability to recover the costs of our
production assets may depend on increased volumes and revenue from the products
manufactured at our facilities. There
are no assurances that we will be able to achieve this goal. If it is estimated that we will not be able
to ultimately recover the carrying amounts of the production assets, we would
be required to record an asset impairment write-down. The effect of such
write-down could be material. In
addition, when experiencing excess capacity, we may be unable to produce the
required quantities of oil cost-effectively, which could have a material
adverse effect on our product margins and overall profitability.
36
Table
of Contents
Item 2. Unregistered Sales of Equity Securities and
Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
Not Applicable.
Item 4. Removed and Reserved.
Item 5. Other Information.
None.
Item 6. Exhibits.
10.01
|
|
Amendment to Supply Agreement with
Mead Johnson & Company, LLC, dated January 1, 2006, as amended
on August 6, 2009, deemed effective as of June 1, 2010.^
*
|
|
|
|
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.*
|
101.INS
|
|
XBRL Instance Document.*
|
101.SCH
|
|
XBRL Taxonomy Extension Schema Document.*
|
101.CAL
|
|
XBRL Taxonomy Extension Calculation Linkbase
Document.*
|
101.DEF
|
|
XBRL Taxonomy Extension Definition Linkbase
Document.*
|
101.LAB
|
|
XBRL Taxonomy Extension Label Linkbase Document.*
|
101.PRE
|
|
XBRL Taxonomy Extension Presentation Linkbase
Document.*
|
^
Confidential treatment was requested by the Securities and Exchange
Commission for certain portions of this agreement. The confidential portions
were filed separately with the Commission.
*
Filed or furnished herewith.
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.
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MARTEK BIOSCIENCES CORPORATION
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(Registrant)
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Date:
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September 8, 2010
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/s/ Peter L. Buzy
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Peter
L. Buzy
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Chief
Financial Officer, Treasurer and Executive Vice President for Finance and
Administration
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(Principal Financial and Accounting Officer)
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38
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