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**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-Q**

 

**x****     ****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the Quarterly Period Ended April 30,2010**

 

**or**

 

**o****        ****TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the Transition Period From         to         **

 

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**COMMISSION FILE NUMBER 0-22354**

 

**MARTEK BIOSCIENCES CORPORATION**

(Exact name of registrantas 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 principalexecutive offices)

 

Registrant’s telephonenumber, including area code:**   (410) 740-0081**

 

**None**

(Former name, formeraddress and former fiscal year, if changed since last report)

 

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Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.   x Yes  o No

 

Indicate by check mark whether the registrant hassubmitted electronically and posted on its corporate Web site, if any, everyInteractive Data File required to be submitted and posted pursuant to Rule 405of Regulation S-T during the preceding 12 months (or for such shorter periodthat the registrant was required to submit and post such files).   o Yes  o No

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer, or asmaller reporting company.  See thedefinitions of “large accelerated filer,” “accelerated filer” and “smallerreporting 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 ashell company (as defined in Rule 12b-2 of the Exchange Act).   o Yes  x No

 

The number of shares ofCommon Stock outstanding as of June 1, 2010 was 33,460,268.

 

 

 

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MARTEKBIOSCIENCES CORPORATION

FORM 10-Q

 

ForThe Quarterly Period Ended April 30, 2010

 

INDEX

 
| PART I  | FINANCIAL INFORMATION                                                                       |   |
|--------------|---------------------------------------------------------------------------------------------|--------|
| Item 1.      | Financial Statements                                                                        | 3      |
| Item 2.      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 20     |
| Item 3.      | Quantitative  and Qualitative Disclosures about Market Risk                                 | 31     |
| Item 4.      | Controls and  Procedures                                                                    | 31     |
|         |                                                                                        |   |
| PART II | OTHER INFORMATION                                                                           |   |
| Item 1.      | Legal Proceedings                                                                           | 32     |
| Item 1A.     | Risk Factors                                                                                | 34     |
| Item 2.      | Unregistered  Sales of Equity Securities and Use of Proceeds                                | 37     |
| Item 3.      | Defaults Upon  Senior Securities                                                            | 37     |
| Item 4.      | Removed and Reserved                                                                        | 37     |
| Item 5.      | Other Information                                                                           | 37     |
| Item 6.      | Exhibits                                                                                    | 37     |
|         |                                                                                        |   |
|         | Signatures                                                                                  | 38     |

 

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**PART I- FINANCIAL INFORMATION**

**Item 1.Financial Statements.**

 

**MARTEK BIOSCIENCES CORPORATION**

 

CONSOLIDATED BALANCE SHEETS

 
| ** **                                                                                                                           | ** ** | **April 30,**    | ** ** | ** **                 | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|----------------------------|------------|
| **In  thousands, except share and per share data**                                                                                   | ** ** | **2010  (unaudited)** | ** ** | **October 31,  2009** | ** ** |
| ** **                                                                                                                           | ** ** | ** **            | ** ** | ** **                 | ** ** |
| ** **                                                                                                                           | ** ** | ** **            | ** ** | ** **                 | ** ** |
| **Assets**                                                                                                                           |       |                  |       |                       |       |
| *Current assets*                                                                                                                     |       |                  |       |                       |       |
| Cash  and cash equivalents                                                                                                           |       | $                     | 30,207     |                       | $          | 141,063 |   |
| Short-term  investments                                                                                                              |       | 7,292                 |       | 7,301                      |       |
| Accounts  receivable, net                                                                                                            |       | 68,234                |       | 44,304                     |       |
| Inventories,  net                                                                                                                    |       | 119,456               |       | 116,179                    |       |
| Deferred  tax asset                                                                                                                  |       | 25,071                |       | 24,303                     |       |
| Other  current assets                                                                                                                |       | 6,368                 |       | 5,240                      |       |
| Total  current assets                                                                                                                |       | 256,628               |       | 338,390                    |       |
|                                                                                                                                 |       |                  |       |                       |       |
| Property,  plant and equipment, net                                                                                                  |       | 249,396               |       | 252,279                    |       |
| Long-term  investments                                                                                                               |       | 4,579                 |       | 4,495                      |       |
| Goodwill                                                                                                                             |       | 150,567               |       | 51,592                     |       |
| Customer  relationships, net                                                                                                         |       | 90,154                |       | —                     |       |
| Other  intangible assets, net                                                                                                        |       | 89,541                |       | 42,631                     |       |
| Other  assets, net                                                                                                                   |       | 3,834                 |       | 430                        |       |
|                                                                                                                                 |       |                  |       |                       |       |
| Total  assets                                                                                                                        |       | $                     | 844,699    |                       | $          | 689,817 |   |
|                                                                                                                                 |       |                  |       |                       |       |
| **Liabilities and stockholders’ equity**                                                                                        |       |                  |       |                       |       |
| *Current liabilities*                                                                                                                |       |                  |       |                       |       |
| Accounts  payable                                                                                                                    |       | $                     | 20,031     |                       | $          | 13,122 |   |
| Accrued  liabilities                                                                                                                 |       | 38,410                |       | 18,243                     |       |
| Current  portion of notes payable and other long-term obligations                                                                    |       | 16,295                |       | 410                        |       |
| Current  portion of deferred revenue                                                                                                 |       | 970                   |       | 2,981                      |       |
| Total  current liabilities                                                                                                           |       | 75,706                |       | 34,756                     |       |
|                                                                                                                                 |       |                  |       |                       |       |
| Notes  payable and other long-term obligations                                                                                       |       | 28,110                |       | 400                        |       |
| Long-term  portion of deferred revenue                                                                                               |       | 8,155                 |       | 8,426                      |       |
| Deferred  tax liability                                                                                                              |       | 71,872                |       | 10,091                     |       |
|                                                                                                                                 |       |                  |       |                       |       |
| Total  liabilities                                                                                                                   |       | 183,843               |       | 53,673                     |       |
|                                                                                                                                 |       |                  |       |                       |       |
| Commitments                                                                                                                          |       |                  |       |                       |       |
| * *                                                                                                                             |       |                  |       |                       |       |
| *Stockholders’ equity*                                                                                                          |       |                  |       |                       |       |
| Preferred  stock, $.01 par value, 4,700,000 shares authorized; none issued or  outstanding                                           |       | —                |       | —                     |       |
| Common  stock, $.10 par value; 100,000,000 shares authorized; 33,460,268 and  33,269,686 shares issued and outstanding, respectively |       | 3,346                 |       | 3,327                      |       |
| Additional  paid-in capital                                                                                                          |       | 560,011               |       | 557,519                    |       |
| Accumulated  other comprehensive loss                                                                                                |       | (633                  | )          | (674                       | )          |
| Retained  earnings                                                                                                                   |       | 98,132                |       | 75,972                     |       |
|                                                                                                                                 |       |                  |       |                       |       |
| Total  stockholders’ equity                                                                                                     |       | 660,856               |       | 636,144                    |       |
|                                                                                                                                 |       |                  |       |                       |       |
| Total  liabilities and stockholders’ equity                                                                                     |       | $                     | 844,699    |                       | $          | 689,817 |   |

 

*See accompanying notes.*

 

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**MARTEK BIOSCIENCES CORPORATION**

 

CONSOLIDATED STATEMENTS OF INCOME

 
| ** **                                           | ** ** | **Three months ended April 30,** | ** ** | **Six months ended April 30,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **Unaudited - In thousands,  except per share data** | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                           |       |                                  |       |                                |       |   |   |   |   |
| **Revenues:**                                        |       |                                  |       |                                |       |   |   |   |   |
| Product sales                                        |       | $                                     | 119,082    |                                | $          | 88,152 |   | $ | 203,168 |   | $ | 172,174 |   |
| Contract  manufacturing and collaborations           |       | 4,886                                 |       | 4,259                               |       | 10,556 |   | 7,600 |   |
|                                                 |       |                                  |       |                                |       |   |   |   |   |
| Total revenues                                       |       | 123,968                               |       | 92,411                              |       | 213,724 |   | 179,774 |   |
| ** **                                           |       |                                  |       |                                |       |   |   |   |   |
| **Cost of  revenues:**                               |       |                                  |       |                                |       |   |   |   |   |
| Cost of product sales                                |       | 62,362                                |       | 49,299                              |       | 108,299 |   | 96,208 |   |
| Cost of contract manufacturing and collaborations    |       | 4,097                                 |       | 4,017                               |       | 9,330 |   | 7,426 |   |
|                                                 |       |                                  |       |                                |       |   |   |   |   |
| Total cost of  revenues                              |       | 66,459                                |       | 53,316                              |       | 117,629 |   | 103,634 |   |
|                                                 |       |                                  |       |                                |       |   |   |   |   |
| Gross margin                                         |       | 57,509                                |       | 39,095                              |       | 96,095 |   | 76,140 |   |
|                                                 |       |                                  |       |                                |       |   |   |   |   |
| **Operating  expenses:**                             |       |                                  |       |                                |       |   |   |   |   |
| Research and  development                            |       | 8,821                                 |       | 7,157                               |       | 15,887 |   | 13,906 |   |
| Selling, general  and administrative                 |       | 17,926                                |       | 12,280                              |       | 30,706 |   | 25,031 |   |
| Advertising and  promotion                           |       | 3,965                                 |       | 595                                 |       | 4,474 |   | 941 |   |
| Amortization of  intangible assets                   |       | 2,594                                 |       | 1,595                               |       | 4,039 |   | 3,376 |   |
| Acquisition  costs                                   |       | 1,801                                 |       | —                              |       | 2,988 |   | — |   |
| Other operating  expenses                            |       | 171                                   |       | 569                                 |       | 205 |   | 722 |   |
|                                                 |       |                                  |       |                                |       |   |   |   |   |
| Total operating  expenses                            |       | 35,278                                |       | 22,196                              |       | 58,299 |   | 43,976 |   |
|                                                 |       |                                  |       |                                |       |   |   |   |   |
| Income from  operations                              |       | 22,231                                |       | 16,899                              |       | 37,796 |   | 32,164 |   |
|                                                 |       |                                  |       |                                |       |   |   |   |   |
| Interest and  other income, net                      |       | (26                                   | )          | 280                                 |       | (75 | ) | 535 |   |
| Interest expense                                     |       | (1,352                                | )          | (94                                 | )          | (1,440 | ) | (189 | ) |
|                                                 |       |                                  |       |                                |       |   |   |   |   |
| Income before  income tax provision                  |       | 20,853                                |       | 17,085                              |       | 36,281 |   | 32,510 |   |
| Income tax  provision                                |       | 8,336                                 |       | 6,068                               |       | 14,121 |   | 11,887 |   |
|                                                 |       |                                  |       |                                |       |   |   |   |   |
| Net income                                           |       | $                                     | 12,517     |                                | $          | 11,017 |   | $ | 22,160 |   | $ | 20,623 |   |
|                                                 |       |                                  |       |                                |       |   |   |   |   |
| Net income per  share                                |       |                                  |       |                                |       |   |   |   |   |
| Basic                                                |       | $                                     | 0.37       |                                | $          | 0.33 |   | $ | 0.66 |   | $ | 0.62 |   |
| Diluted                                              |       | $                                     | 0.37       |                                | $          | 0.33 |   | $ | 0.66 |   | $ | 0.62 |   |
|                                                 |       |                                  |       |                                |       |   |   |   |   |
| Weighted average  common shares outstanding     |       |                                  |       |                                |       |   |   |   |   |
| Basic                                                |       | 33,383                                |       | 33,190                              |       | 33,329 |   | 33,170 |   |
| Diluted                                              |       | 33,578                                |       | 33,310                              |       | 33,514 |   | 33,349 |   |

 

*See accompanying notes.*

 

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**MARTEK BIOSCIENCES CORPORATION**

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 
| ** **                                                                         | ** ** | **Six months ended April 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| **Unaudited  – In thousands**                                                 | ** ** | **2010**                            | ** ** | **2009** | ** ** |
| ** **                                                                         |       |                                |       |   |   |
| **Operating activities**                                                           |       |                                |       |   |   |
|                                                                               |       |                                |       |   |   |
| Net  income                                                                        |       | $                                   | 22,160     |   | $ | 20,623 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                                |       |   |   |
| Depreciation  and amortization                                                     |       | 17,021                              |       | 14,115 |   |
| Deferred  tax provision                                                            |       | 13,795                              |       | 11,244 |   |
| Equity-based  compensation expense                                                 |       | 2,305                               |       | 1,924 |   |
| Loss  on asset disposal and other, net                                             |       | 605                                 |       | 467 |   |
| Changes  in operating assets and liabilities:                                      |       |                                |       |   |   |
| Accounts  receivable                                                               |       | (10,905                             | )          | (12,460 | ) |
| Inventories                                                                        |       | 4,427                               |       | (10,016 | ) |
| Other  assets                                                                      |       | 1,145                               |       | 1,119 |   |
| Accounts  payable                                                                  |       | 2,942                               |       | 4,687 |   |
| Accrued  liabilities                                                               |       | 11,417                              |       | (5,571 | ) |
| Deferred  revenue and other liabilities                                            |       | (1,938                              | )          | (501 | ) |
|                                                                               |       |                                |       |   |   |
| Net  cash provided by operating activities                                         |       | 62,974                              |       | 25,631 |   |
| ** **                                                                         |       |                                |       |   |   |
| **Investing activities**                                                           |       |                                |       |   |   |
|                                                                               |       |                                |       |   |   |
| Cash  paid for acquisition of Amerifit, net of cash acquired                       |       | (200,743                            | )          | — |   |
| Sales  of investments and marketable securities, net                               |       | 50                                  |       | — |   |
| Expenditures  for property, plant and equipment                                    |       | (6,827                              | )          | (5,263 | ) |
| Capitalization  of intangible assets                                               |       | (2,458                              | )          | (4,435 | ) |
|                                                                               |       |                                |       |   |   |
| Net  cash used in investing activities                                             |       | (209,978                            | )          | (9,698 | ) |
| ** **                                                                         |       |                                |       |   |   |
| **Financing activities**                                                           |       |                                |       |   |   |
|                                                                               |       |                                |       |   |   |
| Repayments  of notes payable and other long-term obligations                       |       | (35,061                             | )          | (59 | ) |
| Proceeds  of term loan                                                             |       | 75,000                              |       | — |   |
| Borrowings  from revolving line of credit                                          |       | 11,000                              |       | — |   |
| Repayments  of borrowings from revolving line of credit                            |       | (11,000                             | )          | — |   |
| Payment  of debt issuance costs                                                    |       | (3,944                              | )          | — |   |
| Issuance  of common stock under employee stock plans                               |       | 1,202                               |       | 111 |   |
| Tax  payments from shares withheld upon vesting of restricted stock units          |       | (1,047                              | )          | (536 | ) |
|                                                                               |       |                                |       |   |   |
| Net  cash provided by (used in) financing activities                               |       | 36,150                              |       | (484 | ) |
|                                                                               |       |                                |       |   |   |
| Foreign  currency translation adjustment                                           |       | (2                                  | )          | — |   |
|                                                                               |       |                                |       |   |   |
| Net  (decrease) increase in cash and cash equivalents                              |       | (110,856                            | )          | 15,449 |   |
| Cash  and cash equivalents, beginning of period                                    |       | 141,063                             |       | 102,495 |   |
|                                                                               |       |                                |       |   |   |
| Cash  and cash equivalents, end of period                                          |       | $                                   | 30,207     |   | $ | 117,944 |   |
|                                                                               |       |                                |       |   |   |
| Supplemental cash flow disclosures:                                                |       |                                |       |   |   |
| Interest paid                                                                      |       | $                                   | 742        |   | $ | 101 |   |
| Income taxes paid                                                                  |       | $                                   | 550        |   | $ | 734 |   |
| Long-term license fee obligation                                                   |       | $                                   | 2,229      |   | $ | — |   |

 

*See accompanying notes.*

 

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**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

***1.ORGANIZATION AND DESCRIPTION OF BUSINESS***

 

MartekBiosciences Corporation (the “Company” or “Martek”), a Delaware corporation,was founded in 1985. The Company is a leader in the innovation, development,production and sale of high-valueproducts from microbial sources that promote health and wellness throughnutrition.  The Company’s technologyplatform consists of its core expertise, broad experience and proprietarytechnology in areas such as microbial biology, algal genomics, fermentation anddownstream processing.  This technologyplatform has resulted in the Company’s development of a number of products, includingits flagship product, *life’sDHATM*, asustainable and vegetarian source of algal DHA (docosahexaenoicacid) important for brain, heart and eye health throughout life for use ininfant formula, pregnancy and nursing products, foods and beverages, dietarysupplements and animal feeds.  Martekalso produces *life’sARATM*(arachidonic acid), anomega-6 fatty acid, for use in infant formula and growing-up milks.   The Company’s DHA andARA are collectively referred to as “nutritional ingredients”.

 

On February 12, 2010, Martek completedthe acquisition of Charter Amerifit LLC and all of its subsidiaries(“Amerifit”). Amerifit develops, markets and distributes branded consumerhealth and wellness products and holds leading brand positions in all of itskey product categories. Amerifit products include: Culturelle®, a leadingprobiotic supplement; AZO, the leading over-the-counter brand addressingsymptom relief, detection and prevention of urinary tract infections; andESTROVEN®, the leading all-natural nutritional supplement brand addressing thesymptoms of menopause.  The products soldthrough the Amerifit subsidiary are collectively referred to as “brandedconsumer health products”.   The Companysells its branded consumer health products to retail outlets, including mostmajor mass, club, drug, food and specialty stores in the United States.  The results of operations of Amerifit areincluded in our consolidated financial statements as of the acquisition datefor the three and six months ended April 30, 2010.

 

Martekalso provides contract manufacturing and performs technical collaboration workwith corporate partners.  The contractmanufacturing services are for both large and small companies and relateprimarily to the production of enzymes, specialty chemicals, vitamins, andagricultural specialty products. Collaboration work utilizes the Company’s core expertise in microbialbiology, algal genomics, fermentation and downstream processing to collaboratewith these corporate partners in the development of new products andtechnologies.

 

***2.BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES***

 

***Basis of Presentation***   The accompanying unaudited consolidatedfinancial statements of the Company have been prepared in accordance withaccounting principles generally accepted in the United States for interimfinancial information and with the instructions to Form 10-Q and Article 10of Regulation S-X.  Accordingly, they donot include all of the information and footnotes required by accountingprinciples generally accepted in the United States for complete financialstatements.  In the opinion ofmanagement, all adjustments (consisting of normal recurring adjustments)considered necessary for a fair presentation have been included.  Operating results for the three months ended April 30,2010 are not necessarily indicative of the results that may be expected for theyear ending October 31, 2010.  Theaccompanying unaudited financial statements and these notes should be read inconjunction with the consolidated financial statements and footnotes theretoincluded in the Company’s Annual Report on Form 10-K for the year ended October 31,2009.

 

***Consolidation*** Theconsolidated financial statements include the accounts of Martek and itswholly-owned subsidiaries, Martek Biosciences Boulder Corporation, MartekBiosciences Kingstree Corporation and Martek Amerifit LLC (formerly calledCharter Amerifit LLC) along with its subsidiaries, Martek Amerifit HoldingCorporation, Amerifit Brands, Inc., Amerifit, Inc., Amerifit Pharma, Inc.and Estroven Ltd., after elimination of all significant intercompany balancesand transactions.

 

***Useof Estimates***Thepreparation of consolidated financial statements in conformity with accountingprinciples generally accepted in the United States requires management to makeestimates and assumptions that affect the amounts reported in the Company’sconsolidated financial statements and accompanying notes. On an ongoing basis,the Company evaluates its estimates and judgments, which are based on historicaland anticipated results and trends and on various other assumptions that theCompany believes to be reasonable under the circumstances. By their nature,estimates are subject to an inherent degree of uncertainty and, as such, actualresults may differ from the Company’s estimates.

 

***RevenueRecognition***The Company derivesrevenue from three sources: product sales, contract manufacturing andcollaborations. The Company recognizes product sales revenue when persuasiveevidence of an arrangement exists, the fee is fixed or determinable,collectibility is reasonably assured, the product is shipped andtitle and risk of loss are transferred.Sales are recorded net of allowances for returns, trade promotions, coupons andother discounts. Additionally, with respect to its branded consumer healthproducts, the Company routinely commits to trade-promotion programs with itsretail customers that require the Company to estimate and accrue the expectedcosts of such programs. Trade-promotion programs include cooperative marketingprograms, temporary price reductions, slotting and other trade-promotionactivities conducted by the retail customer. Trade-promotion costs are recordedas a reduction of product sales.

 

A number of infant formula license contracts for nutritional ingredients include an upfrontlicense fee, a prepayment of product sales and established pricing on futureproduct sales, which also may include discounts based on the achievement ofcertain volume purchases. The consideration from these contracts is allocatedbased on the relative fair values of the separate elements. Revenue isrecognized on product sales when goods are shipped 

 

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and all otherconditions for revenue recognition are met. If volume pricing discounts aredeemed to be a separate element, revenue on related product shipments isrecognized using the estimated average price to the customer over the term ofthe discount period, which requires an estimation of total production shipmentsover that time frame.  Amounts billed in excess ofthe estimated average price are recorded as deferred revenue.  Conversely, a receivable isrecorded for the excess of the estimated average price over amounts billed.Estimates of average prices are reviewed and, if necessary, adjustedperiodically based on updated estimates of product shipments during eachcontract year.  The Company’s historicalestimates of product shipments have approximated actual results.  Amounts recorded as either deferred revenueor a receivable are settled at the end of each contract year, which generallyis December 31.  Once the requisite volume thresholds have been satisfied, thepreviously recorded deferred revenue is recognized over the remaining discountperiod.  Cash received as a prepayment onfuture product purchases is deferred and recognized as revenue when product isshipped. Revenue from product licenses is deferred and recognized on astraight-line basis over the term of the agreement and included in productsales in the consolidated statements of income.

 

Contractmanufacturing revenue is recognized when goods are shipped to customers and allother conditions for revenue recognition are met. Cash received that is relatedto future performance under such contracts is deferred and recognized asrevenue when earned.

 

Revenueearned from collaboration work may come from stand-alone arrangements forcertain discrete development work or multiple deliverable arrangements thatinclude such development work followed by larger-scale manufacturing efforts.Revenue is recognized based on the nature of the arrangements, with each of themultiple deliverables in a given arrangement having distinct and separate fairvalues. Fair values are determined via consistent pricing between stand-alonearrangements and multiple deliverable arrangements, as well as a competitivebidding process. Collaborations may be performed on a time and materials basisor fixed fee basis. For time and materials arrangements, revenue is recognizedas services are performed and billed. For fixed fee arrangements where customerdelivery and acceptance provisions are substantive, revenue is recognized uponcompletion and acceptance by the customer.

 

***ShippingIncome and Costs*******  Shipping costscharged to customers are recorded as revenue in the period that the relatedproduct sale revenue is recorded, and associated costs of shipping are includedin cost of revenues.  Shipping andhandling costs were approximately $1.1 million and $1.8 million in the threeand six months ended April 30, 2010, respectively, and $500,000 and $1.2million in the three and six months ended April 30, 2009, respectively.

 

***IncomeTaxes*********Income tax provisionor benefit includes U.S. federal, state and local income taxes and is based onpre-tax income or loss.  The interimperiod provision or benefit for income taxes is based upon the Company’sestimate of its annual effective income tax rate.  In determining the estimated annual effectiveincome tax rate, the Company analyzes various factors, including projections ofthe Company’s annual earnings and taxing jurisdictions in which the earningswill be generated, the impact of state and local income taxes and the abilityof the Company to use tax credits and net operating loss carryforwards.

 

The Company recognizes the benefits of taxpositions in the financial statements if such positions are more likely thannot to be sustained upon examination by the taxing authority and satisfy theappropriate measurement criteria.  If therecognition threshold is met, the tax benefit is generally measured and recognizedas the tax benefit having the highest likelihood, in management’s judgment, ofbeing realized upon ultimate settlement with the taxing authority, assumingfull knowledge of the position and all relevant facts.  The Companyalso recognizes interest and penalties accrued related to unrecognized taxbenefits in the provision for income taxes. The Company believes appropriate provisions for all outstanding issueshave been made for all jurisdictions and all open tax years.  It is reasonably possible that the totalamount of unrecognized tax benefits as of April 30, 2010 will changewithin the next 12 months as various uncertainties are resolved.  The Company cannot reasonably estimate therange of potential outcomes.

 

***ForeignCurrency Transactions and Hedging Activities*****Foreign currencytransactions are translated into U.S. dollars at prevailing rates. Gains orlosses resulting from foreign currency transactions are included in currentperiod income or loss as incurred. All material transactions of the Company aredenominated in U.S. dollars with the exception of a portion of purchases of arachidonic acid (“ARA”) from DSM Food SpecialtiesB.V. (“DSM”), which are denominated in Euros.

 

The Company’s foreign subsidiary, EstrovenLtd., maintains its accounts in its respective local currency, the PoundSterling.   Assets and liabilities aretranslated to U.S. dollars at period-end exchange rates.  Income and expenses are translated at averagerates of exchange prevailing during the reporting period.  Foreign currency translation adjustments areaccumulated and reported as other comprehensive income.  The effects of changes in exchange rates onforeign currency transactions included in net income are not material.

 

The Company periodically enters into foreigncurrency forward contracts to reduce its transactional foreign currencyexposures associated with the purchases of ARA from DSM.   The Company does not use derivativefinancial instruments for speculative purposes.   These forward contracts are highly effectivecash flow hedges and qualify for hedge accounting.   Consequently, the resulting unrealized gainsand losses are recorded as a component of other comprehensive income until therelated product is sold.    As of April 30, 2010, outstanding forwardcontracts had notional values aggregating approximately 1.9 million Euros(equivalent to $2.6 million at April 30, 2010), which mature by September 2010.Amounts recorded due to hedge ineffectiveness have not been material.

 

***Advertisingand Promotion***The Companyadvertises and promotes its products primarily through national and regional printand electronic media and expenses such activities when the promotion is run,the electronic advertising is aired or the print media is released publicly.

 

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***AcquisitionCosts***Acquisitioncosts are expensed as incurred.  Thesecosts primarily include investment banking and professional service feesdirectly attributable to the Company’s acquisition of Amerifit in February 2010.

 

***Comprehensive Income***Comprehensive income is comprised of net earnings and othercomprehensive income, which includes certain changes in equity that areexcluded from net income. The Company includes unrealized holding gains andlosses on available-for-sale securities, changes in the market value ofexchange rate forward contracts designated as cash flow hedges and foreigncurrency translation adjustments in other comprehensive income.

 

***Investments***The Company has classifiedinvestments at April 30, 2010 and October 31, 2009 as either tradingor available-for-sale. Unrealized gains and losses on available-for-salesecurities are reported as accumulated other comprehensive income, which is aseparate component of stockholders’ equity. Unrealized gains and losses ontrading securities and realized gains and losses on both types of securitiesare included in other income as incurred based on the specific identificationmethod.

 

The Company periodically evaluates whether anydeclines in the fair value of its available-for-sale investments are other thantemporary.  This evaluation consists of areview of several factors, including, but not limited to:  length of time and extent that a security hasbeen in an unrealized loss position; the existence of an event that wouldimpair the issuer’s future earnings potential; the near term prospects forrecovery of the market value of a security; the intent of the Company to sellthe impaired security;  and whether the Companywill be required to sell the security prior to the anticipated recovery in market value.  Declines in value below cost for debtsecurities where it is considered probable that all contractual terms of thesecurity will be satisfied, where the decline is due primarily to changes ininterest rates (and not because of increased credit risk), and where theCompany does not intend to sell or would be required to sell the investmentprior to a recovery of amortized cost, are assumed to be temporary. If managementdetermines that an other-than-temporary impairment exists, the carrying valueof the investment will be reduced to the current fair value of theinvestment.  An other-than-temporaryimpairment resulting from credit-related matters is recognized as a charge inthe consolidated statements of income equal to the amount of the carrying valuereduction. Other-than-temporary impairment write-downs resulting fromnon-credit-related matters are recognized in other comprehensive income.

 

The fair value option for financial assets and liabilities permits anentity to elect to measure eligible items at fair value (“fair value option”),including many financial instruments. The decision to elect the fair valueoption is made individually for each instrument and is irrevocable oncemade.  Changes in fair value for theselected instruments are recorded in earnings. The Company has elected the fairvalue option for the auction rate securities rights agreement (the “PutAgreement”), which is recorded within short-term investments at April 30,2010. The Put Agreement is the only instrument of its nature or type held bythe Company and for which the Company has elected the fair value option. SeeNote 6 for further discussion.

 

The Company classifies its investments as eithercurrent or long-term based upon the investments’ contractual maturities and theCompany’s ability and intent to convert such instruments to cash within oneyear.

 

***FairValue of Financial Instruments***The Company considers the carrying cost of its financial assets andliabilities, which consist primarily of cash and cash equivalents, investments,accounts receivable, accounts payable, notes payable and long-term debt, toapproximate the fair value of the respective assets and liabilities at April 30,2010 and October 31, 2009.  See Note7 for further discussion of the Company’s fair value measurements.

 

***PatentCosts***TheCompany has filed a number of patent applications in the U.S. and in foreigncountries. Certain external legal and related costs are incurred in connectionwith patent applications. If a future economic benefit is anticipated from theresulting patent or an alternate future use is available to the Company, suchcosts are capitalized and amortized over the expected life of the patent.  The Company also capitalizes external legalcosts incurred in the defense of its patents when it is believed that thefuture economic benefit of the patent will be maintained or increased and asuccessful defense is probable. Capitalized patent defense costs are amortizedover the remaining life of the related patent.

 

***Goodwilland Other Intangible Assets*******Goodwill istested for impairment annually, on August 1, or more frequently whenevents occur or circumstances change that would more likely than not reduce thefair value of the asset below its carrying amount.

 

Purchasedintangible assets other than goodwill are amortized over their useful livesunless these lives are determined to be indefinite. The Company’s amortizingintangible assets, which consist primarily of patents, licenses, trademarksunrelated to Amerifit and customer relationships resulting from the Amerifitacquisition, are carried at cost less accumulated amortization. Amortization iscomputed over the estimated useful lives of the respective assets, generally 10to 18 years.

 

Trademarksresulting from the Amerifit acquisition have been determined to have anindefinite useful life.  During theperiod these assets are considered indefinite-lived, the trademarks will not beamortized but will be tested for impairment on an annual basis and betweenannual tests if management becomes aware of any events occurring or changes incircumstances that would potentially indicate a reduction in the fair value ofthe trademarks below their carrying amounts. Furthermore, during thisnon-amortizing period, the trademarks will be evaluated for determining whetherevents and circumstances continue to support an indefinite useful life. If atrademark not being amortized is determined to have a finite useful life, theasset will be amortized prospectively over the estimated remaining useful lifeand accounted for in the same manner as intangible assets subject toamortization.

 

SeeNote 3 for further discussion of the goodwill and other intangible assetsassociated with the Company’s acquisition of Amerifit in February 2010.

 

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***Impairmentof Long-Lived Assets*** TheCompany reviews long-lived assets for impairment whenever events or changes incircumstances indicate that the carrying amount of an asset may not berecoverable. Recoverability of assets to be held and used is measured bycomparing the carrying amount of an asset to future undiscounted net cash flowsexpected to be generated by the asset. Assets are grouped and evaluated forimpairment at the lowest level for which there is identified cash flows.  The Company deems an asset to be impaired ifa forecast of undiscounted cash flows is less than its carrying amount.  The impairment to be recognized is measuredby the amount by which the carrying amount of assets exceeds the fair value ofthe assets. The Company generally measures fair value by discounting projectedfuture cash flows.  Assets to be disposedof are reported at the lower of the carrying amount or fair value less costs tosell.

 

***RecentlyIssued Accounting Pronouncements***In December 2007,the FASB issued Statement No. 141(R), “Business Combinations”, whichhasprincipallybeencodifiedinFASBAccountingStandardsCodification(“ASC”)Topic805,“BusinessCombinations” (“ASC 805”).  ASC 805 establishes principles andrequirements for how an acquirer recognizes and measures in its financialstatements the identifiable assets acquired, the liabilities assumed, anynoncontrolling interest in the acquiree and the goodwill acquired. ASC 805 alsoestablishes disclosure requirements to enable the evaluation of the nature andfinancial effects of the business combination. ASC 805 was effective for theCompany beginning with the first quarter of fiscal 2010. As further describedin Note 3, the Company acquired Charter Amerifit LLC and all of itssubsidiaries (“Amerifit”) in February 2010. The adoption of ASC 805 didnot have a cumulative effect upon adoption; however, ASC 805 will be materialto the Company’s financial condition and results of operations.  Specifically, the adoption of ASC 805required the immediate expensing of acquisition-related costs and additionalimpacts of ASC 805 are anticipated as the total purchase price is allocated toAmerifit’s net tangible and intangible assets based on their estimated fairvalues on the date of acquisition.

 

In October 2009,the FASB issued Accounting Standards Update No. 2009-13, “RevenueRecognition (Topic 605)—Multiple-Deliverable Revenue Arrangements: a consensusof the FASB Emerging Issues Task Force” (“ASU 2009-13”). ASU 2009-13establishes a selling-price hierarchy for determining the selling price of eachelement within a multiple-deliverable arrangement. Specifically, the sellingprice assigned to each deliverable is to be based on vendor-specific objectiveevidence (“VSOE”), if available, third-party evidence, if VSOE is unavailable,and estimated selling prices if neither VSOE or third-party evidence isavailable. In addition, ASU 2009-13 eliminates the residual method ofallocating arrangement consideration and instead requires allocation using therelative selling price method. ASU 2009-13 will be effective prospectively formultiple-deliverable revenue arrangements entered into, or materially modified,in fiscal years beginning on or after June 15, 2010. The Company isassessing what impact, if any, the adoption of ASU 2009-13 may have on itsconsolidated financial statements.

 

***3.ACQUISITION OF AMERIFIT***

 

On February 12, 2010, Martek completedthe acquisition and obtained 100% of the voting interests of Amerifit.  In addition to the Company’s expectation thatthe Amerifit acquisition will be financially accretive, Martek expects to beable to use Amerifit’s marketing platform to commercialize and distribute thenutritional health and wellness products that Martek is currently developing.See Note 1 for an overall description of the Amerifit business.

 

The results of operations of Amerifit since February 12,2010 have been included in the Company’s consolidated statements of income.This includes revenue of $18.0 million and income from operations of $1.9million for the three and six months ended April 30, 2010.

 

Upon the closing of the acquisition, Martekpaid total cash consideration of approximately $218 million, of which amount$27 million was placed into an escrow that secures certain post-closingadjustment obligations and certain indemnification obligations.  The considerationincluded approximately $1 million related to the effects of the preliminarydeterminations of Amerifit’s net debt level and net working capital at theclosing, both of which are subject to adjustment based on the finaldeterminations of what Amerifit’s net debt level and net working capitalactually were at the closing.  TheCompany expects these final determinations to be made by October 31,2010.  To finance the Amerifitacquisition, Martek utilized existing cash of approximately $115 million, proceedsfrom the $75 million Term Loan (as defined below), $11 million drawn from theRevolver (as defined below) and approximately $17 million of cash held byAmerifit at closing.  See Note 11 foradditional discussion of the debt instruments.

 

Under the acquisition method of accounting,the total purchase price will be allocated to Amerifit’s net tangible andintangible assets based on their estimated fair values as of the February 12,2010 closing date of the acquisition. The table below summarizes the preliminaryallocation of the purchase price based upon fair values of assets acquired andliabilities assumed at February 12, 2010. This preliminary allocation is based upon information that was availableto management at the time the financial statements were prepared.  Accordingly, the allocation may change.  The Company has no information that indicatesthe final purchase price allocation could differ materially from the preliminaryestimates noted below other than potential changes associated with the finaldetermination of deferred tax assets acquired and certain accrued liabilitiesassumed in connection with the acquisition of Amerifit.

 

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| **(In thousands)**                    |   |    |    |
|---------------------------------------|--------|---------|---------|
|                                  |   |    |    |
| Assets                                |   |    |    |
| Cash                                  |   | $       | 17,145  |   |
| Accounts receivable                   |   | 13,025  |    |
| Inventories                           |   | 7,634   |    |
| Other current assets                  |   | 2,243   |    |
| Identifiable intangible assets        |   | 137,260 |    |
| Property and equipment                |   | 1,813   |    |
|                                  |   |    |    |
| Total identifiable assets acquired    |   | 179,120 |    |
|                                  |   |    |    |
| Liabilities                           |   |    |    |
| Accounts payable and accrued expenses |   | (10,218 | )       |
| Deferred tax liability                |   | (49,376 | )       |
| Other liabilities                     |   | (614    | )       |
|                                  |   |    |    |
| Total liabilities assumed             |   | (60,208 | )       |
|                                  |   |    |    |
| Net identifiable assets acquired      |   | 118,912 |    |
| Goodwill                              |   | 98,975  |    |
|                                  |   |    |    |
| Net assets acquired                   |   | $       | 217,887 |   |

 

The estimated fair value of the inventory acquiredresulted in a $1.9 million step-up from cost. Of such step-up, $1.7 million was recorded as a cost of product sales inthe three and six months ended April 30, 2010 in the accompanyingconsolidated statements of income.  Thecost basis of all other current assets acquired, all current liabilitiesassumed and of all acquired property and equipment approximated their fairvalues.

 

*Identified Intangible Assets*

 

Asubstantial portion of the assets acquired consisted of intangible assetsrelated to customer relationships, trademarks and the Culturelle® drug masterfile (“DMF”). Management determined that the estimated acquisition-date fairvalues of the intangible assets related to Amerifit’s customer relationships,trademarks and the DMF were $91.4 million, $45.4 million and $500,000,respectively.

 

TheCompany used the income method to estimate the value of Amerifit’s customerrelationships. Through this approach, the fair value of these customerrelationships was determined by discounting to their present value theestimated cash flows associated with the existing customers as of the date ofacquisition taking into consideration estimated attrition of the existingcustomer base. The estimated cash flows were based on revenues for thoseexisting customers, net of operating expenses and other intangible assets thatcontribute to the projected cash flow from those customers. The projectedrevenues were based on assumed revenue growth rates and customer renewal rates.Operating expenses were estimated based on the supporting infrastructureexpected to sustain the assumed revenue growth rates. A discount rate was basedon the risks associated with the respective cash flows taking intoconsideration the Company’s weighted average cost of capital. Martek expects toamortize the value of Amerifit’s customer relationships using an acceleratedmethod over a period of 18 years, which is the period over which the acquiredcustomers are expected to contribute future cash flows to the Company. Anaccelerated amortization method was considered the most appropriate means ofreflecting the consumption of the asset relative to the pattern of economicbenefits derived from the customer relationships.

 

TheCompany used the relief-from-royalty method to estimate the fair value ofAmerifit’s trademarks. Through this method, the fair value of the trademarkswas determined based on the present value of the projected cost savings attributableto the ownership of the asset. This approach is based on the theory that theowner of the intangible asset is relieved of paying a royalty or license feefor the use of the trademark. The method included assumptions related toprojected revenues attributable to the trademark and a reasonable marketroyalty rate that would otherwise be charged by a licensor of the trademark toa licensee of the trademark. A discount rate was based on the risks associatedwith the respective cash flows taking into consideration the Company’s weightedaverage cost of capital. As there are believed to be no legal, regulatory,contractual, competitive, economic or any other factors that may limit theperiod over which the acquired trademarks are expected to contribute directlyor indirectly to our future cash flows, the trademarks are determined to havean indefinite useful life.

 

The Company used thecost approach to value the DMF.  The costapproach measures the value of an asset by the cost to replace it with another oflike utility.  

 

*Deferred Income Taxes*

 

The$2.4 million of deferred tax assets resulting from the acquisition wasprimarily related to federal and state net operating loss carryforwardsacquired. The $51.8 million of deferred tax liabilities resulting from theacquisition was primarily related to the difference between the book basis andtax basis of the identifiable intangible assets.

 

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*Goodwill*

 

Theexcess of the consideration transferred over the fair values assigned to theidentifiable assets acquired and liabilities assumed was $99.0 million, whichrepresents the goodwill amount resulting from the acquisition. Managementbelieves that the goodwill mainly represents the future earnings potential ofAmerifit as well as the economic synergies to be gained from Martek usingAmerifit’s marketing platform to commercialize and distribute the nutritionalhealth and wellness products that Martek is currently developing. The Companyhas recorded the goodwill as an intangible asset in our consolidated balancesheet as of the acquisition date and has attributed the goodwill to Martek’sbranded consumer health products segment. The assignment of goodwill to reporting units has not been completed.Goodwill is tested for impairment on an annual basis and between annual testsif management becomes aware of any events occurring or changes in circumstancesthat would potentially indicate a reduction in the fair value of the goodwillbelow its carrying amount.  None of thegoodwill generated from the Amerifit acquisition is expected to be deductiblefor tax purposes.

 

*Unaudited Pro FormaInformation*

 

Thefollowing unaudited pro forma information presents the combined results ofoperations of Martek and Amerifit for the three and six months ended April 30,2010 and 2009 as if the acquisition of Amerifit had been completed on November 1,2009 and 2008, respectively, with adjustments to give effect to pro formaevents that are directly attributable to the acquisition. The unaudited proforma results do not reflect any operating efficiencies or potential costsavings which may result from the consolidation of the operations of Martek andAmerifit. Accordingly, these unaudited pro forma results are presented forillustrative purposes and are not intended to represent or be indicative of theactual results of operations of the combined company that would have beenachieved had the acquisition occurred at the beginning of each periodpresented, nor are they intended to represent or be indicative of futureresults of operations.

 

Thefollowing table summarizes the unaudited pro forma results of operations (inthousands, except per share amounts):

 
| ** **            | ** ** | **Three months  ended April 30,** | ** ** | **Six  months ended April 30,** | ** ** |
|-----------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **            | ** ** | **2010**                               | ** ** | **2009**                             | ** ** | **2010** | ** ** | **2009** | ** ** |
|                  |       |                                   |       |                                 |       |   |   |   |   |
| Revenues              |       | $                                      | 126,981    |                                 | $          | 111,953 |   | $ | 237,335 |   | $ | 216,361 |   |
|                  |       |                                   |       |                                 |       |   |   |   |   |
| Net income            |       | $                                      | 13,776     |                                 | $          | 12,663 |   | $ | 28,296 |   | $ | 22,807 |   |
|                  |       |                                   |       |                                 |       |   |   |   |   |
| Net income per  share |       |                                   |       |                                 |       |   |   |   |   |
| Basic                 |       | $                                      | 0.41       |                                 | $          | 0.38 |   | 0.85 |   | 0.69 |   |
| Diluted               |       | $                                      | 0.41       |                                 | $          | 0.38 |   | 0.84 |   | 0.68 |   |

 

***4.SEGMENT INFORMATION***

 

Martekoperates in two material business segments, the development andcommercialization of high-value nutritional ingredients products from microbialsourcesand, with the acquisition of Amerifit in February 2010,the marketing and sale of branded consumer health products.   Outside of these two segments, the Companyderives revenues primarily from contract manufacturing and collaborations,which are included in “other” in the tables below.

 

Martek measures segment performance based onincome from operations.  As follows aresegment revenues and overall segment operating performance (in thousands).

 
| ** **                                 | ** ** | **Three months ended April 30,** | ** ** | **Six months ended April 30,** | ** ** |
|--------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                 | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                       |       |                                  |       |                                |       |   |   |   |   |
| **Segment Revenues**                       |       |                                  |       |                                |       |   |   |   |   |
| Branded consumer health products           |       | $                                     | 18,009     |                                | $          | — |   | $ | 18,009 |   | $ | — |   |
| Nutritional ingredients                    |       | 99,668                                |       | 87,163                              |       | 182,772 |   | 170,036 |   |
| Other                                      |       | 6,291                                 |       | 5,248                               |       | 12,943 |   | 9,738 |   |
| Total                                      |       | $                                     | 123,968    |                                | $          | 92,411 |   | $ | 213,724 |   | $ | 179,774 |   |
|                                       |       |                                  |       |                                |       |   |   |   |   |
| **Segment Income (Loss) From  Operations** |       |                                  |       |                                |       |   |   |   |   |
| Branded consumer health products           |       | $                                     | 1,893      |                                | $          | — |   | $ | 1,893 |   | $ | — |   |
| Nutritional ingredients                    |       | 19,680                                |       | 17,149                              |       | 35,320 |   | 32,591 |   |
| Other                                      |       | 658                                   |       | (250                                | )          | 583 |   | (427 | ) |
| Total                                      |       | $                                     | 22,231     |                                | $          | 16,899 |   | $ | 37,796 |   | $ | 32,164 |   |

 

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Includedin segment operating performance is depreciation and amortization attributed tothe branded consumer health products segment of $1.5 million in the three andsix months ended April 30, 2010 and depreciation and amortizationattributed to the nutritional ingredients segment of $6.0 million and $12.4million in the three and six months ended April 30, 2010, respectively,and $6.2 million and $12.5 million in the three and six months ended April 30,2009, respectively.

 

Approximately 78% and 76%of the Company’s nutritional ingredients sales in the three and six months endedApril 30, 2010, respectively, were generated by sales to its top five nutritionalingredients customers.  In addition,approximately 51% of the Company’s branded consumer health products sales inboth the three and six months ended April 30, 2010 was generated by sales toits top two branded consumer health products customers. Although the Company isnot given precise information by its customers as to the countries in which itsnutritional ingredients are sold, the Company estimates that approximately 50%of its nutritional ingredients sales for the three and six months ended April30, 2010 and the three and six months ended April 30, 2009 relate to sales inthe U.S. Virtually all sales of branded consumer health products are tocustomers in the U.S.

 

Assetsof the branded consumer health products segment total $264.3 million at April 30,2010.  The remainder of the Company’sassets are almost entirely related to the operations of the nutritionalingredients segment.

 

***5.DSM SUPPLY AND LICENSE AGREEMENT***

 

In July 2009, theCompany entered into the First Amended and Restated ARA Alliance, Purchase, andProduction Agreement (the “Restated Agreement”) with DSM. The RestatedAgreement, which extends the original supply term through December 31,2023,  amended, consolidated and restatedall existing agreements between the two parties governing the cross-licensing,purchase, supply and production of ARA. While, subject to certain limitedexceptions, Martek is committed to purchasing all of its ARA requirements fromDSM through the term of the Restated Agreement, the Restated Agreement also setminimum ARA purchase quantities for Martek in calendar years 2010 and2011.  As of April 30, 2010, thevalue of the remaining calendar year 2010 and full calendar year 2011 minimumpurchase requirements are approximately $58.4 million and $87.1 million,respectively. These minimum purchase quantities approximate the amountsexpected to be procured by Martek in the normal course of business. Undercertain circumstances, either Martek or DSM may terminate the RestatedAgreement after 2012. Upon early termination by Martek, Martek would berequired to make a payment to DSM with the value of such payment decreasingover the remaining term of the Restated Agreement and being dependent upon DSM’sphysical infrastructure at the early termination date. A termination payment byMartek as of January 1, 2013 would currently range from $15 million to $20million and a termination payment as of January 1, 2016 would currentlyrange from less than $1 million to $7 million.

 

***6. INVESTMENTS***

 

At April 30, 2010 and October 31,2009, the Company had investments consisting of auction rate securities (“ARS”),the underlying assets of which are student loans originated under the FederalFamily Education Loan Program (“FFELP”). FFELP student loans are guaranteed by state guarantors who havereinsurance agreements with the U.S. Department of Education.  These ARS are intended to provide liquidityvia an auction process that resets the applicable interest rate approximatelyevery 30 days and allows the Company to either roll over its holdings or gainimmediate liquidity by selling such investments at par. The underlyingmaturities of these investments range from 16 to 38 years. Since February 2008,as a result of negative conditions in the global credit markets, the largemajority of the auctions for the Company’s investment in these securities havefailed to settle, resulting in Martek continuing to hold such securities.Consequently, the investments are not currently liquid and the Company will notbe able to access these funds, except as noted below, until a future auction ofthese investments is successful, a buyer is found outside of the auctionprocess or the investments reach their contractual maturity date.

 

While Martek continues to receive interestpayments on these investments involved in failed auctions, the Company believesthat 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 thesecurities and the timing of expected future cash flows.

 

In November 2008, the Companyexecuted a Put Agreement with a financial institution that provides Martek theability to sell certain of its ARS to the financial institution and allows thefinancial institution, at its sole discretion, to purchase such ARS at parduring the period June 30, 2010 through July 2, 2012 (see furtherdiscussion below). The Company’s ARS holdings to which this relates have a costbasis of approximately $7.3 million and a fair value at April 30, 2010 ofapproximately $6.2 million.  Uponexecution of the Put Agreement, the Company no longer had the intent orunilateral ability to hold the ARS covered by the Put Agreement tomaturity.  Therefore, the Company hasclassified such investments as “trading”. Net gains associated with these ARS of approximately $100,000 during thethree and six months ended April 30, 2010 were recognized in interest andother income in the consolidated statements of income. In the six months ended April 30,2009, the Company recognized a $1.9 million impairment charge on these ARS,which was recognized in interest and other income in the consolidatedstatements of income.  The impairmentcharge consisted of $1.0 million of unrealized losses reclassified from othercomprehensive income and $900,000 of unrealized fair value declines occurringafter such reclassification, of which $170,000 was recognized during the threemonths ended April 30, 2009.

 

The Company has recorded the PutAgreement at its fair value, which as of April 30, 2010 is approximately$1.1 million. The Company elected to adopt the fair value option for the PutAgreement so that future changes in thefair value of this asset will largely offset the fair value movements of therelated ARS. The Company believes that the accounting for the Put Agreementwill then match its purpose as an economic hedge to the changes in the fairvalue of the related ARS. The ability of the Put Agreement to act as aneconomic hedge is subject to the continued expected performance by thefinancial institution of its obligations under the agreement. The fair value ofthe Put Agreement considers, among other things, the

 

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creditworthiness of the issuer and theliquidity of the financial instrument.  In May 2010, Martek alerted the financial institution of theCompany’s intention to sell the ARS covered by the Put Agreement on June 30,2010.   Due to the Company’s intent tosell its ARS covered by the Put Agreement to the financial institution on June 30,2010, the fair value of such ARS along with the fair value of the Put Agreementare classified as short-term investments in the accompanying consolidatedbalance sheet as of April 30, 2010. Net losses associated with the Put Agreement of approximately $100,000during the three and six months ended April 30, 2010 were recognized in interestand other income in the consolidated statements of income.   In the six months ended April 30, 2009,the Company recognized a gain of $1.8 million related to the Put Agreement,which was recognized in interest and other income in the consolidated statementsof income, of which $219,000 was recognized during the three months ended April 30,2009.

 

As of April 30, 2010, the Company’sARS holdings not covered by the Put Agreement have a cost basis ofapproximately $5.6 million and a fair value of approximately $4.6 million. Thetotal decline in fair value of $1.0 million has been recorded as a netreduction to other comprehensive income. The Company believes that theunrealized losses on these ARS are temporary.  In making this determination, Martek primarily considered the financialcondition of the issuers, collateralization underlying the securities, theintent of the Company to sell the impaired security, and whether the Companywill be required to sell the security prior to the anticipated recovery inmarket value.  The Company continues tomonitor the market for ARS and consider its impact, if any, on the fair valueof these investments. If the Company determines that any valuation adjustmentis other than temporary, the Company would record an impairment charge toearnings.  Dueto the underlying maturities of these investments and the Company’s belief thatthe market for the ARS not covered by the Put Agreement may take in excess oftwelve months to fully recover, the fair value of such ARS is classified aslong-term investments in the accompanying consolidated balance sheet as of April 30,2010.  Net unrealized gains associatedwith these ARS during the three and six months ended April 30, 2010 werenot material.  In six months ended April 30,2009, the Company recognized $600,000 as a reduction to other comprehensiveincome related to the temporary unrealized losses for the Company’s ARS notcovered by the Put Agreement, of which $300,000 was recorded as an increase toother comprehensive income during the three months ended April 30, 2009.

 

***7. FAIR VALUE MEASUREMENTS***

 

The Company has adopted the provisions ofguidance codified as ASC Topic 820, “Fair Value Measurements and Disclosures” (“ASC820”), for financial instruments. ASC 820 defines fair value, establishes afair value hierarchy for assets and liabilities measured at fair value andrequires expanded disclosures about fair value measurements.  The ASC 820 hierarchy ranks the quality andreliability of inputs, or assumptions, used in the determination of fair valueand requires assets and liabilities carried at fair value to be classified anddisclosed 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 Companyevaluates financial assets and liabilities subject to fair value measurementson a recurring basis to determine the appropriate level at which to classifythem for each reporting period. This determination requires highly subjectivejudgments as to the significance of inputs used in determining fair value andwhere such inputs lie within the ASC 820 hierarchy.

 

As of April 30,2010, the Company held certain assets that are required to be measured at fairvalue on a recurring basis.  These financial assets were as follows(in thousands):

 
| ** **                             | ** ** | **As of April 30, 2010** | ** ** |
|----------------------------------------|------------|-------------------------------|------------|
| ** **                             | ** ** | **Level 1**                   | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Balance** | ** ** |
| Assets                                 |       |                          |       |   |   |   |   |   |   |
| Available-for-sale  securities (1)     |       | $                             | —     |   | $ | — |   | $ | 4,579 |   | $ | 4,579 |   |
| Trading securities (2)                 |       | —                        |       | — |   | 6,208 |   | 6,208 |   |
| Put Agreement(2)                       |       | —                        |       | — |   | 1,084 |   | 1,084 |   |
| Investments in money  market funds (3) |       | 5,110                         |       | — |   | — |   | 5,110 |   |
| Total assets                           |       | $                             | 5,110      |   | $ | — |   | $ | 11,871 |   | $ | 16,981 |   |
|                                   |       |                          |       |   |   |   |   |   |   |
| Liabilities                            |       |                          |       |   |   |   |   |   |   |
| Exchange rate forward  contracts (4)   |       | —                        |       | 14 |   | — |   | 14 |   |
| Total liabilities                      |       | $                             | —     |   | $ | 14 |   | $ | — |   | $ | 14 |   |

 

----

(1)          Includedin long-term investments in the accompanying consolidated balance sheets.

(2)          Includedin short-term investments in the accompanying consolidated balance sheets.

(3)          Includedin cash and cash equivalents in the accompanying consolidated balance sheets.

(4)          Includedin accrued liabilities in the accompanying consolidated balance sheets.

 

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The table belowprovides a reconciliation of the beginning and ending balances of the Company’sinvestments measured at fair value using significant unobservable inputs (Level3) for the three months ended April 30, 2010 (in thousands):

 
| ** **                                          | ** ** | **Auction Rate  Securities** | ** ** | **Put Agreement** | ** ** | **Total** | ** ** |
|-----------------------------------------------------|------------|------------------------------|------------|-------------------|------------|-----------|------------|
|                                                |       |                         |       |              |       |      |       |
| Balance on January 31, 2010                    |       | $                            | 10,644     |              | $          | 1,190     |       | $ | 11,834 |   |
|                                                |       |                         |       |              |       |      |       |
| Transfers to/(from)  Level 3                        |       | —                       |       | —            |       | —    |       |
| Total gains (losses)  (realized or unrealized): (1) |       |                         |       |              |       |      |       |
| Included in earnings                                |       | 120                          |       | (106              | )          | 14        |       |
| Included in other  comprehensive income             |       | 23                           |       | —            |       | 23        |       |
| Purchases, sales,  issuances and settlements, net   |       | —                       |       | —            |       | —    |       |
|                                                |       |                         |       |              |       |      |       |
| Balance on  April 30, 2010                     |       | $                            | 10,787     |              | $          | 1,084     |       | $ | 11,871 |   |

 

----

(1) SeeNote 6 for discussion of Auction Rate Securities and related Put Agreement.

 

The table belowprovides a reconciliation of the beginning and ending balances of the Company’sinvestments measured at fair value using significant unobservable inputs (Level3) for the six months ended April 30, 2010 (in thousands):

 
| ** **                                          | ** ** | **Auction Rate  Securities** | ** ** | **Put Agreement** | ** ** | **Total** | ** ** |
|-----------------------------------------------------|------------|------------------------------|------------|-------------------|------------|-----------|------------|
|                                                |       |                         |       |              |       |      |       |
| Balance on November 1, 2009                    |       | $                            | 10,575     |              | $          | 1,221     |       | $ | 11,796 |   |
|                                                |       |                         |       |              |       |      |       |
| Transfers to/(from)  Level 3                        |       | —                       |       | —            |       | —    |       |
| Total gains (losses)  (realized or unrealized): (1) |       |                         |       |              |       |      |       |
| Included in earnings                                |       | 178                          |       | (137              | )          | 41        |       |
| Included in other  comprehensive income             |       | 84                           |       | —            |       | 84        |       |
| Purchases, sales,  issuances and settlements, net   |       | (50                          | )          | —            |       | (50       | )          |
|                                                |       |                         |       |              |       |      |       |
| Balance on  April 30, 2010                     |       | $                            | 10,787     |              | $          | 1,084     |       | $ | 11,871 |   |

 

----

(1) SeeNote 6 for discussion of Auction Rate Securities and related Put Agreement.

 

The table belowprovides a reconciliation of the beginning and ending balances of the Company’sinvestments measured at fair value using significant unobservable inputs (Level3) for the three months ended April 30, 2009 (in thousands):

 
| ** **                                          | ** ** | **Auction Rate  Securities** | ** ** | **Put Agreement** | ** ** | **Total** | ** ** |
|-----------------------------------------------------|------------|------------------------------|------------|-------------------|------------|-----------|------------|
|                                                |       |                         |       |              |       |      |       |
| Balance on January 31, 2009                    |       | $                            | 9,722      |              | $          | 1,588     |       | $ | 11,310 |   |
|                                                |       |                         |       |              |       |      |       |
| Transfers to/(from)  Level 3                        |       | —                       |       | —            |       | —    |       |
| Total gains (losses)  (realized or unrealized): (1) |       |                         |       |              |       |      |       |
| Included in earnings                                |       | (170                         | )          | 219               |       | 49        |       |
| Included in other  comprehensive income             |       | 256                          |       | —            |       | 256       |       |
| Purchases, sales,  issuances and settlements, net   |       | —                       |       | —            |       | —    |       |
|                                                |       |                         |       |              |       |      |       |
| Balance on  April 30, 2009                     |       | $                            | 9,808      |              | $          | 1,807     |       | $ | 11,615 |   |

 

----

(1) SeeNote 6 for discussion of Auction Rate Securities and related Put Agreement.

 

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The table belowprovides a reconciliation of the beginning and ending balances of the Company’sinvestments measured at fair value using significant unobservable inputs (Level3) for the six months ended April 30, 2009 (in thousands):

 
| ** **                                          | ** ** | **Auction Rate Securities** | ** ** | **Put Agreement** | ** ** | **Total** | ** ** |
|-----------------------------------------------------|------------|-----------------------------|------------|-------------------|------------|-----------|------------|
|                                                |       |                        |       |              |       |      |       |
| Balance on November 1, 2008                    |       | $                           | 11,336     |              | $          | —    |       | $ | 11,336 |   |
|                                                |       |                        |       |              |       |      |       |
| Transfers to/(from)  Level 3                        |       | —                      |       | —            |       | —    |       |
| Total gains (losses)  (realized or unrealized): (1) |       |                        |       |              |       |      |       |
| Included in earnings                                |       | (1,887                      | )          | 1,807             |       | (80       | )          |
| Included in other  comprehensive income             |       | 359                         |       | —            |       | 359       |       |
| Purchases, sales,  issuances and settlements, net   |       | —                      |       | —            |       | —    |       |
|                                                |       |                        |       |              |       |      |       |
| Balance on  April 30, 2009                     |       | $                           | 9,808      |              | $          | 1,807     |       | $ | 11,615 |   |

 

----

(1) SeeNote 6 for discussion of Auction Rate Securities and related Put Agreement.

 

Some of the inputs into the discounted cashflow models from which the Company bases its Level 3 valuations for the ARS andPut Agreement are unobservable in the market and have a significant effect onvaluation. The assumptions used in preparing the models include, but are notlimited to, periodic coupon rates, market required rates of return, theexpected term of each security and the credit-adjusted rate of the counterpartyto the Put Agreement. The coupon rate was estimated using implied forward ratedata on interest rate swaps and U.S. Treasuries, and limited where necessary byany contractual maximum rate paid under a scenario of continuing auctionfailures. Assumptions regarding required rates of return were based onrisk-free interest rates and credit spreads for investments of similar creditquality. The expected term for the ARS was based on a weightedprobability-based estimate of the time the principal will become available tothe Company. The expected term for the Put Agreement was based on the earliestdate on which the Company can exercise the Put Agreement rights.

 

***8.  INVENTORIES***

 

Inventoriesconsist of the following (in thousands):

 
| ** **       | ** ** | **April 30,** | ** ** | **October 31,** | ** ** |
|------------------|------------|--------------------|------------|----------------------|------------|
| ** **       | ** ** | **2010**           | ** ** | **2009**             | ** ** |
|             |       |               |       |                 |       |
| Finished goods   |       | $                  | 66,709     |                 | $          | 56,203 |   |
| Work in process  |       | 46,739             |       | 56,501               |       |
| Raw materials    |       | 6,008              |       | 3,475                |       |
|             |       |               |       |                 |       |
| Inventories, net |       | $                  | 119,456    |                 | $          | 116,179 |   |

 

Inventorylevels are evaluated by management based upon anticipated product demand,shelf-life, future marketing plans and other factors.  Reserves for obsolete and slow-movinginventories are recorded for amounts that may not be realizable.

 

***9.  PROPERTY, PLANT AND EQUIPMENT***

 

Property,plant and equipment consists of the following (in thousands):

 
| ** **                                      | ** ** | **April 30,** | ** ** | **October 31,** | ** ** |
|-------------------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                      | ** ** | **2010**           | ** ** | **2009**             | ** ** |
|                                            |       |               |       |                 |       |
| Land                                            |       | $                  | 2,320      |                 | $          | 2,320 |   |
| Building and improvements                       |       | 69,264             |       | 67,094               |       |
| Machinery and equipment                         |       | 270,106            |       | 266,257              |       |
| Furniture and fixtures                          |       | 3,309              |       | 3,094                |       |
| Computer hardware and software                  |       | 18,708             |       | 17,220               |       |
|                                            |       | 363,707            |       | 355,985              |       |
| Less: accumulated depreciation and amortization |       | (125,124           | )          | (113,437             | )          |
|                                            |       | 238,583            |       | 242,548              |       |
| Construction in progress                        |       | 10,813             |       | 9,731                |       |
|                                            |       |               |       |                 |       |
| Property, plant and equipment, net              |       | $                  | 249,396    |                 | $          | 252,279 |   |

 

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Assetsavailable for commercial use that were not in productive service had a net bookvalue of $32.7 million and $34.4 million at April 30, 2010 and October 31,2009, respectively.  Depreciation as wellas certain other fixed costs related to such idle assets is recorded as cost ofproduct sales in the accompanying consolidated statements of income.

 

***10.  INTANGIBLE ASSETS***

 

Intangibleassets and related accumulated amortization consist of the following (inthousands):

 
| ** **                    | ** ** | **April 30, 2010** | ** ** | **October 31, 2009** | ** ** |
|-------------------------------|------------|-------------------------|------------|---------------------------|------------|
| ** **                    | ** ** | ** **              | ** ** | **Accumulated**           | ** ** | ** ** | ** ** | ** ** | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
| **Intangible Asset**     | ** ** | **Gross**               | ** ** | **Amortization**          | ** ** | **Net** | ** ** | **Gross** | ** ** | **Amortization** | ** ** | **Net** | ** ** |
|                          |       |                    |       |                      |       |   |   |   |   |   |   |   |   |
| Trademarks (amortizing)       |       | $                       | 2,242      |                      | $          | (1,087 | ) | $ | 1,155 |   | $ | 2,202 |   | $ | (1,004 | ) | $ | 1,198 |   |
| Trademarks (indefinite-lived) |       | 45,400                  |       | —                    |       | 45,400 |   | — |   | — |   | — |   |
| Patents                       |       | 28,421                  |       | (10,986                   | )          | 17,435 |   | 25,732 |   | (9,046 | ) | 16,686 |   |
| Current products              |       | 10,676                  |       | (5,719                    | )          | 4,957 |   | 10,676 |   | (5,363 | ) | 5,313 |   |
| Licenses and other            |       | 27,603                  |       | (7,009                    | )          | 20,594 |   | 24,899 |   | (5,465 | ) | 19,434 |   |
|                          |       | 114,342                 |       | (24,801                   | )          | 89,541 |   | 63,509 |   | (20,878 | ) | 42,631 |   |
|                          |       |                    |       |                      |       |   |   |   |   |   |   |   |   |
| Customer relationships        |       | 91,400                  |       | (1,246                    | )          | 90,154 |   | — |   | — |   | — |   |
| Goodwill                      |       | 150,567                 |       | —                    |       | 150,567 |   | 51,592 |   | — |   | 51,592 |   |
|                          |       |                    |       |                      |       |   |   |   |   |   |   |   |   |
|                          |       | $                       | 356,309    |                      | $          | (26,047 | ) | $ | 330,262 |   | $ | 115,101 |   | $ | (20,878 | ) | $ | 94,223 |   |

 

SeeNote 3 for discussion of the additions to trademarks, customer relationshipsand goodwill resulting from the Amerifit acquisition in February 2010.

 

In February 2009,Martek entered into a license agreement with an international food company forcertain patented technology expected to be used in the production of Martek’s *life’sDHATM*for certain applications*.*Underthe agreement, Martek was granted a perpetual and generally exclusive licenseto the technology. As consideration for this license, Martek paid an upfrontlicense fee of $1.0 million.  In April 2010,certain development goals were achieved by the licensor related to the licensedtechnology which has resulted in future license payment obligations for Martek.  During the three months ended April 30,2010, the Company recorded the present value of such future payments, totalingapproximately $2.2 million, as an additional license fee asset as well as alicense fee obligation.   In addition,Martek will be required to pay royalties of up to 4.5% of sales of productsproduced using the licensed technology, including certain minimum royaltypayments of approximately $2.0 million, and may be required to pay additionallicense fees of approximately $2.5 million if certain commercially beneficialrights are exercised by the Company in the future.  The license fees paid in connection with thisarrangement are being amortized over 10 years.

 

Includedin amortization of intangible assets is approximately $2.4 million and $3.6million in the three and six months ended April 30, 2010, respectively,and approximately $1.4 million and $3.0 million in the three and six monthsended April 30, 2009, respectively, related to assets supporting theCompany’s commercial products.

 

Basedon the current amount of intangible assets subject to amortization, theestimated total amortization expense for each year in fiscal 2010 throughfiscal 2014 will be approximately $12.4 million, $14.1 million, $12.9 million,$12.6 million and $12.0 million, respectively.

 

***11.  NOTES PAYABLE AND LONG-TERM DEBT***

 

In January 2010, the Company entered intoa Credit Agreement, subsequently amended in March 2010 (the “CreditAgreement”), that includes a $75 million term loan (the “Term Loan”) and a $100million secured revolving credit facility (the “Revolver”).  The Credit Agreement replaced the existing$135 million credit facility (the “Former Facility”). The proceeds from theTerm Loan were received by, and the funds under the Revolver became available to,Martek on February 12, 2010, coincident with the closing of the Company’sacquisition of Amerifit (see further discussion in Note 3).

 

The Term Loan and the Revolver arecollateralized by certain of the Company’s and its subsidiaries’ assets,including accounts receivable, deposit accounts, inventory and certainsoftware, general intangibles and records pertaining to the foregoing as wellas a pledge of 100% of its domestic subsidiaries’ equity.  The Revolver, which may be increasedduring the term of the facility by up to an additional $50 million subject tocertain conditions, expires in February 2013.  The Term Loan maturesin February 2013. Martek is required to make quarterly installmentpayments on the 

 

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Term Loan of $3,750,000, which began in April 2010,plus additional annual repayments on January 31 of each year based onconsolidated excess cash flow, as defined in the Credit Agreement, of thepreceding fiscal year.    During thethree months ended April 30, 2010, the Company made the required quarterlypayment as well as an additional discretionary repayment of $31,250,000.

 

The Term Loan will bear interest at theelection of Martek at either LIBOR plus up to 3.375% or a base rate plus up to1.25% depending upon the consolidated leverage ratio during each precedingfiscal quarter. The Revolver will bear interest at the election of Martek ateither LIBOR plus up to 3.00% or a base rate plus up to 1.00% depending uponthe consolidated leverage ratio during each preceding fiscal quarter.  Thebase rate is the higher of the lender’s prime rate, the federal funds rate plus0.50% or LIBOR plus 1.50%.  For purposes of the Credit Agreement, LIBOR isthe greater of 1.25% per annum or LIBOR at the time of such determination.

 

There were no amounts outstanding under theFormer Facility from November 1, 2009 through its refinancing in January 2010. The weighted average annual commitment fee rate on unused amounts under theRevolver was approximately 0.3% for the three months ended April 30,2010.   The weighted average annualcommitment fee rate on unused amounts under the Former Facility in the firstquarter of fiscal 2010 was approximately 0.1%. The commitment fee rate underthe Credit Agreement of up to 0.50% on the Revolver is based on the Company’sconsolidated leverage ratio during each preceding fiscal quarter. Among otherthings, the Credit Agreement contains restrictions on future debt, the paymentof dividends and the further encumbrance of assets. In addition, the CreditAgreement requires that the Company comply with specified financial ratios andtests, including minimum coverage ratios and maximum leverage ratios.

 

During the three and six months ended April 30,2010, the Company incurred interest on borrowings of approximately $800,000,including $700,000 of interest on the Term Loan and $100,000 on theRevolver.    The weighted average annualinterest rate during the three and six months ended April 30, 2010 on theTerm Loan the Revolver was 4.9% and 4.5%, respectively.

 

In connection with the Credit Agreementfinancing, the Company incurred debt issuance costs totaling approximately $3.9million. Such amounts were allocated to the Term Loan and the Revolver on apro-rata basis. Amounts allocated to the Term Loan are amortized using theeffective interest method and amounts allocated to the Revolver are amortizedusing the straight-line method. Amortization of amounts allocated to the TermLoan and Revolver totaled $300,000 and $200,000, respectively, from the date offunding on February 12, 2010 through April 30, 2010.   If repayment of the Term Loan is acceleratedby the Company, the amortization of debt issuance costs attributable to theTerm Loan would also accelerate.

 

Thecarrying amounts of notes payable and long-term debt at April 30, 2010 andOctober 31, 2009 approximate their fair values based on instruments ofsimilar terms available to the Company.

 

***12.  COMMITMENTS AND CONTINGENCIES***

 

***ScientificResearch Collaborations***TheCompany has entered into various collaborative research and license agreementsfor its algal technology. Under these agreements, the Company is required tofund research or to collaborate on the development of potential products.Certain of these agreements also commit the Company to pay royalties upon thesale of certain products resulting from such collaborations.

 

In May 2008,the Company entered into a collaboration agreement with a global biotechnologycompany to jointly develop and commercialize a canola seed that producesDHA.  Martek and its co-collaboratoranticipate a multi-year effort to produce this oil. The Company’s financialcommitments associated with this development initiative are subject to thesuccessful completion of identified milestones. As of April 30, 2010, the Company’s financial commitment, primarilythrough internal research efforts, to the first projected milestone date totalsapproximately $300,000.   Commitmentsthereafter, also primarily through internal research efforts, assumingsuccessful achievement of all identified milestones, total approximately $5.6million.

 

In August 2009,the Company entered into a collaboration agreement with BP for the jointdevelopment 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. Inconnection with this agreement, BP has agreed to contribute up to $10 millionto the initial phases of the collaboration, which utilizes Martek’s significantexpertise in microbial oil production and BP’s production and commercializationexperience in biofuels as the platform for the joint development effort. Martekwill perform the biotechnology research and development associated with theinitial phases and receive fees from BP for such efforts.  All intellectual property owned prior to theexecution of the collaboration agreement will be retained by each respectivecompany, and all intellectual property developed during the collaborationperiod will be owned by BP, with an exclusive license to Martek forcommercialization in nutrition, cosmetic and pharmaceutical applications. Additionally,each party is entitled to certain commercial payments from the counterparty forcommercialization of the technology in the other party’s fields of use.

 

***Patent Infringement Litigation*** In September 2003,the Company filed a patent infringement lawsuit in the U.S. District Courtin Delaware against Nutrinova Nutrition Specialties & Food IngredientsGmbH (“Nutrinova”) and others alleging infringement of certain of ourU.S. patents.  In December 2005,Nutrinova’s DHA business was sold to Lonza Group LTD, a Swiss chemical andbiotechnology group, and the parties agreed to add Lonza to the U.S.lawsuit.  In October 2006, theinfringement action in the United States was tried, and a verdict favorable toMartek was returned.  The jury found thatthe defendants infringed all the asserted claims of three Martek patents andthat these patents were valid.  It alsofound that the defendants willfully infringed one of these patents.  In October 2007, the judge upheld the October 2006jury 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 

 

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injunction against the defendants with respectto those two patents.  The judge alsoupheld the jury verdict that the defendants had acted willfully in theirinfringement of U.S. Patent No. 6,410,281.  Regarding the thirdpatent involved in the case, U.S. Patent No. 6,451,567, the judge reversedthe jury verdict and found that the asserted claims of this patent wereinvalid.  Martek’s request to the judgeto reconsider his ruling on the third patent was denied.  Martek and the defendants appealed aspects ofthe judge’s final decision and a hearing was held before the U.S. Court ofAppeals in April 2009.  In September 2009,the Court of Appeals ruled in Martek’s favor on all of the patents that werethe 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 Martek’sappeal as a result of the trial court’s decision at a pre-trial hearing on themeaning 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 court’s interpretation of certain claimlanguage and remanded this patent to the trial court for furtherproceedings.  U.S. Patent Nos. 5,340,594and 6,454,567 have expired and U.S. Patent Nos. 6,410,281 and 5,698,244 arescheduled to expire in August 2011 and December 2014,respectively.  The defendants requested arehearing with the Court of Appeals on the decision, but their request wasdenied. The trial for US Patent No. 5,698,244likely will not occur before 2011. Discovery is expected to be completed before the end of 2010, and thedefendants will be permitted to file a summary judgment motion at the end of2010. Additionally, in early 2010 Lonza requested reexamination of U.S. PatentNos. 6,410,281 and 5,698,244 in the U.S. Patent and Trademark Office, andthese two requests have been granted.

 

In January 2004,the Company filed a patent infringement lawsuit in Germany against Nutrinovaand Celanese Ventures GmbH.  Lonza Ltd.and a customer of Nutrinova have also been added to this lawsuit.  The complaint alleges infringement of Martek’sEuropean patent relating to DHA-containing oils.  A hearing was held in a district court inDusseldorf in September 2007 and the court issued its decision in October 2007,ruling that Martek’s patent was infringed by the defendants.  The defendants have appealed, and the appealis expected to be heard in 2010 or 2011. This patent is scheduled to expire in February 2011.

 

Inconnection with these patent lawsuits, the Company has incurred and capitalizedsignificant external legal costs. As of April 30, 2010, the patents beingdefended in the Lonza matter had a net book value of approximately $3.8million, including capitalized legal costs, which is being amortized over aweighted average remaining period of approximately five years.  This amount is subject to future impairment,in whole or in part, pending the outcome of these patent lawsuits.

 

These lawsuits are further described in Item1. “Legal Proceedings” of Part II of this Form 10-Q.

 

***Other*** The Company isinvolved in various other legal actions. Management believes that these actions, either individually or in theaggregate, will not have a material adverse effect on the Company’s results ofoperations or financial condition.

 

***13.  STOCKHOLDERS’ EQUITY***

 

The Company recognized approximately $1.5million and $2.4 million in the three and six months ended April 30, 2010,respectively, and approximately $1.1 million and $1.9 million in the three andsix months ended April 30, 2009, respectively, in compensation costrelated to employee stock plans.   Suchcosts were recorded approximately 75%, 15% and 10% as selling, general andadministrative expenses, research and development expenses and cost ofrevenues, respectively, in all periods.

 

The Company granted 474,424 restricted stockunits during the six months ended April 30, 2010, which generally vestover 62 months from the date of grant. The total fair value of the restricted stock units granted of $9.1million was based on fair market value on the date of grant.

 

As of April 30, 2010, there wasapproximately $18.3 million remaining in unrecognized compensation cost relatedto restricted stock units. The cost is expected to be recognized through fiscal2015 with a weighted average recognition period of approximately two years.

 

Unrecognized compensation cost relatedto unvested stock options as of April 30, 2010 is not material.

 

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***14.  NET INCOME PER SHARE***

 

Basicnet income per share is computed using the weighted average number of commonshares outstanding. Diluted net income per share is computed using the weightedaverage number of common shares outstanding, giving effect to stock options andrestricted stock units using the treasury stock method.

 

The following table presents the calculation of basic and diluted netincome per share (in thousands, except per share amounts):

 
| ** **                                   | ** ** | **Three  months ended April 30,** | ** ** | **Six  months ended April 30,** | ** ** |
|----------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                                   | ** ** | **2010**                               | ** ** | **2009**                             | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                         |       |                                   |       |                                 |       |   |   |   |   |
| Net income                                   |       | $                                      | 12,517     |                                 | $          | 11,017 |   | $ | 22,160 |   | $ | 20,623 |   |
|                                         |       |                                   |       |                                 |       |   |   |   |   |
| Weighted average shares outstanding, basic   |       | 33,383                                 |       | 33,190                               |       | 33,329 |   | 33,170 |   |
| Effect of dilutive potential common shares:  |       |                                   |       |                                 |       |   |   |   |   |
| Stock options                                |       | 59                                     |       | 66                                   |       | 55 |   | 105 |   |
| Restricted stock units                       |       | 136                                    |       | 54                                   |       | 130 |   | 74 |   |
| Total dilutive potential common shares       |       | 195                                    |       | 120                                  |       | 185 |   | 179 |   |
| Weighted average shares outstanding, diluted |       | 33,578                                 |       | 33,310                               |       | 33,514 |   | 33,349 |   |
|                                         |       |                                   |       |                                 |       |   |   |   |   |
| Net income per share, basic                  |       | $                                      | 0.37       |                                 | $          | 0.33 |   | $ | 0.66 |   | $ | 0.62 |   |
| Net income per share, diluted                |       | $                                      | 0.37       |                                 | $          | 0.33 |   | $ | 0.66 |   | $ | 0.62 |   |

 

Stockoptions to purchase approximately 2.0 million shares were outstanding but werenot included in the computation of diluted net income per share for both thethree and six months ended April 30, 2010, and stock options to purchaseapproximately 2.2 million shares and 2.1 million shares were outstanding butwere not included in the computation of diluted net income per share for thethree and six months ended April 30, 2009, respectively, because theeffects would have been antidilutive.

 

***15. COMPREHENSIVE INCOME***

 

Comprehensiveincome and its components for the three and six months ended April 30,2010 and 2009 were as follows (in thousands):

 
| ** **                                                                                                               | ** ** | **Three months ended April 30,** | ** ** | **Six months ended April 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                               | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                                                                                               | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income, as reported                                                                                                  |       | $                                     | 12,517     |                                | $          | 11,017 |   | $ | 22,160 |   | $ | 20,623 |   |
|                                                                                                                     |       |                                  |       |                                |       |   |   |   |   |
| Other comprehensive income (loss):                                                                                       |       |                                  |       |                                |       |   |   |   |   |
| Foreign currency translation adjustment                                                                                  |       | (2                                    | )          | —                              |       | (2 | ) | — |   |
| Reclassification of available-for-sale securities, net  of tax of $—, $—, $— and $383, respectively       |       | —                                |       | —                              |       | — |   | 646 |   |
| Unrealized gain (loss) on available-for-sale  securities, net of tax of $9, $95, $31 and $(249), respectively            |       | 14                                    |       | 162                                 |       | 52 |   | (420 | ) |
| Realized loss on exchange rate forward contracts, net  of tax of $5, $484, $5 and $920, respectively                     |       | 8                                     |       | 818                                 |       | 8 |   | 1,553 |   |
| Unrealized (loss) gain on exchange rate forward  contracts, net of tax of $(10), $324, $(10) and $372, respectively |       | (17                                   | )          | 466                                 |       | (17 | ) | 674 |   |
|                                                                                                                     |       |                                  |       |                                |       |   |   |   |   |
| Comprehensive income                                                                                                     |       | $                                     | 12,520     |                                | $          | 12,463 |   | $ | 22,201 |   | $ | 23,076 |   |

 

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**Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations.**

 

*This Management’s Discussion and Analysis of Financial Condition andResults of Operations contains forward-looking statements concerning ourbusiness and operations, including, among other things, statements concerningthe following:*

 

·                  *expectations regarding future revenue,revenue growth, gross margin, operating cash flow and  profitability of Martek, including itsnewly-acquired subsidiary, Charter Amerifit LLC , now Martek Amerifit LLC, andall of its subsidiaries (“Amerifit”) ;*

·                  *expectations regarding product introductionsand growth in nutritional product sales;*

·                  *expectations regarding Martek’s ability touse the marketing platform of Amerifit to commercialize products underdevelopment;*

·                  *expectations regarding potentialcollaborations and acquisitions;*

·                  *expectations regarding demand for ournutritional ingredients and branded consumer health products;*

·                  *expectations regarding sales of ournutritional ingredients to and by our infant formula customers and supplementedinfant formula market penetration levels;*

·                  *expectationsregarding our ability to enter into new or extend existing sole source infantformula supply agreements;*

·                  *expectations regarding sales of our brandedconsumer health products to retail and other customers;*

·                  *expectations regarding marketing of our oilsby our infant formula customers;*

·                  *expectations regarding future agreementswith, and revenues from, companies in the food and beverage, pregnancy andnursing, nutritional supplement and animal feed markets;*

·                  *expectations regarding future revenues fromcontract manufacturing customers;*

·                  *expectations regarding future revenues fromcollaborations;*

·                  *expectations regarding growing consumerrecognition of the key health benefits of DHA and ARA;*

·                  *expectations regarding competitive products;*

·                  *expectations regarding future efficienciesand improvements in manufacturing processes and the cost of production of ournutritional ingredients;*

·                  *expectations regarding future purchasevolumes and costs of third-party manufactured products;*

·                  *expectations regarding the amount ofproduction capacity and our ability to meet future demands for our nutritionalingredients;*

·                  *expectations regarding the amount ofinventory held by us or our customers;*

·                  *expectations regarding our productioncapacity utilization and the effects of excess production capacity;*

·                  *expectations regarding the amount ofproduction capacity and key raw materials we can procure and our ability tomeet future demands for our branded consumer health products;*

·                  *expectations regarding future selling,general and administrative and research and development costs;*

·                  *expectations regarding future capitalexpenditures;*

·                  *expectations regarding levels of consumptionthrough governmental programs of infant formula products containing ournutritional oils; and*

·                  *expectations regarding our ability to maintainand protect our intellectual property.*

 

*Forward-looking statements include those statements containing wordssuch as the following:*

 

·                  *“will,”*

·                  *“should,”*

·                  *“could,”*

·                  *“anticipate,”*

·                  *“believe,”*

·                  *“plan,”*

·                  *“estimate,”*

·                  *“expect,”*

·                  *“intend,” and other similar expressions.*

 

*All of these forward-looking statements involve risks anduncertainties. They and other forward-looking statements in this Form 10-Qare all made pursuant to the safe harbor provisions of the Private SecuritiesLitigation Reform Act of 1995. We wish to caution you that our actual resultsmay differ significantly from the results we discuss in our forward-lookingstatements. 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 variousother filings with the Securities and Exchange Commission.  Our forward-looking statements speak only asof the date of this document, and we do not intend to update these statementsto reflect events or circumstances that occur after that date.*

 

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**GENERAL**

 

Martek was founded in 1985. We are a leader inthe innovation, development, production and sale of high-value products frommicrobial sources that promote health and wellness through nutrition.   Our technology platform consists of our coreexpertise, broad experience and proprietary technology in areas such asmicrobial biology, algal genomics, fermentation and downstream processing.  This technology platform has resulted in ourdevelopment of a number of products, including our flagship product, *life’sDHA*TM, a sustainable and vegetarian source of algal DHA(docosahexaenoic acid) important for brain, heart and eye health throughoutlife for use in infant formula, pregnancy and nursing products, foods andbeverages, dietary supplements and animal feeds. We also produce *life’sARA*TM (arachidonic acid), an omega-6 fatty acid, foruse in infant formula and growing-up milks.  Our DHA and ARA are collectively referred to as “nutritional ingredients”.   On February 12, 2010, we acquiredAmerifit.  Amerifit develops, markets anddistributes branded consumer health and wellness products and holds leadingbrand positions in all of its key product categories. Amerifit productsinclude: Culturelle®, a leading probiotic supplement; AZO, the leadingover-the-counter brand addressing symptom relief, detection and prevention ofurinary tract infections; and ESTROVEN®, the leading all-natural nutritionalsupplement brand addressing the symptoms of menopause.   The products sold through the Amerifitsubsidiary are collectively referred to as “branded consumer health products”.  There are currently a number of nutritionalhealth and wellness products under development that we plan to commercializeand distribute through Amerifit’s marketing platform.

 

We operate in two material business segments,the development and commercialization of high-value nutritional ingredientsproducts from microbial sourcesand, with the acquisition of Amerifit in February 2010,the marketing and sale of branded consumer health products. The nutritionalingredients segment sells to manufacturers of infant formula, foods andbeverages, animal feeds, supplements and pregnancy and nursing products.  The branded consumer health products segmentsells to retail outlets, including most major mass, club, drug, food andspecialty stores in the United States.

 

In ournutritional ingredients segment, we sell oils and powders containingnutritional ingredients as *life’sDHATM*,DHASCO®, Neuromins®, ARASCO® and *life’sARATM*. Wederive DHA from microalgae and ARA from fungi, using proprietaryprocesses.   Cell membranes throughoutthe body contain these fatty acids, and they are particularly concentrated inthe brain, central nervous system, retina and heart.  Research has shown that DHA and ARA mayenhance mental and visual development in infants.  In addition, research has shown that DHA mayplay a pivotal role in brain function throughout life and may reduce the riskof cardiovascular disease. Low levels of DHA in adults have been linked to avariety of health risks, including Alzheimer’s disease, dementia,cardiovascular problems and various other neurological and visual disorders.Further research is underway to assess the role of supplementation with our DHAon mitigating a variety of health risks.

 

We aresupplying over 35 infant formula customers with our nutritionalingredients.   These companiescollectively represent approximately 75% of the estimated $15 billion worldwideretail market for infant formula and nearly 100% of the estimated $4.5 billionU.S. retail market for infant formula, including the retail value of Women,Infants and Children program (“WIC”) rebates. WIC is a federal grant programadministered by the states for the benefit of low-income, nutritionally at-riskwomen, infants and children.  Ourcustomers include infant formula market leaders Mead Johnson Nutritionals,Nestle, Abbott Nutrition, Pfizer and Danone, each of whom is selling infantformula supplemented with our nutritional ingredients.   Our customers are now selling infant formulaproducts containing our nutritional ingredients collectively in over 75countries.  Supplemented infant formulasfrom Mead Johnson Nutritionals, Abbott Nutrition, Perrigo Company (formerly PBMProducts), Nestle, Hain Celestial and Nutricia North America are currentlybeing sold in the United States. In addition, certain infant formula customersare selling products in the United States and abroad that contain our nutritionalingredients and target the markets for children ages nine months to seven yearsand older.

 

**RECENT HIGHLIGHTS**

 

Thefollowing highlights some recent positive developments in our business and theliterature around our nutritional ingredients. Please read our Risk Factorscarefully for certain factors that should be considered in evaluating thesedevelopments and our business.

 

·                  *MIDAS StudyPublished Which Shows Martek’s Algal DHA Improved Memory and Learning InHealthy Adults with Memory Complaints -*TheMemory Improvement with Docosahexaenoic Acid (DHA) Study (MIDAS) published in May 2010in *Alzheimer’s & Dementia: TheJournal of the**Alzheimer’s**Association* showed that Martek’salgal DHA improved memory function in healthy aging adults.  MIDAS is the first large,randomized, placebo-controlled study to demonstrate the benefits of DHA inmaintaining and improving brain health in older adults. MIDAS found thathealthy people with memory complaints who took 900mg of Martek’s algal DHAcapsules for six months had almost double the reduction in errors on a testthat measures learning and memory performance versus those who took a placebo,a benefit roughly equivalent to having the learning and memory skills ofsomeone three years younger. The DHA was well-tolerated and subjects taking theDHA also experienced a lower heart rate, providing a significant cardiovascularbenefit.  The study was funded by Martek.

 

·                  *Non-InfantFormula Product Launches* —

 

·                  Foods and Beverages - Fortune Natural GrainsBlended Cooking Oil (COFCO — China), Future Star Kid Milk (Mengniu — China),Quiznos® salad dressings (U.S.)  Milkana® Golden Baby Cheese (BSI (Tianjin)®Food Company — China), dha

 

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Omega3TM Eggs (M. Lasser — Israel), Earth’sBest® Organic Nutritional Mommy Bars (Hain Celestial — U.S.), H-E-B® ReducedFat Milk (2%) with DHA Omega-3 and H-E-B® Whole Milk with DHA Omega-3(Morningstar — U.S.), Rice Milk with Omega3 DHATM (Freedom Foods — Australia)

 

·                  Pregnancy and nursing and nutritionalsupplements- Pharmaceutical LLC PreferaOB OneTM (Alaven® — U.S.), Algal-900 DHA Softgels (Walgreens —U.S.), Natural Omega-3 Vegetarian DHA100 mg Softgels (Bluebonnet® — U.S.), Natural Omega-3 Vegetarian DHA 200 mg Softgels (Bluebonnet® —U.S.) and Merck KidabionTM DHAPowder Drink for Children (China)

 

·                  *NewScientific Data/Recommendations Published on DHA and ARA*— In addition tothe MIDAS study noted above, the benefits of DHA and ARA supplementation wererecently discussed in the following publications:

 

·                  The *Journalof Nutrition* (April 2010) published the results of a studyexamining the association between omega-3 fatty acids in serum and cognitivefunction in mid-life adults.   Levels of serum phospholipid ALA, EPA,and DHA and performance in five major dimensions of cognitive function were determinedin 280 healthy volunteers, ages 35 to 54. Using regression analysis, higherlevels of DHA were associated with better performance on the tests of nonverbalreasoning and mental flexibility, working memory and vocabulary.  NeitherALA nor EPA showed a significant relationship to cognitive function.

 

·                  In the *EFSA Journal*  (March 2010), the European Food SafetyAuthority’s (“EFSA”) Panel on Dietetic Products, Nutrition, and Allergies (“NDA”)officially adopted and published an Opinion on Dietary Reference Values forfats, including polyunsaturated fatty acids.  The NDA Panel concluded thata daily intake of 250 mg of long-chain omega-3 fatty acids for adults mayreduce the risk of heart disease. The NDA Panel set an Adequate Intake (“AI”)of 250 mg/day EPA+DHA for adults and an AI of 100 mg DHA/day for infants (>6months) and young children <24 months. For pregnant or lactating women, 100-200 mg preformed DHA is recommendedin addition to the 250 mg/day omega-3 DHA+EPA AI for adults.

 

·                  The Joint FAO/WHO Expert Group Consultation onFats and Fatty Acids in Human Nutrition released their recommendations as aninterim report from the meeting which was held in Geneva in November 2008. The report recommends an AI for DHA for ages 0-6 months of 0.1-0.18% energywith no upper limit other than recognizing high maternal milk levels of 1.5%total energy.  The Committee refers to DHA during this period as aconditionally essential nutrient.  The recommended AI for ages 6-24 monthsis 10-12 mg/kg.  The Committee recognized the importance of DHA forretinal and brain development during this period.  A combination ofEPA+DHA was recommended for children ages 2-10 years ranging from 100-250mg/day.  For adults, daily consumption of 100-250 mg/day DHA+EPA isrecommended.

 

·                  The *Journalof Pediatrics* (June 2010) published a report on medical recordsas reviewed by investigators unaware of treatment assignment for two cohorts ofinfants looking at the incidence of respiratory infections and allergies at threeyears of age. The original two cohorts included 147 infants who had receivedeither a DHA/ARA containing formula (0.32%-0.36% DHA/0.64%-0.73% ARA) or aformula without supplementation for one year. Eighty-nine infants wereavailable for follow up evaluation at age three, 38 in the active and 51 in theplacebo group. The DHA/ARA-supplemented groups had significantly lower odds fordeveloping upper respiratory infections, wheezing, asthma, or symptoms ofallergy. Martek’s *life’sDHA*TM and *life’sARA*TM were used in the study.

 

**SALES AND MARKETING**

 

In ournutritional ingredients segment, we are currently marketing and selling *life’sDHATM,*directly or through distributors, for food andbeverage, supplement and animal feed applications to both U.S. andinternational companies. To date, over 200 domestic and international companieshave launched non-infant formula products that contain *life’sDHATM*,most of which remain on the market. Certain of our DHA license and supply agreements with major consumerfood products companies establish Martek, subject to certain exceptions, astheir exclusive supplier of DHA for minimum periods of time.  Certain of these agreements establish thecustomer as the exclusive customer of *life’sDHA*TM in aparticular food or beverage category or categories or geographic region.   We, along with our customers and certainthird parties, are developing other DHA delivery methods, including powders andemulsions, to facilitate further entry into the non-infant formula markets.  Management believes that over the next fewyears, the non-infant formula markets will continue to expand and couldultimately represent a larger opportunity than infant formula.

 

Theproducts in our branded consumer health products segment are sold primarilythrough a direct sales force, brokers, distributors and wholesalers.  We are currently marketing and selling suchproducts to most major mass, club, drug, food and specialty stores in theUnited States.

 

Weexpect that our future revenues and operating results will continue toexperience quarter-to-quarter and year-to-year fluctuations, some of which maybe significant.  We currently have solesource supply agreements, in most cases through 2011, with customers comprisingnearly 75% of our current infant formula revenues. Our success in entering intonew sole source agreements or in extending these existing sole source infantformula supply agreements will be significant in determining the extent of suchrevenue fluctuations.  In order to extendour sole source arrangements beyond 2011, reductions to our existing per-unitpricing may be required, which is likely to result in declines to our futureinfant formula revenues and may negatively impact related infant formula grossprofit margins.  The Company has severalcost saving and product innovation strategies designed to mitigate a portion ofthe possible negative gross profit margin impact of lower future infant formulapricing. We anticipate continued growth in our nutritional ingredients segmentoutside of infant formula and in our branded consumer health products segment,which should also mitigate any decrease to infant formula revenues andmargins.  In addition, any growth in theoverall market for DHA and ARA in infant formula would also help reduce theimpact of any such decreases.  

 

Inaddition to these aforementioned matters, the timing and extent of futureproduct sales are largely dependent upon the following factors:

 

·                  the timing of international infant formula marketintroductions by our customers;

·                  the timing of our customers’ ordering patterns;

 

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·                  the timing and effectiveness of promotional and advertisingcampaigns for our branded consumer health products;

·                  the timing and extent of stocking and de-stocking ofinventory by our customers;

·                  the timing and extent of our customers’ production campaignsand plant maintenance shutdowns;

·                  the timing and extent of introductions of DHA into variouschild and/or adult applications and the marketplace success of suchapplications;

·                  the levels of inclusion of our nutritional ingredients ininfant formula;

·                  the continued acceptance, and extent thereof, of productscontaining our nutritional ingredients under WIC and other regulatory programsin the U.S.;

·                  our continued ability to make product claims on our brandedconsumer health products;

·                  the continued acceptance of our products by consumers andcontinued demand by our customers;

·                  our ability to introduce new, internally-developed productsthrough Amerifit’s sales and marketing channels;

·                  the ability of our customers to incorporate our nutritionalingredients into various foods and beverages;

·                  our ability to protect against competitive nutritionalingredients products through our patents;

·                  competition from alternative sources of our nutritionalingredients and branded consumer health products; and

·                  agreements with other future third-party collaborators tomarket our products or develop new products.

 

Assuch, the likelihood, timing and extent of future profitability are largelydependent on factors such as those mentioned above, as well as others, overwhich we have limited or no control.

 

**PRODUCTION AND SOURCES OF SUPPLY**

 

***NutritionalIngredients***

 

Wemanufacture 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 theOrthodox Union and are certified Halal by the Islamic Food and NutritionCouncil of America.  Both manufacturingfacilities have received favorable ratings by the American Institute of Baking,an independent auditor of food manufacturing facilities, and have achievedcompliance with the ISO 14001 Environmental Management System (“EMS”)International Standard, the most recognized EMS standard in the world.

 

Over90% of our ARA oils are purchased from DSM. Because DSM is a third-party manufacturer, we have only limited controlover the timing and level of its production volumes. The balance of our ARArequirements is produced at our Kingstree facility.  In July 2009, we enteredinto the First Amended and Restated ARA Alliance, Purchase, and ProductionAgreement (the “Restated Agreement”) with DSM. The Restated Agreement, whichextends the original supply term through December 31, 2023,  amended, consolidated and restated allexisting agreements between the two parties governing the cross-licensing,purchase, supply and production of ARA. While, subject to certain limitedexceptions, Martek is committed to purchasing all of its ARA requirements fromDSM through the term of the Restated Agreement, the Restated Agreement also setminimum ARA purchase quantities for Martek in calendar years 2010 and2011.  As of April 30, 2010, thevalue of the remaining calendar year 2010 and full calendar year 2011 minimumpurchase requirements are approximately $58.4 million and $87.1 million,respectively. These minimum purchase quantities approximate the amountsexpected to be procured by us in the normal course of business.

 

We have attempted to reduce the risk inherent inhaving a single supplier through certain elements of our supply agreement withDSM.  In connection with this agreement,we have the ability to produce, either directly or through an approved thirdparty, an unlimited amount of ARA. The sale of such self-produced ARA islimited annually, however, to the greater of (i) 100 tons of ARA oil or (ii) anyamounts ordered by us that DSM is unable to fulfill.  Although we currently produce ARA ourselves,our existing manufacturing capacity would not permit us to produce ARAquantities sufficient to meet current demand without impacting our productionof DHA.   To further improve our overallARA supply chain, we have directly engaged a U.S.-based provider of certainpost-fermentation ARA manufacturing services. Along with our ARA downstream processing capabilities at Kingstree, thisthird-party facility provides us with multiple U.S. sites for the fulldownstream processing of ARA.

 

Under theterms of several of our agreements with infant formula customers, thosecustomers may elect to manufacture these oils themselves. While our customersare not required to disclose to us that they have begun the process, we arecurrently unaware of any of our customers producing our oils or preparing toproduce our oils, and estimate that it would take a customer a minimum of oneyear to implement a process for making our oils.

 

Our raw material suppliers for production ofour nutritional ingredients include major chemical companies and food andbeverage ingredient suppliers. We have identified and validated multiplesources for most of our major ingredients and do not anticipate that the lack ofavailability of raw materials will cause future production shortages.

 

When combining our current DHA and ARAproduction capabilities in Kingstree and Winchester with DSM’s current ARAproduction capabilities, we have production capacity for DHA and ARA productsin excess of $500 million in annualized sales, collectively, to the infantformula and non-

 

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infant formula markets.  As such, our production capacity exceedscurrent demand; however, we have the ability to manage production levels and,to a certain extent, control our manufacturing costs.  Nonetheless, when experiencing excesscapacity, we may be unable to produce the required quantities of oilcost-effectively due to the existence of significant levels of fixed productioncosts at our plants and the plants of our suppliers.

 

***BrandedConsumer Health Products***

 

Wecurrently outsource the production and packaging of all of our branded consumerhealth products with oversight by our internal managers. We expect to continueto rely on third parties for these manufacturing requirements. Where possible,we qualify more than one source for the manufacturing and packaging of ourproducts to manage the risk of supply disruptions. In such circumstances, ifone of our manufacturers or packagers were unable to supply our needs, webelieve we would have an alternative source available for those products.  While one of our products does not have analternative manufacturer qualified, we have identified another manufacturer forsuch product and have commenced the qualification process. However, qualifyingsuch replacement manufacturer, if successful, could take up to twelve months,and, as a result, we would not be able to guarantee an uninterrupted supply ofthe affected product to our customers.

 

When economicallyadvantageous, we directly procure key raw materials used by our manufacturersthat are contracted to produce our branded consumer health products. With theexception 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 ournutritional ingredients and branded consumer health products will depend, inpart, on our ability, or the ability of our contract manufacturers,  to produce our products at large scale on aroutine basis and at a commercially acceptable cost.  Our success will also be somewhat dependenton our ability to align our production or the production of our contractmanufacturers with customer demand, which is inherently uncertain.  There can also be no assurance that we or ourcontract manufacturers will be able to continue to comply with applicable regulatoryrequirements, including the Food and Drug Administration’s good manufacturingpractice (“GMP”) requirements.

 

**CRITICAL ACCOUNTING POLICIES AND**

**THE USE OF ESTIMATES**

 

The preparation of our consolidated financialstatements in conformity with U.S. generally accepted accounting principlesrequires management to make estimates and assumptions that affect the amountsreported in our consolidated financial statements and accompanying notes. On anongoing basis, we evaluate our estimates and judgments, which are based onhistorical and anticipated results and trends and on various other assumptionsthat we believe are reasonable under the circumstances, including assumptionsas to future events. By their nature, estimates are subject to an inherentdegree of uncertainty and, as such, actual results may differ from ourestimates. We discuss accounting policies and assumptions that involve a higherdegree of judgment and complexity than others in our Management’s Discussionand Analysis of Financial Condition and Results of Operations in our AnnualReport to shareholders on Form 10-K for the year ended October 31,2009.  Other than the changes andadditions noted below, which resulted from our acquisition of Amerifit in February 2010,there have been no significant changes in the Company’s critical accountingpolicies since October 31, 2009.

 

***RevenueRecognition***We derive revenue fromthree sources: product sales, contract manufacturing and collaborations. Werecognize product sales revenue when persuasive evidence of an arrangementexists, the fee is fixed or determinable, collectibility is reasonably assured,the product is shipped and title and risk of loss are transferred. Sales are recorded net of allowances for returns, trade promotions,coupons and other discounts. Additionally, with respect to our branded consumerhealth products, we routinely commit to trade-promotion programs with ourretail customers that require the Company to estimate and accrue the expectedcosts of such programs.  Such cost estimatesgenerally utilize the historical results of similar trade-promotion programswith additional allowances for any unique facts and circumstances.  Trade-promotion programs include cooperativemarketing programs, temporary price reductions, slotting and othertrade-promotion activities conducted by the retail customer. Trade-promotioncosts are recorded as a reduction of product sales.  If our actual costs of trade-promotionprograms differ from our historical results, actual product sales will differfrom those estimated and the differences could be material.

 

***IdentifiedIntangible Assets*****In conjunction withthe recent acquisition of Amerifit, we have recorded customer relationship andtrademark intangible assets as part of our recognition and measurement of assetsacquired and liabilities assumed. Identifiable intangible assets, such asthose, 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 insuch areas as growth rates, profitability and the discount rate applied to thecash flows.  While we believe the fairvalues assigned to our acquired intangible assets are based on reasonable estimatesand assumptions given the available facts and circumstances as of theacquisition dates, unanticipated market events may occur which could affect theaccuracy or validity of the estimates and assumptions.

 

We believe thatthe acquired customer relationships have an estimated useful life of 18 yearsbased on estimates of value derived from these relationships andattrition.  The acquired trademarks havean indefinite useful life due to the fact that no legal, regulatory,contractual, competitive, economic or any other factors that may limit theperiod over which the acquired trademarks are expected to contribute directlyor indirectly to our

 

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future cash flows.Due to their indefinite life, the trademarks will not be amortized. Differentconclusions with respect to the amortizability of the trademarks or the periodover which the customer relationships are amortized could have a materialeffect on our results of operations.

 

Thenon-amortizing trademarks will be tested annually for impairment, or morefrequently, if events or changes in circumstances indicate that the asset mightbe impaired. In assessing the recoverability of the trademarks, we will makeassumptions about our estimated future cash flows and other factors todetermine the fair value of these assets.  If the Company does notachieve its growth targets as contemplated, the Company may need to record animpairment charge in the future.

 

***Impairmentof Goodwill*********Goodwill istested for impairment annually, on August 1, or more frequently whenevents occur or circumstances change that would more likely than not reduce thefair value of the asset below its carrying amount.    Judgments regarding the existence ofimpairment indicators, including lower than expected cash flows from theacquired Amerifit business, are based on variety of factors including marketconditions and operational performance. Future events could cause us toconclude that impairment indicators exist. The Company estimates fair valueusing valuation techniques such as discounted cash flows. This requiresmanagement to make assumptions regarding future income, working capital anddiscount rates. Different assumptions could affect the fair value determinationand ultimately the need to record an impairment charge in the future.

 

**RESULTS OF OPERATIONS**

 

***Revenues***

 

The following table presents revenues bycategory (in thousands):

 
| ** **                                | ** ** | **Three months ended April 30,** | ** ** | **Six months ended April 30,** | ** ** |
|-------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                      |       |                                  |       |                                |       |   |   |   |   |
| Product sales                             |       | $                                     | 119,082    |                                | $          | 88,152 |   | $ | 203,168 |   | $ | 172,174 |   |
| Contract manufacturing and collaborations |       | 4,886                                 |       | 4,259                               |       | 10,556 |   | 7,600 |   |
| Total revenues                            |       | $                                     | 123,968    |                                | $          | 92,411 |   | $ | 213,724 |   | $ | 179,774 |   |

 

Product sales increased $30.9 million or 35%in the three months ended April 30, 2010 as compared to the three monthsended April 30, 2009 and increased $31.0 million or 18% in the six monthsended April 30, 2010 as compared to the six months ended April 30,2009.  This increase was partiallyattributable to the branded consumer health product sales of our newly-acquiredAmerifit subsidiary, which totaled $18 million for the period from theacquisition date (February 12, 2010) through April 30, 2010.  The remainder of the increase, or $12.9million, was the result of growth in demand for our nutritional ingredients inboth the infant formula and non-infant formula markets. Demand increasesoutside the United States, particularly in Asia, were a key driver of thisgrowth. We believe that a portion of the nutritional ingredient revenueincrease, estimated to be in the range of $4 million to $8 million, wasassociated with inventory stocking in the ordinary course by our customersfollowing depletion of inventories in 2009 as well as their production timingand related product ordering patterns.

 

Product sales were comprised of the following(in thousands):

 
| ** **                                                           | ** ** | **Three months ended April 30,** | ** ** | **Six months ended April 30,** | ** ** |
|----------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                           | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                                                 |       |                                  |       |                                |       |   |   |   |   |
| Nutritional ingredients:                                             |       |                                  |       |                                |       |   |   |   |   |
| Infant formula                                                       |       | $                                     | 86,318     |                                | $          | 77,383 |   | $ | 157,859 |   | $ | 151,974 |   |
| Food and beverage                                                    |       | 4,519                                 |       | 2,979                               |       | 8,712 |   | 5,597 |   |
| Pregnancy and nursing, nutritional supplements and  animal nutrition |       | 8,831                                 |       | 6,801                               |       | 16,201 |   | 12,465 |   |
| Total nutritional ingredients                                        |       | 99,668                                |       | 87,163                              |       | 182,772 |   | 170,036 |   |
|                                                                 |       |                                  |       |                                |       |   |   |   |   |
| Branded consumer health products                                     |       | 18,009                                |       | —                              |       | 18,009 |   | — |   |
|                                                                 |       |                                  |       |                                |       |   |   |   |   |
| Non-nutritional products                                             |       | 1,405                                 |       | 989                                 |       | 2,387 |   | 2,138 |   |
| Total product sales                                                  |       | $                                     | 119,082    |                                | $          | 88,152 |   | $ | 203,168 |   | $ | 172,174 |   |

 

Approximately 78% and 76% of our nutritionalingredients sales in the three and six months ended April 30, 2010,respectively, were generated by sales to our top five nutritional ingredientscustomers.  In addition, approximately51% of our branded consumer health products sales in both the three and sixmonths ended April 30, 2010 was generated by sales to our top two brandedconsumer health products customers. Although we are not given preciseinformation by our customers as to the countries in which our nutritionalingredients are sold, we estimate that approximately 50% of our nutritionalingredients sales for the three and six

 

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months ended April 30, 2010 and the threeand six months ended April 30, 2009 relate to sales in the U.S. Virtuallyall sales of our branded consumer health products are to customers in the U.S.

 

As of April 30, 2010, we estimate thatformula supplemented with our oils had penetrated almost all of the U.S. infantformula market.

 

Weexpect that our future nutritional ingredients sales will continue to besubject to quarter-to-quarter fluctuations and will continue to be dependent toa significant degree upon the following factors: (i) the expansions ofcurrent products containing our nutritional ingredients by our customers in newand existing markets; (ii) the launches of new products containing ournutritional ingredients by current or future customers and the success in themarketplace of such launches; (iii) the timing and extent of stocking andde-stocking of inventory by our customers; (iv) the levels of inclusion ofour oils in infant formula; (v) the timing and extent of our customers’production campaigns and plant maintenance shutdowns; and (vi) theavailability and use by our customers and others of competitive products.

 

Weexpect that our future branded consumer health product sales will also besubject to quarter-to-quarter fluctuations and will be dependent to asignificant degree upon the following factors: (i) including the timingand effectiveness of product promotions and advertising campaigns by us or ourcompetitors; (ii)  new product launches by us or our competitors; and (iii) thetiming and extent of stocking and de-stocking of inventory by our customers.

 

Contractmanufacturing and collaborations revenues totaled approximately $4.9 millionand $10.6 million in the three and six months ended April 30, 2010, respectively,and $4.3 million and $7.6 million in the three and six months ended April 30,2009, respectively.  Of the totalcontract manufacturing and collaborations revenue in the three and six monthsended April 30, 2010, approximately $3.9 million and $8.5 million,respectively, relates to contract manufacturing activities that we anticipateexiting, in large measure, in the third quarter of fiscal 2010.  The remaining $1.0 million and $2.1 millionin the three and six months ended April 30, 2010, respectively, relates tothe revenues associated with Martek’s joint development agreement with BP forwork on microbial oils for use in biofuels, which began in late fiscal 2009 andis expected to continue through at least 2011.    The cessation of contract manufacturingactivities is not expected to have any material impact on our financialcondition or results of operations.

 

As aresult of the above, total revenues increased by $31.6 million or 34.1% in thethree months ended April 30, 2010 as compared to the three months ended April 30,2009, and total revenues increased by $34.0 million or 18.9% in the six monthsended April 30, 2010 as compared to the six months ended April 30,2009.

 

***Costof Revenues***

 

The following table presents our cost ofrevenues (in thousands):

 
| ** **                                        | ** ** | **Three months ended April 30,** | ** ** | **Six months ended April 30,** | ** ** |
|---------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                        | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                              |       |                                  |       |                                |       |   |   |   |   |
| Cost of product sales                             |       | $                                     | 62,362     |                                | $          | 49,299 |   | $ | 108,299 |   | $ | 96,208 |   |
| Cost of contract manufacturing and collaborations |       | 4,097                                 |       | 4,017                               |       | 9,330 |   | 7,426 |   |
| Total cost of revenues                            |       | $                                     | 66,459     |                                | $          | 53,316 |   | $ | 117,629 |   | $ | 103,634 |   |

 

Cost ofproduct sales as a percentage of product sales improved to 52% in the threemonths ended April 30, 2010 from 56% in the three months ended April 30,2009 and improved to 53% in the six months ended April 30, 2010 from 56%in the six months ended April 30, 2009. The decrease in the comparativethree and six months was due to ARA cost reductions and the positive impact ongross margins of branded consumer health product sales.  Included in the gross margin for the secondquarter of fiscal 2010 is the negative effect of approximately $1.7 million ofone-time inventory step-up in fair value resulting from the Amerifitacquisition.

 

Cost ofcontract manufacturing and collaborations was $4.1 million and $9.3 million inthe three and six months ended April 30, 2010, respectively, and $4.0million and $7.4 million in the three and six months ended April 30, 2009,respectively.  Our contract manufacturingand services margins vary between periods primarily due to contract mix andvolume.

 

See “Management Outlook” for discussion ofexpected operating resultsfor the second half of fiscal 2010.

 

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***OperatingExpenses***

 

The following table presents our operatingexpenses (in thousands):

 
| ** **                          | ** ** | **Three months ended April 30,** | ** ** | **Six months ended April 30,** | ** ** |
|-------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                          | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                |       |                                  |       |                                |       |   |   |   |   |
| Research and development            |       | $                                     | 8,821      |                                | $          | 7,157 |   | $ | 15,887 |   | $ | 13,906 |   |
| Selling, general and administrative |       | 17,926                                |       | 12,280                              |       | 30,706 |   | 25,031 |   |
| Advertising and promotion           |       | 3,965                                 |       | 595                                 |       | 4,474 |   | 941 |   |
| Amortization of intangible assets   |       | 2,594                                 |       | 1,595                               |       | 4,039 |   | 3,376 |   |
| Acquisition costs                   |       | 1,801                                 |       | —                              |       | 2,988 |   | — |   |
| Other operating expenses            |       | 171                                   |       | 569                                 |       | 205 |   | 722 |   |
| Total operating expenses            |       | $                                     | 35,278,    |                                | $          | 22,196 |   | $ | 58,299 |   | $ | 43,976 |   |

 

Our research and development costs increasedby $1.7 million or 23% in the three months ended April 30, 2010 ascompared to the three months ended April 30, 2009 and increased by $2.0million or 14% in the six months ended April 30, 2010 as compared to thesix months ended April 30, 2009. The increases were due to our expanded clinical and pre-clinicalresearch activities along with higher personnel costs.  Our research and development efforts continueto focus on: (i) broadening the scientific evidence supporting ourproducts; (ii) improving manufacturing processes; (iii) broadeningthe market applications for the Company’s *life’sDHA*TM; and(iv) leveraging our microbialtechnology platform to develop new high-value product offerings. Wecontinue to expect quarter-to-quarter fluctuations in research and developmentexpenses mainly due to the timing of outside services, including third-partyclinical trial services.

 

Our selling, general and administrative costsincreased by $5.6 million or 46% in the three months ended April 30, 2010as compared to the three months ended April 30, 2009 and increased by $5.7million or 23% in the six months ended April 30, 2010 as compared to thesix months ended April 30, 2009.  These increases include expenses attributable to Amerifit, which totaled$3.4 million for the period from the acquisition date through April 30,2010, and increases to the estimate of annual incentive compensation payoutsbased on the probable achievement of certain pre-established operational andfinancial goals for the year.

 

Advertising and promotion increased fromapproximately $600,000 in the three months ended April 30, 2009 to $4.0million in the three months ended April 30, 2010 and increased fromapproximately $900,000 in the six months ended April 30, 2009 to $4.5million in the six months ended April 30, 2010.  These increases resulted from advertising andpromotion attributable to Amerifit from the date of acquisition through April 30,2010.  We anticipate significantadvertising and promotion expenses each quarter; however, quarter-to-quarterfluctuations will occur as a result of the timing of particular advertising andpromotion campaigns.

 

We capitalize patent application and patentdefense costs in addition to certain other external costs related to ourintellectual property portfolio to the extent that we anticipate a futureeconomic benefit or an alternate future use is available to us from suchexpenditures. We amortize these costs over the expected life of the respectiveassets. We recorded amortization expense related to our intangible assets of$2.6 million and $4.0 million in the three and six months ended April 30,2010, respectively, and $1.6 million and $3.4 million in the three and sixmonths ended April 30, 2009, respectively. The increase in the three and six months ended April 30, 2010includes $1.3 million amortization associated with the intangible assetsacquired with Amerifit for the period from date of acquisition through April 30,2010, partially offset by certain assets becoming fully amortized in the priorperiod. See Item 1. “Legal Proceedings” of Part II of this Form 10-Qfor further discussion of certain patent matters.

 

Acquisition costs relate primarily toinvestment banking and professional service fees incurred during the six monthsended April 30, 2010 associated with the Amerifit acquisition, which underASC 805, “Business Combinations”, are required to be expensed as incurred.  There were no acquisition-related costsincurred in the 2009 periods.

 

***Interestand Other Income, Net***

 

Interestand other income, net, decreased by $300,000 in the three months ended April 30,2010 as compared to the three months ended April 30, 2009 and decreased by$600,000 in the six months ended April 30, 2010 as compared to the sixmonths ended April 30, 2009 due primarily to lower cash balances and interestrates earned on those cash balances.

 

***InterestExpense***

 

Interestexpense increased by $1.3 million in the three and six months ended April 30,2010 as compared to the three and six months ended April 30, 2009 due tointerest costs incurred on borrowings used to finance the Amerifit acquisition.See Note 11 to the consolidated financial statements for additional discussionof the Former Facility and the Credit Agreement we entered in January 2010,as amended in March 2010.

 

***IncomeTax Provision***

 

Theprovision for income taxes reflected an effective tax rate of 40.0% and38.9%  in the three and six months ended April 30,2010, respectively, and 35.5% and 36.6% in the three and six months ended April 30,2009, respectively.  The higher effectivetax rate in the 2010 periods results from the non-deductibility of certainexpenses incurred related to the acquisition of Amerifit.

 

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As of October 31,2009, we had net operating loss carryforwards for Federal income tax purposesof approximately $82 million, which expire at various dates between 2021 and2025. The timing and manner in which U.S. net operating loss carryforwards maybe utilized may be limited if we incur a change in ownership as defined under Section 382of the Internal Revenue Code.  Althoughwe have net operating losses available to offset future taxable income, we maybe subject to Federal alternative minimum taxes.

 

***NetIncome***

 

As aresult of the foregoing, net income was $12.5 million in the three months endedApril 30, 2010 as compared to net income of $11.0 million in the threemonths ended April 30, 2009, and net income was $22.2 million in the sixmonths ended April 30, 2010 as compared to net income of $20.6 million inthe six months ended April 30, 2009.

 

***SegmentProfitability***

 

Weoperate in two material business segments, the development andcommercialization of high-value nutritional ingredients products from microbialsources and, with the acquisition of Amerifit in February 2010, the marketingand sale of branded consumer health products.  Outside of these two segments, we derive revenues primarily fromcontract manufacturing and collaborations, which are included in “other” in thetable below. Segment profitability is measured based on income from operations.As follows is segment operating performance (in thousands).

 
| ** **                                 | ** ** | **Three months ended April 30,** | ** ** | **Six months ended April 30,** | ** ** |
|--------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                 | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                       |       |                                  |       |                                |       |   |   |   |   |
| **Segment Income (Loss) From  Operations** |       |                                  |       |                                |       |   |   |   |   |
| Branded consumer health products           |       | $                                     | 1,893      |                                | $          | — |   | $ | 1,893 |   | $ | — |   |
| Nutritional ingredients                    |       | 19,680                                |       | 17,149                              |       | 35,320 |   | 32,591 |   |
| Other                                      |       | 658                                   |       | (250                                | )          | 583 |   | (427 | ) |
| Total                                      |       | $                                     | 22,231     |                                | $          | 16,899 |   | $ | 37,796 |   | $ | 32,164 |   |

 

Theprofitability of the nutritional ingredients segment increased in both thethree and six months ended April 30, 2010 as compared to the comparable prioryear periods due primarily to the revenue growth and gross margin improvementsnoted above. Profitability of the combined contract manufacturing andcollaborations groups increased primarily as a result of our contract mix andour joint development agreement with BP for work on microbial oils for use inbiofuels, which began in late fiscal 2009. 

 

**RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS**

 

In December 2007,the FASB issued Statement No. 141(R), “Business Combinations”, which hasprincipally been codified in FASB Accounting Standards Codification (“ASC”)Topic 805, “Business Combinations” (“ASC 805”).  ASC 805 establishes principles andrequirements for how an acquirer recognizes and measures in its financialstatements the identifiable assets acquired, the liabilities assumed, anynoncontrolling interest in the acquiree and the goodwill acquired. ASC 805 alsoestablishes disclosure requirements to enable the evaluation of the nature andfinancial effects of the business combination. ASC 805 was effective for usbeginning with the first quarter of fiscal 2010. As further described in Note 3to the consolidated financial statements, we acquired Charter Amerifit LLC andall of its subsidiaries (“Amerifit”) in February 2010. The adoption of ASC805 did not have a cumulative effect upon adoption; however, ASC 805 will bematerial to our financial condition and results of operations.  Specifically, the adoption of ASC 805required the immediate expensing of acquisition-related costs and additionalimpacts of ASC 805 are anticipated as the total purchase price is allocated toAmerifit’s net tangible and intangible assets based on their estimated fairvalues on the date of acquisition.

 

In October 2009,the FASB issued Accounting Standards Update No. 2009-13, “RevenueRecognition (Topic 605)—Multiple-Deliverable Revenue Arrangements: a consensusof the FASB Emerging Issues Task Force” (“ASU 2009-13”). ASU 2009-13establishes a selling-price hierarchy for determining the selling price of eachelement within a multiple-deliverable arrangement. Specifically, the sellingprice assigned to each deliverable is to be based on vendor-specific objectiveevidence (“VSOE”), if available, third-party evidence, if VSOE is unavailable,and estimated selling prices if neither VSOE or third-party evidence isavailable. In addition, ASU 2009-13 eliminates the residual method ofallocating arrangement consideration and instead requires allocation using therelative selling price method. ASU 2009-13 will be effective prospectively formultiple-deliverable revenue arrangements entered into, or materially modified,in fiscal years beginning on or after June 15, 2010. We are assessing whatimpact, if any, the adoption of ASU 2009-13 may have on our consolidatedfinancial statements.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

We havefinanced our operations primarily from the following sources:

 

·                  cash generated from operations;

·                  debt financing; and

·                  cash received from the exercise of stock options.

 

Ourcash flows for the six months ended April 30, 2010 and 2009 were asfollows (in thousands):

 
| ** **                                           | ** ** | **Six  months ended April 30,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                           | ** ** | **2010**                             | ** ** | **2009** | ** ** |
|                                                 |       |                                 |       |   |   |
| Net cash provided  by operating activities           |       | $                                    | 62,974     |   | $ | 25,631 |   |
| Net cash used in  investing activities               |       | (209,978                             | )          | (9,698 | ) |
| Net cash  provided by (used in) financing activities |       | 36,150                               |       | (484 | ) |
| Foreign currency  translation adjustment             |       | (2                                   | )          | — |   |
| Total cash (outflows) inflows                        |       | $                                    | (110,856   | ) | $ | 15,449 |   |

 

Cash and cash equivalents decreased $110.9million since October 31, 2009 due to the acquisition of Amerifit in February 2010.  To finance the Amerifit acquisition, weutilized existing cash of approximately $115 million, the proceeds from a termloan totaling $75 million and $11 million drawn from our revolving creditfacility (see below for further discussion) and approximately $17 million ofcash held by Amerifit at closing.  Ourincome excluding non-cash items of approximately $56 million in the six monthsended April 30, 2010 contributed to the generation of $63.0 million in cashfrom operating activities. Capital expenditures, including both property andequipment as well as patent and other intangible asset costs, totaled $9.3million during the six months ended April 30, 2010.   Our financing activities in the six monthsended April 30, 2010 primarily include borrowings described above tofinance the acquisition of Amerifit, of which the $11 million borrowed underthe revolving credit facility was repaid

 

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in full and $35 million of borrowings underthe Term Loan were repaid by April 30, 2010.  As of April 30, 2010, the Term Loan hada remaining principal balance of $40 million. The Company expects to repay the remaining balance on the Term Loan by October 31,2010.

 

As of April 30, 2010, we hadapproximately $30.2 million in cash and cash equivalents.  In January 2010, we entered into aCredit Agreement, subsequently amended in March 2010 (the “CreditAgreement”), that includes a $75 million term loan (the “Term Loan”) and a $100million secured revolving credit facility (the “Revolver”).  The Credit Agreement  replaced our existing $135 million creditfacility.

 

The Term Loan and the Revolver arecollateralized by certain of our and our subsidiaries’ assets, includingaccounts receivable, deposit accounts, inventory and certain software, generalintangibles and records pertaining to the foregoing as well as a pledge of 100%of our  domestic subsidiaries’equity.  The Revolver, which may beincreased during the term of the facility by up to an additional $50 millionsubject to certain conditions, expires in February 2013.  The TermLoan matures in February 2013. We are required to make quarterlyinstallment payments on the Term Loan of $3,750,000, which began in April 2010,plus additional annual repayments on January 31 of each year based onconsolidated excess cash flow, as defined in the Credit Agreement, of the precedingfiscal year.  As noted above, we madeadditional discretionary repayments during the quarter ended April 30,2010 and expect to be able to repay the Term Loan, in full, by October 31,2010, in advance of the mandatory repayment schedule.

 

The Term Loan will bear interest at theelection of Martek at either LIBOR plus up to 3.375% or a base rate plus up to1.25% depending upon the consolidated leverage ratio during each precedingfiscal quarter. The Revolver will bear interest at the election of Martek ateither LIBOR plus up to 3.00% or a base rate plus up to 1.00% depending uponthe consolidated leverage ratio during each preceding fiscal quarter.  Thebase rate is the higher of the lender’s prime rate, the federal funds rate plus0.50% or LIBOR plus 1.50%.  For purposes of the Credit Agreement, LIBOR isthe greater of 1.25% per annum or LIBOR at the time of such determination.  The commitment fee rate under the CreditAgreement of up to 0.50% on the Revolver is based on our consolidated leverageratio during each preceding fiscal quarter. Among other things, the CreditAgreement contains restrictions on future debt, the payment of dividends andthe further encumbrance of assets. In addition, the Credit Agreement requiresthat we comply with specified financial ratios and tests, including minimumcoverage ratios and maximum leverage ratios. As of April 30, 2010, we were in compliance with all loancovenants.

 

At April 30, 2010, our investments had afair value of $10.8 million and consisted primarily of auction rate securities(“ARS”), the underlying assets of which are student loans originated under theFederal Family Education Loan Program (“FFELP”).  FFELP student loans are guaranteed by stateguarantors who have reinsurance agreements with the U.S. Department ofEducation.  These ARS are intended toprovide liquidity via an auction process that resets the applicable interestrate approximately every 30 days and allows investors to either roll over theirholdings or gain immediate liquidity by selling such investments at par. Theunderlying maturities of these investments range from 16 to 38 years.  Since February 2008, as a result ofnegative conditions in the global credit markets, the large majority of theauctions for our investment in these securities have failed to settle,resulting in Martek continuing to hold such securities.  Consequently, the investments are notcurrently liquid and we will not be able to access these funds, except as notedbelow, until a future auction of these investments is successful, a buyer isfound outside of the auction process or the investments reach their contractualmaturity date.  To this end, in November 2008,we executed an auction rate securities rights agreement (the “Put Agreement”)with a financial institution that provides us the ability to sell certain ofour ARS to the financial institution and allows the financial institution, atits sole discretion, to purchase such ARS at par during the period June 30,2010 through July 2, 2012.  In May 2010,we alerted the financial institution of our intention to sell the ARS coveredby the Put Agreement on June 20, 2010. Our ARS holdings to which this relates have a cost basis ofapproximately $7.3 million and a fair value at April 30, 2010 ofapproximately $6.2 million.  The PutAgreement, which is deemed a discrete short-term investment, has a recordedfair value at April 30, 2010 of approximately $1.1 million.  Due to the Company’s intent to sell its ARScovered by the Put Agreement to the financial institution on June 30,2010, the investment values of the Put Agreement and the ARS to which the PutAgreement relates are classified as short-term investments in the accompanyingconsolidated balance sheet as of April 30, 2010.  We based our valuation of these ARS and thePut Agreement on discounted cash flow models that include various unobservableinputs.  Changes to the inputs used as ofApril 30, 2010 would cause fluctuations to the fair value of the affectedinstruments and such fair value changes could be material.

 

Thefollowing table sets forth our future minimum payments under contractualobligations at April 30, 2010:

 
| ** **                                   | ** ** | ** ** | ** ** | **Less than** | ** ** | **1-3**    | ** ** | **3-5**    | ** ** | **More than** | ** ** |
|----------------------------------------------|------------|------------|------------|---------------|------------|------------|------------|------------|------------|---------------|------------|
| **In thousands**                             | ** ** | **Total**  | ** ** | **1 year**    | ** ** | **years**  | ** ** | **years**  | ** ** | **5 years**   | ** ** |
| ** **                                   | ** ** | ** ** | ** ** | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** | ** **    | ** ** |
| Notes payable  (1)                           |       | $          | 520        |          | $          | 66         |       | $          | 77         |          | $          | 77 |   | $ | 300 |   |
| Borrowings under  Term Loan (1)              |       | 41,930     |       | 16,308        |       | 25,622     |       | —     |       | —        |       |
| Borrowings under  Revolver                   |       | —     |       | —        |       | —     |       | —     |       | —        |       |
| Long-term license fee obligation (2)         |       | 2,450      |       | 792           |       | 1,533      |       | 125        |       | —        |       |
| Operating lease  obligations (3)             |       | 10,969     |       | 2,025         |       | 2,834      |       | 2,213      |       | 3,897         |       |
| Unconditional  purchase obligations (4), (5) |       | 145,523    |       | 87,447        |       | 58,076     |       | —     |       | —        |       |
| Total  contractual cash obligations (6)      |       | $          | 201,392    |          | $          | 106,638    |       | $          | 88,142     |          | $          | 2,415 |   | $ | 4,197 |   |

 

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(1)          Minimum payments above include interest and principal.

(2)          Excludes$2.5 million of additional license fees due if we exercise certain commerciallybeneficial rights in the future.

(3)          Includesrenewal and expansion of Columbia headquarters facility leases part of whichexpire in 2015, with the remainder expiring in 2020.

 

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(4)   Comprisedof future inventory purchases from DSM pursuant to minimum purchasecommitment.  Excludes any additional futureinventory purchases from DSM pursuant to the Restated Agreement or thepotential payment by us associated with our rights to terminate the RestatedAgreement after 2012.  A terminationpayment by us as of January 1, 2013 would currently range from $15 millionto $20 million and a termination payment as of January 1, 2016 wouldcurrently range from less than $1 million to $7 million (see Note 5 to theconsolidated financial statements).

(5)   Excludes$5.6 million of financial commitments associated with a research collaborationthat are contingent upon the successful completion of identified milestones(see Note 12 to the consolidated financial statements).

(6)   Thetable above excludes uncertain tax payments of $2.8 million, the timing ofwhich is uncertain.

 

We believe that the Revolver, when combinedwith our cash and cash equivalents on-hand at April 30, 2010, andanticipated operating cash flows, will provide us with adequate capital to meetour obligations for at least the next 12 to 18 months. The ultimate amountof capital that we may require will depend, among other things, on one or moreof the following factors:

 

·                  our ability to operate profitably and generate positive cashflow;

·                  our ability to enter into new or extend existing sole sourceinfant formula supply agreements;

·                  the level of sales of our infant formula, food and beverageand other nutritional products and of our branded consumer health products;

·                  the extent and progress of our research and developmentprograms;

·                  the cost and progress of pre-clinical and clinical studies;

·                  the time and costs of obtaining and maintaining regulatoryclearances for our products that are subject to such clearances;

·                  the costs involved in filing, protecting and enforcingpatent claims;

·                  competing technological and market developments;

·                  the development or acquisition of new products;

·                  the cost of acquiring additional and/or operating andexpanding existing manufacturing facilities for our various products andpotential products (depending on which products we decide to manufacture andcontinue to manufacture ourselves);

·                  the costs associated with our internal build-up of inventorylevels;

·                  the costs associated with litigation to which we are aparty;

·                  the costs associated with integrating Amerifit into ouroperations;

·                  the costs of, and any capital requirements related to,future merger and acquisition activity; and

·                  the costs of marketing and commercializing our products.

 

We canoffer no assurance that, if needed, any of our financing alternatives will beavailable to us on terms that would be acceptable, if at all.

 

**MANAGEMENTOUTLOOK**

 

Martek is providingcertain financial information for Amerifit on a stand-alone basis to provideinvestors greater clarity through the integration process. Projected resultsfor Martek (not including Amerifit), Amerifit (stand-alone, post-acquisition)and on a consolidated basis for the three months ended July 31, 2010 areas follows:

 
| ** **                                | ** ** | **Three months ended July 31, 2010** |
|-------------------------------------------|------------|-------------------------------------------|
| **(in millions, except per share  data)** | ** ** | **Martek**                                | ** ** | **Amerifit** | ** ** | **Consolidated** |
|                                      |       |                                      |   |   |   |   |
| Revenue                                   |       | $                                         | 93.0 — 97.0 |   | $ | 19.0 — 21.0 |   | $ | 113.0 — 118.0 |
| Income  from operations                   |       | $                                         | 17.0 — 18.0 |   | $ | 2.0 — 3.0 |   | $ | 19.0 — 21.0 |
| Net  income                               |       |                                      |   |   |   | $ | 11.0 — 12.0 |
|                                      |       |                                      |   |   |   |   |   |
| Diluted  EPS                              |       |                                      |   |   |   | $ | 0.33 — 0.36 |

 

For the third quarter of fiscal 2010, Martekexpects infant formula revenue to be between $76.0 million and $80.0 million,non-infant formula nutritional revenue to be between $12.0 million and $14.0million, and contract manufacturing and collaborations revenue to be between$2.5 million and $3.0 million.

 

Consolidated gross margin in the third quarterof fiscal 2010 is expected to be between 49% and 50%.

 

While our revenuesfor the balance of 2010 are projected to be somewhat uneven on aquarter-to-quarter basis due to customer plant shutdowns for maintenance andother timing matters, Martek expects full fiscal year 2010 revenue to bebetween $440 million and $445 million, including infant formula revenues ofbetween $307 million and $312 million. These forecasted revenues includeprojected fourth quarter 2010 revenues similar to those projected for Martek’sthird quarter. Such projected fourth quarter revenues would equate toyear-over-year growth of more than 25%. Furthermore, the projected 2010 annualrevenues would represent year-over-year growth in total revenues of 27% to 29%(9% to 11% excluding Amerifit-related revenues) and contemplate meaningfulgains in all markets for our nutritional ingredients, including growth ininfant formula revenues of 7% to 9% and growth in non-infant formulanutritional revenues of 27% to 35%.

 

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**Item 3. Quantitative and QualitativeDisclosures about Market Risk.**

 

We are subject to market risk associated withchanges in foreign currency exchange rates and interest rates.

 

In July 2009,we entered into the First Amended and Restated ARA Alliance, Purchase, andProduction Agreement (the “Restated Agreement”) with DSM.  As part of the agreement, it was establishedthat 25% of the ARA we buy from DSM will be denominated in Euros.  As such, consistent with our paymentarrangements with DSM prior to the execution of the Restated Agreement, we areexposed to risks related to changes in exchange rates between the U.S. dollarand the Euro.  We enter into foreigncurrency cash flow hedges to reduce the related market risk on our paymentobligations.  We do not enter intoforeign currency cash flow hedges for speculative purposes.  At April 30, 2010, we had unrealizedlosses on such hedge instruments totaling approximately $9,000, net of incometaxes.  To the extent not covered bythese hedge instruments, fluctuations between the U.S. dollar and the Euro willimpact our cost of ARA oil and gross margins. We estimate that a 5% change in the Euro-U.S. dollar exchange rate wouldimpact gross margins of our infant formula products by less than 0.5%.

 

We aresubject to risk from adverse changes in interest rates, primarily relating tovariable-rate borrowings under the Credit Agreement. The Term Loan and theRevolver bear interest at rates that are determined by reference to, at theelection of the Company, LIBOR or a base rate that is equal to the higher ofthe lender’s prime rate, the federal funds rate plus 0.50 % or LIBOR plus1.50%.  Based on variable-rate borrowingsof $40 million outstanding at April 30, 2010, we estimate that a 1%increase in either LIBOR or the base rate would impact our net income byapproximately $300,000.

 

We have investments at April 30, 2010with a fair value of $11.9 million, which consist primarily of auction rate securities(“ARS”). These ARS are intended to provide liquidity via an auction processthat resets the applicable interest rate approximately every 30 days and allowsinvestors to either roll over their holdings or gain immediate liquidity byselling such investments at par. Since February 2008, as a result ofnegative conditions in the global credit markets, the large majority of theauctions for our investment in these securities have failed to settle,resulting in our continuing to hold such securities. Based on the estimatedfair value of the ARS, during fiscal 2008 through fiscal 2010, we recorded netunrealized losses on these securities totaling approximately $2.1 million ($1.3million, net of income tax benefit), reflecting the decline in the estimatedfair value of these securities.  Wecontinue to monitor the market for auction rate securities and consider itsimpact, if any, on the fair value of these investments. If current marketconditions deteriorate further, the Company may be required to recordadditional write-downs. In November 2008, we executed an auction ratesecurities rights agreement (the “Put Agreement”) with a financial institutionthat provides us the ability to sell certain of our ARS to the financialinstitution and allows the financial institution, at its sole discretion, topurchase such ARS at par during the period June 30, 2010 through July 2,2012. In May 2010, Martek alerted the financial institution of the Company’sintention to sell the ARS covered by the Put Agreement on June 30, 2010.  Our ARS holdings to which this relates have acost basis of approximately $7.3 million and a fair value at April 30,2010 of approximately $6.2 million.  ThePut Agreement, which is deemed a discrete short-term investment, has a recordedfair value of $1.1 million.  The benefitsof the Put Agreement are subject to the continued expected performance by thefinancial institution of its obligations under the agreement.  We based our valuation of these ARS and thePut Agreement on discounted cash flow models that include various unobservableinputs.  Changes to the inputs used as ofApril 30, 2010 would cause fluctuations to the fair value of the affectedinstruments and such fair value changes could be material.

 

**Item 4. Controls and Procedures.**

 

a)              *Evaluationof Disclosure Controls and Procedures.*As of the end of the periodcovered by this report, we, under the supervision and with the participation ofour management, including our Chief Executive Officer and Chief FinancialOfficer, have evaluated the effectiveness of our disclosure controls andprocedures pursuant to Exchange Act rules 13a-15(e) and15d-15(e).  Based on this evaluation, ourChief Executive Officer and Chief Financial Officer have concluded that, as ofthe end of the period covered by this report, the disclosure controls andprocedures were effective.

 

b)             *InternalControl Over Financial Reporting.* There was no change in ourinternal control over financial reporting in connection with the evaluationrequired by paragraph (d) of Rules 13a-15 or 15d-15 under theExchange Act that occurred during Martek’s quarter ended April 30, 2010that materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

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**PART II- OTHER INFORMATION**

 

**Item1.  Legal Proceedings.**

 

Information regarding reportable legalproceedings is contained in Item 3. “LegalProceedings” of Part I of our Annual Report on Form 10-Kfor the year ended October 31, 2009 and Item 1. “Legal Proceedings” of Part IIof  our Quarterly Report on Form 10-Qfor the period ended January 31, 2010, as well as in the other reports wefile with the Securities and Exchange Commission (the “SEC”). The following isprovided to supplement and update the description of reportable legalproceedings contained in those reports:

 

**Aventis S.A. and Nagase &Co. Ltd. are challenging our European patent covering our DHA-containing oils,which expires in February 2011.  Ata hearing in October 2000, the Opposition Division of the European PatentOffice (“EPO”) revoked our patent on the grounds that it was not novel. Weimmediately appealed this ruling, and in July 2002 we received a positiveruling from an Appeal Board of the EPO, setting aside the prior decision torevoke this patent. The patent was returned to the Opposition Division for adetermination as to whether it has met the legal requirement of “inventive step”.A hearing in August 2005 resulted in a ruling by the Opposition Divisionthat this requirement had been met and the validity of the patent was upheld.Aventis appealed the decision to the Appeal Board of the EPO.  Martek filed its answer to Aventis’ groundsfor appeal in July 2006.  The appealhearing was scheduled for March 2009. Martek submitted new evidence that the appeal was inadmissible becauseAventis was not the proper party. Because the Appeal Board found that there are questions relating to theadmissibility of Aventis’ appeal, it postponed the hearing and directed theparties to submit additional briefs on this issue.  Aventis submitted its brief in May 2009and Martek submitted its brief in August 2009, and both parties filedfurther briefs.  The Appeal Board hearinghas been scheduled for July 2010, and the Appeal Board will likely issue afinal, oral decision at the end of the hearing. Martek’s patent will remain infull force and effect during the pendency of these proceedings.  Claim 1 of this patent is the basis of thepatent infringement suit against Nutrinova and Lonza in Germany and againstLonza in France, discussed below. In the event Martek were to lose this appeal,this DHA patent would be revoked. The revocation of this patent would result inthe dismissal of the patent infringement suit against Nutrinova and Lonza inGermany and against Lonza in France, discussed below, and patent protection forMartek’s DHA-containing oils for use in infant formula would be compromised inEurope. Currently, annual sales of Martek’s DHA for use in infant formula inEurope to companies other than those with whom Martek has an exclusive supplyagreement are less than $1 million. Such exclusive agreements generally runthrough 2011.  An adverse decision wouldnot impact Martek’s ARA patent position in Europe. Moreover, the outcomeof this appeal will not affect the patent infringement lawsuit againstLonza in the U.S., as the U.S. lawsuit is based on a different family ofpatents.**

** **

Prior to our purchase of OmegaTech in fiscal2002, Aventis Research and Technologies GmbH & Co. KG, and NagaseLimited challenged OmegaTech’s European patent covering its DHA-containingoils. At a hearing in December 2000, the Opposition Division of the EPOupheld some of the claims and revoked other claims. OmegaTech immediatelyappealed this ruling, as did Aventis. At an appeal hearing in May 2005, wereceived a favorable decision from the Appeal Board of the EPO, whichoverturned the decision of the Opposition Division and returned the case to theOpposition Division for review on the merits of the patent claims.  In a November 2007 hearing, theOpposition Division upheld claims that are narrower than the claims originallygranted but broader than the claims that were previously upheld in the December 2000Opposition Division hearing.  Martek andAventis have appealed.  The patent, whichexpires in November 2010, will remain in full force and effect during theappeal process. This appeal involves the same admissibility issues that Aventishas with the appeal of the DHA patent discussed above.

 

In October 2007, the EPO granted a patentto Martek for fermentation processes for producing microbial lipids (e.g., DHAoil) under low dissolved oxygen conditions.  Lonza AG filed an oppositionagainst this process patent in July 2008, and Martek filed a writtenresponse in April 2009.  A hearing before the Opposition Division ofthe EPO in Munich, Germany was held in April 2010. We received a favorableruling in that all the claims were upheld with only minor amendments to some ofthe claims.  This patent is scheduled toexpire in January 2021.

 

In September 2003,we filed a patent infringement lawsuit in the U.S. District Court inDelaware against Nutrinova Inc., Nutrinova Nutrition Specialties &Food Ingredients GmbH, Celanese Ventures GmbH, and Celanese AG. CelaneseVentures GmbH and Celanese AG were dropped from the lawsuit.  Lonza Ltd. was added to the lawsuit.  In October 2006, after an almost twoweek trial in Wilmington, Delaware, the jury returned a favorable verdict toMartek, deciding that all three of the asserted Martek DHA patents were validand infringed, and that one was willfully infringed.  In October 2007, the judge upheld the October 2006jury 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 notinvalid.  The judge has granted apermanent injunction against the defendants with respect to those twopatents.  The judge also upheld the juryverdict that the defendants had acted willfully in their infringement of U.S.Patent No. 6,410,281.  Regarding the third patent involved in thecase, U.S. Patent No. 6,451,567, the judge reversed the jury verdict andfound that the asserted claims of this patent were invalid.  Martek’s request to the judge to reconsiderhis ruling on the third patent was denied. Martek and the defendants appealed aspects of the judge’s final decisionand a hearing was held before the U.S. Court of Appeals for the Federal Circuitin April 2009.  In September 2009, the Court of Appeals ruled inMartek’s favor on all of the patents that were the subject of the appeal, whichincluded U.S. Patent Nos. 5,340,594, 6,410,281, 6,451,567 noted above and5,698,244, which was included in Martek’s appeal as a result of the trial court’sdecision at a pre-trial hearing on the meaning and scope of the patent claimsin dispute. With respect to U.S. Patent No. 5,698,244, the Court ofAppeals reversed the trial court’s interpretation of certain claim language andremanded this patent to the trial court for further proceedings. U.S. PatentNos. 5,340,594 and 6,454,567 have expired and U.S. Patent Nos. 6,410,281 and5,698,244 are scheduled to expire in August 2011 and December 2014,respectively.  The defendants requested arehearing with the Court of Appeals on the decision, but their request wasdenied.  The trial for US Patent No. 5,698,244likely will not occur before 2011. Discovery is expected to be completed before the end of 2010, and thedefendants will be permitted to file a summary judgment motion at the end of2010.

 

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Also, in February 2010, Lonzafiled a Request seeking reexamination of Martek’s U.S. Patent No. 6,410,281, which is the only unexpired patent ofthe three patents that Lonza was found to have infringed in the U.S., asdiscussed above.  The U.S. Patent andTrademark Office granted this Request in March 2010.

 

We also filed a patentinfringement suit involving Nutrinova Nutrition Specialties & FoodIngredients GmbH and Celanese Ventures GmbH in Germany in January 2004.  Lonza Ltd. and a customer of Nutrinova havealso been added to this lawsuit.  Thecomplaint alleges infringement of our European patent relating toDHA-containing oils.  A hearing was heldin a district court in Dusseldorf in September 2007 and the court issuedits decision in October 2007, ruling that Martek’s patent was infringed bythe defendants.  The defendants haveappealed, and an appeal hearing was scheduled for February 2009.  Martek and the defendants requested that theappeal hearing be delayed until the Appeal Board of the EPO decides whether touphold Martek’s European patent covering our DHA-containing oils.  This EPO Appeal Board hearing was scheduledfor March 2009 and has been postponed until July 2010, as discussedabove.  In December 2008, Martekrequested that the court expand the appeal to include Lonza’s production of DHAin Germany, based on evidence discovered in October 2008.

 

We filed a patentinfringement suit involving Lonza Ltd AG and Capsugel France in France in November 2008.  The complaint alleges infringement of ourEuropean patent relating to DHA-containing oils. Lonza’s request that the trialbe delayed until the Appeal Board of the EPO decides whether to uphold Martek’sEuropean patent covering our DHA-containing oils has been granted.  This EPO Appeal Board hearing was scheduledfor March 2009 and has been postponed until July 2010, as discussedabove.  We agreed to dismiss our claimsagainst Capsugel France in November 2009 based on Capsugel and itsaffiliates agreeing to purchase all of their microbial DHA exclusively from Martekfor the life of the patent in question.

 

Martek is opposing two of Suntory’s low sterol ARA oil patents in Europeand one in Australia.  The patents aregenerally directed to processes for producing microbial ARA oil having a lowratio of certain sterols, the resulting oil and its use in infant formula.  Martek believes that the patents are invalidfor a number of reasons, including prior art that anticipates the claimsrelevant to Martek.  An OppositionDivision hearing on the first European patent was held in April 2008, andthe Opposition Division revoked the Suntory patent.  A hearing on the other European patent tookplace in December 2009, resulting in the revocation of the Suntorypatent.  Suntory has appealed bothEuropean decisions, during which time the patents will remain in full force andeffect.  A hearing on the Australianpatent is expected in late 2010 or 2011.

 

In 2008, third parties filed Requestsseeking reexamination of eleven of Martek’s U.S. patents.  Eight of theseRequests were filed by Lonza with respect to eight of Martek’s DHA patentswhich are generally not relevant to Martek’s infant formula business.  Four of these patents have now expired.  Additionally, in 2008 an anonymous partyfiled three other Requests with respect to two of Martek’s blended oils patentsand one ARA patent, all of which relate to our infant formula business.  The U.S. Patent and Trademark Office grantedall eleven of the Requests to initiate a Reexamination process (“Reexamination(s)”). As a result of Reexaminations, the claims of the subject patents may be upheldin their current form, narrowed, abandoned, or revoked, or the term of a patentmay be shortened.  Not all of the claimsof the patents were subject to Reexamination.

 

With respect to the ARA patent, whichis scheduled to expire in August 2014, theReexamination Certificate issued in May 2010.  The ARApatent emerged from this Reexamination with narrower claims, as the broaderproduct claims were canceled.  Specifically, the  reexamined patent contains narrower productclaims and process claims that, among other things, provide patent protectionfor a production process that we believe: i)  results in higher qualityoil and  higher ARA potency and ii) is cost efficient compared to otherprocesses for producing ARA.  Whencombined with our in-licensed patents from our ARA production partner DSM, webelieve that it will be technologically difficult and less cost efficient forcompetitors to design around these claims.  Nonetheless, it is uncertain howmuch protection they will provide.

 

In February 2010, an anonymousparty filed a new Request seeking reexamination of certain claims of Martek’sARA patent, discussed above. Specifically, reexamination of certain claims that were not reexaminedduring the initial Reexamination and reexamination of other claims which havenow been canceled was requested.  TheU.S. Patent and Trademark Office granted this Request in May 2010.

 

We received positive advisory actionsfrom the examiners regarding claims pending in the Reexaminations of two DHApatents that have not expired and the two blended oils patents.  The blended oils patents expire in December 2011,which generally coincides with the expiration of some of our infant formulacustomers’ sole source purchase obligations. All four Reexamination Certificates have issued for these two DHApatents and two blended oils patents.  TheReexaminations are continuing for the remaining two unexpired DHA patents, which do not cover commercially material products or processes.  We received a second office actionrejection for one of these DHA patents in April 2010, and filed a Noticeof Appeal in May 2010, and have until July 2010 to determine whetherto file an appeal brief or allow the rejected claims to be revoked.  We have not yet received a second officeaction in the other, related DHA patent reexamination.  If we are unable to obtain commerciallymeaningful claim coverage, we may appeal within the U.S. Patent and TrademarkOffice, and in the event that we do appeal and receive a negative outcome, wewill have an opportunity to further appeal to the federal courts.  These patents will remain in full force andeffect during the appeal process. However, if the appeals are not successful or are not pursued, some orall of the claims of these patents could be revoked.

 

There are additional intellectualproperty proceedings pending against Martek or that Martek has pending againstthird parties that are not considered material.

 

In addition, from time to time, Martek is aparty to additional litigation or administrative proceedings relating to claimsarising from its operations in the normal course of business or othermatters.  Management believes that theultimate resolution of any such additional litigation or administrativeproceedings currently pending against Martek is unlikely, either individuallyor in the aggregate, to have a material adverse effect on Martek’s results ofoperations or financial condition.

 

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**Item 1A.Risk Factors.**

 

Investing in our securities involves a highdegree of risk. Before making aninvestment decision, you should carefully consider the risks set forth in Item1A. “Risk Factors” of Part I of our Annual Report on Form 10-K forthe year ended October 31, 2009, Item 1A. “Risk Factors” of Part IIof our Quarterly Report on Form 10-Q for the quarter ended January 31,2010 and all other information we include in this report and the additionalinformation in the other reports we file with the Securities and ExchangeCommission (the “SEC”). If any of the risks contained in those reports, ordescribed below, actually occur, our business could be harmed. In such case,the trading price of our securities could decline and you could lose all orpart of your investment.

 

The riskfactors below are provided to supplement and update the risk factors containedin the reports we file with the SEC, including the risk factors containedin Item 1A. of Part I of our Annual Report on Form 10-K for the yearended October 31, 2009 and Item 1A. of Part II of our QuarterlyReport on Form 10-Q for the quarter ended January 31, 2010.  It should be noted that certain of ourpreviously-disclosed risk factors referred and related specifically to ournutritional ingredients business.  Whilethey have not been updated and restated below, on a going forward basis, thesegeneral risks are intended to include all products offered and businesses ownedand operated by Martek, including the branded consumer health products businessof recently-acquired Amerifit.

 

***Our opportunity in the U.S. infant formulamarket, which represents approximately half of our total infant formula sales,may be limited by the renewal rate of supplemented formulas into the Women,Infants and Children program if the eligibility requirements for participatingin the program are made more restrictive, if the amount of infant formulaoffered to participants is reduced, or if legislative changes result in thereduction or elimination of ingredients added to infant formula currentlyprovided under the program.***

 

Weestimate that of the total current annual U.S. market opportunity for sales ofsupplemented infant formula, approximately half represents Women, Infants andChildren (“WIC”)-funded sales.  WIC is afederal grant program that is state-administered for the benefit of low-incomenutritionally at-risk women, infants and children.  Most WIC state agencies provide only onebrand of term infant formula to its participants, depending on which companyhas the infant formula contract in a particular state.  Currently, WIC programs in 50 states and theDistrict of Columbia offer term and certain specialty infant formula productssupplemented with our oils. If supplemented formulas are removed from WICprograms that previously adopted them, eligibility requirements forparticipating in WIC become more restrictive and/or participation decreases, orif any of our customers fail to renew, in a timely fashion, their contractawards from WIC agencies for the adoption of a supplemented infant formula,then our future revenues from supplemented infant formula sales in the U.S.would be limited.  Recently, certainlegislators have proposed draft amendments to the proposed 2010 Healthy,Hunger-Free Kids Act that have the potential to seriously impact the additionof certain ingredients, including DHA and ARA, to infant formula supplied under the WIC program.  If this draft legislation were to be enacted,potential outcomes include, but are not limited to, the commissioning ofstudies to assess the cost benefit justification and/or efficacy rationale forthe inclusion of DHA and ARA in infant formula sold under the program,eliminating these ingredients from infant formula sold under the WIC program,or maintenance of the status quo  forpreviously approved ingredients.  Ifcertain of these possible outcomes were to occur, sales of our oils for use inWIC program infant formula and potentially outside of the WIC program would beadversely impacted.  Further, in December 2007,the USDA, the federal agency which governs WIC, issued an interim final rule whichincluded a reduction in the amount of infant formula to be offered throughWIC.  State WIC agencies had until October 2009to implement this change and the interim  rule comment periodended in  February 2010.  USDA is currently reviewing and analyzingcomments and expects to promulgate a final rule in early 2011. If there isa permanent reduction in the amount of infant formula offered through WIC, thenour future infant formula revenues could be materially adversely affected.

 

***If our oils areunable to be used in organic food and beverage products, the opportunity forsales of our oils into the food and beverage market will be limited tonon-organic products.***

 

TheOrganic Foods Production Act of 1990 required the U.S. Department ofAgriculture (“USDA”) to develop national standards for organically producedagricultural products to assure consumers that agricultural products marketedas organic meet consistent, uniform standards. Accordingly, the USDA has put inplace a set of national standards (the “National Organic Program” or “NOP”)that food labeled “organic” must meet, whether it is grown in the United Statesor imported from other countries. Under the NOP regulations, only aUSDA-accredited certifying agent may make the determination that a food productmay be labeled as organic. Martek is not a USDA-accredited certifying agent.

 

Someof our customers have obtained organic certification from USDA-accreditedcertifying agents and have received authorization to use the USDA’s organicseal on certain products that contain our DHA and ARA-containing oils.  In some instances, such products have beenfurther reviewed and the authorization to use Martek’s oils has been explicitlyratified by the USDA.  Certain advocacygroups, however, have challenged these authorizations and ratifications.  In April 2010, the USDA elected torevise its prior interpretations and ratifications of the specificrecommendations and standards which allowed for the use of nutrients (includingMartek’s DHA and ARA-containing oils) in organic products.  Under the USDA’s revised interpretation, ithas asserted that the regulations do not permit the use of any nutrient(including DHA and ARA) in certified organic products unless the nutrient isconsidered either a vitamin or mineral, or the nutrient has been specificallyreviewed and recommended for inclusion by the National Organic Standards Board(“NOSB”).  The USDA has indicated that itwill issue draft guidance to formalize its revised interpretation later thisyear.  Following a public comment period,it will likely take between three and six months for the USDA’s new guidance tobe finalized.  Thereafter, we anticipatea period of transition for companies currently using previously approvednutrients (including DHA and ARA) to petition the NOSB to have the nutrientsreviewed, recommended and listed as acceptable for use in certified organicproducts, or to make appropriate label changes, or to remove the nutrients fromproducts previously certified organic.

 

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Becausethe NOP regulations are subject to change and interpretation, there can be noguarantee that our oils will continue to be acceptable for use in organicproducts. Organic food sales accounted for approximately 3.5% of the total U.S.food sales in 2008; sales of Martek’s oils for use in organic food productswere less than $5 million during fiscal 2009. However, we believe that interest from food manufacturers in producingand selling organic products is expanding, and we have emphasized sales in thismarket in our non-infant formula business. If our oils are ineligible for inclusion in products that bear the USDAorganic seal, our sales opportunity in the food and beverage market may beadversely impacted.

 

***A******substantial******portion of our nutritional ingredients products sales is made to five of ourexisting customers under agreements with no minimum purchase requirements. Ifdemand by these customers for our nutritional ingredients products decreases,our revenues may materially decline.***

 

We rely on a substantial portion of our nutritional ingredients sales tofive of our existing customers. Approximately 76% of our nutritionalingredients sales in the six months ended April 30, 2010 was generated bysales of DHA and ARA to five customers: Mead Johnson Nutritionals, AbbottNutrition, Nestle, Pfizer (formerly Wyeth) and Danone (formerly Numico). Wecannot guarantee that these customers will continue to demand our nutritionalproducts at current or predictable levels. None of our license agreementsrequires our licensees to purchase any minimum amount of products from us nowor in the future, and certain of our license agreements can be terminatedwithin short periods and also allow our customers to manufacture our products themselvesor purchase nutritional oils from other sources. We have limited visibilityinto our customers’ future actual level of demand, notwithstanding our view ofconsumer demand.

 

We have sole source supply agreements (in mostcases through 2011) with customers comprising nearly 75% of our current infantformula revenues. We are currently attempting to extend these sole sourceagreements as well as enter into new such arrangements, but our ultimatesuccess in doing so is uncertain. If we are unable to successfully enter intothese new or extended arrangements, our future infant formula revenues maymaterially decline. Furthermore,even if we are successful in the execution of these agreements, the resultingarrangements may include price reductions which could yield material decreasesto our future infant formula revenues. In addition, if demand by any of our significantcustomers for our nutritional products decreases, either prior to or subsequentto the expiration of such supply agreements, we may experience a materialdecline in our revenues.

 

If purchasing patterns by our significant customerscontinue to be uneven or inconsistent, we will likely experience fluctuationsin our quarter-to-quarter revenues and cash flows. In addition, if thesecustomers attempt to utilize their purchasing power in order to receive pricereductions on our products, we may be unable to maintain prices of our oils atcurrent levels, which could materially affect future revenues and productmargins.

 

Our major customers are part of either the pharmaceutical or food andbeverage industries. Mergers and acquisitions are prevalent in both industries.If one of our major customers or divisions thereof are acquired, as there areno minimum purchase requirements in our license agreements with them, there isno guarantee that the acquirer will continue purchasing our oils at currentlevels or continue selling infant formula at all. An acquisition of one of ourmajor customers could have a material effect on future revenues.

 

Our major customers also employ differing strategies with respect to thetiming of their inventory and raw material purchases. To the extent that thesestrategies change (i.e., further advancements to a “just-in-time”procurement process), our revenues in the quarter of such change could bematerially affected by this modification in customer ordering patterns. Inaddition, our major customers use varying inclusion levels of DHA and ARA intheir infant formulas. If significant changes in their market shares occur, or,in general, our customers reduce such inclusion levels, we could experiencematerial changes in our infant formula revenues.

 

***The success of our brandedconsumer health products business depends on our ability to maintain the valueof the brands.***

 

The success of our branded consumer health products business depends, toa significant degree, on the value of our Culturelle®, AZO, and ESTROVEN®brands. These brand names are integral to the existing branded consumer healthproducts business and to the implementation of certain of our strategies forexpanding this business. Maintaining this brand value will depend largely onthe success of our marketing efforts and our ability to provide a consistentand competitively differentiating health benefit to the end users of ourproducts. Our brands could be adversely affected if we fail to achieve theseobjectives and our public image and reputation could be tarnished by negativepublicity. Any of these events could negatively impact sales.

 

***A substantial portion of ourbranded consumer health product sales is made to two of our existing customersunder agreements with no minimum purchase requirements. If demand by thesecustomers decreases, the revenues associated with this business may materiallydecline.***

 

Approximately 51% of our branded consumer health product sales revenueduring the quarter ended April 30, 2010 was generated by sales to twocustomers.  We cannot guarantee thatthese customers will continue to demand our products at current levels. Oursupply arrangements with these customers do not require them to purchase anyminimum amount of products from us now or in the future.  We have limited visibility into our customers’future actual level of demand, notwithstanding our view of consumerdemand.  If demand by these significantcustomers decreases, we may experience a material decline in our brandedconsumer health products revenues.  Furthermore,if purchasing patterns by our significant customers are uneven or inconsistent,we will likely experience fluctuations in the quarter-to-quarter revenues andcash flows of the branded consumer health products business.

 

***Our branded consumer healthproducts business has a material amount of value associated with customerrelationships, goodwill and trademarks, which, if they become impaired wouldresult in a reduction to our earnings.***

 

For the acquisitionof Amerifit, we paid total cash consideration of approximately $218 million.Under the acquisition method of accounting, the total purchase price wasallocated to Amerifit’s net tangible and intangible assets based on theirestimated fair values at the February 12, 2010 acquisition date. Thepreliminary allocation of the purchase price resulted in value being assignedto customer relationships, goodwill and trademarks of $91.4 million, $99.0million and $46.4 million, respectively. We expect to amortize the value ofAmerifit’s customer relationships using an accelerated method over a period of18 years. Both the goodwill and trademarks are intangibles with indefinite usefullives and will not be amortized. Current accounting standards require thatintangible assets with indefinite lives be periodically evaluated forimpairment. Declines in the profitability or estimated cash flows of thebranded consumer health products business or potential changes in marketvaluations for similar assets, may negatively impact the fair value of thegoodwill and trademarks as well as the customer relationships, which couldresult in an impairment charge. These charges may have a material impact on ouroperating results and financial position.

 

***The Amerifit acquisition mayexpose us to significant unanticipated liabilities that could adversely affectour business and results of operations.***

 

Our purchase of Amerifit may expose us to significant unanticipatedliabilities. We may incur unforeseen liabilities relating to the operation ofthe newly-acquired business. The liabilities may include employment, retirementor severance-related obligations under applicable law or other benefits arrangements,legal claims, warranty or similar liabilities to customers or vendors, andclaims by or amounts owed to suppliers. We have placed $25 million, subject toannual reductions over the next three years, in an escrow to secure certainindemnification obligations of Amerifit’s previous equity holders; however, theincurrence of unforeseen or unanticipated liabilities, should they besignificant and in excess of the amounts placed in escrow, could have amaterial adverse affect on our business, results of operations and financialcondition.

 

***The Amerifit business relies onthird- party manufacturers and certain key raw material suppliers for theproduction of its product portfolio.***

 

We use third-party manufacturers andcertain key raw material suppliers******to produce Amerifit products. These third-party manufacturers and suppliers are not bound by fixed term commitments inour contracts with them, and they may discontinue production with little or noadvance notice. Manufacturers also may experience problems with product qualityor timeliness of product delivery. We rely on these manufacturers and suppliersto

 

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comply with applicable current good manufacturing practices (“GMPs”).The loss of a contract manufacturer or key raw material supplier may force usto shift production to different vendors and possibly cause manufacturingdelays and disrupt our ability to fill orders until we find and qualify anotherthird party manufacturer or key raw material supplier, if one can be found atall. Additionally, should any of these manufacturers or suppliers fail to meetour standards, we may face regulatory sanctions, additional product liabilityclaims or customer complaints, any of which could harm our reputation and ourbusiness. Disruption in supply by our third-party manufacturers and rawmaterial suppliers could have a material adverse effect on the future sales andoperations of the Amerifit business.

 

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**Item2.  Unregistered Sales of EquitySecurities and Use of Proceeds.**

 

None.

 

**Item3.  Defaults Upon Senior Securities.**

 

Not Applicable.

 

**Item4.  Removed and Reserved.**

 

**Item5.  Other Information.**

 

None.

 

**Item6.  Exhibits.**

 

10.01                       Amended and Restated Credit Agreement by and amongMartek Biosciences Corporation, a Delaware corporation, as Borrower (“Martek”),and Manufacturers and Traders Trust Company, as Administrative Agent andIssuing Lender, and Bank of America, NA, as Syndication Agent, and SunTrustBank, as Documentation Agent, and Capital One N.A., as Co-Agent, andManufacturers and Traders Trust Company  and various other financialinstitutions  now orhereafterparty hereto, as Lenders, dated to be effective March 19, 2010.(1)

 

10.02                       Amendment No. 1 by and among Martek; MartekBiosciences Boulder Corporation, a Delaware corporation, Martek BiosciencesKingstree Corporation, a Delaware corporation, Martek Amerifit HoldingCorporation, a Delaware corporation, Amerifit Pharma, Inc. a Massachusetts corporation, Amerifit Brands, Inc., a Delaware corporation, MartekAmerifit LLC, a Delaware limited liability company, and Amerifit, Inc., aDelaware corporation;  Manufacturers and Traders Trust Company, asadministrative agent; and Manufacturers and Traders Trust Company.(1)

 

31.01                       Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a).*

 

31.02                       Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a).*

 

32.01                       Certification ofChief Executive Officer Pursuant  to 18U.S.C. Section 1350, as adopted Pursuant to Section 906 of theSarbanes-Oxley Act of 2002. *

 

32.02                       Certification of Chief Financial Officer Pursuant to 18U.S.C. Section 1350, as adopted Pursuant to Section 906 of theSarbanes-Oxley Act of 2002.*

 

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*                                    Filed or furnished herewith.

(1) Incorporatedby reference from our Current Report on Form 8-K (File No. 0-22354)filed with the Securities and Exchange Commission on March 25, 2010.

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

 
|   | **MARTEK BIOSCIENCES CORPORATION**                                                              |
|--------|-------------------------------------------------------------------------------------------------|
|   | (Registrant)                                                                                    |
|   |                                                                                            |
|   |                                                                                            |
| Date:  | June 9, 2010                                                                               |   | /s/ Peter L. Buzy |
|   | Peter L. Buzy                                                                                   |
|   | Chief Financial Officer, Treasurer and Executive Vice President for  Finance and Administration |
|   | (Principal Financial and Accounting Officer)                                                    |
|        |                                                                                                 |  |  |

 

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