##### 



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the Quarterly Period Ended January 31, 2006
 or
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the Transition Period From  to
 COMMISSION
FILE NUMBER 0-22354
 MARTEK BIOSCIENCES CORPORATION
  Delaware
(State or other jurisdiction of incorporation or organization)
    
    52-1399362
(I.R.S. Employer Identification Number)
 6480 Dobbin Road, Columbia, Maryland 21045
 (410) 740-0081
 
 
 þ o
  þ o o
 o þ




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##### 



PART I
    
    FINANCIAL INFORMATIONItem 1.
    
    Financial Statements
    
    
    1Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    14Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    22Item 4.
    
    Controls and Procedures
    
    
    22PART II
    
    OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    23Item 1A.
    
    Risk Factors
    
    
    25Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    34Item 3.
    
    Defaults Upon Senior Securities
    
    
    34Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    34Item 5.
    
    Other Information
    
    
    34Item 6.
    
    Exhibits
    
    
    34Signatures
    
    
    35




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##### 



PART I  FINANCIAL INFORMATION
 Item 1. Financial Statements.
 MARTEK BIOSCIENCES CORPORATION
  January 31,2006
    
    
    October 31,In thousands, except share and per share data
    
    (unaudited)
    
    
    2005AssetsCurrent assetsCash and cash equivalents
    
    $
    17,985
    
    
    $
    11,047Short-term investments and marketable securities
    
    
    18,700
    
    
    
    22,300Accounts receivable, net
    
    
    36,838
    
    
    
    27,603Inventories, net
    
    
    96,948
    
    
    
    91,535Other current assets
    
    
    8,482
    
    
    
    5,929Total current assets
    
    
    178,953
    
    
    
    158,414Property, plant and equipment, net
    
    
    289,749
    
    
    
    290,733Deferred tax asset
    
    
    44,990
    
    
    
    48,201Goodwill
    
    
    48,536
    
    
    
    48,490Other intangible assets, net
    
    
    32,214
    
    
    
    31,129Other assets, net
    
    
    1,489
    
    
    
    1,518Total assets
    
    $
    595,931
    
    
    $
    578,485Liabilities and stockholders equityCurrent liabilitiesAccounts payable
    
    $
    16,146
    
    
    $
    16,661Accrued liabilities
    
    
    16,676
    
    
    
    13,692Current portion of notes payable and other long-term obligations
    
    
    1,119
    
    
    
    3,113Current portion of unearned revenue
    
    
    2,263
    
    
    
    740Total current liabilities
    
    
    36,204
    
    
    
    34,206Long-term debt under revolving credit facility
    
    
    63,000
    
    
    
    55,000Notes payable and other long-term obligations
    
    
    10,897
    
    
    
    11,115Long-term portion of unearned revenue
    
    
    8,926
    
    
    
    8,959Total liabilities
    
    
    119,027
    
    
    
    109,280CommitmentsStockholders equityPreferred stock, $.01 par value, 4,700,000 shares authorized; none issued or outstanding
    
    
    
    
    
    
    Series A junior participating preferred stock, $.01 par value; 300,000 shares authorized; none issued or outstanding
    
    
    
    
    
    
    Common stock, $.10 par value; 100,000,000 shares authorized; 32,064,751 and 32,026,595 shares issued and
outstanding, respectively
    
    
    3,206
    
    
    
    3,203Additional paid-in capital
    
    
    517,086
    
    
    
    515,237Accumulated other comprehensive income
    
    
    265
    
    
    
    1Accumulated deficit
    
    
    (43,653
    )
    
    
    (49,236
    )Total stockholders equity
    
    
    476,904
    
    
    
    469,205Total liabilities and stockholders equity
    
    $
    595,931
    
    
    $
    578,485
 See accompanying notes.
 1




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##### 



MARTEK BIOSCIENCES CORPORATION
  Three months ended January 31,Unaudited - In thousands, except share and per share data
    
    2006
    
    
    2005RevenuesProduct sales
    
    $
    60,497
    
    
    $
    63,111Contract manufacturing sales
    
    
    2,395
    
    
    
    3,378Total revenues
    
    
    62,892
    
    
    
    66,489Cost of revenues:Cost of product sales
    
    
    34,467
    
    
    
    36,102Cost of contract manufacturing sales
    
    
    2,039
    
    
    
    2,804Idle capacity costs
    
    
    1,703
    
    
    
    Total cost of revenues
    
    
    38,209
    
    
    
    38,906Gross margin
    
    
    24,683
    
    
    
    27,583Operating expenses:Research and development (1)
    
    
    5,480
    
    
    
    4,816Selling, general and administrative (1)
    
    
    9,867
    
    
    
    8,145Other operating expenses
    
    
    41
    
    
    
    3,485Total operating expenses
    
    
    15,388
    
    
    
    16,446Income from operations
    
    
    9,295
    
    
    
    11,137Interest and other income, net
    
    
    363
    
    
    
    180Interest expense
    
    
    (864
    )
    
    
    (180
    )Income before income tax provision
    
    
    8,794
    
    
    
    11,137Income tax
provision (1)
    
    
    3,211
    
    
    
    4,065Net income
    
    $
    5,583
    
    
    $
    7,072Net income per shareBasic
    
    $
    0.17
    
    
    $
    0.24Diluted
    
    $
    0.17
    
    
    $
    0.23Weighted average common shares outstandingBasic
    
    
    32,055,930
    
    
    
    29,614,831Diluted
    
    
    32,431,559
    
    
    
    30,577,066(1) Includes the following amounts related to equity-based
compensation expense:Research and development
    
    
    352
    
    
    
    Selling, general and administrative
    
    
    636
    
    
    
    Income tax provision
    
    
    (361
    )
    
    
    
 See accompanying notes.
 2




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##### 



MARTEK BIOSCIENCES CORPORATION
  AccumulatedAdditional
    
    
    OtherCommon Stock
    
    
    Paid-in
    
    
    Comprehensive
    
    
    AccumulatedUnaudited - In thousands, except share data
    
    Shares
    
    
    Amount
    
    
    Capital
    
    
    Income
    
    
    Deficit
    
    
    TotalBalance at October 31, 2005
    
    
    32,026,595
    
    
    $
    3,203
    
    
    $
    515,237
    
    
    $
    1
    
    
    $
    (49,236
    )
    
    $
    469,205Exercise of stock options and warrants
    
    
    38,156
    
    
    
    3
    
    
    
    704
    
    
    
    
    
    
    
    
    
    
    
    707Equity-based compensation
    
    
    
    
    
    
    
    
    
    
    1,145
    
    
    
    
    
    
    
    
    
    
    
    1,145Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,583
    
    
    
    5,583Other comprehensive income:Unrealized gain on exchange rate forward
contract, net of tax of $159
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    264
    
    
    
    
    
    
    
    264Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,847Balance at January 31, 2006
    
    
    32,064,751
    
    
    $
    3,206
    
    
    $
    517,086
    
    
    $
    265
    
    
    $
    (43,653
    )
    
    $
    476,904
 See accompanying notes.
 3




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##### 



MARTEK BIOSCIENCES CORPORATION
  Three months ended January 31,Unaudited  In thousands
    
    2006
    
    
    2005Operating activitiesNet income
    
    $
    5,583
    
    
    $
    7,072Adjustments to reconcile net income to net cash used in operating activities:Depreciation and amortization
    
    
    4,072
    
    
    
    3,756Deferred tax provision
    
    
    3,211
    
    
    
    4,065Equity-based compensation expense
    
    
    988
    
    
    
    Other
    
    
    
    
    
    
    288Changes in operating assets and liabilities:Accounts receivable
    
    
    (9,235
    )
    
    
    (10,730
    )Inventories
    
    
    (5,256
    )
    
    
    (7,060
    )Other assets
    
    
    (2,244
    )
    
    
    (1,707
    )Accounts payable
    
    
    (516
    )
    
    
    1,118Accrued liabilities
    
    
    2,060
    
    
    
    2,241Unearned revenue and other liabilities
    
    
    1,515
    
    
    
    (516
    )Net cash provided by (used in) operating activities
    
    
    178
    
    
    
    (1,473
    )Investing activitiesSale (purchase) of short-term investments and marketable securities, net
    
    
    3,600
    
    
    
    (25,812
    )Expenditures for property, plant and equipment
    
    
    (2,415
    )
    
    
    (26,316
    )Proceeds from sale-leaseback transaction
    
    
    
    
    
    
    4,128Capitalization of intangible and other assets
    
    
    (880
    )
    
    
    (394
    )Net cash provided by (used in) investing activities
    
    
    305
    
    
    
    (48,394
    )Financing activitiesRepayments of notes payable and other long-term obligations
    
    
    (2,252
    )
    
    
    (4,138
    )Borrowings (repayments) under revolving credit facility, net
    
    
    8,000
    
    
    
    (30,000
    )Proceeds
from the issuance of common stock and exercise of stock options and
warrants, net
    
    
    707
    
    
    
    83,090Net cash provided by financing activities
    
    
    6,455
    
    
    
    48,952Net increase (decrease) in cash and cash equivalents
    
    
    6,938
    
    
    
    (915
    )Cash and cash equivalents, beginning of period
    
    
    11,047
    
    
    
    29,445Cash and cash equivalents, end of period
    
    $
    17,985
    
    
    $
    28,530Supplemental cash flow disclosures:Interest paid
    
    $
    987
    
    
    $
    1,071
 See accompanying notes.
 4




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##### 



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
 1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
 Basis of Presentation
 Consolidation
 Use of Estimates
 Segment Information
 Revenue Recognition
  Foreign Currency Transactions and Hedging Activities
  5




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##### 



Research and Development
 Other Operating Expenses
 Deferred Income Taxes
  Equity-Based Compensation
 Net Income Per Share
 Comprehensive Income
 Cash and Cash Equivalents
 Short-Term Investments and Marketable Securities
   Fair Value of Financial Instruments
 6




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##### 



Trade Receivables
 Inventories
 Property, Plant and Equipment
 Asset Description
    
    Useful Life (years)Building
    
    
    15  30Fermentation equipment
    
    
    10  20Oil processing equipment
    
    
    10  20Other machinery and equipment
    
    
    5  10Furniture and fixtures
    
    
    5  7Computer hardware and software
    
    
    3  7
  Goodwill and Other Intangible Assets
 Impairment of Long-Lived Assets
 Reclassification
 2. DSM SUPPLY AND LICENSE AGREEMENT
  7




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##### 



3. SHORT-TERM INVESTMENTS AND MARKETABLE SECURITIES
  4. INVENTORIES
  January 31,
    
    
    October 31,2006
    
    
    2005Finished goods
    
    $
    40,335
    
    
    $
    34,328Work in process
    
    
    54,372
    
    
    
    55,073Raw materials
    
    
    3,841
    
    
    
    3,634Total inventory
    
    
    98,548
    
    
    
    93,035Less: inventory reserve
    
    
    (1,600
    )
    
    
    (1,500
    )Inventories, net
    
    $
    96,948
    
    
    $
    91,535
 5. PROPERTY, PLANT AND EQUIPMENT
  January 31,
    
    
    October 31,2006
    
    
    2005Land
    
    $
    2,320
    
    
    $
    2,318Building and improvements
    
    
    44,210
    
    
    
    45,515Machinery and equipment
    
    
    158,749
    
    
    
    164,039Furniture and fixtures
    
    
    3,246
    
    
    
    3,161Computer hardware and software
    
    
    8,157
    
    
    
    8,085Construction in progress
    
    
    57,370
    
    
    
    56,840Assets held for future use
    
    
    45,705
    
    
    
    37,539Property, plant and equipment
    
    
    319,757
    
    
    
    317,497Less: accumulated depreciation and amortization
    
    
    (30,008
    )
    
    
    (26,764
    )Property, plant and equipment, net
    
    $
    289,749
    
    
    $
    290,733
  8




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##### 



6. GOODWILL AND OTHER INTANGIBLE ASSETS
  January 31, 2006
    
    
    October 31, 2005Accumulated
    
    
    
    
    
    
    
    
    
    
    AccumulatedIntangible Asset
    
    Gross
    
    
    Amortization
    
    
    Net
    
    
    Gross
    
    
    Amortization
    
    
    NetTrademarks
    
    $
    2,030
    
    
    $
    (434
    )
    
    $
    1,596
    
    
    $
    2,026
    
    
    $
    (401
    )
    
    $
    1,625Patents
    
    
    13,497
    
    
    
    (1,982
    )
    
    
    11,515
    
    
    
    11,741
    
    
    
    (1,734
    )
    
    
    10,007Core technology
    
    
    1,708
    
    
    
    (370
    )
    
    
    1,338
    
    
    
    1,708
    
    
    
    (342
    )
    
    
    1,366Current products
    
    
    10,676
    
    
    
    (2,694
    )
    
    
    7,982
    
    
    
    10,676
    
    
    
    (2,516
    )
    
    
    8,160Licenses
    
    
    11,091
    
    
    
    (1,308
    )
    
    
    9,783
    
    
    
    11,091
    
    
    
    (1,120
    )
    
    
    9,971Goodwill
    
    
    48,536
    
    
    
    
    
    
    
    48,536
    
    
    
    48,490
    
    
    
    
    
    
    
    48,490$
    87,538
    
    
    $
    (6,788
    )
    
    $
    80,750
    
    
    $
    85,732
    
    
    $
    (6,113
    )
    
    $
    79,619
 7. NOTES PAYABLE AND LONG-TERM DEBT
    8. COMMITMENTS AND CONTINGENCIES
 Purchase Commitments
   Scientific Research Collaborations
 9




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##### 



OmegaTech Contingent Purchase Price
 Class Action Lawsuits
 Other
 9. STOCKHOLDERS EQUITY
 Equity-Based Compensation
    10




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##### 



Three months ended January 31,2006
    
    
    2005Net income, as reported
    
    $
    5,583
    
    
    $
    7,072Deduct: Total equity-based employee compensation expense
determined under fair value-based methods for all awards
    
    
    
    
    
    
    (35,794
    )Pro forma net income (loss)
    
    $
    5,583
    
    
    $
    (28,722
    )Net income (loss) per share:Basic  as reported
    
    $
    0.17
    
    
    $
    0.24Basic  pro forma
    
    $
    0.17
    
    
    $
    (0.97
    )Diluted  as reported
    
    $
    0.17
    
    
    $
    0.23Diluted  pro forma
    
    $
    0.17
    
    
    $
    (0.97
    )
   Expected volatility
    
    
    61.9
    %Risk-free interest rate
    
    
    4.4
    %Expected life of options
    
    5
    yearsExpected dividend yield
    
    
    0
    %Forfeiture rate
    
    
    2
    %
 Dividend Yield
 Expected Volatility
 Risk-Free Interest Rate
 Expected Life of the Option
 Forfeiture Rate
  11




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##### 



Number of
    
    
    Weighted Average
    
    
    AggregateShares
    
    
    Price/Share
    
    
    Intrinsic ValueOptions outstanding at October 31, 2005
    
    
    3,924
    
    
    $
    38.39Options exercisable at October 31, 2005
    
    
    3,438
    
    
    $
    40.14Granted
    
    
    18
    
    
    $
    27.83Exercised
    
    
    (6
    )
    
    $
    17.49Canceled
    
    
    (15
    )
    
    $
    43.93Options outstanding at January 31, 2006
    
    
    3,921
    
    
    $
    38.36
    
    
    $
    12,699Options exercisable at January 31, 2006
    
    
    3,500
    
    
    $
    39.72
    
    
    $
    10,884
    Stockholder Rights Plan
      12




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##### 



10. NET INCOME PER SHARE
   Three months ended January 31,2006
    
    
    2005Net income
    
    $
    5,583
    
    
    $
    7,072Weighted average shares outstanding, basic
    
    
    32,056
    
    
    
    29,615Effect of dilutive potential common shares:Employee stock options
    
    
    374
    
    
    
    944Warrants
    
    
    2
    
    
    
    18Total dilutive potential common shares
    
    
    376
    
    
    
    962Weighted average shares outstanding, diluted
    
    
    32,432
    
    
    
    30,577Net income per share, basic
    
    $
    0.17
    
    
    $
    0.24Net income per share, diluted
    
    $
    0.17
    
    
    $
    0.23
  11. COMPREHENSIVE INCOME
  Three months ended January 31,2006
    
    
    2005Net income, as reported
    
    $
    5,583
    
    
    $
    7,072Other comprehensive income (loss):Unrealized gain (loss) on exchange rate forward contract,
net of income tax
provision (benefit) of
$159 and ($154),
respectively
    
    
    264
    
    
    
    (324
    )Comprehensive income
    
    $
    5,847
    
    
    $
    6,748
 13




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##### 



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
 This Managements Discussion and Analysis of Financial Condition and Results of Operations contains
forward-looking statements concerning our business and operations, including, among other things,
statements concerning the following:
 
    
    expectations regarding future revenue growth, product
introductions, growth in nutritional product sales, margin and productivity improvements
and potential collaborations and acquisitions;
    
    expectations regarding sales to and by our infant formula licensees;
    
    expectations regarding marketing of our oils by our infant formula licensees;
    
    expectations regarding future efficiencies in manufacturing processes and the cost of production of our nutritional oils;
    
    expectations regarding future purchases of third-party manufactured oils;
    
    expectations regarding the amount of production capacity and our ability to meet future demands for our nutritional oils;
    
    expectations regarding the amount of inventory held by us or our customers;
    
    expectations regarding the effects of excess production capacity;
    
    expectations regarding future research and development costs;
    
    expectations regarding additional capital expenditures needed in relation to our fermentation and oil processing activities;
    
    expectations regarding possibly significant expenses to defend
putative securities class action lawsuits alleging false and material misstatements and
omissions of material facts concerning our business and prospects; and
    
    expectations regarding our ability to protect our intellectual property.
 Forward-looking statements include those statements containing words such as the following:
 
    
    will,
    
    should,
    
    could,
    
    anticipate,
    
    believe,
    
    plan,
    
    estimate,
    
    expect,
    
    intend, and other similar expressions.
 All of these forward-looking statements involve risks and uncertainties. They and other
forward-looking statements in this Form 10-Q are all made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995. We wish to caution you that our actual
results may differ significantly from the results we discuss in our forward-looking statements. We
discuss some of the risks that could cause such differences in Item 1A. Risk Factors in this report
on Form 10-Q and in our various other filings with the Securities and Exchange Commission. Our
forward-looking statements speak only as of the date of this document, and we do not intend to
update these statements to reflect events or circumstances that occur after that date.
 GENERAL
   14




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##### 




    
    the timing of infant formula market introductions by our licensees
both domestically and internationally;
    
    the timing and extent of stocking and destocking of inventory by our
licensees, including the potential that licensees will move to just in time inventory
purchasing now that we have reached a base finished goods inventory level;
    
    the timing and extent of our customers plant maintenance shutdowns;
    
    the timing and extent of introductions of DHA into various child and/or adult applications;
    
    the continued acceptance of products containing our oils under state-administered reimbursement programs in the U.S.;
    
    the continued acceptance of these products by consumers and continued demand by our customers;
    
    the ability by us, DSM and other third-party manufacturers to
produce adequate levels of our nutritional oils on a consistent basis;
    
    our ability to protect against competitive products through our patents;
    
    competition from alternative sources of DHA and ARA; and
    
    agreements with other future third-party collaborators to market our products or develop new products.
  OVERVIEW AND RECENT HIGHLIGHTS
 CITRACAL Prenatal + DHA
  Odwalla Soymilk Odwalla Soymilk Odwalla Soymilk
  Bright Beginnings Target GlucoBurst CITRACAL Prenatal +
DHA Odwalla Soymilk
 MANAGEMENT OUTLOOK
  15




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##### 



PRODUCTION
       16




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##### 



CRITICAL ACCOUNTING POLICIES AND
THE USE OF ESTIMATES
  RESULTS OF OPERATIONS
 Revenues
  Three months ended January 31,2006
    
    
    2005Product sales
    
    $
    60,497
    
    
    $
    63,111Contract manufacturing sales
    
    
    2,395
    
    
    
    3,378Total revenues
    
    $
    62,892
    
    
    $
    66,489
     17




---



##### 



Cost of Revenues
  Three months ended January 31,2006
    
    
    2005Cost of product sales
    
    $
    34,467
    
    
    $
    36,102Cost of contract manufacturing sales
    
    
    2,039
    
    
    
    2,804Idle capacity costs
    
    
    1,703
    
    
    
    Total cost of revenues
    
    $
    38,209
    
    
    $
    38,906
 Cost of Product Sales
 Cost of Contract Manufacturing Sales
 Idle capacity costs
  Operating Expenses
  Three months ended January 31,2006
    
    
    2005Research and development
    
    $
    5,480
    
    
    $
    4,816Selling, general and administrative
    
    
    9,867
    
    
    
    8,145Other operating expenses
    
    
    41
    
    
    
    3,485Total operating expenses
    
    $
    15,388
    
    
    $
    16,446
 Research and Development
 Selling, General and Administrative
 Other
Operating Expenses
 18




---



##### 



Interest and Other Income, Net
  Interest Expense
  Income Tax Provision
    Net Income
     LIQUIDITY AND CAPITAL RESOURCES
  
    
    cash generated from operations;
    
    proceeds from the sale of equity securities;
    
    cash received from the exercise of stock options and warrants; and
    
    debt financing.
 19




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Less than
    
    
    1-3
    
    
    3-5
    
    
    More thanIn thousands
    
    Total
    
    
    1 year
    
    
    years
    
    
    years
    
    
    5 yearsNotes payable (1)
    
    $
    12,262
    
    
    $
    1,182
    
    
    $
    9,732
    
    
    $
    451
    
    
    $
    897Borrowings under revolving credit facility
    
    
    63,000
    
    
    
    
    
    
    
    
    
    
    
    63,000
    
    
    
    Operating and capital lease obligations
    
    
    15,047
    
    
    
    3,667
    
    
    
    7,277
    
    
    
    3,731
    
    
    
    372Unconditional inventory purchase obligations
    
    
    28,345
    
    
    
    20,861
    
    
    
    7,484
    
    
    
    
    
    
    
    Total
contractual cash obligations (2)
    
    $
    118,654
    
    
    $
    25,710
    
    
    $
    24,493
    
    
    $
    67,182
    
    
    $
    1,269
 
 (1)
    
    Minimum payments above include interest and principal due under these notes.(2)
    
    Does not include $3 million capital reimbursement
obligation to DSM related to the Amendment
signed in February 2006.     20




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
    
    the cost and extent of capital expenditures at our manufacturing facilities;
    
    growth in our infant formula, food and beverage and other nutritional product sales;
    
    the extent and progress of our research and development programs;
    
    the progress of pre-clinical and clinical studies;
    
    the time and costs of obtaining and maintaining regulatory clearances for our products that are subject to such clearances;
    
    the costs involved in filing, protecting and enforcing patent claims;
    
    competing technological and market developments;
    
    the development or acquisition of new products;
    
    the cost of acquiring additional and/or operating and expanding
existing manufacturing facilities for our various products and potential products
(depending on which products we decide to manufacture and continue to manufacture
ourselves);
    
    the costs associated with our internal build-up of inventory levels;
    
    the costs associated with our defense against putative securities class action lawsuits; and
    
    the costs of marketing and commercializing our products.
  OFF-BALANCE SHEET ARRANGEMENTS
    21




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Item 3. Quantitative and Qualitative Disclosures about Market Risk.
    Item 4. Controls and Procedures.
 a)
    
    Evaluation of Disclosure Controls and Procedures.The Chief Executive
Officer and Chief Financial Officer of Martek Biosciences Corporation have evaluated the
effectiveness of our disclosure controls and procedures pursuant to Exchange Act rules
13a-15(e) and 15d-15(e) and have concluded that, as of the end of the period covered by
this report, the disclosure controls and procedures were effective.b)
    
    Internal Control Over Financial Reporting.There was no change in our
internal control over financial reporting in connection with the evaluation required by
paragraph (d) of Rules 13a-15 or 15d-15 under the Exchange Act that occurred during
Marteks quarter ended January 31, 2006 that materially affected, or is reasonably likely
to materially affect, our internal control over financial reporting.
 22




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PART II  OTHER INFORMATION
 Item 1. Legal Proceedings.
     Thraustochytrium Schizochytrium
    23




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Reed Black v. Martek
Biosciences Corporation, et al. Brocco v. Martek Biosciences
Corp., et. al. Sowattanangkul v. Martek Biosciences Corp., et. al. Wright v. Martek Biosciences Corp., et. al. Epstein v.
Martek Biosciences Corp., et. al., Fujitake v. Martek Biosciences Corp.,
et. al. Peterson v. Martek Biosciences Corporation, et. al., In re Martek Biosciences Corp. Securities Litigation
  24




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Item 1A. Risk Factors.
 Investing in our securities involves a high degree of risk. Before making an investment decision,
you should carefully consider the risk factors set forth herein, as well as other information we
include in this report and the additional information in the other reports we file with the
Securities and Exchange Commission (the SEC or the Commission). If any of the following risks
actually occur, our business could be harmed. In such case, the trading price of our securities
could decline and you could lose all or part of your investment.
  
    
    our ability to generate future revenues;
    
    the commercialization of our products;
    
    the expansion and ongoing operation of facilities producing our products;
    
    our ability to produce adequate amounts of our products ourselves or through third-party manufacturers;
    
    the optimization of production costs; and
    
    our ability to enter into future business collaborations and marketing partnerships.
  A substantial portion of our nutritional oil products sales is made to four of our existing
customers under agreements with no minimum purchase requirements. If demand by these customers
for our nutritional oil products declines, our revenues may materially decline.
  We are aware of several products that are currently available, and products under development,
that may present a serious competitive threat to our products.
  25




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
    
    the Ross Products Division of Abbott Laboratories, a significant
Martek licensee and customer, filed a generally recognized as safe notification on January
2, 2002 seeking Food and Drug Administration (FDA) concurrence that its fish oil source
of DHA and its fungal source of ARA are generally recognized as safe when used as
ingredients in infant formula. At this time, the notification continues to be under
consideration by the FDA;
    
    Reliant Pharmaceuticals launched Omacor, a DHA/ EPA ethyl ester, in
the second half of 2005 for treatment of hyperlipidemia. Omacor is a lipid-regulating
agent which includes both EPA and DHA from fish oil. We expect additional studies to
expand the approved indications for Omacor. Other pharmaceutical applications using
omega-3 fatty acids may be expected.
    
    Suntory Limited, Cargill Inc., through a joint venture with a
company in China, and other independent Chinese manufacturers are producing and
distributing a fungal source of ARA. In addition, we are aware that there may be
manufacturers in China attempting to produce an
algal source of DHA, but we are uncertain of the overall status and commercial potential of
these development efforts;
    
    some infant formulas now on the market outside the United States use
DHA derived from other sources, such as fish oil or eggs;
    
    Nutrinova Nutrition Specialties & Food Ingredients GmbH, a
wholly-owned subsidiary of Celanese Corporation, had been actively marketing a DHA-rich
microalgal oil to the food and beverage and dietary supplement markets in the United
States, China and Europe. We have filed a patent infringement suit against Nutrinova in
both the United States and Germany. These lawsuits are further described in Item 1 of Part
II of this Form 10-Q, Legal Proceedings. In
December 2005, the sale of Nutrinovas DHA business to Lonza Group LTD, a Swiss chemical and
biotechnology group, was announced; and
    
    other companies, several with greater financial resources than ours,
are developing plant-based DHA and other companies are developing chemically synthesized
DHA.
  If we are unable to obtain or maintain patent protection or if our patents do not provide
protection against competitive products, our results of operations may be adversely affected.
    
    
    Aventis S.A. and Nagase & Co. Ltd. are challenging our European
patent covering our DHA-containing oils. At a hearing in October 2000, the Opposition
Division of the European Patent Office (EPO) revoked our patent on the grounds that it
was not novel. We immediately appealed this ruling, and in July 2002 we received a positive
ruling from an Appeal Board of the EPO, setting aside the prior decision to revoke this
patent. The patent was returned to the Opposition Division for a determination as to
whether it has met the legal requirement of inventive step. A hearing in August 2005
resulted in a ruling by the Opposition Division that this requirement had been met and the
validity of the patent was upheld. Aventis has appealed the decision to the Appeal Board of
the EPO. The appeal process is not expected to be completed before 2007. Claim 1 of this
patent is the basis of the patent infringement suit against Nutrinova
and Lonza in Germany, discussed
below.
 26




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
    
    With respect to our ARA patent issued by the EPO, BASF AG,
Friesland Brands B.V., and Suntory Limited filed their grounds for opposing this patent
with the Opposition Division of the EPO. At a hearing at the Opposition Division in April
2005, the Opposition Division of the EPO upheld the patent in a form containing modified
claims that are narrower than the claims originally granted. In an effort to broaden the
claims of the patent, we appealed the decision. Suntory and BASF have
also appealed. Friesland Brands B.V. has withdrawn from the
opposition. The
patent in the form containing the claims that were originally granted will remain in full
force and effect throughout the appeal process. The appeal process is not expected to be
completed until late 2006 or 2007. Further, in order to broaden the scope of protection,
Martek has pending patent applications and intends to pursue new patent applications which
would be based on the existing patent. If the patent in the narrower form approved by the
Opposition Division is ultimately upheld and certain pending and new related patent
applications are not granted with the desired claim scope, it is likely that Marteks
European intellectual property position with respect to ARA would not afford much
competitive protection.
    
    With respect to our blended oil (blend of DHA and ARA oils for
use in various applications, including infant formula) patent issued by the EPO, BASF AG
and Suntory Limited filed their grounds for opposing this patent with the Opposition
Division of the EPO. In November 2004, the Opposition Division of the EPO revoked Marteks
European blended oil patent as a result of these challenges. We immediately filed an appeal
of this decision; as a consequence, the blended oil patent has been reinstated and will
remain in full force and effect during the appeal. Both Suntory and BASF have now filed
responses to our appeal. The appeal process is not expected to be completed until 2007.
    
    Prior to our purchase of OmegaTech, Aventis Research and
Technologies GmbH & Co. KG, and Nagase Limited challenged OmegaTechs European patent
covering its DHAcontaining oils. At a hearing in December 2000, the Opposition Division of
the EPO upheld some of the claims and revoked other claims. OmegaTech immediately appealed
this ruling, as did Aventis. At an appeal hearing in May 2005, we received a favorable
decision from the Appeal Board of the EPO, which overturned the decision of the Opposition
Division and returned the case to the Opposition Division for review on the merits of the
patent claims. Any decision made by the Opposition Division can be appealed. Assuming an
appeal, the review process is not expected to be completed until 2009, during which time the patent will remain in full force and effect.
    
    An EPO Opposition Division hearing was held on November 15,
2005, with respect to a European DHA patent acquired by Martek as part of the OmegaTech
purchase. The patent was upheld in modified form. This patent is directed to processes for
fermenting Thraustochytriumand Schizochytriumunder low chloride conditions and the
resulting products. Nutrinova Nutrition Specialities & Food Ingredients GmbH is the only
opponent, and we expect it to appeal. The appeal process is not expected to be completed
before 2007.
    
    In September 2003, we filed a patent infringement lawsuit in
the U.S. District Court in Delaware against Nutrinova Inc., Nutrinova Nutrition Specialties
& Food Ingredients GmbH, Celanese Ventures GmbH, and Celanese AG alleging infringement of
two of our U.S. patents. Celanese Ventures GmbH and Celanese AG have been dropped from the
lawsuit. We have added an additional three patents to the suit, bringing the total number
that Nutrinova was accused of infringing at that time to five patents. The lawsuit alleges that Nutrinova
has been making, using, offering to sell, selling and/or importing into the United States
DHA that infringes the patents. In October 2003, Nutrinova filed counterclaims alleging
inequitable conduct and invalidity, unenforceability and/or noninfringement of 19 of our
U.S. patents, but the parties reached an agreement to limit the counterclaims to
the patents involved in the suit at the time of the agreement. A scheduling hearing in the case was held in January 2005, and
the trial is scheduled for October 2006. In July 2005, the court granted Marteks motion to
add as a defendant in the case a company that is a U.S. customer for Nutrinovas DHA, and
in January 2006, Martek settled its dispute with this defendant on terms favorable to
Martek. A hearing before the court on the meaning and scope of the patent claims in dispute
was held in late November 2005, and the judge issued his written
decision in December 2005. As a result of this decision by the
judge, Martek has decided to limit the number of patents that it is
accusing Nutrinova of infringing to three. In December 2005, it was announced that Nutrinovas DHA business
was sold to Lonza Group LTD, a Swiss chemical and biotechnology
group, and the parties agreed to add Lonza to the U.S. lawsuit.
 We also
filed a patent infringement suit involving Nutrinova Nutrition Specialties & Food
Ingredients GmbH and Celanese Ventures GmbH in Germany in January 2004. The complaint
alleges infringement of our European patent relating to DHA-containing oils. A hearing in
this case was held in a district court in Dusseldorf in April 2005 and the court delayed
its decision pending input from a court-appointed technical expert. The courts decision is
expected at some point in the second half of 2006. Lonza has also been
added to this lawsuit.
    
    With respect to our ARA patent in South Korea, where we believe
there are limited sales of infant formula containing our ARA oil, Suntory has also filed an
opposition. A hearing on the matter was held in late January 2006 and the decision is still
pending. If the decision is in Marteks favor, Suntory cannot appeal, but if the decision
is against Martek, Martek can appeal. Suntory has also initiated an invalidation case
against our blended oil patent in South Korea. Our response to Suntory was filed in
February 2005 and Suntory responded in March 2006. No hearing date has been set, and is not expected before late 2006.
   27




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##### 



If clinical trials do not continue to yield positive results on the benefits of DHA on cognitive
function, cardiovascular health or other health applications, our future revenues may be limited
in the food and beverage market and the dietary supplement market.
  Our oils are very sensitive to oxidation and may not be very compatible with many liquid or dry
foods that are currently on the market. If economical methods are not developed to successfully
incorporate our oils into various food and beverage applications, we may never be able to gain
large-scale entry into the food and beverage market.
  We have a single third-party supplier of our ARA with whom we have a contractual relationship.
If this supplier of our ARA is unable to supply us with our required amounts of ARA or if an
over-capacity situation by our supplier leads to higher cost ARA, our results of operations
and/or financial position may be adversely affected.
  If we are unable to continuously utilize and adequately manage our production capacity or enter
into favorable agreements with third parties to produce our oils or if our suppliers fail to
produce and supply us with adequate amounts of oil, our customers may not be able to obtain a
sufficient supply of DHA and ARA from us and our future revenues from these products may be
limited.
  28




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##### 



As we and our major suppliers increase production of our nutritional oils, we may experience
certain risks associated with the start-up/ ramp-up of commercial manufacturing that could have
a material adverse effect on our business, financial condition, and/ or results of operations.
   
    
    we may experience problems processing, handling and shipping the
higher quantities of oil produced from our expanded facilities;
    
    the costs of expanding, operating and maintaining our production facilities may exceed our expectations;
    
    product defects may result;
    
    lower than anticipated fermentation success rates may result;
    
    lower downstream processing yields may result;
    
    environmental and safety problems may result from our production process; and
    
    regulatory issues relating to the scale-up and operation regarding our production processes may arise.
  We have significantly increased our manufacturing capacity and have incurred substantial costs
in doing so. If we are unable to increase our revenues from our nutritional oils produced at
these facilities, we may continue to experience excess production capacity and we may be unable to recover
these plant expansion costs.
  Failure to effectively manage our growth could disrupt our operations and prevent us from
generating the revenues and gross profit margins we expect.
  29




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##### 



Experts differ in their opinions on the importance of DHA and/or ARA in infant formula and the
levels of DHA and/or ARA required to achieve health benefits for babies. Some experts feel that
they are not necessary ingredients for infant development and that supplemented
formulas will remain a premium product and never gain widespread acceptance worldwide. If
clinical trials do not continue to yield positive results and certain favorable regulatory
guidelines are not enacted, our future revenues in the infant formula market may be limited.
   If it is determined that large amounts of eicosapentaenoic acid (EPA) must be added to DHA in
order to achieve optimal health benefits, we may never be able to gain large-scale entry into
the food and beverage market.
  Because infant formula pricing is very competitive, the premium that our oils adds to the cost
of the formula may never allow it to be priced at levels that will allow worldwide acceptance by
consumers.
  We may need additional capital in the future to continue our research and development efforts,
to conduct product testing, including preclinical and clinical trials, and to market our
products. We may also need significant additional capital to expand our production capability
if market demand for our products continues to grow.
   30




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##### 



The market price of our common stock may experience a high level of volatility due to factors
such as the volatility in the market for biotechnology stocks generally, and the short-term
effect of a number of possible events.
  
    
    announcements of technical innovations, new commercial products and product launches by us or our competitors;
    
    arrangements or strategic partnerships by us or our competitors;
    
    announcements of license agreements, acquisitions or strategic alliances;
    
    announcements of sales by us or our competitors;
    
    patent or other intellectual property achievements or adverse developments;
    
    quarterly fluctuations in our revenues and results of operations;
    
    failure or delay in expansion and continuous operation regarding our
commercial manufacturing or failure or delay of our third-party manufacturers in expansion
and continuous operation regarding their commercial manufacturing;
    
    failure to enter into favorable third-party manufacturing agreements;
    
    regulatory decisions (approvals or disapprovals) or changes concerning our products and our competitors products;
    
    announcements related to threatened, new or existing litigation;
    
    changes in our estimates of financial performance or changes in recommendations by securities analysts; and
    
    general market conditions for growth companies and bioscience companies.
   If significant shares eligible for future sales are sold, the result may depress our stock price
by increasing the supply of our shares in the market at a time when demand may be limited.
  31




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##### 



Our business would be harmed if we fail to comply with applicable good manufacturing practices
as required by the FDA.
  Our corporate compliance program cannot guarantee that we are in compliance with all potentially
applicable federal and state regulations.
  Our business exposes us to potential product liability claims and recalls, and our insurance may
not provide adequate coverage.
  Our opportunity in the U.S. infant formula market may be limited by the renewal rate of
supplemented formulas into the Women, Infants and Children program.
  32




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Our manufacturing process involves the handling of hazardous materials and the mishandling of
these hazardous materials could result in substantial costs and harm to our business.
   Changes in foreign currency exchange rates or interest rates could result in losses.
  We
are a defendant in a putative class action lawsuit which, if determined adversely, could have
a material adverse affect on us.
   33




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##### 



Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
  Item 3. Defaults Upon Senior Securities.
  Item 4. Submission of Matters to a Vote of Security Holders.
  Item 5. Other Information.
  Item 6. Exhibits.
 3.1
    
    Certificate of Designation, Preferences and Rights of Series B Junior Participating Preferred
Stock (filed as Exhibit 3.1 to the Companys current report on Form 8-K, File No. 22354, filed
on February 8, 2006, and incorporated by reference herein).4.1
    
    Rights Agreement, dated as of February 7, 2006, between the Company and Registrar and
Transfer Company, as Rights Agent (filed as Exhibit 4.1 to the Companys current report on
Form 8-K, File No. 22354, filed on February 8, 2006, and incorporated by reference herein).10.01
    
    First Amendment to ARA Alliance, Purchase, and Production
Agreement.*+31.01
    
    Certification of Chief Executive Officer Pursuant to
Rule 13a-14(a)/15d-14(a).*31.02
    
    Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a).*32.01
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *32.02
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
 
 *
    
    Filed or furnished herewith.+
    
    Confidential treatment was requested for certain portions of this agreement. The confidential
portions were filed separately with the Commission. 34




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SIGNATURES
  MARTEK BIOSCIENCES CORPORATION
                            (Registrant)Date:
March 13, 2006
    
    /s/ Peter L. BuzyPeter L. Buzy, Chief Financial Officer and Treasurer(Principal Financial and Accounting Officer)
 35