##### 



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 April 30, 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
    
    52-1399362(State or other jurisdiction of incorporation or organization)
    
    (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
    
    
    15Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    24Item 4.
    
    Controls and Procedures
    
    
    24PART II
    
    OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    25Item 1A.
    
    Risk Factors
    
    
    26Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    35Item 3.
    
    Defaults Upon Senior Securities
    
    
    35Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    35Item 5.
    
    Other  Information
    
    
    35Item 6.
    
    Exhibits
    
    
    36Signatures
    
    
    37




---



##### 



PART I  FINANCIAL INFORMATION  Item 1. Financial Statements.
 MARTEK BIOSCIENCES CORPORATION
  April 30,2006
    
    
    October 31,In thousands, except share and per share data
    
    (unaudited)
    
    
    2005AssetsCurrent assetsCash and cash equivalents
    
    $
    14,320
    
    
    $
    11,047Short-term investments and marketable securities
    
    
    11,250
    
    
    
    22,300Accounts receivable, net
    
    
    31,564
    
    
    
    27,603Inventories, net
    
    
    102,628
    
    
    
    91,535Other current assets
    
    
    11,366
    
    
    
    5,929Total current assets
    
    
    171,128
    
    
    
    158,414Property, plant and equipment, net
    
    
    288,699
    
    
    
    290,733Deferred tax asset
    
    
    41,433
    
    
    
    48,201Goodwill
    
    
    48,575
    
    
    
    48,490Other intangible assets, net
    
    
    32,825
    
    
    
    31,129Other assets, net
    
    
    3,156
    
    
    
    1,518Total assets
    
    $
    585,816
    
    
    $
    578,485Liabilities and stockholders equityCurrent liabilitiesAccounts payable
    
    $
    20,259
    
    
    $
    16,661Accrued liabilities
    
    
    13,399
    
    
    
    13,692Current portion of notes payable and other long-term obligations
    
    
    1,141
    
    
    
    3,113Current portion of unearned revenue
    
    
    1,783
    
    
    
    740Total current liabilities
    
    
    36,582
    
    
    
    34,206Long-term debt under revolving credit facility
    
    
    43,000
    
    
    
    55,000Notes payable and other long-term obligations
    
    
    10,738
    
    
    
    11,115Long-term portion of unearned revenue
    
    
    8,822
    
    
    
    8,959Total liabilities
    
    
    99,142
    
    
    
    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
    
    
    
    
    
    
    Series B 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; 32,132,832 and 32,026,595 shares issued and
outstanding, respectively
    
    
    3,213
    
    
    
    3,203Additional paid-in capital
    
    
    519,986
    
    
    
    515,237Accumulated other comprehensive income
    
    
    840
    
    
    
    1Accumulated deficit
    
    
    (37,365
    )
    
    
    (49,236
    )Total stockholders equity
    
    
    486,674
    
    
    
    469,205Total liabilities and stockholders equity
    
    $
    585,816
    
    
    $
    578,485
 See accompanying notes.
 1




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##### 



MARTEK BIOSCIENCES CORPORATION
  Three months ended April 30,
    
    
    Six months ended April 30,Unaudited - In thousands, except share and per share data
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005RevenuesProduct sales
    
    $
    65,210
    
    
    $
    52,834
    
    
    $
    125,707
    
    
    $
    115,945Contract manufacturing sales
    
    
    5,008
    
    
    
    2,997
    
    
    
    7,403
    
    
    
    6,375Total revenues
    
    
    70,218
    
    
    
    55,831
    
    
    
    133,110
    
    
    
    122,320Cost of revenues:Cost of product sales
    
    
    36,476
    
    
    
    32,792
    
    
    
    70,943
    
    
    
    68,894Cost of contract manufacturing sales
    
    
    4,777
    
    
    
    2,585
    
    
    
    6,816
    
    
    
    5,389Idle capacity costs
    
    
    1,722
    
    
    
    
    
    
    
    3,425
    
    
    
    Total cost of revenues
    
    
    42,975
    
    
    
    35,377
    
    
    
    81,184
    
    
    
    74,283Gross margin
    
    
    27,243
    
    
    
    20,454
    
    
    
    51,926
    
    
    
    48,037Operating expenses:Research and development (1)
    
    
    6,258
    
    
    
    5,321
    
    
    
    11,738
    
    
    
    10,137Selling, general and administrative (1)
    
    
    10,270
    
    
    
    8,107
    
    
    
    20,137
    
    
    
    16,252Other operating expenses
    
    
    435
    
    
    
    2,075
    
    
    
    476
    
    
    
    5,560Total operating expenses
    
    
    16,963
    
    
    
    15,503
    
    
    
    32,351
    
    
    
    31,949Income from operations
    
    
    10,280
    
    
    
    4,951
    
    
    
    19,575
    
    
    
    16,088Interest and other income, net
    
    
    437
    
    
    
    456
    
    
    
    800
    
    
    
    636Interest expense
    
    
    (817
    )
    
    
    
    
    
    
    (1,681
    )
    
    
    (180
    )Income before income tax provision
    
    
    9,900
    
    
    
    5,407
    
    
    
    18,694
    
    
    
    16,544Income tax provision(1)
    
    
    3,612
    
    
    
    1,974
    
    
    
    6,823
    
    
    
    6,039Net income
    
    $
    6,288
    
    
    $
    3,433
    
    
    $
    11,871
    
    
    $
    10,505Net income per shareBasic
    
    $
    0.20
    
    
    $
    0.11
    
    
    $
    0.37
    
    
    $
    0.34Diluted
    
    $
    0.19
    
    
    $
    0.11
    
    
    $
    0.37
    
    
    $
    0.33Weighted average common shares outstandingBasic
    
    
    32,099,288
    
    
    
    31,497,317
    
    
    
    32,077,250
    
    
    
    30,540,473Diluted
    
    
    32,605,494
    
    
    
    32,649,141
    
    
    
    32,481,844
    
    
    
    31,595,277(1) 
Includes the following amounts related to
equity-based compensation expense:Research and development

    
    308
    
    
    
    
    
    
    
    660
    
    
    
    Selling, general and administrative

    
    646
    
    
    
    
    
    
    
    1,282
    
    
    
    Income tax provision

    
    (348
    )
    
    
    
    
    
    
    (709
    )
    
    
    
 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
    
    
    106,237
    
    
    
    10
    
    
    
    2,503
    
    
    
    
    
    
    
    
    
    
    
    2,513Equity-based compensation
    
    
    
    
    
    
    
    
    
    
    2,246
    
    
    
    
    
    
    
    
    
    
    
    2,246Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,871
    
    
    
    11,871Other comprehensive income:Unrealized gain on exchange rate forward
contract, net of tax of $413
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    839
    
    
    
    
    
    
    
    839Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,710Balance at April 30, 2006
    
    
    32,132,832
    
    
    $
    3,213
    
    
    $
    519,986
    
    
    $
    840
    
    
    $
    (37,365
    )
    
    $
    486,674
 See accompanying notes.
 3




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##### 



MARTEK BIOSCIENCES CORPORATION
  Six months ended April 30,Unaudited
- In thousands
    
    2006
    
    
    2005Operating activitiesNet income
    
    $
    11,871
    
    
    $
    10,505Adjustments to reconcile net income to net cash used in operating activities:Depreciation and amortization
    
    
    7,991
    
    
    
    7,895Deferred tax provision
    
    
    6,823
    
    
    
    6,039Equity-based compensation expense
    
    
    1,942
    
    
    
    Other
    
    
    
    
    
    
    1,117Changes in operating assets and liabilities:Accounts receivable
    
    
    (3,961
    )
    
    
    559Inventories
    
    
    (10,789
    )
    
    
    (19,129
    )Other assets
    
    
    (6,176
    )
    
    
    1,738Accounts payable
    
    
    3,598
    
    
    
    (10,613
    )Accrued liabilities
    
    
    (365
    )
    
    
    568Unearned revenue and other liabilities
    
    
    947
    
    
    
    (1,424
    )Net cash provided by (used in) operating activities
    
    
    11,881
    
    
    
    (2,745
    )Investing activitiesSale (purchase) of short-term investments and marketable securities, net
    
    
    11,050
    
    
    
    (32,395
    )Expenditures for property, plant and equipment
    
    
    (4,631
    )
    
    
    (45,546
    )Proceeds from sale-leaseback transaction
    
    
    
    
    
    
    4,128Capitalization of intangible assets
    
    
    (3,035
    )
    
    
    (1,186
    )Net cash provided by (used in) investing activities
    
    
    3,384
    
    
    
    (74,999
    )Financing activitiesRepayments of notes payable and other long-term obligations
    
    
    (2,505
    )
    
    
    (4,310
    )Repayments under revolving credit facility, net
    
    
    (12,000
    )
    
    
    (30,000
    )Proceeds from the issuance of common stock and exercise of stock options and warrants, net
    
    
    2,513
    
    
    
    93,581Other
    
    
    
    
    
    
    500Net cash (used in) provided by financing activities
    
    
    (11,992
    )
    
    
    59,771Net increase (decrease) in cash and cash equivalents
    
    
    3,273
    
    
    
    (17,973
    )Cash and cash equivalents, beginning of period
    
    
    11,047
    
    
    
    29,445Cash and cash equivalents, end of period
    
    $
    14,320
    
    
    $
    11,472Supplemental cash flow disclosures:Interest paid
    
    $
    2,066
    
    
    $
    1,775Income taxes paid
    
    $
    55
    
    
    $
    
 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
  Shipping Income and Costs
 Foreign Currency Transactions and Hedging Activities
  5




---



##### 



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
   6




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##### 



Fair Value of Financial Instruments
 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
 2. DSM SUPPLY AND LICENSE AGREEMENT
  7




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##### 



3. SHORT-TERM INVESTMENTS AND MARKETABLE SECURITIES
  4. INVENTORIES
  April 30,
    
    
    October 31,2006
    
    
    2005Finished goods
    
    $
    53,444
    
    
    $
    34,328Work in process
    
    
    47,417
    
    
    
    55,073Raw materials
    
    
    3,467
    
    
    
    3,634Total inventory
    
    
    104,328
    
    
    
    93,035Less: inventory reserve
    
    
    (1,700
    )
    
    
    (1,500
    )Inventories, net
    
    $
    102,628
    
    
    $
    91,535
 5. PROPERTY, PLANT AND EQUIPMENT
  April 30,
    
    
    October 31,2006
    
    
    2005Land
    
    $
    2,320
    
    
    $
    2,318Building and improvements
    
    
    38,347
    
    
    
    45,515Machinery and equipment
    
    
    149,415
    
    
    
    164,039Furniture and fixtures
    
    
    3,342
    
    
    
    3,161Computer hardware and software
    
    
    7,243
    
    
    
    8,085200,667
    
    
    
    223,118Less: accumulated depreciation and amortization
    
    
    (31,544
    )
    
    
    (26,764
    )169,123
    
    
    
    196,354Construction in progress
    
    
    51,996
    
    
    
    56,840Assets held for future use, net
    
    
    67,580
    
    
    
    37,539Property, plant and equipment, net
    
    $
    288,699
    
    
    $
    290,733
  8




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##### 



6. GOODWILL AND OTHER INTANGIBLE ASSETS
  April 30, 2006
    
    
    October 31, 2005Accumulated
    
    
    
    
    
    
    
    
    
    
    AccumulatedIntangible Asset
    
    Gross
    
    
    Amortization
    
    
    Net
    
    
    Gross
    
    
    Amortization
    
    
    NetTrademarks
    
    $
    2,041
    
    
    $
    (467
    )
    
    $
    1,574
    
    
    $
    2,026
    
    
    $
    (401
    )
    
    $
    1,625Patents
    
    
    13,776
    
    
    
    (1,234
    )
    
    
    12,542
    
    
    
    11,741
    
    
    
    (1,734
    )
    
    
    10,007Core technology
    
    
    1,708
    
    
    
    (399
    )
    
    
    1,309
    
    
    
    1,708
    
    
    
    (342
    )
    
    
    1,366Current products
    
    
    10,676
    
    
    
    (2,872
    )
    
    
    7,804
    
    
    
    10,676
    
    
    
    (2,516
    )
    
    
    8,160Licenses
    
    
    11,091
    
    
    
    (1,495
    )
    
    
    9,596
    
    
    
    11,091
    
    
    
    (1,120
    )
    
    
    9,971Goodwill
    
    
    48,575
    
    
    
    
    
    
    
    48,575
    
    
    
    48,490
    
    
    
    
    
    
    
    48,490$
    87,867
    
    
    $
    (6,467
    )
    
    $
    81,400
    
    
    $
    85,732
    
    
    $
    (6,113
    )
    
    $
    79,619
 7. NOTES PAYABLE AND LONG-TERM DEBT
    8. COMMITMENTS AND CONTINGENCIES
 Purchase Commitments
  Scientific Research Collaborations
 9




---



##### 



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




---



##### 



Three months ended April 30,
    
    
    Six months ended April 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Net income, as reported
    
    $
    6,288
    
    
    $
    3,433
    
    
    $
    11,871
    
    
    $
    10,505Deduct: Total equity-based employee compensation expense
determined under fair value-based methods for all awards
    
    
    
    
    
    
    (8,176
    )
    
    
    
    
    
    
    (43,970
    )Pro forma net income (loss)
    
    $
    6,288
    
    
    $
    (4,743
    )
    
    $
    11,871
    
    
    $
    (33,465
    )Net income (loss) per share:Basic  as reported
    
    $
    0.20
    
    
    $
    0.11
    
    
    $
    0.37
    
    
    $
    0.34Basic  pro forma
    
    $
    0.20
    
    
    $
    (0.15
    )
    
    $
    0.37
    
    
    $
    (1.10
    )Diluted  as reported
    
    $
    0.19
    
    
    $
    0.11
    
    
    $
    0.37
    
    
    $
    0.33Diluted  pro forma
    
    $
    0.19
    
    
    $
    (0.15
    )
    
    $
    0.37
    
    
    $
    (1.10
    )
   Three months ended
    
    Six months endedApril 30, 2006
    
    April 30, 2006Expected volatility
    
    
    60.8
    %
    
    
    61.1
    %Risk-free interest rate
    
    
    4.6
    %
    
    
    4.5
    %Expected life of options
    
    5
    years

    5
yearsExpected dividend yield
    
    
    0
    %
    
    
    0
    %Forfeiture rate
    
    
    0
    %
    
    
    1
    %
 Expected Volatility
 Risk-Free Interest Rate
 Expected Life of Options
 Expected Dividend Yield
 Forfeiture Rate
 11




---



##### 



Weighted AverageWeighted
    
    
    
    
    
    
    RemainingNumber of
    
    
    Average
    
    
    Aggregate
    
    
    ContractualShares
    
    
    Price/Share
    
    
    Intrinsic Value
    
    
    Term (years)Options outstanding at October 31, 2005
    
    
    3,924
    
    
    $
    38.39Options exercisable at October 31, 2005
    
    
    3,438
    
    
    $
    40.14Granted
    
    
    59
    
    
    $
    31.71Exercised
    
    
    (75
    )
    
    $
    26.87Canceled
    
    
    (108
    )
    
    $
    39.37Options outstanding at April 30, 2006
    
    
    3,800
    
    
    $
    38.49
    
    
    $
    13,710
    
    
    
    6.9Options exercisable at April 30, 2006
    
    
    3,466
    
    
    $
    39.58
    
    
    $
    11,885
    
    
    
    6.9
   Stockholder Rights Plan
    12




---



##### 



10. NET INCOME PER SHARE
   Three months ended April 30,
    
    
    Six months ended April 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Net income
    
    $
    6,288
    
    
    $
    3,433
    
    
    $
    11,871
    
    
    $
    10,505Weighted average shares outstanding, basic
    
    
    32,099
    
    
    
    31,497
    
    
    
    32,077
    
    
    
    30,540Effect of dilutive potential common shares:Stock options
    
    
    506
    
    
    
    1,131
    
    
    
    404
    
    
    
    1,035Warrants
    
    
    
    
    
    
    21
    
    
    
    1
    
    
    
    20Total dilutive potential common shares
    
    
    506
    
    
    
    1,152
    
    
    
    405
    
    
    
    1,055Weighted average shares outstanding, diluted
    
    
    32,605
    
    
    
    32,649
    
    
    
    32,482
    
    
    
    31,595Net income per share, basic
    
    $
    0.20
    
    
    $
    0.11
    
    
    $
    0.37
    
    
    $
    0.34Net income per share, diluted
    
    $
    0.19
    
    
    $
    0.11
    
    
    $
    0.37
    
    
    $
    0.33
  13




---



##### 



11. COMPREHENSIVE INCOME
  Three months ended April 30,
    
    
    Six months ended April 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Net income, as reported
    
    $
    6,288
    
    
    $
    3,433
    
    
    $
    11,871
    
    
    $
    10,505Other comprehensive income (loss):Unrealized gain (loss) on exchange rate forward contract,
net of income tax provision
(benefit) of $254, $92, $413
and $(62), respectively
    
    
    575
    
    
    
    154
    
    
    
    839
    
    
    
    (170
    )Comprehensive income
    
    $
    6,863
    
    
    $
    3,587
    
    
    $
    12,710
    
    
    $
    10,335
 14




---



##### 



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
   15




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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.
  RECENT HIGHLIGHTS
   Mortierella Alpina
  ® ®
  16




---



##### 




    
    A letter published by world-renowned scientist Dr. B. Ames and associate J. McCann in
April 2006 in the American Journal of Clinical Nutritionurges the American Academy of
Pediatrics (AAP) to strengthen its position on the addition of DHA to infant formula.
    
    Research conducted by Dr. E. Kawakita and others published in March 2006 in
Neurosciencedemonstrated that DHA both in cell culture and animals stimulated new nerve
cell growth. This supports the important role of DHA in the developing brain.
    
    Research conducted by Alan Grossfield and others published in March 2006 in the
Proceedings of the National Academy of Sciencesdemonstrated the important role of DHA in
the function of rhodopsin, the light receptor protein in the retina that converts photons
to electrons for processing in the brain.
    
    A study conducted by Dr. C. Agostoni and others published in March 2006 in
Developmental Medicine & Child Neurologyfound that in children with the rare genetic
disorder phenylketonuria (PKU), addition of DHA in formula was associated with improved
visual scores.
    
    A study published by Dr. D. Hoffman and others in March 2006 in Journal of Pediatric
Gastroenterology and Nutritiondemonstrated that increasing levels of alpha linolenic
acid in formula was not adequate to improve DHA levels in infants receiving formula. They
concluded that healthy formula fed infants appear to require preformed DHA in an amount
closer to that of average worldwide human milk in order to approximate the DHA levels
seen in breastfed infants.
 MANAGEMENT OUTLOOK
   PRODUCTION
   17




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##### 



CRITICAL ACCOUNTING POLICIES AND
THE USE OF ESTIMATES
  18




---



##### 



RESULTS OF OPERATIONS
 Revenues
  Three months ended April 30,
    
    
    Six months ended April 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Product sales
    
    $
    65,210
    
    
    $
    52,834
    
    
    $
    125,707
    
    
    $
    115,945Contract manufacturing sales
    
    
    5,008
    
    
    
    2,997
    
    
    
    7,403
    
    
    
    6,375Total revenues
    
    $
    70,218
    
    
    $
    55,831
    
    
    $
    133,110
    
    
    $
    122,320
     Cost of Revenues
  Three months ended April 30,
    
    
    Six months ended April 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Cost of product sales
    
    $
    36,476
    
    
    $
    32,792
    
    
    $
    70,943
    
    
    $
    68,894Cost of contract manufacturing sales
    
    
    4,777
    
    
    
    2,585
    
    
    
    6,816
    
    
    
    5,389Idle capacity costs
    
    
    1,722
    
    
    
    
    
    
    
    3,425
    
    
    
    Total cost of revenues
    
    $
    42,975
    
    
    $
    35,377
    
    
    $
    81,184
    
    
    $
    74,283
   19




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##### 



Operating Expenses
  Three months ended April 30,
    
    
    Six months ended April 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Research and development
    
    $
    6,258
    
    
    $
    5,321
    
    
    $
    11,738
    
    
    $
    10,137Selling, general and administrative
    
    
    10,270
    
    
    
    8,107
    
    
    
    20,137
    
    
    
    16,252Other operating expenses
    
    
    435
    
    
    
    2,075
    
    
    
    476
    
    
    
    5,560Total operating expenses
    
    $
    16,963
    
    
    $
    15,503
    
    
    $
    32,351
    
    
    $
    31,949
 Research and Development
 Selling, General and Administrative
 Other Operating Expenses
 Interest and Other Income, Net
  Interest Expense
  Income Tax Provision
   20




---



##### 



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.
    21




---



##### 



Less than
    
    
    1-3
    
    
    3-5
    
    
    More thanIn thousands
    
    Total
    
    
    1 year
    
    
    years
    
    
    years
    
    
    5 yearsNotes payable (1)
    
    $
    11,965
    
    
    $
    1,176
    
    
    $
    9,503
    
    
    $
    424
    
    
    $
    862Borrowings under revolving credit facility
    
    
    43,000
    
    
    
    
    
    
    
    
    
    
    
    43,000
    
    
    
    Operating and capital lease obligations
    
    
    14,112
    
    
    
    3,657
    
    
    
    7,236
    
    
    
    2,857
    
    
    
    362Unconditional inventory purchase obligations (2)
    
    
    42,063
    
    
    
    2,922
    
    
    
    39,141
    
    
    
    
    
    
    
    Total contractual cash obligations
    
    $
    111,140
    
    
    $
    7,755
    
    
    $
    55,880
    
    
    $
    46,281
    
    
    $
    1,224
 
 (1)
    
    Minimum payments above include interest and principal due under these notes.(2)
    
    Primarily includes future inventory purchases from DSM pursuant to the guarantee described
below in Off-Balance Sheet Arrangements.      
    
    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 and other lawsuits; and
    
    the costs of marketing and commercializing our products.
  22




---



##### 



OFF-BALANCE SHEET ARRANGEMENTS
    23




---



##### 



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
April 30, 2006 that materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.
 24




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##### 



PART II  OTHER INFORMATION
 Item 1. Legal Proceedings.
  In re Martek Biosciences Corp.
Securities Litigation
    25




---



##### 



Item 1A. Risk Factors.
  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.
   
    
    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 tuna oil source of DHA and its fungal
source of ARA, as manufactured by Suntory, are generally recognized as safe when used as
ingredients in infant formula. In April 2006, the FDA notified Ross Products that it had no
questions at this time regarding Ross generally recognized as safe notification While Ross
Products has not announced any introduction of its oils into infant formula, the GRAS
notification removes a significant regulatory hurdle to the introduction of competitive
products in the U.S. If Ross Products introduces such competitive products, we cannot be certain that the economic protection that we believe we have via existing patents, royalty requirements of
license agreements and market factors will protect us from the financial impact of such product introductions.
    
    Reliant Pharmaceuticals has launched Omacor, a DHA/ EPA ethyl ester 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, including those
marketed by certain of Marteks licensees, 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.
    
    Other companies, several with greater financial resources than ours, are developing
plant-based DHA and other companies are developing chemically synthesized DHA.
 26




---



##### 




    
    Several large companies, including BASF AG, DSM and Ocean Nutrition, and a number of
smaller companies, manufacture microencapsulated fish oil products. Although
microencapsulation of the oil resolves many of the odor, stability and taste issues found
with fish oil, a microencapsulated product currently is more costly than regular fish oil.
Fish oil-based products are used as a DHA source by some infant formula companies,
currently dominate the adult DHA supplement market and are included in certain foods on the
market in various parts of the world. Because fish oil is generally less costly than our
DHA oil and continues to improve in quality and gain general market acceptance, fish oil
presents a substantial competitive threat.
 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.
    
    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
 27




---



##### 



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 has appealed. 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, Suntory has also filed an opposition. A
hearing on the matter was held in late January 2006 and the Examiner has indicated she will
rule against Martek. Martek intends to appeal, during which time the patent would remain in full force and effect. Suntory has also initiated an invalidation
case against our blended oil patent in South Korea. Our response to Suntory was filed in
February 2005, Suntory responded in March 2006 and Martek filed further submissions in May
2006. No hearing date has been set, but it is expected in the second half of 2006.
    
    There are additional intellectual property oppositions pending against Martek that are
not considered material.
   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.
  Because food and beverage pricing is very competitive, the premium that our oils adds to the
cost of the food or beverage may never allow it to be priced at levels that will allow
acceptance by consumers.
  28




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##### 



If it is determined that large amounts of eicosapentaenoic acid (EPA) must accompany DHA in
order to achieve optimal health benefits, we may never be able to gain large- scale entry into
the food and beverage 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 are unable to 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.
  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.
  29




---



##### 




    
    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.
  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.
  30




---



##### 



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.
   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;
    
    announcements of use of competitors DHA and/or ARA products by our customers;
    
    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;
 31




---



##### 




    
    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.
   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.
  32




---



##### 



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.
  Our manufacturing process involves the handling of hazardous materials and emission of regulated
waste. If we fail to properly handle these hazardous materials and/or waste
emissions, substantial costs and harm to our business could result.
   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




---



##### 



34




---



##### 



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.
    Votes For
    
    Votes Withheld%
    
    
    
    
    
    %James R. Beery
    
    
    25,920,295
    
    
    
    90.5
    
    
    
    2,718,305
    
    
    
    9.5Robert J. Flanagan
    
    
    20,885,997
    
    
    
    72.9
    
    
    
    7,752,603
    
    
    
    27.1
   Term ExpiresPolly B. Kawalek
    
    
    2008Jerome C. Keller
    
    
    2008Henry Linsert, Jr.
    
    
    2008Douglas J. MacMaster, Jr.
    
    
    2007John H. Mahar
    
    
    2007Sandra Panem, Ph.D.
    
    
    2008Eugene H. Rotberg
    
    
    2007
   For
    
    Against
    
    Abstain
    
    Non-vote%
    
    
    
    
    
    %
    
    
    
    
    
    %
    
    
    
    
    
    %17,770,251
    
    
    83.2
    
    
    
    3,597,276
    
    
    
    16.8
    
    
    
    171,419
    
    
    
    0.0
    
    
    
    7,099,654
    
    
    
    0.0
 Item 5. Other Information.
  35




---



##### 



Item 6. Exhibits.
 10.01
    
    Supply Agreement with Mead Johnson & Company dated May 17, 2006.*+10.02
    
    Letter agreement between the Company and Henry Pete Linsert, Jr. dated May 18, 2006.*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. 36




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SIGNATURES
  MARTEK BIOSCIENCES CORPORATION(Registrant)Date:  June 9, 2006
    /s/ Peter L. BuzyPeter L. Buzy, Chief Financial Officer and Treasurer(Principal Financial and Accounting Officer) 37