<PAGE> 1
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 2
TO
FORM 10-K
------------------------
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED OCTOBER 31, 1999
COMMISSION FILE NUMBER: 0-22354
------------------------
MARTEK BIOSCIENCES CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
------------------------
<TABLE>
<S> <C>
DELAWARE 52-1399362
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
</TABLE>
6480 DOBBIN ROAD, COLUMBIA, MARYLAND 21045
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER INCLUDING AREA CODE: (410) 740-0081
------------------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
<TABLE>
<S> <C>
NONE NONE
(TITLE OF CLASS:) (NAME OF EACH EXCHANGE ON WHICH REGISTERED:)
</TABLE>
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.10 PAR VALUE
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the last 90 days. [X] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of Common Stock held by non-affiliates of
registrant is $161,449,892 (based upon a last sale price of $12.0625 per share
of the Common Stock as reported on the NASDAQ National Market System on January
14, 2000). The number of shares of Common Stock outstanding as of January 14,
2000 was 16,517,364.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE> 2
PART I
ITEM I. BUSINESS.
OVERVIEW
Martek Biosciences Corporation ("We", "Martek" or "the Company") is a
leader in the development and commercialization of products derived from
microalgae. Martek's leading products are nutritional oils used as ingredients
in infant formula and foods, and as ingredients in, and encapsulated for use as,
dietary supplements. The Company's nutritional oils are comprised of fatty acid
components, primarily docosahexaenoic acid, commonly known as DHA, and
arachidonic acid, commonly known as ARA, which many researchers believe may
enhance mental and visual development in infants and play a pivotal role in
brain function throughout life. Low levels of DHA in adults has also been linked
to a variety of health risks, including cardiovascular problems, cancer, and
various neurological and visual disorders. Martek has licensed its nutritional
oils to six infant formula manufacturers, representing over 40% of the estimated
$6 billion worldwide market for infant formula. Four of these licensees are
marketing term infant formula products containing Martek's oils in seven
countries and pre-term infant formula products containing the Company's oils in
over 60 countries. Additional applications of the Company's patented technology
based upon microalgae include currently marketed products and technologies that
can be used by researchers as an aid in drug discovery and diagnostics. Martek
intends to continue to exploit the largely untapped commercial opportunities of
microalgae. To that end, the Company maintains a library of more than 3,300 live
microalgal species and a related database, which it believes are among the
largest such resources available worldwide.
PRODUCTS
Nutritional Oils for Infant Formula, Dietary Supplementation and Other
Applications. Using its patented technology based upon microalgae, Martek has
developed nutritional oils which provide two fatty acids that are naturally
present in breast milk but are not available in most infant formulas. We derive
DHA from microalgae and ARA from fungi, using patented technologies. Studies
published by others have indicated that DHA may play a vital role in the
development and function of the brain and retina. Investigators at universities
around the world and at other research centers, such as the National Institutes
of Health, have observed a relationship between low levels of DHA and a variety
of health risks, including increased cardiovascular problems, cystic fibrosis,
cancer, and various neurological and visual disorders. We are currently trying
to establish what contribution, if any, supplementation with our oils will make
in addressing these problems. We have recently begun sponsoring studies to
further investigate the potential benefit of DHA supplementation on
cardiovascular health and breast cancer, and we, as well as others, are
conducting research regarding the impact of DHA supplementation on cystic
fibrosis and certain visual and neurological disorders. Martek's blended oils
containing DHA and ARA provide the closest available match, with regard to
molecular form of these fatty acids, to the DHA and ARA in human milk when added
to infant formula. In 1994, the Company received a U.S. patent covering certain
blends of a microbial oil enriched with DHA and a microbial oil enriched with
ARA, as well as the use of such blends in infant formulas. In 1995, the Company
received a U.S. patent covering a process for making an edible oil containing
DHA and the edible oil made by such process as well as a U.S. patent covering an
infant formula comprising a specified edible oil containing DHA. In 1996 the
Company received two additional U.S. patents covering its nutritional oils
technology. The first patent protects pharmaceutical compositions and dietary
supplements comprising a single cell oil in concentrations of at least 20% DHA
in a triglyceride form made using Martek's method of producing DHA oil. The
second patent clarifies that Martek's patent coverage includes the blending, in
infant formula and nutritional supplements, of microbially derived ARA oil with
low eicosapentaenoic acid ("EPA") fish oils. Fish oil is a potential competitive
source of DHA to Martek's algal-derived DHA oil. This patent will make it more
difficult for low EPA fish oils to be combined with microbial sources of ARA
oils without violating Martek's patents. Two U.S. patents were granted in 1997,
one of which protects the production, use and sale of oils rich in ARA (30% or
greater concentration). In 1998 a U.S. patent was issued protecting the
Company's DHA-rich algal biomass. DHA-rich algal biomass is the raw product of
the DHA fermentation process and represents an inexpensive source of DHA that
may potentially be a low cost product
2
<PAGE> 3
itself. The Company also has been awarded a number of foreign patents covering
various aspects of its nutritional oils.
Martek has entered into royalty-bearing license agreements to utilize its
oils with six infant formula manufacturers, including Mead Johnson & Company (a
subsidiary of Bristol-Myers Squibb Company), American Home Products, Royal
Numico N.V. ("Numico", formerly Nutricia), Maabarot Products Ltd. ("Maabarot")
and Novartis Nutrition S.A. ("Novartis"). The Company has one additional
licensing agreement with an infant formula manufacturer and it has contractually
agreed not to disclose the licensee's name. The undisclosed infant formula
manufacturer has less than 3% of the world-wide market share and has not
purchased products from the Company to date. Each of these royalty-bearing
license agreements calls for the Company to provide to the licensees its
nutritional oils at the transfer price and receive a royalty from the licensee
upon the final sale of infant formula containing the oils. Licensees have the
right to buy other sources of DHA and ARA oils provided royalty payments are
still made to the Company upon the sale of the final infant formula product
containing the oils. The license agreements have terms exceeding 20 years,
contain no future funding commitments on the part of the Company or the
licensees, and may be terminated by the licensee upon proper notification.
Numico, Wyeth-Ayerst (a subsidiary of American Home Products), Maabarot, and
Novartis are currently marketing term infant formula products containing
Martek's oils in seven countries and pre-term infant formula products containing
the Company's oils in over 60 countries worldwide. More than one company is
marketing supplemented term infant formulas in Spain, Australia and New Zealand.
The infant formula industry represents over $2 billion in annual wholesale sales
in the United States and approximately $6 billion worldwide. Martek is actively
pursuing licenses with other infant formula producers throughout the world to
continue penetrating these markets. Martek anticipates that 100% penetration
into the worldwide infant formula market could bring the Company in excess of
$300 million in annual revenues. To date, products containing the Company's oils
have penetrated less than 1% into the worldwide infant formula market. Market's
sales to infant formula licencees was approximately $400,000 in 1997, $600,000
in 1998 and $1.1 million in 1999. In 1999, American Home Products, an infant
formula licensee, accounted for approximately 15% of Martek's total product
sales. No single company accounted for more than 10% of Martek's total product
sales in 1998 or 1997.
In the latter part of 1996, Martek initiated sales of its first consumer
products, Neuromins(R), a DHA dietary supplement, and Neuromins(R) PL, a DHA
dietary supplement for pregnant and lactating women. Since then, Martek has
expanded distribution of its Neuromins(R) DHA. Martek has entered into
agreements with Natrol, Inc., Source Naturals, Inc., Solgar Vitamin and Herb
Company, Leiner Health Products, Nature's Way and Neutraceutical Corporation for
the packaging and distribution of these products in retail outlets nationwide,
including Safeway, Vitamin World, and General Nutrition Centers (GNC), the
nation's largest natural products chain. Neuromins(R) DHA is also sold through
mail order distributors and a multi-level marketer.
In 1999, Martek began selling bulk DHA oil and powder for additional
applications, including inclusion in children's chewables and nutritional drinks
and adult combination supplements which not only include Martek's DHA but other
ingredients such as Gingko and St. Johns Wort. Martek is continuing to explore
additional applications for DHA, including use in pharmaceuticals, functional
foods and animal feeds. Martek's sales of nutritional oils for adult supplements
and food additives totaled approximately $1 million in 1997 and $1.5 million in
1998 and 1999.
Aquaculture. Larval fish, crustaceans (shrimp) and mollusks (oysters and
clams), like humans, require certain dietary fats such as DHA and ARA for
optimal growth and health. Recently, Martek has entered into joint activities
with acquaculture research and production facilities to develop its AquaGrow(R)
line of enrichment feeds for larval fish, crustaceans and mollusks. Because
Martek's expertise is not in the aquaculture feed market, by entering into these
joint activities, the Company has increased the possibility for successful
penetration of its DHA and ARA products into this market. The Company has not
yet received any revenues from the sales of products for aquaculture.
Products for Drug Discovery. Using its fundamental understanding of
microalgae, Martek has developed and markets a range of products and
technologies for use in structure based drug discovery, molecular
3
<PAGE> 4
structure and metabolic research. The Company markets these products worldwide
to many of the world's largest pharmaceutical companies and research
institutions. These products aid researchers in expediting new drug discovery by
enabling them to determine the 3-dimensional structure of certain molecules in
solution and to study characteristics of the structure and its binding
interaction with drugs. Martek also markets a proprietary cell growth medium,
Celtone(R) M, which the Company believes will enable researchers, for the first
time, to determine the 3-D structure of certain human proteins. The Company has
entered into a royalty-bearing license agreement with Genetics Institute
regarding the use of Celtone(R) M. U.S. patents were issued to Martek for its
Celtone(R) M technology in 1995, 1997 and 1998. The Company is currently working
on developing a proprietary protein labeling system which would, by using
advanced nuclear magnetic resonance, or NMR, technology, enable researchers to
determine the structure and movement of pharmaceutical target binding sites in
significantly reduced time. This technology could greatly reduce the time needed
to understand a given target/drug candidate interaction and thereby speed up the
rejection of unsuitable compounds and reduce the overall time needed to develop
new pharmaceuticals. Martek's sales of isotope products for drug discovery
totaled approximately $1.7 million in 1997 and $2 million in 1998 and 1999.
The Company has also developed and been issued a U.S. patent covering a
proprietary library of small flexible probe molecules, the Reconnaissance
Probe(TM) Library, which can be labeled with stable isotopes for use to
specifically interrogate the binding sites of receptor molecules. If successful,
such information could be critical for the screening of virtual chemical
libraries, and could also be used to quickly eliminate false positive leads from
libraries already screened. The Company has received less than $100,000 in
revenues from this technology through October 31, 1999.
Diagnostics. Martek identifies, isolates, and markets powerful fluorescent
dyes (phycobiliproteins) from various algae for use in applications that require
high sensitivity detection. Martek has also developed proprietary positions
around large, intensely fluorescent forms of the phycobiliproteins
(PBXL(TM)dyes) that provide extreme sensitivity with ease of use that is
unmatched by other common dyes or detection systems. These dyes provide 100
times the sensitivity of common direct fluorescent dyes while retaining the
simple detection possible with direct fluorescence. PBXL(TM) dyes are being
developed for use in protein blot detection kits for instrumented systems and
have potential for DNA and RNA blotting applications. In 1999, the PBXL(TM) dyes
also showed potential utility in gene detection and drug discovery formats. The
Company has exclusively in-licensed the rights to the PBXL(TM) technology based
on a U.S. Patent issued in 1997 and several pending applications. The Company's
CryptoFluor(TM) dyes have the advantage of smaller size compared to the standard
phycobiliproteins, and provide additional colors for multi-color tests. In 1998,
Martek began marketing some of its fluorescent detection products through
partnerships with Intergen(R) Company and Kirkegaard and Perry Laboratories. In
1999, Martek began distributing the PBXL(TM) based products through
Chemdex(R),an internet supplier of scientific products. Martek's sales of
diagnostic products was less than $200,000 in 1997, 1998, and 1999.
Algal Genomics. Microalgae are microplants and, as such, have many
biochemical pathways and genes in common with higher plants. They offer the
further advantage, however, of having the genetic material required for the
production of certain compounds, DHA for example, that are not present in higher
plants. Consequently, Martek believes that microalgae represent a valuable gene
pool for modern agricultural biotechnology. Gene coding for enzymes in
microalgal fatty acid biosynthesis have been identified, isolated and
characterized by Martek scientists. Gene sequencing from several different and
distinct algal species is also underway and many new genes have been identified
from several different species.
Martek has utilized its understanding of heterotrophic (without light)and
autotrophic (with light) growth of microalgae, and its proprietary technology in
microalgal transformation, to convert an otherwise photoautotrophic species of
microalgae, into one capable of growing heterotrophically. Martek believes that
this represents the first time such a transformation has ever been made.
Martek's Trophic Conversion(TM) technology is the subject of several patent
applications and opens the door to the commercial heterotrophic production
(growth via fermentation) of algal species that could only be grown previously
using a photobioreactor system. The favorable production economics associated
with fermentation compared to those of the photobioreactor will allow the
Company to pursue new algal products not previously believed to be
4
<PAGE> 5
economically feasible and potentially represents a means to commercially exploit
a greater portion of the kingdom of microalgae.
TECHNOLOGY
Martek applies its microalgal expertise and culturing technology to its
expanding library of over 3,300 live microalgal species and related database to
achieve technical and commercial advantages. Certain fundamental and unique
attributes of microalgae allow for the development and production of Martek's
products:
- microalgae are a genetically diverse group of organisms that have a wide
range of physiological and biochemical characteristics; thus, they
naturally produce many different and unusual fats, sugars, proteins and
bioactive compounds that may have commercial applications, such as the
fatty acids that are the principal ingredients in the Company's
nutritional oils, and highly sensitive fluorescent diagnostic products;
- microalgae are essentially "microplants," which use simple substances
such as carbon dioxide, water and nitrate to grow. When Martek
substitutes the heavy stable isotope forms of these nutrients, microalgae
will cost-effectively incorporate certain stable isotopes (carbon-13,
deuterium and nitrogen-15) into the various compounds that the microalgae
produce. This characteristic provides the basis for Martek's drug design
products; and
- microalgae comprise a large, substantially unexplored group of organisms,
and thus provide a virtually untapped source that can be screened for a
variety of new products, including pharmaceuticals.
Martek's scientists have developed and patented novel microalgal culturing
systems which allow for the routine scale-up of microalgae of commercial
interest. Proprietary closed-system, light-driven photobioreactors and numerous
techniques for maintaining and manipulating microalgal monocultures form the
basis of this culturing technology. Where possible, and for applications that
require large quantities of product (e.g., nutritional products), the Company
has selected and developed microalgae capable of growing without light by using
nutrient feeds in a manner similar to bacteria, yeast or fungi. These microalgae
can be grown in existing commercial fermenters using current technology,
resulting in economies of scale and substantially lower production costs than
microalgae grown in photobioreactors.
Martek's product development process involves the following primary steps:
Identification of Appropriate Microalgae. Martek selects specific
microalgae to produce potentially marketable compounds through a
comprehensive process involving in-house algal expertise and experience,
searches of scientific literature and the Company's proprietary microalgal
database, biochemical analyses, and preliminary product-yield experiments.
The Company currently maintains an increasing in-house collection of over
3,300 strains of microalgae, which includes representatives of virtually
all of the significant taxonomic microalgal groups. Equally important is
the Company's proprietary microalgal database, which contains biochemical
and physiological data on the strains in the collection. The Company
believes that its microalgal collection and associated database are among
the largest such resources available in the world. Coupled with the
Company's extensive microalgal expertise, these
---------------
Celtone(R) is a trademark of the Company registered with the U.S. Patent and
Trademark Office.
Neuromins(R) is a trademark of the Company registered with the U.S. Patent and
Trademark Office.
Aquagrow(R) is a trademark of the Company registered with the U.S. Patent and
Trademark Office.
PBXL(TM) is a trademark of the Company.
CryptoFluor(TM) is a trademark of the Company.
Trophic Conversion(TM) is a trademark of the Company.
Reconnaissance Probe(TM) is a trademark of the Company.
SureLight APC(TM) is a trademark of the Company.
XLExpress(TM) is a trademark of the Company.
5
<PAGE> 6
resources are used to select organisms for initial testing. Further testing
ultimately results in the selection of production strains.
Modification of Microalgae and Growth Conditions. Martek applies
standard industrial microbiological techniques to microalgae and
manipulates culturing conditions (such as light intensity, temperature and
growth medium composition) to optimize productivity. After selecting
strains with the best yields and growth characteristics, the Company
enhances their production through mutagenesis and natural selection under
biochemical stress. Martek has not used genetic engineering techniques to
develop any of its existing products, but may use these methods for certain
products currently in development.
Culturing Microalgae. Successful exploitation of the unique
characteristics of microalgae is in large measure dependent upon the
availability of large-scale culturing technology. Martek has discovered and
uniquely cultured a microalga capable of producing large amounts of DHA
heterotrophically by using organic nutrients. Heterotrophic culturing of
this DHA-producing microalga was previously not believed to be possible at
commercially viable levels. Heterotrophic microalgae have the advantage of
being able to be cultured in conventional fermenters employed by the food,
pharmaceutical and biotechnology industries. Microalgal fermentation has an
advantage over photobioreactor production (i.e. with light) because
larger-scale production of products such as the Company's nutritional oils,
for which the incorporation of high-priced stable isotopes is not required,
can be conducted in existing fermentation equipment, resulting in lower
production costs. Aspects of Martek's technology for the heterotrophic
growth of DHA-producing microalgae are the subject of several U.S. patents.
Similar patent applications have issued in certain countries and are
pending in certain other countries around the world.
For many other product applications, the Company uses its proprietary,
light-driven, closed-culture system photobioreactors for microalgal
production. Photobioreactors are closed to the atmosphere and designed to
make the most efficient use of light while keeping contaminating microbes
out of the culture. Using its photobioreactors, Martek is able to culture
isolated microalgal strains without contamination and to manipulate such
strains to influence growth and biochemical makeup, thus efficiently
generating products of interest. For example, for the production of
Martek's drug discovery products, the Company is able to culture certain
microalgae to produce compounds containing predominantly heavier stable
isotopes rather than the more common forms of atoms by growing microalgae
in its photobioreactors using carbon dioxide, water and/or certain
nitrogen-containing compounds containing predominantly heavier stable
isotopes, carbon-13, deuterium and nitrogen-15. Use of its photobioreactors
also provides Martek a means to conserve and recycle liquid and gaseous
components of the culture, a feature critical for those applications that
involve the use of expensive stable isotopes. Martek's microalgal method of
stable isotope incorporation is significantly less expensive than
alternative microbial or chemical synthesis in many instances.
Martek uses a series of photobioreactors of varying sizes, controls
and methods of operation to achieve culturing consistency. The different
sizes are used primarily for scale-up purposes, from laboratory bench scale
to commercial culturing and manufacturing. Certain aspects of these
photobioreactors are the subject of U.S. patents.
PRODUCTS AND PRODUCT CANDIDATES
NUTRITIONAL PRODUCTS
Certain microalgae and fungi produce large quantities of oils and fats
containing long-chain, polyunsaturated fatty acids, or PUFA's, that are
important to human nutrition and health. Studies have indicated that a
particular PUFA, DHA, may be associated with mental and visual development in
infants and play a pivotal role in normal brain function throughout life.
Investigators at universities around the world and at other research centers,
such as The National Institutes of Health, have observed a relationship between
low levels of DHA and a variety of health risks, including increased
cardiovascular problems, cystic fibrosis, cancer and various neurological and
visual disorders. We are currently trying to establish what contribution, if
any,
6
<PAGE> 7
supplementation with our oils will make addressing these problems. We have
recently begun sponsoring studies to further investigate the potential benefit
of DHA supplementation on cardiovascular health and breast cancer, and we, as
well as others, are conducting research regarding the impact of DHA
supplementation on cystic fibrosis and certain visual and neurological
disorders. DHA is the predominant structural fatty acid in the grey matter of
the brain and retinal tissues in humans and other mammals. Children and adults
obtain DHA primarily from their diets, since humans synthesize only small
amounts of DHA from dietary precursors. Infants acquire DHA and ARA, an
important structural lipid in human tissues, initially in utero during
pregnancy, and then from their diet via their mother's milk. DHA and ARA dietary
supplementation may be particularly important for premature and low birth weight
infants who may not get their full in utero allotment. These fatty acids are
naturally present in breast milk, but are not added to most infant formulas
today.
Martek has identified a strain of microalgae which produces an oil rich in
DHA and has developed the means to grow it by fermentation, with a relatively
high oil and DHA content. To supplement its DHA for infant formula, the Company
has isolated and cultured a strain of fungus that produces large amounts of ARA.
DHA and ARA are also present in high levels in egg yolk phospholipids and
various fish oils. There have been over 30 clinical studies during the past 10
years evaluating the impact of DHA and ARA supplementation on infants. Although
certain recent studies using egg yolk phospholipids and fish oil sources of DHA
and ARA have shown minimal impact on infant cognitive development, the majority
of these studies, including a recent study using Martek's nutritional oils, have
demonstrated that these fatty acids have a significant impact on early cognitive
and visual development in infants. Martek's oils also do not possess potentially
undesirable fatty acids found in fish oil sources of DHA.
Martek first realized revenues from license fees related to its nutritional
oils and sale of sample quantities of these oils in 1992. In late 1994, one of
the Company's licensees launched the first pre-term infant formula containing
Martek's oils in Europe, and in 1995, Martek recognized its first royalty
revenue from sales of this product. Additional product introductions have
continued through 1999. Currently, four of the Company's infant formula
licensees are marketing term infant formula products containing Martek's oils in
seven countries and pre-term infant formula containing the Company's oils in
over 60 countries worldwide.
Independent studies indicate that the mental development and visual acuity
of infants are positively affected by breast feeding and that breast-fed infants
have higher levels of DHA in their brain tissue and enhanced mental acuity later
in life when compared to those fed infant formula not containing DHA. Brain
development in humans takes place primarily in the last trimester in utero and
in the first 12 months of postnatal life. For a fetus, DHA is provided through
its mother's bloodstream via the placenta and for a nursing infant, it is
provided via breast milk. DHA is generally the most abundant omega-3 long-chain
PUFA in human milk. Breast-fed infants have been found to have higher levels of
DHA in their brain tissue than those fed infant formula. There is evidence
indicating that for infants who are breast-fed, mental development and visual
acuity are positively affected. This evidence is from retrospective studies
comparing intelligence in breast-fed versus formula-fed infants and from
intervention studies in infants using DHA-supplemented infant formula.
There are numerous studies which support the importance of DHA and ARA in
the infant diet. Although there are some studies which have not supported such a
benefit, the following are examples of some of the studies which have found a
benefit:
- In 1999, a meta-analysis of over 20 published reports concluded that
infants deprived of the nutrients in breast milk are likely to have a
lower IQ, lower educational achievement, and poorer social adjustment
than breast-fed infants. The nutritional benefits of breast-feeding were
associated with at least a 3.2 point difference in cognitive development
compared to formula feeding, and the longer the baby was breast fed, the
greater the increase in cognitive developmental benefit.
- A National Institutes of Health (NIH) sponsored study published in the
August 1998 edition of Pediatric Research concluded that early dietary
intake of preformed DHA and ARA appears necessary for optimal development
of the brain and eye. The study reported that healthy, full-term infants
fed formula supplemented with Martek's oils had visual development
results consistent with breast-fed
7
<PAGE> 8
infants, but those fed a standard formula without DHA and ARA had a
deficiency of about "one line on an eye chart". The study also indicated
that infant formula without preformed DHA and ARA may put infants at risk
for DHA deficiency, and suggested that the availability of dietary DHA
during the critical developmental period may lead to persistent changes
in the underlying neural structure and/or function of infants.
- The January 1998 issue of Pediatrics (Vol. 101 No. 1 January 1998) in an
article entitled "Breastfeeding and Later Cognitive and Academic
Outcomes" by Horwood and Fergusson (New Zealand), reported that in an
18-year longitudinal study of over 1,000 children, those who were breast-
fed as infants had both better intelligence and greater academic
achievement than those who were infant-formula fed children. The authors
cited the importance of DHA in the neurological development of children
and recommend the need to "develop improved infant formulas with
properties more similar to those of human breast milk that may lead to
improved developmental outcomes in children." The study indicated that
breast-fed babies have a 38% greater likelihood of completing their high
school matriculation than formula-fed babies even after allowances were
made for confounding social, familial and perinatal factors. Although the
study could not conclude that DHA provided to the breast-fed infants from
their mother's milk was the sole cause of the improved achievement
scores, the authors pointed out recent controlled intervention studies
demonstrating similar outcomes in infants with DHA-supplemented formulas
and concluded that:
". . . the weight of evidence clearly favors the view that exposure to
breast-feeding is associated with small but detectable increases in
childhood cognitive ability and educational achievement, with it being
likely that these increases reflect the effects of long chain
polyunsaturated fatty acid levels and, particularly, DHA levels on early
neurodevelopment."
In the November 12, 1994 edition of The Lancet, a scientific journal
published in the UK, scientists concluded that "some components of breast-milk
may have a beneficial effect on brain development. . .arachidonic acid [ARA]and
docosahexaenoic acid [DHA] should be considered as essential nutrients for
infants because they are present in structural lipids in brain and nervous
tissue." Preliminary data submitted to The Society of Pediatric Research in May
1994 and a separate study, presented in July 1995 at the Second International
Congress of the International Society for the Study of Fatty Acids and Lipids,
showed that low birth weight infants fed formula supplemented with Martek's
nutritional oils have blood lipid levels of DHA and ARA comparable to those of
breast-fed, low birth weight infants. In addition, the British Nutrition
Foundation ("BNF"), the European Society for Pediatric Gastroenterology and the
Expert Committee on Human Nutrition of the United Nations Food and Agriculture
Organization ("FAO") and World Health Organization ("WHO"), have recommended
that these fatty acids be included in pre-term infant formulas at levels found
in human milk. The BNF and the FAO/WHO Committee have gone further to recommend
that DHA and ARA also be included in formulas for term infants as well. Also, in
addition to recommending the inclusion of DHA and ARA in infant formula, the BNF
and FAO/WHO Committees have recognized their importance in pregnancy and
lactation. To address these markets, Martek introduced Neuromins(R) PL DHA
dietary supplements for pregnant and lactating women.
In response to increasing information on the importance of omega-3 fatty
acids and DHA in psychiatric health, the National Institutes of Health sponsored
a symposium of experts in 1998 to discuss the latest research in this field. The
focus of the conference was neurological and behavioral disorders; infant
nutrition, visual disorders and cardiovascular benefits were also discussed. The
need for intervention studies was discussed to further investigate potential
benefits in these areas.
The Company is currently working, along with its customers, to develop
other DHA delivery methods to address these markets, including powders, an
emulsion, use as a food ingredient, and use as a pharmaceutical.
8
<PAGE> 9
Martek believes that its nutritional oils and Neuromins(R)capsules have the
following advantages over other currently available sources of DHA and ARA for
use in infant formula, as food ingredients, or as nutritional supplements:
- the oils can be blended in a variety of mixtures in precise ratios for
specific applications;
- each of the oils is comprised of a fatty acid blend that has no other
bioactive PUFAs in significant quantities so that desirable PUFAs can be
included and undesirable ones (e.g., EPA) can be excluded;
- the DHA- and ARA-enriched oils are in a triglyceride form similar to that
found in breast milk and are therefore easily digested;
- the position of the DHA within the triglyceride in Martek's
DHA-containing oil is similar to that in breast milk, but different from
that in fish oils or fish eye-socket oils;
- Martek's oils have a higher oxidative stability and longer shelf life
than fish oil and are, therefore, amenable to the spray drying process
required for powdered formula; and
- the oils can be produced in large quantities under controlled conditions
satisfying regulatory scrutiny.
The Company has also received patents protecting the blend of its DHA and
ARA oils, as well as the blend of certain other microbial oils and the blend of
microbial derived ARA oils and low EPA fish oils, that may compete with Martek's
nutritional oils for use in infant formula.
PRODUCTS AND TECHNOLOGIES FOR DRUG DISCOVERY
Structure-based drug discovery has recently emerged to improve the
efficiency of new pharmaceutical development. Many drugs work by mimicking the
interaction between two molecules, a ligand and a receptor. Rather than rely
solely on the chance identification of an active chemical compound,
practitioners of structure-based drug discovery seek to study the interaction
between the ligand and receptor, and to design a specific drug prototype on the
basis of that interaction. The ability to determine the structures of the
ligand, the receptor, and ideally, the complex between the two, is key to
structure-based drug discovery.
Martek has developed a series of products which enable 3-D structures of
certain molecules of pharmaceutical interest to be determined in solution. Some
of these products are used as growth media which allow for the generation of
proteins incorporating stable isotopes. Others can be used to make isotopically
labeled DNA and RNA. The presence of stable isotopes allows for the
determination of the 3-D structure of these molecules using NMR technology.
Proteins incorporating stable isotopes such as carbon-13 and/or nitrogen-15 have
been obtained by growing micro-organisms, such as bacteria and yeast, on
Martek's media, and the 3-D structures subsequently deduced from information
provided by NMR. In addition, incorporating deuterium, an NMR "invisible"
isotope of hydrogen, into the protein allows for the structure of either the
ligand or the receptor to be determined while bound to its NMR invisible
partner.
The Company markets these products and technologies to pharmaceutical and
structure-based drug discovery companies, universities and research institutes.
Future growth in sales of these products and technologies may depend in large
measure on the future growth of structure-based drug discovery and use of NMR
techniques.
Martek's drug discovery products and technologies include the following:
Celtone(R) M -- The classical technique for determining the 3-D
structures of proteins, X-ray crystallography, is limited in that certain
of the most important protein targets (i.e., human proteins with sugar
attached) frequently do not crystallize. Celtone M, Martek's isotopically
labeled mammalian cell growth medium, has enabled determination of the 3-D
structures of glycosylated human proteins through NMR. The Company believes
Celtone M is a proprietary enabling technology, and, in many cases, the
only way of making glycosylated mammalian proteins in stable isotope form.
By unveiling the structures of these elusive and important proteins, the
drug design process may be expedited against new targets U.S. patents were
issued to the Company for the composition of matter and use of Celtone M in
1995, 1997 and 1998.
9
<PAGE> 10
Celtone(R) -- Martek's cell growth medium for bacteria and yeast,
Celtone, has been on the market since 1990 and has been instrumental in
determining the structure of a number of proteins. Celtone is available in
any combination of deuterium, carbon-13 and nitrogen-15. In June 1994, a
U.S. patent was issued to the Company for the composition of matter and
method for producing its Celtone medium.
Glucose -- Carbon-13-glucose is the most widely used reagent for
isotopically labeling bacterial proteins. Glucose is available in
combinations of deuterium and carbon-13.
Nucleic Acids -- Martek sells isotopically labeled nucleic acid
derivatives. These are available labeled with any combination of deuterium,
carbon-13 and nitrogen-15 and are used to solve the structures of DNA and
RNA, especially when bound to proteins.
Fast-Track Technology -- Martek is currently working on developing a
proprietary fast-track labeling system which would, by using advanced NMR
technology, enable researchers to determine the structure and movement of
pharmaceutical target binding sites in significantly reduced time. This
technology could greatly reduce the time needed to understand a given
target/drug candidate interaction and thereby speed up the rejection of
unsuitable compounds and reduce the overall time needed to develop new
pharmaceuticals.
Martek's patented Reconnaissance Probe(TM) Technology provides an
accelerated way to obtain accurate structural information about a receptor's
binding site and the interaction between a receptor and its ligand.
Reconnaissance probes are small, flexible molecules in which the atoms are
labeled with NMR "visible" isotopes. When bound to the selected receptor it is
possible that the "docked" conformation of the probe can be determined and, in
theory, through the proper alignment of a series of superimposed, docked
structures, the geometric constraints of the receptor binding site can be
established. The detailed chemoinformatic map that would be produced could then
be used to design a focused library of new compounds (leads) designed
specifically to the molecular constraints of the receptor.
DIAGNOSTICS
Products and Technologies for Fluorescence Detection. Martek's
fluorescence technology is a sensitive and direct method for detection of a
specific binding event. That event could be a receptor mediated binding, cell
based binding, antibody driven binding, or essentially any event where one
entity recognizes another. Because of environmental concerns with the use of
radioactivity as a sensitive method of detection, higher sensitivity detection
technologies are in demand. The main advantages of fluorescence as a method of
detection is that it is direct, fast, and relatively simple in that it does not
require enzymatic steps for signal amplification or prolonged development times
for signal measurement. The phycobiliproteins fulfill that role well but cannot
match the detection sensitivity of chemiluminescent methods. The PBXL(TM) dye
technology was developed to attain those sensitivities. A 100-fold improvement
in sensitivity has been demonstrated with the PBXL dyes over existing direct
fluorescent dyes, and multiple new applications are now accessible by simple,
direct fluorescence. Such increased sensitivity allows: 1) the detection of
receptors or small molecules at 100-fold lower concentrations; 2) detection with
the same level of sensitivity but in 100-fold smaller volumes; and 3) detection
with the same level of sensitivity but using much lower cost equipment.
Martek's fluorescent products include the following:
Phycobiliproteins -- Classical direct fluorescent detection dyes, which
have been produced by Martek for several years and fill an existing market in
immunodetection and flow cytometry. In 1999, the Company introduced its own
brand of improved fluorescent dyes (XL-APC and SureLight-APC(TM)) to be used for
time resolved fluorescence applications in the high throughput screening market.
CryptoFluor(TM) dyes -- A product line of small molecular weight, yet high
intensity phycobiliproteins isolated from an unusual group of microalgae. These
dyes are capable of entering permeablilized cells and are used for internal
detection of markers in cells which could be used for discovering diseases, and
in flow cytometry and Fluorescence In Situ Hybridization (FISH). Different
CryptoFluor(TM) dyes have different fluorescence emission wavelengths and,
therefore, provide the possibility of multiplexing assays. They have also been
used in fluorescence microscopy and fluorescence energy transfer applications.
10
<PAGE> 11
PBXL(TM) dyes -- A proprietary line of ultrasensitive dyes which provide a
very large signal per binding event. The PBXL dyes have demonstrated an
increased sensitivity compared to other direct detection dyes in all
applications evaluated thus far. They provide sensitivity similar to
enzymatically amplified or radioactive detection systems but with fewer steps,
generating more rapid results at lower costs. These dyes have been used in
immunodiagnostic detection, DNA arrays, flow cytometry, western blotting and
other applications. In 1999, Martek began beta-testing PBXL-based Western blot
detection kits and its proprietary XLExpress(TM) Rapid Labeling system which
allows individual researchers to label their own molecules with the PBXL dye of
their choice in a simple and convenient format.
AQUACULTURE TECHNOLOGY
Aquaculture is a fast growing industry in Southeast Asia, Australia and
Europe. Martek's primary library of over 3,300 live microalgal species and its
large scale systems for the production of microalgae formed the basis for the
development of a new product line of high-value aquaculture feeds (AquaGrow(R)).
Just like the requirement of human infants for DHA and ARA early in development,
larval fish, mollusks (oysters and clams) and crustaceans (shrimp) also require
these important fatty acids in their early development. In the natural
developmental process, these marine species ordinarily have access to the
primary sources of these materials (i.e., microalgae), but with the development
of intensive aquaculture practices, these fatty acids need to be provided in
large quantities at high concentration for high density fish culture.
Since 1997, Martek has been part of an Israeli/US bi-national consortium
(the Aquaculture Technology Joint Venture) to develop new high value aquaculture
feeds. New enrichment feeds based on Martek's proprietary DHA and ARA technology
were developed and tested in aquaculture facilities worldwide. As a result of
the initial successes in new product development, Martek began beta-testing the
AquaGrow(R) line of enrichment feeds for rotifers and artemia. These zooplankton
are used as direct feeds to provide larval fish (e.g. seabream, turbot, halibut,
etc.) with the DHA and ARA enrichment required for rapid growth. Research
articles and papers presented in 1999 by the Center of Marine Biotechnology at
the University of Maryland and others have described significant improvements in
DHA content of artemia and rotifers when fed Martek's AquaGrow(R) products
compared to other enrichment feeds. Furthermore, they have shown that this
results in improved growth rates and fish quality as well as a reduction in
production losses due to stress and disease of the fish.
COLLABORATIVE AND LICENSING AGREEMENTS
Martek has entered into licensing agreements with six infant formula
manufacturers, including Mead Johnson & Company (a subsidiary of Bristol-Myers
Squibb Company), American Home Products, Numico, Maabarot and Novartis, that
together comprise over 40% of the worldwide infant formula market. The Company
has one additional licensing agreement with an infant formula manufacturer and
it has contractually agreed not to disclose the licensee's name. The undisclosed
infant formula manufacturer has less than 3% of the world-wide market share and
has not purchased products from the Company to date. Under these agreements,
Martek received up-front licensing fees and is entitled to royalties based on
sales of infant formula containing its nutritional oils. These licensees are not
required to include these oils in their formulas under the terms of these
agreements, and there can be no assurance that such infant formula manufacturers
will include the oils in any or all of their product lines. Each of these
royalty-bearing license agreements calls for the Company to provide to the
licensees its nutritional oils at a transfer price and receive a royalty from
the licensee upon the final sale of infant formula containing the oils.
Licensees have the right to buy other sources of DHA and ARA oils provided
royalty payments are still made to the Company upon the sale of the final infant
formula product containing the oils. The license agreements have terms exceeding
20 years, contain no future funding commitments on the part of the Company or
the licensees, and may be terminated by the licensee upon proper notification.
Under the terms of these licensing agreements, the licensees are responsible for
obtaining Food and Drug Administration ("FDA") and all other necessary
regulatory approvals with respect to these nutritional oils. Under each of its
current license agreements, Martek's licensees generally are obligated to
indemnify Martek against product liability claims relating to its nutritional
oils unless they are related to manufacturing impurities in the oils. In
addition to compensation payable to the Company under
11
<PAGE> 12
these agreements, the Company expects to receive transfer payments to the extent
it supplies nutritional oils to its licensees.
The infant formula industry represents over $2 billion in annual wholesale
sales in the United States and approximately $6 billion worldwide. Martek is
actively pursuing licenses with other infant formula producers throughout the
world to continue penetrating these markets. Martek anticipates that 100%
penetration into the worldwide infant formula market could bring the Company in
excess of $300 million in annual revenues. To date, products containing the
Company's oils have penetrated less than 1% into the worldwide infant formula
market. Martek's sales to infant formula licensees were approximately $400,000
in 1997, $600,000 in 1998 and $1.1 million in 1999. In 1999, American Home
Products, an infant formula licensee, accounted for approximately 15% of
Martek's total product sales. No single company accounted for more than 10% of
Martek's total product sales in 1998 or 1997.
Under the terms of several of its current license agreements, Martek is
prohibited from granting a license to any party for the inclusion of its
nutritional oils in infant formula with payment terms that are more favorable to
such licensee than those provided in its agreements with its current licensees
without either the prior written consent of the current licensees or
prospectively offering such new favorable terms to these licensees. This
restriction does not apply to any lump sum payments to Martek pursuant to a
territorially restricted license under which the reduced payment is reasonably
related to the reduced marketing opportunities available under such a restricted
license. In addition, under the terms of several of the agreements, Martek is
prohibited from granting a license to any party for the inclusion of its
nutritional oils with a royalty rate that is more favorable to other licensees
than that provided in these agreements without either the prior written consent
of such licensees or prospectively offering such royalty rate to these current
licensees.
In 1993, Martek entered into an agreement with Columbia University pursuant
to which Columbia University will try to determine the structure of the human
chorionic gonadotropin, known as hCG, protein using Celtone(R) M. The hCG
molecule affects fertility by controlling the attachment of the egg to the
uterus. Martek and Columbia University will share any commercial proceeds
resulting from their joint efforts. Martek's share of any such proceeds will be
based upon the successful conclusion of certain events but will not be less than
75%. In May 1994, the Company initiated commercialization of Celtone(R) M
through a license agreement with Genetics Institute under which Martek will
receive royalties on sales of products resulting from Genetics Institute's work
with Celtone(R) M. In October 1994, Martek entered into a collaboration with the
University of St. Andrews in Scotland (which has now been assigned to Leeds
University). This collaboration is dedicated to the development of NMR
techniques for the study of large proteins and determining the 3-D structures of
certain human proteins of pharmaceutical interest. Under this agreement, Leeds
University will provide NMR facilities and expertise in large protein
resolution. Martek will provide funding and pay royalties for certain
proprietary products arising from this research.
In January 1997, Martek signed an agreement with DSM Food Specialties
("DSM", formerly Royal Gist-Brocades B.V.) under which DSM became Martek's
exclusive contract supplier for nutritional oils containing ARA. As part of this
agreement, Martek recognized license fee revenue in January, 1998 and will
receive guaranteed supplies of oil rich in ARA from DSM on advantageous terms.
The Company markets certain of its fluorescent detection products under a
royalty-bearing license from Stanford University and certain fluorescent
detection products under an exclusive royalty-bearing license from a private
inventor.
The Company has also entered into various additional collaborative research
and license agreements. Under these agreements, the Company is required to fund
research or to collaborate on the development of potential products. Certain of
these agreements also commit the Company to make payments upon the occurrence of
certain milestones and pay royalties upon the sale of certain products resulting
from such collaborations. One such collaboration, with the U.S.-Israel Science
and Technology Foundation ("USISTF"), commits Martek to remit a royalty of 3% on
all sales of aquaculture products related to the research collaboration between
the Company and USISTF.
12
<PAGE> 13
COMMERCIAL AND U.S. GOVERNMENT RESEARCH AND DEVELOPMENT CONTRACTS
Martek's technology development has been funded in part by commercial and
federal government contracts. While not expected to be a primary source of
revenue in the future, Martek plans to continue applying for government
contracts and soliciting commercial research and development contracts on a
selective basis when such contracts involve research of future commercial
benefit to the Company.
As a result of Martek's receiving Small Business Innovation Research
grants, the U.S. Government will have certain rights (the "Government Rights")in
the technology developed with the funding. These rights include a non-exclusive,
paid-up, worldwide license to practice or have practiced such inventions for any
governmental purpose. In addition, the government has the right to require the
Company to grant licenses which may be exclusive under any of such inventions to
a third-party if the government determines that (i) adequate steps have not been
taken to commercialize such inventions, (ii) such action is necessary to meet
public health or safety needs, or (iii) such action is necessary to meet
requirements for public use under federal regulations. The government also has
the right to take title to a subject invention if the Company fails to disclose
the invention and elect title within specified time limits. In addition, the
government may acquire title in any country in which the Company fails to file a
patent application within specified time limits. Federal law requires any
licensor of an invention that was partially funded by federal grants to obtain a
covenant from any exclusive licensee to manufacture products using the invention
substantially in the United States. In addition, the Company's licenses from
third parties may also relate to technology developed with federal funding and
therefore may also be subject to Government Rights.
Costs under U.S. government contracts are subject to audit by the U.S.
government. The Company believes that cost disallowances, if any, arising from
such audits of costs charged to government contracts through October 31, 1999
would not be material to the Company.
MANUFACTURING
Martek manufactures oils rich in DHA and ARA in its fermentation facility
located in Winchester, Kentucky by conventional fermentation processes. The
Company acquired the Winchester facility in 1995 from a subsidiary of ACX
Technologies, Inc. Martek's oils produced in this facility have been certified
kosher by the Orthodox Union. Martek is currently in the process of optimizing
production of its nutritional oils, and believes that a continued optimization
effort will be required for at least the next two years. In 1996, the Company
constructed a "state of the art" oil processing plant at its Winchester facility
which was put into production in early 1997. Martek has also entered into an
agreement with a third party, DSM, to produce its ARA oil, and may enter into
additional production agreements with third parties if demand for its oils
requires. The commercial success of its nutritional oils will depend, in part,
on Martek's ability to manufacture these oils or have them manufactured at a
commercially acceptable cost. There can be no assurance that the Company will be
able to successfully optimize production of its nutritional oils, or continue to
comply with applicable regulatory requirements (including Good Manufacturing
Practices ("GMP") requirements) or that these facilities will be sufficient to
meet the future demand for the oils. Under the terms of several of its infant
formula licenses, Martek's licensees may elect to manufacture these oils
themselves, although the Company believes this is unlikely.
SOURCES OF SUPPLY
Martek's raw material suppliers for production of nutritional oils include
major chemical companies and food ingredient suppliers. We have identified
several sources for each of our major ingredients and have never had problems
obtaining adequate quantities of any of these materials. Crude ARA oil is
provided to the Company by DSM Food Specialties, a third-party processor. DSM,
through a fermentation process, produces a fungal biomass rich in ARA oil, which
is then sent to a sub-contractor for extraction of the oil. After extraction,
the crude ARA oil is sent to our Winchester, Kentucky production facility for
final processing. If DSM fails to supply us with required amounts under the
contract, we would not be able to meet our customers' demands. In this case, we
would either have to manufacture the ARA containing oil at our plant,
13
<PAGE> 14
which would reduce our DHA containing oil production capacity, or enter into
other third party manufacturer supply agreements. Although we feel that DSM can
fill the Company's ARA needs for at least the next several years, there is no
guarantee the DSM will be able to adequately supply all of the Company's ARA
needs in the long-term. Additional capacity may need to be obtained, either
within DSM or at another facility.
For us to produce many of our products for drug discovery, we require
carbon-13 gas. The market supply of carbon-13 gas is very limited, and several
of the large suppliers of this gas also compete with us in the sale of carbon-13
labeled isotope products. In an effort to alleviate these problems, we have
focused recent efforts on producing more refined products that have higher
market values and do not require as much carbon-13 gas consumption to produce.
Additionally, we have limited the manufacturing and selling of less refined
products with lower market values that utilize high levels of carbon-13 gas.
Our aquaculture technology currently relies on our DHA biomass and
by-products from our oil extraction process as raw material ingredients. Our DHA
biomass is also utilized as a starting product for creation of our DHA-rich
nutritional oils for all of our other nutritional product sales. Thus, the
supply of DHA biomass for aquaculture may be limited by the needs for this
material for our other nutritional products. The by-products from our oil
extraction process may also be limited by future changes in our processing which
may alter or limit the amount of by-product produced. We are currently working
on ways to re-formulate our aquacultural products to limit some of these
potential future risks.
RESEARCH AND DEVELOPMENT
Research and development expenses, including contract-related costs, were
$11,051,000 in 1997, $9,787,000 in 1998, and $10,309,000 in 1999.
Contract-related research and development costs included in these amounts were
$509,000 in 1997, $446,000 in 1998, and $464,000 in 1999. Consistent with the
Company's plans, nutritional oils development costs accounted for over 75% of
all research and development costs, as a result of the Company's continued
development efforts to refine its production process and lower its DHA
production cost. Research and development costs may increase in the future as
the Company evaluates new technologies and continues efforts to optimize the
efficiency of its large scale fermentation and oil extraction processes.
SALES AND MARKETING
The Company currently markets its products both directly to end users and
through distributors. The Company markets its nutritional oils for use in infant
formula directly to infant formula manufacturers. The Company markets its
Neuromins(R) DHA dietary supplements primarily through distributors and directly
to end users through its toll free number (1-800-662-6339). Martek has entered
into agreements with Natrol, Inc., and Leiner Health Products for the packaging
and distribution of Neuromins(R) to mass market retail outlets, and with
Nutraceuticals Corporation, Solgar Vitamin and Herb Company, Source Naturals,
and Nature's Way for the packaging and distribution of its Neuromins(R) DHA
capsules to the natural foods markets. Neuromins(R) DHA is currently being
marketed in over 10,000 retail stores nationwide, including Safeway, Vitamin
World and General Nutrition Center (GNC) stores. Neuromins(R)DHA is also
marketed through several mail order distributors. In the aggregate, these
distributors have access to approximately 58,000 health food and mass retail
outlets nationwide. Martek has continued its own DHA awareness campaign in an
effort to support the marketing efforts of its infant formula licensees and
capsule distributors. This campaign will continue and could intensify in 2000.
There can be no assurance that the Company will be able to successfully market
these nutritional oils products for use in infant formula or as dietary
supplements.
COMPETITION
The health care and biological sciences industries are characterized by
rapidly evolving technology and intense competition. The Company's competitors
include major pharmaceutical, chemical and specialized biotechnology companies,
many of which have financial, technical and marketing resources significantly
greater than those of the Company. In addition, many specialized biotechnology
companies have formed
14
<PAGE> 15
collaborations with large, established companies to support research,
development and commercialization of products and technologies that may be
competitive with those of the Company. Academic institutions, governmental
agencies and other public and private research organizations are also conducting
research activities and seeking patent protection and may commercialize products
and technologies competitive with those of the Company on their own or through
joint ventures. The existence of products and technologies of which the Company
is not aware, or products and technologies that may be developed in the future,
may adversely affect the marketability of products and technologies developed by
the Company.
The development of a DHA-containing fish oil low in EPA provides an
alternative to Martek's DHA oil for infant formula applications. Though it is a
lower cost product relative to Martek's DHA, fish oil, including low-EPA fish
oil, has odor, stability and taste characteristics that may limit the usefulness
of the oil in food products. Martek is also aware of the development of
microencapsulated low-EPA fish oil products by several large companies,
including BASF and F. Hoffman-LaRoche Ltd. Though microencapsulation of the oil
resolves much of the odor, stability and taste issues found with fish oil, a
microencapsulated product is significantly more costly than regular fish oil.
Because fish oil is significantly less costly than Martek's DHA oil, fish oil
will present a substantial competitive threat to Martek's Neuromins(R) DHA.
Published reports, however, have cited a number of fish oils as containing
chemical toxins that are not present in Martek's oils. In addition, management
believes that the combination of either low-EPA fish oil or microencapsulated
fish oil with a microbial source of ARA for use in infant formula would likely
infringe claims of Martek's patents. Martek is also aware that Omegatech, Inc.,
an early stage company, is currently able to produce DHA from a strain of fungus
containing DHA. Martek believes that Omegatech has licensed human applications
of this fungal-derived DHA to a division of Monsanto Corporation. The Company is
currently unable to evaluate the degree of competitive threat that this fungal
source of DHA will present to its DHA oil in the future.
Martek is also aware of several large companies promoting ARA oil. Martek
is currently unable to evaluate whether any of these companies has the ability
to produce ARA oil or whether these companies will present a competitive threat
to Martek's ARA in the future.
Small amounts of ARA can be derived from egg yolk lipids, but are not in
the same molecular form as found in breast milk. DHA can also be found in egg
yolks of chickens fed a special diet containing, for example, fish meal. ARA and
DHA derived by this method are currently being added to infant formula by
Milupa, which was acquired by Numico in 1995. The Company believes it is more
expensive to produce DHA and ARA using this source than the Company's process of
producing DHA and ARA oils. Furthermore, the addition of DHA and ARA from egg
yolk at levels equivalent to those found in human milk will result in dietary
levels of lecithin and cholesterol in excess of that found in human milk.
There may be other competitive sources of DHA and ARA of which Martek is
not aware. The fact that many of the Company's mentioned above are larger, more
experienced and better capitalized than Martek raises the significant risk that
these companies may be able to use their resources to develop cheaper sources of
DHA and ARA in the future than Martek's current technology permits.
Sales of certain of the Company's isotope products for drug discovery,
especially the Company's carbon-13 labeled glucose (a non-proprietary product),
are the subject of intense competition. Martek's primary competitors for
carbon-13 glucose are Isotec, Inc. and Cambridge Isotope Labs, companies that
are also manufacturers of carbon-13, a primary raw material in the production of
carbon-13 glucose. In an effort to compete better with these companies in the
reagents market, Martek has focused recent efforts on producing new, carbon-13
labeled media that have demonstrated better performance and competitive pricing
with carbon-13 labeled glucose. The Company expects that competition in the
carbon-13 glucose market will continue to remain strong in 2000, and as a
result, may limit the manufacturing and selling of these products in favor of
new, higher performance media.
In the area of diagnostics for drug discovery, the Company's major
competitors consist of life science reagent suppliers such as Amersham
Pharmacia, Molecular Probes, Prozyme and Cyanotech.
15
<PAGE> 16
The Company's products for drug discovery compete primarily on the basis of
product performance, proprietary position and price, and Martek expects those
products approved for sale to compete primarily on the basis of product
efficacy, safety, patient convenience, reliability, price and proprietary
position.
The Company's competitive position will also depend on its ability to
attract and retain qualified scientific and other personnel, develop effective
proprietary products, implement production and marketing plans, obtain patent
protection and secure adequate capital resources.
PATENTS, LICENSES AND PROPRIETARY TECHNOLOGY
The Company's success is dependent in part on its ability to obtain patent
protection for its products, maintain trade secret protection and operate
without infringing the proprietary rights of others. The Company's policy is to
protect aggressively its proprietary technology through patents, where
appropriate, and through trade secrets in other cases. Additionally, the
Company, in certain cases, relies on the licenses of patents and technology of
third parties. The Company has obtained approximately 25 U.S. patents, covering
various aspects of its technology, which will expire on various dates between
2007 and 2015. The Company has filed, and intends to file, applications for
additional patents covering both products and processes as appropriate. There
can be no assurance that any patent applications filed by, assigned to, or
licensed to, the Company will be granted, that the Company will develop
additional products that are patentable or that any patents issued to or
licensed by the Company will provide the Company with any competitive advantages
or adequate protection for inventions. Moreover, no assurance can be given that
any patents issued to or licensed by the Company will not be challenged,
invalidated or circumvented by others.
There can be no assurance that issued patents, or patents that may issue,
will provide protection against competitive products or otherwise be
commercially valuable. Furthermore, patent law relating to the scope of claims
in the fields of health care and biosciences is still evolving, and the
Company's patent rights are subject to this uncertainty. The Company's patent
rights on its products therefore might conflict with the patent rights of
others, whether existing now or in the future. Alternatively, the products of
others could infringe the patent rights of the Company. The defense and
prosecution of patent claims is both costly and time consuming, even if the
outcome were favorable to the Company. An adverse outcome could subject the
Company to significant liabilities to third parties, require disputed rights to
be licensed from third parties or require the Company to cease selling its
affected products.
The Company has been issued seven U.S. patents covering certain aspects of
its DHA and/or ARA oils. The Company has applied for other patents in the United
States covering certain other aspects of its nutritional oils and has also filed
patent applications on a selective basis in other industrialized countries, some
of which are pending and some of which have been granted. The Company is unable
to predict, however, whether these patents will be challenged, invalidated or
circumvented by others. Failure by the Company to obtain adequate patent
protection for its nutritional oils would have a material adverse effect on the
Company's ability to gain a competitive advantage for these oils and may have a
material adverse effect on the Company's results of operations, particularly
future sales of its nutritional oils, future royalties on sales of infant
formula containing these oils or license fees related thereto. In particular,
failure to maintain patent protection would permit competitors of the Company to
produce products which would be directly competitive with its nutritional oils
using similar or identical processes, and it is possible that the infant formula
manufacturers currently under license by the Company or which may be under
license in the future may choose formula ingredients from these competitors if
they choose to include the ingredients in their formulas at all.
The Company's other patents cover its photobioreactor system for culturing
microalgae and certain aspects of Martek's breath test technology; its
Celtone(R) and Celtone(R) M technology; and its combinatorial library
technology.
The Company also relies on trade secrets and proprietary know-how, which it
seeks to protect in part by confidentiality agreements with its collaborators,
employees and consultants. There can be no assurance that these agreements will
not be breached, that the Company will have adequate remedies for any such
breach or
16
<PAGE> 17
that the Company's trade secrets will not otherwise become known or be
independently developed by competitors.
GOVERNMENT REGULATION AND PRODUCT TESTING
The Company's products and its manufacturing and research activities are
subject to varying degrees of regulation by a number of government authorities
in the United States and other countries, including the FDA pursuant to the
Federal Food, Drug and Cosmetic Act (the "FDC Act"). The FDA regulates, to
varying degrees and sometimes in very different ways, infant formulas, dietary
supplements, medical foods, enteral and parenteral nutritional products and
diagnostic and pharmaceutical products, including their manufacture and
labeling. Generally, prescription pharmaceuticals and certain types of
diagnostic products are regulated more rigorously than foods, such as dietary
supplements. Infant formulas are special types of food that are regulated more
rigorously than most other types of foods. Federal and state laws, regulations
and policies are always subject to change and depend heavily on administrative
policies and interpretations. There can be no assurance that any changes with
respect to federal and state laws, regulations and policies, and, particularly,
with respect to the FDA or other such regulatory bodies, with possible
retroactive effect, will not have a material adverse effect on the Company.
Martek's infant formula licensees are responsible for obtaining the
requisite regulatory clearances to market their products containing Martek's
oils. Sales of the Company's products outside the United States are subject to
foreign regulatory requirements that may vary widely from country to country.
Four of the Company's infant formula licensees have obtained the regulatory
approval, where required, to sell infant formula supplemented with Martek's oils
in over 60 countries for term or pre-term infant formula products. The Company
and its licensees are in the process of responding to certain questions raised
by the FDA in connection with evaluating Martek's oils for inclusion in U.S.
infant formula. While management believes that FDA approval should ultimately be
obtained, it is management's belief that this process will take a minimum of six
to twelve additional months. There is no assurance that the Company and its
licensees will be able to adequately respond to the FDA's questions, that the
licensees will continue to press forward, that clearances will in fact be
granted, that the process will not involve significant delays that may
materially and adversely affect the timing and extent of potential future
introductions of the Company's products, or that once and if approval is
obtained, a licensee will actually market a U.S. infant formula product
containing the Company's oils. There also can be no assurance that additional
clearances needed for new introductions of Martek's oils in foreign countries
can be obtained on a timely basis, if at all.
There can be no assurance that DHA and ARA used in medical foods, infant
formulas or enteral nutritional products will not be subject to food additive
regulation under the FDC Act. Additional data also may be needed to support the
use of DHA and ARA in medical foods.
Many of the Company's products are in research or development phases. The
Company cannot predict all regulatory requirements or issues that may apply to
or arise in connection with the Company's products. Changes in existing laws,
regulations or policies and the adoption of new laws, regulations or policies
could prevent the Company or its licensees or collaborators from, or could
affect the timing of, achieving compliance with regulatory requirements,
including obtaining current and future regulatory clearances, where necessary.
Due to the cost and time commitment associated with the FDA regulatory
process, as well as the Company's lack of experience in obtaining FDA regulatory
clearances, the Company will decide on a product-by-product basis whether to
handle relevant clearance and other requirements independently or to assign such
responsibilities to its licensees or future collaborative partners. There can be
no assurance that the Company, its licensees or collaborators will be able to
obtain such regulatory clearances, if required, on a timely basis or at all.
Delays in receipt of, or failure to receive, such clearances, the loss of
previously received approvals or clearances, or failure to comply with existing
or future regulatory requirements would have a material adverse effect on the
Company's business, financial condition and results of operations.
In connection with the Company's decision to manufacture certain of its
products which it markets directly, or licenses to or collaborates with others
to market, it will be required to adhere to applicable current
17
<PAGE> 18
GMP as required by the FDA. GMP regulations specify component and product
testing standards, control quality assurance requirements, and records and other
documentation controls. In general, drug GMP requirements are more stringent
than food GMP requirements although significant quality control procedures exist
for infant formulas. Depending upon the type of FDA application that is
submitted, compliance with relevant GMP requirements can be onerous and time
consuming, and there can be no assurance that the Company can meet relevant FDA
manufacturing requirements, particularly for scale-up operations involving
product marketing applications. Because the Company is manufacturing its DHA and
ARA oils, it is subject to GMP and various other requirements applicable to
infant formulas and dietary supplements as well as periodic inspections by the
FDA. Further, the Company has had only limited experience in the area of
regulatory compliance with respect to its products. There can be no assurance
that the Company will be able to continue to manufacture its nutritional oils in
accordance with relevant infant formula and dietary supplement requirements for
commercial use. Ongoing compliance with GMP and other applicable regulatory
requirements are monitored through periodic inspections by state and federal
agencies, including the FDA and comparable agencies in other countries. A
determination that the Company is in violation of such GMP and other regulations
could lead to the imposition of civil penalties, including fines, product
recalls or product seizures, and, in the most egregious cases, criminal
sanctions.
Each line of products that is or may be marketed by the Company or its
licensees or collaborators can present unique regulatory problems and risks,
depending on the product type, uses and method of manufacture.
The Federal Dietary Supplement Health and Education Act of 1994 ("DSHEA")
regulates the use and marketing of dietary supplements. The DSHEA sets forth
standards for adulteration of dietary supplements or ingredients thereof,
prescribes detailed requirements for labeling dietary supplements and
establishes GMP requirements for dietary supplements. Martek is currently
marketing a line of DHA dietary supplements, Neuromins(R) and Neuromins(R) PL.
In addition, it is researching and developing new applications for its DHA and
ARA oils. There can be no assurance that the Company will be able to comply with
the requirements of the DSHEA or any regulations that the FDA may promulgate
thereunder with regards to ARA as a dietary supplement or that the Company will
be able to continue to meet such requirements with regard to DHA as a dietary
supplement.
The fluorescent pigment and other products derived from microalgae are
subject to potential regulation by FDA as either medical devices or as a
combination medical device/drug product to the extent that they are used in the
diagnosis, mitigation, treatment, cure or prevention of diseases. Such
classification would subject the products to premarket clearances and/or
regulatory approvals. There can be no assurances that the Company or its
licensees or collaborators would be able to develop the extensive safety and
efficacy data needed to support such FDA premarket clearances and/or regulatory
approvals or that FDA ultimately would authorize the marketing of such products
on a timely basis, if at all.
For pharmaceutical uses of products derived from microalgae, there can be
no assurance that required clinical testing will be completed successfully
within any specified time period, if at all, with respect to the Company's
products. Additionally, there is no assurance that the Company or its licensees
or collaborators will be able to develop the extensive data needed to establish
the safety and efficacy of these products for approval for drug uses, or that
such drug products will not be subject to regulation as biological products or
as controlled substances, which would affect marketing and other requirements.
EMPLOYEES
As of October 31, 1999, the Company had 118 full-time employees, of whom 15
had Ph.D.'s. Approximately 38 employees are engaged in research and development
and contract related research and development activities, 55 are engaged in
production or production development related activities and 25 are in
administrative, business development, and sales and marketing positions. The
Company considers relations with its employees to be good. None of the Company's
employees is covered by a collective bargaining agreement.
18
<PAGE> 19
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information concerning the Company's directors contained under the
captions "Nominees for Election as a Director For Terms Expiring in 2003" and
"Directors Continuing in Office" and, with regard to Item 405 of Regulation S-K,
the information contained under the caption "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Company's 2000 Proxy Statement is hereby
incorporated herein by reference.
The executive officers and key employees of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Henry Linsert, Jr. 59 Chairman, Chief Executive Officer and Director
Richard J. Radmer, Ph.D. 57 President, Chief Scientific Officer and
Director
Thomas C. Fisher 53 Senior Vice President, Operations
David J. Kyle, Ph.D. 46 Senior Vice President, Research and Development
Jerome C. Keller 57 Senior Vice President, Sales & Marketing
Steve Dubin 46 Senior Vice President, Business Development,
General Counsel and Secretary
Peter L. Buzy 40 Chief Financial Officer and Treasurer
Paul W. Behrens, Ph.D. 43 Director of Physiology
Jonathan Miles Brown, Ph.D. 44 Director, Stable Isotope Group
Paul J. Kelley 46 Vice President of Manufacturing
</TABLE>
Henry Linsert, Jr. joined Martek as Chairman of the Board in 1988 and
became Chief Executive Officer in 1989. From 1987 to 1988 he was primarily
engaged as President of American Technology Investments Corp. ("ATI"), a
consulting company specializing in the development and financing of early stage
companies in the Mid-Atlantic area. He was President and Chief Executive Officer
of Suburban Capital Corporation, a venture capital subsidiary of Sovran
Financial Corporation (now Bank of America), from 1983 to 1987. Prior to 1983,
Mr. Linsert was Vice President of Inverness Capital Corporation, a small
business investment company, and Vice President of First Virginia Bank. He also
served as a Captain in the U.S. Marine Corps and as an artillery officer in
Vietnam. He received an M.A. in economics from George Washington University and
a B.A. from Duke University.
Dr. Richard J. Radmer, a founder of Martek, has served since 1985 as a
director and as President and Chief Scientific Officer of the Company. Prior to
1985, he worked for 17 years at Martin Marietta Corp. where he headed the
Biosciences Department which performed research to develop new products from
microalgae, among other activities. He has served as an Adjunct Associate
Professor and Associate Member of the Graduate Faculty at the University of
Maryland. Dr. Radmer received a Ph.D. in biology, an M.S. in botany and a B.S.
in biochemistry from the University of Chicago. He completed his Ph.D. studies
while in residence at Harvard University.
Thomas C. Fisher joined Martek in 1991 and was named Senior Vice President
of Operations in 1992 after 18 years with Merck & Co., Inc. ("Merck") and
Dupont-Merck. Mr. Fisher's last position was Vice President for Technical
Operations at Dupont-Merck, and in that capacity he was responsible for
world-wide pharmaceutical production, quality control and engineering. During
his tenure at Merck, Mr. Fisher was Director of Biological Manufacturing and
held management positions in sterile operations, development and quality
control. Mr. Fisher received an M.S. in genetics from West Virginia University
and a B.S. in biology from Waynesburg College.
Dr. David J. Kyle, a founder of Martek, is currently Senior Vice President,
Head of Research and Development. Prior to co-founding Martek in 1985, Dr. Kyle
was a research scientist in the Biosciences Department at Martin Marietta Corp.
from 1984 to 1985. He has been a post-doctoral fellow at Michigan State
University and a visiting scientist at the Centre d'Etudes Nucleaires of Saclay,
France, and the Institute of Physical and Chemical Research, Tokyo, Japan. Dr.
Kyle received a Ph.D. in physiology and biochemistry from the University of
Alberta, and a B.S. degree in biology from the University of Victoria.
19
<PAGE> 20
Jerome C. Keller joined Martek in September 1997 as Senior Vice President
of Sales and Marketing. Prior to joining Martek, Mr. Keller had been consulting
after spending a 25-year career at Merck, most recently as Vice President of
Sales from 1986 to 1993. In this position, he was responsible for all U.S. sales
operations, including the direction of a support staff of 4,500 personnel and a
sales volume of $4.2 billion. Some of the products introduced under Mr. Keller
included Pepcid, Mefoxin, Primaxin, Vasotec, Mevocor, Zocor, Proscor and
Prilosec. Mr. Keller has a M.S. degree from the University of Pittsburgh and a
B.S. degree from Duquesne University.
Steve Dubin is currently Senior Vice President of Business Development,
General Counsel and Secretary. Mr. Dubin joined Martek in 1992 as Chief
Financial Officer and from 1988 to the time he joined Martek on a full-time
basis, Mr. Dubin consulted with the Company on financial and accounting matters.
Prior to joining Martek, Mr. Dubin was Chief Financial Officer of the J.L.
Wickham Co., Inc., a machine tool company, from 1987 to 1992. From 1986 to 1991,
Mr. Dubin was active as Vice President of ATI, a consulting company of which Mr.
Dubin was a co-founder, specializing in the development and financing of early
stage companies in the Mid-Atlantic area. Prior to 1986, he served as Vice
President of Suburban Capital Corporation, a venture capital subsidiary of
Sovran Financial Corporation (now Bank of America), where he participated in the
original financing of the Company. Mr. Dubin also held a variety of financial
management positions with Suburban Bank. Mr. Dubin is a Certified Public
Accountant and an attorney. He received his J.D. from the National Law Center,
George Washington University and his B.S. in accounting from the University of
Maryland.
Peter L. Buzy joined Martek in March 1998 as Chief Financial Officer. Prior
to joining Martek, Mr. Buzy spent 13 years with the accounting and consulting
firm of Ernst & Young LLP, most recently as an audit partner in the Northern
Virginia High Technology/Life Sciences Practice. Mr. Buzy was a member of the
Ernst & Young audit team servicing Martek from 1986 -- 1996, and as such has
played a vital role in advising the Company on various technical accounting and
finance related issues. Mr. Buzy is a Certified Public Accountant and a member
of the American Institute of Certified Public Accountants. He received his B.S.
in accounting from Salisbury State University.
Dr. Paul W. Behrens, a founder of Martek, has served as Director of
Physiology since 1985 and is responsible for the Company's microalgal-screening
activity, aquaculture product development and microalgal-physiology expertise.
Prior to joining Martek, Dr. Behrens was a research scientist in the Biosciences
Department at Martin Marietta Corp. from 1983 to 1985. He received a Ph.D. in
physiology and biochemistry and a M.S. in biology from the University of
Maryland. He also received a B.A. in biology from The Johns Hopkins University.
Dr. Jonathan Miles Brown, who is overseeing the development of Martek's
Stable Isotope products, joined Martek in September 1991 following a period as a
consultant with British Biotechnology Ltd. Prior thereto, he was Research and
Development Manager for Oxford Virology plc from 1987 to 1990 where his
responsibilities included market research, preparation of all marketing
documents and protection of intellectual property. Dr. Brown received his Ph.D.
from the University of London where he developed the first synthetic process for
the unambiguous synthesis of long chain oligoribonucleotides. He is a Chartered
Chemist and Member of the Royal Society of Chemistry.
Paul J. Kelley joined Martek in April 1997 as Vice President of
Manufacturing at the Company's Winchester, Kentucky production plant. Prior to
joining Martek, Mr. Kelley spent four years as the Plant Manager of a
Biotechnology plant in the Pharmaceutical Division of Bayer. Prior to 1993, Mr.
Kelley held several other positions at Bayer, including Production Manager of a
plant in West Germany from 1989 to 1991. Prior to working for Bayer, Mr. Kelley
was the Plant Manager of a facility in the Biotechnology Division of Miles, Inc.
from 1983 to 1989. Mr. Kelley received an M.B.A. from Rutgers Graduate School of
Business and a B.S.C.E. from the New Jersey Institute of Technology.
20
<PAGE> 21
PART II
ITEM 6. SELECTED FINANCIAL DATA.
MARTEK BIOSCIENCES CORPORATION
SELECTED FINANCIAL DATA
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED OCTOBER 31,
---------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- -------
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA
Revenues
Product sales............................ $ 5,350 $ 4,850 $ 3,566 $ 933 $1,262
License fees and other revenues.......... 6 1,165 293 2,244 270
Royalties................................ 394 391 28 11 5
Research and development contracts and
grants................................ 383 484 530 769 662
-------- -------- -------- -------- -------
Total revenues................... 6,133 6,890 4,417 3,957 2,199
Costs and expenses
Cost of product sales.................... 4,209 3,856 2,697 539 652
Research and development................. 10,309 9,787 11,051 10,294 7,720
Selling, general and administrative...... 6,822 7,360 7,415 4,134 3,219
-------- -------- -------- -------- -------
Total costs and expenses......... 21,340 21,003 21,163 14,967 11,591
-------- -------- -------- -------- -------
Loss from operations..................... (15,207) (14,113) (16,746) (11,010) (9,392)
Other income, net........................ 359 652 1,349 2,096 583
-------- -------- -------- -------- -------
Net loss................................. $(14,848) $(13,461) $(15,397) $ (8,914) $(8,809)
======== ======== ======== ======== =======
Net loss per share, basic and diluted.... $ (.95) $ (.94) $ (1.14) $ (.67) $(.94)
======== ======== ======== ======== =======
Weighted average common shares
outstanding........................... 15,581 14,330 13,559 13,281 9,412
======== ======== ======== ======== =======
</TABLE>
<TABLE>
<CAPTION>
OCTOBER 31,
-----------------------------------------------
1999 1998 1997 1996 1995
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET AND OTHER DATA
Cash, cash equivalents, short-term investments
and marketable securities.................... $16,358 $17,645 $20,675 $39,392 $51,623
Working capital................................ 20,202 21,000 21,990 35,306 49,681
Total assets......................... 39,172 40,736 41,342 57,123 65,158
Long-term debt................................. 472 1,951 3,292 1,199 4,175
Accumulated deficit............................ (73,898) (59,049) (45,588) (30,191) (21,277)
Total stockholders' equity........... 35,199 35,282 34,687 49,416 57,346
Cash dividends declared--common stock.......... -- -- -- -- --
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
GENERAL
This Management's Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements concerning the
Company's business and operations, including, among other things, statements
concerning: (1) expectations regarding future revenue growth, product
introductions, distribution, sales, applications and potential marketing
partnerships; (2) expectations regarding sales and royalties by and from formula
licensees; (3) expectations regarding FDA approval of the Company's oils for
inclusion in U.S. infant formula; (4) expectations regarding future efficiencies
in manufacturing processes and the cost of production of the Company's
nutritional oils; (5) expectations regarding future research and development
21
<PAGE> 22
costs; (6) Year 2000 business risks; and (7) expectations regarding additional
capital expenditures needed in relation to fermentation and oil processing
activities. Forward-looking statements include those statements containing such
words as "will," "should," "could," "anticipate," "believe," "plan," "estimate,"
"expect," "intend," and other similar expressions. Such statements involve risks
and uncertainties and actual results may differ materially due to a variety of
risk factors set forth from time to time in the Company's filings with the
Securities and Exchange Commission.
Martek, founded in 1985, is a leader in the development and
commercialization of high value products derived from microalgae, including
nutritional products, pharmaceutical research and development tools and
diagnostics. The Company's products include: (1) specialty, nutritional oils for
infant formula, nutritional supplements and food ingredients that may play a
beneficial role in promoting mental and cardiovascular health, and in the
development of the eyes and central nervous system in newborns; (2) stable
isotope products and technologies to visualize molecular interactions for drug
discovery and development; and (3) new, powerful fluorescent markers for
diagnostics, rapid miniaturized screening and gene and protein detection. In
1989, Martek began to realize revenues from sales of its stable isotope
products. In 1992, Martek realized its first revenues from license fees related
to its nutritional oils containing docosahexaenoic acid ("DHA") and arachidonic
acid ("ARA") and sales of sample quantities of these oils. In 1995, Martek
recognized its first product and royalty revenues from sales of infant formula
containing these oils, and in 1996, Martek began to realize revenues from the
sale of Neuromins(R), a DHA dietary supplement. In 1998, Martek first realized
revenues from the sale of its new phycobilisome fluorescent detection products.
Martek has incurred losses in each year since its inception. At October 31,
1999, the Company's accumulated deficit was $73,898,000. The Company expects to
continue its development, production optimization and product marketing
activities and, as a result, expects losses to continue for at least the next
year, or until significant sales of its nutritional oils and Neuromins(R) DHA
products occur and/or until significant royalties from sales of infant formula
products containing its oils are recognized. In addition, the Company expects to
continue to experience quarter-to-quarter and year-to-year fluctuations in
revenues, expenses and losses, some of which may be significant. The timing and
extent of such fluctuations will depend, in part, on the timing and receipt of
oils-related revenues. Because the extent and timing of future oils-related
revenues are largely dependent upon the Company's licensees and/or other future
third-party collaborators, the timing or likelihood of future profitability is
largely dependent on factors over which the Company has no control.
MANAGEMENT OUTLOOK AND REGULATORY ISSUES
Management believes that while quarterly results may show fluctuations in
product sales, the outlook for future revenue growth remains positive and that
fiscal 2000 sales will surpass prior year levels. Specifically, Management
believes that for fiscal 2000 as a whole: (1) term infant formula containing
Martek's oils will be introduced in additional countries; (2) sales and
royalties related to the Company's nutritional oils will continue to grow; and
(3) sales of new high value products from the Company's stable isotope group
will increase.
Management believes that recent scientific evidence supports the contention
that humans throughout life will benefit from DHA supplementation. This could
represent a far larger market for DHA than the market for infants. To realize
this market, the Company is pursuing a long-term marketing partnership with a
large nutritional products and/or pharmaceutical company to promote Martek's
non-infant formula nutritional oil products. Because of this objective, certain
shorter-term marketing arrangements of lesser scope have been avoided, thus
modestly sacrificing short-term product sales. Management believes that broad
introductions of infant formula containing Martek's nutritional oils and/or a
strategic alliance with a large scale nutritional products and/or pharmaceutical
company will occur in the future. However, Management is unable to accurately
predict when, or if, such events will occur.
Four of the Company's infant formula licensees have obtained the regulatory
approval, where required, to sell infant formula supplemented with Martek's oils
in over 60 countries for term or pre-term infant formula products, including,
most recently, approval by the French Scientific Committee for Foods for
pre-term and
22
<PAGE> 23
term infant formula. The Company and its licensees are in the process of
responding to certain questions raised by the FDA in connection with evaluating
Martek's oils for inclusion in U.S. infant formula. While Management believes
that FDA approval should ultimately be obtained, it is Management's belief that
this process will take a minimum of six to twelve additional months. There is
also no assurance that the Company and its licensees will be able to adequately
respond to the FDA's questions, that the licensees will continue to press
forward, that clearances will, in fact, be granted, that the process will not
involve significant delays that may materially and adversely affect the timing
and extent of potential future introductions of the Company's products in the
U.S., or that once, and if, approval is obtained, a licensee will actually
market a U.S. infant formula product containing the Company's oils.
Nevertheless, Management anticipates that during the next twelve months, new
infant formula products containing Martek's oils will continue to be introduced
around the world and overall product sales, including sales from infant formula
related products, will increase over the prior year.
RESULTS OF OPERATIONS
Revenues Revenues increased from $4,417,000 in 1997 to $6,890,000 in 1998,
an increase of 56%, mainly as a result of a $1,284,000 increase in product sales
in 1998 over 1997, coupled with an increase in license fees and related revenues
of $872,000, which was primarily due to the recognition of a $1,125,000
licensing fee associated with a pre-1998 arrangement. Revenues in 1999 decreased
to $6,133,000, or 11%, mainly due to the non-recurrence of the $1,125,000
license fee recognized in 1998.
Nutritional product sales increased $963,000 in 1998 over 1997 and an
additional $381,000 in 1999 over 1998. The increase of 54% in 1998 and 14% in
1999 was the result of the expanded market penetration of infant formula
products, including term introductions, containing the Company's oils, as well
as expanded distribution of Neuromins(R) into mainstream markets.
The expansion of infant formula containing Martek's oils has grown steadily
in the last several years, and these products are now in over 60 countries
worldwide. The resulting growth in product sales has been less dramatic,
however, as many of these introductions have been pre-term infant formula
products for low birth weight infants. While pre-term product introductions are
important because they show the commitment by the Company's licensees to obtain
regulatory approval and also show acceptance in the health care community for
these products, these introductions usually generate minimal revenues due to the
small markets for low birth weight infant formula products. However, to date,
two of Martek's licensees have introduced specialty infant formula products
containing Martek's oils for full-term infants in a total of seven countries.
These products have much greater revenue generating potential, and Management is
optimistic that as market acceptance of these products grows, corresponding
revenues will grow as more term infant formula launches will occur in additional
countries around the world. Revenues from sales of products to infant formula
manufacturers under existing license agreements totaled approximately $400,000
in 1997, $600,000 in 1998, and $1.1 million in 1999. 1999 revenues represented
less than 1% penetration into the total world-wide infant formula market.
Stable isotope and other product sales increased $321,000 in 1998, or 18%,
as a result of increased sales and marketing efforts, and increased an
additional $119,000, or 6%, in 1999, primarily the result of increased sales of
high-value products including the Company's fluorescent detection products,
offset somewhat by competition in the reagents market. This competition may
continue and negatively impact stable isotope sales in fiscal 2000.
Royalty revenues increased by $363,000, or thirteen-fold, in 1998 and
increased an additional $3,000, or 1%, in 1999, due to the increased volume of
infant formula sales by licensees. Although royalty revenues may continue to
fluctuate based on the timing of sales to licensees, Management anticipates that
royalty revenues will grow at a more rapid rate in fiscal 2000 as sales of
nutritional oils to licensees grows. Contract and grant revenues decreased by
$46,000 in 1998 and further decreased by $101,000 in 1999 due to fewer grants
outstanding under which the Company is receiving funding. Management expects to
continue its efforts to secure research and development contracts and grants.
The timing and ultimate success of these efforts cannot be predicted.
23
<PAGE> 24
Cost Of Product Sales Cost of product sales increased from 76% in 1997 to
80% in 1998, and decreased to 79% in 1999. These fluctuations resulted primarily
from a change in the mix of product sales. Cost of product sales will increase
when the mix includes higher volumes of sales to infant formula licensees, or
bulk oil sales for encapsulation by others or for use as food ingredients.
Infant formula royalties may ultimately comprise up to half of revenues from oil
sold for such purposes. Since royalty revenues are not included in product
sales, this creates a significantly higher cost of goods sold as a percentage of
revenues than would be the case if royalties were incorporated into the product
price and recognized at the same time as the product sale. In addition, oil
production cost has remained high due to the current low volume of production
and because of ongoing process optimization. As sales volumes increase, and
manufacturing efficiencies and optimization occurs, Management believes that the
cost of production will decrease. Management believes that significant
optimization efforts will be required for at least the next year to realize
these increases in efficiency.
Cost of sales has also been impacted by certain price reductions brought
about by competition, primarily in the Company's low-end stable isotope drug
discovery products.
The Company offset these price reductions in part by sales of high-end
proprietary products in late 1998 and 1999. Management believes that, in the
future, sales of the Company's stable isotope drug discovery products can be
increased at the same time that production costs can be decreased by allocating
expensive raw materials over a range of new, high-value products, but the
ultimate impact of these efforts on cost of sales cannot be reasonably predicted
at this time.
Research And Development Research and Development expenses, including
contract-related costs, decreased from $11,051,000 in 1997 to $9,787,000 in
1998, a decrease of 11%, and increased to $10,309,000 in 1999, an increase of 5%
compared to 1998. Contract-related research and development costs included in
these amounts were $509,000 in 1997, $446,000 in 1998, and $464,000 in 1999.
Consistent with the Company's plans, nutritional oils development costs
accounted for over 75% of all research and development costs, as a result of the
Company's continued development efforts to refine its production process and
lower its DHA production cost. Research and development costs may increase in
the future as the Company evaluates new technologies and continues efforts to
optimize the efficiency of its large scale fermentation and oil extraction
processes.
Selling, General And Administrative Selling, general and administrative
costs decreased from $7,415,000 in 1997 to $7,360,000 in 1998, a decrease of 1%,
and decreased to $6,822,000 in 1999, a decrease of 7% from 1998. These costs
decreased primarily due to lower marketing expenses due to the timing of various
advertising and promotional campaigns for the Company's products. These costs
may increase in the future as the Company expands the sales and marketing
efforts related to its products.
Other Income, Net Other income decreased from $1,349,000 in 1997 to
$652,000 in 1998, and to $359,000 in 1999, primarily due to a lower amount of
interest earned on the investment of funds as these funds are used to support
Company operations.
Net Loss As a result of the above, net losses decreased from $15,397,000
in 1997 to $13,461,000 in 1998, a decrease of 13%, and increased to $14,848,000
in 1999, an increase of 10% compared to 1998.
Recent Accounting Pronouncements In June 1997, the FASB issued SFAS No.
130, "Reporting Comprehensive Income," which requires companies to report by
major components and in total, the change in its net assets during the period
from non-owner sources. This Statement is effective for the annual reporting of
companies with fiscal years beginning after December 15, 1997. Adoption of SFAS
No. 130 has had no impact on the reporting of the Company, as the Company has no
significant items related to comprehensive income. The FASB also recently issued
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," which establishes annual and interim reporting standards for a
company's operating segments and related disclosures about its products,
services, geographic areas and major customers. This Statement is effective for
the annual reporting of companies with fiscal years beginning after December 15,
1997. Adoption of this standard has had no significant impact on the Company's
financial position, results of operations, cash flows, or the presentation of
its disclosures.
24
<PAGE> 25
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Transactions," which require companies to recognize all
derivative financial instruments as either assets or liabilities on the balance
sheet and measure those instruments at fair value. This statement is effective
for fiscal years beginning after June 15, 2000. Adoption of this standard is not
expected to have a significant impact on the Company's financial position,
results of operations, cash flows, or the presentation of its disclosures.
In December 1999, the Staff of the SEC issued Staff Accounting Bulletin No.
101, "Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101
summarizes certain of the Staff's views in applying generally accepted
accounting principles to revenue recognition in the financial statements,
including recognition of non-refundable license fees received upon entering into
licensing arrangements. The Company is currently in the process of assessing the
impact of adopting SAB 101 on its revenue recognition policies and on prior
revenue generating transactions. The Company currently anticipates that adoption
of SAB 101 would not have had a material impact on prior revenue transactions
and will not have a material impact on future financial position, cash flows or
results of operations.
Impact Of Year 2000 The Company uses a number of computer software
programs and operating systems in its internal operations, including
applications used in financial business systems and various administrative
functions. Management believes that the business risk associated with these
internal information systems is minimal and has completed its Year 2000
compliance implementation work on them. The Company is also evaluating its
non-information technology systems, including the various equipment in operation
at the oil production facilities in Winchester, Kentucky. Management has
completed this evaluation and subsequent implementation, and believes that the
business risk associated with this equipment is minimal. Management believes
that its compliance work on the Company's information and non-information
technology systems is completed; however, if significant, new, non-compliance
issues are identified, the process may be delayed and the Company's operations
and financial condition may be materially adversely affected.
Additionally, Martek's third party relationships are being reviewed to
assess their Year 2000 status and potential impact on the Company. Where
potential business risk has been identified, additional information has been
requested from certain third parties to obtain assurance that they are Year 2000
compliant. To date, the Company's third party suppliers have represented that
they are Year 2000 compliant or are in the process of becoming compliant by
December 31, 1999. Although Management has identified multiple suppliers for
most of the goods and services purchased from third parties, there can be no
guaranty that the failure of any individual supplier to adequately address the
Year 2000 issue for the products or services that they provide to the Company
will not have a material adverse impact on the Company's operations and
financial results.
Management believes that the worst possible problem that could arise from a
Year 2000 computer failure would be a loss of power at its Kentucky plant. This
could result in production downtime and the potential loss of inventory.
Contingency plans, including the transport of any product subject to temperature
spoilage to an outside facility, have been made to reduce the impact on the
Company from such a failure. As such, we believe that the disruption from such
an event could be rectified in a maximum of five business days, and cause total
losses to the Company of less than $100,000.
Through October 31, 1999, the Company has incurred less than $100,000 in
costs associated with Year 2000 issues. Approximately 50% of these costs have
been related to system analysis work and 50% related to software and hardware
upgrades. These efforts have had minimal impact on other information technology
projects that are in process.
Based on currently available information, Management believes that total
costs associated with Year 2000 issues will be less than $200,000, and that it
will be able to manage the Year 2000 transition without any material adverse
effect on the Company's operations, liquidity or capital resources. However,
there can be no assurance that Year 2000 issues will not require a significant
commitment of resources to resolve potential problems.
Liquidity And Capital Resources Martek has financed its operations
primarily from the issuance and sale of equity securities, debt financing,
revenues received under research and development contracts and
25
<PAGE> 26
grants, product sales and receipt of license fees. Since its inception, the
Company has raised approximately $107 million from public and private sales of
its equity securities, as well as option and warrant exercises. Recent
fundraising efforts include approximately $10.25 million raised from a private
placement of stock in 1998 and $13.8 million from a private placement in May,
1999. The 1998 private placement investors also agreed to a two-year funding
commitment to provide up to an additional $10.25 million in financing in the
form of common stock and warrants at the discretion of the Company, subject to
certain conditions, which include the stock price being within twenty percent of
the 1998 initial issuance price of $15.63.
Through October 31, 1999, Martek has incurred an accumulated deficit of
$73,898,000. The Company's balance of cash, cash equivalents, short-term
investments and marketable securities at October 31, 1999 was $16,358,000. The
investments and securities consist of U.S. government securities and are
available to meet the future cash needs of the Company. Cash, cash equivalents,
short-term investments and marketable securities decreased $1,287,000 in 1999,
primarily due to the Company's continued operating losses, partially offset by
the additional funds raised in the private placement of common stock which
closed in May, 1999 (see Note 9 of Notes to the Financial Statements).
Capital expenditures of $697,000 were made in 1999, a significant portion
of which represents upgrades to the Company's fermentation and oil processing
facilities in Winchester, Kentucky. Management expects additional capital
expenditures of at least $1,000,000 in 2000 as fermentation and oil processing
activities increase and production optimization efforts continue. On June 20,
1996, the Company entered into an equipment line of credit in the amount of
$2,000,000 to finance a portion of the construction of the oil processing
facility at its Winchester, Kentucky plant. Draws on the line of credit as of
June 20, 1996 converted to a four-year term loan bearing interest at the rate of
9.02%. As of October 31, 1999, the Company had $413,000 outstanding under this
loan. On March 21, 1997 the Company entered into a four-year term loan in the
amount of $4,000,000 to refinance notes payable related to the Company's 1995
purchase of its fermentation facility (see Note 6 of Notes to the Financial
Statements). The term loan bears interest at the rate of 8.61% and, as of
October 31, 1999, the outstanding balance was $1,538,000. The Company was in
compliance with all of the covenants related to these loans at October 31, 1999,
including a covenant requiring a minimum cash balance of at least $12,000,000.
Martek will require substantial additional funds in the future to continue
its research and development programs, to conduct preclinical and clinical
studies to maintain compliance with its loan covenants, and to commercialize its
nutritional oils, Neuromins(R), and its other products under development. The
ultimate levels of funding required will depend, in part, on whether the Company
seeks independently, or with other parties through collaborative agreements, to
develop, manufacture and market its products. The capital requirements of Martek
will also depend, among other things, on one or more of the following factors:
growth in the Company's infant formula and nutritional product sales; the extent
and progress of its research and development programs; the progress of
preclinical and clinical studies; the time and costs of obtaining regulatory
clearances for those products subject to such clearances; the costs involved in
filing, protecting and enforcing patent claims; competing technological and
market developments; the cost of capital expenditures at the Company's
manufacturing facilities; the cost of acquiring additional and/or operating
existing manufacturing facilities for its various products and potential
products (depending on which products the Company decides to manufacture and
continues to manufacture itself); and the costs of marketing and commercializing
the Company's products. The continued development and optimization of the
Company's production facility has had, and will continue to have, a material
effect upon Martek's liquidity and capital resources. Additional plant
modifications costing at least $1,000,000 are expected in fiscal 2000.
Expenditures beyond fiscal 2000 will depend, in part, on production capacity
needs, and the extent of development and implementation of process improvements.
Management believes that its existing capital resources, consisting
primarily of cash, short-term investments and marketable securities, will
provide adequate capital for at least the next 12 months. However, Management
believes that additional funds will be needed in the longer term to continue the
Company's research and development, manufacturing and marketing efforts.
Management intends to seek additional funding through commercial and government
research and development contracts and grants, product sales and license fee
arrangements, asset-based borrowing, equity issuances, additional lease
financing and/or
26
<PAGE> 27
collaborative arrangements with partners if such methods are available to the
Company and on favorable terms. There can be no assurance that such funds will
be available to the Company on acceptable terms, if at all.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Company's 1999 Financial Statements and Report of Independent Auditors
by Ernst & Young LLP set forth in Item 14 are incorporated by reference into
Part II of this Report.
27
<PAGE> 28
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a)(1) Financial Statements
The following Financial Statements of the Company and Report of Independent
Auditors are incorporated into Item 8 of this Report:
MARTEK BIOSCIENCES CORPORATION
BALANCE SHEETS
<TABLE>
<CAPTION>
OCTOBER 31,
---------------------------
1999 1998
------------ ------------
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents................................. $ 1,180,098 $ 4,497,879
Short-term investments and marketable securities (Note
3)..................................................... 15,178,152 13,146,950
Accounts receivable....................................... 1,646,148 1,336,268
Inventories (Notes 2 and 4)............................... 5,216,265 5,001,990
Other current assets...................................... 482,772 519,373
------------ ------------
Total current assets.............................. 23,703,435 24,502,460
Property, plant and equipment, net (Notes 2 and 5).......... 15,468,836 16,233,049
------------ ------------
$ 39,172,271 $ 40,735,509
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable.......................................... $ 693,464 $ 595,644
Accrued liabilities....................................... 1,328,950 1,565,952
Current portion of notes payable (Note 6)................. 1,479,333 1,340,919
------------ ------------
Total current liabilities......................... 3,501,747 3,502,515
Long-term portion of notes payable (Note 6)................. 471,907 1,951,240
Commitments (Note 7)
Stockholders' equity (Note 9)
Preferred 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; 30,000,000 shares
authorized; 16,492,229 and 14,879,434 shares issued and
outstanding at October 31, 1999 and 1998,
respectively........................................... 1,649,223 1,487,943
Additional paid-in capital................................ 107,446,950 92,843,259
Accumulated deficit....................................... (73,897,556) (59,049,448)
------------ ------------
Total stockholders' equity........................ 35,198,617 35,281,754
------------ ------------
$ 39,172,271 $ 40,735,509
============ ============
</TABLE>
See accompanying notes.
28
<PAGE> 29
MARTEK BIOSCIENCES CORPORATION
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED OCTOBER 31,
------------------------------------------
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
REVENUES (NOTES 2 AND 8)
Product sales:
Nutritional product sales..................... $ 3,143,512 $ 2,762,844 $ 1,799,839
Stable isotope and other product sales........ 2,206,133 2,086,791 1,766,148
------------ ------------ ------------
Total product sales...................... 5,349,645 4,849,635 3,565,987
License fees and other revenues.................. 6,000 1,165,000 292,839
Royalties........................................ 394,003 391,215 28,475
Research and development contracts and grants.... 383,415 483,948 529,795
------------ ------------ ------------
Total revenues........................... 6,133,063 6,889,798 4,417,096
COSTS AND EXPENSES
Cost of product sales............................ 4,208,488 3,855,675 2,697,050
Research and development......................... 10,309,452 9,786,829 11,050,574
Selling, general and administrative.............. 6,822,440 7,360,019 7,415,127
------------ ------------ ------------
Total costs and expenses................. 21,340,380 21,002,523 21,162,751
------------ ------------ ------------
Loss from operations............................... (15,207,317) (14,112,725) (16,745,655)
OTHER INCOME (EXPENSE)
Miscellaneous income............................. 132,358 96,021 93,770
Interest income.................................. 806,238 1,076,587 1,682,785
Interest expense................................. (579,387) (521,198) (427,941)
------------ ------------ ------------
359,209 651,410 1,348,614
------------ ------------ ------------
Net loss........................................... $(14,848,108) $(13,461,315) $(15,397,041)
============ ============ ============
Net loss per share, basic and diluted (Note 2)..... $ (.95) $ (.94) $ (1.14)
============ ============ ============
Weighted average common shares outstanding......... 15,580,791 14,329,825 13,559,419
============ ============ ============
</TABLE>
See accompanying notes.
29
<PAGE> 30
MARTEK BIOSCIENCES CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
ADDITIONAL
COMMON STOCK COMMON STOCK PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
------------ ------------ ------------ ------------ -----------
<S> <C> <C> <C> <C> <C>
BALANCE AT OCTOBER 31, 1996...... 13,392,250 $1,339,225 $ 78,268,418 $(30,191,092) $49,416,551
Exercise of stock options...... 281,409 28,141 639,032 -- 667,173
Net loss....................... -- -- -- (15,397,041) (15,397,041)
---------- ---------- ------------ ------------ -----------
BALANCE AT OCTOBER 31, 1997...... 13,673,659 1,367,366 78,907,450 (45,588,133) 34,686,683
Issuance of common stock and
warrants in private
placement, net of issuance
costs........................ 655,563 65,556 9,944,000 -- 10,009,556
Exercise of stock options and
warrants..................... 550,212 55,021 3,991,809 -- 4,046,830
Net loss....................... -- -- -- (13,461,315) (13,461,315)
---------- ---------- ------------ ------------ -----------
BALANCE AT OCTOBER 31, 1998...... 14,879,434 1,487,943 92,843,259 (59,049,448) 35,281,754
Issuance of common stock in
private placement, net of
issuance costs............... 1,528,935 152,894 13,592,001 -- 13,744,895
Exercise of stock options and
other........................ 83,860 8,386 1,011,690 -- 1,020,076
Net loss....................... -- -- -- (14,848,108) (14,848,108)
---------- ---------- ------------ ------------ -----------
BALANCE AT OCTOBER 31, 1999...... 16,492,229 $1,649,223 $107,446,950 $(73,897,556) $35,198,617
---------- ---------- ------------ ------------ -----------
</TABLE>
See accompanying notes.
30
<PAGE> 31
MARTEK BIOSCIENCES CORPORATION
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED OCTOBER 31,
------------------------------------------
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss......................................... $(14,848,108) $(13,461,315) $(15,397,041)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization................. 1,461,159 1,368,789 1,201,179
Other non-cash items.......................... 348,600 174,300 --
Changes in operating assets and liabilities:
Accounts receivable......................... (309,880) (155,577) (858,580)
Inventories................................. (214,275) (2,096,538) (1,064,324)
Other current assets........................ 36,601 71,733 (332,796)
Accounts payable............................ 97,820 (412,463) 366,188
Accrued liabilities......................... (237,002) 525,103 (453,952)
------------ ------------ ------------
Net cash used in operating activities.............. (13,665,085) (13,985,968) (16,539,326)
INVESTING ACTIVITIES
Change in short-term investments and marketable
securities.................................... (2,031,202) 5,550,909 12,061,493
Purchase of property, plant and equipment........ (696,946) (1,612,406) (1,881,369)
------------ ------------ ------------
Net cash provided by (used in) investing
activities....................................... (2,728,148) 3,938,503 10,180,124
FINANCING ACTIVITIES
Borrowings on notes payable...................... -- -- 4,000,000
Repayment of notes payable....................... (1,340,919) (1,313,769) (4,964,258)
Proceeds from the exercise of warrants and
options....................................... 671,476 3,872,530 667,173
Proceeds from the issuance of common stock and
warrants in private placement................. 13,744,895 10,009,556 --
------------ ------------ ------------
Net cash provided by (used in) financing
activities....................................... 13,075,452 12,568,317 (297,085)
------------ ------------ ------------
Net increase (decrease) in cash and cash
equivalents...................................... (3,317,781) 2,520,852 (6,656,287)
Cash and cash equivalents at beginning of year..... 4,497,879 1,977,027 8,633,314
------------ ------------ ------------
Cash and cash equivalents at end of year........... $ 1,180,098 $ 4,497,879 $ 1,977,027
============ ============ ============
</TABLE>
See accompanying notes.
31
<PAGE> 32
MARTEK BIOSCIENCES CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION
Martek Biosciences Corporation (the "Company") develops, manufactures and
sells products primarily derived from microalgae. The Company is currently
selling nutritional supplements for infant formula and other nutritional product
applications, products for use in basic structural molecular research and
structure-based drug design and diagnostic products. The Company is developing
additional nutritional and diagnostic products as well as pharmaceutical
discovery technologies. A portion of the Company's research and development
efforts is performed under various contracts and grants. The Company sells to a
broad range of companies and academic and research institutions worldwide.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
Contracts and Grants A significant portion of contract and grant revenues
are derived from Small Business Innovation Research ("SBIR") grants. SBIR grants
are intended to aid small businesses in meeting federal research and development
needs while stimulating technological innovation. In addition, such grants are
used to increase private-sector commercialization of innovations derived from
federal research and development.
As a result of such funding, the U.S. government will have certain rights
in the technology developed with the funding. These rights include a
nonexclusive, paid-up, worldwide license under such inventions for any
governmental purpose. In addition, the government has the right to require the
Company to grant an exclusive license under any of such inventions to a third
party if the government determines (1) adequate steps have not been taken to
commercialize such inventions, (2) such action is necessary to meet public
health or safety needs, or (3) such action is necessary to meet requirements for
public use under federal regulations. Federal law requires any licensor of an
invention that was partially funded by federal grants to obtain a covenant from
its exclusive licensee to substantially manufacture products using the invention
in the United States.
The Company's revenue from SBIR research and development contracts and
grants amounted to $101,098 in 1999, $255,000 in 1998, and $333,000 in 1997.
Costs for products, contracts and grants, and research and development are
based on direct costs incurred plus an allocation of indirect costs, which
include such items as utilities, insurance and administrative labor and
supplies. Total allocated indirect costs for the years ended October 31, 1999,
1998 and 1997 were $154,459, $103,140 and $118,613, respectively. Estimated
losses on contracts, if any, are recorded as they become known.
Segment Information The Company currently operates in one business
segment, that being the development and commercialization of novel products from
microalgae. The Company is managed and operated as one business. The entire
business is comprehensively managed by a single management team that reports to
the Chief Executive Officer. The Company does not operate separate lines of
business or separate business entities with respect to its products or product
candidates. Accordingly, the Company does not accumulate discrete financial
information with respect to separate product areas and does not have separately
reportable segments as defined by SFAS No. 131, "Disclosure about Segments of an
Enterprise and Related Information."
Revenue Recognition Revenues on cost reimbursement and fixed price
contracts are generally recognized on the percentage of completion method of
accounting as costs are incurred. Revenue is recognized on product sales when
goods are shipped. Revenue from licensing agreements is recognized generally
over the
32
<PAGE> 33
MARTEK BIOSCIENCES CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
term of the agreement, or in certain circumstances, when milestones are met.
Revenue recognized in the accompanying Statements of Operations is not subject
to repayment. Revenue received that is related to future performance under such
contracts is deferred and recognized as revenue when earned.
Approximately 6% in 1999, 6% in 1998 and 12% in 1997 of the Company's total
revenues were generated from U.S. government contracts, subcontracts, and SBIR
grants.
Concentration of Credit Risk and Significant Customers Financial
instruments, which potentially subject the Company to concentrations of credit
risk, consist principally of accounts receivable. The Company's reserve for
uncollectable accounts at October 31, 1999 and 1998 was not material. The
Company grants credit to customers based on evaluations of their financial
condition, generally without requiring collateral. Concentrations of credit risk
with respect to accounts receivable are present due to the small number of
customers comprising the Company's customer base. However, the credit risk is
reduced through the Company's efforts to monitor its exposure for credit losses
and maintain allowances for anticipated losses. One customer accounted for
approximately 15% of the Company's sales for the years ended October 31, 1999,
1998 and 1997.
Research and Development Research and development costs are charged to
operations as incurred and include contract and grant-related costs of $464,000
in 1999, $446,000 in 1998 and $509,000 in 1997.
Advertising Costs All advertising costs are expensed when incurred.
Advertising costs expensed for the years ended October 31, 1999, 1998 and 1997
approximated $1,650,000, $1,765,000 and $1,198,000, respectively.
Income Taxes Net operating loss carryforwards differ for financial
statement and income tax purposes due principally to revenue recognition methods
used for income tax purposes. Under the liability method, deferred tax assets
and liabilities are determined based on differences between financial reporting
and tax bases of assets and liabilities, and are measured using the enacted tax
rates and laws that will be in effect when the differences are expected to
reverse.
Fair Value of Financial Instruments The Company considers the recorded
cost of its financial assets and liabilities, which consists primarily of cash
and cash equivalents, short-term investments and marketable securities, accounts
receivable, accounts payable and long-term debt, to approximate the fair value
of the respective assets and liabilities at October 31, 1999.
Stock-Based Compensation The Company has adopted Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation." SFAS
No. 123 allows companies to either account for stock-based compensation under
the new provisions of SFAS No. 123 or under the provisions of APB No. 25,
"Accounting for Stock Issued to Employees." The Company has elected to continue
accounting for its stock-based compensation in accordance with the provisions of
APB No. 25, but will disclose the pro forma effects on net income (loss) as if
the fair value of the options had been expensed. See Note 9 of Notes to
Financial Statements for further information.
Net Loss Per Share Net loss per share is computed using the weighted
average number of shares of common stock outstanding during the period. Common
equivalent shares from stock options and warrants are excluded as their effect
is antidilutive.
Inventories Inventories are stated at the lower of cost or market, reflect
appropriate reserves for potential obsolete, slow-moving or otherwise impaired
material, and include appropriate elements of material, labor and indirect costs
and are valued using the average cost method. The Company analyzes both
historical and projected sales volumes and, when needed, reserves for
questionable inventory that is either obsolete, slow moving or impaired.
Inventories include products and materials held for sale as well as products and
materials
33
<PAGE> 34
MARTEK BIOSCIENCES CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
that are also used in the Company's research and development activities.
Inventories identified for development activities are expensed in the period in
which such inventories are designated for such use.
Property, Plant and Equipment Property, plant and equipment, including
leasehold improvements, are stated at cost and depreciated or amortized using
the straight-line method, based on useful lives which are twenty years for the
Company's fermentation plant, fifteen years for the Company's oil processing
plant, generally ten years for machinery and equipment, five years for furniture
and fixtures, and the shorter of the useful life or the lease term for leasehold
improvements.
The Company reviews long-lived assets and certain identifiable intangibles
for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset
to future undiscounted net cash flows expected to be generated by the asset.
Recoverability measurement and estimating of undiscounted cash flows is done at
the lowest possible level for which there are identifiable assets. If such
assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of assets exceed the fair
value of the assets. Assets to be disposed of are reported at the lower of the
carrying amount or fair value less costs to sell. To date, the Company has not
incurred any impairment expenses.
Statements of Cash Flows Cash equivalents consist of highly liquid
investments with an original maturity of three months or less and are stated at
market value.
Interest paid by the Company amounted to approximately $408,000 in 1999,
$349,000 in 1998 and $689,000 in 1997. For the years ended October 31, 1999,
1998 and 1997 the Company paid no income taxes.
Reclassification Certain amounts in the prior years' financial statements
have been reclassified to conform to the 1999 presentation.
3. SHORT-TERM INVESTMENTS AND MARKETABLE SECURITIES
The Company has classified all debt securities as available-for-sale.
Available-for-sale securities are carried at specific identification and have
average maturities of approximately six months. The amount of unrealized holding
gain (loss) on these available-for-sale securities was $12,005 and $(27,601) at
October 31, 1998 and 1999, respectively. Realized gains and losses and declines
in value judged to be other-than-temporary on available-for-sale securities are
included in other income. Available-for-sale securities consisted of U.S.
government obligations totaling $15,178,152 and $13,146,950 for the years ended
October 31, 1999 and 1998, respectively. At October 31, 1999 and 1998, the
estimated fair value of these securities approximated cost.
4. INVENTORIES
Inventories consisted of the following:
<TABLE>
<CAPTION>
OCTOBER 31,
-----------------------
1999 1998
---------- ----------
<S> <C> <C>
Finished products........................................... $2,206,051 $1,406,053
Work in process............................................. 2,683,477 3,343,911
Raw materials............................................... 326,737 252,026
Inventory reserve........................................... (237,000) (400,000)
---------- ----------
$5,216,265 $5,001,990
========== ==========
</TABLE>
34
<PAGE> 35
MARTEK BIOSCIENCES CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consisted of the following:
<TABLE>
<CAPTION>
OCTOBER 31,
-------------------------
1999 1998
----------- -----------
<S> <C> <C>
Land....................................................... $ 149,860 $ 149,860
Building and improvements.................................. 1,742,123 1,742,123
Machinery and equipment.................................... 18,847,913 18,220,885
Furniture and fixtures..................................... 734,360 664,442
Leasehold improvements..................................... 396,986 396,986
----------- -----------
21,871,242 21,174,296
Less accumulated depreciation and amortization............. 6,402,406 4,941,247
----------- -----------
$15,468,836 $16,233,049
=========== ===========
</TABLE>
Depreciation expense amounted to $1,461,000, $1,369,000 and $1,201,000 for
the years ended October 31, 1999, 1998 and 1997, respectively.
6. NOTES PAYABLE
In March 1997, the Company entered into a four-year term loan in the amount
of $4,000,000 to refinance the debt associated with the purchase of its
fermentation facility located in Winchester, Kentucky. The term loan bears
interest at a rate of 8.61% and, as of October 31, 1999, the outstanding balance
was $1,538,000. The loan is collateralized solely by the fermentation plant.
In June 1996, the Company entered into a four-year term loan in the amount
of $1,540,000, bearing interest at the rate of 9.02% to finance a portion of the
construction of its oil processing facility in Winchester, Kentucky. As of
October 31, 1999 the outstanding balance was $413,000. This loan is
collateralized by the equipment purchased with the proceeds.
Future minimum payments on the Company's term loans at October 31, 1999
were as follows:
<TABLE>
<S> <C>
2000........................................................ $1,479,333
2001........................................................ 471,907
----------
$1,951,240
==========
</TABLE>
7. COMMITMENTS
Facilities Leases The Company leases its premises under an operating lease
agreement which expires in November 2004. The terms of the lease call for annual
rent escalations of 3%. The Company has an option to extend the lease for five
additional years at 95% of the then prevailing fair rental value. Rent expense
was approximately $371,577 in 1999, $329,000 in 1998 and $311,000 in 1997.
Future minimum lease payments
35
<PAGE> 36
MARTEK BIOSCIENCES CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. COMMITMENTS -- (CONTINUED)
under the lease, assuming the Company will not exercise any additional
cancellation or expansion rights it has under the lease, at October 31, 1999,
were as follows:
<TABLE>
<S> <C>
2000........................................................ $ 403,000
2001........................................................ 416,000
2002........................................................ 429,000
2003........................................................ 441,000
2004 and after.............................................. 455,000
----------
$2,144,000
==========
</TABLE>
Scientific Research Collaborations The Company has entered into various
collaborative research and license agreements. Under the agreements, the Company
is required to fund research or to collaborate on the development of potential
products. Existing agreements have committed the Company to fund up to
approximately $100,000 for such future development activities. Certain of these
agreements also commit the Company to pay royalties upon the sale of certain
products resulting from such collaborations.
SBIR Grants The Company had commitments at October 31, 1999 to fund up to
$1.5 million of Phase III SBIR technology commercialization expenses, provided
the technology under existing Phase II SBIR grants yields commercial
opportunities favorable to the Company.
Costs under U.S. government contracts are subject to audit by the
appropriate U.S. government agency. Management believes that cost disallowances,
if any, arising from audits of costs charged to government contracts through
October 31, 1999, would not have a material effect on the financial statements.
Loan Covenants The Company is required to meet certain covenants in
relation to its outstanding term loans. These covenants, which outline minimum
cash, current ratio and net worth requirements, have been met by the Company at
October 31, 1999.
Other The Company was not a party to any material legal proceedings.
8. LICENSE AGREEMENTS
The Company has licensed certain technologies and recognized license fee
revenue under various agreements. Potentially refundable license fees are
recorded as unearned revenue and are not recognized as revenue until the
earnings process is complete and amounts are not subject to refund. In 1998, the
Company recognized a license fee of $1,125,000 associated with a pre-1998
arrangement. Certain agreements include royalty payments, which are based upon a
percentage of product sales. Royalties in the amount of $394,000, $391,000 and
$28,000 were earned in the years ended October 31, 1999, 1998 and 1997,
respectively.
9. CAPITAL ACCOUNTS
Private Placement of Common Stock On April 27, 1998, 655,563 shares of the
Company's common stock and warrants to purchase 196,670 shares of common stock
were issued in a private placement resulting in net proceeds to the Company of
approximately $10 million. The warrants are exercisable for a period of three
years from the date of issuance at a price of $18.76. The investors have also
agreed to a two-year funding commitment to provide up to an additional $10.25
million in financing in the form of common stock and warrants. This commitment,
which expires on April 27, 2000, can be drawn upon at the discretion of the
Company, subject to certain conditions, which includes the stock price being
within twenty percent of the initial issuance price of $15.63. In consideration
for the additional $10.25 million two-year funding commitment, the Company
issued warrants to purchase up to 51,250 shares of common stock on April 27,
36
<PAGE> 37
MARTEK BIOSCIENCES CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. CAPITAL ACCOUNTS -- (CONTINUED)
1999 at $7.51 per share and is obligated to again issue warrants to purchase up
to 51,250 shares of common stock at the end of year two if the Company does not
utilize the additional funding by such date. The cost of approximately $350,000
associated with the additional warrants has been calculated using the
Black-Scholes option pricing model and is included in interest expense for the
year ended October 31, 1999. With the exception of the two year funding
commitment, there were no future performance obligations on behalf of the
Company or the investors in connection with the 1998 private placement.
On May 28, 1999, 1,528,935 shares of the Company's common stock, and
warrants to purchase 458,679 shares of common stock were issued in a private
placement, resulting in net proceeds to the Company of approximately $13.7
million. The stock was issued at a thirty-day average trading price of $9.03 per
share. The warrants are exercisable for a period of three years from date of
issuance at $10.84 per share. There were no future performance obligations on
behalf of the Company or the investors in connection with the 1999 private
placement.
Stock Option Plan Options to purchase common stock under the Company's
stock option plan ("Option Plan") are granted at prices as determined by the
Board of Directors, but shall not be less than the fair market value of the
Company's common stock on the date of grant. The options are qualified and
nonqualified and generally vest over a period of up to five years. The exercise
dates and expiration of options (up to a maximum of ten years from the date of
grant) are determined by the Company's Board of Directors.
Details of shares under option were as follows:
<TABLE>
<CAPTION>
WEIGHTED
NUMBER OF OPTION AVERAGE
SHARES PRICE/SHARE PRICE/SHARE
--------- ------------- -----------
<S> <C> <C> <C>
BALANCE AT OCTOBER 31, 1996..................... 1,479,959 $1.50-$34.25 $11.08
Granted......................................... 586,900 $12.88-$25.00 $16.76
Exercised....................................... (281,409) $1.50-$18.00 $ 2.37
Forfeited....................................... (28,170) $8.00-$34.25 $16.01
--------- ------------- ------
BALANCE AT OCTOBER 31, 1997..................... 1,757,280 $2.00-$34.25 $14.29
Granted......................................... 340,750 $8.63-$15.50 $13.07
Exercised....................................... (195,785) $2.00-$13.50 $ 2.78
Forfeited....................................... (129,375) $2.00-$34.25 $19.97
--------- ------------- ------
BALANCE AT OCTOBER 31, 1998..................... 1,772,870 $8.00-$34.25 $14.90
Granted......................................... 859,450 $6.25-$9.625 $ 6.75
Exercised....................................... (83,860) $8.00-$9.875 $ 8.01
Forfeited....................................... (380,400) $6.25-$34.25 $ 9.60
--------- ------------- ------
BALANCE AT OCTOBER 31, 1999..................... 2,168,060 $6.25-$34.25 $13.16
</TABLE>
At October 31, 1999, 1,099,400 options were exercisable at a weighted
average exercise price of $14.99 per share, and a total of 596,500 shares of
common stock were available for future grants under the Option Plan. The
weighted average contractual life for all options outstanding under the Option
Plan at October 31, 1999 was 7.9 years.
37
<PAGE> 38
MARTEK BIOSCIENCES CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. CAPITAL ACCOUNTS -- (CONTINUED)
Detailed information on the options outstanding on October 31, 1999 by
price range are set forth below:
<TABLE>
<CAPTION>
WEIGHTED
WEIGHTED AVERAGE WEIGHTED
AVERAGE REMAINING AVERAGE
OPTIONS EXERCISE CONTRACTUAL SHARES EXERCISE
PRICE RANGE OUTSTANDING PRICE LIFE EXERCISABLE PRICE
----------- ----------- -------- ----------- ----------- --------
<S> <C> <C> <C> <C> <C>
$ 6.25-9.88 1,024,510 $ 7.20 8.74 360,260 $ 7.70
$10.25-14.44 581,350 $12.65 7.36 398,030 $12.44
$15.50-25.50 375,500 $18.72 7.42 200,690 $18.88
$32.88-34.25 186,700 $33.08 6.40 140,420 $33.04
--------- ---------
2,168,060 1,099,400
========= =========
</TABLE>
Directors' Stock Option Plan In 1994, the Company established a Directors'
Stock Option Plan ("Directors' Plan"). The Directors' Plan provided for the
award of stock options to nonemployee directors. At October 31, 1999, 140,800
options were outstanding and no additional options were available for future
grant under the Directors' Plan. The weighted average contractual life for all
options outstanding under the Directors' Plan at October 31, 1999 was 6.8 years.
No awards were made under the Director's Plan after 1998. During 1999, Directors
of the Company received option grants under the Company's Option Plan.
Pro Forma Disclosure The Company applies APB 25 in accounting for its
stock option incentive plan and, accordingly, recognizes compensation expense
for the difference between the fair value of the underlying common stock and the
grant price of the option at the date of the grant. The effects of applying SFAS
No. 123 on 1999 and 1998 pro forma net loss and per share calculations as stated
below are not necessarily representative of effects on reported net income and
earnings per share for future years due to such things as the vesting period of
the stock options and the potential for issuance of additional stock options in
future years. Had compensation expense for the Company's stock option incentive
plan been determined based on the estimated fair value at the grant dates for
awards under the plan consistent with the methodology prescribed under SFAS No.
123, the Company's net loss in 1999, 1998 and 1997 would have been approximately
$18.9 million, $17.2 million and $17.7 million, or $1.22, $1.20 and $1.31 per
share, respectively. The weighted average fair value of the options granted
during 1999 is estimated at $5.91 per share for options whose exercise price
equals fair market value on the date of the grant, using the Black-Scholes
option-pricing model with the following assumptions: dividend yield 0%,
volatility of 87.5%, risk-free interest rate of 5.5% and average expected life
of approximately 7 years.
Stockholder Rights Plan In January 1996, the Board of Directors adopted a
Stockholder Rights Plan ("Rights Plan") in which preferred stock purchase rights
("Rights") have been granted as a dividend at the rate of one Right for each
share of the Company's common stock held of record at the close of business on
February 7, 1996. Each Right provides the holder the opportunity to purchase
1/1000th of a share of Series A Junior Participating Preferred Stock under
certain circumstances at a price of $150 per share of such preferred stock. All
rights expire on February 7, 2006.
At the time of adoption of the Rights Plan, the Rights were neither
exercisable nor traded separately from the common stock. The Rights will be
exercisable only if a person or group in the future becomes the beneficial owner
of 20% or more of the common stock or announces a tender or exchange offer which
would result in its ownership of 20% or more of the common stock. Ten days after
a public announcement that a person or group has become the beneficial owner of
20% or more of the common stock, each holder of a Right, other than the
acquiring person, would be entitled to purchase $300 worth of the common stock
of the Company for each Right at the exercise price of $150 per Right, which
would effectively enable such Right holders to purchase the common stock at
one-half of the then current price.
38
<PAGE> 39
MARTEK BIOSCIENCES CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. CAPITAL ACCOUNTS -- (CONTINUED)
If the Company is acquired in a merger, or 50% or more of the Company's
assets are sold in one or more related transactions, each Right would entitle
the holder thereof to purchase $300 worth of common stock of the acquiring
company at the exercise price of $150 per Right, which would effectively enable
such Right holders to purchase the acquiring company's common stock at one-half
of the then current market price.
At any time after a person or group of persons becomes the beneficial owner
of 20% or more of the common stock, the Board of Directors, on behalf of all
stockholders, may exchange one share of common stock for each Right, other than
Rights held by the acquiring person.
The Board of Directors may authorize the redemption of the Rights, at a
redemption price of $.001 per Right, at any time until ten days (as such period
may be extended or shortened by the Board) following the public announcement
that a person or group of persons has acquired beneficial ownership of 20% or
more of the outstanding common stock.
10. INCOME TAXES
At October 31, 1999, the Company had net operating loss carryforwards of
approximately $88,272,000 for income tax reporting purposes that expire in years
2000 through 2019.
Section 382 of the Internal Revenue Code limits the utilization of net
operating losses when ownership changes, as defined by that section, are greater
than 50%. The Company has had significant ownership changes over the past six
years, including an initial public offering of its common stock in December 1993
and a follow-on offering of its stock in October 1995, which may have caused
these limitations to apply. Deferred income taxes reflect the net tax effects of
temporary differences between the carrying amounts of assets and liabilities for
financial reporting and the amounts used for income tax reporting. The Company's
total net deferred tax assets, which resulted primarily from net operating
losses, were $35,309,000 and $29,889,000 at October 31, 1999 and 1998,
respectively. Because of the uncertainty with the ultimate realization of these
net deferred tax assets, they were fully reserved for by a valuation allowance
at October 31, 1999 and 1998.
11. EMPLOYEE 401(K) PLAN
The Company maintains an employee 401(k) plan. The plan, which covers all
employees 21 years of age or older, stipulates that participating employees may
elect an amount between 1% and 15% of their total compensation to contribute to
the plan, not to exceed the maximum allowable by Internal Revenue Service
regulations. As of October 31, 1999, the Company had not contributed to the
plan.
39
<PAGE> 40
REPORT OF INDEPENDENT AUDITORS
BOARD OF DIRECTORS
MARTEK BIOSCIENCES CORPORATION
We have audited the accompanying balance sheets of Martek Biosciences
Corporation as of October 31, 1999 and 1998, and the related statements of
operations, stockholders' equity, and cash flows for each of the three years in
the period ended October 31, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Martek Biosciences
Corporation at October 31, 1999 and 1998, and the results of its operations and
its cash flows for each of the three years in the period ended October 31, 1999,
in conformity with accounting principles generally accepted in the United
States.
McLean, Virginia
December 14, 1999
/s/ Ernst & Young LLP
40
<PAGE> 41
(a)(2) Financial Statement Schedules
Financial statement schedules have been omitted since they are either not
required, not applicable, or the information is otherwise included.
(a)(3) Exhibits
<TABLE>
<C> <S>
3.01 Revised Restated Certificate of Incorporation of Registrant.
3.02 Amendment to the Restated Certificate of Incorporation,
effective March 14, 1995 (filed as Exhibit 3.1 to the
Company's Registration Statement on Form S-3, File No.
33-89760, filed March 15, 1995, and incorporated by
reference herein).
3.03 Certificate of Designation, Preferences and Rights of Series
A Junior Participating Preferred Stock (filed as Exhibit 4
to the Company's Form 8-K, File No. 0-22354, filed January
29, 1996, and incorporated by reference herein).
3.04 Amended By-Laws of Registrant.
3.05 Amendment to By-Laws, effective March 14, 1995 (filed as
Exhibit 3.2 to the Company's Registration Statement on Form
S-3, File No. 33-89760, filed March 15, 1995, and
incorporated by reference herein).
4.01 Specimen Stock Certificate for Common Stock.
4.02 Common Stock and Warrant Purchase Agreements, dated May 19,
June 1, June 6, and June 8, 1995, by and among the Company
and the Selling Stockholders (filed as Exhibit 4.2 to the
Company's Registration Statement on Form S-3, File No.
33-93580, filed June 16, 1995, and incorporated by reference
herein).
4.03 Warrant No. 1 issued pursuant to Common Stock and Warrant
Purchase Agreements and Schedule of Warrants (filed as
Exhibit 4.3 to the Company's Registration Statement on Form
S-3, File No. 33-93580, filed June 16, 1995, and
incorporated by reference herein).
4.04 Form of Rights Agreement dated as of January 24, 1996
between the Company and Registrar and Transfer Company, as
Rights Agent (filed as Exhibit 1 to the Company's Form 8-K,
File No. 0-22354, filed January 29, 1996, and incorporated
by reference herein).
4.05 Form of First Amendment to Rights Agreement between the
Company and Registrar and Transfer Company, as Rights Agent
(filed as Exhibit 99.1 to the Company's Form 8-K, File No.
0-22354, filed November 9, 1998 and incorporated by
reference herein).
10.01 Form Indemnification Agreement for directors.
10.02 1986 Stock Option Plan, as amended.
10.03 1992 Registration Rights Agreement between the Company and
Preferred Stockholders.
10.04 Employment Agreement, dated May 4, 1990, between the Company
and Henry Linsert, Jr.
10.05 Employment Agreement, dated May 7, 1990, between the Company
and Richard J. Radmer.
10.06 Employment Agreement, dated May 7, 1990, between the Company
and David J. Kyle.
10.07 Employment Agreement, dated May 7, 1990, between the Company
and Paul W. Behrens.
10.08 Form of Proprietary Information, Inventions and
Non-Solicitation Agreement.
10.12 Collaborative Research and License Agreement, dated April
30, 1993, as amended June 11, 1993, between the Company and
the Trustees of Columbia University.
10.13 Lease, commencement date October 15, 1992, between the
Company and Aetna Life Insurance Company, as modified on
August 5, 1993.
10.14 License Agreement, dated September 10, 1992, between the
Company and Bestuurcentrum Der Verenigde Bedrijven Nutricia
B.V.*
10.14A Exhibits to September 10, 1992 License Agreement between the
Company and Bestuurcentrum Der Verenigde Bedrijven Nutricia
B.V.*
10.15 License Agreement, dated October 28, 1992, between the
Company and Mead Johnson & Company.*
10.15A Exhibits to October 28, 1992 License Agreement between the
Company and Mead Johnson & Company.*
</TABLE>
41
<PAGE> 42
<TABLE>
<C> <S>
10.16 License Agreement, dated January 28, 1993 between the
Company and American Home Products Corporation represented
by the Wyeth-Ayerst Division (Domestic Version) and American
Home Products Corporation represented by its agent
Wyeth-Ayerst International (International Version).*
10.16A Exhibits to January 28, 1993 License Agreements between the
Company and American Home Products Corporation represented
by the Wyeth-Ayerst Division (Domestic Version) and American
Home Products Corporation represented by its agent
Wyeth-Ayerst International (International Version).*
10.17 Management Cash Bonus Incentive Plan, dated June 10, 1993.
10.18 Lease Modification Agreement, dated October 14, 1993 between
the Company and Aetna Life Insurance Company.
10.19 Letter of Intent, dated January 13, 1995, between the
Company and Golden Technologies Corporation (filed as
Exhibit 10.19 to the Company's 1994 Form 10-K, File No.
0-22354, and incorporated by reference herein).
10.20 Second Lease Modification Agreement, dated September 27,
1994, between the Company and Aetna Life Insurance Company
(filed as Exhibit 10.20 to the Company's 1994 Form 10-K,
File No. 0-22354, and incorporated by reference herein).
10.21 Purchase and Sale Agreement, dated February 16, 1995,
between the Company and Zeagan, Inc. (filed as Exhibit 4.3
to the Company's Registration Statement on Form S-3, File
No. 33-89760, filed March 15, 1995, and incorporated by
reference herein).
10.22 Directors' Stock Option Plan (filed as Exhibit 4.1(b) to the
Company's Registration Statement on Form S-8, File No.
33-79222, filed May 23, 1994, and incorporated by reference
herein).
10.23 Manufacturing Agreement, dated December 31, 1996, between
the Company and DSM Food Specialties (formerly Royal
Gist-brocades B.V.)* (filed as Exhibit 10.23 to the
Company's Annual Report on Form 10-K for the fiscal year
ended October 31, 1996).
10.24 Martek Biosciences Corporation 1997 Stock Option Plan (filed
as Exhibit 4.1(e) to the Company's Registration Statement on
Form S-8, File No. 333-27671, filed May 22, 1997, and
incorporated by reference herein).
10.25 Third Amendment of Lease, dated August 1, 1997 between the
Company and M.O.R Columbia Limited Partnership (filed as
exhibit 10.25 to the Company's 1997 10-K, File No. 22354,
and incorporated by reference herein).
10.26 Fourth Amendment of Lease, dated August 5, 1998 between the
Company and M.O.R Columbia Limited Partnership (filed as
exhibit 10.26 to the Company's 1998 Form 10-K, File No.
22354, and incorporated by reference herein).
10.27 Employment Agreement, dated January 16, 1998, between the
Company and Peter L. Buzy (filed as exhibit 10.27 to the
Company's 1998 Form 10-K, File No. 22354, and Incorporated
by reference herein).
10.28 Common Stock and Warrant Purchase Agreement, dated April 27,
1998, by and among the Company and the Selling Stockholders
(filed as exhibit 99.2 to the Company's Form 8-K, File No.
22354, dated April 27, 1998 and incorporated by reference
herein).
10.29 Common Stock and Warrant Purchase Agreement, dated May 28,
1999, by and among the Company and the Selling Stockholders
(filed as exhibit 99.2 to the Company's Form 8-K, File No.
22354, dated June 9, 1999 and incorporated by reference
herein).
13.01 Portions of the Annual Report to Stockholders of the Company
for the year ended October 31, 1999.**
23.01 Signed Consent of Ernst & Young LLP, Independent Auditors.**
24.01 Power of Attorney of the Board of Directors.**
27.01 Financial Data Schedule.**
99.1 Cautionary Statements for purposes of the "safe harbor"
provisions of the private securities reform act of 1995.**
</TABLE>
---------------
* Confidential treatment was granted by the Securities and Exchange Commission
for certain portions of these agreements. The confidential portions were
filed separately with the Commission.
42
<PAGE> 43
** Filed with the Form 10-K on January 31, 2000. Unless otherwise noted, all
other Exhibits are incorporated by reference as an Exhibit to the
Registrant's Registration Statement on Form S-1 (No. 33-68522).
(b) Reports on Form 8-K
None
43
<PAGE> 44
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized on December 8, 2000.
MARTEK BIOSCIENCES CORPORATION
By /s/ PETER L. BUZY
------------------------------------
Peter L. Buzy
Principal Financial Accounting
Officer
44
<PAGE> 45
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
3.01 Revised Restated Certificate of Incorporation of Registrant.
3.02 Amendment to the Restated Certificate of Incorporation,
effective March 14, 1995 (filed as Exhibit 3.1 to the
Company's Registration Statement on Form S-3, File No.
33-89760, filed March 15, 1995, and incorporated by
reference herein ).
3.03 Certificate of Designation, Preferences and Rights of Series
A Junior Participating Preferred Stock (filed as Exhibit 4
to the Company's Form 8-K, File No. 0-22354, filed January
29, 1996, and incorporated by reference herein).
3.04 Amended By-Laws of Registrant.
3.05 Amendment to By-Laws, effective March 14, 1995 (filed as
Exhibit 3.2 to the Company's Registration Statement on Form
S-3, File No. 33-89760, filed March 15, 1995, and
incorporated by reference herein).
4.01 Specimen Stock Certificate for Common Stock.
4.02 Common Stock and Warrant Purchase Agreements, dated May 19,
June 1, June 6, and June 8, 1995, by and among the Company
and the Selling Stockholders (filed as Exhibit 4.2 to the
Company's Registration Statement on Form S-3, File No.
33-93580, filed June 16, 1995, and incorporated by reference
herein ).
4.03 Warrant No. 1 issued pursuant to Common Stock and Warrant
Purchase Agreements and Schedule of Warrants (filed as
Exhibit 4.3 to the Company's Registration Statement on Form
S-3, File No. 33-93580, filed June 16, 1995, and
incorporated by reference herein).
4.04 Form of Rights Agreement dated as of January 24, 1996
between the Company and Registrar and Transfer Company, as
Rights Agent (filed as Exhibit 1 to the Company's Form 8-K,
File No. 0-22354, filed January 29, 1996, and incorporated
by reference herein).
4.05 Form of First Amendment to Rights Agreement between the
Company and Registrar and Transfer Company, as Rights Agent
(filed as Exhibit 99.1 to the Company's Form 8-K, File No.
0-22354, filed November 9, 1998 and incorporated by
reference herein).
10.01 Form Indemnification Agreement for directors.
10.02 1986 Stock Option Plan, as amended.
10.03 1992 Registration Rights Agreement between the Company and
Preferred Stockholders.
10.04 Employment Agreement, dated May 4, 1990, between the Company
and Henry Linsert, Jr.
10.05 Employment Agreement, dated May 7, 1990, between the Company
and Richard J. Radmer.
10.06 Employment Agreement, dated May 7, 1990, between the Company
and David J. Kyle.
10.07 Employment Agreement, dated May 7, 1990, between the Company
and Paul W. Behrens.
10.08 Form of Proprietary Information, Inventions and
Non-Solicitation Agreement.
10.12 Collaborative Research and License Agreement, dated April
30, 1993, as amended June 11, 1993, between the Company and
the Trustees of Columbia University.
10.13 Lease, commencement date October 15, 1992, between the
Company and Aetna Life Insurance Company, as modified on
August 5, 1993.
10.14 License Agreement, dated September 10, 1992, between the
Company and Bestuurcentrum Der Verenigde Bedrijven Nutricia
B.V.*
10.14A Exhibits to September 10, 1992 License Agreement between the
Company and Bestuurcentrum Der Verenigde Bedrijven Nutricia
B.V.*
10.15 License Agreement, dated October 28, 1992, between the
Company and Mead Johnson & Company.*
</TABLE>
45
<PAGE> 46
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.15A Exhibits to October 28, 1992 License Agreement between the
Company and Mead Johnson & Company.*
10.16 License Agreement, dated January 28, 1993 between the
Company and American Home Products Corporation represented
by the Wyeth-Ayerst Division (Domestic Version) and American
Home Products Corporation represented by its agent
Wyeth-Ayerst International (International Version).*
10.16A Exhibits to January 28, 1993 License Agreements between the
Company and American Home Products Corporation represented
by the Wyeth-Ayerst Division (Domestic Version) and American
Home Products Corporation represented by its agent
Wyeth-Ayerst International (International Version).*
10.17 Management Cash Bonus Incentive Plan, dated June 10, 1993.
10.18 Lease Modification Agreement, dated October 14, 1993 between
the Company and Aetna Life Insurance Company.
10.19 Letter of Intent, dated January 13, 1995, between the
Company and Golden Technologies Corporation (filed as
Exhibit 10.19 to the Company's 1994 Form 10-K, File No.
0-22354, and incorporated by reference herein).
10.20 Second Lease Modification Agreement, dated September 27,
1994, between the Company and Aetna Life Insurance Company
(filed as Exhibit 10.20 to the Company's 1995 Form 10-K,
File No. 0-22354, and incorporated by reference herein).
10.21 Purchase and Sale Agreement, dated February 16, 1995,
between the Company and Zeagan, Inc. filed as Exhibit 4.3 to
the Company's Registration Statement on Form S-3, File No.
33-89760, filed March 15, 1995, and incorporated by
reference herein).
10.22 Directors' Stock Option Plan (filed as Exhibit 4.1(b) to the
Company's Registration Statement on Form S-8, File No.
33-79222, filed May 23, 1994, and incorporated by reference
herein).
10.23 Manufacturing Agreement, dated December 31, 1996, between
the Company and DSM Food Specialties (formerly Royal
Gist-Brocades B.V.)* (filed as exhibit 10.23 to the
Company's Annual Report on Form 10-K for the fiscal year
ended October 31, 1996).
10.24 Martek Biosciences Corporation 1997 Stock Option Plan (filed
as Exhibit 4.1(e) to the Company's Registration Statement on
Form S-8, File No. 333-27671, filed May 22, 1997, and
incorporated by reference herein).
10.25 Third Amendment of Lease, dated August 1, 1997 between the
Company and M.O.R Columbia Limited Partnership (filed as
exhibit 10.25 to the Company's 1997 10-K, File No.
000-22354, and incorporated by reference herein).
10.26 Fourth Amendment of Lease, dated August 5, 1998 between the
Company and M.O.R Columbia Limited Partnership (filed as
exhibit 10.26 to the Company's 1998 Form 10-K, File No.
22354, and incorporated by reference herein).
10.27 Employment Agreement, dated January 16, 1998, between the
Company and Peter L. Buzy (filed as exhibit 10.27 to the
Company's 1998 Form 10-K, File No. 22354, and Incorporated
by reference herein).
10.28 Common Stock and Warrant Purchase Agreement, dated April 27,
1998, by and among the Company and the Selling Stockholders
(filed as exhibit 99.2 to the Company's Form 8-K, File No.
22354, dated April 27, 1998 and incorporated by reference
herein).
10.29 Common Stock and Warrant Purchase Agreement, dated May 28,
1999, by and among The Company and the Selling Stockholders
(filed as exhibit 99.2 to the Company's Form 8-K, File No.
22354, dated June 9, 1999 and incorporated by reference
herein).
</TABLE>
46
<PAGE> 47
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
13.01 Portions of the Annual Report to Stockholders of the Company
for the year ended October 31, 1999.**
23.01 Signed Consent of Ernst & Young LLP, Independent Auditors.**
24.01 Power of Attorney of the Board of Directors.**
27.01 Financial Data Schedule.**
99.1 Cautionary Statements for purposes of the "safe harbor"
provisions of the private securities reform act of 1995.**
</TABLE>
---------------
* Confidential treatment was granted by the Securities and Exchange Commission
for certain portions of these agreements. The confidential portions were
filed separately with the Commission.
** Filed with the Form 10-K on January 31, 2000.
Unless otherwise noted, all other Exhibits are incorporated by reference as
an Exhibit to the Registrant's Registration Statement on Form S-1 (No.
33-68522).
47
