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Martek Biosciences Corp. said that that for the first quarter ended January 31, 2006, its profit slipped 21 percent, but results came in ahead of expectations. The Company earned $5.6 million, or 17 cents per share, down from $7.1 million, or 23 cents per share last year. Revenue for the quarter was $62.9 million, down 5 percent from $66.5 million last year.
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The decrease in the quarter compared to the first quarter of fiscal 2005 was primarily due to a previously disclosed build-up of inventory by certain customers in the three months ended January 31, 2005, which corporate now believes has since been substantially eliminated.
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Analysts polled by Thomson Financial had expected the company to earn, on average, 13 cents per share on $61.3 million in revenue.
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Martek has entered into license agreements with 21 infant formula manufacturers, who collectively represent approximately 70% of the estimated $8.5 to $9.5 billion worldwide wholesale market for infant formula and nearly 100% of the estimated $3.0 to $3.5 billion U.S. wholesale market for infant formula. Customers include infant formula market leaders Mead Johnson Nutritionals, Nestle, Abbott Laboratories, Wyeth and Royal Numico, each of whom is selling infant formula fortified with Martek’s nutritional oils, which contain DHA (docosahexaenoic acid).
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DHA, an omega-3 fatty acid, is the prominent structural fatty acid in the gray matter of the brain and retinal tissues of humans, as well as other animals. DHA is vital for normal brain development for the fetus and infant and for the maintenance of normal brain function throughout life. Whether to supplement infant formulas in the U.S. continues to be a matter of considerable controversy.
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DHA is found primarily in tuna, salmon and deep-water fish, and in some algae. DHA is found in fish, primarily tuna, salmon and deep-water fish, but with the threat of mercury contamination, the safest route for DHA supplementation, according to Martek, is a non-fish source, such as algae.
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Martek manufactures oils rich in DHA through a fermentation and oil process at manufacturing facilities located in Winchester, Kentucky and Kingstree, South Carolina.
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Martek is also expanding its DHA footprint by signing manufacturing deals to sell its branded DHA for use in foods, beverages, and nutritional supplements.
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In 2005, Hidden Villa Ranch began selling Gold Circle Farms liquid egg whites containing Martek’s DHA and Vincent Foods launched Oh Mama! nutritional bars for pregnant and nursing women.
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In February 2006, the Company and Odwalla, Inc. announced that Odwalla would launch Odwalla Soymilk, which features Martek-branded DHA. Odwalla Soymilk is the first soymilk in the United States to contain DHA.
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GlucoBurst, a diabetic drink, and CITRACAL prenatal vitamins, are two other new products launched that are fortified with Martek’s DHA.
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The Nutritional Products Group of Martek also specializes in the research and development of another nutritional fatty acids, ARA (arachidonic acid). ARA is a principal omega-6 acid that is present in the membranes of the body's cells, and—like DHA—is highly enriched in the brain. It is a precursor in the production of eicosanoids ( the prostaglandins, thromboxanes, prostacyclin, and leukotrienes. Eicosanoids are important in immunity, blood clotting and other vital functions in the body. Since little or no ARA is found in plants, humans obtain ARA by eating foods such as meat, eggs and milk.
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Martek has signed worldwide license and supply agreements with Mead Johnson, Nestlé, and other manufacturers relating to the use of Martek DHA and ARA in infant formulas.
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Encouraged by better-than-expected first quarter results and positive analyst commentaries, investors have driven the shares of Martek up almost 13% since its March 7 earnings report.
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Citigroup analyst Elise Wang—for one—told clients in a report that the Company's revenue is already tracking above the $235 million low end of Martek's guidance for the year. “New deals and expansion in the company's infant formula market will likely serve as catalysts for the stock,” she said.
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Wang rates the stock a "Buy" with a $48 target price.
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Despite the Company’s intent to expand the scale and scope of its operations, the 10Q Detective warns its readers that substantially all of the product sales in the quarters ended January 31, 2006 and 2005 relate to the sale of nutritional oils for use in infant formulas.
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Approximately 85% of product sales in the quarter ended January 31, 2006 were generated by sales to Mead Johnson Nutritionals, Abbott Laboratories, Nestle and Wyeth. Albeit corporate cannot give precise information by its customers as to the countries in which infant formula containing Martek oils are ultimately sold, management estimates that approximately two-thirds of the sales to infant formula licensees for the three months ended January 31, 2006 related to sales in the U.S.
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The first infant formulas containing Martek oils were introduced in the U.S. in February 2002 and, as of January 31, 2006, corporate estimates that formula supplemented with its oils had penetrated approximately 79% of the U.S. infant formula market.
The 10Q Detective unearthed the following item in Martek’s recent 10-Q filing:
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....the Ross Products Division of Abbott Laboratories, a significant Martek licensee and customer, filed a generally recognized as safe notification on January 2, 2002 seeking Food and Drug Administration (“FDA”) concurrence that its fish oil source of DHA and its fungal source of ARA are generally recognized as safe when used as ingredients in infant formula. At this time, the notification continues to be under consideration by the FDA.
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If and when the FDA approves labeling for Abbott Lab’s infant formula subsidiary, the 10Q Detective expects Abbot Labs to back away from use of Martek’s branded DHA, and for revenues to materially decline.
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Martek is dependent on a single third-party supplier for its ARA (with whom the Company has a contractual relationship). If this supplier of ARA, Netherlands’-based DSM Food Specialties is unable to supply Martek with its required amounts of ARA or if an over-capacity situation by the supplier leads to higher cost ARA, results of operations and/or financial position may be adversely affected.
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Martek spent 8.7% of net revenue of $62.9 millions on R&D. Costs increased by $700,000 or 14% in the 1Q:06, as compared to the quarter ended January 31, 2005. The increase is attributable to $400,000 of non-cash equity-based compensation charges in the most recent quarter and to costs incurred on clinical studies focusing on the cognitive benefits of DHA. Readers ought to be aware that management expects (as we do), for R&D expenses to increase during fiscal 2006 as ongoing clinical studies increase in scope.
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In addition, through Martek’s collaboration with a Canadian biotechnology company, corporate continues to expend amounts in the development of DHA products from plants. If certain milestones are achieved during fiscal 2006 in connection with this collaboration, Martek would be required to make and expense a milestone payment in the current fiscal year of up to $2.5 million.
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Selling, general and administrative costs (SG&A) increased by $1.7 million or 21% in the quarter ended January 31, 2006 compared to last year. The increase was attributable to ($600,000) in non-cash equity-based compensation charges, personnel costs (increase of $700,000), legal costs (increase of $200,000) and costs associated with Sarbanes-Oxley Act compliance (increase of $200,000).
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We anticipate that operating margins will shrink further in upcoming quarters as additional marketing costs are incurred related to new personnel and promotional campaigns, primarily in support of international infant formula expansion and growth in the foods and beverages market. Legal dollars will also increase, too, for the Company is continually under assault from would-be competitors and must litigate patent-infringement related-matters.
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Despite the aforementioned investor giddiness and Wall Street analysts’ positive reviews, the price of Martek’s common stock is down (41.33%) in price in the last 52-weeks. That said, for shareholders’ owning the stock at much higher prices, there might be some soap opera-like antics and protestations waiting to spill out at the Company’s Annual Shareholder meeting to be held on March 16, 2006.
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The 10Q Detective had an opportunity to review Martek’s recent DEF 14-A Filing with the SEC.
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One of the two proposals to be voted on is the election of two Class II Directors for the term expiring at the 2009 Annual Meeting of Stockholders. Henry Linsert, Jr., CEO, and George P. Barker, General Counsel, or each of them acting singularly in the absence of the other, are proxies whom are instructed in the absence of specific instructions, to vote “FOR” proposal 1 and in the discretion of the proxy holders as to any other matters.
Why should this be of any unusual interest? One of the two director nominees, Robert J. Flanagan, who currently is both on the compensation and the nominating committees, is an affiliated outsider. He is an executive vice president of Clark Enterprises, whose wholly owned subsidiary Clark Construction, provided $6.8 million in building and project management services to Martek as of December 31,2005, to expand the latter's Kingstree, S.C. DHA production facility.
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The Board has determined that: (i) all Director nominees are independent under the NASDAQ Stock Market’s listing standards and (ii) except for Messrs. Linsert and Jerome Keller, Senior VP-Sales & Marketing, all directors continuing in office at the 2006 Annual Meeting are independent under the NASDAQ Stock Market’s listing standards.
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According to Merriam-Webster’s Collegiate Dictionary [11th edition-2004), the definition of independent is: "not affiliated with a larger controlling unit."
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Perhaps the SEC & NASDAQ have their own nominal definition, for the 10Q Detective adamantly believes that Mess. Flanagan, whose construction company has made $6.8 million in services provided to Martek, and who owns 362,705, or 1.1% of shares outstanding, cannot be considered a casual, or an outside observer.
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Executive compensation is sure to be brought up by disgruntled shareholders’, too. Reflecting the troubled operating environment in 2005, the price of Martek’s stock price fell from $51.20 to $24.69, a loss of almost 52 percent!
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Still, the Board of Directors, at the recommendation of the Compensation Committee [see Flanagan, Robert: Member — Compensation Committee, Nominating and Corporate Governance Committee], voted to hand out bonuses to the top five executives, Messrs. Linsert, Dubin, Keller, Buzy, and Barker—they were paid [excluding stock options] $133,238, $104,458, $81,009, $81,009, and $86,959, respectively.
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The shares of Martek have moved up 24 percent since the start of the year, and currently trades at a forward multiple of 51.89 times 2007 share-net of $0.66, on estimated sales of $292.6 million. In our opinion, apparent in the current share price is built-in optimism that past inventory issues are a lesson learned, ample growth prospects in the company's infant formula market still exist overseas, and that new product introductions, such as products developed to promote cognitive function and cardiovascular health, will be successful.
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Investor and analysts’ enthusiasm also fed on Martek’s pronouncement. The belief that DHA-branded O-T-C products for improvement of cognitive function, cardiovascular health or other health applications, whether packaged in the food and beverage market or the dietary supplement market, is still in its infancy—and “annual sales will continue to expand and could ultimately represent a larger potential market than infant formula.”
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We remind readers to come back from the Twilight Zone, for even though clinical data are not required to market food and beverage ingredients or dietary supplements outside of the infant formula market, clinical studies may be needed to validate the benefits of DHA supplementation in order to gain widespread entry into these markets.
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Hello? Are you listening Wall Street? Also, substantially all of the Company’s product sales in the quarters ended January 31, 2006 relate to the sale of oils for use in infant formulas, for which barriers to entry are limited.
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The 10Q Detective is not certain, too, that the Wall-Street analysts who optimistically raised forward sales/EPS even took the time to read Martek’s recent 10-Q filing:
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We [Martek] are currently in and may continue to face a period of excess production capacity. When experiencing excess capacity, we may be unable to produce the required quantities of oil cost-effectively, which could have a material adverse effect on our product margins and overall profitability…. - Infant formula pricing is very competitive and the market is very sensitive to product price changes. Because the inclusion of our oils into infant formula may add 10% to 20% to the retail cost of standard infant formula, there is the risk that our licensees may not be able to sell supplemented products at prices that will allow them to gain worldwide market acceptance while, at the same time, remaining profitable. This may lead to price pressure on us. If we have to reduce our prices, we may not be able to sell products at a price that would enable us to be profitable.....
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Martek estimates that approximately two-thirds of its sales to infant formula licensees for the three months ended January 31, 2006 relate to sales in the U.S. Ergo, corporate believes ample room exists to grow the Company’s branded nutritional oil sales overseas, particularly in Asian countries.
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Suntory Limited, Cargill Inc., through a joint venture with a company in China, and other independent Chinese manufacturers are producing and distributing a fungal source of ARA. In addition, it is probable that there may be manufacturers in China attempting to produce an algal source of DHA. And other companies, several with greater financial resources than Martek, are developing plant-based DHA and other companies are developing chemically synthesized DHA.
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First Albany Capital analyst David Webber said the stronger-than-expected results prompted him to upgrade the stock to a "Buy" from "Neutral." Martek also forecast "record" second-quarter revenue, he said. Webber had downgraded the stock back in September, citing concerns over the company's production and international business. "With improved guidance, orderly manufacturing, and equilibrated customer inventories, the biggest problems of the recent past appear less threatening," the analyst wrote in a client note.
Technically, the price of Martek has broken through resistance at $31.75 (200 day-moving average). In our opinion, the price of Martek will probable pop another 5 percent to 10 percent in the coming weeks, for there a possible short-squeeze in play, too [short ratio: 10.3].
Mark Twain liked to say: “Whenever you find yourself on the side of the majority, it's time to pause and reflect.”
Readers—it’s time to pause and reflect.
R&D spending does not necessarily raise innovation success, and securing new networking deals are not in of itself sufficient to guarantee consumer acceptance of Martek’s new DHA-branded products. All said, the 10Q Detective believes that it is not the known, but the unknown, that will serve as the catalyst to unravel Martek’s current price.
The stock is priced for the perfect execution of new product rollouts, no FDA interference of purported health labeling, and continued sequential improvement in sales driven by mommy or mommies-to-be demand.
West Texas Intermediate (WTI) crude oil is of very high quality and is excellent for refining a larger portion of gasoline. Its API gravity is 39.6 degrees (making it a “light” crude oil), and it contains only about 0.24 percent of sulfur (making a “sweet” crude oil). WTI is generally priced at about a $2-per-barrel premium to the OPEC Basket price.
What has WTI to do with DHA/ARA? Answer: Both are known as premium “oils.” Martek’s oils, though rich in DHA or ARA, are not WTI—and the stock should not carry a premium price!
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