Stockpiling brings financial, legal woes for Martek

Related tags Martek Docosahexaenoic acid Supply and demand

Shareholders who have become aware of an omega-6 mountain in the
stockrooms of Martek customers have filed a lawsuit seeking class
action status against the company, alleging that it flooded
customers with inventory in order to meet financial targets,
reports Jess Halliday.

The filing alleges that Martek's financial results were "materially inflated"​, and that its statements about financial performance in 2005 were "lacking in any reasonable basis when made"​.

But the company, which supplies omega-6 ARA (arachidonic acid) and omega-3 DHA (docosahexaenioc acid) nutritional oils for use in infant formulas and functional foods, is placing responsibility for the stock build-up on the shoulders of its customers, saying they over-bought to protect themselves from supply problems that have beset the biotech company for the past two years.

Whilst not commenting directly on the lawsuit, director of finance Kevin Connolly told that the amount of ARA stockpiled by customers is thought to be two to four months.

A spate of problems with ARA supply, 90 percent of which Martek sources from its third party producer DSM Food Specialties, has had a knock-on effect for the US company's customers.

A power outage at DSM's facility in Italy in 2003 interrupted production and affected sales, as well as causing higher production costs that were passed on to Martek. This also meant that Martek's inventory of DHA built up, as ARA was not available for it to be blended with. It resorted to delivery of ARA by air freight in order to meet demand.

Further problems were caused by a fire at the Belvidere, New Jersey facility in May 2004, a month after it began producing ARA in addition to DHA.

These issues let the company to put in place an allocation system for its major customers based on prior ordering history, so they could build up a moderate level of stock and continue to do business if future shortages occur. Martek has said it will be able take its customers off allocation in 3Q 2005.

But the lawsuit alleges that Martek exceeded the allotted inventory distributed during 2Q 2004 and 1Q 2005 so it could meet its financial numbers and complete an $81.4 million stock offering.

Martek says it has only recently become aware of the inventory build-up, and on 27 April revised its expected earnings for the remainder of the fiscal year to account for a slower rate of sales while its customers use up existing supplies.

Earnings for 2Q are expected to be between $3.4 and $3.6 million on revenues of around $55 million, in line with previous guidance. But by 3Q it will be feeling the bite of reduced customer demand and has lowered its estimated revenues for this period to between $38 and $42 million, and to between $61 and $76 million for 4Q.

Full fiscal 2005 revenues are now forecast to come in at $220 to $240 million - at least $46.6 million short of Wall Street's expectation.The revised earning projects caused Martek shares to fall $32.49 per share, or 45.9 percent, the following day.

Connelly told in January that funds raised by the stock offering were earmarked to fund expansion as and when needed, which would help prevent future shortages.

This flexibility means that Martek is able to step up its own ARA production to compensate for any waver in supply from DSM.

Martek has been careful to disassociate the dip in demand from its industry customers from the consumer demand for omega-3 ingredients. "We do not believe that the decrease in sales is an indication of reduced demand at the consumer level, which we believe continues to grow,"​ said the company in a statement.

Media attention and the FDA's concurrence on a qualified health claim stating that foods containing DHA and EPA (eiscosapentaenoic acid) may help reduce the risk of coronary heart disease means that consumers are becoming increasingly aware of the benefits of a diet rich in omega-3, which occurs in foods such as oily fish. Martek's products are derived from microalgae, meaning that they are suitable for those with an aversion to fish.

In February Martek signed a license agreement with consumer foods giant Kellogg to supply it with DHA for use in a new line of fortified foods. The first fruits of the deal are expected to be on shelves by mid-2006. But it is ARA not DHA that has been causing the supply headache for Martek and its customers.

It said it will begin building a finished goods inventory of ARA in 3Q to assure customers that it can protect against shortages and meet market demand.

In the second half of the year, Martek plans to have $500 million annualized capacity of ARA and DHA. As of May, it was estimated at between $380 and $400 million.

This, it says, will bring an end the supply shortage - and not a moment too soon.

The worldwide infant formula market presents Martek with an opportunity worth more than $400 million, it says, but the supply inconsistency has restricted its customers' ability to expand into international markets. Martek currently holds 75 percent share of the DHA and ARA infant formula market in the United States and aims to be in the upper-90s by the end of 2005. It counts Mead Johnson, Wyeth, Abbott Laboratories and Nestle amongst its licensees.

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