##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended January 31, 2005 or o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period From _____ to _____   COMMISSION FILE NUMBER 0-22354
 MARTEK BIOSCIENCES CORPORATION  Delaware
    
    52-1399362(State or other jurisdiction of incorporation or organization)
    
    (I.R.S. Employer Identification
Number)
 6480 Dobbin Road, Columbia, Maryland 21045
(Address of principal executive offices) Registrants telephone number, including area code:      (410) 740-0081 None
(Former name, former address and former fiscal year, if changed since last report)    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 past 90 days. þ Yes o No Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of
the Exchange Act). þ Yes o No Common stock, par value
$.10 per share: 31,410,210 shares outstanding as of March 8, 2005.




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MARTEK BIOSCIENCES CORPORATION
FORM 10-Q For The Quarterly Period Ended January 31, 2005 INDEX 
  PART I
    
    FINANCIAL INFORMATIONItem 1.
    
    Financial Statements
    
    
    1Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    13Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    21Item 4.
    
    Controls and Procedures
    
    
    21PART II
    
    OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    22Item 2.
    
    Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    23Item 3.
    
    Defaults Upon Senior Securities
    
    
    23Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    23Item 5.
    
    Other Information
    
    
    23Item 6.
    
    Exhibits
    
    
    23Signatures
    
    
    24




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PART I  FINANCIAL INFORMATION 
 Item 1. Financial Statements. MARTEK BIOSCIENCES CORPORATION CONSOLIDATED BALANCE SHEETS January 31,
    
    
    October 31,2005
    
    
    2004In thousands, except share and per share data
    
    (unaudited)AssetsCurrent assetsCash and cash equivalents
    
    $
    28,530
    
    
    $
    29,445Short-term investments and marketable securities
    
    
    39,017
    
    
    
    13,205Accounts receivable, net
    
    
    48,022
    
    
    
    37,292Inventories, net
    
    
    37,439
    
    
    
    30,379Other current assets
    
    
    8,560
    
    
    
    6,793Total current assets
    
    
    161,568
    
    
    
    117,114Property, plant and equipment, net
    
    
    270,154
    
    
    
    255,430Deferred tax asset
    
    
    45,594
    
    
    
    49,378Goodwill
    
    
    48,232
    
    
    
    48,175Other intangible assets, net
    
    
    29,458
    
    
    
    29,994Other long-term assets, net
    
    
    1,401
    
    
    
    1,307Total assets
    
    $
    556,407
    
    
    $
    501,398Liabilities and stockholders equityCurrent liabilitiesAccounts payable
    
    $
    25,743
    
    
    $
    28,902Accrued liabilities
    
    
    15,736
    
    
    
    13,040Current portion of notes payable and other long-term obligations
    
    
    2,942
    
    
    
    4,946Current portion of unearned revenue
    
    
    1,607
    
    
    
    2,031Total current liabilities
    
    
    46,028
    
    
    
    48,919Long-term debt under revolving credit facility
    
    
    55,000
    
    
    
    85,000Notes payable and other long-term obligations
    
    
    10,055
    
    
    
    12,175Long-term portion of unearned revenue
    
    
    9,033
    
    
    
    9,140Total liabilities
    
    
    120,116
    
    
    
    155,234CommitmentsStockholders equityPreferred stock, $.01 par value, 4,700,000 shares authorized; none issued or outstanding
    
    
    
    
    
    
    Series A junior participating preferred stock, $.01 par value; 300,000 shares authorized;
none issued or outstanding
    
    
    
    
    
    
    Common stock, $.10 par value; 100,000,000 shares authorized; 31,295,309 and 29,491,127
shares issued and outstanding, respectively
    
    
    3,130
    
    
    
    2,949Additional paid-in capital
    
    
    490,865
    
    
    
    407,667Accumulated other comprehensive (loss) income
    
    
    (256
    )
    
    
    68Accumulated deficit
    
    
    (57,448
    )
    
    
    (64,520
    )Total stockholders equity
    
    
    436,291
    
    
    
    346,164Total liabilities and stockholders equity
    
    $
    556,407
    
    
    $
    501,398
 See accompanying notes. 1




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##### 



MARTEK BIOSCIENCES CORPORATION CONSOLIDATED STATEMENTS OF INCOME Three months ended January 31,Unaudited - In thousands, except share and per share data
    
    2005
    
    
    2004RevenuesProduct sales
    
    $
    63,111
    
    
    $
    32,231Contract manufacturing sales
    
    
    3,378
    
    
    
    3,344Total revenues
    
    
    66,489
    
    
    
    35,575Costs and expensesCost of product sales
    
    
    36,102
    
    
    
    19,525Cost of contract manufacturing sales
    
    
    2,804
    
    
    
    2,709Research and development
    
    
    4,816
    
    
    
    4,027Selling, general and administrative
    
    
    8,145
    
    
    
    5,797Other operating expenses
    
    
    3,485
    
    
    
    450Total costs and expenses
    
    
    55,352
    
    
    
    32,508Income from operations
    
    
    11,137
    
    
    
    3,067Other income, netInterest and other income
    
    
    180
    
    
    
    284Interest expense
    
    
    (180
    )
    
    
    Total other income, net
    
    
    
    
    
    
    284Income before income taxes
    
    
    11,137
    
    
    
    3,351Provision for income taxes
    
    
    4,065
    
    
    
    Net income
    
    $
    7,072
    
    
    $
    3,351Net income per shareBasic
    
    $
    0.24
    
    
    $
    0.12Diluted
    
    $
    0.23
    
    
    $
    0.11Weighted average common shares outstandingBasic
    
    
    29,614,831
    
    
    
    28,330,649Diluted
    
    
    30,577,066
    
    
    
    30,898,912
 See accompanying notes. 2




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##### 



MARTEK BIOSCIENCES CORPORATION CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY AccumulatedAdditional
    
    
    OtherCommon Stock
    
    
    Paid-in
    
    
    Comprehensive
    
    
    AccumulatedUnaudited - In thousands, except share data
    
    Shares
    
    
    Amount
    
    
    Capital
    
    
    Income (Loss)
    
    
    Deficit
    
    
    TotalBalance at October 31, 2004
    
    
    29,491,127
    
    
    $
    2,949
    
    
    $
    407,667
    
    
    $
    68
    
    
    $
    (64,520
    )
    
    $
    346,164Issuance of common stock, net of issuance costs
    
    
    1,756,614
    
    
    
    176
    
    
    
    81,287
    
    
    
    
    
    
    
    
    
    
    
    81,463Exercise of stock options
    
    
    47,568
    
    
    
    5
    
    
    
    1,622
    
    
    
    
    
    
    
    
    
    
    
    1,627Amortization of deferred compensation
    
    
    
    
    
    
    
    
    
    
    8
    
    
    
    
    
    
    
    
    
    
    
    8Tax benefit of exercise of non-qualified stock options
    
    
    
    
    
    
    
    
    
    
    281
    
    
    
    
    
    
    
    
    
    
    
    281Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,072
    
    
    
    7,072Other comprehensive income:Unrealized loss on exchange rate forward
contract, net of tax benefit of $154
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (324
    )
    
    
    
    
    
    
    (324
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,748Balance at January 31, 2005
    
    
    31,295,309
    
    
    $
    3,130
    
    
    $
    490,865
    
    
    $
    (256
    )
    
    $
    (57,448
    )
    
    $
    436,291
 See accompanying notes. 3




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MARTEK BIOSCIENCES CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS Three months ended January 31,Unaudited - In thousands
    
    2005
    
    
    2004Operating activitiesNet income
    
    $
    7,072
    
    
    $
    3,351Adjustments to reconcile net income to net cash used in operating activities:Depreciation and amortization
    
    
    3,756
    
    
    
    1,725Provision for inventory obsolescence
    
    
    650
    
    
    
    (216
    )Deferred tax provision
    
    
    4,065
    
    
    
    Loss on disposal of assets and other
    
    
    288
    
    
    
    Changes in operating assets and liabilities:Accounts receivable
    
    
    (10,730
    )
    
    
    (3,531
    )Inventories
    
    
    (7,710
    )
    
    
    (3,689
    )Other assets
    
    
    (1,707
    )
    
    
    481Accounts payable
    
    
    1,141
    
    
    
    (3,769
    )Accrued liabilities
    
    
    2,218
    
    
    
    (1,685
    )Unearned revenue and other liabilities
    
    
    (516
    )
    
    
    (408
    )Net cash used in operating activities
    
    
    (1,473
    )
    
    
    (7,741
    )Investing activities(Purchase) sale of short-term investments and marketable securities, net
    
    
    (25,812
    )
    
    
    40,936Expenditures for property, plant and equipment
    
    
    (26,316
    )
    
    
    (55,991
    )Proceeds from sale/leaseback transaction
    
    
    4,128
    
    
    
    Capitalization of intangible and other assets
    
    
    (394
    )
    
    
    (1,874
    )Net cash used in investing activities
    
    
    (48,394
    )
    
    
    (16,929
    )Financing activitiesRepayments of notes payable and other long-term obligations
    
    
    (4,138
    )
    
    
    (2,315
    )(Repayments) borrowings under revolving credit facility
    
    
    (30,000
    )
    
    
    20,000Proceeds from the exercise of stock options
    
    
    1,627
    
    
    
    15,533Proceeds from the issuance of common stock, net of issuance costs
    
    
    81,463
    
    
    
    Net cash provided by financing activities
    
    
    48,952
    
    
    
    33,218Net (decrease) increase in cash and cash equivalents
    
    
    (915
    )
    
    
    8,548Cash and cash equivalents, beginning of period
    
    
    29,445
    
    
    
    29,924Cash and cash equivalents, end of period
    
    $
    28,530
    
    
    $
    38,472Supplemental cash flow disclosures:Interest paid
    
    $
    1,071
    
    
    $
    144Income taxes paid
    
    $
    
    
    
    $
    30
 See accompanying notes. 4




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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES Basis of PresentationThe accompanying unaudited consolidated financial statements of Martek
Biosciences Corporation and its wholly-owned subsidiaries (the Company) have been prepared in
accordance with accounting principles generally accepted in the United States for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by accounting principles
generally accepted in the United States for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included. Operating results for the quarter ended January 31, 2005 are
not necessarily indicative of the results that may be expected for the year ending October 31,
2005. For further information, refer to the consolidated financial statements and footnotes
thereto included in Martek Biosciences Corporations Annual Report on Form 10-K for the year ended
October 31, 2004. ConsolidationThe consolidated financial statements include the accounts of Martek Biosciences
Corporation and its wholly-owned subsidiaries, Martek Biosciences Boulder Corporation (Martek
Boulder) and Martek Biosciences Kingstree Corporation (Martek Kingstree), after elimination of
all significant intercompany balances and transactions. Use of EstimatesThe preparation of consolidated financial statements in conformity with accounting
principles generally accepted in the United States requires management to make estimates and
assumptions that affect the amounts reported in the Companys consolidated financial statements and
accompanying notes. On an ongoing basis, the Company evaluates its estimates and judgments, which
are based on historical and anticipated results and trends and on various other assumptions that
the Company believes to be reasonable under the circumstances. By their nature, estimates are
subject to an inherent degree of uncertainty and, as such, actual results may differ from the
Companys estimates. Segment InformationThe Company currently operates in one business segment, the development and
commercialization of novel products from microalgae and other microbes. 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 any material
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
Statement of Financial Accounting Standards (SFAS) No. 131, Disclosures about Segments of an
Enterprise and Related Information. Revenue RecognitionThe Company derives revenue principally from two sources: product sales and
contract manufacturing. The Company recognizes revenue when persuasive evidence of an arrangement
exists, delivery has occurred, the fee is fixed or determinable and collectibility is probable.
Typical infant formula license contracts include an upfront license fee, a prepayment of product
sales and established pricing on future product sales. In accordance with Emerging Issues Task
Force No. 00-21 (EITF No. 00-21), Revenue Arrangements with Multiple Deliverables, the
consideration from these contracts is allocated based on the relative fair values of the separate
elements. Revenue is recognized on product sales when goods are shipped. Cash received as a
prepayment on future product purchases is deferred and recognized as revenue when product is
shipped. Revenue from product licenses is deferred and recognized on a straight-line basis over the
term of the agreement. Royalty income is recorded when earned, based on information provided by
the Companys licensees. Royalty income was approximately $600,000 and $80,000 in the three months
ended January 31, 2005 and 2004, respectively, and is included in product sales revenue in the
consolidated statements of income. Contract manufacturing revenue is recognized when goods are shipped to customers and all other
conditions for revenue recognition are met. Cash received that is related to future performance
under such contracts is deferred and recognized as revenue when earned. Foreign Currency TransactionsForeign currency transactions are translated into U.S. dollars at
prevailing rates. Gains or losses resulting from foreign currency transactions are included in
current period income or loss as incurred. All material transactions of the Company are denominated
in U.S. dollars with the exception of purchases of arachidonic acid (ARA) from DSM Food
Specialties (DSM) Capua, Italy plant, which are denominated in euros. The Company has entered into foreign currency forward contracts with outstanding notional values
aggregating approximately 13.8 million euros at January 31, 2005 to reduce its transactional
foreign currency exposures associated with the purchases of ARA from DSM. The resulting unrealized
gains and losses are recorded as a component of other comprehensive income. These contracts
effectively fix our exchange rate between the U.S. dollar and the euro for periods ranging from 30
to 90 days. Research and DevelopmentResearch and development costs are charged to operations as incurred and
include internal labor, materials and overhead costs associated with the Companys ongoing research
and development activity, in addition to third-party costs for contracted work as well as ongoing
clinical trials costs. Other Operating ExpensesOther operating expenses relate primarily to production start-up costs,
including materials, training and other such costs, incurred in connection with the expansion of
the Companys internal manufacturing operations, costs incurred in connection with qualification of
certain third-party manufacturers, and amounts related to the Winchester wastewater treatment
matter. All such costs are expensed as incurred. 5




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Deferred Income TaxesDeferred tax assets and liabilities are determined based on temporary
differences between the financial reporting bases and the tax bases of assets and liabilities.
Deferred tax assets are also recognized for tax net operating loss carryforwards. These deferred
tax assets and liabilities are measured using the enacted tax rates and laws that will be in effect
when such amounts are expected to reverse or be utilized. The realization of total deferred tax
assets is contingent upon the generation of future taxable income. Valuation allowances are
provided to reduce such deferred tax assets to amounts more likely than not to be ultimately
realized. Income tax expense includes U.S. federal, state and local income taxes and is based on pre-tax
income. The interim period provision for income taxes is based upon the Companys estimate of its
annual effective income tax rate. In determining the estimated annual effective income tax rate,
the Company analyzes various factors, including projections of the Companys annual earnings and
taxing jurisdictions in which the earnings will be generated, the impact of state and local income
taxes and the ability of the Company to use tax credits and net operating loss carryforwards. During the fourth quarter of fiscal 2004, the Company reversed approximately $51 million of its
deferred tax asset valuation allowance, having determined that it is more likely than not that this
portion of the deferred tax asset will be realized. As a result, income tax expense has been
recorded based on pre-tax income for the quarter. The effective income tax rate for the quarter
ended January 31, 2005 is 36.5%. There was no provision for income taxes in the quarter ended
January 31, 2004. Net Income Per ShareBasic net income per share is computed using the weighted average number of
shares of common stock outstanding during the period. Diluted net income per share is computed
using the weighted average number of shares of common stock outstanding, giving effect to stock
options and warrants using the treasury stock method. Comprehensive IncomeComprehensive income is comprised of net earnings and other comprehensive
income, which includes certain changes in equity that are excluded from net income. The Company
includes unrealized holding gains and losses on available-for-sale securities, if any, as well as
changes in the market value of exchange rate forward contracts in other comprehensive income in the
Consolidated Statement of Stockholders Equity. Comprehensive income, net of related tax, was $6.7
million for the quarter ended January 31, 2005. Comprehensive income for the quarter ended January
31, 2005 includes unrealized losses on exchange rate forward contracts of $324,000. Comprehensive
income in the quarter ended January 31, 2004 equals net income for the period. Cash and Cash EquivalentsCash equivalents consist of highly liquid investments with an
original maturity of three months or less. Short-Term Investments and Marketable SecuritiesThe Company has classified all short-term
investments and marketable securities as available-for-sale. Unrealized gains and losses on these
securities, if any, are reported as accumulated other comprehensive income, which is a separate
component of stockholders equity. Realized gains and losses are included in other income based on
the specific identification method. The Company periodically evaluates whether any declines in the fair value of investments are other
than temporary. This evaluation consists of a review of several factors, including, but not
limited to: length of time and extent that a security has been in an unrealized loss position; the
existence of an event that would impair the issuers future earnings potential; the near term
prospects for recovery of the market value of a security; and the intent and ability of the Company
to hold the security until the market value recovers. Declines in value below cost for debt
securities where it is considered probable that all contractual terms of the security will be
satisfied, the decline is due primarily to changes in interest rates (and not because of increased
credit risk), and where the Company intends and has the ability to hold the investment for a period
of time sufficient to allow a market recovery, are not assumed to be other than temporary. If
management determines that such an impairment exists, the carrying value of the investment will be
reduced to the current fair value of the investment and the Company will recognize a charge in the
consolidated statements of income equal to the amount of the carrying value reduction. Fair Value of Financial InstrumentsThe Company considers the recorded cost of its financial assets
and liabilities, which consist primarily of cash and cash equivalents, short-term investments and
marketable securities, accounts receivable, accounts payable, notes payable and long-term debt, to
approximate the fair value of the respective assets and liabilities at January 31, 2005 and October
31, 2004. Trade ReceivablesTrade receivables are reported in the consolidated balance sheets at outstanding
principal less any allowance for doubtful accounts. The Company writes off uncollectible
receivables against the allowance for doubtful accounts when the likelihood of collection is
remote. The Company may extend credit terms up to 50 days and considers receivables past due if not
paid by the due date. The Company performs ongoing credit evaluations of its customers and extends
credit without requiring collateral. The Company maintains an allowance for doubtful accounts,
which is determined based on historical experience, existing economic conditions and managements
expectations of losses. The Company analyzes historical bad debts, customer concentrations,
customer credit-worthiness, and current economic trends when evaluating the adequacy of the
allowance for doubtful accounts. Losses have historically been within managements expectations. InventoriesInventories are stated at the lower of cost or market and include appropriate elements
of material, labor and indirect costs. Inventories are valued using a weighted average approach
that approximates the first-in, first-out method. The Company analyzes both historical and
projected sales volumes and, when needed, reserves for inventory that is either obsolete, slow
moving or impaired. 6




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Property, Plant and EquipmentProperty, plant and equipment, including leasehold improvements, are
stated at cost and depreciated or amortized when placed into service using the straight-line
method, based on useful lives as follows: Asset Description
    
    Useful Life (years)Building
    
    15  30Fermentation equipment
    
    10  20Oil processing equipment
    
    10  20Other machinery and equipment
    
    5  10Furniture and fixtures
    
    5  7Computer hardware and software
    
    3  7
 Leasehold improvements are amortized over the shorter of the useful life of the asset or the
lease term, including renewals when probable. Costs for capital assets not yet placed into service,
including those related to expansion of the Companys Kingstree, South Carolina fermentation
facility, have been capitalized as construction in progress and will be depreciated in accordance
with the above guidelines once placed into service. Costs for repairs and maintenance are expensed
as incurred. Goodwill and Other Intangible AssetsThe Company recorded goodwill and purchased intangible assets
in its acquisition of OmegaTech, Inc. (OmegaTech) in April 2002 and goodwill in its acquisition
of FermPro Manufacturing, LP (FermPro) in September 2003. The goodwill acquired in the OmegaTech
and FermPro acquisitions is subject to the provisions of SFAS No. 142, Goodwill and Other
Intangible Assets (SFAS 142), and, accordingly, is not being amortized. In accordance with SFAS
142, goodwill is tested for impairment on an annual basis and between annual tests in certain
circumstances, and written down when impaired. Furthermore, SFAS 142 requires purchased intangible
assets other than goodwill to be amortized over their useful lives unless these lives are
determined to be indefinite. Purchased intangible assets and patents are carried at cost less
accumulated amortization. Amortization is computed over the estimated useful lives of the
respective assets, generally ten to seventeen years. Impairment of Long-Lived AssetsIn accordance with SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets (SFAS 144), 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 exceeds 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 recognized any impairment losses. Stock-Based CompensationIn October 1995, the Financial Accounting Standards Board (FASB) issued
SFAS No. 123, Accounting for Stock-Based Compensation (SFAS 123). SFAS 123 allows companies to
account for employee stock-based compensation under the fair value-based method or using the
intrinsic value method provided by Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees (APB 25) and related interpretations, but requires pro forma
disclosure in the footnotes to the financial statements as if the measurement provisions of SFAS
123 had been adopted. In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure (SFAS 148). SFAS 148 amends SFAS 123 to provide
alternative methods of transition for a voluntary change to the fair value-based method of
accounting for stock-based compensation. The Company has elected to continue accounting for its employee stock-based compensation in
accordance with the provisions of APB 25, and to present the pro forma disclosures required by SFAS
123, as amended by SFAS 148. No stock-based employee compensation cost for stock options is
reflected in net income, as all options granted under the plans had an exercise price equal to the
market value of the underlying common stock on the date of grant. Stock-based compensation for
non-employees is accounted for using the fair value-based method in accordance with SFAS 123. The
Company has adopted the disclosures outlined in SFAS 123, as amended by SFAS 148. See Recently
Issued Accounting Pronouncements for discussion of new accounting rules to be implemented related
to stock options. 7




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##### 



In December 2004 and January 2005, the Company modified the terms of all outstanding and unvested
stock options whose exercises prices were greater than Marteks closing stock price on the
modification dates. The modifications served to immediately vest approximately 1.1 million unvested
stock options. The following table illustrates the effect on net income and net income per share
as if the Company had applied the fair value recognition provisions of SFAS 123, as amended by SFAS
148, to stock-based employee compensation (in thousands, except per share amounts): Three months ended January 31,2005
    
    
    2004Net income, as reported
    
    $
    7,072
    
    
    $
    3,351Deduct: Total stock-based employee compensation expense
determined under fair value-based methods for all awards
    
    
    (35,794
    )
    
    
    (2,888
    )Pro forma net income (loss)
    
    $
    (28,722
    )
    
    $
    463Net income (loss) per share:Basic  as reported
    
    $
    0.24
    
    
    $
    0.12Basic  pro forma
    
    $
    (0.97
    )
    
    $
    0.02Diluted  as reported
    
    $
    0.23
    
    
    $
    0.11Diluted  pro forma
    
    $
    (0.97
    )
    
    $
    0.01
 The effect of applying SFAS 123 on pro forma net income and per share calculations for the
three months ended January 31, 2005, as stated above, is not representative of the effect on
reported net income and net income per share for future periods due to such things as the vesting
period of the stock options, the issuance of additional stock options in future periods and the
potential granting of alternative forms of equity-based compensation. The weighted average fair market values of the options at the date of grant for options granted
during the three months ended January 31, 2005 and 2004 were $25.75 and $43.56, respectively. The
fair market value of each option grant is estimated on the date of grant using the Black-Scholes
option pricing model with the following weighted average assumptions for the respective periods: Three months ended January 31,2005
    
    2004Expected volatility
    
    
    69.0
    %
    
    
    69.8
    %Risk-free interest rate
    
    
    3.6
    %
    
    
    3.7
    %Expected average life of options
    
    5 years
    
    7 yearsExpected dividend yield
    
    
    0
    %
    
    
    0
    %
 ReclassificationCertain amounts in the prior periods financial statements have been
reclassified to conform to the current period presentation. Recently Issued Accounting PronouncementsIn October 2004, the FASB concluded that SFAS No. 123
(revised 2004), Share-Based Payment (SFAS 123R), which would require all companies to measure
compensation cost for all share-based payments (including employee stock options) at fair value,
would be effective for interim or annual periods beginning after June 15, 2005. SFAS 123R
provides two tentative adoption methods. The first method is a modified prospective transition
method whereby a company would recognize share-based employee costs from the beginning of the
fiscal period in which the recognition provisions are first applied as if the fair-value-based
accounting method had been used to account for all employee awards granted, modified, or settled
after the effective date and to any awards that were not fully vested as of the effective date.
Measurement and attribution of compensation cost for awards that are unvested as of the effective
date of SFAS 123R would be based on the same estimate of the grant-date fair value and the same
attribution method used previously under SFAS 123. The second adoption method is a modified
retrospective transition method whereby a company would recognize employee compensation cost for
periods presented prior to the adoption of SFAS 123R in accordance with the original provisions of
SFAS 123; that is, an entity would recognize employee compensation costs in the amounts reported in
the pro forma disclosures provided in accordance with SFAS 123. A company would not be permitted to
make any changes to those amounts upon adoption of SFAS 123R unless those changes represent a
correction of an error. For periods after the date of adoption of SFAS 123R, the modified
prospective transition method described above would be applied. In December 2004 and January 2005,
the Company modified the terms of all outstanding and unvested stock options whose exercises prices
were greater than Marteks closing stock price on the modification dates. 8




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The modifications served to immediately vest approximately 1.1 million unvested stock options.
Under the accounting guidance of APB 25, the accelerated vesting did not result in any compensation
to be recognized as these unvested stock options had no intrinsic value. The acceleration, however,
will enable the Company to avoid recording approximately $28 million of future compensation expense
that would have been required to be recognized under SFAS 123R. The Company currently expects to
adopt SFAS 123R in the quarter ended October 31, 2005, using the modified prospective method,
although the Company continues to review its options for adoption under this new pronouncement.
After giving effect to this acceleration of vesting and based upon the Companys projection of
unvested stock options at the implementation date, the Company expects the adoption to result in
the recognition of additional compensation expense of approximately $1.2 million to $1.7 million in
the fourth quarter of fiscal 2005. In December 2004, the FASB issued SFAS No. 151, Inventory Costs (SFAS 151). SFAS 151 requires
abnormal amounts of inventory costs related to idle facility, freight handling and wasted material
expenses to be recognized as current period charges. Additionally, SFAS 151 requires that
allocation of fixed production overheads to the costs of conversion be based on the normal capacity
of the production facilities. The standard is effective for fiscal years beginning after June 15,
2005. The Company believes the adoption of SFAS 151 will not have a material impact on its
consolidated financial statements. 2. DSM SUPPLY AND LICENSE AGREEMENT In April 2004, the Company entered into a new agreement with DSM Food Specialties B.V. (DSM)
extending the existing relationship between the two companies involving the production and supply
of arachidonic acid (ARA), one of the Companys nutritional oils that it sells to its infant
formula licensees. Among other things, this agreement provides for the sale to the Company by DSM
of a license related to certain technologies associated with the manufacture of ARA. This sale
involved a license fee totaling $10 million, $4 million of which was paid upon execution of the
agreement, $4 million of which was paid on November 2, 2004, and the remaining $2 million of which
will be paid by the Company on November 2, 2005. The license fee is being amortized over the
15-year term of the agreement using the straight-line method and the remaining obligation as of
January 31, 2005 is recorded as a current obligation in the consolidated balance sheet. This
agreement also provides for the guarantee by Martek of DSMs recovery of certain expansion costs
incurred by them. This guarantee will decline in value as Martek purchases ARA from DSM in the
future. As of January 31, 2005, the value of the Companys current guarantee to DSM related to
DSMs phase one expansion is approximately $2.4 million. In addition, the Company is in the
process of negotiating an amendment to the April 2004 agreement with DSM. This amendment is
expected to establish the overall economics associated with DSMs current expansions at both
of its facilities, including the Companys guarantee of such
expansion costs, with such guarantee expected to
approximate $40 million. 3. SHORT-TERM INVESTMENTS AND MARKETABLE SECURITIES The Companys available-for-sale securities consist of federally-sponsored debt securities and
taxable municipal auction rate securities, and totaled $39.0 million and $13.2 million as of
January 31, 2005 and October 31, 2004, respectively. There were no unrealized holding gains or
losses on these available-for-sale securities as of January 31, 2005 and October 31, 2004. There
were no realized gains or losses during the three months ended January 31, 2005 and January 31,
2004. At January 31, 2005 and October 31, 2004, the estimated fair value of these securities
approximated cost. 4. INVENTORIES Inventories consist of the following (in thousands): January 31,
    
    
    October 31,2005
    
    
    2004Finished goods
    
    $
    13,054
    
    
    $
    10,827Work in process
    
    
    22,524
    
    
    
    18,171Raw materials
    
    
    3,511
    
    
    
    2,381Total inventory
    
    
    39,089
    
    
    
    31,379Less: inventory reserve
    
    
    (1,650
    )
    
    
    (1,000
    )Inventories, net
    
    $
    37,439
    
    
    $
    30,379
 9




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5. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consists of the following (in thousands): January 31,
    
    
    October 31,2005
    
    
    2004Land
    
    $
    712
    
    
    $
    712Building and improvements
    
    
    40,959
    
    
    
    29,421Machinery and equipment
    
    
    170,422
    
    
    
    133,886Furniture and fixtures
    
    
    2,871
    
    
    
    2,772Computer hardware and software
    
    
    7,049
    
    
    
    5,173Construction in progress
    
    
    71,866
    
    
    
    104,053Property, plant and equipment
    
    
    293,879
    
    
    
    276,017Less: accumulated depreciation and amortization
    
    
    (23,725
    )
    
    
    (20,587
    )Property, plant and equipment, net
    
    $
    270,154
    
    
    $
    255,430
 6. GOODWILL AND OTHER INTANGIBLE ASSETS Intangible assets and related accumulated amortization consist of the following (in thousands): January 31, 2005
    
    
    October 31, 2004Accumulated
    
    
    
    
    
    
    
    
    
    
    AccumulatedIntangible Asset
    
    Gross
    
    
    Amortization
    
    
    Net
    
    
    Gross
    
    
    Amortization
    
    
    NetTrademarks
    
    $
    2,038
    
    
    $
    (318
    )
    
    $
    1,720
    
    
    $
    2,023
    
    
    $
    (284
    )
    
    $
    1,739Patents
    
    
    8,380
    
    
    
    (1,319
    )
    
    
    7,061
    
    
    
    8,409
    
    
    
    (1,226
    )
    
    
    7,183Core technology
    
    
    1,708
    
    
    
    (256
    )
    
    
    1,452
    
    
    
    1,708
    
    
    
    (228
    )
    
    
    1,480Current products
    
    
    10,676
    
    
    
    (1,983
    )
    
    
    8,693
    
    
    
    10,676
    
    
    
    (1,805
    )
    
    
    8,871Licenses
    
    
    11,091
    
    
    
    (559
    )
    
    
    10,532
    
    
    
    11,091
    
    
    
    (370
    )
    
    
    10,721Goodwill
    
    
    48,232
    
    
    
    
    
    
    
    48,232
    
    
    
    48,175
    
    
    
    
    
    
    
    48,175$
    82,125
    
    
    $
    (4,435
    )
    
    $
    77,690
    
    
    $
    82,082
    
    
    $
    (3,913
    )
    
    $
    78,169
 7. NOTES PAYABLE AND LONG-TERM DEBT In May 2004, the Company entered into a $100 million secured revolving credit facility which
amended and expanded the $85 million credit facility established in January 2004. The revolving
credit facility is collateralized by accounts receivable and inventory and expires in February
2007. The weighted average interest rate on the credit facility was approximately 4.4% for the
three months ended January 31, 2005 and is based on LIBOR and the Companys current leverage ratio.
Among other things, the credit facility agreement contains restrictions on future debt, the payment
of dividends and the further encumbrance of assets. In addition, the credit facility requires that
the Company comply with specified financial ratios and tests, including minimum liquidity, minimum
coverage ratios and maximum leverage ratios. As of January 31, 2005, the Company is in compliance
with all of these debt covenants and has outstanding borrowings of $55 million under the revolving
credit facility. All borrowings are due at maturity. In connection with the purchase of certain assets and the assumption of certain liabilities of
FermPro in September 2003, the Company assumed a $10 million secured note. The note was amended in
January 2004 and is now an unsecured obligation of the Company with a maturity date of December 31,
2008. The note has a stated interest rate of 5% and principal is amortized over a 20-year period
with the balance due at maturity. Also as part of the FermPro acquisition, the Company assumed a
long-term note of approximately $400,000, due in 2023 with a 7% stated interest rate. During the three months ended January 31, 2005 and 2004, the Company incurred interest on
borrowings of approximately $1.1 million and $200,000, respectively, and recorded amortization of
related debt fees of approximately $100,000 in the first quarter of fiscal 2005. The majority of 10




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the interest incurred and debt fee amortization recorded was capitalized as part of the cost of the
Companys construction at the Kingstree, South Carolina and Winchester, Kentucky manufacturing
facilities. The carrying amounts of notes payable and the line of credit at January 31, 2005 and October 31,
2004 approximate their fair values. 8. COMMITMENTS AND CONTINGENCIES LeasesIn October 2004, the Company entered an operating lease for equipment at its Kingstree
facility as part of a sale/leaseback transaction. The equipment subject to lease was sold at its
cost basis and fair value of $10.8 million and simultaneously leased back to the Company. The
lease expires in October 2009 and contains the same restrictions as the Companys revolving credit
facility. In December 2004, the Company entered an operating lease for equipment at its Kingstree
facility subject to the same terms and expiration as the October 2004 transaction. This second
sale/leaseback transaction involved the sale of equipment with a cost basis and fair value of $4.1
million. The Company is contingently liable for a residual value guarantee of approximately $2.3
million under these agreements. The relative fair value associated with these guarantees is not
material. Purchase CommitmentsThe Company has entered into an agreement to purchase a minimum
quantity of certain material used in the production of Marteks
food docosahexaenoic acid (DHA) product from a
third-party manufacturer. The commitment expires on June 30, 2006. As of January 31, 2005, the
Companys remaining obligation was approximately $3.8 million. The Company has entered into an agreement to purchase from a third-party manufacturer a minimum
quantity of extraction services to be utilized in ARA production. The commitment expires on
December 31, 2007. As of January 31, 2005, the Companys remaining obligation was approximately
$15.3 million. Kentucky Wastewater MatterOn March 12, 2003, an explosion occurred at a public wastewater
treatment works in Winchester, Kentucky, resulting in property damage. The Company continues to
have active discussions relating to the cause of and determination of responsibility for the
property damage with the City of Winchester, the Winchester Municipal Utilities Commission (WMU)
and WMUs insurer. The Company learned in March 2004 that the federal Environmental Protection
Agency, utilizing personnel from its Criminal Investigation Division, had asked questions of
current and former employees relating to the explosion at the wastewater treatment plant. Current
and former employees have testified before a federal grand jury that is investigating the matter.
As of January 31, 2005, the Company has recorded a liability totaling approximately $1.0 million as
an estimate of certain future costs that might be incurred as a result of this incident. While the
Company cannot be certain of the outcome, the Company believes that the outcome will not have a
material adverse impact on its financial condition or results of operations. OmegaTech Contingent Purchase PriceIn connection with the Companys purchase of OmegaTech, the
purchase agreement provided for additional stock consideration of up to $40 million, subject to
certain pricing adjustments, if four milestones were met. Two of these milestones relate to
operating results (sales and gross profit margin objectives by October 2003 and October 2004) and
two relate to regulatory and labeling approvals in the U.S. and Europe. In June 2003, the
Commission of the European Community granted approval of the use of the OmegaTech DHA oil in
certain foods in Europe, meeting the conditions of one of the regulatory milestones. Accordingly,
approximately 358,566 shares of Martek common stock, valued at approximately $14.2 million, were
issued during fiscal 2003 upon the achievement of this milestone. The payment of this additional
consideration was recorded as goodwill. As of January 31, 2005, the Company does not believe the
second regulatory milestone has been achieved. In addition, the Company does not believe that
either financial milestone related to sales and gross profit margin for the periods ended October
31, 2004 and 2003 has been achieved. The representative of the former OmegaTech stockholders has
advised us that he believes that the common stock issuable with respect to the second regulatory
milestone as well as the financial milestone related to the period ended October 31, 2003 should be
issued. Martek disagrees with that conclusion. The parties are currently involved in litigation to
resolve this dispute with respect to the second regulatory milestone. The total Martek common
stock that may be issued relating to any remaining milestones is subject to a formula that is based
on the average market price of the Companys stock on the dates that the individual milestones are
determined to have been achieved, up to a maximum of 1.9 million shares. Any contingent
consideration paid related to these milestones would be recorded as goodwill. OtherThe Company is involved in various other legal actions primarily concerning its intellectual
property. Management believes that these actions, either individually or in the aggregate, will not
have a material adverse effect on the Companys results of operations or financial condition. From
time to time, Martek may also be a party to litigation or administrative proceedings relating to
claims arising from its operations in the normal course of business. Management believes that the
ultimate resolution of any such litigation or administrative proceedings against the Company is
unlikely, either individually or in the aggregate, to have a material adverse effect on the
Companys financial condition or results of operations. 9. STOCKHOLDERS EQUITY In January 2005, the Company completed an underwritten public offering of 1,756,614 shares of
common stock at price of $49.10 per share pursuant to a shelf registration statement. Net proceeds
to the Company, after deducting an underwriting discount and offering expenses, amounted to
approximately $81.5 million. Of the proceeds, $30 million was used for the partial repayment of
debt with the remainder intended to be used for capital expenditures, working capital and general
corporate purposes. 11




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##### 



10. NET INCOME PER SHARE Basic net income per share is computed using the weighted average number of common shares
outstanding. Diluted net income per share is computed using the weighted average number of common
shares outstanding, giving effect to stock options and warrants using the treasury stock method. The following table presents the calculation of basic and diluted net income per share (in
thousands, except per share amounts): Three months ended January 31,2005
    
    
    2004Net income
    
    $
    7,072
    
    
    $
    3,351Weighted average shares outstanding, basic
    
    
    29,615
    
    
    
    28,331Effect of dilutive potential common shares:Employee stock options
    
    
    944
    
    
    
    2,524Warrants
    
    
    18
    
    
    
    44Total dilutive potential common shares
    
    
    962
    
    
    
    2,568Weighted average shares outstanding, diluted
    
    
    30,577
    
    
    
    30,899Net income per share, basic
    
    $
    0.24
    
    
    $
    0.12Net income per share, diluted
    
    $
    0.23
    
    
    $
    0.11
 Employee stock options to purchase approximately 1.4 million and 100,000 shares were outstanding
but were not included in the computation of diluted net income per share for the three months ended
January 31, 2005 and 2004, respectively, because the effects would have been antidilutive. 12




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations. This Managements Discussion and Analysis of Financial Condition and Results of Operations contains
forward-looking statements concerning our business and operations, including, among other things,
statements concerning the following:  
    expectations regarding future revenue growth, product introductions, growth in
nutritional product sales, margin and productivity improvements and potential
collaborations and acquisitions;
    expectations regarding sales to and by our infant formula licensees;
    expectations regarding marketing of our oils by our infant formula licensees;
    expectations regarding future efficiencies in manufacturing processes and the cost of production of our nutritional oils;
    expectations regarding future purchases of third-party manufactured oils and expansion of third-party manufacturing facilities;
    expectations regarding the timing and amount of production capacity and our ability
to meet future demands for our nutritional oils;
    expectations regarding future research and development costs;
    expectations regarding our expansion at our Kingstree, South Carolina facility;
    expectations regarding the impact of the incident at the Winchester Wastewater Treatment Plant;
    expectations regarding additional capital expenditures needed in relation to our fermentation and oil processing activities; and
    expectations regarding our ability to protect our intellectual property. Forward-looking statements include those statements containing words such as the following:  
    will,
    should,
    could,
    anticipate,
    believe,
    plan,
    estimate,
    expect,
    intend, and other similar expressions. All of these forward-looking statements involve risks and uncertainties. They are all made pursuant
to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. We wish to
caution you that our actual results may differ significantly from the results we discuss in our
forward-looking statements. We discuss the risks that could cause such differences in Exhibit 99.01
to this report incorporated by reference into this Form 10-Q , and in our various other filings
with the Securities and Exchange Commission. Our forward-looking statements speak only as of the
date of this document, and we do not intend to update these statements to reflect events or
circumstances that occur after that date. GENERAL Martek was founded in 1985. We are a leader in the development and commercialization of products
derived from microalgae and other microbes. Our leading products are nutritional oils used as
ingredients in infant formula and foods and as ingredients in, and encapsulated for use as, dietary
supplements. Our nutritional oils are comprised of fatty acid components, primarily docosahexaenoic
acid, commonly known as DHA, and arachidonic acid, commonly known as ARA. Many researchers believe
that these fatty acids may enhance mental and visual development in infants, may play a pivotal
role in brain function throughout life and may reduce risks associated with coronary heart disease.
Low levels of DHA in adults have also been linked with a variety of health risks. Research is
underway to assess what impact, if any, supplementation with our DHA will have on these health
risks. Additional applications of our patented technology based upon microalgae include our
currently marketed fluorescent detection products that can be used by researchers as an aid in drug
discovery and diagnostics. We currently have license agreements with sixteen infant formula manufacturers, including Mead
Johnson Nutritionals, Wyeth, Abbott Laboratories, Nestle, Royal Numico N.V. (formerly Nutricia),
Novartis, Maabarot, Heinz-Watties, Laboratorios Ordesa, American St. George Biological
Corporation, International Nutrition Company, PT Sanghiang Perkasa, Takaso Rubber and three
companies whose identities we have agreed not to disclose at this time. Collectively, these
companies 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, including the wholesale value of Women, Infant & Children program
(W.I.C.) rebates. W.I.C. is a federal grant program administered by the states for the benefit of
low-income, nutritionally at-risk women, infants and children. Our licensees are now selling term
infant formula products containing our oils collectively in over 30 countries and pre-term infant
formula products containing our oils collectively in over 60 countries around the world.
Supplemented term infant formulas manufactured by Mead Johnson Nutritionals, Abbott Laboratories,
Wyeth and Nestle are currently being sold in the United States. 13




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For the quarter ended January 31, 2005, we generated approximately $7.1 million in net income on
revenues of $66.5 million. Although we anticipate significant continued growth in sales of our
nutritional oils, and we have achieved operating profits since fiscal 2003, we may continue to
experience quarter-to-quarter and year-to-year fluctuations in our future operating results, 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. The extent and timing of future oils-related
revenues are largely dependent upon the following factors:  
    the ability by us and our third-party manufacturers to produce adequate levels of our nutritional oils on a continuous basis;
    the timing of the completion of construction at our Kingstree facility and related expanded production capabilities;
    the timing and extent of production and production expansion by DSM at its facilities;
    the timing of infant formula market introductions by our licensees;
    the timing and extent of introductions of DHA into various child and/or adult applications;
    the timing and extent of acceptance of products containing our oils under state-administered reimbursement programs in the U.S.;
    the acceptance of these products by consumers and demand by our customers;
    our ability to protect against competitive products through our patents;
    competition from alternative sources of DHA and ARA; and
    agreements with other future third-party collaborators to market our products or develop new products. As such, the likelihood, timing and extent of future profitability are largely dependent on factors
such as those mentioned above, as well as others, over which we have limited or no control. OVERVIEW As of January 31, 2005, we are nearing completion of our extensive expansion at our Kingstree
facility for the fermentation and processing of our nutritional oils. We have spent approximately
$176 million on the expansion since the inception of the project and expect the total cost of the
expansion to be approximately $185 million when complete. Certain components of the initial phase
of the expansion, including the first fermentation area with four new fermentors, commenced
commercial operation in late 2004. The second phase of the expansion, which includes four
additional fermentors, is complete with respect to construction and commercial operation is
expected to commence by the end of the second quarter of fiscal 2005. With this expansion, the
expected commencement of downstream ARA processing capacity from a third-party provider and a
phase-in of the DSM expansion, Martek expects to achieve production capacity equivalent to
approximately $500 million in annualized sales at some point in the second half of fiscal 2005. In February 2005, we announced that we had entered into a DHA license and supply agreement with a
major consumer food products company. The agreement has a 15-year term and provides that the food
company will develop foods containing Martek DHA and must purchase, subject to certain exceptions,
almost all of its DHA needs from us for products in the United States and other designated
territories. There are no minimum purchase requirements or other financial commitments to us. The
agreement is non-exclusive, although we have agreed that we will not allow other companies to
commence retail sales in North America of products limited to ready-to-eat cereal and cereal bars
containing Martek DHA before July 1, 2007, so long as the food company launches its own products
containing Martek DHA by an earlier specified date. While subject to final product selection,
food formulation and consumer testing, the food company intends for the initial product launch to
take place in mid-2006. In products containing Martek DHA, the food company must display the
Martek DHA logo on all product packages, print advertisements and certain other promotional
materials. Additional information regarding this agreement can be found in our Form 8-K filed on
February 4, 2005, the contents of which are incorporated by reference in this report. In January 2005, we offered and sold 1,756,614 shares of our common stock under our effective shelf
registration statement in an underwritten public offering. We received net proceeds of
approximately $81.5 million from the offering after deducting an underwriting discount and offering
expenses. Of these proceeds, $30 million was used for the partial repayment of debt with the
remainder intended to be used for capital expenditures, working capital and general corporate
purposes. In January 2005, the U.S. Department of Health and Human Services and U.S. Department of
Agriculture released updated Dietary Guidelines mentioning for the first time DHA, an omega-3 fatty
acid. The 2005 Dietary Guidelines recognize that limited evidence suggests an association between
consumption of fatty acids in fish and reduced risks of mortality from cardiovascular disease for
the general population. In addition, the 2005 Dietary Guidelines recognize that there are other
sources of DHA and eicosapentaenoic acid (EPA) that may provide similar cardiovascular benefits,
but state that more research is needed. MANAGEMENT OUTLOOK We believe that the outlook for future revenue growth remains positive, although quarterly results
may show fluctuations, particularly if we experience unforeseen variances in production or continue
to experience inconsistent supply from our third-party manufacturers. Specifically, we believe
that during the second half of fiscal 2005, current term infant formula products containing our
oils will continue to gain market share in existing markets, new products will be added in those
markets and term infant formulas containing our oils will also be introduced in additional 14




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##### 



countries. To date, twelve of our infant formula licensees are selling term infant formula products
containing our oils collectively in over 30 countries and pre-term infant formula products
containing our oils collectively in over 60 countries around the world. Supplemented term infant
formulas manufactured by four of our licensees are currently being sold in the United States and we
expect these sales to increase during the remainder of fiscal 2005. In the quarter ended January 31, 2005, approximately 93% of our product sales revenues related to
the sales of our oils for use in infant formula and recently introduced toddler products. We
anticipate increased future sales of our oils for other products such as products developed for
pregnant and nursing mothers, cardiovascular health, and the food and beverage market. We expect
that the majority of these sales will come through partnering relationships with larger companies
in the nutritional and food and beverage markets. We anticipate that over the next few years, these
sales will expand and represent a much larger potential market than infant formula. We have an aggressive growth plan that includes substantial additional investments in our
manufacturing facilities. To accommodate our growth plan, we will need to continue to improve our
operational and financial information systems and controls, expand our management team, continue to
attract and retain new employees, accurately anticipate demand for our products and effectively
bring on line and integrate new production capacity. In addition, we will rely on third-party
manufacturers to effectively bring on line and integrate new production capacity. All of these
factors present numerous challenges and could result in unanticipated costs and delays in product
manufacture and product revenue. PRODUCTION We manufacture oils rich in DHA at our fermentation and oil processing facilities located in
Winchester, Kentucky and Kingstree, South Carolina. We are nearing completion of our extensive
expansion in Kingstree for the fermentation and processing of our nutritional oils. Phase one of
this expansion, which included four new fermentors, commenced commercial operation in late 2004 and
phase two, which includes four additional fermentors, is complete with respect to construction and
commercial operation is expected to commence by the end of the second quarter of fiscal 2005. Our ARA oils are purchased from DSM as manufactured at its Capua, Italy and Belvidere, New Jersey
plants. DSM is currently expanding its ARA production capabilities at both facilities. We are now
receiving approximately 40% of our ARA from DSMs Belvidere facility with that percentage expected
to grow to approximately 60% to 65% as DSM completes its current expansion at Belvidere, in phases,
over the next 9 to 12 months. As part of the April 2004 agreement with DSM, we are required to
guarantee the recovery to DSM of certain expansion costs incurred by them. This guarantee will
decline in value as we purchase ARA from DSM in the future. As of January 31, 2005, the value of
our current guarantee to DSM, which is related to DSMs phase one expansion, is approximately $2.4
million. In addition, we are in the process of negotiating an amendment to the April 2004 agreement
with DSM. This amendment is expected to establish the overall economics associated with DSMs
current expansions at both facilities, including our guarantee of
such expansion costs, with such guarantee
expected to approximate $40 million. Because DSM is a third-party manufacturer, we do not have
full control over the timing and extent of its Capua and Belvidere production volumes. We have attempted to reduce the risk inherent in having a single supplier, such as DSM, through
certain elements of a new supply agreement entered into with DSM in April 2004. In connection with
the new agreement, we have licensed the DSM technology associated with ARA production. Through this
license and the overall supply arrangement, we have the ability to produce, either directly or
through another third party, an unlimited amount of ARA. The sale of such self-produced ARA is
limited annually, however, to the greater of (i) 100 tons of ARA oil or (ii) any amounts ordered by
us that DSM is unable to fulfill. We have begun the internal fermentation of ARA at both our
Kingstree and Winchester facilities and anticipate having the resulting ARA oil available for sale
by the end of the second quarter of fiscal 2005. In addition, to further reduce our ARA
production risk, we have directly engaged and recently added a new U.S.-based provider of certain
post-fermentation ARA manufacturing services. Along with existing ARA extraction capabilities at
Winchester and our planned ARA extraction capabilities at Kingstree, the addition of a new
third-party facility will give us multiple U.S. sites for the downstream processing of ARA. Since fiscal 2003, the demand for our nutritional oils for use in infant formula products has
exceeded production capacity. These shortfalls resulted from an acceleration of such demand over
what our customers had projected, coupled with a shortage or inconsistent supply of ARA from DSM
that began in the first quarter of fiscal 2004. As customer demand has increased, we have requested
that our customers provide us with longer lead-times in order to fill their orders. Even with the
longer lead-times and increased production each quarter, since fiscal
2003, we have limited the
orders we accept for our nutritional oils. When combining our current and projected DHA
production capabilities in Winchester and Kingstree with DSMs current and projected ARA production
capabilities in Italy and the U.S., we had total production capacity equivalent to between $280 and
$300 million in annualized sales of our nutritional oils at January 31, 2005. Capacity is expected
to increase throughout the remainder of fiscal 2005 and we expect to
achieve production capacity
equivalent to approximately $500 million in annualized sales of
our nutritional oils at some point in the second
half of fiscal 2005 based on current prices. We also believe that production optimization efforts
will continue at our plants for the next several years as new technologies and additional algal
strains are tested to further increase output and reduce costs. With our pending increase to $500
million of production capacity, our production capabilities are expected to significantly exceed
current demand. As such, during the third quarter of fiscal 2005, we expect that we will no longer
have to limit the orders we accept from customers. If, however, the production expansion in Kingstree does not proceed as planned or if DSM is not
able to further expand its ARA production capacity in the U.S., our ability to produce at these
levels may be negatively impacted. To meet demand in excess of these levels, we will need to do
one or more of the following: 15




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
    further expand our production facilities in Winchester and Kingstree;
    build another production facility to manufacture our oils; or
    enter into additional agreements with third-party manufacturers to produce our oils. We have several other contractual agreements with third-party manufacturers to assist in the
production of our nutritional oils. We have an agreement for the production of DHA-S biomass that
we sell to animal feed companies or process further for use in the adult supplement and food and
beverage markets. We currently have a minimum purchase commitment under this agreement that
expires on June 30, 2006. As of January 31, 2005, our remaining obligation was approximately $3.8
million. We also have an agreement to purchase from a third-party manufacturer a minimum quantity
of extraction services to be utilized in ARA production. This commitment expires on December 31,
2007. As of January 31, 2005, our remaining obligation under this commitment was approximately
$15.3 million. The commercial success of our nutritional oils will depend, in part, on our ability to manufacture
these oils or have them manufactured at large scale on a continuous basis and at a commercially
acceptable cost. If the production expansion plans of Martek or DSM do not proceed as anticipated
or if market demand subsides due to our inability to meet demand for our products, our results
could be negatively impacted. There can also be no assurance that we will be able to successfully
optimize production of our nutritional oils, or continue to comply with applicable regulatory
requirements, including GMP requirements. Under the terms of several of our infant formula
licenses, our licensees may elect to manufacture these oils themselves. We are currently unaware of
any of our licensees producing our oils or preparing to produce our oils, and estimate that it
would take a licensee a minimum of one year to implement our process of making our oils. CRITICAL ACCOUNTING POLICIES AND
THE USE OF ESTIMATES The preparation of our consolidated financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates and assumptions that
affect the amounts reported in our consolidated financial statements and accompanying notes. On an
ongoing basis, we evaluate our estimates and judgments, which are based on historical and
anticipated results and trends and on various other assumptions that we believe are reasonable
under the circumstances, including assumptions as to future events. By their nature, estimates are
subject to an inherent degree of uncertainty and, as such, actual results may differ from our
estimates. We discuss accounting policies and assumptions that involve a higher degree of judgment
and complexity than others in our Managements Discussion and Analysis of Financial Condition and
Results of Operations in our Annual Report to shareholders on Form 10-K for the year ended October
31, 2004. RESULTS OF OPERATIONS Revenues
The following table presents revenues by category (in thousands): Three months ended January 31,2005
    
    
    2004Product sales
    
    $
    63,111
    
    
    $
    32,231Contract manufacturing sales
    
    
    3,378
    
    
    
    3,344Total revenues
    
    $
    66,489
    
    
    $
    35,575
 Product sales increased by $30.9 million or 96% in the quarter ended January 31, 2005 as
compared to the quarter ended January 31, 2004, primarily due to a continued increase in sales of
our oils to both existing and new infant formula licensees. Substantially all of our product sales
in the three months ended January 31, 2005 and 2004 relate to the sale of our oils for use in
infant formulas. Included in product sales in the three months ended January 31, 2005 were $2.3
million in sales of DHA oil for the pregnancy and nursing market, such sales having begun during
the fourth quarter of fiscal 2004. Approximately 44% of our sales in the quarter ended January
31, 2005 was generated by sales to Mead Johnson Nutritionals, 17% was generated by sales to Abbott
Laboratories, 17% was generated by sales to Nestle and 13% was generated by sales to Wyeth.
Collectively, these four companies are currently manufacturing term infant formulas supplemented
with our oils for sale in the U.S., and in over 30 countries around the world. Although we are not
given precise information by our customers as to the countries in which infant formula containing
our oils is ultimately sold, we estimate that approximately two-thirds of our sales to infant
formula licensees for the three months ended January 31, 2005 relate to sales in the U.S. The first
infant formulas containing our oils were introduced in the U.S. in February 2002 and, as of January
31, 2005, formula supplemented with our oils had penetrated
approximately 75% of the U.S.
infant formula market. We anticipate that annual product sales will continue to grow as
our licensees expand in countries where our products are currently
sold and as our licensees introduce
infant formulas and other products containing
our oils in additional countries. We also
anticipate, however, that product sales and total revenues in the second quarter of fiscal 2005 will decline from the levels achieved
in the first quarter of fiscal 2005. Our future sales growth is
dependent to a significant degree upon the following factors:
(i) our
ability to complete the expansion of our production capabilities in
Kingstree, (ii) the ability of DSM
to complete the expansion of its production of ARA at its Belvidere, New Jersey and Capua, Italy 16




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facilities,
(iii) our ability to secure sufficient ARA extraction capacity at
third-party facilities, (iv) our ability to maintain a consistent flow of
production, both internally and from DSM, from month to month, and
(v) the launches of products by our customers in new markets. Contract manufacturing sales revenues, totaling approximately $3.4 million and $3.3 million in the
three months ended January 31, 2005 and 2004, respectively, relate to fermentation work performed
for various third parties at the Kingstree, South Carolina facility. Current plans are that
contract manufacturing sales will be mostly phased out over the next few years to allow for
increased fermentation capacity for our DHA and ARA production. As a result of the above, total revenues increased by $30.9 million or 87% in the quarter ended
January 31, 2005 as compared to the quarter ended January 31, 2004. Cost and Expenses
The following table presents our operating costs and expenses (in thousands): Three months ended January 31,2005
    
    
    2004Cost of revenue:Cost of product sales
    
    $
    36,102
    
    
    $
    19,525Cost of contract manufacturing sales
    
    
    2,804
    
    
    
    2,709Operating expenses:Research and development
    
    
    4,816
    
    
    
    4,027Selling, general and administrative
    
    
    8,145
    
    
    
    5,797Other operating expenses
    
    
    3,485
    
    
    
    450Total costs and expenses
    
    $
    55,352
    
    
    $
    32,508
 Cost of Product SalesCost of product sales decreased as a percentage of product sales to 57%
in the quarter ended January 31, 2005 from 61% in the quarter ended January 31, 2004. The decrease
was due in part to a decrease in our overall cost of ARA from DSM (a decrease of approximately 2%
in cost of product sales as a percentage of product sales) resulting from DSMs increased U.S.
production of ARA at its Belvidere facility. The gross margin improvements were also partially due
to the benefits of certain DHA production improvements recently implemented (a decrease of
approximately 2% in cost of product sales as a percentage of product sales). We expect our gross
profit margins to further improve in the second half of fiscal 2005 due to the benefits of the
newly implemented DHA production improvements coupled with further expansion by DSM of its U.S. ARA
manufacturing capabilities and a gradual decrease in air freight. Cost of Contract Manufacturing SalesCost of contract manufacturing sales, totaling $2.8 million
and $2.7 million for the quarters ended January 31, 2005 and 2004, respectively, are the costs
related to the fermentation work performed for various third parties at our Kingstree, South
Carolina facility. Our contract manufacturing sales achieve significantly lower gross margins than
our product sales. Current plans are that contract manufacturing sales will be mostly phased out
over the next few years to allow for increased fermentation capacity for our DHA and ARA
production. Research and DevelopmentResearch and development expenses, primarily development, increased by
$800,000 or 20% in the quarter ended January 31, 2005 as compared to the quarter ended January 31,
2004. The increase was primarily the result of additional resources directed toward our internal
ARA production and our continuing efforts to lower our DHA production costs by increasing
fermentation production yields and developing new downstream processing techniques. In addition,
costs were incurred in connection with new clinical studies regarding the potential benefits of DHA
as well as other research in connection with the development of plant-based DHA under a
collaboration agreement with SemBioSys. Selling, General and AdministrativeOur selling, general and administrative costs
increased by $2.3 million or 41% in the quarter ended January 31, 2005 as compared to the quarter
ended January 31, 2004. The increase was primarily due to additional personnel costs ($900,000),
legal costs ($500,000) and insurance costs ($400,000) required to accelerate and manage our overall
growth. Specifically, we have increased staffing in our business development, food and beverage
sales and marketing and finance departments. Other Operating ExpensesWe incurred other operating expenses of $3.5 million and $500,000 in the
three months ended January 31, 2005 and 2004, respectively. During fiscal 2005, we began
large-scale production trials with certain fermentors and extraction facilities at both Kingstree
and Winchester for the production of ARA. These large-scale trials commenced after completion of
the ARA technology transfer from DSM to Martek in late fiscal 2004 and generated start-up costs of
approximately $2.0 million in the current quarter. Other operating expenses in the current quarter
also included costs associated with the expansion at our Kingstree facility and start-up costs
related to new extraction technology used in the production of Marteks food DHA product. 17




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Other Income, Net
Our other income, net, decreased by $300,000 in the three months ended January 31, 2005 as compared
to the three months ended January 31, 2004, due primarily to the recognition of interest expense in
the current period. In the prior period, all interest costs were capitalized. Provision for Income Taxes
The provision for income taxes totaled $4.1 million in the three months ended January 31, 2005 and
has been recorded based upon our estimated effective tax rate for fiscal 2005. Based on our
positive historical earnings trend and projected operating results, during the fourth quarter of
fiscal 2004, we reversed approximately $51 million of our deferred tax asset valuation allowance,
having determined that it is more likely than not that this portion of the deferred tax asset will
be realized. As a result, income tax expense has been recorded based on pre-tax income for the
quarter despite the fact that we continue to have significant net operating loss carryforwards
which will mitigate much of our cash tax expenditures during fiscal 2005. As of October 31, 2004, we had net operating loss carryforwards for federal income tax purposes of
approximately $200 million. Approximately $3 million of this amount will expire, if unused, by the
end of fiscal 2007 with the remainder expiring through fiscal 2023. Of the total net operating
loss carryforwards, approximately $56 million continues to be fully reserved through a valuation
allowance as realizability of these assets is uncertain at this time. Should realization of these
and other deferred tax assets become more likely than not, approximately $9.4 million of the
resulting benefit will be reflected as an income tax benefit upon reversal of the allowance,
approximately $8.8 million will be reflected as a reduction to goodwill and approximately $3.9
million will be reflected as an increase to stockholders equity. Net Income
As a result of the foregoing, net income was $7.1 million in the three months ended January 31,
2005 as compared to net income of $3.4 million in the three months ended January 31, 2004. RECENTLY ISSUED
ACCOUNTING PRONOUNCEMENTS In October 2004, the FASB concluded that SFAS No. 123 (revised 2004), Share-Based Payment (SFAS
123R), which would require all companies to measure compensation cost for all share-based
payments (including employee stock options) at fair value, would be effective for interim or annual
periods beginning after June 15, 2005. SFAS 123R provides two tentative adoption methods. The
first method is a modified prospective transition method whereby a company would recognize
share-based employee costs from the beginning of the fiscal period in which the recognition
provisions are first applied as if the fair-value-based accounting method had been used to account
for all employee awards granted, modified, or settled after the effective date and to any awards
that were not fully vested as of the effective date. Measurement and attribution of compensation
cost for awards that are unvested as of the effective date of SFAS 123R would be based on the same
estimate of the grant-date fair value and the same attribution method used previously under SFAS
No. 123, Accounting for Stock-Based Compensation (SFAS 123). The second adoption method is a
modified retrospective transition method whereby a company would recognize employee compensation
cost for periods presented prior to the adoption of SFAS 123R in accordance with the original
provisions of SFAS 123; that is, an entity would recognize employee compensation costs in the
amounts reported in the pro forma disclosures provided in accordance with SFAS 123. A company would
not be permitted to make any changes to those amounts upon adoption of SFAS 123R unless those
changes represent a correction of an error. For periods after the date of adoption of SFAS 123R,
the modified prospective transition method described above would be applied. We currently expect
to adopt SFAS 123R in the quarter ended October 31, 2005, using the modified prospective method,
although we continue to review our options for adoption under this new pronouncement. After giving
effect to the accelerated vesting of certain stock options in December 2004 and January 2005 and
based upon our projection of unvested stock options at the implementation date, we expect the
adoption to result in the recognition of additional compensation expense of approximately $1.2
million to $1.7 million in the fourth quarter of fiscal 2005. In December 2004, the FASB issued SFAS No. 151, Inventory Costs (SFAS 151). SFAS 151 requires
abnormal amounts of inventory costs related to idle facility, freight handling and wasted material
expenses to be recognized as current period charges. Additionally, SFAS 151 requires that
allocation of fixed production overheads to the costs of conversion be based on the normal capacity
of the production facilities. The standard is effective for fiscal years beginning after June 15,
2005. We believe the adoption of SFAS 151 will not have a material impact on our consolidated
financial statements. 18




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LIQUIDITY AND CAPITAL RESOURCES We have financed our operations primarily from the following sources:  
    cash generated from operations;
    proceeds from the sale of equity securities;
    cash received from the exercise of stock options and warrants; and
    debt financing. At January 31, 2005, our primary source of liquidity was our cash, cash equivalents and short-term
investments totaling $67.5 million as well as the available portion of our revolving credit
facility of $45.0 million. Cash, cash equivalents and short-term investments increased $24.9
million from October 31, 2004. This increase was primarily generated by the proceeds from the
issuance of common stock under our shelf registration statement of $81.5 million, partially offset
by the repayment of borrowings under our revolving credit facility of $30 million and capital
expenditures of $26.3 million, the majority of which related to the expansion of the Kingstree
facility to increase output of our nutritional oils. The expansion of our production facility in Kingstree, South Carolina and, to a lesser degree,
production improvements at our facility in Winchester, Kentucky, have and will continue to have a
material effect upon our liquidity and capital resources in fiscal 2005. We expect to invest at
least $40 million in the next twelve months in plant and equipment expenditures to complete the
expansion and production improvements as well as for other company-wide capital needs. Throughout
the construction period, all interest incurred on borrowings will be capitalized to the extent that
the borrowings are used to cover the balance of projects under construction. In the three months
ended January 31, 2005, we incurred interest on borrowings of approximately $1.1 million and
recorded amortization of related debt fees of approximately $100,000, of which approximately $1.0
million was capitalized. Since our inception, we have raised approximately $400 million from public and private sales of our
equity securities, as well as from option and warrant exercises. Including net income of $7.1
million in the quarter ended January 31, 2005, our accumulated deficit at January 31, 2005 is $57.4
million. The following table sets forth our future minimum payments under contractual obligations at January
31, 2005: Less than
    
    
    1-3
    
    
    3-5
    
    
    More thanIn thousands
    
    Total
    
    
    1 year
    
    
    years
    
    
    years
    
    
    5 yearsNotes payable
    
    $
    9,949
    
    
    $
    609
    
    
    $
    1,025
    
    
    $
    7,987
    
    
    $
    328Borrowings under revolving credit facility
    
    
    55,000
    
    
    
    
    
    
    
    55,000
    
    
    
    
    
    
    
    Operating and capital lease obligations
    
    
    17,199
    
    
    
    3,422
    
    
    
    6,961
    
    
    
    6,105
    
    
    
    711DSM license fee and other obligations
    
    
    3,000
    
    
    
    2,333
    
    
    
    667
    
    
    
    
    
    
    
    Unconditional inventory purchase obligations
    
    
    19,164
    
    
    
    8,925
    
    
    
    10,239
    
    
    
    
    
    
    
    Total contractual cash obligations
    
    $
    104,312
    
    
    $
    15,289
    
    
    $
    73,892
    
    
    $
    14,092
    
    
    $
    1,039
 As part of the acquisition of FermPro, we assumed a $10 million note with a stated interest
rate of 5%. The note was amended in January 2004 and is now an unsecured obligation with a maturity
date of December 31, 2008. Principal is amortized over a 20-year period, with the balance due at
maturity. Also as part of the FermPro acquisition, we assumed a long-term note of approximately
$400,000, due in 2023 with a 7% stated interest rate. In April 2004, we entered into a new agreement with DSM extending the existing relationship between
the two companies involving the production and supply of ARA, one of our nutritional oils that we
sell to our infant formula licensees. Among other things, this agreement provides for the sale to
us by DSM of a license related to certain technologies associated with the manufacture of ARA. This
sale involved a license fee totaling $10 million, $4 million of which was paid upon execution of
the agreement, $4 million of which was paid on November 2, 2004, and the remaining $2 million of
which will be paid on November 2, 2005. This agreement also provides for the guarantee by us of
DSMs recovery of certain expansion costs incurred by them. This guarantee will decline in value
as we purchase ARA from DSM in the future. As of January 31, 2005, the value of our current
guarantee to DSM related to DSMs phase one expansion is approximately $2.4 million. In addition,
we are in the process of negotiating an amendment to the April 2004 agreement with DSM. This
amendment is expected to establish the overall economics associated with DSMs current expansions
at both of its facilities, including our guarantee of such expansion
costs, with such guarantee expected to
approximate $40 million. In May 2004, we entered into a $100 million secured revolving credit facility which amended and
expanded the $85 million credit facility established in January 2004. The revolving credit
facility is collateralized by accounts receivable and inventory and expires in February 2007. The
weighted average interest rate on the credit facility was approximately 4.4% for the quarter ended
January 31, 2005 and is based on LIBOR and our current leverage ratio. Among other things, the
credit facility agreement contains restrictions on future debt, the payment of dividends and the
further 19




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encumbrance of assets. In addition, the credit facility requires that we comply with
specified financial ratios and tests, including minimum liquidity, minimum coverage ratios and
maximum leverage ratios. We do not believe that these covenants restrict our ability to carry out
our current business plan. As of January 31, 2005, we are in compliance with all of these debt
covenants and have outstanding borrowings of $55 million under the revolving credit facility. In August 2004, our shelf registration statement was declared effective by the Securities and
Exchange Commission. The shelf registration statement enables us to raise funds through the
offering of debt securities, preferred stock, common stock and warrants, as well as any combination
thereof, from time to time and through one or more methods of distribution, in an aggregate amount
of up to $200 million. In January 2005, we completed an underwritten public offering of 1,756,614
shares of our common stock at price of $49.10 per share pursuant to the shelf registration
statement. Net proceeds to us, after deducting an underwriting discount and offering expenses,
amounted to approximately $81.5 million. Of the proceeds, $30 million was used for the partial
repayment of debt with the remainder intended to be used for capital expenditures, working capital
and general corporate purposes. Remaining availability under the shelf registration statement is
approximately $113.8 million at January 31, 2005. In October 2004, we entered an operating lease for equipment at our Kingstree facility as part of a
sale/leaseback transaction. The equipment subject to lease was sold at its cost basis and fair
value of $10.8 million and simultaneously leased back to us. The lease expires in October 2009 and
contains the same restrictions as our revolving credit facility. In December 2004, we entered an
operating lease for equipment at our Kingstree facility subject to the same terms and expiration as
the October 2004 transaction. This second sale/leaseback transaction involved the sale of
equipment with a cost basis and fair value of $4.1 million. We believe that the revolving credit facility, when combined with our cash and short-term
investments of $67.5 million on-hand at January 31, 2005, and anticipated operating cash flows,
will provide us with adequate capital to meet our obligations for at least the next 12 to 18
months. The ultimate amount of additional funding that we may require will depend, among other things, on
one or more of the following factors:  
    the cost of capital expenditures at our manufacturing facilities;
    growth in our infant formula, food and beverage and other nutritional product sales;
    the extent and progress of our research and development programs;
    the progress of pre-clinical and clinical studies;
    the time and costs of obtaining and maintaining regulatory clearances for our products that are subject to such clearances;
    the costs involved in filing, protecting and enforcing patent claims;
    competing technological and market developments;
    the development or acquisition of new products;
    the cost of acquiring additional and/or operating and expanding existing manufacturing
facilities for our various products and potential products (depending on which products we
decide to manufacture and continue to manufacture ourselves); and
    the costs of marketing and commercializing our products. We can offer no assurance that, if needed, any of our financing alternatives will be available to
us on terms that would be acceptable, if at all. OFF-BALANCE SHEET ARRANGEMENTS We have entered into lease agreements for certain laboratory and administrative space as well as
manufacturing equipment with rental payments aggregating $17.2 million over the lease terms, which
expire through 2011. Included in these aggregate rentals are amounts related to certain equipment
leases, for which we are contingently liable for a residual value guarantee of approximately $2.3
million. As part of our agreement with DSM, we agreed to guarantee DSMs recovery of certain expansion costs
incurred by them. This guarantee will decline in value as we purchase ARA from DSM in the future.
As of January 31, 2005, the value of our current guarantee to DSM related to DSMs phase one
expansion is approximately $2.4 million and the value of our guarantee to DSM related to DSMs
phase two expansion is expected to approximate $40 million upon completion of the current

negotiations described above. We do not engage in any other off-balance sheet financing arrangements. In particular, we do not
have any interest in entities referred to as variable interest entities, which include special
purpose entities and structured finance entities. 20




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Item 3. Quantitative and Qualitative Disclosures about Market Risk. Beginning in January 2004, purchases of ARA from DSMs plant in Capua, Italy were denominated in
euros, which exposes us to risks related to changes in exchange rates between the U.S. dollar and
the euro. Fluctuations between the U.S. dollar and the euro will impact our cost of ARA oil and
gross margins. We estimate that a 5% change in the exchange rate would impact gross margins of our
infant formula products by approximately 1.5%. Our exposure to these currency fluctuations has
begun to slightly decrease as DSM has now commenced ARA production in the U.S. at its Belvidere,
New Jersey facility. In April 2004, we began entering into foreign currency cash flow hedges to
reduce the related market risk on our payment obligations. We do not enter into foreign currency
cash flow hedges for speculative purposes. At January 31, 2005, we had unrealized losses on such
hedge instruments totaling $256,000, net of income tax benefit. We are subject to risk from adverse changes in interest rates, primarily relating to variable-rate
borrowings used to maintain liquidity and finance our manufacturing facility expansion. Based on
our variable-rate debt outstanding at January 31, 2005, a 1% change in LIBOR would change annual
interest by $550,000. At January 31, 2005, the carrying amounts of debt approximate fair value. 
 Item 4. Controls and Procedures.  a)
    Evaluation of Disclosure Controls and Procedures.The management of Martek Biosciences
Corporation, with the participation of our Chief Executive Officer and the Chief Financial
Officer, has evaluated the effectiveness of our disclosure controls and procedures (as
defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as
amended (the Exchange Act)), as required by paragraph (b) of Rules 13a-15 and 15d-15
under the Exchange Act, and has concluded as of the end of the period covered by this
report that the disclosure controls and procedures were effective.b)
    Changes in Internal Controls.There were no changes in our internal controls over
financial reporting in connection with the evaluation required by paragraph (d) of Rules
13a-15 or 15d-15 under the Exchange Act that occurred during Marteks last fiscal quarter
that materially affected or are reasonably likely to materially affect the internal
controls over financial reporting. 21




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PART II  OTHER INFORMATION 
 Item 1. Legal Proceedings. Aventis S.A. and Nagase & Co. Ltd. are challenging our European patent covering our DHA-containing
oils. At a hearing in October 2000, the Opposition Division of the European Patent Office (EPO)
revoked our patent on the grounds that it was not novel. We immediately appealed this ruling, and
in July 2002 we received a positive ruling from an Appeal Board of the EPO, setting aside the prior
decision to revoke this patent. Consistent with our request, the patent has been returned to the
Opposition Division for a determination as to whether it has met the legal requirement of
inventive step. A hearing is now scheduled for August 2005 and the process is not expected to be
completed until 2007. With respect to our ARA patent issued by the EPO, BASF AG, Friesland Brands B.V., and Suntory
Limited have filed their grounds for opposing this patent with the Opposition Division of the EPO.
Marteks blended oil patent will remain in full force and effect throughout the opposition process.
An initial hearing at the Opposition Division is scheduled for April 2005. The opposition process
is not expected to be completed until some time in late 2006 or 2007. With respect to our blended-oil (blend of DHA and ARA oils for use in various applications,
including infant formula) patent issued by the EPO, BASF AG and Suntory Limited have filed their
grounds for opposing this patent with the Opposition Division of the EPO. In November 2004, the
Opposition Division of the EPO revoked Marteks European DHA/ ARA oil blends patent as a result of
these challenges. The Company immediately filed an appeal of this decision; as a consequence, the
blends patent has been reinstated and will remain in full force and effect during the appeal. The
appeal process is not expected to be complete until 2006. Prior to our purchase of OmegaTech, Aventis Research and Technologies GmbH & Co. KG, and Nagase
Limited challenged OmegaTechs European patent covering its DHAcontaining oils. At a hearing in
December 2000, the Opposition Division of the EPO upheld some of the claims and revoked other
claims. OmegaTech immediately appealed this ruling, as did Aventis. During the appeal process, the
patent will remain in full force and effect. An appeal hearing is scheduled for May 2005. On March 12, 2003, an explosion occurred at a public wastewater treatment works in Winchester,
Kentucky, resulting in property damage. On April 8, 2003, we received a report from the state fire
marshal that concluded that the incident resulted from the introduction of n-hexane into the local
sewer system. We use n-hexane in the production process for our DHA oil. The state fire marshal
report did not rule out other possible contributors to the incident. Although n-hexane was found at
the site of the incident, there are other factors which we believe may be relevant, including the
presence of other flammable substances that were not discharged from our plant and existing
conditions at the water treatment facility. We continue to have active discussions relating to the
cause of and determination of responsibility for the property damage with the City of Winchester,
the Winchester Municipal Utilities Commission (WMU) and WMUs insurer. We have entered into an
agreement with the City of Winchester, WMU and WMUs insurer to extend any applicable statute of
limitations and allow the parties to continue discussing this matter. We learned in March 2004 that
the federal Environmental Protection Agency, utilizing personnel from its Criminal Investigation
Division, had asked questions of current and former employees relating to the explosion at the
wastewater treatment plant and n-hexane. Current and former employees have testified before a
federal grand jury that is investigating the matter. While we cannot be certain of the ultimate
outcome of our discussions with the City of Winchester, WMU and WMUs insurer or the Environmental
Protection Agency and grand jury activity, we believe that they will not have a material adverse
impact on our production, financial condition or results of operations. In September 2003, we filed a patent infringement lawsuit in the U.S. District Court in Delaware
against Nutrinova Inc., Nutrinova Nutrition Specialties & Food Ingredients GmbH, Celanese Ventures
GmbH, and Celanese AG alleging infringement of two of our U.S. patents. Celanese Ventures GmbH and
Celanese Ag have been dropped from the lawsuit. We have added an additional two patents to the
suit, bringing the total number that Nutrinova is accused of infringing to four patents. The
lawsuit alleges that Nutrinova has been making, using, offering to sell, selling and/or importing
into the United States DHA that infringes the patents. In October 2003, Nutrinova filed
counterclaims alleging inequitable conduct and invalidity, unenforceability and/or noninfringement
of 19 of our U.S. patents. A scheduling hearing in the case was held in January 2005, and the trial
is scheduled for October 2006. A hearing before the court on the meaning and scope of the patent
claims in dispute is scheduled to be held in late November 2005. We also filed a patent
infringement suit involving Nutrinova Nutrition Specialties & Food Ingredients GmbH and Celanese
Ventures GmbH in Germany in January 2004. The complaint alleges infringement of our European patent
relating to DHA-containing oils. A hearing in this case is scheduled to be held in a district court
in Dusseldorf in April 2005. Suntory has opposed our blended oil patent in Japan, where we believe there currently are no sales
of infant formula containing our blended oils. The patent was revoked by the Japanese Patent Office
and the revocation upheld by the Tokyo High Court in September 2004. We appealed this decision to
the Japanese Supreme Court and, as expected, that court has declined to hear the matter. Thus, the
revocation of this patent has become final. We believe that, with respect to our Japanese ARA
patent, the same result will be reached. On October 18, 2004, we filed a Declaratory Judgment Complaint in the United States District Court
for the District of Maryland against Robert Zuccaro, as stockholders representative of the former
security holders of OmegaTech, Inc. The complaint was brought to seek to resolve Mr. Zuccaros
claim that the former OmegaTech security holders are owed 666,119 additional Martek shares under
the Agreement and Plan of Merger by which we acquired OmegaTech because a milestone under that
agreement was allegedly met. That milestone was to be triggered if a report issued by the Institute
of Medicine of the National Academy of Science regarding the nutritional properties of DHA met
criteria specified in the merger agreement. We have asked the Court to declare that the report
does not fulfill the requirements of the milestone and that we are not required to 22




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distribute the shares to the former security holders of OmegaTech. While we believe that our
position is meritorious and that the milestone was not met, no assurance can be given as to the
outcome of the litigation. On October 25, 2004, Mr. Zuccaro submitted a demand to the Judicial
Arbitration and Mediation Service, seeking to arbitrate this dispute. In December 2004, the
District Court ruled that the dispute over the milestone is not subject to arbitration.
Thereafter, on February 9, 2005, Mr. Zuccaro filed an answer and counterclaim. We have filed a
timely answer denying the allegations set forth in the counterclaim. At this point, we project
that a trial of the case would take place in the first half of 2006. With respect to our ARA patent in South Korea, where we believe there are limited sales of infant
formula containing our ARA oil, Suntory has also filed an opposition. A hearing on the matter has
not been scheduled. Suntory has also initiated an invalidation case against our blended oil patent
in South Korea. Our response to Suntory was filed in February 2005. No hearing date has been set.
At this point, it is not possible to indicate what the likely outcome of these two South Korean
matters will be. In addition, from time to time, Martek is a party to litigation or administrative proceedings
relating to claims arising from its operations in the normal course of business. Management
believes that the ultimate resolution of any such litigation or administrative proceedings
currently pending against Martek is unlikely, either individually or in the aggregate, to have a
material adverse effect on Marteks results of operations or financial condition. 
 Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities. None. 
 Item 3. Defaults Upon Senior Securities. Not Applicable. 
 Item 4. Submission of Matters to a Vote of Security Holders. No matters were voted upon during the first quarter of fiscal 2005. 
 Item 5. Other Information. None. 
 Item 6. Exhibits.  31.01
    Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a).31.02
    Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a).32.01
    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.02
    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.99.01
    Cautionary Statements for purposes of the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. 23




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized. MARTEK BIOSCIENCES CORPORATION(Registrant)Date: March 14, 2005
    
    /s/ Peter L. BuzyPeter L. Buzy, Chief Financial Officer and Treasurer(Principal Financial and Accounting Officer)
 24