##### 



MARTEK BIOSCIENCES CORPORATION
SELECTED FINANCIAL DATA

The following selected financial data should be read in conjunction with Managements Discussion
and Analysis of Financial Condition and Results of Operations and the consolidated financial statements
and notes contained in this Annual Report.

|                                           |                                                     |      |                        |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |         |  
|------------------------------------------ | --------------------------------------------------- | ---- | ---------------------- | ------- | - | ---- | - | ------- | - | ---- | - | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                           |                                                     |      | Year Ended October 31,
|                                           |                                                     |      |                       
|In thousands except per share data         |                                                     | 2003 |                        | 2002    |   | 2001 |   | 2000    |   | 1999
|                                           |                                                     |      |                        |         |   |      |   |         |   |     
|Consolidated Statements of Operations Data |                                                     |      |                        |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |        
|Revenues                                   |                                                     |      |                        |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |        
|                                           | Product sales                                       |      | $                      | 112,041 |   |      | $ | 45,903  |   |      | $ | 18,575  |   |  | $ | 8,726   |   |  | $ | 5,744   |  
|                                           | Contract manufacturing sales                        |      |                        | 2,439   |   |      |   |        |   |      |   |        |   |  |   |        |   |  |   |        |  
|                                           | Other revenues                                      |      |                        | 257     |   |      |   | 152     |   |      |   | 249     |   |  |   | 951     |   |  |   | 389     |  
|                                           |                                                     |      |                        |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |         |  
|                                           | Total revenues                                      |      |                        | 114,737 |   |      |   | 46,055  |   |      |   | 18,824  |   |  |   | 9,677   |   |  |   | 6,133   |  
|Costs and expenses                         |                                                     |      |                        |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |        
|                                           | Cost of product sales                               |      |                        | 66,347  |   |      |   | 29,794  |   |      |   | 12,554  |   |  |   | 7,092   |   |  |   | 4,209   |  
|                                           | Cost of contract manufacturing sales                |      |                        | 2,192   |   |      |   |        |   |      |   |        |   |  |   |        |   |  |   |        |  
|                                           | Research and development                            |      |                        | 12,218  |   |      |   | 11,648  |   |      |   | 12,705  |   |  |   | 12,517  |   |  |   | 10,309  |  
|                                           | Acquired in-process research and development        |      |                        |        |   |      |   | 15,788  |   |      |   |        |   |  |   |        |   |  |   |        |  
|                                           | Selling, general and administrative                 |      |                        | 17,211  |   |      |   | 12,344  |   |      |   | 7,969   |   |  |   | 6,942   |   |  |   | 6,822   |  
|                                           | Restructuring charge                                |      |                        | (250    | ) |      |   | 1,266   |   |      |   |        |   |  |   |        |   |  |   |        |  
|                                           | Other operating expenses                            |      |                        | 1,943   |   |      |   | 406     |   |      |   | 565     |   |  |   |        |   |  |   |        |  
|                                           |                                                     |      |                        |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |         |  
|                                           | Total costs and expenses                            |      |                        | 99,661  |   |      |   | 71,246  |   |      |   | 33,793  |   |  |   | 26,551  |   |  |   | 21,340  |  
|                                           |                                                     |      |                        |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |         |  
|                                           | Income (loss) from operations                       |      |                        | 15,076  |   |      |   | (25,191 | ) |      |   | (14,969 | ) |  |   | (16,874 | ) |  |   | (15,207 | )
|                                           | Other income, net                                   |      |                        | 916     |   |      |   | 958     |   |      |   | 1,267   |   |  |   | 1,147   |   |  |   | 359     |  
|                                           |                                                     |      |                        |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |         |  
|                                           | Net income (loss)                                   |      | $                      | 15,992  |   |      | $ | (24,233 | ) |      | $ | (13,702 | ) |  | $ | (15,727 | ) |  | $ | (14,848 | )
|                                           |                                                     |      |                        |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |         |  
|                                           | Net income (loss) per share, basic                  |      | $                      | 0.63    |   |      | $ | (1.10   | ) |      | $ | (0.73   | ) |  | $ | (0.91   | ) |  | $ | (0.95   | )
|                                           |                                                     |      |                        |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |         |  
|                                           | Net income (loss) per share, diluted                |      | $                      | 0.58    |   |      | $ | (1.10   | ) |      | $ | (0.73   | ) |  | $ | (0.91   | ) |  | $ | (0.95   | )
|                                           |                                                     |      |                        |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |         |  
|                                           | Weighted average common shares outstanding, basic   |      |                        | 25,510  |   |      |   | 21,982  |   |      |   | 18,864  |   |  |   | 17,335  |   |  |   | 15,581  |  
|                                           |                                                     |      |                        |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |         |  
|                                           | Weighted average common shares outstanding, diluted |      |                        | 27,417  |   |      |   | 21,982  |   |      |   | 18,864  |   |  |   | 17,335  |   |  |   | 15,581  |  
|                                           |                                                     |      |                        |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |         |  

|                                                                         |  |             |          |      |  |      |          |      |  |      |          |   |  |   |         |   |  |   |         |  
|------------------------------------------------------------------------ |  | ----------- | -------- | ---- |  | ---- | -------- | ---- |  | ---- | -------- | - |  | - | ------- | - |  | - | ------- | -
|                                                                         |  | October 31,
|                                                                         |  |            
|                                                                         |  | 2003        |          | 2002 |  | 2001 |          | 2000 |  | 1999
|                                                                         |  |             |          |      |  |      |          |      |  |     
|Consolidated Balance Sheets and Other Data                               |  |             |          |      |  |      |          |      |  |      |          |   |  |   |         |   |  |   |         |  
|Cash, cash equivalents, short-term investments
and marketable securities |  | $           | 96,971   |      |  | $    | 22,419   |      |  | $    | 26,682   |   |  | $ | 19,264  |   |  | $ | 16,331  |  
|Working capital                                                          |  |             | 106,218  |      |  |      | 30,457   |      |  |      | 31,501   |   |  |   | 21,266  |   |  |   | 20,162  |  
|Total assets                                                             |  |             | 295,523  |      |  |      | 124,312  |      |  |      | 56,603   |   |  |   | 45,442  |   |  |   | 39,145  |  
|Long-term portion of unearned revenue                                    |  |             | 8,992    |      |  |      | 2,246    |      |  |      | 2,353    |   |  |   | 2,460   |   |  |   |        |  
|Long-term obligations                                                    |  |             | 10,441   |      |  |      |         |      |  |      |         |   |  |   |        |   |  |   | 472     |  
|Accumulated deficit                                                      |  |             | (111,568 | )    |  |      | (127,560 | )    |  |      | (103,327 | ) |  |   | (89,625 | ) |  |   | (73,898 | )
|Total stockholders equity                                               |  |             | 243,964  |      |  |      | 105,977  |      |  |      | 46,701   |   |  |   | 35,455  |   |  |   | 35,172  |  
|Cash dividends declared  common stock                                   |  |             |         |      |  |      |         |      |  |      |         |   |  |   |        |   |  |   |        |  

6



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##### 



MANAGEMENTS DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CAUTIONARY STATEMENTS
FOR PURPOSES OF THE SAFE HARBOR PROVISIONS OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

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 production capacity
and our ability to meet future demands
for our DHA and ARA oils;                                                                                  
|
| |  |  | expectations regarding future research and development
costs;                                                                                                                                
|
| |  |  | expectations regarding the integration of the former FermPro
Manufacturing, LP (FermPro) facility with Martek;                                                                             
|
| |  |  | expectations regarding our expansion at our Kingstree, SC facility
(formerly FermPro); and                                                                                                   
|
| |  |  | expectations regarding additional capital expenditures
needed in relation to our fermentation and oil processing activities.                                                                 

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 this report and in
our 10-K for the year ended October 31, 2003 as
well as in various other filings with the SEC.

GENERAL

Martek was founded in 1985. We are a leader in
the development and commercialization of
products derived from microalgae. 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 and play a pivotal role in brain
function throughout life. 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 algal genomics
technology and our currently marketed
fluorescent detection products and technologies
that can be used by researchers as an aid in
drug discovery and diagnostics.

In 1992, we realized our first revenues from license
fees related to our nutritional oils containing
DHA and ARA and sales of sample quantities of
these oils. In 1995, we recognized our first
product and royalty revenues from sales of
infant formula containing these oils, and in
1996 we began to realize revenues from the sale
of Neuromins®, a DHA dietary supplement. In
1998, we first realized revenues from the sale
of our fluorescent detection products. We
currently have license agreements with fourteen
infant formula manufacturers, including Mead
Johnson Nutritionals, Wyeth, Abbott
Laboratories, Nestle, Nutricia, Novartis,
Maabarot, Heinz-Watties, Laboratorios Ordesa
and five companies whose identities we have
agreed not to disclose at this time.
Collectively, these companies represent more
than 70% of the estimated $8.5 to $9.5 billion
worldwide wholesale market for infant formula
and 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. Mead Johnson Nutritionals, Wyeth,
Abbott Laboratories, Nestle, Nutricia, Novartis
and Maabarot are now marketing term infant
formula products containing our oils in over 30
countries and pre-term infant formula products
containing our oils in over 60 countries around
the world. The seven licensees that are not
currently marketing term infant formula
products containing our oils represent less
than 5% of the estimated worldwide wholesale
market for infant formula. Supplemented term
infant formulas manufactured by Mead Johnson
Nutritionals, Abbott Laboratories, Wyeth and
Nestle are currently being marketed in the
United States.

In April 2002, we acquired OmegaTech,
Inc. (OmegaTech or Martek Boulder), a
low-cost algal DHA producer located in
Boulder, Colorado. OmegaTech had been in the
fermentable

7



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##### 



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

DHA business since 1987, and had accumulated
over 100 issued and pending patents protecting
its DHA technology. Its revenues mainly
consisted of sales of DHA into the dietary
supplement, food, beverage, and animal feed
markets. We acquired Omega-Tech to obtain its
low-cost DHA oil and related intellectual
property for use in the adult supplements
market and future use in the food and beverage
markets. We refer to this DHA oil, which comes
from a different strain of algae than the
strain that we use for the production of DHA
for inclusion in infant formulas, as DHA-S.

In June 2003, the Commission of the
European Community authorized the use of our
DHA-S oil for human consumption. The Commission
declared that our DHA-S may be marketed in the
European Community as a Novel Food ingredient.
This Novel Food designation authorizes the use
of our DHA-S as an ingredient in certain foods
such as certain dairy products, including
cheese and yogurt (but not milk-based drinks), spreads and dressings,
breakfast cereals, food supplements and medical
foods in the European Community. This
authorization met the requirements of one of
the milestones under the OmegaTech merger
agreement.

In August 2003, we submitted a Generally
Recognized as Safe (GRAS) notification with
the U.S. Food and Drug Administration (FDA)
relating to our DHA-S oil for use in food and
beverage applications. Although our oils can
be sold for these applications now, GRAS
status should increase customer acceptance in
the food and beverage market. We expect to
receive a response from the FDA in fiscal
2004.

In September 2003, we purchased certain
assets and assumed certain liabilities of
FermPro Manufacturing, LP (FermPro), which
operated a fermentation facility located in
Kingstree, South Carolina. FermPro provides
contract fermentation services and has an
experienced workforce of over 100 personnel on
a site of over 500 acres with extensive
fermentation, recovery, laboratory and
warehousing capabilities. FermPro has produced
a limited amount of DHA for Martek in the last
year. The addition of the FermPro facility and
workforce will enable us to expand the
Companys production capabilities using the
existing facility, coupled with the extensive
construction build-out and employee build-up
that are currently underway.

Prior to fiscal 2003, we incurred losses
in each year since our inception. For the year
ended October 31, 2003 we recognized
approximately $16.0 million in net income and
at October 31, 2003, our accumulated deficit
was approximately $111.6 million. Although we
anticipate significant continued growth in
sales of our nutritional oils, and we achieved
an operating profit in 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 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,                                                                                  
|
| |  |  | the ability to produce adequate levels of our nutritional
oils by us and our third-party manufacturers,                         
|
| |  |  | the timing of the construction at our new Kingstree facility,                                                                   
|
| |  |  | 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.

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.

CRITICAL ACCOUNTING POLICIES AND
THE USE OF ESTIMATES

The preparation of our consolidated financial
statements in conformity with accounting
principles generally accepted in the U.S.
requires management to make estimates and
assumptions that affect the amounts reported
in our consolidated financial statements and
accompanying notes. On an on-going 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 believe that the
following significant accounting policies and
assumptions may involve a higher degree of
judgment and complexity than others.

Allocation of FermPro Purchase
Price On
September 5, 2003, we completed the
transaction to purchase certain assets and
assume certain liabilities of FermPro, for
cash and Martek stock. In addition, we also
assumed a promissory note as part of the
purchase. As part of the preliminary purchase
price allocation, we contracted with a third
party to determine the fair value of the
assets. In addition, we used a discounted cash
flow analysis to determine the relative fair
value of any identifiable intangible assets
related to FermPros existing contracts and
product lines. However, no material intangible
assets were identified. Such a valuation
requires significant estimates and
assumptions, including, but not limited to,
estimating future cash flows from contracts
and products and developing

8



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##### 



appropriate discount rates. The excess of the
purchase price over the fair value of the net
assets was allocated to goodwill. We believe
the assumptions made to assign fair values to
the assets acquired and liabilities assumed to
be reasonable, however the assumptions used to
conduct these valuations may be incomplete or
inaccurate, and unanticipated events and
circumstances may occur. Additionally,
estimates for the purchase price allocation
may change as subsequent information becomes
available.

Allocation of OmegaTech Purchase
Price On
April 25, 2002, we completed the acquisition of
OmegaTech in exchange for Martek stock. As part
of the purchase price allocation, we engaged a
third party to identify and value all
intangible assets included in the merger. Such
a valuation requires significant estimates and
assumptions including, but not limited to,
estimating future cash flows from product sales
resulting from completed products and
in-process projects, and developing appropriate
discount rates for each. The excess of the
purchase price over the fair value of tangible
and identifiable intangible net assets was
allocated to goodwill. The preliminary
valuation was based on facts and circumstances
available at the time of the acquisition and we
subsequently adjusted the value of these assets
within one year of the acquisition date, once
information that we were aware of at the time
of the acquisition was finalized. We believe
the assumptions made to assign fair values to
the assets acquired and liabilities assumed to
be reasonable, however these assumptions may be
incomplete or inaccurate, and unanticipated
events and circumstances may occur. As a result
of our identification and valuation process, we
allocated approximately $15.8 million of the
purchase price to in-process research and
development projects. This allocation
represented the fair value based on
risk-adjusted cash flows pertaining to the
incomplete research and development related
primarily to two projects. At the date
of acquisition, the development of these
projects had not yet reached technological
feasibility and the research and development in
process had no alternative future uses.
Accordingly, the amount allocated to acquired
in-process research and development was charged
to expense as of the date of the acquisition.

The merger agreement also provided for
additional stock consideration if certain
milestones were met. In June 2003, one of the
milestones outlined in the purchase agreement
was achieved and, accordingly, additional stock
consideration was paid. This additional
consideration was recorded as goodwill.

Impairment of Goodwill In accordance with
SFAS No. 142, Goodwill and Other Intangible
Assets, goodwill is tested for impairment on
an annual basis and between annual tests in
certain circumstances, and written down when
impaired. We compare the estimated fair value
of the Company to the carrying value as of our
annual testing date of August 1, to determine
if any impairment exists. Since the estimated
fair value of the Company significantly
exceeded the carrying value as of August 1,
2003, it was determined that no impairment
existed.

Impairment of Long-Lived
Assets We review 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 are done at the lowest
possible level for which there are identifiable
assets. If such assets are considered to be
impaired, the impairment to be recognized is
measured by the amount by which the carrying
amount of assets exceed the fair value of the
assets. Assets to be disposed of are reported
at the lower of the carrying amount or fair
value less costs to sell. To date, we have not
incurred any impairment losses. Impairments of
other intangible assets are determined in
accordance with SFAS No. 144, Accounting for
the Impairment or Disposal of Long-Lived
Assets.

Costs of ARA Oil
Production We contract
with a third party in Europe, DSM Food
Specialties B.V. (DSM), to produce our ARA
oil. Pricing is based on a cost-plus
arrangement and is stated in U.S. dollars.
Prices are set at an estimated production cost
based on forecasted production volumes, and at
a forecasted currency conversion rate, and are
adjusted periodically for variances to actual
cost. Any portion of the cost adjustment
applicable to the product in inventory is
first allocated to the carrying value of
inventory with the remainder impacting cost of
sales.

Restructuring Charge We recorded a charge
of approximately $1.3 million in the third
quarter of 2002 relating to the restructuring
of our food and beverage sales efforts. The
charge consisted of severance payments to
employees and consultants, as well as an
accrual for idle space in our Boulder facility
and legal and other fees associated with
compiling and implementing the restructuring
plan. Although we believe that the estimates
and underlying assumptions used in calculating
this charge are accurate, they are subject to
fluctuation as the final costs associated with
the restructuring plan are incurred.

Revenue Recognition We recognize 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 product is shipped.
Revenue from product licenses is deferred and
recognized on a straight-line basis over the
term of the agreement. At October 31, 2003, the
Company had approximately $2.8 million in
short-term and $9.0 million in long-term
unearned revenue relating to third-party
license agreements and prepayments

9



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##### 



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

on product purchases.

Contract manufacturing revenue is
recognized when goods are shipped to customers
and all other conditions for revenue
recognition are met. Revenues on cost
reimbursement and fixed price contracts are
recognized on the percentage of completion
method of accounting as costs are incurred.
Revenue recognized is not subject to
repayment. Cash received that is related to
future performance under such contracts is
deferred and recognized as revenue when
earned.

MANAGEMENT OUTLOOK

We believe that the outlook for future revenue
growth remains positive, although quarterly
results may show fluctuations. Specifically,
we believe that for fiscal 2004 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
countries. To date, seven of our infant
formula licensees have obtained the regulatory
approval, where required, to sell term infant
formula products containing our oils in over
30 countries and pre-term infant formula
products containing our oils in over 60
countries around the world. Supplemented term
infant formulas manufactured by four of our
licensees are currently being marketed in the
United States and we expect these sales to
increase in fiscal 2004.

In fiscal 2003,
over 97% of our revenues related to the sales
of our oils for use in infant formula
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.

PRODUCTION

The demand for our nutritional oils for use in
infant formula products significantly exceeded
our customers initial forecasts in fiscal
2003, resulting in customer orders in excess of
our planned production. Although we produced
significantly more nutritional oils than our
customers initial projections, accelerated
market demand has caused a
production shortfall. Earlier in the year we
requested from our customers that they provide
us with longer lead-times in order to fill
their orders. Even with the longer lead-times
and increased production each quarter during
the year, we have begun to see a backlog of
orders for our nutritional oils.

Including the expansion at our Winchester
facility, which was completed in 2003, we
currently have the production capacity
equivalent to approximately $140- $150 million
in annual sales of our nutritional oils. We are
now in the process of an extensive expansion at
the Kingstree facility. The expanded Kingstree
facility should begin initial production in
mid-fiscal 2004 and should more than triple our production capacity
in phases over the next 12-18 months. 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.

Our ARA
oil is currently produced by DSM at its plant
in Capua, Italy. DSM recently completed an
expansion of these facilities and is in the
process of adding U.S. production by
converting existing facilities in Belvidere, NJ
to the production of ARA. We expect to begin
receiving ARA from the Belvidere facility in
the second quarter of 2004; however, as a
third-party manufacturer, we have limited
control over the progress of DSMs initial
production. ARA is further processed at our
plant in Winchester and we plan to begin
similar ARA processing at our Kingstree
facility in mid-fiscal 2004.

Our cost of
ARA from DSM is experiencing upward pressure
due to the decline of the U.S. dollar against
the euro. To date, cost savings from production
efficiencies at DSMs Capua plant have largely
offset the impact of the declining dollar/euro
exchange rate. We expect continued decreases in
the cost of ARA production from DSM; however, a
portion, or all, of the production savings may
be offset by further weakness in the U.S.
dollar against the euro. Our exposure to
currency fluctuations should decrease once
DSM begins ARA production in the U.S. as
planned in the second quarter of 2004.

The production of ARA by DSM was impacted by a
nationwide power failure in Italy in late
September 2003. The Italian power outage is
expected to result in a production loss of ARA
that will cause a reduction of approximately
$3-5 million in revenue to Martek during the
first quarter of fiscal year 2004. In addition
to the impact on revenue, the production
inefficiencies incurred as a result of the
restart of production by DSM in Capua led to
increased costs of ARA in the first quarter of
fiscal year 2004.

When combined with DSMs expanded
production, we plan to have production capacity
equivalent to approximately $300 million in
annualized sales of our nutritional oils by the
end of 2004 and equivalent to approximately
$500 million in annualized sales of our
nutritional oils by mid-2005 If the production
expansion in Kingstree does not proceed as
planned, if DSM is not able to start production
in the U.S. as planned, or if market demand
subsides due to our inability to meet demand
for our products, our financial results may be
negatively impacted.

Our DHA-S oil, which is currently used in the adult supplements and
animal feed markets, is currently produced by
third-party contract manufacturers including
C.P. Kelco U.S. Inc. (CP Kelco). We have a
three-year purchase commitment with CP Kelco
that was originally set to expire on December
31, 2004 and totals approximately $2.4 million
per year. In October 2003, we signed an
amendment to continue the contract and
commitment for an additional six months,
through June 2005, with options to extend
further.

On March 12, 2003, an explosion occurred
at a public waste-water treatment works in
Winchester, KY, 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

10



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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 may have been other
contributing factors, including the presence of
other flammable substances that were not
discharged from our plant. Production at our
facility has not been negatively impacted by
these events. We have entered into discussions
with the Winchester Municipal Utilities and its
insurer as to our financial responsibility, if
any, for property damage. We have requested,
and continue to await, the receipt of further
information from the utility and its insurer
regarding the details of the incident. We
accrued $400,000 in the quarter ended April 30,
2003 to account for an estimate of costs that
we may incur as a result of this incident.
During fiscal 2003, we incurred approximately
$146,000 in legal fees related to the incident,
which were applied to the liability. In
addition to any potential liabilities for
property damage, this incident resulted in the
delay of the issuance of certain permits
required for the expansion of our existing
Winchester plant and was a consideration in our
decision to begin immediate expansion at our
Kingstree plant. While we cannot be certain of
its ultimate outcome, we believe that this
event will not have a material adverse impact
on our production, financial condition or
results of operations.

ACQUISITIONS AND DISPOSITIONS

On September 5, 2003, we purchased, through a
wholly-owned subsidiary, certain assets and
assumed certain liabilities of FermPro, which
operated a fermentation facility located in
Kingstree, SC. The addition of the FermPro
facility will add to the Companys production
capabilities as well as establish a second
manufacturing facility with redundant
capabilities. The purchase price of the assets
acquired and liabilities assumed included a
payment of approximately $12.0 million,
comprised of $5.4 million in cash, 124,788
shares of the Companys common stock valued at
approximately $5.6 million, and approximately
$1.0 million in acquisition-related fees and
expenses. In addition, a $10 million note was assumed as part of the transaction.

The acquisition has been accounted for as a
purchase in accordance with SFAS No. 141 and,
accordingly, the results of operations of
FermPro have been included in the accompanying
consolidated statements of operations from the
date of the acquisition. In accordance with
SFAS No. 141, the purchase price has been
allocated to the assumed assets and liabilities
of FermPro based on their relative fair value.

On April 25, 2002, we completed our
acquisition of OmegaTech for approximately
$54.1 million. Approximately $49.3 million of
the purchase price was related to the value of
1,765,728 shares of our common stock ($1.5
million of which related to OmegaTech
transaction costs paid by us), approximately
$2.1 million was for our acquisition-related
fees and expenses, and approximately $2.7
million was related to the fair value of
154,589 vested OmegaTech stock options that
were assumed as part of the transaction. The
merger agreement also provides for additional
stock consideration of up to $40 million,
subject to certain pricing adjustments, if
certain milestones are 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 approvals in the U.S. and Europe.
One of the regulatory approval milestones
related to the granting of Novel Foods approval
in Europe for the OmegaTech DHA-S oil. In June
2003, the Commission of the European Community
granted approval of the use of this oil in
certain foods in Europe, meeting the conditions
of this regulatory milestone. Accordingly,
approximately 358,566 shares of Martek common
stock, with a fair market value of
approximately $14.2 million, were issued during
the third quarter of fiscal 2003. The payment
of this additional consideration was recorded
as goodwill.

As of October 31, 2003 the
second regulatory related milestone has not
been achieved. In addition, the first financial
milestone related to sales and gross profit
margin for the eighteen-month period ended
October 31, 2003, has also not been achieved.
The representative of the former OmegaTech
stockholders has advised us that he believes
that the common stock issuable with respect to
these two milestones should be issued. We
disagree with that conclusion and are in
discussions with the stockholders
representative regarding our differences of
opinion. If these differences of opinion cannot
be resolved as a result of these discussions,
it is likely that the dispute-resolution
procedures contractually provided for will be
utilized. The total Martek common stock,
relating to the remaining three milestones,
that may be issued is approximately 775,000
shares based on the Companys closing stock
price on October 31, 2003 of $48.81, but could
potentially increase up to a maximum of
approximately 1.9 million shares depending on
the average market price of the Companys stock
on the dates that the milestones are achieved.
(The agreement with the former OmegaTech
stockholders includes a share adjustment
feature, based upon the Companys stock price
as of the milestone date that either increases
or decreases the number of shares to be issued
upon achievement of milestones.) Any additional
consideration paid related to these milestones
will be recorded as goodwill.

The acquisition has been accounted for as
a purchase in accordance with SFAS No. 141 and,
accordingly, the results of operations of
OmegaTech have been included in the
accompanying consolidated statements of
operations from the date of the acquisition. In
accordance with SFAS No. 141, the purchase
price has been allocated to the assets and
liabilities of OmegaTech based on their
relative fair value.

As part of the
purchase price allocation, we allocated
approximately $15.8 million of the purchase
price to in-process research and development
projects. This allocation represented the
estimated fair value based on risk-adjusted
cash flows pertaining to the incomplete
research and development related primarily to
two projects. At the date of acquisition, the
development of these projects had not yet
reached technological feasibility and the
research and development in progress had no
alternative future uses. Accordingly, the
acquired in-process research and development
was charged to expense as of the date of the
merger.

On November 1, 2001 we sold the
assets, consisting primarily of inventory and
technology surrounding our former stable

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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

isotope product line to Spectra Gases, Inc., a
privately held New Jersey company. As part of
the agreement, we received approximately
$800,000 for the assets of the stable isotope
business. We also retained an ongoing royalty
from future reagent sales for five years up to
a maximum of $500,000, and also received a 9%
equity position and royalty interest in a new
company that was formed to pursue the high-end
protein labeling technology. As of October 31,
2003 and October 31, 2002, the value of the
investment in the new company was fully
reserved. The Company recognized approximately
$140,000 and $106,000 during 2003 and 2002, respectively, in
royalty revenue in connection with this
arrangement.

RESULTS OF OPERATIONS

RevenuesNutritional product sales
increased by $66.0 million or 146% in 2003 as
compared to 2002, primarily due to increased
sales of our oils to our infant formula
licensees. Over 55% of our 2003 revenue was
generated by sales of DHA and ARA to Mead
Johnson and 33% was generated by sales of DHA
and ARA to Wyeth, Abbott and Nestle combined.
Nestle began licensing our product in late
2003. All four of these companies are
currently manufacturing infant formulas
supplemented with our oils for sale in the
U.S., and Mead Johnson, Abbott, Wyeth and
Nestle are collectively marketing supplemented
term infant formula in over 30 countries
around the world. Although we are not given
precise information as to the countries in
which infant formula containing our oils is
ultimately sold, we estimate that
approximately 50-60% of our sales to infant
formula licensees for the year ended October
31, 2003 relates 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 October 31, 2003, formula supplemented
with Marteks oils had gained greater than 40%
penetration into the U.S. infant formula
market. We anticipate sales of nutritional
products will continue to grow as infant
formulas containing our oils are introduced by
new licensees and by current licensees in
additional countries. We also anticipate that
sales of our nutritional oils will continue to
grow in countries where our oils are currently
sold. Nutritional product sales increased by
$28.3 million, or 169% in 2002 as compared to
2001. Over 50% of our 2002 revenue was
generated by sales of DHA and ARA to Mead
Johnson and 30% was generated by sales of DHA
and ARA to Wyeth and Abbott. A large part of
this increase was due to the introduction of
infant formulas containing our oils in the
U.S. in 2002.

Sales of fluorescent detection products
increased $107,000 or 14% in 2003 as compared
to 2002 due to increased sales under a
distribution agreement with PerkinElmer Life
Sciences, Inc. (PerkinElmer). Fluorescent
detection products sales decreased $985,000 or
56% in 2002 as compared to 2001, primarily due
to the sale of our stable isotope product line
in November 2001 to Spectra Gases, Inc.

Contract manufacturing sales, totaling
approximately $2.4 million, relate to
fermentation work performed for various third
parties at the Kingstree, SC facility since the
September 5, 2003 acquisition date. The
contract manufacturing sales are expected
to decrease in the future as this business is
phased out over the next few years to allow
for increased fermentation capacity for DHA
and ARA production.

Other revenue, which consists primarily of
revenues from third-party license agreements,
research and development contracts and grants
increased $105,000 or 69% in 2003 with the
addition of the Nestle licensing agreement. In
fiscal 2003, we recorded approximately $117,000
in license fee revenue related to the Nestle
licensing agreement, which is amortized over
the life of the agreement. Other revenue
decreased $97,000 or 39% in 2002 as compared to
2001, as several development grants were
completed in 2001.

As a result of the
above, total revenues increased by $68.7
million or 149% in 2003 as compared to 2002 and
increased $27.2 million or 145% in 2002 as
compared to 2001.

Cost of Product SalesOur cost of product
sales as a percentage of product sales
continued to improve during 2003 compared to
2002. This was due primarily to lower ARA costs
from DSM, our third-party supplier of ARA, despite increases in the
fourth quarter of the year. Our gross profit
margins are most significantly impacted by the
cost of ARA oil (as compared to DHA oil), which
represents approximately two-thirds of all
sales to our infant formula licensees.
Specifically, our cost of product sales
decreased to 59% of revenues from product sales
for 2003, down from 65% in 2002 primarily due
to efficiencies realized from increased volumes
of sales, partially offset by continued
decreases in the exchange ratio between the
euro and the U.S. dollar. Our cost of product
sales also improved during 2002 compared to
2001 due to lower costs from DSM. ARA costs
decreased in 2002 as a result of the complete
amortization of the start-up costs of DSM
(previously included in the cost of ARA) and
increased purchase volumes compared to 2001.
Cost of contract manufacturing sales relates
specifically to the fermentation business with
third parties at our Kingstree facility.

Research and DevelopmentOur research and
development costs increased approximately
$570,000 or 5% in 2003 as compared to 2002.
This increase is primarily the result of the
additional resources directed toward improving
the quality and stability of our products, as
well as research related to increasing our
production yields and reducing waste at our
manufacturing facilities. Research and
development costs decreased $1.1 million or 8%
in 2002 as compared to 2001. Approximately
$500,000 of this decrease relates to the sale
of the stable isotope product line in November
2001 to Spectra-Gases.

Approximately 65% of the $12.2 million in
research and development expenditures incurred
in 2003 related to research conducted in our
Columbia, MD laboratory and was directed
toward improving the quality, sensory
properties and stability of our nutritional
oils, optimizing production characteristics of
microalgal strains, investigating the clinical
health benefits of DHA and ARA fatty acids,
and exploring the biochemical pathways
utilized by microalgae to produce DHA.
Additional research and development expenses
incurred at our Winchester, KY facility were
directed toward increasing our production

12



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yields, reducing waste and continuing to
improve the quality of our oils. Research
conducted at our laboratory in Boulder, CO is
focused on developing feasible approaches to
the expression of nutritional fatty acids,
especially DHA, in plant oilseeds,
investigating the feasibility of utilizing our
proprietary genes to produce other bioactive
compounds with application in the healthcare
fields and developing new ingredient forms and
applications technology for DHA-enriched food
products.

Selling, General and AdministrativeOur
selling, general and administrative costs
increased by $4.9 million or 39% in 2003 as
compared to 2002. The increase is primarily due
to the hiring of additional personnel,
increases in legal fees and insurance, and the
addition of the Companys new Kingstree
facility in September 2003. Our selling,
general and administrative costs increased by
$4.4 million or 55% in 2002 as compared to
2001. $2.9 million of the increase relates to
operating costs associated with approximately
six months of operations at Martek Boulder. The
remainder of the increase primarily relates to
the additional number of employees and other
overhead costs related to our overall corporate
growth. Management expects these costs to
increase in 2004 as the Companys
infrastructure grows in line with our continued
revenue growth.

RestructuringOn July 29, 2002, we
announced a restructuring of our food and
beverage sales and marketing efforts. As part
of this restructuring, eight employees and
five consultants associated with
food and beverage sales were terminated. A
one-time operating charge of approximately
$1.3 million was recorded in the third quarter
of fiscal year 2002 to account for severance
and other costs associated with this
restructuring. Employee separation benefits of
approximately $766,000 under the restructuring
plan include severance, medical and other
benefits. Other costs of the restructuring,
totaling approximately $500,000, include
consultant termination costs, idle office
space and professional fees. During the first
quarter of fiscal 2003, the Company reduced
the liability for employee separation benefits
related to severance costs due to changes in
previous estimates. Additionally, the Company
increased the restructuring liability related
to other charges such as consultant
termination fees and costs related to idle
space. The net result of the related
adjustments to the restructuring liability was
a reversal of $250,000 in the fiscal quarter
ended January 31, 2003. As of October 31,
2003, approximately $276,000 has been paid in
employee separation benefits and approximately
$361,000 has been paid in other costs. The
remaining liability at October 31, 2003
relates primarily to certain contractual
liabilities as of the restructuring date.

Other Operating ExpensesWe incurred other
operating expenses of $1.9 million in 2003.
These expenditures relate in part to the
start-up costs surrounding the expansion in
Winchester, KY, which include costs related to
unsuccessful fermentation runs in connection
with the scale-up and validation of new
equipment into our production process. In
addition, we incurred expenditures related to
start-up costs of additional ARA capacity at
DSMs Capua, Italy facility under the terms of
our contract with DSM. We incurred other
operating expenses of $406,000 in 2002
associated with evaluating and obtaining
additional capacity for the production of our
DHA and ARA oils, including costs associated
with testing and validating the fermentation
technology at FermPro.

Other Income, NetOur other income, net,
decreased by $42,000 in 2003 as compared to
2002. Interest income increased $110,000, due
primarily to the investment of the April 2003
stock offering proceeds, offset in part by
decreasing interest rates. This was partially
offset by interest expense, which increased
$75,000 due to the assumption of a $10 million
note in September 2003 related to the FermPro
acquisition. Our other income, net decreased
by $309,000 in 2002 as compared to 2001.
Interest income decreased $516,000 as
short-term interest rates decreased in 2002.
This was partially offset by other income,
which increased $207,000 related to rent paid
by the former stable isotope group that was
sold in November 2001, but continues to occupy
space in our facilities.

Net Income (Loss)As a result of the
foregoing, net income was $16.0 million as
compared to our net loss of $24.2 million in
2002. $20.3 million of the net loss in 2002
was related to Martek Boulder, including the
$15.8 charge for in-process research and
development and restructuring. Our net loss
increased approximately $10.5 million in 2002
from a net loss of $13.7 million in 2001.

Deferred Income TaxesDeferred income taxes
reflect the net tax effects of temporary
differences between the carrying amount of
assets and liabilities for financial reporting
purposes and the amounts used for income tax
purposes. We recognized a valuation allowance
to the full extent of our deferred tax assets
since the likelihood of realization of the
benefit cannot be determined. When and if the
likelihood of realization of the benefit
becomes probable, the Company will reverse a
portion of the valuation allowance and
recognize a gain. At October 31, 2003, we had
net operating loss carryforwards for federal
income tax purposes of approximately $169.1
million, which will expire, if unused, in the
year 2004 through the year 2023. A tax benefit
of approximately $28.1 million of net operating
losses related to stock options will be
credited to equity when the benefit is realized
through utilization of the net operating loss
carryforwards.

RECENTLY ISSUEDACCOUNTING
PRONOUNCEMENTS

In November 2002, the Emerging Issues Task
Force (EITF) reached a consensus on Issue No.
00-21, Revenue Arrangements with Multiple
Deliverables. EITF No. 00-21 provides
guidance on how to account for arrangements
that involve the delivery or performance of
multiple products, services and/or rights to
use assets. The provisions of EITF No. 00-21
apply to revenue arrangements entered into in
fiscal periods beginning after June 15, 2003.
The adoption of EITF No. 00-21 had no material
impact on the Companys financial statements.

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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

In April 2003, the Financial Accounting Standards Board (FASB) issued
SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging
Activities. SFAS No. 149 amends and clarifies accounting for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities under SFAS No. 133. The statement requires
that contracts with comparable characteristics be accounted for similarly and
clarifies when a derivative contains a financing component that warrants
special reporting treatment in the statement of cash flows. SFAS No. 149 is
effective for contracts entered into or modified after June 30, 2003, except
in certain circumstances, and for hedging relationships designated after June
30, 2003. The adoption of SFAS No. 149 had no material impact on the Companys
financial statements.

In May 2003, the FASB issued SFAS No. 150, Accounting
for Certain Financial Instruments with Characteristics of both Liabilities and
Equity. This statement establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both
liabilities and equity in its balance sheets. It requires that an issuer
classify a financial instrument that is within its scope as a liability (or an
asset in some circumstances) because that financial instrument embodies an
obligation of the issuer. This statement is effective for financial instruments
entered into or modified after May 31, 2003, and is otherwise effective at the
beginning of the first interim period beginning after June 15, 2003, except
for mandatory redeemable financial instruments of nonpublic entities. The FASB
has deferred implementation of SFAS No. 150 indefinitely for certain
noncontrolling interests, the provisions of which are currently not applicable
to the Company. The adoption of SFAS No. 150 had no material impact on the
Companys financial statements.

COLLABORATIVE AND LICENSING AGREEMENTS

We have entered into licensing agreements with fourteen infant formula
manufacturers, including Mead Johnson & Company (a subsidiary of Bristol-Myers
Squibb Company), Wyeth, Abbott Laboratories, Nestle, Nutricia, Novartis,
Maabarot, Heinz-Wattie s, Laboratorios Ordesa and five companies whose
identities we have agreed not to disclose at this time. Collectively, these
companies represent more than 70% of the estimated $8.5 to $9.5 billion
worldwide wholesale market for infant formula, and 100% of the estimated $3.0 to
$3.5 billion U.S. wholesale market for infant formula. Under all of these
agreements, we received up-front license fees and will receive either a) a flat
rate price per kilogram upon the sale of our oils to our licensees, or b) a
transfer price on sales of our oils to our licensees plus ongoing royalties
based on our licensees sales of infant formula products containing our oils.
The most significant agreements have remaining terms ranging from approximately
16 to 25 years, contain no future funding commitments on our part or that of our
licensees, and may be terminated by our licensees upon proper notification to
us pursuant to the terms of each agreement. We recognized total product sales
relating to our license agreements of approximately $107.1 million in 2003,
$40.8 million in 2002 and $16.0 million in 2001.

During 2003 we signed five new licensing agreements, including a
license agreement with Nestle, entered into in June 2003. We received total
license fees and product prepayments of $5.5 million related to these
agreements, and recognized a receivable for an additional $3 million in license
fees due in January 2004. We recorded the non-refundable license fee payments as
unearned revenue and are recognizing them as revenue on a straight-line basis
over the 25-year term of the agreements. We recognize the non-refundable
prepayment as revenue as products are shipped, in accordance with the terms of
the agreements.

LIQUIDITY AND CAPITAL RESOURCES

We have financed our operations primarily from the following sources:



| |  |  | proceeds from the sale of equity securities,                      
| | - |  | ------------------------------------------------------------------
|
| |  |  | product sales and receipt of license fees,                        
|
| |  |  | cash received from the exercise of stock options and warrants, and
|
| |  |  | debt financing.                                                   

Since our inception, we have raised approximately $283 million from
public and private sales of our equity securities, as well as from option and
warrant exercises. In fiscal 2003, we achieved our first fiscal year of
positive net income of approximately $16.0 million.

Through October 31, 2003, we have incurred an accumulated deficit of
$111.6 million. Our balance of cash and cash equivalents at October 31, 2003 was
$29.9 million. In addition, at October 31, 2003, we had $67.0 million in
short-term investments and marketable securities. This increase is primarily
attributable to approximately $83.2 million raised in a public offering of our
common stock in April 2003. Operating activities provided approximately $24.6
million in cash and the exercise of options and warrants provided approximately
$19.0 million in cash during the year. These cash inflows were partially
offset by capital expenditures of approximately $45.2 million during fiscal
2003 related to completion of our Winchester, KY expansion and the start of the
expansion at our Kingstree, SC facility.

The expansion of our production facility in Kingstree, SC and to a
lesser degree, production improvements at our facility in Winchester, KY, will
have a material effect upon our liquidity and capital resources in fiscal 2004.
We expect to spend approximately $120-140 million over the next 12 to 18
months in plant and equipment to increase output at these facilities.

The following table sets forth our future minimum payments under
contractual obligations at October 31, 2003:

|                                             |  |       |        |        |  |           |       |       |  |       |       |         |  |   |       |  |  |   |     | 
|-------------------------------------------- |  | ----- | ------ | ------ |  | --------- | ----- | ----- |  | ----- | ----- | ------- |  | - | ----- |  |  | - | --- | 
|                                             |  |       |        |        |  | Less than |       | 1-3   |  | 4-5   |       | After 5
|In thousands                                 |  | Total |        | 1 year |  | years     |       | years |  | years
|                                             |  |       |        |        |  |           |       |       |  |      
|Long-term debt                               |  | $     | 10,406 |        |  | $         | 427   |       |  | $     | 1,536 |         |  | $ | 8,111 |  |  | $ | 332 | 
|Capital lease obligations                    |  |       | 100    |        |  |           | 65    |       |  |       | 35    |         |  |   |      |  |  |   |    | 
|Operating leases                             |  |       | 987    |        |  |           | 791   |       |  |       | 196   |         |  |   |      |  |  |   |    | 
|Unconditional inventory
purchase obligations |  |       | 4,286  |        |  |           | 2,311 |       |  |       | 1,975 |         |  |   |      |  |  |   |    | 
|Settlement of royalty
agreement              |  |       | 2,300  |        |  |           | 2,300 |       |  |       |      |         |  |   |      |  |  |   |    | 
|                                             |  |       |        |        |  |           |       |       |  |       |       |         |  |   |       |  |  |   |     | 
|Total contractual cash
obligations           |  | $     | 18,079 |        |  | $         | 5,894 |       |  | $     | 3,742 |         |  | $ | 8,111 |  |  | $ | 332 | 

14



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##### 



In December 2002, the Company signed a promissory note as part of a settlement
of a royalty agreement that had been assumed in the purchase of OmegaTech. The
Company paid $500,000 and signed a promissory note for approximately $3.3
million in exchange for the discharge of all future royalty agreement
obligations, which totaled more than $7 million. The first $1 million payment
under the note was paid in August 2003, and the remainder of $2.3 million was
recorded as a note payable at October 31, 2003 and subsequently paid in full in
December 2003.

As part of the acquisition of FermPro, the Company assumed a $10 million note.
The note has a stated interest rate of 5% and an amended maturity date of
December 31, 2008. Principal is amortized over a 20-year period, with the
balance due at maturity date. Payments through December 31, 2003 were
comprised of interest only. In addition, the Company assumed a long-term note of
approximately $400,000 due in 2023 with a 7% stated interest rate.

In January 2004, we entered into a three-year $85 million secured revolving line
of credit with a group of banks, replacing a $10 million line of credit, which
had no borrowings under it. The new revolving line of credit is collateralized
by accounts receivable and inventory. It contains restrictions on future debt and the further encumbrance of assets and contains several financial covenants. We do not
believe that these covenants restrict our ability to carry out our current
business plan.

We currently have approximately $11.5 million remaining under a
shelf registration statement filed in April 2003 with the SEC and plan to sell
the remaining common stock under this registration statement in the second
quarter of 2004.

We believe that the new line of credit, when combined with our
cash and short-term investments of $97.0 million on-hand at October 31, 2003 and
anticipated operating cash flows will provide us with adequate capital to meet
our obligations for at least the next 12 to 18 months. If we determine that
additional production capacity is needed to meet anticipated demand beyond 2005,
we may need to raise more capital in the form of equity securities or debt, or a
combination of equity and debt.

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 cost of
acquiring additional and/or operating 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 these financing alternatives will be available
to us on terms that would be acceptable, if at all.

OFF-BALANCE SHEET ARRANGEMENTS

We do not engage in any 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.

15



---



##### 



MARTEK BIOSCIENCES CORPORATION
CONSOLIDATED BALANCE SHEETS

|                                              |                                                                                                                                                                 |      |             |        |  |   |          |        | 
|--------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---- | ----------- | ------ |  | - | -------- | ------ | 
|                                              |                                                                                                                                                                 |      | October 31,
|                                              |                                                                                                                                                                 |      |            
|In thousands, except share and per share data |                                                                                                                                                                 | 2003 |             | 2002  
|                                              |                                                                                                                                                                 |      |             |       
|Assets                                        |                                                                                                                                                                 |      |             |        |  |   |          |       
|Current
assets                                |                                                                                                                                                                 |      |             |        |  |   |          |       
|                                              | Cash and cash equivalents                                                                                                                                       |      | $           | 29,924 |  |   | $        | 20,419 | 
|                                              | Short-term investments and marketable securities                                                                                                                |      |             | 67,047 |  |   |          | 2,000  | 
|                                              | Accounts receivable, net                                                                                                                                        |      |             | 20,164 |  |   |          | 9,597  | 
|                                              | Inventories, net                                                                                                                                                |      |             | 14,543 |  |   |          | 9,718  | 
|                                              | Other current assets                                                                                                                                            |      |             | 6,666  |  |   |          | 1,312  | 
|                                              |                                                                                                                                                                 |      |             |        |  |   |          |        | 
|Total current assets                          |                                                                                                                                                                 |      | 138,344     |        |  |   | 43,046   |       
|Property, plant and equipment, net            |                                                                                                                                                                 |      | 88,314      |        |  |   | 36,506   |       
|Goodwill                                      |                                                                                                                                                                 |      | 50,274      |        |  |   | 25,568   |       
|Other intangible assets, net                  |                                                                                                                                                                 |      | 18,378      |        |  |   | 18,497   |       
|Other assets                                  |                                                                                                                                                                 |      | 213         |        |  |   | 695      |       
|                                              |                                                                                                                                                                 |      |             |        |  |   |          |        | 
|Total assets                                  |                                                                                                                                                                 | $    | 295,523     |        |  | $ | 124,312  |       
|                                              |                                                                                                                                                                 |      |             |        |  |   |          |        | 
|Liabilities and stockholders equity          |                                                                                                                                                                 |      |             |        |  |   |          |       
|Current
liabilities                           |                                                                                                                                                                 |      |             |        |  |   |          |       
|                                              | Accounts payable                                                                                                                                                |      | $           | 14,988 |  |   | $        | 3,854  | 
|                                              | Accrued liabilities                                                                                                                                             |      |             | 12,020 |  |   |          | 6,687  | 
|                                              | Notes payable and other current obligations                                                                                                                     |      |             | 2,277  |  |   |          | 111    | 
|                                              | Current portion of unearned revenue                                                                                                                             |      |             | 2,841  |  |   |          | 1,937  | 
|                                              |                                                                                                                                                                 |      |             |        |  |   |          |        | 
|Total current liabilities                     |                                                                                                                                                                 |      | 32,126      |        |  |   | 12,589   |       
|Notes payable and other long-term obligations |                                                                                                                                                                 |      | 10,441      |        |  |   |         |       
|Long-term portion of unearned revenue         |                                                                                                                                                                 |      | 8,992       |        |  |   | 2,246    |       
|Commitments                                   |                                                                                                                                                                 |      |            |        |  |   | 3,500    |       
|Stockholders
equity                          |                                                                                                                                                                 |      |             |        |  |   |          |       
|                                              | Preferred stock, $.01 par value, 4,700,000 shares authorized;
none issued or outstanding                                                                        |      |             |       |  |   |          |       | 
|                                              | Series A junior participating preferred stock, $.01 par value;
300,000 shares authorized; none issued or outstanding                                            |      |             |       |  |   |          |       | 
|                                              | Common stock, $.10 par value; 100,000,000 shares authorized;
28,041,323 and 23,331,091 shares issued and outstanding at
October 31, 2003 and 2002, respectively |      |             | 2,804  |  |   |          | 2,333  | 
|Additional paid-in capital                    |                                                                                                                                                                 |      | 352,728     |        |  |   | 231,224  |       
|Deferred compensation                         |                                                                                                                                                                 |      |            |        |  |   | (20      | )     
|Accumulated deficit                           |                                                                                                                                                                 |      | (111,568    | )      |  |   | (127,560 | )     
|                                              |                                                                                                                                                                 |      |             |        |  |   |          |        | 
|Total stockholders equity                    |                                                                                                                                                                 |      | 243,964     |        |  |   | 105,977  |       
|                                              |                                                                                                                                                                 |      |             |        |  |   |          |        | 
|Total liabilities and stockholders equity    |                                                                                                                                                                 | $    | 295,523     |        |  | $ | 124,312  |       
|                                              |                                                                                                                                                                 |      |             |        |  |   |          |        | 

See accompanying notes.

16



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##### 



MARTEK BIOSCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS

|                                                    |                                              |                                     |            |                        |         |      |            |        |        |   |            |        |        | 
|--------------------------------------------------- | -------------------------------------------- | ----------------------------------- | ---------- | ---------------------- | ------- | ---- | ---------- | ------ | ------ | - | ---------- | ------ | ------ | 
|                                                    |                                              |                                     |            | Year ended October 31,
|                                                    |                                              |                                     |            |                       
|In thousands, except share and per share data       |                                              | 2003                                |            | 2002                   |         | 2001
|                                                    |                                              |                                     |            |                        |         |     
|Revenues                                            |                                              |                                     |            |                        |         |      |            |        |        |   |            |       
|                                                    | Product sales:                               |                                     |            |                        |         |      |            |        |        |   |            |        |       
|                                                    |                                              | Nutritional product sales           |            | $                      | 111,145 |      |            | $      | 45,114 |   |            | $      | 16,801 | 
|                                                    |                                              | Fluorescent detection product sales |            |                        | 896     |      |            |        | 789    |   |            |        | 1,774  | 
|                                                    |                                              |                                     |            |                        |         |      |            |        |        |   |            |        |        | 
|                                                    | Total product sales                          |                                     |            | 112,041                |         |      |            | 45,903 |        |   |            | 18,575 |       
|                                                    | Contract manufacturing sales                 |                                     |            | 2,439                  |         |      |            |       |        |   |            |       |       
|                                                    | Other revenue                                |                                     |            | 257                    |         |      |            | 152    |        |   |            | 249    |       
|                                                    |                                              |                                     |            |                        |         |      |            |        |        |   |            |        |        | 
|Total revenues                                      |                                              |                                     | 114,737    |                        |         |      | 46,055     |        |        |   | 18,824     |       
|Costs and expenses                                  |                                              |                                     |            |                        |         |      |            |        |        |   |            |       
|                                                    | Cost of product sales                        |                                     |            | 66,347                 |         |      |            | 29,794 |        |   |            | 12,554 |       
|                                                    | Cost of contract manufacturing sales         |                                     |            | 2,192                  |         |      |            |       |        |   |            |       |       
|                                                    | Research and development                     |                                     |            | 12,218                 |         |      |            | 11,648 |        |   |            | 12,705 |       
|                                                    | Acquired in-process research and development |                                     |            |                       |         |      |            | 15,788 |        |   |            |       |       
|                                                    | Selling, general and administrative          |                                     |            | 17,211                 |         |      |            | 12,344 |        |   |            | 7,969  |       
|                                                    | Restructuring charge                         |                                     |            | (250                   | )       |      |            | 1,266  |        |   |            |       |       
|                                                    | Other operating expenses                     |                                     |            | 1,943                  |         |      |            | 406    |        |   |            | 565    |       
|                                                    |                                              |                                     |            |                        |         |      |            |        |        |   |            |        |        | 
|Total costs and expenses                            |                                              |                                     | 99,661     |                        |         |      | 71,246     |        |        |   | 33,793     |       
|                                                    |                                              |                                     |            |                        |         |      |            |        |        |   |            |        |        | 
|Income (loss) from operations                       |                                              |                                     | 15,076     |                        |         |      | (25,191    | )      |        |   | (14,969    | )     
|Other Income (expense), net                         |                                              |                                     |            |                        |         |      |            |        |        |   |            |       
|                                                    | Interest income                              |                                     |            | 717                    |         |      |            | 607    |        |   |            | 1,123  |       
|                                                    | Interest expense                             |                                     |            | (84                    | )       |      |            | (9     | )      |   |            | (9     | )     
|                                                    | Other income                                 |                                     |            | 283                    |         |      |            | 360    |        |   |            | 153    |       
|                                                    |                                              |                                     |            |                        |         |      |            |        |        |   |            |        |        | 
|Total other income, net                             |                                              |                                     | 916        |                        |         |      | 958        |        |        |   | 1,267      |       
|                                                    |                                              |                                     |            |                        |         |      |            |        |        |   |            |        |        | 
|Net income (loss)                                   |                                              | $                                   | 15,992     |                        |         | $    | (24,233    | )      |        | $ | (13,702    | )     
|                                                    |                                              |                                     |            |                        |         |      |            |        |        |   |            |        |        | 
|Net income (loss) per share, basic                  |                                              | $                                   | 0.63       |                        |         | $    | (1.10      | )      |        | $ | (0.73      | )     
|                                                    |                                              |                                     |            |                        |         |      |            |        |        |   |            |        |        | 
|Net income (loss) per share, diluted                |                                              | $                                   | 0.58       |                        |         | $    | (1.10      | )      |        | $ | (0.73      | )     
|                                                    |                                              |                                     |            |                        |         |      |            |        |        |   |            |        |        | 
|Weighted average common shares outstanding, basic   |                                              |                                     | 25,510,376 |                        |         |      | 21,982,117 |        |        |   | 18,863,924 |       
|                                                    |                                              |                                     |            |                        |         |      |            |        |        |   |            |        |        | 
|Weighted average common shares outstanding, diluted |                                              |                                     | 27,416,757 |                        |         |      | 21,982,117 |        |        |   | 18,863,924 |       
|                                                    |                                              |                                     |            |                        |         |      |            |        |        |   |            |        |        | 

See accompanying notes.

17



---



##### 



MARTEK BIOSCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

|                                |                                                                                   |                                       |                      |              |   |         |       |              |   |               |         |             |   |       |      |       |   |   |    |   |             |   |          |         |   |   |         |          |    |         |  
|------------------------------- | --------------------------------------------------------------------------------- | ------------------------------------- | -------------------- | ------------ | - | ------- | ----- | ------------ | - | ------------- | ------- | ----------- | - | ----- | ---- | ----- | - | - | -- | - | ----------- | - | -------- | ------- | - | - | ------- | -------- | -- | ------- | -
|                                |                                                                                   |                                       |                      |              |   |         |       |              |   |               |         |             |   |       |      |       |   |   |    |   | Accumulated |   |          |         |   |   |         |          |   
|                                |                                                                                   |                                       |                      |              |   |         |       |              |   | Additional    |         |             |   |       |      | Other |   |   |    |   |             |   |          |        
|                                |                                                                                   | Common Stock                          |                      | Common Stock |   | Paid-in |       | Deferred     |   | Comprehensive |         | Accumulated |   |       |      |      
|In thousands, except share data |                                                                                   | Shares                                |                      | Amount       |   | Capital |       | Compensation |   | Income (Loss) |         | Deficit     |   | Total
|                                |                                                                                   |                                       |                      |              |   |         |       |              |   |               |         |             |   |      
|Balance at October 31, 2000     |                                                                                   |                                       | 17,806,079           |              |   | $       | 1,781 |              |   | $             | 123,475 |             |   | $     | (173 | )     |   | $ | (2 | ) |             | $ | (89,625  | )       |   | $ | 35,455  |         
|                                | Issuance of common stock and
warrants in private placement,
net of issuance costs |                                       |                      | 1,279,237    |   |         |       | 128          |   |               |         | 18,582      |   |       |      |      |   |   |    |  |             |   |          |        |   |   |         | 18,710   |   
|                                | Exercise of stock options
and warrants                                            |                                       |                      | 467,000      |   |         |       | 47           |   |               |         | 5,877       |   |       |      |      |   |   |    |  |             |   |          |        |   |   |         | 5,924    |   
|                                | Deferred compensation
on stock options                                            |                                       |                      |             |   |         |       |             |   |               |         | 227         |   |       |      | (227  | ) |   |    |  |             |   |          |        |   |   |         |         |   
|                                | Amortization of
deferred compensation                                             |                                       |                      |             |   |         |       |             |   |               |         |            |   |       |      | 312   |   |   |    |  |             |   |          |        |   |   |         | 312      |   
|                                | Net loss                                                                          |                                       |                      |             |   |         |       |             |   |               |         |            |   |       |      |      |   |   |    |  |             |   |          | (13,702 | ) |   |         | ( 13,702 | ) 
|                                | Other comprehensive
income (loss):                                                |                                       |                      |              |   |         |       |              |   |               |         |             |   |       |      |       |   |   |    |   |             |   |          |         |   |   |         |          |   
|                                |                                                                                   | Unrealized gain
on investments        |                      |              |  |         |       |              |  |               |         |             |  |       |      |       |  |   |    |   | 3           |   |          |         |  |   |         |          | 3  |        
|                                |                                                                                   |                                       |                      |              |   |         |       |              |   |               |         |             |   |       |      |       |   |   |    |   |             |   |          |         |   |   |         |         
|                                |                                                                                   |                                       | Comprehensive loss   |              |   |         |       |              |   |               |         |             |   |       |      |       |   |   |    |   |             |   |          |         |   |   |         |          |    | (13,699 | )
|                                |                                                                                   |                                       |                      |              |   |         |       |              |   |               |         |             |   |       |      |       |   |   |    |   |             |   |          |         |   |   |         |         
|Balance at October 31, 2001     |                                                                                   |                                       | 19,522,316           |              |   |         | 1,955 |              |   |               | 148,161 |             |   |       | (89  | )     |   |   | 1  |   |             |   | (103,327 | )       |   |   | 46,701  |         
|                                | Issuance of common stock and
warrants in private placement,
net of issuance costs |                                       |                      | 1,177,000    |   |         |       | 118          |   |               |         | 21,171      |   |       |      |      |   |   |    |  |             |   |          |        |   |   |         | 21,289   |   
|                                | Exercise of stock options
and warrants                                            |                                       |                      | 836,047      |   |         |       | 84           |   |               |         | 9,977       |   |       |      |      |   |   |    |  |             |   |          |        |   |   |         | 10,061   |   
|                                | Deferred compensation
on stock options                                            |                                       |                      |             |   |         |       |             |   |               |         | 149         |   |       |      | (149  | ) |   |    |  |             |   |          |        |   |   |         |         |   
|                                | Amortization of
deferred compensation                                             |                                       |                      |             |   |         |       |             |   |               |         |            |   |       |      | 218   |   |   |    |  |             |   |          |        |   |   |         | 218      |   
|                                | Shares issued in connection with
purchase of OmegaTech, Inc.                      |                                       |                      | 1,765,728    |   |         |       | 176          |   |               |         | 51,766      |   |       |      |      |   |   |    |  |             |   |          |        |   |   |         | 51,942   |   
|                                | Net loss                                                                          |                                       |                      |             |   |         |       |             |   |               |         |            |   |       |      |      |   |   |    |  |             |   |          | (24,233 | ) |   |         | ( 24,233 | ) 
|                                | Other comprehensive
income (loss):                                                |                                       |                      |              |   |         |       |              |   |               |         |             |   |       |      |       |   |   |    |   |             |   |          |         |   |   |         |          |   
|                                |                                                                                   | Unrealized loss
on investments        |                      |              |  |         |       |              |  |               |         |             |  |       |      |       |  |   |    |   | (1          | ) |          |         |  |   |         |          | (1 | )      
|                                |                                                                                   |                                       |                      |              |   |         |       |              |   |               |         |             |   |       |      |       |   |   |    |   |             |   |          |         |   |   |         |         
|                                |                                                                                   |                                       | Comprehensive loss   |              |   |         |       |              |   |               |         |             |   |       |      |       |   |   |    |   |             |   |          |         |   |   |         |          |    | (24,234 | )
|                                |                                                                                   |                                       |                      |              |   |         |       |              |   |               |         |             |   |       |      |       |   |   |    |   |             |   |          |         |   |   |         |         
|Balance at October 31, 2002     |                                                                                   |                                       | 23,331,091           |              |   |         | 2,333 |              |   |               | 231,224 |             |   |       | (20  | )     |   |   |   |   |             |   | (127,560 | )       |   |   | 105,977 |         
|                                | Issuance of common stock
in public offering, net of
issuance costs                |                                       |                      | 2,922,250    |   |         |       | 292          |   |               |         | 82,903      |   |       |      |      |   |   |    |  |             |   |          |        |   |   |         | 83,195   |   
|                                | Issuance of common stock
in connection with
OmegaTech acquisition                 |                                       |                      | 358,566      |   |         |       | 36           |   |               |         | 14,116      |   |       |      |      |   |   |    |  |             |   |          |        |   |   |         | 14,152   |   
|                                | Issuance of common stock
in connection with
FermPro acquisition                   |                                       |                      | 124,788      |   |         |       | 12           |   |               |         | 5,578       |   |       |      |      |   |   |    |  |             |   |          |        |   |   |         | 5,590    |   
|                                | Exercise of stock options
and warrants                                            |                                       |                      | 1,304,628    |   |         |       | 131          |   |               |         | 18,907      |   |       |      |      |   |   |    |  |             |   |          |        |   |   |         | 19,038   |   
|                                | Amortization of
deferred compensation                                             |                                       |                      |             |   |         |       |             |   |               |         |            |   |       |      | 20    |   |   |    |  |             |   |          |        |   |   |         | 20       |   
|                                | Net income                                                                        |                                       |                      |             |   |         |       |             |   |               |         |            |   |       |      |      |   |   |    |  |             |   |          | 15,992  |   |   |         | 15,992   |   
|                                | Other comprehensive income:                                                       |                                       |                      |              |   |         |       |              |   |               |         |             |   |       |      |       |   |   |    |   |             |   |          |         |   |   |         |          |   
|                                |                                                                                   | Unrealized gain (loss) on
investments |                      |              |  |         |       |              |  |               |         |             |  |       |      |       |  |   |    |   |            |   |          |         |  |   |         |          |   |        
|                                |                                                                                   |                                       |                      |              |   |         |       |              |   |               |         |             |   |       |      |       |   |   |    |   |             |   |          |         |   |   |         |         
|                                |                                                                                   |                                       | Comprehensive income |              |   |         |       |              |   |               |         |             |   |       |      |       |   |   |    |   |             |   |          |         |   |   |         |          |    | 15,992  |  
|                                |                                                                                   |                                       |                      |              |   |         |       |              |   |               |         |             |   |       |      |       |   |   |    |   |             |   |          |         |   |   |         |         
|Balance at October 31, 2003     |                                                                                   |                                       | 28,041,323           |              |   | $       | 2,804 |              |   | $             | 352,728 |             |   | $     |     |       |   | $ |   |   |             | $ | (111,568 | )       |   | $ | 243,964 |         
|                                |                                                                                   |                                       |                      |              |   |         |       |              |   |               |         |             |   |       |      |       |   |   |    |   |             |   |          |         |   |   |         |         

See accompanying notes.

18



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##### 



MARTEK BIOSCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                     |                                                                                                    |                                                 |                     |         |                        |        |         |         |        |        |         |         |       |        |  
|---------------------------------------------------- | -------------------------------------------------------------------------------------------------- | ----------------------------------------------- | ------------------- | ------- | ---------------------- | ------ | ------- | ------- | ------ | ------ | ------- | ------- | ----- | ------ | -
|                                                     |                                                                                                    |                                                 |                     |         | Year ended October 31,
|                                                     |                                                                                                    |                                                 |                     |         |                       
|In thousands                                         |                                                                                                    | 2003                                            |                     | 2002    |                        | 2001  
|                                                     |                                                                                                    |                                                 |                     |         |                        |       
|Operating activities                                 |                                                                                                    |                                                 |                     |         |                        |        |         |         |        |        |         |        
|                                                     | Net income (loss)                                                                                  |                                                 | $                   | 15,992  |                        |        | $       | (24,233 | )      |        | $       | (13,702 | )    
|                                                     | Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating activities: |                                                 |                     |         |                        |        |         |         |        |        |         |         |      
|                                                     |                                                                                                    | Depreciation                                    |                     |         | 3,414                  |        |         |         | 1,861  |        |         |         | 1,720 |       
|                                                     |                                                                                                    | Amortization                                    |                     |         | 1,066                  |        |         |         | 772    |        |         |         | 239   |       
|                                                     |                                                                                                    | Amortization of deferred compensation and other |                     |         | 217                    |        |         |         | 218    |        |         |         | 312   |       
|                                                     |                                                                                                    | Acquired in-process research and development    |                     |         |                       |        |         |         | 15,788 |        |         |         |      |       
|                                                     |                                                                                                    | Changes in operating assets and liabilities:    |                     |         |                        |        |         |         |        |        |         |         |       |       
|                                                     |                                                                                                    |                                                 | Accounts receivable |         |                        | (8,214 | )       |         |        | (3,934 | )       |         |       | (2,581 | )
|                                                     |                                                                                                    |                                                 | Inventories         |         |                        | (2,708 | )       |         |        | (1,967 | )       |         |       | (1,341 | )
|                                                     |                                                                                                    |                                                 | Other assets        |         |                        | (3,332 | )       |         |        | (746   | )       |         |       | 1,065  |  
|                                                     |                                                                                                    |                                                 | Accounts payable    |         |                        | 8,996  |         |         |        | (385   | )       |         |       | 503    |  
|                                                     |                                                                                                    |                                                 | Accrued liabilities |         |                        | 4,092  |         |         |        | (588   | )       |         |       | 128    |  
|                                                     |                                                                                                    |                                                 | Unearned revenue    |         |                        | 5,065  |         |         |        | (160   | )       |         |       | (245   | )
|                                                     |                                                                                                    |                                                 |                     |         |                        |        |         |         |        |        |         |         |      
|Net provided by (used in) operating activities       |                                                                                                    |                                                 | 24,588              |         |                        |        | (13,374 | )       |        |        | (13,902 | )      
|Investing activities                                 |                                                                                                    |                                                 |                     |         |                        |        |         |         |        |        |         |        
|                                                     | Purchase of short-term investments and
marketable securities                                       |                                                 |                     | (75,751 | )                      |        |         | (9,967  | )      |        |         | (37,028 | )    
|                                                     | Proceeds from sale of short-term investments
and marketable securities                             |                                                 |                     | 10,704  |                        |        |         | 14,000  |        |        |         | 47,576  |      
|                                                     | Capitalization of patent costs                                                                     |                                                 |                     | (1,002  | )                      |        |         | (1,230  | )      |        |         | (547    | )    
|                                                     | Purchase of property, plant and equipment                                                          |                                                 |                     | (45,219 | )                      |        |         | (21,108 | )      |        |         | (2,298  | )    
|                                                     | Cash impact of acquisitions, net                                                                   |                                                 |                     | (5,038  | )                      |        |         | 191     |        |        |         |        |      
|                                                     |                                                                                                    |                                                 |                     |         |                        |        |         |         |        |        |         |         |      
|Net cash (used in) provided by investing activities  |                                                                                                    |                                                 | (116,306            | )       |                        |        | (18,114 | )       |        |        | 7,703   |        
|Financing activities                                 |                                                                                                    |                                                 |                     |         |                        |        |         |         |        |        |         |        
|                                                     | Repayment of notes payable and capital leases                                                      |                                                 |                     | (1,010  | )                      |        |         | (88     | )      |        |         | (472    | )    
|                                                     | Proceeds from the exercise of warrants and options                                                 |                                                 |                     | 19,038  |                        |        |         | 10,061  |        |        |         | 5,924   |      
|                                                     | Proceeds from the issuance of common stock and warrants                                            |                                                 |                     | 83,195  |                        |        |         | 21,289  |        |        |         | 18,710  |      
|                                                     |                                                                                                    |                                                 |                     |         |                        |        |         |         |        |        |         |         |      
|Net cash provided by financing activities            |                                                                                                    |                                                 | 101,223             |         |                        |        | 31,262  |         |        |        | 24,162  |        
|                                                     |                                                                                                    |                                                 |                     |         |                        |        |         |         |        |        |         |         |      
|Net increase (decrease) in cash and cash equivalents |                                                                                                    |                                                 | 9,505               |         |                        |        | (226    | )       |        |        | 17,963  |        
|Cash and cash equivalents at beginning of year       |                                                                                                    |                                                 | 20,419              |         |                        |        | 20,645  |         |        |        | 2,682   |        
|                                                     |                                                                                                    |                                                 |                     |         |                        |        |         |         |        |        |         |         |      
|Cash and cash equivalents at end of year             |                                                                                                    | $                                               | 29,924              |         |                        | $      | 20,419  |         |        | $      | 20,645  |        
|                                                     |                                                                                                    |                                                 |                     |         |                        |        |         |         |        |        |         |         |      
|Supplemental disclosure of non-cash transactions:    |                                                                                                    |                                                 |                     |         |                        |        |         |         |        |        |         |        
|                                                     | Common stock issued related to the acquisition of OmegaTech                                        |                                                 | $                   | 14,152  |                        |        | $       | 49,228  |        |        | $       |        |      
|                                                     | Common stock issued related to the acquisition of FermPro                                          |                                                 | $                   | 5,590   |                        |        | $       |        |        |        | $       |        |      

See accompanying notes.

19



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS1.     ORGANIZATION & BUSINESS DESCRIPTION

Martek Biosciences Corporation (the Company
or Martek or we), a Delaware corporation,
was founded in 1985. The Company develops,
manufactures and sells products from
microalgae. The Companys products include:
(1) nutritional oils used in infant formula,
nutritional supplements and food fortification ingredients; and (2) powerful fluorescent markers for diagnostics, rapid
miniaturized screening, and gene and protein
detection.

Marteks 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, and play a pivotal role in brain
function throughout life. Low levels of DHA in
adults have also been linked to a variety of
health risks, including cardiovascular
problems, cancer and various neurological and
visual disorders. Additional research is
underway to assess what impact, if any,
supplementation with the Companys DHA will
have on these health risks. Marteks fluorescent detection products and technologies
can aid researchers in drug discovery and
diagnostics. The Company is also developing
additional applications of its patented
technology based upon microalgae including its
algal genomics technology.

In April 2002, the Company acquired OmegaTech, Inc.
(OmegaTech), a low-cost algal DHA producer
located in Boulder, CO. Subsequent to the
acquisition, OmegaTechs name was changed to
Martek Biosciences Boulder Corporation (Martek
Boulder). OmegaTech had been in the
fermentable DHA business since 1987 and had
accumulated over 100 issued and pending patents
protecting its DHA technology.

In September 2003, Martek Biosciences Kingstree
Corporation (Martek Kingstree) was created as
a wholly-owned subsidiary of Martek to purchase
certain assets and assume certain liabilities
of FermPro Manufacturing, LP (FermPro), which
operated a fermentation facility located in
Kingstree, SC. FermPro provided contract
fermentation services and had an experienced
work-force of over 100 personnel on a site of
over 500 acres with extensive fermentation,
recovery, laboratory and warehousing
capabilities. FermPro had produced a limited
amount of DHA for Martek in the last year. The
addition of the FermPro facility and workforce
will enable us to add to the Companys
production capabilities using the existing
facility, coupled with an extensive
construction build-out that is currently
underway.

2.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ConsolidationThe consolidated financial
statements include the accounts of Martek and
its wholly-owned subsidiaries, Martek Boulder
and Martek Kingstree, after elimination of all
significant intercompany balances and
transactions.

Use of EstimatesThe preparation of
financial statements in conformity with
generally accepted accounting principles
requires
management to make estimates and assumptions
that affect the reported amounts of assets and
liabilities and disclosure of contingent assets
and liabilities at the date of the financial
statements and the reported amounts of revenues
and expenses during the reporting period.
Actual results could differ from those
estimates.

Segment InformationThe Company currently
operates in one business segment, that being
the development and commercialization of novel
products from microalgae. The Company is
managed and operated as one business. The
entire business is comprehensively managed by a
single management team that reports to the
Chief Executive Officer. The Company does not
operate 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
SFAS No. 131, Disclosure about Segments of an
Enterprise and Related Information.

Revenue RecognitionThe 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 EITF No. 00-21, Revenue
Arrangements with Multiple Deliverables, the
consideration from those 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 product is shipped.
Revenue from product licenses is deferred and
recognized on a straight-line basis over the
term of the agreement. At October 31, 2003,
the Company had approximately $2.8 million in
short-term and $9.0 million in long-term
unearned revenue relating to third-party
license agreements and prepayments on product
purchases.

Contract manufacturing revenue is
recognized when goods are shipped to the
customer. Revenues on cost reimbursement and fixed price contracts are recognized on the
percentage of completion method of accounting
as costs are incurred. Revenue recognized is
not subject to repayment. 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

20



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##### 



current period income or loss as incurred.
Currently, all material transactions of the
Company are denominated in U.S. dollars, and
the Company has not entered into any material
transactions that are denominated in foreign
currencies.

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. Over 65% of the Companys
research and development expenditures in 2003
were associated with development activity at
the Columbia, MD laboratory directed toward
improving the quality, sensory properties and
stability of our nutritional oils, optimizing
production characteristics of
microalgal strains, investigating the clinical
health benefits of DHA and ARA fatty acids,
and exploring the biochemical pathways utilized
by microalgae to produce DHA. Additional
research and development expenses incurred at
the Companys Winchester, KY facility were
directed toward increasing our production
yields, reducing waste and continuing to
improve the quality of our oils. Research
conducted at the Companys laboratory in
Boulder, CO is focused on developing feasible
approaches to the expression of nutritional
fatty acids, especially DHA, in plant oilseeds,
investigating the feasibility of utilizing our
proprietary genes to produce other bioactive
compounds with application in the healthcare
fields and developing new ingredient forms and
applications technology for DHA-enriched food
products. The Companys total research and
development expense was approximately $12.2
million, $11.6 million and $12.7 million for
the years ended October 31, 2003, 2002 and
2001, respectively.

Advertising CostsAll advertising costs
are expensed when incurred. Advertising
costs expensed for the years ended October
31, 2003, 2002 and 2001 approximated $0.9
million, $1.2 million and $1.2 million,
respectively.

InterestInterest paid by the Company
amounted to approximately $7,000 in 2003,
$4,000 in 2002 and $10,000 in 2001.

Income TaxesUnder SFAS No. 109, deferred tax
assets and liabilities are determined based on
differences between financial reporting and the
tax basis of assets and liabilities, and are
measured using the enacted tax rates and laws
that will be in effect when the differences are
expected to reverse. Valuation allowances are
provided against assets, including net
operating losses, if it is anticipated that
some or all of the asset may not be realized
through future taxable earnings. During 2003,
the Company paid approximately $150,000 in
alternative minimum tax. This payment will be
treated as a prepayment and will be deducted
from future tax amounts due. For the years
ended October 31, 2002 and 2001, the Company
paid no income taxes.

Net Income (Loss) Per ShareNet income
(loss) per share is computed using the
weighted average number of shares of common
stock outstanding during the period. See
Note 15 -  Earnings (Loss) Per Share Calculation.

Comprehensive Income (Loss)The Company
displays comprehensive income (loss) and its
components as part of the consolidated
financial statements. Comprehensive income
(loss) is comprised of net earnings (loss) and
other comprehensive income (loss), which
includes certain changes in equity that are
excluded from net income (loss). The Company
includes unrealized holding gains and losses
on available-for-sale securities in other
comprehensive income (loss) on its
Consolidated Statements of Stockholders
Equity.

Cash and Cash EquivalentsCash equivalents
consist of highly liquid investments with an
original maturity of three months or less and
are stated at market value.

Short-Term Investments and Marketable Securities

The Company has classified all debt securities
as available-for-sale. Available-for-sale
securities are carried at fair value and
consist of U.S. government obligations, U.S.
agency obligations and taxable municipal
auction rate securities with average maturities
of less than one year.
Unrealized gains and losses on these securities
are reported as accumulated other comprehensive
income (loss), which is a separate component of
stockholders equity. Realized gains and losses
and declines in value judged to be other than
temporary are included in other income, based
on the specific identification method.

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 and
accounts payable, to approximate the fair
value of the respective assets and liabilities
at October 31, 2003.

Concentration of Credit Risk and Significant
Customers

Financial instruments that potentially subject the Company to
concentrations of credit risk consist
principally of accounts receivable. The
Companys reserve for uncollectible accounts at
October 31, 2003 and 2002 was not material. The
Company grants credit to customers based on
evaluations of their financial condition,
generally without requiring collateral.
Concentrations of credit risk with respect to
accounts receivable are present due to the
small number of customers comprising the
Companys customer base. However, the credit
risk is reduced through the Companys efforts
to monitor its exposure for credit losses and
by maintaining allowances, if necessary. Three
customers accounted for approximately 84% of
the Companys sales for fiscal 2003, and two
customers accounted for approximately 79% for
fiscal 2002. At October 31, 2003, three
customers accounted for approximately 75% of
the Companys outstanding accounts receivable
balance and at October 31, 2002, two customers
accounted for approximately 73% of the
Companys outstanding accounts receivable
balance. The Companys policy is to perform an
analysis of the recoverability of its trade
accounts receivable at the end of each
reporting period and to establish allowances
for those accounts considered uncol-

21



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##### 



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

lectible. 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. The allowance for
doubtful accounts was approximately $91,000 as
of October 31, 2003 and approximately $37,000
as of October 31, 2002.

InventoriesInventories are stated at the
lower of cost or market, reflect appropriate
reserves for potential obsolete, slow-moving or
otherwise impaired material, and include
appropriate elements of material, labor and
indirect costs. 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.

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 which are twenty years for the
Companys fermentation plants and equipment,
fifteen years for the Companys oil processing
plant and equipment, generally ten years for
all other machinery and equipment, five years
for furniture and fixtures, three to
five years for computers and software, and the
shorter of the useful life or the lease term
for leasehold improvements. Costs for capital
assets not yet placed into service, including
those related to expansion of the Companys
Kingstree, SC fermentation facility, have been
capitalized as construction in progress and
will be depreciated in accordance with the
above guidelines once placed into service.

Goodwill and Purchased Intangible Assets
The Company recorded goodwill and purchased
intangible assets in its acquisition of
OmegaTech in April, 2002 and goodwill in its
acquisition of FermPro in September 2003 (see
Note 3  Acquisition of OmegaTech, Inc, and
Note 4  Acquisition of FermPro
Manufacturing, LP). The goodwill acquired in
the OmegaTech and FermPro acquisitions is
subject to the provisions of 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. The Company
performs this impairment test annually on
August 1. 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 are
carried at cost less accumulated amortization.
Amortization is computed over the estimated
useful lives of the respective assets,
generally ten to fifteen years, unless their
useful lives are determined to be indefinite. It is the Companys policy to assess
periodically the carrying amount of its
purchased intangible assets to determine if
there has been an impairment to their carrying
value. Impairments of other intangible assets
are determined in accordance with SFAS No.
144, Accounting for the Impairment or
Disposal of Long-Lived Assets.

Impairment of Long-Lived AssetsThe 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 incurred any impairment losses.

PatentsPatents include issued and pending
patents and are stated at cost. Amortization of
patents and patent-related costs is recorded
using the straight-line method over the legal
lives of the patents, generally for periods up
to 17 years. The carrying value of patents is
reviewed for impairment whenever events or
changes in circumstances indicate that the
carrying amount of a patent may not be
recoverable. Recoverability of patents is
measured by a comparison of the carrying amount
of an asset to future undiscounted net cash
flows expected to be generated by the patent.
If such patents 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.
See Note 9  Goodwill and Intangible Assets.

Stock-Based CompensationIn October 1995,
the Financial Accounting Standards Board
(FASB) issued Statement of Financial
Accounting Standards No. 123, Accounting for
Stock-Based Compensation (SFAS No. 123).
SFAS No. 123 allows companies to account for
employee stock-based compensation under the new
fair value-based method or using the intrinsic
value method provided by Accounting Principles
Board Opinion No. 25 (APB No. 25),
Accounting for Stock Issued to Employees, but
requires pro forma disclosure in the footnotes
to the financial statements as if the
measurement provisions of SFAS No. 123 had been
adopted. In December 2002, the FASB issued SFAS
No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure. 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. In addition, SFAS No.
148 amends the disclosure requirements of SFAS
No. 123 to require prominent disclosures in
both annual and interim financial statements
about the method of accounting for stock-based
employee compensation and the effect of the
method used on reporting results.

The Company has elected to continue
accounting for its employee stock-based
compensation in accordance with the
provisions of APB No. 25, and to present the
pro forma disclosures required by SFAS No.
123, as amended by SFAS No. 148.
Accordingly, the Company recognizes
compensation expense for the difference
between the fair value of the underlying
common stock and the grant price of the
option at the date of

22



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##### 



the grant. The Company does not issue options
at values less than fair market value;
therefore, no stock-based employee compensation
cost is reflected in earnings. The following
table illustrates the effect on net income
(loss) and earnings (loss) per share as if the
Company had applied the fair value recognition
provisions of SFAS No. 123, as amended by SFAS
No. 148, to stock-based employee compensation:

|                               |                                                                                                          |      |                        |         |   |      |         |         |   |   |         |        |  
|------------------------------ | -------------------------------------------------------------------------------------------------------- | ---- | ---------------------- | ------- | - | ---- | ------- | ------- | - | - | ------- | ------ | -
|                               |                                                                                                          |      | Year Ended October 31,
|In thousands                   |                                                                                                          | 2003 |                        | 2002    |   | 2001
|                               |                                                                                                          |      |                        |         |   |     
|Net income (loss),
as reported |                                                                                                          | $    | 15,992                 |         |   | $    | (24,233 | )       |   | $ | (13,702 | )     
|Deduct:                        |                                                                                                          |      |                        |         |   |      |         |         |   |   |         |       
|                               | Total stock-based
employee compensation
expense determined
under fair value-based
methods for all awards |      |                        | (15,815 | ) |      |         | (15,967 | ) |   |         | (7,098 | )
|                               |                                                                                                          |      |                        |         |   |      |         |         |   |   |         |        |  
|Pro forma net income
(loss)    |                                                                                                          | $    | 177                    |         |   | $    | (40,200 | )       |   | $ | (20,800 | )     
|                               |                                                                                                          |      |                        |         |   |      |         |         |   |   |         |        |  
|Earnings (loss) per share:     |                                                                                                          |      |                        |         |   |      |         |         |   |   |         |       
|                               | Basic  as reported                                                                                      |      | $                      | 0.63    |   |      | $       | (1.10   | ) |   | $       | (0.73  | )
|                               | Basic  pro forma                                                                                        |      | $                      | 0.01    |   |      | $       | (1.83   | ) |   | $       | (1.10  | )
|                               | Diluted  as reported                                                                                    |      | $                      | 0.58    |   |      | $       | (1.10   | ) |   | $       | (0.73  | )
|                               | Diluted  pro forma                                                                                      |      | $                      | 0.01    |   |      | $       | (1.83   | ) |   | $       | (1.10  | )

The effects of applying SFAS No. 123, as
amended by SFAS No. 148, on 2003, 2002 and
2001 pro forma net income (loss) and earnings
(loss) per share calculations as stated above
are not necessarily representative of effects
on reported net income (loss) and earnings
(loss) per share for future years due to such
things as the vesting period of the stock
options and the potential for issuance of
additional stock options in future years.

ReclassificationCertain amounts in the
prior years financial statements have been
reclassified to conform to the current year
presentation.

Recently Issued Accounting PronouncementsIn
November 2002, the Emerging Issues Task Force
(EITF) reached a consensus on Issue No.
00-21, Revenue Arrangements with Multiple
Deliverables. EITF No. 00-21 provides
guidance on how to account for arrangements
that involve the delivery or performance of
multiple products, services and/or rights to
use assets. The provisions of EITF No. 00-21
apply to revenue arrangements entered into in
fiscal periods beginning after June 15, 2003.
The adoption of EITF No. 00-21 had no material
impact on the Companys financial statements.

In April 2003, the FASB issued SFAS No.
149, Amendment of Statement 133 on Derivative
Instruments and Hedging Activities. SFAS No.
149 amends and clarifies accounting for
derivative instruments, including certain
derivative instruments embedded in other
contracts, and for hedging activities under
SFAS No. 133. The statement requires that
contracts with comparable characteristics be
accounted for similarly and clarifies when a
derivative contains a financing component
that warrants special reporting in the
statement of cash flows. SFAS No. 149 is
effective
for contracts entered into or modified after
June 30, 2003, except in certain circumstances,
and for hedging relationships designated after
June 30, 2003. The adoption of SFAS No. 149 had
no material impact on the Companys financial
statements.

In May 2003, the FASB issued SFAS No. 150,
Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and
Equity. This Statement establishes standards
for how an issuer classifies and measures in
its statement of financial position certain
financial instruments with characteristics of
both liabilities and equity. It requires that
an issuer classify a financial instrument
that is within its scope as a liability (or an
asset in some circumstances) because that financial instrument embodies an obligation of
the issuer. This Statement is effective for financial instruments entered into or modified
after May 31, 2003, and is otherwise effective
at the beginning of the first interim period
beginning after June 15, 2003, except for
mandatory redeemable financial instruments of
nonpublic entities. The FASB has deferred
implementation of SFAS No. 150 indefinitely
for certain non-controlling interests, the
provisions of which are currently not
applicable to the Company. The adoption of SFAS
No. 150 had no material impact on the Companys
financial statements.

3. ACQUISITION OF OMEGATECH, INC.

On April 25, 2002, the Company completed
its acquisition of OmegaTech, Inc., a
DHA-producer located in Boulder, CO. Upon the
completion of the acquisition, OmegaTech became
a wholly-owned
subsidiary of the Company and its name was
changed to Martek Biosciences Boulder
Corporation.

The Company issued 1,765,728 shares of the
Companys common stock in exchange for all of
the outstanding capital stock of OmegaTech. The
aggregate purchase price for OmegaTech was
approximately $54.1 million, of which
approximately $49.3 million was related to the
value of 1,765,728 shares of the Companys
common stock ($1.5 million of which related to
OmegaTech transaction costs paid by the
Company), approximately $2.1 million was for
the Companys acquisition-related fees and
expenses, and approximately $2.7 million was
related to the fair value of 154,589 vested
OmegaTech stock options that were assumed as
part of the transaction. The merger agreement
also provides for additional stock
consideration of up to $40 million, subject to
certain pricing adjustments, if four milestones
are 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 approvals in the U.S. and Europe. One of these
milestones relates to the granting of Novel
Foods approval in Europe for the OmegaTech DHA
oil. In June 2003, the Commission of the
European Community granted approval of the use
of this oil in certain foods in Europe, meeting
the conditions of this regulatory milestone.
Accordingly, approximately 358,566 shares of
Martek common stock, with a fair market value
of approximately $14.2 million, were issued
during the third quarter of fiscal 2003 upon
the achievement of this milestone. The payment
of this additional consideration was recorded
as goodwill.

As of October 31, 2003 the second
regulatory related milestone

23



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##### 



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

has not been achieved. In addition, the first
financial milestone related to sales and
gross profit margin for the eighteen-month
period ended October 31, 2003, has also not
been achieved. The representative of the former
OmegaTech stockholders has advised us that he
believes that the common stock issuable with
respect to these two milestones should be
issued. We disagree with that conclusion and
are in discussions with the stockholders
representative regarding our differences of
opinion. If these differences of opinion cannot
be resolved as a result of these discussions,
it is likely that the dispute-resolution
procedures contractually provided for will be
utilized. The total Martek common stock,
relating to the remaining three milestones,
that may be issued is approximately 775,000
shares based on the Companys closing stock
price on October 31, 2003 of $48.81, but could
potentially increase up to a maximum of
approximately 1.9 million shares depending on
the average market price of the Companys stock
on the dates that the milestones are achieved.
(The agreement with the former OmegaTech
stockholders includes a share adjustment
feature, based upon the Companys stock price
as of the milestone date that either increases
or decreases the number of shares to be issued
upon achievement of milestones.) Any additional
consideration paid related to these milestones
will be recorded as goodwill.

The
acquisition has been accounted for as a
purchase in accordance with SFAS No. 141 and,
accordingly, the results of operations of
OmegaTech have been included in the
accompanying consolidated statements of
operations from the date of the acquisition. In
accordance with SFAS No. 141, the purchase
price has been allocated to the assets and
liabilities of OmegaTech based on their
relative fair value.

4. ACQUISITION OF FERMPRO MANUFACTURING, LP

On September 5, 2003, Martek Biosciences
Kingstree Corporation (Martek Kingstree) was
created as a wholly-owned subsidiary of Martek
to purchase certain assets and assume certain
liabilities of FermPro Manufacturing, LP
(FermPro), which operated a fermentation
facility located in Kingstree, SC. The addition
of the FermPro facility will enable the Company
to add to its production capabilities using the
existing facility, coupled with the extensive
construction build-out that is currently
underway.

The purchase price of the assets acquired
and liabilities assumed included a payment of
approximately $12.0 million, comprised of $5.4
million in cash, 124,788 shares of the
Companys common stock valued at approximately
$5.6 million, and approximately $1.0 million in
acquisition-related fees and expenses. In
addition, a $10 million secured note was
assumed as part of the transaction. The common
stock issued was valued based on the average
closing price of Marteks common stock for the
period beginning two trading days prior to, and
ending two trading days after the announcement
of the acquisition.

The acquisition has been accounted for as a
purchase in accordance with SFAS No. 141, and
accordingly, the results of consolidated
statements of operations from the date of the
acquisition. In accordance with SFAS No. 141,
the purchase price has been allocated to the
assumed assets and liabilities of FermPro based
on their relative fair value.

As part of the preliminary purchase price
allocation, no material intangible assets were
identified. The excess of the purchase price
over the fair value of tangible and identifiable intangible net assets of approximately
$11.1 million, has been allocated to goodwill
and is expected to be deductible for tax
purposes. The Company reports one operating
segment and, therefore, reports only certain
enterprise-wide disclosures. Accordingly, the
goodwill from this transaction is not part of
a reportable segment.

The aggregate purchase price of approximately
$12.0 million, including acquisition costs,
was allocated as follows:

|                                         |  |   |         |  
|---------------------------------------- |  | - | ------- | -
|In thousands                             | 
|                                         | 
|Accounts receivable and inventory        |  | $ | 5,813   |  
|Property, plant and equipment            |  |   | 9,511   |  
|Goodwill                                 |  |   | 11,138  |  
|Other assets                             |  |   | 2,183   |  
|Accounts payable and accrued liabilities |  |   | (3,123  | )
|Deferred revenue                         |  |   | (2,585  | )
|Long-term notes payable                  |  |   | (10,939 | )
|                                         |  |   |         |  
|Total purchase price                     |  | $ | 11,998  |  
|                                         |  |   |         |  

The above allocation of the purchase is
subject to revision based on the final
determination of fair values that is
anticipated to be completed during the
Companys second quarter of fiscal year
2004.

The following unaudited pro forma
operating results combine the results of the
Company for the years ended October 31, 2003
and 2002 with the results of the former
FermPro entity for the years ended October 31,
2003 and 2002, assuming the acquisition had
been consummated at the beginning of each
period.

|                                             |  |                                |         |      |  |   |         |  
|-------------------------------------------- |  | ------------------------------ | ------- | ---- |  | - | ------- | -
|                                             |  | For the year ended October 31,
|In thousands, except per share data          |  | 2003                           |         | 2002
|                                             |  |                                |         |     
|                                             |  | (unaudited)                   
|Revenues                                     |  | $                              | 124,000 |      |  | $ | 58,000  |  
|Net income (loss)                            |  | $                              | 16,000  |      |  | $ | (24,000 | )
|Net income (loss) per share  basic          |  | $                              | 0.64    |      |  | $ | (1.07   | )
|Net income (loss) per share  diluted        |  | $                              | 0.59    |      |  | $ | (1.07   | )
|Weighted average shares outstanding, basic   |  |                                | 25,616  |      |  |   | 22,107  |  
|Weighted average shares outstanding, diluted |  |                                | 27,658  |      |  |   | 22,107  |  

5. SALE OF STABLE ISOTOPES PRODUCT LINE

On November 1, 2001 the Company sold the
assets, consisting primarily of inventory and
technology, surrounding our former stable
isotope product line to Spectra Gases, Inc., a
privately held New Jersey
company. As part of the agreement, Martek
received approximately $800,000 for the assets
of the stable isotope business. The Company
also retained an ongoing royalty from future
reagent sales for five years, up to a
maximum of $500,000, and also received a 9%
equity position and royalty interest in a new
company that was formed to pursue the high-

24



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##### 



end protein labeling technology. As of October 31,
2003, the value of the investment in the new
company was fully reserved. The Company
recognized approximately $140,000 and $106,000
during 2003 and 2002, respectively, in royalty
revenue in connection with this arrangement.

6. SHORT-TERM INVESTMENTS AND MARKETABLE SECURITIES

The Company has classified all debt
securities as available-for-sale.
Available-for-sale securities are carried at
fair value, based on specific identification and have average maturities of less
than one year. Unrealized gains and losses on
these securities are reported as accumulated
other comprehensive income (loss), which is a
separate component of stockholders equity.
There was no material unrealized holding gain
(loss) on these available-for-sale securities
at October 31, 2003 and October 31, 2002.
Realized gains and losses and declines in
value judged to be other-than-temporary on
available-for-sale securities are included in other income, based on the specific identification method. There were no realized gains
or losses recorded for the years ended October
31, 2003, 2002 or 2001. Available-for-sale
securities consist of U.S. government, agency
obligations and taxable municipal auction rate
securities and totaled approximately $67.0
million and $2.0 million at October 31, 2003
and 2002, respectively. At October 31, 2003
and 2002, the estimated fair value of these
securities approximated cost.

7. INVENTORIES

Inventories consisted of the following:

|                       |  |             |        |      |  |   |       |  
|---------------------- |  | ----------- | ------ | ---- |  | - | ----- | -
|                       |  | October 31,
|In thousands           |  | 2003        |        | 2002
|                       |  |             |        |     
|Finished products      |  | $           | 2,074  |      |  | $ | 3,443 |  
|Work in process        |  |             | 7,801  |      |  |   | 6,078 |  
|Raw materials          |  |             | 5,207  |      |  |   | 397   |  
|                       |  |             |        |      |  |   |       |  
|Total inventory        |  |             | 15,082 |      |  |   | 9,918 |  
|Less inventory reserve |  |             | (539   | )    |  |   | (200  | )
|                       |  |             |        |      |  |   |       |  
|Inventory, net         |  | $           | 14,543 |      |  | $ | 9,718 |  
|                       |  |             |        |      |  |   |       |  

The Company writes down its inventory for
estimated obsolescence or unmarketable
inventory equal to the difference between the
cost of inventory and the estimated market
value based on assumptions about future demand
and market conditions.

8. PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consisted of the following:

|                                               |  |             |         |      |  |   |         |  
|---------------------------------------------- |  | ----------- | ------- | ---- |  | - | ------- | -
|                                               |  | October 31,
|In thousands                                   |  | 2003        |         | 2002
|                                               |  |             |         |     
|Land                                           |  | $           | 683     |      |  | $ | 150     |  
|Building and improvements                      |  |             | 9,220   |      |  |   | 1,871   |  
|Machinery and equipment                        |  |             | 56,458  |      |  |   | 23,906  |  
|Furniture and fixtures                         |  |             | 2,727   |      |  |   | 1,598   |  
|Leasehold improvements                         |  |             | 662     |      |  |   | 556     |  
|Construction in progress                       |  |             | 33,533  |      |  |   | 19,960  |  
|                                               |  |             |         |      |  |   |         |  
|Property, plant
and equipment                  |  |             | 103,283 |      |  |   | 48,041  |  
|Less accumulated
depreciation and amortization |  |             | (14,969 | )    |  |   | (11,535 | )
|                                               |  |             |         |      |  |   |         |  
|Net property, plant
and equipment              |  | $           | 88,314  |      |  | $ | 36,506  |  
|                                               |  |             |         |      |  |   |         |  

Depreciation and amortization expense on
property, plant and equipment amounted to
approximately $3.4 million, $1.9 million and
$1.7 million for the years ended October 31,
2003, 2002, and 2001, respectively.

9. GOODWILL AND INTANGIBLE ASSETS

As of October 31, 2003 and 2002, the
Companys intangible assets and related
accumulated amortization consisted of the
following:

|                 |  |                        |        |                        |  |             |       |       |  |                  |        |             |  |   |        |  |  |   |     |  |  |   |        | 
|---------------- |  | ---------------------- | ------ | ---------------------- |  | ----------- | ----- | ----- |  | ---------------- | ------ | ----------- |  | - | ------ |  |  | - | --- |  |  | - | ------ | 
|In thousands     |  | As of October 31, 2003 |        | As of October 31, 2002
|                 |  |                       
|                 |  |                        |        |                        |  | Accumulated |       |       |  |                  |        | Accumulated
|Intangible Asset |  | Gross                  |        | Amortization           |  | Net         |       | Gross |  | Amortization Net
|                 |  |                        |        |                        |  |             |       |       |  |                 
|Trademarks       |  | $                      | 2,030  |                        |  | $           | 170   |       |  | $                | 1,860  |             |  | $ | 1,809  |  |  | $ |    |  |  | $ | 1,809  | 
|Patents          |  |                        | 6,013  |                        |  |             | 672   |       |  |                  | 5,341  |             |  |   | 5,287  |  |  |   | 602 |  |  |   | 4,685  | 
|Core
technology  |  |                        | 1,708  |                        |  |             | 114   |       |  |                  | 1,594  |             |  |   | 1,708  |  |  |   |    |  |  |   | 1,708  | 
|Current
products |  |                        | 10,676 |                        |  |             | 1,093 |       |  |                  | 9,583  |             |  |   | 10,676 |  |  |   | 381 |  |  |   | 10,295 | 
|Goodwill         |  |                        | 50,274 |                        |  |             |      |       |  |                  | 50,274 |             |  |   | 25,568 |  |  |   |    |  |  |   | 25,568 | 
|                 |  |                        |        |                        |  |             |       |       |  |                  |        |             |  |   |        |  |  |   |     |  |  |   |        | 
|Total            |  | $                      | 70,701 |                        |  | $           | 2,049 |       |  | $                | 68,652 |             |  | $ | 45,048 |  |  | $ | 983 |  |  | $ | 44,065 | 
|                 |  |                        |        |                        |  |             |       |       |  |                  |        |             |  |   |        |  |  |   |     |  |  |   |        | 

Core technology and current products
relate to the value assigned to the products
purchased as part of the OmegaTech
acquisition. The Company recorded amortization
expense of approximately $1.1 million in 2003,
$772,000 in 2002, and $239,000 in 2001. Based
on the current amount of intangible assets
subject to amortization, the estimated
amortization expense for each of the
succeeding five years will be approximately
$1.5 million.

In accordance with SFAS No. 142, which
requires annual testing to determine and
measure goodwill impairment on a reporting
unit basis, management performed an assessment
of the fair value of the Companys single
reporting unit and its intangible assets as of
August 1, 2003. The Company compared the fair
value of the reporting unit to
the carrying value, including goodwill, and
determined that the carrying value did not

25



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##### 



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

exceed the units fair value. As a result, no
impairment charge was recorded. During the
year ended October 31, 2003, approximately
$24.7 million was recorded as additional
goodwill, $11.1 million of which related to the
acquisition of FermPro; see Note
4  Acquisition of FermPro Manufacturing,
LP. An additional $13.6 million of goodwill
was recorded in fiscal 2003 related to the
OmegaTech purchase, primarily related to the
milestone achieved under the purchase
agreement; see Note 3  Acquisition of
OmegaTech, Inc.

10. ACCRUED LIABILITIES

Accrued liabilities at October 31 included the following:

|                               |  |      |        |      |  |   |       | 
|------------------------------ |  | ---- | ------ | ---- |  | - | ----- | 
|In thousands                   |  | 2003 |        | 2002
|                               |  |      |        |     
|Salaries and employee benefits |  | $    | 4,378  |      |  | $ | 2,252 | 
|Restructuring accrual          |  |      | 153    |      |  |   | 837   | 
|Inventory purchase obligations |  |      | 1,583  |      |  |   | 336   | 
|Other accrued liabilities      |  |      | 5,906  |      |  |   | 3,262 | 
|                               |  |      |        |      |  |   |       | 
|Accrued liabilities            |  | $    | 12,020 |      |  | $ | 6,687 | 
|                               |  |      |        |      |  |   |       | 

11. NOTES PAYABLE

As part of the FermPro acquisition, the
Company assumed a $10 million secured note.
The note has a stated interest rate of 5% and
a maturity date of December 31, 2013.
Principal is amortized over a 20-year period
with the balance due at maturity. Payments
through December 31, 2003 are comprised of
interest only. In addition, 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 (see
Note
19  Subsequent Events for additional information).

12. RESTRUCTURING CHARGE

On July 29, 2002, the Company announced a
restructuring of the food and beverage sales
and marketing efforts at Martek Boulder. As
part of this restructuring, eight employees
and five consultants associated with food
and beverage sales were terminated. A one-time
operating charge of approximately $1.3 million
was recorded in fiscal year 2002 to account
for severance and other costs associated with
this restructuring. Employee separation benefits of approximately $766,000 under the
restructuring plan include severance, medical,
and other benefits. Other costs of the
restructuring, totaling approximately
$500,000, included consultant termination
costs, idle office space and professional
fees. During the first quarter of fiscal
2003, the Company reduced the liability for
employee separation benefits related to
severance costs due to changes in previous
estimates. Additionally, the Company increased
the restructuring liability related to other
charges such as consultant termination fees
and costs related to idle space. The net
result of the related adjustments to the
restructuring liability was a reversal of
$250,000 in the fiscal quarter ended January
31, 2003. The following table summarizes the
activity related to the liability for
restructuring costs as of October 31, 2003:

|                                                 |  |            |      |         |  |       |      |   |  |   |       |  
|------------------------------------------------ |  | ---------- | ---- | ------- |  | ----- | ---- | - |  | - | ----- | -
|                                                 |  | Employee   |      |         |  |       |      |   |  |  
|                                                 |  | Separation |      | Other   |  |       |      |  
|In thousands                                     |  | Benefits   |      | Changes |  | Total
|                                                 |  |            |      |         |  |      
|Initial charge in the 3rd quarter of fiscal 2002 |  | $          | 766  |         |  | $     | 500  |   |  | $ | 1,266 |  
|Cash payments                                    |  |            | (242 | )       |  |       | (187 | ) |  |   | (429  | )
|                                                 |  |            |      |         |  |       |      |   |  |   |       |  
|Balance at October 31, 2002                      |  |            | 524  |         |  |       | 313  |   |  |   | 837   |  
|Cash payments                                    |  |            | (260 | )       |  |       | (174 | ) |  |   | (434  | )
|Adjustments                                      |  |            | (264 | )       |  |       | 14   |   |  |   | (250  | )
|                                                 |  |            |      |         |  |       |      |   |  |   |       |  
|Balance at October 31, 2003                      |  | $          |     |         |  | $     | 153  |   |  | $ | 153   |  
|                                                 |  |            |      |         |  |       |      |   |  |   |       |  

13. COMMITMENTS AND CONTINGENCIES

LeasesThe Company leases its Columbia, MD
premises under an operating lease agreement
that expires in November 2004. The terms of the
lease call for annual rent escalations of 3%.
The Company has an option to extend the lease
for five additional years at 95% of the
then-prevailing fair rental value. The Company
also leases its premises in Boulder, CO under
an operating lease that expires in May 2005.
The terms of the lease call for annual rent
escalations based on CPI, not to exceed 5%.
Additionally, the Company leases certain
equipment classified as operating leases at its
Winchester, Kentucky manufacturing facility and
its Boulder offices. Rent expense was
approximately $859,000 in 2003, $742,000 in
2002 and $434,000 in 2001. The Company received
sublease income of approximately $294,000 in
2003, $352,000 in 2002 and $133,000 in 2001 for
office and lab space that it subleases in
Columbia, MD.

Future minimum lease payments under
operating leases at October 31, 2003, assuming
the Company will not exercise any additional
cancellation, renewal or expansion rights it
has under the leases, are as follows:

|               |  |              |     |               |  |             |     |  |  |   |     | 
|-------------- |  | ------------ | --- | ------------- |  | ----------- | --- |  |  | - | --- | 
|In thousands   |  | Rent Expense |     | Sublet Income |  | Net Expense
|               |  |              |     |               |  |            
|2004           |  | $            | 791 |               |  | $           | 134 |  |  | $ | 657 | 
|2005           |  |              | 192 |               |  |             |    |  |  |   | 192 | 
|2006           |  |              | 4   |               |  |             |    |  |  |   | 4   | 
|2007 and after |  |              |    |               |  |             |    |  |  |   |    | 
|               |  |              |     |               |  |             |     |  |  |   |     | 
|               |  | $            | 987 |               |  | $           | 134 |  |  | $ | 853 | 
|               |  |              |     |               |  |             |     |  |  |   |     | 

The Company had four capital leases
covering lab equipment and furniture at its
Boulder office, all of which ended during fiscal 2003. The Company entered into a new
furniture lease in the Boulder office in
September 2003 for approximately $111,000.
This capital lease expires during fiscal
year 2005 with future minimum lease payments
as of October 31, 2003 totaling approximately
$100,000. Depreciation for assets under
capital lease arrangements is included in the
Companys depreciation expense for fiscal
year 2003.

Scientific Research CollaborationsThe
Company has entered into various collaborative
research and license agreements for its
non-nutritional algal technology. Under these
agreements, the Company is required to fund
research or to collaborate on the development
of potential products. The Company currently
has no commitments to fund such future
development activities. Certain of these
agreements also commit the Company to pay
royalties upon the sale of certain products
resulting from such

26



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##### 



collaborations. For the year ended October 31,
2003 and 2002, Martek incurred approximately
$121,000 and $106,000, respectively, in
royalties under such agreements pertaining to
the Companys fluorescent detection
products.

Government GrantsCosts under U.S.
government contracts are subject to audit by
the appropriate U.S. government agency.
Management believes that cost disallowances,
if any, arising from audits of costs charged
to government contracts through October 31,
2003, would not have a material effect on the
financial statements.

RoyaltiesIn connection with the purchase of
OmegaTech, the Company assumed an obligation to
pay a minimum of $7 million over the next eight
years associated with an agreement with a third
party relating to human and animal applications
for OmegaTechs DHA. In December 2002, the
Company signed an amendment to this agreement
under which the Company paid $500,000 and
signed a promissory note for approximately $3.3
million in exchange for the discharge of all
future obligations under the agreement. The first payment under the note of $1 million was
paid in August 2003, and the remainder of $2.3
million was recorded as a note payable at
October 31, 2003 and subsequently paid in
December 2003.

Purchase CommitmentsAs a result of the
acquisition of OmegaTech, the Company is
subject to a prior commitment to purchase a
minimum quantity of DHA biomass on favorable
terms from a third-party manufacturer. The
3.5-year commitment expires on June 31, 2005.
As of October 31, 2003, the Companys remaining
obligation was approximately $4.3 million, of
which the Company has open purchase orders
totaling approximately $511,000. The Company
has the option to extend the contract for
annual periods with minimum purchase
requirements.

OtherThe Company is involved in various
legal actions primarily concerning its
intellectual property. Management believes that
these actions will not materially affect the
Companys consolidated financial position or
results of operations.

14. LICENSE AGREEMENTS

The Company has licensed certain technologies
and recognized license fee revenue under
various agreements. License fees are recorded
as unearned revenue and amortized on a
straight-line basis over the term of the
agreement. During 2003, the Company signed five new license agreements relating to the use
of its oils in infant formula and received
license fees and product pre-payments of
approximately $5.5 million. In addition, the
Company recorded a receivable for an additional
$3 million in license fees due. There were
approximately $4.6 million in license fees and
prepayments recorded in 2002 and none in 2001.
The Company recognized approximately $224,000,
$159,000 and $225,000 as license revenue for
the years ended October 31, 2003, 2002 and
2001, respectively.

The balance of these
license fees and prepaid product purchases
remaining in unearned revenue was approximately
$11.8 million at October 31, 2003 and $4.2
million at October 31, 2002.

Certain license agreements include
ongoing royalty payments, which are based upon
a percentage of product sales. The Companys
total royalty revenues were approximately
$732,000 in 2003, $411,000 in 2002 and $1.2
million in 2001.

15. EARNINGS (LOSS) PER SHARE CALCULATION

Basic Earnings Per Share (EPS) is computed
using the weighted average number of common
shares outstanding. Diluted EPS is computed
using the weighted average number of common
shares outstanding, giving effect to stock
options and warrants using the treasury stock
method. Approximately 47,000, 4.2 million and
3.4 million options were outstanding but were
not included in the computation of diluted EPS
as the effect would be anti-dilutive during fiscal 2003, 2002 and 2001, respectively.

The following table presents the calculation
of basic and diluted net income (loss) per
share:

|                                              |  |      |        |      |  |      |         |   |  |   |         |  
|--------------------------------------------- |  | ---- | ------ | ---- |  | ---- | ------- | - |  | - | ------- | -
|In thousands, except per share amounts        |  | 2003 |        | 2002 |  | 2001
|                                              |  |      |        |      |  |     
|Net income (loss)                             |  | $    | 15,992 |      |  | $    | (24,233 | ) |  | $ | (13,702 | )
|Weighted average shares
outstanding  basic   |  |      | 25,510 |      |  |      | 21,982  |   |  |   | 18,864  |  
|Effect of dilutive potential common shares:   |  |      |        |      |  |      |         |   |  |   |         |  
|Employee stock options                        |  |      | 1,821  |      |  |      |       |   |  |   |       |  
|Warrants                                      |  |      | 86     |      |  |      |       |   |  |   |       |  
|                                              |  |      |        |      |  |      |         |   |  |   |         |  
|Total dilutive potential common shares        |  |      | 1,907  |      |  |      |       |   |  |   |       |  
|                                              |  |      |        |      |  |      |         |   |  |   |         |  
|Weighted average shares
outstanding  diluted |  |      | 27,417 |      |  |      | 21,982  |   |  |   | 18,864  |  
|                                              |  |      |        |      |  |      |         |   |  |   |         |  
|Net income (loss) per share  basic           |  | $    | 0.63   |      |  | $    | (1.10   | ) |  | $ | (0.73   | )
|                                              |  |      |        |      |  |      |         |   |  |   |         |  
|Net income (loss) per share  diluted         |  | $    | 0.58   |      |  | $    | (1.10   | ) |  | $ | (0.73   | )
|                                              |  |      |        |      |  |      |         |   |  |   |         |  

16. STOCKHOLDERS EQUITY

Private Placement of Common StockOn March 2,
2001, the Company sold 1,279,237 shares of its
common stock and issued warrants to purchase
319,811 shares of common stock in a private
placement, resulting in net proceeds of
approximately $18.7 million. The stock was
issued at $15.875 per share, representing the
closing market price on February 27, 2001. The
remaining warrants are exercisable for a period
of five years from the date of issuance at
$19.05 per share.

On December 17, 2001, the Company sold
1,177,000 shares of its common stock in a
private placement resulting in net proceeds to
the Company of approximately $21.3 million. The
stock was issued at a price of $19.25 per
share.

At October 31, 2003, the Company had
warrants outstanding to purchase up to 64,566
shares of common stock. These warrants had a
weighted average exercise price of $19.05 per
share and a weighted average remaining
contractual life of 2.3 years at October 31,
2003.

Public Offering of Common StockOn April
22, 2003, the Company completed a follow-on
public offering of its common stock in which
2,922,250 shares were issued at a price of
$30.25

27



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##### 



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

per share. Net proceeds to the Company,
after deducting underwriters fees and
estimated expenses, amounted to
approximately $83.2 million.

Stock Option PlanOptions to purchase common
stock under the Companys 1997 Stock Option
Plan, the Companys 2002 Stock Incentive Plan,
and the new 2003 New Employee Stock Option
Plan, collectively referred to as the Option
Plans, are granted at prices as determined by
the Compensation Committee, but shall not be
less than the fair market value of the
Companys common stock on the date of grant.
The options are a mix of qualified and
non-qualified and generally vest over a period
of up to five years. The Companys Compensation
Committee determines the exercise dates and
term of options (up to a maximum of ten years
from the date of grant).

As result of the Companys purchase of
OmegaTech, the Company assumed 154,589 options
from the OmegaTech, Inc. 1996 Stock Option Plan
(OmegaTech Plan). No new options may be
issued under this plan as of the date of the
purchase. Under the OmegaTech Plan, prices were
determined by the Compensation Committee, but
at an exercise price not less than the fair
market value of OmegaTechs common stock on the
date of grant. The options are a mix of
qualified and non-qualified and were all 100%
vested as of the purchase date. The 2003 New
Employee Stock Option Plan (2003 Plan) was
adopted in conjunction with the acquisition of
FermPro. 300,000 shares of common stock were
authorized to be issued under the 2003 Plan.
The options are non-qualified and generally
vest over a period of up to five years.

Details of shares under option were as follows:

|                                        |  |        |       |             |  |   |       | 
|--------------------------------------- |  | ------ | ----- | ----------- |  | - | ----- | 
|                                        |  | Number |       | Weighted   
|                                        |  | of     |       | Average    
|Shares in thousands                     |  | Shares |       | Price/Share
|                                        |  |        |       |            
|Options outstanding at October 31, 2000 |  |        | 2,813 |             |  | $ | 13.40 | 
|                                        |  |        |       |             |  |   |       | 
|Granted                                 |  |        | 863   |             |  | $ | 16.03 | 
|Exercised                               |  |        | (203  | )           |  | $ | 10.59 | 
|Canceled                                |  |        | (37   | )           |  | $ | 16.81 | 
|                                        |  |        |       |             |  |   |       | 
|Options outstanding at October 31, 2001 |  |        | 3,436 |             |  | $ | 14.17 | 
|Options exercisable at October 31, 2001 |  |        | 1,907 |             |  | $ | 14.63 | 
|                                        |  |        |       |             |  |   |       | 
|Granted                                 |  |        | 1,554 |             |  | $ | 25.99 | 
|Exercised                               |  |        | (500  | )           |  | $ | 12.86 | 
|Canceled                                |  |        | (332  | )           |  | $ | 25.14 | 
|                                        |  |        |       |             |  |   |       | 
|Options outstanding at October 31, 2002 |  |        | 4,158 |             |  | $ | 17.82 | 
|Options exercisable at October 31, 2002 |  |        | 2,603 |             |  | $ | 15.74 | 
|                                        |  |        |       |             |  |   |       | 
|Granted                                 |  |        | 1,112 |             |  | $ | 33.85 | 
|Exercised                               |  |        | (977  | )           |  | $ | 13.68 | 
|Canceled                                |  |        | (101  | )           |  | $ | 28.34 | 
|                                        |  |        |       |             |  |   |       | 
|Options outstanding at October 31, 2003 |  |        | 4,192 |             |  | $ | 22.68 | 
|Options exercisable at October 31, 2003 |  |        | 2,412 |             |  | $ | 18.50 | 
|                                        |  |        |       |             |  |   |       | 

The Company did not issue any options to
non-employees during the year ended October
31, 2003. The Company issued 9,000 and 24,000
options to non-employees during the years
ended October 31, 2002 and 2001,
respectively. All of these options were
vested as of January 2003. These options had
vesting periods of between 0-24 months. The
fair value of these options was recorded as
deferred compensation and amortized over the
performance period, which was generally 12
months.

At October 31, 2003, approximately
380,000 shares of common stock were available
for future grants under the Option Plans,
including the 2003 Plan. The weighted average
contractual life for all options outstanding
under the Option Plans at October 31, 2003 was
7.4 years.

Detailed information on the options
outstanding on October 31, 2003 by price range
is set forth as follows:

|                    |  |                     |       |             |  |           |     |             |  |           |       |         |  |          |       |  |  |   |       | 
|------------------- |  | ------------------- | ----- | ----------- |  | --------- | --- | ----------- |  | --------- | ----- | ------- |  | -------- | ----- |  |  | - | ----- | 
|OPTIONS OUTSTANDING |  | OPTIONS EXERCISABLE
|                    |  |                    
|Shares in thousands |  |                     |       |             |  | Weighted  |     |             |  |           |       |         |  |          |       |  |  |  
|                    |  |                     |       |             |  | Average   |     | Weighted    |  |           |       |         |  | Weighted
|                    |  |                     |       |             |  | Remaining |     | Average     |  | Remaining |       | Average
|Range of            |  | Options             |       | Contractual |  | Exercise  |     | Shares      |  | Exercise 
|Exercise Prices     |  | Outstanding         |       | Life        |  | Price     |     | Exercisable |  | Price    
|                    |  |                     |       |             |  |           |     |             |  |          
|$0.12-16.93         |  |                     | 1,545 |             |  |           | 6.0 |             |  | $         | 11.72 |         |  |          | 1,327 |  |  | $ | 11.52 | 
|$16.94-33.85        |  |                     | 2,256 |             |  |           | 8.0 |             |  | $         | 25.69 |         |  |          | 1,074 |  |  | $ | 26.97 | 
|$33.86-50.78        |  |                     | 295   |             |  |           | 9.5 |             |  | $         | 46.81 |         |  |          | 11    |  |  | $ | 34.35 | 
|$50.79-67.71        |  |                     | 96    |             |  |           | 9.9 |             |  | $         | 54.23 |         |  |          |     |  |  | $ |     | 
|                    |  |                     |       |             |  |           |     |             |  |           |       |         |  |          |       |  |  |   |       | 
|                    |  |                     | 4,192 |             |  |           | 7.4 |             |  | $         | 22.68 |         |  |          | 2,412 |  |  | $ | 18.50 | 

Directors Stock Option PlanIn 1994, the
Company established a Directors Stock Option
Plan (Directors Plan). The Directors Plan
provided for the award of stock options to
non-employee directors. At October 31, 2003,
101,500 options were outstanding and no
additional options were available for future
grant under the Directors Plan. The weighted
average contractual life for all options
outstanding under the Directors Plan at
October 31, 2003 was 3.0 years. No awards have
been made under the Directors Plan since 1998.
During 2003, Directors of the Company received option grants
under the Companys Option Plans.

Pro Forma DisclosureThe weighted average
fair market values of the options at the date
of grant for options granted during fiscal
2003, 2002 and 2001 were $37.59, $18.74 and
$10.44, 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 fiscal years 2003, 2002 and
2001:

|                        |  |                        |      |      |  |      |      |   |  |  |      |  
|----------------------- |  | ---------------------- | ---- | ---- |  | ---- | ---- | - |  |  | ---- | -
|                        |  | Year Ended October 31,
|In thousands            |  | 2003                   |      | 2002 |  | 2001
|                        |  |                        |      |      |  |     
|Expected volatility     |  |                        | 71.2 | %    |  |      | 68.2 | % |  |  | 66.3 | %
|Risk-free interest rate |  |                        | 3.5  | %    |  |      | 4.5  | % |  |  | 3.0  | %
|Expected life (years)   |  |                        | 7    |      |  |      | 7    |   |  |  | 7    |  
|Expected dividend yield |  |                        | 0    | %    |  |      | 0    | % |  |  | 0    | %

Stockholder Rights PlanIn January 1996, the
Board of Directors adopted a Stockholder
Rights Plan (Rights Plan) in which preferred
stock purchase rights (Rights) have been
granted as a dividend at the rate of one Right
for each share of the Companys common stock
held of record at the close of business on
February 7, 1996. Each Right provides the
holder the opportunity to purchase 1/1000th of
a share of Series A Junior Participating
Preferred Stock under certain circumstances

28



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##### 



at a price of $150 per share of such preferred
stock. All rights expire on February 7, 2006.

At the time of adoption of the Rights
Plan, the Rights were neither exercisable nor
traded separately from the common stock. The
Rights will be exercisable only if a person or
group in the future becomes the beneficial
owner of 20% or more of the common stock or
announces a tender or exchange offer which
would result in its ownership of 20% or more
of the common stock. Ten days after a public
announcement that a person or group has become
the beneficial owner of 20% or more of the
common stock, each holder of a Right, other
than the acquiring person, would be entitled
to purchase $300 worth of the common stock of
the Company for each Right at the exercise
price of $150 per Right, which would
effectively enable such Right-holders to
purchase the common stock at one-half of the
then-current price.

If the Company is acquired in a merger,
or 50% or more of the Companys assets are
sold in one or more related transactions, each
Right would entitle the holder thereof to
purchase $300 worth of common stock of the
acquiring company at the exercise price of
$150 per Right, which would effectively enable
such Right-holders to purchase the acquiring
companys common stock at one-half of the
then-current market price.

At any time after a person or group of
persons becomes the beneficial owner of 20%
or more of the common stock, the Board of
Directors, on behalf of all stockholders, may
exchange one share of common stock for each
Right, other than Rights held by the acquiring
person.

The Board of Directors may authorize the
redemption of the Rights, at a redemption
price of $.001 per Right, at any time until
ten days (as such period may be extended or
shortened by the Board) following the public
announcement that a person or group of persons
has acquired beneficial ownership of 20% or
more of the outstanding common stock.

17. INCOME TAXES

The difference between the tax provision and
the amount that would be computed by applying
the statutory Federal income tax rate to
income before taxes is attributable to the
following:

|                                  |  |                        |        |      |  |      |        |   |  |   |        |  
|--------------------------------- |  | ---------------------- | ------ | ---- |  | ---- | ------ | - |  | - | ------ | -
|                                  |  | Year Ended October 31,
|In thousands                      |  | 2003                   |        | 2002 |  | 2001
|                                  |  |                        |        |      |  |     
|Federal income
tax benefit
at 34% |  | $                      | 5,438  |      |  | $    | (8,239 | ) |  | $ | (4,659 | )
|Permanent items                   |  |                        | (6,045 | )    |  |      | 5,088  |   |  |   | 22     |  
|State taxes                       |  |                        | (83    | )    |  |      | (428   | ) |  |   | (630   | )
|Change in valuation
allowance     |  |                        | 690    |      |  |      | 3,579  |   |  |   | 5,267  |  
|                                  |  |                        |        |      |  |      |        |   |  |   |        |  
|Total expense                     |  | $                      |       |      |  | $    |       |   |  | $ |       |  
|                                  |  |                        |        |      |  |      |        |   |  |   |        |  

For the year ended October 31, 2003, the
exercise of non-qualified stock options
resulted in a permanent tax benefit to the
Company. For the year ended October 31, 2002,
permanent items increased substantially from
the prior years because of the
non-deductibility of certain items charged to
expense related to the OmegaTech acquisition.
Additionally, deferred tax liabilities
increased because of the purchased identified
intangibles from OmegaTech.

Deferred income taxes reflect the net
tax effects of temporary differences between
the carrying amount of assets and liabilities
for financial reporting purposes and the
amounts used for income tax purposes. Significant components of the Companys net deferred
income taxes are as follows:

|                                 |                   |      |             |        |   |   |         |        |  
|-------------------------------- | ----------------- | ---- | ----------- | ------ | - | - | ------- | ------ | -
|                                 |                   |      | October 31,
|In thousands                     |                   | 2003 |             | 2002  
|                                 |                   |      |             |       
|Deferred tax assets:             |                   |      |             |        |   |   |         |       
|Patent expenses                  |                   | $    | 546         |        |   | $ | 561     |       
|Net operating loss carryforwards |                   |      | 65,311      |        |   |   | 65,084  |       
|Deferred revenue                 |                   |      | 3,699       |        |   |   | 1,615   |       
|Other                            |                   |      | 3,402       |        |   |   | 2,351   |       
|                                 |                   |      |             |        |   |   |         |       
|                                 | Total assets      |      | $           | 72,958 |   |   | $       | 69,611 |  
|Deferred tax liabilities:        |                   |      |             |        |   |   |         |       
|Depreciation                     |                   | $    | (1,217      | )      |   | $ | ( 564   | )     
|Identified intangibles           |                   |      | (5,960      | )      |   |   | (6,411  | )     
|                                 |                   |      |             |        |   |   |         |       
|                                 | Total liabilities |      |             | (7,177 | ) |   |         | (6,975 | )
|                                 |                   |      |             |        |   |   |         |       
|Net deferred tax asset           |                   |      | 65,781      |        |   |   | 62,636  |       
|Valuation allowance              |                   |      | (65,781     | )      |   |   | (62,636 | )     
|                                 |                   |      |             |        |   |   |         |       
|Net deferred tax asset           |                   | $    |            |        |   | $ |        |       
|                                 |                   |      |             |        |   |   |         |       

The Company recognized a valuation
allowance to the full extent of its deferred
tax assets since the likelihood of realization
of the benefit cannot be determined. When and
if the likelihood of realization of the benefit becomes probable, the Company will reverse
the valuation allowance. The Company
anticipates establishing a deferred tax asset
in late 2004 or early 2005, based on expected
operating results. At October 31, 2003, the
Company had net operating loss carryforwards
for federal income tax purposes of
approximately $169.1 million, which will
expire, if unused, in the year 2004 through the
year 2023. A tax benefit of approximately
$28.1 million of net operating losses related
to stock options will be credited to equity
when the benefit is realized through
utilization of the net operating loss
carryforwards.

Section 382 of the Internal Revenue Code
limits the utilization of net operating losses
when ownership changes, as defined by that
section, are greater than 50%. The Company is
currently performing an analysis to determine
the effects of ownership changes on the
utilization of net operating losses. The
Company believes, based on a preliminary
analysis, that although a 382 limitation may
impact the timing of the use of a portion of
its net operating losses, no net operating
losses will expire unused.

18. EMPLOYEE 401(K) PLAN

The Company maintains an employee 401(k) Plan
(the Plan). The Plan, which covers all
employees 21 years of age or older, stipulates
that participating employees may elect an
amount between 1% and 15% of their total
compensation to contribute to the Plan, not to
exceed the maximum allowable by Internal

29



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##### 



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Revenue Service regulations. The Company may
make matching contributions equal to a
discretionary percentage up to 3% of a
participants salary deductions. All amounts
deferred by a participant under the 401(k)
Plans salary reduction feature vest
immediately in the participants account while
contributions the Company may make would vest
over a five-year period in the participants
account. The Company contributed approximately
$374,000 to the Plan related to fiscal 2003.

19. SUBSEQUENT EVENTS

On December 17, 2003, the Company executed a
collaboration agreement with SemBioSys
Genetics, Inc., a Canadian biotechnology
company, to co-develop plant-based DHA
products. Under the terms of the multi-year
agreement, SemBioSys will use its safflower
biotechnology capabilities to attempt to
develop plant-based DHA products for Martek in
return for up to $10 million in research
payments and milestone payments as well as
royalties on new product sales.

On January 26, 2004, the Company entered
into an $85 million secured revolving line of
credit that expires in 2007. Interest on the
line of credit is Libor based. The line of
credit will be used primarily to assist in financing the expansion at the Companys new
Kingstree, SC facility. This new line of credit
replaces the $10 million secured working
capital line of credit established in February
2003 by the Company. The Company did not have
any borrowings under the previous working
capital line of credit.

On January 26, 2004, the terms of the $10 million secured note
assumed in the FermPro acquisition were amended. The
maturity date was changed from December 31,
2013 to December 31, 2008. In addition, the
note was amended to be unsecured.

20. QUARTERLY FINANCIAL INFORMATION (unaudited)

Quarterly financial information for fiscal
2003 and 2002 is presented in the
following table:

|                                     |  |         |        |         |  |         |         |          |  |   |        |   |  |   |        | 
|------------------------------------ |  | ------- | ------ | ------- |  | ------- | ------- | -------- |  | - | ------ | - |  | - | ------ | 
|In thousands,                        |  | 1st     |        | 2nd     |  | 3rd     |         | 4th     
|except per share data                |  | Quarter |        | Quarter |  | Quarter |         | Quarter1
|                                     |  |         |        |         |  |         |         |         
|2003                                 |  |         |        |         |  |         |         |          |  |   |        |   |  |   |        | 
|Total revenues                       |  | $       | 20,545 |         |  | $       | 26,447  |          |  | $ | 29,115 |   |  | $ | 38,630 | 
|Cost of sales                        |  |         | 12,342 |         |  |         | 15,642  |          |  |   | 17,017 |   |  |   | 23,538 | 
|Income from operations               |  |         | 1,924  |         |  |         | 2,921   |          |  |   | 4,254  |   |  |   | 5,977  | 
|Net income                           |  |         | 2,061  |         |  |         | 3,091   |          |  |   | 4,603  |   |  |   | 6,237  | 
|Net income per share, basic          |  |         | 0.09   |         |  |         | 0.13    |          |  |   | 0.17   |   |  |   | 0.23   | 
|Net income per share, diluted        |  |         | 0.08   |         |  |         | 0.12    |          |  |   | 0.16   |   |  |   | 0.21   | 
|2002                                 |  |         |        |         |  |         |         |          |  |   |        |   |  |   |        | 
|Total revenues                       |  | $       | 5,970  |         |  | $       | 11,423  |          |  | $ | 13,544 |   |  | $ | 15,118 | 
|Cost of sales                        |  |         | 4,184  |         |  |         | 8,285   |          |  |   | 8,538  |   |  |   | 8,787  | 
|(Loss) income from operations        |  |         | (3,206 | )       |  |         | (18,178 | )        |  |   | (3,977 | ) |  |   | 170    | 
|Net (loss) income                    |  |         | (2,947 | )       |  |         | (17,917 | )        |  |   | (3,744 | ) |  |   | 375    | 
|Net (loss) income
per share, basic   |  |         | (0.15  | )       |  |         | (0.84   | )        |  |   | (0.16  | ) |  |   | 0.02   | 
|Net (loss) income
per share, diluted |  |         | (0.15  | )       |  |         | (0.84   | )        |  |   | (0.16  | ) |  |   | 0.02   | 

1Approximately $2.4 million of the sales and
$2.2 million of the cost of sales relate to
the FermPro acquisition.

30



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REPORT OF INDEPENDENT AUDITORS

Board of Directors
Martek Biosciences Corporation

We have audited the accompanying consolidated balance
sheets of Martek Biosciences Corporation as of October 31,
2003 and 2002, and the related consolidated statements of
operations, stockholders equity, and cash flows for each
of the three years in the period ended October 31, 2003.
These financial statements are the responsibility of the
Companys management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing
standards generally accepted in the United States. Those
standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles
used and significant estimates made by management, as well
as evaluating the overall financial statement
presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the financial statements referred to above
present fairly, in all material respects, the consolidated
financial position of Martek Biosciences Corporation at
October 31, 2003 and 2002, and the consolidated results of
its operations and its cash flows for each of the three
years in the period ended October 31, 2003, in conformity
with accounting principles generally accepted in the
United States.

-s- Ernst & Young LLP

McLean, Virginia
December 12, 2003 except for Note 19,  as
to which the date is January 26, 2004

31



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Stock Description and Form 10-K

The Companys common stock is traded on the
NASDAQ National Market System under the symbol
MATK. As of December 31, 2003, there were
approximately 455 holders of record of the
Companys common stock. The closing price of
the Companys common stock was $67.84 on
January 26, 2004. No cash dividends have been
paid on the common stock and the Company does
not anticipate paying any cash dividend in the
foreseeable future. The following table sets
forth, for the calendar periods indicated, the
range of high and low sale prices for the
Companys common stock as reported by NASDAQ:

Price Range of Common Stock

|                                    |  |      |       |     |  |   |       | 
|----------------------------------- |  | ---- | ----- | --- |  | - | ----- | 
|Fiscal 2002                         |  | High |       | Low
|                                    |  |      |       |    
|November 1, 2001 - January 31, 2002 |  | $    | 30.90 |     |  | $ | 19.12 | 
|February 1, 2002 - April 30, 2002   |  | $    | 34.25 |     |  | $ | 25.09 | 
|May 1, 2002 - July 31, 2002         |  | $    | 30.80 |     |  | $ | 13.82 | 
|August 1, 2002 - October 31, 2002   |  | $    | 18.53 |     |  | $ | 12.50 | 

|                                    |  |      |       |     |  |   |       | 
|----------------------------------- |  | ---- | ----- | --- |  | - | ----- | 
|Fiscal 2003                         |  | High |       | Low
|                                    |  |      |       |    
|November 1, 2002 - January 31, 2003 |  | $    | 27.38 |     |  | $ | 15.40 | 
|February 1, 2003 - April 30, 2003   |  | $    | 34.38 |     |  | $ | 21.11 | 
|May 1, 2003 - July 31, 2003         |  | $    | 53.25 |     |  | $ | 31.30 | 
|August 1, 2003 - October 31, 2003   |  | $    | 58.55 |     |  | $ | 43.19 | 

32