##### 



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 financial statements and notes
contained in this Annual Report.

|                                           |                                               |      |                        |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |         |  
|------------------------------------------ | --------------------------------------------- | ---- | ---------------------- | ------- | - | ---- | - | ------- | - | ---- | - | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                           |                                               |      | Year Ended October 31,
|                                           |                                               |      |                       
|In thousands except per share data         |                                               | 2002 |                        | 2001    |   | 2000 |   | 1999    |   | 1998
|                                           |                                               |      |                        |         |   |      |   |         |   |     
|Consolidated Statements of Operations Data |                                               |      |                        |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |        
|Revenues                                   |                                               |      |                        |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |        
|                                           | Product sales and royalties                   |      | $                      | 45,903  |   |      | $ | 18,575  |   |      | $ | 8,726   |   |  | $ | 5,744   |   |  | $ | 5,241   |  
|                                           | Research and development contracts and grants |      |                        | 45      |   |      |   | 142     |   |      |   | 879     |   |  |   | 383     |   |  |   | 484     |  
|                                           | License fees and other revenues               |      |                        | 107     |   |      |   | 107     |   |      |   | 72      |   |  |   | 6       |   |  |   | 1,165   |  
|                                           |                                               |      |                        |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |         |  
|                                           | Total revenues                                |      |                        | 46,055  |   |      |   | 18,824  |   |      |   | 9,677   |   |  |   | 6,133   |   |  |   | 6,890   |  
|Costs and expenses                         |                                               |      |                        |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |        
|                                           | Cost of product sales and royalties           |      |                        | 29,794  |   |      |   | 12,554  |   |      |   | 7,092   |   |  |   | 4,209   |   |  |   | 3,856   |  
|                                           | Research and development                      |      |                        | 11,648  |   |      |   | 12,705  |   |      |   | 12,517  |   |  |   | 10,309  |   |  |   | 9,787   |  
|                                           | Acquired in-process research and development  |      |                        | 15,788  |   |      |   |        |   |      |   |        |   |  |   |        |   |  |   |        |  
|                                           | Restructuring charge                          |      |                        | 1,266   |   |      |   |        |   |      |   |        |   |  |   |        |   |  |   |        |  
|                                           | Selling, general and administrative           |      |                        | 12,344  |   |      |   | 7,969   |   |      |   | 6,942   |   |  |   | 6,822   |   |  |   | 7,360   |  
|                                           | Other operating expenses                      |      |                        | 406     |   |      |   | 565     |   |      |   |        |   |  |   |        |   |  |   |        |  
|                                           |                                               |      |                        |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |         |  
|                                           | Total costs and expenses                      |      |                        | 71,246  |   |      |   | 33,793  |   |      |   | 26,551  |   |  |   | 21,340  |   |  |   | 21,003  |  
|                                           |                                               |      |                        |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |         |  
|                                           | Loss from operations                          |      |                        | (25,191 | ) |      |   | (14,969 | ) |      |   | (16,874 | ) |  |   | (15,207 | ) |  |   | (14,113 | )
|                                           | Other income, net                             |      |                        | 958     |   |      |   | 1,267   |   |      |   | 1,147   |   |  |   | 359     |   |  |   | 652     |  
|                                           |                                               |      |                        |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |         |  
|                                           | Net loss                                      |      | $                      | (24,233 | ) |      | $ | (13,702 | ) |      | $ | (15,727 | ) |  | $ | (14,848 | ) |  | $ | (13,461 | )
|                                           |                                               |      |                        |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |         |  
|                                           | Net loss per share, basic and diluted         |      | $                      | (1.10   | ) |      | $ | (0.73   | ) |      | $ | (0.91   | ) |  | $ | (0.95   | ) |  | $ | (0.94   | )
|                                           |                                               |      |                        |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |         |  
|                                           | Weighted average common shares outstanding    |      |                        | 21,982  |   |      |   | 18,864  |   |      |   | 17,335  |   |  |   | 15,581  |   |  |   | 14,330  |  
|                                           |                                               |      |                        |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |         |  

|                                                                         |  |             |          |      |  |      |          |      |  |      |         |   |  |   |         |   |  |   |         |  
|------------------------------------------------------------------------ |  | ----------- | -------- | ---- |  | ---- | -------- | ---- |  | ---- | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                                                         |  | October 31,
|                                                                         |  |            
|                                                                         |  | 2002        |          | 2001 |  | 2000 |          | 1999 |  | 1998
|                                                                         |  |             |          |      |  |      |          |      |  |     
|Consolidated Balance Sheet and Other Data                                |  |             |          |      |  |      |          |      |  |      |         |   |  |   |         |   |  |   |         |  
|Cash, cash equivalents, short-term investments
and marketable securities |  | $           | 22,419   |      |  | $    | 26,682   |      |  | $    | 19,264  |   |  | $ | 16,331  |   |  | $ | 17,657  |  
|Working capital                                                          |  |             | 30,457   |      |  |      | 31,501   |      |  |      | 21,266  |   |  |   | 20,162  |   |  |   | 21,011  |  
|Total assets                                                             |  |             | 124,312  |      |  |      | 56,603   |      |  |      | 45,442  |   |  |   | 39,145  |   |  |   | 40,747  |  
|Long-term portion of unearned revenue                                    |  |             | 2,246    |      |  |      | 2,353    |      |  |      | 2,460   |   |  |   |        |   |  |   |        |  
|Long-term debt                                                           |  |             |         |      |  |      |         |      |  |      |        |   |  |   | 472     |   |  |   | 1,951   |  
|Accumulated deficit                                                      |  |             | (127,560 | )    |  |      | (103,327 | )    |  |      | (89,625 | ) |  |   | (73,898 | ) |  |   | (59,049 | )
|Total stockholders equity                                               |  |             | 105,977  |      |  |      | 46,701   |      |  |      | 35,455  |   |  |   | 35,172  |   |  |   | 35,294  |  
|Cash dividends declared  common stock                                   |  |             |         |      |  |      |         |      |  |      |        |   |  |   |        |   |  |   |        |  

6



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##### 



MANAGEMENTS DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULS 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, production
expansion, margin and productivity
improvements and potential collaborations and
acquisitions;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |  | expectations regarding sales and
royalties by and from 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 and
purchase of third-party manufactured oils;                                            
| |  |  | 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 our expansion at our Winchester, KY facility;                                                                                                                                               
| |  |  | expectations regarding additional capital
expenditures needed in relation to our
fermentation and oil processing activities;                                                                                       
| |  |  | expectations regarding the integration of
the former OmegaTech with Martek; and                                                                                                                                    
| |  |  | expectations regarding production from the
FermPro Manufacturing, LP (FermPro)
facility.                                                                                                                         

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, 2002
as well as in various other filings with the
Securities and Exchange Commission (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 phycobili-some fluorescent detection
products. We currently have license agreements
with seven infant formula manufacturers
representing approximately 60% of the
estimated $7.5 to $8 billion worldwide wholesale market
for infant formula. Five of these licensees
are now marketing term infant formula products
containing our oils in 25 countries and
pre-term infant formula products containing
our oils in over 60 countries around the
world. Supplemented term infant formulas
manufactured by three of our licensees are
currently being marketed in the United States.

In April 2002, we purchased OmegaTech,
Inc. (OmegaTech or Martek Boulder) a
low-cost algal DHA producer located in
Boulder, Colorado. OmegaTech had been in the
fermentable DHA business since 1987, and had
accumulated over 100 issued and pending
patents protecting its DHA technology. Its
revenues, which mainly consisted of sales of
DHA into the dietary supplement, food,
beverage, and animal feed markets, averaged
approximately $6.0 million in each of its
fiscal years ended 2001 and 2000, and its
historical losses were $16.5 million in 2001
and $11.7 million in 2000. On July 29, 2002,
we announced a restructuring of the food and
beverage sales efforts in Boulder. This
restructuring, combined with cost-cutting
efforts made prior to the acquisition, has
significantly reduced the ongoing operating
expenses of Martek Boulder.

We have incurred losses in each year
since our inception. At October 31, 2002, our
accumulated deficit was approximately $127.6
million. Although we anticipate significant
growth in sales of our nutritional oils, and
we achieved an operating

7



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##### 



Managements Discussion and Analysis of Financial Condition and Results of Operations (continued)

profit in our fiscal fourth quarter of 2002,
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-sponsored reimbursement programs in the
U.S.,
| |  |  | the acceptance of these products by consumers,                                                                               
| |  |  | the production of adequate levels of our
nutritional oils by ourselves and our
third-party manufacturers,                    
| |  |  | competition from alternative sources of DHA and ARA, and/or                                                                  
| |  |  | 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.

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.

Restructuring ChargeWe 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 over the
first two fiscal quarters of 2003.

Allocation of OmegaTech Purchase PriceOn
April 25, 2002, we completed the acquisition
of OmegaTech for approximately $54.1 million in
Martek stock. As part of the purchase price
allocation, we preliminarily identified and
valued all intangible assets that were a part
of the merger. As a result of updated
information relating to our preliminary
estimates, we have adjusted the valuation of
the identifiable intangible assets to a net
value of approximately $17.2 million. The
excess of the purchase price over the fair
value of tangible and identifiable intangible
net assets of approximately $25.6 million was
allocated to goodwill. We determined that the
technology assets acquired had continuing
value. As a result of this 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 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 amount allocated
to acquired in-process research and
development was charged to expense as of the
date of the acquisition. Based on current
information, management believes that the
estimates and assumptions underlying the
purchase price allocation are accurate.
However, the allocation of the purchase price
may be subject to further revision based on
the final determination of fair values and
final assessment of certain tax matters.

Impairment of GoodwillIn July 2001, the
Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting
Standards No. 142, Goodwill and Other
Intangible Assets (SFAS 142). SFAS 142
requires goodwill to be tested for impairment
on an annual basis and between annual tests in
certain circumstances, and written down when
impaired, rather than being amortized as
previous accounting standards required.
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. We
recorded goodwill related to our acquisition
of OmegaTech in April, 2002. The goodwill
acquired in the OmegaTech acquisition is
subject to the provisions of SFAS 142 and
accordingly, is not being amortized. We are
required to perform an annual impairment
review of our goodwill balance beginning with
a recurring annual measurement date. We have
chosen August 1 to be the annual measurement
date for our annual impairment review and will
perform our first review as of August 1, 2003.
If certain conditions occur, we may need to
take a goodwill impairment charge at that
time.

Impairment of Long-Lived AssetsWe 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 is done at the lowest possible
level for which there are identifiable assets.
If such assets are considered to be impaired,
the impairment to be recognized is measured by
the amount by which the carrying amount of
assets exceed the fair value of the assets.
Assets to be disposed of are reported at the
lower of the carrying amount or fair value
less costs to sell. To date, we have not

8



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##### 



incurred any impairment losses.

Costs of ARA Oil ProductionWe contract with
a third party in Europe, DSM Gist 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.

For discussion of our significant accounting
policies, see Note 2 of Notes to Consolidated
Financial Statements (Significant Accounting
Policies).

MANAGEMENT OUTLOOK

We believe that the outlook for future
revenue growth remains positive, although
quarterly results may show fluctuations, and
we expect fiscal 2003 sales to surpass prior
year levels. Specifically, we believe that for
fiscal 2003 as a whole, term infant formulas
containing our oils will be introduced in
additional countries and sales of our
nutritional oils will continue to grow in
countries where our oils are currently sold.
To date, five of our infant formula licensees
have obtained the regulatory approval, where
required, to sell term infant formula products
containing our oils in 25 countries and
pre-term infant formula products containing
our oils in over 60 countries around the
world. Supplemented term infant formulas
manufactured by three of our licensees are
currently being marketed in the United States
and we expect these sales to increase in 2003.

In fiscal year 2002, over 90% of our
revenues related to the sales of our oils for
use in infant formula products. We anticipate
increased sales of our oils in 2003 for other
products such as products developed for
pregnant and nursing mothers 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 larger
potential market than infant formula.

We are currently in the start-up phase of
production for the expansion of our facility
in Winchester, KY. We expect to begin full
production in the second quarter of 2003,
which should more than double our current
capacity. DSM is also in the process of
expanding its production capability for ARA
and estimates completion in the second quarter
of 2003. Once these expansions are complete,
we should have the production capacity to
generate nutritional oil sales of
approximately $120 to $160 million per year.
If the start-up phase of our production
expansion does not proceed as
planned, or if market demand increases
faster than anticipated, our sales could be
negatively impacted by our inability to meet
demand for our products. In addition, if
market demand increases faster than
anticipated, our capital needs related to
further expansion of our production facilities
may accelerate.

ACQUISITIONS AND DISPOSITIONS

On April 25, 2002, we completed our
purchase 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 if
certain milestones are met. Two of these
milestones relate to operating results (sales
and gross profit margin objectives by October
2004) and two relate to regulatory and
labeling approvals in the U.S. and Europe. An
authoritative statement was issued during 2002
relating to the milestone concerning labeling
approvals in the U.S., however we have
determined that as of October 31, 2002, the
requirements of this milestone have not been
met. The total of our common stock that may be
issued relating to this additional
consideration is approximately 1.4 million
shares based on the price of $27.88 per share,
but may increase to approximately 2.3 million
shares depending on the average market price
of our stock on the dates that the milestones
are achieved. 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 fair
value. We have revised our preliminary
purchase price allocation as permitted under
SFAS 142 primarily to adjust the life and
assigned value to the trademarks acquired in
the purchase as we further redefined our
marketing strategy related to DHA Gold®.

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 the former stable
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,
2002 the value of the investment in the new
company was fully reserved. During 2002, we
recognized approximately $106,000 in royalty
revenue in connection with this arrangement.

RESULTS OF OPERATIONS

RevenuesNutritional product sales and
royalties increased by $28.3 million or 169%
in 2002 as compared to 2001 primarily due to
increased sales of our oils to our infant
formula licensees. A portion of the increase
can be attributed to the introduction of
infant formulas containing our oils in the
U.S.

9



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##### 



Managements Discussion and Analysis of Financial Condition and Results of
Operations (continued)

in 2002. Approximately $1.6 million of the
increase is from revenue related to the
ongoing operations of OmegaTech. Over fifty
percent 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. All three of these companies are
currently manufacturing infant formulas
supplemented with our oils for sale in the
U.S., and Mead Johnson, Abbott and Wyeth are
collectively marketing supplemented term
infant formula in over 25 countries around the
world. We anticipate sales of nutritional
products will continue to grow as infant
formulas containing our oils will be
introduced in additional countries and sales
of our nutritional oils will continue to grow
in countries where our oils are currently
sold. Nutritional product sales and royalties
increased $9.9 million, or 144% in 2001 as
compared to 2000. The increase in 2001 as
compared to 2000 was primarily due to
increased sales of oil to infant formula
licensees as our licensees launched premium
term infant formulas with our oils in twelve
additional countries in 2001, including the
United Kingdom and Spain. Royalties decreased
as a percentage of total product sales and
royalties to 1% in 2002 from 7% in 2001 and
from 11% in 2000 as we converted most of our
customers payment structures from a
royalty-based pricing structure to an
all-inclusive pricing structure. Under
royalty-based pricing, we sell products to our
licensees at an initial transfer price and
there is an approximate three- to six-month
delay after this sale until royalties are
received and recognized as revenue. Under
all-inclusive pricing, we incorporate a
slightly discounted royalty up-front into our
sales price. The overall economics of an
all-inclusive price closely match those of our
royalty-bearing arrangements; however, the
all-inclusive price eliminates major
fluctuations in the timing of revenue
recognition and cash flows that result from
the delayed impact of royalties.

Sales of other products decreased
$985,000 or 56% in 2002 as compared to 2001
primarily due to the sale of the stable
isotope product line in November 2001 to
Spectra Gases, Inc. Revenue of $789,000 in
2002 primarily relates to sales of our
fluorescent detection products, which
increased $508,000 or 182% as compared to 2001
due to increased sales under a distribution
agreement with PerkinElmer Life Sciences,
Inc., (PerkinElmer). Our sales of other
products decreased $80,000, or 4% in 2001 as
compared to 2000. For 2001, decreased sales of
stable isotopes were offset by improved sales
of fluorescent detection products, which
increased primarily due to the distribution
agreement with PerkinElmer that was entered
into during the first quarter of fiscal year
2001.

Other revenue, which consists primarily
of revenues from research and development
contracts and grants and third party license
agreements decreased $97,000 or 39% in 2002 as
several development grants were completed in
2001. Other revenue decreased $702,000 or 74%
in 2001 as compared to 2000 as a third-party development project
that occurred during 2000 at our Winchester,
KY plant did not repeat in 2001.

As a result of the above, total
revenues increased by $27.2 million or 145%
in 2002 as compared to 2001 and increased
$9.1 million or 95% in 2001 as compared to
2000.

Cost of Product Sales and RoyaltiesOur cost
of product sales and royalties improved during
2002 primarily due to lower costs from DSM,
our third-party supplier of ARA. 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 and royalties decreased to 65% of
revenues from product sales and royalties for
2002, down from 68% in 2001. 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. We expect
continued decreases in the future costs of ARA
from DSM as our sales volumes continue to
increase. However, volume savings could be
partially offset by continued decreases in the
exchange ratio between the Euro and the U.S.
dollar. We also anticipate reductions in DHA
oil production costs as: (1) economies of
scale are realized from increased output from
the fermentation expansion which is currently
in the start-up phase of production at our
Winchester, KY production plant, and (2) yield
improvements from our R&D efforts are
realized. Our cost of product sales and
royalties decreased to 68% in 2001 from 81% in
2000. The improvement in margin in 2001 is
primarily a result of the change in pricing to
most of our infant formula licensees from a
royalty-based price to an all-inclusive
pricing structure. The all-inclusive price
eliminates major fluctuations in the timing of
the realization of costs of sales with the
recognition of royalty revenue and the related
cash flows.

Research and DevelopmentOur research and
development costs decreased $1.1 million or 8%
in 2002 as compared to 2001. Approximately
$539,000 of this decrease relates to the sale
of the stable isotope product line in November
2001 to Spectra-Gases with the remaining
decrease primarily due to large-scale
development activity at our Winchester, KY
plant being placed into production in 2002.
These decreases were partially offset by $1.2
million of research and development costs
incurred in 2002 related to approximately six
months of operations of Martek Boulder.
Research and development costs increased
$188,000 or 2% in 2001 as compared to 2000.

Approximately 40% of the $11.6 million in
research and development expenditures incurred
in 2002 related to large-scale development
activity at our Winchester, KY plant. Although
we implemented many of these projects into our
production process in 2002, we expect to incur
at least an additional $2-$4 million of such
costs in 2003. The remainder
of our research and development expenditures
in 2002 relate primarily to the following:

1) Approximately $5.0 million on pilot
scale research on our nutritional oils
at our facilities in Winchester, KY,
Columbia, MD and Boulder, CO. This
work, which is primarily aimed at
gaining an increased understanding of
the biology, genetics and behavior of
our oils, should continue and may
increase in 2003, along with the
related costs.

2) Approximately $1.3 million on
developing new presentations for our
oils. This includes emulsions, powders
and various types of dried
presentations that will improve the
integration of our products into
different types of supplements, foods
and beverages. These costs will likely
increase in 2003 as demand for new
potential applications for DHA
increases in the marketplace.

3) Approximately $1.2 million to manage and
fund ongoing clinical trials on our
nutritional oils. We anticipate these costs
to increase slightly in 2003 as some of our
trials near completion.

10



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##### 



Acquired In-Process Research and Development

Approximately one-third of the OmegaTech
purchase price was allocated to research
projects in which the technical feasibility
had not yet been established, resulting in a
one-time charge to acquired in-process
research and development of $15.8 million
under applicable accounting rules in the
quarter ended April 30, 2002. 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. Of the $15.8 million
total, $12.8 million was assigned to a project
to develop a lower cost, oil extraction
process and $3.0 million was assigned to a
project to develop a lower cost delivery
mechanism for DHA oil for the food and
beverage market.

The goal of the lower cost oil extraction
project is to develop a cheaper, less
capital-intensive process for the manufacture
of the DHA oil used by Martek in its food and
beverage products. As of the acquisition date,
prototypes had been tested but the scale-up to
a manufacturing process was still uncertain.
Total spending on this project as of the date
of acquisition was approximately $1.6 million,
and future spending was estimated to reach
approximately $600,000 before
commercialization in 2004. The project was
valued assuming that cash flows commence in
2004 based on projections of additional sales
that could be obtained with a lower cost
product. Cash flows were discounted at a
risk-adjusted rate of 48%. As of the date of
acquisition, there were significant risks in
both the time and costs necessary to bring
this project to a technically feasible
product. If this project is not completed, the
potential cost savings will not be realized
and additional sales opportunities for a
cheaper source of DHA oil may not come to
fruition.

The goal of the lower cost delivery
mechanism project for DHA oil is to develop a
cheaper, naturally encapsulated, dry source of
DHA for use in food fortification
applications. As of the date of acquisition,
prototypes had been tested but many commercial
requirements had not been adequately
demonstrated. Total spending on this project
as of the date of acquisition was
approximately $842,000 and future spending was
anticipated to be approximately $2.4 million
prior to commercialization in late 2003. The
project was valued assuming cash flows
commence in 2003 based on projections of
additional sales that could be obtained in the
food and beverage market. Cash flows were
discounted at a risk-adjusted rate of 48%. As
of the date of acquisition, there were
significant risks in both the time and costs
necessary to bring this project to a
technically feasible product. If this project
is not completed then additional sales
opportunities in the food and beverage market
may not be realized.

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
terminations costs, idle office space and
professional fees. As of October 31, 2002,
approximately $242,000 has been paid in
employee separation benefits and approximately
$187,000 has been paid in other costs,
resulting in an accrued liability related to
the restructuring of approximately $837,000.
The liability at October 31, 2002 relates
primarily to certain contractual liabilities
as of the restructuring date.

Selling, General and AdministrativeOur
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 increases in employees
and other overhead costs related to our
overall corporate growth. Management expects
these costs to increase in 2003 as a result of
the financial statements reflecting a full
year of expenses from Martek Boulder, albeit
at a lower level due to the restructuring of
the food and beverage sales efforts that
occurred in the third quarter of 2002, as
discussed above. Our selling, general and
administrative costs increased by $1.0
million, or 15%, in 2001 as compared to 2000.
These increases are primarily the result of
increased general corporate insurance and
legal expenses.

Other Operating ExpensesWe incurred other
operating expenses of $406,000 in 2002 and
$565,000 in 2001 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. We
expect to continue to incur these types of
expenses in 2003.

Other Income, NetOur other income, net
decreased by $309,000 in 2002 as compared to
2001. Interest income decreased $516,000 as
short-term interest rates have continued to
decrease in 2002. Other income 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. Other income,
net increased $120,000 in 2001 as compared to
2000, primarily due to higher cash balances on
which interest income was earned and a
decrease in interest expense on outstanding
debt, which was extinguished during the second
quarter of fiscal 2001.

Net LossAs a result of the foregoing, our net
loss increased to $24.2 million in 2002 from
$13.7 million in 2001. $20.3 million of the
net loss in 2002 was related to Martek
Boulder, including the charges for in-process
research and development and restructuring.
Our net loss decreased approximately $2.0
million in 2001 from a net loss of
approximately $15.7 million in 2000.

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

11



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##### 



Managements Discussion and Analysis of Financial Condition and Results of
Operations (continued)

assets since the likelihood of realization of
the benefit cannot be determined. At October
31, 2002, we had net operating loss
carryforwards for federal income tax purposes
of approximately $168.6 million, which will
expire, if unused, in the year 2003 through
the year 2022. A tax benefit of approximately
$22.1 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 ISSUED
ACCOUNTING PRONOUNCEMENTS

In October 2001, the Financial Accounting
Standards Board (FASB) issued SFAS No. 144,
Accounting for Impairment or Disposal of
Long-Lived Assets, which addresses financial
accounting and reporting for the impairment or
disposal of long-lived assets and supercedes
SFAS No. 121 and APB No. 30. SFAS No. 144 is
effective for Martek beginning November 1,
2002. We do not expect adoption of SFAS No.
144 to have a material effect on our financial
condition, results of operations or liquidity.

In June 2002, the FASB issued SFAS No. 146,
Accounting for Costs Associated with Exit or
Disposal Activities. SFAS 146 nullifies
previous accounting guidance and requires that
a liability for a cost associated with an exit
or disposal activity be recognized when the
liability is incurred. The provisions of SFAS
146 are effective for exit or disposal
activities that are initiated after December
31, 2002. The adoption of SFAS No. 146 will
have an effect on the timing of the
realization of future restructuring charges
taken, if and when they occur. We cannot
determine at this time whether this Statement
will have a material effect on our financial
condition, results of operations or liquidity.

COLLABORATIVE AND LICENSING AGREEMENTS

We have entered into licensing agreements with
seven infant formula manufacturers, including
Mead Johnson & Company (a subsidiary of
Bristol-Myers Squibb Company), Abbott
Laboratories, Wyeth (formerly American Home
Products), Numico, Maabarot and Novartis, that
together comprise over 85% of the U.S. and 60%
of the worldwide infant formula markets. We
have contractually agreed not to disclose the
name of our seventh licensee, a small infant
formula manufacturer with less than 3% of the
worldwide market who has yet to purchase any
products from us. 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 22
years, contain no future funding commitments
on our part or that of our licensees, and may
be terminated by our licensees upon proper
notification. We recognized total product
sales and royalties relating to our license
agreements of approximately $40.8 million in
2002, $16.0 million in 2001 and $5.0 million
in 2000.

Pursuant to our most recent license agreement
with Abbott Laboratories, entered into on
March 31, 2000, we received total
consideration of $4.5 million, which
represented license fees, royalty prepayments
and product prepayments. We recorded the
non-refundable license fee payments as
unearned revenue and are recognizing them as
revenue on a straight-line basis over the
twenty-five year term of the agreement. We
recognize as revenue the non-refundable
prepayment as payments are due, in accordance
with the terms of the agreement. The license
agreement may be terminated by Abbott upon
proper notification to us in accordance with
the agreement.

NUTRITIONAL OILS PRODUCTION

We currently manufacture our DHA-rich
nutritional oils at our production facility in
Winchester, KY. In response to the growing
demand for our oils, in October 2001, we began
construction at our Winchester, KY plant to
significantly increase our fermentation
capacity and add a new shipping, packaging,
cold storage and office building at that
location. The start-up phase of production has
recently begun for this expansion and upon
completion, production capacity at the plant
should more than double. We have also signed a
DHA production agreement with FermPro, a
contract fermentation company in South
Carolina. We began receiving DHA under this
agreement with FermPro in late June of 2002.
We are also actively pursuing additional
fermentation capacity at several other
locations both within and outside the United
States.

In January 1997, we entered into an
agreement with DSM under which they became our
contract supplier for nutritional oils
containing ARA. DSM is a multi-billion dollar
international group of companies that is
active worldwide in the fields of life
science, product performance materials and
chemicals. Our agreement with DSM expires in
2007 and allows for Martek or another third
party to produce certain quantities of ARA if
customer demand requires it or if DSM does not
meet competitive pricing guidelines. At
October 31, 2002, we had outstanding inventory
purchase commitments to DSM totaling
approximately $3.9 million.

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,        
| |  |  | debt financing, and                                                   
| |  |  | revenues received under research and development contracts and grants.

Since our inception, we have raised
approximately $181 million from public and
private sales of our equity securities, as
well as option and warrant exercises.

Through October 31, 2002, we have incurred an
accumulated deficit of $127.6 million. Our
balance of cash and cash equivalents at
October 31, 2002 was $20.4 million. In
addition, at October 31, 2002, we had $2.0
million in short-term investments and
marketable securities, which consist primarily
of U.S. government agency securities with
average maturities of less than one year. Our
cash, cash equivalents, short-term investments
and marketable securities decreased
approximately $4.3 million since October 31,
2001. This decrease was attributable to cash
used in operating activities, which totaled
approximately $13.4 million, as well as cash
used for investing activities. Cash used for
investing activities primarily related to
approximately $21.1 million used for the
purchase of property, plant and equipment,

12



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##### 



which consisted primarily of the expansion of
and improvements made to our facility in
Winchester, KY and $1.2 million pertaining to
patent-related costs. These activities were
financed by cash raised in a common stock
private placement of approximately $21.3
million, and cash raised from the exercise of
options and warrants of $10.1 million during
fiscal 2002.

The expansion and continuing development
and optimization of our production facility in
Winchester, KY continues to have a material
effect upon our liquidity and capital
resources. The initial expansion of our
fermentation facility, which is in the
start-up phase and should more than double our
production capacity at our Winchester, KY
plant, may cost up to $15 million. Expansion
of office, warehouse and packaging facilities,
which is also nearing completion, as well as
the purchase of related equipment, may total
an additional $4 million. We have spent
approximately $13.5 million on facilities and
capital equipment surrounding these expansions
since October 31, 2001 and anticipate spending
approximately an additional $5.5 million in
2003.

We believe that our existing capital
resources will provide us with adequate
capital to meet these obligations as well as
our other operating and capital needs for at
least the next 12 months. However, we will need
additional cash if we continue expanding our
production capacity to meet the anticipated
future demand for our nutritional oils in 2004
and beyond. We are in the process of
establishing an $8 million to $10 million
working capital line of credit with a
financial institution to assist us in meeting
short-term cash needs and expect to have this in
place in early 2003. We plan to raise
additional capital in 2003 in the form of
equity securities or debt, or a combination of
equity and debt, to finance some or all of the
following activities:



| |  |  | further expansion of production capacity at our Winchester, KY plant,                                   
| | - |  | --------------------------------------------------------------------------------------------------------
| |  |  | expansion of acquired or third-party manufacturing facilities,                                          
| |  |  | research and development programs,                                                                      
| |  |  | pre-clinical and clinical studies,                                                                      
| |  |  | commercialization of our nutritional
oils, Neuromins® DHA, and our other products
under development, and
| |  |  | future contractual obligations.                                                                         

The table below sets forth our future
minimum payments under contractual
obligations at October 31, 2002.

|                                             |  |       |        |        |  |           |       |       |  |       |       |         |  |   |       |  |  |   |       | 
|-------------------------------------------- |  | ----- | ------ | ------ |  | --------- | ----- | ----- |  | ----- | ----- | ------- |  | - | ----- |  |  | - | ----- | 
|                                             |  |       |        |        |  | Less than |       | 1-3   |  | 4-5   |       | After 5
|In thousands                                 |  | Total |        | 1 year |  | years     |       | years |  | years
|                                             |  |       |        |        |  |           |       |       |  |      
|Long-term debt                               |  | $     |       |        |  | $         |      |       |  | $     |      |         |  | $ |      |  |  | $ |      | 
|Capital lease
obligations                    |  |       | 111    |        |  |           | 111   |       |  |       |      |         |  |   |      |  |  |   |      | 
|Operating leases                             |  |       | 1,985  |        |  |           | 695   |       |  |       | 1,290 |         |  |   |      |  |  |   |      | 
|Unconditional
inventory purchase
obligations |  |       | 9,865  |        |  |           | 5,065 |       |  |       | 4,800 |         |  |   |      |  |  |   |      | 
|Other long-term
obligations                  |  |       | 7,000  |        |  |           | 500   |       |  |       | 1,500 |         |  |   | 1,000 |  |  |   | 1,000 | 
|                                             |  |       |        |        |  |           |       |       |  |       |       |         |  |   |       |  |  |   |       | 
|Total contractual
cash obligations           |  | $     | 18,961 |        |  | $         | 6,371 |       |  | $     | 7,590 |         |  | $ | 1,000 |  |  | $ | 1,000 | 

In connection with the purchase of
OmegaTech, we 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. Subsequent
to October 31, 2002, we signed an amendment to
the agreement under which the Company paid
$500,000 and signed a promissory note for $3.3
million in exchange for the discharge of all
future obligations under the agreement. The
first payment under the note of $1.0 million
is payable in August of 2003 with the
remainder due in December of 2003.

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.

QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK

We contract with DSM, a third-party supplier
based in Europe, to produce our ARA oil.
Although we purchase ARA oil in U.S. dollars,
this price is based upon exchange rates
between the U.S. dollar and the Euro.
Fluctuations in the exchange rate between the
U.S. dollar and the Euro will impact our cost
of ARA oil and gross margins. A 5% change in
the exchange rate would impact gross margins
of our infant formula products by
approximately 1.5% to 2%. Although we expect
the price that we pay for ARA oil will
continue to decrease as volume increases, such
price decreases could be affected by exchange
rate fluctuations. We currently do not hedge
this exposure.

13



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MARTEK BIOSCIENCES CORPORATION

CONSOLIDATED BALANCE SHEETS

|                                                                                                                                                                |                                                  |      |             |        |  |   |          |        | 
|--------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------ | ---- | ----------- | ------ |  | - | -------- | ------ | 
|                                                                                                                                                                |                                                  |      | October 31,
|                                                                                                                                                                |                                                  |      |            
|In thousands, except share and per share data                                                                                                                   |                                                  | 2002 |             | 2001  
|                                                                                                                                                                |                                                  |      |             |       
|Assets                                                                                                                                                          |                                                  |      |             |        |  |   |          |       
|Current assets                                                                                                                                                  |                                                  |      |             |        |  |   |          |       
|                                                                                                                                                                | Cash and cash equivalents                        |      | $           | 20,419 |  |   | $        | 20,645 | 
|                                                                                                                                                                | Short-term investments and marketable securities |      |             | 2,000  |  |   |          | 6,037  | 
|                                                                                                                                                                | Accounts receivable, net                         |      |             | 9,597  |  |   |          | 5,101  | 
|                                                                                                                                                                | Inventories, net                                 |      |             | 9,718  |  |   |          | 6,466  | 
|                                                                                                                                                                | Other current assets                             |      |             | 1,312  |  |   |          | 800    | 
|                                                                                                                                                                |                                                  |      |             |        |  |   |          |        | 
|Total current assets                                                                                                                                            |                                                  |      | 43,046      |        |  |   | 39,049   |       
|                                                                                                                                                                | Property, plant and equipment, net               |      |             | 36,506 |  |   |          | 16,724 | 
|                                                                                                                                                                | Goodwill                                         |      |             | 25,568 |  |   |          |       | 
|                                                                                                                                                                | Intangible asset  current products, net         |      |             | 10,295 |  |   |          |       | 
|                                                                                                                                                                | Other intangible assets, net                     |      |             | 8,202  |  |   |          | 773    | 
|                                                                                                                                                                | Other assets                                     |      |             | 695    |  |   |          | 57     | 
|                                                                                                                                                                |                                                  |      |             |        |  |   |          |        | 
|Total assets                                                                                                                                                    |                                                  | $    | 124,312     |        |  | $ | 56,603   |       
|                                                                                                                                                                |                                                  |      |             |        |  |   |          |        | 
|Liabilities and stockholders equity                                                                                                                            |                                                  |      |             |        |  |   |          |       
|Current liabilities                                                                                                                                             |                                                  |      |             |        |  |   |          |       
|                                                                                                                                                                | Accounts payable                                 |      | $           | 3,854  |  |   | $        | 1,451  | 
|                                                                                                                                                                | Accrued liabilities                              |      |             | 6,687  |  |   |          | 4,108  | 
|                                                                                                                                                                | Obligations under capital leases                 |      |             | 111    |  |   |          |       | 
|                                                                                                                                                                | Current portion of unearned revenue              |      |             | 1,937  |  |   |          | 1,990  | 
|                                                                                                                                                                |                                                  |      |             |        |  |   |          |        | 
|Total current liabilities                                                                                                                                       |                                                  |      | 12,589      |        |  |   | 7,549    |       
|Long-term portion of unearned revenue                                                                                                                           |                                                  |      | 2,246       |        |  |   | 2,353    |       
|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;
23,331,091 and 19,552,316 shares issued and outstanding at
October 31, 2002 and 2001, respectively |                                                  |      | 2,333       |        |  |   | 1,955    |       
|Additional paid-in capital                                                                                                                                      |                                                  |      | 231,224     |        |  |   | 148,161  |       
|Deferred compensation                                                                                                                                           |                                                  |      | (20         | )      |  |   | (89      | )     
|Accumulated other comprehensive income                                                                                                                          |                                                  |      |            |        |  |   | 1        |       
|Accumulated deficit                                                                                                                                             |                                                  |      | (127,560    | )      |  |   | (103,327 | )     
|                                                                                                                                                                |                                                  |      |             |        |  |   |          |        | 
|Total stockholders equity                                                                                                                                      |                                                  |      | 105,977     |        |  |   | 46,701   |       
|                                                                                                                                                                |                                                  |      |             |        |  |   |          |        | 
|Total liabilities and stockholders equity                                                                                                                      |                                                  | $    | 124,312     |        |  | $ | 56,603   |       
|                                                                                                                                                                |                                                  |      |             |        |  |   |          |        | 

See accompanying notes.

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MARTEK BIOSCIENCES CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

|                                              |                                              |                           |            |                        |        |      |            |        |        |   |            |        |       | 
|--------------------------------------------- | -------------------------------------------- | ------------------------- | ---------- | ---------------------- | ------ | ---- | ---------- | ------ | ------ | - | ---------- | ------ | ----- | 
|                                              |                                              |                           |            | Year ended October 31,
|                                              |                                              |                           |            |                       
|In thousands, except share and per share data |                                              | 2002                      |            | 2001                   |        | 2000
|                                              |                                              |                           |            |                        |        |     
|Revenues                                      |                                              |                           |            |                        |        |      |            |        |        |   |            |       
|                                              | Product sales and royalties:                 |                           |            |                        |        |      |            |        |        |   |            |        |      
|                                              |                                              | Nutritional product sales |            | $                      | 44,703 |      |            | $      | 15,579 |   |            | $      | 5,924 | 
|                                              |                                              | Other product sales       |            |                        | 789    |      |            |        | 1,774  |   |            |        | 1,854 | 
|                                              |                                              | Royalties                 |            |                        | 411    |      |            |        | 1,222  |   |            |        | 948   | 
|                                              |                                              |                           |            |                        |        |      |            |        |        |   |            |        |       | 
|                                              | Total product sales and royalties            |                           |            | 45,903                 |        |      |            | 18,575 |        |   |            | 8,726  |      
|                                              | Other revenue                                |                           |            | 152                    |        |      |            | 249    |        |   |            | 951    |      
|                                              |                                              |                           |            |                        |        |      |            |        |        |   |            |        |       | 
|Total revenues                                |                                              |                           | 46,055     |                        |        |      | 18,824     |        |        |   | 9,677      |       
|Costs and expenses                            |                                              |                           |            |                        |        |      |            |        |        |   |            |       
|                                              | Cost of product sales and royalties          |                           |            | 29,794                 |        |      |            | 12,554 |        |   |            | 7,092  |      
|                                              | Research and development                     |                           |            | 11,648                 |        |      |            | 12,705 |        |   |            | 12,517 |      
|                                              | Acquired in-process research and development |                           |            | 15,788                 |        |      |            |       |        |   |            |       |      
|                                              | Restructuring charge                         |                           |            | 1,266                  |        |      |            |       |        |   |            |       |      
|                                              | Selling, general and administrative          |                           |            | 12,344                 |        |      |            | 7,969  |        |   |            | 6,942  |      
|                                              | Other operating expenses                     |                           |            | 406                    |        |      |            | 565    |        |   |            |       |      
|                                              |                                              |                           |            |                        |        |      |            |        |        |   |            |        |       | 
|Total costs and expenses                      |                                              |                           | 71,246     |                        |        |      | 33,793     |        |        |   | 26,551     |       
|                                              |                                              |                           |            |                        |        |      |            |        |        |   |            |        |       | 
|Loss from operations                          |                                              |                           | (25,191    | )                      |        |      | (14,969    | )      |        |   | (16,874    | )     
|Other income (expense)                        |                                              |                           |            |                        |        |      |            |        |        |   |            |       
|                                              | Interest income                              |                           |            | 607                    |        |      |            | 1,123  |        |   |            | 1,240  |      
|                                              | Interest expense                             |                           |            | (9                     | )      |      |            | (9     | )      |   |            | (193   | )    
|                                              | Other income                                 |                           |            | 360                    |        |      |            | 153    |        |   |            | 100    |      
|                                              |                                              |                           |            |                        |        |      |            |        |        |   |            |        |       | 
|Total other income, net                       |                                              |                           | 958        |                        |        |      | 1,267      |        |        |   | 1,147      |       
|                                              |                                              |                           |            |                        |        |      |            |        |        |   |            |        |       | 
|Net loss                                      |                                              | $                         | (24,233    | )                      |        | $    | (13,702    | )      |        | $ | (15,727    | )     
|                                              |                                              |                           |            |                        |        |      |            |        |        |   |            |        |       | 
|Net loss per share, basic and diluted         |                                              | $                         | (1.10      | )                      |        | $    | (0.73      | )      |        | $ | (0.91      | )     
|                                              |                                              |                           |            |                        |        |      |            |        |        |   |            |        |       | 
|Weighted average common shares outstanding    |                                              |                           | 21,982,117 |                        |        |      | 18,863,924 |        |        |   | 17,335,403 |       
|                                              |                                              |                           |            |                        |        |      |            |        |        |   |            |        |       | 

See accompanying notes.

15



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##### 



MARTEK BIOSCIENCES CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

|                                |                                                                                   |                    |            |              |  |              |       |         |  |              |         |               |  |             |      |       |   |   |     |             |   |   |          |         |   |   |         |         |         |  
|------------------------------- | --------------------------------------------------------------------------------- | ------------------ | ---------- | ------------ |  | ------------ | ----- | ------- |  | ------------ | ------- | ------------- |  | ----------- | ---- | ----- | - | - | --- | ----------- | - | - | -------- | ------- | - | - | ------- | ------- | ------- | -
|                                |                                                                                   |                    |            |              |  |              |       |         |  |              |         |               |  |             |      |       |   |   |     | Accumulated |   |   |          |         |   |   |         |        
|In thousands, except share data |                                                                                   |                    |            |              |  | Additional   |       |         |  |              |         | Other         |  |             |      |       |   |   |     |            
|                                |                                                                                   |                    |            | Common Stock |  | Common Stock |       | Paid-in |  | Deferred     |         | Comprehensive |  | Accumulated |      |       |   |  
|                                |                                                                                   |                    |            | Shares       |  | Amount       |       | Capital |  | Compensation |         | Income (Loss) |  | Deficit     |      | Total
|                                |                                                                                   |                    |            |              |  |              |       |         |  |              |         |               |  |             |      |      
|Balance at October 31, 1999     |                                                                                   |                    | 16,492,229 |              |  | $            | 1,649 |         |  | $            | 107,447 |               |  | $           |     |       |   | $ | (27 | )           |   | $ | (73,898  | )       |   | $ | 35,172  |        
|                                | Issuance of common
stock and warrants
in private placement,
net of issuance costs |                    |            | 845,652      |  |              |       | 85      |  |              |         | 10,128        |  |             |      |      |   |   |     |            |   |   |          |        |   |   |         | 10,212  |        
|                                | Exercise of stock options,
and warrants                                           |                    |            | 468,198      |  |              |       | 47      |  |              |         | 5,554         |  |             |      |      |   |   |     |            |   |   |          |        |   |   |         | 5,601   |        
|                                | Deferred compensation
on stock options                                            |                    |            |             |  |              |       |        |  |              |         | 346           |  |             |      | (346  | ) |   |     |            |   |   |          |        |   |   |         |        |        
|                                | Amortization of
deferred compensation                                             |                    |            |             |  |              |       |        |  |              |         |              |  |             |      | 173   |   |   |     |            |   |   |          |        |   |   |         | 173     |        
|                                | Net loss                                                                          |                    |            |             |  |              |       |        |  |              |         |              |  |             |      |      |   |   |     |            |   |   |          | (15,727 | ) |   |         | (15,727 | )      
|                                | Other comprehensive
income:                                                       |                    |            |              |  |              |       |         |  |              |         |               |  |             |      |       |   |   |     |             |   |   |          |         |   |   |         |         |        
|                                | Unrealized gain
on investments                                                    |                    |            |             |  |              |       |        |  |              |         |              |  |             |      |      |   |   |     | 25          |   |   |          |        |   |   |         | 25      |        
|                                |                                                                                   |                    |            |              |  |              |       |         |  |              |         |               |  |             |      |       |   |   |     |             |   |   |          |         |   |   |         |        
|                                | Comprehensive loss                                                                |                    |            |              |  |              |       |         |  |              |         |               |  |             |      |       |   |   |     |             |   |   |          |         |   |   |         | (15,703 | )      
|                               
|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:                                                       |                    |            |              |  |              |       |         |  |              |         |               |  |             |      |       |   |   |     |             |   |   |          |         |   |   |         |         |        
|                                | 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 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
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 |        
|                                |                                                                                   |                    |            |              |  |              |       |         |  |              |         |               |  |             |      |       |   |   |     |             |   |   |          |         |   |   |         |        

See accompanying notes.

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MARTEK BIOSCIENCES CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                     |                                                                              |                                              |                     |         |                        |        |         |         |       |        |        |         |       |        |  
|---------------------------------------------------- | ---------------------------------------------------------------------------- | -------------------------------------------- | ------------------- | ------- | ---------------------- | ------ | ------- | ------- | ----- | ------ | ------ | ------- | ----- | ------ | -
|                                                     |                                                                              |                                              |                     |         | Year ended October 31,
|                                                     |                                                                              |                                              |                     |         |                       
|In thousands                                         |                                                                              | 2002                                         |                     | 2001    |                        | 2000  
|                                                     |                                                                              |                                              |                     |         |                        |       
|Operating activities                                 |                                                                              |                                              |                     |         |                        |        |         |         |       |        |        |        
|                                                     | Net loss                                                                     |                                              | $                   | (24,233 | )                      |        | $       | (13,702 | )     |        | $      | (15,727 | )    
|                                                     | Adjustments to reconcile net loss to
net cash used in operating activities:  |                                              |                     |         |                        |        |         |         |       |        |        |         |      
|                                                     |                                                                              | Depreciation                                 |                     |         | 1,861                  |        |         |         | 1,720 |        |        |         | 1,552 |       
|                                                     |                                                                              | Amortization                                 |                     |         | 772                    |        |         |         | 239   |        |        |         | 7     |       
|                                                     |                                                                              | Amortization of deferred compensation        |                     |         | 218                    |        |         |         | 312   |        |        |         | 173   |       
|                                                     |                                                                              | Acquired in-process research and development |                     |         | 15,788                 |        |         |         |      |        |        |         |      |       
|                                                     |                                                                              | Other non-cash items                         |                     |         |                       |        |         |         |      |        |        |         | 261   |       
|                                                     |                                                                              | Changes in operating assets and liabilities: |                     |         |                        |        |         |         |       |        |        |         |       |       
|                                                     |                                                                              |                                              | Accounts receivable |         |                        | (3,934 | )       |         |       | (2,581 | )      |         |       | (874   | )
|                                                     |                                                                              |                                              | Inventories         |         |                        | (1,967 | )       |         |       | (1,341 | )      |         |       | 90     |  
|                                                     |                                                                              |                                              | Other assets        |         |                        | (746   | )       |         |       | 1,065  |        |         |       | (1,439 | )
|                                                     |                                                                              |                                              | Accounts payable    |         |                        | (385   | )       |         |       | 503    |        |         |       | 255    |  
|                                                     |                                                                              |                                              | Accrued liabilities |         |                        | (588   | )       |         |       | 128    |        |         |       | 2,650  |  
|                                                     |                                                                              |                                              | Unearned revenue    |         |                        | (160   | )       |         |       | (245   | )      |         |       | 4,588  |  
|                                                     |                                                                              |                                              |                     |         |                        |        |         |         |       |        |        |         |      
|Net cash used in operating activities                |                                                                              |                                              | (13,374             | )       |                        |        | (13,902 | )       |       |        | (8,464 | )      
|Investing activities                                 |                                                                              |                                              |                     |         |                        |        |         |         |       |        |        |        
|                                                     | Purchase of short-term investments and
marketable securities                 |                                              |                     | (9,967  | )                      |        |         | (37,028 | )     |        |        | (26,971 | )    
|                                                     | Proceeds from sale of short-term investments
and marketable securities       |                                              |                     | 14,000  |                        |        |         | 47,576  |       |        |        | 25,565  |      
|                                                     | Capitalization of patent costs                                               |                                              |                     | (1,230  | )                      |        |         | (547    | )     |        |        | (472    | )    
|                                                     | Purchase of property, plant and equipment                                    |                                              |                     | (21,108 | )                      |        |         | (2,298  | )     |        |        | (2,229  | )    
|                                                     | Cash impact of purchase transaction                                          |                                              |                     | 191     |                        |        |         |        |       |        |        |        |      
|                                                     |                                                                              |                                              |                     |         |                        |        |         |         |       |        |        |         |      
|Net cash (used in) provided by investing activities  |                                                                              |                                              | (18,114             | )       |                        |        | 7,703   |         |       |        | (4,107 | )      
|Financing activities                                 |                                                                              |                                              |                     |         |                        |        |         |         |       |        |        |        
|                                                     | Repayment of notes payable                                                   |                                              |                     |        |                        |        |         | (472    | )     |        |        | (1,479  | )    
|                                                     | Principal payments on capital leases                                         |                                              |                     | (88     | )                      |        |         |        |       |        |        |        |      
|                                                     | Proceeds from the exercise of warrants and options                           |                                              |                     | 10,061  |                        |        |         | 5,924   |       |        |        | 5,339   |      
|                                                     | Proceeds from the issuance of
common stock and warrants in private placement |                                              |                     | 21,289  |                        |        |         | 18,710  |       |        |        | 10,213  |      
|                                                     |                                                                              |                                              |                     |         |                        |        |         |         |       |        |        |         |      
|Net cash provided by financing activities            |                                                                              |                                              | 31,262              |         |                        |        | 24,162  |         |       |        | 14,073 |        
|                                                     |                                                                              |                                              |                     |         |                        |        |         |         |       |        |        |         |      
|Net (decrease) increase in cash and cash equivalents |                                                                              |                                              | (226                | )       |                        |        | 17,963  |         |       |        | 1,502  |        
|Cash and cash equivalents at beginning of year       |                                                                              |                                              | 20,645              |         |                        |        | 2,682   |         |       |        | 1,180  |        
|                                                     |                                                                              |                                              |                     |         |                        |        |         |         |       |        |        |         |      
|Cash and cash equivalents at end of year             |                                                                              | $                                            | 20,419              |         |                        | $      | 20,645  |         |       | $      | 2,682  |        
|                                                     |                                                                              |                                              |                     |         |                        |        |         |         |       |        |        |         |      

See accompanying notes.

17



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION & BUSINESS DESCRIPTION

Martek Biosciences Corporation (the Company or Martek),
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) new, 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. 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, Colorado. 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.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ConsolidationThe consolidated financial statements include
the accounts of Martek and its wholly owned subsidiary,
Martek Boulder, 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 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 generally recognizes
revenue when persuasive evidence of an arrangement exists,
delivery has occurred, the fee is fixed or determinable, and
collectibility is probable. Revenue is recognized on product
sales when goods are shipped. Royalty revenue is recognized
when product is sold to the end user. Revenue from licensing
agreements is deferred and recognized over the term of the
agreement, or in certain circumstances, when milestones 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. At October 31, 2002, the Company
had approximately $1.9 million in short-term and $2.2 million
in long-term unearned revenue relating to third-party license
agreements and prepayments on product purchases.

Foreign Currency TransactionsForeign currency transactions
are translated into U.S. dollars at prevailing rates. Gains or losses resulting from foreign currency transactions are included in
current period income or loss as incurred. 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, material 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 trial costs. Over 40% of the Companys
research and development expenditures in 2002 were associated
with development activity at the Winchester, KY plant. The
Companys total research and development expense was
approximately $11.6 million in 2002, $12.7 million in 2001 and
$12.5 million in 2000.

Advertising CostsAll advertising costs are expensed when

18



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##### 



incurred. Advertising costs expensed for the years ended
October 31, 2002, 2001 and 2000 approximated $1.2 million,
$1.2 million, and $1.7 million, respectively.

InterestInterest paid by the Company amounted to approximately $4,000 in 2002, $10,000 in 2001 and $197,000 in 1999.

Income TaxesUnder the SFAS 109, deferred tax assets and liabilities are determined based on differences between financial
reporting and tax bases of assets and liabilities, and are measured using the enacted tax rates and laws that will be in effect
when the differences are expected to reverse. 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. For the years
ended October 31, 2002, 2001 and 2000 the Company paid no
income taxes.

Net Loss Per ShareNet loss per share is computed using the
weighted average number of shares of common stock outstanding
during the period. Common equivalent shares from stock
options and warrants are excluded as their effect is antidilutive.

Comprehensive Income (Loss)Under SFAS No. 130, the
Company is required to display comprehensive income (loss)
and its components as part of the 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 specific identifi-
cation cost and consist of U.S. government obligations or U.S.
agency obligations 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
consists 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, 2002.

Concentration of Credit Risk and Significant Customers
Financial instruments, which potentially subject the Company
to concentrations of credit risk, consist principally of accounts
receivable. The Companys reserve for uncollectible accounts
at October 31, 2002 and 2001 was not material. The Company
grants credit to customers based on evaluations of their financial
condition, generally without requiring collateral. Concentrations
of credit risk with respect to accounts receivable are present
due to the small number of customers comprising the
Companys customer base. However, the credit risk is reduced
through the Companys efforts to monitor its exposure for credit
losses and maintain allowances, if necessary. Two customers
accounted for approximately 79% of the Companys sales for
fiscal 2002, 72% for fiscal 2001 and 34% for fiscal 2000. These
two customers accounted for approximately 73% and 80% of
the Companys outstanding accounts receivable balance at
October 31, 2002 and 2001, respectively. 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 uncollectible.
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.

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 plant, fifteen years for the Companys
oil processing plant, generally ten years for machinery and equipment, five years for furniture and fixtures, and the shorter of the
useful life or the lease term for leasehold improvements. Costs for
capital assets not yet placed into service, including those related
to expansion of the Companys Winchester, KY 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 AssetsIn July 2001, the
Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets (SFAS 142). SFAS 142
19Notes to Financial Consolidated Statements (continued)requires goodwill to be tested for impairment on an annual
basis and between annual tests in certain circumstances, and
written down when impaired, rather than being amortized as
previous accounting standards required. 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.The Company recorded goodwill and purchased intangible
assets in its acquisition of OmegaTech in April, 2002 (see Note 3).
The goodwill acquired in the OmegaTech acquisition is subject
to the provisions of SFAS 142 and accordingly, is not being
amortized. The Company is required to perform an annual
impairment review of its goodwill balance beginning with a
recurring annual measurement date. The Company has chosen
August 1 to be its annual measurement date for its annual
impairment review and will perform its first review as of August
1, 2003.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.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 exceed the fair
value of the assets. Assets to be disposed of are reported at the
lower of the carrying amount or fair value less costs to sell. To
date, the Company has not incurred any impairment 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 exceed the fair value of
the assets. Patent-related amortization expense was approximately $356,000 in 2002, $239,000 in 2001 and $7,000 in 2000.
Accumulated patent amortization totaled approximately
$602,000 and $246,000 at October 31, 2002 and 2001, respectively.Stock-Based CompensationThe Company has adopted
Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation. SFAS No. 123
allows companies to either account for employee stock-based
compensation under the new provisions of SFAS No. 123 or
under the provisions of APB No. 25, Accounting for Stock
Issued to Employees. The Company has elected to continue
accounting for its employee stock-based compensation in
accordance with the provisions of APB No. 25. Stock-based
compensation for non-employees is accounted for using the
fair value method in accordance with SFAS No. 123. The
Company has made pro forma disclosures required by SFAS
No. 123 for all options granted (see Note 13).ReclassificationCertain amounts in the prior years financial
statements have been reclassified to conform to the current
year presentation.Recently Issued Accounting PronouncementsIn October 2001,
FASB issued Statement of Financial Accounting Standards No.
144, Accounting for the Impairment or Disposal of Long-Lived
Assets (SFAS 144). The Statement supersedes FASB Statement
No. 121, Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed Of (SFAS 121), however
it retains the fundamental provisions of that statement related
to the recognition and measurement of the impairment of
long-lived assets to be held and used. SFAS 142 is effective for
the Company beginning November 1, 2002. The Company does
not expect the provisions of SFAS 144 to have a material impact
on its financial position, results of operations or liquidity.In June 2002, the FASB issued Statement of Financial Accounting
Standard Statement of Financial Accounting Standards No. 146,
Accounting for Costs Associated With Exit or Disposal
Activities. SFAS 146 nullifies previous accounting guidance
and requires that a liability for a cost associated with an exit or
disposal activity be recognized when the liability is incurred.
The provisions of SFAS 146 are effective for exit or disposal
activities that are initiated after December 31, 2002. The Company
does not expect the adoption of this statement to have a
material impact on its financial position, results of operations
or liquidity.3. ACQUISITION OF OMEGATECH, INC.On April 25, 2002, the Company completed its purchase of
OmegaTech, Inc., a DHA-producer located in Boulder,
Colorado. 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. A portion of the stock proceeds from this
issuance were used by the former OmegaTech shareholders to
pay off certain pre-closing liabilities to certain lenders and vendors of OmegaTech, and to certain employees to satisfy certain
liabilities of OmegaTech. The aggregate purchase price for
OmegaTech was approximately $54.1 million, of which approx-20imately $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 purchase
agreement also provides for additional stock consideration of
up to $40 million if certain milestones are met. Two of these
milestones relate to operating results (sales and gross profit
margin objectives through October 2004) and two relate to
regulatory and labeling approvals in the U.S. and Europe. The
total Martek common stock that may be issued relating to this
additional consideration is approximately 1.4 million shares
based on the closing deal price of $27.88 per share, but may
increase to approximately 2.3 million shares depending on the
average market price of the Companys stock on the dates that
the milestones are achieved. 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 fair value.As part of the purchase price allocation, all intangible assets
that were a part of the acquisition were identified and valued.
It was determined that the technology assets acquired had
continuing value. As a result of this identification and valuation
process, the Company 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 acquisition. The
Company has revised the preliminary purchase price allocation
as of October 31, 2002, as permitted under SFAS 142, primarily
to adjust the life and assigned value to the trademarks acquired
in the acquisition to properly reflect the Companys marketing
strategy.As a result of the revised valuation of the purchase price
and identification of related assets, the Company allocated the
following to identifiable intangible assets at October 31, 2002:

|                 |  |                |        |             |  |          |  | 
|---------------- |  | -------------- | ------ | ----------- |  | -------- |  | 
|                 |  | Fair Value     |        | Estimated  
|Intangible Asset |  | (in thousands) |        | Useful Life
|                 |  |                |        |            
|Trademarks       |  | $              | 1,803  |             |  | 15 years
|Patents          |  | $              | 3,039  |             |  | 10 years
|Core technology  |  | $              | 1,708  |             |  | 15 years
|Current products |  | $              | 10,676 |             |  | 15 years

The excess of the purchase price over the fair value of
tangible and identifiable intangible net assets of approximately
$25.6 million, has been allocated to goodwill. In accordance
with SFAS No. 142, this amount will not be systematically
amortized but, rather, the Company will perform an annual
assessment for impairment by applying a fair-value-based test.

The aggregate purchase price of approximately $54.1 million,
including acquisition costs, was allocated as follows:

|                                               |  |   |        |  
|---------------------------------------------- |  | - | ------ | -
|In thousands                                   |  |   |        |  
|Trademarks                                     |  | $ | 1,803  |  
|Patents                                        |  |   | 3,039  |  
|Core technology                                |  |   | 1,708  |  
|Current products                               |  |   | 10,676 |  
|In-process research and development            |  |   | 15,788 |  
|Goodwill                                       |  |   | 25,568 |  
|                                               |  |   |        |  
|Total intangible assets purchased              |  |   | 58,582 |  
|Tangible net liabilities assumed at fair value |  |   | (4,517 | )
|                                               |  |   |        |  
|Total aggregate purchase price                 |  | $ | 54,065 |  

The above allocation of the purchase is subject to revision
based on the final determination of fair values, including the
final assessment of certain tax matters, and is anticipated to be
completed during the Companys second quarter of fiscal year
2003.

The following unaudited pro forma operating results combine
the results of the Company for the years ended October 31,
2002 and 2001 with the results of the former OmegaTech entity
for the years ended October 31, 2002 and 2001, assuming the
acquisition had been consummated at the beginning of each
period. These pro forma amounts for both periods presented
exclude the one-time charge of $15.8 million for in-process
research and development related to the acquisition.

|                                       |  |                    |         |      |  |   |         |  
|-------------------------------------- |  | ------------------ | ------- | ---- |  | - | ------- | -
|                                       |  | For the year ended
|                                       |  | October 31,       
|In thousands, except per share data    |  | 2002               |         | 2001
|                                       |  |                    |         |     
|Revenues                               |  | $                  | 48,862  |      |  | $ | 25,698  |  
|Net loss                               |  | $                  | (14,493 | )    |  | $ | (29,796 | )
|Net loss per share 
basic and diluted |  | $                  | (0.63   | )    |  | $ | (1.44   | )
|Weighted average shares
outstanding    |  |                    | 22,865  |      |  |   | 20,630  |  

4. SALE OF STABLE ISOTOPES PRODUCT LINE

On November 1, 2001 the Company sold the assets, consisting
primarily of inventory and technology, surrounding the 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

21



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$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, 2002 the
value of the investment in the new company was fully reserved.
During 2002, the Company recognized approximately $106,000
in royalty revenue in connection with this arrangement.

5. SHORT-TERM INVESTMENTS AND MARKETABLE SECURITIES

The Company has classified all debt securities as available-for-sale. Available-for-sale securities are carried at specific
identification and have average maturities of under 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. The amount of
unrealized holding gain (loss) on these available-for-sale securities
was $(14) and $1,015 at October 31, 2002 and 2001, respectively.
Realized gains and losses and declines in value judged to be
other-than-temporary on available-for-sale securities are
included in other income, based on the specific identification
method. There were no realized gains or losses recorded for the
years ended October 31, 2002, 2001, or 2000. Available-for-sale
securities consisted of U.S. government and agency obligations
and totaled approximately $2.0 million and $6.0 million at
October 31, 2002 and 2001, respectively. At October 31, 2002
and 2001, the estimated fair value of these securities approximated
cost.

6. INVENTORIES

Inventories consisted of the following:

|                       |  |             |       |      |  |   |       |  
|---------------------- |  | ----------- | ----- | ---- |  | - | ----- | -
|                       |  | October 31,
|In thousands           |  | 2002        |       | 2001
|                       |  |             |       |     
|Finished products      |  | $           | 3,443 |      |  | $ | 5,575 |  
|Work in process        |  |             | 6,078 |      |  |   | 711   |  
|Raw materials          |  |             | 397   |      |  |   | 274   |  
|                       |  |             |       |      |  |   |       |  
|Total inventory        |  |             | 9,918 |      |  |   | 6,560 |  
|Less inventory reserve |  |             | (200  | )    |  |   | (94   | )
|                       |  |             |       |      |  |   |       |  
|Inventory, net         |  | $           | 9,718 |      |  | $ | 6,466 |  
|                       |  |             |       |      |  |   |       |  

Approximately $1.9 million of the inventory balance in
2002 as compared to 2001 related to inventory purchased in
the OmegaTech transaction used for the food and beverage and
animal feed markets.

7. PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consisted of the following:

|                                  |  |             |         |      |  |   |        |  
|--------------------------------- |  | ----------- | ------- | ---- |  | - | ------ | -
|                                  |  | October 31,
|In thousands                      |  | 2002        |         | 2001
|                                  |  |             |         |     
|Land                              |  | $           | 150     |      |  | $ | 150    |  
|Building and improvements         |  |             | 1,871   |      |  |   | 1,795  |  
|Machinery and equipment           |  |             | 23,906  |      |  |   | 21,335 |  
|Furniture and fixtures            |  |             | 1,598   |      |  |   | 1,017  |  
|Leasehold improvements            |  |             | 556     |      |  |   | 496    |  
|Construction in progress          |  |             | 19,960  |      |  |   | 1,605  |  
|                                  |  |             |         |      |  |   |        |  
|Property, plant
and equipment     |  |             | 48,041  |      |  |   | 26,398 |  
|Less accumulated
depreciation     |  |             | (11,535 | )    |  |   | (9,674 | )
|                                  |  |             |         |      |  |   |        |  
|Net property, plant
and equipment |  | $           | 36,506  |      |  | $ | 16,724 |  
|                                  |  |             |         |      |  |   |        |  

Depreciation and amortization expense on property, plant
and equipment amounted to approximately $1.9 million, $1.7
million and $1.6 million for the years ended October 31, 2002,
2001, and 2000, respectively.

8. GOODWILL AND INTANGIBLE ASSETS

As of October 31, 2002 and 2001, the Companys intangible
assets and related accumulated amortization consisted of the
following:

|                 |  |                        |        |                        |  |             |     |       |  |              |        |     |  |   |       |             |  |   |     |  |  |   |     | 
|---------------- |  | ---------------------- | ------ | ---------------------- |  | ----------- | --- | ----- |  | ------------ | ------ | --- |  | - | ----- | ----------- |  | - | --- |  |  | - | --- | 
|                 |  | As of October 31, 2002 |        | As of October 31, 2001
|                 |  |                        |        |                       
|In thousands     |  |                        |        |                        |  |             |     |       |  |              |        |     |  |   |       |             |  |   |     |  |  |   |     | 
|                 |  |                        |        |                        |  | Accumulated |     |       |  |              |        |     |  |   |       | Accumulated |  |   |     | 
|Intangible Asset |  | Gross                  |        | Amortization           |  | Net         |     | Gross |  | Amortization |        | Net
|                 |  |                        |        |                        |  |             |     |       |  |              |        |    
|Trademarks       |  | $                      | 1,809  |                        |  | $           |    |       |  | $            | 1,809  |     |  | $ |      |             |  | $ |    |  |  | $ |    | 
|Patents          |  |                        | 5,287  |                        |  |             | 602 |       |  |              | 4,685  |     |  |   | 1,019 |             |  |   | 246 |  |  |   | 773 | 
|Core
technology  |  |                        | 1,708  |                        |  |             |    |       |  |              | 1,708  |     |  |   |      |             |  |   |    |  |  |   |    | 
|Current
products |  |                        | 10,676 |                        |  |             | 381 |       |  |              | 10,295 |     |  |   |      |             |  |   |    |  |  |   |    | 
|Goodwill         |  |                        | 25,568 |                        |  |             |    |       |  |              | 25,568 |     |  |   |      |             |  |   |    |  |  |   |    | 
|                 |  |                        |        |                        |  |             |     |       |  |              |        |     |  |   |       |             |  |   |     |  |  |   |     | 
|Total            |  | $                      | 45,048 |                        |  | $           | 983 |       |  | $            | 44,065 |     |  | $ | 1,019 |             |  | $ | 246 |  |  | $ | 773 | 
|                 |  |                        |        |                        |  |             |     |       |  |              |        |     |  |   |       |             |  |   |     |  |  |   |     | 



The Company recorded amortization expense of approximately
$772,000 in 2002, $239,000 in 2001 and $7,000 in 2000. Based
on the current amount of intangible assets subject to
amortization, the estimated amortization expense for each of
the succeeding 5 years will be approximately $1.5 million.

9. NOTES PAYABLE

At October 31, 2002, the Company had no outstanding notes
payable. Two term loans, which were used to finance the
Companys fermentation and extraction facilities in Winchester,
KY were paid down in full in July 2000 and March 2001.

10. RESTRUCTURING CHARGE

On July 29, 2002, the Company announced a restructuring of
the food and beverage sales and marketing efforts. As part of

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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, include consultant
termination costs, idle office space and professional fees. As of
October 31, 2002, approximately $242,000 has been paid in
employee separation benefits and approximately $187,000 has
been paid in other costs, resulting in a remaining accrued liability
related to the restructuring of approximately $837,000, relating
primarily to certain contractual liabilities as of the restructuring
date.

11. COMMITMENTS

LeasesThe Company leases its Maryland 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, Colorado 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, KY manufacturing
facility and its Boulder, CO offices. Rent expense was approximately $742,000 in 2002, $434,000 in 2001 and $403,000 in
2000. The Company received sublease income of approximately
$352,000 in 2002, $133,000 in 2001 and $98,000 in 2000 for
office and lab space that it subleases in Columbia, MD.

Future minimum lease payments under operating leases at
October 31, 2002, 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
|               |  |              |       |               |  |            
|2003           |  | $            | 695   |               |  | $           | 301 |  |  | $ | 394   | 
|2004           |  |              | 687   |               |  |             | 171 |  |  |   | 516   | 
|2005           |  |              | 600   |               |  |             |    |  |  |   | 600   | 
|2006           |  |              | 4     |               |  |             |    |  |  |   | 4     | 
|2007 and after |  |              |      |               |  |             |    |  |  |   |      | 
|               |  |              |       |               |  |             |     |  |  |   |       | 
|               |  | $            | 1,986 |               |  | $           | 472 |  |  | $ | 1,514 | 
|               |  |              |       |               |  |             |     |  |  |   |       | 

The Company has four capital leases covering lab equipment
and furniture at its Boulder office with a recorded value of
$169,000 and accumulated amortization of $9,000 at October 31,
2002. All four of these capital leases expire during fiscal year
2003 with future minimum lease payments totaling approximately $111,000. Depreciation for the assets under these leases
since the date of acquisition is included in the Companys
depreciation expense for fiscal year 2002.

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
collaborations. For the year ended October 31, 2002 and 2001,
Martek incurred approximately $106,00 and $27,000, 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, 2002, would not have a material effect on
the financial statements.

RoyaltiesThe Company is a party to a settlement agreement
in which OmegaTech had previously licensed and then transferred
back certain technology relating to human and animal applications for DHA developed by a third party. The 10-year agreement
calls for minimum cash payments as well as ongoing royalties
to the third party upon the sale of products containing
OmegaTechs DHA oil. Under the agreement, the Company
must pay royalties of 5% on net sales for human application
and aquaculture products, and 2% on net sales for animal
application products for sales of DHA derived from OmegaTechs
patented organism. Commencing with the year ending June 30,
2003 through the year ending June 30, 2010, the agreement is
subject to annual minimums of $500,000. A $3 million payment
is due at the end of the term of the agreement on July 31, 2010.
The Company has estimated the present value of the future
minimum payments due under this agreement to be approximately $4 million, and has accrued $3.5 million of this amount
in long-term liabilities and $500,000 in accrued liabilities at
October 31, 2002 as part of its purchase price allocation (see Note
16 Subsequent Event for additional information).

Purchase CommitmentsMartek currently contracts with a
third-party supplier to produce its arachidonic acid oil. At
October 31, 2002, the Company had outstanding inventory
purchase commitments to this supplier totaling approximately
$3.9 million.

As a result of the acquisition of OmegaTech, the Company
is subject to a prior commitment to purchase a minimum
quantity of DHA biomass for use in products other than infant
formula from a third-party manufacturer. The three-year
commitment expires on December 31, 2004 and totals approximately $2.4 million per year. From April 25, 2002 to October 31,
2002, the Company purchased approximately $926,000 of DHA
biomass under this commitment.

23



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##### 



Notes to Consolidated Financial Statements (continued)

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

12. 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 2000, the Company
received license fees and pre-payments of royalties and product
purchases of approximately $4.6 million, of which approximately
$159,000, $225,000 and $72,000 was recognized as license and
royalty revenue for the years ended October 31, 2002, 2001 and
2000, respectively.

The balance of these license fees, prepaid royalties and prepaid purchases remaining in unearned revenue was approximately
$4.2 million at October 31, 2002 and $4.3 million at October 31,
2001.

Certain license agreements include ongoing royalty payments, which are based upon a percentage of product sales. The
Companys total royalty revenues were approximately $411,000
in 2002, $1.2 million in 2001 and $948,000 in 2000.

13. CAPITAL ACCOUNTS

Private Placement of Common StockOn February 8, 2000, the
Company sold 845,652 shares of the its common stock and
issued warrants to purchase 253,695 shares of common stock
in a private placement, resulting in net proceeds of approximately
$10.3 million. The stock was issued at $12.12 per share, representing a thirty-day average trading price. The warrants are
exercisable for a period of three years from date of issuance at
$14.55 per share.

On 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 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, 2002 the Company had warrants outstanding
to purchase up to 362,677 shares of common stock. These warrants had a weighted average exercise price of $17.67 per share
and a weighted average remaining contractual life of 2.4 years
at October 31, 2002.

Stock Option PlanOptions to purchase common stock under
the Companys 1997 Stock Option Plan and the Companys
2002 Stock Incentive Plan, collectively referred to as the
Option Plans, are granted at prices as determined by the
Board of Directors, but shall not be less than the fair market
value of the Companys common stock on the date of grant.
The options are a mix of qualified and nonqualified and generally vest over a period of up to five years. The Companys Board
of Directors 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
Board of Directors, 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 nonqualified and
were all 100% vested as of the purchase date.

Details of shares under option were as follows:

|                                        |  |           |       |             |  |          |       | 
|--------------------------------------- |  | --------- | ----- | ----------- |  | -------- | ----- | 
|                                        |  |           |       |             |  | Weighted
|                                        |  | Number of |       | Average    
|Shares in thousands                     |  | Shares    |       | Price/Share
|                                        |  |           |       |            
|Options outstanding at October 31, 1999 |  |           | 2,168 |             |  | $        | 13.16 | 
|                                        |  |           |       |             |  |          |       | 
|Granted                                 |  |           | 940   |             |  | $        | 13.74 | 
|Exercised                               |  |           | (242  | )           |  | $        | 9.94  | 
|Canceled                                |  |           | (53   | )           |  | $        | 15.27 | 
|                                       
|Options outstanding at October 31, 2000 |  |           | 2,813 |             |  | $        | 13.40 | 
|Options exercisable at October 31, 2000 |  |           | 1,389 |             |  | $        | 14.80 | 
|                                        |  |           |       |             |  |          |       | 
|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 | 
|                                       

The Company issued 9,000 options to non-employees during
the year ended October 31, 2002 and 24,000 in 2001. These
options have vesting periods of between 0-24 months. The fair
value of these options has been recorded as deferred compensation and is being amortized over the performance period,
which is generally 12 months. Under variable plan accounting,
the value of the unvested options will be re-measured and
recognized in income at each reporting date until fully vested.

A total of 789,080 shares of common stock was available for
future grants under the Option Plans at October 31, 2002. The
weighted average contractual life for all options outstanding
under the Option Plans at October 31, 2002 was 7.4 years.

24



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Detailed information on the options outstanding on October
31, 2002 by price range is set forth below:

|                    |  |                     |       |                     |  |           |     |             |  |           |       |         |  |          |       |  |  |   |       | 
|------------------- |  | ------------------- | ----- | ------------------- |  | --------- | --- | ----------- |  | --------- | ----- | ------- |  | -------- | ----- |  |  | - | ----- | 
|                    |  | 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    
|                    |  |                     |       |                     |  |           |     |             |  |          
|$0.12-9.75          |  |                     | 662   |                     |  |           | 5.8 |             |  | $         | 6.92  |         |  |          | 579   |  |  | $ | 6.78  | 
|$10.25-14.57        |  |                     | 1,536 |                     |  |           | 7.1 |             |  | $         | 13.14 |         |  |          | 1,158 |  |  | $ | 13.03 | 
|$15.50-19.50        |  |                     | 596   |                     |  |           | 7.2 |             |  | $         | 18.04 |         |  |          | 318   |  |  | $ | 18.08 | 
|$21.68-25.00        |  |                     | 261   |                     |  |           | 8.7 |             |  | $         | 23.63 |         |  |          | 38    |  |  | $ | 23.73 | 
|$25.50-29.30        |  |                     | 931   |                     |  |           | 9.2 |             |  | $         | 28.70 |         |  |          | 337   |  |  | $ | 28.51 | 
|$32.88-34.25        |  |                     | 172   |                     |  |           | 3.4 |             |  | $         | 33.00 |         |  |          | 173   |  |  | $ | 33.00 | 
|                    |  |                     |       |                     |  |           |     |             |  |           |       |         |  |          |       |  |  |   |       | 
|                    |  |                     | 4,158 |                     |  |           | 7.4 |             |  | $         | 17.82 |         |  |          | 2,603 |  |  | $ | 15.74 | 

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, 2002, 125,800 options were outstanding
and no additional options were available for future grant under
the Directors Plan. The weighted average contractual life for all
options outstanding under the Directors Plan at October 31,
2002 was 3.8 years. No awards were made under the Directors
Plan after 1998. During 2002, Directors of the Company received
option grants under the Companys Option Plans.

Pro Forma DisclosureThe Company applies APB 25 in
accounting for its stock option incentive plan and, accordingly,
recognizes compensation expense for the difference between
the fair value of the underlying common stock and the grant
price of the option at the date of the grant. The Company generally does not issue options at values less than fair market
value. The effects of applying SFAS No. 123 on 2002, 2001 and
2000 pro forma net loss and per share calculations as stated
below are not necessarily representative of effects on reported
net income and earnings per share for future years due to such
things as the vesting period of the stock options and the potential for issuance of additional stock options in future years. Had
compensation expense for the Companys stock option incentive plan been determined based on the estimated fair value at
the grant dates for awards under the plan consistent with the
methodology prescribed under SFAS No. 123, the Companys
net loss in fiscal years 2002, 2001 and 2000 would have been
approximately $40.2 million, $20.8 million and $21.4 million, or
$1.83, $1.10 and $1.24 per share, respectively. The weighted
average fair market value of the options granted during fiscal
year 2002 is estimated at $18.74 per share for options whose
exercise price equals fair market value on the date of the grant,
using the Black-Scholes option-pricing model with the following assumptions: dividend yield 0%, volatility of 68.2%, risk-
free interest rate of 4.5% and average expected life of approximately seven years.

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
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.

14. 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                      |  | 2002                   |        | 2001 |  | 2000
|                                  |  |                        |        |      |  |     
|Federal income
tax benefit
at 34% |  | $                      | (8,239 | )    |  | $    | (4,659 | ) |  | $ | (5,347 | )
|Permanent items                   |  |                        | 5,088  |      |  |      | 22     |   |  |   | 18     |  
|State taxes                       |  |                        | (428   | )    |  |      | (630   | ) |  |   | (724   | )
|Change in valuation
allowance     |  |                        | 3,579  |      |  |      | 5,267  |   |  |   | 6,053  |  
|                                  |  |                        |        |      |  |      |        |   |  |   |        |  
|Total expense                     |  |                        |       |      |  | $    |       |   |  | $ |       |  
|                                  |  |                        |        |      |  |      |        |   |  |   |        |  

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Notes to Consolidated Financial Statements (continued)

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                     |                   | 2002 |             | 2001  
|                                 |                   |      |             |       
|Deferred tax assets:             |                   |      |             |        |   |   |         |       
|Patent expenses                  |                   | $    | 561         |        |   | $ | 517     |       
|Net operating loss carryforwards |                   |      | 65,084      |        |   |   | 37,571  |       
|Deferred revenue                 |                   |      | 1,615       |        |   |   | 1,677   |       
|Other                            |                   |      | 2,351       |        |   |   | 426     |       
|                                 |                   |      |             |        |   |   |         |       
|                                 | Total assets      |      | $           | 69,611 |   |   | $       | 40,191 |  
|Deferred tax liabilities:        |                   |      |             |        |   |   |         |       
|Depreciation                     |                   | $    | (564        | )      |   | $ | ( 482   | )     
|Identified intangibles           |                   |      | (6,411      | )      |   |   |        |       
|                                 |                   |      |             |        |   |   |         |       
|                                 | Total liabilities |      |             | (6,975 | ) |   |         | ( 482  | )
|                                 |                   |      |             |        |   |   |         |       
|Net deferred tax asset           |                   |      | 62,636      |        |   |   | 39,709  |       
|Valuation allowance              |                   |      | (62,636     | )      |   |   | (39,709 | )     
|                                 |                   |      |             |        |   |   |         |       
|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. At October 31, 2002, the
Company had net operating loss carryforwards for federal
income tax purposes of approximately $168.6 million, of which
approximately $37.2 were assumed in the purchase of OmegaTech
and $22.1 were a result of stock option exercises. These net
operating loss carryforwards will expire, if unused, in the year
2003 through the year 2022.

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 effects of any potential
ownership changes, if any, have not been analyzed by the
Company.

15. EMPLOYEE 401(K) PLAN

The Company maintains an employee 401(k) plan. The plan,
which covers all employees 21 years of age or older, stipulates
that participating employees may elect an amount between 1%
and 15% of their total compensation to contribute to the plan,
not to exceed the maximum allowable by Internal Revenue
Service regulations. As of October 31, 2002, the Company had
not contributed to the plan.

16. SUBSEQUENT EVENT

In 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. On December 20, 2002 the Company signed an
amendment to this agreement under which the Company paid
$500,000 and signed a promissory note for $3.3 million in
exchange for the discharge of all future obligations under the
agreement. The first payment under the note of $1.0 million is
payable in August of 2003 with the remainder due in December
of 2003. As of October 31, 2002, the Company had accrued $4.0
million, the approximate present value of this commitment. The
difference between the accrual and the actual payments will be
offset to goodwill in fiscal year 2003.

17. QUARTERLY FINANCIAL INFORMATION (unaudited)

Quarterly financial information for fiscal 2002 and 2001 is
presented in the following table:

|                                      |  |         |        |         |  |         |         |         |  |   |        |   |  |   |        |  
|------------------------------------- |  | ------- | ------ | ------- |  | ------- | ------- | ------- |  | - | ------ | - |  | - | ------ | -
|In thousands,                         |  | 1st     |        | 2nd     |  | 3rd     |         | 4th    
|except per share data                 |  | Quarter |        | Quarter |  | Quarter |         | Quarter
|                                      |  |         |        |         |  |         |         |        
|2002                                  |  |         |        |         |  |         |         |         |  |   |        |   |  |   |        |  
|Total revenues                        |  | $       | 5,970  |         |  | $       | 11,423  |         |  | $ | 13,544 |   |  | $ | 15,118 |  
|Income (loss) from operations         |  |         | (3,206 | )       |  |         | (18,178 | )       |  |   | (3,977 | ) |  |   | 170    |  
|Net income (loss)                     |  |         | (2,947 | )       |  |         | (17,917 | )       |  |   | (3,744 | ) |  |   | 375    |  
|Net income (loss)
per share, basic    |  |         | (0.15  | )       |  |         | (0.84   | )       |  |   | (0.16  | ) |  |   | 0.02   |  
|Net income (loss)
per share, diluted  |  |         | (0.15  | )       |  |         | (0.84   | )       |  |   | (0.16  | ) |  |   | 0.02   |  
|2001                                  |  |         |        |         |  |         |         |         |  |   |        |   |  |   |        |  
|Total revenues                        |  | $       | 3,496  |         |  | $       | 4,013   |         |  | $ | 5,565  |   |  | $ | 5,750  |  
|Loss from operations                  |  |         | (3,857 | )       |  |         | (3,606  | )       |  |   | (3,657 | ) |  |   | (3,849 | )
|Net loss                              |  |         | (3,576 | )       |  |         | (3,240  | )       |  |   | (3,311 | ) |  |   | (3,575 | )
|Net loss per share,
basic and diluted |  |         | (0.20  | )       |  |         | (0.17   | )       |  |   | (0.17  | ) |  |   | (0.18  | )

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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, 2002
and 2001, and the related consolidated statements of operations,
stockholders equity, and cash flows for each of the three
years in the period ended October 31, 2002. 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 consolidated financial  statements referred to above
present fairly, in all material respects, the consolidated financial position
of Martek Biosciences Corporation at October 31, 2002
and 2001, and the consolidated results of its operations and its cash
flows for each of the three years in the period ended
October 31, 2002, in conformity with accounting principles
generally accepted in the United States.                                                                                                                                                                                                                  

Ernst & Young LLP Signature



| |  | McLean, Virginia
December 10, 2002 except for Note 16
    as to which the date is December 20, 2002
| |  | ---------------------------------------------------------------------------------------------------

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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, 2002, there were approximately 385 holders of
record of the Companys common stock. 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 2001                         |  | High |       | Low
|                                    |  |      |       |    
|November 1, 2000  January 31, 2001 |  | $    | 21.63 |     |  | $ | 12.00 | 
|February 1, 2001  April 30, 2001   |  | $    | 19.13 |     |  | $ | 12.25 | 
|May 1, 2001  July 31, 2001         |  | $    | 28.50 |     |  | $ | 13.73 | 
|August 1, 2001  October 31, 2001   |  | $    | 24.25 |     |  | $ | 14.00 | 

|                                    |  |      |       |     |  |   |       | 
|----------------------------------- |  | ---- | ----- | --- |  | - | ----- | 
|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 | 

Neuromins®, DHA Gold®, DHASCO® and ARASCO®
are registered trademarks of the Company.
Solaray® is a registered trademark of Nutraceutical Corporation.
Natrol® is a registered trademark of Natrol Inc.
Natures Way® is a registered trademark of Natures Way.
Source Naturals® is a registered trademark of Source Naturals, Inc.
Whole Foods® is a registered trademark of Whole Foods Market, Inc.
Enfamil LIPILTM is a trademark of Mead Johnson Nutritionals.
Coca-Cola® and Coke® are registered trademarks of the Coca-Cola Company

© 2003 Martek Biosciences Corporation.
All rights reserved.

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