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, revenue growth, gross margin, operating cash flow and profitability;

• expectations regarding product introductions and growth in nutritional product sales;

• expectations regarding potential collaborations and acquisitions;

• expectations regarding demand for products with our nutritional oils;

• expectations regarding sales to and by our infant formula licensees and supplemented infant formula market penetration levels;

• expectations regarding marketing of our oils by our infant formula licensees;

• expectations regarding future agreements with, and revenues from, companies in the food and beverage, pregnancy and nursing, nutritional supplement, and animal feed markets;

• expectations regarding future revenues from contract manufacturing customers;

• expectations regarding growing consumer recognition of the key health benefits of DHA and ARA;

• expectations regarding competitive products;

• expectations regarding future efficiencies and improvements in manufacturing processes and the cost of production of our nutritional oils;

• expectations regarding future purchase volumes and costs of third-party manufactured oils;

• expectations regarding the amount of production capacity and our ability to meet future demands for our nutritional oils;

• expectations regarding the amount of inventory held by us or our customers;

• expectations regarding production capacity utilization and the effects of excess production capacity;

• expectations regarding future selling, general and administrative and research and development costs;

• expectations regarding future capital expenditures;

• expectations regarding levels of consumption through governmental programs of infant formula products containing our nutritional oils; and

• expectations regarding our ability to maintain and protect our intellectual property.

Forward-looking statements include those statements containing words such as the following:
• "will,"

• "should,"

• "could,"

• "anticipate,"

• "believe,"

• "plan,"

• "estimate,"

• "expect,"

• "intend," and other similar expressions.

All of these forward-looking statements involve risks and uncertainties. They and other forward-looking statements in this Form 10-Q 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 some of the risks that could cause such differences in Part II, Item 1A. "Risk Factors" in this report on Form 10-Q and in our various other filings with the Securities and Exchange Commission. Our forward-looking statements speak only as of the date of this document, and we do not intend to update these statements to reflect events or circumstances that occur after that date.

• the timing of our customers' ordering patterns;

• the timing and extent of stocking and destocking of inventory by our customers;

• the timing and extent of our customers' production campaigns and plant maintenance shutdowns;

• the timing and extent of introductions of DHA into various child and/or adult applications and the marketplace success of such applications;

• the levels of inclusion of our oils in infant formula;

• the continued acceptance, and extent thereof, of products containing our oils under WIC and other regulatory programs in the U.S.;

• the continued acceptance of these products by consumers and continued demand by our customers;

• the ability of our customers to incorporate our oils into various foods and beverages;

• our ability to protect against competitive products through our patents;

• competition from alternative sources of DHA and ARA; and

• agreements with other future third-party collaborators to market our products or develop new products.

As such, the likelihood, timing and extent of future profitability are largely dependent on factors such as those mentioned above, as well as others, over which we have limited or no control.

• Multi-Year Sole-Source Infant Formula Supply Agreements - Martek entered into a multi-year sole-source supply agreement with Puleva Food for the use of ARA in infant formulas produced by Puleva and sold in Spain. Puleva is part of the Ebro-Puleva group, Spain's largest agro-food business. Martek also entered into a multi-year sole-source supply agreement with Milk Powder Solutions under which Martek will serve as Milk Powder Solutions' exclusive supplier for all of its ARA needs for infant formula products in China and Vietnam under the Gold Cow brand name.

• Non-Infant Formula Product Launches - Several non-infant formula nutritional products with Martek's life'sDHA™ were launched by Martek's customers, including Parent's Choice™ Pediatric Drink, Walgreens Finest Natural Multi-vitamins and Walgreens Flax + DHA dietary supplement.

• Approval in European Union of New Food Applications for life'sDHA™ - Martek received approval from the Standing Committee On The Food Chain and Animal Health (SCFCAH) of the European Union for the use of Martek's life'sDHA™ in bakery products, cereal bars, and beverages, including milk-based and milk analogue drinks, throughout the 27 Member States of the European Union. This expands the current categories approved in 2003 which include breakfast cereals, spreadable fat and dressings, certain dairy products and food supplements.

• New Scientific Data Published on DHA - The benefits of DHA supplementation were recently discussed in the following publications.

• A report published in Developmental Neuropsychology (June 2009) evaluated resting heart rate during the first six months of life in healthy, full-term infants. The newborns were either breastfed or given cow's milk-based or soy-based commercial infant formula containing different levels of DHA and ARA throughout the study period. Results showed that infants fed higher levels of DHA and ARA from either breast milk or infant formula had lower heart rates and higher values for heart rate variability measures compared to infants fed lower levels of DHA and ARA. According to the authors, these results indicate that adequate DHA is important for parasympathetic tone during this important period in development of cardiovascular regulation.

• A study published in the British Journal of Ophthalmology (March/April 2009) reported findings from a multi-year study of the effects of diet on the progression of age-related macular degeneration. This large clinical trial supplemented over 2,000 people with 5, 6, and 18 times the Recommended Dietary Allowance levels of vitamins C, E and/or zinc and other minerals. In this current report, the investigators quantified the dietary intake of DHA and EPA in the study groups as well. Results showed that consuming a diet rich in DHA slowed the progression of early age-related macular degeneration and that the DHA benefit occurred independently from EPA and the usual study supplements.

Over 90% of our ARA oils are purchased from DSM. Because DSM is a third-party manufacturer, we have only limited control over the timing and level of its production volumes. The balance of our ARA requirements is produced at our Kingstree facility. Under our agreement with DSM, ARA pricing to Martek has been established for calendar years 2009 through 2014 with the potential for only limited changes. ARA pricing subsequent to 2014 will be negotiated in the future by the parties.
We have attempted to reduce the risk inherent in having a single supplier through certain elements of our supply agreement with DSM. In connection with this agreement, we have the ability to produce, either directly or through an approved third party, an unlimited amount of ARA. The sale of such self-produced ARA is limited annually, however, to the greater of (i) 100 tons of ARA oil or
(ii) any amounts ordered by us that DSM is unable to fulfill. When combining our current DHA and ARA production capabilities in Winchester and Kingstree with DSM's current ARA production capabilities, we have production capacity for DHA and ARA products in excess of $500 million in annualized sales, collectively, to the infant formula, pregnancy and nursing, food and beverage, dietary supplement and animal feed markets. As such, our production capabilities exceed current demand; however, we have the ability to manage production levels and, to a certain extent, control our manufacturing costs. Nonetheless, when experiencing excess capacity, we may be unable to produce the required quantities of oil cost-effectively due to the existence of significant levels of fixed production costs at our plants and the plants of our suppliers. The commercial success of our nutritional oils will depend, in part, on our ability to manufacture these oils or have them manufactured at large scale on a routine basis and at a commercially acceptable cost. Our success will also be somewhat dependent on our ability to align our production with customer demand, which is inherently uncertain. There can also be no assurance that we will be able to continue to comply with applicable regulatory requirements, including the Food and Drug Administration's "good manufacturing practice" ("GMP") requirements. Under the terms of several of our agreements with infant formula customers, those customers may elect to manufacture these oils themselves. We are currently unaware of any of our customers producing our oils or preparing to produce our oils, and estimate that it would take a licensee a minimum of one year to implement a process for making our oils.
CRITICAL ACCOUNTING POLICIES AND THE USE OF ESTIMATES The preparation of our consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. On an ongoing basis, we evaluate our estimates and judgments, which are based on historical and anticipated results and trends and on various other assumptions that we believe are reasonable under the circumstances, including assumptions as to future events. By their nature, estimates are subject to an inherent degree of uncertainty and, as such, actual results may differ from our estimates. We discuss accounting policies and assumptions that involve a higher degree of judgment and complexity than others in our Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report to shareholders on Form 10-K for the year ended October 31, 2008. Other than the adoption of SFAS No. 157, "Fair Value Measurements" ("SFAS 157") as discussed below (see also Note 4 to the consolidated financial statements), there have been no significant changes in the Company's critical accounting policies since October 31, 2008. Fair Value Measurements As of November 1, 2008, the Company adopted the provisions of SFAS 157 for financial instruments. SFAS 157 defines fair value, establishes a fair value hierarchy for assets and liabilities measured at fair value and requires expanded disclosures about fair value measurements. The SFAS 157 hierarchy ranks the quality and reliability of inputs, or assumptions, used in the determination of fair value and requires assets and liabilities carried at fair value to be classified and disclosed as either a Level 1, 2 or 3 fair value instrument. Different from Levels 1 and 2, Level 3 instruments are valued using unobservable inputs that are not corroborated by market data. At July 31, 2009, we had Level 3 assets of $11.6 million which include both auction rate securities and an auction rate securities rights agreement (the "Put Agreement"). Of this amount, fair value changes in assets totaling $7.4 million would be recorded through earnings and changes in the remainder would be recorded through other comprehensive income. Some of the unobservable inputs into the discounted cash flow models from which we base our Level 3 valuations include, but are not limited to, periodic coupon rates, market required rates of return and the expected term of each security. Changes to the inputs used as of July 31, 2009 would cause fluctuations to the fair value of the affected instruments and such fair value changes could be material.

                             RESULTS OF OPERATIONS
Revenues
The following table presents revenues by category (in thousands):

                                           Three months ended July 31,            Nine months ended July 31,
                                            2009                 2008                2009               2008

Product sales                          $       75,044       $       83,481      $      247,218       $  249,965
Contract manufacturing sales                    2,790                4,922              10,390           12,045

Total revenues                         $       77,834       $       88,403      $      257,608       $  262,010

Product sales decreased $8.4 million or (10.1%) in the three months ended July 31, 2009 as compared to the three months ended July 31, 2008 and decreased $2.7 million or (1.1%) in the nine months ended July 31, 2009 as compared to the nine months ended July 31, 2008. Product sales were comprised of the following (in thousands):

                                           Three months ended July 31,            Nine months ended July 31,
                                            2009                 2008                2009               2008

Infant formula market                  $       63,320       $       74,815      $      215,294       $  223,483
Food and beverage market                        2,681                2,526               8,278            7,793
Pregnancy and nursing, nutritional
supplements and animal feeds                    7,931                5,019              20,396           15,424
Non-nutritional products                        1,112                1,121               3,250            3,265

Total product sales                    $       75,044       $       83,481      $      247,218       $  249,965

Sales to the infant formula market during the three and nine months ended July 31, 2009 decreased as compared to the three and nine months ended July 31, 2008 due primarily to the de-stocking of inventory by certain of the Company's infant formula customers. Launches of new products and increased market penetration of existing products containing life'sDHA™ also resulted in higher sales to the food and beverage market in the three and nine months ended July 31, 2009 compared to the same period of the prior fiscal year. Sales into the pregnancy and nursing, nutritional supplement and animal feed markets increased in both the three and nine months ended July 31, 2009 due to a continued expansion of Martek's customer base in these markets. Approximately 75% and 80% of our product sales in the three and nine months ended July 31, 2009, respectively, was generated by sales to Mead Johnson Nutritionals, Abbott Laboratories, Nestle, Wyeth and Danone (formerly Numico). Although we are not given precise information by our customers as to the countries in which infant formula containing our oils is ultimately sold, we estimate that approximately 55% of our sales to infant formula customers for the three and nine months ended July 31, 2009 and 2008 relate to sales in the U.S. As of July 31, 2009, we estimate that formula supplemented with our oils had penetrated almost all of the U.S. infant formula market.
Although we anticipate that annual product sales will continue to grow, our future sales growth is subject to quarter-to-quarter fluctuations and is dependent to a significant degree upon the following factors: (i) the expansions of current products containing our nutritional oils by our customers in new and existing markets; (ii) the launches of new products containing our nutritional oils by current or future customers and the success in the marketplace of such launches; (iii) the timing and extent of stocking and destocking of inventory by our customers; (iv) the levels of inclusion of our oils in infant formula;
(v) the timing and extent of our customers' production campaigns and plant maintenance shutdowns; and (vi) the availability and use by our customers and others of competitive products. Contract manufacturing sales revenues, totaling approximately $2.8 million and $10.4 million in the three and nine months ended July 31, 2009, respectively, and $4.9 million and $12.0 million in the three and nine months ended July 31, 2008, respectively, relate mainly to fermentation work performed for various third parties at our Kingstree, South Carolina facility. The decrease in contract manufacturing revenues in the three and nine months ended July 31, 2009 as compared to the three and nine months ended July 31, 2008 was primarily due to a change in the timing of orders from one existing customer. While we plan to continue reducing the scope of our contract manufacturing activities, we will provide contract services to both existing and new customers if reasonable profit margins can be generated, there is no impact to our higher margin nutritional oils business or we believe that such services could have a strategic fit in the future. As a result of the above, total revenues decreased $10.6 million or (12.0%) in the three months ended July 31, 2009 as compared to the three months ended July 31, 2008 and decreased $4.4 million or (1.7%) in the nine months ended July 31, 2009 as compared to the nine months ended July 31, 2008. Cost of Revenues
The following table presents our cost of revenues (in thousands):

                                            Three months ended July 31,            Nine months ended July 31,
                                             2009                 2008                2009               2008

Cost of product sales                   $       41,129       $       47,334      $      137,337       $  143,010
Cost of contract manufacturing sales             2,675                4,374              10,101           10,826

Total cost of revenues                  $       43,804       $       51,708      $      147,438       $  153,836

Cost of product sales as a percentage of product sales improved to 55% in the three months ended July 31, 2009 from 57% in the three months ended July 31, 2008 and improved to 56% in the nine months ended July 31, 2009 from 57% in the nine months ended July 31, 2008. The decrease in the comparative three and nine months was due primarily to ARA cost reductions and DHA productivity increases.

Cost of contract manufacturing sales, totaling $2.7 million and $10.1 million in the three and nine months ended July 31, 2009, respectively, and $4.4 million and $10.8 million in the three and nine months ended July 31, 2008, respectively, are the costs related to the fermentation work performed for various third parties at our Kingstree, South Carolina facility. Our contract manufacturing margins vary between periods primarily due to contract mix and volume.
See "Management Outlook" for discussion of expected overall profit margins for the remainder of fiscal 2009.
Operating Expenses
The following table presents our operating expenses (in thousands): . . .