Omega Protein Corporation
OMEGA PROTEIN CORP (Form: 10-Q, Received: 11/06/2007 16:49:28)
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-Q

 


 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 001-14003

 


OMEGA PROTEIN CORPORATION

(Exact name of Registrant as specified in its charter)

 


 

State of Nevada   76-0562134

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

2105 City West Blvd., Suite 500

Houston, Texas

  77042-2838
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (713) 623-0060

 


Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x     No   ¨ .

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer   ¨     Accelerated filer   x     Non-accelerated filer   ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)    Yes   ¨     No   x .

Number of shares outstanding of the Registrant's Common Stock, par value $0.01 per share, on November 2, 2007: 17,446,920.

 



Table of Contents

OMEGA PROTEIN CORPORATION

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION

  

Item 1. Financial Statements

  

Unaudited Condensed Consolidated Balance Sheet as of September 30, 2007 and December 31, 2006

   3

Unaudited Condensed Consolidated Statement of Operations and Comprehensive Income for the three and nine months ended September 30, 2007 and 2006

   4

Unaudited Condensed Consolidated Statement of Cash Flows for the nine months ended September 30, 2007 and 2006

   5

Unaudited Consolidated Statements of Stockholders’ Equity for the nine months ended September 30, 2007

   6

Notes to Unaudited Condensed Consolidated Financial Statements

   7

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

   23

Item 3. Quantitative and Qualitative Disclosures About Market Risk

   40

Item 4. Controls and Procedures

   40

PART II. OTHER INFORMATION

  

Item 1. Legal Proceedings

   42

Item 1A. Risk Factors

   42

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

   49

Item 3. Defaults Upon Senior Securities

   49

Item 4. Submission of Matters to a Vote of Security Holders

   49

Item 5. Other Information

   49

Item 6. Exhibits

   49

Signatures

   50

 

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OMEGA PROTEIN CORPORATION

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET

(Dollars in thousands, except per share amounts)

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements and Notes

 

     September 30,
2007
   

December 31,

2006

 
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 6,715     $ 7,993  

Receivables, net

     22,646       19,632  

Inventories

     76,686       60,045  

Prepaid expenses and other current assets

     1,943       2,089  
                

Total current assets

     107,990       89,759  

Other assets, net

     3,508       6,080  

Deferred tax assets, net

     1,320       4,103  

Property and equipment, net

     96,767       100,776  
                

Total assets

   $ 209,585     $ 200,718  
                
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current liabilities:

    

Current maturities of long-term debt

   $ 5,830     $ 2,467  

Accounts payable

     2,516       2,456  

Accrued liabilities

     22,497       13,760  
                

Total current liabilities

     30,843       18,683  

Long-term debt

     60,567       72,693  

Interest rate swap liability

     199       —    

Pension liabilities, net

     5,921       8,252  
                

Total liabilities

     97,530       99,628  
                

Commitments and contingencies

    

Stockholders’ equity:

    

Preferred stock, $0.01 par value; authorized 10,000,000 shares; none issued

     —         —    

Common stock, $0.01 par value; authorized 80,000,000 shares; 17,034,216 and 16,209,527 shares issued and outstanding at September 30, 2007 and December 31, 2006, respectively

     171       162  

Capital in excess of par value

     99,728       95,961  

Retained earnings

     18,652       11,895  

Accumulated other comprehensive loss

     (6,496 )     (6,928 )
                

Total stockholders’ equity

     112,055       101,090  
                

Total liabilities and stockholders’ equity

   $ 209,585     $ 200,718  
                

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

 

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OMEGA PROTEIN CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOME

(Dollars in thousands, except per share amounts)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2007     2006     2007     2006  

Revenues

   $ 44,590     $ 52,089     $ 112,813     $ 113,730  

Cost of sales

     33,640       44,610       86,805       93,678  
                                

Gross profit

     10,950       7,479       26,008       20,052  

Selling, general, and administrative expense

     3,477       3,605       11,656       10,827  

Research and development expense

     278       —         665       —    

(Insurance recoveries) losses relating to natural disaster (see Notes 1 and 11)

     (5,172 )     918       (5,172 )     1,351  

Loss on disposal of assets

     55       —         239       29  
                                

Operating income

     12,312       2,956       18,620       7,845  

Interest income

     71       100       205       507  

Interest expense

     (1,275 )     (498 )     (4,215 )     (1,550 )

Loss resulting from debt refinancing

     —         —         (3,024 )     —    

Other income (expense), net

     (75 )     (33 )     (246 )     (159 )
                                

Income before income taxes

     11,033       2,525       11,340       6,643  

Provision for income taxes

     3,880       713       3,984       1,675  
                                

Net income

     7,153       1,812       7,356       4,968  

Other comprehensive income:

        

Pension benefit adjustment

     204       —         612       —    

Interest rate swap

     (259 )     —         (188 )     —    

Foreign currency translation adjustment, net of tax benefit

     —         4       8       (5 )
                                

Comprehensive income

   $ 7,098     $ 1,816     $ 7,788     $ 4,963  
                                

Basic earnings per share

   $ 0.42     $ 0.07     $ 0.44     $ 0.20  
                                

Weighted average common shares outstanding

     16,971       25,153       16,635       25,095  
                                

Diluted earnings per share

   $ 0.41     $ 0.07     $ 0.42     $ 0.19  
                                

Weighted average common shares and common share equivalents outstanding

     17,591       26,083       17,325       26,053  
                                

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

 

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OMEGA PROTEIN CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(Dollars in thousands, except per share amounts)

 

     Nine Months Ended
September 30,
 
     2007     2006  
     (in thousands)  

Cash flows from operating activities:

    

Net income

   $ 7,356     $ 4,968  

Adjustments to reconcile net income to net cash (used in) provided by operating activities:

    

Depreciation and amortization

     9,998       9,748  

(Additional insurance recoveries) involuntary conversion from natural disasters

     (5,172 )     897  

Loss resulting from debt refinancing

     2,151       —    

Loss on sale of assets, net

     239       29  

Provision for losses on receivables

     23       13  

Share based compensation

     225       97  

Deferred income taxes

     2,280       1,455  

Changes in assets and liabilities:

    

Receivables

     (9,389 )     628  

Amounts due from majority owner

     —         105  

Inventories

     (16,641 )     (12,874 )

Prepaid expenses and other current assets

     146       (1,492 )

Other assets

     (1,343 )     (9,667 )

Accounts payable

     60       (1,546 )

Accrued liabilities

     8,652       12,443  

Pension liabilities, net

     (1,719 )     (1,440 )

Other, net

     32       2  
                

Total adjustments

     (10,458 )     (1,602 )
                

Net cash (used in) provided by operating activities

     (3,102 )     3,366  
                

Cash flows from investing activities:

    

Proceeds from disposition of assets

     —         1  

Proceeds from insurance company, hurricanes

     13,172       2,000  

Capital expenditures

     (5,389 )     (17,238 )
                

Net cash provided by (used in) investing activities

     7,783       (15,237 )
                

Cash flows from financing activities:

    

Principal payments of long-term debt obligations

     (56,112 )     (1,852 )

Debt issuance costs

     (723 )     —    

Proceeds from borrowings

     47,349       —    

Proceeds from stock options exercised

     1,872       688  

Tax effect of stock options exercised

     1,647       220  
                

Net cash used in financing activities

     (5,967 )     (944 )
                

Effect of exchange rate changes on cash and cash equivalents

     8       (5 )
                

Net decrease in cash and cash equivalents

     (1,278 )     (12,820 )

Cash and cash equivalents at beginning of year

     7,993       26,362  
                

Cash and cash equivalents at end of period

   $ 6,715     $ 13,542  
                

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

 

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OMEGA PROTEIN CORPORATION

UNAUDITED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Dollars and shares in thousands)

 

     Common Stock   

Capital
Excess of

  

Retained

    Accumulated
Other
Comprehensive
   

Total
Stockholders’

 
     Shares    Amount    Par Value    Earnings     Loss     Equity  

Balance at December 31, 2006

   16,210    $ 162    $ 95,961    $ 11,895     $ (6,928 )   $ 101,090  

Issuance of common stock

   824      9      2,120      —         —         2,129  

Tax benefit from exercise of stock options

   —        —        1,647      —         —         1,647  

FIN 48 adoption, net of tax

   —        —        —        (599 )     —         (599 )

Comprehensive income:

               

Net income

   —        —        —        7,356       —         7,356  

Other comprehensive income:

               

Interest rate swap adjustment, net of tax benefit of $96

   —        —        —        —         (188 )     (188 )

Foreign currency translation adjustment, net of tax expense of $4 stock stock stock stock

   —        —        —        —         8       8  

Pension benefits adjustment, net of tax expense of $315

   —        —        —        —         612       612  
                                 

Total comprehensive income

              7,356       432       7,788  
                                           

Balance at September 30, 2007

   17,034    $ 171    $ 99,728    $ 18,652     $ (6,496 )   $ 112,055  
                                           

The accompanying notes are an integral part of the consolidated financial statements.

 

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OMEGA PROTEIN CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Significant Accounting Policies

Summary Of Operations And Basis Of Presentation

Business Description

Omega Protein Corporation (“Omega” or the “Company”) produces and markets a variety of products produced from menhaden (a herring-like species of fish found in commercial quantities in the U.S. coastal waters of the Atlantic Ocean and Gulf of Mexico), including regular grade and value-added specialty fish meals, crude and refined fish oils and fish solubles. The Company’s fish meal products are primarily used as a protein ingredient in animal feed for swine, cattle, aquaculture and household pets. Fish oil is utilized for animal and aquaculture feeds, industrial applications, as well as for additives to human food products and dietary supplements. The Company’s fish solubles are sold primarily to livestock feed manufacturers, aquaculture feed manufacturers and for use as an organic fertilizer.

Basis of Presentation

These interim financial statements of Omega have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information, the instructions to Quarterly Report on Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and footnote disclosures normally provided have been omitted. The interim financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2006.

In the opinion of management the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair statement of the Company’s consolidated financial position as of September 30, 2007, and the results of its operations for the three and nine month periods ended September 30, 2007 and its cash flows for the nine month periods ended September 30, 2007 and 2006. Operating results are not necessarily indicative of the results that may be expected for the year ending December 31, 2007.

Consolidation

The consolidated financial statements include the accounts of Omega and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

Financial Statement Preparation

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 Company’s financial statements and the accompanying notes and the reported amounts of revenues and expenses during the reporting period. Actual amounts, when available, could differ from those estimates and those differences could have a material affect on the financial statements.

The Company has reclassified certain amounts previously reported to conform with the presentation at September 30, 2007.

 

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OMEGA PROTEIN CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (continued)

 

Hurricane Losses

On August 29, 2005, the Company’s Moss Point, Mississippi fish processing facility and adjacent shipyard were severely damaged by Hurricane Katrina. On September 25, 2005, the Company’s Cameron, Louisiana and Abbeville, Louisiana fish processing facilities were also severely damaged by Hurricane Rita. Each of these facilities was non-operational immediately after these weather events. Operations at the Moss Point fish processing facility, the Abbeville fish processing facility and the shipyard were re-established in mid-October, 2005, but at reduced processing capabilities. These two plants became fully operational prior to the start of the 2006 Gulf fishing season. Operations at the Cameron fish processing facility were re-established in June 2006, but at reduced processing capabilities. The Cameron facility became fully operational in September 2006.

The direct impact of the two hurricanes upon the Company was a loss of physical inventories and physical damage to the plants. The interruption of processing capabilities caused the Company to address the impact of abnormal downtime of its processing facilities, which resulted in the immediate recognition of costs which would ordinarily have been captured as inventory costs. See Note 11 for the amounts of these losses.

The Company maintains insurance coverage for a variety of these damages, most notably property, inventory and vessel insurance. The nature and extent of the insurance coverage varies by line of policy and the Company has previously recorded insurance recoveries as long-term receivables within other assets based on estimates of probable recoveries. The Company does not maintain business interruption insurance.

In order to facilitate the insurance recovery process, on July 28, 2006, the Company filed a lawsuit against its property insurance carriers, Lexington Insurance Company and RSUI Indemnity Company, in the U.S. District Court for the Western District of Louisiana, alleging breach of contract and bad faith based on the insurance carriers’ failure to pay amounts due to the Company under its property insurance policies for damages sustained from Hurricanes Katrina and Rita in the third quarter of 2005. The Company settled its lawsuit with its primary property insurance carrier, Lexington Insurance Company, for a total of $19.8 million during the third quarter of 2007. Of the $19.8 million, $12.0 million was previously recorded as a receivable and was fully received as of September 30, 2007, $3.3 million was paid to outside legal counsel in connection with the settlement and $4.5 was recognized during the third quarter as insurance recoveries relating to natural disaster in the statement of operations and comprehensive income. In addition, the Company settled its lawsuit with its secondary property insurance carrier, RSUI Indemnity Company, for a total of $9.2 million during the fourth quarter of 2007. Of the $9.2 million, $0.7 million was advanced during the third quarter of 2007 and recognized as insurance recoveries relating to natural disaster in the statement of operations and comprehensive income, $3.0 million will be paid to outside legal counsel in connection with the settlement during the fourth quarter of 2007 and $5.5 will be recognized during the fourth quarter of 2007 as insurance recoveries relating to natural disaster in the statement of operations and comprehensive income. The Company still has a pending lawsuit against its insurance broker alleging negligent procurement, negligent misrepresentation, breach of contract and violations of Texas Insurance and Consumer laws. See “Part II, Item 1. Legal Proceedings” for additional information.

Revenue Recognition

The Company derives revenue principally from the sales of a variety of protein and oil products derived from menhaden. The Company recognizes revenue for the sale of its products when title and rewards of ownership to its products are transferred to the customer.

 

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OMEGA PROTEIN CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (continued)

 

Cash and Cash Equivalents

The Company considers cash in banks and short-term investments with original maturities of three months or less as cash and cash equivalents.

Allowances for Doubtful Accounts

The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of the Company’s customers to make required payments. The Company considers the following factors when determining if collection is reasonably assured: customer credit worthiness, past transaction history with the customer, and changes in customer payment terms. If the Company has no previous experience with the customer, the Company typically obtains reports from credit organizations to ensure that the customer has a history of paying its creditors. The Company may also request financial information, including financial statements or other documents (e.g., bank statements), or may obtain a letter of credit from the customer to ensure that the customer has the means of making payment. If the financial condition of the Company’s customers were to deteriorate, adversely affecting their ability to make payments, additional allowances would be required.

Inventories

Inventory is stated at the lower of cost or market. The Company’s fishing season runs from mid-April to the first of November in the Gulf of Mexico and from the beginning of May into December in the Atlantic. Government regulations generally preclude the Company from fishing during the off-seasons.

The Company’s inventory cost system considers all costs associated with an annual fish catch and its processing, both variable and fixed, including both costs incurred during the off-season and during the fishing season. The Company’s costing system allocates cost to inventory quantities on a per unit basis as calculated by a formula that considers total estimated inventoriable costs for a fishing season (including off-season costs) to total estimated fish catch and the relative fair market value of the individual products produced. The Company adjusts the cost of sales, off-season costs and inventory balances at the end of each quarter based on revised estimates of total inventoriable costs and fish catch. The Company’s lower-of-cost-or-market-value analyses at year-end and at interim periods compare the total estimated per unit production cost of the Company’s expected production to the projected per unit market prices of the products. The impairment analyses involve estimates of, among other things, future fish catches and related costs, and expected commodity prices for the fish products as well as projected purchase commitments from customers. These estimates, which management believes are reasonable and supportable, involve estimates of future activities and events which are inherently imprecise and from which actual results may differ materially.

Any costs incurred during abnormal downtime related to activity at the Company’s plants are charged to expense as incurred.

During the off-seasons, in connection with the upcoming fishing seasons, the Company incurs costs (i.e., plant and vessel related labor, utilities, rent, repairs, and depreciation) that are directly related to the Company’s infrastructure. These costs accumulate in inventory and are applied as elements of the cost of production of the Company’s products throughout the fishing season ratably based on the Company’s monthly fish catch and the expected total fish catch for the season.

 

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OMEGA PROTEIN CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (continued)

 

Insurance

The Company carries insurance for certain losses relating to its vessels and Jones Act liabilities for employees aboard its vessels. The Company provides reserves for those portions of the annual aggregate deductible for which the Company remains responsible by using an estimation process that considers Company-specific and industry data as well as management’s experience, assumptions and consultation with counsel, as these reserves include estimated settlement costs. Management’s current estimated range of liabilities related to such cases is based on claims for which management can estimate the amount and range of loss. For those claims where there may be a range of loss, the Company has recorded an estimated liability inside that range, based on management’s experience, assumptions and consultation with counsel. The process of estimating and establishing reserves for these claims is inherently uncertain and the actual ultimate net cost of a claim may vary materially from the estimated amount reserved. There is some degree of inherent variability in assessing the ultimate amount of losses associated with these claims due to the extended period of time that transpires between when the claim might occur and the full settlement of such claims. This variability is generally greater for Jones Act claims by vessel employees. The Company continually evaluates loss estimates associated with claims and losses as additional information becomes available and revises its estimates. Although management believes estimated reserves related to these claims are adequately recorded, it is possible that actual results could significantly differ from the recorded reserves, which could materially impact the Company’s results of operations, financial position and cash flow.

The Company is primarily self-insured for health insurance. The Company purchases individual stop loss coverage with a large deductible. As a result, the Company is primarily self-insured for claims and associated costs up to the amount of the deductible, with claims in excess of the deductible amount being covered by insurance. Expected claims estimates are based on health care trend rates and historical claims data; actual claims may differ from those estimates. The Company evaluates its claims experience related to this coverage with information obtained from its risk management consultants.

Assumptions used in preparing these insurance estimates are based on factors such as claims settlement patterns, claim development trends, claim frequency and severity patterns, inflationary trends and data reasonableness. Together these factors will generally affect the analysis and determination of the “best estimate” of the projected ultimate claim losses. The results of these evaluations are used to both analyze and adjust the Company’s insurance loss reserves.

Advertising Costs

The costs of advertising are expensed as incurred in accordance with Statement of Position 93-7 “Reporting on Advertising Costs.”

Research and Development

Costs incurred in research and development activities are expensed as incurred.

Interest Rate Swap Agreements

The Company does not enter into financial instruments for trading or speculative purposes. The principal financial instrument used for cash flow hedging purposes is an interest rate swap described below. The Company entered into an interest rate swap agreement to manage its exposure to interest rate changes. The swap effectively converts a portion of the Company’s variable rate debt under the Revolving Credit Facility (as defined below) to a fixed rate, without exchanging the notional principal amounts.

 

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OMEGA PROTEIN CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (continued)

 

In April 2007, the Company entered into an interest rate swap agreement with a notional amount of $19,950,000 that is scheduled to mature in March 2012. Under this agreement, the Company receives a floating rate based on the LIBOR interest rate, and pays a fixed rate of 5.16% on the notional amount of $19,950,000. The Company has recorded a long-term liability of $199,000, net of the current portion of $85,000, to recognize the fair value of interest derivatives, and has also recorded a deferred tax asset of $96,000 associated therewith. The change in fair value from inception to September 30, 2007 is recorded in “other comprehensive income” in the Company’s consolidated financial statements.

The $188,000 reported for cash flow hedge effectiveness in accumulated other comprehensive loss as of September 30, 2007 will be reclassified to earnings on a quarterly basis through 2012, when the interest rate swap expires. The amount to be reclassified to earnings during the next 12 months is expected to be approximately $85,000.

If, at any time, the swap is determined to be ineffective, in whole or in part, due to changes in the interest rate swap or underlying debt agreements, the fair value of the portion of the interest rate swap determined to be ineffective will be recognized as gain or loss in “interest expense” in the statement of operations for the applicable period.

Accounting for the Impairment of Long-Lived Assets

The Company evaluates at each balance sheet date for continued appropriateness of the carrying value of its long-lived assets including its long-term receivables and property, plant and equipment in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposals of Long-Lived Assets.” The Company reviews long-lived assets for impairment when events or changes in circumstances indicate that the carrying amount of any such assets or grouping of assets may not be recoverable. The Company has grouped certain assets together (primarily marine vessels) for impairment testing on a fleet basis. If indicators of impairment are present, management evaluates the undiscounted cash flows estimated to be generated by those assets or grouping of assets compared to the carrying amount of those items. The net carrying value of assets or grouping of assets not recoverable is reduced to fair value. The Company considers continued operating losses, or significant and long-term changes in business conditions, to be its primary indicators of potential impairment.

Income Taxes

The Company utilizes the liability method to account for income taxes. This method requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of existing temporary differences between the financial reporting and tax reporting basis of assets and liabilities, and operating loss and tax credits carryforwards for tax purposes. The Company records a valuation allowance to reduce the deferred tax assets to the amount that is more likely than not to be realized. The Company believes that the deferred tax assets recorded as of September 30, 2007 are realizable through future reversals of existing taxable temporary differences and future taxable income. If the Company were to subsequently determine that it would be able to realize deferred tax assets in the future in excess of the net recorded amount, an adjustment to deferred tax assets would increase earnings for the period in which such determination was made. The Company will continue to assess the adequacy of the valuation allowance on a quarterly basis. Any changes to the estimated valuation allowance could be material to the consolidated financial condition and results of operations.

 

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OMEGA PROTEIN CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (continued)

 

Property, Equipment and Depreciation

Property and equipment additions are recorded at cost. Depreciation of property and equipment is computed by the straight-line method at rates expected to amortize the cost of property and equipment, net of salvage value, over their estimated useful lives. Estimated useful lives, determined at the date of acquisition, of new assets acquired are based primarily on the review of existing property and equipment. Estimated useful lives are as follows:

 

     Useful Lives
(years)

Fishing vessels and fish processing plants

   15-20

Machinery, equipment, furniture and fixtures and other

   3-10

Replacements and major improvements are capitalized and amortized over a period of 5 to 15 years, maintenance and repairs are charged to expense as incurred. Upon sale or retirement, the costs and related accumulated depreciation are eliminated from the accounts. Any resulting gains or losses are included in the statement of operations. The Company capitalizes interest as part of the acquisition cost of a qualifying asset.

Interest is capitalized only during the period of time required to complete and prepare the asset for its intended use. For the three and nine month periods ended September 30, 2007 and 2006, the Company capitalized interest of approximately $16,000, $0, $55,800 and $0, respectively.

Pension Plans

As of December 31, 2006, the Company adopted SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans”. This statement requires the recognition of the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through other comprehensive income. The statement also changes financial reporting by requiring an employer to measure the funded status of a plan as of the date of its year-end statement of financial position. The Company’s policy is to fund U.S. pension plans at amounts not less than the minimum requirements of the Employee Retirement Income Security Act of 1974 and generally for obligations under its foreign plans to deposit funds with trustees under insurance policies.

In 2002, the Board of Directors authorized a plan to freeze the Company’s pension plan in accordance with ERISA rules and regulations so that new employees, hired after July 31, 2002, will not be eligible to participate in the pension plan and further benefits will no longer accrue for existing participants. The freezing of the pension plan had the effect of vesting all existing participants in their pension benefits in the plan.

Comprehensive Loss

Comprehensive loss is defined as change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources, including foreign currency translation adjustments and pension benefits adjustments, including recognition of actuarial losses. The Company presents comprehensive loss in its consolidated statements of operations and comprehensive income.

 

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OMEGA PROTEIN CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (continued)

 

Accumulated Comprehensive Loss

The components of accumulated other comprehensive loss included in shareholder’s equity are as follows:

 

     September 30,
2007
    December 31,
2006
 
     (in thousands)  

Cumulative Translation Adjustments, net of tax benefit of $13 as of September 30, 2007 and $17 as of December 31, 2006

   $ (25 )   $ (33 )

Pension Benefits Adjustments, net of tax benefit of $3,237 as of September 30, 2007 and $3,552 as of December 31, 2006

     (6,283 )     (6,895 )

Fair Value of Interest Rate Swap, net of tax expense of $96 as of September 30, 2007

     (188 )     —    
                

Accumulated Other Comprehensive Loss

   $ (6,496 )   $ (6,928 )
                

Foreign Currency Translation

The Company’s Mexican operations use the local currency as the functional currency. Assets and liabilities of those operations are translated into U.S. dollars using period-end exchange rates; income and expenses are translated using the average exchange rates for the reporting period. Translation adjustments are deferred in accumulated other comprehensive income (loss), a separate component of stockholders’ equity.

Concentrations of Credit Risk

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and trade accounts receivable. The Company’s customer base generally remains consistent from year to year. The Company performs ongoing credit evaluations of its customers and generally does not require material collateral. The Company maintains reserves for potential credit losses and such losses have historically been within management’s expectations.

At September 30, 2007 and December 31, 2006, the Company had cash deposits concentrated primarily in one major bank. In addition, the Company had certificates of deposit and commercial quality grade investments A2P2 rated or better with companies and financial institutions. The Company believes that credit risk in such investments is minimal.

Earnings per Share

Basic earnings per common share (EPS) were computed by dividing net earnings by the weighted average number of common shares outstanding during the reporting period. Diluted EPS reflects the dilution that could occur if securities or contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. Diluted earnings per common share was computed by dividing net earnings by the sum of the weighted average number of common shares outstanding plus the number of additional common shares that would have been outstanding if the dilutive potential common shares (in this case, exercise of the Company’s employee stock options) had been issued during each period as discussed in Note 9.

 

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OMEGA PROTEIN CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (continued)

 

Purchase and Retirement of Common Stock

The Company accounts for the retirement of treasury shares under the par value method. Under this method, the excess of the cost of treasury stock over its par value is charged to retained earnings.

Recently Issued Accounting Standards

In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement No. 109” (“FIN 48”), which clarifies the accounting and disclosure for uncertain tax positions in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN 48 addresses the recognition, measurement, classification and disclosure issues related to the recording of financial statement benefits for income tax positions that have some degree of uncertainty. The Company adopted the provisions FIN 48 on January 1, 2007. As a result of the implementation of FIN 48, the Company recognized a decrease of approximately $0.6 million in deferred tax assets, net, which was accounted for as a decrease to the January 1, 2007 balance of retained earnings. As of January 1, 2007, the total gross unrecognized tax benefits were approximately $2.0 million. Of this total, approximately $1.6 million, net of federal tax benefits, would favorably affect the effective income tax rate if recognized. During the third quarter of 2007, the Company recognized a tax benefit of $72,000 relating to the adjustment of a tax position which was over accrued during the initial assessment stage of the impact of FIN 48.

The Company is no longer subject to U.S. Federal, state and local non-U.S. income tax examinations by tax authorities for years prior to 2003.

Additionally, the Company recognizes interest and penalties related to uncertain tax positions in income tax expense. As of September 30, 2007, the Company has approximately $5,000 of accrued interest and penalties related to uncertain tax positions.

While the Company expects the amount of unrecognized tax positions to change in the next 12 months, the Company does not expect the change to have a significant impact on the results of operations or financial position.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosure about fair value measurements. The statement is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company is currently evaluating the effect, if any, that the adoption of SFAS 157 will have on its consolidated results of operations, financial position and related disclosures.

In February 2007, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115 (“SFAS No. 159”). This statement permits entities to choose to measure many financial assets and liabilities and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This statement is effective as of the beginning of the entity’s first fiscal year beginning after November 15, 2007. The Company is currently evaluating the impact, if any, the adoption of SFAS No. 159 will have on its consolidated financial statements.

Stock-Based Compensation

The Company has a stock-based compensation plan, which is described in more detail in Note 11 to the consolidated financial statements of the Company’s Form 10-K for the fiscal year ended December 31, 2006. Net

 

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OMEGA PROTEIN CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (continued)

 

earnings for the three and nine months ended September 30, 2007 and 2006 include $177,000, $64,800, $340,000 and $97,300 ($117,000, $42,800, $225,000 and $64,200 after-tax), respectively, of share-based compensation costs which are included in selling, general and administrative expenses in the condensed consolidated statement of operations and comprehensive income. As of September 30, 2007, there was $324,000 of total unrecognized compensation costs related to nonvested share-based compensation that is expected to be recognized over a weighted-average period of 1.89 years, of which $90,000 of total share-based compensation is expected to be recognized during the remainder of fiscal year 2007.

Note 2. Accounts Receivable

Accounts receivable as of September 30, 2007 and December 31, 2006 are summarized as follows:

 

     September 30,
2007
    December 31,
2006
 
     (in thousands)  

Trade

   $ 20,797     $ 11,703  

Insurance

     719       1,090  

Insurance – 2005 hurricanes

     —         6,352  

Employee

     156       39  

Income tax

     373       309  

Other

     823       339  
                

Total accounts receivable

     22,868       19,832  

Less: allowance for doubtful accounts

     (222 )     (200 )
                

Receivables, net

   $ 22,646     $ 19,632  
                

Note 3. Inventory

The major classes of inventory as of September 30, 2007 and December 31, 2006 are summarized as follows:

 

     September 30,
2007
   December 31,
2006
     (in thousands)

Fish meal

   $ 52,254    $ 34,719

Fish oil

     16,985      13,490

Fish solubles

     1,959      680

Unallocated inventory cost pool (including off-season costs)

     55      5,882

Other materials & supplies

     5,433      5,274
             

Total inventory

   $ 76,686    $ 60,045
             

Inventory at September 30, 2007 and December 31, 2006 is stated at the lower of cost or market. The elements of unallocated inventory cost pool include plant and vessel related labor, utilities, rent, repairs and depreciation, to be allocated to inventories produced through the remainder of the 2007 fishing season.

 

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OMEGA PROTEIN CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (continued)

 

Note 4. Other Assets

Other assets as of September 30, 2007 and December 31, 2006 are summarized as follows:

 

     September 30,
2007
   December 31,
2006
     (in thousands)

Fish nets, net of accumulated amortization of $2,008 and $1,597

   $ 1,341    $ 929

Insurance receivable, net of allowance for doubtful accounts

     995      768

Insurance receivable – 2005 hurricanes

     —        1,648

Title XI loan origination fee

     386      416

Other debt issuance costs

     727      2,270

Deposits

     49      49

Other

     10      —  
             

Total other assets, net

   $ 3,508    $ 6,080
             

Amortization expense for fishing nets amounted to approximately $225,000, $160,000, $597,000 and $496,000 for the three and nine months ended September 30, 2007 and 2006, respectively.

As a result of Hurricanes Katrina and Rita (see Note 11 – Hurricane Losses), the Company sustained damage to its three fish processing facilities and its shipyard located in the Gulf of Mexico region. Based on estimates, the Company believed its hurricane related insurance recoveries would total approximately at least $12 million and as a result, recorded related receivables as of September 30, 2005. During the fourth quarter of 2005 and the first quarter of 2006, the Company obtained two separate $2.0 million advances against the hurricane claims from its primary property insurance carrier. In February 2007 and May 2007, the Company received additional advances of $6.4 million and $0.2 million, respectively, against the hurricane claims from its primary property insurance carrier. In order to facilitate the insurance recovery process, on July 28, 2006, the Company filed a lawsuit against its property insurance carriers, Lexington Insurance Company and RSUI Indemnity Company, in the U.S. District Court for the Western District of Louisiana, alleging breach of contract and bad faith based on the insurance carriers’ failure to pay amounts due to the Company under its property insurance policies for damages sustained from Hurricanes Katrina and Rita in the third quarter of 2005. The Company settled its lawsuit with its primary property insurance carrier, Lexington Insurance Company, for a total of $19.8 million during the third quarter of 2007. Of the $19.8 million, $12.0 million was previously recorded as a receivable and was fully received as of September 30, 2007, $3.3 million was paid to outside legal counsel in connection with the settlement and $4.5 was recognized during the third quarter as insurance recoveries relating to natural disaster in the statement of operations and comprehensive income. In addition, the Company settled its lawsuit with its secondary property insurance carrier, RSUI Indemnity Company, for a total of $9.2 million during the fourth quarter of 2007. Of the $9.2 million, $0.7 million was advanced during the third quarter of 2007 and recognized as insurance recoveries relating to natural disaster in the statement of operations and comprehensive income, $3.0 million was paid to outside legal counsel in connection with the settlement during the fourth quarter of 2007 and $5.5 was received and will be recognized during the fourth quarter of 2007 as insurance recoveries relating to natural disaster in the statement of operations and comprehensive income. The Company still has a pending lawsuit against its insurance broker alleging negligent procurement, negligent misrepresentation, breach of contract and violations of Texas Insurance and Consumer laws. See “Part II, Item 1. Legal Proceedings” for additional information.

The Company carries insurance for certain losses relating to its vessels and Jones Act liability for employees aboard its vessels (collectively, “Vessel Claims Insurance”). The typical Vessel Claims Insurance policy contains an annual aggregate deductible (“AAD”) for which the Company remains responsible, while the insurance carrier is responsible for all applicable amounts which exceed the AAD. It is the Company’s policy to accrue current

 

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OMEGA PROTEIN CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (continued)

 

amounts due and record amounts paid out on each claim. Once payments exceed the AAD, the Company records an insurance receivable for a given policy year, net of allowance for doubtful accounts. As of September 30, 2007 and December 31, 2006 the allowance for doubtful insurance receivable accounts was $2.0 million.

Note 5. Property and Equipment

Property and equipment at September 30, 2007 and December 31, 2006 are summarized as follows:

 

     September 30,
2007
    December 31,
2006
 
     (in thousands)  

Land

   $ 7,630     $ 7,630  

Plant assets

     102,388       100,963  

Fishing vessels

     94,008       94,268  

Furniture and fixtures

     4,902       3,135  

Construction in progress

     4,206       3,035  
                

Total property and equipment

     213,134       209,031  

Less: accumulated depreciation and impairment

     (116,367 )     (108,255 )
                

Property, plant and equipment, net

   $ 96,767     $ 100,776  
                

Depreciation expense for the three and nine months ended September 30, 2007 and 2006 was $2.9 million, $3.2 million, $9.2 million and $9.2 million, respectively.

Note 6. Notes Payable and Long-Term Debt

At September 30, 2007 and December 31, 2006, the Company’s long-term debt consisted of the following:

 

     September 30,
2007
    December 31,
2006
 
     (in thousands)  

U.S. government guaranteed obligations (Title XI loan) collateralized by a first lien on certain vessels and certain plant assets:

    

Amounts due in installments through 2016, interest from 6.49% to 7.6%

   $ 31,547     $ 27,343  

Amounts due in installments through 2014, interest at Eurodollar rates plus 0.45% (5.81% and 5.82% at September 30, 2007 and December 31, 2006, respectively)

     287       317  

Bank of America term loan, quarterly principal payments beginning September 30, 2007, as defined, interest payable quarterly based on LIBOR plus 2.38% (7.57% as of September 30, 2007) maturing March 2012

     34,563       —    

Ableco revolving credit facility, annual principal payments based on defined calculation, interest payable monthly based on LIBOR plus 3.25 basis points (8.6% as of December 31, 2006) maturing in October 2011

     —         12,500  

Ableco term loan, annual principal payments based on defined calculation, interest payable monthly based on LIBOR plus 4.25 basis points (9.6% as of December 31, 2006) maturing in October 2011

     —         35,000  
                

Total debt

     66,397       75,160  

Less current maturities

     (5,830 )     (2,467 )
                

Long-term debt

   $ 60,567     $ 72,693  
                

The Title XI loans are secured by liens on certain of the Company’s fishing vessels and mortgages on the Company’s Reedville, Virginia and Abbeville, Louisiana plants. Loans are now available under similar terms pursuant to the Title XI program without intervening lenders.

 

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OMEGA PROTEIN CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (continued)

 

In September 2004, the United States Department of Commerce Fisheries Finance Program (the “FFP”) approved the Company’s financing application in an amount not to exceed $14 million (the “Approval Letter”). Borrowings under the Approval Letter are to be used to finance and/or refinance approximately 73% of the actual depreciable cost of the Company’s future fishing vessel refurbishments and capital expenditures relating to shore-side fishing assets, for a term not to exceed 15 years from inception at interest rates determined by the U.S. Treasury. Final approval for all such future projects requires individual approval through the Secretary of Commerce, National Oceanic and Atmospheric Administration, and National Marine Fisheries Service (“National Marine Fisheries Service”). Borrowings under the FFP are required to be evidenced by security agreements, undertakings, and other documents deemed in the sole discretion of the National Marine Fisheries Service as necessary to accomplish the intent and purpose of the Approval Letter. The Company is required to comply with customary National Marine Fisheries Service covenants as well as certain special covenants. In December 2004, the Company submitted a $4.9 million financing request against the $14 million approval, and subsequently amended that request to include the entire $14 million. The Company closed on the $14 million FFP loan on October 17, 2005.

On December 1, 2005, pursuant to the Title XI program, the FFP approved a second financing application made by the Company in the amount of $16.4 million (the “Second Approval Letter”). In May 2006, the Company submitted a $6.3 million financing request under the Second Approval Letter. The Company closed on the $6.3 financing in the first quarter of 2007. As of September 30, 2007, the Company was in compliance with all of the covenants contained therein.

On October 20, 2006, the Company, certain of its subsidiaries and Abelco Finance LLC (“Ableco”), A3 Fund Management LLC, an affiliate of Abelco, and Wachovia Bank, National Association entered into the financing agreement (the “Financing Agreement”) pursuant to which the lenders agreed to provide the Company with a senior secured financing facility (“the “Financing Facility”) in the maximum amount of $65 million. The Financing Facility consisted of (a) a revolving credit facility of up to $30 million outstanding at any time, including a $5 million subfacility for the issuance of letters of credit, and (b) a term loan facility of $35 million. On October 20, 2006, the Company drew down the $35 million term loan and approximately $13.6 million of revolving loans, and approximately $3.3 million in letters of credit were issued pursuant to the letter of credit subfacility. The Financing Facility was secured by a first priority lien on all of the Company’s assets, other than vessels, real estate and other assets pledged to secure loans made to the Company under the FFP, including the Pending Loan.

On March 26, 2007 (the “Closing Date”), the Company entered into a Credit Agreement (the “Credit Agreement”) with Bank of America, N.A., as administrative agent, lender, swing line lender and letter of credit issuer, Regions Bank, Compass Bank and Farm Credit Bank of Texas (collectively, the “Lenders”). The Credit Agreement provides the Company with a $55 million senior credit facility (the “Senior Credit Facility”) consisting of (i) a 5-year revolving credit facility (the “Revolving Credit Facility”) of up to $20 million, including a $7.5 million sub-limit for the issuance of standby letters of credit and a $2.5 million sub-limit for swing line loans and (ii) a 5-year term loan (the “Term Loan”) of $35 million. The Senior Credit Facility replaced the Company’s Financing Facility, under which, as of the Closing Date, $28.7 million in principal was outstanding under a term loan and $6.5 million in principal was outstanding under revolving loans, and approximately $3.3 million in letters of credit were issued, primarily in support of worker’s compensation insurance programs. On the Closing Date, the Company drew down $35 million under the Term Loan and approximately $2.0 million under the Revolving Credit Facility, and had approximately $3.1 million issued in standby letters of credit, primarily in support of worker’s compensation insurance programs. The Senior Credit Facility is secured by a first priority lien on all of the Company’s assets, other than vessels, real estate and other assets pledged to secure loans made to the Company under the FFP.

 

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OMEGA PROTEIN CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (continued)

 

For the nine months ended September 30, 2007, as a result of the above mentioned refinancing, the Company expensed approximately $2.2 million in deferred debt issuance costs and $0.8 million as a prepayment penalty related to the Financing Facility.

As of September 30, 2007, the Company had $34.6 million outstanding under the Term Loan and $3.1 million in letters of credit issued primarily in support of worker’s compensation insurance programs. As of September 30, 2007, the Company had $16.9 million available under the Revolving Credit Facility and the Company was in compliance with all of the covenants under the Senior Credit Facility. The Company has no off-balance sheet arrangements other than normal operating leases and standby letters of credit.

Note 7. Accrued Liabilities

Accrued liabilities as of September 30, 2007 and December 31, 2006 are summarized as follows:

 

     September 30,
2007
   December 31,
2006
     (in thousands)

Salary and benefits

   $ 10,355    $ 4,023

Insurance

     4,853      4,186

Taxes, other than income tax

     1,064      130

Trade creditors

     5,682      4,664

Fair market value of interest rate swap, current portion

     85      —  

Other

     458      757
             

Total accrued liabilities

   $ 22,497    $ 13,760
             

Note 8. Commitments and Contingencies

Litigation

The Company is defending various claims and litigation arising from its operations which arise in the ordinary course of the Company’s business. In the opinion of management, and based on advice of legal counsel, it is believed that any existing litigation involving the Company will not materially adversly affect its financial condition, cash flows or future results of operations.

Insurance

The Company carries insurance with coverages and coverage limits that it believes to be appropriate for the business. Although there can be no assurance that such insurance is sufficient to protect the Company against all contingencies, management believes that its insurance protection is reasonable in view of the nature and scope of the Company’s operations. Should the Company’s insurers become insolvent, the Company is responsible for payment of all outstanding claims associated with the insurer’s policies.

Environmental Matters

The Company is subject to various possible claims and lawsuits regarding environmental matters. Management believes that costs, if any, related to these matters will not have a material adverse effect on the results of operations, cash flows or financial position of the Company.

 

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OMEGA PROTEIN CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (continued)

 

Indemnification

The Company’s Articles of Incorporation and By-Laws limit the liability of the Company’s officers and directors to the fullest extent permitted by Nevada law. Nevada provides that directors of Nevada corporations may be relieved of monetary liabilities for breach of their fiduciary duties as directors, except under certain circumstances, including (i) acts or omissions which involve intentional misconduct, fraud or a knowing violation of law or (ii) the willful or grossly negligent payment of unlawful distributions.

The Company’s Articles of Incorporation and By-Laws generally require the Company to indemnify its directors and officers to the fullest extent permitted by Nevada law. The Company’s Articles of Incorporation and By-Laws also require the Company to advance expenses to its directors and its officers to the fullest extent permitted by Nevada law upon receipt of an undertaking by or on behalf of such director or officer to repay such amount if it should be ultimately determined that they are not entitled to indemnification by the Company. The Company also has entered into indemnification agreements with all of its directors and certain of its officers which provides for the indemnification and advancement of expenses by the Company. The Company also maintains director and officer liability insurance with respect to liabilities arising out of certain matters, including matters arising under the securities laws. This insurance is subject to limitations, conditions and deductibles set forth in the respective insurance policy.

Note 9. Reconciliation of Basic and Diluted Per Share Data (in thousands except per share data)

 

     Earnings
(Numerator)
   Shares
(Denominator)
   Per Share
Data

Three Months Ended September 30, 2007

        

Net earnings

   $ 7,153    —     
              

Basic earnings per common share:

        

Earnings available to common shareholders

   $ 7,153    16,971    $ 0.42
            

Effect of dilutive securities:

        

Stock options assumed exercised

     —      620   
              

Diluted earnings per common share:

        

Earnings available to common shareholders plus stock options assumed exercised

   $ 7,153    17,591    $ 0.41
                  
     Earnings
(Numerator)
   Shares
(Denominator)
   Per Share
Data

Three Months Ended September 30, 2006

        

Net earnings

   $ 1,812    —     
              

Basic earnings per common share:

        

Earnings available to common shareholders

   $ 1,812    25,153    $ 0.07
            

Effect of dilutive securities:

        

Stock options assumed exercised

     —      930   
              

Diluted earnings per common share:

        

Earnings available to common shareholders plus stock options assumed exercised

   $ 1,812    26,083    $ 0.07
                  

 

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OMEGA PROTEIN CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (continued)

 

     Earnings
(Numerator)
   Shares
(Denominator)
   Per Share
Data

Nine Months Ended September 30, 2007

        

Net earnings

   $ 7,356      
            

Basic earnings per common share:

        

Earnings available to common shareholders

   $ 7,356    16,635    $ 0.44
            

Effect of dilutive securities:

        

Stock options assumed exercised

     —      690   
              

Diluted earnings per common share:

        

Earnings available to common shareholders plus stock options assumed exercised

   $ 7,356    17,325    $ 0.42
                  
     Earnings
(Numerator)
   Shares
(Denominator)
   Per Share
Data

Nine Months Ended September 30, 2006

        

Net earnings

   $ 4,968      
            

Basic earnings per common share:

        

Earnings available to common shareholders

   $ 4,968    25,095    $ 0.20
            

Effect of dilutive securities:

        

Stock options assumed exercised

     —      958   
              

Diluted earnings per common share:

        

Earnings available to common shareholders plus stock options assumed exercised

   $ 4,968    26,053    $ 0.19
                  

Options to purchase 2,085,000 and 2,597,000 shares of common stock at exercise prices ranging from $8.61 to $17.25 and $7.25 to $17.25 per share were outstanding during the three and nine months ended September 30, 2007, respectively, but were not included in the computation of diluted earnings per share because the exercise prices of the options were greater than the average market price of the shares during that period.

Options to purchase 2,575,000 shares of common stock at exercise prices ranging from $6.13 to $17.25 per share were outstanding during the three and nine months ended September 30, 2006, but were not included in the computation of diluted earnings per share because the exercise prices of the options were greater than the average market price of the shares during that period.

 

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OMEGA PROTEIN CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (continued)

 

Note 10. Components of Net Periodic Benefit Cost

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2007     2006     2007     2006  

Service cost

   $ —       $ —       $ —       $ —    

Interest cost

     376       358       1,128       1,074  

Expected return on plan assets

     (405 )     (343 )     (1,215 )     (1,029 )

Amortization of prior service costs

     —         —         —         —    

Amortization of net loss

     204       227       612       681  
                                

Net periodic pension cost

   $ 175     $ 242     $ 525     $ 726  
                                

For the nine months ended September 30, 2007, the Company made approximately $2.2 million in contributions to the Company’s pension plan. The Company expects to make contributions of $0.4 million to the pension plan during the remainder of 2007. For the nine months ended September 30, 2006, the Company had made $2.2 million in contributions to the pension plan.

Note 11. Hurricane Losses

On August 29, 2005, the Company’s Moss Point, Mississippi fish processing facility and adjacent shipyard were severely damaged by Hurricane Katrina. On September 24, 2005, the Company’s Cameron, Louisiana and the Abbeville, Louisiana fish processing facilities were also severely damaged by Hurricane Rita. For the three and nine-month periods ended September 30, 2007 and 2006, the following amounts have been recognized in the Company’s statement of operations:

 

     Three Months Ended
September 30,
   Nine Months Ended
September 30,
     2007     2006    2007     2006
     (in thousands)

Involuntary conversion of property and equipment

   $ —       $ 897    $ —       $ 897

Clean-up costs incurred

     —         21      —         454

Insurance recoveries

     (5,172 )     —        (5,172 )     —  
                             

(Insurance recoveries) losses relating to natural disaster

   $ (5,172 )   $ 918    $ (5,172 )   $ 1,351
                             

Note 12. Subsequent Event

In October 2007, the Company and RSUI Indemnity Company entered into a Settlement Agreement pursuant to which RSUI Indemnity Company made an additional payment to the Company of approximately $8,244,000 on October 29, 2007. The net proceeds to the Company, after legal fees, to be recognized in the fourth quarter of 2007 were approximately $5,496,000.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-looking statements in this Form 10-Q, future filings by the Company with the Securities and Exchange Commission (the “Commission”), the Company’s press releases and oral statements by authorized officers of the Company are intended to be subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that all forward-looking statements involve risks and uncertainty, including without limitation, the risks set forth under the caption “Risk Factors and Significant Factors that May Affect Forward-Looking Statements” appearing in Item 1A. “Risk Factors.” The Company believes that forward-looking statements made by it are based on reasonable expectations; however, no assurances can be given that actual results will not differ materially from those contained in such forward-looking statements. Forward-looking statements include statements that are predictive in nature, that depend upon or refer to future events or conditions, or that include the words “estimate,” “project,” “anticipate,” “expect,” “predict,” “assume,” “believe,” “could,” “would,” “hope,” “may,” and similar expressions.

General

Omega Protein Corporation is the largest processor, marketer and distributor of fish meal and fish oil products in the United States. As used herein, the term “Omega” or the “Company” refers to Omega Protein Corporation or to Omega Protein Corporation and its consolidated subsidiaries, as applicable. The Company’s principal executive offices are located at 2105 City West Boulevard, Suite 500, Houston, Texas 77042-2838 (Telephone: (713) 623-0060).

The Company produces and sells a variety of protein and oil products derived from menhaden, a species of wild herring-like fish found along the Gulf of Mexico and Atlantic coasts. The fish are not genetically modified or genetically enhanced. The Company processes several grades of fish meal, as well as fish oil and fish solubles. The Company’s fish meal products are primarily used as a protein ingredient in animal feed for swine, cattle, aquaculture and household pets. Fish oil is utilized for animal and aquaculture feeds, industrial applications, additives to human food products and as dietary supplements. The Company’s fish solubles are sold primarily to livestock feed manufacturers, aquaculture feed manufacturers and for use as an organic fertilizer.

The Company operates four menhaden processing plants: two in Louisiana, one in Mississippi and one in Virginia. The Company also operates a Health and Science Center in Reedville, Virginia, which provides 100-metric tons per day fish oil processing capacity for the Company’s food, industrial and feed grade oils. In January 2007, the Company opened its new technical center in Houston, Texas – The OmegaPure Technology and Innovation Center. The technical center has food science application labs as well as analytical, sensory, lipids research and pilot plant capabilities.

In August 2005, the Company’s Moss Point, Mississippi fish processing facility and adjacent shipyard were severely damaged by Hurricane Katrina. In September 2005, the Company’s Cameron, Louisiana and Abbeville, Louisiana fish processing facilities were also severely damaged by Hurricane Rita. Each of these facilities was non-operational immediately after these weather events. The Moss Point, Abbeville and Cameron facilities accounted for approximately 16%, 31% and 22%, respectively, of the Company’s full year 2004 production tonnage, so as an immediate result of the two hurricanes, approximately 70% of the Company’s operating capacity was impaired and the Company’s business, results of operations and financial condition were materially adversely affected. The Company’s four plants, assuming that no hurricane damage had occurred, would have had an aggregate annual processing capacity as of December 31, 2005 of approximately 950,000 tons of fish. The hurricane damages reduced the Company’s annual aggregate processing capacity to approximately 850,000 tons as of September 30, 2007. The Company anticipates that the decrease in annual processing capacity will have no effect on the Company’s ability to process in the future because the Company has historically operated at processing levels substantially below maximum capacity.

 

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Operations at the Moss Point and Abbeville fish processing facilities and the shipyard were re-established in mid-October 2005, but at reduced processing capabilities. These two facilities were returned to full operational status prior to the beginning of the Gulf fishing season in April 2006. Operations at the Cameron fish processing facility were re-established in June 2006, but at reduced processing capabilities. The Cameron facility became fully operational in September 2006.

The direct impact of the two hurricanes upon the Company was a loss of physical inventories and physical damage to the plants. As of September 30, 2007, the Company estimated its cumulative hurricane damages at approximately $29.3 million, of which $12.0 million was recorded as a receivable under insurance policies as of September 30, 2005. Of the $12.0 million, $2.0 million, $2.0 million, $6.4 million, $0.2 million and $1.4 million was received in the fourth quarter of 2005, first quarter of 2006, first quarter of 2007, second quarter of 2007 and third quarter of 2007, respectively. In addition to the $12.0 million receivable recorded as of September 30, 2005, the Company realized additional insurance recoveries of $5.2 million during the third quarter of 2007. The Company has recognized a cumulative $12.1 million net loss through September 30, 2007 due to estimated damages in excess of recognized insurance recoveries. Of the damage estimate, approximately $2.5 million was related to damaged fish meal inventory and approximately $13.0 million was related to write-offs of inventory costs that had been allocated and deferred to future production that did not occur. The Company did not maintain business interruption insurance for these types of deferred inventory costs due to its high cost and limited availability.

In order to facilitate the insurance recovery process, on July 28, 2006, the Company filed a lawsuit against its property insurance carriers, Lexington Insurance Company and RSUI Indemnity Company, in the U.S. District Court for the Western District of Louisiana, alleging breach of contract and bad faith based on the insurance carriers’ failure to pay amounts due to the Company under its property insurance policies for damages sustained from Hurricanes Katrina and Rita in the third quarter of 2005. The Company settled its lawsuit with its primary property insurance carrier, Lexington Insurance Company, for a total of $19.8 million during the third quarter of 2007. Of the $19.8 million, $12.0 million was previously recorded as a receivable and was fully received as of September 30, 2007, $3.3 million was paid to outside legal counsel in connection with the settlement and $4.5 was recognized during the third quarter as insurance recoveries relating to natural disaster in the statement of operations and comprehensive income. In addition, the Company settled its lawsuit with its secondary property insurance carrier, RSUI Indemnity Company, for a total of $9.2 million during the fourth quarter of 2007. Of the $9.2 million, $0.7 million was advanced during the third quarter of 2007 and recognized as insurance recoveries relating to natural disaster in the statement of operations and comprehensive income, $3.0 million was paid to outside legal counsel in connection with the settlement during the fourth quarter of 2007 and $5.5 million was received and will be recognized during the fourth quarter of 2007 as insurance recoveries relating to natural disaster in the statement of operations and comprehensive income. The Company still has a pending lawsuit against its insurance broker alleging negligent procurement, negligent misrepresentation, breach of contract and violations of Texas Insurance and Consumer laws. See “Part II, Item 1. Legal Proceedings” for additional information.

The 2006 oil yield results were the poorest in recent Company history. For illustrative purposes, the Company’s oil yields for the 2006 fishing season were lower by 28% compared to those in the 2005 fishing season and were lower by 24% compared to the Company’s 10 year oil yield average. The causes of lower fish oil yields are believed to relate to fish diet, weather and water temperature but are not generally well understood. The impact of these poor oil yields have resulted in significantly higher per unit inventory costs and fewer volumes available for future sale. These higher unit costs and fewer volumes available for sale have adversely impacted financial results for the fourth quarter of 2006 and first quarter of 2007, and have adversely impacted financial results, to some extent, for the second quarter of 2007. There was no material impact in the third quarter of 2007.

 

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All of the Company’s products contain healthy long-chain Omega-3 fatty acids. Omega-3 fatty acids are commonly referred to as “essential fatty acids” because the human and animal bodies do not produce them. Instead, essential fatty acids must be obtained from outside sources, such as food or special supplements. Long-chain Omega-3s are also commonly referred to as a “good fat” for their health benefits, as opposed to the “bad fats” that create or aggravate health conditions through long-term consumption. Scientific research suggests that long-chain Omega-3s as part of a balanced diet may provide significant benefits for health issues such as cardiovascular disease, inflammatory conditions and other ailments.

Under its production process, the Company produces OmegaPure ® , a taste-free, odorless refined fish oil which is the only marine source of long-chain Omega-3’s directly affirmed by the U.S. Food and Drug Administration (“FDA”) as a food ingredient that is Generally Recognized as Safe (“GRAS”). For additional information, see “Company Overview—Products – Refined Fish Oil – Food Grade Oils” in Items 1 and 2 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

The Company operates through two primary subsidiaries: Omega Protein, Inc. and Omega Shipyard, Inc. Omega Protein, Inc. is the Company’s principal operating subsidiary for its menhaden processing business and is the successor to a business conducted since 1913. Omega Shipyard, Inc. owns a drydock facility in Moss Point, Mississippi, which is used to provide shoreside maintenance for the Company’s fishing fleet and, subject to outside demand and excess capacity, occasionally for third-party vessels. Revenues from shipyard work for third-party vessels for the three and nine months ended September 30, 2007 and 2006 were not material. The Company also has a number of other immaterial direct and indirect subsidiaries.

Until April 1998, the Company, including its predecessors, was a wholly-owned subsidiary of Zapata Corporation (“Zapata”). In April 1998, the Company completed an initial public offering of its common stock. Immediately following the initial public offering, Zapata owned approximately 60% of the Company’s outstanding common stock. On December 8, 2005, Zapata announced that its Board of Directors had authorized Zapata’s management to seek a buyer for its then 58% equity ownership interest in the Company.

On November 28, 2006, the Company purchased 9,268,292 shares of the Company’s common stock from Zapata at a purchase price of $5.125 per share, or an aggregate purchase price of $47.5 million. The Company financed the purchase of the shares from Zapata with a senior secured financing facility from Albeco Finance LLC, an affiliate of Cerberus Capital Management, L.P. Concurrent with the purchase, Zapata’s two representatives, Avram A. Glazer and Leonard DiSalvo, resigned from Omega’s Board of Directors. Immediately following the purchase by the Company, Zapata owned approximately 33% of the Company’s outstanding common stock. For a more detailed description of the terms of the purchase by the Company, see the Company’s Current Reports on Form 8-K filed with the SEC on September 12, 2006 and December 1, 2006.

On December 4, 2006, Zapata sold the remaining 5,232,708 shares of the Company’s common stock held by Zapata to certain purchasers in a private transaction. As a result of the sale by Zapata, Zapata no longer owns any shares of the Company’s common stock. For a more detailed description of the terms of the sale by Zapata, see the Company’s Current Report on Form 8-K filed with the SEC on December 5, 2006.

Available Information

The Company files annual, quarterly and current reports and other information with the SEC. The Company’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to

 

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these reports filed under the Securities and Exchange Act of 1934 (“Exchange Act”), as well as Section 16 filings by officers and directors, are available free of charge at the Company’s website at www.omegaproteininc.com or at the SEC’s website at www.sec.gov and are posted as soon as reasonably practicable after they are filed with the SEC. The Company will provide a copy of these documents to stockholders upon request. Information on the Company’s website or any other website is not incorporated by reference into this report and does not constitute part of this report.

In addition, the public may read and copy any materials filed by the Company with the SEC at the SEC’s Public Reference Room at 100 F. Street, NE., Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov .

The Company’s Corporate Governance Guidelines, Code of Business Conduct and Ethics, Code of Ethics for Financial Professionals, as well as the Charters for the Board’s Audit Committee, Compensation Committee, Corporate Governance Committee and Scientific Committee, are available at the Company’s website. These Guidelines, Codes and Charters are not incorporated by reference into this report and do not constitute part of this report. The Company will provide a copy of these documents to stockholders upon request.

Company Overview

Business . Omega is the largest U.S. producer of protein-rich meal and oil derived from marine sources. The Company’s products are produced from menhaden (a herring-like fish found in commercial quantities), and includes regular grade and value-added specialty fish meals, crude and refined fish oils and fish solubles.

Fishing . During the third quarter of 2007, the Company owned a fleet of 59 fishing vessels and 32 spotter aircraft for use in its fishing operations and also leased additional aircraft where necessary to facilitate operations. During the 2007 fishing season in the Gulf of Mexico, which runs from mid-April through October, the Company operated 31 fishing and carry vessels and 28 spotter aircraft. The fishing area in the Gulf is generally located along the Gulf Coast, with a concentration off the Louisiana and Mississippi coasts. The fishing season along the Atlantic coast begins in early May and usually extends into December. During the 2007 season, the Company is operating 10 fishing vessels and 8 spotter aircraft along the Mid-Atlantic coast, concentrated primarily in and around Virginia and North Carolina. The remaining fleet of fishing vessels and spotter aircraft are not routinely operated during the fishing season and are back-up to the active fleet, used for other transportation purposes, inactive or in the process of refurbishment in the Company’s shipyard.

Menhaden usually school in large, tight clusters and are commonly found in warm, shallow waters. Spotter aircraft locate the schools and direct the fishing vessels to them. The principal fishing vessels transport two 40-foot purse boats, each carrying several fishermen and one end of a 1,500-foot net. The purse boats encircle the school and capture the fish in the net. The fish are then pumped from the net into refrigerated holds of the fishing vessel or onto a carry vessel, and then are unloaded at the Company’s processing plants. “Carry vessels” do not engage in active fishing but instead carry fish from the Company’s offshore fishing vessels to its plants. Utilization of carry vessels increases the amount of time that certain of the Company’s fishing vessels remain offshore fishing productive waters and therefore increases the Company’s fish catch per vessel employed. The carry vessels have reduced crews and crew expenses and incur less maintenance cost than the actual fishing vessels.

The Company’s principal raw material is menhaden, a species of fish that inhabits coastal and inland tidal waters in the United States. Menhaden are undesirable for direct human consumption due to their small size, prominent bones and high oil content. Certain state agencies, as well as interstate compacts, impose resource

 

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depletion restrictions on menhaden pursuant to fisheries management legislation or regulations and may impose additional legislation or regulations in the future. For example, in February 2007, the Commonwealth of Virginia established an annual cap for a five year period beginning in 2006 on the Company’s menhaden landings from the Chesapeake Bay in an amount equal to the Company’s average annual landings over a five year period from 2001 to 2005 (approximately 109,020 metric tons). The Virginia restrictions also allow the Company a credit whereby any under-harvest in a particular year below the 109,020 metric ton cap would be added to increase the cap for the following year, up to a maximum of 122,740 metric tons per year. See the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006 “Items 1 and 2. Business and Properties – Company Overview—Regulation”. To date, the Company has not experienced any material adverse impact on its fish catch or results of operations as a result of these restrictions.

Meal and Oil Processing Plants . The Company operates four meal and oil processing plants, two in Louisiana, one in Mississippi and one in Virginia, where the menhaden are processed into three general products types: fish meal, fish oil and fish solubles. The Company’s processing plants are located in coastal areas near the Company’s fishing fleet. Annual volume processed varies depending upon menhaden catch. Each plant maintains a dedicated dock to unload fish, fish processing equipment and storage facility. The fish are unloaded from the fishing vessels into storage boxes and then conveyed into steam cookers. The fish are then passed through presses to remove most of the oil and water. The solid portions of the fish are dried and ground into fish meal. The liquid that is produced in the cooking and pressing operations contains oil, water, dissolved protein and some fish solids. This liquid is decanted to remove the solids and is put through a centrifugal oil and water separation process. The separated fish oil is a finished product called crude oil. The separated water and protein mixture is further processed through evaporators to recover the soluble protein, which can be sold as a finished product or added to the solid portions of the fish for processing into fish meal.

Shipyard. The Company owns a 49.4 acre shipyard facility in Moss Point, Mississippi which includes two dry docks, each with a capacity of 1,300 tons. The shipyard is used for routine maintenance and vessel refurbishment on the Company’s fishing vessels and occasionally for shoreside maintenance services to third-party vessels if excess capacity exists.

Health and Science Center . In October 2004, the Company completed construction and commenced operation of a new Health and Science Center that provides 100-metric tons per day fish oil processing capacity. The new center is located adjacent to the Company’s Reedville, Virginia processing plant. The food-grade facility includes state-of-the-art processing equipment and controls that will allow the Company to refine, bleach, fractionate and deodorize its menhaden fish oil and has more than tripled the Company’s previous refined fish oil production capacity for food, industrial and feed grade oils. The facility also provides the Company with automated packaging and on-site refrigerated storage capacity and has a lipids analytical laboratory to enhance the development of Omega-3 oils and food products.

OmegaPure Technology and Innovation Center. In January 2007, the Company opened its new OmegaPure Technology and Innovation Center located in Houston, Texas to further develop its OmegaPure ® food grade Omega-3 product line. The new facility has food science application labs, as well as analytical, sensory and pilot plant capabilities. The new facility also has a lipids research lab where the Company plans to continue to develop new Omega-3 products that have improved functionality and technical characteristics.

Hurricane Damages . In August 2005, the Company’s Moss Point, Mississippi fish processing facility and adjacent shipyard were severely damaged by Hurricane Katrina. In September 2005, the Company’s Cameron, Louisiana and Abbeville, Louisiana fish processing facilities were also severely damaged by Hurricane Rita. Each of these facilities was non-operational immediately after these weather events. The Moss Point, Abbeville and Cameron facilities accounted for approximately 16%, 31% and 22%, respectively, of the Company’s full year 2004

 

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production tonnage, so as an immediate result of the two hurricanes, approximately 70% of the Company’s operating capacity was impaired and the Company’s business, results of operations and financial condition were materially adversely affected.

Operations at the Moss Point and Abbeville fish processing facilities and the shipyard were re-established in mid-October 2005, but at reduced processing capabilities. These two facilities were returned to full operational status prior to the beginning of the Gulf fishing season in April 2006. Operations at the Cameron fish processing facility were re-established in June 2006, but at reduced processing capabilities. The Cameron plant became fully operational in September 2006.

The Company maintains insurance coverage for a variety of these damages, most notably property, inventory and vessel insurance. The nature and extent of the insurance coverage varies by line of policy and the Company has recorded insurance recoveries as an account receivable based on the preliminary discussions with insurers and adjusters. The Company does not maintain business interruption insurance due to its high cost and limited availability.

The direct impact of the two hurricanes upon the Company was a loss of physical inventories and physical damage to the plants. As of September 30, 2007, the Company estimated its cumulative hurricane damages at approximately $29.3 million, of which $12.0 million was recorded as a receivable under insurance policies as of September 30, 2005. Of the $12.0 million, $2.0 million, $2.0 million, $6.4 million, $0.2 million and $1.4 million was received in the fourth quarter of 2005, first quarter of 2006, first quarter of 2007, second quarter of 2007 and third quarter of 2007, respectively. In addition to the $12.0 million receivable recorded as of September 30, 2005, the Company realized additional insurance recoveries of $5.2 million during the third quarter of 2007. The Company has recognized a cumulative $12.1 million net loss through September 30, 2007 due to estimated damages in excess of recognized insurance recoveries. Of the damage estimate, approximately $2.5 million was related to damaged fish meal inventory and approximately $13.0 million was related to write-offs of inventory costs that had been allocated and deferred to future production that did not occur. The Company did not maintain business interruption insurance for these types of deferred inventory costs due to its high cost and limited availability.

The Company did not maintain business interruption insurance for these types of deferred inventory costs due to its high cost and limited availability. See “Item 8. Financial Statements and Supplementary Data – Note 12 Hurricane Losses” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 for additional information on the components of the hurricane related losses. A substantial portion of the amounts listed are based upon estimates and assumptions. Actual amounts, when available, could differ materially from those estimates and changes to those estimates could have a material effect on the Company’s future financial statements.

In order to facilitate the insurance recovery process, on July 28, 2006, the Company filed a lawsuit against its property insurance carriers, Lexington Insurance Company and RSUI Indemnity Company, in the U.S. District Court for the Western District of Louisiana, alleging breach of contract and bad faith based on the insurance carriers’ failure to pay amounts due to the Company under its property insurance policies for damages sustained from Hurricanes Katrina and Rita in the third quarter of 2005. The Company settled its lawsuit with its primary property insurance carrier, Lexington Insurance Company, for a total of $19.8 million during the third quarter of 2007. Of the $19.8 million, $12.0 million was previously recorded as a receivable and was fully received as of September 30, 2007, $3.3 million was paid to outside legal counsel in connection with the settlement and $4.5 was recognized during the third quarter as insurance recoveries relating to natural disaster in the statement of operations and comprehensive income. In addition, the Company settled its lawsuit with its secondary property insurance carrier, RSUI Indemnity Company, for a total of $9.2 million during the fourth quarter of 2007. Of the

 

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$9.2 million, $0.7 million was advanced during the third quarter of 2007 and recognized as insurance recoveries relating to natural disaster in the statement of operations and comprehensive income, $3.0 million was paid to outside legal counsel in connection with the settlement during the fourth quarter of 2007 and $5.5 million was received and will be recognized during the fourth quarter of 2007 as insurance recoveries relating to natural disaster in the statement of operations and comprehensive income. The Company still has a pending lawsuit against its insurance broker alleging negligent procurement, negligent misrepresentation, breach of contract and violations of Texas Insurance and Consumer laws. See “Part II, Item 1. Legal Proceedings” for additional information.

As of December 31, 2005, the Company’s four active processing plants, assuming that no hurricane damages had occurred, would have had an aggregate annual capacity to process approximately 950,000 tons of fish . The previously described hurricane damages reduced the annual aggregate processing capacity to approximately 850,000 tons as of September 30, 2007. The Company anticipates that the decrease in annual processing capacity will have no effect on the Company’s ability to process in the future because the Company has historically operated at processing levels substantially below maximum capacity. Operations at the Cameron fish processing facility were re-established in June 2006, but at reduced processing capabilities. The Cameron facility became fully operational in September 2006.

Because of the damages to the Company’s Cameron, Louisiana facility caused by Hurricane Rita, the Company began its 2006 fishing season by operating its full contingent of 30 Gulf of Mexico fishing and carry vessels out of its two operating facilities in Abbeville, Louisiana and Moss Point, Mississippi. These activities substantially increased the number of vessels at the Abbeville and Moss Point plants to a level that the Company had not operated previously. Although these two facilities had adequate processing capacity, the Company’s fishing efforts were diminished because increased unloading time due to additional vessels reduced the number of vessels on the fishing grounds during the most optimal fishing times. During June 2006, 10 vessels were shifted to the Cameron facility when it became operational.

Distribution System . The Company’s distribution system of warehouses, tank storage facilities, vessel loading facilities, trucks, barges and railcars allows the Company to service customers throughout the United States and also foreign locations. The Company owns and leases warehouses and tank storage space for storage of its products, generally at terminals along the Mississippi River. The Company generally contracts with third-party trucking, vessel, barge and railcar companies to transport its products to and from warehouses and tank storage facilities and directly to its customers.

Historically, approximately 35% to 40% of Omega’s FAQ grade fish meal was sold on a two-to-twelve-month forward contract basis. The balance of FAQ grade fish meal and other products was substantially sold on a spot basis through purchase orders. In 2002, the Company began a similar forward sales program for its specialty grade meals and crude fish oil due to increasing demand for these products. During 2004, 2005 and 2006, approximately 43%, 70% and 70%, respectively, of the Company’s specialty meals and crude fish oil had been sold on a forward contract basis. Prior to the beginning of the Company’s 2007 fishing season, approximately 51% and 49% of the Company’s 2007 forecasted fish meal and crude fish oil, respectively, had either been sold or sold forward on a contract basis. The percentage of fish meal and crude fish oil sold on a forward contract basis will fluctuate from year to year based upon perceived market availability.

The Company’s annual revenues are highly dependent on annual fish catch, production yields and inventories and, in addition, inventory is generally carried over from one year to the next year. The Company determines the level of inventory to be carried over based on prevailing market prices of the products and anticipated customer usage and demand during the off-season. Thus, production volume does not necessarily correlate with sales volume in the same year and sales volumes will fluctuate from quarter to quarter. The Company’s fish meal

 

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products have a useable life of approximately one year from date of production. Practically, however, the Company attempts to empty its warehouses of the previous season’s products by the second or third month of the new fishing season. The Company’s crude fish oil products do not lose efficacy unless exposed to oxygen and, therefore, their storage life typically is longer than that of fish meal.

The following table sets forth the Company’s revenues by product (in millions) and the approximate percentage of total revenues represented thereby, for the indicated periods:

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2007     2006     2007     2006  
     Revenues    Percent     Revenues    Percent     Revenues    Percent     Revenues    Percent  

Regular Grade

   $ 6.3    14.1 %   $ 4.4    8.4 %   $ 15.1    13.4 %   $ 13.1    11.4 %

Special Select

     18.0    40.4       23.4    44.9       55.3    49.0       49.3    43.4  

Sea-Lac

     5.7    12.8       2.9    5.6       8.7    7.7       7.4    6.5  

Crude Oil

     10.8    24.2       18.5    35.5       22.1    19.6       34.9    30.7  

Refined Oil

     3.3    7.4       2.1    4.0       9.5    8.4       6.7    5.9  

Fish Solubles

     0.5    1.1       0.6    1.2       1.9    1.7       1.9    1.7  

Other

     0.0    0.0       0.2    0.4       0.2    0.2       0.4    0.4  
                                                    

Total

   $ 44.6    100.0 %   $ 52.1    100.0 %   $ 112.8    100.0 %   $ 113.7    100.0 %
                                                    

Customers and Marketing.  Most of the Company’s marine protein products are sold directly to approximately 600 customers by the Company’s agriproducts sales department, while a smaller amount is sold through independent sales agents. Product inventory was $71.2 million on September 30, 2007 versus $48.9 million as of December 31, 2006.

The Company’s fish meal is sold primarily to domestic feed producers for utilization as a high-protein ingredient for the swine, aquaculture, dairy and pet food industries. Crude fish oil sales primarily involve export markets where the fish oil is used for aquaculture feeds and is refined for use as a hydrogenated edible oil.

The Company’s products are sold both in the U.S. and internationally. International sales consist mainly of fish oil sales to Norway, Canada, Chile and Japan. The Company’s sales in these foreign markets are denominated in U.S. dollars and are not directly affected by currency fluctuations. Such sales could be adversely affected by changes in demand resulting from fluctuations in currency exchange rates.

A number of countries in which the Company currently sells products impose various tariffs and duties, none of which have a significant impact on the Company’s foreign sales. Certain of these duties have been reduced in recent years for certain countries under the North American Free Trade Agreement and the Uruguay Round Agreement of the General Agreement on Tariffs and Trade. In all cases, the Company’s products are shipped to its customers either by FOB shipping point or CIF terms, and therefore, the customer is responsible for any tariffs, duties or other levies imposed on the Company’s products sold into these markets.

During the off season, the Company fills purchase orders from the inventory it has accumulated during the fishing season or in some cases, by re-selling meal purchased from other suppliers. Prices for the Company’s products tend to be lower during the fishing season when product is more abundant than in the off season. Throughout the entire year, prices are often significantly influenced by supply and demand in world markets for competing products, primarily other global sources of fish meal and oil, and also soybean meal for its fish meal products, and vegetable oils for its fish oil products when used as an alternative.

Quality Control . The Company believes that maintaining high standards of quality in all aspects of its manufacturing operations play an important part in its ability to attract and retain customers and maintain its

 

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competitive position. To that end, the Company has adopted strict quality control systems and procedures designed to test the quality aspects of its products, such as protein content and digestibility. The Company regularly reviews, updates and modifies these systems and procedures as appropriate.

Purchases and Sales of Third-Party Meal and Oils . Omega has from time to time purchased fish meal and fish oil from other domestic and international manufacturers. These purchase and resale transactions have to date been ancillary to the Company’s base manufacturing and sales business.

During 2005 and 2006, the Company’s fish catch and resultant product inventories were reduced, primarily due to adverse weather conditions, and the Company further expanded its purchase and resale of other fish meals and oils (primarily Panamanian, Peruvian and Mexican fish meal and U.S. menhaden oil). Although operating margins from these activities are less than the margins typically generated from the Company’s base domestic production, these operations provide the Company with a source of fish meal and oil to sell into other markets, some of which, the Company has not historically had a presence. During 2005, the Company purchased products totaling approximately 16,600 tons, or approximately 8% of total volume 2005 sales. During 2006, the Company purchased products totaling approximately 14,600 tons, or approximately 7% of total volume 2006 sales. During the nine months ended September 30, 2007, the Company purchased fish oil totaling approximately 2,500 tons, or approximately 6.1% of fish oil sales, for nine months ended September 30, 2007.

Insurance.  The Company maintains insurance against physical loss and damage to its assets, coverage against liabilities to third parties it may incur in the course of its operations, as well as workers’ compensation, United States Longshoremen’s and Harbor Workers’ Compensation Act and Jones Act coverage. Assets are insured at replacement cost, market value or assessed earning power. The Company’s limits for liability coverage are statutory or $50 million. The $50 million limit is comprised of several excess liability policies, which are subject to deductibles, underlying limits, annual aggregates and exclusions. The Company believes its insurance coverage to be in such form, against such risks, for such amounts and subject to such deductibles and self-retentions as are prudent and normal for its operations. Over recent years, the Company has elected to increase its deductibles and self-retentions in order to achieve lower insurance premium costs. These higher deductibles and self-retentions have resulted in greater costs to the Company in the cases of Hurricanes Katrina and Rita and will expose the Company to greater risk of loss if additional future claims occur. In addition, the Company’s cost of insurance for property damage has increased materially and may further increase materially in future years as insurers recoup losses paid and to be paid out in connection with Hurricanes Katrina and Rita by charging higher premiums. The Company does not maintain business interruption insurance due to its high cost and limited availability.

Competition.  The Company competes with a smaller domestic privately-owned menhaden fishing company and with international marine protein and oil producers, including Mexican sardine processors and South American anchovy and mackerel processors. In addition, but to a lesser extent, the Company’s marine protein and oil business is also subject to significant competition from producers of vegetable and other animal protein products and oil products such as Archer Daniels Midland and Cargill. Many of these competitors have significantly greater financial resources and more extensive and diversified operations than those of the Company.

Omega competes on price, quality and performance characteristics of its products, such as protein level and amino acid profile in the case of fish meal. The principal competition for the Company’s fish meal and fish solubles is from other global production of marine proteins as well as other protein sources such as soybean meal and other vegetable or animal protein products. The Company believes, however, that these other non-marine sources are not complete substitutes because fish meal offers nutritional values not contained in such other sources. Other globally produced fish oils provide the primary market competition for the Company’s fish oil, as well as soybean and rapeseed oil, from time to time.

 

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Fish meal prices have historically borne a relationship to prevailing soybean meal prices (more weakly correlated in recent years), while prices for fish oil are generally influenced by prices for vegetable fats and oils, such as rapeseed, soybean and palm oils. Thus, the prices for the Company’s products are established by worldwide supply and demand relationships over which the Company has no control and tend to fluctuate significantly over the course of a year and from year to year.

Critical Accounting Policies and Estimates

For information on critical accounting policies and estimates, see Note 1 to the unaudited condensed consolidated financial statements included in Item 1 – Financial Statements.

Results of Operations

The following table sets forth as a percentage of revenues certain items of the Company’s operations for each of the indicated periods.

 

     Three Months Ended
September 30,
   

Nine Months Ended

September 30,

 
     2007     2006     2007     2006  

Revenues

   100.0 %   100.0 %   100.0 %   100.0 %

Cost of sales

   75.4     85.6     76.9     82.4  
                        

Gross profit

   24.6     14.4     23.1     17.6  

Selling, general and administrative expense

   7.9     6.9     10.4     9.5  

Research and development expense

   0.6     —       0.6     —    

(Insurance recoveries) losses relating to natural disaster

   (11.6 )   1.8     (4.6 )   1.2  

Loss on disposal of assets

   0.1     —       0.2     —    
                        

Operating income

   27.6     5.7     16.5     6.9  

Interest income

   0.2     0.3     0.2     0.4  

Interest expense

   (2.9 )   (1.0 )   (3.7 )   (1.4 )

Loss resulting from debt refinancing

   —       —       (2.7 )   —    

Other income (expense), net

   (0.2 )   (0.1 )   (0.2 )   (0.1 )
                        

Income before income taxes

   24.7     4.9     10.1     5.8  

Provision for income taxes

   8.7     1.4     3.6     1.5  
                        

Net income

   16.0 %   3.5 %   6.5 %   4.3 %
                        

Interim Results for the Third Quarters ended September 30, 2007 and September 30, 2006

Revenues. Revenues decreased $7.5 million or 14.4% for the quarter ended September 30, 2007 as compared to the quarter ended September 30, 2006. The decrease was primarily due to a 21.8% and 39.0% decrease in sales volumes of the Company’s fish meal and fish oil, respectively, partially offset by a 24.7% and 12.2% increase in sales prices of the Company’s fish meal and fish oil, respectively. The Company experienced a $9.5 million increase in revenues due to increased sales prices and a $17.0 million decrease in revenues due to decreased sales volumes of the Company’s fish meal and fish oil. The decline in sales volumes of the Company’s fish meal and fish oil is primarily attributable to timing of shipments being delayed beyond September 30, 2007. Additionally, there has been a general weakening in demand, particularly relating to fish meal, due to higher prices.

Cost of Sales. Cost of sales, including depreciation and amortization, for the current quarter ended September 30, 2007 was $33.6 million, a decrease of $11.0 million or 24.7%, from $44.6 million for the quarter ended September 30, 2006. Cost of sales as a percentage of revenues decreased 10.2% to 75.4% for the quarter ended September 30, 2007 as compared to the quarter ended September 30, 2006. The decrease in cost of sales as a percentage of revenues was due to higher sales prices, as noted above, partially offset by a higher per unit cost for the current quarter.

 

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Gross Profit. Gross profit increased 46.4% from a $7.5 million gross profit in the quarter ended September 30, 2006 to $11.0 million in the current quarter ended September 30, 2007. The increase in gross profit was primarily due to increased sales prices, partially offset by a higher per unit cost for the current quarter, as discussed above.

Selling, general and administrative expenses. Selling, general, and administrative expenses decreased $0.1 million from $3.6 million for the quarter ended September 30, 2006 to $3.5 million for the quarter ended September 30, 2007. This decrease was attributable primarily to decreased consulting fees.

Research and development expenses. Research and development expenses were approximately $278,000, for the quarter ended September 30, 2007. This balance represents costs incurred at the Company’s OmegaPure Technology and Innovation Center which commenced operations in January 2007.

(Insurance recoveries) losses relating to natural disaster. During the quarter ended September 30, 2007, the Company settled the lawsuit with its primary insurance carrier which resulted in the recognition of $4.5 million in net proceeds in excess of amounts previously recorded. Additionally, the Company received an additional $0.7 million in net proceeds from the lawsuit with its secondary insurance carrier during the current quarter. For the quarter ended September 30, 2006, the Company incurred losses of $0.9 million relating to damages, clean up costs, incurred at its Moss Point, Mississippi fish processing facility and adjacent shipyard from Hurricane Katrina, and damages incurred at its Cameron and Abbeville, Louisiana fish processing facilities from Hurricane Rita.

Loss on disposal of assets . For the quarter ended September 30, 2007, the Company incurred a loss of $55,000 relating to the disposal of assets in the ordinary course of business. There was no such loss for the quarter ended September 30, 2006.

Operating income. As a result of the factors discussed above (the most material of which were higher sales prices and the insurance settlement), the Company’s operating income increased $9.3 million from operating income of $3.0 million for the quarter ended September 30, 2006 to operating income of $12.3 million for the quarter ended September 30, 2007.

Interest income. Interest income decreased $29,000 for the current quarter ended September 30, 2007 as compared to the quarter ended September 30, 2006. The decrease was primarily due to a lower balance of the Company’s cash and cash equivalents on which returns are generated.

Interest expense. Interest expense increased $0.8 million for the current quarter ended September 30, 2007 as compared to the quarter ended September 30, 2006. The increase in interest expense is primarily due to additional debt the Company had outstanding in the quarter ended September 30, 2007 that was incurred in October 2006 and refinanced in March 2007.

Other income (expense), net. Other expense, net increased $42,000 in the current quarter ended September 30, 2007 as compared to the quarter ended September 30, 2006. The increase was primarily due to fees paid to the Company’s bank and miscellaneous penalties in the quarter ended September 30, 2007 compared to the third quarter in 2006.

Provision for income taxes. The Company recorded a $3.9 million provision for income taxes for the quarter ended September 30, 2007, representing an effective tax rate of 35.2% for income taxes compared to 28.2% for the quarter ended September 30, 2006. This increase in the effective tax rate is primarily a result of factors experienced in the prior quarter that had less of an impact in the current quarter. These factors include increased amounts of interest income exempt from income tax, the partial exclusion of income on foreign sales, income tax

 

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credits attributable to post-hurricane wages and a state income tax benefit. The Company believes that it is more probable than not that the recorded estimated deferred tax asset benefits and state operating loss carry-forwards will be realized except for the amount for which a valuation allowance has been provided. The statutory tax rate of 34% for U.S. federal taxes was in effect for the respective periods.

Interim Results for the Nine Months ended September 30, 2007 and September 30, 2006

Revenues. Revenues decreased $0.9 million or 0.8% for the nine months ended September 30, 2007 as compared to the nine months ended September 30, 2006. The decrease was due to a 9.7% and 36.0% decrease in sales volumes of the Company’s fish meal and fish oil, respectively, offset by a 25.3% and 18.9% increase in sales prices of the Company’s fish meal and fish oil, respectively. The Company experienced a $23.2 million increase in revenues due to increased sales prices and a $24.1 million decrease in revenues due to decreased sales volumes of the Company’s fish meal and fish oil. The decline in sales volumes of the Company’s fish oil is primarily attributable to decreased quantities available for sale resulting from reduced oil yields experienced during the 2006 fishing season, combined with shipments being delayed beyond September 30, 2007. Additionally, there has been a general weakening in demand, particularly relating to fish meal, due to high prices.

Cost of Sales. Cost of sales, including depreciation and amortization, for the nine months ended September 30, 2007 was $86.8 million, a decrease of $6.9 million or 7.4% from $93.7 million for the nine months ended September 30, 2006. Cost of sales as a percentage of revenues decreased 5.5% to 76.9% for the nine months ended September 30, 2007 as compared to the nine months ended September 30, 2006. The decrease in cost of sales as a percentage of revenues was due to higher sales prices, as noted above, partially offset by a higher per unit cost for the current nine months.

Gross Profit. Gross profit increased 29.7% from a $20.1 million gross profit in the nine months ended September 30, 2006 to $26.0 million in the current nine months ended September 30, 2007. The increase in gross profit was primarily due to increased sales prices, partially offset by a higher per unit cost for the current quarter, as discussed above.

Selling, general and administrative expenses. Selling, general, and administrative expenses increased $0.9 million from $10.8 million for the nine months ended September 30, 2006 to $11.7 million for the nine months ended September 30, 2007. This increase was attributable primarily to bonuses, increased audit and audit related expenditures and other consulting expenditures relating to hurricane insurance recovery efforts.

Research and development expenses. Research and development expenses were approximately $665,000, for the nine months ended September 30, 2007. This balance represents costs incurred at the Company’s OmegaPure Technology and Innovation Center which commenced operations in January 2007.

(Insurance recoveries) losses relating to natural disaster. During the nine months ended September 30, 2007, the Company settled the lawsuit with its primary insurance carrier which resulted in the recognition of $4.5 million in net proceeds in excess of amounts previously recorded. Additionally, the Company received an additional $0.7 million in net proceeds from its lawsuit with its secondary insurance carrier during the current nine month period. For the nine months ended September 30, 2006, the Company incurred losses of $1.4 million relating to damages, clean up costs, incurred at its Moss Point, Mississippi fish processing facility and adjacent shipyard from Hurricane Katrina, and damages incurred at its Cameron and Abbeville, Louisiana fish processing facilities from Hurricane Rita.

Loss on disposal of assets . For the nine months ended September 30, 2007 the Company incurred a loss of $239,000 relating to the disposal of an asset in the ordinary course of business. The loss for the nine months ended September 30, 2006 amounted to $29,000.

 

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Operating income. As a result of the factors discussed above (the most material of which were higher sales prices and the insurance settlement), the Company’s operating income increased $10.8 million from operating income of $7.8 million for the nine months ended September 30, 2006 to operating income of $18.6 million for the nine months ended September 30, 2007.

Interest income. Interest income decreased $302,000 for the nine months ended September 30, 2007 as compared to the nine months ended September 30, 2006. The decrease was primarily due to a lower balance of the Company’s cash and cash equivalents on which returns are generated.

Interest expense. Interest expense increased $2.7 million for the nine months ended September 30, 2007 as compared to the nine months ended September 30, 2006. The increase in interest expense is primarily due to additional debt the Company had outstanding during the nine months ended September 30, 2007 that was incurred in October 2006 and refinanced in March 2007.

Loss resulting from debt refinancing. Refinancing expenses were $3.0 million for the nine months ended September 30, 2007. The expenses relate to previously deferred debt issuance costs and other costs that became immediately recognized when the Company refinanced the Financing Facility with Abelco Finance LLC on March 26, 2007. No such expenses were recognized in the nine months ended September 30, 2006.

Other income (expense), net. Other expense, net increased $87,000 in the nine months ended September 30, 2007 as compared to the nine months ended September 30, 2006. The increase was primarily due to increased fees paid to the Company’s bank and miscellaneous penalties during the nine months ended September 30, 2007.

Provision for income taxes. The Company recorded a $4.0 million provision for income taxes for the nine months ended September 30, 2007, representing an effective tax rate of 35.1% for income taxes compared to 25.2% for the nine months ended September 30, 2006. This increase in the effective tax rate is primarily a result of factors experienced in the prior year that will have less of an impact in the current year. These factors include increased amounts of interest income exempt from income tax, the partial exclusion of income on foreign sales, income tax credits attributable to post-hurricane wages and a state income tax benefit. The Company believes that it is more probable than not that the recorded estimated deferred tax asset benefits and state operating loss carry-forwards will be realized except for the amount for which a valuation allowance has been provided. The statutory tax rate of 34% for U.S. federal taxes was in effect for the respective periods.

Seasonal and Quarterly Results

The Company’s menhaden harvesting and processing business is seasonal in nature. The Company generally has higher sales during the menhaden harvesting season (which includes the second and third quarter of each year) due to increased product availability, but prices during the fishing season tend to be lower than during the off-season. As a result, the Company’s quarterly operating results have fluctuated in the past and may fluctuate in the future. In addition, from time to time the Company defers sales of inventory based on worldwide prices for competing products that affect prices for the Company’s products which may affect comparable period comparisons.

Liquidity and Capital Resources

Historically, the Company’s primary sources of liquidity and capital resources have been cash flows from operations, bank credit facilities and term loans from various lenders provided pursuant to the U.S. Maritime Administration’s Fisheries Finance Program (“FFP”), which is offered through National Marine Fisheries Services (“NMFS”) under Title XI of the Marine Act of 1936 (“Title XI”). These sources of cash flows have been used for operations, capital expenditures, payment of long-term debt and the purchase and retirement of shares of the Company’s common stock in 2006.

 

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At September 30, 2007, the Company had an unrestricted cash balance of $6.7 million, down $1.3 million from December 31, 2006. This decrease was primarily due to capital expenditures, fishing season expenditures, the refinancing of the Financing Facility with Abelco Finance LLC which was offset by the receipt of insurance proceeds related to the 2005 hurricanes, and other events as described in “—Results of Operations”. The Company’s annual revenues and its resulting liquidity are highly dependent on annual fish catch, production yields, selling prices for its products and inventories available for sale. While the Company’s fish catch and selling prices for its products increased in 2007 and 2006 over 2005, those increases were offset by very poor fish oil yields during 2006, which resulted in significantly higher per unit inventory costs and fewer volumes of fish oil available for future sale. These higher costs and lower volumes of fish oil available for sale have adversely impacted the financial results in the first and second quarters of 2007. There was no material impact in the third quarter of 2007.

The aggregate amount of the Company’s outstanding indebtedness at September 30, 2007 was approximately $66.4 million compared to approximately $75.2 million at December 31, 2006. As a result, the Company has a highly leveraged financial structure, limiting its financial flexibility. In particular, the Company will be required to use a portion of its cash flows to pay principal and interest on its debt, which will reduce the amount of money the Company has for operations, capital expenditures, expansion, acquisitions or general corporate or other business activities. In addition, the covenants contained in the Company’s debt agreements limit its ability to borrow money in the future for acquisitions, capital expenditures or to meet the Company’s operating expenses or other general corporate obligations. See “Risk Factors—The Company has a substantial amount of indebtedness, which may adversely affect its ability to operate its business, remain in compliance with debt covenants and make payments on its debt.”

Source of Capital: Operations

Net cash flow provided by (used in) operating activities decreased from approximately $3.4 million for the nine month period ended September 30, 2006 to ($3.1) million for the nine month period ended September 30, 2007. The decrease in operating cash flow is primarily attributable to increased uses of cash associated with the production of inventory.

Source of Capital: Debt

Net financing activities used cash of $6.0 million and $0.9 million during the nine month periods ended September 30, 2007 and 2006, respectively. The nine month period ended September 30, 2007 included approximately $47.3 million in total borrowings, $47.5 million in principal payments with respect to the Company’s prior Financing Facility with Ableco Finance LLC, $0.7 million in debt issuance costs associated with the new Senior Credit Facility, $8.6 million used for payments of other debt obligations and $3.5 million in proceeds received from stock options exercised. The nine month period ended September 30, 2006 included $1.8 million used for payments of debt obligations and $0.9 million in proceeds received from stock options exercised.

Under Title XI, as administered under the FFP, the Company has secured loans through lenders with terms generally ranging between 12 and 20 years at interest rates between 6% and 8% per annum which are enhanced with a government guaranty to the lender for up to 80% of the financing. The Company’s current Title XI borrowings are secured by liens on 17 fishing vessels and mortgages on the Company’s Reedville, Virginia and Abbeville, Louisiana plants. In 1996, Title XI borrowing was modified to permit use of proceeds from borrowings obtained through this program for shore-side construction.

 

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In September 2004, the FFP approved the Company’s financing application in an amount not to exceed $14.0 million (the “Approval Letter”). Borrowings under the Approval Letter are required to be used to finance and/or refinance approximately 73% of the actual depreciable cost of the Company’s future fishing vessel refurbishments and capital expenditures relating to shore-side fishing assets, for a term not to exceed 15 years from inception at interest rates determined by the U.S. Treasury. Final approval for all such future projects requires individual approval through the Secretary of Commerce, National Oceanic and Atmospheric Administration, and NMFS. Borrowings under the FFP are required to be evidenced by security agreements, undertakings, and other documents deemed in the sole discretion of the NMFS as necessary to accomplish the intent and purpose of the Approval Letter. The Company is required to comply with customary NMFS covenants as well as certain special covenants. The Company closed on a $14.0 million FFP loan on October 17, 2005.

On December 1, 2005, pursuant to the Title XI program, the FFP approved a second financing application made by the Company in the amount of $16.4 million (the “Second Approval Letter”). In May 2006, the Company submitted a $6.3 million financing request under the Second Approval Letter. The Company closed on the $6.3 financing in the first quarter of 2007. As of September 30, 2007, the Company had approximately $31.8 million of borrowings outstanding under Title XI and was in compliance with all of the covenants contained therein.

On October 20, 2006, the Company, certain of its subsidiaries and Abelco Finance LLC (“Ableco”), A3 Fund Management LLC, an affiliate of Abelco, and Wachovia Bank, National Association entered into the financing agreement (the “Financing Agreement”) pursuant to which the Lenders agreed to provide the Company with a senior secured financing facility (“the “Financing Facility”) in the maximum amount of $65 million. The Financing Facility consisted of (a) a revolving credit facility of up to $30 million outstanding at any time, including a $5 million subfacility for the issuance of letters of credit, and (b) a term loan facility of $35 million. On October 20, 2006, the Company drew down the $35 million term loan and approximately $13.6 million of revolving loans, and approximately $3.3 million in letters of credit were issued pursuant to the letter of credit subfacility. The Financing Facility was secured by a first priority lien on all of the Company’s assets, other than vessels, real estate and other assets pledged to secure loans made to the Company under the FFP, including the Pending Loan. For a more detailed description of the terms and conditions of the Financing Facility and Financing Agreement, see the Company’s Current Report on Form 8-K filed with the SEC on October 24, 2006.

On March 26, 2007 (the “Closing Date”), the Company entered into a Credit Agreement (the “Credit Agreement”) with Bank of America, N.A., as administrative agent, lender, swing line lender and letter of credit issuer, Regions Bank, Compass Bank and Farm Credit Bank of Texas (collectively, the “Lenders”). The Credit Agreement provides the Company with a $55 million senior credit facility (the “Senior Credit Facility”) consisting of (i) a 5-year revolving credit facility (the “Revolving Credit Facility”) of up to $20 million, including a $7.5 million sub-limit for the issuance of standby letters of credit and a $2.5 million sub-limit for swing line loans and (ii) a 5-year term loan (the “Term Loan”) of $35 million. The Senior Credit Facility replaced the Company’s Financing Facility, under which, as of the Closing Date, $28.7 million in principal was outstanding under a term loan and $6.5 million in principal was outstanding under revolving loans, and approximately $3.3 million in letters of credit were issued, primarily in support of worker’s compensation insurance programs. On the Closing Date, the Company drew down $35 million under the Term Loan and approximately $2.0 million under the Revolving Credit Facility, and had approximately $3.1 million issued in standby letters of credit, primarily in support of worker’s compensation insurance programs. The Financing Facility is secured by a first priority lien on all of the Company’s assets, other than vessels, real estate and other assets pledged to secure loans made to the Company under the FFP, including the Pending Loan.

Aggregate amounts outstanding under the Revolving Credit Facility (including standby letters of credit and swing line loans) are limited to an amount not to exceed the lesser of (i) $20 million and (ii) an amount equal to the sum of (a) 80% of Eligible Accounts Receivable (as defined in the Credit Agreement) plus (b) 50% of net book

 

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value of Eligible Inventory (as defined in the Credit Agreement), provided that Eligible Inventory shall not comprise more than 50% of the total of (a) and (b). Standby letters of credit will be issued by, and swing line loans will be made available by, Bank of America, N.A. and each Lender will purchase an irrevocable and unconditional participation in each standby letters of credit and swing line loan, subject to certain conditions. Swing line loans will be made available on a same day basis in minimum amounts of $100,000, subject to certain conditions.

Any loan (other than swing line loans) under the Senior Credit Facility bears interest at a rate equal to the Applicable Margin, as determined in accordance with the pricing grid set forth below, plus one of the following indexes: (i) Eurodollar and (ii) the Base Rate (defined as the higher of (a) the Federal Funds Rate plus 0.50% and (b) the rate of interest in effect for such day as publicly announced from time to time by Bank of America as its “prime rate”). Each swing line loan bears interest at the Base Rate plus the Applicable Margin for Base Rate loans.

 

Consolidated

Leverage Ratio of

the Company and

its Subsidiaries

   Applicable
Commitment
Fee
   

Letters of Credit

Fee

    Applicable
Margin for
Eurodollar
Loans
   

Applicable

Margin for

Base Rate

Loans

 

Less than 2.0x

   0.40 %   2.00 %   2.00 %   0.50 %

Less than 2.50x but greater than or equal to 2.0x

   0.40 %   2.25 %   2.25 %   0.75 %

Less than 3.0x but greater than or equal to 2.5x

   0.40 %   2.38 %   2.38 %   1.00 %

Less than 3.5x but greater than or equal to 3.0x

   0.40 %   2.50 %   2.50 %   1.25 %

Greater than or equal to 3.5x

   0.50 %   2.75 %   2.75 %   1.50 %

All borrowings made on the Closing Date were made as Base Rate loans. These Base Rate loans were converted to Eurodollar loans three days after the Closing Date. On March 26, 2007, the Company entered into a cash-based interest rate swap agreement with Bank of America N.A for $19,950,000 of the Term Loan. The Term Loan effectively locks in the LIBOR portion of the interest rate for the $19,950,000 at 5.16% for the remaining term of the Term Loan.

The Credit Agreement requires the Company comply with various affirmative and negative covenants affecting its business and operations. In addition, the Company is required to comply with the following financial covenants:

 

   

The Company is required to maintain Consolidated Net Worth (as defined in the Credit Agreement) of at least $85,000,000, which is increased on a cumulative basis as of the end of each fiscal quarter (commencing June 30, 2007) by an amount equal to 75% of Consolidated Net Income (as defined in the Credit Agreement) (to the extent positive) for the fiscal quarter then ended plus 100% of the amount of certain equity issuances after the Closing Date that increase consolidated shareholders’ equity.

 

   

The Company is required to maintain, as of the end of each fiscal quarter (commenced March 31, 2007), a Consolidated Leverage Ratio (as defined in the Credit Agreement) of 4.0 to 1.0, which will be reduced to (i) 3.75 to 1.0 on September 30, 2007, (ii) 3.25 to 1.0 on December 31, 2007, (iii) 3.0 to 1.0 on December 31, 2008, (iv) 2.75 to 1.0 on December 31, 2009 and (iv) 2.5 to 1.0 on December 31, 2010 for thereafter.

 

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The Company is required to maintain, as of the end of each fiscal quarter (commenced March 31, 2007), a Consolidated Fixed Charge Coverage Ratio (as defined in the Credit Agreement) of at least 1.1 to 1.0.

 

   

The Company is required to maintain, at the end of each fiscal quarter (commenced March 31, 2007), a Consolidated Asset Coverage Ratio (as defined in the Credit Agreement) of 1.5 to 1.0, which will be increased to 2.0 to 1.0 on December 31, 2008 for thereafter.

 

   

The Company is not permitted to have Consolidated Capital Expenditures (as defined in the Credit Agreement) in excess of $15 million for any fiscal year.

As of September 30, 2007, the Company was in compliance with all applicable financial covenants.

The Senior Credit Facility will terminate on March 26, 2012 (the “Maturity Date”). All loans and all other obligations outstanding under the Senior Credit Facility shall be payable in full on the Maturity Date. For a more detailed description of the terms and conditions of the Credit Agreement, see the Company’s Current Report on Form 8-K filed with the SEC on March 30, 2007.

As of September 30, 2007, the Company had $34.6 million outstanding under the Term Loan and approximately $3.1 million in letters of credit issued primarily in support of worker’s compensation insurance programs. As of September 30, 2007, the Company had $16.9 million available under the Revolving Credit Facility and the Company was in compliance with all of the covenants under the Senior Credit Facility. The Company has no off-balance sheet arrangements other than normal operating leases and standby letters of credit.

Use of Capital: Operations

Net investing activities provided (used) cash of $7.8 million and ($15.2) million for the nine month periods ended September 30, 2007 and 2006, respectively. The Company’s investing activities consist mainly of capital expenditures for equipment purchases, replacements, vessel refurbishments, and fish oil refining processes. The Company made capital expenditures of approximately $5.4 million and $17.2 million, for the nine month periods ended September 30, 2007 and 2006, respectively. The Company anticipates making an additional $3.6 million in capital expenditures in the fourth quarter of 2007 primarily for the refurbishment of vessels and plant assets and for the repair of certain equipment. Investing activities also includes the receipt of $13.2 million and $2.0 million from insurance companies relating to hurricanes Katrina and Rita for the nine month periods ended September 30, 2007 and 2006, respectively.

The Company believes that the existing cash, cash equivalents, short-term investments and funds available through the Senior Credit Facility and/or Title XI indebtedness described above will be sufficient to meet its working capital and capital expenditure requirements through at least the next twelve months. In addition, the Company expects to receive insurance proceeds from hurricane damages to assist in meeting its capital expenditures. As of September 30, 2007, the Company had received the original $12.0 related to hurricane damages. In addition to the original receivable, the Company realized additional insurance recoveries of $5.2 million during the third quarter of 2007 and $5.5 million in the fourth quarter of 2007.

Use of Capital: Acquisitions

The Company from time to time considers potential transactions including, but not limited to, enhancement of physical facilities to improve production capabilities and the acquisition of other businesses. Certain of the potential transactions reviewed by the Company would, if completed, result in its entering new lines of business (generally including certain businesses to which the Company sells its products such as pet food manufacturers, aquaculture feed manufacturers, fertilizer companies and organic foods manufacturers and distributors), although historically, reviewed opportunities have been generally related in some manner to the Company’s existing operations or which would have added new protein products to the Company’s product lines. Although the

 

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Company does not explicitly budget for acquisitions and, as of the date hereof, does not have any commitment with respect to a material acquisition, it could enter into such agreement in the future. Depending on the size of the acquisition, the Company would expect to finance the transaction using internally generated cash flows and its Financing Facility, or, if necessary, equity or debt financings. The Company cannot assure that such financings will be available on acceptable terms, if at all.

Use of Capital: Contractual Obligations

The following tables aggregate information about the Company’s contractual cash obligations and other commercial commitments (in thousands) as of September 30, 2007:

 

     Payments Due by Period

Contractual Cash Obligations

   Total    Less than
1 year
   1 to 3
years
   4 to 5
years
   After 5
years

Long Term Debt

   $ 66,397    $ 5,830    $ 16,274    $ 25,174    $ 19,119

Interest on long term debt

     22,542      4,693      7,722      4,698      5,429

Operating Leases

     8,571      2,010      2,790      1,588      2,183

Pension Funding

     4,767      1,878      1,505      1,314      70

Standby Letters of Credit (1)

     3,099      3,099      —        —        —  

Energy Commitment (2)

     1,510      1,510      —        —        —  
                                  

Total Contractual Cash Obligations

   $ 106,886    $ 19,020    $ 28,291    $ 32,774    $ 26,801
                                  

(1) As of September 30, 2007, the Company had $3.1 million in standby letters of credit under the Senior Credit Facility.
(2) As of September 30, 2007, the Company had purchase commitments for energy usage in the normal course of business of approximately $1.5 million that will be delivered in quantities expected to be used in the normal course of business during the 2007 fishing season.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

In the normal course of business, the financial condition of the Company is exposed to minimal market risk associated with interest rate movements on the Company’s borrowings. A one percent increase or decrease in the levels of interest rates on variable rate debt would not result in a material change to the Company’s results of operations.

Although the Company sells products in foreign countries, all of the Company’s revenues are billed and paid for in US dollars. As a result, management does not believe that the Company is exposed to any significant foreign country currency exchange risk, and the Company does not utilize market risk sensitive instruments to manage its exposure to this risk.

 

Item 4. Controls and Procedures.

(a) Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this report, the Company conducted an evaluation of the effectiveness of its “disclosure controls and procedures,” as that phrase is defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934. The evaluation was carried out under the supervision and with the participation of management, including the Company’s Chief Executive Office (“CEO”) and Chief Financial Officer (“CFO”).

 

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Based on and as of the date of that evaluation, the Company’s CEO and CFO have concluded that (i) the Company’s disclosure controls and procedures are designed to ensure that information required to be included by the Company in the reports that the Company files or submits to the Securities and Exchange Commission (“SEC”) under the Securities Exchange Act of 1934, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure, and (ii) that the Company’s disclosure controls and procedures are effective.

Notwithstanding the foregoing, there can be no assurance that the Company’s disclosure controls and procedures will detect or uncover all failures of persons within the Company and its consolidated subsidiaries to disclose material information otherwise required to be set forth in the Company’s periodic reports. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable, not absolute, assurance of achieving their control objectives.

(b) Changes in Internal Controls

There were no changes in the Company’s internal controls over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

The Company is defending various claims and litigation arising from operations which arise in the ordinary course of the Company’s business. In the opinion of management, any losses resulting from these matters will not have a material adverse affect on the Company’s results of operations, cash flows or financial position.

On September 25, 2007, RSUI Indemnity Company (“RSUI”) paid the Company $1,005,563 as a partial tender under the Company’s excess layer property insurance policy. In addition, on October 1, 2007, the Company and RSUI entered into a Settlement Agreement pursuant to which RSUI made an additional payment to the Company of $8,244,437 on October 29, 2007. With the additional payment, in the aggregate the Company has received $9,250,000 from RSUI. The net proceeds to the Company after legal fees were $6.2 million. In connection with the settlement, the Company and RSUI each waived and dismissed with prejudice any and all contractual and extra-contractual claims they may have had against each other in connection with all Company claims against RSUI emanating out of Hurricanes Rita and Katrina.

The above funds are in addition to the previously reported $19.75 million insurance settlement that the Company received from its primary property insurance carrier, Lexington Insurance Company.

The above settlement concludes the previously reported litigation filed by the Company against its two property insurance carriers in the United States District Court – Western District of Louisiana. Still pending is a lawsuit that the Company filed on August 31, 2007 in District Court of Harris County, Texas, 295th Judicial District, against its prior insurance broker, Aon Risk Services of Texas, who procured the Company’s insurance policies with Lexington and RSUI. The Company’s lawsuit against Aon alleges negligent procurement, negligent misrepresentation, breach of contract and violations of Texas insurance and consumer protection laws. No trial date has yet been assigned in this matter.

 

Item 1A. Risk Factors

Risk Factors and Significant Factors That May Affect Forward-Looking Statements

The Company cautions investors that the following risk factors, and those factors described elsewhere in this Report, other filings by the Company with the SEC from time to time and press releases issued by the Company, could affect the Company’s actual results which could differ materially from those expressed in any forward-looking statements made by or on behalf of the Company.

The risks described below are not the only ones facing the Company. The Company’s business is also subject to other risks and uncertainties that affect many other companies, such as competition, technological obsolescence, labor relations (including risks of strikes), general economic conditions and geopolitical events. Additional risks not currently known to the Company or risks that the Company currently believes are immaterial may also impair the Company’s business, results of operations and financial results.

Risks Relating to the Company’s Business and Industry:

The Company is dependent on a single natural resource and may not be able to catch the amount of menhaden that it requires to operate profitably. The Company’s primary raw material is menhaden. The Company’s business is totally dependent on its annual menhaden harvest in ocean waters along the U.S.

 

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Atlantic and Gulf coasts. The Company’s ability to meet its raw material requirements through its annual menhaden harvest fluctuates from year to year and month to month, due to natural conditions over which the Company has no control. These natural conditions, which include varying fish population, adverse weather conditions and fish disease, may prevent the Company from catching the amount of menhaden required to operate profitably.

The Company’s operations are geographically concentrated in the Gulf of Mexico where they are susceptible to regional adverse weather patterns such as hurricanes. Three of the Company’s four operating plants are located in the Gulf of Mexico (two in Louisiana and one in Mississippi), a region which has historically been subject to a late summer/early fall hurricane season. The Company’s Virginia facility has in the past also at times been adversely affected by hurricanes. All three of the Company’s Gulf of Mexico plants were severely damaged within a one-month span by Hurricanes Katrina and Rita in August and September 2005. Immediately after the second hurricane, approximately 70% of the Company’s 2004 production capacity was impaired and the Company’s business, results of operations and financial condition were materially adversely affected. Additional future weather related disruptions could, if they occur, also have a material adverse effect on the Company’s business, results of operations and financial condition. In addition, the Company’s costs of insurance for property damage have increased as insurers recoup losses paid and to be paid out in connection with the Katrina and Rita hurricanes by charging higher premiums.

The costs of energy may materially impact the Company’s business. The Company has experienced substantially higher costs for energy in recent years, particularly in 2005 and 2006, and have continued into 2007. The Company’s business is materially dependent on diesel fuel for its vessels and natural gas for its operating facilities. The costs of these commodities, which are beyond the Company’s control, may have an adverse material impact on the Company’s business, results of operations and financial condition.

Fluctuation in “oil yields” derived from the Company’s fish catch could impact the Company’s ability to operate profitably. The “oil yield,” or the percentage of oil derived from the menhaden fish, while it is relatively high compared to many species of fish, has fluctuated over the years and from month to month due to natural conditions relating to fish biology over which the Company has no control. The oil yield has at times materially impacted the amount of fish oil that the Company has been able to produce from its available fish catch and it is possible that oil yields in the future could also adversely impact the Company’s ability to operate profitably.

The Company’s 2006 oil yield results were the poorest in its recent history. For illustrative purposes, the Company’s oil yields for the 2006 fishing season were lower by 28% compared to those in the 2005 fishing season and were lower by 24% compared to the Company’s 10 year oil yield average. The Company believes that the causes of lower fish oil yields relate to fish diet, weather and water temperature but such causes are not generally well understood. The impact of these poor oil yields have resulted in significantly higher per unit inventory costs and fewer volumes available for future sale. These higher unit costs and fewer volumes available for sale have adversely impacted financial results for the fourth quarter of 2006, first quarter of 2007 and second quarter of 2007. There was no material impact in the third quarter of 2007.

Laws or regulations that restrict or prohibit menhaden or purse seine fishing operations could adversely affect the Company’s ability to operate. The adoption of new laws or regulations at federal, regional, state or local levels that restrict or prohibit menhaden or purse seine fishing operations, or stricter interpretations of existing laws or regulations, could materially adversely affect the Company’s business, results of operations and financial condition. In addition, the impact of a violation by the Company of federal, regional, state or local law or regulation relating to its fishing operations, the protection of the environment or the health and safety of its employees could have a material adverse affect on the Company’s business, results of operations and financial condition.

 

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One example of potentially restrictive regulation is an addendum to a fisheries management plan recommended by a regional regulatory commission in August 2005. The Commonwealth of Virginia has declined to adopt the regulatory commission’s recommended plan but has instead adopted its own restrictions whereby the Company’s Chesapeake Bay menhaden harvest would be capped for a five year period at a recent five-year average (2001 to 2005) of 109,020 metric tons per year. The Virginia restrictions also allow for a credit whereby any under-harvest in a particular year below the 109,020 metric ton cap would be added to increase the cap for the following year, up to a maximum of 122,740 metric tons per year. The Company supported Virginia’s proposal and voluntarily complied with its limitations in 2006. This compliance had no effect on the Company’s Chesapeake Bay harvest in 2006 and is not expected to have a material adverse effect on the Chesapeake Bay harvest in 2007. As a result of the 2006 Chesapeake Bay’s underharvest, the 2007 Chesapeake Bay catch limit will be 122,740 metric tons.

In October 2007, two bills were introduced in the U.S. House of Representatives (H.R. 3840 and H.R. 3841) by two congressmen representing portions of New Jersey and Maryland, areas where the Company has no operations. The bills, if enacted, would effectively prohibit commercial fishing for Atlantic menhaden for reduction purposes in inland, state and federal waters along the Atlantic coast. The Company believes that the bills are premised on inaccurate assumptions and depictions of facts about the menhaden resource which the National Marine Fisheries Service continues to classify as healthy and not overfished. The bills would also supplant decades of fisheries management previously undertaken by the Atlantic States Marine Fisheries Commission and the National Marine Fisheries Service. The Company believes that the passage of these bills is unlikely; however the enactment of either of the bills, or any restrictions similar to those described in the bills, would have a material adverse effect on the Company’s business, results of operations and financial condition.

The Company’s fish catch may be impacted by restrictions on its spotter aircraft. If the Company’s spotter aircraft are prohibited or restricted from operating in their normal manner during the Company’s fishing season, the Company’s business, results of operations and financial condition could be adversely affected. For example, as a direct result of the September 11, 2001 terrorist attacks, the Secretary of Transportation issued a federal ground stop order that grounded certain aircraft (including the Company’s fish-spotting aircraft) for approximately nine days. This loss of spotter aircraft coverage severely hampered the Company’s ability to locate menhaden fish during this nine-day period and thereby reduced its amount of saleable product.

Worldwide supply and demand relationships, which are beyond the Company’s control, influence the prices that the Company receives for many of its products and may from time to time result in low prices for many of the Company’s products. Prices for many of the Company’s products are subject to, or influenced by, worldwide supply and demand relationships over which the Company has no control and which tend to fluctuate to a significant extent over the course of a year and from year to year. The factors that influence these supply and demand relationships are world supplies of fish meal made from other fish species, animal proteins and fats, palm oil, rapeseed oil, soy meal and oil, and other edible oils.

New laws or regulation regarding contaminants in fish oil or fish meal may increase the Company’s cost of production or cause the Company to lose business. It is possible that future enactment of increasingly stringent regulations regarding contaminants in fish meal or fish oil by foreign countries or the United States may adversely affect the Company’s business, results of operations and financial condition. More stringent regulations could result in: (i) the Company’s incurrence of additional capital expenditures on contaminant reduction technology in order to meet the requirements of those jurisdictions, and possibly higher production costs for Company’s products, or (ii) the Company’s withdrawal from marketing its products in those jurisdictions.

 

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Risks Relating to the Company’s Ongoing Operations:

The Company has a substantial amount of indebtedness, which may adversely affect its ability to operate its business, remain in compliance with debt covenants and make payments on its debt. As of September 30, 2007, the aggregate amount of the Company’s outstanding indebtedness under its Senior Credit Facility and its loan agreements under the Title XI Fisheries Finance Program was approximately $66.4 million. The Company’s outstanding indebtedness could have important consequences for you, including the following:

 

   

it may be more difficult for the Company to satisfy its obligations with respect to its Senior Credit Facility and its loan agreements under the Title XI Fisheries Finance Program, and any failure to comply with the obligations of any of the agreements governing such indebtedness, including financial and other restrictive covenants, could result in an event of default under such agreements;

 

   

the covenants contained in the Company’s debt agreements limit its ability to borrow money in the future for acquisitions, capital expenditures or to meet its operating expenses or other general corporate obligations;

 

   

the amount of the Company’s interest expense may increase because certain of its borrowings are at variable rates of interest, which, if interest rates increase, could result in higher interest expense;

 

   

the Company will need to use a portion of its cash flows to pay principal and interest on its debt, which will reduce the amount of money the Company has for operations, working capital, capital expenditures, expansion, acquisitions or general corporate or other business activities;

 

   

the Company may have a higher level of debt than some of its competitors, which could put it at a competitive disadvantage;

 

   

the Company may be more vulnerable to economic downturns and adverse developments in its industry or the economy in general; and

 

   

the Company’s debt level could limit its flexibility in planning for, or reacting to, changes in its business and the industry in which it operates.

The Company’s ability to meet its expenses and debt obligations will depend on its future performance, which will be affected by financial, business, economic, regulatory and other factors. The Company will not be able to control many of these factors, such as economic conditions and governmental regulation. The Company cannot be certain that its earnings will be sufficient to allow it to pay the principal and interest on its existing or future debt and meet its other obligations. If the Company does not have enough money to service its existing or future debt, it may be required to refinance all or part of its existing or future debt, sell assets, borrow more money or raise equity. The Company may not be able to refinance its existing or future debt, sell assets, borrow more money or raise equity on terms acceptable to it, if at all.

 

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Three of the Company’s four operating plants were severely damaged by Hurricanes Katrina and Rita and the Company has had to undertake substantial rebuilding efforts. As an immediate result of the two hurricanes, approximately 70% of the Company’s operating capacity was impaired. Operations at the Moss Point and Abbeville fish processing facilities and the shipyard were re-established in mid-October 2005, but at reduced processing capabilities. These two facilities were returned to full operational status prior to the beginning of the Gulf fishing season in April 2006. Operations at the Cameron fish processing facility were re-established in June 2006, but at reduced processing capabilities. The Cameron facility became fully operational in September 2006. The costs of the rebuilding efforts have been substantial and not all costs will be covered by insurance due to deductibles, exclusions and other policy limitations.

The Company’s strategy to expand into the functional food grade oils market may be unsuccessful. The Company’s attempts to expand its fish oil sales into the market for refined, functional food grade fish oils for human consumption may not be successful. The Company’s expectations regarding future demand for Omega-3 fatty acids may prove to be incorrect or, if future demand does meet the Company’s expectations, it is possible that purchasers could utilize Omega-3 sources other than the Company’s products.

The Company’s quarterly operating results will fluctuate as its business is seasonal in nature. The Company’s menhaden harvesting and processing business is seasonal in nature. The Company generally has higher sales during the menhaden harvesting season (which includes the second and third quarter of each fiscal year) due to increased product availability, but prices during the fishing season tend to be lower than during the off-season. As a result, the Company’s quarterly operating results have fluctuated in the past and may fluctuate in the future. In addition, from time to time the Company defers sales of inventory based on worldwide prices for competing products that affect prices for its products, which may affect comparable period comparisons.

The Company’s business is subject to significant competition, and some competitors have significantly greater financial resources and more extensive and diversified operations than the Company. The marine protein and oil business is subject to significant competition from producers of vegetable and other animal protein products and oil products such as Archer Daniels Midland and Cargill. In addition the Company competes with a smaller domestic privately-owned menhaden fishing company and international marine protein and oil producers, including Scandinavian herring processors and South American anchovy and sardine processors. Many of these competitors have significantly greater financial resources and more extensive and diversified operations than the Company.

The Company’s foreign customers are subject to disruption typical to foreign countries. The Company’s sales of its products in foreign countries are subject to risks associated with foreign countries such as changes in social, political and economic conditions inherent in foreign operations, including:

 

 

Changes in the law and policies that govern foreign investment and international trade in foreign countries;

 

 

Changes in U.S. laws and regulations relating to foreign investment and trade;

 

 

Changes in tax or other laws;

 

 

Partial or total expropriation;

 

 

Current exchange rate fluctuations;

 

 

Restrictions on current repatriation; or

 

 

Political disturbances, insurrection or war.

In addition, it is possible that the Company, at any one time, could have a significant amount of its revenues generated by sales in a particular country which would concentrate the Company’s susceptibility to adverse events in that country.

 

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The Company may undertake acquisitions that are unsuccessful and the Company’s inability to control the inherent risks of acquiring businesses could adversely affect its business, results of operations and financial condition operations. In the future the Company may undertake acquisitions of other businesses, located either in the United States or in other countries, although there can be no assurances that this will occur. There can be no assurance that the Company will be able (i) to identify and acquire acceptable acquisition candidates on favorable terms, (ii) to profitably manage future businesses it may acquire, or (iii) to successfully integrate future businesses it may acquire without substantial costs, delays or other problems. Any of these outcomes could have a material adverse effect on the Company’s business, results of operations and financial condition.

The Company’s failure to comply with federal U.S. citizenship ownership requirements may prevent it from harvesting menhaden in the U.S. jurisdictional waters. The Company’s harvesting operations are subject to the Shipping Act of 1916 and the regulations promulgated thereunder by the Department of Transportation, Maritime Administration which require, among other things, that the Company be incorporated under the laws of the U.S. or a state, the Company’s chief executive officer be a U.S. citizen, no more of the Company’s directors be non-citizens than a minority of a number necessary to constitute a quorum and at least 75% of the Company’s outstanding capital stock (including a majority of its voting capital stock) be owned by U.S. citizens. If the Company fails to observe any of these requirements, the Company will not be eligible to conduct its harvesting activities in U.S. jurisdictional waters which would have a material adverse effect on the Company’s business, results of operations and financial condition.

The Company may not be able to recruit, train and retain qualified marine personnel in sufficient numbers. The Company’s business is dependent on its ability to recruit, train and retain qualified marine personnel in sufficient numbers such as vessel captains, vessel engineers and other crewmembers. The Company has experienced difficulty in recent years in recruiting its optimal number of employees. To the extent that the Company is not successful in recruiting, training and retaining employees in sufficient numbers, its productivity may suffer. If the Company were unable to secure a sufficient number of workers during periods of peak employment, the lack of personnel could have an adverse effect on the Company’s business, results of operations and financial condition. The impact of Hurricanes Katrina and Rita has exacerbated the difficulties of recruiting and retaining qualified marine personnel in the Gulf Coast area.

The Company participates in the United States H2B Visa Program whereby foreign nationals are permitted to enter the United States temporarily and engage in seasonal, non-agricultural employment. The Company utilizes its H2B Visa workers for a portion of its fishing vessel crews and plant personnel. Changes in the H2B Visa Program, the termination of that program, or caps on the number of workers available under that program, could have a material adverse effect upon the Company’s ability to secure a sufficient number of workers during periods of peak employment. In April 2007, the Company’s Moss Point, Mississippi facility was adversely affected for approximately a two week period due to paperwork delays in the H2B Visa Program caused by the federal government which did not allow the Company a full allocation of H2B Visa workers at the start of its 2007 fishing season.

The Company’s Senior Credit Facility and other Fisheries Finance Program loan agreements contain covenants and restrictions that may limit the Company’s financial flexibility. The Company’s Senior Credit Facility and the Company’s loan agreements under the Title XI Fisheries Finance Program contain various covenants and restrictions such as prohibitions on dividends and stock repurchases without the lender’s consent. The Senior Credit Facility also contains various financial covenants that the Company must comply with.

 

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Investment Risks. Investment risks specifically related to the Company’s common stock include:

The limited liquidity for the Company’s common stock could affect your ability to sell your shares at a satisfactory price. The Company’s common stock is relatively illiquid. As of September 30, 2007, the Company had approximately 17.0 million shares of common stock outstanding. The average daily trading volume in the common stock during the prior 60 calendar days ending on that date was approximately 47,600 shares. A more active public market for the Company’s common stock, however, may not develop, which would continue to adversely affect the trading price and liquidity of the common stock. Moreover, a thin trading market for the common stock causes the market price for the common stock to fluctuate significantly more than the stock market as a whole. Without a large float, the Company’s common stock is less liquid than the stock of companies with broader public ownership and, as a result, the trading prices of the common stock may be more volatile. In addition, in the absence of an active public trading market, you may be unable to liquidate your investment in the Company at a satisfactory price.

Issuance of shares in connection with financing transactions or under stock incentive plans will dilute current stockholders. Pursuant to the Company’s stock incentive plans, the Company’s management is authorized to grant stock awards to its employees, directors and consultants. You will incur dilution upon exercise of any outstanding stock awards. In addition, if the Company raises additional funds by issuing additional common stock, or securities convertible into or exchangeable or exercisable for common stock, further dilution to its existing stockholders will result, and new investors could have rights superior to existing stockholders.

The number of shares of the Company’s common stock eligible for future sale could adversely affect the market price of its stock. The Company has reserved approximately 3.7 million shares of common stock for issuance under outstanding stock options, and the Company had outstanding options to purchase approximately 3.5 million shares of its common stock with a weighted average exercise price of $9.07 per share as of September 30, 2007. These shares of common stock are registered for resale on currently effective registration statements. In addition, the Company has registered the resale of 5,232,708 shares of common stock that were sold by Zapata to certain purchasers in a private transaction on a currently effective registration statement. Certain of the Company’s officers and directors have also entered into Rule 10b5-1 sales plans with brokers unaffiliated with the Company whereby they have committed to sell automatically and without discretion a predetermined number of shares of the Company’s common stock over a period of time according to their own individual criteria. The Company may issue additional restricted securities or register additional shares of common stock under the Securities Act in the future. The issuance of a significant number of shares of common stock upon the exercise of stock options, or the availability for sale, or sale, of a substantial number of the shares of common stock eligible for future sale under effective registration statements, under Rule 144 or otherwise, could adversely affect the market price of the common stock.

The Company’s Articles of Incorporation and Bylaws, Nevada Law, and Federal Law have provisions that discourage corporate takeovers and could prevent stockholders from realizing a premium on their investment. Certain provisions of the Company’s Articles of Incorporation and Bylaws, as well as the Nevada Corporation Law, to which the Company is subject, could delay or frustrate the removal of incumbent directors and could make difficult a merger, tender offer or proxy contest involvement the Company, even if such events could be viewed as beneficial by its stockholders. The Company’s Board of Directors is empowered to issue preferred stock in one or more series without stockholder action. Any issuance of this blank-check preferred stock could materially limit the rights of holders of the Company’s common stock and render more difficult or discourage an attempt to obtain control of the Company by means of a tender offer, merger, proxy contest or otherwise. In additional, the Articles of Incorporation and Bylaws contain a number of provisions which could impede a takeover or change in control of the Company, including, among other things, staggered terms for members of its Board of Directors, the requiring of two-thirds vote of stockholders to amend certain provisions of the Articles of Incorporation or the inability to take action by written consent or

 

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to call special stockholder meetings. Certain provisions of the Nevada Corporation Law could also discourage takeover attempts that have not been approved by the Company’s Board of Directors. In addition, federal law requires that at least 75% of the Company’s outstanding capital stock be owned by U.S. citizens which will discourage takeover attempts by potential foreign purchasers.

The Company has not paid dividends and does not expect to pay dividends in the near future. The Company has never declared or paid any cash dividends on its common stock since it became a public company in April 1998 and has no intention to do so in the near future. Any determination as to payment of dividends will be made at the discretion of the Company’s Board of Directors and will depend upon the Company’s operating results, financial condition, capital requirements, general business conditions and such other factors that the Board of Directors deems relevant. In addition, the payment of cash dividends is not permitted by the terms of the Company’s Senior Credit Facility.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

 

Item 3. Defaults Upon Senior Securities

None

 

Item 4. Submission of Matters to a Vote of Security Holders

None

 

Item 5. Other Information

None

 

Item 6. Exhibits

 

Exhibit No.  

Description of Exhibit

31.1   Rule 13a-14(a)/15d-14(a) Certification for Chief Executive Officer.
31.2   Rule 13a-14(a)/15d-14(a) Certification for Chief Financial Officer.
32.1   Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for Chief Executive Officer.
32.2   Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for Chief Financial Officer.

* Incorporated by reference

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

  OMEGA PROTEIN CORPORATION
 

(Registrant)

November 6, 2007   By:  

/s/ ROBERT W. STOCKTON

    (Executive Vice President, Chief Financial Officer)

 

50

CERTIFICATION

I, Joseph L. von Rosenberg III, certify that:

 

  1. I have reviewed this quarterly report on Form 10-Q of Omega Protein Corporation;

 

  2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

  3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

  4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

  a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

  5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: November 6, 2007

  By:  

/s/ Joseph L. von Rosenberg

  Name:   Joseph L. von Rosenberg III
  Title:   President and Chief Executive Officer

CERTIFICATION

I, Robert W. Stockton, certify that:

 

  1. I have reviewed this quarterly report on Form 10-Q of Omega Protein Corporation;

 

  2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

  3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

  4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

  a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

  5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: November 6, 2007

  By:  

/s/ Robert W. Stockton

  Name:   Robert W. Stockton
  Title:   Executive Vice President and Chief Financial Officer

Certification of Form 10-Q for the Quarter ended September 30, 2007, pursuant to Section

906 of the Sarbanes-Oxley Act of 2002

The undersigned Chief Executive Officer of Omega Protein Corporation, certifies, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

 

 

the Quarterly Report on Form 10-Q for the quarter ended September 30, 2007 fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934, and

 

 

the information contained in the Quarterly Report on Form 10-Q for the quarter ended September 30, 2007 fairly presents, in all material respects, the financial condition and results of operations of Omega Protein Corporation.

This certification is being furnished solely to comply with the requirements of Section 906 of the Sarbanes-Oxley Act of 2002 and is not being filed as a part of the Form 10-Q.

A signed original of this written statement required by Section 906 has been provided to Omega Protein Corporation and will be retained by Omega Protein Corporation and furnished to the Securities and Exchange Commission or its staff upon request.

Dated: November 6, 2007

 

/s/ JOSEPH L. VON ROSENBERG, III

Joseph L. von Rosenberg, III
President and Chief Executive Officer

Certification of Form 10-Q for the Quarter ended September 30, 2007, pursuant to Section

906 of the Sarbanes-Oxley Act of 2002

The undersigned Chief Financial Officer of Omega Protein Corporation, certifies, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

 

 

the Quarterly Report on Form 10-Q for the quarter ended September 30, 2007 fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934, and

 

 

the information contained in the Quarterly Report on Form 10-Q for the quarter ended September 30, 2007 fairly presents, in all material respects, the financial condition and results of operations of Omega Protein Corporation.

This certification is being furnished solely to comply with the requirements of Section 906 of the Sarbanes-Oxley Act of 2002 and is not being filed as a part of the Form 10-Q.

A signed original of this written statement required by Section 906 has been provided to Omega Protein Corporation and will be retained by Omega Protein Corporation and furnished to the Securities and Exchange Commission or its staff upon request.

Dated: November 6, 2007

 

/s/ ROBERT W. STOCKTON

Robert W. Stockton
Executive Vice President and
Chief Financial Officer