10-Q 1 omega_10q-093012.htm FORM 10-Q omega_10q-093012.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________

 
FORM 10-Q
 
[U] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
 
For the quarterly period ended September 30, 2012
 
OR
 
[   ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
 
For the Transition Period From __________ to __________.

Commission file number: 001-14003

OMEGA PROTEIN CORPORATION
(Exact name of Registrant as specified in its charter)
 
State of Nevada
 
76-0562134
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes  X   No __.

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨ Small reporting company ¨
 
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 October 29, 2012:  19,683,940.
 


 
 
 
 

OMEGA PROTEIN CORPORATION
TABLE OF CONTENTS

PART I.  FINANCIAL INFORMATION
   
     
Item 1.  Financial Statements and Notes
   
     
Unaudited Condensed Consolidated Balance Sheet as of September 30, 2012 and December 31, 2011
 
3
Unaudited Condensed Consolidated Statement of Comprehensive Income for the three months and nine months ended September 30, 2012 and 2011
 
4
Unaudited Condensed Consolidated Statement of Cash Flows for the nine months ended September 30, 2012 and 2011
  5
Notes to Unaudited Condensed Consolidated Financial Statements   6
     
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
  22
     
Item 3.  Quantitative and Qualitative Disclosures About Market Risk
  36
     
Item 4.  Controls and Procedures
 
36
     
     
PART II. OTHER INFORMATION
   
     
Item 1.  Legal Proceedings
 
37
     
Item 1A.  Risk Factors
 
38
     
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
 
39
     
Item 3.  Defaults Upon Senior Securities
 
39
     
Item 4.  Mine Safety Disclosures
 
39
     
Item 5.  Other Information
 
39
     
Item 6.  Exhibits
 
39
     
Signatures
 
40

 
2

 
 
OMEGA PROTEIN CORPORATION
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET
(Dollars in thousands)

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements and Notes
 
   
September 30,
2012
   
December 31,
2011
 
ASSETS
           
Current assets:
           
Cash and cash equivalents 
  $ 40,617     $ 51,391  
Receivables, net
   
       29,883
      16,788  
Inventories
    78,741       64,893  
Deferred tax asset, net
    238       1,784  
Prepaid expenses and other current assets
    5,516       2,238  
Total current assets
    154,995       137,094  
Other assets, net
    8,728       5,423  
Energy swap asset, net of current portion
    95        
Property, plant and equipment, net
    128,768         122,512  
Goodwill and other intangible assets, net
    12,429       12,801  
Total assets
  $ 305,015     $ 277,830  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
                 
Current liabilities:
               
Current maturities of long-term debt
  $ 3,080     $ 2,992  
Current portion of capital lease obligation 
    407       517  
Accounts payable 
    2,199       3,779  
Accrued liabilities
    44,659        19,818  
Total current liabilities
    50,345       27,106  
Long-term debt, net of current maturities
    24,991       27,302  
Capital lease obligation, net of current portion
          268  
Energy swap liability, net of current portion
          113  
Deferred tax liability, net
   
13,180
      13,900  
Pension liabilities, net
    8,904       10,868  
Other long-term liabilities
    1,742       1,712  
Total liabilities 
    99,162       81,269  
                 
Commitments and contingencies
               
Stockholders’ equity:
               
Preferred stock, $0.01 par value; 10,000,000 authorized shares; none issued
     —        —  
Common Stock, $0.01 par value; 80,000,000 authorized shares; 19,682,635 and 19,568,851 shares issued and outstanding at September 30, 2012 and December 31, 2011, respectively
     195        194  
Capital in excess of par value
    128,086       124,817  
Retained earnings
    86,800       82,229  
Accumulated other comprehensive loss
    (9,228 )     (10,679 )
Total stockholders’ equity 
    205,853       196,561  
                    Total liabilities and stockholders’ equity 
  $ 305,015     $ 277,830  

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

 
3

 
 
OMEGA PROTEIN CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(In thousands, except per share amounts)

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2012
   
2011
   
2012
   
2011
 
Revenues 
  $ 77,778     $ 71,741     $ 162,499     $ 172,373  
Cost of sales
    64,380       58,315       133,362       128,511  
Gross profit
    13,398       13,426       29,137       43,862  
                                 
Selling, general, and administrative expense
    5,645       5,613       16,373       15,231  
Research and development expense
    553       466       1,672       1,450  
Charges related to U.S. Attorney investigation
    4,137             4,440        
Impairment of intangible assets     129        —       129        —  
Proceeds/gains resulting from Gulf of Mexico oil spill
     —        —        —       (26,177 )
Other proceeds/gains resulting from natural disaster, net – 2005 storms
     —        —        —       (787 )
(Gain) loss on disposal of assets
    30       199       (3,752 )     649  
Operating income
    2,904       7,148       10,275       53,496  
Interest income
    11       6       21       34  
Interest expense
    (299 )     (496 )     (996 )     (1,638 )
Other expense, net
    (94 )     (50 )     (282 )     (164 )
Income before income taxes
    2,522       6,608       9,018       51,728  
                                 
Provision for income taxes
    2,291       1,873       4,447       18,134  
Net income
    231       4,735       4,571       33,594  
                                 
Other comprehensive income (loss):
                               
Energy swap adjustment, net of tax expense (benefit) of $545, ($864), $383 and ($395), respectively
    1,011       (1,605 )     711       (756 )
Pension benefits adjustment, net of tax expense of $133, $105, $398 and $123, respectively
    248       194       740       583  
Comprehensive income
  $ 1,490     $ 3,324     $
6,022
    $ 33,421  
                                 
Basic earnings per share
  $ 0.01     $ 0.24     $ 0.23     $ 1.75  
                                 
Weighted average common shares outstanding
    19,683       19,374       19,630       19,200  
                                 
Diluted earnings per share
  $ 0.01     $ 0.24     $ 0.23     $ 1.69  
                                 
Weighted average common shares and potential common share equivalents outstanding
     20,239        20,073        20,102        19,931  
 
The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

 
4

 

OMEGA PROTEIN CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollars in thousands)

   
Nine Months Ended
September 30,
 
   
2012
   
2011
 
Cash flows from operating activities:
           
Net income
  $ 4,571     $ 33,594  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    13,308       12,072  
Other proceeds/gains resulting from natural disaster, net – 2005 storms
     —       (787 )
(Gain) loss on disposal of assets
    (3,752 )     649  
Impairment of intangible assets     129        —  
Provisions for losses on receivables
    36       36  
Stock-based compensation
    2,777       2,408  
Deferred income taxes
    443       4,703  
Changes in assets and liabilities:
               
Receivables
    (13,312 )     (14,557 )
Inventories
    (13,848 )     (8,075 )
Prepaid expenses and other current assets
    (2,392 )     (2,088 )
Other assets
    (3,958 )     (4,524 )
Accounts payable
    (1,580 )     252  
Accrued liabilities 
      24,954         28,124  
Pension liability, net
    (1,224 )     (639 )
Other long term liabilities
    30        
Net cash provided by operating activities
     6,182        51,168  
Cash flows from investing activities:
               
Proceeds from disposition of assets
    5,930       2,232  
Acquisition of InCon
    181       (9,028 )
Acquisition of Cyvex, net of cash acquired
     —       (2,086 )
Capital expenditures
     (20,570 )     (13,248 )
Net cash used in investing activities
      (14,459 )       (22,130 )
Cash flows from financing activities:
               
Principal payments of long-term debt
    (2,223 )     (2,238 )
Principal payments of capital lease obligation
    (378 )     (356 )
Debt issuance costs
    (389 )      
Proceeds from stock options exercised
    459       2,879  
Excess tax benefit of stock options exercised
    34       1,913  
Net cash (used in) provided by financing activities
    (2,497 )      2,198  
Net (decrease) increase in cash and cash equivalents
    (10,774 )     31,236  
Cash and cash equivalents at beginning of year
    51,391       19,784  
Cash and cash equivalents at end of period
  $ 40,617     $ 51,020  
 
The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

 
5

 

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 (the “Company”) operates through four primary subsidiaries: Omega Protein, Inc., Omega Shipyard, Inc., Cyvex Nutrition, Inc. and InCon Processing, L.L.C.  Omega Protein, Inc. (“Omega Protein”), which is the Company’s principal operating subsidiary, operates in the menhaden harvesting and processing business and is the successor to a business conducted since 1913. Omega Shipyard, Inc. (“Omega Shipyard”) owns and operates a drydock facility in Moss Point, Mississippi. Cyvex Nutrition, Inc. (“Cyvex”), founded in 1984 and acquired by the Company in December 2010, is located in Irvine, California and is an ingredient supplier in the nutraceutical industry.  InCon Processing, L.L.C. (“InCon”), acquired by the Company in September 2011, is located in Batavia, Illinois and is a specialty toll processor that utilizes molecular distillation technology to concentrate a variety of compound products, including Omega-3 fish oils.  The Company also has a number of other immaterial direct and indirect subsidiaries.

Omega Protein Corporation is a nutritional ingredient company and the nation's leading vertically integrated producer of Omega-3 fish oil and specialty fish meal products.  Omega Protein 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.  Omega Protein’s fish meal products are primarily used as a protein ingredient in animal feed for swine, aquaculture and household pets.  Fish oil is utilized primarily for animal and aquaculture feeds, as well as additives to human food products and dietary supplements.  Omega Protein’s fish solubles are sold primarily to livestock feed manufacturers, aquaculture feed manufacturers and for use as an organic fertilizer.
 
Omega Shipyard’s drydock facility is used to provide shoreside maintenance for Omega Protein’s fishing fleet and, subject to outside demand and excess capacity, occasionally for third-party vessels.

Cyvex is a premium, nutraceutical supplier to dietary supplement manufacturers that focus on human health and wellness.

InCon is a specialty toll processor that designs, pilots, synthesizes and purifies specialty chemical compounds, utilizing molecular distillation technology to concentrate a variety of compound products, including Omega-3 fish oils. See Note 2 - Acquisition of InCon Processing, L.L.C. for additional information related to the Company’s acquisition of InCon.

Basis of Presentation

These interim financial statements of the Company 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, 2011.  The year end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

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, 2012, and the results of its operations for the three and nine month periods ended September 30, 2012 and 2011 and its cash flows for the nine month periods ended September 30, 2012 and 2011.  Operating results are not necessarily indicative of the results that may be expected for the year ending December 31, 2012.

Certain amounts applicable to the prior periods have been reclassified to conform to the classifications currently followed.  Specifically, the Company reclassified $303,500 previously reported on the unaudited condensed consolidated statement of comprehensive income for the six months ended June 30, 2012 as selling, general and administrative expenses to charges related to U.S. Attorney investigation to conform with the presentation for the three and nine month periods ended September 30, 2012.  Such reclassifications do not affect current assets, operating cash flows, net income or stockholders’ equity.
 
Consolidation

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

 
6

 
OMEGA PROTEIN CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

 
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.

Inventories

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

Any costs incurred during abnormal downtime related to activity at Omega Protein’s plants are charged to expense as incurred.  Such costs were incurred and offset by proceeds received from the Gulf Coast Claims Facility (“GCCF”) during 2010 and 2011 as a consequence of the Deepwater Horizon explosion and the resulting oil spill in the Gulf of Mexico in April 2010.  For additional information, see Note 3 – Gulf of Mexico Oil Spill.

Business Interruption Insurance Proceeds

 During the nine months ended September 30, 2012, the Company received approximately $0.3 million in proceeds, net of deductible, from its business interruption insurance coverage provider related to an incident causing downtime at one of its Gulf of Mexico production facilities in September 2011.  The proceeds were calculated based on lost inventory production as well as a small amount of excess costs incurred by the Company as a result of the incident.  Given that the Company experienced a slight decrease in production as a result of the incident, the proceeds related to lost inventory production were recognized as an increase in revenues and the proceeds related to excess costs were recognized as a reduction in cost of goods sold.

Interest Rate Swap Agreements

The Company does not enter into financial instruments for trading or speculative purposes.  In conjunction with a prior credit facility, the Company entered into interest rate swap agreements to manage its cash flow exposure to interest rate changes with notional amounts as indicated.  As originally established, the swaps effectively converted all the Company’s variable rate debt under a term loan under a prior bank credit facility to a fixed rate, without exchanging the notional principal amounts.  Prior to September 30, 2009, these agreements were designated as a cash flow hedge and reflected at fair value in the Company’s Consolidated Balance Sheet as a component of total liabilities, and the related gains or losses were deferred in stockholders’ equity as a component of accumulated other comprehensive loss.

In September and October 2009, the Company prepaid all of the borrowings outstanding under the term loan under its prior credit facility.  As a consequence of this debt prepayment and refinancing, the Company determined that the forecasted interest payments associated with the interest rate swaps would not occur.  As a result, hedge accounting relating to the interest rate swaps was discontinued and all amounts previously recognized in accumulated other comprehensive loss were reclassified to interest expense during 2009.  As of December 31, 2011, the Company recorded a $103,100 liability to recognize the fair value of interest rate derivatives.  The interest rate swap agreements matured at the end of March 2012 and are no longer outstanding.

Interest rate swap balances at December 31, 2011:

Date of Contract
 
Original Notional Amount
   
Notional Amounts as of
December 31, 2011
   
Contracted Interest Rate
   
Total Liability as of
December 31, 2011
 
April 4, 2007
  $ 19,950,000     $ 6,483,750       5.16 %   $ 71,600  
February 7, 2008
    10,237,500       3,412,500       3.36 %     22,900  
March 19, 2008
    4,436,250       1,478,750       2.96 %     8,600  
            $ 11,375,000             $ 103,100  

 
7

 
OMEGA PROTEIN CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

 
The total interest (income) expense associated with the interest rate swap transactions was $0 and $(3,400) for the three months ended September 30, 2012 and 2011, respectively, and $145 and $24,700 for the nine months ended September 30, 2012 and 2011, respectively.

Energy Swap Agreements

The Company does not enter into financial instruments for trading or speculative purposes.  During 2012, 2011 and 2010, Omega Protein entered into energy swap agreements to manage portions of its cash flow exposure related to the volatility of natural gas, diesel and fuel oil energy prices for its fish meal and fish oil production operations. The swaps effectively fix pricing for the quantities listed below during the consumption periods.
 
Energy swap balances at September 30, 2012:
Energy Swap
 
Consumption Period
 
Quantity
 
Price Per Unit
   
Energy Swap Asset/(Liability) as of
September 30, 2012
   
Deferred Tax Asset/(Liability) as of
September 30, 2012
 
Diesel - NYMEX Heating Oil Swap
 
October - November, 2012
 
442,500 Gallons
  $ 2.87     $ 128,000     $ (44,800 )
Natural Gas - NYMEX Natural Gas Swap
 
October, 2012
 
47,843 MMBTUs
  $ 4.19       (27,700 )     9,700  
Fuel Oil – No.6 1.0% NY-Platts Swap
 
October - November, 2012
 
376,110 Gallons
  $ 2.31        70,000       (24,500 )
Diesel - NYMEX Heating Oil Swap
 
April - November, 2013
 
1,359,782 Gallons
  $ 2.82        263,000       (92,000 )
Natural Gas - NYMEX Natural Gas Swap
 
April – October, 2013
 
381,150 MMBTUs
  $ 3.94       (76,300 )      26,700  
Fuel Oil – No.6 1.0% NY-Platts Swap
 
May - November, 2013
 
  676,200 Gallons
  $ 2.26        91,100       (31,900 )
                    $ 448,100     $ (156,800 )

Energy swap balances at December 31, 2011:
Energy Swap
 
Consumption Period
 
Quantity
 
Price Per Unit
   
Energy Swap Asset (Liability) as of
December 31, 2011
   
Deferred Tax Asset (Liability) as of
December 31, 2011
 
Diesel - NYMEX Heating Oil Swap
 
May - November, 2012
 
2,779,000 Gallons
  $ 2.87     $ (56,200 )   $ 19,700  
Natural Gas - NYMEX Natural Gas Swap
 
April – October, 2012
 
308,000 MMBTUs
  $ 4.90       (507,000 )      177,400  
Fuel Oil – No.6 1.0% NY-Platts Swap
 
May - November, 2012
 
1,584,240 Gallons
  $ 2.33        29,700       (10,400 )
Natural Gas - NYMEX Natural Gas Swap
 
April – October, 2013
 
104,000 MMBTUs
  $ 5.00       (113,100 )      39,600  
                    $ (646,600 )   $ 226,300  
 
As of September 30, 2012 and December 31, 2011, Omega Protein has recorded a long-term asset (liability) of $95,500 and ($113,100), respectively, net of the current portion included in prepaid expenses and other current assets (accrued liabilities) of $352,600 and ($533,500), respectively, to recognize the fair value of energy swap derivatives. The effective portion of the change in fair value from inception to September 30, 2012 is recorded in “accumulated other comprehensive loss” in the Company’s consolidated financial statements.  The following table (in thousands) illustrates the changes recorded, net of tax, in accumulated other comprehensive loss resulting from the energy swap agreements.

 
8

 
OMEGA PROTEIN CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

 
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2012
   
2011
   
2012
   
2011
 
Beginning balance
  $ (720 )   $ 1,354     $ (420 )   $ 505  
Net loss (gain), net of tax, reclassified to unallocated inventory cost pool
    116       (768 )     377       (1,266 )
Net change associated with current period swap transactions, net of tax
    895       (837 )     334       510  
Ending balance
  $ 291     $ (251 )   $ 291     $ (251 )
 
The $0.3 million reported in accumulated other comprehensive loss as of September 30, 2012 will be reclassified to the unallocated inventory cost pool in the period when the energy consumption takes place.  The amount to be reclassified, net of taxes, during the next 12 months is expected to be approximately $0.2 million.

If, at any time, the swaps are determined to be ineffective, in whole or in part, due to changes in the Company’s energy usage or underlying hedge agreements or assumptions, the fair value of the portion of the energy swaps determined to be ineffective will be recognized as a gain or loss in cost of sales for the applicable period.  See Note 17 – Fair Value Disclosures for additional information.

Construction Contract

Omega Shipyard is engaged in a single fixed price construction contract with a third party that is expected to be completed in the fourth quarter of 2012.  The contract calls for revenue to be billed as milestones are attained based on the total estimated construction cost.  The Company recognizes revenue and expenses related to the contract on a percentage of completion basis based on a ratio that costs incurred to date bear to total projected costs.  If at any time the Company projects a loss on a construction contract, the estimated total loss is immediately recognized once it is deemed probable to occur.

During the quarter ended June 30, 2012, Omega Shipyard revised its total estimated construction costs such that the Company expects to have a gross loss upon completion.  As a result, gross profit recognized on the contract in previous quarters was reversed and the full extent of the expected loss was recognized during the quarter ended June 30, 2012.  The Company reassesses these estimates on a quarterly basis. For the three and nine months ended September 30, 2012, the Company recognized gross losses of $0.1 million and $0.5 million, respectively, with respect to the construction contract.  For the three and nine months ended September 30, 2011, the Company had recognized a gain of $5,000 relating to the construction contract.

Accumulated Other Comprehensive Loss

The components of accumulated other comprehensive gain (loss) included in stockholders’ equity are as follows:

   
September 30,
   
December 31,
 
   
2012
   
2011
 
   
(in thousands)
 
Fair Value of Energy Swaps, net of tax (expense) benefit of ($157) as of September 30, 2012 and $226 as of December 31, 2011.
  $ 291     $ (420 )
Pension Benefits Adjustments, net of tax benefit of $5,126 as of September 30, 2012 and $5,524  as of December 31, 2011
    (9,519 )     (10,259 )
Accumulated Other Comprehensive Loss
  $ (9,228 )   $ (10,679 )

Recently Issued Accounting Standards
 
In July 2012, the FASB issued ASU No. 2012-02 regarding subsequent measurement guidance for long-lived intangibles. This guidance is meant to reduce the cost and complexity of performing an impairment test for indefinite-lived intangible assets by simplifying how an entity tests those assets for impairment and to improve consistency in impairment testing guidance among long-lived asset categories. This guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, which corresponds to the Company’s first fiscal quarter beginning January 1, 2013. The Company is currently evaluating the impact, if any, the adoption of this guidance will have on its consolidated financial statements.

 
9

 
OMEGA PROTEIN CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

 
In December 2011, the FASB issued ASU No. 2011-11, Disclosures about Offsetting Assets and Liabilities.  The standard requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position.  The amendments in this update will enhance disclosures required by U.S. GAAP by requiring improved information about financial instruments and derivative instruments to help reconcile differences in the offsetting requirements under U.S. GAAP and International Financial Reporting Standards (IFRS).  The amendments are effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods.  The Company is evaluating the impact, if any, the adoption of this standard will have on its consolidated financial statements.

In September 2011, the FASB issued ASU No. 2011-08, Testing Goodwill for Impairment.  The revised standard is intended to reduce the cost and complexity of the annual goodwill impairment test by providing entities the option of performing a qualitative assessment to determine whether further impairment testing is necessary.  The revised standard is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011.  The Company’s adoption of FASB ASU No. 2011-08 effective January 1, 2012 did not have an impact on the Company’s consolidated results of operations, financial position and related disclosures.

In June 2011, the FASB issued ASU No. 2011-05, Presentation of Comprehensive Income.  The standard eliminates the current option to report other comprehensive income and its components in the statement of changes in equity.  An entity may present items of net income and other comprehensive income in one continuous statement, or in two separate, but consecutive statements.  The change is intended to enhance comparability between entities that report under U.S. GAAP and those that report under International Financial Reporting Standards (IFRS), and to provide a more consistent method of presenting non-owner transactions that affect an entity’s equity.  The guidance is effective as of the beginning of a fiscal year that begins after December 15, 2011, which corresponds to the Company’s first fiscal quarter beginning January 1, 2012.  However, in December 2011, the FASB issued ASU No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05, which deferred the guidance on whether to require entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement where net income is presented and the statement where other comprehensive income is presented for both interim and annual financial statements. ASU 2011-12 reinstated the requirements for the presentation of reclassifications that were in place prior to the issuance of ASU 2011-05 and did not change the effective date for ASU 2011-05. For public entities, the amendments in ASU 2011-05 and ASU 2011-12 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, and should be applied retrospectively. The Company’s adoption of these standards effective January 1, 2012 did not have an impact on the Company’s consolidated results of operations, financial position and related disclosures.

Stock-Based Compensation

Stock Options

The Company has a stock-based compensation plan, which is described in more detail in Note 16 to the consolidated financial statements of the Company’s Form 10-K for the fiscal year ended December 31, 2011.  The Company has issued non-qualified stock options under its stock incentive plans. The options generally vest in equal installments over three years and expire in ten years. Non-vested options are generally forfeited upon termination of employment.

Net income for the three months ended September 30, 2012 and 2011 includes $0.8 million and $0.9 million ($0.5 million and $0.6 million after-tax), respectively, of stock-based compensation costs related to stock options.  Net income for the nine months ended September 30, 2012 and 2011 includes $2.3 million and $2.4 million ($1.5 million and $1.6 million after-tax), respectively, of stock-based compensation costs related to stock options.  The stock-based compensation costs related to stock options are recorded primarily in selling, general and administrative expenses in the unaudited condensed consolidated statement of comprehensive income.  As of September 30, 2012 there was $1.3 million ($0.9 million after-tax) of total unrecognized compensation costs related to non-vested stock options that is expected to be recognized over a weighted-average period of 0.8 years, of which $0.8 million ($0.5 million after-tax) of total stock option compensation is expected to be recognized during the remainder of fiscal year 2012.

Restricted Stock

The Company has issued shares of restricted stock under its 2006 Incentive Plan.  Holders of shares of restricted stock are entitled to all rights of a stockholder of the Company with respect to the restricted stock, including the right to vote the shares and receive any dividends or other distributions.  The shares are considered issued and outstanding on the date granted and are included in the basic earnings per share calculation.

During the nine month periods ended September 30, 2012 and 2011, the Company issued 25,000 shares and 15,698 shares, respectively, of restricted stock under the 2006 Incentive Plan.  The Company’s stock-based compensation expense related to restricted stock was approximately $0.1 million and $17,000 ($0.1 million and $11,000 after-tax) for the three months ended September 30, 2012 and 2011, respectively, and $0.4 million and $17,000 ($0.3 million and $11,000 after-tax) for the nine months ended September 30, 2012 and 2011, respectively, which is primarily reflected in selling, general and administrative expenses in the unaudited condensed consolidated statement of comprehensive income.  As of September 30, 2012, there was approximately $1.2 million ($0.8 million after tax) of unrecognized stock-based compensation cost related to non-vested restricted stock that is expected to be recognized over a weighted-average period of 2.2 years, of which $0.1 million ($0.1 million after-tax) of total restricted stock compensation is expected to be recognized during the remainder of fiscal year 2012.

 
10

 
OMEGA PROTEIN CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

 
NOTE 2.  ACQUISITION OF INCON PROCESSING, L.L.C.

A. Description of the Transaction

In September 2011, the Company acquired all of the outstanding equity of InCon Processing, L.L.C., a Delaware limited liability company, in a cash transaction pursuant to the terms of an equity purchase agreement.  The equity of InCon was indirectly held by four individuals (the “Sellers”), three of whom continue to be employed by InCon and manage InCon’s business.  InCon is now a wholly owned subsidiary of the Company.  InCon is a specialty toll processor that designs, pilots, synthesizes and purifies specialty chemical compounds, utilizing molecular distillation technology to concentrate a variety of compound products, including Omega-3 fish oils.

At closing, the Company paid an aggregate cash purchase price for the equity of InCon of $8.7 million, utilizing cash on hand, and also paid $0.6 million representing InCon’s estimated working capital on the closing date.  The working capital portion of the purchase price was subject to a post-closing adjustment to account for differences between estimated working capital and actual working capital of InCon as of the closing date.  During the nine months ended September 30, 2012, the Company received a payment from the Sellers of $0.2 million to account for the final working capital adjustment.

B. Unaudited Pro Forma Financial Information

The unaudited financial information in the table below summarizes the combined results of operations of the Company and InCon on a pro forma basis, as though the companies had been combined as of January 1, 2011.  The pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had actually taken place on January 1, 2011 and is not intended to be a projection of future results or trends.
 
    Revenues     Net income  
    (in thousands)  
2011 supplemental pro forma for the three months ended September 30, 2011
  $ 72,682     $ 4,686  
2011 supplemental pro forma for the nine months ended September 30, 2011
  $ 175,794     $ 33,529  

NOTE 3.  GULF OF MEXICO OIL SPILL

As a result of the oil spill caused by the Deepwater Horizon oil rig explosion in the Gulf of Mexico in April 2010 and the subsequent temporary and intermittent closures of certain commercial and recreational fishing grounds by the Louisiana Department of Fisheries and Wildlife, the Mississippi Department of Marine Resources and the National Oceanic and Atmospheric Administration (“NOAA”), Omega Protein’s total fish catch for 2010 was materially impacted.  In addition, Omega Protein incurred costs associated with the temporary re-deployment of many of its Gulf of Mexico fishing vessels, costs to purchase fish meal from third party vendors to offset lost production, and increased costs per unit of production resulting from intermittent plant closures.

During 2010, Omega Protein filed a claim for damages with BP and also met with BP’s third party claims adjuster.  On August 23, 2010, the claims process for BP was moved to the GCCF, a claims facility tasked with claims administration and payment distribution for those businesses and individuals that suffered damages and incurred other costs related to the oil spill.

In September and October 2010, Omega Protein received its first and second emergency payments from the GCCF of $7.3 million and $11.4 million, respectively.  The majority of the first and second emergency payments were credited to the 2010 unallocated inventory cost pool (including off-season costs).  Because both of these payments were included in the cost per unit of production calculation for the 2010 fishing season, cost of sales was partially reduced by 6.0%, or $8.2 million for the nine months ended September 30, 2011.

In April 2011, the Company agreed to a final settlement of all of its claims for costs and damages incurred as a result of the oil spill caused by the Deepwater Horizon explosion and received a final payment of $26.2 million, net of fees and expenses, from the GCCF.  The amount was recognized as “Proceeds/gains resulting from Gulf of Mexico oil spill disaster” in the Company’s Consolidated Statement of Operations for the year ended December 31, 2011, and is more fully explained in Note 3 to the consolidated financial statements of the Company’s Form 10-K for the fiscal year ended December 31, 2011.

 
11

 
OMEGA PROTEIN CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

 
In total, the Company received payments of $44.8 million, net of fees and expenses, from the GCCF in 2010 and 2011.  As a part of the final settlement, the Company released and waived all current and future claims against BP and all other potentially responsible parties with regard to the oil spill.

NOTE 4. RECEIVABLES, NET

Receivables are summarized as follows:
   
September 30,
2012
   
December 31,
2011
 
    (in thousands)  
Trade                                                                                              
  $ 23,238     $ 10,208  
Insurance                                                                                              
    5,549       4,687  
Income tax                                                                                              
    952       1,919  
InCon working capital                                                                                              
          181  
Other                                                                                              
    464       78  
Total accounts receivable                                                                                              
    30,203       17,073  
Less allowance for doubtful accounts                                                                                              
     (320 )      (285 )
Receivables, net                                                                                              
  $ 29,883     $ 16,788  
 
As of September 30, 2012, the insurance receivable includes approximately $3.4 million related to the salvage costs and other related claims incurred by the Company associated with the sinking of the F/V Sandy Point in May 2011.  InCon working capital represents post-closing working capital adjustments resulting from the September 9, 2011 acquisition of InCon.   See Note 14 – Related Party Transactions.

NOTE 5. INVENTORIES

The major classes of inventory are summarized as follows:
   
September 30,
2012
   
December 31,
2011
 
   
(in thousands)
 
Fish meal                                                                                              
  $ 46,712     $ 30,738  
Fish oil                                                                                              
    16,653       14,533  
Fish solubles                                                                                              
    1,920       1,101  
Nutraceutical products                                                                                              
    3,697       2,325  
Unallocated inventory cost pool (including off-season costs)
    597       7,443  
Other materials and supplies                                                                                              
    9,162       8,753  
Total inventories                                                                                              
  $ 78,741     $ 64,893  

Inventory at September 30, 2012 and December 31, 2011 is stated at the lower of cost or market.  The elements of September 30, 2012 unallocated inventory cost pool include Omega Protein’s plant and vessel related labor, utilities, rent, repairs and depreciation, to be allocated to inventories produced through the 2012 fishing season.

NOTE 6.  PREPAID EXPENSES AND OTHER CURRENT ASSETS

Prepaid expenses and other current assets are summarized below:
   
September 30,
2012
   
December 31,
2011
 
   
(in thousands)
 
Prepaid insurance
  $ 2,763     $ 1,808  
Selling expenses
    993       107  
Costs in excess of billings on certain construction contracts
    789        
Fair market value of energy swaps, current portion 
    353        
Leases
    123       105  
Guarantee fees
    5         17  
Other prepaids and expenses
    490       201  
Total prepaid expenses and other current assets
  $ 5,516     $ 2,238  

Amounts included in prepaid expenses and other current assets consist primarily of prepaid operating expenses including insurance, rents, and selling expenses.  Energy swap assets are valued at each reporting date at their fair market value (see Note 17 – Fair Value Disclosures for additional information).  Prepaid selling expenses are expensed in the period that the related revenue is recognized.

 
12

 
OMEGA PROTEIN CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

 
NOTE 7. OTHER ASSETS, NET

Other assets are summarized as follows:
   
September 30,
2012
   
December 31,
2011
 
    (in thousands)  
Fish nets, net of accumulated amortization of $913 and $1,175
  $ 1,762     $ 1,288  
Insurance receivable, net of allowance for doubtful accounts
    6,211       3,645  
Title XI debt issuance costs                                                                                              
    309       332  
Other debt issuance costs                                                                                              
    414       118  
Deposits and other                                                                                              
    32       40  
Total other assets, net                                                                                              
  $ 8,728     $ 5,423  

Amortization expense for fishing nets amounted to approximately $0.3 million and $0.9 million for the three and nine months ended September 30, 2012 and 2011, respectively.

As of September 30, 2012 and December 31, 2011, the insurance receivable of $6.2 million and $3.6 million, respectively, primarily relates to Jones Act claims for employees aboard its vessels.  This estimated amount is recorded gross of estimated claims which may be due to claimants and is included in accrued insurance liabilities.

The Company carries insurance for certain losses relating to its fishing unit’s vessels and Jones Act liability for employees aboard its vessels (collectively, “Vessel Claims Insurance”).  The typical Vessel Claims Insurance policy contains a per incident stop loss and an annual aggregate deductible (“AAD”) for which Omega Protein remains responsible, while the insurance carrier is responsible for all applicable amounts which exceed the per incident stop loss and AAD.  It is Omega Protein’s policy to accrue current amounts due and record amounts paid out on each claim.  Once payments exceed the per incident stop loss and AAD, Omega Protein records an insurance receivable for a given policy year, net of allowance for doubtful accounts.  As of September 30, 2012 and December 31, 2011, the allowance for doubtful insurance receivable accounts was $0.

NOTE 8. PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment are summarized as follows:
    September 30,
2012
   
December 31,
2011
 
    (in thousands)  
Land
  $ 7,229     $ 7,873  
Plant assets
    143,552       138,025  
Fishing vessels
    99,353       95,055  
Furniture and fixtures
    6,582       6,571  
Construction in progress
    23,213       16,909  
Total property and equipment
    279,929       264,433  
Less accumulated depreciation and impairment
    (151,161 )     (141,921 )
Property, plant and equipment, net
  $ 128,768     $ 122,512  
 
Depreciation expense was $4.1 million and $3.6 million for the three months ended September 30, 2012 and 2011, respectively, and $12.0 million and $10.8 million for the nine months ended September 30, 2012 and 2011, respectively.
 
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 month periods ended September 30, 2012 and 2011, the Company capitalized interest of approximately $211,200 and $75,700, respectively.  For the nine month periods ended September 30, 2012 and 2011, the Company capitalized interest of approximately $609,300 and $127,600, respectively.

 
13

 
OMEGA PROTEIN CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

 
On June 1, 2012, the Company completed the sale of its Morgan City, Louisiana facility.  The property last operated as a processing facility in 1999 but had recently been used primarily as a storage and training facility.  Net cash proceeds from the sale after preparation costs, fees and expenses were approximately $5.1 million.  For the nine months ended September 30, 2012, the Company recognized a gain on the sale of approximately $3.7 million which is included in gain on disposal of assets in the Company’s statement of comprehensive income.  In addition to the preceding amount, the Company recorded an estimated reserve of $250,000 which the Company will receive as an additional escrow payment from the seller if certain post-closing environmental testing procedures on the property are satisfactorily completed.  To the extent that the escrow amount received differs from the estimated reserve, the Company will recognize additional gain or loss on the sale in subsequent periods.  That difference is not expected to be material.

NOTE 9. GOODWILL AND OTHER INTANGIBLE ASSETS, NET

During the third quarter of 2012, the Company completed its annual impairment testing of goodwill and indefinite life intangible assets related to its acquisition of InCon in September 2011.  As a result of that testing, the Company concluded that the carrying value of InCon’s trade names exceeded the fair value by approximately $0.1 million.  As such, an impairment expense of $0.1 million was recognized during the three and nine months ended September 30, 2012 and the carrying value of the trade names was reduced from $0.2 million to $0.1 million.
 
The Company’s intangible assets, other than goodwill, were as follows (dollars in thousands):
 
 
 
September 30,
2012
   
December 31,
2011
   
Weighted
Average
Life
 
Carrying value of intangible assets subject to amortization:
                 
Customer relationships, net
  $ 2,691     $ 2,934       10  
Total intangible assets subject to amortization, net
  $ 2,691     $ 2,934          
Indefinite life intangible assets – trade names, trade secrets
    1,753       1,882          
Total intangible assets, other than goodwill
  $ 4,444     $ 4,816          
 
Amortization expense of the Company’s intangible assets for the three and nine month periods ended September 30, 2012 was approximately $81,100 and $243,400, respectively. Amortization expense of the Company’s intangible assets for the three and nine month periods ended September 30, 2011 was approximately $76,700 and $230,200, respectively.  Estimated future amortization expense related to intangible assets is as follows (in thousands):

Remainder of 2012
  $ 81  
2013
    325  
2014
    325  
2015
    325  
Thereafter
    1,635  
Total estimated future amortization expense
  $ 2,691  
 
The Company’s goodwill and other intangible assets are more fully explained in Note 10 to the consolidated financial statements of the Company’s Form 10-K for the fiscal year ended December 31, 2011.

NOTE 10. LONG-TERM DEBT

The Company's long-term debt consisted of the following:
 
   
September 30,
   
December 31,
 
   
2012
   
2011
 
   
(in thousands)
 
U.S. government guaranteed obligations (Title XI loans) collateralized by a first lien on certain vessels and certain plant assets:
           
Amounts due in installments through 2025, interest from 5.7% to 7.6%
  $ 27,989     $ 30,181  
Amounts due in installments through 2014, interest at Eurodollar rates plus 0.5% (0.9%  and 0.8% at September 30, 2012 and December 31, 2011, respectively)
      82         113  
Total debt
    28,071       30,294  
Less current maturities
    (3,080 )     (2,992 )
Long-term debt
  $ 24,991     $ 27,302  

 
14

 
OMEGA PROTEIN CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)


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.

On June 20, 2011, pursuant to the Title XI program, the United States Department of Commerce Fisheries Finance Program (the “FFP”) approved a financing application made by the Company in the amount of $10.0 million (the “Approval Letter”).  To date, the Company has not submitted any financing requests under the Approval Letter.

On March 21, 2012, the Company entered into an Amended and Restated Loan Agreement (the “Loan Agreement”) with Wells Fargo Bank, National Association, as administrative agent (the “Agent”) for the lenders (currently Wells Fargo Bank, National Association and JP Morgan Chase Bank, N.A.) (collectively, the “Lenders”) pursuant to which the Lenders agreed to extend credit to the Company in the form of loans (each a “Loan” and collectively, the “Loans”) on a revolving basis of up to $60.0 million (the “Commitment”). The Commitment includes a sub-facility for swingline loans up to an amount not to exceed $5.0 million, a sub-facility for standby letters of credit up to an amount not to exceed $15.0 million and an accordion feature that allows the Company to increase the amount of the Commitment up to an additional $10.0 million, subject to the further commitments of the Lenders and other customary conditions precedent. The Loan Agreement amended and restated the Company’s existing senior secured credit facility with Wells Fargo Bank, National Association. On the Closing Date, no amounts were outstanding under the existing senior secured credit facility and approximately $3.3 million in letters of credit were issued primarily in support of the Company’s worker’s compensation insurance programs. The Company incurred $0.4 million in deferred debt issuance costs associated with the Loan Agreement.

At the election of the Company, any Loans will bear interest at the lesser of (a) the Base Rate (defined as a fluctuating rate equal to the highest of: (x) the rate of interest most recently announced by Agent as its “prime rate,” (y) a rate determined by Agent to be 1.50% above daily one month LIBOR (except during certain periods of time), and (z) the Federal Funds Rate plus 1.00%) plus the Applicable Margin (as defined in the Loan Agreement), (b) a rate per annum determined by Agent to be equal to LIBOR in effect for the applicable interest period plus the Applicable Margin, or (c) the Maximum Rate (as defined in the Loan Agreement).

All obligations of the Company under the Loan Agreement are secured by a first and superior lien (subject to Permitted Liens, as defined in the Loan Agreement) against any and all assets of the Company (other than certain excluded property, including property pledged to secure Title XI loans).

The Loan Agreement requires the Company to comply with various affirmative and negative covenants affecting the Company’s businesses and operations.  In addition, the Loan Agreement requires the Company to comply with the following financial covenants:
 
 
The Company is required to maintain on a consolidated basis Tangible Net Worth equal to at least the sum of the following: (a) $150,000,000, plus (b) 50% of net income (if positive, with no deduction for losses) earned in each quarterly accounting period commencing after June 30, 2011, plus (c) 100% of the net proceeds from any Equity Interests (as defined in the Loan Agreement) issued after the date of the Loan Agreement, plus (d) 100% of any increase in stockholders’ equity resulting from the conversion of debt securities to Equity Interests after the Closing Date.
 
 
The Company is required to maintain on a consolidated basis an Asset Coverage Ratio (as defined in the Loan Agreement) of at least 2.50 to 1.00.
 
 
The Company is required to maintain a positive Adjusted Profitability (as defined in the Loan Agreement), measured on a trailing four quarters basis.
 
As of September 30, 2012, the Company was in compliance with all financial covenants under the Loan Agreement.

All Loans and all other obligations outstanding under the Loan Agreement shall be payable in full on March 21, 2017.  As of September 30, 2012 and December 31, 2011, the Company had no amounts outstanding under the $60 million Loan Agreement and $35 million prior revolving credit facility, respectively, and approximately $3.1 million and $3.3 million, respectively, in letters of credit.  The Company has no off-balance sheet arrangements other than normal operating leases and standby letters of credit.

 
15

 
OMEGA PROTEIN CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)


NOTE 11. CAPITAL LEASE OBLIGATION

On May 29, 2008 and July 10, 2008, Omega Protein entered into capital lease agreements to lease barges for a period of 5 years.  Following is a summary of future minimum payments under the capitalized lease agreements (in thousands):

Remainder of 2012
  $ 149  
2013
    277  
Total minimum lease payments
    426  
Less amount representing interest
    (19 )
Present value of minimum payments
  $ 407  

Assets recorded under capital lease obligations are included in property, plant and equipment, net as follows (in thousands):

   
September 30,
   
December 31,
   
2012
   
2011
Fishing vessels and marine equipment, at cost
  $ 2,076     $ 2,076  
Less accumulated depreciation
    (1,783 )     (1,471 )
Property, plant and equipment, net
  $ 293     $ 605  
 
NOTE 12. ACCRUED LIABILITIES
 
Accrued liabilities are summarized as follows:
   
September 30,
   
December 31,
 
   
2012
   
2011
 
   
(in thousands)
 
Insurance
  $ 11,281     $ 8,475  
Salary and benefits
    16,177       3,638  
Trade creditors
    4,717       4,908  
Reserve for U.S. Attorney investigation
    4,250       325  
Taxes, other than federal income tax
    1,833       51  
Deferred revenue
    5,732       361  
Fair market value of energy swaps, current portion
          534  
Fair market value of interest rate swap, current portion
          103  
Legal reserves
    104       200  
Contractual obligations
    250       618  
Accrued interest
    226       251  
Other
    89       354  
Total accrued liabilities
  $ 44,659     $ 19,818  
 
As of September 30, 2012 and December 31, 2011, deferred revenue was $5.7 million and $0.4 million, respectively, representing payments received from international customers related to revenues which were not recognized until the subsequent period due to revenue recognition criteria.

See Note 13.  Commitments and Contingencies – Regulatory Matters for information on the U.S. Attonrey's Office investigation reserve.

NOTE 13.  COMMITMENTS AND CONTINGENCIES

Purchase Obligation

In May 2012, the Company entered into a contract to purchase 4 million gallons of renewable diesel oil (“RDO”) beginning in July 2012 through the 2013 fishing season.  The RDO will be utilized in one of the Company’s four fish processing plants.  The contract is priced at a discount to prevailing market prices of the BTU equivalent of Platts NY Harbor 2.2% Sulfur No.6 Oil as delivery is made throughout the fishing seasons.  As of September 30, 2012, approximately 2.9 million gallons are still committed under the contract.

InCon Contingency

In September 2011, the Company acquired all of the outstanding equity of InCon Processing, L.L.C., (“InCon”), a Delaware limited liability company, in a cash transaction pursuant to the terms of an equity purchase agreement.  The equity of InCon was indirectly held by four individuals (the “Sellers”), three of whom continue to be employed by InCon and manage InCon’s business.  InCon is now a wholly owned subsidiary of the Company.

 
16

 
OMEGA PROTEIN CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

 
In addition to the acquisition date cash purchase price, the Sellers may also earn additional amounts based on the annual earnings before interest, taxes, depreciation, and amortization (“EBITDA”) of InCon’s toll processing and specialty product business during calendar years 2012 through 2016.  The annual earn-out payments are determined based on a percentage of InCon’s EBITDA which percentage ranges from five percent (5%) of the first $3.0 million of EBITDA to thirty percent (30%) of EBITDA in excess of $12.0 million.

The annual earn-out payments, if any, will be estimated on a quarterly basis and paid subsequent to year end.  The Company will record the estimated contractual obligation as compensation expense during each year as it is deemed probable that such amount will be payable.  In addition, the earn-out payments are subject to certain reductions associated with future InCon capital expenditures and forfeitures based on termination of employment.  For the nine months ended September 30, 2012, the Company has not recorded an annual earn-out estimate.

Legal Contingencies

On May 18, 2011, the Company’s fishing vessel, F/V Sandy Point, was involved in a collision with a commercial cargo vessel, Eurus London. As a result of the collision, the Company’s vessel sank and three Company crew members died.  The Company has filed a limitation action under maritime law to limit its potential liability for the incident to $50,000, the value of the sunken vessel, in the U.S. District Court for the Southern District of Mississippi. Representatives of the three deceased crewmembers, as well as certain other crewmembers, filed lawsuits against the Company. The claims relating to the deceased crewmembers and all but one of the personal injury claims have been settled.  All claims arising from the incident have been or are expected to be covered by the Company’s insurance program, subject to customary deductibles, which are not expected to have a material adverse effect on the Company’s business, financial results or results of operations.

In conjunction with the sinking of the vessel, the Company recorded a net insurance receivable of approximately $5.9 million related primarily to costs expended salvaging the sunken vessel from the Mississippi ship channel and other claims and a net receivable of $1.8 million related to the insurance value of the vessel.  The $1.8 million receivable related to the vessel value was received in 2011. An additional $2.6 million related to the salvage of the vessel has been received from the Company’s primary insurance carrier, including $0.1 million during the first nine months of 2012.  As of September 30, 2012, the Company has an insurance receivable of approximately $3.4 million related to salvaging costs and other claims.

In March 2010, the Company was named as one of the defendants in a lawsuit filed in the Superior Court of the State of California, County of San Francisco, by Chris Manthey, Benson Chiles and Mateel Environmental Justice Foundation.  The plaintiffs allege that fish oil dietary supplements produced by the defendants do not have adequate warnings regarding possible exposure to polychlorinated biphenyls (PCBs) as required by Proposition 65 under California law, and request that the court grant injunctive relief and award monetary civil penalties.  The Company’s total fish oil supplement sales in the State of California since inception have been immaterial and the Company believes that its products comply fully with federal law promulgated by the U.S. Food & Drug Administration, standards of the European Commission and state law, including California.  In July 2012, the Company agreed to settle the lawsuit for $30,000, subject to court approval.

Regulatory Matters

The Company is subject to various possible claims and lawsuits regarding environmental matters.  Except as noted below, 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.

In April 2010, the Company received a request for information pursuant to Section 308 of the Federal Water Pollution Control Act (Clean Water Act) from Region 3 of the United States Environmental Protection Agency (the “EPA”) concerning the Company’s bail wastewater practices used in its fishing operations at its Reedville, Virginia facility. The Company responded to the request. The Company cannot predict the outcome of the EPA’s review.

In February 2011, the United States Coast Guard conducted inspections of the vessels at the Company’s Reedville, Virginia facility regarding the vessels’ bilge water discharge practices. Based on the results of those inspections and subsequent communications with the Coast Guard, the Company conducted a survey of its Virginia fishing fleet to determine compliance with applicable laws and regulations.  Following the completion of certain improvements and repairs, the Coast Guard inspected the vessels and all but two were approved for full operations prior to the beginning of the 2011 Atlantic fishing season.  The other two vessels were approved for full operations shortly after the beginning of the fishing season and the delay did not materially impact the fleet’s Atlantic fishing operations.

 
17

 
OMEGA PROTEIN CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

 
The Company spent approximately $3.0 million during 2011 to make the above improvements and repairs to the Reedville fleet. The Company has evaluated the vessels in its Gulf fleet based on the review of its Reedville vessels.  Based on the results of that evaluation, it is likely that the Company will incur additional costs to make improvements and repairs to its Gulf fleet.  The Company had requested a waiver from the Coast Guard for its Atlantic and Gulf of Mexico fleets regarding the use of certain vessel equipment applicable to “ocean-going vessels” (as defined by Coast Guard regulations) that operate beyond the 12 nautical mile limit and in May 2012 the Coast Guard granted the Company a partial waiver for its 2012 fishing season only that allows the Company to travel, but not fish, outside 12 nautical miles of shore.  If the Coast Guard does not extend the waiver in 2013, the Company will have to restrict its fishing operations to within 12 nautical miles of shore or install additional equipment on its vessels which will result in additional expense.

In recent discussions with the Company, the U.S. Attorney’s Office has proposed a criminal plea disposition of the above matters that would involve a fine, community service contributions, and a probationary period for the Company. Based on the information presently known to the Company and the on-going status of its discussions with the U.S. Attorney’s Office, the Company currently estimates that fines, contributions and associated legal fees in connection with the matters could range from $4.25 million to $10 million. Accordingly, the Company has recorded an accrual for the matters of $4.25 million, the low end of that estimated range, in its third quarter 2012 financial statements. Any settlement amount is not expected to be tax deductible. Discussions with the U.S. Attorney’s Office are continuing but there can be no assurance that a criminal or civil settlement will be achieved or that costs and payments made in connection with these matters will not exceed either the amount of the accrual currently recorded or the range that is currently estimated, or that the government will not also impose additional non-monetary remedies or penalties that could have a material adverse effect on the Company.

In May 2012, the North Carolina Division of Marine Fisheries in the Department of Environment and Natural Resources issued a proclamation that banned the commercial fishing of menhaden using purse seine netting in North Carolina state waters. The restrictions in the proclamation were subsequently enacted into law by the North Carolina General Assembly, effectively prohibiting the Company’s fishing operations in these state waters.  Federal waters outside the North Carolina three-nautical mile state water limit remain unaffected. In 2011, the Company caught approximately 1.6% of its total 2011 fish catch in North Carolina state waters.

NOTE 14. RELATED PARTY TRANSACTIONS

In September 2011, the Company acquired all of the outstanding equity of InCon Processing, L.L.C., (“InCon”), a Delaware limited liability company, in a cash transaction pursuant to the terms of an equity purchase agreement.  The equity of InCon was indirectly held by four individuals (the “Sellers”), three of whom continue to be employed by InCon and manage InCon’s business.  During the nine months ended September 30, 2012, the Company received a payment from the Sellers of $0.2 million to account for a final working capital adjustment in conjunction with the acquisition.

The Sellers own and operate privately held businesses with which InCon continues to provide toll distillation services and pilot plant runs, primarily InCon Process Systems and InCon Industries.  The services for these related party transactions are generally invoiced at prevailing market prices.  During the three and nine month periods ending September 30, 2012, InCon recorded revenue of approximately $142,600 and $149,200 respectively, from these related parties.  Purchases from these same related parties were approximately $0 and $2,500 for the three and nine month periods ending September 30, 2012.
 
NOTE 15. RECONCILIATION OF BASIC AND DILUTED PER SHARE DATA (in thousands except per share date)

   
Earnings
   
Shares
   
Per Share
 
   
(Numerator)
   
(Denominator)
   
Data
 
Three Months Ended September 30, 2012
                 
Net earnings
  $ 231              
                       
Basic earnings per common share:
                 
 
 
Earnings available to common shareholders
  $ 231       19,683     $ 0.01  
                         
Effect of dilutive securities:
                       
Stock options assumed exercised
          556          
                         
Diluted earnings per common share:
                       
Earnings available to common shareholders plus stock options assumed exercised
  $ 231       20,239     $ 0.01  

 
18

 
OMEGA PROTEIN CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

 
   
Earnings
   
Shares
   
Per Share
 
   
(Numerator)
   
(Denominator)
   
Data
 
Three Months Ended September 30, 2011
                       
Net Earnings
  $ 4,735                
                         
Basic earnings per common share:
                       
Earnings available to common shareholders
  $ 4,735       19,374     $ 0.24  
                         
Effect of dilutive securities:
                       
Stock options assumed exercised
          699          
                         
Diluted earnings per common share:
                       
Earnings available to common shareholders plus stock options assumed exercised
  $ 4,735       20,073     $ 0.24  

   
Earnings
   
Shares
   
Per Share
 
   
(Numerator)
   
(Denominator)
   
Data
 
Nine Months Ended September 30, 2012
                 
Net earnings
  $ 4,571              
                       
Basic earnings per common share:
                 
 
 
Earnings available to common shareholders
  $ 4,571       19,630     $ 0.23  
                         
Effect of dilutive securities:
                       
Stock options assumed exercised
     ―       472          
                         
Diluted earnings per common share:
                       
Earnings available to common shareholders plus stock options assumed exercised
  $ 4,571        20,102     $ 0.23  
 
   
Earnings
   
Shares
   
Per Share
 
   
(Numerator)
   
(Denominator)
   
Data
 
Nine Months Ended September 30, 2011
                 
Net earnings
  $ 33,594              
                       
Basic earnings per common share:
                 
 
 
Earnings available to common shareholders
  $ 33,594       19,200     $ 1.75  
                         
Effect of dilutive securities:
                       
Stock options assumed exercised
          731          
                         
Diluted earnings per common share:
                       
Earnings available to common shareholders plus stock options assumed exercised
  $ 33,594        19,931     $ 1.69  
 
Options to purchase 237,500 and 751,700 shares of common stock at exercise prices ranging from $6.53 to $14.69 per share were outstanding during the three and nine months ended September 30, 2012, respectively, but were not included in the computation of diluted earnings per share because the adjusted exercise prices of the options based upon the assumed proceeds were greater than the average market price of the shares during that period.

 
19

 
OMEGA PROTEIN CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

 
Options to purchase 135,000 shares of common stock at exercise prices ranging from $13.41 to $14.69 per share were outstanding during the three and nine months ended September 30, 2011, respectively, but were not included in the computation of diluted earnings per share because the adjusted exercise prices of the options based upon the assumed proceeds were greater than the average market price of the shares during that period.

NOTE 16. COMPONENTS OF NET PERIODIC BENEFIT COST

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2012
   
2011
   
2012
   
2011
 
   
(in thousands)
   
(in thousands)
 
Service cost
  $     $     $     $  
Interest cost
    274       319       822       957  
Expected return on plan assets
    (326 )     (315 )     (978 )     (945 )
Amortization of prior service costs
                 ―        
Amortization of net loss
    379       294       1,138       882  
                                 
     Net periodic pension cost
  $ 327     $ 298     $ 982     $ 894  
 
For the nine months ended September 30, 2012 and 2011, the Company contributed approximately $1.8 million and $1.5 million, respectively, to the Company’s pension plan. The Company expects to make contributions of $0.1 million to the pension plan during the remainder of 2012.

NOTE 17. FAIR VALUE DISCLOSURES

The following disclosures of the estimated fair value of financial instruments are made in accordance with the requirements of FASB ASC 825-10-50, Disclosure About Fair Value of Financial Instruments.  The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies.

At September 30, 2012, the Company had no borrowings under its bank credit facility and $3.1 million in letters of credit support obligations outstanding. The carrying values and respective fair values of the Company’s long-term debt are presented below (in thousands).  The fair value of the Company’s long-term debt is estimated based on the quoted market prices available to the Company for issuance of similar debt with similar terms and therefore is categorized as Level 2 in the fair value hierarchy.

   
September 30,
   
December 31,
 
   
2012
   
2011
 
Long-term Debt:
           
Carrying Value
  $ 28,071     $ 30,294  
                 
Estimated Fair Value
  $ 31,005     $ 33,381  
 
The following tables set forth by level within the fair value hierarchy the Company's financial assets and liabilities that were accounted for at fair value on a recurring basis.  As required by FASB ASC 820-10, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company's assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels.

 
September 30, 2012
 
 
Fair Value Measurements Using
 
Assets (Liabilities) at
Fair Value
 
 
Level 1
   
Level 2
 
Level 3
 
Assets (Liabilities) (in thousands)
                       
Energy swap asset
  $     $ 448     $     $ 448  
Interest rate swap liability
                       
Total Assets (Liabilities)
  $     $ 448     $     $ 448  

 
20

 
OMEGA PROTEIN CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

 
 
December 31, 2011
 
 
Fair Value Measurements Using
 
Assets (Liabilities) at
Fair Value
 
 
Level 1
   
Level 2
 
Level 3
 
Assets (Liabilities)  (in thousands)
                       
Energy swap liability
  $     $ (647 )   $     $ (647 )
Interest rate swap liability
                (103 )     (103 )
Total Assets (Liabilities)
  $     $ (647 )   $ (103 )   $ (750 )
 
The following table provides a reconciliation of all assets and (liabilities) measured at fair value on a recurring basis which use Level 3 or significant unobservable inputs or significant value drivers.  There have been no transfers between the hierarchy levels for the periods presented.
 
   
Fair Value Measurements Using Significant Unobservable Inputs (Level 3 Inputs)
(in thousands)
 
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2012
   
2011
   
2012
   
2011
 
Beginning liability balance
  $     $ (394 )   $ (103 )   $ (721 )
                                 
Net gain (loss) reclassified into interest expense related to interest rate swap transactions unrealized
          3             (25 )
Net change associated with current period interest rate swap transactions realized
          156       103       511  
                                 
Ending liability balance
  $     $ (235 )   $     $ (235 )
 
NOTE 18. INCOME TAXES
 
The Company generally determines, with the exception of certain nonrecurring items, its periodic income tax benefit or expense based upon the current period income and the annual estimated tax rate for the Company adjusted for any change to prior period estimates. The estimated tax rate is revised, if necessary, as of the end of each successive interim period during the fiscal year to the Company’s current annual estimated tax rate.
 
For the three months ended September 30, 2012, the income tax provision reflects an effective tax rate of 90.8%, compared to an effective tax rate of 28.3% for the quarter ended September 30, 2011.  For the nine months ended September 30, 2012, the income tax provision reflects an effective tax rate of 49.3%, compared to an effective tax rate of 35.1% for the nine months ended September 30, 2011.  The statutory tax rate of 35% for U.S. federal taxes was in effect for the three and nine months ended September 30, 2012 and 2011, respectively.  The increase in the effective tax rates for the three and nine month periods ended September 30, 2012 is primarily a result of a predominately non-deductible charge related to the U.S. Attorney investigation recognized during the quarter ended September 30, 2012.  See Note 13 Commitments and Contingencies – Regulatory Matters for additional information.
 
 
21

 
OMEGA PROTEIN CORPORATION

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

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with the Company’s MD&A and Risk Factors contained in the Form 10-K for the fiscal year ended December 31, 2011 (the “2011 Form 10-K”), and in conjunction with the consolidated financial statements included in this report and in the 2011 Form 10-K.

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.  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,” or similar expressions.

General

Omega Protein Corporation is a nutritional ingredient company and the nation's leading vertically integrated producer of Omega-3 fish oil and specialty fish meal products. As used herein, the term the “Company” refers 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 operates through four primary subsidiaries: Omega Protein, Inc., Omega Shipyard, Inc., Cyvex Nutrition, Inc.  and InCon Processing, L.L.C.  Omega Protein, Inc. (“Omega Protein”), the Company’s principal operating subsidiary, operates in the menhaden harvesting and processing business and is the successor to a business conducted since 1913. Omega Shipyard, Inc. (“Omega Shipyard”) owns and operates a drydock facility in Moss Point, Mississippi that is used to provide shoreside maintenance for Omega Protein’s fishing fleet and, subject to outside demand and excess capacity, occasionally for third-party vessels. Cyvex Nutrition, Inc. (“Cyvex”), founded in 1984 and acquired by the Company in December 2010, is located in Irvine, California and participates in the nutraceutical industry as an ingredient provider.  InCon Processing, L.L.C. (“InCon”), acquired by the Company in September 2011, is located in Batavia, Illinois and is a specialty toll processor that utilizes molecular distillation technology to concentrate a variety of compound products, including Omega-3 fish oils. The Company also has a number of other immaterial direct and indirect subsidiaries.

Omega Protein 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 enhanced. Omega Protein markets several grades of fish meal, as well as fish oil and fish solubles. Omega Protein’s fish meal products are primarily used as a protein ingredient in animal feed for swine, aquaculture and household pets. Fish oil is used primarily for animal and aquaculture feeds, and also as additives to human food products and dietary supplements. Omega Protein’s fish solubles are sold primarily to livestock feed manufacturers, aquaculture feed manufacturers and for use as an organic fertilizer.

All of Omega Protein’s products contain healthy long-chain Omega-3 fatty acids.  Omega-3 fatty acids are commonly referred to as “essential fatty acids” because 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 “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, Omega Protein produces OmegaPure®, a taste-free, odorless refined fish oil which is the only marine source of long-chain Omega-3s directly affirmed (as opposed to self affirmed) by the U.S. Food and Drug Administration (“FDA”) as a food ingredient that is Generally Recognized as Safe (“GRAS”).  Omega Protein also produces OmegaActiv ™, a concentrated form of OmegaPure® which is marketed as a dietary supplement.

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

 
22

 
OMEGA PROTEIN CORPORATION


In December 2010, the Company acquired Cyvex, a dietary supplement ingredient supplier based in Irvine, California.  Cyvex is a nutraceutical supplier to dietary supplement manufacturers that focus on human health and wellness.  The Company believes that the acquisition of Cyvex will expand its presence in the human health and wellness market and will provide access to supplement manufacturers who purchase a variety of ingredients, including fish oil.

In September 2011, the Company acquired InCon, a specialty toll processor that designs, pilots, synthesizes and purifies specialty chemical compounds utilizing molecular distillation technology to concentrate a variety of compound products, including Omega-3 fish oils.  The Company believes that the acquisition of InCon’s concentration technology will allow Omega Protein to provide its customers with an enhanced range of Omega-3 fish oils in concentrated forms such as ethyl esters and triglycerides.  The concentrated fish oils manufactured by InCon are expected to be marketed and sold under the Company’s OmegaActiv™ brand by Cyvex.

Company Overview

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

   
Three Months Ended September 30,
 
   
2012
   
2011
 
   
Revenues
   
Percent
   
Revenues
   
Percent
 
Fish Meal                                         
  $ 58.3       74.9 %   $ 44.9       62.6 %
Fish Oil                                         
    8.5       10.9       18.5       25.8  
Refined Fish Oil                                         
    4.2       5.4       3.0       4.2  
Fish Solubles                                         
    1.2       1.5       1.6       2.2  
Dietary Supplement Ingredients
    4.4       5.7       3.4       4.8  
Other                                         
    1.2       1.6       0.3       0.4  
Total                                         
  $ 77.8       100.0 %   $ 71.7       100.0 %

   
Nine Months Ended September 30,
 
   
2012
   
2011
 
   
Revenues
   
Percent
   
Revenues
   
Percent
 
Fish Meal                                         
  $ 103.8       63.9 %   $ 113.9       66.1 %
Fish Oil                                         
    24.8       15.3       32.9       19.1  
Refined Fish Oil                                         
    12.0       7.4       10.8       6.2  
Fish Solubles                                         
    3.3       2.0       3.8       2.2  
Dietary Supplement Ingredients
    14.6       9.0       10.4       6.0  
Other                                         
    4.0       2.4       0.6       0.4  
Total                                         
  $ 162.5       100.0 %   $ 172.4       100.0 %
 
The following table sets forth Omega Protein’s revenues by geography (in millions) and the approximate percentage of total revenues represented thereby, for the indicated periods:

   
Three Months Ended September 30,
 
   
2012
   
2011
 
   
Revenues
   
Percent
   
Revenues
   
Percent
 
                         
Domestic Revenues
  $ 20.9       26.9 %   $ 20.5       28.6 %
Export Revenues
    56.9       73.1       51.2         71.4  
Total
  $ 77.8       100.0 %   $ 71.7       100.0 %

   
Nine Months Ended September 30,
 
   
2012
   
2011
 
   
Revenues
   
Percent
   
Revenues
   
Percent
 
                         
Domestic Revenues
  $ 64.4       39.6 %   $ 62.4       36.2 %
Export Revenues
    98.1       60.4       110.0       63.8  
Total
  $ 162.5       100.0 %   $ 172.4       100.0 %

 
23

 
OMEGA PROTEIN CORPORATION


    Menhaden Fishing

2012 Fishing Information.  At September 30, 2012, Omega Protein owned a fleet of 44 fishing vessels and 34 spotter aircraft for use in its fishing operations and also leased additional aircraft where necessary to facilitate operations. During the 2012 fishing season in the Gulf of Mexico, which runs from mid-April through October, Omega Protein is operating up to 26 fishing and carry vessels and 29 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.  Omega Protein is operating up to 9 fishing and carry vessels and 7 leased spotter aircraft along the Mid-Atlantic coast, concentrated primarily in and around Virginia. 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.  Historical fish catch and production results at the end of the third quarter for the past five years are as follows:
 
   
2012
   
2011
   
2010
   
2009
   
2008
 
Fish Catch in tons as of September 30,
    512,474       514,527       367,650       417,712       388,935  
Fish meal, oil and solubles production in tons
(excludes refined)
    171,256       176,699       129,803       159,227       156,077  
 
The Company cautions that, because of the volatility of fish catch generally, partial year catch numbers are not indicative of results that may be expected for a full year. In addition, fish oil yields, which affect inventory costs and volumes available for sale, fluctuate from year to year and month to month. The Company’s 2012 oil yield results through September 30, 2012 have been the poorest in its recent history. For illustrative purposes, the Company’s oil yields for the 2012 fishing season through September 30, 2012 were lower by 19.3% compared to those in the same period in the 2011 fishing season and were lower by 41.0% compared to the Company’s five year oil yield average. Total yields decreased by 2.7% compared to those in the same 2011 fishing season and were lower by 9.7% compared to the Company’s five year total yield average, due primarily to the lower fish oil yields. The Company believes that fish yields are influenced by multiple factors, including but not limited to, fish diet, weather, water temperature, fish population and age of fish, but such possible relationships and inter-relationships are not generally well understood.  The impact of these poor oil yields has resulted in significantly higher per unit inventory cost and fewer volumes available for future sale. These higher unit costs and fewer volumes available for sale have adversely impacted financial results for the second and third quarters of 2012 and can be expected to adversely affect financial results through the second quarter of 2013.

Sales Contracts. Omega Protein sells a material portion of its products on a two-to-twelve-month forward contract basis with the balance sold on a spot basis through purchase orders.  Omega Protein’s sales contracts generally contain force majeure and other production allocation provisions.   Historically, fish meal and fish oil sold on a forward contract basis has fluctuated from year to year based upon perceived market availability and forward price expectations.  As of September 30, 2012 and 2011, the volume of fish oil expected to be sold forward on a contract basis for the remainder of the respective years was not significant due to limited product inventory.  As of September 30, 2012, Omega Protein had sold forward on a contract basis up to approximately 39,000 short tons of fish meal for the remainder of the year.  As a basis of comparison, as of September 30, 2011, Omega Protein had sold forward on a contract basis approximately 30,200 short tons of fish meal for 2011.        

Omega Protein’s annual revenues are highly dependent on pricing, annual fish catch, production yields and inventories and, in addition, inventory is generally carried over from one year to the next year.  Omega Protein determines the level of inventory to be carried over based on existing contracts, 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.  Omega Protein’s fish meal products have a useable life of approximately one year from date of production. Practically, however, Omega Protein attempts to empty its warehouses of the previous season’s products by the second or third month of the new fishing season.  Omega Protein’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.

Customers and Marketing.    Most of Omega Protein’s marine protein products are sold directly to approximately 320 customers by Omega Protein’s agriproducts sales department, while a smaller amount is sold through independent sales agents.
 
Omega Protein’s products are sold both in the U.S. and internationally. International sales consist of both fish meal and fish oil and are primarily to China, Norway, Canada, Chile, Saudi Arabia and Japan. Omega Protein’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.

 
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OMEGA PROTEIN CORPORATION

 
A number of countries in which Omega Protein currently sells products impose various tariffs and duties, none of which have a significant impact on Omega Protein’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, Omega Protein’s products are shipped to its customers either by free on board shipping point or costs, insurance and freight terms, and therefore, the customer is responsible for any tariffs, duties or other levies imposed on Omega Protein’s products sold into these markets.

During the off season, Omega Protein fills purchase orders from the inventory it has accumulated during the fishing season or in some cases, by re-selling meal and oil purchased from other suppliers. Generally, prices for Omega Protein’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.

Competition.    Omega Protein competes with a smaller domestic privately-owned menhaden fishing company and with numerous fish processors outside the United States.  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 Darling International, 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 Protein 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 Omega Protein’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. Omega Protein 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 Omega Protein’s fish oil, as well as soybean and rapeseed oil.

Fish meal prices have generally borne a relationship to prevailing soybean meal prices, and the prices for Omega Protein’s fish meal and fish oil products are established by worldwide supply and demand relationships over which Omega Protein has no control and tend to fluctuate significantly over the course of a year and from year to year. 

Regulation.    Omega Protein’s operations are subject to federal, state and local laws and regulations relating to the locations and periods in which fishing may be conducted as well as environmental and safety matters. At the state and local level, certain state and local government agencies have enacted legislation or regulations which prohibit, restrict or regulate menhaden fishing within their jurisdictional waters.

Omega Protein’s menhaden fishing operations are also subject to regulation by two interstate compact commissions created by federal law: the Atlantic States Marine Fisheries Commission (“ASMFC”) which consists of 15 states along the Atlantic Coast, and the Gulf States Marine Fisheries Commission which consists of 5 states along the Gulf of Mexico. The ASMFC manages the menhaden fishery throughout the stock’s coast-wide range.  In 2005, the ASMFC recommended precautionary restrictions on the Chesapeake Bay menhaden harvest, despite its finding that menhaden are not overfished and that overfishing is not occurring on a coast wide basis, in order to determine whether localized depletion was occurring in Chesapeake Bay.

In February 2007, the Commonwealth of Virginia declined to adopt an ASMFC recommended plan but instead adopted its own restrictions whereby Omega Protein’s Chesapeake Bay menhaden harvest was capped for a five year period (and subsequently extended for an additional three-year period) at a 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 and subsequently thereafter after the cap was formally in place. The cap had no effect on Omega Protein’s Chesapeake Bay harvests for the years 2007 through 2011, and is not expected to have any material adverse effect on its Chesapeake Bay harvest in 2012.  As a result of the underharvest in 2011, the 2012 Chesapeake Bay catch limit will be 122,740 metric tons.

The Company supports the ASMFC’s goal of maintaining a healthy population of menhaden and the current research program designed to answer ecological questions regarding menhaden in the Chesapeake Bay and coast-wide.  The Chesapeake Bay cap was established as a precautionary measure while research is conducted to address, among other things, the question whether the menhaden harvest in the Bay could cause what is being termed “localized depletion” of menhaden there.  No evidence of such localized depletion has been produced.

 
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OMEGA PROTEIN CORPORATION

 
Because the research regarding menhaden is on-going, in 2009 the ASMFC and Virginia approved an extension of the existing Chesapeake Bay cap for an additional three years to 2013.  Even though no evidence of localized depletion has been produced, the Company continues to support the Chesapeake Bay cap as a way to maintain the status quo while research on these matters continues.
 
The most recent stock assessment for the Atlantic menhaden was completed in 2010 using data collected through 2008.  According to federal and ASMFC technical experts, the assessment found that the Atlantic menhaden stock had undergone slight overfishing in one year, 2008; however, the population was not considered overfished, meaning that the stock abundance remained at or near target levels, above levels of concern, and can produce enough eggs to replace itself.  The assessment indicated that the population was subject to slight overfishing in 2008 by an estimated four-tenths of one percent. Multiple runs of the stock assessment model revealed that there was a 53% probability that overfishing had occurred and a 47% probability that overfishing had not occurred.
 
In 2011, the ASMFC initiated a regulatory review process that would: (1) require annual updates on menhaden recruits, or the numbers of fish in their first year of life, currently reviewed only every three years; (2) begin a long-term process of managing menhaden on a multi-species basis; and (3) with a goal of establishing increased menhaden abundance, initiate a management action to implement an interim overfishing threshold reference point based on achieving a rate of fishing that should result in 15% of the spawning potential that the Atlantic menhaden stock would have if such stock were not fished (a “maximum spawning potential”). By comparison, in 2008, the estimate of this maximum spawning potential was estimated to be 8%; however, those numbers have not been estimated for 2009, 2010, or 2011. These percentages do not necessarily translate into corresponding percentage reductions in fish catch.

In November 2011, the ASMFC established a new overfishing reference point at the 15% threshold level of maximum spawning potential. It also established a management target at a rate of fishing that is associated with a 30% maximum spawning potential level. The ASMFC also decided to move forward with an amendment to develop a new system of managing the fishery in line with these new reference points.

Also in November 2011, the ASMFC approved the consideration of options for phasing in potential reductions in fishing effort over a period of one to five years. In February 2012, the ASMFC approved a public scoping document with a series of potential management options. At this meeting, the ASMFC added an option to extend the phase-in period to as long as ten years. Public hearings were held throughout the spring of 2012, during which time the Company had the opportunity to comment on these alternatives, which included a full range of options for quotas, limitations on the number of days fished annually, a shortened season, and other measures. Following these hearings, in May 2012 the ASMFC narrowed these alternatives to be included in a draft amendment document that was reviewed, refined and promulgated for distribution for public hearing at an August 8, 2012 ASMFC meeting.

As a result, a number of public hearings are currently underway, and mail and e-mail comments will also be received in preparation for the final ASMFC 2012 meeting that is currently scheduled to be held on December 14, 2012.  The Company expects that the ASMFC will approve an amendment to the menhaden fisheries plan at that time.

Due to the uncertain timing and outcome of this regulatory process, the Company cannot predict with certainty what effect any new regulations will have on the Company’s business. Depending on how and when these new reference points are implemented, and what future Atlantic menhaden stock assessments conclude, it is possible that the implementation of these new regulations could have a material adverse effect on the Company’s business, financial results and results of operations. On average over the past 5 years, the Company’s Atlantic operations based in Reedville, Virginia have produced approximately 31.3% of Omega Protein’s fish meal, oil and solubles products.    

The Texas Parks and Wildlife Commission has adopted regulations related to the menhaden reduction fishery in Texas waters which limits the Total Allowable Catch (“TAC”) to 31.5 million pounds annually. The regulations also allow for a 10% underage or overage in each year which is credited or deducted, as applicable, to the TAC in the following year.

In 2011, the Company’s Texas fish catch approached the TAC (including the 10% overage credit).  In 2012, the Company does not expect the Texas fish catch to approach the TAC.  The limitation is not expected to have a material adverse effect on Omega Protein’s business, results of operation or financial condition.

In May 2012, the North Carolina Division of Marine Fisheries in the Department of Environment and Natural Resources issued a proclamation that banned the commercial fishing of menhaden using purse seine netting in North Carolina state waters. The restrictions in the proclamation were subsequently enacted into law by the North Carolina General Assembly, effectively prohibiting the Company’s fishing operations in these state waters.  Federal waters outside the North Carolina three-nautical mile state water limit remain unaffected. In 2011, the Company caught approximately 1.6% of its total 2011 fish catch in North Carolina state waters.

 
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OMEGA PROTEIN CORPORATION

 
Omega Protein, through its operation of fishing vessels, is subject to the jurisdiction of the U.S. Coast Guard, the National Transportation Safety Board and the U.S. Customs Service. The U.S. Coast Guard and the National Transportation Safety Board set safety standards and are authorized to investigate vessel accidents and recommend improved safety standards. The U.S. Customs Service is authorized to inspect vessels at will.
 
The Company’s operations are subject to federal, state and local laws and regulations relating to the protection of the environment, including the federal Clean Water Act, which imposes strict controls against the discharge of pollutants in reportable quantities, and along with the Oil Pollution Act, imposes substantial liability for the costs of oil removal, remediation and damages. Omega Protein’s operations also are subject to the federal Comprehensive Environmental Response, Compensation, and Liability Act, which imposes liability, without regard to fault, on certain classes of persons that contributed to the release of any “hazardous substances” into the environment and the federal Occupational Safety and Health Act (“OSHA”). The implementation of continuing safety and environmental regulations from these authorities could result in additional requirements and procedures for the Company, and it is possible that the costs of these requirements and procedures could be material.
 
The OSHA hazard communications standard, the Environmental Protection Agency community right-to-know regulations under Title III of the federal Superfund Amendment and Reauthorization Act and similar state statutes require the Company to organize information about hazardous materials used or produced in its operations. Certain of this information must be provided to employees, state and local governmental authorities and local citizens. Numerous other environmental laws and regulations, along with similar state laws, also apply to the operations of the Company, and all such laws and regulations are subject to change.
 
In April 2010, the Company received a request for information pursuant to Section 308 of Federal Water Pollution Control Act (Clean Water Act) from Region 3 of the EPA concerning the Company’s bail wastewater practices used in its fishing operations at its Reedville, Virginia facility. The Company responded to the request.  The Company cannot predict the outcome of the EPA’s review.

In February 2011, the United States Coast Guard conducted inspections of the vessels at the Company’s Reedville, Virginia facility regarding the vessels’ bilge water discharge practices. Based on the results of those inspections and subsequent communications with the Coast Guard, the Company conducted a survey of its Reedville fishing fleet to determine compliance with applicable laws and regulations.  Following completion of certain improvements and repairs, the Coast Guard inspected the vessels and all but two were approved for full operations prior to the beginning of the 2011 Atlantic fishing season.  The other two vessels were approved for full operations shortly after the beginning of the 2011 fishing season and the delay did not materially impact the fleet’s Atlantic fishing operations.

In recent discussions with the Company, the U.S. Attorney’s Office has proposed a criminal plea disposition of the above matters that would involve a fine, community service contributions, and a probationary period for the Company. Based on the information presently known to the Company and the on-going status of its discussions with the U.S. Attorney’s Office, the Company currently estimates that fines, contributions and associated legal fees in connection with the matters could range from $4.25 million to $10 million. Accordingly, the Company has recorded an accrual for the matters of $4.25 million, the low end of that estimated range, in its third quarter 2012 financial statements. Any settlement amount is not expected to be tax deductible. Discussions with the U.S. Attorney’s Office are continuing but there can be no assurance that a criminal or civil settlement will be achieved or that costs and payments made in connection with these matters will not exceed either the amount of the accrual currently recorded or the range that is currently estimated, or that the government will not also impose additional non-monetary remedies or penalties that could have a material adverse effect on the Company.

The Company spent approximately $3.0 million during 2011 to make the above improvements and repairs to the Reedville fleet.  The Company has evaluated its Gulf fleet vessels based on its review of its Reedville vessels and Coast Guard regulations, as well as discussions with the Coast Guard.  Based on the results of that evaluation, it is likely that the Company will incur additional costs to make improvements and repairs to its Gulf fleet.  The Company had requested a waiver from the Coast Guard for its Atlantic and Gulf of Mexico fleets regarding the use of certain vessel equipment applicable to “ocean-going vessels” (as defined by Coast Guard regulations) that operate beyond the 12 nautical mile limit and in May 2012 the Coast Guard granted the Company a partial waiver for its 2012 fishing season only that allows the Company to travel, but not fish, outside 12 nautical miles of shore.  If the Coast Guard does not extend the waiver in 2013, the Company will have to restrict its fishing operations to within 12 nautical miles of shore or install additional equipment on its vessels which will result in additional expense.

The Company has made, and anticipates that it will make in the future, expenditures in the ordinary course of its business in connection with environmental matters. It is possible that environmental laws and regulations will require material expenditures or otherwise adversely affect the Company’s operations.

 
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OMEGA PROTEIN CORPORATION

 
The Company monitors regulations which affect fish meal and fish oil in the United States and in those foreign jurisdictions where it sells its products. To date, such regulations have not had a material adverse effect on the Company’s business, but it is possible they may do so in the future.
 
Omega Protein’s harvesting operations are subject to the Shipping Act of 1916 and the regulations promulgated there under by the Department of Transportation, Maritime Administration which require, among other things, that Omega Protein 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 the number necessary to constitute a quorum and at least 75% of the Company’s outstanding capital stock (including a majority of the Company’s voting capital stock) be owned by U.S. citizens. If the Company fails to observe any of these requirements, it will not be eligible to conduct its harvesting activities in U.S. jurisdictional waters. Such a loss of eligibility would have a material adverse effect on the Company’s business, results of operations and financial condition.
 
To protect against such loss of eligibility, the Company’s Articles of Incorporation (i) contain provisions limiting the aggregate percentage ownership by non-citizens of each class of the Company’s capital stock to no more than 25% of the outstanding shares of each such class (the “Permitted Percentage”) so that any purported transfer to non-citizens of shares in excess of the Permitted Percentage will be ineffective as against the Company for all purposes (including for purposes of voting, dividends and any other distribution, upon liquidation or otherwise), (ii) provide for a dual stock certificate system to determine such ownership pursuant to which certificates representing shares of Company Common Stock bear legends that designate such certificates as either “citizen” or “non-citizen” depending on the citizenship of the owner, and (iii) permit the Company’s Board of Directors to make such determinations as may reasonably be necessary to ascertain such ownership and implement restrictive limitations on those shares that exceed the Permitted Percentage (the “Excess Shares”). For example, the Company’s Board is authorized, among other things, to redeem for cash (upon written notice) any Excess Shares in order to reduce the aggregate ownership by non-citizens to the Permitted Percentage.

Dietary Supplement Ingredients

In December 2010, the Company acquired Cyvex Nutrition, Inc., a dietary supplement ingredient supplier based in Irvine, California.  Cyvex is a nutraceutical supplier to dietary supplement manufacturers that focus on human health and wellness.

In relevant part, the FDA Federal Food, Drug and Cosmetic Act (“FDC Act”) defines a dietary supplement to be a product taken by mouth that contains a dietary ingredient intended to supplement the diet.  Dietary ingredients may include vitamins, minerals, herbs or other botanicals, amino acids, and substances such as enzymes, organ tissues, glandulars, and metabolites.  Dietary ingredients can also include the form of extracts or concentrates of any of these.  Dietary supplements may be manufactured and sold in many forms, such as tablets, capsules, softgels, gelcaps, liquids, or powders.

Cyvex markets and sells an extensive list of nutraceutical ingredients derived from fruit, vegetable and botanicals.  Cyvex’s products include over 20 general ingredients and 18 signature ingredients, including:

•  
BioVin®, a GRAS (Generally Regarded as Safe) full spectrum grape extract for cardiovascular support;
 
•  
Alfapro Agglomerated™, a green protein concentrate for nutritional beverage mixes;
 
•  
Cognisetin™, a mental acuity ingredient for use in dietary supplements;
 
•  
Euro Black Currant, a berry extract that provides anthocyanins with a high ORAC (Oxygen Radical Absorbance Capacity value); and
 
•  
Broccoli extracts including BroccoPhane and BroccoSinolate standardized to sulforophane and glucosinolates respectively.
 
Cyvex utilizes its NutriPrint® quality assurance system, which includes identity testing of incoming raw materials through FT-NIR (Fourier Transform – Near Infrared), third party certification by independent laboratories for dietary ingredients, microbiology, heavy metals and pesticide and solvent residues when applicable.

In September 2011, the Company acquired InCon, a specialty toll processor that designs, pilots, synthesizes and purifies specialty chemical compounds, utilizing molecular distillation technology to concentrate a variety of compound products, including Omega-3 fish oils. The Company believes that the acquisition of InCon’s concentration technology will allow Omega Protein to provide its customers with an enhanced range of Omega-3 fish oils in concentrated forms such as ethyl esters and triglycerides.  The concentrated fish oils manufactured by InCon are marketed and sold under the Company’s OmegaActiv™ brand by Cyvex.

More information concerning Cyvex’s and InCon’s products, markets, competition, and regulation may be found in the “Business” section of the Company’s Form 10-K for the fiscal year ended December 31, 2011.

 
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OMEGA PROTEIN CORPORATION

 
Critical Accounting Policies and Estimates

The methods, estimates and judgments used in applying the Company’s critical accounting policies have a significant impact on the results reported in the Consolidated Financial Statements.  The SEC has defined the critical accounting policies as the ones that are most important to the portrayal of the Company’s financial condition and operating results, and requires the Company to make difficult and subjective judgments, often as a result of the need to make estimates of matters that are highly uncertain at the time of estimation.  Based on this definition, the Company’s most critical policies include: valuation of inventory (Notes 1 and 6 in the Company’s Form 10-K for the fiscal year ended December 31, 2011 (the “2011 Form 10-K”)), valuation of losses related to Jones Act and worker’s compensation insurance claims (Note 1 in the Company’s 2011 Form 10-K), valuation of income and deferred taxes (Notes 1 and 14 in the Company’s 2011 Form 10-K) and the valuation of pension plan obligations (Notes 1 and 16 in the Company’s 2011 Form 10-K).

Specifically with respect to inventory, Omega Protein’s per unit cost of production is estimated prior to the beginning of each fishing season based on total estimated fishing costs (including off-season costs) divided by estimated total units of production.  Omega Protein adjusts the cost of sales, unallocated inventory cost pool and inventory balances at the end of the second, third and fourth quarters based on revised estimates of total units of production to total inventoriable costs.  For the most part, Omega Protein begins selling its current season’s production during the third quarter and sells that production until the second quarter of the following year.  From 2006 to 2009, the average cost per unit of production estimate increased 3% from the third quarter to the fourth quarter of each respective year.  During 2010, as a result of the larger than anticipated production in the fourth quarter, cost per unit of production for the 2010 fourth quarter decreased 9% as compared to the 2010 third quarter.  During 2011, the cost per unit of production decreased 2% from the third quarter of 2011 to the fourth quarter of 2011.

The Company also has other key accounting policies and accounting estimates relating to the allowance of doubtful accounts (Note 1 in the Company’s 2011 Form 10-K), goodwill and other intangible assets (Notes 1 and 10 in the Company’s 2011 Form 10-K), valuation of shares-based compensation (Note 16 in the Company’s 2011 Form 10-K) and interest rate and energy swap valuations (Notes 1 and 21 in the Company’s 2011 Form 10-K).  The Company believes that these key accounting policies and accounting estimates either do not generally require us to make estimates and judgments that are as difficult or as subjective as its critical accounting policies, or it is less likely that they would have a material impact on our reported results of operations for a given period.

For all financial statement periods presented, there have been no material modifications to the application of these critical accounting policies.

Results of Operations

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

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2012
   
2011
   
2012
   
2011
 
Revenues 
    100.0 %     100.0 %     100.0 %     100.0 %
Cost of sales 
    82.8       81.3       82.1       74.6  
Gross profit  
    17.2       18.7       17.9       25.4  
Selling, general and administrative expense
    7.3       7.8       10.1       8.8  
Research and development expense 
    0.7       0.6       1.0       0.8  
Charges related to U.S. Attorney investigation
    5.3             2.7        
Impairment of intangible assets     0.2             0.1