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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q (Mark One)x
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended June 30, 2004ORo
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from  to
 Commission file number 000-31167 Genencor International, Inc. (Exact name of registrant as specified in its charter)
 Delaware
(State or other jurisdiction of
incorporation or organization)
    
    16-1362385
(I.R.S. Employer
Identification Number)
 925 Page Mill Road
Palo Alto, California 94304
(650) 846-7500
(Address, including zip code, and telephone number, including area code, of registrants principal executive offices)   Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or15(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 report(s), and (2) has been subject to
such filing requirements for the past 90 days Yes
[X] No [   ]
 Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No
[   ]
  Indicate the number of shares outstanding of each of the issuers classes
of common stock, as of the latest practicable date. Class
    
    Number of Shares Outstanding at July 30, 2004Common stock, par value $0.01 per share
    
    59,464,245




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TABLE OF CONTENTS PagePART I. FINANCIAL INFORMATIONItem 1. Financial Statements:Condensed Consolidated Unaudited Balance Sheets as of June 30, 2004 and December 31, 2003
    
    
    4Condensed Consolidated Unaudited Statements of Operations for the three and six months
ended June 30, 2004 and 2003
    
    
    5Condensed Consolidated Unaudited Statements of Cash Flows for the six months ended
June 30, 2004 and 2003
    
    
    6Notes to Condensed Consolidated Unaudited Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    13Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    26Item 4. Controls and Procedures
    
    
    26PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    27Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    27Item 3. Defaults Upon Senior Securities
    
    
    27Item 4. Submission of Matters to a Vote of Security Holders
    
    
    28Item 5. Other Information
    
    
    28Item 6. Exhibits and Reports on Form 8-K
    
    
    29SIGNATURES
    
    
    31INDEX to EXHIBITS
    
    
    32EX-10.1 AMENDED AND RESTATED RESEARCH AGREEMENTEX-10.2 Employment and Separation AgreementEX-10.3 Employment AgreementEX-10.4 Employment AgreementEX-10.5 Rental AgreementEX-31.1 CertificationEX-31.2 CertificationEX-32.1 Certification
 2






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Unless otherwise specified, all references to the Company, we, us,
our, and ourselves refer to Genencor International, Inc. or Genencor
International, Inc. and its subsidiaries collectively, as appropriate in the
context of the disclosure. This Report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934, as amended. These include statements concerning plans,
objectives, goals, strategies, future events or performance and all other
statements which are other than statements of historical fact, including
without limitation, statements containing the words believes, anticipates,
expects, estimates, intends, plans, projects, will, may, might,
and words of a similar nature. The forward-looking statements contained in
this Report reflect the Companys current beliefs and expectations on the date
of this Report. Actual results, performance or outcomes may differ materially
from those expressed in the forward-looking statements. Some of the important
factors which, in the view of the Company, could cause actual results to differ
from those expressed in the forward-looking statements are discussed in Part I,
Item 2 of this Report and in the Companys Annual Report onForm 10-Kfor the
year ended December 31, 2003. The Company disclaims any obligation to update
any forward-looking statement to reflect facts or circumstances after the date
hereof. 3




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PART I. FINANCIAL INFORMATION 
 Item 1. Financial Statements GENENCOR INTERNATIONAL, INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED UNAUDITED BALANCE SHEETS
(Amounts in thousands, except per share data) June 30,2004
    
    December 31, 2003AssetsCurrent assets:Cash and cash equivalents
    
    $
    155,084
    
    
    $
    166,551Trade accounts receivable, net
    
    
    67,879
    
    
    
    58,249Inventories
    
    
    75,667
    
    
    
    64,159Other current assets
    
    
    24,452
    
    
    
    36,253Total current assets
    
    
    323,082
    
    
    
    325,212Property, plant and equipment, net
    
    
    224,120
    
    
    
    232,902Goodwill
    
    
    29,380
    
    
    
    29,380Intangible assets, net
    
    
    43,961
    
    
    
    47,075Other assets
    
    
    74,590
    
    
    
    77,853Total assets
    
    $
    695,133
    
    
    $
    712,422Liabilities, Redeemable Preferred Stock and Stockholders EquityCurrent liabilities:Notes payable
    
    $
    4,999
    
    
    $
    5,926Current maturities of long-term debt
    
    
    28,249
    
    
    
    28,249Accounts payable and accrued expenses
    
    
    40,604
    
    
    
    49,143Other current liabilities
    
    
    18,670
    
    
    
    18,850Total current liabilities
    
    
    92,522
    
    
    
    102,168Long-term debt
    
    
    29,483
    
    
    
    58,466Other long-term liabilities
    
    
    38,443
    
    
    
    39,101Total liabilities
    
    
    160,448
    
    
    
    199,735Redeemable preferred stock:71⁄2% cumulative series A preferred stock, without par value, authorized
1 shares, 1 shares issued and outstanding
    
    
    180,663
    
    
    
    177,025Stockholders equity:Common stock, par value $0.01 per share, 200,000 shares authorized, 61,148
and 60,991 shares issued at June 30, 2004 and
December 31, 2003, respectively
    
    
    611
    
    
    
    610Additional paid-in capital
    
    
    361,639
    
    
    
    359,344Treasury stock, 1,780 shares at cost at June 30, 2004 and December 31, 2003
    
    
    (21,030
    )
    
    
    (21,030
    )Deferred stock-based compensation
    
    
    (789
    )
    
    
    (1,036
    )Retained earnings
    
    
    23,843
    
    
    
    589Accumulated other comprehensive loss
    
    
    (10,252
    )
    
    
    (2,815
    )Total stockholders equity
    
    
    354,022
    
    
    
    335,662Total liabilities, redeemable preferred stock and stockholders equity
    
    $
    695,133
    
    
    $
    712,422
 The accompanying notes are an integral part of the condensed consolidated unaudited financial statements. 4




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GENENCOR INTERNATIONAL, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED UNAUDITED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data) Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Revenues:Product revenue
    
    $
    96,173
    
    
    $
    89,744
    
    
    $
    187,712
    
    
    $
    179,782Fees and royalty revenues
    
    
    13,759
    
    
    
    6,603
    
    
    
    16,583
    
    
    
    12,226Total revenues
    
    
    109,932
    
    
    
    96,347
    
    
    
    204,295
    
    
    
    192,008Operating expenses:Cost of products sold
    
    
    55,031
    
    
    
    51,786
    
    
    
    105,496
    
    
    
    102,627Research and development
    
    
    17,527
    
    
    
    16,833
    
    
    
    34,407
    
    
    
    33,293Sales, marketing and business development
    
    
    9,366
    
    
    
    7,902
    
    
    
    17,686
    
    
    
    15,601General and administrative
    
    
    9,412
    
    
    
    7,982
    
    
    
    17,914
    
    
    
    15,783Amortization of intangible assets
    
    
    1,148
    
    
    
    1,498
    
    
    
    2,323
    
    
    
    2,890Other (income)/expense
    
    
    (90
    )
    
    
    54
    
    
    
    (7,995
    )
    
    
    759Total operating expenses
    
    
    92,394
    
    
    
    86,055
    
    
    
    169,831
    
    
    
    170,953Operating income
    
    
    17,538
    
    
    
    10,292
    
    
    
    34,464
    
    
    
    21,055Non operating expenses/(income):Investment expense
    
    
    
    
    
    
    1,018
    
    
    
    
    
    
    
    1,018Interest expense
    
    
    1,006
    
    
    
    1,569
    
    
    
    2,542
    
    
    
    3,589Interest income
    
    
    (822
    )
    
    
    (1,558
    )
    
    
    (1,693
    )
    
    
    (2,403
    )Total non operating expenses/(income)
    
    
    184
    
    
    
    1,029
    
    
    
    849
    
    
    
    2,204Income before income taxes
    
    
    17,354
    
    
    
    9,263
    
    
    
    33,615
    
    
    
    18,851Provision for income taxes
    
    
    3,471
    
    
    
    1,644
    
    
    
    6,723
    
    
    
    4,712Net income
    
    $
    13,883
    
    
    $
    7,619
    
    
    $
    26,892
    
    
    $
    14,139Net income available to holders of common stock
    
    $
    12,064
    
    
    $
    5,800
    
    
    $
    23,254
    
    
    $
    10,501Earnings per common share:Basic
    
    $
    0.20
    
    
    $
    0.10
    
    
    $
    0.39
    
    
    $
    0.18Diluted
    
    $
    0.20
    
    
    $
    0.10
    
    
    $
    0.38
    
    
    $
    0.18Weighted average common shares:Basic
    
    
    59,305
    
    
    
    58,570
    
    
    
    59,285
    
    
    
    58,534Diluted
    
    
    60,826
    
    
    
    60,230
    
    
    
    61,050
    
    
    
    59,515
 The accompanying notes are an integral part of the condensed consolidated unaudited financial statements. 5




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GENENCOR INTERNATIONAL, INC. AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED UNAUDITED STATEMENTS OF CASH FLOWS
(Amounts in thousands) Six months endedJune 30,2004
    
    2003Cash flows from operating activities:Net income
    
    $
    26,892
    
    
    $
    14,139Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization
    
    
    18,128
    
    
    
    17,702Amortization of deferred stock-based
compensation
    
    
    418
    
    
    
    554Loss on disposition of property, plant and
equipment
    
    
    
    
    
    
    521Loss from impairment of investment in
marketable equity securities
    
    
    
    
    
    
    1,018(Increase) decrease in operating assets:Trade accounts receivable
    
    
    (8,521
    )
    
    
    (1,648
    )Inventories
    
    
    (12,122
    )
    
    
    2,307Other assets
    
    
    10,846
    
    
    
    (13,260
    )Decrease in operating liabilities:Accounts payable and accrued expenses
    
    
    (5,350
    )
    
    
    (4,491
    )Other liabilities
    
    
    (5,210
    )
    
    
    (963
    )Net cash provided by operating activities
    
    
    25,081
    
    
    
    15,879Cash flows from investing activities:Purchases of property, plant and equipment
    
    
    (9,456
    )
    
    
    (10,553
    )Proceeds from sale of business
    
    
    
    
    
    
    1,145Proceeds from note receivable
    
    
    251
    
    
    
    Assumption of controlling interest in joint venture
    
    
    3,751
    
    
    
    Payments related to prior acquisition
    
    
    (632
    )
    
    
    Net cash used in investing activities
    
    
    (6,086
    )
    
    
    (9,408
    )Cash flows from financing activities:Proceeds from exercise of stock options
    
    
    1,134
    
    
    
    1,876Proceeds from employee stock purchase plan
    
    
    833
    
    
    
    732Net (payments on)/proceeds
from notes payable of foreign affiliate
    
    
    (1,772
    )
    
    
    91Payment of long-term debt
    
    
    (28,126
    )
    
    
    (28,123
    )Net cash used in financing activities
    
    
    (27,931
    )
    
    
    (25,424
    )Effect of exchange rate changes on cash
    
    
    (2,531
    )
    
    
    5,333Net decrease in cash and cash equivalents
    
    
    (11,467
    )
    
    
    (13,620
    )Cash and cash equivalents  beginning of period
    
    
    166,551
    
    
    
    169,001Cash and cash equivalents  end of period
    
    $
    155,084
    
    
    $
    155,381
 The accompanying notes are an integral part of the condensed consolidated unaudited financial statements. 6




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GENENCOR INTERNATIONAL, INC. AND SUBSIDIARIES 
 NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS
(Amounts in thousands, except per share data) 1  Basis of Presentation The condensed consolidated unaudited financial statements should be read
in conjunction with the Companys audited consolidated financial statements and
related footnotes for the year ended December 31, 2003, as included in the
Companys Annual Report on Form 10-K. These interim financial statements have
been prepared in conformity with the rules and regulations of the U.S.
Securities and Exchange Commission. Certain disclosures normally included in
financial statements prepared in conformity with accounting principles
generally accepted in the United States of America have been condensed or
omitted pursuant to such rules and regulations pertaining to interim financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring adjustments) necessary for fair presentation of the interim financial
statements have been included therein. The results of operations of any interim
period are not necessarily indicative of the results of operations for the full
year. 2  New Accounting Pronouncements In December 2003, the Financial Accounting Standards Board (FASB) issued a
revision of Statement of Financial Accounting Standards (SFAS) No. 132,
Employers Disclosures about Pensions and Other Postretirement Benefits. The
revised Statement provides required disclosures for pensions and other
postretirement benefit plans and is designed to improve disclosure transparency
in financial statements. The revised Statement replaces existing year-end and
interim disclosure requirements. This Statement was in effect for the
Companys fiscal year ending December 31, 2003 and for quarters beginning
thereafter for domestic plans, and is effective for fiscal years ending
after June 15, 2004 for the Companys foreign plans. In May 2004, the FASB issued FASB Staff Position (FSP) No. 106-2,
Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003. This Position supersedes FSP
No. 106-1 of the same title, which was issued in January 2004. FSP No. 106-1
permitted employers that sponsor postretirement benefit plans which provide
prescription drug benefits to retirees to make a one-time election to defer
accounting for any effects of the Medicare Prescription Drug, Improvement and
Modernization Act of 2003. FSP No. 106-2 provides guidance on accounting for
the effects of the new Medicare prescription drug legislation by employers
whose prescription drug benefits are actuarially equivalent to the drug benefit
under Medicare Part D. For all public companies that sponsor one or more plans
with more than 100 participants, the Position is effective as of the first
interim or annual period beginning after June 15, 2004. The Company does not
expect the adoption of FSP No. 106-2 to have a material impact on its
financial position or its results of operations. 3  Pension Plans A summary of the components of net periodic pension cost, a non-cash item,
for the six months ended June 30 is as follows: 2004
    
    2003Service Cost
    
    $
    1,365
    
    
    $
    1,303Interest Cost
    
    
    352
    
    
    
    313Expected return on plan assets
    
    
    (519
    )
    
    
    (338
    )Net amortization
    
    
    13
    
    
    
    51Net periodic pension cost
    
    $
    1,211
    
    
    $
    1,329
 7




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4  Earnings Per Share SFAS No. 128, Earnings per Share, requires the disclosure of basic and
diluted earnings per share. Basic earnings per share is computed based on the
weighted average number of common shares outstanding during the period. In
arriving at net income available to holders of common stock, undeclared and
unpaid dividends on redeemable preferred stock of $1,819 were deducted from net
income for each quarter presented. Diluted earnings per common share reflects the potential dilution that
could occur if dilutive securities and other contracts to issue common stock
were exercised or converted into common stock or resulted in the issuance of
common stock that then shared in the net income available to holders of common
stock of the Company. As a result of stock options outstanding under the
Companys 2002 Omnibus Incentive Plan, successor to the Companys Stock Option
and Stock Appreciation Right Plan, there were dilutive securities for the three
and six months ended June 30, 2004 and 2003. The weighted-average impact of
these has been reflected in the calculation of diluted earnings per common
share for the respective periods presented. The following table
 reflects the calculation of basic and diluted earnings
per common share: Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net income
    
    $
    13,883
    
    
    $
    7,619
    
    
    $
    26,892
    
    
    $
    14,139Less: Accrued dividends on preferred stock
    
    
    (1,819
    )
    
    
    (1,819
    )
    
    
    (3,638
    )
    
    
    (3,638
    )Net income available to holders of common stock
    
    $
    12,064
    
    
    $
    5,800
    
    
    $
    23,254
    
    
    $
    10,501Weighted average common shares:Basic
    
    
    59,305
    
    
    
    58,570
    
    
    
    59,285
    
    
    
    58,534Effect of stock options
    
    
    1,521
    
    
    
    1,660
    
    
    
    1,765
    
    
    
    981Diluted
    
    
    60,826
    
    
    
    60,230
    
    
    
    61,050
    
    
    
    59,515Earnings per common share:Basic
    
    $
    0.20
    
    
    $
    0.10
    
    
    $
    0.39
    
    
    $
    0.18Diluted
    
    $
    0.20
    
    
    $
    0.10
    
    
    $
    0.38
    
    
    $
    0.18
 5  Stock-Based Compensation Under the provisions of SFAS No. 123, Accounting for Stock-Based
Compensation, as amended by SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure, the Company has elected to continue to
account for stock options using the intrinsic value method in accordance with the provisions of APB Opinion No.
25, Accounting for Stock Issued to Employees. 8




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Pursuant to SFAS No. 148, Accounting for Stock Based Compensation 
Transition and Disclosure, on a pro forma basis, had the Companys stock option
plans been accounted for under the fair value method of SFAS No. 123, the Companys net income and earnings per share would have been reduced to the
pro forma amounts shown below: Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net income available
to holders of common
stock- as reported
    
    $
    12,064
    
    
    $
    5,800
    
    
    $
    23,254
    
    
    $
    10,501Add: Stock-based
employee compensation
expense included in
reported net income
available, net of
related tax
    
    
    108
    
    
    
    124
    
    
    
    108
    
    
    
    286Deduct: Total
stock-based employee
compensation expense
determined under fair
value based
method for all
awards, net of
related tax effect
    
    
    (1,376
    )
    
    
    (1,324
    )
    
    
    (2,874
    )
    
    
    (2,624
    )Net income
available to
holders of common
stock -pro forma
    
    $
    10,796
    
    
    $
    4,600
    
    
    $
    20,488
    
    
    $
    8,163Basic - as reported
    
    $
    0.20
    
    
    $
    0.10
    
    
    $
    0.39
    
    
    $
    0.18Basic - pro forma
    
    $
    0.18
    
    
    $
    0.08
    
    
    $
    0.34
    
    
    $
    0.14Diluted - as reported
    
    $
    0.20
    
    
    $
    0.10
    
    
    $
    0.38
    
    
    $
    0.18Diluted - pro forma
    
    $
    0.18
    
    
    $
    0.08
    
    
    $
    0.33
    
    
    $
    0.14
 The pro forma figures in the preceding table may not be representative of
pro forma amounts in future quarters. 6  Inventories Inventories consist of the following: June 30,
    
    December 31,2004
    
    2003Raw materials
    
    $
    8,710
    
    
    $
    7,682Work-in-progress
    
    
    10,861
    
    
    
    9,106Finished goods
    
    
    56,096
    
    
    
    47,371Inventories
    
    $
    75,667
    
    
    $
    64,159
 The Company sustained damage to its finished bioproducts inventory in the
second quarter of 2003 as a result of an accident in a third party warehouse in
Rotterdam, the Netherlands. At the end of the first quarter of 2004, the
Company reached a final settlement of its accident-related claim with its
insurer totaling approximately $21,000 and recorded a
net gain of $8,290. 7  Goodwill and Other Intangible Assets In accordance with the provisions of SFAS No. 142,
Goodwill and Other Intangible Assets the Company does not
amortize goodwill or other intangible assets with indefinite useful lives. The
Company has identified such other indefinite-lived intangible assets to include
certain previously acquired technology. The Company periodically evaluates its
indefinite-lived intangible assets for impairment in accordance with the
provisions of SFAS No. 142. The Company also has other intangible assets, such
as patents, licenses, and customer lists, which will continue to be amortized
using the straight-line method. These assets are expected to have no residual
value once they are fully amortized. 9




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The following table summarizes the changes in each major class of
intangible assets from January 1, 2004 through June 30, 2004: Intangible Assets
    
    GoodwillOtherAmortizableTechnology
    
    Assets
    
    TotalBalances, January 1, 2004
    
    $
    15,831
    
    
    $
    73,591
    
    
    $
    89,422
    
    
    $
    29,380Foreign currency translation
and other adjustments
    
    
    (6
    )
    
    
    (1,120
    )
    
    
    (1,126
    )
    
    
    Balances, June 30, 2004
    
    $
    15,825
    
    
    
    72,471
    
    
    
    88,296
    
    
    $
    29,380Less: Accumulated amortization
    
    
    
    
    
    
    (44,335
    )
    
    
    (44,335
    )Intangible assets, net
    
    
    
    
    
    $
    28,136
    
    
    $
    43,961
 Estimated fiscal year amortization expense is as follows: 2004
    
    $
    4,6002005
    
    
    4,1002006
    
    
    3,8002007
    
    
    2,5002008
    
    
    1,300
 8  Stockholders Equity Accumulated other comprehensive loss consists of the following: Foreign
    
    Marketable
    
    AccumulatedCurrency
    
    Securities
    
    OtherTranslation
    
    Valuation
    
    ComprehensiveAdjustment
    
    Adjustment
    
    LossBalances, December 31, 2003
    
    $
    (2,350
    )
    
    $
    (465
    )
    
    $
    (2,815
    )Current period change
    
    
    (6,860
    )
    
    
    (577
    )
    
    
    (7,437
    )Balances, June 30, 2004
    
    $
    (9,210
    )
    
    $
    (1,042
    )
    
    $
    (10,252
    )
 The change in the foreign currency translation adjustment for the six
months ended June 30, 2004 relates primarily to Company operations with
functional currencies in Euros. The change in the
marketable securities valuation adjustment for the six months ended June 30,
2004 of $577 ($916 pre-tax) relates to unrealized holding losses on the
Companys available-for-sale securities. 9  Income Taxes The effective income tax rate for the six months ended June 30, 2004 was
20%, compared to 25% for the six months ended June 30, 2003, which reflects the
Companys assessment of its annual effective income tax rate. Factors
affecting the Companys estimated annual effective income tax rate include
increased operating expenses, the statutory income tax rates in foreign
jurisdictions and the relative amount of income in each jurisdiction, certain
items which are not deductible for tax purposes, and research and
experimentation tax credits. In addition, the estimated annual effective rate
for the six months ended June 30, 2003 included the effect of estimated
valuation allowances, since the Company did not anticipate having the ability
to utilize certain tax credits. 10




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10  Fees and Royalty
Revenues The increase in fees and royalty revenues of $4,357 for the six months
ended June 30, 2004 from the six months ended June 30, 2003 was primarily
driven by the technology transfer discribed in Note 12,
Technology Transfer, and a reduction in funding
from the Companys strategic alliance with the Dow
Corning Corporation. 11  Segment Reporting In accordance with SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information, segments were determined based on products
and services provided by each segment. Accounting policies for the segments
are the same as those described in Note 1, Summary of Significant Accounting
Policies of the Companys Annual Report on Form 10-K for the year ended
December 31, 2003. Performance of the segments is evaluated based on operating
income of the segment. No items below operating income are allocated to the
segments. The Company accounts for transactions, if any, between the segments
as though they were transactions with third parties at approximate market
prices. There were no material inter-segment transactions in the periods
presented. The Companys managerial financial reporting reflects two operating
segments: Bioproducts and Health Care. The Bioproducts segment develops and delivers products and services to the
industrial, consumer and agri-processing markets to a global customer base.
All of the Companys current product revenues are derived from this segment. The Health Care segment is focused on expanding the Companys current
technology and product platforms into the health care market. This segment is
primarily engaged in the performance of research and development, the securing
of intellectual property and the establishment of strategic investments and
collaborations. The following table provides information by business segment: For the three months ended June 30, 2004 Corporate
    
    ConsolidatedBioproducts
    
    Health Care
    
    Segment Subtotal
    
    and Other
    
    TotalsProduct revenue
    
    $
    96,173
    
    
    $
    
    
    
    $
    96,173
    
    
    $
    
    
    
    $
    96,173Fees and royalty revenues
    
    
    3,759
    
    
    
    10,000
    
    
    
    13,759
    
    
    
    
    
    
    
    13,759Total revenues
    
    
    99,932
    
    
    
    10,000
    
    
    
    109,932
    
    
    
    
    
    
    
    109,932Research and development
    
    
    12,198
    
    
    
    5,329
    
    
    
    17,527
    
    
    
    
    
    
    
    17,527Operating income
    
    
    14,212
    
    
    
    3,216
    
    
    
    17,428
    
    
    
    110
    
    
    
    17,538
 For the three months ended June 30, 2003 Corporate
    
    ConsolidatedBioproducts
    
    Health Care
    
    Segment Subtotal
    
    and Other
    
    TotalsProduct revenue
    
    $
    89,744
    
    
    $
    
    
    
    $
    89,744
    
    
    $
    
    
    
    $
    89,744Fees and royalty revenues
    
    
    6,453
    
    
    
    150
    
    
    
    6,603
    
    
    
    
    
    
    
    6,603Total revenues
    
    
    96,197
    
    
    
    150
    
    
    
    96,347
    
    
    
    
    
    
    
    96,347Research and development
    
    
    10,914
    
    
    
    5,919
    
    
    
    16,833
    
    
    
    
    
    
    
    16,833Operating income/(loss)
    
    
    17,737
    
    
    
    (7,536
    )
    
    
    10,201
    
    
    
    91
    
    
    
    10,292
 11




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##### Table of Contents



For the six months ended June 30, 2004 Corporate
    
    ConsolidatedBioproducts
    
    Health Care
    
    Segment Subtotal
    
    and Other
    
    TotalsProduct revenue
    
    $
    187,712
    
    
    $
    
    
    
    $
    187,712
    
    
    $
    
    
    
    $
    187,712Fees and royalty revenues
    
    
    6,358
    
    
    
    10,225
    
    
    
    16,583
    
    
    
    
    
    
    
    16,583Total revenues
    
    
    194,070
    
    
    
    10,225
    
    
    
    204,295
    
    
    
    
    
    
    
    204,295Research and development.
    
    
    23,174
    
    
    
    11,233
    
    
    
    34,407
    
    
    
    
    
    
    
    34,407Operating income/(loss)
    
    
    38,154
    
    
    
    (3,581
    )
    
    
    34,573
    
    
    
    (109
    )
    
    
    34,464
 For the six months ended June 30, 2003 Corporate
    
    ConsolidatedBioproducts
    
    Health Care
    
    Segment Subtotal
    
    and Other
    
    TotalsProduct revenue
    
    $
    179,782
    
    
    $
    
    
    
    $
    179,782
    
    
    $
    
    
    
    $
    179,782Fees and royalty revenues
    
    
    12,001
    
    
    
    225
    
    
    
    12,226
    
    
    
    
    
    
    
    12,226Total revenues
    
    
    191,783
    
    
    
    225
    
    
    
    192,008
    
    
    
    
    
    
    
    192,008Research and development.
    
    
    21,234
    
    
    
    12,059
    
    
    
    33,293
    
    
    
    
    
    
    
    33,293Operating income/(loss)
    
    
    36,795
    
    
    
    (15,442
    )
    
    
    21,353
    
    
    
    (298
    )
    
    
    21,055
 The following table provides a reconciliation of segment information to
total consolidated information: Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net income:Operating income/(loss)
for reportable segments
    
    $
    17,428
    
    
    $
    10,201
    
    
    $
    34,573
    
    
    $
    21,353Other (income)/expense
    
    
    (110
    )
    
    
    (91
    )
    
    
    109
    
    
    
    298Investment expense
    
    
    
    
    
    
    1,018
    
    
    
    
    
    
    
    1,018Interest expense
    
    
    1,006
    
    
    
    1,569
    
    
    
    2,542
    
    
    
    3,589Interest (income)
    
    
    (822
    )
    
    
    (1,558
    )
    
    
    (1,693
    )
    
    
    (2,403
    )Provision for/(benefit
from) income taxes
    
    
    3,471
    
    
    
    1,644
    
    
    
    6,723
    
    
    
    4,712Consolidated net income
    
    $
    13,883
    
    
    $
    7,619
    
    
    $
    26,892
    
    
    $
    14,139
 12  Technology Transfer During March 2004,
 the Companys Health Care segment sold its therapeutic
vaccine program to Innogenetics N.V. Upon transfer of certain intellectual
property, contractual relationships and technologies to Innogenetics, the
Company recognized fees during the quarter ended June 30, 2004 totaling
$10,000. The Company expects to receive further payments as development
milestones are achieved. Once products are commercialized, the Company would
also receive royalty payments on future product sales. 13  Joint Venture On April 1, 2004 the Company assumed majority ownership and controlling
interest of the Companys eight-year-old joint venture with Kyowa Hakko Kogyo
Co. Ltd., as a result of the joint ventures partial repurchase of a portion of the
other owners share. This venture has been named Genencor Kyowa Co. Ltd. The
financial position, results of operations and cash flows of the joint venture
have been included the Companys consolidated financial statements beginning
April 1, 2004. 12




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Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS The following discussion of our financial condition and results of
operations should be read in conjunction with the consolidated financial
statements and the notes to those statements included in our Annual Report on
Form 10-K for the year ended December 31, 2003 and the condensed consolidated
unaudited financial statements and related notes included elsewhere in this
Report. Executive Summary Leveraging over twenty years of experience, we use our molecular
technologies to develop products and deliver services for varied markets, some
on a global basis. Since our research and commercial expertise and
competencies are at the molecular level we can produce products and deliver
services to many different types of industries. Our current revenues result
primarily from the sale of enzyme products as ingredients or processing aids to
the cleaning, textiles, sweeteners, fermentation alcohol and food, feed and
specialties markets, and from research funding, fees and royalties. In the
three months ended June 30, 2004, we expended $12.2 million on our Bioproducts
research and development programs. In addition to developing products for our
current Bioproduct markets, we are now involved in Bioproduct research projects
and programs that are directed toward providing new products and services in
the emerging fields of biomaterials, biochemicals and nanobiotechnology.
Furthermore, we expended $5.3 million in the second quarter of 2004 on our
Health Care research and development programs. We believe that this
diversification of our research and development expenditures will increase the
probability of achieving success in our commercial portfolio and result in
increased value for our stockholders. Overall, for the three months ended June 30, 2004, net income available to
common stockholders was $12.1 million, or $0.20 per diluted share, compared to
$5.8 million or $0.10 per diluted share during the same period in 2003.
Product revenues increased by 7% to $96.2 million, compared to $89.7 million in
the second quarter of 2003. Total revenues for the three months ended June 30,
2004 were $109.9 million, compared to $96.3 million for the same period in
2003. Fees and royalty revenues were $13.8 million in the second quarter as
compared to $6.6 million in the prior year, driven primarily by the recognition
of fees totaling $10.0 million from the technology transfer of our therapeutic
vaccine program to Innogenetics N.V. For the three months ended June 30, 2004,
we generated $17.5 million in operating income and $18.8 million in cash flow
from operations. We also invested $5.7 million in purchases of property, plant
and equipment and recognized the cash and cash equivalents of Genencor Kyowa
Co. Ltd. of $3.8 million at April 1, 2004 due to our assumption of a 70%
interest in that venture. The financial position, results of operations and
cash flows of the joint venture have been included in our consolidated
financial statements beginning April 1, 2004. For the six months ended June 30, 2004, total revenues were $204.3
million, compared to $192.0 million for the same period in 2003. Net income
available to common stockholders was $23.3 million, or $0.38 per diluted share
for the six months ended June 30, 2004, compared to $10.5 million or $0.18 per
diluted share for that same period in 2003. Our Bioproducts segment continues to generate all of our product revenues.
In the three months ended June 30, 2004, our Bioproducts segment set a
quarterly product revenue record for the Company, driven by increases in all
product revenue categories. Particular strength was seen in the fermentation
alcohol, sweeteners and food and specialties markets. Globally, most regions
reported increased sales, with Asia Pacific reflecting double-digit growth. We
manufacture our products at our eight Bioproducts manufacturing facilities
located in the United States, Finland, Belgium, China and Argentina. We conduct
our sales and marketing activities through our direct sales organizations in
the United States, the Netherlands, Singapore, Japan, China, United Kingdom,
Argentina and Brazil and through other distribution channels in selected
markets and geographies. For the three months ended June 30, 2004, we derived
approximately 55% of our revenues from our foreign operations. During the second quarter, we also continued to make significant progress
on new applications within the Bioproducts segment. We moved closer to the
commercialization of new products for the growing biodefense industry. We
manufactured sample quantities of enzymes that neutralize sarin nerve gas and
other organophospate-based agents and are providing samples to formulators for
development into foams, sprays and detergents for use by both military and
civilian first responders, such as fire departments, police and hazardous
material response teams. The enzymes were developed in collaboration with the
U.S. Army Edgewood Chemical Biological Center. We expect to receive final
regulatory approval from the U.S. Environmental Protection Agency and we expect
to commercialize these products in the fourth quarter of 13




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2004. In addition, we continued making progress toward commercialization
of proprietary enzyme products that effectively reduce prion infectivity.
Prions are widely seen as the causative agent of Bovine Spongiform
Encephalopathy (commonly known as mad cow disease), and its human variant,
Cruetzfelt-Jakob Disease. Concerning Silicon Biotechnology platform, we entered into a two-year extension, effective January 1, 2004, of our
collaboration with the Dow Corning Corporation focusing
on biosensors and other novel products. Efforts also continued on other
Bioproducts projects, including personal care and the conversion of biomass to
fuel ethanol. In our Health Care segment, we recognized $10.0 million in fees during the
second quarter of 2004 from the technology transfer of our therapeutic vaccine
program to Innogenetics N.V. As more completely discussed under the heading
Technology Transfer within Item 2 of this Report, we sold our therapeutic
vaccine program to Innogenetics in March 2004. During the second quarter, we
completed the transfer to Innogenetics of sponsorship of the investigational
new drug application (IND) and Phase I clinical trial for our lead hepatitis B
product candidate, plus intellectual property, research compounds and various
third party relationships. This transaction has the potential to generate
additional milestone and royalty revenues for us in the future. The Health
Care segment is now focused entirely on discovery, in-licensing and development
of therapeutic products for the oncology market. Accordingly, our Health Care segment continued to make progress during the
second quarter focusing its attention and resources on targeted cancer
biotherapeutics. As previously announced, we advanced our first product
candidate for treating cancer into IND-enabling development earlier this year.
Based upon the Antibody Directed Enzyme Prodrug Therapy (ADEPT) platform, the
lead product candidate will initially target significant unmet medical needs in
colorectal carcinoma. The preliminary timeline anticipates filing an IND in
late 2005 with clinical trials to follow thereafter. We are pleased with our strong financial performance during the second
quarter and for the first six months of 2004. As more completely discussed
under the heading Warehouse Inventory Loss within Item 2 of this Report, we
are also pleased to have settled our insurance claim from last years
third-party warehouse accident during the first quarter, resulting in a net
gain of $8.3 million, which is included in other income for the six months
ended June 30, 2004. Results of Operations Comparison of the Three Months Ended June 30, 2004 and 2003 Revenues.Total revenues for the three-month period ended June 30, 2004
increased $13.6 million, or 14%, to $109.9 million from the three-month period
ended June 30, 2003, due to increases in product revenues and fees and royalty
revenues. Product Revenues.Product revenues for the three months ended June 30,
2004 increased $6.5 million, or 7%, to $96.2 million from the three months
ended June 30, 2003. For the three months ended June 30, 2004, unit volume/mix
increased 6% and the impact of foreign currency, primarily the Euro, increased
revenues 3% while average prices fell 2%. Volume/mix increased primarily in our
sweeteners, fermentation alcohol, textiles, cleaning and food and specialties markets. Regionally, North American product revenues for the three months ended
June 30, 2004 increased $2.6 million, or 7%, to $41.7 million from the three
months ended June 30, 2003, driven primarily by increased sales to our
fermentation alcohol, sweeteners, food, feed and specialties and textiles
markets, partially offset by decreased sales to our cleaning markets. Product
revenues in Europe, Africa and the Middle East for the three months ended June
30, 2004 increased $3.0 million, or 8%, to $38.8 million from the three months
ended June 30, 2003, driven primarily by increased sales to our cleaning,
textiles and sweeteners markets, partially offset by decreased sales to our
fermentation alcohol and food, feed and specialties markets. Our product
revenues in the Asia Pacific region increased $1.8 million, or 16%, to $13.1
million for three months ended June 30, 2004 from the three months ended June
30, 2003 due primarily to increased sales to our food, feed and specialties,
sweeteners and cleaning markets, partially offset by decreased sales to our textiles
markets. Our product revenues in Latin America for the three months ended June
30, 2004 decreased $0.9 million, or 26%, to $2.6 million from the three months
ended June 30, 2003, primarily due to decreased sales to our cleaning,
sweeteners, food, feed and specialties markets, partially offset by increased
sales to our textiles markets. Fees and Royalty Revenues.Fees and royalty revenues increased $7.2
million, to $13.8 million, for the three months ended June 30, 2004 from the
three months ended June 30, 2003, primarily due to the recognition of fees
totaling $10.0 14




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million from the sale of our therapeutic vaccine program to Innogenetics
N.V., as more completely discussed in Technology Transfer  within Item 2 of
this Report. Funded research revenues for the three months ended June 30, 2004
decreased $2.7 million, or 44%, to $3.4 million from the three months ended
June 30, 2003. Revenues generated by research funding result from
collaborative agreements with various parties, including the U.S. Government,
whereby we perform research activities and receive revenues that partially
reimburse us for expenses incurred. Under such agreements, we retain a
proprietary interest in the products and technology developed. Our funded research revenue as it relates to U.S. Government
collaborations increased $0.8 million, or 47%, to $2.5 million for the three
months ended June 30, 2004 from the three months ended June 30, 2003 primarily
due to funding provided by the National Renewable Energy Laboratory to develop
an enzymatic process to convert biomass into ethanol. Funded research
revenues provided by customers decreased $3.5 million, or 80%, to $0.9 million
for the three months ended June 30, 2004 from the three months ended June 30,
2003, due primarily to the reduction in funding from our strategic alliance
with the Dow Corning Corporation. During the second quarter, we renewed our Silicon Biotechnology
collaboration with the Dow Corning Corporation by agreeing to a two-year
extension, effective January 1, 2004. Royalties decreased $0.1 million, or 25%, to $0.3 million for the three
months ended June 30, 2004 from the three months ended June 30, 2003, due
primarily to the timing of customer royalty payments that are based on the
sales of the customers products produced using our technology. All other fees increased
$10.0 million to $10.1 million for the three
months ended June 30, 2004 from the three months ended June 30, 2003. This
increase was primarily driven by the recognition of $10.0 million from the
technology transfer of our therapeutic vaccine program to Innogenetics N.V., as
more completely discussed in Technology Transfer  within Item 2 of this
Report. Operating Expenses Cost of Products Sold.Cost of products sold increased $3.3 million, or
6%, to $55.0 million for the three months ended June 30, 2004 from the three
months ended June 30, 2003. Our expanded sales volume/mix increased costs $1.9
million, along with increases due to the impact of the U.S. Dollar against
foreign currencies, primarily the Euro, of $0.9 million, and an increase in
unit production costs of approximately $0.4 million. Gross Profit and Margins from Products Sold.Gross profit from products
sold increased $3.3 million, or 9%, to $41.2 million for the three months ended
June 30, 2004 from the three months ended June 30, 2003, and gross margin
increased to 42.8% for the three months ended June 30, 2004 from 42.3% for the
three months ended June 30, 2003. The overall increase was primarily driven by
favorable product volume/mix, partially offset by a reduction in average price.
Our gross profit was also benefited by a $1.4 million increase due to the
impact of the U.S. Dollar against foreign currencies, primarily the Euro. Research and Development.Research and development expenses primarily
consist of the personnel-related, consulting, and facilities costs incurred in
connection with our research activities conducted in Palo Alto, California and
Leiden, the Netherlands. These expenses increased $0.7 million, or 4%, to
$17.5 million for the three months ended June 30, 2004 from the three months
ended June 30, 2003, due primarily to increases in personnel-related costs,
including salaries, benefits and travel expenses of $0.4 million, supply costs
of $0.2 million and facilities costs of $0.3 million, partially offset by a
decrease in outside services of $0.2 million. As a part of total research and
development expenses, estimated expenses related to research collaborations
partially funded by customers increased $0.7 million, or 23%, to $3.8 million
for the three months ended June 30, 2004 from the three months ended June 30,
2003. Sales, Marketing and Business Development.Sales, marketing and business
development expenses primarily consist of the personnel-related and marketing
costs incurred by our global sales force. These expenses increased $1.5
million, or 19%, to $9.4 million for the three months ended June 30, 2004 from
the three months ended June 30, 2003, due primarily to increases in
personnel-related costs, including salaries, benefits and travel expenses of
$0.9 million, outside services of $0.3 million, facilities costs of $0.1
million and increased insurance, tax and royalty expenses of $0.2 million. General and Administrative.General and administrative expenses include
the costs of our corporate executive, finance, information technology, legal,
human resources, and communications functions. In total, these expenses
increased $1.4 million, or 18%, to $9.4 million for the three months ended June
30, 2004 from the three months ended June 30, 2003, due 15




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primarily to increases in outside services of $1.0 million and in
personnel-related costs, including salaries, benefits, travel expenses of $0.3
million and incentive compensation of $0.2 million. Amortization of Intangible Assets.We amortize our definite-lived
intangible assets, consisting of patents, licenses, customer lists and other
contractual agreements on a straight-line basis over their estimated useful
lives. Amortization expense decreased $0.4 million, or 27%, to $1.1 million
for the three months ended June 30, 2004 from the three months ended June 30,
2003. This decrease was primarily due to certain intangible assets becoming
fully amortized at year-end 2003. Other Income and Expense.Other expense and income relates primarily to
foreign currency exchange gains and losses on transactions denominated in other
than the functional currency of the entity in which the transaction occurred.
Other income for the three months ended June 30, 2004 was $0.1 million as
compared with other expense of $0.1 million for the three months ended June 30,
2003. Non Operating Expense and Income Investment Expense.We recorded an investment loss of $1.0 million in the
three months ended June 30, 2003, as a result of our assessment of an other
than temporary decline in the fair market value of an investment in certain
common stock. There was no such investment income or loss in the three months
ended June 30, 2004. Interest Income. Interest income decreased $0.8 million, or 50%, to $0.8
million for the three months ended June 30, 2004 from the three months ended
June 30, 2003. The decrease in interest income was primarily due
to interest received on a tax refund claim in the second quarter of 2003. Income Taxes. The effective income tax rate for the three months ended
June 30, 2004 was 20%, compared to 18% for the three months ended June 30,
2003, which reflects our assessment of the annual effective income tax rate.
Factors affecting our estimated annual effective income tax rate include
operating expense increases, the statutory income tax rates in foreign
jurisdictions and the relative amount of income in each jurisdiction, certain
items which are not deductible for tax purposes, and research and
experimentation tax credits. In addition, the estimated annual effective rate
in the three months ended June 30, 2003 included the effect of estimated
valuation allowances, since we did not anticipate having the ability to utilize
certain tax credits. Comparison of the Six Months Ended June 30, 2004 and 2003 Revenues.Total revenues for the six months ended June 30, 2004 increased
$12.3 million, or 6%, to $204.3 million from the six months ended June 30,
2003, due to increases in both product revenues and fees and royalty revenues. Product Revenues.Product revenues in the six months ended June 30, 2004
increased $7.9 million, or 4%, to $187.7 million from the six months ended June
30, 2003. For the six months ended June 30, 2004, unit volume/mix increased 2%
and the impact of foreign currency, primarily the Euro, increased revenues 4%,
while average prices fell 2%. Volume/mix increased in our sweeteners,
fermentation alcohol, cleaning and textiles markets, partially offset by a
decrease in our food, feed and specialties markets. Regionally, North American product revenues for the six months ended June
30, 2004 increased $1.5 million, or 2%, to $78.3 million from the six months
ended June 30, 2003, driven primarily by increased sales to our fermentation
alcohol, sweeteners and our food, feed and specialties markets, partially
offset by decreased sales to our cleaning and textiles markets. Product
revenues in Europe, Africa and the Middle East for the six months ended June
30, 2004 increased $7.0 million, or 10%, to $78.8 million from the six months
ended June 30, 2004, driven primarily by increased sales to our cleaning,
textiles and sweeteners markets, partially offset by decreased sales to our
fermentation alcohol and food, feed and specialties markets. Product revenues
in the Asia Pacific region increased $0.3 million, or 1%, to $24.7 million for
the six months ended June 30, 2004 from the six months ended June 30, 2003, due
to increased sales to our food, feed and specialties, sweeteners and
fermentation alcohol markets, partially offset by decreased sales to our
cleaning and textiles markets. Our product revenues in Latin America for the
six months ended June 30, 2004 decreased $0.9 million, or 13%, to $5.9 million
from the six months ended June 30, 2003, due primarily to decreased sales to our
food, feed and specialties, sweeteners and cleaning markets, partially offset
by increased sales to our textiles markets. 16




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Fees and Royalty Revenues.Fees and royalty revenues increased $4.4
million, or 36%, to $16.6 million for the six months ended June 30, 2004 from
the six months ended June 30, 2003, due to the recognition of fees totaling
$10.0 million from the sale of our therapeutic vaccine program to Innogenetics
N.V., as more completely discussed in Technology Transfer  within Item 2 of
this Report. Funded research revenues decreased $5.7 million, or 51%, to $5.5 million
for the six months ended June 30, 2004 from the six months ended June 30, 2003.
Revenues generated by research funding result from collaborative agreements
with various parties, including the U.S. Government, whereby we perform
research activities and receive revenues that partially reimburse us for
expenses incurred. Under such agreements, we retain a proprietary interest in
the products and technology developed. Our funded research revenue as it
relates to U.S. Government collaborations increased $0.7 million, or 25%, to
$3.5 million for the six months ended June 30, 2004 from the six months ended
June 30, 2003, primarily due to funding provided by the National Renewable
Energy Laboratory to develop an enzymatic process to convert biomass into
ethanol. Funded research revenues provided by customers decreased $6.4
million, or 76%, to $2.0 million for the six months ended June 30, 2004 from
the six months ended June 30, 2003, due primarily to the reduction in funding from our strategic
 alliance with the Dow Corning Corporation. During the second quarter, we renewed our
Silicon Biotechnology collaboration with the Dow Corning Corporation by
agreeing to a two-year extension, effective January 1, 2004. Royalties increased $0.1 million, or 11%, to $1.0 million for the six
months ended June 30, 2004 from the six months ended June 30, 2003, due
primarily to the timing of customer royalty payments that are based on the
sales of the customers products produced using our technology. All other fees increased
 $10.0  million to $10.1 million for the six months
ended June 30, 2004 from the six months ended June 30, 2003. This increase was
primarily driven by the recognition of $10.0 million from the technology
transfer of our therapeutic vaccine program to Innogenetics N.V., as more
completely discussed in Technology Transfer  within Item 2 of this Report. Operating Expenses Cost of Products Sold.Cost of products sold increased $2.9 million, or
3%, to $105.5 million for the six months ended June 30, 2004 from the six
months ended June 30, 2003. Our expanded product volume/mix increased costs
$1.4 million, along with an increase of $4.0 million due to the impact of the
U.S. Dollar against foreign currencies, primarily the Euro. These increases
were partially offset by a $2.5 million decrease due to lower unit production
costs for the period. Gross Profit and Margins from Products Sold.Gross profit from products
sold increased $5.0 million, or 6%, to $82.2 million for the six months ended
June 30, 2004 from the six months ended June 30, 2003 and gross margin
increased to 43.8% for the six months ended June 30, 2004 from 42.9% for the
six months ended June 30, 2003. The overall increase was primarily driven by
favorable product volume/mix and unit production costs, partially offset by a
reduction in average price. Our gross profit was also benefited by a $4.0
million increase due to the impact of the U.S. Dollar against foreign
currencies, primarily the Euro. Research and Development.Research and development expenses increased
$1.1 million, or 3%, to $34.4 million for the six months ended June 30, 2004
from the six months ended June 30, 2003, primarily due to increases in
personnel-related costs, including salaries, benefits and travel expenses of
$0.8 million, supply costs of $0.3 million and facilities costs of $0.5
million, partially offset by decreases in outside services of $0.5 million and
incentive compensation of $0.2 million. As a part of total research and
development expenses, estimated expenses related to research collaborations
partially funded by customers decreased $0.4 million, or 6%, to $5.8 million
for the six months ended June 30, 2004 from the six months ended June 30, 2003. Sales, Marketing and Business Development.Sales, marketing and business
development expenses increased $2.1 million, or 13%, to $17.7 million for the
six months ended June 30, 2004 from the six months ended June 30, 2003,
primarily due to increases in personnel-related costs, including salaries,
benefits and travel expenses of $1.5 million, supply costs of $0.1 million,
insurance, tax and royalty expenses of $0.2 million, and an increase in the
provision for doubtful accounts at our Chinese affiliate of $0.2 million. General and Administrative.General and administrative expenses increased
$2.1 million, or 13%, to $17.9 million for the six months ended June 30, 2004
from the six months ended June 30, 2003, due primarily to increases in outside
services of $1.7 million, personnel-related costs, including salaries,
benefits, and travel expenses, of $0.2 million and incentive compensation of
$0.1 million. 17




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Amortization of Intangible Assets.Amortization expense decreased $0.6
million, or 21%, to $2.3 million for the six months ended June 30, 2004 from
the six months ended June 30, 2003. This decrease was primarily due to certain
intangible assets becoming fully amortized at year-end 2003. Other Income and Expense.Other income for the six months ended June 30,
2004 was $8.0 million as compared to $0.8 million of other expense for the six
months ended June 30, 2003. This difference in income of $8.8 million was
primarily driven by the $8.3 million net gain recorded during the quarter ended
March 31, 2004, resulting from the final settlement of our insurance claim
related to the warehouse accident in Rotterdam, the Netherlands that occurred
in the second quarter of 2003. Non Operating Expense and Income Investment Expense.We recorded an investment loss of $1.0 million in the
six months ended June 30, 2003, as a result of our assessment of an other than
temporary decline in the fair market value of an investment in certain common
stock. There was no such investment income or loss in the six months ended
June 30, 2004. Interest Income. Interest income decreased $0.7 million, or 29%, to $1.7
million for the six months ended June 30, 2004 from the six months ended June
30, 2003. The decrease in interest income was primarily due to
interest received on a tax refund claim in the second quarter of 2003. Income Taxes.The effective income tax rate for the six months ended June
30, 2004 was 20%, compared to 25% for the six months ended June 30, 2003, which
reflects our assessment of our annual effective income tax rate. Factors
affecting our estimated annual effective income tax rate include operating
expense increases, the statutory income tax rates in foreign jurisdictions and
the relative amount of income in each jurisdiction, certain items which are not
deductible for tax purposes, and research and experimentation tax credits. In
addition, the estimated annual effective rate for the six months ended June 30,
2003 included the effect of estimated valuation allowances, since we did not
anticipate having the ability to utilize certain tax credits. Financial Results by Segment Our managerial financial reporting provides information that aligns with
the two-segment structure of Bioproducts and Health Care. Accordingly, we have
provided financial data in this financial segment reporting for the three
months and the six months ended June 30, 2004 and 2003. The Bioproducts segment develops and delivers products and services for
the industrial, consumer and agri-processing markets to a global customer base.
All of our current product revenues are derived from this segment. For the
three months ended June 30, 2004, the Bioproducts segment achieved operating
income of $14.2 million as compared to operating income of $17.7 million for
the three months ended June 30, 2003. For the six months ended June 30, 2004,
the Bioproducts segment achieved operating income of $38.2 million as compared
to operating income of $36.8 million for the six months ended June 30, 2003. The Health Care segment is primarily engaged in the performance of
research and development, securing intellectual property and the establishment
of strategic investments and collaborations in support of our product
objectives in the health care market. For the three months ended June 30, 2004,
the Health Care segment experienced operating income of $3.2 million as
compared to an operating loss of $7.5 million for the three months ended June
30, 2003. This was primarily due to the recognition of fees totaling $10.0
million from the technology transfer of our therapeutic vaccine program to
Innogenetics N.V. during the quarter ended June 30, 2004. For the six months
ended June 30, 2004, the Health Care segment experienced an operating loss of
$3.6 million as compared to an operating loss of $15.4 million for the six
months ended June 30, 2003. Joint Venture On April 1, 2004 we assumed majority ownership and controlling interest of
our eight-year-old joint venture with Kyowa Hakko Kogyo Co. Ltd., as a result
of the joint ventures partial repurchase of a portion of the other owners share. This venture
has been 18




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named Genencor Kyowa Co. Ltd. The financial position, results of
operations and cash flows of the joint venture have been included in our
consolidated financial statements beginning April 1, 2004. Technology Transfer During March 2004, our Health Care segment sold its therapeutic vaccine
program to Innogenetics N.V. Upon transfer of certain intellectual property,
contractual relationships and technologies to Innogenetics, we recognized fees
during the quarter ended June 30, 2004 totaling $10.0 million. We expect to
receive further payments as development milestones are achieved. Once products
are commercialized, we would also receive royalty payments on future product
sales. Warehouse Inventory Loss We sustained damage to our finished bioproducts inventory in the second
quarter of 2003 as a result of an accident in a third party warehouse in
Rotterdam, the Netherlands. At the end of the first quarter of 2004, we
reached a final settlement of our accident-related claim with our insurer
totaling approximately $21.0 million and recorded a net
gain of $8.3 million. Liquidity and Capital Resources Our funding needs consist primarily of capital expenditures, research and
development activities, sales and marketing expenses, and general corporate
purposes. We have financed our operations primarily through cash from the sale
of products, the sale of stock, research and development funding from partners,
government grants, and short-term and long-term borrowings. We believe that our current cash and cash equivalent balances plus funds
to be provided from our current year operating activities, together with those
available under our lines of credit, will satisfy our funding needs over the
next twelve months. Factors that could negatively impact our cash position
include, but are not limited to, future levels of product revenues, fees and
royalty revenues, expense levels, capital expenditures, acquisitions, and
foreign currency exchange rate fluctuations. As of June 30, 2004, cash and cash equivalents totaled $155.1 million.
The funds were invested in short-term instruments, including A-1/P1 and A-2/P2
rated commercial paper, AAA and AA rated medium term notes, institutional money
market funds, auction rate preferred securities and bank deposits. Cash provided by operations was $25.1 million and $15.9 million for the
six months ended June 30, 2004 and 2003, respectively. The increase of $9.2
million in 2004 from 2003 was generated principally by the increase in operating income, net of
non-cash items such as depreciation and amortization, partially
offset by changes in operating
assets and liabilities. Cash used in investing activities was $6.1 million and $9.4 million for
the six months ended June 30, 2004 and 2003, respectively. This decrease in
cash used of $3.3 million was driven primarily by the
recognition of the cash and cash equivalents of Kyowa Hakko Kogyo Co.
Ltd. of $3.8 million at April 1, 2004 due to our assumption of
a controlling interest in the venture. This venture has been named
Genencor Kyowa Co. Ltd. Capital expenditures for the six months ended
June 30, 2004 were $9.5 million compared with $10.6 million in 2003.
 A significant portion of this spending
included process improvement projects at our manufacturing and research and
development facilities and information technology enhancements. During the six
months ended June 30, 2003, construction continued on our facility for the
clinical-scale manufacture of human therapeutic proteins in Rochester, New
York. Construction of this facility was completed during the third quarter of
2003. Cash used in financing activities was $27.9 million and $25.4 million for
the six months ended June 30, 2004 and 2003, respectively, which reflects our
$28.0 million annual installment payments made on our senior debt in each
period. The increase of $2.5 million during the six months ended June 30, 2004
was primarily driven by payments on notes payable for one of the Companys
foreign affiliates. While we are permitted to pay dividends to our common
stockholders, we currently intend to utilize our resources to finance the
expansion of our business. Any future determination to pay cash dividends to
our common stockholders will be at the discretion of our board of directors and
will depend upon our financial condition, results of operations, capital
requirements, general business conditions and other factors that the board of
directors may deem relevant, including covenants in our debt instruments that
may limit our ability to declare and pay cash dividends on 19




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our capital stock. Covenants in our senior note agreement restrict the
payment of dividends or other distributions in cash or other property to the
extent the payment puts us in default of these covenants. Such covenants
include, but are not limited to, maintaining a debt to total capitalization of
no greater than 55% and a maximum ratio of debt to earnings before interest,
taxes, depreciation and amortization (EBITDA) of 3.5:1. At June 30, 2004, we had a $40.0 million revolving credit facility with a
syndicate of banks, which is available for general corporate purposes. The
credit facility, which consists of a credit agreement, makes available to the
Company $40.0 million of committed borrowings and expires on December 23, 2006.
The credit facility fees were 0.25% on the amount of unborrowed principal
under the agreement for the three months ended June 30, 2004. As of June 30,
2004, there were no borrowings under the facility. Our long-term debt consists primarily of the 6.82% senior notes issued in
1996 to certain institutional investors. The remaining principal amount of
these notes is $56.0 million. Annual installment payments of $28.0 million
commenced on March 30, 2002. We are currently in compliance with the financial
covenants included in the senior note agreement. New Accounting Pronouncements In December 2003, the FASB issued a revision of SFAS No. 132, Employers
Disclosures about Pensions and Other Postretirement Benefits. The revised
Statement provides required disclosures for pensions and other postretirement
benefit plans and is designed to improve disclosure transparency in financial
statements. The revised Statement replaces existing year-end and interim
disclosure requirements. This Statement was in effect for our fiscal year
ending December 31, 2003 and for quarters beginning thereafter for domestic
plans, and is effective for fiscal years ending after June 15, 2004 for
our foreign plans. In May 2004,
 the FASB issued FASB Staff Position (FSP) No. 106-2,
Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003. This Position supersedes FSP
No. 106-1 of the same title, which was issued in January 2004. FSP No. 106-1
permitted employers that sponsor postretirement benefit plans which provide
prescription drug benefits to retirees to make a one-time election to defer
accounting for any effects of the Medicare Prescription Drug, Improvement and
Modernization Act of 2003. FSP No. 106-2 provides guidance on accounting for
the effects of the new Medicare prescription drug legislation by employers
whose prescription drug benefits are actuarially equivalent to the drug benefit
under Medicare Part D. For all public companies that sponsor one or more plans
with more than 100 participants, the Position is effective as of the first
interim or annual period beginning after June 15, 2004. We do not expect the
adoption of FSP No. 106-2 to have a material impact on our financial
position or our results of operations. Market Risk Foreign currency risk and interest rate risk are the primary sources of
our market risk. Foreign operations, mainly denominated in Euros, accounted
for approximately 55% of our revenues for the six months ended June 30, 2004.
We believe that we mitigate this risk by locating our manufacturing facilities
so that the costs are denominated in the same currency as our product revenues.
We may manage the foreign currency exposures that remain through the use of
foreign currency forward contracts, currency options and off-setting currency
positions in assets and liabilities where deemed appropriate. We do not use
these instruments for speculative purposes. There was no material foreign
currency gains in connection with these types of contracts recorded in the
statement of operations for the six months ended June 30, 2004. As of June 30, 2004, cash and cash equivalents totaled $155.1 million. Of
this amount, $78.1 million was denominated in Euros. The remainder, or $77.0
million, was primarily denominated in U.S. Dollars. Short-term debt was mainly
comprised of our fourth installment of $28.0 million due March 30, 2005 under
our 6.82% senior notes discussed under the heading Liquidity and Capital
Resources in Item 2 of this Report. To the extent U.S. Dollar and Euro interest rates
fluctuate either up or down, the return on the cash investments will also
fluctuate. To the extent such Euro cash investments remain outstanding, we will
be subject to the risks of future foreign exchange fluctuations and the impact
on the translation of these cash investments into U.S. Dollars. 20




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Interest Rates Our interest income is sensitive to changes in the general level of
short-term interest rates primarily in the United States and Europe. In this
regard, changes in the U.S. Dollar and Euro currency rates affect the interest
earned on our cash equivalents, short-term investments, and long-term
investments. Our interest expense is generated primarily from fixed rate debt.
The $56.0 million 6.82% senior notes outstanding at June 30, 2004 mature evenly
in installments of $28.0 million per year. The two remaining installments are
due March 30, 2005 and 2006. Foreign Currency Exposure We conduct business throughout the world. During the six months ended
June 30, 2004, we derived approximately 55% of our revenues and approximately
40% of our operating income from foreign operations. Economic conditions in
countries where we conduct business and changing foreign currency exchange
rates affect our financial position and results of operations. We are exposed
to changes in foreign exchange rates in Europe, Latin America, and Asia. The
Euro and Argentine Peso present our most significant foreign currency exposure
risk. Changes in foreign currency exchange rates, especially the strengthening
of the U.S. Dollar, may have an adverse effect on our financial position and
results of operations as they are expressed in U.S. Dollars. Our manufacturing
and administrative operations for Latin America are located in Argentina. A
significant part of our Latin American revenues are denominated in U.S.
Dollars. Net foreign exchange loss from U.S. Dollar/Euro and U.S.
Dollar/Argentine Peso transactions were $0.2 million for the six-month period
ended June 30, 2004. Management monitors foreign currency exposures and may in the ordinary
course of business enter into foreign currency forward contracts or options
contracts related to specific foreign currency transactions or anticipated cash
flows. These contracts generally cover periods of nine months or less and are
not material. For the six months ended June 30, 2004, foreign currency
contracts had an approximately neutral impact on our statement of operations.
We do not hedge the translation of financial statements of consolidated
subsidiaries that maintain their local books and records in foreign currencies. Risk Factors Biotechnology and especially the development of products for the health
care market are areas of intense competition and high risk. While we believe
that our business is unique in its history and areas of focus, the risk factors
described below or other risks not known to us now or that we currently believe
to be immaterial may have a material and adverse effect on our business,
financial condition, results of operations, or the price of our common stock. If we fail to develop products for the health care and bioproducts markets, we
may not achieve a return on our research and development expenditures or
realize product revenues from these markets. A key element of our business strategy is to utilize our technologies for
the development and delivery of new products to the health care market and new
sectors of the bioproducts market. We intend to continue to invest heavily in
research and development to develop products for these markets. The successful
development of these products, especially those in the health care market, is
highly uncertain and is dependent on numerous factors, many of which are beyond
our control, and may include the following:  
    
    The product may be ineffective or have undesirable side effects in preliminary and commercial testing or, specifically in
the health care area, in preclinical and clinical trials;
    
    The product may fail to receive necessary governmental and regulatory approvals, or such regulatory approvals may be
delayed significantly;
    
    The product may not be economically viable because of manufacturing costs or other factors;
    
    The product may not gain acceptance in the marketplace; or 21




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
    
    The proprietary rights of others or competing products or technologies for the same application may preclude us from
commercializing the product. Due to these factors we may never achieve a return on our research and
development expenditures or realize product revenues from the health care and
new bioproducts markets that we are targeting. If we fail to enter into strategic alliances with partners in our target
markets or fail to independently raise additional capital, we will not have the
resources necessary to capitalize on all of the market opportunities available
to us. We do not currently possess the resources necessary to independently
develop and commercialize products for all of the market opportunities that may
result from our technologies. We intend to form strategic alliances with
industry leaders in our target markets to gain access to funding for research
and development, expertise in areas we lack and distribution channels. We may
fail to enter into the necessary strategic alliances or fail to commercialize
the products anticipated from the alliances. Our alliances could be harmed if:  
    
    We fail to meet our agreed upon research and development objectives;
    
    We disagree with our strategic partners over material terms of the alliances, such as intellectual property or
manufacturing rights; or
    
    Our strategic partners become competitors or enter into agreements with our competitors. New strategic alliances that we enter into, if any, may conflict with the
business objectives of our current strategic partners and negatively impact
existing relationships. In addition, to capitalize on the market opportunities
we have identified, we may need to seek additional capital, either through
private or public offerings of debt or equity securities. Due to market and
other conditions beyond our control, we may not be able to raise additional
capital on acceptable terms or conditions, if at all. If the demand for protein degrading enzymes decreases or if major customers
reduce or terminate business with us, our revenues could significantly decline. Our largest selling family of products, protein degrading enzymes, or
proteases, accounted for approximately 48% of our 2003 product revenues. If the
demand for proteases decreases or alternative proteases render our products
noncompetitive, our revenues could significantly decline. In addition, our five largest customers collectively accounted for
approximately 53% of our 2003 product revenues, with our largest customer, The
Procter & Gamble Company, accounting for more than 35% of such revenues. Our
five largest customers in 2003 were Broin Group; Cargill, Incorporated; Danisco
Animal Nutrition - the feed ingredients business unit of Danisco A/S; The
Procter & Gamble Company; and Reckitt Benckiser, plc. Any one of these
customers may reduce their level of business with us. Should any of our
largest customers decide to reduce or terminate business with us, our revenues
and profitability could decline significantly. We have arrangements of various durations with our major customers and are
routinely involved in discussions regarding the status of these relationships.
These discussions may lead to extensions or new commercial arrangements, or may
be unsuccessful. Our customer relationships involve uncertainty by virtue of
economic conditions, customer needs, competitive pressures, our production
capabilities and other factors. Consequently, we expect that our customer base
will continue to change over time as will the nature of our relationships with
individual customers, including major customers. We intend to acquire businesses, technologies and products; however, we may
fail to realize the anticipated benefits of such acquisitions and we may incur
costs that could significantly reduce our profitability. In the future, we may acquire other businesses, technologies and products
that we believe are a strategic fit with our business. If we undertake any
transaction of this sort, we may not be able to successfully integrate any
businesses, products, technologies or personnel that we might acquire without a
significant expenditure of operating, financial and management resources, if at
all. Further, we may fail to realize the anticipated benefits of any
acquisition. Future acquisitions could dilute 22




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our stockholders interest in us and could cause us to incur substantial
debt, expose us to contingent liabilities and could negatively impact our
profitability. If we are unable to secure or maintain adequate intellectual property
protection or become involved in an intellectual property dispute, it could
significantly harm our financial results and ability to compete. The patent positions of biotechnology companies, including our patent
positions, can be highly uncertain and involve complex legal and factual
questions, and, therefore, enforceability is uncertain. We will be able to
protect our proprietary rights from unauthorized use by third parties only to
the extent that we protect our technologies with valid and enforceable patents
or as trade secrets. We rely in part on trade secret protection for our
confidential and proprietary information by entering into confidentiality
agreements and non-disclosure policies with our employees and consultants.
Nonetheless, confidential and proprietary information may be disclosed, and
others may independently develop substantially equivalent information and
techniques or otherwise gain access to our trade secrets. We file patent applications in the United States and in foreign countries
as part of our strategy to protect our proprietary products and technologies.
The loss of significant patents or the failure of patents to issue from pending
patent applications that we consider significant could impair our operations.
In addition, third parties could successfully challenge, invalidate or
circumvent our issued patents or patents licensed to us so that our patent
rights would not create an effective competitive barrier. Further, we may not
obtain the patents or licenses to technologies that we will need to develop
products for our target markets. The laws of some foreign countries may also
not protect our intellectual property rights to the same extent as United
States law. Extensive litigation regarding patents and other intellectual property
rights is common in the biotechnology industry. In the ordinary course of
business, we periodically receive notices of potential infringement of patents
held by others and patent applications that may mature to patents held by
others. The impact of such claims of potential infringement, as may from time
to time become known to us, are difficult to assess. In the event of an
intellectual property dispute, we may become involved in litigation.
Intellectual property litigation can be expensive and may divert managements
time and resources away from our operations. The outcome of any such
litigation is inherently uncertain. Even if we are successful, the litigation
can be costly in terms of dollars spent and diversion of management time. If a third party successfully claims an intellectual property right to
technology we use, it may force us to discontinue an important product or
product line, alter our products and processes, pay license fees, pay damages
for past infringement or cease certain activities. Under these circumstances,
we may attempt to obtain a license to this intellectual property; however, we
may not be able to do so on commercially reasonable terms, or at all. In
addition, regardless of the validity of such a claim, its mere existence may
affect the willingness of one or more customers to use or continue to use our
products and thereby materially impair our business. Those companies with which we have entered or may enter into strategic
alliances encounter similar risks and uncertainties with respect to their
intellectual property. To the extent that any such alliance companies suffer a
loss or impairment of their respective technologies, we may suffer a
corresponding loss or impairment that may materially and adversely affect our
investments. Also, our patent portfolio includes patents that are nearing the end of
their period of protection. While we do not expect to experience a material
adverse effect related to patent expirations in the near term, the expiration
of patents may submit us to new competition and price pressures that may lead
to a significant loss of product revenue. Foreign currency fluctuations and economic and political conditions in foreign
countries could cause our revenues and profits to decline. In 2003, we derived approximately 55% of our product revenues from our
foreign operations. Our foreign operations generate sales and incur expenses
in local currency. As a result, we are exposed to market risk related to
unpredictable interest rates and foreign currency exchange rate fluctuations.
We recognize foreign currency gains or losses arising from our operations in
the period incurred. As a result, currency fluctuations between the U.S.
Dollar and the currencies in which we do business could cause our revenues and
profits to decline. 23




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Product revenues denominated in Euros accounted for approximately 37% of
our total product revenues in 2003, and the fluctuations in the currency
exchange rate against the U.S. Dollar can have a significant impact on our
reported product revenues. We expect to continue to operate in foreign countries and that our
international sales will continue to account for a significant percentage of
our revenues. As such, we are subject to certain risks arising from our
international business operations that could be costly in terms of dollars
spent, the diversion of managements time, and revenues and profits, including:  
    
    Difficulties and costs associated with staffing and managing foreign operations;
    
    Unexpected changes in regulatory requirements;
    
    Difficulties of compliance with a wide variety of foreign laws and regulations;
    
    Changes in our international distribution network and direct sales forces;
    
    Political trade restrictions and exchange controls;
    
    Political, social, or economic unrest including armed conflict and acts of terrorism;
    
    Labor disputes including work stoppages, strikes and embargoes;
    
    Inadequate and unreliable services and infrastructure;
    
    Import or export licensing or permit requirements; and
    
    Greater risk on credit terms and long accounts receivable collection cycles in some foreign countries. If the ownership of our common stock continues to be highly concentrated, it
may prevent other stockholders from influencing significant corporate decisions
and may result in conflicts of interest that could cause our stock price to
decline. After our initial public offering and continuing to the present, Eastman
Chemical Company and Danisco A/S and their affiliates, which we refer to as our
majority stockholders, each own in excess of 40% of our outstanding common
stock. Moreover, pursuant to a Stockholder Agreement, as amended, among
Eastman, Danisco and us, each of our majority stockholders also has the right
to nominate three of our ten directors. The majority stockholders will
therefore have the ability, in the event they act together, to control
fundamental corporate transactions requiring stockholder approval, including
the election of our directors, the approval of merger transactions involving
us, and the sale of all or substantially all of our assets or other business
combination transactions. The concentration of ownership of our common stock
may have the effect of either delaying or preventing a change to our control
favored by our other stockholders or accelerating or approving a change to our
control opposed by our other stockholders. In addition, the majority
stockholders control over our management could create conflicts of interest
between the majority stockholders and us with respect to the allocation of
corporate opportunities and between the majority stockholders and other
stockholders. If stockholders sell large numbers of shares of our common stock, our stock
price could decline. The market price of our common stock could decline as a result of sales of
our stock into the public market or the perception that these sales could
occur. Our two majority stockholders, for example, hold more than 80% of our
common stock, and all of these shares are subject to registration rights. In
addition, we have a significant number of stock options outstanding with our
officers, directors and employees pursuant to our 2002 Omnibus Incentive Plan,
approved by our stockholders in May 2002, and its predecessor plan. Our stock price has been, and may continue to be, particularly volatile. The stock market from time to time, has experienced significant price and
volume fluctuations that are unrelated to the operating performance of
companies. The market prices for securities of biotechnology companies,
including ours, 24




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have been highly volatile in the period since our initial public offering
in July 2000 and may continue to be highly volatile in the future. Our stock
may be affected by this type of market volatility, as well as by our own
performance. The following factors, among other risk factors, may have a
significant effect on the market price of our common stock:  
    
    Developments in our relationships with current or future strategic partners;
    
    Conditions or trends in the biotechnology industry;
    
    Announcements of technological innovations or new products by us or our competitors;
    
    Announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital
commitments;
    
    Developments in patent or other intellectual proprietary rights or announcements relating to these matters;
    
    Investor concern regarding the public acceptance of the safety of biotechnology products or announcements relating to these
matters;
    
    Litigation or governmental proceedings or announcements relating to these matters;
    
    Economic and other external factors or other disaster or crisis;
    
    Future royalties from product sales, if any, by our licensees;
    
    Sales of our common stock or other securities in the open market; and
    
    Period-to-period fluctuations in our operating results. We expect that our quarterly results of operations will fluctuate, and this
fluctuation could cause our stock price to decline thereby causing investor
losses. A large portion of our expenses, including expenses for facilities,
equipment and personnel, are relatively fixed. Accordingly, if product revenue
declines or does not grow as we anticipate or non-product revenue declines due
to the expiration or termination of strategic alliance agreements or the
failure to obtain new agreements or grants, we may not be able to
correspondingly reduce our operating expenses in any particular quarter. Our
quarterly revenue and operating results have fluctuated in the past and are
likely to do so in the future. If our operating results in some quarters fail
to meet the expectations of stock market analysts and investors, our stock
price would likely decline. Some of the factors that could cause our revenue
and operating results to fluctuate include:  
    
    The ability and willingness of strategic partners to commercialize
products derived from our technology or containing our products on
expected timelines;
    
    Our ability to successfully commercialize products developed
independently and the rate of adoption of such products;
    
    Fluctuations in consumer demand for products containing our
technologies or products, such as back to school sales of blue jeans
and other denim products, resulting in an increase in the use of
textile processing enzymes, and fluctuations in laundry detergent use
due to promotional campaigns run by consumer products companies; and
    
    Fluctuations in geographic conditions including currency and other
economic conditions such as economic crises in Latin America or Asia
and increased energy and related transportation costs. We also have incurred significant infrequently occurring charges within
given quarters, such as those incurred in conjunction with restructuring
activities and recognized investment income/expense from available-for-sale
marketable securities. 25




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Concerns about genetically engineered products could result in our inability to
commercialize products. We produce a significant amount of our products from genetically modified
microorganisms. We cannot predict public attitudes and acceptance of existing
or future products made from genetically modified microorganisms. As a result,
if we are not able to overcome the ethical, legal and social concerns relating
to safety and environmental hazards of genetic engineering, the general public
may not accept our products and this may prevent us from commercializing
products dependent on our technologies or inventions. In addition, public
attitudes may influence laws and regulations governing the ownership or use of
genetic material, which could result in greater government regulation of
genetic research and bioengineered products. If we are subject to a costly product liability damage claim or award, our
profits could decline. We may be held liable if any product we develop, or any product that a
third party makes with the use or incorporation of any of our products, causes
injury or is found otherwise unsuitable during product testing, manufacturing,
marketing or sale. Our current product liability insurance may not cover our
potential liabilities. Inability to obtain sufficient insurance coverage in
the future at an acceptable cost or otherwise to protect against potential
liability claims could prevent or inhibit the commercialization of products
developed by us or our strategic partners. If a third party sues us for any
injury caused by our products, our liability could exceed our insurance
coverage amounts and total assets and our profits could decline. If we are subject to costly environmental liability due to the use of hazardous
materials in our business, our profits could decline. Our research and development processes involve the controlled use of
hazardous materials, including chemical, radioactive and biological materials.
Our operations also generate potentially hazardous waste. We cannot eliminate
entirely the risk of contamination or the discharge of hazardous materials and
any resultant injury from these materials. Federal, state, local and foreign
laws and regulations govern the use, manufacture, storage, handling and
disposal of these materials. Third parties may sue us for any injury or
contamination resulting from our use or the third partys use of these
materials. Any accident could partially or completely shut down our research
and manufacturing facilities and operations. In addition, if we are required
to comply with any additional applicable environmental laws and regulations, we
may incur additional costs, and any such current or future environmental
regulations may impair our research, development or production efforts. 
 Item 3. Quantitative and Qualitative Disclosures About Market Risk The information presented in Item 2 of Part I of this Report on Form 10-Q
under the heading Market Risk is hereby incorporated by reference. 
 Item 4. Controls and Procedures Disclosure Controls and Internal Controls Disclosure Controls are procedures that are designed with the objective of
ensuring that information required to be disclosed in our reports filed under
the Securities Exchange Act of 1934 (Exchange Act), such as this Report, is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commissions rules and forms. Disclosure
Controls are also designed with the objective of ensuring that such information
is accumulated and communicated to our management, including the Chief
Executive Officer and Chief Financial Officer, as appropriate to allow timely
decisions regarding required disclosure. Internal Controls are procedures which
are designed with the objective of providing reasonable assurance that (1) our
transactions are properly authorized; (2) our assets are safeguarded against
unauthorized or improper use; and (3) our transactions are properly recorded
and reported, all to permit the preparation of our financial statements in
conformity with accounting principles generally accepted in the United States
of America. Accordingly, a control system, no matter how well conceived and
operated, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met. Because of the inherent limitations
in any control system, misstatements due to error or fraud may occur and not be
detected. 26




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Evaluation of Disclosure Controls and Procedures As of the end of the period covered by this Report, we carried out an
evaluation, under the supervision and with the participation of our management,
including Jean-Jacques Bienaimé, our Chairman, Chief Executive Officer and
President, and Raymond J. Land, our Senior Vice President and Chief Financial
Officer, of the effectiveness of our disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based upon that
evaluation, Mr. Bienaimé and Mr. Land concluded that our disclosure controls
and procedures were effective as of the end of the period covered by this
Report. Changes in Internal Controls Over Financial Reporting There has been no change in our internal control over financial reporting
that occurred during the second quarter of 2004 that has materially affected,
or is reasonably likely to materially affect, our internal control over
financial reporting. 
 PART II. OTHER INFORMATION 
 Item 1. Legal Proceedings On or about July 16, 2004, three former employees of the Company in
Rochester, New York commenced a lawsuit in the United States District Court for
the Western District of New York in which they alleged that the Company had
discriminatorily discharged each of them in violation of the Age Discrimination
in Employment Act, the Older Workers Benefit Protection Act, and the New York
Human Rights Law. In the lawsuit, the plaintiffs are seeking an award from the
court that includes compensation for the value of lost back pay and benefits,
front pay, compensatory damages, punitive damages and attorneys fees. The
Company believes these claims are without merit and intends to defend the
claims alleged in the lawsuit. 
 Item 2. Change in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities The information presented in Item 2 of Part I of this Report on Form 10-Q
under the heading Liquidity and Capital Resources is hereby incorporated by
reference. The Companys Registration Statement on Form S-1 (Registration No.
333-36452) was effective as of July 27, 2000. 
 Item 3. Defaults Upon Senior Securities None 27




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Item 4. Submission of Matters to a Vote of Security Holders The Annual Meeting of Stockholders of the Company was held on May 27,
2004. At that meeting, the stockholders elected directors and ratified the
selection of PricewaterhouseCoopers LLP as independent accountants for the
fiscal year ended December 31, 2004. The total votes at the meeting were as
follows:  (i)
    
    To elect directors to serve a three-year term. VotesNominee
    
    For
    
    WithheldTheresa K. Lee
    
    
    58,596,432
    
    
    
    275,510Robert H. Mayer
    
    
    58,385,036
    
    
    
    486,906Jorgen Rosenlund
    
    
    58,596,357
    
    
    
    275,585
 There were no broker non-votes. Directors whose term in office continued after the meeting: Term expiring in 2005: Soren Bjerre-Nielsen, Joseph A.Mollica, Gregory O.
Nelson, James P. Rogers Term expiring in 2006: Jean-Jacques Bienaimé, Bruce C.
Cozadd, Norbert G. Riedel  (ii)
    
    To ratify the selection of PricewaterhouseCoopers LLP as
independent accountants for the fiscal year ending December 31, 2004. VotesFor
    
    Against
    
    Abstain58,501,166
    
    
    367,112
    
    
    
    3,664
 There were no broker non-votes. 
 Item 5. Other Information On June 15, 2004, the Company appointed Margaret (Peg) Horn as its new
Senior Vice President, General Counsel and Secretary to the Board of Directors.
Ms. Horn succeeded Stuart Melton who stepped down from his positions as
General Counsel and Secretary immediately prior to Ms. Horns appointment and
will retire effective January 1, 2005. On July 8, 2004, the Company amended its employment agreement with
Jean-Jacques Bienaimé, our Chairman, Chief Executive Officer and President.
The employment agreement provides for an annual salary of $546,000 and provides
that Mr. Bienaimés salary may be increased from time to time by action of our
board of directors or by our management development and compensation committee
and that these increases constitute amendments to Mr. Bienaimés employment
agreement. Mr. Bienaimé is entitled to participate in all insurance, pension,
retirement, deferred compensation, stock and stock option, stock purchase or
similar compensation and benefit plans and programs of the Company. Mr.
Bienaimé is also entitled to cash payments to cover the costs of an annual
physical not covered by health insurance benefits and the costs of financial
planning and income tax preparation services. In addition, the Company has
agreed to maintain for his benefit a fully-paid whole life insurance policy
with a stated death benefit of $500,000. In the event that the Company
terminates Mr. Bienaimés employment without cause or in the event that Mr.
Bienaimé resigns due to a constructive removal, a forced 28




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relocation, a decrease in salary or benefits or the Companys breach of
the agreement, he will receive severance in the form of continued compensation
for 24 months at his then current annual salary rate, a cash bonus under the
Companys variable pay plan, continuation of company-paid benefits for 24
months, and customary executive outplacement services limited to $18,000. Further, in the event the Company terminates Mr. Bienaimés employment
without cause following a change in our ownership or control in which more than
50 percent of our outstanding shares of common stock are acquired by an
unaffiliated third party, in lieu of the foregoing severance, he will receive
an enhanced severance (Enhanced Severance) in the form of continued cash
compensation for 30 months equal to the sum of his then current annual salary
rate plus bonus at 100 percent of target, continuation of company-paid benefits
for 30 months, the monetary equivalent of the crediting of an additional five
years of service to the pension plan and immediate eligibility for retiree
medical plan for purposes of determining benefits payable under these plans, a
cash payment of $18,000 for customary executive outplacement services, a cash
payment for the cost of annual physical examinations in the year of termination
and for two additional years thereafter which are not covered by health
insurance benefits, a fully-paid whole life insurance policy with a stated
death benefit of $500,000, a cash payment intended to cover the out of pocket
expenses incurred by Mr. Bienaimé annually for state and federal income tax
return preparation for the year of termination and two additional years, the
Companys annual contribution to his 401K Plan account for the year in which
termination occurs, and a full years credit towards his benefits under the
Companys pension plan. In addition to the Enhanced Severance, Mr. Bienaimé
would be eligible for a discretionary bonus, if granted, in connection with a
change in control and would be entitled to receive an additional payment to
reimburse Mr. Bienaimé for any excise tax otherwise payable by him as a result
of the Enhanced Severance. Also, certain benefits included in the agreement
are to be supplemented by the Company to compensate Mr. Bienaimé for taxes
payable on such benefits. In either severance event, we would compensate Mr.
Bienaimé for the applicable 24 or 30 month-period, respectively, if his
employment is terminated due to a permanent disability. In July, the Company also entered into employment agreements with each of
the executive officers. These employment agreements each have a one year term
with automatic one year renewals unless otherwise agreed, with bonus
compensation to be determined by our board of directors or our management
development and compensation committee. Each executive officers salary may be
increased from time to time by action of our management development and
compensation committee, and these increases constitute amendments to his or her
employment agreement. Each executive officer is entitled to participate in all
of our insurance, pension, retirement, deferred compensation, stock and stock
option, stock purchase or similar compensation and benefit plans and programs
of the Company. In the event that the Company terminates a named executive
officers employment without cause, or in the event that the executive officer
resigns due to a constructive removal, a forced relocation, a decrease in
salary or benefits or the Companys breach of the agreement, he or she will
receive severance in the form of continued compensation for 18 months at his or
her then current annual salary rate, a cash bonus under the Companys variable
pay plan, continuation of company-paid benefits for 18 months, and outplacement
services of $18,000. As with Mr. Bienaimé, each executive officer is also
eligible to receive the Enhanced Severance termination compensation for 30
months in lieu of the foregoing severance, except that the whole life insurance
policy stated death benefit shall be $300,000. The Company will continue to
compensate each of these individuals for the applicable 18 or 30 month-period,
respectively, if that persons employment is terminated due to a permanent
disability. In addition, for the two executive officers currently receiving
declining housing supplements, at levels which were frozen in 2003, these
officers would continue to receive such payments for the applicable 18 or
30-month period described above. 
 Item 6. Exhibits and Reports on Form 8-K  a.
    
    Exhibits (10)
    
    Material
Contracts+10.1
    
    Amended and Restated Research Agreement dated June 14, 2004
between Dow Corning Corporation and the Company#10.2
    
    Employment and Separation Agreement dated May 1, 2004 between
the Company and Stuart Melton#10.3
    
    Employment Agreement dated July 8, 2004 between the Company and Jean-Jacques Bienaimé
 29




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#10.4
    
    Form of Employment Agreement between the Company and its
executive officers10.5
    
    Rental Agreement originally dated April 29, 1966 between the
City of Hanko and the Companys ultimate precedessor-in-interest,
Suomen Sokeri Osakeyhtio [Ground Lease for Hanko, Finland](31)
    
    Rule 13a-14(a)/15d-14(a)
Certifications31.1
    
    Rule 13a-14(a)/15d-14(a) Certification of Chief Executive
Officer31.2
    
    Rule 13a-14(a)/15d-14(a) Certification of Chief Financial
Officer(32)
    
    Section 1350
Certifications32.1
    
    Section 1350 Certifications of the Chief Executive
Officer and the Chief Financial Officer+
    
    Confidential treatment requested as to certain information
which has been omitted from the agreement and which has been
separately filed with the Securities and Exchange Commission pursuant
to an application for such treatment.#
    
    Management contract or compensatory plan.
  b.
    
    Reports on Form 8-K On April 29, 2004 the Company furnished a Current Report on Form
8-K reporting its press release concerning financial results for the first quarter of 2004
 under Items 7 and 12. The report included condensed financial statements and other financial
information. 30




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this Report to be signed on its behalf by
the undersigned, thereunto duly authorized. GENENCOR INTERNATIONAL, INC.August 6,
2004Date
    
    By:/s/
    
    Raymond J. LandRaymond J. LandSenior Vice President and Chief Financial Officer(Principal Financial Officer)August 6, 2004
Date
    
    By:/s/
    
    Darryl L. CanfieldDarryl L. CanfieldVice President and Corporate Controller(Chief Accounting Officer)
 31




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EXHIBIT INDEX ExhibitNumber
    
    Description+10.1
    
    Amended and Restated Research
Agreement dated June 14, 2004 between Dow Corning Corporation and the
Company.#10.2
    
    Employment and Separation Agreement dated May 1, 2004 between the Company and
Stuart Melton#10.3
    
    Employment Agreement dated July 8, 2004 between the Company and Jean-Jacques
Bienaimé#10.4
    
    Form of Employment Agreement between the Company and its executive officers10.5
    
    Rental Agreement originally dated April 29, 1966 between the City of Hanko and the Companys
ultimate precedessor-in-interest, Suomen Sokeri Osakeyhtio [Ground Lease for Hanko, Finland]31.1
    
    Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer31.2
    
    Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer32.1
    
    Section 1350 Certifications of the Chief Executive Officer and the Chief Financial
Officer
    +
    
    Confidential treatment requested as to certain information
which has been omitted from the agreement and which has been
separately filed with the Securities and Exchange Commission pursuant
to an application for such treatment.#
    
    Management contract or compensatory plan 32