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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 1934
 For the quarterly period ended September 30, 2004 OR [   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from _____________ to______________ Commission file number 000-31167 Genencor International, Inc. (Exact Name of Registrant as Specified in Its Charter)
   Delaware
    
    16-1362385(State or Other Jurisdiction of
    
    (I.R.S. EmployerIncorporation or Organization)
    
    Identification Number)
 925 Page Mill RoadPalo Alto, California
    
    94304(Address of principal executive offices)
    
    (zip code)
 (650) 846-7500
(Registrants telephone number, including area code)   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 October 29, 2004Common stock, par value $0.01 per share
    
    59,661,708




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TABLE OF CONTENTS PagePART I. FINANCIAL INFORMATIONItem 1. Financial Statements:Condensed Consolidated Unaudited Balance Sheets as of September 30, 2004 and December 31, 2003
    
    
    4Condensed Consolidated Unaudited Statements of Operations for the three and nine months ended September 30, 2004 and 2003
    
    
    5Condensed Consolidated Unaudited Statements of Cash Flows for the nine months ended September 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
    
    
    14Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    28Item 4. Controls and Procedures
    
    
    28PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    29Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    29Item 3. Defaults Upon Senior Securities
    
    
    29Item 4. Submission of Matters to a Vote of Security Holders
    
    
    29Item 5. Other Information
    
    
    29Item 6. Exhibits
    
    
    29SIGNATURES
    
    
    30EXHIBIT INDEX
    
    
    31EX-10.1 AWARD NOTICEEX-10.2 RESIDENTIAL LEASEEX-10.3 RESIDENTIAL LEASEEX-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) September 30,
    
    December 31,2004
    
    2003AssetsCurrent assets:Cash and cash equivalents
    
    $
    167,663
    
    
    $
    166,551Trade accounts receivable, net
    
    
    63,219
    
    
    
    58,249Inventories
    
    
    76,248
    
    
    
    64,159Other current assets
    
    
    26,179
    
    
    
    36,253Total current assets
    
    
    333,309
    
    
    
    325,212Property, plant and equipment, net
    
    
    227,515
    
    
    
    232,902Goodwill
    
    
    29,381
    
    
    
    29,380Intangible assets, net
    
    
    43,205
    
    
    
    47,075Other assets
    
    
    71,808
    
    
    
    77,853Total assets
    
    $
    705,218
    
    
    $
    712,422Liabilities, Redeemable Preferred Stock and Stockholders EquityCurrent liabilities:Notes payable
    
    $
    5,908
    
    
    $
    5,926Current maturities of long-term debt
    
    
    28,249
    
    
    
    28,249Accounts payable and accrued expenses
    
    
    35,287
    
    
    
    49,143Other current liabilities
    
    
    23,936
    
    
    
    18,850Total current liabilities
    
    
    93,380
    
    
    
    102,168Long-term debt
    
    
    28,463
    
    
    
    58,466Other long-term liabilities
    
    
    39,051
    
    
    
    39,101Total liabilities
    
    
    160,894
    
    
    
    199,735Redeemable preferred stock:7 1/2% cumulative series A preferred stock, without par value, authorized
1 shares, 1 shares issued and outstanding
    
    
    182,482
    
    
    
    177,025Stockholders equity:Common stock, par value $0.01 per share, 200,000 shares authorized, 61,350
and 60,991 shares issued at September 30, 2004 and
December 31, 2003, respectively
    
    
    614
    
    
    
    610Additional paid-in capital
    
    
    363,982
    
    
    
    359,344Treasury stock, 1,780 shares at cost at September 30, 2004 and December 31,
2003
    
    
    (21,030
    )
    
    
    (21,030
    )Deferred stock-based compensation
    
    
    (666
    )
    
    
    (1,036
    )Retained earnings
    
    
    25,038
    
    
    
    589Accumulated other comprehensive loss
    
    
    (6,096
    )
    
    
    (2,815
    )Total stockholders equity
    
    
    361,842
    
    
    
    335,662Total liabilities, redeemable preferred stock and stockholders equity.
    
    $
    705,218
    
    
    $
    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
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Revenues:Product revenue
    
    $
    99,469
    
    
    $
    89,795
    
    
    $
    287,181
    
    
    $
    269,577Fees and royalty revenues
    
    
    2,385
    
    
    
    4,349
    
    
    
    18,968
    
    
    
    16,575Total revenues
    
    
    101,854
    
    
    
    94,144
    
    
    
    306,149
    
    
    
    286,152Operating expenses:Cost of products sold
    
    
    58,366
    
    
    
    52,096
    
    
    
    163,862
    
    
    
    154,723Research and development
    
    
    18,450
    
    
    
    18,315
    
    
    
    52,857
    
    
    
    51,608Sales, marketing and business development
    
    
    9,680
    
    
    
    8,320
    
    
    
    27,366
    
    
    
    23,921General and administrative
    
    
    10,506
    
    
    
    7,946
    
    
    
    28,420
    
    
    
    23,729Amortization of intangible assets
    
    
    1,159
    
    
    
    1,414
    
    
    
    3,482
    
    
    
    4,304Other (income)/expense
    
    
    (339
    )
    
    
    (351
    )
    
    
    (8,334
    )
    
    
    408Total operating expenses
    
    
    97,822
    
    
    
    87,740
    
    
    
    267,653
    
    
    
    258,693Operating income
    
    
    4,032
    
    
    
    6,404
    
    
    
    38,496
    
    
    
    27,459Non operating expenses/(income):Investment expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,018Interest expense
    
    
    1,163
    
    
    
    1,539
    
    
    
    3,705
    
    
    
    5,128Interest income
    
    
    (897
    )
    
    
    (601
    )
    
    
    (2,590
    )
    
    
    (3,004
    )Total non operating expenses/(income)
    
    
    266
    
    
    
    938
    
    
    
    1,115
    
    
    
    3,142Income before income taxes
    
    
    3,766
    
    
    
    5,466
    
    
    
    37,381
    
    
    
    24,317Provision for income taxes
    
    
    753
    
    
    
    1,367
    
    
    
    7,476
    
    
    
    6,079Net income
    
    $
    3,013
    
    
    $
    4,099
    
    
    $
    29,905
    
    
    $
    18,238Net income available to holders of common stock
    
    $
    1,195
    
    
    $
    2,281
    
    
    $
    24,449
    
    
    $
    12,782Earnings per common share:Basic
    
    $
    0.02
    
    
    $
    0.04
    
    
    $
    0.41
    
    
    $
    0.22Diluted
    
    $
    0.02
    
    
    $
    0.04
    
    
    $
    0.40
    
    
    $
    0.21Weighted average common shares:Basic
    
    
    59,468
    
    
    
    58,895
    
    
    
    59,346
    
    
    
    58,655Diluted
    
    
    61,199
    
    
    
    61,859
    
    
    
    61,100
    
    
    
    60,296
 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) Nine months endedSeptember 30,2004
    
    2003Cash flows from operating activities:Net income
    
    $
    29,905
    
    
    $
    18,238Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization
    
    
    27,337
    
    
    
    26,639Amortization of deferred stock-based
compensation
    
    
    540
    
    
    
    679Loss on disposition of property, plant and
equipment
    
    
    
    
    
    
    631Loss from impairment of investment in
marketable equity securities
    
    
    
    
    
    
    1,018(Increase) decrease in operating assets:Trade accounts receivable
    
    
    (3,254
    )
    
    
    (4,134
    )Inventories
    
    
    (11,975
    )
    
    
    1,239Other assets
    
    
    9,255
    
    
    
    (12,894
    )Increase (decrease) in operating liabilities:Accounts payable and accrued expenses
    
    
    (10,152
    )
    
    
    (13,440
    )Other liabilities
    
    
    92
    
    
    
    3,625Net cash provided by operating activities
    
    
    41,748
    
    
    
    21,601Cash flows from investing activities:Purchases of property, plant and equipment
    
    
    (16,784
    )
    
    
    (18,640
    )Proceeds from sale of business
    
    
    
    
    
    
    1,145Proceeds from note receivable
    
    
    377
    
    
    
    Assumption of controlling interest in joint venture
    
    
    3,751
    
    
    
    Payments related to prior acquisition
    
    
    (632
    )
    
    
    Net cash used in investing activities
    
    
    (13,288
    )
    
    
    (17,495
    )Cash flows from financing activities:Proceeds from exercise of stock options
    
    
    2,377
    
    
    
    4,362Proceeds from employee stock purchase plan
    
    
    1,280
    
    
    
    1,103Net (payments on) proceeds from notes payable of
foreign affiliate
    
    
    (1,830
    )
    
    
    278Payment of long-term debt
    
    
    (28,189
    )
    
    
    (28,185
    )Net cash used in financing activities
    
    
    (26,362
    )
    
    
    (22,442
    )Effect of exchange rate changes on cash
    
    
    (986
    )
    
    
    6,432Net increase (decrease) in cash and cash equivalents
    
    
    1,112
    
    
    
    (11,904
    )Cash and cash equivalents  beginning of period
    
    
    166,551
    
    
    
    169,001Cash and cash equivalents  end of period
    
    $
    167,663
    
    
    $
    157,097
 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 adoption of FSP
No. 106-2 has had no material impact on the Companys financial position or
results of operations. 3  Pension Plans A summary of the components of net periodic pension cost, a non-cash item,
for the nine months ended September 30 is as follows: 2004
    
    2003Service Cost
    
    $
    2,047
    
    
    $
    1,954Interest Cost
    
    
    528
    
    
    
    469Expected return on plan assets
    
    
    (778
    )
    
    
    (507
    )Net amortization
    
    
    19
    
    
    
    77Net periodic pension cost
    
    $
    1,816
    
    
    $
    1,993
 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 $1,818 and $5,456 were
deducted from net income for each quarter presented and for each nine month
period presented, respectively. 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 and its predecessor plan, the Stock
Option and Stock Appreciation Right Plan, there were dilutive securities for
the three and nine months ended September 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
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net income
    
    $
    3,013
    
    
    $
    4,099
    
    
    $
    29,905
    
    
    $
    18,238Less: Accrued dividends on preferred stock
    
    
    (1,818
    )
    
    
    (1,818
    )
    
    
    (5,456
    )
    
    
    (5,456
    )Net income available to holders of common stock
    
    $
    1,195
    
    
    $
    2,281
    
    
    $
    24,449
    
    
    $
    12,782Weighted average common shares:Basic
    
    
    59,468
    
    
    
    58,895
    
    
    
    59,346
    
    
    
    58,655Effect of stock options
    
    
    1,731
    
    
    
    2,964
    
    
    
    1,754
    
    
    
    1,641Diluted
    
    
    61,199
    
    
    
    61,859
    
    
    
    61,100
    
    
    
    60,296Earnings per common share:Basic
    
    $
    0.02
    
    
    $
    0.04
    
    
    $
    0.41
    
    
    $
    0.22Diluted
    
    $
    0.02
    
    
    $
    0.04
    
    
    $
    0.40
    
    
    $
    0.21
 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. Pursuant to SFAS No. 148, 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: 8




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Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net income available to
holders of common stock
- as reported
    
    $
    1,195
    
    
    $
    2,281
    
    
    $
    24,449
    
    
    $
    12,782Add: Stock-based
employee compensation
expense included in
reported net income
available, net of
related tax
    
    
    
    
    
    
    16
    
    
    
    108
    
    
    
    302Deduct: Total
stock-based employee
compensation expense
determined under fair
value based method
for all awards, net of
related tax effect
    
    
    (1,290
    )
    
    
    (1,516
    )
    
    
    (4,164
    )
    
    
    (4,140
    )Net income available to
holders of common stock
- pro forma
    
    $
    (95
    )
    
    $
    781
    
    
    $
    20,393
    
    
    $
    8,944Basic  as reported
    
    $
    0.02
    
    
    $
    0.04
    
    
    $
    0.41
    
    
    $
    0.22Basic  pro forma
    
    $
    0.00
    
    
    $
    0.01
    
    
    $
    0.34
    
    
    $
    0.15Diluted  as reported
    
    $
    0.02
    
    
    $
    0.04
    
    
    $
    0.40
    
    
    $
    0.21Diluted  pro forma
    
    $
    0.00
    
    
    $
    0.01
    
    
    $
    0.33
    
    
    $
    0.15
 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: September 30,
    
    December 31,2004
    
    2003Raw materials
    
    $
    10,503
    
    
    $
    7,682Work-in-progress
    
    
    9,946
    
    
    
    9,106Finished goods
    
    
    55,799
    
    
    
    47,371Inventories
    
    $
    76,248
    
    
    $
    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 December 31, 2003 through September 30, 2004: Intangible Assets
    
    GoodwillOtherAmortizableTechnology
    
    Assets
    
    TotalBalances, December 31, 2003
    
    $
    15,831
    
    
    $
    73,591
    
    
    $
    89,422
    
    
    $
    29,380Foreign currency
translation
and other adjustments
    
    
    (2
    )
    
    
    (474
    )
    
    
    (476
    )
    
    
    1Balances, September 30, 2004
    
    $
    15,829
    
    
    
    73,117
    
    
    
    88,946
    
    
    $
    29,381Less: Accumulated
amortization
    
    
    
    
    
    
    (45,741
    )
    
    
    (45,741
    )Intangible assets, net
    
    
    
    
    
    $
    27,376
    
    
    $
    43,205
 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
    
    
    (2,191
    )
    
    
    (1,090
    )
    
    
    (3,281
    )Balances, September 30, 2004
    
    $
    (4,541
    )
    
    $
    (1,555
    )
    
    $
    (6,096
    )
 The change in the foreign currency translation adjustment for the nine
months ended September 30, 2004 relates primarily to Company operations with
functional currencies in Euros. The change in the marketable securities
valuation adjustment for the nine months ended September 30, 2004 of $1,090
($1,732 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 nine months ended September 30, 2004
was 20%, compared to 25% for the nine months ended September 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 nine months ended September 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 $2,393 for the nine months
ended September 30, 2004 from the nine months ended September 30, 2003 was
primarily driven by the technology transfer described 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 primarily engaged in the performance of
research and development, the securing of intellectual property and the
establishment of strategic investments and collaborations with the main
objective of creating and advancing new therapeutic products for the health
care market. The following table provides information by business segment: For the three months ended September 30, 2004 Corporate
    
    ConsolidatedBioproducts
    
    Health Care
    
    Segment Subtotal
    
    and Other
    
    TotalsProduct revenue
    
    $
    99,469
    
    
    $
    
    
    
    $
    99,469
    
    
    $
    
    
    
    $
    99,469Fees and royalty revenues
    
    
    2,235
    
    
    
    150
    
    
    
    2,385
    
    
    
    
    
    
    
    2,385Total revenues
    
    
    101,704
    
    
    
    150
    
    
    
    101,854
    
    
    
    
    
    
    
    101,854Research and development
    
    
    12,229
    
    
    
    6,221
    
    
    
    18,450
    
    
    
    
    
    
    
    18,450Operating income/(loss)
    
    
    11,553
    
    
    
    (7,753
    )
    
    
    3,800
    
    
    
    232
    
    
    
    4,032
 For the three months ended September 30, 2003 Corporate
    
    ConsolidatedBioproducts
    
    Health Care
    
    Segment Subtotal
    
    and Other
    
    TotalsProduct revenue
    
    $
    89,795
    
    
    $
    
    
    
    $
    89,795
    
    
    $
    
    
    
    $
    89,795Fees and royalty revenues
    
    
    4,149
    
    
    
    200
    
    
    
    4,349
    
    
    
    
    
    
    
    4,349Total revenues
    
    
    93,944
    
    
    
    200
    
    
    
    94,144
    
    
    
    
    
    
    
    94,144Research and development
    
    
    10,925
    
    
    
    7,390
    
    
    
    18,315
    
    
    
    
    
    
    
    18,315Operating income/(loss)
    
    
    15,379
    
    
    
    (9,183
    )
    
    
    6,196
    
    
    
    208
    
    
    
    6,404
 11




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##### Table of Contents



For the nine months ended September 30, 2004 Corporate
    
    ConsolidatedBioproducts
    
    Health Care
    
    Segment Subtotal
    
    and Other
    
    TotalsProduct revenue
    
    $
    287,181
    
    
    $
    
    
    
    $
    287,181
    
    
    $
    
    
    
    $
    287,181Fees and royalty revenues
    
    
    8,593
    
    
    
    10,375
    
    
    
    18,968
    
    
    
    
    
    
    
    18,968Total revenues
    
    
    295,774
    
    
    
    10,375
    
    
    
    306,149
    
    
    
    
    
    
    
    306,149Research and development
    
    
    35,403
    
    
    
    17,454
    
    
    
    52,857
    
    
    
    
    
    
    
    52,857Operating income/(loss)
    
    
    49,707
    
    
    
    (11,334
    )
    
    
    38,373
    
    
    
    123
    
    
    
    38,496
 For the nine months ended September 30, 2003 Corporate
    
    ConsolidatedBioproducts
    
    Health Care
    
    Segment Subtotal
    
    and Other
    
    TotalsProduct revenue
    
    $
    269,577
    
    
    $
    
    
    
    $
    269,577
    
    
    $
    
    
    
    $
    269,577Fees and royalty revenues
    
    
    16,150
    
    
    
    425
    
    
    
    16,575
    
    
    
    
    
    
    
    16,575Total revenues
    
    
    285,727
    
    
    
    425
    
    
    
    286,152
    
    
    
    
    
    
    
    286,152Research and development
    
    
    32,159
    
    
    
    19,449
    
    
    
    51,608
    
    
    
    
    
    
    
    51,608Operating income/(loss)
    
    
    52,174
    
    
    
    (24,625
    )
    
    
    27,549
    
    
    
    (90
    )
    
    
    27,459
 The following table provides a reconciliation of segment information to total
consolidated information: Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net income:Operating income for
reportable segments
    
    $
    3,800
    
    
    $
    6,196
    
    
    $
    38,373
    
    
    $
    27,549Other (income)/expense
    
    
    (232
    )
    
    
    (208
    )
    
    
    (123
    )
    
    
    90Investment expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,018Interest expense
    
    
    1,163
    
    
    
    1,539
    
    
    
    3,705
    
    
    
    5,128Interest (income)
    
    
    (897
    )
    
    
    (601
    )
    
    
    (2,590
    )
    
    
    (3,004
    )Provision for income taxes
    
    
    753
    
    
    
    1,367
    
    
    
    7,476
    
    
    
    6,079Consolidated net income
    
    $
    3,013
    
    
    $
    4,099
    
    
    $
    29,905
    
    
    $
    18,238
 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. 12




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13  Joint Venture On April 1, 2004 the Company assumed majority ownership and controlling
interest of the Companys joint venture with Kyowa Hakko Kogyo Co. Ltd., in
which the Company has had an equity position since 1996. This ownership change
resulted from the joint ventures partial repurchase of the other owners
share. This venture has been renamed Genencor Kyowa Co. Ltd. The financial
position, results of operations and cash flows of the joint venture have been
included in the Companys consolidated financial statements beginning April 1,
2004. 14  Related Party Transactions The Company previously had relocation-related notes receivable from
certain of its officers, including a $1,200 note from Richard J. Ranieri,
Senior Vice President of Human Resources, and a $1,350 note from Raymond J.
Land, Senior Vice President and Chief Financial Officer. Both of these loans
commenced in 2000, were non-interest bearing and were due five years from their
date of issuance. During the third quarter of 2004, the Company purchased
these officers residences for an aggregate of $5,190 and cancelled these notes
as partial payment for the properties. Third party appraisals were used to
confirm that the purchase price for each property approximated fair market
value on the date of acquisition. Each officer, together with his spouse, then
entered into a lease with the Company for his residence providing for a lease
term of up to 36 months. 15  Supplemental Cash Flow Information Nine months endedSeptember 30,2004
    
    2003Schedule of non-cash investing and
financing activity:Issuance of restricted stock
    
    $
    
    
    
    $
    675Acquisition of residential properties
    
    $
    2,550
    
    
    $
    
 15  Subsequent Events On October 22, 2004, President George W. Bush signed into law the American
Jobs Creation Act of 2004 (H.R. 4520). This Act contains numerous corporate
tax provisions, which could affect the Companys current and future tax
provisions. The Company is currently assessing any potential impact of these
provisions. 13




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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, carbohydrate processing (formerly referred to as
sweeteners), fermentation alcohol and food, feed and specialties markets, and
from research funding, fees and royalties. In the three months ended September
30, 2004, we expended $12.2 million on our Bioproducts research and development
programs. In addition to developing products for our current Bioproducts
markets, we are also involved in Bioproducts 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 $6.2 million in the third 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 September 30, 2004, net income
available to common stockholders was $1.2 million, or $0.02 per diluted share,
compared to $2.3 million or $0.04 per diluted share during the same period in
2003. Product revenues increased by 11% to $99.5 million, compared to $89.8
million in the third quarter of 2003. Total revenues for the three months
ended September 30, 2004 were $101.9 million, compared to $94.1 million for the
same period in 2003. Fees and royalty revenues were $2.4 million in the third
quarter as compared to $4.3 million in the prior year, due primarily to the end
of the amortization period for an upfront research payment from Dow Corning in
the 2003 period. Lower net income available to stockholders was
due in part to increased general and administrative expenses. For the three
months ended September 30, 2004, we generated $4.0 million in operating income
and $16.7 million in cash flow from operations. We also invested $7.3 million
in purchases of property, plant and equipment. For the nine months ended September 30, 2004, total revenues were $306.1
million, compared to $286.2 million for the same period in 2003. Net income
available to common stockholders was $24.4 million or $0.40 per diluted share
for the nine months ended September 30, 2004, compared to $12.8 million or
$0.21 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 September 30, 2004, our Bioproducts segment set a
quarterly product revenue record for the Company, driven by increased revenue
in all regions. Particular strength was seen in the fermentation alcohol,
carbohydrate processing and the food, feed and specialties markets. Globally,
all regions reported increased sales, with Asia Pacific, Europe and Latin
America 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 September 30, 2004, we derived approximately 55% of our
revenues from our foreign operations. During the third quarter, we also continued to make significant progress
on new applications within the Bioproducts segment. We, along with the
Stanford Linear Accelerator Center, achieved an important breakthrough
in the ability to compute, in record time, all possible metabolic behaviors
open to a microorganism. This development is expected to facilitate
engineering of a given microorganism to assist in the creation of an array of
desired products. A significant decrease in the time to compute the reaction
spectrum paves the way for new applications in metabolic engineering and
beyond. Moving from a small target molecule back to the pathway and then back
to the gene industrializes the process of developing co-products in, for
example, a biorefinery. Our progress in developing low cost enzymes for
cellulosic biomass 14




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conversion to ethanol has exceeded the contractual goals and expectations
of the National Renewable Energy Laboratory (NREL) and the Department of
Energy. Based upon NRELs model, our scientists have achieved an estimated
30-fold improvement in enzyme cost for the process. NREL is expected to
validate these results at pilot scale within the next quarter. As
biorefineries come on line, we expect to be ready with technology instrumental
to bioethanol production. We continued our progress in commercializing new
products for the safety and protection opportunities within our specialty
business category. Biodefense enzymes for the neutralization of
organophosophate nerve agents, like sarin, are expected to generate initial
revenue in the near term. Our proprietary enzyme system for the elimination of
prion infectivity also continues to advance through development and is
currently under regulatory review. Once approved, we expect to commercialize
the product in 2005 for use in hospitals and other medical settings, with
future possible uses in the meat packing and processing industries. Efforts
also continued in other Bioproducts projects, including personal care and the
Silicon BiotechnologyTM platform. Our
Health Care segment continued to make progress during the third
quarter focusing its attention and resources on targeted cancer
biotherapeutics. As previously announced, we advanced our first
product candidate for treating cancer into investigational new drug
application (IND) enabling development earlier this year. The lead
product candidate is intended to target significant unmet medical
needs in colorectal and pancreatic carcinoma. The preliminary
time line anticipates filing an IND in late 2005 with clincal trials
to follow thereafter. Results of Operations Comparison of the Three Months Ended September 30, 2004 and 2003 Revenues.Total revenues for the three-month period ended September 30,
2004 increased $7.8 million, or 8%, to $101.9 million from the three-month
period ended September 30, 2003, due to increases in product revenues. Product Revenues.Product revenues for the three months ended September
30, 2004 increased $9.7 million, or 11%, to $99.5 million from the three months
ended September 30, 2003. For the three months ended September 30, 2004, unit
volume/mix increased revenues 10% and the impact of foreign currency, primarily
the Euro, increased revenues 4% while average prices fell 3%. Volume/mix
increased primarily in our carbohydrate processing, fermentation alcohol,
cleaning and food, feed and specialties markets. Regionally, North American product revenues for the three months ended
September 30, 2004 increased $2.2 million, or 6%, to $40.9 million from the
three months ended September 30, 2003, driven primarily by increased sales to
our fermentation alcohol, carbohydrate processing, textiles, and food, feed and
specialties markets, partially offset by decreased sales to our cleaning
markets. Product revenues in Europe, Africa and the Middle East for the three
months ended September 30, 2004 increased $5.7 million, or 16%, to $42.0
million from the three months ended September 30, 2003, driven primarily by
increased sales to our cleaning, food, feed and specialties, carbohydrate
processing and fermentation alcohol markets, partially offset by decreased
sales to our textiles markets. Our product revenues in the Asia Pacific region
increased $1.4 million, or 12%, to $13.0 million for three months ended
September 30, 2004 from the three months ended September 30, 2003, due
primarily to increased sales to our food, feed and specialties, cleaning, and
carbohydrate processing markets, partially offset by decreased sales to our
textiles and fermentation alcohol markets. Our product revenues in Latin
America for the three months ended September 30, 2004 increased $0.4 million,
or 13%, to $3.6 million from the three months ended September 30, 2003,
primarily due to increased sales to our carbohydrate processing, textiles and
food, feed and specialties markets partially offset by decreased sales to our
cleaning markets. Fees and Royalty Revenues.Fees and royalty revenues decreased $1.9
million, or 44% to $2.4 million, for the three months ended September 30, 2004
from the three months ended September 30, 2003. Funded research revenues for the three months ended September 30, 2004
decreased $2.7 million, or 66%, to $1.4 million from the three months ended
September 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 was $0.3 million for the three months ended September 30, 2004
primarily due to funding pursuant to our work with Cargill Dow on a U.S.
Department of Energy supported biorefinery project and 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
$3.0 million, or 73%, to $1.1 million for the three months ended September 30,
2004 from the three months ended September 30, 2003, due primarily to a
reduction in funding from our strategic alliance with the Dow Corning
Corporation. 15




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##### Table of Contents



Royalties increased $0.1 million, or 50%, to $0.3 million for the three
months ended September 30, 2004 from the three months ended September 30, 2003,
due primarily to the sales of customers products produced using our
technology. All other fees were $0.7 million for the three months ended September 30,
2004. These fees are related to the sale of rights to third parties for the
use of our technology and patents to manufacture products. There were no such
fees for the three months ended September 30, 2003. Operating Expenses Cost of Products Sold.Cost of products sold increased $6.3 million, or
12%, to $58.4 million for the three months ended September 30, 2004 from the
three months ended September 30, 2003. Our expanded sales volume/mix increased
costs by $3.2 million, along with increases due to the impact of the U.S.
Dollar against foreign currencies, primarily the Euro, of $1.8 million, and an
increase in production costs of approximately $1.3 million. Gross Profit and Margins from Products Sold.Gross profit from products
sold increased $3.4 million, or 9%, to $41.1 million for the three months ended
September 30, 2004 from the three months ended September 30, 2003. This
increase in gross profit was primarily driven by favorable product volume/mix
partially offset by a reduction in average prices and an increase in production
costs. Our gross profit was also benefited by a $1.5 million increase due to
the impact of the U.S. Dollar against foreign currencies, primarily the Euro.
As a result of these factors, however, gross margin on product revenue
decreased to 41.3% for the three months ended September 30, 2004 from 42.0% for
the three months ended September 30, 2003, driven primarily by the impact of
lower average selling prices and higher production costs, partially offset by
the impact of favorable product volume/mix. 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 $0.2 million, or 1%, to
$18.5 million for the three months ended September 30, 2004 from the three
months ended September 30, 2003, due primarily to increases in
personnel-related costs, including salaries, benefits, travel expenses and
other costs of $0.7 million, supply costs of $0.5 million, and other expenses
of $0.3 million, partially offset by a decrease in outside services of $1.3
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 17%, to $2.0 million for the three months ended
September 30, 2004 from the three months ended September 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 and business development functions.
These expenses increased $1.4 million, or 17%, to $9.7 million for the three
months ended September 30, 2004 from the three months ended September 30, 2003,
due primarily to increases in personnel-related costs, including salaries,
benefits and travel expenses of $0.5 million, outside services of $0.4 million,
facilities costs of $0.2 million and other costs 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. These expenses increased $2.6
million, or 33%, to $10.5 million for the three months ended September 30, 2004
from the three months ended September 30, 2003, due primarily to increases in
outside services of $1.9 million, and in personnel-related costs, including
salaries, benefits, and travel expenses of $0.6 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 $0.2 million, or 14%, to $1.2 million
for the three months ended September 30, 2004 from the three months ended
September 30, 2003. This decrease was due to certain intangible assets
becoming fully amortized by year-end 2003. Other Expense and Income.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 was $0.3 million for the three months ended September 30, 2004 and
for the three months ended September 30, 2003. 16




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Non Operating Expense and Income Interest Income. Interest income increased $0.3 million, or 50%, to $0.9
million for the three months ended September 30, 2004 from the three months
ended September 30, 2003, due mainly to higher cash balances as discussed below
under the heading Liquidity and Capital Resources. Income Taxes.The effective income tax rate for the three months ended
September 30, 2004 was 20%, compared to 25% for the three months ended
September 30, 2003. Factors affecting our 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 effective rate for the
three months ended September 30, 2003 included the effect of estimated
valuation allowances, since we did not anticipate the ability to utilize
certain tax credits. On October 22 2004, President George W. Bush signed into law the American Jobs Creation Act of 2004 (H.R. 4520). This Act contains numerous corporate tax provisions, which could affect our current and future tax provisions. We are currently assessing any potential impact of these provisions. Comparison of the Nine Months Ended September 30, 2004 and 2003 Revenues.Total revenues for the nine months ended September 30, 2004
increased $19.9 million, or 7%, to $306.1 million from the nine months ended
September 30, 2003, due to increases in both product revenues and fees and
royalty revenues. Product Revenues.Product revenues in the nine months ended September 30,
2004 increased $17.6 million, or 7%, to $287.2 million from the nine months
ended September 30, 2003. For the nine months ended September 30, 2004, unit
volume/mix increased revenues 5% and the impact of foreign currency, primarily
the Euro, increased revenues 4%, while average prices fell 2%. Volume/mix
increased in our carbohydrate processing, fermentation alcohol, cleaning,
textiles and food, feed and specialties markets. Regionally, North American product revenues for the nine months ended
September 30, 2004 increased $3.7 million, or 3%, to $119.1 million from the
nine months ended September 30, 2003, driven primarily by increased sales to
our fermentation alcohol, carbohydrate processing, and 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 nine months ended September 30, 2004 increased $12.8 million, or 12%, to
$120.9 million from the nine months ended September 30, 2003, driven primarily
by increased sales to our cleaning, textiles, carbohydrate processing, and
food, feed and specialties markets, partially offset by decreased sales to our
fermentation alcohol markets. Product revenues in the Asia Pacific region
increased $1.7 million, or 5%, to $37.7 million for the nine months ended
September 30, 2004 from the nine months ended September 30, 2003, due to
increased sales to our food, feed and specialties, carbohydrate processing and
cleaning markets, partially offset by decreased sales to our textiles and
fermentation alcohol markets. Our product revenues in Latin America for the
nine months ended September 30, 2004 decreased $0.5 million, or 5%, to $9.5
million from the nine months ended September 30, 2003, due primarily to
decreased sales to our food, feed and specialties and cleaning markets,
partially offset by increased sales to our textiles and carbohydrate processing
markets. Fees and Royalty Revenues.Fees and royalty revenues increased $2.3
million, or 14%, to $18.9 million for the nine months ended September 30, 2004
from the nine months ended September 30, 2003, due mainly to the recognition in
2004 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 Part I of this Report. This increase is partially
offset by a decrease during the nine months ended September 30, 2004 of
approximately $7.7 million in funding from our strategic alliance with the Dow
Corning Corporation. Funded research revenues decreased $8.5 million, or 56%, to $6.8 million
for the nine months ended September 30, 2004 from the nine months ended
September 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 $1.0 million, or 36%, to $3.8 million for the nine
months ended September 30, 2004 from the nine months ended September 30, 2003,
primarily due to funding provided by the National Renewable Energy Laboratory
to develop an enzymatic process to convert biomass into ethanol and funding
pursuant to our work with Cargill Dow on a U.S. Department of Energy supported
biorefinery project. Funded research revenues provided by customers decreased
$9.5 million, or 76%, to $3.0 million for the nine months ended 17




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September 30, 2004 from the nine months ended September 30, 2003, due
primarily to the reduction in funding from our strategic alliance with the Dow
Corning Corporation. During the second quarter of 2004, we renewed our
collaboration with the Dow Corning Corporation regarding the Silicon
Biotechnology platform by agreeing to a two-year extension, effective January
1, 2004. Royalties increased $0.1 million, or 9%, to $1.2 million for the nine
months ended September 30, 2004 from the nine months ended September 30, 2003,
due primarily to the sales of customers products produced using our
technology. All other fees increased $10.7 million to $10.9 million for the nine
months ended September 30, 2004 from the nine months ended September 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 Part I of
this Report. The increase was also impacted by fees received related to the
sale of rights to third parties for the use of our technology and patents to
manufacture products. Operating Expenses Cost of Products Sold.Cost of products sold increased $9.2 million, or
6%, to $163.9 million for the nine months ended September 30, 2004 from the
nine months ended September 30, 2003. Our expanded product volume/mix
increased costs $4.8 million, along with an increase of $5.7 million due to the
impact of the U.S. Dollar against foreign currencies, primarily the Euro. These
increases were partially offset by a $1.3 million decrease due to lower
production costs for the period. Gross Profit and Margins from Products Sold.Gross profit from products
sold increased $8.4 million, or 7%, to $123.3 million for the nine months ended
September 30, 2004 from the nine months ended September 30, 2003 and gross
margin increased to 42.9% for the nine months ended September 30, 2004 from
42.6% for the nine months ended September 30, 2003. The overall increase was
primarily driven by favorable product volume/mix and production costs,
partially offset by a reduction in average prices. Our gross profit was also
benefited by a $5.6 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
$1.3 million, or 3%, to $52.9 million for the nine months ended September 30,
2004 from the nine months ended September 30, 2003, primarily due to increases
in personnel-related costs, including salaries, benefits and travel expenses of
$1.5 million, supply costs of $0.7 million, facilities costs of $0.5 million,
depreciation of $0.3 million and other costs of $0.3 million. These increases
were partially offset by decreases in outside services of $1.8 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 $3.0 million, or 34%, to $5.8 million
for the nine months ended September 30, 2004 from the nine months ended
September 30, 2003. Sales, Marketing and Business Development.Sales, marketing and business
development expenses increased $3.5 million, or 15%, to $27.4 million for the
nine months ended September 30, 2004 from the nine months ended September 30,
2003, primarily due to increases in personnel-related costs, including
salaries, benefits and travel expenses of $2.0 million, outside services of
$0.4 million, facilities costs of $0.2 million, supply costs of $0.1 million,
insurance, tax and royalty expenses of $0.5 million, an increase in the
provision for doubtful accounts at our Chinese affiliate of $0.2 million, and
in other expenses of $0.1 million. General and Administrative.General and administrative expenses increased
$4.7 million, or 20%, to $28.4 million for the nine months ended September 30,
2004 from the nine months ended September 30, 2003, due primarily to increases
in outside services of $3.7 million, personnel-related costs, including
salaries, benefits, and travel expenses, of $0.8 million, incentive
compensation of $0.1 million, and other costs of $0.1 million. Amortization of Intangible Assets.Amortization expense decreased $0.8
million, or 19%, to $3.5 million for the nine months ended September 30, 2004
from the nine months ended September 30, 2003. This decrease was primarily due
to certain intangible assets becoming fully amortized by year-end 2003. Other Income and Expense.Other income for the nine months ended
September 30, 2004 was $8.3 million as compared to $0.4 million of other
expense for the nine months ended September 30, 2003. This difference in
income of $8.7 million was primarily driven by the $8.3 million net gain
recorded during the quarter ended March 31, 2004, resulting from the final 18




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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
nine months ended September 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 nine
months ended September 30, 2004. Interest Income. Interest income decreased $0.4 million, or 13%, to $2.6
million for the nine months ended September 30, 2004 from the nine months ended
September 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 nine months ended
September 30, 2004 was 20%, compared to 25% for the nine months ended September
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 nine months ended September 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 nine months ended September 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 September 30, 2004, the Bioproducts segment achieved
operating income of $11.6 million as compared to operating income of $15.4
million for the three months ended September 30, 2003. For the nine months
ended September 30, 2004, the Bioproducts segment achieved operating income of
$49.7 million as compared to operating income of $52.2 million for the nine
months ended September 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 September 30,
2004, the Health Care segment experienced an operating loss of $7.8 million as
compared to an operating loss of $9.2 million for the three months ended
September 30, 2003. For the nine months ended September 30, 2004, the Health
Care segment experienced an operating loss of $11.3 million as compared to an
operating loss of $24.6 million for the nine months ended September 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. Joint Venture On April 1, 2004 we assumed majority ownership and controlling interest of
our joint venture with Kyowa Hakko Kogyo Co. Ltd., in which we have had an equity
position since 1996. This ownership change resulted from the joint ventures
partial repurchase of the other owners share. This venture has been renamed
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. 19




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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. Related Party Transactions We previously had relocation-related notes receivable from certain of our
officers, including a $1.2 million note from Richard J. Ranieri, our Senior
Vice President of Human Resources, and a $1.4 million note from Raymond J.
Land, our Senior Vice President and Chief Financial Officer. Both of these
loans commenced in 2000, were non-interest bearing and were due five years from
their date of issuance. During the third quarter of 2004, we purchased these
officers residences for an aggregate of $5.2 million, and cancelled these
notes as partial payment for the properties. Third party appraisals were used
to confirm that the purchase price for each property approximated fair market
value on the date of acquisition. Each officer, together with his spouse, then
entered into a lease with us for his residence providing for a lease term of up
to 36 months. 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 September 30, 2004, cash and cash equivalents totaled $167.7
million. The funds were invested in short-term instruments, including A-1/P1
and A-2/P2 rated commercial paper, certificates of deposit, AAA and AA rated
medium term notes, institutional money market funds, preferred and
non-preferred auction rate securities and bank deposits. Cash provided by operations was $41.7 million and $21.6 million for the
nine months ended September 30, 2004 and 2003, respectively. The increase of
$20.1 million in 2004 from 2003 was generated principally by the receipt of
cash from our insurer in settlement of our accident-related claim for damage
sustained to our finished bioproducts inventory in the second quarter of 2003
as discussed above under the heading Warehouse Inventory Loss and the
out-licensing of our vaccine technology as discussed above under the heading
Technology Transfer, partially offset by changes in operating assets and
liabilities. Cash used in investing activities was $13.3 million and $17.5 million for
the nine months ended September 30, 2004 and 2003, respectively. This decrease
in cash used of $4.2 million was driven primarily by the recognition of the
cash and cash equivalents of our joint venture with Kyowa Hakko Kogyo Co. Ltd. of $3.8 million at
April 1, 2004 due to our assumption of a controlling interest in that venture.
This venture has been renamed Genencor Kyowa Co. Ltd. Capital expenditures for
the nine months ended September 30, 2004 were $16.8 million compared with $18.6
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. This spending also
included the purchase of officers residences during the third quarter of 2004 20




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as discussed above under the heading Related Party Transactions. During
the third quarter of 2003, construction was completed on our facility for the
clinical-scale manufacture of human therapeutic proteins in Rochester, New
York. Cash used in financing activities was $26.4 million and $22.4 million for
the nine months ended September 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 $4.0 million during the nine months ended September
30, 2004 was primarily driven by payments on notes payable of one of
our foreign affiliates and fewer stock option exercises. 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 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 September 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
us $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 September 30, 2004.
As of September 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. The adoption of FSP
No. 106-2 has had no 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 nine months ended September 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
were no material foreign currency gains or losses in connection with these types of
contracts recorded in the statement of operations for the nine months ended
September 30, 2004. 21




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As of September 30, 2004, cash and cash equivalents totaled $167.7
million. Of this amount, $81.9 million was denominated in Euros. The
remainder, or $85.8 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 Part I 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. 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 September 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 nine months ended
September 30, 2004, we derived approximately 55% of our revenues and
approximately 60% 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 losses from U.S. Dollar/Euro
and U.S. Dollar/Argentine Peso transactions for the nine-month period ended
September 30, 2004 were immaterial. 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 nine months ended September 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
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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  
    
    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 23




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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 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
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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. 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 25




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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, 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; 26




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
    
    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. 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. If we are not able to timely comply with Section 404 of the Sarbanes-Oxley Act
of 2002, public perception of weakness in our internal controls could cause our
stock price to decline. We must comply with the rules promulgated under Section 404 of the
Sarbanes-Oxley Act of 2002 (Section 404), which require (i) our management to
evaluate and report on the effectiveness of our internal controls over
financial reporting and (ii) our auditors to evaluate and attest to our
aforesaid report on internal controls. Rules related to this subject were
adopted as recently as June 2004, and we and our auditors are required to
comply with these rules by the end of the current fiscal year. Because these
rules were only recently adopted, no proven methods for compliance currently
exist, and, as a result, our management must exercise significant judgment in
its efforts to fully and timely comply with Section 404. As a result, we
cannot provide assurances, should any control deficiencies be identified, that
they will either be remediated before the end of our fiscal year or that they
will not rise to the level of significant deficiencies or material weaknesses.
Although 27




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we have made Section 404 compliance a top priority, for the reasons
identified above we cannot be certain that we will be in a position to timely
comply with the requirements of Section 404. If we are not able to timely
comply with the requirements of Section 404, our management could be forced to
devote additional time, attention and resources to achieving compliance, which
could negatively affect our results of operations. In addition, public
perception of our internal controls over financial reporting could be damaged,
which could cause our stock price to decline. 
 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. 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 third quarter of 2004 that has materially affected, or
is reasonably likely to materially affect, our internal control over financial
reporting. 28




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PART II. OTHER INFORMATION 
 Item 1. Legal Proceedings In the Companys Form 10-Q for the quarter ended June 30, 2004, the
Company reported the initiation of a lawsuit on or about July 16, 2004 alleging
that the Company had discriminatorily discharged three workers. 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 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 Nothing to report. 
 Item 4. Submission of Matters to a Vote of Security Holders Nothing to report. 
 Item 5. Other Information Nothing to report. 
 Item 6. Exhibits  (10)
    
    Material Contracts10.1
    
    Standard Form of Option Grant Agreement used by the Company to
issue stock options pursuant to the Genencor International, Inc. 2002
Omnibus Incentive Plan#10.2
    
    Residential Lease dated August 20, 2004, between Raymond J.
Land and Kathleen A. Land and the Company#10.3
    
    Residential Lease, dated August 20, 2004, between Richard J.
Ranieri and Nancy J. Ranieri and the Company(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  #
    
    Management contract or compensatory plan. 29




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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.November 8, 2004
    
    
    
    By: /s/
    
    Raymond J. LandDate
    
    
    
    Raymond J. LandSenior Vice President and Chief Financial Officer(Principal Financial Officer)November 8, 2004
    
    
    
    By: /s/
    
    Darryl L. CanfieldDate
    
    
    
    Darryl L. CanfieldVice President and Corporate Controller(Chief Accounting Officer)
 30




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EXHIBIT INDEX Exhibit Number
    
    Description10.1
    
    Standard Form of Option Grant Agreement used by the Company to issue stock options
pursuant to the Genencor International, Inc. 2002 Omnibus Incentive Plan#10.2
    
    Residential Lease, dated August 20, 2004, between Raymond J. Land and Kathleen A. Land
and the Company#10.3
    
    Residential Lease, dated August 20, 2004, between Richard J. Ranieri and Nancy J. Ranieri
and the Company31.1
    
    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
  #
    
    Management contract or compensatory plan 31