Verenium 10-Q 2007 Q1 Quarterly report

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 March 31, 2007

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 000-29173

DIVERSA CORPORATION

(Exact name of registrant as specified in its charter)

Delaware	22-3297375
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

4955 Directors Place, San Diego, California	92121
(Address of principal executive offices)	(Zip Code)

(Registrant’s telephone number, including area code (858) 526-5000)

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

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

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

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

The number of shares of the registrant’s Common Stock outstanding as of April 30, 2007 was 48,550,692.

DIVERSA CORPORATION

INDEX

		Page No.
PART I - FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements
	Condensed Consolidated Balance Sheets as of March 31, 2007 (unaudited) and December 31, 2006	3
	Condensed Consolidated Statements of Operations for the three months ended March 31, 2007 and 2006 (unaudited)	4
	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2007 and 2006 (unaudited)	5
	Notes to Condensed Consolidated Financial Statements (unaudited)	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	26
Item 4.	Controls and Procedures	27
PART II - OTHER INFORMATION
Item 1.	Legal Proceedings	27
Item 1A.	Risk Factors	28
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	45
Item 3.	Defaults Upon Senior Securities	45
Item 4.	Submission of Matters to a Vote of Security Holders	45
Item 5.	Other Information	45
Item 6.	Exhibits	45
SIGNATURES		46

2

DIVERSA CORPORATION

PART I—FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.

DIVERSA CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value)

	MARCH 31, 2007			DECEMBER 31, 2006
	(Unaudited)			(Note)
ASSETS
Current assets:
Cash and cash equivalents	$	117,086		$	38,541
Short-term investments		8,398			13,371
Accounts receivable (including $399 and $418 from a related party at March 31, 2007 and December 31, 2006)		9,617			8,646
Inventories, net		4,120			4,098
Prepaid expenses and other current assets		2,494			2,378
Total current assets		141,715			67,034
Property and equipment, net		11,454			12,418
Note receivable from Celunol Corp.		8,500			—
Other assets		6,871			453
Total assets	$	168,540		$	79,905
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	6,457		$	5,192
Accrued compensation and other		6,572			8,876
Restructuring reserve, current portion		1,908			1,908
Deferred revenue, current portion (including $2,816 and $3,106 from a related party at March 31, 2007 and December 31, 2006)		5,270			5,395
Notes payable, current portion		4,429			5,223
Total current liabilities		24,636			26,594
5  1/2% convertible senior notes		100,000			—
Notes payable, less current portion		3,002			3,724
Deferred revenue, less current portion (including $150 from a related party at March 31, 2007)		587			783
Restructuring reserve, less current portion		5,418			5,888
Commitments and contingencies
Stockholders’ equity:
Preferred stock—$0.001 par value; 5,000 shares authorized, no shares issued and outstanding at March 31, 2007 and December 31, 2006		—			—
Common stock—$0.001 par value; 90,000 shares authorized, 48,548 and 48,235 shares issued and outstanding at March 31, 2007 and December 31, 2006		49			48
Additional paid-in capital		374,672			372,415
Accumulated deficit		(339,804	)		(329,486	)
Accumulated other comprehensive loss		(20	)		(61	)
Total stockholders’ equity		34,897			42,916
Total liabilities and stockholders’ equity	$	168,540		$	79,905

Note: The balance sheet data at December 31, 2006 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.

See accompanying notes to condensed consolidated financial statements.

3

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

	THREE MONTHS ENDED MARCH 31,
	2007			2006
Revenues (including related party revenues of $2,901 and $4,439 for the three months ended March 31, 2007 and 2006):
Product-related	$	5,352		$	2,535
Collaborative		4,735			6,324
Grant		1,221			651
Total revenue		11,308			9,510
Operating expenses:
Cost of product-related revenue		4,892			2,182
Research and development		12,872			14,061
Selling, general and administrative		4,014			3,871
Restructuring charges		83			11,023
Total operating expenses		21,861			31,137
Loss from operations		(10,553	)		(21,627	)
Interest and other income, net		235			226
Net loss	$	(10,318	)	$	(21,401	)
Net loss per share, basic and diluted	$	(0.22	)	$	(0.47	)
Weighted average shares used in calculating basic and diluted net loss per share		47,567			45,368

See accompanying notes to condensed consolidated financial statements.

4

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	THREE MONTHS ENDED MARCH 31,
	2007			2006
Operating activities:
Net loss	$	(10,318	)	$	(21,401	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		2,151			2,668
Non-cash share-based compensation charges		1,061			1,301
Non-cash restructuring charges		—			226
Changes in operating assets and liabilities:
Accounts receivable		(971	)		1,826
Other assets		(2,208	)		(598	)
Accounts payable and accrued expenses		(1,039	)		(246	)
Restructuring liabilities		(470	)		8,317
Deferred revenue		(321	)		1,525
Net cash used in operating activities		(12,115	)		(6,382	)
Investing activities:
Purchases of short-term investments		(14,323	)		(42,131	)
Sales and maturities of short-term investments		19,336			38,392
Purchases of property and equipment		(1,186	)		(668	)
Advances made to Celunol Corp.		(8,500	)		—
Net cash used in investing activities		(4,673	)		(4,407	)
Financing activities:
Net proceeds from sale of common stock		1,197			2,111
Principal payments on debt obligations		(1,516	)		(1,784	)
Proceeds from convertible debt, net of issuance costs of $4,348		95,652			828
Net cash provided by financing activities		95,333			1,155
Net increase (decrease) in cash and cash equivalents		78,545			(9,634	)
Cash and cash equivalents at beginning of period		38,541			43,859
Cash and cash equivalents at end of period	$	117,086		$	34,225
Supplemental disclosure of non-cash operating and financing activities:
Common stock issued to settle employee bonus liabilities	$	—		$	620

See accompanying notes to condensed consolidated financial statements.

5

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Organization and Business

The Company

Diversa Corporation (the “Company) is a biotechnology company, founded in 1992, that develops customized enzymes for use within the alternative fuels, industrial, and health and nutrition markets to enable higher throughput, lower costs, and improved environmental outcomes.

In January 2007, the Company announced that it would pursue opportunities for the vertically-integrated commercialization of biofuels, in particular ethanol from cellulosic biomass. To date, the Company has focused primarily on the development of novel, high-performance enzymes for cellulosic biomass feedstocks as part of its specialty enzyme business.

In February 2007, the Company entered into a definitive merger agreement with Celunol Corp. (“Celunol”), a Delaware corporation that is directing its integrated technologies to the production of low-cost cellulosic ethanol from an array of biomass sources. The merger agreement has been approved by the boards of directors of both the Company and Celunol, and is subject to shareholder approval.

As more fully described inNote 7, “Convertible Notes Offering”, in March and April 2007 the Company completed a convertible debt offering which generated net cash proceeds of approximately $114.9 million.

2. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared by the Company in accordance with U.S. generally accepted accounting principles for interim financial information. Accordingly, they do not include all the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, which are necessary for a fair presentation of the results of the interim periods presented, have been included. The results of operations for the interim periods are not necessarily indicative of results to be expected for any other interim period or for the year as a whole. These unaudited condensed consolidated financial statements and footnotes thereto should be read in conjunction with the audited financial statements and footnotes thereto contained in the Company’s Annual Report on Form 10-K and 10-K/A for the year ended December 31, 2006.

The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect amounts reported in the condensed consolidated financial statements and related footnotes. Changes in the estimates may affect amounts reported in future periods.

3. Revenue Recognition

The Company recognizes revenue in accordance with Securities and Exchange Commission Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition” and Emerging Issues Task Force (“EITF”) Issue No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.”

Under SAB No. 104 revenue is recognized when the following criteria have been met: i) persuasive evidence of an arrangement exists; ii) services have been rendered or product has been delivered; iii) price to the customer is fixed and determinable; and iv) collection of the underlying receivable is reasonably assured.

Billings to customers or payments received from customers are included in deferred revenue on the balance sheet until all revenue recognition criteria are met.

Revenue Arrangements with Multiple Deliverables

The Company sometimes enters into revenue arrangements that contain multiple deliverables. The Company recognizes revenue from such arrangements entered into subsequent to June 30, 2003 in accordance with EITF No. 00-21. This issue addresses the timing and method of revenue recognition for revenue arrangements that include the delivery of more than one product or service. In these cases, the Company recognizes revenue from each element of the arrangement as long as separate value for each element can be determined, the Company has completed its obligation to deliver or perform on that element, and collection of the resulting receivable is reasonably assured.

6

Collaborative Revenue

The Company recognizes revenue from research funding under collaboration agreements when earned on a “proportional performance” basis as research hours are incurred. The Company performs services as specified in each respective agreement on a best-efforts basis, and is reimbursed based on labor hours incurred on each contract. The Company initially defers revenue for any amounts billed or payments received in advance of the services being performed and recognize revenue pursuant to the related pattern of performance, based on total labor hours incurred relative to total labor hours estimated under the contract.

The Company recognizes fees received to initiate research projects over the life of the project. The Company recognizes fees received for exclusivity in a field over the period of exclusivity.

The Company recognizes milestone payments when earned, as evidenced by written acknowledgement from the collaborator, provided that (i) the milestone event is substantive and its achievability was not reasonably assured at the inception of the agreement, (ii) the milestone represents the culmination of an earnings process, (iii) the milestone payment is non-refundable and (iv) the Company’s past research and development services, as well as its ongoing commitment to provide research and development services under the collaboration, are charged at fees that are comparable to the fees that the Company customarily charges for similar research and development services.

Product-Related Revenue

The Company recognizes product-related revenue at the time of shipment to the customer provided all other revenue recognition criteria have been met. The Company recognizes revenue on product sales through third-party distribution agreements, if the distributor has a right of return, in accordance with the provisions set forth in Financial Accounting Standards Board Statement (“FASB”) No. 48,“Revenue Recognition When Right of Return Exists.” Under FASB No. 48, the Company recognizes product revenues upon shipment to distributors, provided that (i) the price is substantially fixed and determinable at the time of sale; (ii) the distributor’s obligation to pay the Company is not contingent upon resale of the products; (iii) title and risk of loss passes to the distributor at time of shipment; (iv) the distributor has economic substance apart from that provided by the Company; (v) the Company has no significant obligation to the distributor to bring about resale of the products; and (vi) future returns can be reasonably estimated. For any sales that do not meet all of the above criteria, revenue is deferred until all such criteria have been met.

The Company recognizes product-related profit-sharing revenue during the quarter in which such revenue is earned, based on estimates provided by the Company’s profit-sharing partner. These estimates are adjusted for actual results in the subsequent quarter. Profit-sharing revenue is included in product-related revenue in the statement of operations.

Grant Revenue

The Company recognizes revenue from grants as related costs are incurred, as long as such costs are within the funding limits specified by the underlying grant agreements.

Deferred Revenue

As of March 31, 2007, the Company had $5.9 million in deferred revenue, of which $4.6 million was related to funding from collaborative partners, and $1.3 million was related to product sales, including approximately $1.1 million attributed to sales to Valley Research, inc. (“Valley”), a former distributor for certain of the Company’s products. As more fully described inNote 10, “Contingencies,” the Company is currently in a legal dispute with Valley and, accordingly, there is no assurance that this amount, or any portion thereof, will be recognized as revenue in the foreseeable future, or at all. In addition, at March 31, 2007, the Company had approximately $0.8 million in deferred cost of sales related to sales to Valley included in other current assets on the accompanying balance sheet, and there is no assurance that any of this amount will ever be realized.

4. Note Receivable

In accordance with the terms of the merger agreement, on February 12, 2007, Celunol issued to Diversa an unsecured promissory note pursuant to which Diversa has agreed to lend Celunol up to $20 million. Any principal outstanding under the promissory note accrues interest at 9% per annum. Under the terms of the promissory note, to the extent that Celunol has borrowed the full $20.0 million under the note and desires to borrow additional funds, Diversa has a right of first refusal to be the lender for any such additional borrowings. To the extent that Diversa does not exercise its right of first refusal, Diversa has agreed to be subordinated to any loans with third parties that Celunol subsequently receives. In addition, if the merger agreement terminates, any amounts borrowed under the promissory note will be fully subordinated to any other indebtedness for borrowed money that Celunol may incur following such termination. The promissory note includes provisions for acceleration of the outstanding principal and interest under such note in the event that, among other things, a termination fee becomes payable by Celunol to Diversa pursuant to the merger agreement. In addition, in the event that the merger does not close and the merger agreement has been terminated and Celunol completes an equity financing with total proceeds to Celunol of at least $25.0 million, not including the conversion of the promissory note or other debt, in connection with such financing, then 50% of amounts owed under the note shall automatically convert into the equity securities issued by Celunol in the financing. As of March 31, 2007 there was $8.5 million due from Celunol pursuant to the promissory note.

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5. Equity Incentive Plans and Share-based Compensation

Equity Incentive Plans

2005 Non-Employee Directors’ Equity Incentive Plan

In March 2005, the Board of Directors of the Company (“Board”) adopted the Company’s 2005 Non-Employee Directors’ Equity Incentive Plan (“Directors’ Plan”), and has reserved a total of 930,000 shares for issuance thereunder. The Directors’ Plan replaced the 1999 Non-Employee Directors’ Stock Option Plan. As of March 31, 2007, there were approximately 330,000 shares outstanding under the Directors’ Plan and approximately 312,000 shares outstanding under the 1999 Non-Employee Directors’ Stock Option Plan.

1999 Employee Stock Purchase Plan

In December 1999, the Board of Directors adopted the 1999 Employee Stock Purchase Plan (the “ESPP”). As of March 31, 2007, a total of 1,784,000 shares of the Company’s common stock have been reserved for issuance under ESPP. The ESPP permits eligible employees to purchase common stock at a discount, but only through payroll deductions, during defined offering periods. The price at which stock is purchased under the ESPP is equal to 85% of the fair market value of the common stock on the first or last day of the offering period, whichever is lower. The ESPP provides for annual increases of shares available for issuance under the ESPP. As of March 31, 2007, there were approximately 90,000 shares available for future issuance under the ESPP.

1997 Equity Incentive Plan

In August 1997, the Company adopted the 1997 Equity Incentive Plan (the “1997 Plan”), which provides for the granting of incentive or non-statutory stock options, stock bonuses, and rights to purchase restricted stock to employees, directors, and consultants as administered by the Board. Unless terminated sooner by the Board, the 1997 Plan will terminate in August 2007. The incentive and non-statutory stock options are granted with an exercise price of not less than 100% and 85%, respectively, of the estimated fair value of the underlying common stock as determined by the Board. The 1997 Plan allows the purchase of restricted stock at a price that is not less than 85% of the estimated fair value of the Company’s common stock as determined by the Board of Directors. Options granted under the 1997 Plan vest over periods up to four years and are exercisable over periods not exceeding ten years. As of March 31, 2007, the aggregate number of shares which may be awarded under the 1997 Plan is 12,983,000, with approximately 4,026,000 available for grant.

Outstanding awards that were previously granted under predecessor plans also remain in effect in accordance with their terms.

Share-Based Compensation

The Company has adopted the fair value recognition provisions of FASB No. 123(R), “Share-Based Payment,” using the modified prospective transition method. Under this transition method, compensation expense includes options vesting for 1) share-based payments granted prior to, but not vested as of December 31, 2005, based on the grant date fair value estimated in accordance with the original provisions of FASB No. 123; 2) share-based payments granted after December 31, 2005, based on the grant date fair value estimated in accordance with the provisions of FASB No. 123(R); and 3) shares issued under the ESPP after December 31, 2005, based on calculations of fair value which are similar to how stock option valuations are made. Because this transition method was selected, results of prior periods have not been restated.

All of the Company’s equity incentive plans are considered to be compensatory plans under FASB No. 123(R).

The Company recognized $1.1 million ($0.02 per share) and $1.3 million ($0.03 per share) in share-based compensation expense for its share-based awards during the three-month periods ended March 31, 2007 and 2006. These charges had no impact on the Company’s reported cash flows. Share-based compensation expense was allocated among the following expense categories:

	THREE MONTHS ENDED MARCH 31,
	2007		2006
Research and development	$	420	$	872
Selling, general and administrative		641		429
	$	1,061	$	1,301

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As of March 31, 2007, there was $5.8 million of total unrecognized compensation expense related to nonvested share-based compensation arrangements granted under the equity incentive plans. This expense is expected to be recognized over a weighted-average period of 1.3 years as follows:

	(in thousands)
Fiscal Year 2007 (April 1, 2007 to December 31, 2007)	$	3,011
Fiscal Year 2008		2,272
Fiscal Year 2009		488
Fiscal Year 2010		29
	$	5,800

Equity Incentive Awards Activity

Information with respect to all of the Company’s stock option plans is as follows (in thousands, except per share data):

	Shares		Weighted Average Exercise Price Per Share		Aggregate Intrinsic Value
Outstanding at January 1, 2007	3,657		$	11.60
Granted	31		$	9.52
Exercised	(72	)	$	6.21
Cancelled	(42	)	$	10.77
Outstanding at March 31, 2007	3,574		$	11.70	$	1,069
Exercisable at March 31, 2007	3,134		$	12.22	$	741

The grant date fair value of options granted during the three months ended March 31, 2007 was $5.24 per share. The total intrinsic value of options exercised during the three months ended March 31, 2007 was $0.2 million, or $3.41 per share.

A further detail of the options outstanding as of March 31, 2007 is set forth as follows (in thousands, except per share data):

Range of Exercise Prices	Options Outstanding	Weighted- Average Remaining Life in Years	Weighted- Average Exercise Price Per Share		Options Exercisable	Weighted- Average Exercise Price Per Share
$ 0.42 – $8.32	918	6.5	$	6.66	785	$	6.88
$ 8.33 – $10.05	1,538	6.9	$	9.50	1,258	$	9.62
$10.12 – $26.98	902	4.7	$	15.91	875	$	16.05
$27.00 – $88.63	216	3.3	$	31.27	216	$	31.27
$ 0.42 – $88.63	3,574	6.0	$	11.70	3,134	$	12.22

Non-Restricted and Restricted Share Awards

Information with respect to all of the Company’s non-restricted and restricted share awards is as follows (in thousands, except per share data):

	Shares		Weighted Average Fair Value
Nonvested awards outstanding at January 1, 2007	1,118		$	6.31
Granted	100		$	9.55
Vested	(339	)	$	6.32
Forfeited and cancelled	(39	)	$	6.18
Nonvested awards outstanding at March 31, 2007	840		$	6.69

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Warrants

In connection with the closing of a series of transactions with Syngenta Participations AG in February 2003, the Company issue to Syngenta a warrant to purchase 1,293,000 shares of common stock at $22 per share that is exercisable for ten years starting in 2008.

Common Stock Reserved for Future Issuance

At March 31, 2007, the Company has reserved shares of common stock for future issuance as follows (in thousands):

Employee Stock Purchase Plan	90
Equity Incentive Plans	4,832
Warrants	1,293
	6,215

6. Computation of Net Loss per Share

Basic and diluted net loss per share has been computed using the weighted-average number of shares of common stock outstanding during the period. As of March 31, 2007, there were approximately 840,000 outstanding nonvested restricted shares. For purposes of the computation of net loss per share, these nonvested shares are considered contingently returnable shares under FASB No. 128,“Earnings Per Share,” and are not considered outstanding common shares for purposes of computing net loss per share until all necessary conditions are met that no longer cause the shares to be contingently returnable. The impact of these nonvested shares on weighted average shares outstanding has been excluded for purposes of computing net loss per share.

The following table presents the calculation of basic and diluted net loss per share (in thousands, except per share data):

	Quarter Ended March 31,
	2007			2006
Weighted average shares outstanding during the period		48,371			46,298
Less: Weighted average nonvested restricted shares outstanding		(804	)		(930	)
Weighted average shares used in computing basic and diluted net loss per share		47,567			45,368
Net loss	$	(10,318	)	$	(21,401	)
Net loss per share, basic and diluted	$	(0.22	)	$	(0.47	)

The Company has excluded all common stock equivalent shares issuable upon exercise or conversion of outstanding stock options, warrants, and convertible debt from the calculation of diluted net loss per share because all such securities are anti-dilutive for all applicable periods presented.

7. Comprehensive Loss

Comprehensive loss is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources, including unrealized gains and losses on marketable securities. The Company presents comprehensive loss in its statements of stockholders’ equity.

The comprehensive loss consisted of the following (in thousands):

	THREE MONTHS ENDED MARCH 31,
	2007			2006
Net loss	$	(10,318	)	$	(21,401	)
Other comprehensive gain (loss):
Unrealized gain (loss) on investments		41			43
Comprehensive loss	$	(10,277	)	$	(21,358	)

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8. Convertible Notes Offering

In late March 2007, the Company completed an offering of $100 million aggregate principal amount of 5.50% Convertible Senior Notes due April 1, 2027 (“Convertible Notes”) in a private placement, generating net cash proceeds of approximately $95.6 million. In April 2007, the initial purchasers exercised in full their over-allotment option to purchase an additional $20 million aggregate Convertible Notes, generating additional net cash proceeds of approximately $19.3 million. The Convertible Notes are convertible, at the option of the holders, at any time prior to maturity, into shares of Diversa common stock at an initial conversion rate of 122.5490 shares of common stock per $1,000 principal amount of notes (subject to adjustment in certain circumstances), which represents an initial conversion price of $8.16 per share. On or after April 5, 2012, and subsequent to the Company having made at least 10 semi-annual interest payments, the Company is able to unilaterally redeem the debt at any time prior to maturity. The Company also must repay the debt, plus any accrued and unpaid interest, if there is a qualifying change in control or termination of trading of its common stock.

9. Contingencies

Class Action Shareholder Lawsuit

In June 2004, the Company executed a settlement agreement with the Plaintiffs pursuant to the terms of the memorandum of understanding. On February 15, 2005, the Court issued a decision certifying a class action for settlement purposes and granting preliminary approval of the settlement subject to modification of certain bar orders contemplated by the settlement. On August 31, 2005, the Court reaffirmed class certification and preliminary approval of the modified settlement in a comprehensive Order. On February 24, 2006, the Court dismissed litigation filed against certain underwriters in connection with the claims to be assigned to the Plaintiffs under the settlement. On April 24, 2006, the Court held a Final Fairness Hearing to determine whether to grant final approval of the settlement. On December 5, 2006, the Second Circuit Court of Appeals vacated the lower Court’s earlier decision certifying as class actions the six IPO Cases designated as “focus cases.” The Court has ordered a stay of all proceedings in all of the IPO Cases pending the outcome of Plaintiffs’ rehearing petition to the Second Circuit. Accordingly, the Court’s decision on final approval of the settlement remains pending. The Company is covered by a claims-made liability insurance policy which it believes will satisfy any potential liability of the Company under this settlement. Due to the inherent uncertainties of litigation and assignment of claims against the underwriters, and because the settlement has not yet been finally approved by the Court, the ultimate outcome of this matter cannot be predicted. In accordance with FASB No. 5,“Accounting for Contingencies” the Company believes any contingent liability related to this claim is not probable or estimable and therefore no amounts have been accrued in regards to this matter.

Valley Research, inc.

On September 22, 2006, the Company issued a letter to Valley which communicated the Company’s intent to exercise certain rights under the distribution agreement between the Company and Valley. Specifically, the Company stated that it terminated Valley’s exclusivity on the basis of certain minimum sales requirements not having been met as of August 24, 2006, as provided by the distribution agreement. Under the distribution agreement, Valley was previously the Company’s exclusive distributor in the United States for the Valley “Ultra-Thin” enzyme for ethanol and high fructose corn sweetener applications, subject to certain limitations, and subject to certain conditions required to be met for such exclusivity to be maintained. Pursuant to the distribution agreement, the termination was effective immediately upon Valley’s receipt of notice from the Company of its intention to terminate the Agreement.

On December 7, 2006, Valley filed a civil complaint in San Diego Superior Court against the Company, alleging breach of contract. In the complaint, Valley alleges that the Valley “Ultra-Thin”^™ product was unstable and performed poorly, which caused Valley to be unable to satisfy certain contractual requirements. In the complaint, Valley seeks money damages for alleged breach of contract by the Company and potentially for additional damages for termination of Valley’s exclusivity. The Company believes that the claims made by Valley have no merit, and intends to defend itself vigorously.

On January 8, 2007 the Company filed a cross-complaint in San Diego Superior Court against Valley, alleging breach of contract, breach of the implied covenant of good faith and fair dealing, and violation of the California Business and Professional

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Code. In its cross-complaint, the Company seeks payment in full of outstanding invoices due from Valley. Pursuant to a letter dated March 7, 2007, Diversa Corporation, a Delaware corporation, terminated that certain Distribution Agreement, dated January 1, 2005, and the Amendment thereto dated August 1, 2005 (the“Agreement”), between Diversa and Valley covering the enzyme Diversa currently markets under the Fuelzyme-LF label .

Under the Agreement, Valley was previously Diversa’s exclusive distributor in the United States for the Valley “Ultra-Thin” enzyme for ethanol and high fructose corn sweetener applications, subject to certain limitations, and subject to certain conditions required to be met for such exclusivity to be maintained. On September 22, 2006, Diversa terminated Valley’s exclusivity on the basis of certain minimum sales requirements not having been met as of August 24, 2006, as provided by the Agreement. The term of the Agreement was set to expire on February 24, 2011. Diversa’s termination of the Agreement was based on, among other things, Valley’s failure to meet certain minimum purchase requirements for the Valley “Ultra-Thin” enzyme. Specifically, Valley failed to purchase a minimum of $2,600,000 worth of the Valley “Ultra-Thin” enzyme from Diversa within one year of the U.S. Food and Drug Administration’s Center for Veterinary Medicine’s approval of the Valley “Ultra-Thin” enzyme. Pursuant to the Agreement, the termination was effective immediately upon Valley’s receipt of notice from Diversa of its intention to terminate the Agreement.

In accordance with FASB No. 5,“Accounting for Contingencies” the Company believes any contingent losses related to this claim are not probable or estimable and therefore no amounts have been accrued in regards to this matter.

As of March 31, 2007 the Company’s deferred revenue balance related to Valley was $1.1 million, and there is no assurance that this amount, or any portion thereof, will be recognized as revenue in the foreseeable future, or at all. In addition, at March 31, 2007, the Company had approximately $0.8 million in deferred cost of sales included in other current assets on the accompanying balance sheet, and there is no assurance that any of this amount will ever be realized.

Patent Interference Proceeding

On February 14, 2007, a patent interference proceeding was declared in the U.S. Patent and Trademark Office between a U.S. patent assigned to Diversa and a pending U.S. patent application owned by a third party with allowable claims directed to GeneReassembly. The third party seeks an entry of adverse judgment against Diversa. A schedule for the motion phase of the interference proceeding was discussed with the Administrative Patent Judge in April 2007. The Administrative Patent Judge granted Diversa’s request to treat two of its motions as threshold motions. The first is a motion for no interference in fact, and the second is a motion for unpatentability of Maxygen’s patent application due to lack of written description. Both of Diversa’s motions must be submitted to the Administrative Patent Judge by May 10, 2007 for consideration. In accordance with FASB No. 5 “Accounting for Contingencies” the Company believes any contingent liability related to this claim is not probable or estimable and therefore no amounts have been accrued in regards to this matter.

The Company is also, from time to time, subject to legal proceedings and claims which arise in the normal course of business. In management’s opinion, the amount of ultimate liability with respect to these actions will not have a material adverse effect on the Company’s consolidated financial position, results of operations, or cash flows.

10. Restructuring Charges

In connection with the January 2006 decision to reorganize and refocus the Company’s resources, management commenced several cost containment measures, including a reduction in workforce of 83 employees and the consolidation of its facilities. Pursuant to FASB No. 146,“Accounting for Costs Associated with Exit or Disposal Activities,”the Company recorded net charges of $12.0 million in 2006 related to these activities. The following table sets forth the activity in the restructuring reserves through March 31, 2007 (in thousands):

	Facility Consolidation Costs			Employee Separation Costs			Other Costs			Total
Balance at January 1, 2006	$	—		$	—		$	—		$	—
Accrued and expensed		8,356			2,607			60			11,023
Charged against accrual		(1,563	)		(2,607	)		(60	)		(4,230	)
Adjustments and revisions		1,003			—			—			1,003
Balance at December 31, 2006	$	7,796		$	—		$	—		$	7,796
Charged against accrual		(553	)		—			—			(553	)
Adjustments and revisions		83			—			—			83
Balance at March 31, 2007	$	7,326		$	—		$	—		$	7,326

During the first quarter of 2006, the Company completed the employee termination activities under this restructuring and no further payments or expenses related to employee separation are anticipated under this program. The facility consolidation costs are based on estimates, representing the discounted cash flow of lease payments (net of anticipated sublease income) on the vacated space

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through its contractual lease term in 2016. Pursuant to FASB No. 146 the Company is required to re-assess these estimates on a periodic basis. Accordingly, the Company may revise these estimates in future periods, which could give rise to additional charges or adjustments.

11. Related Party Transactions

Syngenta AG

The Company has had an ongoing research collaboration with Syngenta, a greater-than 10% owner of the Company’s outstanding common stock since 1999.

The Company recognized revenue from Syngenta and its affiliates of $2.9 million and $4.4 million for the three months ended March 31, 2007, and 2006. Accounts receivable due from Syngenta were $0.4 million and $0.4 million, and deferred revenue associated with Syngenta was $3.0 million and $3.1 million, at March 31, 2007 and December 31, 2006.

In connection with the research collaboration with Syngenta, the Company recorded $49,000 and $94,500 in rental cost reimbursements from Syngenta during the three months ended March 31, 2007 and 2006, which was included as a reduction in rent expense.

12. Concentration of Business Risk

During the three months ended March 31, 2007 and 2006, the Company had collaborative research agreements that accounted for 42% and 67% of total revenue. Additionally, during the three months ended March 31, 2007 and 2006, one collaborator accounted for 26% and 47% of total revenue.

A relatively small number of customers and collaboration partners historically have accounted for a significant percentage of the Company’s revenue. Revenue from significant customers and/or collaboration partners as a percentage of total revenue was as follows:

	THREE MONTHS ENDED MARCH 31,
	2007		2006
Customer A	26	%	47	%
Customer B	33	%	14	%

Accounts receivable from one significant customer comprised approximately 51% of accounts receivable at March 31, 2007. Accounts receivable from four significant customers comprised approximately 27%, 22%, 12%, and 11% of accounts receivable at December 31, 2006. Accounts receivable derived directly or indirectly from agencies of the U.S. Government comprised 13% and 19% of total accounts receivable at March 31, 2007 and December 31, 2006.

Revenue by geographic area was as follows (in thousands):

	THREE MONTHS ENDED MARCH 31,
	2007		2006
North America	$	4,392	$	3,092
South America		—		465
Europe		6,691		5,953
Asia		225		—
	$	11,308	$	9,510

For the three-month periods ended March 31, 2007 and 2006, more than 75% of the Company’s product-related revenue was derived from one focus area, Health and Nutrition.

13. Impact of Recently Issued Accounting Standards

Income Taxes

On July 13, 2006, the FASB issuedFASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes.”Under FIN 48, the impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Additionally, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006.

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The Company adopted the provisions of FIN 48 on January 1, 2007. There were no unrecognized tax benefits as of the date of adoption. As a result of the implementation of FIN 48, the Company did not recognize an increase in the liability for unrecognized tax benefits. There are no unrecognized tax benefits included in the balance sheet that would, if recognized, affect the effective tax rate.

The Company’s practice is to recognize interest and/or penalties related to income tax matters in income tax expense. The Company had no accrual for interest and penalties on its balance sheets at December 31, 2006 and at March 31, 2007, and has recognized no interest and/or penalties in the statement of operations for the first quarter of 2007.

The Company is subject to taxation in the US and various state jurisdictions. The Company’s tax years for 1993 and forward are subject to examination by the US and California tax authorities due to the carryforward of unutilized net operating losses and research and development credits.

The adoption of FIN No. 48 did not impact the Company’s financial condition, results of operations or cash flows. At January 1, 2007, the Company had no net deferred tax assets on its balance sheet. Gross deferred tax assets are primarily composed of federal and state tax net operating loss carryfowards and federal and state research and development (“R&D”) credit carryforwards. Due to uncertainties surrounding the Company’s ability to generate future taxable income to realize these assets, a full valuation allowance has been established to offset the Company’s gross deferred tax asset. Additionally, the future utilization of the Company’s net operating loss and R&D credit carryforwards to offset future taxable income may be subject to a substantial annual limitation as a result of ownership changes that may have occurred previously or that could occur in the future. The Company has not yet determined whether such an ownership change has occurred, however, the Company plans to complete a Section 382/383 analysis regarding the limitation of the net operating losses and R&D credits. When this analysis is completed, the Company plans to update its unrecognized tax benefits under FIN No. 48. Therefore, the Company expects that the unrecognized tax benefits may change within 12 months of this reporting date. At this time, the Company cannot estimate how much the unrecognized tax benefits may change. Any carryforwards that will expire prior to utilization as a result of such limitations will be removed from deferred tax assets with a corresponding reduction of the valuation allowance. Due to the existence of the valuation allowance, future changes in our unrecognized tax benefits will not impact the Company’s effective tax rate.

Fair Value Accounting

In February 2007, FASB issued FASB Statement No. 159 (“FAS 159”), “The Fair Value Option for Financial Assets and Financial Liabilities.” FAS 159 is effective for fiscal years beginning after November 15, 2007. The new Statement allows entities to choose, at specified election dates, to measure eligible financial assets and liabilities at fair value that are not otherwise required to be measured at fair value. If a company elects the fair value option for an eligible item, changes in that item’s fair value in subsequent reporting periods must be recognized in current earnings. FAS 159 also establishes presentation and disclosure requirements designed to draw comparison between entities that elect different measurement attributes for similar assets and liabilities. Management is currently evaluating the effect of this pronouncement on the Company’s financial statements.

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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 elsewhere in this report.

Except for the historical information contained herein, the following discussion contains forward-looking statements that involve risks and uncertainties. These statements speak only as of the date on which they are made, and we undertake no obligation to update any forward-looking statement. Forward-looking statements include statements related to our increased investments in commercialization efforts and technology and enzyme development, our future product-related revenues, our future losses and the timing for those losses, the benefits of our proposed merger with Celunol and the proposed timing for its closing, the use of the net proceeds from our convertible debt offering, our future grant revenue, research and development expenses, selling, general and administrative expenses, and capital expenditure requirements, and our estimated costs for building a commercial-scale cellulosic ethanol facility, all of which are prospective. Such statements are only predictions, and the actual events or results may differ materially from those projected in the forward-looking statements. Factors that could cause or contribute to differences include, but are not limited to, risks involved with our new and uncertain technologies, risks associated with our dependence on patents and proprietary rights, risks associated with our protection and enforcement of our patents and proprietary rights, our dependence on existing collaborations, our ability to enter into and/or maintain collaboration and joint venture agreements, our ability to commercialize products directly and through our collaborators, the timing of anticipated regulatory approvals and product launches, risks associated with our merger with Celunol and our ability to close the merger, and the development or availability of competitive products or technologies, as well as other risks and uncertainties set forth below and in the section of this report entitled “Risk Factors.”

Overview

We were incorporated in Delaware in December 1992 under the name Industrial Genome Sciences, Inc. In August 1997 we changed our name to Diversa Corporation. In January 2006, following a comprehensive review of our operations, we announced a strategic reorganization designed to focus our resources on advancing our most promising products and product candidates in three key areas: alternative fuels; specialty industrial processes; and health and nutrition. As a result of this decision, we discontinued development of a number of less promising products and programs and reduced our workforce by 83 employees. In 2006 we recorded $12.0 million in restructuring charges, consisting primarily of employee separation and facilities consolidation costs. In January 2007, in connection with an announcement of our refocused collaborative agreement with Syngenta, we announced a new strategy of vertical integration within biofuels to allow us to better capture the value that we believe our technology will bring to this emerging market. On February 12, 2007, as part of this strategy of vertical integration within biofuels, we announced that we signed a definitive agreement to merge with Celunol Corp., a science- and technology-driven company that is directing its integrated technologies to the production of low-cost cellulosic ethanol from an array of biomass sources. Provided that all required regulatory, stockholder, and other approvals are received, we expect this merger to close in the second quarter of 2007.

To date, we have dedicated substantial resources to the development of our proprietary technologies, which include capabilities for sample collection from the world’s microbial populations, generation of environmental libraries, screening of these libraries using ultra high-throughput methods capable of analyzing more than one billion genes per day, and optimization based on our gene evolution technologies. During 2006, we continued to shift more of our resources from technology development to commercialization efforts for our existing and future products. We expect to continue to invest heavily in these commercialization efforts, and to expand our investment in technology and enzyme development, primarily in the area of biofuels.

For the three months ended March 31, 2007, total revenues increased 19% compared to the three months ended March 31, 2006, while product-related revenue increased 111% over the same period. We expect that product-related revenue will continue to represent a larger percentage of our total revenues in the future. Beginning in 2006, we began to de-emphasize grant revenue and certain collaborations that are not strategic to our current market focus; however, certain of our partners and funding sources have ongoing obligations to fund our programs, and we have ongoing obligations to provide research and development services under our current agreements. As of March 31, 2007 our strategic partners have provided us with more than $275 million in funding since inception and are committed to additional funding of more than $20 million through 2010, subject to our performance under existing agreements, excluding milestone payments, license and commercialization fees, and royalties or profit sharing. Our strategic partners often pay us before we recognize the revenue, and these payments are deferred until earned. As of March 31, 2007, we had deferred revenue totaling $5.9 million, of which $4.6 million was related to funding from collaborative partners, and $1.3 million was related to product sales, including approximately $1.1 million attributed to sales to Valley Research, inc., or Valley, a former distributor for certain of the Company’s products. As more fully described inNote 9 to Condensed Consolidated Financial Statements, “Contingencies,” we are currently in a legal dispute with Valley and, accordingly, there is no assurance that this amount, or any portion thereof, will be recognized as revenue in the foreseeable future, or at all. In addition, at March 31, 2007, we had approximately $0.8 million in deferred cost of sales related to sales to Valley included in other current assets on the accompanying balance sheet, and there is no assurance that any of this amount will ever be realized.

We have incurred net losses since our inception. As of March 31, 2007, our accumulated deficit, including $45.7 million in non-cash asset impairment charges in 2005 and $12.0 million in restructuring charges in 2006, was $339.8 million. Our results of operations have fluctuated from period to period and likely will continue to fluctuate substantially in the future. We expect to incur losses through at least 2010 as a result of:

• our continued investment in sales and marketing infrastructure intended to strengthen our customer contact and focus;

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• our continued investment in manufacturing facilities necessary to meet increased demand for our products;

• continued research and development expenses for our internal product candidates; and,

• anticipated additional investments to implement our vertical integration strategy, including our proposed merger with Celunol Corp., which is more fully described below.

Results of operations for any period may be unrelated to results of operations for any other period. In addition, we believe that our historical results are not a good indicator of our future operating results.

Recent Strategic Events

Research Collaboration with Syngenta AG

In January 2007, we announced a new 10-year research and development partnership with Syngenta AG, or Syngenta, focused on the discovery and development of a range of novel enzymes to convert pre-treated cellulosic biomass to mixed sugars economically—a critical step in the process of biofuel production. The new agreement replaced our prior agreement with Sygnenta.

Our prior collaboration agreement with Syngenta was a seven-year agreement that started in early 2003. It was a broad research and product development collaboration in which our companies worked on various exclusive projects together across a multitude of fields. The prior agreement provided for a minimum of $118 million of research funding over the seven year research period, of which approximately $83 million was received through termination of the agreement. The agreement led to product candidates for the production of biofuels such as ethanol from corn, and enzymes to improve the digestibility and reduce the environmental impact of phosphorus and other nutrients naturally contained in animal feed. However, the prior agreement covered significantly more exclusive fields and applications than were ultimately being taken to the marketplace.

In contrast, we believe the new agreement, which replaces the prior agreement, is more focused and better aligned with each company’s core strengths. Under the terms on the new 10-year agreement, Syngenta will commit a minimum of $16 million over the next two years to fund joint research and development activities, largely in defined areas of biofuels. In addition, we will be entitled to development- and commercialization-related milestone payments as well as royalties on any products that are commercialized by Syngenta. In addition, the new agreement allows us the freedom to operate independently in all fields, and to market and sell fermentation-based enzyme products developed either under the collaboration or by us independently. Syngenta will have the rights to market and sell plant-expressed, or transgenic, enzyme products developed under the collaboration in the fields of animal feed or biofuels. We have also licensed our existing collection of enzymes for plant expression to Syngenta within these two fields.

As a result of the restructuring of our Syngenta agreement, our minimum guaranteed collaborative revenue will be reduced by approximately $19.0 million over the next 3 years, with $12.0 million of this reduction occurring in 2007. Accordingly, we expect to incur an increased loss in 2007, before consideration of restructuring charges, as compared to 2006.

Announcement of Vertical Integration Strategy for the End-to-End Production of Cellulosic Ethanol

In January of 2007, we announced that we would pursue opportunities for vertically integrated commercialization of biofuels, in particular ethanol from cellulosic biomass. Converting biomass to biofuels requires the successful integration of developing technologies in three areas: chemical preparation of the cellulosic biomass (pre-treatment), conversion of pre-treated cellulosic biomass to fermentable sugars by combinations or “cocktails” of efficient enzymes (saccharification), and the development of novel microorganisms to ferment the sugars to ethanol or other fuels cost-effectively (fermentation). To date, we have focused primarily on the development of novel, high-performance enzyme cocktail for saccharification of a variety of cellulosic biomass feedstocks as part of our specialty enzyme business. However, we believe that our enzyme optimization technologies and expertise can be applied to improve the performance of fermentation organisms, and we believe that our high-throughput culturing technologies can be applied to the discovery of novel microorganisms that may assist in the development of improved fermentation organisms. In addition, a number of our scientific, business development, operations, and finance personnel have developed significant additional expertise in the other technologies and process components, beyond the saccharification component, that are emerging for making cellulosic ethanol, as well as the criteria and variables that are typically involved in the integration of these technologies and processes. Beginning in 2007, we expect to begin to incur additional losses as we pursue our vertical integration strategy within biofuels.

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Proposed Merger Transaction with Celunol Corp

On February 12, 2007, we entered into a definitive merger agreement with Celunol Corp., a Delaware corporation, pursuant to which the parties agreed to a merger transaction involving the merger of a wholly-owned subsidiary of Diversa into Celunol, with Celunol continuing as the surviving corporation and a wholly-owned subsidiary of Diversa. The merger agreement has been approved by the boards of directors of both Diversa and Celunol.

We believe that the combined company will be the first within the cellulosic ethanol industry to possess integrated end-to-end capabilities in pre-treatment, novel enzyme development, fermentation, engineering, and project development. It will seek to build a global enterprise as a leading producer of cellulosic ethanol and as a strategic partner in bio-refineries around the world. At the same time, we will continue to pursue broad market opportunities for specialty industrial enzymes within the areas of alternative fuels, specialty industrial processes, and health and nutrition, with a primary focus on enzymes for the production of biofuels. The combined company will be headquartered in Cambridge, Massachusetts and have research and operations facilities in San Diego, California; Jennings, Louisiana; and Gainesville, Florida. Substantial capital and cash will be required to execute the combined business plan.

In February 2007, Celunol completed a significant upgrade of its pilot-scale facility in Jennings, Louisiana and, on the same Celunol-owned property, has begun construction of a 1.4 million gallons-per-year, demonstration-scale facility to produce cellulosic ethanol from sugarcane bagasse and specially-bred energy cane. Celunol expects that its demonstration-scale facility will be mechanically complete by the end of 2007.

Under the terms of the merger agreement, upon completion of the merger, and subject to certain adjustments, Celunol’s security holders will receive an aggregate of 15 million shares of stock in Diversa, collectively representing approximately 24% of the fully diluted equity of the combined organization following the completion of the merger. In conjunction with the merger, we are committed to fund up to $20 million in cash to fund Celunol’s operations through the close of the merger, subject to the terms of a promissory note. As of March 31, 2007 we had funded $8.5 million under this agreement.

We expect the transaction, which will be accounted for as a purchase, to close in the second quarter of 2007, subject to the satisfaction of certain customary closing conditions, including the approval of the stockholders of both companies. Diversa will require the approval of a majority of the total shares of Diversa common stock voting at the annual stockholders’ meeting to approve the issuance of Diversa common stock in connection with the merger. Celunol will require the approval of (a) a majority of the total voting shares represented by Celunol common stock and preferred stock, voting as a single class, and (b) a majority of the total voting shares represented by Celunol preferred stock, voting as a single class, to approve the merger. Stockholders of Diversa representing approximately 22% of the total shares of Diversa common stock have entered into voting agreements and irrevocable proxies agreeing to vote in favor of, and otherwise support, the issuance of Diversa common stock in connection with the merger. Stockholders of Celunol have entered into voting agreements and irrevocable proxies covering (a) 35% of the total voting shares represented by Celunol common stock and preferred stock, as a single class and (b) 35% of the total voting shares represented by Celunol preferred stock, as a single class, pursuant to which these stockholders have agreed to vote in favor of, and otherwise support, the merger.

We filed an amended registration statement on Form S-4 on May 8, 2007 in connection with the proposed merger. Information relating to Celunol, Celunol’s business and the merger are set forth in more detail in that registration statement, and is not part of this Quarterly Report on Form 10-Q. The description of Diversa and our business in this Form 10-Q, except for specific references to the contrary, describe Diversa as a stand-alone entity and not assuming the combined business of Diversa and Celunol. We can not assure you that the merger will be completed.

Completion of Convertible Notes Offering

As more fully described in our Annual Report on Form 10-K for the year ended December 31, 2006, our independent registered public accounting firm included an explanatory paragraph in their report on our 2006 financial statements related to the uncertainty in our ability to continue as a going concern. At that time, we had insufficient cash and working capital to effect the merger with Celunol and the combined business plan as contemplated. In late March 2007 and early April 2007, we completed an offering of $120 million aggregate principal amount of 5.50% Convertible Senior Notes due 2027 (“Convertible Notes”) in a private placement, generating net cash proceeds of approximately $114.9 million. The Convertible Notes are convertible, at the option of the holders, at any time prior to maturity, into shares of our common stock at an initial conversion rate of 122.5490 shares of common stock per $1,000 principal amount of notes (subject to adjustment in certain circumstances), which represents an initial conversion price of $8.16 per share. On or after April 5, 2012, and subsequent to us having made at least 10 semi-annual interest payments, we are able to unilaterally redeem the debt at any time prior to maturity. We also must repay the debt, plus any accrued and unpaid interest, if there is a qualifying change in control or termination of trading of our common stock.

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We intend to use the net proceeds of this offering for continued expansion of our biofuels business, continued investment in product development and commercialization efforts in our specialty enzyme business, and for general corporate purposes, including working capital. Though this offering is not contingent upon our pending merger with Celunol Corp. (the “Merger”), if the Merger is successfully consummated, we intend to use a portion of the net proceeds from this offering to fund the operations of the combined company, including the planned construction of a demonstration-scale ethanol facility.

Results of Operations

Three Months Ended March 31, 2007 and 2006

Revenues

Revenues increased 19%, or $1.8 million, to $11.3 million for the three months ended March 31, 2007 from $9.5 million for the three months ended March 31, 2006, attributed primarily to a an increase in product-related revenue, offset in part by a decrease in collaborative and grant revenue.

Product-related revenue for the three months ended March 31, 2007 increased 111% to $5.4 million from $2.5 million for the three months ended March 31, 2006. This increase was attributable primarily to increased revenue associated with Phyzyme^™ XP phytase sold through our collaboration with Danisco Animal Nutrition, or Danisco, as well as increased sales from our other commercial enzyme products, including Quantum phytase and Luminase^™ PB-100. In September 2006, the EU Commission granted permanent authorization for the use of Phyzyme XP in broiler poultry feed in Europe, which we expect will positively impact sales of Phyzyme XP in 2007.

During 2006 and the first quarter of 2007, we shipped a total of approximately $1.1 million in Valley “Ultra-Thin” enzyme to our U.S. distributor, Valley Research, inc., or Valley. We have deferred revenue on our 2006 and 2007 sales of this product to Valley, as we do not yet believe that, given our limited commercial experience with this product and Valley, all criteria for recognizing revenue related to our sales to Valley have been met. As more fully described inItem 1 of Part II of this Quarterly Report on Form 10-Q—Legal Proceedings, and in theNotes to Condensed Consolidated Financial Statements, we are currently in a legal dispute with Valley over alleged breach of contract, and do not expect significant revenue to result from this distribution agreement. Instead, we plan to market this product under the Fuelzyme^™-LF brand through our direct salesforce or other distributors. On March 7, 2007, we issued a letter to Valley terminating our distribution agreement with Valley, effective immediately, on the basis of Valley’s not having met certain minimum purchase requirements. As of March 31, 2007 our deferred revenue balance related to Valley was $1.1 million, and there is no assurance that this amount, or any portion thereof, will be recognized as revenue in the foreseeable future, or at all. In addition, at March 31, 2007, we had approximately $0.8 million in deferred cost of sales related to sales to Valley included in other current assets on the accompanying balance sheet, and there is no assurance that any of this amount will ever be realized.

Collaborative revenue decreased 25%, or $1.6 million, to $4.7 million from $6.3 million and accounted for 42% and 67% of total revenue for the three month periods ended March 31, 2007 and 2006. This decrease is primarily a result of the restructuring of our Syngenta collaboration, as well as continued de-emphasis of certain collaborations that are not core to our current focus, in favor of greater emphasis on sales of products. We anticipate that collaborative revenue will decrease in 2007 as compared to 2006, primarily related to our new agreement with Syngenta, pursuant to which our minimum guaranteed collaborative revenue will be reduced by approximately $19.0 million over the next three years, with $12.0 million of this reduction occurring in 2007.

Grant revenue increased 88%, or $0.6 million, to $1.2 million for the three months ended March 31, 2007 as compared to $0.6 million for the three months ended March 31, 2006. This increase is attributed primarily to a delay in funding for one of our grants during the first quarter of 2006. Since late 2005, we have continued to de-emphasize grants and government contracts that are not core to our strategic focus. We do not expect our grant revenue to return to the levels we achieved in 2005 and 2004.

Our revenues have historically fluctuated from period to period and likely will continue to fluctuate substantially in the future based upon the timing and composition of funding under existing and future collaboration agreements, regulatory approval timelines for new products, as well as adoption rates of our new and existing commercial products. We anticipate that our revenue mix will continue to shift toward a higher percentage of product-related revenue. For 2007, we plan to continue to de-emphasize grant revenue and certain collaborations that are not strategic to our current market focus.

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Cost of Product-Related Revenue

Cost of product-related revenue includes both fixed and variable costs, including materials and supplies, labor, facilities and other overhead costs, associated with our product-related revenues. Excluded from cost of product-related revenue are costs associated with the scale-up of manufacturing processes for new products which have not reached commercial-scale production volumes, which we include in our research and development expenses. For the three months ended March 31, 2007, cost of product-related revenue increased $2.7 million, or 125%, to $4.9 million compared to $2.2 million for the three months ended March 31, 2006. This increase resulted primarily from the increase in our fixed manufacturing costs under our contract with Fermic, S.A., or Fermic, our manufacturing partner in Mexico City, as well as the increase in product-related revenues. We generated gross margin of approximately 9% during the first quarter of 2007 despite an increase in fixed costs over the prior year. This compares to a gross margin of 14% in the first quarter of 2006. This is primarily the result of a decrease in our profit share from Danisco. Under our agreement with Danisco, we sell our Phyzyme inventory to Danisco at cost and then share 50% of Danisco’s profit when the product is sold to the end user. The decrease in gross margin for the quarter is primarily the result of increased sales of zero gross margin inventory to Danisco and one-time marketing roll-out expenses for the new thermally-stable formulation of Phyzyme XP, as well as costs related to ramped-up sales efforts of Phyzyme in Europe following the recent expanded approval within the European Union. We expect both our revenue and gross margins for the remainder of 2007 to be positively impacted by both of these new market initiatives, as well as our recent success in further reducing manufacturing cost of the active intermediate supplied to Danisco for these formulations.

We also expect that the cost of product-related revenue will decrease as a percentage of product-related revenue once we have completed our manufacturing ramp-up and have achieved a scalable volume of product sales for our other products, as well as cost efficiencies we expect to achieve as we scale up production and improve our manufacturing yields. Because a large percentage of our manufacturing costs are fixed, we will realize continued margin improvements as product-related revenues increase; however, our margins may be negatively impacted in the future if our product-related revenues do not grow in line with our increase in minimum capacity requirements at Fermic. For example, during the quarter ending September 30, 2006, we expanded our manufacturing capabilities at Fermic, which increased our fixed manufacturing costs by approximately $0.7 million per quarter, and we are committed to further expand our manufacturing capabilities in the second quarter of 2007, which will increase our fixed manufacturing costs by an additional $0.7 million per quarter. In addition, our gross margins are dependent upon the mix of product-related sales as the cost of product-related revenue varies from product to product.

Research and Development

Research and development expenses consist primarily of costs associated with internal development of our technologies and our product candidates, manufacturing scale-up and bioprocess development for our current products, and costs associated with research activities performed on behalf of our collaborators. We track our researchers’ time by type of project. However, we do not track other research and development costs by project; rather, we track such costs by the type of cost incurred.

For the three months ended March 31, 2007, we estimate that approximately 63% of our research and development personnel costs, based upon hours incurred, were spent on research activities funded by our collaborators and grants, and that approximately 37% were spent on internal product and technology development. For the three months ended March 31, 2006, we estimate that approximately 61% of our research and development personnel costs, based upon hours incurred, were spent on research activities funded by our collaborators and grants, and that approximately 39% were spent on internal product and technology development.

Research and development direct costs and unallocated costs incurred by type of project during quarters ended March 31, 2007 and 2006 were as follows (in thousands):

	2007		2006
Collaborations:
Syngenta	$	804	$	1,113
Other		1,694		1,515
Total collaborations		2,498		2,628
Grants		412		290
Internal development		1,724		1,668
Unallocated		8,238		9,475
	$	12,872	$	14,061

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Our internal development costs relate primarily to early-stage discovery of new enzymes, regulatory work for mid-stage development products, and bioprocess development and technical support for late-stage development. We consider early-stage projects to be those which are experimental in nature, and are often short-lived. We consider mid-stage development products to be those that are potential candidates to advance to regulatory and commercialization stages. We consider late-stage products those that have been approved for their intended use by one or more regulatory agencies, have already been introduced commercially, or such commercial introduction is pending.

We estimate that our allocation of internal research and development direct costs during the quarters ended March 31, 2007 and 2006 was as follows (in thousands):

	2007		2006
Early-stage product development	$	332	$	49
Mid-stage product development		77		126
Late-stage product development		1,055		739
R&D support activities		260		754
	$	1,724	$	1,668

The increase in our internal development costs was largely the result of the decrease in funding from Syngenta. We have re-deployed these resources into internal development projects, primarily within biofuels. Our allocation of research and development resources varies from period to period and is largely dependent upon resources we have available over and above what is funded by our partners; however, we believe that our internal development projects are benefited to some extent by work we perform under our funded collaborative agreements.

Research and development costs based upon type of cost incurred for the quarters ended March 31, 2007 and 2006 were as follows (in thousands):

	2007		2006
Personnel related	$	4,634	$	4,586
Laboratory and supplies		1,190		1,542
Outside services		2,783		1,474
Equipment and depreciation		1,526		1,923
Facilities, overhead and other		2,189		3,183
Scale-up manufacturing costs		130		481
Share-based compensation		420		872
	$	12,872	$	14,061

Our research and development expenses decreased $1.2 million to $12.9 million (including share-based compensation of $0.4 million) for the three months ended March 31, 2007 from $14.1 million (including share-based compensation of $0.9 million) for the quarter ended March 31, 2006. Our facilities and overhead costs decreased by $1.0 million, primarily related to our strategic reorganization in January 2006, and our laboratories and supplies costs decreased $0.5 million, related primarily to continued cost control initiatives. These decreases were offset in large part by an increase in outside services, related primarily to third-party costs incurred under our grants, reflective of the corresponding increase in our grant revenue.

We have a limited history of developing commercial products. We determine which products to pursue independently based on various criteria, including: investment required, estimated time to market, regulatory hurdles, infrastructure requirements, and industry-specific expertise necessary for successful commercialization. Successful products require significant development and investment prior to regulatory approval and commercialization. As a result of the significant risks and uncertainties involved in developing and commercializing such products, we are unable to estimate the nature, timing, and cost of the efforts necessary to complete each of our major projects. These risks and uncertainties include, but are not limited to, the following:

• Our products may require more resources than we anticipate if we are technically unsuccessful in initial development or commercialization efforts.

• The outcome of research is unknown until each stage of testing is completed, up through and including product trials and regulatory approvals, if needed.

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• It can take many years from the initial decision to perform research through development until products, if any, are ultimately marketed.

• We have several product candidates in various stages of development related to collaborations and grants as well as internally developed products. At any time, we may modify our strategy and pursue additional collaborations for the development and commercialization of some products that we had intended to pursue independently.

Any one of these risks and uncertainties could have a significant impact on the nature, timing, and costs to complete our product development efforts. Accordingly, we are unable to predict which potential product candidates we may proceed with, the time and costs to complete development, and ultimately whether we will have any products approved by the appropriate regulatory bodies. The various risks associated with our research and development activities are discussed more fully in this report under “Risk Factors.” Despite the expected decrease in research and development funding under our new agreement with Syngenta, we do not intend to dramatically reduce our R&D efforts. Instead, we will redirect these resources away from the Syngenta collaboration and towards our own internal efforts, either independently or with 3rd parties, focused primarily on biofuels. We also expect that our research and development expenses will increase significantly to support the combined company if the pending merger with Celunol is completed.

Selling, General and Administrative Expenses

Selling, general and administrative expenses remained level at $4.0 million (including share-based compensation of $0.6 million) for the quarter ended March 31, 2007, as compared to $3.9 million (including share-based compensation of $0.4 million) for the quarter ended March 31, 2006. We expect our sales and marketing expenses to remain at comparable levels, or increase, in future periods as we introduce new products and invest in the necessary infrastructure to support our anticipated increase in product revenue. We also expect that our selling, general and administrative expenses will increase significantly to support the combined company if the pending merger with Celunol is completed.

Non-Cash, Share-Based Compensation Charges

Pursuant to Financial Accounting Standards Board Statement, or FASB, No. 123(R), “Share-Based Payment,” we recognized $1.1 million, or $0.02 per share, and $1.3 million, or $0.03 per share, in share-based compensation expense for our share-based awards during the first three months of 2007 and 2006. Share-based compensation expense was allocated among the following expense categories (in thousands):

	THREE MONTHS ENDED MARCH 31,
	2007		2006
Research and development	$	420	$	872
Selling, general and administrative		641		429
	$	1,061	$	1,301

These charges had no impact on our reported cash flows.

Restructuring Charges

In connection with the decision to reorganize and refocus our resources, in January 2006, we commenced several cost containment measures, including a reduction in workforce of 83 employees and the consolidation of our facilities. We recorded charges of $11.0 million in the first quarter of 2006 related to these activities, under the provisions set forth by FASB No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” During the first quarter of 2006, we completed the employee termination activities under this restructuring and do not anticipate further payments or expenses related to employee separation under this program. The facility consolidation costs are based on estimates that represent the discounted cash flow of lease payments (net of anticipated sublease income) on the vacated space through its contractual lease term in 2016. Pursuant to current accounting rules, we are required to re-assess these estimates on a periodic basis. We recorded $0.1 million of additional charges during the quarter ended March 31, 2007, reflecting revisions in our estimates for our remaining net facilities consolidation costs. We may further revise these estimates in future periods, which could give rise to additional charges or adjustments.

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Interest and other income, net

Interest Income, net

Interest income on cash and short-term investments was $0.2 million for the quarter ended March 31, 2007 compared to $0.2 million for the quarter ended March 31, 2006, reflective of higher average rates of return on our investments, consistent with the increase in short-term interest rates from 2006 to 2007, and offset by a decrease in cash and investment balances during 2006.

Provision for Income Taxes

For the years ended December 31, 2006 and 2005, we incurred net operating losses and, accordingly, did not record a provision for income taxes. As of December 31, 2006, we had federal net operating loss carry-forwards of approximately $233.5 million, which will begin to expire in 2011 unless utilized. Our estimated net operating loss carry-forwards for state tax purposes were approximately $48.0 million as of December 31, 2006, which began to expire in 2007 unless utilized. We also had estimated federal research credits of approximately $5.2 million which will begin to expire in 2011, California research credits of approximately $4.0 million which will carry over indefinitely, and California manufacturer’s investment credits of approximately $0.7 million which will begin to expire in 2010. Our utilization of the net operating losses and credits may be subject to substantial annual limitations pursuant to Section 382 of the Internal Revenue Code, and similar state provisions, as a result of changes in our ownership structure. The annual limitations may result in the expiration of a portion of our net operating loss carry-forwards and credits. We anticipate that we may be subject to limitations pursuant to Section 382 if our pending merger with Celunol is completed.

On July 13, 2006, theFASB issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes – An Interpretation of FASB Statement No. 109.” FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance withFASB Statement No. 109, “Accounting for Income Taxes” and prescribes a recognition threshold and measurement attributes for financial statement disclosure of tax positions taken or expected to be taken on a tax return. Under FIN 48, the impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Additionally, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. Pursuant to the adoption of FIN 48, our net operating loss carryforwards and other credits may be subject to revision. We are currently assessing the impact of FIN 48 on our tax positions.

Liquidity and Capital Resources

Since inception, we have financed our business primarily through the sale of common and preferred stock, funding from strategic partners and government grants, and our convertible debt issuance. As of March 31, 2007, our strategic partners have provided us more than $275 million in funding since inception and are also committed to additional funding of more than $20 million through 2010, subject to our performance under existing agreements, excluding milestone payments, license and commercialization fees, and royalties or profit sharing. Future committed funding is subject to our performance under existing agreements, and excludes milestone payments, license and commercialization fees, and royalties or profit sharing. Our future committed funding is concentrated within a limited number of collaborators. Our failure to successfully maintain our relationship with these collaborators could have a material adverse impact on our operating results and financial condition.

As more fully described in our Annual Report on Form 10-K and 10-K/A for the year ended December 31, 2006, our independent registered public accounting firm included an explanatory paragraph in their report on our 2006 financial statements related to the uncertainty in our ability to continue as a going concern. At that time, we had insufficient cash and working capital to effect the merger with Celunol and the combined business plan as contemplated. In late March 2007 and early April 2007, we completed an offering of $120 million aggregate principal amount of 5.50% Convertible Senior Notes due 2027 (“Convertible Notes”) in a private placement, generating net cash proceeds of approximately $114.9 million. The Convertible Notes are convertible by holders into shares of our common stock at an initial conversion rate of 122.5490 shares of common stock per $1,000 principal amount of notes (subject to adjustment in certain circumstances), which represents an initial conversion price of $8.16 per share.

As of March 31, 2007, we had cash, cash equivalents, and short-term investments of approximately $125.5 million and raised additional net proceeds of approximately $19.3 million in April 2007 from the exercise of the underwriters’ overallotment option in our convertible debt issuance. Our short-term investments as of such date consisted primarily of U.S. Treasury and government agency obligations and investment-grade corporate obligations. Historically, we have funded our capital equipment purchases through available cash, capital leases and equipment financing line of credit agreements.

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During 2002, we entered into a manufacturing agreement with Fermic to provide us with the capacity to produce commercial quantities of certain enzyme products. Based on actual and projected increased product requirements, the agreement was amended in 2004 to provide for additional capacity to be installed over the succeeding four year period. Under the terms of the agreement, we can cancel the committed purchases with thirty months’ notice provided that the term of the agreement, including the termination notice period, aggregates four years. Pursuant to our agreement with Fermic, we are also obligated to reimburse monthly costs related to manufacturing activities. These costs scale up as our projected manufacturing volume increases. As of March 31, 2007, under this agreement we have made minimum commitments to Fermic of approximately $24.9 million over the next three years. In addition, under the terms of the agreement, we are required to purchase certain equipment required for fermentation and downstream processing of the products. Through March 31, 2007, we had incurred costs of approximately $14.4 million for equipment related to this agreement.

We purchased capital equipment totaling $1.2 million during the first quarter of 2007. We anticipate the cost of capital equipment required to support the ongoing needs of our existing research could be as much as $8.0 million for 2007. We also expect that our capital expenditure requirements will increase as we begin to implement our vertical integration strategy within biofuels, and particularly if our pending merger with Celunol is completed.

Our operating activities used cash of $12.1 million for the quarter ended March 31, 2007. Our cash used by operating activities consisted primarily of cash used to fund our net loss of $10.3 million, as well as $2.2 million in merger-related costs. This cash usage was offset in part by depreciation of $2.2 million and non-cash share-based and compensation charges of $1.1 million.

Our investing activities used cash of $4.7 million for the quarter ended March 31, 2007. Our investing activities consisted primarily of advances of $8.5 million made to Celunol in connection with our merger agreement and purchases of property and equipment of $1.2 million, partially offset by cash generated through net maturities of short-term investments of $5.0 million to fund operations.

Our financing activities generated net cash of $95.3 million for the quarter ended March 31, 2007, consisting primarily of net proceeds from our convertible notes offering

The following table summarizes our contractual obligations at March 31, 2007 (in thousands), excluding our obligation to fund Celunol up to an additional $11.5 million in connection with our proposed merger:

			Payments due by period
	Total		Less Than 1 Year		1-3 Years		3-5 Years		More Than 5 Years
Contractual Obligations
Long-term debt	$	7,947	$	3,972	$	3,887	$	88	$	—
Operating leases		50,543		3,634		10,165		10,877		25,867
Manufacturing costs to Fermic		24,885		9,698		15,187		—		—
License and research agreements		2,031		540		731		290		470
Total Contractual Obligations	$	85,406	$	17,844	$	29,970	$	11,255	$	26,337

We do not have any off-balance sheet arrangements that would give rise to additional contractual obligations as of March 31, 2007.

During 2007, we anticipate funding as much as $3.0 million in additional equipment costs related to our manufacturing agreement with Fermic. As we continue to develop our commercial manufacturing platforms, we will be required to purchase additional capital equipment under this agreement.

On September 30, 2005, we entered into a $14.6 million Loan and Security Agreement (the “Bank Agreement”) with a commercial bank (the “Bank”). The Bank Agreement provided for a one-year credit facility for up to $10.0 million in financing for qualified equipment purchases in the United States and Mexico (the “Equipment Advances”) and a $4.6 million letter of credit sub-facility (the “Letter of Credit Sublimit”). The Bank Agreement was amended in October 2006 to increase the Letter of Credit Sublimit to $4.7 million. Borrowings under the Equipment Advances are structured as promissory notes which are secured by qualified equipment purchases and repaid over 36 to 48 months, depending on the location of the equipment financed. Borrowings bear interest at the Bank’s prime rate (8.25% at March 31, 2007) plus 0.75%. On September 30, 2006, our draw-down period under the Equipment Advances expired.

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At March 31, 2007, there was approximately $3.5 million in outstanding borrowings under the Equipment Advances and a letter of credit for approximately $4.7 million under the Letter of Credit Sublimit, as required under the our facilities leases.

The Bank Agreement contains standard affirmative and negative covenants and restrictions on actions by us including, but not limited to, activity related to our common stock repurchases, liens, investments, indebtedness, and fundamental changes in, or dispositions of, our assets. We may take certain of these actions with the consent of the Bank. In addition, we are required to meet certain financial covenants, primarily a minimum balance of unrestricted cash, cash equivalents, and investments in marketable securities of $25.0 million, including $15.0 million maintained in accounts at the Bank or its affiliates.

As of March 31, 2007, we were in compliance with all debt covenants under our various financing agreements;

As previously described, in February 2007, our Board of Directors approved a merger transaction with Celunol. In connection with our proposed merger, we are committed to funding Celunol up to $20 million in cash prior to the close of the transaction, subject to the terms and conditions of a promissory note. Through March 31, 2007, we had funded Celunol $8.5 million under this agreement. In addition, substantial cash requirements will be necessary to execute the combined business plan subsequent to the closing, which is expected by the end of the second quarter of 2007. Following the closing of our convertible notes offering in late March 2007 and early April 2007, we believe our cash and investments are sufficient to meet the operating needs of the combined company through at least 2008.

We currently estimate the cost of building a commercial-scale cellulosic ethanol facility to be approximately $5 per gallon of capacity, or approximately $125 million for a 25 million-gallon-per-year facility. We intend to finance the construction of commercial-scale facilities through project finance structures that have been well-established in other industries, particularly the energy industry, which generally involve the use of non-recourse debt financing to finance a majority of total construction costs, and we currently intend to rely on third party, non-managing partners to provide 50% or more of the amount of the required equity for each project. Accordingly, we currently expect that the amount of our required equity contribution will represent less than or equal to 50% of the required equity for each project. These are forward-looking statements that are based on a variety of assumptions and estimates, a substantial portion of which is beyond our ability to control, and consequently are subject to a number of risks and uncertainties.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures. On an ongoing basis, we evaluate these estimates, including those related to revenue recognition, long-lived assets, accrued liabilities, and income taxes. These estimates are based on historical experience, information received from third parties, and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe the following critical accounting policies affect the significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue Recognition

We follow the provisions as set forth by current accounting rules, which primarily include the Securities and Exchange Commission’s Staff Accounting Bulletin, or SAB, No. 104, “Revenue Recognition.”

We generally recognize revenue when we have satisfied all contractual obligations and we are reasonably assured of collecting the resulting receivable. We are often entitled to bill our customers and receive payment from our customers in advance of recognizing the revenue under current accounting rules. In those instances where we have billed our customers or received payment from our customers in advance of recognizing revenue, we include the amounts in deferred revenue on the balance sheet.

We generate revenue from research collaborations generally through funded research, up-front fees to initiate research projects, fees for exclusivity in a field, and milestones. We recognize revenue from research funding on a percentage-of-completion basis, as research hours are incurred under each agreement. We recognize fees to initiate research over the life of the project. We recognize revenue from exclusivity fees over the period of exclusivity. Our collaborations often include contractual milestones. When we

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achieve these milestones, we are entitled to payment, as defined by the underlying agreements. We recognize revenue for milestone payments when earned, as evidenced by written acknowledgement from the collaborator, provided that (i) the milestone event is substantive and its achievement was not reasonably assured at the inception of the agreement, and (ii) our performance obligations after the milestone achievement will continue to be funded by the collaborator at a level comparable to the level before the milestone achievement.

We recognize revenue from grants as related costs are incurred, as long as such costs are within the funding limits specified by the underlying grant agreements.

We recognize revenue related to the sale of our inventory as we ship or deliver products, provided all other revenue recognition criteria have been met. We recognize revenue from products sold through distributors or other third-party arrangements upon shipment of the products, if the distributor has a right of return, provided that (a) the price is substantially fixed and determinable at the time of sale; (b) the distributor’s obligation to pay us is not contingent upon resale of the products; (c) title and risk of loss passes to the distributor at time of shipment; (d) the distributor has economic substance apart from that provided by us; (e) we have no significant obligation to the distributor to bring about resale of the products; and (f) future returns can be reasonably estimated. For any sales that do not meet all of the above criteria, revenue is deferred until all such criteria have been met. We include our profit-sharing revenues in product-related revenues on the statement of operations. We recognize profit-sharing revenues during the quarter in which such profit sharing revenues are earned, based on estimates provided by our profit-sharing partner. We adjust these estimates for actual results in the subsequent quarter. To date, we have generated a substantial portion of our product-related revenues, including profit-sharing revenues, through our agreements with Danisco.

We sometimes enter into revenue arrangements that include the delivery of more than one product or service. In these cases, we recognize revenue from each element of the arrangement as long as we are able to determine a separate value for each element, we have completed our obligation to deliver or perform on that element and we are reasonably assured of collecting the resulting receivable.

Share-based Compensation

Effective January 1, 2006, we calculate the fair value of all share-based payments to employees and non-employee directors, including grants of stock options, non-restricted and restricted shares, and awards issued under the employee stock purchase plan, and amortize these fair values to share-based compensation in the income statement over the respective vesting periods of the underlying awards.

Share-based compensation related to stock options includes both the amortization of the fair value of options at the date of grant determined using Black-Scholes Merton (“BSM”) valuation model. We amortize the fair value of options to expense over the vesting periods of the underlying options.

Share-based compensation related to awards issued under the employee stock purchase plan (“ESPP”) after December 31, 2005 are based on calculations of fair value under the BSM valuation model which are similar to how stock option valuations are made. We amortize the fair value of ESPP awards to expense over the vesting periods of the underlying awards.

We estimate the fair value of stock option awards and awards under the ESPP on the date of grant using assumptions about volatility, expected life of the awards, risk-free interest rate, and dividend yield rate. The expected volatility in this model is based on the historical volatility of our common stock. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time awards are granted, based on maturities which approximate the expected life of the options. The expected life of the options granted is estimated using the historical exercise behavior of employees. The expected dividend rate takes into account the absence of any historical payments and management’s intention to retain all earnings for future operations and expansion.

We estimate the fair value of non-restricted and restricted stock awards based upon the closing market price of our common stock at the date of grant. We charge the fair value of non-restricted awards to share-based compensation upon grant. We amortize the fair value of restricted awards to share-based compensation expense over the vesting period of the underlying awards.

Long-Lived Assets

We review long-lived assets, including leasehold improvements, property and equipment, and acquired intangible assets for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. This requires us to estimate future cash flows related to these assets. Actual results could differ from those estimates, which may affect the carrying amount of assets and the related amortization expense.

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Income Taxes

We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. While we have considered future taxable income and ongoing tax planning strategies in assessing the need for the valuation allowance, in the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of their net recorded amounts, an adjustment to the deferred tax assets would increase our income in the period such determination was made. Likewise, should we determine that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to income in the period such determination was made. As of December 31, 2006, we had $128.9 million in gross deferred tax assets, which were fully offset by a valuation allowance.

On July 13, 2006, the FASB issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes – An Interpretation of FASB Statement No. 109.” FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes” and prescribes a recognition threshold and measurement attributes for financial statement disclosure of tax positions taken or expected to be taken on a tax return. Under FIN 48, the impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Additionally, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. Pursuant to the adoption of FIN 48, our net operating loss carryforwards and other credits may be subject to revision. We are currently assessing the impact of FIN 48 on our tax positions.

Inventories

We value inventory at the lower of cost (first in, first out) or market value and, if necessary, reduce the value by an estimated allowance for excess and obsolete inventories. The determination of the need for an allowance is based on our review of inventories on hand compared to estimated future usage and sales, as well as, judgments, quality control testing data, and assumptions about the likelihood of obsolescence.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Our exposure to market risk is limited to interest rate risk and, to a lesser extent, foreign currency risk. Our exposure to changes in interest rates relates primarily to the increase or decrease in the amount of interest income we can earn on our investment portfolio and on the increase or decrease in the amount of interest expense we must pay with respect to our various outstanding debt instruments. Our risk associated with fluctuating interest expense is limited to our future financings, including any future equipment financing line of credit agreements, the interest rates under which are expected to be closely tied to market rates. Our risk associated with fluctuating interest income is limited to our investments in interest rate sensitive financial instruments. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. We ensure the safety and preservation of our invested principal funds by limiting default risk, market risk, and reinvestment risk. We mitigate default risk by investing in short-term investment grade securities and limiting the amount invested in any single security. We mitigate market risk by maintaining an average maturity of less than one year for our investments. We mitigate reinvestment risk by investing in securities with varying maturity dates. A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would have had an immaterial impact on the fair value of our interest sensitive financial instruments at March 31, 2007 and

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December 31, 2006. Declines in interest rates over time will reduce our interest income, while increases in interest rates over time will increase our interest expense. In connection with one of our research collaborations, we engage third parties to provide various services. Certain of these services result in obligations that are denominated in other than U.S. dollars. Foreign currency risk is minimized because the amount of such obligations is not material. Additionally, the collaboration under which such services are performed provides for reimbursement of such costs in U.S. dollars.

ITEM 4. CONTROLS AND PROCEDURES.

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”), who is our principal executive officer, and Chief Financial Officer (“CFO”), who is our principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (“the Exchange Act”), as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Quarterly Report on Form 10-Q.

There are inherent limitations in the effectiveness of any internal control, including the possibility of human error and the circumventions or overriding of controls. Consequently, even effective internal controls can only provide reasonable assurances with respect to any disclosure controls and procedures and internal control over financial statement preparation and presentation.

Changes in Internal Control over Financial Reporting

Our CEO and CFO also evaluated whether a change had occurred in our internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. Based on such evaluation, such officers have concluded that there was no change in our internal control over financial reporting that occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

In December 2002, we and certain of our officers and directors were named as defendants in a class action shareholder complaint filed in the United States District Court for the Southern District of New York, now captioned In re Diversa Corp. Initial Public Offering Sec. Litig., Case No. 02-CV-9699. In the amended complaint, the plaintiffs allege that we and certain of our officers and directors, and the underwriters (the “Underwriters”) of our initial public offering, or IPO, violated Sections 11 and 15 of the Securities Act of 1933, as amended, based on allegations that our registration statement and prospectus prepared in connection with our IPO failed to disclose material facts regarding the compensation to be received by, and the stock allocation practices of, the Underwriters. The complaint also contains claims for violation of Sections 10(b) and 20 of the Securities Exchange Act of 1934, as amended, based on allegations that this omission constituted a deceit on investors. The plaintiffs seek unspecified monetary damages and other relief. This action is related to In re Initial Public Offering Sec. Litig., Case No. 21 MC 92, in which similar complaints were filed by plaintiffs (the “Plaintiffs”) against hundreds of other public companies (collectively, the “Issuers”) that conducted IPOs of their common stock in the late 1990s and 2000 (collectively, the “IPO Cases”). On January 7, 2003, the IPO Case against us was assigned to United States Judge Shira Scheindlin of the Southern District of New York, before whom the IPO Cases have been consolidated for pretrial purposes.

In February 2003, the Court issued a decision denying the motion to dismiss the Sections 11 and 15 claims against us and our officers and directors, and granting the motion to dismiss the Section 10(b) claim against us without leave to amend. The Court similarly dismissed the Sections 10(b) and 20 claims against two of our officers and directors without leave to amend, but denied the motion to dismiss these claims against one officer/director.

In June 2003, Issuers and Plaintiffs reached a tentative settlement agreement and entered into a memorandum of understanding providing for, among other things, a dismissal with prejudice and full release of the Issuers and their officers and directors from all further liability resulting from Plaintiffs’ claims, and the assignment to Plaintiffs of certain potential claims that the Issuers may have against the Underwriters. The tentative settlement also provides that, in the event that Plaintiffs ultimately recover less than a

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guaranteed sum of $1 billion from the Underwriters in the IPO Cases and related litigation, Plaintiffs would be entitled to payment by each participating Issuer’s insurer of a pro rata share of any shortfall in the Plaintiffs’ guaranteed recovery. In the event, for example, the Plaintiffs recover nothing in judgment against the Underwriter defendants in the IPO Cases and the Issuers’ insurers therefore become liable to the Plaintiffs for an aggregate of $1 billion pursuant to the settlement proposal, the pro rata liability of our insurers, with respect to us, would be $5 million, assuming that 200 Issuers which approved the settlement proposal, and their insurers, were operating and financially viable as of the settlement date. We are covered by a claims-made liability insurance policy that would satisfy our insurers’ pro rata liability described in this hypothetical example.

In June 2004, we executed a settlement agreement with the Plaintiffs pursuant to the terms of the memorandum of understanding. On February 15, 2005, the Court issued a decision certifying a class action for settlement purposes and granting preliminary approval of the settlement subject to modification of certain bar orders contemplated by the settlement. On August 31, 2005, the Court reaffirmed class certification and preliminary approval of the modified settlement in a comprehensive Order. On February 24, 2006, the Court dismissed litigation filed against certain underwriters in connection with the claims to be assigned to the Plaintiffs under the settlement. On April 24, 2006, the Court held a Final Fairness Hearing to determine whether to grant final approval of the settlement. On December 5, 2006, the Second Circuit Court of Appeals vacated the lower Court’s earlier decision certifying as class actions the six IPO Cases designated as “focus cases.” The Court has ordered a stay of all proceedings in all of the IPO Cases pending the outcome of Plaintiffs’ rehearing petition to the Second Circuit. Accordingly, the Court’s decision on final approval of the settlement remains pending.

On September 22, 2006, we issued a letter to Valley communicating our intent to terminate Valley’s exclusive distributorship for Ultra-Thin enzyme on the basis of Valley’s not having met certain minimum sales requirements. On December 7, 2006, Valley filed a civil complaint in San Diego Superior Court against us, alleging breach of contract. In the complaint, Valley alleges that the Valley “Ultra-Thin”^™ product was unstable and performed poorly, which caused Valley to be unable to satisfy certain contractual requirements. In the complaint, Valley seeks money damages for our alleged breach of contract, and potentially for additional damages for termination of Valley’s exclusivity. We believe that the claims made by Valley have no merit, and we intend to defend ourselves vigorously. We filed an answer and cross complaint in January 2007 responding to the charges and asserting certain other charges against Valley. On March 7, 2007, we issued a letter to Valley terminating our distribution agreement with Valley, effective immediately, on the basis of Valley’s not having met certain minimum purchase requirements.

On February 14, 2007, a patent interference proceeding was declared in the U.S. Patent and Trademark Office between a U.S. patent assigned to us and a pending U.S. patent application owned by Maxygen, Inc. with allowable claims directed to GeneReassembly. Maxygen seeks an entry of adverse judgment against us. A schedule for the motion phase of the interference proceeding was discussed with the Administrative Patent Judge in April 2007. The Administrative Patent Judge granted our request to treat two of our motions as threshold motions. The first is a motion for no interference in fact, and the second is a motion for unpatentability of Maxygen’s patent application due to lack of written description. Both of our motions must be submitted to the Administrative Patent Judge by May 10, 2007 for consideration.

We are also, from time to time, subject to legal proceedings and claims which arise in the normal course of business. In our opinion, the amount of ultimate liability with respect to these actions will not have a material adverse effect on our consolidated financial position, results of operations, or cash flows.

ITEM 1A. RISK FACTORS

Except for the historical information contained herein, this quarterly report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those discussed here. Factors that could cause or contribute to differences in our actual results include those discussed in the following section, as well as those discussed in Part I, Item 2 entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere throughout this quarterly report on Form 10-Q. You should consider carefully the following risk factors, together with all of the other information included in this quarterly report on Form 10-Q. Each of these risk factors could adversely affect our business, operating results, and financial condition, as well as adversely affect the value of an investment in our common stock.

We have marked with an asterisk those risk factors that reflect substantive changes from the risk factors previously discussed in our Form 10-K for the year ended December 31, 2006.

Risks Applicable to Our Business Generally

We should be viewed as an early stage company.

You must evaluate our business in light of the uncertainties and complexities affecting an early stage biotechnology company or cellulosic ethanol manufacturing company. Our existing proprietary technologies are new and in the early stage of development for both biofuels and specialty enzymes. We may not be successful in the commercial development of these or any further technologies,

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products or processes. Successful products and processes require significant development and investment, including testing, to demonstrate their cost- effectiveness prior to regulatory approval and commercialization. To date, we have commercialized nine of our own products, all in the specialty enzymes area, Fuelzyme^™-LF enzyme, Pyrolase^™ 160 enzyme, Pyrolase^™ 200 enzyme, Cottonase^™ enzyme, Luminase^™ PB-100 enzyme, Luminase^™ PB-200 enzyme, Bayovac^® SRS, and blue and green fluorescent proteins. In addition, four of our collaborative partners, Invitrogen Corporation, Danisco Animal Nutrition, Givaudan Flavors Corporation, and Syngenta Animal Nutrition (formerly known as Zymetrics, Inc.), have incorporated our technologies or inventions into their own commercial products from which we have generated and/or can generate royalties. We have not yet commercialized any products or processes in our integrated strategy within biofuels. Our specialty enzyme products and technologies have generated only modest revenues to date. Because of these uncertainties, our discovery process may not result in the identification of product candidates or biofuels production processes that we or our collaborative partners will successfully commercialize. If we are not able to use our technologies to discover new materials, products, or processes with significant commercial potential, or if we are unable to sell our cellulosic ethanol or an integrated solution for the production of cellulosic ethanol, we could have significant losses in the future due to ongoing expenses for research, development and commercialization efforts and our inability to obtain additional funding in connection with such efforts.

In addition, the amounts we spend will impact our ability to become profitable and this will depend, in part, on:

• the progress of our research and development programs for the production of ethanol from various sources of cellulosic biomass;

• the cost of building, operating and maintaining research and production facilities;

• the number of production facilities that we ultimately attempt to develop;

• the time and expense required to prosecute, enforce and/or challenge patent and other intellectual property rights;

• how competing technological and market developments affect our proposed activities; and

• the cost of obtaining licenses required to use technology owned by others for proprietary products and otherwise.

We may not achieve any or all of these goals and, thus, we cannot provide assurances that we will ever be profitable or achieve significant revenues. If we fail to achieve profitability or significant revenues, the market price of our common stock will likely decrease.

We have a history of net losses, we expect to continue to incur net losses, and we may not achieve or maintain profitability.

We have incurred net losses since our inception, including a net loss of approximately $10.3 million for the quarter ended March 31, 2007. As of March 31, 2007, we had an accumulated deficit of approximately $339.8 million. Through March 31, 2007, our losses were attributable to our specialty enzymes business. We expect to continue to incur additional losses in 2007 and 2008 in our specialty enzymes business as we continue to develop specialty enzyme products, and as a result of our continued investment in our sales and marketing infrastructure to support anticipated growth in product sales. Beginning in mid-2007, we expect to begin to incur additional losses as we pursue our vertical integration strategy within biofuels.

To date, most of our revenue has been derived from collaborations and grants related to our specialty enzymes business, and we expect that a significant portion of our revenue for 2007 will result from the same sources. Future revenue from collaborations is uncertain and will depend upon our ability to maintain our current collaborations, enter into new collaborations and to meet research, development, and commercialization objectives under new and existing agreements. We anticipate that our sales and marketing expenses will remain at comparable levels, or increase, in future periods as we introduce new products and invest in the necessary infrastructure to support an anticipated increased level of product revenues. Even if we generate significant additional revenue in our specialty enzymes business, we do not expect to achieve overall profitability for at least the next four years assuming our pending merger with Celunol is completed as we make additional investments to implement our vertical integration strategy within biofuels. In order for us to generate revenue, we must not only retain our existing collaborations and/or attract new ones and achieve milestones under them, but we must also develop products or technologies that we or our partners choose to commercialize and that are commercially successful and from which we can derive revenue through sales or royalties. Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis.

* We recently sold an aggregate $120 million of our 5.50% Convertible Senior Notes due 2027, or the Notes, and may not have the ability to raise the funds to pay interest on the Notes or to purchase the Notes on required purchase dates or upon a fundamental change.

        In March 2007, we completed the sale of $120 million of Notes, the terms of which include provisions whereby on each of April 1, 2012, April 1, 2017 and April 1, 2022, holders of the Notes may require us to purchase, for cash, all or a portion of their Notes at 100% of their principal amount, plus any accrued and unpaid interest to, but excluding, that date. If a “fundamental change”, which is defined in the indenture related to the Notes, occurs, holders of the Notes may require us to repurchase, for cash, all or a portion of their Notes. We may not have sufficient funds to pay the interest, purchase price or repurchase price when due. In addition, the terms of any borrowing agreements which we may enter into from time to time may require early repayment of borrowings under circumstances similar to those constituting a “fundamental change”. These agreements may also make our repurchase of Notes an event of default under the agreements. If we fail to pay interest on the Notes or to purchase or repurchase the Notes when required, we will be in default under the indenture for the Notes.

*Our increased leverage as a result of its issuance of the Notes may harm our financial condition and results of operations.

As adjusted to include the sale of the Notes, our total consolidated long-term debt as of March 31, 2007 would have been approximately $123.7 million and would have represented approximately46% of our total capitalization as of that date. In addition, the indenture for the Notes does not restrict our ability to incur additional indebtedness.

Our level of indebtedness could have important consequences on our future operations, including:

• making it more difficult for us to meet our payment and other obligations under the Notes and our other outstanding debt;

• resulting in an event of default if we fail to comply with the financial and other restrictive covenants contained in our debt agreements, which could result in all of our debt becoming immediately due and payable;

• reducing the availability of our cash flow to fund working capital, capital expenditures, acquisitions and other general corporate purposes, and limiting our ability to obtain additional financing for these purposes;

• limiting our flexibility in planning for, or reacting to, and increasing our vulnerability to, changes in our business, the industry in which we operate and the general economy; and

• placing us at a competitive disadvantage compared to our competitors that have less debt or are less leveraged.

We expect to require additional capital to fund our operations, especially in relation to our implementation of our vertical integration strategy within biofuels, and we may need to enter into financing arrangements with unfavorable terms or which could adversely affect the ownership interest and rights of our common stockholders as compared to our other stockholders. If such financing is not available, we may need to cease operations.

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Our capital requirements depend on several factors, including:

• The level of research and development investment required to maintain our technology leadership position;

• Our ability to enter into new agreements with collaborative partners or to extend the terms of our existing collaborative agreements, and the terms of any agreement of this type;

• The success rate of our discovery efforts associated with milestones and royalties;

• Our ability to successfully commercialize products developed independently and the demand for such products;

• The timing and willingness of strategic partners and collaborators to commercialize our products that would result in royalties;

• Costs of recruiting and retaining qualified personnel;

• Our need to acquire or license complementary technologies or acquire complementary businesses; and

• Expenditures and investments to implement our vertical integration strategy within biofuels, including increased capital expenditures in relation to such strategy, for example, to build pilot and demonstration plants.

We cannot assure you that additional financing will be available on terms favorable to us, or at all. If adequate funds are not available or are not available on acceptable terms, our ability to fund our operations, take advantage of opportunities, develop products or technologies, or otherwise respond to competitive pressures could be significantly limited. In addition, if financing is not available, we may need to cease operations. If we raise additional funds through the issuance of equity securities, the percentage ownership of our stockholders will be reduced, stockholders may experience additional dilution or such equity securities may provide for rights, preferences or privileges senior to those of the holders of our common stock. If we raise additional funds through the issuance of debt securities, such debt securities would have rights, preferences and privileges senior to holders of common stock and the terms of such debt could impose restrictions on our operations.

If we engage in any acquisitions, we will incur a variety of costs and may potentially face numerous other risks that could adversely affect our business operations.

If appropriate opportunities become available, we may consider acquiring businesses, assets, technologies, or products that we believe are a strategic fit with our business. Other than our definitive merger agreement with Celunol Corp., we have no commitments or agreements with respect to any material acquisitions. If we further pursue such a strategy, we could:

• issue additional equity securities which would dilute current stockholders’ percentage ownership;

• incur substantial additional debt; or

• assume additional liabilities.

We may not be able to successfully integrate Celunol Corp. or any businesses, assets, products, technologies, or personnel that we might acquire in the future without a significant expenditure of operating, financial, and management resources, if at all. In addition, future acquisitions might negatively impact our business relations with our current and/or prospective collaborative partners and/or customers. Any of these adverse consequences could harm our business.

If we are unable to continue to collect genetic material from diverse natural environments, our research and development efforts and our product and process development programs could be harmed.

We collect genetic material from organisms found in diverse environments. We collect material from government-owned land in foreign countries and in areas of the United States under formal resource access agreements and from private lands under individual agreements with private landowners. We also collect samples from other environments where agreements are currently not required, such as the deep sea. If our access to materials under biodiversity access agreements or other arrangements, or where agreements are not currently required, is reduced or terminates, it could harm our internal and our collaborative research and development efforts. For example, we have voluntarily ceased collections of further samples in Yellowstone National Park pending the park’s resolution of collection guidelines.

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Ethical, legal, and social concerns about genetically engineered products and processes could limit or prevent the use of our products, processes, and technologies and limit our revenue.

Some of our anticipated products and processes are genetically engineered or involve the use of genetically engineered products or genetic engineering technologies. If we and/or our collaborators are not able to overcome the ethical, legal, and social concerns relating to genetic engineering, our products and processes may not be accepted. Any of the risks discussed below could result in expenses, delays, or other impediments to our programs or the public acceptance and commercialization of products and processes dependent on our technologies or inventions. Our ability to develop and commercialize one or more of our technologies, products, or processes could be limited by the following factors:

• Public attitudes about the safety and environmental hazards of, and ethical concerns over, genetic research and genetically engineered products and processes, which could influence public acceptance of our technologies, products and processes;

• Public attitudes regarding, and potential changes to laws governing, ownership of genetic material which could harm our intellectual property rights with respect to our genetic material and discourage collaborative partners from supporting, developing, or commercializing our products, processes and technologies; and

• Governmental reaction to negative publicity concerning genetically modified organisms, which could result in greater government regulation of genetic research and derivative products, including labeling requirements.

The subject of genetically modified organisms has received negative publicity, which has aroused public debate. This adverse publicity could lead to greater regulation and trade restrictions on imports of genetically altered products.

Stringent laws and required government approvals may be time consuming and costly, and could delay our introduction of products.

All phases, especially the field testing, production, and marketing, of our potential products and processes are subject to significant federal, state, local, and/or foreign governmental regulation. Regulatory agencies may not allow us to produce and/or market our products in a timely manner or under technically or commercially feasible conditions, or at all, which could harm our business.

In the United States, specialty enzyme products for our target markets are regulated based on their application, by either the Food and Drug Administration, or FDA, the Environmental Protection Agency, or EPA, or, in the case of plants and animals, the United States Department of Agriculture, or USDA. The FDA regulates drugs, food, and feed, as well as food additives, feed additives, and substances generally recognized as safe that are used in the processing of food or feed. While substantially all of our specialty enzyme projects to date have focused on non-human applications and specialty enzyme products outside of the FDA’s review, in the future we may pursue collaborations for further research and development of drug products for humans that would require FDA approval before they could be marketed in the United States. In addition, any drug product candidates must also be approved by the regulatory agencies of foreign governments before any product can be sold in those countries. Under current FDA policy, our products, or products of our collaborative partners incorporating our technologies or inventions, to the extent that they come within the FDA’s jurisdiction, may be subject to lengthy FDA reviews and unfavorable FDA determinations if they raise safety questions which cannot be satisfactorily answered, if results from pre-clinical or clinical trials do not meet regulatory requirements or if they are deemed to be food additives whose safety cannot be demonstrated. An unfavorable FDA ruling could be difficult to resolve and could prevent a product from being commercialized. Even after investing significant time and expenditures, our collaborators may not obtain regulatory approval for any drug products that incorporate our technologies or inventions. Our collaborators have not submitted an investigational new drug application for any product candidate that incorporates our technologies or inventions, and no drug product candidate developed with our technologies has been approved for commercialization in the United States or elsewhere. The EPA regulates biologically derived chemical substances not within the FDA’s jurisdiction. An unfavorable EPA ruling could delay commercialization or require modification of the production process resulting in higher manufacturing costs, thereby making the product uneconomical. In addition, the USDA may prohibit genetically engineered plants from being grown and transported except under an exemption, or under controls so burdensome that commercialization becomes impracticable. Our future products may not be exempted by the USDA.

In order to achieve and maintain market acceptance, our biofuels business will need to meet a significant number of regulations and standards. As these regulations and standards evolve, and if new regulations or standards are implemented, we may be required to modify our proposed facilities and processes or develop and support new facilities or processes and this will increase our costs. Any failure to comply, or delays in compliance, with the various existing and evolving industry regulations and standards could prevent or delay our production of ethanol and the provision of related services including plant operation and engineering services in support of anticipated licenses of our technology, which could harm our biofuels business. Market uncertainty regarding future policies may also

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affect our ability to develop new ethanol production facilities or license our technologies to third parties. Any inability to address these requirements and any regulatory changes could have a material adverse effect on our biofuels business, financial condition and operating results.

Many competitors and potential competitors who have greater resources and experience than we do may develop products and technologies that make ours obsolete or may use their greater resources to gain market share at our expense.

The biotechnology industry is characterized by rapid technological change, and the area of biomolecule discovery and optimization from biodiversity is a rapidly evolving field. Our future success will depend on our ability to maintain a competitive position with respect to technological advances. Technological development by others may result in our products and technologies becoming obsolete.

We face, and will continue to face, intense competition. There are a number of companies who compete with us in various steps throughout our technology process. For example, Codexis, Maxygen, Inc., Evotec, and Xencor have alternative evolution technologies. Integrated Genomics Inc., Myriad Genetics, Inc., and ArQule, Inc. perform screening, sequencing, and/or bioinformatics services. Novozymes A/S, Genencor International Inc., and Dyadic International are involved in development, overexpression, fermentation, and purification of enzymes. Amgen Inc., Cambridge Antibody Technology, Medarex, Inc., and Morphosys AG are involved in the development of human monoclonal antibodies. There are also a number of academic institutions involved in various phases of our technology process. Many of these competitors have significantly greater financial and human resources than we do. These organizations may develop technologies that are superior alternatives to our technologies. Further, our competitors may be more effective at implementing their technologies for modifying DNA to develop commercial products.

The ethanol production and marketing industry is extremely competitive. In addition to cellulosic ethanol producers using different technology platforms, our competitors will be grain ethanol producers, as well as other providers of alternative and renewable fuels. Significant competitors in the grain ethanol production and marketing industry include Archer Daniels Midland Company, Cargill, Inc., VeraSun Energy Corporation, Aventine Renewable Energy, Inc. Many companies are engaged in research and development activities in the emerging cellulosic ethanol industry, and companies with announced pilot plant and/or demonstration plant development activities in the cellulosic ethanol space include Abengoa Bioenergy Corp., BlueFire, Genencor, Iogen Corporation, Losonoco, Mascoma, Range Fuels, and Xethanol. Larger industrial companies with announced cellulosic strategies include Archer Daniels Midland, DONG Energy (Elsam), DuPont/Broin, Tate & Lyle, and Novozymes. Cellulosic gasification technologies are being pursued by companies including ClearFuels and BRI-Infinium. Some or all of these competitors or other competitors, as well as academic, research and government institutions, are developing or may develop technologies for, and are competing or may compete with us in, the production of ethanol from cellulosic biomass or other feedstocks, such as municipal or construction waste, production of cellulosic ethanol or other fuels employing different steps within the production process, such as acid hydrolysis and/or gasification, and/or the production of other alternative fuels or biofuels, such as biobutanol. Some of our competitors have substantially greater production, financial, research and development, personnel and marketing resources than we do. As a result, our competitors may be able to develop competing and/or superior technologies and processes, and compete more aggressively and sustain that competition over a longer period of time than we could. Our lack of resources relative to many of our significant competitors may cause us to fail to anticipate or respond adequately to new developments and other competitive pressures. This failure could reduce our competitiveness and prevent us from achieving any market share, sales and/or profitability, adversely affect our results of operations and financial position.

Our ability to compete successfully will depend on our ability to develop proprietary products that reach the market in a timely manner and are technologically superior to and/or are less expensive than other products on the market. Current competitors or other companies may develop technologies and products that are more effective than ours. Our technologies and products may be rendered obsolete or uneconomical by technological advances or entirely different approaches developed by one or more of our competitors. The existing approaches of our competitors or new approaches or technology developed by our competitors may be more effective than those developed by us.

Our ability to compete may decline if we do not adequately protect our proprietary technologies or if we lose some of our intellectual property rights due to becoming involved in expensive lawsuits or administrative proceedings.

Our success depends in part on our ability to obtain patents and maintain adequate protection of our other intellectual property for our technologies and products in the United States and other countries. In addition, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. Monitoring unauthorized use of our intellectual property is difficult, and we cannot be certain that the steps we have taken will prevent unauthorized use of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. If competitors are able to use our technology, our ability to compete effectively could be harmed. Although we have adopted a strategy of seeking patent protection in the United States

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and in foreign countries with respect to certain of the technologies used in or relating to our products, and anticipated production facilities and processes, others may independently develop and obtain patents for technologies that are similar to or superior to our technologies. If that happens, we may need to license these technologies and we may not be able to obtain licenses on reasonable terms, if at all, which could cause great harm to our business.

Our commercial success depends in part on not infringing patents and proprietary rights of third parties, and not breaching any licenses or other agreements that we have entered into with regard to our technologies, products, and business. The patent positions of companies whose businesses are based on biotechnology, including our patent position, involve complex legal and factual questions and, therefore, enforceability cannot be predicted with certainty. We intend to apply for patents relating to our technologies, processes and products as we deem appropriate. Patents, if issued, may be challenged, invalidated, or circumvented. We cannot be sure that patents have not been issued that could block our ability to obtain patents or to operate as we would like. Others may develop similar technologies or duplicate technologies developed by us. There may be patents in some countries that, if valid, may block our ability to commercialize products in these countries if we are unsuccessful in circumventing or acquiring the rights to these patents. There also may be claims in published patent applications in some countries that, if granted and valid, may also block our ability to commercialize processes or products in these countries if we are unable to circumvent or license them.

Our intellectual property rights may be challenged by others. In February 2007, an interference proceeding was declared in the U.S. Patent and Trademark Office between a U.S. patent assigned to us and a pending U.S. patent application owned by another company with allowable claims directed to GeneReassembly. A schedule for the motion phase of the interference proceeding was discussed with the Administrative Patent Judge in April 2007. The Administrative Patent Judge granted our request to treat two of our motions as threshold motions. The first is a motion for no interference in fact, and the second is a motion for unpatentability of Maxygen’s patent application due to lack of written description. Both of our motions must be submitted to the Administrative Patent Judge by May 10, 2007 for consideration. Other than this interference proceeding, we are not currently a party to any litigation with regard to our patent position. However, the biotechnology industry is characterized by frequent and extensive litigation regarding patents and other intellectual property rights. Many biotechnology companies have employed intellectual property litigation as a way to gain a competitive advantage. If we became involved in litigation or interference proceedings declared by the United States Patent and Trademark Office, or oppositions or other intellectual property proceedings outside of the United States, to defend our intellectual property rights or as a result of alleged infringement of the rights of others, we might have to spend significant amounts of money.

We are aware of a significant number of patents and patent applications relating to aspects of our technologies filed by, and issued to, third parties. For example, we received a letter dated May 4, 2006 from a third party in which it was suggested that our technology may be relevant to certain claims of a patent owned by another third party. We cannot assure you that if we are sued on this patent we would prevail.

Should any of our competitors have filed patent applications or obtained patents that claim inventions also claimed by us, we may have to participate in an interference proceeding declared by the relevant patent regulatory agency to determine priority of invention and, thus, the right to a patent for these inventions in the United States. Such a proceeding, like the one described above, could result in substantial cost to us even if the outcome is favorable. Even if successful, an interference may result in loss of claims. The litigation or proceedings could divert our management’s time and efforts. Even unsuccessful claims could result in significant legal fees and other expenses, diversion of management time, and disruption in our business. Uncertainties resulting from initiation and continuation of any patent or related litigation could harm our ability to compete.

An adverse ruling arising out of any intellectual property dispute would undercut or invalidate our intellectual property position. An adverse ruling could also subject us to significant liability for damages, prevent us from using processes or products, or require us to negotiate licenses to disputed rights from third parties. Although patent and intellectual property disputes in the biotechnology area are often settled through licensing or similar arrangements, costs associated with these arrangements may be substantial and could include ongoing royalties. Furthermore, necessary licenses may not be available to us on satisfactory terms, if at all.

We may encounter difficulties managing our growth, which could adversely affect our results of operations.

Our strategy includes entering into and working on simultaneous projects, frequently across multiple industries, in both our specialty enzymes and biofuels businesses. This strategy places increased demands on our limited human resources and require us to substantially expand the capabilities of our administrative and operational resources and to attract, train, manage and retain qualified management, technicians, scientists and other personnel, especially with respect to our vertical integration strategy within biofuels. Our ability to effectively manage our operations, growth, and various projects requires us to continue to improve our operational, financial and management controls, reporting systems and procedures and to attract and retain sufficient numbers of talented employees, which we may be unable to do. We may not be able to successfully implement improvements to our management information and control systems in an efficient or timely manner. In addition, we may discover deficiencies in existing systems and controls.

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Confidentiality agreements with employees and others may not adequately prevent disclosure of trade secrets and other proprietary information.

In order to protect our proprietary technology and processes, we also rely in part on trade secret protection for our confidential and proprietary information. We have taken measures to protect our trade secrets and proprietary information, but these measures may not be effective. Our policy is to execute confidentiality agreements with our employees and consultants upon the commencement of an employment or consulting arrangement with us. These agreements generally require that all confidential information developed by the individual or made known to the individual by us during the course of the individual’s relationship with us be kept confidential and not disclosed to third parties. These agreements also generally provide that inventions conceived by the individual in the course of rendering services to us shall be our exclusive property. Nevertheless, our proprietary information may be disclosed, and others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could adversely affect our competitive business position.

If we lose our key personnel or are unable to attract and retain qualified personnel as necessary, it could delay our product development programs and harm our research and development efforts.

Our success depends to a significant degree upon the continued contributions of our executive officers, management, and scientific staff. If we lose the services of one or more of these people, we may be unable to achieve our business objectives or our stock price could decline. In connection with our proposed merger with Celunol, Edward T. Shonsey, our Chief Executive Officer, Anthony E. Altig, our Vice President, Finance, Chief Financial Officer and Secretary, and R. Patrick Simms, our Senior Vice President, Operations, are each expected to resign from their positions as executive officers of ours. Messrs. Shonsey, Altig, and Simms have had significant roles in the development and expansion of our specialty enzymes business. We may not be able to attract or retain qualified employees in the future due to the intense competition for qualified personnel among biotechnology and other technology-based businesses, particularly in the San Diego area, or due to competition for, or availability of, personnel with the qualifications or experience necessary for our biofuels business. If we are not able to attract and retain the necessary personnel to accomplish our business objectives, we may experience constraints that will adversely affect our ability to meet the demands of our collaborative partners in a timely fashion or to support our internal research and development programs. In particular, our product and process development programs are dependent on our ability to attract and retain highly skilled scientists, including molecular biologists, biochemists, and engineers. Competition for experienced scientists and other technical personnel from numerous companies and academic and other research institutions may limit our ability to do so on acceptable terms. All of our employees are at-will employees, which means that either the employee or we may terminate their employment at any time.

Our planned activities will require additional expertise in specific industries and areas applicable to the products and processes developed through our technologies or acquired through strategic or other transactions, especially in our biofuels business. These activities will require the addition of new personnel, including management, and the development of additional expertise by existing management personnel. The inability to acquire these services or to develop this expertise could impair the growth, if any, of our business.

We may be sued for product liability.

We may be held liable if any product or process we develop, or any product which is made or process which is performed with the use of any of our technologies, causes injury or is found otherwise unsuitable during product testing, manufacturing, marketing, or sale. We currently have limited product liability insurance covering claims up to $5 million that may not fully cover our potential liabilities. In addition, if we attempt to obtain additional product liability insurance coverage, this additional insurance may be prohibitively expensive, or may not fully cover our potential liabilities. Inability to obtain sufficient insurance coverage at an acceptable cost or otherwise to protect against potential product liability claims could prevent or inhibit the commercialization of products or processes developed by us or our collaborative partners. If we are sued for any injury caused by our products, our liability could exceed our total assets.

We use hazardous materials in our business. Any claims relating to improper handling, storage, or disposal of these materials could be time consuming and costly and could adversely affect our business and results of operations.

Our research and development processes involve the controlled use of hazardous materials, including chemical, radioactive, and biological materials. Our operations also produce hazardous waste products. We cannot eliminate entirely the risk of accidental contamination or discharge and any resultant injury from these materials. Federal, state, and local laws and regulations govern the

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use, manufacture, storage, handling, and disposal of these materials. We may be sued for any injury or contamination that results from our use or the use by third parties of these materials, and our liability may exceed our total assets. In addition, compliance with applicable environmental laws and regulations may be expensive, and current or future environmental regulations may impair our research, development, or production efforts.

Risks Specific to Our Vertically Integrated Biofuels Business

We may not be successful in the development of individual steps in, or an integrated process for, the production of ethanol from cellulosic biomass at commercial scale in a timely or economic manner or at all.

The production of ethanol from cellulosic biomass requires multiple integrated steps, including:

• obtaining the cellulosic raw material,

• pretreatment of the biomass to make its constituent fibers accessible to enzymes,

• treatment with enzymes to produce fermentable sugars,

• fermentation by organisms to produce ethanol from the fermentable sugars,

• distillation of the ethanol to concentrate it and separate it from other materials,

• purification of the ethanol, and

• storage and distribution of the ethanol.

We are at an early stage of development of pretreatment and enzymatic conversion processes for cellulosic biomass. We are currently focused on laboratory-scale research and development of such processes. We have not yet attempted to perform pretreatment at a pilot scale, or to produce such enzymes on a pilot or larger scale, or to utilize such enzymes at greater than a research scale. We have limited experience, via our integrated corn-based biorefinery (“ICBR”) collaboration with DuPont Bio-Based Materials and others utilizing any such enzymes in an integrated process for the production of cellulosic ethanol. If we do not produce an enzyme at the research scale, we may not be able to scale-up production on such enzyme by our fermentation platform.

We have not begun research and development for the optimization of organisms for the fermentation of sugars produced from saccharification, or of an integrated process that includes sourcing, pretreatment, saccharification, fermentation, distillation, storage and distribution. To date we have focused our research and development efforts on producing ethanol from corn stover, sugarcane bagasse, and wood. The technological challenges associated with each one of these processes are extraordinary and we may not be able to resolve such difficulties in a timely or cost effective fashion, or at all. If we are successful in developing a process for converting a particular cellulosic biomass to cellulosic ethanol, we may not be able to adapt such process to other biomass raw materials.

Because we have yet to begin construction on any scale of an integrated production facility, manufacturing costs at any such facility are unknown, and we cannot be sure that we can manufacture cellulosic ethanol in an economical manner. If we fail to commence production in a timely manner or to develop manufacturing capacity and experience, or fail to manufacture cellulosic ethanol economically on a commercial scale or in commercial volumes, our commercialization of cellulosic ethanol and our business, financial condition and results of operations will be materially adversely affected.

We may not be able to implement our planned expansion strategy to build, own and operate commercial-scale cellulosic ethanol facilities, including as a result of our failure to successfully manage our growth, which would prevent us from achieving our goals.

Our strategy currently includes the development of a pilot-scale plant for process development, a demonstration plant to validate the economics of our processes at commercial-scale volumes of cellulosic ethanol production, and commercial scale plants for the production of large quantities of ethanol for commercial distribution and sale. We plan to grow our business by investing in new facilities and/or acquiring existing facilities, as well as pursuing other business opportunities such as the production of other renewable fuels to the extent we deem those opportunities advisable. We believe that there is increasing competition for suitable production sites. We may not find suitable sites for construction of new facilities, suitable acquisition candidates or other suitable expansion opportunities.

We must also obtain numerous regulatory approvals and permits in order to construct and operate facilities. These requirements may not be satisfied in a timely manner or at all. Federal and state governmental requirements may substantially increase our costs, which could have a material adverse effect on our results of operations and financial position. Our expansion plans may also result in other unanticipated adverse consequences, such as the diversion of management’s attention from our existing operations and products.

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Our construction costs may also increase to levels that would make a new facility too expensive to complete or, for demonstration and commercial-scale plants, unprofitable to operate. We have not entered into any construction contracts. Contractors, engineering firms, construction firms and equipment suppliers also receive requests and orders from other ethanol companies and, therefore, we may not be able to secure their services or products on a timely basis or on acceptable financial terms. Contractors, engineering firms, construction firms and equipment suppliers may lack the expertise in cellulosic ethanol. We may suffer significant delays or cost overruns as a result of a variety of factors, such as shortages of workers or materials, transportation constraints, adverse weather, unforeseen difficulties or labor issues, any of which could prevent us from commencing operations as expected at our facilities.

Rapid growth may impose a significant burden on our administrative and operational resources. Our ability to effectively manage our growth will require us to substantially expand the capabilities of our administrative and operational resources and to attract, train, manage and retain qualified management, technicians and other personnel. We may be unable to do so.

We may not find additional appropriate sites for new facilities, and we may not be able to finance, construct, develop or operate these new facilities successfully. We also may be unable to find suitable acquisition candidates. Accordingly, we may fail to implement our planned expansion strategy, including as a result of our failure to successfully manage our growth, and as a result, we may fail to achieve our goals.

We will rely heavily on future strategic partners.

An important component of our current business plan is to enter into strategic partnerships:

• to provide capital, equipment and facilities, including significant capital for the construction of cellulosic ethanol research and production facilities;

• to provide expertise in performing certain process development, production and logistical activities;

• to provide funding for research and development programs, process development programs and commercialization activities;

• to provide access to cellulosic feedstocks; and

• to support or provide sales, marketing and distribution services.

These arrangements with collaborative partners are, and will continue to be, critical to our success in implementing our vertical integration biofuels strategy and manufacturing and selling cellulosic ethanol profitably. We cannot guarantee that any collaborative relationship(s) will be entered into, or if entered into, will continue or be successful. Failure to make or maintain these arrangements or a delay or failure in a collaborative partner’s performance under any such arrangements would materially adversely affect our business and financial condition.

We cannot control our collaborative partners’ performance or the resources they devote to our programs. We may not always agree with our partners nor will we have control of our partners’ activities on behalf of any alliance. The performance of our programs may be adversely affected and programs may be delayed or terminated or we may have to use funds, personnel, equipment, facilities and other resources that we have not budgeted to undertake certain activities on our own as a result of these disagreements. Performance issues, program delays or termination or unbudgeted use of our resources may materially adversely affect our business and financial condition.

Disputes may arise between us and a collaborative partner and may involve the issue of which of us owns the technology and other intellectual property that is developed during a collaboration or other issues arising out of the collaborative agreements. Such a dispute could delay the program on which we are working or could prevent us from obtaining the right to commercially exploit such developments. It could also result in expensive arbitration or litigation, which may not be resolved in our favor. Our collaborative partners could merge with or be acquired by another company or experience financial or other setbacks unrelated to our collaboration that could, nevertheless, adversely affect us.

We may not be able to develop manufacturing capacity sufficient to meet demand in an economical manner or at all.

If demand for cellulosic ethanol increases beyond the scope of our production facilities, we may incur significant expenses in the expansion and/or construction of production facilities and increases in personnel in order to increase production capacity. To finance the expansion of a commercial-scale production facility is complex and expensive. We cannot assure you that we will have the necessary funds to finance the development of production facilities, or that we will be able to develop this infrastructure in a timely or economical manner, or at all.

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The feedstocks, raw materials and energy necessary to produce ethanol may be unavailable or may increase in price, adversely affecting our sales and profitability.

We intend to use various sources of cellulosic biomass, such as sugarcane bagasse, corn stover, switchgrass and wood, to make cellulosic ethanol. However, rising prices for any or all of these feedstocks would produce lower profit margins and, therefore, represent unfavorable market conditions. This is especially true since market conditions generally would not allow us to pass along increased costs to customers, because the price of ethanol is primarily determined by other factors, such as the price of oil and gasoline. Additionally, once we elect to use a particular feedstock in the ethanol production process, it may be technically or economically impractical to change to a different feedstock. At certain levels, feedstock prices may make ethanol uneconomical to use in markets where the use of fuel oxygenates is not mandated.

The price of raw materials is influenced by general economic, market and regulatory factors. These factors include weather conditions, farmer planting decisions, government policies and subsidies with respect to agriculture and international trade and global demand and supply. The significance and relative impact of these factors on the price of raw materials is difficult to predict. Any event that tends to negatively impact the supply of a particular material will tend to increase prices and potentially harm our business.

The production of ethanol also requires a significant amount of other raw materials and energy, primarily water, electricity and natural gas. We plan to utilize the lignin remaining after the pretreatment of cellulosic biomass as a source of energy to power our cellulosic ethanol production facilities, however we may not be successful in using lignin as a source of energy and, if so, we may have to use electricity and natural gas. The prices of electricity and natural gas have fluctuated significantly in the past and may fluctuate significantly in the future. Local water, electricity and gas utilities may not be able to reliably supply the water, electricity and natural gas that our facilities will need or may not be able to supply such resources on acceptable terms. In addition, if there is an interruption in the supply of water or energy for any reason, we may be required to halt ethanol production.

The high concentration of our efforts towards developing processes for the production of cellulosic ethanol could increase our losses, especially if demand for ethanol declines.

If we are successful in producing and marketing cellulosic ethanol, our revenue will be derived primarily from sales of ethanol. Ethanol competes with several other existing products and other alternative products could also be developed for use as fuel additives. An industry shift away from ethanol or the emergence of new competing products may reduce the demand for ethanol. A downturn in the demand for ethanol would significantly and adversely affect any sales and/or profitability.

The market price of ethanol is volatile and subject to significant fluctuations, which may cause our profitability from the production of cellulosic ethanol to fluctuate significantly.

The market price of ethanol is dependent upon many factors, including the price of gasoline, which is in turn dependent upon the price of petroleum. Petroleum prices are highly volatile and difficult to forecast due to frequent changes in global politics and the world economy. The distribution of petroleum throughout the world is affected by incidents in unstable political environments, such as Iraq, Iran, Kuwait, Saudi Arabia, Nigeria, Venezuela, the former U.S.S.R. and other countries and regions. The industrialized world depends critically upon oil from these areas, and any disruption or other reduction in oil supply can cause significant fluctuations in the prices of oil and gasoline. We cannot predict the future price of oil or gasoline and may establish unprofitable prices for the sale of ethanol due to significant fluctuations in market prices. In recent years, the prices of gasoline, petroleum and ethanol have all reached historically unprecedented high levels. If the prices of gasoline and petroleum decline, we believe that the demand for and price of ethanol may be adversely affected. Fluctuations in the market price of ethanol may cause our profitability to fluctuate significantly.

We believe that the production of ethanol is expanding rapidly. There are a number of new plants under construction and planned for construction throughout the United States. We expect existing ethanol plants to expand by increasing production capacity and actual production. Increases in the demand for ethanol may not be commensurate with increasing supplies of ethanol. Thus, increased production of ethanol may lead to lower ethanol prices. Also, the increased production of ethanol could result in increased demand for feedstocks for the production of ethanol. This could result in higher prices for feedstocks and cause higher ethanol production costs and, in the event that we are unable to pass increases in the price of feedstocks on to our customers, will result in lower profits. We cannot predict the future price of ethanol or feedstocks. Any material decline in the price of ethanol, or any material increase in the price of feedstocks, will adversely affect any sales and/or profitability.

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If ethanol demand does not increase, or if ethanol demand stays the same or decreases, there may be excess capacity in our industry which would likely cause a decline in ethanol prices, adversely impacting our results of operations, cash flows and financial condition.

Domestic ethanol production capacity has increased steadily from 1.7 billion gallons per year in January of 1999 to 5.4 billion gallons per year at January 2007 according to the Renewable Fuels Association, or RFA. In addition, there is a significant amount of capacity being added to the fuel ethanol industry, including capacity that may be added as a result of government programs and/or incentives, and capacity added to address anticipated increases in demand. However, demand for ethanol may not increase as quickly as expected, or at all. If the ethanol industry has excess capacity, a fall in prices will likely occur which will have an adverse impact on the viability of our vertical integration strategy within biofuels, as well as our results of operations, cash flows and financial condition if we proceed to market ethanol. Demand for ethanol could be impaired due to a number of factors, including regulatory developments and reduced United States gasoline consumption. Reduced gasoline consumption could occur as a result of increased gasoline or oil prices. For example, price increases could cause businesses and consumers to reduce driving or acquire vehicles with more favorable gasoline mileage capabilities.

The United States ethanol industry is highly dependent upon a myriad of federal and state legislation and regulation and any changes in such legislation or regulation could materially adversely affect our results of operations and financial condition.

The elimination or significant reduction in the Federal Excise Tax Credit could have a material adverse effect on our results of operations.

The production of ethanol is made significantly more competitive by federal tax incentives. The Volumetric Ethanol Excise Tax Credit, or VEETC, program, which is scheduled to expire on December 31, 2010, allows gasoline distributors who blend ethanol with gasoline to receive a federal excise tax rate reduction for each blended gallon they sell regardless of the blend rate. The current federal excise tax on gasoline is $0.184 per gallon, and is paid at the terminal by refiners and marketers. If the fuel is blended with ethanol, the blender may claim a $0.51 tax credit for each gallon of ethanol used in the mixture. The VEETC may not be renewed prior to its expiration in 2010, or if renewed, it may be renewed on terms significantly less favorable than current tax incentives. In addition, the blenders’ credits, as well as other federal and state programs benefiting ethanol (such as tariffs), generally are subject to U.S. government obligations under international trade agreements, including those under the World Trade Organization Agreement on Subsidies and Countervailing Measures, and might be the subject of challenges thereunder, in whole or in part. The elimination or significant reduction in the VEETC could have a material adverse effect on our results of operations.

Waivers of the Renewable Fuels Standard minimum levels of renewable fuels included in gasoline, or the lapse of the increased weight given for the use of cellulosic ethanol for compliance with the Renewable Fuels Standard, could have a material adverse affect on our results of operations.

Under the Energy Policy Act of 2005, the Department of Energy, in consultation with the Secretary of Agriculture and the Secretary of Energy, may waive the Renewable Fuels Standard, or RFS, mandate with respect to one or more states if the Administrator determines that implementing the requirements would severely harm the economy or the environment of a state, a region or the United States, or that there is inadequate supply to meet the requirement. Additionally, under the RFS, through 2013, one gallon of cellulosic ethanol is credited as 2.5 gallons for compliance with the RFS. Any waiver of the RFS with respect to one or more states or with respect to a particular year, or the lapse or alteration of the extra weight cellulosic ethanol is given in complying with the RFS, could adversely affect demand for ethanol and could have a material adverse effect on our results of operations and financial condition.

While the Energy Policy Act of 2005 imposes the RFS, it does not mandate the use of ethanol and eliminates the oxygenate requirement for reformulated gasoline in the Reformulated Gasoline Program included in the Clean Air Act.

The Reformulated Gasoline, or RFG, program’s oxygenate requirements contained in the Clean Air Act, was completely eliminated on May 5, 2006 by the Energy Policy Act of 2005. While the RFA expects that ethanol should account for the largest share of renewable fuels produced and consumed under the RFS, the RFS is not limited to ethanol and also includes biodiesel and any other liquid fuel produced from biomass or biogas. The elimination of the oxygenate requirement for reformulated gasoline in the RFG program included in the Clean Air Act may result in a decline in ethanol consumption in favor of other alternative fuels, which in turn could have a material adverse effect on our results of operations and financial condition.

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The elimination or alteration of the special depreciation allowances for cellulosic ethanol facilities.

Under the Tax Relief and Health Care Act of 2006, a special first year depreciation allowance for qualified cellulosic biomass ethanol plant property was created. Under this allowance, a qualifying facility would be eligible for a depreciation deduction of up to 50% of its adjusted basis in the year the facility is placed in service. The elimination or alteration of this depreciation allowance could have a material adverse effect on our results of operations and financial condition.

Certain countries can export ethanol to the United States duty-free, which may undermine the ethanol production industry in the United States.

Imported ethanol is generally subject to a $0.54 per gallon tariff and a 2.5% ad valorem tax that was designed to offset the $0.51 per gallon ethanol subsidy available under the federal excise tax incentive program for refineries that blend ethanol in their fuel. There is a special exemption from the tariff for ethanol imported from certain countries in Central America and the Caribbean islands which is limited to a total of 7.0% of United States production per year (with additional exemptions for ethanol produced from feedstock in the Caribbean region over the 7.0% limit). We do not know the extent to which the volume of imports would increase or the effect on United States prices for ethanol if the tariff is not renewed beyond its current expiration in December 2007. In addition The North America Free Trade Agreement countries, Canada and Mexico, are exempt from duty. Imports from the exempted countries have increased in recent years and are expected to increase further as a result of new plants under development. In particular, the ethanol industry has expressed concern with respect to a new plant under development by Cargill, Inc., one of the largest ethanol producers in the United States, in El Salvador that would take the water out of Brazilian ethanol and then ship the dehydrated ethanol from El Salvador to the United States duty-free. Since production costs for ethanol in Brazil are estimated to be significantly less than what they are in the United States, the import of the Brazilian ethanol duty-free through El Salvador, or the import of ethanol duty-free from any country not exempted from the tariff through a country exempted from the tariff, may negatively impact the demand for domestic ethanol and the price at which we sell our ethanol.

Risks Specific to Our Specialty Enzymes Business

*We are dependent on our collaborative partners, and our failure to successfully manage our existing and future collaboration relationships could prevent us from developing and commercializing many of our specialty enzyme products and achieving or sustaining profitability.

We currently have license agreements, strategic alliance agreements, collaboration agreements, supply agreements, and/or distribution agreements relating to our specialty enzymes business with Syngenta AG, BASF, Bayer Animal Health, Bunge Oils, Cargill Health and Food Technologies, DSM Pharma Chemicals, DuPont Bio-Based Materials, Givaudan Flavors Corporation, and Xoma. For the quarter ended March 31, 2007, approximately 26% of our revenue was from Syngenta. While we expect our

product-related revenue to continue to account for a greater proportion of our total revenue, we expect that a significant portion of our 2007 revenue in our specialty enzymes business will be derived from our collaboration agreements. Since we do not currently possess the resources necessary to independently develop and commercialize all of the potential specialty enzyme products that may result from our technologies, we expect to continue to enter into, and in the near-term derive additional revenue from, strategic alliance and collaboration agreements to develop and commercialize specialty enzyme products. We will have limited or no control over the resources that any strategic partner or collaborator may devote to our partnered specialty enzyme products. Any of our present or future strategic partners or collaborators may fail to perform their obligations as expected. These strategic partners or collaborators may breach or terminate their agreements with us or otherwise fail to conduct their collaborative activities successfully and in a timely manner. Further, our strategic partners or collaborators may not develop specialty enzyme products arising out of our collaborative arrangements or devote sufficient resources to the development, manufacture, marketing, or sale of these specialty enzyme products. If any of these events occur, or we fail to enter into or maintain strategic alliance or collaboration agreements, we may not be able to commercialize our specialty enzyme products, grow our specialty enzyme business, or generate sufficient revenue to support our operations. Our present or future strategic alliance and collaboration opportunities could be harmed if:

• We do not achieve our research and development objectives under our strategic alliance and collaboration agreements;

• We develop specialty enzyme products and processes or enter into additional strategic alliances or collaborations that conflict with the business objectives of our strategic partners or collaborators;

• We disagree with our strategic partners or collaborators as to rights to intellectual property we develop, or their research programs or commercialization activities;

• We are unable to manage multiple simultaneous strategic alliances or collaborations;

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• Our strategic partners or collaborators become competitors of ours or enter into agreements with our competitors;

• Our strategic partners or collaborators become less willing to expend their resources on research and development due to general market conditions or other circumstances beyond our control;

• Consolidation in our target markets limits the number of potential strategic partners or collaborators; or

• We are unable to negotiate additional agreements having terms satisfactory to us.

We may not be able to realize any future benefits from the products and programs that we discontinued and/or de-emphasized in connection with the strategic reorganization that we announced in January 2006.

In January 2006, we announced a strategic reorganization designed to focus our resources on programs and products that have the greatest opportunity for success. Accordingly, we elected to discontinue or to exit certain products and programs, many of which we had spent significant amounts of research funds on up to the point of their discontinuation and/or de-emphasis. We will attempt to sell and/or out-license to third parties some of these products and programs, including, but not limited to, our sordarins anti-fungal program. It is possible that we could be unsuccessful in our attempts to sell or out-license these products and/or programs. In the event that we are successful in selling or out-licensing any of these products and/or programs, the structure of such transactions may provide for only future compensation in the event that the third party is ultimately successful in development of the products and/or programs. Accordingly, it is possible that we may not receive any financial benefit from any sale or out license of these products and/or programs.

We do not own equipment with the capacity to manufacture products on a commercial scale. If we are unable to access the capacity to manufacture products in sufficient quantity, we may not be able to commercialize our products or generate significant sales.

We have only limited experience in enzyme manufacturing, and we do not have our own capacity to manufacture specialty enzyme products on a commercial scale. We expect to be dependent to a significant extent on third parties for commercial scale manufacturing of our specialty enzyme products. We have arrangements with third parties that have the required manufacturing equipment and available capacity to manufacture Fuelzyme^™-LF enzyme, Phyzyme^™ XP, Bayovac^® SRS, Quantum^™ phytase, Luminase^™ PB-100 enzyme, Luminase^™ PB-200 enzyme, Pyrolase 160 enzyme, Pyrolase 200 enzyme, and Cottonase^™ enzyme. While we have our own pilot development facility, we continue to depend on third parties for large-scale commercial manufacturing. Additionally, one of our third party manufacturers is located in a foreign country. Any difficulties or interruptions of service with our third party manufacturers or our own pilot manufacturing facility could disrupt our research and development efforts, delay our commercialization of specialty enzyme products, and harm our relationships with our specialty enzyme strategic partners, collaborators, or customers.

We have only limited experience in independently developing, manufacturing, marketing, selling, and distributing commercial specialty enzyme products.

We intend to pursue some specialty enzyme product opportunities independently. We currently have only limited resources and capability to develop, manufacture, market, sell, or distribute specialty enzyme products on a commercial scale. We will determine which specialty enzyme products to pursue independently based on various criteria, including: investment required, estimated time to market, regulatory hurdles, infrastructure requirements, and industry-specific expertise necessary for successful commercialization. At any time, we may modify our strategy and pursue collaborations for the development and commercialization of some specialty enzyme products that we had intended to pursue independently. We may pursue specialty enzyme products that ultimately require more resources than we anticipate or which may be technically unsuccessful. In order for us to commercialize more specialty enzyme products directly, we would need to establish or obtain through outsourcing arrangements additional capability to develop, manufacture, market, sell, and distribute such products. If we are unable to successfully commercialize specialty enzyme products resulting from our internal product development efforts, we will continue to incur losses in our specialty enzymes business, as well as in our business as a whole. Even if we successfully develop a commercial specialty enzyme product, we may not generate significant sales and achieve profitability in our specialty enzymes business, or in our business as a whole.

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Risks Related to Owning Our Common Stock

We are subject to anti-takeover provisions in our certificate of incorporation, bylaws, and Delaware law and have adopted a shareholder rights plan that could delay or prevent an acquisition of our company, even if the acquisition would be beneficial to our stockholders.

Provisions of our certificate of incorporation, our bylaws and Delaware law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. In addition, we adopted a share purchase rights plan that has anti-takeover effects. The rights under the plan will cause substantial dilution to a person or group that attempts to acquire us on terms not approved by our board of directors. The rights should not interfere with any merger or other business combination approved by our board, since the rights may be amended to permit such an acquisition or may be redeemed by us. These provisions in our charter documents, under Delaware law, and in our rights plan could discourage potential takeover attempts and could adversely affect the market price of our common stock. Because of these provisions, our common stockholders might not be able to receive a premium on their investment.

We expect that our quarterly results of operations will fluctuate, and this fluctuation could cause our stock price to decline, causing investor losses.

Our quarterly operating results have fluctuated in the past and are likely to do so in the future. These fluctuations could cause our stock price to fluctuate significantly or decline. Revenue in future periods may be greater or less than revenue in the immediately preceding period or in the comparable period of the prior year. Some of the factors that could cause our operating results to fluctuate include:

• Termination of strategic alliances and collaborations;

• The success rate of our discovery efforts associated with milestones and royalties;

• The ability and willingness of strategic partners and collaborators to commercialize, market, and sell royalty-bearing products or processes on expected timelines;

• Our ability to enter into new agreements with strategic partners and collaborators or to extend the terms of our existing strategic alliance agreements and collaborations, and the terms of any agreement of this type;

• Our ability to successfully satisfy all pertinent regulatory requirements;

• Our ability to successfully commercialize products or processes developed independently and the demand for such products or processes;

• General and industry specific economic conditions, which may affect our, and our collaborative partners’, research and development expenditures.; and

• Increased expenses related to the implementation of our vertical integration strategy within biofuels.

If revenue declines or does not grow as anticipated, we may not be able to correspondingly reduce our operating expenses. A large portion of our expenses, including expenses for facilities, equipment and personnel, are relatively fixed. Failure to achieve anticipated levels of revenue could therefore significantly harm our operating results for a particular fiscal period.

Due to the possibility of fluctuations in our revenue and expenses, we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. Our operating results in some quarters may not meet the expectations of stock market analysts and investors. In that case, our stock price would probably decline.

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 of technology companies, particularly biotechnology companies, have been highly volatile. Our stock has been and may continue to 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 and collaborators;

• Announcements of technological innovations or new products or processes by us or our competitors;

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• Developments in patent or other proprietary rights;

• Our ability to access genetic material from diverse ecological environments and practice our technologies;

• Future royalties from product sales, if any, by our collaborative partners;

• Future royalties and fees for use of our proprietary processes, if any, by our licensees;

• Fluctuations in our operating results;

• Litigation;

• Developments in domestic and international governmental policy or regulation; and

• Economic and other external factors or other disaster or crisis.

Concentration of ownership among our existing officers, directors and principal stockholders may prevent other stockholders from influencing significant corporate decisions and depress our stock price.

Our officers, directors, and stockholders with at least 5% of our stock together controlled approximately 47% of our outstanding common stock as of March 31, 2007. If these officers, directors, and principal stockholders act together, they will be able to exert a significant degree of influence over our management and affairs and over matters requiring stockholder approval, including the election of directors and approval of mergers or other business combination transactions. In addition, as of March 31, 2007, Syngenta and its affiliates controlled approximately 16.4% of our outstanding common stock, and by themselves will be able to exert a significant degree of influence over our management and affairs and over matters requiring stockholder approval. The interests of this concentration of ownership may not always coincide with our interests or the interests of other stockholders. For instance, officers, directors, and principal stockholders, acting together, could cause us to enter into transactions or agreements that we would not otherwise consider. Similarly, this concentration of ownership may have the effect of delaying or preventing a change in control of our company otherwise favored by our other stockholders. This concentration of ownership could depress our stock price.

Future sales of our stock by large stockholders could cause the price of our stock to decline.

A number of our stockholders hold significant amounts of our stock. For example, as of March 31, 2007, Syngenta, our largest stockholder, owned 7,963,593 shares of our common stock, or approximately 16.4% of our outstanding shares. All of our shares owned by Syngenta are eligible for sale in the public market subject to compliance with the applicable securities laws. We have agreed that, upon Syngenta’s request, we will file one or more registration statements under the Securities Act in order to permit Syngenta to offer and sell shares of our common stock. Sales of a substantial number of shares of our stock by our large stockholders, including Syngenta, in the public market could adversely affect the market price of our stock.

Risks Related to Our Merger with Celunol Corp.

Obtaining required approvals and satisfying closing conditions may delay or prevent completion of the proposed transaction.

Completion of the proposed merger with Celunol, or the Merger, is conditioned upon, among other things, the receipt of all consents and approvals of all governmental authorities required for consummation of the proposed transaction. The requirement for these approvals could delay or prevent the completion of the proposed transaction. Moreover, notwithstanding the expiration of the waiting period under the HSR Act, the FTC, the DOJ, a state or private person or entity could seek, under U.S. federal or state antitrust laws, among other things, to enjoin or rescind the proposed transaction. It cannot be assumed that these consents and approvals will be obtained, or that their terms, conditions and timing will not be detrimental to us or Celunol.

If the conditions to the Merger are not met, the Merger will not occur.

Even if the Merger is approved by our stockholders and the stockholders of Celunol, specified conditions must be satisfied or waived to complete the Merger. These conditions are described in detail in the merger agreement. Neither we nor Celunol can assure you that all of the conditions will be satisfied. If the conditions are not satisfied or waived, the Merger will not occur or will be delayed, and we and Celunol each may lose some or all of the intended benefits of the Merger.

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The combined company’s stock price is expected to be volatile, and the market price of its common stock may drop following the merger.

If the merger occurs, the market price of the combined company’s common stock could be subject to significant fluctuations. Some of the factors that may cause the market price of the combined company’s common stock to fluctuate include:

• significant accidents, damage from severe weather or other natural disasters affecting the combined company’s pilot plant;

• interruption or delay in the construction of the combined company’s demonstration plant;

• risks and uncertainties related to siting, permitting, construction, materials and equipment procurement, and other issues related to development of commercial-scale facilities;

• any inability to obtain additional financing on favorable terms to fund the combined company’s operations and pursue its business plan;

• reductions in the price of gasoline or increases in the prices for biomass feedstocks;

• the entry into, or termination of, key agreements, including key collaboration agreements and licensing agreements;

• the initiation of material developments in, or conclusion of litigation to enforce or defend any of the combined company’s intellectual property rights or otherwise;

• general and industry-specific economic and regulatory conditions that may affect the combined company’s ability to successfully develop and commercialize biofuels and cellulosic ethanol and other products;

• the loss of key employees;

• the introduction of technological innovations or alternative energy sources or other products by competitors of the combined company;

• decreases in the market for ethanol, and cellulosic ethanol;

• changes in estimates or recommendations by securities analysts, if any, who cover the combined company’s common stock;

• future sales of the combined company’s common stock; and

• period-to-period fluctuations in the combined company’s financial results.

Moreover, the stock markets in general have experienced substantial volatility that has often been unrelated to the operating performance of individual companies. These broad market fluctuations may also adversely affect the trading price of the combined company’s common stock.

In the past, following periods of volatility in the market price of a company’s securities, stockholders have often instituted class action securities litigation against those companies. Such litigation, if instituted, could result in substantial costs and diversion of management attention and resources, which could significantly harm the combined company’s profitability and reputation.

The combined company may be unable to integrate its operations successfully and realize all of the anticipated benefits of the merger.

The merger involves the integration of two companies that previously have operated independently, which is a complex, costly and time-consuming process. The difficulties of combining the companies’ operations include, among other things:

• the necessity of coordinating geographically disparate organizations, systems and facilities;

• integrating personnel with diverse business backgrounds;

• consolidating corporate and administrative functions;

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• consolidating research and development and operations;

• retaining key employees; and

• preserving our and Celunol’s research and development, collaboration, distribution and other important relationships.

The process of integrating operations could cause an interruption of, or loss of momentum in, the activities of the combined company’s business and the loss of key personnel. The diversion of management’s attention and any delays or difficulties encountered in connection with the merger and the integration of the two companies’ operations could harm the business, results of operations, financial condition or prospects of the combined company after the merger.

Among the factors considered by our board of directors in connection with its approval of the merger agreement were the opportunities for synergies from complementary technologies that could result from the merger. There can be no assurance that these synergies will be realized within the time periods contemplated or that they will be realized at all. There also can be no assurance that our integration with Celunol will result in the realization of the full benefits anticipated by the companies to result from the merger.

Celunol’s business is based on technology licensed to Celunol by the University of Florida Research Foundation, Inc. If that license should terminate, Celunol’s ability to conduct its business would be seriously impaired.

*The combined company may continue to incur losses for the foreseeable future, and might never achieve profitability.

We have incurred net losses since our inception, including a net loss of approximately $10.3 million for the quarter ended March 31, 2007. As of December 31, 2006, we had an accumulated deficit of approximately $339.8 million. Through 2006, our losses were attributable to our specialty enzymes business. We expect to continue to incur additional losses over the next few years as we pursue our specialty enzymes business, continue to develop independent products and as a result of our continued investment in our sales and marketing infrastructure to support anticipated growth in product sales. Beginning in 2007, we expect to begin to incur additional losses as we pursue our vertical integration strategy within biofuels. The extent of our future losses will depend, in part, on the rate of growth, if any, in our contract revenue, future product sales at profitable margins, and on the level of our expenses. To date, most of our revenue has been derived from collaborations and grants related to our specialty enzymes business, and we expect that a significant portion of our revenue for 2007 will result from the same sources.

Celunol is a development stage company and has incurred significant losses in each fiscal year since its inception, which included net losses of $5,409,312 in 2004, $4,433,456 in 2005 and $8,003,763 in 2006. As a result of ongoing operating losses, Celunol had an accumulated deficit of $64,372,482 at December 31, 2006. Celunol expects to continue to incur significant construction, project development, administrative, and other expenses. Celunol will need to generate significant revenue to achieve and maintain profitability, and Celunol cannot be sure that it will achieve profitability at all or, if it does, that it will remain profitable for any substantial period of time.

The combined company will need to conduct significant research, development, testing and plant construction activities that, together with projected general and administrative expenses, are expected to result in substantial increased operating losses for at least the next several years. Even if the combined company does achieve profitability, it may not be able to sustain or increase profitability on a quarterly or annual basis.

If the combined company loses key personnel or is unable to attract and retain additional personnel, the combined company may be unable to pursue collaborations or develop its own products.

The loss of any key members of the combined company’s management, including Carlos Riva, who is expected to be the combined company’s President and Chief Executive Officer or John McCarthy, who is expected to be the combined company’s Chief Financial Officer, or business development or scientific staff, or failure to attract or retain other key management, business development or scientific employees, could prevent the combined company from developing and commercializing biofuels and cellulosic ethanol and other new products and entering into collaborations or licensing arrangements to execute on its business strategy. Recruiting and retaining qualified personnel to perform research and development and commercialization work and to negotiate collaborations and licensing arrangements on behalf of the combined company will be critical to the combined company’s success. There is intense competition for qualified managerial, business development and scientific personnel from numerous companies, as well as from academic and government organizations, research institutions and other entities.

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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

On March 28, 2007, we issued $100 million aggregate principal amount of 5.5% convertible senior notes due April 1, 2027 in a private placement. The notes are convertible into our common stock at a conversion rate of 122.5490 shares of common stock per $1,000 principal amount of notes, which is equivalent to an initial conversion price of approximately $8.16 per share.

We sold the notes to UBS Securities LLC, Jefferies & Company, Inc., Conaccord Adams Inc. and Cantor Fitzgerald & Co. in reliance upon the private placement exemption afforded by Section 4 (2) of the Securities Act of 1933, as amended. The initial purchasers offered and sold the notes to “qualified institutional buyers” under Rule 144A of the Securities Act of 1933, as amended. We have agreed to file a registration statement under the Securities Act to permit registered resale of the notes and of the common stock issuable upon their conversion.

The aggregate offering price of the notes was $100 million, 100% of the principal amount thereof. The initial purchasers’ discount in connection with the offering was $3.4 million of 3.4% of the principal amount of the notes.

The initial purchasers subsequently exercised an over-allotment option that entitled them to purchase, and for us to issue, an additional $20 million aggregate principal amount of the notes. We issued those notes to the initial purchasers on identical terms as described above in early April 2007.

Our Registration Statements on Form S-1 (File Nos. 333-92853 and 333-30290) relating to the initial IPO were declared effective by the Securities and Exchange Commission on February 11 and February 14, 2000, respectively. Upon completion of our initial public offering, we received net proceeds of $184.5 million after underwriting discounts and expenses. Through March 31, 2007, approximately $19 million of the net proceeds had been used to purchase property and equipment and approximately $127 million had been used for general corporate purposes. The balance is invested in cash equivalents and short-term investments.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

None.

ITEM 5. OTHER INFORMATION.

None.

ITEM 6. EXHIBITS.

(a)

Exhibit Number	Description of Exhibit
2.1	Agreement and Plan of Merger and Reorganization among Diversa Corporation, Concord Merger Sub, Inc., Celunol Corp. and William Lese, as the representative of the stockholders of Celunol dated as of February 12, 2007(5)
2.2	Amendment No. 1 to Agreement and Plan of Merger and Reorganization, dated as of March 22, 2007, by and among Diversa Corporation, Concord Merger Sub, Inc., Celunol Corp. and William Lese (8)
2.3	Form of Voting Agreement between Diversa Corporation and certain stockholders of Celunol Corp. (5)
2.4	Form of Voting Agreement between Diversa Corporation and certain stockholders of Diversa Corporation. (5)
2.5	Form of Lock-Up Agreement between Diversa Corporation and certain of its stockholders. (5)
2.6	Form of Lock-Up Agreement between Diversa Corporation and certain stockholders of Celunol Corp. (5)
3.1	Amended and Restated Certificate of Incorporation.(1)
3.2	Amended and Restated Bylaws.(1)
3.4	Amendment to Bylaws of Diversa Corporation (8)
4.1	Form of Common Stock Certificate of the Company.(2)
4.2	Rights Agreement by and between the Company and American Stock Transfer and Trust Company, as Rights Agent, dated as of December 13, 2000 (including the Form of Certificate of Designation of Series A Junior Participating Preferred Stock attached thereto as Exhibit A, the Form of Right Certificate attached thereto as Exhibit B, and the Summary of Rights to Purchase Preferred Shares attached thereto as Exhibit C).(3)
4.3	First Amendment to Rights Agreement by and between the Company and American Stock Transfer and Trust Company, as Rights Agent, dated as of December 2, 2002.(4)
4.4	Second Amendment to Rights Agreement by and between Diversa Corporation and American Stock Transfer and Trust Company, as Rights Agent dated as of February 12, 2007. (5)
4.5	The Company’s Certificate of Designation of Series A Junior Participating Preferred Stock.(3)
4.6	Warrant issued by Diversa Corporation to Syngenta Participations AG. (2)
4.7	Registration Rights Agreement among Diversa Corporation, Syngenta Participations AG and Torrey Mesa Research Institute dated as of December 3, 2002. (2)
4.8†	Registration Rights Agreement by and between Diversa Corporation and Glaxo Group Limited dated as of July 18, 2003. (10)
4.9	Indenture, dated March 28, 2007, between Diversa Corporation and Wells Fargo Bank, National Association, a national banking association, as trustee, including Form of 5.50% Convertible Senior Note due 2027. (9)
4.10	Registration Rights Agreement, dated March 28, 2007, among Diversa Corporation and the Initial Purchasers identified therein. (9)
10.1*	Transitional Employment Agreement, dated February 11, 2007, between Diversa Corporation and Edward T. Shonsey. (7)
10.2*	Transitional Employment Agreement, dated February 11, 2007, between Diversa Corporation and Anthony E. Altig. (7)
10.3	Promissory Note, dated February 12, 2007, by Celunol Corp. for the benefit of Diversa Corporation. (5)
10.5	Offer Letter, dated February 12, 2007, by Diversa Corporation and Carlos A. Riva. (5)
10.6	Purchase Agreement, dated March 22, 2007, among Diversa Corporation and the Initial Purchasers identified therein. (9)
31.1	Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities and Exchange Act of 1934, as amended.
31.2	Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities and Exchange Act of 1934, as amended.
32	Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

* Indicates management or compensatory plan or arrangement.

† Confidential treatment has been requested with respect to portions of this exhibit. A complete copy of the agreement, including the redacted terms, has been separately filed with the Securities and Exchange Commission.

(1) Filed as an exhibit to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2000, filed with the Securities and Exchange Commission on May 12, 2000, and incorporated herein by reference.

(2) Filed as an exhibit to the Company’s Registration Statement on Form S-1 (File No. 333-92853) originally filed with the Securities and Exchange Commission on December 21, 1999, as amended, and incorporated herein by reference.

(3) Filed as an exhibit to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on December 15, 2000, and incorporated herein by reference.

(4) Filed as an exhibit to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on December 4, 2002, and incorporated herein by reference

(5) Filed as an exhibit to Diversa Corporation’s Current Report on Form 8-K filed with the Securities and Exchange Commission on February 12, 2007 and incorporated herein by reference.

(6) Filed as an exhibit to Diversa Corporation’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on January 6, 2003, and incorporated herein by reference.

(7) Filed as an exhibit to Diversa Corporation’s registration statement on Form S-4 (No. 333-141392), originally filed on March 19, 2007, as amended, and incorporated herein by reference.

(8) Filed as an exhibit to Diversa Corporation’s Current Report on Form 8-K filed with the Securities and Exchange Commission on March 27, 2007 and incorporated herein by reference.

(9) Filed as an exhibit to Diversa Corporation’s Current Report on Form 8-K filed with the Securities and Exchange Commission on March 28, 2007 and incorporated herein by reference.

(10) Filed as an exhibit to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, filed with the Securities and Exchange Commission on August 14, 2003, and incorporated herein by reference.

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SIGNATURES

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

	DIVERSA CORPORATION
Date: May 10, 2007	/s/ Anthony E. Altig
	Anthony E. Altig Senior Vice President, Finance and Chief Financial Officer (Principal Financial Officer)

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