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Report of the Board of Directors

Earnings in 2005 were significantly better than anticipated at the beginning of the year. Free cash flow was also highly satisfactory.

Financial results 
The results for 2005 are very satisfactory, exceeding the outlook at the start of the year despite sales growth being below long-term expectations.

Novozymes achieved solid earnings and continued growth in profit margins, as well as a high level of free cash flow. The microorganisms business had a challenging year of lower growth than expected and, as a result, lower earnings.

Sales grew by 5% to DKK 6,281 million. Sales were slightly positively affected by exchange rate movements and growth in local currencies was 4%. The expectation at the beginning of the year was growth in sales of 4% in DKK terms and 6-7% in local currency terms. Operating profit climbed by 11% to DKK 1,206 million, and the operating profit margin increased to 19.2%. Net profit rose by 11% to DKK 861 million. Free cash flow came to DKK 991 million, equivalent to 15.8% of turnover.

Shareholder value
Novozymes A/S' B share ended the year at DKK 345, corresponding to an increase of 24% over the year. Despite factors such as markedly higher oil prices, the atmosphere on the stock market was generally positive in 2005. The entry of investment funds into the Danish stock market, with several large Danish companies being bought up, also helped to drive prices up. The Novozymes share lagged slightly behind the Copenhagen Stock Exchange's OMXC20 blue-chip index, which gained 37% in 2005.

In 2005, for the fifth year in a row, Novozymes was ranked by Dow Jones Sustainability Indexes as the most sustainable biotechnology share both in Europe and worldwide, and for the third year in a row SustainableBusiness.com rated Novozymes one of the world's top 20 shares.

These rankings underline Novozymes' ability to continue to generate long-term shareholder value by working systematically on financial, environmental and social responsibility, and by managing risks in all three areas.

Novozymes made total payments to shareholders of DKK 1,284 million during the year, breaking down into a dividend of DKK 231 million for the 2004 financial year and a share buy-back programme worth DKK 1,053 million. Total distributions to shareholders were equivalent to 149% of the profit for the year. At the Annual Meeting of Shareholders on March 1, 2006 the Board of Directors will recommend payment of a dividend of DKK 4.00 per share for the 2005 financial year. This is equivalent to 30% of the year's net profit and is an increase of 14% per share relative to 2004.

Capital structure
As part of the adjustment of Novozymes' capital structure, the Board approved a programme in 2004 which included buying back shares for up to DKK 2,500 million over a period of three to four years. The shares were to be bought back with a view to cancellation and subsequent write-down of the company's share capital. As a result of better earnings and a higher level of free cash flow than expected, the Board considers it expedient to increase the ceiling for the share buy-back programme by DKK 1,500 million, enabling the purchase of treasury shares with a total value of up to DKK 4,000 million.

The Annual Meeting of Shareholders on March 16, 2005 resolved to write down the company's share capital by DKK 30 million. Fol­lowing this write-down the company has share capital of DKK 696 million, corresponding to 69.6 million shares. In 2005 Novozymes bought back shares for DKK 1,053 million. The ceiling for the year's buy-backs was raised during 2005 from DKK 650 million to DKK 1,050 million, bringing the total value of shares bought back in the overall programme to DKK 1,900 million. Share buy-backs of up to DKK 1,000 million are anticipated in 2006. The Board is also recommending that the Annual Meeting of Shareholders in 2006 resolve to write down the company's share capital by DKK 46 million.

The voting majority at Novozymes is held by the holding company Novo A/S, which owns all the company's A shares. The Board considers it an advantage for Novozymes to have a stable long-term shareholder which is demanding in terms of delivering shareholder value.

Environmental and social results
Novozymes managed to meet the majority of the sustainability targets that were set for 2005. Improvements of 7% and 5% were achieved in the utilisation of water and energy respectively, thus meeting the targets of 4% and 5%. The targets for increasing the waste recycling rate, no unintended releases of GMOs, developing management tools, and conducting lifecycle assessments of products were also met. Emissions of HCFCs fell from 2004 to 2005, but the target was not achieved. There was also one unintended discharge at Novozymes in Salem, USA.

A number of targets for 2005 concerned employees, including targets for employee turnover, the frequency of occupational accidents and the rate of absence. All of these targets were met.

Novozymes carried out a survey of the working climate throughout the company in 2005. Employees were generally satisfied. They feel that they have good development opportunities, and that their managers live up to Novozymes' values. One way in which the results are being used is to identify areas where further efforts would be beneficial, either generally or in specific departments.

Business highlights

Enzymes for industrial use
Novozymes launched six new enzyme products in 2005.

For example, the alliance between Novozymes and Chr. Hansen presented its first joint product for the dairy industry, YieldMAX™ PL. This product increases yields in cheese production by approximately 2%, which is the biggest improvement made in cheese yields for more than a decade.

In April 2005 Novozymes reached the fourth and final milestone in the con­tract with the National Renewable Energy Laboratory (NREL) un­der the US Department of Energy for the development of more effective enzymes for the production of fuel ethanol from biomass. Thanks to more effective enzymes and lower manufacturing costs Novozymes managed to reduce the cost of enzymes by a factor of 30 during the course of the project, and is now continuing the project without further support from the NREL.

In June 2005 Novozymes received a US Presidential Green Chemistry Challenge Award for the second time in four years. The prize was awarded jointly to Novozymes and Archer Daniels Midland for their innovative use of enzymes to develop healthier fats.

Continued productivity improvements meant that investment could be kept below the level of depreciation and amortisation for the sixth year in a row and Novozymes' expectation of keeping three years' investments below the total level of depreciation and amortisation for the period was therefore met.

Microorganisms for industrial use
In 2005 the microorganisms business focused on extending the documentation of its products' efficacy when used by customers. Improving earnings is still a focus area and will remain so until the microorganisms business achieves earnings on a level with Novozymes' long-term expectations.

PondProtect®, a new aquaculture product, was launched in 2005. The product is used on shrimp farms and reduces the amount of harmful ammonia and nitrite in the water.

At the end of 2005 Novozymes took over the Bio division of Octel Gamlen Industries SA, Vernon, France, a small distributor within microorganisms. The investment was made to strengthen the business' distribution network in western Europe.

Biopolymers and pharmaceutical proteins
Novozymes launched its first biopolymer product for the cosmetics industry at the end of 2004. Sales in 2005 were lower than expected.

Novozymes in Lund, Sweden, has been approved as a European cGMP facility. Plans have been drawn up to increase production capacity and also to expand the facility so that it can produce pharmaceutical proteins requiring FDA approval. Official approval for the expansion is pending.

Novozymes was recognised for the provisional results of research into a potential new antibiotic to combat resistant bacteria. This is due to Novozymes' discovery of plectasin, a new antimicrobial peptide (AMP), which, according to preliminary results, can combat bacterial infections that have developed resistance to traditional antibiotics. It is expected that most of the future research and potential commercialisation will be handled together with a partner.

The latest project outside enzymes and microorganisms concerns recombinant production of serum albumin in substrates for cell cultures. Albumin is found in the blood where, among other things, it is a carrier of nutrients. One area where this property is used is biopharmaceutical production. A new product could potentially replace albumin of bovine origin and give a higher degree of purity.

Novozymes is also working on the development of a technology for microbiological production of monoclonal antibodies and is looking for a partner in this area.

Other business aspects 

Significant pending litigation
The Danisco arbitration case mentioned in previous annual reports has yet to be resolved. Danisco is claiming that Novozymes has unlawfully appropriated certain lipase-related in­ventions and that Novozymes has failed to fulfil some of its obligations under a previous contract between the parties. Novozymes contests this and still believes that it has a strong case. A court hearing is currently scheduled for mid-2006.

In March 2005 Novozymes was awarded a patent in the USA. In Novozymes' opinion this patent is infringed by a product which a competitor, Danisco, produces and sells for the fuel ethanol industry. As Danisco did not voluntarily withdraw the product from the market, Novozymes felt obliged to take legal action and requested an injunction. In October 2005 Novozymes' request for a provisional injunction was rejected by the relevant court in the USA. A court hearing for Novozymes' request for the issue of a permanent injunction prohibiting the production and sale of Danisco's product is scheduled for the first quarter of 2006. A court hearing for Novozymes' potential claim for damages resulting from infringement of the patent is scheduled for the fourth quarter of 2006.

Potential business risks
Novozymes' business builds largely on the use of gene technology. Acceptance of our application of this technology is therefore of great importance. Novozymes strives for openness towards its stake­holders and works actively to communicate the advantages associated with our use of gene technology.

As a result of Novozymes' global activities and substantial sales in foreign currencies, the company is exposed to movements in exchange rates. Currency exposure is therefore a significant financial risk factor for the group. Novozymes hedges its currency exposure with the primary aim of reducing any negative impact of changes in exchange rates and increas­ing the predictability of the Group's financial results.

Events occurring after the close of the financial year
On January 24, 2006 Novozymes acquired the shares in Qingdao Huayuan Fine Bio-Products Co. Ltd., Shandong, China, which is a small company within the biopolymers area. The purchase has been made with a view to acquiring a dedicated production facility for hyaluronic acid, and also complements the existing product portfolio.

The Board of Directors has approved a 3-year share option programme for the company's senior management with effect from 2006. The share option programme covers the period 2006-2008 with annual allocations based on achievement of specified financial and non-financial targets. The programme covers approximately 300 managers internationally, but excludes Executive Management. Both the underlying number of shares in the programme and the exercise price will be set on the basis of the average price in the first five trading days after publication of the present consolidated financial statements.

Corporate governance
Corporate governance is about frameworks for business management, including the overall principles and structures regulating interaction between the company's manage­ment bodies. The aim is openness and transparency, to give our stakeholders a relevant insight into the business.

In 2005 the Board's annual self-assessment process resulted among other things in the following:

  • Strengthening the quality of the Executive Management's reporting of risks to the Board, adjusting the structure for this, and allocating more time for joint discussion and consideration of the company's overall risk factors.
  • More structured and active exploitation of the individual Board members' particular skills and experience when considering specific topics or projects on the Board's agenda.
  • Strengthening the Executive Management's follow-up to the Board concerning organisational and human resources matters previously discussed with the Board.
  • More frequent use of relevant external speakers and other sources of inspiration in connection with the Board's work, and increasing the duration and/or frequency of Board meetings where the above measures and focus areas or other factors make this necessary.

Read more about Novozymes' approach to corporate governance and its management and control systems, including an update with respect to the latest Nørby Report, at www.novozymes.com.

Long-term financial targets
Over the last five years Novozymes has generally achieved very good results. Again in 2005 all the long-term targets set in 2000 were met. Earnings are high and continuing to rise, and there are significant financial resources. The Board decided to retain the same long-term financial targets to support the company's growth potential. These are:

As a result, the Board, together with the Executive Management, has decided to use the company's earnings in excess of these targets to invest further in research and business development in enzymes and microorganisms. The new initiatives will focus on new business areas within new industries in Novozymes' core business and on exploiting the opportunities opening up within industrial biotechnology.

Outlook for 2006
Since 96% of Novozymes' sales take place outside Den­mark, fluctuations in exchange rates could impact significantly on the corporate financial results in 2006.

As the DKK is linked to the EUR via Denmark's fixed rate policy, currency exposure linked to the EUR is considered to be low.

(DKK)

USD JPY CNY
Average exchange rate for 2005 600 5.45 73.25
Spot rate on January 23, 2006 608 5.32 75.37
Change 1% (2%) 3%

Assuming that exchange rates remain at their current levels for the rest of the year, especially the USD, CNY and JPY, our expectations for 2006 can be summarised as follows:

  • Growth in sales of 7-9% in DKK terms and 6-8% in local currency terms.
  • Growth in operating profit of 7-9%. A positive currency effect is expected in 2006. All other things being equal, the sensitivity of operating profit to fluctuations in exchange rates in 2006 is expected to be DKK 30-40 million for the USD and DKK 5-15 million for the JPY, based on a 5% change in the exchange rate.
  • Operating profit margin of around 19%.
  • Net financial costs of around DKK 90 million.
  • Growth in net profit of 5-7%.
  • Return on invested capital after tax of 18-19%.
  • Free cash flow before acquisitions of DKK 750-850 million.
  • Investments in property, plant and equipment before acquisitions are expected to be in the range DKK 500-600 million.
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