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, 2000
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 No. 0-20966
--------------
CATALYTICA, INC.
(Exact name of Registrant as specified in its charter)
Delaware 94-2262240
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
430 Ferguson Drive
Mountain View, California 94043
(Address of principal executive offices)
(650) 960-3000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
As of May 7, 2000, on a fully diluted basis, reflecting the conversion of the
registrant's outstanding Class A and Class B Common Stock into Common Stock,
there were outstanding 58,021,023 shares of the registrant's Common Stock. As
of May 7, 2000, there were outstanding 33,021,023 shares of the registrant's
Common Stock, par value $.001, which is the only class of common stock of the
registrant registered under Section 12(g) of the Securities Act of 1933. The
Company also has outstanding 13,270,000 shares of Class A Common Stock and
11,730,000 shares of Class B Common Stock which are convertible into an equal
number of shares of Common Stock.
CATALYTICA, INC.
FORM 10-Q
TABLE OF CONTENTS
March 31, 2000
Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Unaudited Condensed Consolidated Balance Sheets as of March 31, 2000, and December 31, 1999 3
Unaudited Condensed Consolidated Statements of Operations for the three months ended March 31, 2000,
and March 31, 1999 4
Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2000,
and March 31, 1999 5
Notes to Unaudited Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk 27
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 29
Signatures 30
2
PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
March 31, December 31,
2000 1999
-------- --------
ASSETS
Current assets:
Cash and cash equivalents $ 21,455 $ 34,876
Short-term investments 5,464 5,470
Accounts receivable, net 40,127 41,985
Accounts receivable from joint venture 165 177
Notes receivable from employees 201 158
Inventory:
Raw materials 42,792 64,836
Work in process 35,693 27,938
Finished goods 17,298 12,745
-------- --------
95,783 105,519
Deferred tax 12,951 12,951
Prepaid expenses and other assets 3,371 4,060
-------- --------
Total current assets 179,517 205,196
Property, plant and equipment:
Land 6,533 6,533
Buildings and leasehold improvements 81,904 82,273
Equipment 207,495 194,097
-------- --------
295,932 282,903
Less accumulated depreciation and amortization (66,555) (61,772)
-------- --------
229,377 221,131
Notes receivable from employees 903 978
Other assets 1,000 1,203
-------- --------
$410,797 $428,508
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 21,174 $ 38,508
Accrued payroll and related expenses 9,557 18,126
Deferred revenue 7,076 6,771
Other accrued liabilities 8,105 9,184
Current portion of long-term debt 12,748 12,948
Income taxes payable 3,609 1,162
-------- --------
Total current liabilities 62,269 86,699
Long-term debt 51,000 51,000
Non-current deferred revenue 6,696 6,992
Deferred tax 16,031 16,031
Other liabilities 959 959
Minority interest 41,000 41,000
Class A and B common stock 97,079 97,079
Stockholders' equity:
Common stock 33 33
Additional paid-in capital 112,765 112,021
Deferred compensation (125) (156)
Retained earnings 23,090 16,850
-------- --------
Total stockholders' equity 135,763 128,748
-------- --------
$410,797 $428,508
======== ========
See accompanying notes.
3
CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Three Months Ended March 31,
2000 1999
------- -------
Revenues:
Product sales $87,464 $90,611
Research and development contracts 11,230 5,313
------- -------
Total Revenues 98,694 95,924
Costs and expenses:
Cost of goods sold 70,654 72,324
Research and development 10,511 8,442
Selling, general and administrative 5,880 5,744
------- -------
Total costs and expenses 87,045 86,510
Operating income 11,649 9,414
Interest income 562 662
Interest expense (1,976) (2,081)
Loss on joint ventures -- (512)
------- -------
Income before income taxes 10,235 7,483
Provision for income taxes (3,995) (1,111)
------- -------
Net income $ 6,240 $ 6,372
======= =======
Net income per share:
Basic $0.11 $0.11
======= =======
Diluted $0.09 $0.09
======= =======
Number of shares used in computing net income per
share:
Basic 57,964 57,470
======= =======
Diluted 64,508 64,206
======= =======
See accompanying notes.
4
CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (decrease) in cash and cash equivalents
(in thousands)
Three Months Ended March 31,
2000 1999
-------- --------
Cash flows from operating activities:
Net income $ 6,240 $ 6,372
Adjustments to reconcile net income to net cash provided by (used in) operating
activity:
Depreciation 4,800 4,175
Amortization 257 213
Deferred income taxes -- (27)
Losses in joint ventures -- 512
Provision for losses in accounts receivable (293) --
Changes in:
Accounts receivable 2,151 14,342
Accounts receivable from joint venture 12 341
Inventory 9,736 (11,804)
Prepaid expenses, and other current assets 689 (240)
Accounts payable (17,334) 691
Accrued payroll and related expenses (8,569) (7,975)
Deferred revenue 9 (2,750)
Income taxes payable 2,447 (2,089)
Other accrued liabilities (1,079) (65)
-------- --------
Net cash provided by (used in) operating activities (934) 1,696
Cash flows from investing activities:
Purchases of investments (11,500) (9,438)
Maturities of investments 11,500 9,422
Investment in joint ventures -- (512)
Disposition of property and equipment 44 76
Acquisition of property and equipment (13,090) (8,777)
-------- --------
Net cash used in investing activities (13,046) (9,229)
Cash flows from financing activities:
Net receipts on (issuance of) notes receivable from employees 15 7
Borrowings on debt obligations -- 2,656
Payments on debt obligations (200) (371)
Dividends paid -- (85)
Issuance of stock, net of issuance costs 744 347
-------- --------
Net cash provided by financing activities 559 2,554
-------- --------
Net decrease in cash and cash equivalents (13,421) (4,979)
Cash and cash equivalents at beginning of period 34,876 41,269
-------- --------
Cash and cash equivalents at end of period $ 21,455 $ 36,290
======== ========
See accompanying notes.
5
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three-month period ended March 31,
2000, are not necessarily indicative of the results that may be expected for the
year ended December 31, 2000. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Catalytica, Inc.
Annual Report on Form 10-K for the year ended December 31, 1999.
On September 20, 1999, the Company acquired Wyckoff Chemical Company, Inc.
("Wyckoff"). At the completion of the merger, Wyckoff became a wholly owned
subsidiary of the Company. The Wyckoff merger was accounted for as a pooling of
interests for financial reporting purposes in accordance with generally accepted
accounting principles. Catalytica, Inc. ("Catalytica") exchanged 4,029,813
shares of its common stock, and 32,962 shares of Wyckoff options were assumed by
the Company. There were no transactions between Wyckoff and Catalytica prior to
the combination and no significant adjustments were necessary to conform
Wyckoff's accounting policies.
Wyckoff's and Catalytica's results of operations for 1999 were combined. The
condensed consolidated financial statements for the three months ended March 31,
1999, have been restated to include the financial position, results of
operations and cash flows of Wyckoff on the same periods as those presented for
Catalytica.
2. Earnings per share
6
A reconciliation of the numerators and denominators for the Basic and Diluted
EPS calculations follows:
(in thousands, except per share amounts) Three months ended March 31,
2000 1999
------- -------
Numerator:
Numerator for basic earnings per share: Net income $ 6,240 $ 6,372
Less: Reduction of Catalytica Pharmaceuticals income
attributable to holders of subsidiary stock options (486) (466)
------- -------
Numerator for diluted earnings per share $ 5,754 $ 5,906
------- -------
Denominator:
Denominator for basic earnings per share: Weighted-average
shares 57,964 57,470
------- -------
Effect of dilutive securities:
Catalytica, Inc. employee stock options 733 993
Catalytica Pharmaceuticals, Inc. Convertible Preferred Stock 1,917 1,766
Catalytica Pharmaceuticals, Inc. Convertible Junior
Preferred Stock 647 596
Catalytica Combustion Systems, Inc. Convertible Preferred
Stock 3,105 3,021
Catalytica, Inc. warrants issued to Glaxo Wellcome, Inc. 142 360
------- -------
Dilutive potential common shares 6,544 6,736
Denominator for diluted earnings per share: Adjusted
weighted-average shares and assumed conversions 64,508 64,206
------- -------
Basic earnings per share $0.11 $0.11
======= =======
Diluted earnings per share $0.09 $0.09
======= =======
Weighted average shares outstanding for the three months ended March 31, 2000,
includes Class A and B common shares as Catalytica considers Class A and B to be
the equivalent of common stock.
3. Segment Disclosures The Company operates primarily in the pharmaceuticals and
combustion systems businesses. The Company has determined the reportable
operating segments based upon how the businesses are managed and operated.
Catalytica Pharmaceuticals, Inc. ("Catalytica Pharmaceuticals") and Catalytica
Combustion Systems, Inc. ("Combustion Systems") operate as independent
businesses with their own sales, research and development, and operations
departments. Each manufactures and distributes distinct products with different
production processes. As such, the following table discloses their revenues,
operating income, and identifiable assets for the above named operating
segments. Catalytica Advanced Technologies, Inc. ("Advanced Technologies") is
combined with Catalytica's corporate operations as it does not meet the
requirements for separate disclosure. Sales to countries outside of the United
States is less than 10% of total revenues for all periods presented.
7
(In thousands) Three months ended March 31,
-----------------------------------------------
2000 1999
------- -------
Revenues
Catalytica Pharmaceuticals $97,544 $95,238
Combustion Systems 880 293
Corporate and other 270 393
------- -------
Total revenues $98,694 $95,924
======= =======
Operating income
Catalytica Pharmaceuticals $12,337 $10,700
Combustion Systems (407) (1,460)
Corporate and other (281) 174
------- -------
Total operating income $11,649 $ 9,414
======= =======
March 31, 2000
-----------------------
Identifiable assets
Catalytica Pharmaceuticals $374,089
Combustion Systems 19,091
Corporate and other 17,617
--------
Total assets $410,797
========
4. Financial instruments
Catalytica considers all investments with maturities of three months or less
at the date of purchase to be cash and cash equivalents; instruments with
maturities of three months or less at the date of purchase that are planned to
be held-to-maturity ($5.5 million at March 31, 2000) and investments with
maturities greater than three months that are available-for-sale (none at March
31, 2000) are considered to be short-term investments; investments with
maturities greater than one year are considered to be long-term investments and
are available-for-sale (none at March 31, 2000). All investments at March 31,
2000, were carried at amortized cost, which approximated fair market value
(quoted market price). The classification of investments is made at the time of
purchase with classification for held-to-maturity made when the Company has the
positive intent and ability to hold the investments to maturity.
5. Use of estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
8
6. Debt
As of March 31, 2000, nothing was outstanding under the senior secured
revolving facility ("Revolving Debt Facility") and $61.25 million was
outstanding under the senior secured term loan facility ("Term Debt Facility").
This credit agreement, which is guaranteed by the Company, requires that the
Company maintain certain financial ratios and levels of tangible net worth,
profitability, and liquidity and implements restrictions on the Company's
ability to declare and pay dividends. In addition, the credit agreement
contains various covenants restricting further indebtedness, issuance of
preferred stock by the Company or its subsidiaries, liens, acquisitions, asset
sales, and capital expenditures. At March 31, 2000, the Company and Catalytica
Pharmaceuticals were in compliance with the covenants.
9
7. Income taxes
The Company recorded a provision for income taxes for the three months ended
March 31, 2000, of 39%, as compared with 15% for the corresponding period in
1999. The 2000 effective tax rate differs from the federal statutory tax rate
primarily due to state income taxes. The 1999 effective tax rate differed from
the federal statutory tax rate primarily due to the utilization of tax net
operating loss carryforwards and the elimination of the valuation allowance for
deferred tax assets.
8. Agreement with Enron
In December of 1999, an affiliate of the holder of a minority interest in
Combustion Systems, Enron North America ("Enron") announced that Catalytica's
Xonon combustion system had been specified as the preferred emissions control
system with GE 7FA turbines that have been ordered for the proposed Pastoria
Energy Facility. The Pastoria Energy Facility is a project proposed by
affiliates of Enron, and is expected to begin construction in 2001 and enter
commercial operations by the summer of 2003. In conjunction with this project,
Combustion Systems and Enron signed an agreement whereby Combustion Systems
would have advanced $9.9 million to accelerate development of the Xonon-equipped
GE gas turbines. Catalytica expected to recover its advance in late 2000 either
in cash or through the future sale of Xonon-equipped gas turbines. In December
1999, Combustion Systems recorded a provision of $1.2 million related to the
first of these advances and was required to advance an additional $8.7 million
under this agreement in 2000.
Effective March 31, 2000, Catalytica and Enron amended this agreement such
that Enron has agreed to repay all funds advanced thus far, net of certain
expenses, and will continue to accelerate development of the Xonon-equipped GE
gas turbines without any future advances from Catalytica. Accordingly,
approximately $1.0 million of previously recorded provision was eliminated and
included in the results of operations as a reduction of research and
developement expenses in the three months ended March 31, 2000.
9. Subsequent Event
Initial Public Offering
In March 2000, the Company announced that it intends to conduct an initial
public offering of a minority interest in Combustion Systems to infuse
additional capital into the subsidiary, and to offer better recognition of value
for Combustion Systems and Catalytica shareholders.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
This Report contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934, including, without limitation, statements regarding the Company's
expectations, beliefs, intentions or future strategies that are signified by the
words "expects", "anticipates", "intends", "believes", or similar language. All
forward-looking statements included in this document are based on information
available to the Company on the date hereof, and the Company assumes no
obligation to update any such forward-looking statements. Actual results could
differ materially from those projected in the forward-looking statements. In
evaluating the Company's business, prospective investors should carefully
consider the information set forth below under the caption "Risk Factors" set
forth herein. The Company cautions investors that its business and financial
performance are subject to substantial risks and uncertainties.
Catalytica, Inc. ("Catalytica") finds new pathways to improve processes -
reducing time, waste, and costs. Catalytica applies its innovative and patented
catalytic technologies and other scientific processes to the pharmaceutical and
power generation industries. For the pharmaceutical industry, Catalytica
improves the steps for manufacturing pharmaceutical products and also finds
better, more efficient ways to produce them in commercial scale quantities. For
the power generation industry, Catalytica's unique application of a catalyst and
proprietary technology enables gas turbines to produce essentially pollution-
free power.
In addition, Catalytica continues to explore other business opportunities that
capitalize on its rich 25-year history of discovery and effective application of
catalysts. Projects include high throughput screening of catalysts and
processes for rapid analysis of optimum production of products, unique
applications of catalysts to enhance fuel conversion for fuel cells and
production of better catalysts for the manufacture of plastics. Catalytica
operates through three subsidiaries: Catalytica Pharmaceuticals, Inc.
("Catalytica Pharmaceuticals"), Catalytica Combustion Systems, Inc.
(''Combustion Systems"), and Catalytica Advanced Technologies, Inc. ("Advanced
Technologies").
On September 20, 1999, the Company acquired Wyckoff Chemical Company
("Wyckoff"), which develops, manufactures and markets a broad range of active
pharmaceutical and advanced fine chemical ingredients. At the completion of the
acquisition, Wyckoff became a wholly owned subsidiary of the Company and now
markets its services as the Wyckoff Division of Catalytica Pharmaceuticals.
The acquisition was accounted for as a pooling of interests. The consolidated
financial statements were restated to reflect the Company's financial position
and the results of operations as if Wyckoff was a wholly-owned subsidiary of the
Company since inception.
11
In March 2000, the Company announced that it intends to conduct an initial
public offering of a minority interest in Combustion Systems to infuse
additional capital into the subsidiary, and to offer better recognition of value
for Combustion Systems and Catalytica shareholders.
Results of Operations
Net revenues for the three months ended March 31, 2000, increased by 2.9% when
compared with the revenues in the same period in 1999, due to an increase in
research revenues. Product sales decreased by 3.5% during the three months
ended March 31, 2000, when compared with the same period in 1999, due to a shift
in product demand as a result of Y2K concerns that created higher product demand
in the fourth quarter of 1999 and subsequently reduced product demand in the
first quarter of 2000, as well as a scheduled decrease in sales to Warner
Lambert for products which were produced under the original Glaxo Wellcome
Supply Agreement.
During the three months ended March 31, 2000, 65% of Catalytica's revenues
were derived from sales to Glaxo Wellcome, of which 36% were derived from sales
to Glaxo Wellcome under the original supply agreement. During the same period in
1999, 66% of Catalytica's revenues were derived from sales to Glaxo Wellcome, of
which 37% were derived from sales to Glaxo Wellcome under the original supply
agreement. As part of the original supply agreement and amendments to the
original supply agreement, Glaxo Wellcome guarantees a specified minimum level
of revenues in each year of the agreement. Product shipments to Glaxo Wellcome
have exceeded the levels associated with the aggregate annual minimum payments
provided for in the original Supply Agreement and related amendments.
Therefore, Glaxo Wellcome has made no shortfall payments to Catalytica.
Under terms of the original Glaxo Wellcome supply agreement and certain
amendments, there are scheduled reductions in product sales to Glaxo Welcome.
Revenues from non-Glaxo Welcome customers are expected to increase in 2000.
However, depending on the timing and amount of new business, the Company may not
be able to continue its revenue growth in 2000 when compared with 1999.
Research and development ("R&D") revenues increased by 111.4% for the three
months ended March 31, 2000, when compared with the same period in 1999,
primarily due to a significant increase in new R&D partners and related funded
R&D activities at Catalytica Pharmaceuticals. In addition, Combustion Systems'
R&D revenue increased over the same period primarily due to an increase in cost
reimbursement by gas turbine manufacturers and other research institutes related
to the development of Xonon technology. The Company's quarterly R&D revenues
are expected to increase in fiscal 2000 when compared with fiscal 1999, as the
Company continues to expands its R&D efforts and signs new contracts with new
and existing customers, especially in the pharmaceutical business.
Cost of sales decreased 2.3% in the first quarter of 2000 when compared with
the same period in 1999, which corresponds to a 3.5% decrease in product sales.
This decrease in cost of sales reflects slightly lower product sales, as well as
a change in product mix. The gross margin for the quarter ended March 31, 2000,
compared with the same period in 1999, decreased 1%
12
primarily due to slightly lower capacity utilization as a result of lower sales,
a change in product mix, and a higher material component on sales to Glaxo
Wellcome during the quarter. Margins on pharmaceutical products are subject to
fluctuations from quarter to quarter due to various factors, including the mix
of products being manufactured, manufacturing efficiencies achieved on
production runs, the length of down-time associated with setting up new
production runs, and numerous other variables present in the pharmaceutical
manufacturing environment.
Research and development ("R&D") expenses increased 24.5% for the three months
ended March 31, 2000, as compared with R&D expenses in the same period in 1999.
This increase in R&D expenses directly corresponds to increased demand for the
Company's pharmaceutical development services, and is attributable to increased
staffing and associated R&D expenses at Catalytica Pharmaceuticals which is
expanding the R&D services it provides with respect to both chemical process and
formulation development. These activities are important as the Company continues
to obtain new customers for its R&D services which are becoming a meaningful
source of revenues, and are expected to lead to new manufacturing business in
the future. In addition, Combustion Systems' R&D expense decreased over the same
period in 1999. In December 1999, we entered into an agreement with Enron, the
purpose of which was to accelerate the development of Combustion Systems' Xonon
technology. In connection with this agreement, we recorded a $1.2 million
provision. In March, the agreement was amended and Enron has agreed to reimburse
Catalytica for approximately $1.0 million of the previous advance. Accordingly,
that amount has been recorded in the current period as a reduction of related
research and development activities. Partially offsetting this decrease in R&D
expenditures in Combustion Systems was a shift in R&D spending from the GENXON
joint venture back to Combustion Systems. Beginning in the second half of 1996
through the end of the second quarter of 1999, a significant portion of
Combustion Systems' research activity was conducted through the GENXON joint
venture. Upon the completion of the prototype development of the Kawasaki
development program in June 1999, subsequent testing programs were conducted by
Combustion Systems. The Company's R&D expenses are expected to grow in the
future as the Company continues to invest in its R&D capabilities, especially in
Catalytica Pharmaceuticals.
Selling, general and administrative expenses increased 2% for the three months
ended March 31, 2000, compared with the same period in 1999. Selling, general
and administrative has remained relatively flat in the first quarter of 2000
when compared to the same period in 1999, as the sales and marketing efforts at
the Greenville Facility have reached the desired level. Overall, selling,
general and administrative expenses are expected to remain at or near similar
annual levels for Catalytica Pharmaceuticals and Advanced Technologies and may
increase over the coming year for Combustion Systems as they enter later stages
of commercialization for the Xonon Cool Combustion technology.
Interest income decreased 15% for the three months ended March 31, 2000, when
compared to the same period in 1999. This decrease in interest income is
primarily due to lower average cash balances in the first quarter of 2000 when
compared to the same period in 1999. This decrease in cash is primarily due to
lower average cash balances related to Combustion Systems, as it continues to
invest its funds in research and development activities. Interest income is
expected to continue to be moderately lower in the remainder of 2000 as the
Company intends to utilize a portion of its cash to finance capital
expenditures.
13
Interest expense decreased 5% for the three months ended March 31, 2000, when
compared to the same period in 1999. Although the Company's interest rate on the
portion of the Chase Credit Facility not covered by the $50.0 million interest
rate swap increased approximately 1% between March 31, 2000 and March 31, 1999,
the increase was offset by a reduction of almost $27.5 million of the Company's
debt during the twelve months ended March 31, 2000, which contributed to the
overall decrease in interest expense. This reduction in the Company's debt
reflects early payments on the Chase Credit Facility as well as repayment of
$16.1 million of Wyckoff's current and long-term debt upon the acquisition of
Wyckoff. The decrease in interest expense was slightly offset by $0.2 million of
interest expense related to the recovery of a $1.2 million advance incurred to
develop Xonon technology.
No joint venture losses were incurred by Combustion Systems in the first
quarter of 2000. During the three months ended March 31, 1999, Combustion
Systems' share of GENXON's losses was $0.5 million, which represented its
capital contribution during this period. Losses on the joint venture are
recognized in the results of operations. In the third quarter of 1999, GENXON
completed its prototype development of the Kawasaki combustor unit, and
subsequent testing programs were conducted by Combustion Systems. The reduced
level of the Company's investment in GENXON is expected to continue throughout
2000.
The Company recorded a provision for income taxes for the three months ended
March 31, 2000, of 39%, as compared with 15% for the corresponding period in
1999. The 1999 effective tax rate differed from the federal statutory tax rate
primarily due to the utilization of tax net operating loss carryforwards and the
elimination of the valuation allowance for deferred tax assets. The Company's
effective tax rate will approximate the federal statutory rate in 2000.
Year 2000 Computer Systems Compliance
Many computer systems, software, and electronic products require valid dates
to work acceptably but are coded to accept only two-digit entries in the date
code field. These systems needed to be changed to distinguish 21st century dates
from 20th century dates. As a result, some computer systems, software, and
other equipment, such as telephones, office equipment and manufacturing
equipment needed to be upgraded, repaired or replaced. To date we have not
experienced any material problems with the year 2000 in our products or internal
systems.
Liquidity and Capital Resources
Total cash, cash equivalents, and short-term investments decreased from $34.9
million to $21.5 million for the three months ended March 31, 2000, when
compared with December 31, 1999, primarily due to quarterly estimated tax
payments, payments of incentive bonuses, and an increase in investment in
capital expenditures. The Company expects to spend approximately $50.0 million
during 2000 for capital expenditures primarily at Catalytica Pharmaceuticals.
Because of its cash position of $21.5 million (including short-term investments)
and its available line of credit of $100.0 million as of March 31, 2000, coupled
with the anticipated cash flow from operations in 2000, the Company believes
that it has adequate
14
funds to meet its working capital needs and debt repayment obligations for the
near and longer term.
In the second quarter of 1998, the Company entered into a $50.0 million
interest rate swap agreement to reduce the Company's exposure to fluctuations in
short-term interest rates. This agreement effectively fixed the LIBOR
benchmark rate used to calculate the Company's borrowing cost at 5.90% for 4
years on $50.0 million of the Term Debt Facility. The Company accounts for this
agreement as a hedge and accrues the interest rate differential as interest
expense on a monthly basis. The Company does not hold or transact in such
financial instruments for purposes other than risk management.
RISK FACTORS
This Report contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934, including, without limitation, statements regarding the Company's
expectations, beliefs, intentions or future strategies that are signified by the
words "expects", "anticipates", "intends", "believes", or similar language. All
forward-looking statements included in this document are based on information
available to the Company on the date hereof, and the Company assumes no
obligation to update any such forward-looking statements. Actual results could
differ materially from those projected in the forward-looking statements. In
evaluating the Company's business, prospective investors should carefully
consider the information set forth below under the caption "Risk Factors" set
forth herein. The Company cautions investors that its business and financial
performance are subject to substantial risks and uncertainties.
Our quarterly operating results may fluctuate and we may be unable to maintain
profitability
Catalytica's operating results have fluctuated significantly in the past and
we expect that results will continue to vary from quarter to quarter. In
particular, our quarterly results may fluctuate and our profitability may suffer
as a result of:
. loss or reductions of orders from an important customer, such as Glaxo
Wellcome
. delays in availability or increases in costs of raw materials from our
suppliers
. increased price competition or reductions in the prices that we are able
to charge
. the amount and timing of payments and expenses under development and
production contracts
. changes in demand for the pharmaceuticals sold by our customers
. new product introductions or delays in product introductions by our
customers or their competitors
15
. size and timing of receipt of orders for and shipments of pharmaceutical
products
. changes in product mix
. operating efficiencies in manufacturing operations
. seasonality in demand for our products
. general business conditions in our markets, particularly in the
pharmaceutical sector
As a result of these and other factors, quarter-to-quarter comparisons of our
historical results of operations are not good indicators of future performance.
If our future operating results are below the expectations of stock market
analysts, or if we are unable to remain profitable, our stock price may decline.
We depend on a single customer for a large portion of our revenues, and a
reduction in the level of business with this customer could seriously harm our
business
A single customer, Glaxo Wellcome, accounts for a large percentage of
Catalytica's revenues. During the three months ended March 31, 2000, 65% of
Catalytica's revenues were derived from sales to Glaxo Wellcome, of which 36%
were derived from sales to Glaxo Wellcome under the original supply agreement.
During the same period in 1999, 66% of Catalytica's revenues were derived from
sales to Glaxo Wellcome, of which 37% were derived from sales to Glaxo Wellcome
under the original supply agreement. Catalytica's top five customers
collectively accounted for approximately 83% of its revenues for the three
months ended March 31, 2000. Even though the portion of our revenues
attributable to Glaxo Wellcome is expected to decline over time, we anticipate
that sales to Glaxo Wellcome will continue to account for a significant portion
of our revenues for the foreseeable future. Our business would be seriously
harmed if we lost Glaxo Wellcome as a customer or suffered a large reduction in
orders from Glaxo Wellcome.
Our product sales depend on our customers to anticipate industry needs and
accurately forecast future demand for their products
We manufacture both intermediate products used in customers' finished products
and finished products for our customers. Typically, there is a relatively
lengthy lead-time between signing a production contract and the actual
production of products under that contract. Accordingly, we rely upon the
ability of our customers to anticipate changing customer needs, successfully
market the products and obtain necessary regulatory approval. A decrease in
demand for our customers' products would lower demand for our products. We
cannot guarantee that our customers' product development efforts will be
successful, that required regulatory approvals can be obtained on a timely
basis, if at all, that products can be manufactured at acceptable cost and with
appropriate quality or that any products, if approved, can be successfully
marketed. If our customers are not successful in this regard, they might reduce
or eliminate their orders and our results of operations likely would
deteriorate.
16
We may be held responsible for product liability claims and may be unable to
obtain sufficient product liability insurance
As a pharmaceutical and pharmaceutical intermediate manufacturer, we could
experience product liability claims for products we manufacture if they do not
meet customer specifications. Our customers generally agree to indemnify us
with respect to potential liability claims, other than claims related to our
failure to meet their specifications.
We have product liability insurance but cannot guarantee that we will be able
to obtain sufficient levels of product liability insurance on acceptable terms
in the future. If we are held responsible for product liability and do not have
adequate insurance or are not properly indemnified, then our results of
operations could be harmed. Also, under the original Glaxo Wellcome Supply
Agreement, Catalytica Pharmaceuticals is obligated to maintain $100.0 million of
product liability insurance. If Catalytica Pharmaceuticals does not meet this
requirement, Glaxo Wellcome may terminate the Supply Agreement, which would have
a negative impact on our financial results.
Compliance with current Good Manufacturing Practices regulations is costly and
time-consuming, and our failure to comply could lead to delays in filling
product orders and loss of sales revenues
Our pharmaceutical production facilities must comply with the FDA's current
Good Manufacturing Practices ("cGMP") regulations as well as international
regulatory requirements. Additionally, some of our customers require us to
adhere to certain additional manufacturing standards specific to their
companies. Compliance with cGMP regulations as well as other company-specific
specifications requires us to expend time, money and effort to maintain precise
records and quality assurance. Failure to maintain satisfactory cGMP compliance
could have a significant adverse effect on our ability to continue to
manufacture and sell our products and, in the most serious cases, could result
in the seizure or recall of products, injunction and/or civil fines, and such
action could be taken with little or no notice.
Our facilities are subject to routine inspection by the FDA and other
international regulatory authorities for compliance with cGMP requirements and
other applicable regulations. As such, the Greenville Facility has had a total
of four regulatory inspections in 1999. Three of the inspections resulted in a
satisfactory assessment by the regulatory agency. One of the inspections, of
our chemical manufacturing facility, which took place during the week of June
28, 1999, resulted in the issuance by the FDA of an FDA Form 483 followed by a
letter, which detailed specific areas where the FDA inspectors observed that we
were not in full compliance with certain regulatory requirements. Corrective
actions addressing all identified observations were initiated immediately, and a
re-inspection conducted by the FDA within one month of the Company's receipt of
the letter resulted in concurrence by the FDA that all issues had been addressed
to their satisfaction.
17
Our operations must comply with environmental regulations, and any failure to
comply could result in extensive costs, which would harm our business
Our research, development and manufacturing activities involve the use,
storage, transportation and disposal of many hazardous chemicals and are subject
to regulations governing air pollution and wastewater treatment. As a result,
our activities are subject to extensive federal, state and local laws and
regulations, some of which have recently changed. For example, in 1998, the
United States Environmental Protection Agency, or EPA, issued new regulations
for the pharmaceutical industry requiring the installation of "maximum
achievable control technology" for hazardous air pollution sources and
additional pretreatment systems for wastewater discharges. We currently are
evaluating the potential impact of these regulations on our operations and we
believe that these new regulations may require us to make large cash
expenditures. These and any other new regulatory changes could result in
renovations, improvements or other cash expenditures to bring our facilities and
operations into compliance. A failure to comply with present or future
environmental laws could result in:
. imposition of injunctions or orders to stop production and operations
. payment of fines, costs of remediation or damages
. restrictions on expansion of operations
. other expenditures as required to comply with environmental requirements
If our operations do not comply with environmental regulations for any reason,
any of these events could occur and the occurrence could harm our financial
condition.
For example, in 1999, Catalytica's Greenville Facility experienced a chemical
release as a result of a broken pipeline. Shortly thereafter, Catalytica, the
North Carolina Occupational Health and Safety Agency and the North Carolina Air
Quality Division investigated this incident. The investigation was resolved in
February 2000. See Item 1. Legal Proceedings.
Soil and groundwater contamination exists at our facilities, and the
contamination may result in large expenditures of cash and other resources
As the owner of the Greenville Facility, Catalytica Pharmaceuticals is legally
liable for the existing contamination at the site. However, Glaxo Wellcome, the
previous owner, has agreed to pay the costs of remediation to the extent
contamination existed at the time it sold the property to Catalytica. Despite
its agreement with Glaxo Wellcome, Catalytica could be held responsible for the
contamination in an action brought by a governmental agency or a third party.
Catalytica's current operations and future expansion of the Greenville Facility
could be slowed or prevented by required remediation activities at the site.
Catalytica Pharmaceuticals' ongoing operations at the Greenville Facility also
may cause additional contamination. The determination of the existence and cost
of any such additional contamination contributed by Catalytica Pharmaceuticals
could involve costly and time-consuming negotiations and litigation. Additional
contamination could harm Catalytica's business, results of operations and
financial condition.
18
Similarly, Catalytica's Bay View facility has arsenic and volatile organic
compound contamination in the soil and groundwater. The site is subject to a
clean-up and abatement order issued by the Bay Area Regional Water Quality
Control Board. The order requires stabilization, containment and monitoring of
the contamination at the site and surrounding areas by the current owner of the
property, Rhone Poulenc, Inc. Although Catalytica has contractual rights of
indemnity from Rhone Poulenc and from Novartis, the prior owners/operators of
the facilities, Catalytica could be named in an action brought by a governmental
agency or a third party because of the contamination. If Catalytica is
determined to have contributed to the contamination, Catalytica may be liable
for any damage to third parties attributable to its contamination, and may be
required to indemnify Rhone Poulenc and Novartis for any clean up costs or
liability that they may incur as a result. Any litigation or determination of
the existence and cost of this contamination would likely be costly and time-
consuming.
The Wyckoff manufacturing site is listed under Michigan law as a site with
soil and groundwater contamination. Environmental assessments conducted on the
Wyckoff property have identified soil contamination by volatile organic
compounds and heavy metals. We are legally liable under federal and state law
for the remediation of these areas of contamination. In addition, risks of
environmental costs and liabilities are inherent in plant operations and
products produced by Wyckoff. Wyckoff's ongoing operations could cause
additional contamination, which could harm our business, results of operations
and financial condition.
Environmental regulations may delay the commercialization of Catalytica's
catalytic combustion systems or increase the costs of bringing products to
market
The enactment and enforcement of environmental regulations at the federal,
state and local levels will strongly influence the demand for emissions
reduction systems, and thus will affect the rate at which industrial companies
adopt Catalytica's catalytic combustion systems. As a result, Catalytica's
revenues will depend, in part, on the environmental standards that government
authorities adopt for reducing emissions (including emissions of nitrogen oxide)
addressed by its products. Government authorities may revise existing
regulations in a manner that could diminish demand for Catalytica's products.
Moreover, new regulations may impose requirements that are not met by
Catalytica's products or may necessitate costly redevelopment or modification of
its products. Also, certain industries or companies may seek to delay the
implementation of existing or new regulations, or acquire emissions credits from
other sources, which would delay or eliminate their need to purchase emissions
reduction products. If any of these circumstances arise, Catalytica may not
realize the expected returns on its investment in the catalytic combustion
business.
Some of Catalytica's manufacturing facilities are underutilized, and this
underutilization may harm our operating results
Currently, Catalytica's pharmaceutical production and sterile production
facilities at its Greenville Facility are not fully utilized. To utilize its
manufacturing resources fully, Catalytica must continue to successfully obtain
new pharmaceuticals customers, expand business with
19
existing customers and obtain necessary regulatory approvals for production of
new products. As a result of reductions in the level of business attributable to
Glaxo Wellcome and the long lead times required to obtain regulatory approvals
to manufacture at our pharmaceutical and sterile production facilities, if we
are to fully utilize our pharmaceutical and sterile production facilities, we
must continue to enter into agreements for additional business far enough in
advance of production to obtain required regulatory approvals. If we are unable
to do these things, our pharmaceutical and sterile production facilities will
remain underutilized, and this may harm our operating results.
Our success depends on the ability of our customers to develop new
pharmaceutical products and obtain required regulatory approvals for those
products
The success of our pharmaceutical production operations depends on receiving
orders from our customers for the production of active ingredients,
intermediates, and pharmaceutical products in finished dosage form. The
clinical development, testing and sales of these products is subject to
regulation by the FDA and other regulatory authorities in the United States and
abroad. As a result, we depend on our customers to both develop new
pharmaceutical products and obtain the required regulatory approvals. If our
customers are unable to develop new products or obtain required approvals, our
pharmaceutical production facilities may be underutilized and our results of
operations may be harmed.
Ownership of Catalytica's stock is concentrated in one owner, and this owner may
prevent or delay a change of control of Catalytica or otherwise make decisions
contrary to the interests of other stockholders
As of March 31, 2000, Morgan Stanley Dean Witter Capital Partners and its
affiliates held approximately 29% of Catalytica's voting stock and 43% of our
total outstanding voting and non-voting stock. Morgan Stanley Dean Witter can
convert a portion of its non-voting stock into voting stock only if the
conversion results in Morgan Stanley Dean Witter holding 40% or less of
Catalytica's outstanding voting stock. As a result of its stock ownership and
contractual rights, Morgan Stanley Dean Witter has significant influence over
all matters requiring stockholder approval, including the election of directors
and approval of major corporate transactions such as mergers, consolidations or
sales of assets. Morgan Stanley Dean Witter also has the right to designate
three nominees for election to Catalytica's board of directors and rights to a
separate class vote on certain merger and financing transactions. This
concentration of ownership and these contractual rights may allow Morgan Stanley
Dean Witter to require us to take actions, or delay or prevent us from taking
actions, such as entering into a change of control, that would otherwise be in
the stockholders' interest.
The sale by Morgan Stanley Dean Witter of shares of Catalytica's capital stock
could constitute a change of control under Catalytica's credit agreement, which
would trigger a default under the agreement. Although Morgan Stanley Dean
Witter has agreed not to trigger a change of control under the credit agreement,
the sale of shares by Morgan Stanley Dean Witter in breach of this provision
could cause Catalytica to default under its credit agreement. In that event,
Catalytica might not be able to obtain sufficient credit in a timely fashion or
on acceptable
20
terms. In such event, its operations could be adversely affected, causing
product delays, loss of customers and deterioration of financial results.
Integrating two companies is a difficult task and the expected benefits of the
Wyckoff acquisition may not occur
On September 20, 1999, Catalytica, pursuant to the Agreement and Plan of
Reorganization dated July 14, 1999, completed the acquisition of Wyckoff. At the
completion of the acquisition, Wyckoff became a wholly owned subsidiary of
Catalytica. This acquisition will not achieve its anticipated benefits unless
Catalytica and Wyckoff successfully combine their operations and integrate their
products and services in a timely manner. Integrating Catalytica and Wyckoff
has been and will continue to be a complex, time consuming and expensive
process, which has resulted in disruptions to the operations of the business and
may result in further such disruptions. Before the acquisition, Catalytica and
Wyckoff operated independently, each with its own business, business culture,
customers, employees and systems. Following the acquisition, the combined
company must use common information communication systems, operating procedures,
financial controls and human resource practices, including benefit, training and
professional development programs. We may experience difficulties, costs and
delays involved in integrating Catalytica and Wyckoff, as a result of many
factors, including:
. distractions to management from the business of the combined company
. incompatibility of business cultures
. perceived and potential adverse change in customer service standards,
business focus or service offerings available to customers
. inability to successfully coordinate research and development, sales and
marketing efforts
. costs and delays in implementing common systems and procedures, including
financial accounting systems
. costs and inefficiencies in delivering services to the customers of the
combined company
. inability to retain and integrate key management, technical sales and
customer support personnel
Any one or all of the factors identified above may cause increased operating
costs, lower than anticipated financial performance or the loss of key customers
and employees. The failure to integrate Catalytica and Wyckoff could harm our
business.
We depend on retaining and integrating key personnel after the Acquisition of
Wyckoff
Wyckoff's contribution to the combined company's success depends upon the
continued service of Wyckoff's key management and technical personnel. In
November of 1999, Catalytica signed a new employment agreement with James B.
Friederichsen, the former president and chief operating officer of Wyckoff and
current executive vice president of Chemical Manufacturing Operations at
Catalytica Pharmaceuticals. This agreement does not require that Mr.
Friederichsen continue his employment with Catalytica or Wyckoff for a specified
period. No other Wyckoff executive officer has entered into an employment
agreement providing for continued employment with the combined company after the
acquisition. In addition, the
21
competition to retain and motivate qualified technical, sales and operations
personnel is intense. We have at times experienced, and continue to experience,
difficulty retaining qualified personnel. We might not be able to continue to
retain Wyckoff's key personnel after the acquisition. The loss of services of
any of the key members of Wyckoff's management team could harm our business.
If the Acquisition of Wyckoff does not qualify as a pooling of interests,
Catalytica's reported earnings could be lower in future periods
Catalytica expects the acquisition of Wyckoff to be accounted for as a pooling
of interest transaction. To qualify the acquisition as a pooling of interests
for accounting purposes, Wyckoff, Catalytica and their respective affiliates
must meet the criteria for pooling of interests accounting established in
opinions published by the Accounting Principles Board and interpreted by the
Financial Accounting Standards Board and the SEC. These opinions are complex
and the interpretation of them is subject to change.
The availability of pooling of interests accounting treatment for the
acquisition depends, in part, upon circumstances and events occurring after
completion of the acquisition. For example, the business of the combined
company cannot change in a significant manner, including significant sales of
assets, for a period of two years following completion of the acquisition. The
failure of the acquisition to qualify for pooling of interests accounting
treatment for any reason could materially reduce Catalytica's future reported
earnings.
Many of our competitors have greater financial resources, research and
development experience and marketing ability
The market in which we compete is characterized by extensive research efforts
and rapid technological change. We have numerous competitors in the United
States, Europe and Asia, many of whom have greater research and development
capabilities, financial resources, managerial resources, marketing experience
and manufacturing experience. Our primary competition comes from pharmaceutical
companies that manufacture their own products and from other chemical
manufacturers such as Lonza AG, Bayer, Chirex, Cambrex, Great Lakes, Dow and DSM
Fine Chemicals. If our competitors are successful in developing systems and
processes that are more effective than our own, then our ability to sell our
products, services, systems and processes would be harmed. Our competitors may
develop technologies, systems and processes that are more effective than ours or
that would render our technology, systems and processes less competitive or
obsolete. In addition, our success depends in part on our ability to sell
products to potential customers at an early stage of product development, and
there can be no assurance that we will be successful in these efforts.
A small portion of our business experiences substantial competition in
connection with the manufacture and sale of pharmaceutical products for which
patent protection has expired ("off-patent" products). We compete with off-
patent drug manufacturers, brand-name pharmaceutical companies that manufacture
off-patent drugs, and manufacturers of new drugs that may compete with our off-
patent drugs. Because selling prices of off-patent drugs typically decline as
22
competition intensifies, the maintenance of profitable operations will depend on
our ability to maintain efficient production capabilities and to develop and
introduce new products in a timely manner. If we are unable to develop
manufacturing processes soon after products are off-patent, or if other
manufacturers develop alternative manufacturing processes, we would be required
to compete with multiple manufacturers and would experience additional pricing
pressures in its sale of products to the generic market.
In the combustion systems market, our competition comes from large gas turbine
power generation manufacturers, such as Allison Engine Company, General Electric
and Solar Turbines as well as producers of post-combustion emission clean-up
technologies such as selective catalytic reduction systems. Gas turbine
manufacturers are developing competing dry-low-nitrogen oxide systems for their
own turbines. Many of our competitors in the combustion systems market are also
potential customers. We depend on our customers to help commercialize our
products, and would suffer loss of sales and revenues if these customers
withdraw their support or decide to pursue alternate technologies. Our ability
to gain market share may be limited because many of our competitors are existing
or potential customers.
If we are unable to protect and expand our intellectual property rights, our
competitive position will suffer
Our business depends on developing and maintaining a strong intellectual
property portfolio in the United States and abroad. We actively pursue patents
for our inventions in relevant business areas. We have approximately 40 patents
and at least 21 pending patent applications in the United States and
approximately 145 patents and patent applications abroad. Our patent
applications might not result in the issuance of patents. Further, our existing
and future patents might not provide enough protection to protect our technology
and competitive position.
The success of our current products, as well as development of additional
products, depends on our ability to protect our intellectual property portfolio
and obtain additional patents without infringing the proprietary rights of
others. If we do not effectively protect our intellectual property, our
business could be materially harmed.
Even if we are able to obtain patents covering our technology, the patents may
be challenged, circumvented or invalidated. Competitors may develop
independently similar systems or processes or design around patents issued to
us. Also, patents issued in the United States may be unenforceable, or may not
provide as much protection, outside the United States. If any of our patents
are circumvented, invalidated or otherwise do not provide legal protection, our
competitors may be able to develop, manufacture and sell products which compete
directly with our products. In that case, our sales and financial results could
be harmed.
We also protect our proprietary technology and processes in part by
confidentiality agreements with our collaborative partners, employees and
consultants. However, these agreements might be breached, and in that event, we
might not have adequate remedies for the breach. Further, our trade secrets
might otherwise become known or be independently discovered by competitors.
23
A third party claim of infringement of intellectual property could require us to
spend time and money to address the claim and could shut down some of our
operations
We could incur substantial costs in defending ourselves or our licensees in
litigation brought by others or in interference proceedings declared by the
United States Patent and Trademark Office. An adverse ruling, including an
adverse decision as to the priority of our inventions, would undercut our
intellectual property position and could ultimately have a negative impact on
our sales and financial position.
We may be required to obtain licenses to patents or other proprietary rights
held by third parties. However, these licenses might not be available on
acceptable terms, if at all. In that event, we could encounter delays in system
or process introductions while we attempt to design around the patents, or we
may be unable to continue product development in the particular field. In
either case, our competitive position would likely suffer, and our stock price
could decline as a result.
Combustion Systems' product is in early stages of development and its ability to
develop an effective and commercially successful product depends on the
cooperative efforts of its strategic partners
Combustion Systems' product, Xonon Cool Combustion system, is in the
development stage and must be thoroughly tested in gas turbines and integrated
by original equipment manufacturers into their gas turbine products before
commercialization. Whether the Xonon system will ultimately be commercially
successful, and whether Combustion Systems will ultimately be profitable, will
depend on a number of factors, including:
. its ability to overcome technical hurdles associated with the
incorporation of Xonon into particular gas turbines to provide an
effective emissions reduction system
. willingness of gas turbine manufacturers to incorporate the Xonon system
in their products
. prices and effectiveness of alternative emissions reduction systems
. economic conditions in the utilities and power generation sector
. changes in regulatory requirements, particularly emissions standards
governing gas turbines and power generation
In particular, Combustion Systems' ability to complete research and
development and introduce Xonon systems in the large gas turbine market depends
on the continued efforts of General Electric, the world leader in the
manufacture of large gas turbines. Catalytica also must develop and maintain
relationships with other gas turbine suppliers to commercially introduce Xonon
systems in other gas turbine markets. If any major turbine manufacturers
terminate their relationship with Combustion Systems, then Catalytica may not be
able to complete the development and introduction of the Xonon system for that
part of the market.
24
Combustion Systems has limited manufacturing and marketing experience and will
need to develop these capabilities or find strategic partners to make and sell
its products
Catalytica currently has limited manufacturing capability for its Xonon
products. Catalytica expects to expand its manufacturing capability, which will
require capital expenditures. Further, to market any of our combustion system
products, we must develop marketing capability, either on our own or in
conjunction with others. Catalytica may not be able to develop an effective
marketing and sales organization or enter into marketing arrangements on
acceptable terms.
The GENXON joint venture may require additional funding and may not result in
successful products
Combustion Systems' joint venture, GENXON, is not currently profitable and may
not become profitable in the future. GENXON might not succeed in developing new
combustion systems that will work effectively and economically. Neither joint
venture partner is contractually required to make further capital infusions. If
Catalytica's partner were to decide not to make additional capital
contributions, Catalytica would be faced with the possibility of having to fund
the joint venture on its own or find additional sources of financing. In this
event, additional financing might not be available on acceptable terms, or at
all. As a result, Catalytica's results of operations and financial condition
could be adversely affected.
In October 1996, GENXON entered into a technical services agreement with the
City of Glendale in California for the retrofit of one of the City's gas
turbines with the XONON system for a total turnkey price of $700,000. GENXON
did not complete the agreed-upon retrofit and returned the engine to the City in
its original state. In February 1999, Catalytica received a letter from the City
of Glendale alleging contractual damages and requesting monetary restitution in
order to settle this matter. The parties are currently discussing alternatives
to resolve the contractual issues related to the project, however, this matter
may result in litigation. While it is not possible to predict with certainty
the outcome of this matter, and while the Company does not believe an adverse
result would have a material effect on the Company's consolidated financial
position, it could be material to the results of operations for a fiscal year.
Interruption of supply of key raw materials could cause delays in meeting
product orders, loss of customers and increased costs of production
We purchase raw materials, primarily chemicals, from suppliers throughout the
world. These chemicals range from basic commodities to more sophisticated
advanced intermediates. In many instances we use only one supplier to get a
volume discount and to ensure the chemicals meet our stringent quality
standards. If the supply of a key raw material is interrupted for any reason,
this could have an adverse impact on our ability to manufacture a particular
active pharmaceutical ingredient or advanced intermediate for our customers. In
most situations, there are alternate suppliers throughout the world of any
chemical that we require. If there was a significant delay in identifying and
qualifying a new supplier or if there are no alternate suppliers, there could be
a
25
loss of sales and of customers, and ultimately an increase in the cost of
production. Any of these events could have a material adverse effect on our
results of operations.
We do not have a long-term supply agreement with most of our suppliers. We
purchase the chemicals on a purchase order basis and forecast our needs based on
our customers' requirements. There can be no assurance that such suppliers will
continue to make available to us the required raw materials on reasonable terms,
if at all. The availability and price of raw materials may be subject to
curtailment or change due to limitations that may be imposed under new
legislation or governmental regulations, suppliers' allocations to meet demand
of other purchasers, interruptions in production by suppliers and other
conditions. In addition, raw materials used by us may be subject to significant
price fluctuations. A substantial increase in prices or a continued
interruption in supply would have a material adverse effect on our business and
results of operations.
Catalytica's charter and bylaws have provisions that may deter or delay a change
of control of Catalytica
Catalytica's certificate of incorporation and bylaws contain certain
provisions that could make the acquisition of Catalytica more difficult. These
provisions include:
. advance notice procedures for stockholders to nominate candidates for
election as directors of Catalytica
. special voting requirements for removal of directors
. authorization of preferred stock of Catalytica, the powers, preferences
and rights of which may be fixed by its board of directors without
stockholder approval
In addition, Catalytica is subject to Section 203 of the Delaware General
Corporation Law, which limits transactions between a publicly-held company and
"interested stockholders." Interested stockholders generally are those
stockholders who, together with their affiliates and associates, own 10% or more
of a company's outstanding capital stock. This provision of Delaware law may
delay or deter potential acquisitions of Catalytica which may otherwise be in
the stockholders' interest.
FORWARD-LOOKING STATEMENTS MAY PROVE INACCURATE
The statements contained in this annual report that are not historical facts
are "forward-looking statements" within the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995. These statements involve risks
and uncertainties and can be identified by the use of forward-looking
terminology such as "estimates," "projects," "anticipates," "plans," "future,"
"may," "will," "should," "predicts," "potential," "continue," "expects,"
"intends," "believes" and similar expressions. Examples of these forward-looking
statements include:
. our expectations regarding the amounts of future sales revenues from Glaxo
Wellcome and other pharmaceutical customers
. our estimates of future operating results and our ability to remain profitable
26
. statements regarding the development of our business and products, including
our ability to develop new pharmaceutical business and commercialize our XONON
product
. our ability to develop technologies for efficient manufacturing processes and
solve environmental problems
. our expectations regarding our R&D efforts, including our expectations
regarding future R&D reserves
. opportunities for the use and commercialization of our technologies
. the amounts of any future expenditures which may be necessary to comply with
environmental, health and safety regulations and to remediate environmental
contamination
. our expectations regarding our future investment in GENXON
. Year 2000 compliance, including expected costs and timing of ongoing Year 2000
compliance efforts and expectations regarding the potential effects of non-
compliance
. our ability to account for our acquisition of Wyckoff Chemical Company as a
pooling of interests
. our anticipated capital expenditures and future financial condition
. other statements contained in this annual report regarding matters that are
not historical facts
These and other forward-looking statements in this annual report are only
estimates or predictions. While we believe that the expectations reflected in
the forward-looking statements are reasonable, we can give you no assurance that
future results will be achieved. Forward-looking statements are subject to known
and unknown risks, uncertainties and other factors that may cause our actual
operating results, levels of activity, financial performance, achievements and
prospects to be materially different from those expressed or implied by the
forward-looking statements. These risks, uncertainties and other factors
include, among others, those identified in the "Risk Factors" section and
elsewhere in this annual report. We disclaim any obligation to update
information contained in any forward-looking statement.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to financial market risks, including changes in
interest rates. In the second quarter of 1998, following the restructuring of
the Chase credit agreement, Catalytica entered into a $50.0 million interest
rate swap, transaction to reduce Catalytica's exposure to fluctuations in short-
term interest rates. This interest rate swap transaction effectively fixed the
LIBOR benchmark rate used to calculate Catalytica's borrowing cost at 5.9% for
four years on $50.0 million of the debt facilities. Catalytica accounts for this
interest rate swap as a hedge, and accrues the interest rate differential as
interest expense on a monthly basis. If the designated debt obligation is
extinguished early, any realized or unrealized gain or loss from the swap would
be recognized in income coincident with the extinguishment gain or loss.
Catalytica does not hold or transact in such financial instruments for purposes
other than risk management.
The notional principal amount for the off-balance-sheet instrument provides
one measure of the transaction volume outstanding as of year end, and does not
represent the amount of Catalytica's exposure to credit or market loss.
Catalytica believes its gross exposure to potential accounting loss on this
transaction if all counterparties failed to perform according to the terms of
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the contract, based on then-current interest rates at each date, would have no
material financial impact. Catalytica's exposure to credit loss and market risk
will vary over time as a function of interest rates.
With the interest rate swap, Catalytica either makes or receives payments on
the interest rate differential between 5.9% and the actual interest paid on its
debt which has a floating interest rate based on the three-month United States
dollar LIBOR rate. As a result, the swap effectively converts $50.0 million of
Catalytica's floating- rate debt to a four-year fixed-rate debt. The maturity
date for the swap is June 10, 2002. For the year ended December 31, 1999, the
receive rate on the swap hedging debt was 5.3%. The pay rate on the swap is
5.9%. The gain or loss on the swap is recognized in net interest expense in the
same period as the hedged transaction. Given the above agreement, approximately
22% of Catalytica's outstanding debt is variable. A hypothetical increase of
100 basis points in interest rates would not result in a material exposure to
the Company.
The Company's market risk disclosures set forth have not changed significantly
through the quarter ended March 31, 2000.
Item 1 LEGAL PROCEEDINGS
On August 15,1999, Catalytica's Greenville Facility experienced a chemical
release as a result of a broken pipeline. Shortly thereafter, Catalytica. the
North Carolina Occupational Health and Safety Agency and the North Carolina Air
Quality Division initiated an investigation of this incident. On February 14,
2000, OSHA issued its official findings, which included citations and
administrative penalties. OSHA and Catalytica have entered into a settlement
agreement whereby Catalytica has agreed to address the OSHA observations within
stipulated time schedules. The settlement included an agreement by Catalytica to
provide funds to Pitt County Emergency Services in the amount of $93,100. and to
pay OSHA $372,400.
In October 1996, GENXON entered into a technical services agreement with
the City of Glendale in California for the retrofit of one of the City's gas
turbines with the Xonon system for a total turnkey price of $700,000. GENXON did
not complete the agreed-upon retrofit and returned the engine to the City in its
original state. In February 1999, Catalytica received a letter from the City of
Glendale alleging contractual damages and requesting monetary restitution in
order to settle in this manner. The parties are currently discussing
alternatives to resolve the contractual issues related to the project, however,
this matter may result in litigation. While it is not possible to predict with
certainty the outcome of this matter, and while the Company does not believe an
adverse result would have a material effect on the Company's consolidated
financial position, it could be material to the results of operations for a
fiscal year.
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PART II - OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
The Company filed no reports on Form 8-K during the quarter ended March 31,
2000.
All information required by other items in Part II is omitted because the
items are inapplicable, the answer is negative or substantially the same
information has been previously reported by the registrant.
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CATALYTICA, INC.
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.
Date: May 15, 2000
CATALYTICA, INC.
(Registrant)
/s/ Lawrence W. Briscoe
By:_________________________________
Lawrence W. Briscoe
Vice President and Chief
Financial Officer
Signing on behalf of the
registrant and as principal
financial officer
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