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 June 30, 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 August 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 58,184,693 shares of the registrant's Common
Stock. As of August 7, 2000, there were outstanding 33,184,693 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
June 30, 2000
Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Unaudited Condensed Consolidated Balance Sheets as of June 30, 2000, and December 31, 1999 3
Unaudited Condensed Consolidated Statements of Operations for the three and six months ended June
30, 2000, and June 30, 1999 4
Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2000, and
June 30, 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 1. Legal Proceedings 29
Item 4. Submission of Matters to a Vote of Security Holders 29
Item 6. Exhibits and Reports on Form 8-K 30
Signatures 32
2
PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
June 30, December 31,
2000 1999
-------- --------
ASSETS
Current assets:
Cash and cash equivalents $ 14,320 $ 34,876
Short-term investments 5,491 5,470
Accounts receivable, net 47,022 41,985
Accounts receivable from joint venture 175 177
Notes receivable from employees 14 158
Inventory:
Raw materials 49,653 64,836
Work in process 30,552 27,938
Finished goods 19,836 12,745
-------- --------
100,041 105,519
Deferred taxes 12,951 12,951
Prepaid expenses and other assets 2,531 4,060
-------- --------
Total current assets 182,545 205,196
Property, plant and equipment:
Land 6,533 6,533
Equipment 222,303 82,273
Buildings and leasehold improvements 84,463 194,097
-------- --------
313,299 282,903
Less accumulated depreciation and amortization (71,955) (61,772)
-------- --------
241,344 221,131
Notes receivable from employees 903 978
Other assets 798 1,203
-------- --------
$425,590 $428,508
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 27,562 $ 38,508
Accrued payroll and related expenses 8,928 18,126
Deferred revenue 8,345 6,771
Other accrued liabilities 10,358 9,184
Current portion of long-term debt 18,498 12,948
Income taxes payable 5,538 1,162
-------- --------
Total current liabilities 79,229 86,699
Long-term debt 41,000 51,000
Non-current deferred revenue 6,467 6,992
Deferred taxes 16,031 16,031
Other long-term 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 115,281 112,021
Deferred compensation (94) (156)
Accumulated earnings 28,605 16,850
-------- --------
Total stockholders' equity 143,825 128,748
-------- --------
$425,590 $428,508
======== ========
See accompanying notes.
3
CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Three Months Ended June 30, Six Months Ended June 30,
2000 1999 2000 1999
------- -------- -------- --------
Revenues:
Product sales $88,243 $113,105 $175,707 $203,716
Research and development contracts 9,017 5,001 20,247 10,314
------- -------- -------- --------
Total revenues 97,260 118,106 195,954 214,030
Costs and expenses:
Cost of product sales 68,574 85,540 139,228 157,864
Research and development 12,236 10,491 22,747 18,934
Selling, general and administrative 6,327 7,764 12,206 13,507
------- -------- -------- --------
Total costs and expenses 87,137 103,795 174,181 190,305
Operating income 10,123 14,311 21,773 23,725
Interest income 620 675 1,181 1,337
Interest expense (1,706) (2,093) (3,683) (4,174)
Loss on joint ventures -- (462) -- (974)
------- -------- -------- --------
Income before income taxes 9,037 12,431 19,271 19,914
Provision for income taxes (3,521) (2,905) (7,516) (4,016)
------- -------- -------- --------
Net income $ 5,516 $ 9,526 $ 11,755 $ 15,898
======= ======== ======== ========
Net income per share:
Basic $ 0.09 $ 0.17 $ 0.20 $ 0.28
======= ======== ======== ========
Diluted $ 0.08 $ 0.14 $ 0.17 $ 0.23
======= ======== ======== ========
Number of shares used in computing net
income per share:
Basic 58,070 57,543 58,017 57,507
======= ======== ======== ========
Diluted 64,191 63,553 64,186 63,836
======= ======== ======== ========
4
CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (decrease) in cash and cash equivalents
(in thousands)
Six Months Ended June 30,
2000 1999
-------- --------
Cash flows from operating activities:
Net income $ 11,755 $ 15,898
Adjustments to reconcile net income to net cash provided by operating activity:
Depreciation and amortization 10,823 9,144
Deferred income taxes -- 240
Losses in joint ventures -- 974
Stock compensation associated with employee retirement 1,060 --
Changes in:
Accounts receivable (5,037) 7,064
Accounts receivable from joint venture 2 547
Inventory 5,478 (3,348)
Prepaid expenses, and other current assets 1,529 (2,251)
Accounts payable (10,946) (25)
Accrued payroll and related expenses (9,198) (1,666)
Deferred revenue 549 (1,177)
Income taxes payable 4,376 --
Other accrued liabilities 1,174 4,433
-------- --------
Net cash provided by operating activities 11,565 29,833
Cash flows from investing activities:
Purchases of investments (6,500) (15,112)
Maturities of investments 6,500 15,172
Investment in joint ventures -- (974)
Disposition of property and equipment 420 109
Acquisition of property and equipment (30,968) (18,060)
Dividends paid -- (170)
-------- --------
Net cash used in investing activities (30,548) (19,035)
Cash flows from financing activities:
Net receipts on (issuance of) notes receivable from employees 177 (243)
Additions to debt obligations -- 6,247
Payments on debt obligations (3,950) (13,221)
Issuance of stock, net of issuance costs 2,200 1,881
-------- --------
Net cash used in financing activities $ (1,573) $ (5,336)
======== ========
Net increase (decrease) in cash and cash equivalents (20,556) 5,462
Cash and cash equivalents at beginning of period 34,876 41,269
-------- --------
Cash and cash equivalents at end of period $ 14,320 $ 46,731
======== ========
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 and six-month periods ended June
30, 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 and six months
ended June 30, 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.
6
2. Earnings per share
A reconciliation of the numerators and denominators for the Basic and Diluted
EPS calculations follows:
Three months ended Six months ended
(in thousands, except per share amounts) June 30, June 30,
2000 1999 2000 1999
------- ------- ------- -------
Numerator:
Numerator for basic earnings per share:
Income available to common shareholders $ 5,516 $ 9,526 $11,755 $15,898
Less: Reduction of Catalytica
Pharmaceuticals income attributable to
holders of subsidiary stock options (539) (656) (1,056) (1,116)
------- ------- ------- -------
Numerator for diluted earnings per share $ 4,977 $ 8,870 $10,699 $14,782
------- ------- ------- -------
Denominator:
Denominator for basic earnings per share:
Weighted-average shares 58,070 58,017 57,543 57,507
------- ------- ------- -------
Effect of dilutive securities:
Catalytica, Inc. employee stock options 443 717 492 871
Catalytica Pharmaceuticals, Inc.
Convertible Preferred Stock 1,920 1,781 1,918 1,785
Catalytica Pharmaceuticals, Inc.
Convertible Junior Preferred Stock 648 601 647 602
Catalytica Combustion Systems, Inc.
Convertible Preferred Stock 3,111 2,849 3,108 2,853
Catalytica, Inc. warrants issued to Glaxo
Wellcome, Inc. -- 62 4 219
------- ------- ------- -------
Dilutive potential common shares 6,122 6,010 6,169 6,330
Denominator for diluted earnings per share:
Adjusted weighted-average shares and
assumed conversions 64,186 64,191 63,553 63,836
------- ------- ------- -------
Basic earnings per share $ 0.09 $ 0.17 $ 0.20 $ 0.28
======= ======= ======= =======
Diluted earnings per share $ 0.08 $ 0.14 $ 0.17 $ 0.23
======= ======= ======= =======
Weighted average shares outstanding for the three and six months ended June
30, 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
its reportable operating segments
7
based upon how the business is 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.
(In thousands) Three months ended June 30, Six months ended June 30,
--------------------------- -------------------------
2000 1999 2000 1999
------- -------- -------- --------
Revenues
Catalytica Pharmaceuticals $ 95,999 $117,407 $193,543 $212,645
Combustion Systems 529 217 1,408 511
Corporate and other subsidiary 732 482 1,003 874
-------- -------- -------- --------
Total revenues $ 97,260 $118,106 $195,954 $214,030
======== ======== ======== ========
(In thousands) Three months ended June 30, Six months ended June 30,
--------------------------- -------------------------
2000 1999 2000 1999
------- -------- ------- --------
Operating Income
Catalytica Pharmaceuticals $ 12,420 $ 17,065 $ 24,759 $ 27,764
Combustion Systems (2,567) (1,299) (2,989) (2,759)
Corporate and other subsidiary (270) (1,454) 3 (1,279)
-------- -------- -------- --------
Total operating income $ 10,123 $ 14,312 $ 21,773 $ 23,726
-======= ======== ======== ========
(In thousands)
June 30, 2000 December 31, 1999
------------- -----------------
Identifiable Assets
Catalytica Pharmaceuticals $392,157 $389,902
Combustion Systems 16,922 19,335
Corporate and other subsidiary 16,511 19,271
-------- --------
Total assets $425,590 $428,508
======== ========
4. Financial instruments
For the purposes of the consolidated cash flows, all investments with
maturities of three months or less at the date of purchase held as available-
for-sale (none at June 30, 2000) are considered 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 June 30, 2000) and
investments with maturities greater than three months that are available-for-
sale (none at June 30, 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 June 30, 2000). All investments
at June 30, 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 intent and ability to hold the investments to maturity.
8
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.
6. Debt
As of June 30, 2000, nothing was outstanding under the senior secured
revolving facility ("Revolving Debt Facility") and $57.5 million was outstanding
under the senior secured term loan facility ("Term Debt Facility").
The 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 June 30, 2000, the Company and Catalytica
Pharmaceuticals were in compliance with the covenants.
7. Income taxes
The Company recorded a provision for income taxes for the three and six
months ended June 30, 2000, of 39%, as compared with 23% and 20% for the
corresponding periods 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. Change in 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 Combustion
Systems' 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. Combustion Systems 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
9
$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, Combustion Systems 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 Combustion Systems.
All funds were repaid by Enron in the period ended June 30, 2000. Accordingly,
approximately $1.0 million of the previously recorded provision was eliminated
and included in the results of operations as a reduction of research and
development expenses in the three months ended March 31, 2000.
9. Litigation
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 2000, 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.
On April 12, 2000, a complaint was filed with the Supreme Court of the
State of New York, County of Orange by an individual (the "Plaintiff") against
Catalytica Pharmaceuticals and Glaxo Wellcome, alleging Zyban, a product
manufactured by Catalytica Pharmaceuticals and distributed by Glaxo Wellcome,
was dangerous and defective. The Plaintiff alleges symptoms of cognitive
dysfunction and memory loss and has requested a judgement in the sum of
$30,000,000. On July 17, 2000, Catalytica Pharmaceuticals and Glaxo Wellcome
responded by denying all allegations in the Plaintiff's complaint and asking for
a judgement to dismiss her complaint. Since this case is in the early phase of
discovery no documents have been exchanged nor has deposition testimony be
obtained. While the outcome of this case is uncertain, Catalytica believes the
complaint is without merit and intends to defend the action vigorously.
On August 4, 2000, a purported class action complaint was filed in Delaware
Chancery Court in Wilmington, Delaware against Catalytica, Morgan Stanley Dean
Witter and each of the directors of Catalytica by two of Catalytica's
stockholders on behalf of themselves and all other stockholders of Catalytica.
The complaint alleges generally that the proposed merger transaction involving
Catalytica and certain subsidiaries of DSM, N.V. is unfair. The complaint
further alleges conflicts of interest and breaches of fiduciary duties by the
directors. The plaintiffs claim to be seeking preliminary and permanent
injunctions against the proposed merger transaction and unspecified damages and
costs. Catalytica believes this complaint is without merit and intends to defend
itself vigorously.
10. Merger Transaction
On August 2, 2000, Catalytica entered into an Agreement and Plan of Merger
by and among Synotex Company, Inc. ("Synotex"), a Delaware corporation and
wholly owned subsidiary of DSM, N.V., Synotex Acquisition Corporation
("Acquisition Corp."), a Delaware corporation and wholly owned subsidiary of
Synotex, and Catalytica, pursuant to which Acquisition Corp. will merge with and
into Catalytica and Catalytica will become a wholly owned subsidiary of Synotex
(the "Merger"). Immediately prior to the consummation of the Merger, Combustion
Systems and Advanced Technologies will be combined ("Spinco") and all of the
shares of the combined company will be distributed on a pro rata basis to the
Catalytica stockholders. (the "Spin-Off"). If the Merger is consummated,
Catalytica's stockholders will be entitled to receive an aggregate of $750
million (the "Merger Consideration") in cash subject to certain adjustments,
including a reduction in the Merger Consideration for the tax liability incurred
by Catalytica with respect to the Spin-Off. The tax liability, which is expected
to be a material amount, will be based on the value of Spinco as determined by
the weighted average trading price of Spinco on the first full day of trading.
In addition, the Merger Consideration will be reduced by contributions by
Catalytica to Spinco to provide--SPINCO with adequate operating capital. The
amount of that contribution will be determined in the next several weeks. These
reductions will be partially offset by proceeds from any exercises of options
and warrants to purchase Catalytica common stock prior to the consummation of
the Merger. The consummation of the Merger is subject to the satisfaction of
numerous customary conditions, including the approval of the Merger by
Catalytica stockholders, applicable regulatory clearances and the consummation
of the Spin-Off. No assurance can be given that the Merger or Spin-Off will be
consummated.
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
The Merger
On August 2, 2000, Catalytica entered into an Agreement and Plan of Merger
by and among Synotex Company, Inc. ("Synotex"), a Delaware corporation and
wholly owned subsidiary of DSM, N.V., Synotex Acquisition Corporation
("Acquisition Corp."), a Delaware corporation and wholly owned subsidiary of
Synotex, and Catalytica, pursuant to which Acquisition Corp. will merge with and
into Catalytica and Catalytica will become a wholly owned subsidiary of Synotex
(the "Merger"). Immediately prior to the consummation of the Merger, Combustion
Systems and Advanced Technologies will be combined ("Spinco") and all of the
shares of the Combined Company will be distributed on a pro rata basis to the
Catalytica Stockholders. (the "Spin-Off"). If the Merger is consummated,
Catalytica's stockholders will be entitled to receive an aggregate of $750
million (the "Merger Consideration") in cash subject to certain adjustments,
including a reduction in the Merger Consideration for the tax liability incurred
by Catalytica with respect to the Spin-Off. The tax liability, which is expected
to be a material amount, will be based on the value of Spinco as determined by
the weighted average trading price of Spinco on the first full day of trading.
In addition, the Merger Consideration will be reduced by contributions by
Catalytica to Spinco to provide Spinco with adequate operating capital. The
amount of that contribution will be determined in the next several weeks.
These reductions will be partially offset by proceeds from any exercises of
options and warrants to purchase Catalytica common stock prior to the
consummation of the Merger. The consummation of the Merger is subject to the
satisfaction of numerous customary conditions, including the approval of the
Merger by Catalytica stockholders, applicable regulatory clearances and the
consummation of the Spin-Off. No assurance can be given that the Merger or Spin-
Off will be consummated.
Results of Operations
Net revenues for the three and six months ended June 30, 2000, decreased by
17.7% and 8.4%, respectively when compared with the revenues in the same periods
in 1999, primarily due to a scheduled decrease in product sales to Glaxo
Wellcome under the original supply agreement and subsequent amendments. Product
sales decreased by 22.0% and 13.7%, respectively during the three and six months
ended June 30, 2000, when compared with the same periods in 1999, due to a
scheduled decrease in sales to Warner Lambert for products which were produced
under the original Glaxo Wellcome Supply Agreement, 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 reduction in product sales to Pfizer. This decline in product
revenues was partially offset by a significant growth in research revenues
during these periods.
During the six months ended June 30, 2000, 64% of Catalytica's revenues
were derived from sales to Glaxo Wellcome, of which 35% were derived from sales
to Glaxo Wellcome under the original supply agreement. During the same period in
1999, 65% of Catalytica's revenues were derived from sales to Glaxo Wellcome, of
which 38% were derived from sales to Glaxo Wellcome under the original supply
agreement. During the quarter ended June 30, 2000, 64% of Catalytica's revenues
were derived from sales to Glaxo Wellcome, of which 34% were derived
12
from sales to Glaxo Wellcome under the original supply agreement. During the
same quarter in 1999, 65% of Catalytica's revenues were derived from sales to
Glaxo Wellcome, of which 31% 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 the second
half of 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. In this regard, the Company expects that revenues in the second
half of 2000 will be lower than revenues recognized in the second half of
1999.
Research and development ("R&D") revenues increased by 80.3% and 96.3% for
the three and six months ended June 30, 2000, respectively, when compared with
the same periods 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 periods
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 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 19.8% and 11.8% for the three and six months
ended June 30, 2000, respectively, when compared with the same periods in 1999,
which corresponds to a respective 22.0% and 13.7% decrease in product sales
during these periods. This decrease in cost of sales reflects the lower product
sales, as well as a change in product mix. Additionally, Catalytica
Pharmaceuticals received a $2.5 million settlement through its business
interruption insurance as a partial settlement of the lost production incurred
following Hurricane Floyd during the third quarter of 1999. This payment was
included as a reduction in cost of goods sold in the second quarter of 2000.
The gross margin for the three and six months ended June 30, 2000,
decreased by 2.1% and 1.7%, respectively, compared with the same periods in
1999, 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 16.6% and 20.1%,
respectively, for the three and six months ended June 30, 2000, as compared with
R&D expenses in the same
13
periods 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 increased over the same periods 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 reimbursed Catalytica for approximately $1.0 million of the
previous advance. Accordingly, that amount was recorded in the first quarter of
2000 as a reduction of related research and development activities.
Additionally, through the end of the second quarter of 1999, a significant
portion of Combustion Systems' research activity was conducted on behalf of the
GENXON joint venture. Upon the completion of the GENXON prototype development
principally program in June 1999, the engineering efforts relating to additional
catalyst system testing and development were conducted principally by Combustion
Systems and consequently are reflected in R&D costs. 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 decreased 18.5% and 9.5%,
respectively, for the three and six months ended June 30, 2000, compared with
the same periods in 1999. Selling, general and administrative at Catalytica
Pharmaceuticals has declined for the three and six months ended June 30, 2000,
when compared to the same periods in 1999, due to a reserve of selling incentive
bonuses at Wyckoff in the second quarter of 1999, and as the sales and marketing
efforts at the Greenville Facility have reached the desired level in 2000. The
decrease in selling, general and administrative was partially offset by a $1
million non-cash compensation charge related to the retirement of a senior
executive.
Interest income decreased 8.1% and 11.7%, respectively, for the three and
six months ended June 30, 2000, when compared to the same periods in 1999. This
slight decrease in interest income is primarily due to lower average cash
balances in the three and six months ended June 30, 2000, when compared to the
same periods 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.
Interest expense decreased 18.5% and 11.8%, respectively for the three and
six months ended June 30, 2000, when compared to the same periods 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 1.7%
between June 30, 2000 and June 30, 1999, the increase was offset by a reduction
of almost $22.5 million of the Company's debt during the twelve months
14
ended June 30, 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 in the first
quarter of 2000 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 three
and six months ended June 30, 2000. During the three and six months ended June
30, 2000, Combustion Systems' share of GENXON's losses was $0.5 million and $1.0
million, respectively, 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 and six
months ended June 30, 2000, of 39%, as compared with 23% for the three months
ended June 30, 1999 and 20% for the six months ended June 30, 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 $14.3 million for the six months ended June 30, 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 $14.3 million (including short-term investments)
and its available line of credit of $100.0 million as of June 30, 2000, coupled
with the anticipated cash flow from operations in 2000, the Company believes
that it has adequate funds to meet its working capital needs and debt repayment
obligations for the near and longer term.
15
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
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
. 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
16
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 six months ended June 30, 2000, 64% of
Catalytica's revenues were derived from sales to Glaxo Wellcome, of which 35%
were derived from sales to Glaxo Wellcome under the original supply agreement.
During the same period in 1999, 65% of Catalytica's revenues were derived from
sales to Glaxo Wellcome, of which 38% were derived from sales to Glaxo Wellcome
under the original supply agreement. During the quarter ended June 30, 2000, 64%
of Catalytica's revenues were derived from sales to Glaxo Wellcome, of which 34%
were derived from sales to Glaxo Wellcome under the original supply agreement.
During the same quarter in 1999, 65% of Catalytica's revenues were derived from
sales to Glaxo Wellcome, of which 31% were derived from sales to Glaxo Wellcome
under the original supply agreement. Catalytica's top five customers
collectively accounted for approximately 79% of its revenues for the six months
ended June 30, 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.
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 the second
half of 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. In this regard, the Company expects that revenues in the second half
of 2000 will be lower than revenues recognized in the second half of 1999.
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.
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.
17
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.
On April 12, 2000, a complaint was filed with the Supreme Court of the
State of New York, County of Orange by an individual (the "Plaintiff") against
Catalytica Pharmaceuticals and Glaxo Wellcome, alleging Zyban, a product
manufactured by Catalytica Pharmaceuticals and distributed by Glaxo Wellcome,
was dangerous and defective. The Plaintiff alleges symptoms of cognitive
dysfunction and memory loss and has requested a judgement in the sum of
$30,000,000. On July 17, 2000, Catalytica Pharmaceuticals and Glaxo Wellcome
responded by denying all allegations in the Plaintiff's complaint and asking for
a judgement to dismiss her complaint. Since this case is in the early phase of
discovery no documents have been exchanged nor has deposition testimony be
obtained. While the outcome of this case is uncertain, Catalytica believes the
complaint is without merit and intends to defend the action vigorously.
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
18
were initiated immediately, and a re-inspection conducted by the FDA within one
month of our receipt of the letter resulted in concurrence by the FDA that all
issues had been addressed to their satisfaction.
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.
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.
19
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.
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, Aventis, formerly Rhone Poulenc, Inc. Although Catalytica has
contractual rights of indemnity from Aventis 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 Aventis 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.
20
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 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.
Failure to complete the Merger could negatively impact Catalytica's stock price,
future business or operations
On August 2, 2000, Catalytica entered into an Agreement and Plan of Merger
by and among Synotex Company, Inc. ("Synotex"), a Delaware corporation and
wholly owned subsidiary of DSM, N.V., a corporation organized under the laws of
the Netherlands, Synotex Acquisition Corporation ("Acquisition Corp."), a
Delaware corporation and wholly owned subsidiary of Synotex, and Catalytica,
pursuant to which Acquisition Corp. will merge with and into Catalytica and
Catalytica will become a wholly owned subsidiary of Synotex (the "Merger").
Immediately prior to the consummation of the Merger, Catalytica will distribute
to its stockholders on a pro rata basis all of the shares owned by Catalytica of
Catalytica's Combustion Systems and Advanced Technologies. No assurances can be
given that the Merger will be consummated.
The consummation of the Merger is subject to the satisfaction or waiver of
numerous certain customary conditions, including the approval of the Merger by
Catalytica stockholders, the receipt of applicable regulatory clearances and the
consummation of the Spin-Off. Furthermore, on August 4, 2000, a purported class
action complaint was filed in Delaware Chancery Court in Wilmington, Delaware
against Catalytica, Morgan Stanley Dean Witter and each of the directors of
Catalytica by two of Catalytica's stockholders on behalf of themselves and all
other stockholders of Catalytica. The complaint alleges generally that the
proposed merger transaction involving Catalytica and certain subsidiaries of
DSM, N.V. is unfair. The complaint further alleges conflicts of interest and
breaches of fiduciary duties by the directors. The plaintiffs claim to be
seeking preliminary and permanent injunctions against the proposed merger
transaction and unspecified damages and costs. Catalytica believes this
complaint is without merit and intends to defend itself vigorously.
If the Merger is not completed for any reason, Catalytica may be subject to a
number of material risks, including the following:
* Catalytica may be required under certain circumstances to pay Synotex a
termination fee of $20 million and expenses of up to $5 million;
* the price of Catalytica's common stock may decline to the extent that the
relevant current market price reflects a market assumption that the Merger
will be completed; and
* costs related to the Merger, such as legal, accounting, certain financial
advisory and financial printing fees, must be paid even if the Merger is not
completed.
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 June 30, 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, including the Merger. 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. In connection with the Merger
Morgan Stanley Dean Witter and certain other stockholders of Catalytica
21
have entered into a Voting Agreement pursuant to which Morgan Stanley Dean
Witter and such other stockholders have agreed to vote in favor of the
acquisition and against certain other matters. This Voting Agreement is filed as
an exhibit to the report on Form 8-K filed by Catalytica on August 10, 2000.
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 terms. In such event, its operations could be adversely affected,
causing product delays, loss of customers and deterioration of financial
results.
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
22
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
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
23
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.
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 whether it
and its strategic partners can complete development and integration work.
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. Additional development work may also be required in order to
integrate our product into any particular gas turbine. 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
24
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.
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 2000, 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
25
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 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 quarterly 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:
26
. the consummation of the merger with Synotex and the spin-off of the
Combustion Systems and Advanced Technologies businesses
. 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
. 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 quarterly report regarding matters
that are not historical facts
These and other forward-looking statements in this quarterly 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 quarterly 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
27
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 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 was variable at December 31, 1999. 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 June 30, 2000.
28
PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
On April 12, 2000, a complaint was filed with the Supreme Court of the
State of New York, County of Orange by an individual (the "Plaintiff") against
Catalytica Pharmaceuticals and Glaxo Wellcome, alleging Zyban, a product
manufactured by Catalytica Pharmaceuticals and distributed by Glaxo Wellcome,
was dangerous and defective. The Plaintiff alleges symptoms of cognitive
dysfunction and memory loss and has requested a judgement in the sum of
$30,000,000. On July 17, 2000, Catalytica Pharmaceuticals and Glaxo Wellcome
responded by denying all allegations in the Plaintiff's complaint and asking for
a judgement to dismiss her complaint. Since this case is in the early phase of
discovery no documents have been exchanged nor has deposition testimony be
obtained. While the outcome of this case is uncertain, Catalytica believes the
complaint is without merit and intends to defend the action vigorously.
On August 4, 2000, a purported class action complaint was filed in Delaware
Chancery Court in Wilmington, Delaware against Catalytica, Morgan Stanley Dean
Witter and each of the directors of Catalytica by two of Catalytica's
stockholders on behalf of themselves and all other stockholders of Catalytica.
The complaint alleges generally that the proposed merger transaction involving
Catalytica and certain subsidiaries of DSM, N.V. is unfair. The complaint
further alleges conflicts of interest and breaches of fiduciary duties by the
directors. The plaintiffs claim to be seeking preliminary and permanent
injunctions against the proposed merger transaction and unspecified damages and
costs. Catalytica believes this complaint is without merit and intends to defend
itself vigorously.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On June 8, 2000, at the annual stockholder's meeting, a quorum of
stockholders of the Company approved the following proposals: (1) the election
of the Board of Directors; (2) amendment to the Company's 1992 Stock Option Plan
to increase the number of shares of Common Stock reserved for issuance
thereunder by 2,500,000 shares; and (3) ratification of the appointment of Ernst
& Young LLP to serve as the Company's independent auditors for the ensuing year.
29
Proposal 1. Election of Directors
Director For Abstain
-------- --- -------
James A. Cusumano 41,000,431 550,414
Richard Fleming 40,960,333 590,512
Alan Goldberg 40,467,285 1,083,560
Howard I. Hoffen 40,924,042 626,803
Ricardo B. Levy 41,003,659 547,186
Ernest Mario 41,011,887 538,958
John A. Urquhart 41,003,415 547,430
Proposal 2. Approval and amendment of the Company's Stock Option Plan
Broker
------
For Against Abstain Non-Vote
--- ------- ------- --------
31,228,184 1,126,548 177,351 9,018,762
Proposal 3. Ratification of Appointment of Independent Auditors
Broker
------
For Against Abstain Non-Vote
--- ------- ------- --------
35,387,907 5,993,792 169,146 0
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
2.1* Agreement and Plan of Merger by and among Synotex Company,
Inc. Synotex Acquisition Corporation and Catalytica, Inc. dated
August 2, 2000
4.9 Amendment No. 2, dated as of August 2, 2000, to the Preferred
Shares Rights Agreement between Catalytica Inc. and Chase Mellon
Shareholder Services, L.L.C.
9.1* Voting Agreement by and among Synotex Company, Inc.,
Catalytica, Inc. and certain stockholders of Catalytica dated August
2, 2000.
27.1 Financial Data Schedule
* Incorporated by reference to the exhibit of the same number contained in
the Company's report on Form 8-K filed on August 10, 2000.
(b) Reports on Form 8-K
The Company filed no reports on Form 8-K during the quarter ended June 30,
2000.
30
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.
31
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: August 14, 2000
CATALYTICA, INC.
(Registrant)
By: /s/ Lawrence W. Briscoe
--------------------------------
Lawrence W. Briscoe
Vice President and Chief
Financial Officer
Signing on behalf of the
registrant and as principal
financial officer
32