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, 1997
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)
(415) 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.
[X] Yes [ ] No
The number of outstanding shares of the Registrant's Common Stock, $.001 par
value, was 19,889,268 as of April 30, 1997.
CATALYTICA, INC.
FORM 10-Q
TABLE OF CONTENTS
MARCH 31, 1997
PART I. FINANCIAL INFORMATION
PAGE NO.
--------
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidated Balance Sheets
As of March 31, 1997 and December 31, 1996 1
Condensed Consolidated Statements of Operations
For the three months ended March 31, 1997 and March 31, 1996 2
Condensed Consolidated Statements of Cash Flows
For the three months ended March 31, 1997 and March 31, 1996 3
Notes to Condensed Consolidated Financial Statements 4-6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 7-20
PART II. OTHER INFORMATION 20
SIGNATURES 21
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
March 31, December 31,
1997 1996
--------- ------------
ASSETS
Current assets:
Cash and cash equivalents $ 11,228 $ 15,540
Short-term investments 8,454 8,281
Accounts receivable, net 4,525 3,944
Accounts receivable from joint venture 259 865
Notes receivable from employees 298 328
Inventory:
Raw materials 1,448 1,689
Work in process 1,268 249
Finished goods 369 1,479
-------- --------
3,085 3,417
Prepaid expenses and other current 1,131 681
assets
-------- --------
Total current assets 28,980 33,056
Property and equipment:
Equipment 9,482 9,260
Leasehold improvements 10,111 8,173
-------- --------
19,593 17,433
Less accumulated depreciation and
amortization (9,820) (9,536)
-------- --------
9,773 7,897
Notes receivable from employees 50 50
-------- --------
$ 38,803 $ 41,003
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,611 $ 2,055
Accrued payroll and related expenses 1,504 1,372
Deferred revenue 2,007 1,643
Other accrued liabilities 732 949
Borrowings under line of credit 2,755 2,300
Current portion of long-term debt 870 833
-------- --------
Total current liabilities 9,479 9,152
Long-term debt 1,344 1,524
Non-current deferred revenue 4,681 5,064
Minority interest 8,000 8,000
Stockholders' equity:
Common stock 20 19
Additional paid-in capital 65,831 65,482
Deferred compensation (30) (41)
Accumulated deficit (50,522) (48,197)
-------- --------
Total stockholders' equity 15,299 17,263
-------- --------
$ 38,803 $ 41,003
======== ========
See accompanying notes.
1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Three months ended March 31,
----------------------------
1997 1996
---- ----
Revenues:
Product sales $ 3,059 $ 2,017
Research revenues 1,726 1,323
------- -------
4,785 3,340
Costs and expenses:
Cost of sales 3,074 2,010
Research and development 2,199 2,571
Selling, general and administrative 990 1,246
------- -------
Total costs and expenses 6,263 5,827
------- -------
Operating loss (1,478) (2,487)
Interest income 266 245
Interest expense (113) (128)
Loss on joint venture (1,000) -----
------- -------
Net loss $(2,325) $(2,370)
======= =======
Net loss per share $(0.12) $(0.12)
======= =======
Shares used in computing net loss per 19,855 19,196
share ======= =======
See accompanying notes.
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(IN THOUSANDS)
Three months ended March 31,
----------------------------
1997 1996
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(2,325) $(2,370)
Adjustments to reconcile net loss to
net cash provided by (used in)
operating activity:
Depreciation and amortization 275 106
Changes in:
Accounts receivable (581) 1,361
Accounts receivable from joint
venture 606 ----
Inventory 332 (690)
Prepaid expenses and other
current assets (450) (122)
Accounts payable (444) (467)
Accrued payroll and related
expenses 132 (88)
Deferred revenue (19) 158
Other accrued liabilities (217) 73
------- -------
NET CASH USED IN OPERATING
ACTIVITIES (2,691) (2,039)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments (7,353) (9,547)
Maturities of investments 7,200 17,000
Acquisition of property and equipment (2,160) (334)
------- -------
NET CASH PROVIDED BY (USED IN)
INVESTING ACTIVITIES (2,313) 7,119
CASH FLOWS FROM FINANCING ACTIVITIES:
Net receipts on (issuance of) notes 30 (302)
receivable from employees
Additions to debt obligations 785 ---
Payments on debt obligations (473) (1,804)
Sale of common stock 350 (38)
------- -------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES 692 (2,144)
------- -------
Net increase (decrease) in cash and
cash equivalents (4,312) 2,936
Cash and cash equivalents at beginning
of period 15,540 5,021
Cash and cash equivalents at end of ------- -------
period $11,228 $ 7,957
======= =======
See accompanying notes.
3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
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, 1997 are not necessarily indicative
of the results that may be expected for the year ended December 31, 1997.
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, 1996.
2. NET LOSS PER SHARE
Net loss per share is computed using the weighted average number of common
shares outstanding. Common equivalent shares from stock options and
warrants are excluded in the computation as their effect is antidilutive.
3. IMPACT OF STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 128
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, Earnings per Share, which is required to be adopted on December 31,
1997. At that time, the Company will be required to change the method
currently used to compute earnings per share and to restate all prior
periods. Under the new requirements for calculating primary earnings per
share, the dilutive effect of stock options will be excluded. There will be
no impact on earnings per share for the first quarter ended March 31, 1997
and March 31, 1996 as the Company is in a net loss position for the quarters
then ended.
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 are considered to be cash and cash equivalents;
instruments with maturities of three months or less at the date of purchase
which are held-to-maturity ($3,073,000 at March 31, 1997) and investments
with maturities greater than three months which are available-for-sale
($5,381,000 at March 31, 1997) 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 outstanding at March 31,
1997). All investments at March 31, 1997 were carried at
4
amortized cost, which approximated fair market value. 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.
6. FORMATION OF GENXON/TM/ JOINT VENTURE WITH WOODWARD GOVERNOR COMPANY
On October 15, 1996 Catalytica's subsidiary Catalytica Combustion Systems
Inc. (CCSI) and Woodward Governor Company formed a Delaware limited
liability company in connection with a 50/50 joint venture to serve the gas
turbine retrofit market for installed, out-of-warranty engines. The new
company, GENXON/TM/ Power Systems, LLC, will initially provide gas turbine
fleet asset planning and utilization services for both power generation and
mechanical drive markets.
The initial capital commitment of the GENXON joint venture partners is $10
million -- $2 million from CCSI and $8 million from Woodward -- payable over
time as the funds are required by the joint venture. These capital
infusions are predicated upon reaching certain milestones, and neither joint
venture partner is contractually required to make further capital infusions
if these milestones are not met.
CCSI recognized its 50% share of GENXON losses for the three month period
ending March 31, 1997 up to its committed capital contribution of $1.0
million made in January, 1997. Accordingly, a $1.0 million loss on the
joint venture was recognized in the results of operations. GENXON
recognized no revenues and had a loss amounting to $2.2 million for the
three months ending March 31, 1997.
As of March 31, 1997, an accounts receivable for $259K exists from the joint
venture for costs incurred by CCSI. Accordingly these costs have not been
included in the consolidated entity.
7. PROPOSED TRANSACTION WITH GLAXO WELLCOME
On February 5, 1997, the Company signed a letter of intent with Glaxo
Wellcome Inc. to acquire its pharmaceutical production facility in
Greenville, North Carolina. The proposed agreement provides for Catalytica
to purchase all of the land, buildings and equipment at the 1.8 million-
square-foot facility. In addition to the asset purchase agreement,
Catalytica will enter into manufacturing contracts to supply designated
Glaxo Wellcome and third party products.
5
Under the terms of the proposed transaction, Catalytica will pay Glaxo
Wellcome certain cash consideration. In addition, Glaxo Wellcome will
receive a small equity stake in both Catalytica, Inc. and Catalytica Fine
Chemicals. The agreement also provides for Glaxo Wellcome to receive a share
of the profits from Catalytica's production in the Greenville site's sterile
products facility. Determination of the total purchase price will be based
upon the completion of due diligence with respect to the assets acquired and
liabilities assumed.
6
PART I - FINANCIAL INFORMATION
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION
OVERVIEW
--------
Management's Discussion and Analysis of Financial Condition and Results of
Operations contain certain forward-looking statements which involve risks
and uncertainties, including statements regarding the Company's strategy,
financial performance, revenue sources, and the potential transaction with
Glaxo Wellcome Inc. The Company's actual results could differ materially
from the results anticipated in these forward-looking statements as a result
of certain factors set forth under "Risk Factors" and elsewhere in this
report.
Catalytica is developing advanced products and manufacturing processes which
use the Company's proprietary chemical catalysis technologies. These products
and processes can yield economic and environmental benefits, including lower
manufacturing costs and reduced hazardous byproducts than those associated
with traditional manufacturing processes. The Company has developed
significant expertise in catalysis, an essential step in the production of
many industrial products. The Company's product sales are derived from sales
of fine chemicals products and its research and development revenues are
derived principally from the Company's Combustion Systems and Advanced
Technology businesses. In December 1993, the Company acquired a manufacturing
facility from Novartis (formerly Sandoz) to obtain fine chemicals
manufacturing capacity. As part of the acquisition, Novartis entered into a
five-year contract for the manufacture of a fine chemical intermediate. Under
the terms of the agreement, Novartis transferred certain equipment and
technology relating to the manufacture of the particular intermediate, and
agreed to purchase all of its requirements of such intermediate from the
Company, subject to certain volume limitations. These requirements represent
approximately $3.0 million of revenue per year. However, the timing of
receipt of revenues under this contract varies, depending on the timing of
receipt of orders and shipment of products. During the year ended December
31, 1996 and the three months ended March 31, 1997, 18% and 28% respectively
of the Company's fine chemical product revenues were derived from sales to
Novartis. The Company has no contractual volume commitments from Novartis
beyond May 31, 1998, and there can be no assurance the Novartis contract
will be renewed. The Company plans to replace the Novartis contractual
products with higher margin product sales to new customers in the
pharmaceutical industry. The agreement may be terminated by either party upon
30 days prior written notice for failure to perform a material provision of
the agreement, if such failure is not cured within 60 days after receipt of
the notice.
The Company's business has not been profitable to date, and as of March 31,
1997, the Company had an accumulated deficit of $50.5 million. The Company
anticipates incurring additional losses for at least the next several
quarters. However, future results would be significantly impacted by the
completion of the acquisition of the Glaxo Wellcome facility (See Note 7 of
Notes to Unaudited Financial Statements). The Company expects that
7
future operating results will fluctuate from quarter to quarter, as a result
of differences in the amount and timing of expenses incurred and the
revenues received. In particular, the Company's operating results are
affected by the size of and timing of receipt of orders for and shipments of
its fine chemicals products, as well as the amount and timing of payments
and expenses under the Company's research and development contracts. In
1994, the Company began deriving revenues from the sale of fine chemicals
products, and the Company expects that in the future it will rely
increasingly on product sales for its revenues. To achieve profitable
operations, Catalytica must increase significantly its commercial sales of
fine chemicals and successfully develop, manufacture, introduce, and market
or license its combustion systems. There can be no assurance that the
Company will be able to achieve profitability on a sustained basis.
On May 8, 1996, Catalytica Fine Chemicals, Inc., announced that Pfizer Inc.
had signed an agreement to infuse $15 million in Catalytica Fine Chemicals.
These funds provided Pfizer a 15 percent interest in Catalytica Fine
Chemicals Inc. and a five-year R&D commitment by Catalytica Fine Chemicals
to develop new processes and technology for the manufacture of Pfizer
products. Prior to this investment, Catalytica Fine Chemicals was a wholly-
owned subsidiary of Catalytica, Inc.
During the past four years, Catalytica Fine Chemicals and Pfizer have
collaborated on the development of proprietary processes for key
intermediate products for several of Pfizer's promising new pharmaceuticals.
The Pfizer drugs are at varying stages of approval by the Food and Drug
administration, ranging from Phase II clinical trials through the New Drug
Application stage. Catalytica Fine Chemicals currently manufactures
intermediates for certain Pfizer drugs and anticipates becoming a supplier
of intermediates to Pfizer for other pharmaceutical products in the future.
There can be no assurance, however, that orders will be forthcoming from
Pfizer
On June 28, 1996 Catalytica completed the sale of substantially all the
assets of Advanced Sensor Devices, Inc. (ASD) to Monitor Labs, Inc. Prior to
the sale, ASD produced continuous emission monitors (CEMs) based on
proprietary catalytic sensors. The terms for selling substantially all of
ASD's assets included an initial payment of approximately $1.1 million at
the closing, a second payment of $0.5 million a year end, and a royalty
stream based on future revenues. The Company recorded a gain of $0.9 million
on the sale of these assets.
On October 15, 1996 Catalytica's subsidiary Catalytica Combustion Systems
Inc. (CCSI) and Woodward Governor Company formed a Delaware limited
liability company in connection with a 50/50 joint venture to serve the gas
turbine retrofit market for installed, out-of-warranty engines. The new
company, GENXON/TM/ Power Systems, LLC, will initially provide gas turbine
fleet asset planning and utilization services for both power generation and
mechanical drive markets. These planning services will result in the
delivery of an integrated product portfolio which includes CCSI's XONON/TM/
technology for ultra low NOx emissions, Woodward's NetCon(R) control
systems, turbine overhaul and upgrades, as well as contract maintenance and
service.
8
The initial capital commitment of the GENXON joint venture partners is $10
million -- $2 million from CCSI and $8 million from Woodward -- payable over
time as the funds are required by the joint venture. These capital
infusions are predicated upon reaching certain milestones, and neither joint
venture partner is contractually required to make further capital infusions
if these milestones are not met. In addition to the capital commitment,
CCSI has contributed to the joint venture an exclusive license for the use
of its catalytic combustion technology, and Woodward contributed to the
joint venture an exclusive license for the use of its instrumentation and
control systems for gas turbine catalytic combustors. CCSI began
accounting for its share of the joint venture gain or loss upon the first
cash infusion totaling $1.0 million which occurred on January 3, 1997 upon
completion of a milestone. Prior to January 3, 1997, the joint venture was
being funded entirely by Woodward Governor.
RESULTS OF OPERATIONS
---------------------
Net revenues for the first quarter of fiscal 1997 increased by 43% as
compared to the same quarter in fiscal 1996 largely due to a 52% increase in
product sales and a 30% increase in research revenues. The increase in
product sales were primarily due to the shipment of fine chemical products
to new and existing customers. The increase in research revenues reflects
initiation of a funded research commitment associated with the five-year R&D
agreement between Catalytica Fine Chemicals and Pfizer to develop new
processes and technology for the manufacture of Pfizer products (see
Overview above).
The increase in cost of goods sold reflects increased physical volume of
product sales coupled with higher than normal costs associated with
production start-up of several new fine chemical products. Resulting
production delays affected sales and margins for the quarter. Margins on the
fine chemical 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 productions runs, and numerous other
variables present in the chemical manufacturing environment.
Research and development expenses decreased to $2.2 million for the first
quarter of 1997 as compared to $2.6 million for the same quarter last year.
This decrease is largely due to a shift of certain catalytic combustion
research and development costs from Catalytica to the newly formed GENXON
joint venture (see Overview above). This transfer of R&D funding occurred
August 1, 1996, and resulted in approximately $0.7 million of research and
development costs being financed by the joint venture rather than
Catalytica during the first quarter. Cessation of all research activities of
Advanced Sensor Devices (ASD) following the sale of its assets on June 28,
1996 also contributed approximately $0.3 million towards the reduction of
R&D expenses (see Overview above). This decrease in R&D funding during the
first quarter due to the formation of the joint venture and sale of ASD was
partially offset by increases in R&D expenses elsewhere in the Company
including the new research activities supporting the research commitment to
Pfizer Inc. Research and development expenses may fluctuate from quarter to
quarter.
9
Selling, general and administrative expenses (SG&A) decreased to $1.0
million as compared to $1.2 million for the same quarter in fiscal 1996
largely due to the discontinuation of the Advanced Sensor Devices business.
The Company has incurred significant legal, accounting, and other SG&A
related expenditures as a result of the proposed acquisition of the Glaxo
Wellcome facility (see "Proposed Transaction with Glaxo Wellcome" below).
These costs have been capitalized as part of the facilities purchase price
in anticipation of a successful acquisition. However, should this
transaction fail to be completed, the Company will be required to take a
significant one-time charge to its earnings to reflect these various
acquisition expenses.
Net interest income increased 31% due to higher balances of cash and short-
term investments associated with the Company's investment by Pfizer coupled
with decreased interest expense on reduced short-term working capital
financing at the Catalytica Fine Chemicals Bay View manufacturing facility.
On January 3, 1997, Catalytica Combustion Systems, Inc. (CCSI) made it's
first cash infusion of $1.0 million into the GENXON joint venture. CCSI
recognized its 50% share of GENXON losses for the three month period ending
March 31, 1997 up to its committed capital contribution of $1.0 million made
in January, 1997. Accordingly, a $1.0 million loss on the joint venture was
recognized in the results of operations. The Company anticipates an
additional capital contribution to the joint venture of approximately $0.5
million during the remaining 3 quarters of 1997. If GENXON continues to
generate losses during this time frame, the Company will record its share of
these losses to the extent of its capital contribution. However, these
losses may be partially offset by reimbursements for past R&D expenses if
certain GENXON milestones are achieved.
PROPOSED TRANSACTION WITH GLAXO WELLCOME
The Company and Glaxo Wellcome Inc. ("Glaxo") signed a non-binding letter of
intent effective February 5, 1997 to enter into a transaction pursuant to
which the Company would acquire (the "Facility Acquisition") Glaxo's
pharmaceutical production facility in Greenville, North Carolina (the
"Facility") as part of its expansion plans for Fine Chemicals.
The proposed agreement calls for the Company to purchase all of the
buildings and equipment at the 1.8 million-square-foot Facility, as well as
the approximately 600 acres of land on which it is situated. Under the
agreement, the Company will enter into long term manufacturing contracts to
supply designated Glaxo Wellcome products, including bulk active chemicals,
final dosage forms, sterile products, and third party products.
Under the terms of the proposed Acquisition, the Company will pay Glaxo an
undisclosed amount. The Facility Acquisition is expected to be financed by a
combination of an equity investment in Catalytica by Morgan Stanley Capital
Partners and debt from a major global financial institution. In addition,
Glaxo will receive a small equity stake in both Catalytica, Inc. and Fine
Chemicals. The agreements also provide for Glaxo to receive a share of the
profits from Catalytica's production of products in the Greenville site's
sterile products facility. Terms of the equity financing are expected to be
structured to reflect the valuation
10
of the Company's businesses prior to the announcement of the Facility
Acquisition. Terms of the debt financing are expected to be structured to
reflect anticipated cash flows under the supply contracts with Glaxo
Wellcome and other parties.
No definitive agreements have been signed by the Company and Glaxo relating
to the proposed Facility Acquisition. As a result, there can be no
assurance, and stockholders should not assume, that the proposed
transactions will be completed. The completion of the Facility Acquisition
is subject to a number of risks and uncertainties, including the following:
(i) completion of the negotiation of definitive documents, including an
asset purchase agreement and long term supply contracts for chemical, final
dosage, sterile, and third party products; (ii) completion of the due
diligence review by the Company and its equity and debt financing sources;
(iii) completion of the negotiation of the terms of the substantial equity
and debt financings required to consummate the Facility Acquisition; and
(iv) receipt of certain regulatory approvals and consents, including
stockholder approval.
In addition, the proposed Facility Acquisition, which is not expected to
close prior to the summer of 1997, will require significant management time
and legal, accounting and other expenditures, whether or not the
transactions are completed. In the event the Acquisition is consummated, the
additional facilities, employees and business volumes will substantially
increase the Company's expenses and working capital requirements and place
substantial burdens on the Company's management resources. Furthermore, the
success of the Acquisition depends on the levels of new manufacturing
business developed by the Company, and the related terms negotiated by the
parties. In the event the Company does not achieve additional new business
from Glaxo and other customers on terms sufficient to offset the costs
associated with operating and maintaining the new facilities, and with
servicing the debt associated with the acquisition of the new facilities,
the Company's results of operations and financial condition would be
materially adversely affected.
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
Total cash and cash equivalents plus short-term investments decreased to
$19.7 million compared to $23.8 million at December 31, 1996. This decrease
is primarily due to the net loss for the quarter coupled with capital
spending at the Catalytica Fine chemicals Bay View manufacturing facility.
These cash outflows were partially offset by borrowings against various
credit facilities and funds received from the sale of common stock through
stock option exercises.
During the past several years, the Company has obtained various lines of
credit to fund capital purchases and future working capital needs. One of
these lines of credit collateralized with accounts receivable was increased
to $3.5 million in 1996. As of March 31, 1997, the Company had approximately
$2.8 million outstanding under this line of credit, and is in compliance
with it's debt covenants. To the extent the Company does not comply with
various required financial covenants in the future, there can be no
assurance that the bank will waive the covenants. Failure to comply with the
financial covenants could result in acceleration of payment of the principal
amount and interest due under the line and termination of the line of
credit.
11
The Company's operations to date have required substantial amounts of cash.
The Company anticipates that existing capital resources, product revenues,
and research and development revenues will enable the Company to maintain
current and planned operations for at least the next 12 months, excluding
the significant capital which will be required if the Facility Acquisition
is completed. The Company's future capital requirements will depend on many
factors, including rate of commercialization of the Company's catalytic
combustion systems, the need to expand manufacturing capacity for both its
fine chemicals and combustion systems business, and the completion of the
proposed transaction with Glaxo. However, adequate funds for future
operations, whether from the financial markets or from collaborative or
other arrangements, may not be available when needed or on terms acceptable
to the Company and, if available or acceptable to the Company, may result in
significant dilution to existing stockholders. If adequate funds are not
available, the Company may be required to delay, scale back or eliminate
some or all of its research and product development programs. Although there
can be no assurance the Company will obtain orders sufficient to fill the
capacity by such time, the Company's manufacturing facility for
pharmaceutical intermediates is expected to reach capacity in 1997. In order
to augment its current pharmaceutical intermediates manufacturing capacity,
the Company entered into a non-binding letter of intent with Glaxo Wellcome
to acquire Glaxo's pharmaceutical production facility in Greenville, North
Carolina. See "Proposed Transaction with Glaxo Wellcome" as discussed above
and in following "Risk Factors" section.
RISK FACTORS
------------
History of Operating Losses and Uncertainty of Future Results
The Company's business has not been profitable to date, and as of March 31,
1997, the Company had an accumulated deficit of $50.5 million. The Company
anticipates incurring additional losses for at least the next several
quarters. The Company expects that losses will fluctuate from quarter to
quarter as a result of differences in the amount and timing of expenses
incurred and revenues received. In particular, the Company's operating
results are affected by the size and timing of receipt of orders for and
shipments of its fine chemicals products, as well as the amount and timing
of payments and expenses under the Company's research and development
contracts. Through 1993, substantially all of the Company's revenues were
derived from research and development contracts. Most of the Company's
research and development contracts are subject to periodic review by the
funding partner, which may result in modifications, including reduction or
termination of funding. There can be no assurance the Company will continue
to receive research and development funding, and the Company expects that it
will increasingly rely on product sales for its revenues.
In 1994, the Company began deriving revenues from the sale of fine chemicals
products. During the past several years, a significant portion of the
Company's product revenues has been derived from sales to Novartis Agro,
Inc. ("Novartis") under a five-year contract pursuant to which Novartis
committed to buy certain minimum volumes for the first four years and eight
months. The Company has no contractual volume commitment from Novartis
beyond May 31, 1998. There can be no assurance the Novartis contract will be
12
renewed or replaced with new business. The Novartis agreement may be
terminated by either party upon 30 days prior written notice for failure to
perform a material provision of the agreement, if such failure is not cured
within 60 days after receipt of notice. The Company expects that it will
need to manufacture new products to increase revenue. Typically, new
products have lower gross margins during the initial manufacturing phase,
which could have an adverse effect on the Company's results of operations.
For example, during the quarter ended March 31, 1997, costs of goods sold
reflected higher than normal costs associated with production start-up of
several new Fine Chemical products. To achieve profitable operations,
Catalytica must significantly increase its commercial sales of fine
chemicals and successfully develop, manufacture, introduce and market or
license its combustion systems and catalytic processes. There can be no
assurance that the Company will be able to achieve profitability on a
sustained basis, or at all.
Commercialization; Shift from Research and Development
The Company's success will depend on its ability to complete the transition
from emphasizing research and development to full commercialization and sale
of its products. The Company began manufacturing, marketing and selling
pharmaceutical intermediates in 1994. Success of the Company's fine
chemicals business is dependent upon development and commercialization of
appropriate catalytic processes for new customers and new fine chemicals
products. There can be no assurance the Company will be able to develop and
commercialize such processes. In addition, sales of certain of the Company's
fine chemicals intermediates are dependent upon the customer obtaining
clearance from the United States Food and Drug Administration ("FDA") for
marketing of the customer's end-product. Failure of the Company's customers
to obtain the necessary FDA clearance would have an adverse affect on sales
of certain fine chemicals products.
The Company, through its subsidiary Catalytica Combustion Systems, Inc.
("CCSI"), and the GENXON joint venture, is still conducting research and
development on its combustion systems. Prior to commercialization of its
combustion systems, the Company's products will be required to undergo
rigorous testing by turbine manufacturers. Ultimate sales of the Company's
combustion system products will depend upon the acceptance and users of the
Company's technology by a limited number of turbine manufacturers and the
Company's ability to enter into commercial relationships with these
manufacturers. The Company's subsidiary, CCSI, is currently working with
leading turbine manufacturers, including: General Electric in large
turbines, and Allison Engine Co., a subsidiary of Rolls Royce, and Solar, a
subsidiary of Caterpillar, Inc., in medium size turbines. In addition,
through its joint venture company GENXON, the Company is developing complete
combustor systems for Affiliated Group of Companies (AGC), to be used on
small Kawasaki Heavy Industries turbines for mobile cogeneration
applications. GENXON is also developing complete combustor systems utilizing
Catalytica's combustion technology for end users to be "retro fitted" on
older "out-of-warranty" turbines no longer supported by OEM's. Neither the
Company, its subsidiary CCSI, nor the joint venture company GENXON have
formal long-term agreements in place with any of these companies. The
Company's ability to complete research and development and introduce
commercial systems for these markets would be adversely affected if any of
these companies terminated its relationship with the Company or GENXON. If
such terminations occurred, there is no
13
assurance as to whether the Company could enter into a similar relationship
with another manufacturer. The Company currently has limited manufacturing
and marketing capability for its combustion products. The Company's existing
facilities are inadequate for commercial production of the combustion
products under development, and to the extent that the Company chooses to
produce commercial quantities of its products, the Company will be required
to develop or acquire manufacturing capability. In order to market any of
its combustion system products, the Company will be required to develop
marketing capability, either on its own or in conjunction with others. There
can be no assurance that the Company will be able to manufacture its
products successfully or develop an effective marketing and sales
organization. In addition, some of the Company's combustion systems and
processes are expected to be sold as components of large systems such as
natural gas turbines for electric power plants: accordingly, the rate of
adoption of the Company's systems and processes may depend in part on
economic conditions which affect capital investment decisions, as well as
the regulatory environment. There can be no assurance that the Company's
products will be economically attractive when compared to competitive
products.
Proposed Transaction With Glaxo Wellcome
The Company and Glaxo Wellcome Inc. ("Glaxo") signed a non-binding letter of
intent effective February 5, 1997 to enter into a transaction pursuant to
which the Company would acquire (the "Facility Acquisition") Glaxo's
pharmaceutical production facility in Greenville, North Carolina (the
"Facility") as part of its expansion plans for Fine Chemicals.
The proposed agreement calls for the Company to purchase all of the
buildings and equipment at the 1.8 million-square-foot Facility, as well as
the approximately 600 acres of land on which it is situated. Under the
agreement, the Company will enter into long term manufacturing contracts to
supply designated Glaxo Wellcome prescription products.
Under the terms of the proposed Acquisition, the Company will pay Glaxo an
undisclosed amount. The Facility Acquisition is expected to be financed by a
combination of an equity investment in Catalytica by Morgan Stanley Capital
Partners and debt from a major global financial institution. In addition,
Glaxo will receive a small equity stake in both Catalytica, Inc. and Fine
Chemicals. The agreements also provide for Glaxo to receive a share of the
profits from Catalytica's production of medicines in the Greenville site's
sterile products facility. Terms of the equity financing are expected to be
structured to reflect the valuation of the Company's businesses prior to the
announcement of the Facility Acquisition. Terms of the debt financing are
expected to be structured to reflect anticipated cash flows under supply
contracts with Glaxo Wellcome and other parties.
No definitive agreements have been signed by the Company and Glaxo relating
to the proposed Facility Acquisition. As a result, there can be no
assurance, and stockholders should not assume, that the proposed
transactions will be completed. The completion of the Facility Acquisition
is subject to a number of risks and uncertainties, including the following:
(i) completion of the negotiation of definitive documents, including an
asset purchase agreement and long term supply contracts for chemical, final
dosage, sterile, and
14
third party products; (ii) completion of the due diligence review by the
Company and its equity and debt financing sources; (iii) completion of the
negotiation of the terms of the substantial equity and debt financings
required to consummate the Facility Acquisition; and (iv) receipt of certain
regulatory approvals and consents, including stockholder approval.
In addition, the proposed Facility Acquisition, which is not expected to
close prior to the third quarter of 1997, will require significant
management time and legal, accounting and other expenditures, whether or not
the transactions are completed. In the event the Acquisition is consummated,
the additional facilities, employees and business volumes will substantially
increase the Company's expenses and working capital requirements and place
substantial burdens on the Company's management resources. Furthermore, the
success of the Acquisition depends, in part, on the levels of manufacturing
business developed by the Company. In the event the Company does not achieve
additional new business from Glaxo and other customers on terms sufficient
to offset the costs associated with operating and maintaining the new
facilities, and with servicing the debt associated with acquisition of the
new facilities, the Company's results of operations and financial condition
would be materially adversely affected.
Future Capital Requirements and Uncertainty of Additional Funding
See Management's Discussion and Analysis of Financial Condition and Results
of Operations - Liquidity and Capital Resources.
Risks Associated with GENXON Joint Venture
In October 1996 Combustion Systems and Woodward Governor Company formed a
Delaware limited liability company in connection with a 50/50 joint venture
to serve the gas turbine retrofit market for installed, out-of-warranty
engines. The new company, GENXON(TM) Power Systems, LLC, will initially
provide gas turbine fleet asset planning and utilization services for both
power generation and mechanical drive markets. The Company plans to deliver
an integrated product portfolio which includes Combustion Systems' system
for ultra low NOx emissions, Woodward's control systems, turbine overhaul
and upgrades, as well as contract maintenance and service.
The initial capital commitment of the GENXON joint venture partners is $10
million - $2 million from Combustion Systems and $8 million from Woodward -
payable over time as the funds are required by the joint venture. These
capital infusions are predicated upon reaching certain milestones, and
neither joint venture partner is contractually required to make further
capital infusions if these milestones are not met. If the milestones are not
met, and the Company desired to complete any projects being developed by the
joint venture, the Company could be required to fund the projects itself if
Woodward decides not to make any additional capital contributions to GENXON.
If such an event were to occur, it could have a material adverse effect on
the Company's results of operations and financial condition. See "Management
Discussion and Analysis of Financial Conditions and Results of Operations."
15
On January 3, 1997, Catalytica Combustion Systems, Inc. (CCSI) made it's
first cash infusion of $1.0 million into the GENXON joint venture. CCSI
recognized its 50% share of GENXON losses for the three month period ending
March 31, 1997 up to its committed capital contribution of $1.0 million made
in January, 1997. Accordingly, a $1.0 million loss on the joint venture was
recognized in the results of operations. The Company anticipates an
additional capital contribution to the joint venture of approximately $0.5
million during the remaining 3 quarters of 1997. If GENXON continues to
generate losses during this time frame, the Company will record its share of
these losses to the extent of its capital contribution. However, these
losses may be partially offset by reimbursements for past R&D expenses if
certain GENXON milestones are achieved.
Unlike Catalytica Combustion Systems' efforts to date which have focused
only on the design of the catalyst assembly, GENXON is developing entire
combustion systems. The development of complete combustion systems by GENXON
to serve the retrofit market will require the design of new combustion
chambers to be retrofitted on existing turbines. This new combustion chamber
will incorporate a XONON catalyst. There can be no assurance that GENXON
will be successful in developing new combustion chambers that will work in
lieu of the current design that does not incorporate a catalyst. There can
be no assurance that GENXON's products will be economically attractive when
compared to competitive products.
Influence of Environmental Regulations on Rate of Commercialization
The rate at which the Company's catalytic combustion systems are adopted by
industrial companies will be heavily influenced by the enactment and
enforcement of environmental regulations at the federal, state and local
levels. Current federal law governing air pollution generally does not
mandate the specific means for controlling emissions, but instead, creates
ambient air quality standards for individual geographic regions to attain
through individualized planning on a regional basis in light of the general
level of air pollution in the region. Federal law requires state and local
authorities to determine specific strategies for reducing emissions or
specific pollutants. Among other strategies, state and local authorities in
all areas which do not meet ambient air quality standards must adopt
performance standards for all major new and modified sources of air
pollution. The more polluted the air in a particular region has become, the
more stringent such controls must be. The Company's revenues will depend, in
part, on the standards, permit requirements and programs these state and
local authorities promulgate for reducing emissions (including emissions of
NOx) addressed by the Company's combustion and monitoring products systems.
Demand for the Company's systems and processes will be affected by how
quickly the standards are implemented and the level of reductions required.
Certain industries or companies may successfully delay the implementation of
existing or new regulations or purchase or acquire emissions credits from
other sources, which could delay or eliminate their need to purchase the
Company's systems and processes. Moreover, new environmental regulations may
impose different requirements which may not be met by the systems and
processes being developed by Catalytica or which may require costly
modifications of the Company's products. The United States Congress is
currently reviewing existing environmental regulations. There can be no
certainty as to whether Congress will amend or
17
modify existing regulations in a manner that could have an adverse effect on
demand for the Company's combustion system products.
Effect of FDA Regulations on Fine Chemicals Manufacturing
Many of the fine chemicals products the Company manufactures, or will
manufacture in the future, and the final drug products in which they are
used are subject to regulation for safety and efficacy by the FDA and
foreign regulatory authorities before such products can be commercially
marketed. The process of obtaining regulatory clearances for marketing is
uncertain, costly and time consuming. The Company cannot predict how long
the necessary regulatory approvals will take or if its customers will ever
obtain such approval for their products. To the extent the Company's
customers do not obtain the necessary regulatory approvals for marketing new
products, the Company's fine chemicals product sales will be adversely
affected.
In the future, the Company intends to manufacture bulk actives. To do so,
the Company would be required to comply with the FDA's current Good
Manufacturing Practices ("cGMP") regulations, and certain of the Company's
customers may also require the Company to adhere to cGMP regulations, even
if not required by the FDA. In complying with cGMP regulations,
manufacturers must continue to expend time, money and effort in production,
recordkeeping and quality control to ensure that the product meets
applicable specifications and other requirements. The FDA periodically
inspects drug manufacturing facilities to ensure compliance with applicable
cGMP requirements. Failure to comply subjects the manufacturer to possible
FDA action, such as suspension of manufacturing. The FDA also may require
the submission of any lot of the product for inspection and may restrict the
release of any lot that does not comply with FDA regulations, or may
otherwise order the suspension of manufacture, recall or seizure. If the
Facility Acquisition is completed, the Company will also be required to
comply with cGMP requirements for the Greenville Facility. Failure of the
Company's customers to obtain and to maintain FDA clearance for marketing of
the products manufactured by the Company, or failure of the Company to
comply with cGMP regulations as required by the FDA or the Company's
customers, would have a material adverse effect on the Company's results of
operations.
Competition and Technological Change
There are numerous competitors in a variety of industries in the United
States, Europe and Japan which have commercialized and are working on
technologies that could be competitive with those under development by the
Company, including both catalytic and other technological approaches. Some
of these competitive products are in more advanced stages of development and
testing. The Company's competitors may develop technologies and systems and
processes that are more effective than those being developed by the Company
or that would render the Company's technology and systems and processes less
competitive or obsolete. In the fine chemicals market, the Company faces its
primary competition from pharmaceutical companies that produce their own
fine chemicals and from other fine chemicals manufacturers such as Lonza AG
and DSM Fine Chemicals. In the combustion systems market, the Company faces
its primary competition from large gas turbine power generation
manufacturers, such as General Electric Co. ("General Electric"),
17
Allison Engine Company ("Allison") and Solar Turbines Incorporated
("Solar"), each of which is developing competing DLN systems for their own
turbines. Many of the Company's competitors in the combustion systems market
are also potential customers of the Company, and the Company expects to rely
on these potential customers to help commercialize its products. Most of
these competitors have greater research and development capabilities,
financial resources, managerial resources, marketing experience and
manufacturing experience than the Company. If these companies are successful
in developing such products, the Company's ability to sell its systems and
processes would be materially adversely affected. Further, since many of the
Company's competitors are existing or potential customers, the Company's
ability to gain market share may be limited.
Patents and Intellectual Property
The Company has an active program of pursuing patents for its inventions in
the United States and in markets throughout the world relevant to its
business areas. The Company has 38 United State patents and 13 pending
United States patent applications, plus 70 foreign patents and patent
applications.
The Company's success will depend on the ability to continue to obtain
patents, protect trade secrets and operate without infringing on the
proprietary rights of others in the United States and other countries. There
can be no assurance that the Company's patent applications will result in
the issuance of any patent, that any of the Company's existing patents or
any patents that may be issued in the future will provide significant
proprietary protection, that any such patents will be sufficiently broad to
protect the Company's technology, or that any such patents will not be
challenged, circumvented or invalidated. There can also be no assurance that
the patents of others will not have an adverse effect on the Company. Others
may independently develop similar systems or processes or design around
patents issued to the Company. In addition, the Company may be required to
obtain licenses to patents or other proprietary rights. The Company cannot
assure that any licenses required under any such patents or proprietary
rights would be made available on terms acceptable to the Company, if at
all. If Catalytica requires and does not obtain such licenses, it could
encounter delays in system or process introductions while it attempts to
design around such patents, or it could find that the development,
manufacture, sale or licensing of systems or processes requiring such
licenses could be foreclosed. The Company could incur substantial costs in
defending itself or its licensees in litigation brought by others or
prosecuting infringement claims against third parties. The Company could
incur substantial costs in interference proceedings declared by the United
States Patent and Trademark Office in connection with one or more of the
Company's or third parties' patents or patent applications, and those
proceedings could also result in an adverse decision as to the priority of
the Company's inventions. The Company also protects its proprietary
technology and processes in part by confidentiality agreements with its
collaborative partners, employees and consultants. There can be no assurance
that these agreements will not be breached, that the Company will have
adequate remedies for any breach, or that the Company's trade secrets will
not otherwise become known or be independently discovered by competitors.
Dependence on Key Personnel
18
The Company's success is dependent on the retention of principal members of
its management and scientific staff and on the ability to continue to
attract, motivate and retain additional key personnel. Competition for such
key personnel is intense, and the loss of the services of key personnel or
the failure to recruit necessary additional personnel could have a material
adverse effect upon the Company's operations and on its research and
development efforts. The Company does not have non-competition agreements
with any of its key employees. The Company's anticipated expansion into
areas and activities requiring additional expertise, such as manufacturing,
marketing and distribution, are expected to place increased demands on the
Company's resources. These activities are expected to require the addition
of new personnel with expertise in these areas and the development of
additional expertise by existing personnel. The failure to acquire such
personnel or to develop such expertise could materially adversely affect
prospects for the Company's success.
Hazardous Materials and Environmental Matters
The Company's research and development activities and fine chemicals
manufacturing involve the use of many hazardous chemicals. The Company is
subject to extensive federal, state and local laws and regulations governing
the use, manufacture, storage, handling and disposal of such materials and
associated waste products. The Company believes that its properties and
operations comply in all material respects with applicable environmental
laws; however, the risk of environmental liabilities cannot be completely
eliminated. Public awareness of environmental issues has increased the
impact of such laws on the conduct of manufacturing operations and ownership
of property. Any failure by the Company to comply with present or future
environmental laws could result in cessation of portions or all of the
Company's operations, impositions of fines, restrictions on the Company's
ability to carry on or expand its operations, significant expenditures by
the Company to comply with environmental laws and regulations, and/or
liabilities in excess of the resources of the Company. The Company does not
have environmental impairment liability insurance. In 1992, the Company
completed a renovation of its research and development facilities at a cost
of approximately $2.3 million to comply with environmental laws and
regulations. There can be no assurance, however, that the Company will not
be required to make additional renovations or improvements to comply with
environmental laws and regulations in the future. The Company's operations,
business or assets could be materially adversely affected in the event such
environmental laws or regulations require the Company to modify current
facilities substantially or otherwise limit the Company's ability to conduct
or expand its operations.
The Company leases the land on which its Bay View Manufacturing Facility is
located from Rhone Poulenc, Inc., ("Rhone Poulenc"). The past activities of
Rhone Poulenc's predecessor caused significant soil and groundwater
contamination of the facility and a down gradient area located along the San
Francisco Bay. Consequently, the site is subject to a clean up and abatement
order issued by the Bay Area Regional Water Quality Control Board ("RWQCB")
which currently requires stabilization, containment and monitoring of the
arsenic and volatile organic contamination at the site and surrounding
areas. The ground lease between Rhone Poulenc and the Company includes an
indemnity by Rhone Poulenc
20
against any costs and liabilities that the Company might incur to fulfill
the RWQCB order and to otherwise address the contamination that is the
subject of the order. The Company also has obtained an indemnification from
Novartis (the immediately preceding owner/operator of the facility) against
any costs and liability the Company may incur with respect to any
contamination caused by Novartis' operations. However, there can be no
assurance that the Company will not be held responsible with respect to the
existing contamination or named in an action brought by a governmental
agency or a third party because of such contamination. If the Company is
held responsible and it has contributed to the contamination, it will be
liable for any damage to third parties, and will be required to indemnify
Rhone Poulenc and Novartis for any additional clean up costs or liability
they may incur, with respect to the contamination caused by the Company. The
determination of the existence and additional cost of any such incremental
contamination contribution by the Company could involve costly and
time-consuming negotiations and litigation. Further, any such incremental
contamination by the Company or the unenforceability of either of the
indemnity agreements described above could materially adversely affect the
Company's business and results of operations.
If the Facility Acquisition is completed, the Company will be faced with
environmental risks similar to those arising from the Bay View Manufacturing
Facility, including risks arising from future operations and cross
indemnification provisions with Glaxo Wellcome. The Greenville Facility has
existing environmental cleanup which Glaxo Wellcome is responsible for.
PART II - OTHER INFORMATION
Item 6
Exhibits
27.1 Financial Data Schedule
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.
20
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 14, 1997 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
21