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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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, 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
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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 20,302,254 as of July 30, 1997.
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CATALYTICA, INC.
FORM 10-Q
TABLE OF CONTENTS
JUNE 30, 1997
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidated Balance Sheets as of June 30, 1997 and
December 31, 1996................................................... 3
Condensed Consolidated Statements of Operations for the three months
ended June 30, 1997 and June 30, 1996............................... 4
Condensed Consolidated Statements of Cash Flows for the three months
ended June 30, 1997 and June 30, 1996............................... 5
Notes to Condensed Consolidated Financial Statements................. 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS......................................... 8
PART II. OTHER INFORMATION............................................. 21
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............ 21
ITEM 5. OTHER INFORMATION.............................................. 22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K............................... 28
SIGNATURES............................................................. 29
2
PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
JUNE 30, DECEMBER 31,
1997 1996
-------- ------------
ASSETS
Current assets:
Cash and cash equivalents.............................. $ 11,372 $ 15,540
Short-term investments................................. 4,490 8,281
Accounts receivable, net............................... 5,237 3,944
Accounts receivable from joint venture................. 332 865
Notes receivable from employees........................ 255 328
Inventory:
Raw materials........................................ 1,309 1,689
Work in process...................................... 265 249
Finished goods....................................... 131 1,479
-------- --------
1,705 3,417
Prepaid expenses and other acquisition costs........... 4,573 681
-------- --------
Total current assets................................. 27,964 33,056
Property and equipment:
Equipment.............................................. 11,163 9,260
Leasehold improvements................................. 9,230 8,173
-------- --------
20,393 17,433
Less accumulated depreciation and amortization......... (10,197) (9,536)
-------- --------
10,196 7,897
Notes receivable from employees.......................... 50 50
-------- --------
$ 38,210 $ 41,003
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable....................................... $ 1,587 $ 2,055
Accrued payroll and related expenses................... 1,623 1,372
Deferred revenue....................................... 1,627 1,643
Accrued acquisition costs.............................. 1,069 0
Other accrued liabilities.............................. 749 949
Borrowings under line of credit........................ 3,498 2,300
Current portion of long-term debt...................... 784 833
-------- --------
Total current liabilities............................ 10,937 9,152
Long-term debt........................................... 1,285 1,524
Non-current deferred revenue............................. 4,287 5,064
Minority interest........................................ 8,000 8,000
Stockholders' equity:
Common stock........................................... 20 19
Additional paid-in capital............................. 66,050 65,482
Deferred compensation.................................. (19) (41)
Accumulated deficit.................................... (52,350) (48,197)
-------- --------
Total stockholders' equity........................... 13,701 17,263
-------- --------
$ 38,210 $ 41,003
======== ========
See accompanying notes
3
CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
---------------- ----------------
1997 1996 1997 1996
------- ------- ------- -------
Revenues:
Product sales............................ $ 6,262 $ 2,685 $ 9,321 $ 4,702
Research revenues........................ 1,500 1,424 3,226 2,747
------- ------- ------- -------
7,762 4,109 12,547 7,449
Costs and expenses:
Cost of sales............................ 6,013 2,433 9,087 4,443
Research and development................. 2,240 2,971 4,439 5,542
Selling, general and administrative...... 1,001 1,215 1,991 2,461
------- ------- ------- -------
Total costs and expenses................... 9,254 6,619 15,517 12,446
Operating loss............................. (1,492) (2,510) (2,970) (4,997)
Interest income............................ 239 294 505 539
Interest expense........................... (125) (99) (238) (227)
Gain on sale of assets..................... -- 505 -- 505
Loss on joint venture...................... (450) -- (1,450) --
------- ------- ------- -------
Net loss................................... $(1,828) $(1,810) $(4,153) $(4,180)
======= ======= ======= =======
Net loss per share......................... $ (0.09) $ (0.09) $ (0.21) $ (0.22)
======= ======= ======= =======
Shares used in computing net loss per
share..................................... 19,918 19,250 19,987 19,223
======= ======= ======= =======
See accompanying notes.
4
CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(IN THOUSANDS)
SIX MONTHS ENDED
JUNE 30,
------------------
1997 1996
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss................................................... $ (4,153) $ (4,180)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activity:
Depreciation and amortization............................ 630 412
Losses in affiliated company............................. 1,450 --
Changes in:
Accounts receivable.................................... (1,293) 99
Accounts receivable from joint venture................. 533 --
Inventory.............................................. 1,712 (1,128)
Prepaid expenses and other current assets.............. (3,892) (174)
Accounts payable....................................... (468) (292)
Accrued payroll and related expenses................... 251 (89)
Deferred revenue....................................... (793) 7,387
Accrued acquisition costs.............................. 1,069 0
Other accrued liabilities.............................. (200) 352
-------- --------
Net cash provided by (used in) operating activities.. (5,154) 2,387
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments................................... (13,184) (15,520)
Maturities of investments.................................. 17,028 24,000
Investment in affiliate company............................ (1,450) --
Acquisition of property and equipment...................... (2,960) (1,118)
-------- --------
Net cash provided by (used in) investing activities.. (566) 7,362
CASH FLOWS FROM FINANCING ACTIVITIES:
Net receipts on (issuance of) notes receivable from
employees................................................. 73 (224)
Additions to debt obligations.............................. 1,645 1,111
Payments on debt obligations............................... (735) (3,419)
Minority investment........................................ -- 8,000
Sale of common stock....................................... 569 189
-------- --------
Net cash provided by (used in) financing activities.. 1,552 5,657
-------- --------
Net increase (decrease) in cash and cash equivalents....... (4,168) 15,406
Cash and cash equivalents at beginning of period........... 15,540 5,021
-------- --------
Cash and cash equivalents at end of period................. $ 11,372 $ 20,427
======== ========
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 six-month
period ended June 30, 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/A 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 quarters ended June 30, 1997 and June 30, 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 ($1,306,000 at June 30, 1997) and investments with maturities greater
than three months which are available-for-sale (none at June 30, 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 (3,184,000 outstanding at June 30, 1997). All investments at June 30,
1997, were carried at 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)
6
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS--(CONTINUED)
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 and six month
periods ending June 30, 1997 up to its committed capital contribution of $0.45
million and $1.45 million, respectively. Accordingly, losses on the joint
venture were recognized in the results of operations. GENXON recognized
$268,000 in revenues and had a loss amounting to $7.1 million for the six
months ending June 30, 1997.
As of June 30, 1997, an account receivable for $332,000 exists from the
joint venture for costs incurred by CCSI. Accordingly these costs have not
been included in the consolidated entity.
7. ACQUISITION OF GLAXO WELLCOME FACILITY
On July 31, 1997, Catalytica Pharmaceuticals, Inc. (formerly Catalytica Fine
Chemicals, Inc.), a subsidiary of the Company, acquired from Glaxo Wellcome
Inc. a pharmaceutical manufacturing facility (the "Facility") located in
Greenville, North Carolina (the "Acquisition"), in exchange for (i) $246.6
million in cash subject to a post-closing adjustment based on closing date
inventory levels; (ii) 250,000 shares of Junior Preferred Stock of Catalytica
Pharmaceuticals; (iii) warrants to purchase 2,000,000 shares of the Company's
Common Stock at an exercise price of $12.00 per share and (iv) 10% of the
earnings before interest and taxes in excess of an aggregate cumulative amount
of $10 million attributable to the sterile products portion of the Facility,
up to an aggregate cumulative payment to Glaxo Wellcome of an additional $25.0
million. In connection with the Acquisition, Glaxo Wellcome and Catalytica
Pharmaceuticals have entered into a supply agreement under which
Catalytica Pharmaceuticals will manufacture products for Glaxo Wellcome over
the next one and a half years for secondary products, the next three and a
half years for sterile products and the next five years for primary products
(the "Supply Agreement"). See "Item 5--Other Information."
With the closing of the Acquisition, the Company closed a sale of 13,270,000
shares of its Class A Common Stock and 16,730,000 shares of its Class B Common
Stock to Morgan Stanley Capital Partners III, L.P. and two affiliated funds
("MSCP") (collectively, the "Stock Sale"), at a price of $4.00 per share, for
an aggregate of $120,000,000. As a result of the Stock Sale, as of July 31,
1997, MSCP owns approximately 40% of the Company's outstanding voting
securities and approximately 60% of the Company's outstanding securities on a
fully converted basis. See "Item 5--Other Information--Financing of the
Acquisition" for a discussion of the Class A and B Common Stock.
In addition to the equity investment by MSCP, the Company, The Chase
Manhattan Bank ("Chase") and Chase Securities Inc. ("CSI") have entered into a
Credit Agreement pursuant to which a syndicate of banks led by Chase has
agreed to lend Catalytica Pharmaceuticals an aggregate of up to $200,000,000
(the "Debt Facilities"). The Debt Facilities consist of a senior secured term
loan facility (the "Term Debt Facility") in an aggregate principal amount of
$125,000,000 and a senior secured revolving facility (the "Revolving Debt
Facility") in an aggregate principal amount of $75,000,000. Up to $20,000,000
of the Revolving Debt Facility will be available for the issuance of letters
of credit. The Term Debt Facility will mature four and one-half years after
consummation of the Acquisition and will amortize in quarterly installments
commencing on the last day of the third fiscal quarter of 1998 in aggregate
annual amounts of (i) $50,000,000 in the year 1998, (ii) $37,500,000 in the
year 1999, (iii) $20,000,000 in the year 2000, and (iv) $17,500,000 in the
year 2001. The Revolving Debt Facility will mature four and one-half years
after consummation of the Acquisition. See "Item 5--Other Information--
Financing of the Acquisition" for a discussion of the Debt Facilities.
7
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 and Section 21E of the Exchange Act,
including those statements which have been identified by an asterisk ("*") and
other statements regarding the Company's strategy, financial performance and
revenue sources. Actual results could differ materially from those projected
in the 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 by lowering
manufacturing costs and reducing hazardous byproducts. 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 Catalytica Pharmaceuticals, subject to certain volume
limitations. These requirements represent approximately $3 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 six months ended June 30,
1997, 18% and 43%, 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.
On July 31, 1997, Catalytica Pharmaceuticals, Inc. (formerly Catalytica Fine
Chemicals, Inc.), a subsidiary of the Company, acquired from Glaxo Wellcome
Inc. a pharmaceutical manufacturing facility (the "Facility") located in
Greenville, North Carolina (the "Acquisition"), in exchange for (i) $246.6
million in cash subject to a post-closing adjustment based on closing date
inventory levels; (ii) 250,000 shares of Junior Preferred Stock of Catalytica
Pharmaceuticals; (iii) warrants to purchase 2,000,000 shares of the Company's
Common Stock at an exercise price of $12.00 per share and (iv) 10% of the
earnings before interest and taxes in excess of an aggregate cumulative amount
of $10 million attributable to the sterile products portion of the Facility,
up to an aggregate cumulative payment to Glaxo Wellcome of an additional $25.0
million. In connection with the Acquisition, Glaxo Wellcome and Catalytica
Pharmaceuticals have entered into a supply agreement under which Catalytica
Pharmaceuticals will manufacture products for Glaxo Wellcome over the next one
and a half years for secondary products, the next three and a half years for
sterile products and the next five years for primary products (the "Supply
Agreement").
With the closing of the Acquisition, the Company closed a sale of 13,270,000
shares of its Class A Common Stock and 16,730,000 shares of its Class B Common
Stock to Morgan Stanley Capital Partners III, L.P. and two affiliated funds
("MSCP") (collectively, the "Stock Sale"), at a price of $4.00 per share, for
an aggregate of $120,000,000. As a result of the Stock Sale, as of July 31,
1997, MSCP owns approximately 40% of the Company's outstanding voting
securities and approximately 60% of the Company's outstanding securities on a
fully converted basis. See "Item 5--Other Information--Financing of the
Acquisition" for a discussion of the Class A and B Common Stock.
8
In addition to the equity investment by MSCP, the Company, The Chase
Manhattan Bank ("Chase") and Chase Securities Inc. ("CSI") have entered into a
Credit Agreement pursuant to which a syndicate of banks led by Chase has
agreed to lend Catalytica Pharmaceuticals an aggregate of up to $200,000,000
(the "Debt Facilities"). The Debt Facilities consist of a senior secured term
loan facility (the "Term Debt Facility") in an aggregate principal amount of
$125,000,000 and a senior secured revolving facility (the "Revolving Debt
Facility") in an aggregate principal amount of $75,000,000. Up to $20,000,000
of the Revolving Debt Facility will be available for the issuance of letters
of credit. The Term Debt Facility will mature four and one-half years after
consummation of the Acquisition and will amortize in quarterly installments
commencing on the last day of the third fiscal quarter of 1998 in aggregate
annual amounts of (i) $50,000,000 in the year 1998, (ii) $37,500,000 in the
year 1999, (iii) $20,000,000 in the year 2000, and (iv) $17,500,000 in the
year 2001. The Revolving Debt Facility will mature four and one-half years
after consummation of the Acquisition. See "Item 5--Other Information--
Financing of the Acquisition" for a discussion of the Debt Facilities.
The Company's business has not been profitable to date, and as of June 30,
1997, the Company had an accumulated deficit of $52.4 million. To achieve
profitable operations, Catalytica must successfully manage the operations of
the Facility, and, to a lesser extent, successfully develop, manufacture,
introduce and market or license its combustion systems and catalytic
processes. 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 and, with the Acquisition of the
Facility, will substantially increase its manufacturing of pharmaceutical
products in 1997.
The additional facilities, employees and business volumes resulting from the
Acquisition will substantially increase the expenses and working capital
requirements and place substantial burdens on the Company's management
resources. Furthermore, the success of the Acquisition and the Company's
future results depend, in significant part, on the levels of manufacturing
business developed by Catalytica Pharmaceuticals. In the event Catalytica
Pharmaceuticals does not obtain additional new customers, which could involve
additional business from Glaxo Wellcome, on terms sufficient to offset the
costs associated with operating and maintaining the Facility, and with
servicing the debt incurred in connection with the acquisition of the
Facility, the Company's consolidated results of operations and financial
condition would be materially adversely affected.
Due to the size of the Acquisition, the results of operations of Catalytica
Pharmaceuticals will have a material effect on the consolidated results of
operations of the Company, and the results of operations of the Company's
other businesses will be insignificant for the remainder of 1997 and 1998.*
The anticipated revenues from the Supply Agreement with Glaxo Wellcome are
expected to allow the Company to achieve profitable operations for Catalytica
Pharmaceuticals for the remainder of 1997 and for 1998.* After 1998,
Catalytica Pharmaceuticals' profitability will depend on its success and
timing in obtaining new customers, including possible new agreements with
Glaxo Wellcome.* The Company anticipates that its income (loss) per share will
be adversely affected in the second half of 1997, when it expects to
repurchase up to 5,000,000 shares of its Class B Common Stock from MSCP at a
price of $4.75 per share with the proceeds from a warrant issuance it expects
to occur during the third fiscal quarter of 1997.*
Manufacturing at the Facility is conducted in three district operations:
primary, secondary and sterile. There is excess manufacturing capacity
available at the primary facility beginning in mid-1998 and based on marketing
efforts to date Catalytica Pharmaceuticals expects it will have one or more
customers for some or all of the unused primary facility beginning in mid-
1998.* There is substantial excess manufacturing capacity immediately
available at the secondary and sterile facilities, but because of the long
lead times required to obtain necessary regulatory approvals to manufacture
secondary and sterile products at these facilities, Catalytica Pharmaceuticals
does not anticipate additional significant revenue from such facilities until
1998 or 1999 at the earliest. Catalytica Pharmaceuticals' inability to fill
additional available capacity or to reduce costs in conjunction with lower
levels of capacity utilization would have a material adverse effect on the
Company's results of operations.
On May 8, 1996, Catalytica Pharmaceuticals, announced that Pfizer Inc. had
signed an agreement to infuse $15 million in Catalytica Pharmaceuticals. These
funds provided Pfizer a 15 percent interest in Catalytica
9
Pharmaceuticals and a five-year research and development ("R&D") commitment by
Catalytica Pharmaceuticals to develop new processes and technology for the
manufacture of Pfizer products. Prior to this investment, Catalytica
Pharmaceuticals was a wholly-owned subsidiary of Catalytica, Inc. Pursuant to
the terms of the Acquisition, Glaxo Wellcome received a 1.5% equity interest in
Catalytica Pharmaceuticals and the Company purchased additional stock so that
Pfizer's ownership interest was decreased to approximately 4.4%.
During the past four years, Catalytica Pharmaceuticals 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 Pharmaceuticals 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 are expected to 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.*
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 three and six months ended June 30, 1997 increased by
89% and 68% respectively, compared to the same quarter in fiscal 1996 largely
due to an increase in product sales coupled with higher research revenues.
Product sales during the second quarter and first half of 1996 were up 133% and
98% respectively when compared to the same periods of 1996 primarily due to
increased shipments of fine chemical products to Novartis and other customers.
The increase in research revenues reflects a funded research commitment
associated with the five-year R&D agreement between Catalytica Pharmaceuticals
and Pfizer to develop new processes and technology for the manufacture of
Pfizer products (See overview above).
Cost of goods sold increased 147% for the second quarter of 1997 and
increased 105% for the first six months of 1997. The increase in cost of goods
sold for both the three and six month periods reflects increased physical
volume of product sales of fine chemical products coupled with higher than
normal costs associated with production start-up of several new fine chemical
products. 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,
10
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 25% and 20% for the three and
six months ended June 30, 1997, as compared to the same periods in 1996. This
decrease is largely due to a shift of certain catalytic combustion research
and development costs from Catalytica to the GENXON joint venture (See
overview above). This transfer of R&D funding occurred August 1, 1996, and
resulted in approximately $1.1 million of research and development costs being
financed by the joint venture rather than Catalytica during the second quarter
of fiscal 1997. Cessation of all research activities of Advanced Sensor
Devices ("ASD") following the sale of its assets on June 28, 1996, also
contributed approximately $0.4 million towards the reduction of R&D expenses
(See overview above). This decrease in R&D expense during the second quarter
of 1997, 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.
Selling, general and administrative expenses ("SG&A") decreased 18% for the
second quarter of 1997 and decreased 19% for the first six months of 1997
compared to the same periods of 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 Facility. These costs have been capitalized as part of the
purchase price of the Facility.
Net interest income decreased 19% for the second quarter of 1997 and
decreased 6% for the first six months of 1997 when compared to the same
periods last year due to reduced balances of cash and short-term investments.
On January 3, 1997, Catalytica Combustion Systems, Inc. ("CCSI") made its
first cash infusion of $1.0 million into the GENXON joint venture. CCSI
recognized its 50% share of GENXON losses of $.45 million for the second
quarter of 1997 and $1.45 million for the first six months of 1997 up to its
committed capital contribution of $1.45 million. Accordingly, a $1.45 million
loss on the joint venture was recognized in the results of operations. The
Company estimates it may make additional capital contributions to the joint
venture of up to $1.0 million during the remaining two 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.
LIQUIDITY AND CAPITAL RESOURCES
Total cash and cash equivalents plus short-term investments decreased to
$15.9 million during the six months at June 30, 1997, compared to $23.8
million at December 31, 1996. This decrease is primarily due to the net loss
for the period coupled with capital spending at the Catalytica Pharmaceuticals
Bay View manufacturing facility and prepaid acquisition costs related to the
Acquisition. 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 June 30, 1997, the Company had approximately $3.5
million outstanding under this line of credit. On July 31, 1997, this line of
credit was repaid with borrowings under a credit facility with a syndicate of
banks led by The Chase Manhattan Bank entered into in connection with the
Acquisition.
With the closing of the Acquisition, the Company closed a sale of 13,270,000
shares of its Class A Common Stock and 16,730,000 shares of its Class B Common
Stock to Morgan Stanley Capital Partners III, L.P. and two affiliated funds
("MSCP") (collectively, the "Stock Sale"), at a price of $4.00 per share, for
an aggregate of
11
$120,000,000. As a result of the Stock Sale, as of July 31, 1997, MSCP owns
approximately 40% of the Company's outstanding voting securities and
approximately 60% of the Company's outstanding securities on a fully converted
basis. See "Item 5--Other Information--Financing of the Acquisition" for a
discussion of the Class A and B Common Stock.
In addition to the equity investment by MSCP, the Company, The Chase
Manhattan Bank ("Chase") and Chase Securities Inc. ("CSI") have entered into a
Credit Agreement pursuant to which a syndicate of banks led by Chase has
agreed to lend Catalytica Pharmaceuticals an aggregate of up to $200,000,000
(the "Debt Facilities"). The Debt Facilities consist of a senior secured term
loan facility (the "Term Debt Facility") in an aggregate principal amount of
$125,000,000 and a senior secured revolving facility (the "Revolving Debt
Facility") in an aggregate principal amount of $75,000,000. Up to $20,000,000
of the Revolving Debt Facility will be available for the issuance of letters
of credit. The Term Debt Facility will mature four and one-half years after
consummation of the Acquisition and will amortize in quarterly installments
commencing on the last day of the third fiscal quarter of 1998 in aggregate
annual amounts of (i) $50,000,000 in the year 1998, (ii) $37,500,000 in the
year 1999, (iii) $20,000,000 in the year 2000, and (iv) $17,500,000 in the
year 2001. The Revolving Debt Facility will mature four and one-half years
after consummation of the Acquisition. See "Item 5--Other Information--
Financing of the Acquisition" for a discussion of the Debt Facilities.
The Company's operations to date have required substantial amounts of cash.
As part of the financing of the Acquisition, Catalytica Pharmaceuticals
incurred approximately $140 million of long-term indebtedness. The Company and
its subsidiaries have guaranteed this indebtedness. As a result of this
increased leverage, Catalytica Pharmaceuticals' principal and interest
obligations will be increased substantially. The Company anticipates that cash
flows associated with the Supply Agreement will be sufficient to reduce
indebtedness incurred in connection with the Acquisition to a level
supportable by the current assets of the Company.* The degree to which
Catalytica Pharmaceuticals is leveraged could adversely affect Catalytica
Pharmaceuticals' and the Company's ability to obtain additional financing for
working capital, acquisitions or other purposes and could make Catalytica
Pharmaceuticals and the Company more vulnerable to economic downturns and
competitive pressures. The Company's future capital requirements will depend
on many factors, including Catalytica Pharmaceuticals level of business beyond
the Supply Agreement with Glaxo Wellcome, the rate of commercialization of the
Company's catalytic combustion systems, and the need to expand manufacturing
capacity for pharmaceutical or combustion systems business. 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.
12
RISK FACTORS
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act and Section 21E of the Exchange Act,
including those statements which have been identified by an asterisk ("*") and
other statements regarding the Company's strategy, financial performance and
revenue sources. Actual results could differ materially from those projected
in the forward-looking statements as a result of the risk factors set forth
below and elsewhere in this report. In addition to the other information in
this report, the following factors should be carefully considered in
evaluating the Company and its business.
History of Operating Losses and Uncertainty of Future Results. The Company's
business has not been profitable to date, and as of June 30, 1997, the Company
had an accumulated deficit of $52.4 million. To achieve profitable operations,
Catalytica must successfully manage the operations of the Facility, and, to a
lesser extent, successfully develop, manufacture, introduce and market or
license its combustion systems and catalytic processes. 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 and, with the Acquisition of the Facility, will
substantially increase its manufacturing of pharmaceutical products in 1997.
The additional facilities, employees and business volumes resulting from the
Acquisition will substantially increase the expenses and working capital
requirements and place substantial burdens on the Company's management
resources. Furthermore, the success of the Acquisition and the Company's
future results depend, in significant part, on the levels of manufacturing
business developed by Catalytica Pharmaceuticals. In the event Catalytica
Pharmaceuticals does not obtain additional new customers, which could involve
additional business from Glaxo Wellcome, on terms sufficient to offset the
costs associated with operating and maintaining the Facility, and with
servicing the debt incurred in connection with the acquisition of the
Facility, the Company's consolidated results of operations and financial
condition would be materially adversely affected.
Due to the size of the Acquisition, the results of operations of Catalytica
Pharmaceuticals will have a material effect on the consolidated results of
operations of the Company, and the results of operations of the Company's
other businesses will be insignificant for the remainder of 1997 and 1998.*
The anticipated revenues from the Supply Agreement with Glaxo Wellcome are
expected to allow the Company to achieve profitable operations for Catalytica
Pharmaceuticals for the remainder of 1997 and for 1998.* After 1998,
Catalytica Pharmaceuticals' profitability will depend on its success and
timing in obtaining new customers, including possible new agreements with
Glaxo Wellcome.* The Company anticipates that its income (loss) per share will
be adversely affected in the second half of 1997, when it expects to
repurchase up to 5,000,000 shares of its Class B Common Stock from MSCP at a
price of $4.75 per share with the proceeds from a warrant issuance it expects
to occur during the third fiscal quarter of 1997.* Manufacturing at the
Facility is conducted in three district operations: primary, secondary and
sterile. There is excess manufacturing capacity available at the primary
facility beginning in mid-1998 and based on marketing efforts to date
Catalytica Pharmaceuticals expects it will have one or more customers for some
or all of the unused primary facility beginning in mid-1998.* There is
substantial excess manufacturing capacity immediately available at the
secondary and sterile facilities, but because of the long lead times required
to obtain necessary regulatory approvals to manufacture secondary and sterile
products at these facilities, Catalytica Pharmaceuticals does not anticipate
additional significant revenue from such facilities until 1998 or 1999 at the
earliest. Catalytica Pharmaceuticals' inability to fill additional available
capacity or to reduce costs in conjunction with lower levels of capacity
utilization would have a material adverse effect on the Company's results of
operations. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
Management of Substantially Increased Operations and Need for New Computer
System. The Company currently expects that revenues from the operation of the
Facility will represent a substantial portion of the Company's consolidated
revenues for the foreseeable future. The acquisition of the Facility and the
associated Supply Agreement are expected to expand Catalytica's revenues from
$16.3 million during 1996 to an annualized revenue rate in excess of $300
million in the second half of 1997 and in 1998.* Existing management has only
13
limited prior experience in managing a large and geographically dispersed
operation. The Company expects to experience certain inefficiencies as it
begins managing and integrating the operations of the Facility. Computer
systems are used at the Facility to properly track and record the processing
and distribution of products according to drug form, dose, packaging and
destination. Catalytica Pharmaceuticals believes that based on anticipated
changes in operations, the nature of serving multiple customers and the nature
of being a contract manufacturer versus an integrated pharmaceutical company,
that it will need to replace the computer system that is currently used at the
Facility over the next several years. The Company will need to carefully plan
a transition to a new computer system to avoid any disruption to its business.
If the transition is not successfully executed, it could have a material
adverse effect on the Company's results of operations.
Reliance on Relationship with Glaxo Wellcome. Catalytica Pharmaceuticals
estimates that aggregate payments by Glaxo Wellcome under the Supply Agreement
will total approximately $800 million, which include guaranteed revenues plus
the cost of raw materials.* The annual level of guaranteed revenues declines
significantly after 1998, but is expected to continue to represent a
significant source of revenue for Catalytica Pharmaceuticals.* Catalytica
Pharmaceuticals is substantially dependent on Glaxo Wellcome for the next two
and one half years and will continue to be dependent on Glaxo Wellcome in part
thereafter until the end of the term of the Supply Agreement. Catalytica
Pharmaceuticals' business and the Company's consolidated results of operations
would be adversely affected if Catalytica Pharmaceuticals does not
successfully perform its obligations under the Supply Agreement. This could
result in increased costs to the Company or in possible termination of the
Supply Agreement by Glaxo Wellcome.
New Operating Strategy and Need to Hire Additional Personnel. The Facility
has been operated primarily as a captive manufacturing facility by Glaxo
Wellcome with only a limited portion of the Facility devoted to third party
manufacturing. Accordingly, the employees currently operating the Facility and
the managers hired to manage the operations of the Facility have limited prior
experience in conducting operations as a third party manufacturer. There is
limited infrastructure and an insufficient number of personnel at the Facility
currently involved in sales and marketing, research and development, payroll,
purchasing, accounting and information systems functions. The Company will
need to establish and maintain the appropriate infrastructure and hire and
train qualified personnel to perform these functions at the Facility. There
can be no assurance that the Company will successfully establish the
infrastructure or be able to hire qualified personnel in a timely fashion.
There can be no assurance that Catalytica Pharmaceuticals will be able to
establish a successful sales and marketing capability. Any failure to
successfully establish these capabilities at the Facility on a timely basis
would have a material adverse effect on the Company's consolidated results of
operations.
Dependence on Key Personnel. 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 on 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
successful integration of the Facility with the operations of Catalytica
Pharmaceuticals will be significantly dependent upon Catalytica
Pharmaceuticals' ability to attract and retain the personnel (including former
Glaxo Wellcome employees) necessary to effectively integrate, and thereafter
operate, the combined businesses. In this regard, Catalytica Pharmaceuticals
has hired certain key managers of the Facility. Any failure on the part of
Catalytica Pharmaceuticals to attract or retain necessary personnel would have
a material adverse effect on the Company's consolidated results of operations.
Uncertainties Related to Combustion Systems Business. 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
14
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 use 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, 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, CCSI 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 many 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 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 combustion products will be economically attractive when
compared to competitive products.
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 ("GENXON"), will initially
provide gas turbine fleet asset planning and utilization services for both
power generation and mechanical drive markets. GENXON 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. 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.
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.
15
On January 3, 1997, Catalytica Combustion Systems, Inc. (CCSI) made its
first cash infusion of $1.0 million into the GENXON joint venture. CCSI
recognized its 50% share of GENXON losses of $.45 million for the second
quarter of 1997 and $1.45 million for the first six months of 1997 up to its
committed capital contribution of $1.45 million. Accordingly, a $1.45 million
loss on the joint venture was recognized in the results of operations. The
Company estimates it may make additional capital contributions to the joint
venture of up to $1.0 million during the remaining two 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. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Future Capital Requirements and Uncertainty of Additional Funding; Increased
Leverage. The Company's operations to date have required substantial amounts
of cash. As part of the financing of the Acquisition, Catalytica
Pharmaceuticals incurred approximately $140 million of long-term indebtedness.
The Company and its subsidiaries have guaranteed this indebtedness. As a
result of this increased leverage, Catalytica Pharmaceuticals' principal and
interest obligations will be increased substantially. The Company anticipates
that cash flows associated with the Supply Agreement will be sufficient to
reduce indebtedness incurred in connection with the Acquisition to a level
supportable by the current assets of the Company.* The degree to which
Catalytica Pharmaceuticals is leveraged could adversely affect Catalytica
Pharmaceuticals' and the Company's ability to obtain additional financing for
working capital, acquisitions or other purposes and could make Catalytica
Pharmaceuticals and the Company more vulnerable to economic downturns and
competitive pressures. The Company's future capital requirements will depend
on many factors, including Catalytica Pharmaceuticals level of business beyond
the Supply Agreement with Glaxo Wellcome, the rate of commercialization of the
Company's catalytic combustion systems, and the need to expand manufacturing
capacity for pharmaceutical or combustion systems business. 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. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
Risk of Product Liability. Although Catalytica Pharmaceuticals intends to
seek indemnification from its customers for any product liability claims that
may result from the pharmaceutical products it produces, there can be no
assurance that Catalytica Pharmaceuticals will not ultimately be found liable
for any product liability claims regarding products it manufactures.
Catalytica Pharmaceuticals expects it will be required to indemnify its
customers for product liability claims if a manufacturing defect results in
injury. There can be no assurance that Catalytica Pharmaceuticals will be able
to obtain or maintain product liability insurance in the future on acceptable
terms or with adequate coverage against potential liabilities. If Catalytica
Pharmaceuticals is found liable in a product liability claim and the Company
does not have adequate product liability insurance or indemnification, the
Company's consolidated results of operations could be materially adversely
effected. Additionally, under the Supply Agreement, Catalytica Pharmaceuticals
will be obligated to maintain $100,000,000 of product liability insurance. If
Catalytica Pharmaceuticals does not meet this requirement, it would be
considered a default under the Supply Agreement.
Hazardous Materials and Environmental Matters. The Company's research and
development activities and fine chemicals manufacturing involve the use of
many hazardous chemicals. The use of such chemicals will significantly
increase as a result of the acquisition of the Facility from Glaxo Wellcome.
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
16
regulations, and/or liabilities in excess of the resources of the Company. The
Company has environmental impairment insurance with regard to first party and
third party liability in the amount of $25,000,000 (with a $1,000,000
retention) with respect to the Facility only. There can be no assurance that
the Company will not be required to make 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.
Catalytica Pharmaceuticals expects that significant expenditures may be
incurred at the Facility as a result of new environmental regulations
currently under consideration. The United States Environmental Protection
Agency (the "EPA") is considering new regulations for the pharmaceutical
industry under the authority of the federal Clean Air Act. These proposed
regulations would require the installation of "Maximum Achievable Control
Technology" for certain hazardous air pollutant emissions sources
("Pharmaceutical MACT"). The EPA is also considering changes to its
particulate matter emissions regulations as well as regulation of certain
ozone precursor emissions. As these rules are in the early stages of
consideration by the EPA, and as there can be no assurance of their adoption,
the additional cost of complying with such regulations cannot be determined at
this time. There can be no assurance that Catalytica Pharmaceuticals will not
be required to make additional renovations or improvements to comply with
environmental laws and regulations in the future. Catalytica Pharmaceuticals'
operations, business and assets could be materially adversely affected in the
event such environmental laws or regulations require Catalytica
Pharmaceuticals to modify the current Facility substantially or otherwise
limit Catalytica Pharmaceuticals' ability to conduct or expand its operations.
Current and Potential Environmental Contamination at Catalytica
Pharmaceuticals' Two Sites. The Company through a subsidiary leases the land
on which its Bayview facility in East Palo Alto, California 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
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.
Glaxo Wellcome has been working with the EPA and the North Carolina
Department of Environment, Health and Natural Resources (the "NCDEHNR") to
investigate, identify and remediate contamination in the soil and groundwater
at the Facility. This investigation, carried out pursuant to the federal
Resource Conservation and Recovery Act, has identified 16 different areas of
the Facility where contamination has or may have occurred. Of these 16 areas,
at least five have been identified as requiring further investigation and
remediation by NCDEHNR ("Site Contamination"). Contaminants found in the soil
and groundwater at the Facility include solvents, petroleum hydrocarbons and
pesticides. As the new owner of the Facility, Catalytica Pharmaceuticals will
become liable for such contamination. Although it is unknown at this time what
further remediation will be
17
required at the Facility and the cost of such remediation, Glaxo Wellcome has
agreed to be primarily liable for any contamination at the Facility site prior
to the closing of the Acquisition and to perform, at its cost, the remediation
required by law for contamination of the soil and groundwater existing at the
Facility as of the Closing. The Environmental Agreement with Glaxo Wellcome
also requires Catalytica Pharmaceuticals to provide access to the Facility and
certain facility services as required for the remediation, subject to
reimbursement by Glaxo Wellcome. However, there can be no assurance that the
Company or Catalytica Pharmaceuticals will not incur unreimbursed costs or
suffer an interference with ongoing operations as a result of Glaxo Wellcome's
remediation activities or the existence of contamination at the Facility. In
addition, the Company's future development of the Facility may be limited by
the existence of contamination or Glaxo Wellcome's remediation activities.
There also can be no assurance that Catalytica Pharmaceuticals' ongoing
operations at the Facility will not cause additional contamination. The
determination of the existence and cost of any such additional contamination
contributed by Catalytica Pharmaceuticals of the Company could involve costly
and time-consuming negotiations and litigation. Furthermore, any such
contamination caused by Catalytica Pharmaceuticals or the Company could
materially adversely affect the business, results of operations and financial
condition of Catalytica Pharmaceuticals and the consolidated results of
operations and financial condition of the Company.
In addition, a significant amount of asbestos containing material ("ACM") is
present at the Facility. Catalytica Pharmaceuticals believes that the ACM, in
its present condition, does not require abatement. Abatement will only be
required if and as renovations are performed in those areas containing ACM.
Catalytica Pharmaceuticals cannot presently predict whether, when or to what
extent it may need or desire to renovate areas of the Facility containing ACM.
However, should such renovations be necessary, the additional costs could be
substantial. The cash consideration for the Facility was reduced by
approximately $6,400,000, in exchange for the assumption by the Company and
Catalytica Pharmaceuticals of the liability associated with the abatement of
ACM present at the Facility. There is no assurance that such amount will be
adequate to cover the costs associated with any future abatement of ACM at the
Facility. See also "Hazardous Materials and Environmental Matters."
Catalytica Pharmaceuticals' Compliance with FDA Regulations. Many of the
fine chemicals products Catalytica Pharmaceuticals 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. Catalytica Pharmaceuticals 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 Catalytica Pharmaceuticals'
customers do not obtain the necessary regulatory approvals for marketing new
products, Catalytica Pharmaceuticals' fine chemicals product sales will be
adversely affected.
Products manufactured by Catalytica Pharmaceuticals at the facility require
Catalytica Pharmaceuticals to comply with the FDA's current Good Manufacturing
Practices ("cGMP") regulations, and certain of Catalytica Pharmaceuticals'
customers, including Glaxo Wellcome, also require Catalytica Pharmaceuticals
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. Failure
of Catalytica Pharmaceuticals' customers to obtain and to maintain FDA
clearance for marketing of the products manufactured by Catalytica
Pharmaceuticals, or failure of Catalytica Pharmaceuticals to comply with cGMP
regulations as required by the FDA or Catalytica Pharmaceuticals' customers,
would have a material adverse effect on the Company's results of operations.
18
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 modify existing regulations in a manner that could have an
adverse effect on demand for the Company's combustion system products.
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"), 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
States 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
19
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.
Concentration of Ownership. Morgan Stanley Capital Partners III, L.P. and
two affiliated funds (collectively, "MSCP") beneficially own approximately 40%
of the voting control of the Company and 60% of the outstanding capital stock
of the Company. Upon completion of a contemplated repurchase by the Company of
5,000,000 shares of Class B Common Stock from MSCP, MSCP will beneficially own
approximately 40% of the voting control of the Company and 48.5% of the
outstanding Capital Stock of the Company. As a result, MSCP is able to
exercise significant influence over all matters requiring stockholder
approval, including the election of directors and approval of all significant
corporate transactions such as any merger, consolidation or sale of all or
substantially all of the Company's assets. Moreover, the Company has granted
to MSCP certain contractual rights, including representation on the Company's
Board of Directors and committees of the Board of Directors, that will give
MSCP additional rights to participate in certain actions to be taken by the
Company. Such concentration of ownership and contractual rights may have the
effect of delaying, deferring or preventing a change of control of the
Company. The sale by MSCP of shares of the Company's capital stock could
constitute a change of control under the Company's credit agreement which
would trigger a default of the agreement. MSCP has agreed not to trigger a
change of control under the credit agreement. In addition, such concentration
of ownership and contractual rights could allow MSCP to prevent significant
corporate transactions. In addition, Glaxo Wellcome owns approximately 1.5% of
the outstanding capital stock of Catalytica Pharmaceuticals and owns a warrant
to purchase 2,000,000 shares of Common Stock which represents approximately
3.8% of the Company's outstanding capital stock. See "Item 5--Other
Information--Financing of the Acquisition."
20
PART II--OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On July 29, 1996, at the annual stockholder's meeting, a quorum of
stockholders of the Company approved the following proposals: (1) the re-
election of the Board of Directors; (2) issuance of Class A and Class B Common
Stock and Common Stock Warrants for the Acquisition of the Greenville
Facility; (3) Amendment of the Company's Certificate of Incorporation; (4)
amendment of the Company's 1995 Director Stock Option Plan to increase the
number of Shares of Common Stock reserved thereunder by 100,000 shares; (5)
amendment to the Company's 1992 Employee Stock Purchase Plan to increase the
number of shares of Common Stock reserved for issuance thereunder by 1,500,000
shares; (6) amendment to the Company's 1992 Stock Option Plan to increase the
number of shares of Common Stock reserved for issuance thereunder by 1,100,000
shares; and (7) ratification of the appointment of Ernst & Young LLP to serve
as the Company's independent auditors for the ensuing year.
Proposal 1. Election of Directors
DIRECTOR FOR AGAINST ABSTAIN
-------- ---------- --------- -------
James A Cusumano.............................. 13,146,340 0 638,000
Utz Felcht.................................... 13,146,340 0 638,000
Richard Fleming............................... 13,144,340 0 640,000
Ricardo B. Levy............................... 13,146,340 0 638,000
Ernest Mario.................................. 13,144,340 0 640,000
Yoshindo Tomoi................................ 12,929,281 0 855,059
John A. Urquhart.............................. 13,143,500 0 640,840
Proposal 2. Issuance of Class A and Class B Common Stock and Common Stock
Warrants for the Acquisition of the Greenville Facility
FOR AGAINST ABSTAIN
---------- --------- -------
13,136,939 615,201 32,200
Proposal 3. Amendment of the Company's Certificate of Incorporation
FOR AGAINST ABSTAIN
---------- --------- -------
13,655,689 93,701 34,950
Proposal 4. Amendment of the Company's 1995 Director Stock Option Plan to
increase the number of shares of Common Stock reserved thereunder by 100,000
shares
FOR AGAINST ABSTAIN
---------- --------- -------
13,051,965 692,110 40,265
Proposal 5. Amendment to the Company's 1992 Employee Stock Purchase Plan to
increase the number of shares of Common Stock reserved for issuance thereunder
by 1,500,000 shares
FOR AGAINST ABSTAIN
---------- --------- -------
13,618,261 130,979 35,100
Proposal 6. Amendment to the Company's 1992 Stock Option Plan to increase the
number of shares of Common Stock reserved for issuance thereunder by 1,100,000
shares
FOR AGAINST ABSTAIN
---------- --------- -------
10,607,282 3,138,353 38,705
21
Proposal 7. Ratification of Appointment of Independent Auditors
FOR AGAINST ABSTAIN
---------- ------- -------
13,747,169 7,171 30,000
ITEM 5. OTHER INFORMATION
ACQUISITION OF GLAXO WELLCOME MANUFACTURING FACILITY
GENERAL
On July 31, 1997 Catalytica Pharmaceuticals announced the completion of its
acquisition of a 1.8 million-square-foot pharmaceutical manufacturing facility
in Greenville, North Carolina (the "Facility") from Glaxo Wellcome Inc. (the
"Acquisition"). The transaction was financed through a combination of an
equity investment by Morgan Stanley Capital Partners and a debt facility with
a syndicate of banks led by The Chase Manhattan Bank. Shareholders approved
proposals necessary to complete the acquisition at Catalytica's annual meeting
on July 29, 1997.
Catalytica Pharmaceuticals will continue to manufacture many of the Glaxo
Wellcome pharmaceutical products that have been produced at the Facility in
recent years under a five-year, $800 million supply agreement between the two
companies. Plant capacity not dedicated to Glaxo Wellcome will be available to
fill orders from other Catalytica customers. The Greenville plant will be
managed by Gabriel R. Cipau, Ph.D., who has joined Catalytica Pharmaceuticals
as president and chief operating officer. Dr. Cipau was formerly senior vice
president in charge of the Greenville facility for Burroughs Wellcome Co.
prior to that company's merger with Glaxo in 1995.
DESCRIPTION OF THE ACQUISITION
Pursuant to an Asset Purchase Agreement dated June 25, 1997 by and among
Catalytica, Catalytica Pharmaceuticals and Glaxo Wellcome, on July 31, 1997,
Catalytica Pharmaceuticals acquired from Glaxo Wellcome (i) all the land,
buildings and improvements thereon and certain rights relating thereto
comprising the pharmaceutical manufacturing facility of Glaxo Wellcome located
in Greenville, North Carolina, and containing approximately 582 acres of land,
(ii) substantially all of the machinery, equipment, furniture, fixtures,
transportation and distribution equipment, waste treatment facilities,
computers, analytical equipment, instruments, communication equipment, control
systems, spare parts, supplies, materials and all other items of tangible
personal property owned by Glaxo Wellcome and located at the Facility, (iii)
certain permits and related regulatory requirements, certifications and
licenses from governmental or regulatory authorities used in operation of the
Facility and transferable by Glaxo Wellcome, (iv) certain contracts relating
to the operation of the Facility that are transferable or assignable by Glaxo
Wellcome and (v) certain existing inventories of work-in-process, raw
materials and other materials and supplies (collectively, the "Purchased
Assets").
The consideration paid by Catalytica Pharmaceuticals to Glaxo Wellcome for
the Purchased Assets consisted of (i) approximately $246.6 million in cash;
(ii) 250,000 shares of Junior Preferred Stock of Catalytica Pharmaceuticals;
(iii) warrants to purchase 2,000,000 shares of Common Stock of Catalytica at
an exercise price of $12.00 per share exercisable until July 31, 2003 (the
"Warrant Issuance"), and (iv) 10% of the earnings before interest and taxes in
excess of an aggregate cumulative amount of $10 million attributable to the
sterile products portion of the Facility, up to an aggregate cumulative
payment to Glaxo Wellcome of an additional $25.0 million.
The price of the Purchased Assets was determined on the basis of a
comprehensive analysis of the Facility and its capabilities, the Company's
prospects for additional pharmaceutical product business and the cash flows
the Company believed it could generate from operation of the Facility.
Following this analysis there was extensive negotiation with Glaxo Wellcome
with respect to the purchase price and the value of various elements of
Catalytica's acquisition proposal other than the cash payment. The Company did
not receive an independent
22
appraisal of the Facility, but conducted several internal evaluations and
produced various financial models related to the Acquisition.
FINANCING OF THE ACQUISITION
Simultaneous with the closing of the Acquisition, the Company closed a sale
of 13,270,000 shares of its Class A Common Stock and 16,730,000 shares of its
Class B Common Stock to Morgan Stanley Capital Partners III, L.P. and two
affiliated funds ("MSCP") (collectively, the "Stock Sale"), at a price of
$4.00 per share, for an aggregate of $120,000,000. As a result of the Stock
Sale, as of July 31, 1997 MSCP owns approximately 40% of the Company's
outstanding voting securities and approximately 60% of the Company's
outstanding securities on a fully converted basis.
The Class A Common Stock and Class B Common Stock have the following rights
and preferences:
Voting. The Class A Common Stock votes together with the Common Stock as a
single class, except that so long as MSCP owns in the aggregate not less than
20% of the Company's outstanding Common Stock, a separate class vote of the
Class A Common Stock will be required for (i) the issuance of any additional
capital stock that ranks senior or pari passu to the Class A Common Stock or
Class B Common Stock, (ii) any changes to the Company's Certificate of
Incorporation that would adversely affect the rights of the Class A Common
Stock or Class B Common Stock, and (iii) any merger or consolidation of the
Company that has an effect on the Class A Common Stock or Class B Common Stock
substantially similar to (i) or (ii) above. In addition, the approval of a
majority of the outstanding shares of Class A Common Stock will be required
before the Company can (a) enter into any arrangements which would affect the
capital structure or financing of the operations of the Company in excess of
$5,000,000 annually, other than an extension or renewal of any existing
indebtedness, (b) to authorize changes to the aggregate cash or equity
compensation of senior corporate officers of the Company and its subsidiaries,
or (c) to merge or consolidate the Company with or into another corporation or
the sale, transfer or lease all or substantially all of the assets of the
Company.
Dividends. There shall be no dividends on the Class A Common Stock. If a
dividend is paid on the Common Stock, the holders of the Class A Common Stock
shall be entitled to receive an amount equal to the amount which would have
been paid had the Class A Common Stock been converted to Common Stock in
accordance with its terms.
Catalytica has never declared or paid cash dividends on its capital stock.
The Company currently intends to retain its earnings to finance the operation
and expansion of its business and therefore does not expect to pay any cash
dividends in the foreseeable future.
Conversion. Each share of Class A Common Stock may be converted at the
option of the holder into shares of Common Stock at the then effective
conversion price. Each share of Class A Common Stock shall automatically
convert into Common Stock (i) upon any transfer by MSCP, including any
distribution to its partners or affiliated entities, or (ii) if less than 10%
of the shares of Class A Common Stock initially issued are outstanding. The
conversion price initially shall be $4.00 per share and shall be subject to
adjustment in certain cases as described below. The Company may issue up to
$25,000,000 of aggregate amount of capital stock or warrants to stockholders
of the Company prior to May 31, 1998 without triggering an adjustment to the
conversion price of the Class A Common Stock. In addition, the Company may
issue in the aggregate up to an additional $2,500,000 of capital stock or
warrants to stockholders of the Company without triggering an adjustment to
the conversion price of the Class A Common Stock provided that such additional
capital stock is issued in connection with the exercise of the warrants from
the Warrant Issuance.
Liquidation Preference. The liquidation preference of the Class A Common
Stock ranks senior to all other common stock and preferred stock at any time
outstanding of the Company unless agreed to by MSCP. The liquidation
preference of the Class A Common Stock will be equal to the greater of (i)
$4.00 per share plus any accrued and unpaid dividends (the "Liquidation
Preference"), and (ii) the amount that holders thereof would
23
have received in such liquidation had the Class A Common Stock been converted
to common stock in accordance with its terms. For purposes of this provision,
any merger, consolidation or other business combination as a result of which
the stockholders of the Company immediately before such transaction own less
than 50% of the total voting power of the surviving corporation or the sale of
all or substantially all of the assets of the Company shall in each case be
deemed a liquidation of the Company.
Other Terms. Appropriate adjustments shall be made to the liquidation and
conversion rights of the Class A Common Stock in cases of (a) stock splits,
reclassifications, stock dividends, rights offerings and similar events to
existing holders of Common Stock, and (b) in the event of issuance of Common
Stock or securities which are convertible into or which provide the right to
purchase Common Stock at less than fair market value at the time of issuance,
except in the case of shares or options issued or provided (i) upon conversion
of the Class A Common Stock or Class B Common Stock; (ii) to employees,
officers, directors and consultants of the Company pursuant to any employee
stock incentive plans or agreements; (iii) as a dividend or distribution on
the Class A Common Stock or Class B Common Stock; (iv) in connection with the
Acquisition of the assets or voting securities of another corporation or
entity; (v) upon exercise of warrants issued to Glaxo Wellcome in connection
with the Acquisition; (vi) upon issuance of up to $25,000,000 aggregate amount
of capital stock and/or warrants of the Company to stockholders of the Company
at any time prior to May 31, 1998; and (vii) in an underwritten public
offering that results in gross proceeds in excess of $5.0 million to the
Company.
The Class B Common Stock has the same powers, preferences and rights
described above as the Class A Common Stock, except that the Class B Common
Stock is convertible into Class A Common Stock, has no voting rights (except
as required by Delaware law) and has no right for the election of directors.
The shares of Class B Common Stock will, upon any transfer of such shares by
MSCP, be automatically converted into a like number of shares of Common Stock,
subject to adjustment upon certain events with respect to the Common Stock.
The shares of Class B Common Stock are convertible at the option of MSCP into
Common Stock or Class A Common Stock so long as such conversion results in
MSCP holding 40% or less of the Company's outstanding voting securities.
In addition, MSCP has the right, at any time after July 1, 1998, to request
the Company to effect a registration (a "Registration Request") of shares of
Common Stock issuable upon conversion of the Class A Common Stock and Class B
Common Stock held by it with an aggregate offering price of at least $15
million. MSCP is entitled to four Registration Requests. Registration Requests
may not be made within six months of any other Registration Request. In
addition, in the event the Company proposes to register any of its securities
for its own account or the account of any of its stockholders (other than
certain registrations relating solely to a stock option or other similar
employee benefit plan), MSCP will have the right, upon a timely request and
subject to a right of priority in favor of the Company, to have the Common
Stock issuable upon conversion of the Class A Common Stock and Class B Common
Stock included in such registration. All expenses of registration will be
borne by the Company, but any underwriters' fees, discounts or commissions
will be borne by MSCP.
In addition to the equity investment by MSCP, the Company, The Chase
Manhattan Bank ("Chase") and Chase Securities Inc. ("CSI") have entered into a
credit agreement pursuant to which a syndicate of banks led by Chase has
agreed to lend Catalytica Pharmaceuticals an aggregate of up to $200,000,000
(the "Debt Facilities"). The Debt Facilities consist of a senior secured term
loan facility (the "Term Debt Facility") in an aggregate principal amount of
$125,000,000 and a senior secured revolving facility (the "Revolving Debt
Facility") in an aggregate principal amount of $75,000,000. Up to $20,000,000
of the Revolving Debt Facility will be available for the issuance of letters
of credit. The Term Debt Facility will mature four and one-half years after
consummation of the Acquisition and will amortize in quarterly installments
commencing on the last day of the third fiscal quarter of 1998 in aggregate
annual amounts of (i) $50,000,000 in the year 1998, (ii) $37,500,000 in the
year 1999, (iii) $20,000,000 in the year 2000, and (iv) $17,500,000 in the
year 2001. The Revolving Debt Facility will mature four and one-half years
after consummation of the Acquisition.
All obligations of Catalytica Pharmaceuticals under the Debt Facilities are
guaranteed by the Company and each existing or subsequently acquired or
organized domestic (and, to the extent no adverse tax consequences
24
would result, foreign) subsidiary of the Company. The Debt Facilities,
including the guarantees, are secured by (i) substantially all of the assets
of the Company, Catalytica Pharmaceuticals and each existing or subsequently
acquired or organized domestic (and, to the extent no adverse tax consequences
would result, foreign) subsidiary of Catalytica Pharmaceuticals and (ii) a
first-priority pledge of (a) all the capital stock of Catalytica
Pharmaceuticals held by the Company and (b) all the capital stock held by the
Company or held by any domestic (and, to the extent no adverse tax
consequences would result, foreign) subsidiary of the Company or each other
existing or subsequently acquired or organized subsidiary of the Company.
Both the Term Debt Facility and the Revolving Debt Facility will initially
bear interest at an annual rate equal to the Adjusted London Interbank Offered
Rate ("Adjusted LIBOR") plus 1.25% or the Alternate Base Rate ("ABR") plus
0.255. Catalytica Pharmaceuticals is also required to pay a commitment fee on
the undrawn portion of the Debt Facilities initially equal to 0.375% per
annum. Commencing after the last day of the fourth full fiscal quarter after
the closing date in which Catalytica Pharmaceuticals has delivered to Chase
its consolidated financial statements for the applicable period, the spread
over Adjusted LIBOR and ABR and the amount of the commitment fee will be
determined by the relationship between the Company's consolidated earnings
before interest, taxes, depreciation and amortization ("EBITDA") and the then
aggregate amount of the Company's consolidated total debt outstanding (between
0.5% and 1.75% in the case of Adjusted LIBOR elections, 0% and 0.75% in the
case of ABR elections and 0.2% and 0.375% in the case of the commitment fee).
Commencing in fiscal 1998, loans under the Debt Facilities must be prepaid
with 75% of excess cash flow, 100% of net cash proceeds of all non-ordinary
course asset sales or other disposition of property of the Company and its
subsidiaries net of amounts to be agreed upon to be reinvested in the same
line of business within one year of the receipt thereof, subject to certain
limited exceptions, and 100% of the net cash proceeds of issuances of debt
obligations of the Company and its subsidiaries, subject to certain limited
exceptions.
The Debt Facilities contain negative covenants that are customary for debt
facilities and transactions of this type, including but not limited to
limitations on dividends to be paid on capital stock (including the Class A
Common Stock and the Class B Common Stock to be issued to MSCP, the Junior
Preferred Stock to be issued to Glaxo Wellcome and other preferred stock),
limitations on redemptions and repurchases of capital stock (including the
Class A Common Stock and the Class B Common Stock to be issued to MSCP, the
Junior Preferred Stock to be issued to Glaxo Wellcome and other preferred
stock), limitations on debt, limitations on capital expenditures, and
limitations on mergers, acquisitions and asset sales. In addition, the Debt
Facilities will have selected financial covenants, including a minimum
interest coverage ratio and a maximum leverage ratio. Events of default under
the Debt Facilities include but are not limited to nonpayment of principal or
interest, violation of covenants, cross defaults, bankruptcy, invalidity of
the guarantee or the security documents, failure of the Supply Agreement to be
in full force and effect and a change in control of the Company and Catalytica
Pharmaceuticals.
UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
The following information sets forth the unaudited pro forma consolidated
balance sheet of the Company as of June 30, 1997 and gives effect to (a) the
Stock Sale and Warrant Issuance and the borrowings under the senior bank
financing and (b) the use of proceeds therefrom to consummate the Acquisition,
as if such events occurred on June 30, 1997. The unaudited pro forma
consolidated balance sheet is based upon the historical consolidated financial
statements of the Company and should be read in conjunction with the financial
statements and the related notes thereto included in the 1996 annual report on
Form 10-K/A and the quarterly report on Form 10-Q/A for period ended March 31,
1997.
25
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
JUNE 30, 1997
(ALL AMOUNTS IN THOUSANDS)
PRO FORMA ADJUSTMENTS
-----------------------------------------------------
ISSUANCE AND
AS REPORTED BORROWINGS ACQUISITION AS ADJUSTED
----------- ------------ ----------- -----------
ASSETS
Current assets:
Cash and cash
equivalents........... $ 11,372 $249,077 (1) $(248,575)(2) $ 11,874
Short-term investments. 4,490 -- -- 4,490
Accounts receivable,
net................... 5,237 -- -- 5,237
Accounts receivable
from joint venture.... 332 -- -- 332
Note receivable from
employees............. 255 -- -- 255
Inventory.............. 1,705 -- 120,000 (3) 121,705
Prepaid expenses and
other acquisition
costs................. 4,573 -- (863)(9) 3,710
-------- -------- --------- --------
Total current assets. 27,964 249,077 (129,438) 147,603
Property and equipment... 10,196 -- 145,338 (3) 155,534
Other assets............. 3,520 (1) 3,520
Notes receivable from
employees............... 50 -- -- 50
-------- -------- --------- --------
$ 38,210 $252,597 $ 15,900 $306,707
======== ======== ========= ========
LIABILITIES AND
STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable....... $ 1,587 $ -- $ -- $ 1,587
Accrued payroll and
related expenses...... 1,623 -- -- 1,623
Deferred revenue....... 1,627 -- -- 1,627
Accrued acquisition
costs................. 1,069 -- -- 1,069
Other accrued
liabilities........... 749 -- -- 749
Borrowings under line
of credit............. 3,498 (3,498)(1) -- --
Current portion of
long-term debt........ 784 (344)(1) -- 440
-------- -------- --------- --------
Total current
liabilities......... 10,937 (3,842) -- 7,095
Long-term debt........... 1,285 138,646 (1) -- 139,931
Non-current deferred
revenue................. 4,287 -- -- 4,287
Other accrued
liabilities............. -- -- 6,400 (4) 6,400
Minority interest........ 8,000 -- 3,000 (5) 11,000
Class A and B Common
Stock shares authorized,
13,320,000 and
16,680,000 shares issued
and outstanding,
respectively(2)......... -- 117,829 (1) -- 117,829
Stockholders' equity:
Common Stock, $.001 par
value................. 20 -- -- 20
Additional paid-in
capital............... 66,050 -- 6,500 (6) 72,550
Deferred compensation.. (19) -- -- (19)
Accumulated deficit.... (52,350) (36)(8) -- (52,386)
-------- -------- --------- --------
Total stockholders'
equity.............. 13,701 (36) 6,500 20,165
-------- -------- --------- --------
$ 38,210 $252,597 $ 15,900 $306,707
======== ======== ========= ========
26
- --------
(1) Represents (i) the proceeds of $120 million derived from the issuance of
the Class A Common Stock and Class B Common Stock, net of related issuance
costs of $2.171 million and (ii) $139.6 million from the assumed
borrowings under the Senior Credit Facility, net of related issuance costs
of $3.519 million and repayment of existing borrowings of approximately
$4.832 million. Terms of the Class A and Class B Common Stock enable the
holders, at any time after July 1, 2005, the option to require the Company
to repurchase the outstanding shares of Class A and Class B Common Stock
for cash based on the original consideration paid for such shares on the
Closing Date of the Acquisition. In accordance with SEC regulations, the
Class A and Class B Common Stock is therefore not shown as part of equity.
(2) Represents the cash consideration for the acquisition of all of the land,
buildings, machinery and equipment of the Facility and certain
inventories, subject to a post-closing adjustment, in addition to the
payment of other transaction-related costs of $2.84 million and other
prepaid expenses. The post-closing adjustment will be made to reflect the
difference in actual and forecast inventories at the time of Closing.
(3) Represents the estimated fair value of the assets to be acquired, subject
to a post closing adjustment to reflect the difference in actual and
forecast inventories at the time of Closing. In addition, the valuation of
such assets is subject to finalization which will be based upon
independent appraisals. Does not include depreciation of property and
equipment, which will be depreciated over its economic useful life.
(4) Represents a reduction in the cash consideration to be paid by Glaxo
Wellcome in exchange for assumption of the liability relating to any
required asbestos remediation by Catalytica Pharmaceuticals.
(5) Reflects the estimated fair value of the 250,000 shares of junior
convertible preferred stock of Catalytica Pharmaceuticals provided as
additional consideration in connection with the Acquisition.
(6) Reflects the fair value of the warrants provided as additional
consideration in connection with the Acquisition which entitle Glaxo
Wellcome, at its discretion, to purchase 2,000,000 shares of the Company's
Common Stock at $12.00 per share.
(7) Not reflected in the unaudited pro forma consolidated balance sheet is the
additional consideration to Glaxo Wellcome of 10% of the earnings before
interest and taxes in excess of an aggregate cumulative amount of $10
million attributable to the sterile products portion of the Facility for a
period of 10 years following the Closing, limited to an aggregate
cumulative payment of an additional $25 million. To the extent that any
additional cash payments are made to Glaxo Wellcome as a result of the
agreement related to the Acquisition, such payments will be capitalized to
property, plant and equipment and depreciated over the appropriate useful
life of the Sterile Facility.
(8) Reflects interest expense and prepayment penalties related to repayment of
existing borrowings.
(9) Reflects prepaid property taxes and prepaid computer maintenance contracts
included in the consideration paid to Glaxo Wellcome for the acquisition,
which was offset by a $2 million credit from Glaxo Wellcome that was
related to an escrow deposit.
27
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
3.1 Corrected Fourth Amended and Restated Certificate of Incorporation of
the Company
4.1 Stock Purchase Warrant for 2,000,000 Shares of the Registrants Common
Stock dated July 31, 1997
+10.1 Asset Purchase Agreement Among Glaxo Wellcome Inc. and Catalytica
Pharmaceuticals, Inc. and Catalytica, Inc., dated June 25, 1997*
+10.2 Supply Agreement Between Glaxo Wellcome Inc. and Catalytica
Pharmaceuticals, Inc., dated July 31, 1997
10.3 Investment Agreement dated as of June 25, 1997 among Morgan Stanley
Capital Partners III, L.P., Morgan Stanley Capital Investors, L.P.,
MSCP III 892 Investors, L.P. and Catalytica, Inc.
10.4 $200,000,000 Credit Agreement dated July 31, 1997, by and among
Catalytica, Inc., Catalytica Pharmaceuticals, Inc. and The Chase
Manhattan Bank
10.5 Pledge Agreement
10.6 Security Agreement
27.1 Financial Data Schedule
- --------
+ Confidential treatment has been required as to a portion of this Agreement.
* The Company hereby undertakes to furnish supplementally a copy of any
omitted schedule of this Agreement to the Commission upon request.
(b) Reports on Form 8-K
None.
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.
28
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, 1997 CATALYTICA, INC.
(Registrant)
/s/ Lawrence W. Briscoe
By: _______________________________
Lawrence W. Briscoe
Vice President and Chief
Financial Officer
Signing on behalf of the
registrant and as principal
financial officer
29
EXHIBIT INDEX
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGES
------- ----------- ------------
3.1 Corrected Fourth Amended and Restated Certificate of
Incorporation of the Company
4.1 Stock Purchase Warrant for 2,000,000 Shares of the
Registrants Common Stock dated July 31, 1997
+10.1 Asset Purchase Agreement Among Glaxo Wellcome Inc. and
Catalytica Pharmaceuticals, Inc. and Catalytica, Inc.,
dated June 25, 1997*
+10.2 Supply Agreement Between Glaxo Wellcome Inc. and
Catalytica Pharmaceuticals, Inc., dated July 31, 1997
10.3 Investment Agreement dated as of June 25, 1997 among
Morgan Stanley Capital Partners III, L.P., Morgan
Stanley Capital Investors, L.P., MSCP III 892
Investors, L.P. and Catalytica, Inc.
10.4 $200,000,000 Credit Agreement dated July 31, 1997, by
and among Catalytica, Inc., Catalytica
Pharmaceuticals, Inc. and The Chase Manhattan Bank
10.5 Pledge Agreement
10.6 Security Agreement
27.1 Financial Data Schedule
- --------
+ Confidential treatment has been required as to a portion of this Agreement.
* The Company hereby undertakes to furnish supplementally a copy of any
omitted schedule of this Agreement to the Commission upon request.