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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the fiscal year ended December 31, 1998
or
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ____________ to
____________.
Commission File No. 0-20966
CATALYTICA, INC.
(Exact name of Registrant as specified in its charter)
Delaware 94-2262240
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
430 Ferguson Drive
Mountain View, California 94043
(Address of principal executive offices)
(650) 960-3000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
(Title of Class)
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
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
As of February 26, 1999, there were outstanding 28,429,380 shares of the
registrant's Common Stock, par value $.001, which is the only class of common
stock of the registrant registered under Section 12(g) of the Securities Act of
1933. As of that date, the aggregate market value of the shares of common stock
held by nonaffiliates of the registrant (based on the closing price for the
common stock on The NASDAQ National Market on February 26, 1999) was
$405,118,665. For purposes of this disclosure, shares of Common Stock held by
each officer and director of the Registrant and by each person who owns 5% or
more of the outstanding voting stock have been excluded in that such persons may
be deemed to be affiliates. This determination of affiliate status is not
necessarily a conclusive determination for other purposes. The Company also has
outstanding 13,270,000 shares of Class A Common Stock and 11,730,000 shares of
Class B Common Stock which are convertible into an equal number of shares of
Common Stock.
Documents Incorporated by Reference
The information called for by Part III is incorporated by reference to the
definitive Proxy Statement for the Annual Meeting of Stockholders of the Company
which will be filed with the Securities and Exchange Commission no later than
120 days after December 31, 1998.
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CATALYTICA, INC.
Annual Report on Form 10-K
Table of Contents
December 31, 1998
Page No.
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PART I
Item 1. Business 2
Item 2. Properties 28
Item 3. Legal Proceedings 29
Item 4. Submission of Matters to a Vote of Security Holders 29
PART II
Item 5. Market for the Registrant's Common Stock and
Related Stockholder Matters 30
Item 6. Selected Consolidated Financial Data 31
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 32
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 60
Item 8. Consolidated Financial Statements and
Supplementary Data 61
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 62
PART III
Item 10. Directors and Executive Officers of the Registrant 63
Item 11. Executive Compensation 63
Item 12. Security Ownership of Certain Beneficial Owners and
Management 63
Item 13. Certain Relationships and Related Transactions 63
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K 64
1
COMPANY INFORMATION
This report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Exchange Act of 1933 and Section 21E of the
Securities Exchange Act of 1934 which involve risks and uncertainties, including
statements regarding the Company's strategy, financial performance, and revenue
sources. The Company's actual results could differ materially from the results
anticipated in these forward-looking statements as a result of certain factors
including those set forth under "Item 7, Management's Discussion and Analysis of
Financial Condition and Results of Operations--Risk Factors" and elsewhere in
this report. Forward-looking statements include, but are not limited to, those
statements that are indicated by an asterisk (*). References to "Catalytica" and
the "Company" refer to Catalytica, Inc. and its subsidiaries.
ITEM 1. Business
Overview
Catalytica, Inc. ("Catalytica" or "the Company") builds business in high
growth industries where the Company's technologies optimize manufacturing and
solve environmental problems. To enhance its market focus, and increase
flexibility for strategic financial arrangements and business partnerships, the
Company has created three operating subsidiaries: Catalytica Pharmaceuticals,
Inc. ("Catalytica Pharmaceuticals"), Catalytica Combustion Systems, Inc.
("Combustion Systems"), and Catalytica Advanced Technologies, Inc. ("Advanced
Technologies").
Catalytica Pharmaceuticals provides the pharmaceutical and biotech industries
with comprehensive skills and demonstrated commercial experience in a broad
spectrum of areas extending from drug process development through drug
formulation, manufacturing and packaging. Combustion Systems applies proprietary
catalytic technologies to industrial gas turbines enabling the production of
clean, cost-effective electricity. Advanced Technologies identifies and develops
new technologies that offer potential value to industries where manufacturing or
environmental issues play a central role.
Catalytica's basic technology derives from new and improved catalytic systems.
A catalyst is a substance that initiates, accelerates, and determines the
products of a chemical reaction. In a catalytic process, compounds are changed
or combined at the molecular level to create a desired product. Highly selective
catalysts can improve industrial process economics by making possible more
efficient use of raw materials, reducing energy requirements, increasing
manufacturing yields and eliminating or minimizing the formation or use of
environmental pollutants. As a result, catalyst design and performance can have
a significant impact on operating and capital costs across a variety of
industries.
As a result of the broad applications of catalysis, the Company believes that
there are numerous untapped opportunities for its technology. However, it has
chosen to focus on what it believes are markets that offer substantial
opportunity and where gaining entry through its catalytic technologies offers a
competitive advantage.
Catalytica Pharmaceuticals, formerly known as Catalytica Fine Chemicals, began
operations to optimize the manufacture of chemical entities through the use of
catalysis. Following successful
2
endeavors in this area, Catalytica recognized the growing opportunities as a
development and manufacturing partner to the pharmaceutical industry,
expanding its scope significantly.* It is currently undertaking to capitalize
on market opportunities created by major changes that are occurring in the
pharmaceutical industry that are causing pharmaceutical companies to outsource
drug development and manufacturing activities.* These changes include
increased pricing pressures on pharmaceutical companies, the need to shorten
drug development cycles and more stringent environmental and FDA regulations.
In July 1997, Catalytica purchased a full-scale pharmaceutical manufacturing
operation in Greenville, North Carolina (the "Greenville Facility"). It
currently supplies a full range of products and/or services to customers that
include Allergan, Inc. ("Allergan"), Amgen, Inc. ("Amgen"), Astra USA, Inc.
("Astra"), CV Therapeutics, Inc. ("CV Therapeutics"), Glaxo Wellcome, Inc.
("Glaxo Wellcome"), IDEC Pharmaceuticals ("IDEC"), Monarch Pharmaceuticals
("Monarch"), Medeva Pharmaceuticals ("Medeva"), Pfizer, Inc. ("Pfizer"), Vertex
Pharmaceuticals, Inc. ("Vertex"), and Warner Lambert Company ("Warner Lambert").
Combustion Systems is developing its proprietary XONON(R) pollution prevention
system. Through the use of catalytic technology, XONON reduces or eliminates
certain toxic emissions produced by natural gas turbines, including NOx, carbon
monoxide and unburned hydrocarbons. Combustion Systems' proprietary products are
being developed for use by utilities and other users of power generation
systems. Combustion Systems is currently working with leading turbine
manufacturers, including: General Electric, Allison Engine Company, a subsidiary
of Rolls Royce, and Solar Turbines, a subsidiary of Caterpillar, Inc.
Advanced Technologies identifies and develops new commercial opportunities
where application of the Company's core expertise contributes unique value. It
is currently engaged in a number of research and development, consulting, and
special projects, primarily in the petroleum and petrochemical industries.*
Catalytica Pharmaceuticals
Industry Background
The pharmaceutical industry has been undergoing significant change over the
past several years. As part of that change, many pharmaceutical companies have
recognized that their competitive differentiation comes from effective drug
discovery and strong product marketing and sales. Focusing on these core
competencies has led to the outsourcing of other parts of the business.
Initial success in outsourcing certain functions, such as management of
clinical studies, data analysis of these studies, and manufacture of certain
intermediate agents for drugs, has led pharmaceutical industry participants to
begin to outsource other key activities, including the development of optimal
drug manufacturing processes, drug formulations, and the manufacture of the drug
products.* The market drivers for this outsourcing trend include:
Demands for Higher Productivity. Pressure on large pharmaceutical companies
to sustain the growth rates realized in the last several years has led to a step
change in the expectations of
3
the number of new drugs to be introduced commercially. Several pharmaceutical
companies have announced their intentions to bring three to five new chemical
entities ("NCEs") to market per year within the next two or three years. This
compares to the current industry average of less than one NCE introduced per
year. Therefore, to augment their own pipelines, a significant increase in the
numbers of strategic alliances has occurred. Between 1986 and 1996, a four
fold increase in these alliances has been realized as the established
companies attempt to harness the new compound pipelines of biotechnology start-
ups and virtual pharmaceutical companies.
Increased Competitive Pressures. An increase in the acceptance of lower-
priced generic drugs is causing pharmaceutical companies to scrutinize their
manufacturing operations for better utilization of resources that translate to
reduced manufacturing costs. Over the next few years a large number of branded
drugs will lose patent exclusivity, creating added competition from multiple
generic alternatives.
Increased pricing pressures. Increased penetration by managed health care
companies and a continued focus on the cost of publicly sponsored healthcare
programs, such as Medicare and Medicaid, has resulted in increasing pressure for
lower priced drugs. In order to maintain margins, pharmaceutical companies are
focusing on optimizing efficiencies in all aspects of their business, including
manufacturing.
Need to Shorten Drug Development Cycles. To shorten the "time to market" for
a new drug, pharmaceutical companies are focusing on cost effective chemical
development and optimization of product manufacturing protocols as early as
possible in the drug development cycle. As a result, they are turning to outside
suppliers that are capable of providing the full spectrum of drug manufacturing
needs from small research quantities to clinical trial samples to large
commercial volumes.
Efficient Use of Resources. Additional pressures are felt as the cost of the
R&D effort to bring a new drug to market has increased from an average of $231
million in 1987 to $500 million in 1997. This pressure has resulted in greater
demands for higher productivity throughout all phases of the drug development
process.
Requirement to Meet More Stringent FDA and Environmental Regulations. New FDA
regulations have resulted in increased demand for higher levels of drug purity
and increased environmental burdens are being imposed upon the pharmaceutical
industry due to significant toxic waste production that is a byproduct of
complex manufacturing processes. The increase in manufacturing costs due to
higher waste-handling and processing costs combined with requirements for higher
levels of drug purity has necessitated improvements in manufacturing processes.
Strategy
Catalytica Pharmaceuticals' objective is to become a compelling drug
development and manufacturing partner of pharmaceutical and biotechnology
companies by offering a fully integrated solution to pharmaceutical development
and manufacturing.
4
Consistent with its objective, Catalytica Pharmaceuticals has systematically
strengthened its capabilities in both the technical and manufacturing sides of
its business. Its technical endeavors have been focused on manufacturing
processes that are environmentally cleaner and that enable fewer chemical
reaction steps, require less equipment, utilize raw materials more efficiently,
optimize the pharmaceutical process, and improve drug formulation. Its
manufacturing efforts have focused on obtaining state of the art facilities that
will enable complete participation in every phase of the pharmaceutical drug
manufacturing process.
Catalytica Pharmaceuticals currently has research, pilot scale, and
manufacturing facilities that enable it to combine a strong technological
capability to develop manufacturing and drug formulation methods for
pharmaceuticals with a comprehensive manufacturing operation that can produce
products in a cost-effective, reliable, responsive, and high quality manner.
Thus, Catalytica Pharmaceuticals believes that it offers a fully integrated
solution to pharmaceutical manufacturing by providing the full spectrum of
participation in the drug development process, from early stage drug molecule
optimization to full scale drug production.*
Moreover, Catalytica Pharmaceuticals believes pharmaceutical companies have
recognized that establishing "preferred partners" for outsourcing yields
significant benefits.* It not only permits a tighter integration between the
supplier and the customer, but also establishes long-standing relationships that
engender confidence in the capabilities of the supplier. As such, Catalytica
Pharmaceuticals has established supply relationships with many pharmaceutical
and biotech companies and continues to work with these customers to expand its
relationships as well as seek new customers to further its market participation
in the industry.
History and Background
Catalytica has been engaged in research, development and optimization of
manufacturing processes for drug candidates and approved drug substances with
large pharmaceutical companies, such as Pfizer and Merck, since 1992. As a
result of this work, Catalytica Pharmaceuticals, previously known as Catalytica
Fine Chemicals, recognized both the growing trend toward outsourcing and the
necessity for cleaner and more efficient manufacturing processes within the
pharmaceutical industry.
Following careful assessment of these market opportunities and Catalytica's
ability to offer measurable advantages to the industry, Catalytica
systematically began to evaluate and acquire resources to become a major player
in the pharmaceutical outsourcing market. In December 1993, it acquired a
manufacturing facility in California as a first step to serve this growing
market opportunity. Combined with its established chemical research and
development capabilities, this acquisition permitted Catalytica Pharmaceuticals
to begin serving major pharmaceutical customers and to establish itself as a
viable and attractive supplier of intermediates utilized in drug substances.
In furtherance of its strategy, on July 31, 1997, Catalytica Pharmaceuticals
acquired the pharmaceutical development and manufacturing facility of Glaxo
Wellcome located in Greenville, North Carolina. The Greenville Facility was
purchased as a fully operating facility with three to five year contracts for
continuing manufacture of important
5
Glaxo Wellcome products. In addition to this business base, the site offered
additional capacity for new customer business.
With the acquisition of the Greenville Facility, Catalytica Pharmaceuticals
has an integrated capability to produce intermediate chemicals, to synthesize
bulk active drug substance, and to formulate and package final dosage form
products. The Greenville Facility also includes a state-of-the-art sterile
products facility capable of producing injectable formulations. Availability of
such sterile facilities is limited and therefore may offer a competitive
advantage to Catalytica Pharmaceuticals.*
The Company believes that the Greenville Facility permits Catalytica
Pharmaceuticals to offer a fully integrated supply capability that is unique
among outsourcing operations, and offer important advantages to potential
customers.* The Greenville Facility enables Catalytica Pharmaceuticals to
combine technological excellence and innovation with expanded manufacturing
scale and state of the art facilities.
Current Operations
Catalytica Pharmaceuticals currently operates a full service pharmaceutical
development and manufacturing operation. Its customers range from small biotech
companies that have little or no internal manufacturing capabilities to large
pharmaceutical companies that outsource manufacturing to numerous suppliers.
In 1998, Catalytica Pharmaceuticals' revenues were derived primarily from
production of Glaxo Wellcome products that were manufactured under its contracts
from the July 1997 acquisition of the Greenville Facility. In June 1998 and
March 1999, Catalytica Pharmaceuticals announced amendments to certain portions
of this supply agreement that extended production of certain products beyond the
term specified in the original supply agreement.
Several new customer contracts were initiated in the latter half of 1997 and
in 1998 that established the foundation for future growth and contributed
modestly to revenue in 1998. Because pharmaceutical drug manufacturing is a
highly regulated industry, it requires significant documentation and validation
of manufacturing processes and quality control assurance prior to approval of a
facility to manufacture a specific drug. As a result, there can be considerable
transition time between the initiation of a contract to manufacture product and
the actual initiation of manufacture of that product. Catalytica
Pharmaceuticals has entered into several supply agreements that are currently in
various phases of the FDA regulatory approval process. The impact of this
business cannot be fully realized until such approvals are achieved. Catalytica
Pharmaceuticals believes that there will be an increase in the percent of new
business contribution to revenue in 1999 and beyond.*
Catalytica Pharmaceuticals currently collaborates with a number of customers
in the development of efficient manufacturing processes at the research and
clinical samples stage and successfully scales-up such processes for the
manufacture of commercial volumes of drugs. In early 1996, Catalytica
Pharmaceuticals entered into a five-year cooperative process research and
development program with Pfizer to establish economically viable synthetic
methods for select drug
6
candidates in their pipeline. At the initiation of the agreement, Pfizer also
made an equity investment in Catalytica Pharmaceuticals. Consistent with its
objective to broaden its customer relationships, Catalytica Pharmaceuticals'
activity with Pfizer was expanded in 1998 to include the development of new
drug formulations.
Today Catalytica Pharmaceuticals customer list includes a number of key
pharmaceutical and biotech companies, including Allergan, Amgen, Astra, CV
Therapeutics, Glaxo Wellcome, IDEC, Monarch, Medeva, Pfizer, Vertex, and Warner
Lambert.
Technology and Expertise
Catalytica Pharmaceuticals has an extensive intellectual property base and
expertise in catalytic science and engineering, and through the Greenville
Facility acquisition, in product development and formulation. The Company's
staff draws on its experience of many years of catalytic process development in
the petroleum and petrochemical industry, where high yields and efficient
manufacturing represent important competitive factors. Catalytica's technical
staff includes organic and analytical chemists, and chemical engineers, many of
whom hold Ph.D.'s. These scientists have a broad background in the discovery,
development and scale-up of novel catalysts and catalytic processes that are
relevant to developing efficient manufacturing processes of pharmaceutical
intermediates and bulk actives and in the formulation and manufacturing of
pharmaceutical dosage forms.
In addition Catalytica Pharmaceuticals has an active program to identify
technology from external sources that are likely to provide commercial value. In
this regard, Catalytica Pharmaceuticals has been granted an exclusive license to
practice asymmetric hydrogenation technology developed by Professor Zhang at
Penn State University for applications in pharmaceutical and animal health
industries. Additionally, Catalytica Pharmaceuticals has been granted a license
to use a method for the asymmetric epoxidation of trans-olefins developed by
Professor Shi at Colorado State University. These two methodologies provide
novel means to establish chiral sites in drug molecules.
Manufacturing
The Greenville Facility
Catalytica acquired the Greenville Facility in July 1997 from Glaxo Wellcome,
a company formed as a result of the 1995 merger of Glaxo plc and Wellcome plc.
The site was originally developed by Burroughs Wellcome from a green field site
in 1969 to its current state through a series of construction programs over the
years. The latest and most advanced part of the facility, the sterile
manufacturing complex, was completed in 1995. The site comprises 584 acres of
land, approximately 165 of which are developed by 49 buildings totaling 1.77
million square feet of space. The site has approximately 1,250 full-time
employees. The employees are not represented by a labor union.
The site is used to develop and manufacture chemical intermediates and bulk
drug products and to formulate and package those drugs into individual dosage
forms for shipment both domestically
7
and internationally. Manufacturing at the site is conducted in three distinct
operations: chemical, pharmaceutical and sterile manufacturing. One of the
potential advantages of the Greenville Facility is the ability to integrate
the production and packaging in individual dosage form of the final
pharmaceutical product starting from relatively basic raw materials.*
Chemical Manufacturing Operations ("CMO"), involves the basic preparation of
the desired drug substance, in bulk form, primarily by chemical synthesis,
although one product, digoxin, is prepared by solvent extraction from leaves of
digitalis plants grown commercially for this purpose. Carefully selected and
purified raw materials are processed through complex chemical reactions under
tightly prescribed and controlled conditions. Each step typically involves
separation and purification of a derived intermediate chemical that then
proceeds to the next reaction step. The final reaction produces the desired drug
which then is separated, purified, dried, sometimes ground to appropriate
particle size, and then delivered to bulk storage. This bulk product may be
shipped as such to another site for further processing, passed to the
Pharmaceutical Production Operations ("PPO") facility for compounding into non-
sterile dosage forms and packaging, or delivered to the Sterile Production
Operations ("SPO") facility for further processing and ultimately sterile
packaging.
The chemical reactions involved in CMO manufacturing are carried out in
batches in closed, pressurized reaction vessels, generally 500-2,000 gallons in
capacity, in a liquid medium at carefully regulated temperature and pressure.
Depending on the reaction, such vessels may be glass-lined, stainless steel, or
another alloy material. Each such reactor is equipped with appropriate pumps,
condensers, separation equipment or other equipment as required by the process.
There is a high degree of automation and in many cases all important operating
variables are monitored and recorded by computer systems. Carefully documented
and approved quality control testing procedures are followed, results recorded,
and samples retained for future reference. The collection of equipment,
instrumentation, utilities, supplies and other services necessary to carry out
any particular reaction are considered a production module. Because of the
differences in specific reaction requirements, such modules may be well adapted
for certain reactions but not for others. Although modules are built to be
reasonably general purpose, there are certain limitations on their flexibility.
The CMO facility has 41,000 gallons of reactor capacity. A capacity increase
of 5,000 gallons was implemented in 1998 with expected commissioning in the
first quarter of 1999.* The primary unit of this new complex is a hydrogenation
vessel designed to allow the commercial exploitation of catalytic hydrogenation
technology developed by the Catalytica Pharmaceuticals research group. Several
modest capital projects were also implemented in 1998 to enhance the capacity of
the Greenville CMO facility through efficiency projects.
The majority of production capacity of the Greenville CMO facility is
committed to production of products for Glaxo Wellcome (See Glaxo Wellcome
Supply Agreement). However, in an effort to diversify its customer base,
Catalytica Pharmaceuticals has marketed the portion of its Greenville and Bay
View chemical facilities unused capacity to other pharmaceutical customers. The
effort to continue the diversification of the customer base has to date resulted
in commercial business with two additional top ten pharmaceutical companies. A
significant amount of progress has been made in establishing development
business for phase two and three drug candidates with non-
8
manufacturing pharmaceutical companies and virtual companies. In these
relationships the unique capability of Catalytica Pharmaceuticals to provide
both chemical and finished dosage development is of great value. Catalytica
Pharmaceuticals manufacturing is highly attractive to the new customer base as
it allows them to rely upon one vendor.*
Catalytica Pharmaceuticals CMO facilities are currently operating at near full
capacity. The Company believes that there is considerable unfulfilled demand
for products in this facility and is pursuing alternatives to enable increased
capacity for additional business.*
Pharmaceutical Production Operations ("PPO"). The PPO facility converts bulk
drug materials into final dosage forms. It also includes preparation of these
products into tablets and capsules as well as creams, ointments, and liquids. In
addition to the conversion of bulk drug materials into final dosage form, PPO
also processes and packages these products for distribution.
Formulating the final dosage form of the finished pharmaceutical involves
careful development of processes and ingredients suitable both to the specific
drug and the equipment through which it is processed. It must provide
appropriate bio-availability, efficacy, stability, appearance and identification
at the point of administration. Careful selection of the other ingredients of
the formulation and tight quality control are essential elements of these
operations.
Final dosage forms may be solids (such as tablets, caplets, or capsules),
liquids, creams, or ointments. In all cases the formulated dose will contain
other ingredients required to provide a readily usable, recognizable, effective
and stable product.
The packaged product may be intended for prescription use or over-the-counter
sales and must be dated and carefully tracked through the distribution system by
batch and/or lot number. Packaging can be in hospital unit dose packs, samples,
blister packages, plastic or glass bottles, pouches, tubes or foil packs. These
multiple forms require sophisticated equipment and inventory tracking systems.
Computer systems are used throughout this process to properly track and record
the processing and distribution of these products according to drug, form, dose,
personal package, distribution package and destination.
Catalytica Pharmaceuticals currently produces final dose form and/or packaging
for a number of pharmaceutical clients including Allergan, Glaxo Wellcome,
Monarch, Medeva, and Warner Lambert. There is currently excess manufacturing
capacity immediately available at the pharmaceutical facility. As a result of
a planned reduction in Glaxo Wellcome business and the long lead times required
to establish necessary regulatory approvals to manufacture at this facility,
Catalytica Pharmaceuticals anticipates a possible reduction in revenue from its
PPO facility in 1999.* If Catalytica Pharmaceuticals' is unable to use the
available capacity in its PPO facility or to reduce costs commensurate with
lower levels of capacity utilization, it would have an adverse effect on the
Company's consolidated results of operations.
Sterile Production Operations ("SPO"), involves the production of those
products that, by reason of their mode of administration, typically
intravenously or intramuscularly, must be aseptic
9
to avoid microbial contamination. These products are specifically processed to
establish aseptic conditions according to rigid standards in a production
facility that is isolated from other portions of the plant and especially
maintained for this purpose. The sterile manufacturing plant at the Greenville
Facility was completed in 1995 and includes state-of-the-art technology and
equipment for the production of sterile products. The new SPO facility, which
is in a separate building, is used for the manufacture of aseptic products
used predominately for injectable formulations.
The sterile facilities are characterized by high levels of isolation of
processing areas, significant automation, closed operating systems, limited
personnel access, specialized heating, ventilating and air conditioning systems,
and very high levels of data acquisition and recording.
Catalytica Pharmaceuticals believes there is considerable interest in the
manufacturing capabilities provided by its sterile facilities and has signed
agreements with a number of biotechnology and pharmaceutical companies,
including Amgen, Inc., Glaxo Wellcome, Monarch and Astra.* Because of the long
lead-times for regulatory approvals, the manufacture of new products is not
expected to commence for up to 18 24 months from the initiation of a contract,
at the earliest, except for clinical trial materials.* Catalytica
Pharmaceuticals believes the time and cost necessary to build and receive
regulatory certification of a new SPO facility creates a significant barrier to
entry by new competitors.*
Bay View Facility
Catalytica Pharmaceuticals owns and operates a flexible, multi-purpose,
commercial scale chemical manufacturing plant in East Palo Alto, California,
which has approximately 12,000 gallons of reactor capacity set up in a wide
range of reactor sizes. The facility was acquired from Novartis in December
1993.
Glaxo Wellcome Supply Agreement
Amendments to the Original Glaxo Wellcome Supply Agreement. In June 1998 and
March 1999, Catalytica Pharmaceuticals announced amendments to the original
Glaxo Wellcome supply agreement (See "Original Glaxo Wellcome Supply Agreement"
below) that provided for the continued manufacture of certain products at the
Greenville Facility. The announcement in June 1998 increased production of
certain Glaxo Wellcome products in Catalytica Pharmaceuticals' CMO facility in
Greenville in 1998 and 1999. It anticipated a revenue increase of approximately
$50 million, about one-quarter of which was expected to be realized in the
second half of 1998 and the remainder in 1999.* To accommodate the increased
production, a modest amount of capital equipment, funded by both companies, was
added to the Greenville Facility. The announcement in March 1999 provides for
manufacture of certain products over the next two years from production of Glaxo
Wellcome products in Catalytica's Pharmaceutical Production Operations ("PPO")
at its Greenville Facility and for options to extend production of these
products for 2 years beyond the year 2000. Catalytica Pharmaceuticals believes
that over the initial two-year term of the amended agreement, potential revenues
may exceed $70 million.* The amendment also enables Glaxo Wellcome to extend the
sterile products manufacturing portion of the agreement for up to four years
beyond the original expiration date of 2000.
Original Glaxo Wellcome Supply Agreement. In connection with the purchase of
the Greenville Facility in July 1997, Glaxo Wellcome entered into a five-year
Supply Agreement under
10
which Catalytica Pharmaceuticals has agreed to manufacture certain products
for Glaxo Wellcome. This arrangement provides for a transition period for the
reduction of the manufacture of Glaxo Wellcome products and allowed Catalytica
Pharmaceuticals the time to develop new customers and meet certain regulatory
requirements for commencing production of new products under new contracts.
Catalytica Pharmaceuticals estimates that aggregate payments (including the cost
of materials) by Glaxo Wellcome under the original Supply Agreement will total
approximately $800 million over the five year life of the agreement.* Subsequent
amendments to the original supply agreement may provide for approximately $120
million in revenue over a two and one-half year period commencing July 1998 (See
"Amendments to the Original Glaxo Wellcome Supply Agreement" above). A portion
of this additional revenue has been guaranteed by Glaxo Welcome, however; the
majority of this additional revenue is based on a forecast for production as
defined by Glaxo Wellcome in the amended agreement. As such, the forecasted
revenues are subject to fluctuations based on actual production demand by Glaxo
Wellcome.*
Under the terms of the original supply agreement, as well as certain terms of
the amended agreement, Glaxo Wellcome has guaranteed that revenues paid to
Catalytica Pharmaceuticals will meet a minimum level or Glaxo Wellcome will pay
to Catalytica Pharmaceuticals any shortfall. The minimum revenues, which include
compensation for transition services that Catalytica Pharmaceuticals has agreed
to provide Glaxo Wellcome and which exclude the cost of materials in each of the
next five years, are as set forth below in millions of dollars.*
August 1 -
December 31, 1997 1998 1999 2000 2001 Total
------------------ ------ ------ ----- ----- -------------
Total $77.0 $173.4 $113.8* $72.6* $22.6* $459.4*
The price for each product, excluding the cost of materials, is set forth in
the Supply Agreement. The terms of the Supply Agreement provide for reductions
in prices for certain products over time. Pursuant to the Supply Agreement,
Glaxo Wellcome also reimburses Catalytica Pharmaceuticals for the actual costs
of materials used in the production of products delivered to Glaxo Wellcome.
Under the terms of the Supply Agreement, Glaxo Wellcome is to provide periodic
forecasts of its future demand for various products and Catalytica
Pharmaceuticals is committed to produce the products required, with certain
limitations, provided the required production capacity does not exceed the
capacity committed to Glaxo Wellcome. For production requests in excess of the
capacity committed to Glaxo Wellcome, Catalytica Pharmaceuticals has agreed to
undertake to accommodate Glaxo Wellcome's requests with pricing to be negotiated
on terms that reflect then market pricing.
In addition, Catalytica Pharmaceuticals has agreed to produce certain
specialty products for Glaxo Wellcome during the period June 30, 2001 to June
30, 2002 at prices to be negotiated prior to February 2001.
In addition to the minimum revenues set forth above, Glaxo Wellcome will
reimburse Catalytica Pharmaceuticals an aggregate of $4.0 million for certain
software upgrades necessary to achieve Year 2000 compliance at the Greenville
Facility.*
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The provisions of the Supply Agreement related to the production of chemical
and sterile products may only be terminated with two years prior written notice.
Notice of termination may only be given on or after the second anniversary of
the date of the Supply Agreement with respect to the provisions related to the
chemical products. In addition, Glaxo Wellcome has a right to extend the term
of the agreement with respect to one or more pharmaceutical products for up to
an additional twelve months and with respect to one or more of the sterile
products for up to four consecutive quarterly periods. The agreement may be
terminated immediately by the affected party upon a material uncured default by
the other party. A change in control of Catalytica or Catalytica Pharmaceuticals
may also result in the right of Glaxo Wellcome to terminate the agreement.
Catalytica has guaranteed Catalytica Pharmaceuticals' obligations under the
Supply Agreement.
Chemical Manufacturing Operations. Glaxo Wellcome has committed under the
original Supply Agreement to a specified level of reactor capacity at the
chemical facility for each calendar year and has agreed to pay certain
guaranteed revenues whether or not it utilizes this capacity. In addition,
beginning in the second half of 1998, Glaxo Wellcome has reserved an additional
1,500 reactor gallons for each calendar year through the first half of 2001.
However, Glaxo Wellcome is required to give three calendar quarters notice of
its intention to utilize this reserved capacity and, if it chooses to use the
capacity, to pay a specified amount that Catalytica Pharmaceuticals believes
reflects then current market conditions.
In June 1998, Glaxo Wellcome amended its supply agreement to enable additional
manufacture of products through the second half of 1998 and the remainder of
1999. This amended agreement increased the original estimates for capacity
utilization from Glaxo Wellcome business in 1998 and 1999.
Pharmaceutical Production Operations. The obligation under the original Supply
Agreement with Glaxo Wellcome for pharmaceutical products was in effect until
December 31, 1998, for products other than cytotoxics and certain specialty
products, and December 2000, for cytotoxics and certain specialty products. In
addition, Catalytica Pharmaceuticals acted as a subcontractor of Glaxo Wellcome
for another pharmaceutical company. Contracts with other existing third party
customers of the Greenville Facility were assigned or subcontracted to
Catalytica Pharmaceuticals upon the closing of the acquisition of the Greenville
Facility from Glaxo Wellcome.
Pharmaceutical production of cytotoxic and certain specialty products are
conducted in areas of the Greenville Facility dedicated to the production of
these types of products.
Catalytica Pharmaceuticals announced in March 1999, that it had amended the
Original Glaxo Supply Agreement to provide for the manufacture of certain
products over the next two years from production of Glaxo Wellcome products in
Catalytica's PPO facility and for options to extend production of these products
for 2 years beyond 2000. (See "Amendments to the Original Glaxo Wellcome Supply
Agreement" above).
Sterile Production Operations. The obligation under the original Glaxo
Wellcome Supply Agreement for production of sterile products is effective
through December 2000.
12
Catalytica Pharmaceuticals announced in March 1999, that it had amended the
Original Glaxo Wellcome Supply Agreement to enable Glaxo Wellcome to extend the
sterile products manufacturing portion of the agreement for up to four years
beyond the original expiration date of 2000. (See "Amendments to the Original
Glaxo Wellcome Supply Agreement" above).
Employment Matters. On July 31, 1997 Catalytica Pharmaceuticals hired the vast
majority of the Greenville Facility's employees and supplemented its management
team and employee base with experienced personnel where appropriate. As of
December 31, 1998, there were approximately 1,250 employees at the Greenville
Facility. Catalytica Pharmaceuticals has hired personnel to perform marketing,
sales, research and development, contract support, and administration functions.
With the combination of the management teams and employee base of Catalytica
Pharmaceuticals at the Bay View facility, plus selective additions, Catalytica
Pharmaceuticals believes it can continue to effectively operate the Greenville
Facility and develop new business as the level of business with Glaxo Wellcome
declines.*
Environmental Matters. Glaxo Wellcome has been working with the U.S. EPA and
the North Carolina Department of Environmental and Natural Resources ("NCDENR")
to investigate, identify and remediate contamination in the soil and groundwater
at the Greenville Facility now owned by Catalytica Pharmaceuticals. This
investigation, carried out pursuant to the federal Resource Conservation and
Recovery Act, has identified 17 different areas of the Greenville Facility where
contamination has or may have occurred. Of these 17 areas, at least six have
been identified as requiring further investigation and remediation ("Site
Contamination"). Contaminants found in the soil and groundwater at the
Greenville Facility include solvents, petroleum hydrocarbons and pesticides.
While the new owner of the Greenville Facility, Catalytica Pharmaceuticals, has
become legally liable for such contamination. Notwithstanding, such legal
liability, Glaxo Wellcome has agreed to be primarily liable for and to perform,
at its cost, the remediation required by law for contamination of the soil and
groundwater existing at the Greenville Facility as of the date Catalytica
purchased the facility. It is unknown at this time what further remediation will
be required at the Greenville Facility and the cost of such remediation.
Catalytica Pharmaceuticals is also required, pursuant to an environmental
agreement between Catalytica Pharmaceutical and Glaxo Wellcome, to provide
access to the Greenville 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 Greenville Facility. In addition, the Company's future development of the
Greenville 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 Greenville Facility will
not cause additional contamination. The determination of the existence and cost
of any such additional contamination contributed by Catalytica Pharmaceuticals
or 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.
13
Commensurate with the closing of the acquisition of the Greenville Facility,
Catalytica Pharmaceuticals and Glaxo Wellcome entered into additional agreements
regarding certain environmental matters including a release of Glaxo Wellcome
from certain liabilities relating to asbestos containing materials and a
memorandum of understanding between Catalytica Pharmaceuticals and Glaxo
Wellcome indicating to NCDENR that Glaxo Wellcome will be primarily liable for
any pre-closing site contamination. See "Item 2. Properties."
Competition
Catalytica Pharmaceuticals believes that the key competitive factors in the
pharmaceuticals manufacturing industry include reliability of supply, product
quality, ability to comply with environmental and FDA regulations, capacity,
price, and the technical and manufacturing ability to produce a full range of
quantities from small batches for clinical trials to large commercial
quantities.* Catalytica Pharmaceuticals believes it competes favorably with
respect to these factors. Catalytica Pharmaceuticals' primary competition is
from pharmaceutical companies that produce their own fine chemicals and finished
dosage form and to a lesser extent from other independent fine chemical and
dosage form manufacturers. Many of Catalytica Pharmaceuticals' competitors have
substantially greater financial resources than Catalytica Pharmaceuticals.
Catalytica Pharmaceuticals' Management and Directors
As part of the Company's strategy to create focused business units, Catalytica
Pharmaceuticals has assembled a management group that includes dedicated senior
executives and independent directors who provide relevant industry expertise.
The directors and management of Catalytica Pharmaceuticals include:
Name Age Position with Catalytica Pharmaceuticals
- --------------------------------------- ---- ------------------------------------------------
Barry M. Bloom 70 Director
Richard Fleming 74 Director
Thomas L. Gutshall 60 Director
Ricardo B. Levy 53 Director
Ernest Mario 60 Director
James A. Cusumano 56 Chairman of the Board and Chief Strategic Officer
Gabriel R. Cipau 57 President, Chief Executive Officer and Director
Lawrence W. Briscoe 54 Chief Financial Officer and Director
Barry M. Bloom, Ph.D., has been a director of Catalytica Pharmaceuticals since
February 1995. He retired in September 1993 from Pfizer, Inc. where he was most
recently Executive Vice President, Research and Development since 1992, and a
member of the Board of Directors since 1971. Dr. Bloom was with Pfizer, Inc.
since 1952, where he served in executive level positions since 1971. He is a
member of several corporate Board of Directors, including Cubist
Pharmaceuticals, Inc., Neurogen Corp., Incyte Pharmaceuticals, Inc. and Vertex
Pharmaceuticals, Inc. Dr. Bloom was a member of the United States Congressional
Commission on the Federal Drug Approval Process
14
and the Pharmaceutical Manufacturers Association Commission on Drugs for Rare
Diseases. He has a Ph.D. in organic chemistry from the Massachusetts Institute
of Technology.
Richard Fleming has been a director of Catalytica Pharmaceuticals since 1995.
Mr. Fleming has been a director of Catalytica since 1985 and also serves as an
advisor and consultant to Catalytica. Mr. Fleming was President and Chief
Executive Officer of the Company from 1985 through August 1991. From 1969 to
1980, Mr. Fleming served at Air Products and Chemicals, most recently as
Executive Vice President, and from 1980 to 1981, he served as President and
Chief Operating Officer of GAF Corporation, a chemical company. He has served as
President and Chief Executive Officer of Richard Fleming Associates, Inc., a
consulting firm, since May 1981 and is past Vice Chairman for Membership and
Fiscal Affairs of the Chemical Industry Institute of Toxicology. Mr. Fleming has
an M.S. in chemical engineering from New York University.
Thomas L. Gutshall has been a director of Catalytica Pharmaceuticals since
February 1995. He has been Chief Executive Officer and Chairman of Cepheid since
August 1996. Mr. Gutshall was President and Chief Operating Officer of CV
Therapeutics, Inc. from January 1995 to August 1996, and has 35 years of
experience in specialty chemicals, pharmaceuticals, and diagnostics. Mr.
Gutshall served in executive level positions with Syntex Corp. from 1981 to
1994, most recently as Executive Vice President from June 1989 to August 1996.
He previously served with Mallinckrodt Inc., lastly as Vice President and
General Manager, Drug and Cosmetic Chemicals Division. Mr. Gutshall has a B.S.
in chemical engineering from the University of Delaware and is an alumnus of the
Harvard Executive Marketing Program.
Ernest Mario, Ph.D. has been a director of Catalytica Pharmaceuticals and
Catalytica, Inc. since July 1996. Dr. Mario has been Co-Chairman and Chief
Executive Officer of ALZA since August 1993. Prior to joining ALZA, Dr. Mario
was Deputy Chairman and Chief Executive Officer of Glaxo Holding p.l.c., having
served in a variety of executive positions with Glaxo, Inc., beginning in 1986.
From 1977 to 1984, he held various executive level positions with Squibb
Corporation, ending as President and Chief Executive Officer of Squibb Medical
Products. Dr. Mario is a member of the Board of Directors of several companies,
including Advanced Technology Labs, COR Therapeutics, and Pharmaceutical Product
Development Co. Dr. Mario has a Ph.D. and M.S. in physical sciences from the
University of Rhode Island, and a B.S. in pharmacy from Rutgers University. He
is a licensed pharmacist in the states of New York and Rhode Island, and an
adjunct professor of pharmacy at the University of Rhode Island.
Gabriel R. Cipau, Ph.D., was promoted to Chief Executive Officer of Catalytica
Pharmaceuticals in October 1998 and now holds the titles of President, CEO, and
Director of Catalytica Pharmaceuticals. He joined Catalytica in August 1996 as
a consultant, and in August 1997 he became President and COO of Catalytica
Pharmaceuticals, Inc., and a member of the Catalytica Pharmaceuticals, Inc.
Board of Directors. Previously, Dr. Cipau was President and CEO of Copley
Pharmaceutical, Inc. from July 1995 until August 1996, and President and CEO of
Nippon Wellcome K.K. from September 1993 until July 1995, and Executive Director
of Wellcome plc. From 1970 until 1993, he held various positions at Burroughs
Wellcome Co., including Sr. Vice President Production and Engineering. Dr. Cipau
holds Ph.D. and B.S. degrees in Chemical Engineering and Physics from
Polytechnic Institute, Timisoara, Romania, an MBA degree from Duke University,
and an M.S. in Chemistry from East Carolina University.
15
James A. Cusumano, Ph.D., and Ricardo B. Levy, Ph.D., who are directors of
Catalytica Pharmaceuticals, are also officers and directors of Catalytica, Inc.
For information on the business backgrounds of Messrs. Cusumano and Levy, see "-
- -Catalytica, Inc.--Executive Officers."
Lawrence W. Briscoe, who is a director of Catalytica Pharmaceuticals, is also an
officer of Catalytica, Inc. For information on the business backgrounds of Mr.
Briscoe, see "--Catalytica, Inc.--Executive Officers."
Catalytica Combustion Systems
Overview
With the advent of deregulation in the U.S. and growing industrialization
throughout the world, the power generation industry faces a growing demand for
power with a concomitant need to comply with more stringent environmental
protection requirements.* The widely embraced solution for most power
generation participants lies in the use of gas turbines that burn natural gas.
This solution is cleaner than other fossil fuels, offers more efficient energy
production when combined with steam turbines, has shorter construction lead
times, and lower aggregate installation cost per kilowatt hour than alternative
power generation methods.
Despite these advantages, natural gas turbines remain major sources of air
pollution. Without pollution prevention or clean-up processes, a gas turbine
generates nitrogen oxide ("NOx") emissions, a major contributor of air
pollution, of 75 to 200 parts per million ("ppm"). These levels are not
acceptable for turbines in most areas of the United States. For example, in
several metropolitan areas of the United States, new gas turbines have been
required to achieve NOx emission levels of 5 ppm or lower to obtain permits for
installation. Levels achieved by current emission prevention technologies are no
longer adequate in many regions of the United States. Clean-up processes can be
used to reduce emissions further but result in increased costs and the use of
caustic chemicals (See "Current Emissions Control Approaches" below).
Catalytica Combustion Systems manufactures XONON, a proprietary pollution
prevention technology, that is designed to significantly reduce emissions of NOx
to less than 3 ppm. It currently has collaborations with gas turbine and power
utility suppliers.
Industry Background
Gas turbine suppliers include General Electric Power Systems ("GE"), Seimens-
Westinghouse, ABB, Rolls Royce, and its subsidiary, Allison Engine Company
("Allison"), Solar Turbine ("Solar"), Kawasaki, and Pratt & Whitney Canada
("PWC").
These suppliers collectively offer a range of turbine sizes and applications
that are typically divided into two market segments: the utility power
generation market which is further divided into a public utilities sector and a
private sector and the industrial applications market.
Utility Power Generation. The utility power generation segment is comprised
principally of public utilities that operate large turbines ranging from 50 to
250 megawatts, with an average size of
16
approximately 100 megawatts. The principal users of these turbines are major
electric utilities and independent power producers. GE and its affiliates are
estimated to have over a 60% share of the worldwide public utility power
generation market.
Another segment of the power generation market is the private sector, also
referred to as the distributed power segment, which consists of smaller turbines
located close to, or at, the power user's site. The turbines utilized in this
segment range in size from under 1 megawatt to 50 megawatts, with an average
size of approximately 15-20 megawatts. GE and Solar currently have the majority
of this market. Other participants include Allison, European Gas Turbines and
Kawasaki. PWC has recently announced new engines targeted at this market.
Industrial Applications. The industrial applications segment is comprised of
small- and medium-size turbines generally ranging from less than 1 to 25
megawatts, with an average turbine size of approximately 10 megawatts. The
principal users of these turbines are non-utility industrial power generators
and mechanical drive turbines such as those used for processing and transmission
of natural gas in pipelines. Rolls-Royce and Solar together have a majority of
the worldwide market for this size range of gas turbines. Other traditional
suppliers include European Gas Turbines, ABB, and GE.
Market
The total installed base of natural gas turbines in the United States is
approximately 50,000 megawatts, which is estimated to be less than 40% of the
worldwide installed base. One megawatt is sufficient energy to provide power to
approximately 1,000 households or to power two 350,000 square foot commercial
buildings.
Utility Power Generation Market. According to PowerData, a market information
service, the world market for utility power generation has been approximately
1000 turbines per year for the past 10 years and is expected to grow at a
similar rate for the next 10 years.*
The private sector of the utility power generation market is expected to grow
quite rapidly as the deregulation of the power industry manifests itself
throughout the United States and the rest of the world*. Many of these user
sites are located in densely populated areas with strict emission control
requirements. Combustion Systems believes that this will be a significant
market for turbines with ultra-low emissions.*
Industrial Power Generation Market. According to Forecast International, a
market information service, the world market for industrial power generation and
mechanical drive gas turbines is projected to grow at an average rate of 10,000
megawatts per year.* The United States market for industrial power generation is
believed to represent approximately 25% of the world market.
17
Current Emissions Control Approaches
Natural gas turbines currently utilize diffusion flame combustors that operate
at peak flame temperature of about 1800 degrees centigrade (degrees C), or 3270
degrees Fahrenheit (degrees F). Without emissions controls or clean-up
processes, combustion at these temperatures results in unacceptable levels of
NOx emissions of between 75 and 200 ppm. Reducing the operating temperature in
the combustor to 1500 degrees C (2700 degrees F), or below, to the operating
temperature of the turbine blades virtually eliminates production of NOx.
Current technologies are unable to achieve such reduction without dramatically
reduced efficiencies. Two methods have been used to reduce combustor
temperature: wet controls and lean pre-mix. Neither can reduce combustion
temperature to 1500 degrees C, and therefore a post combustion clean up process
is required to achieve acceptable emission levels in many areas of the United
States.
Wet controls, a once-popular prevention technology for reducing NOx, reduces
the peak flame combustor temperature by injecting water or steam into the
turbine combustor. NOx emission levels can be reduced to about 42 ppm with
water and about 25 ppm with steam injection. However, the use of water and steam
requires that purified water be available at the site location. Capital and
operating costs can significantly increase if sufficiently pure water is not
readily available and extensive water clean-up is required. Additionally,
corrosion induced by water impurities can cause serious turbine damage over a
relatively short time period. These reasons, as well as the relatively high
levels of NOx still produced, have significantly limited the use of wet controls
as an adequate NOx control technology.
A second NOx prevention approach currently used to reduce gas turbine
emissions by reducing temperature utilizes a control technology that is
generally referred to as lean pre-mix or dry-low-NOx ("DLN"). DLN is a
combustion process in which natural gas and air are premixed prior to entering
the combustor to provide a low fuel to air ratio. Turbine manufacturers
utilizing this approach achieve emission levels of approximately 15-25 ppm, and
are undertaking development to achieve emission levels in the 10 to 15 ppm range
in the next product generation. Compared to wet controls, DLN capital costs are
moderate to high and operating costs are low to moderate. Operating costs are
projected to increase as emissions are reduced below 25 ppm, due to induced
"noise" (vibrations), which adversely affect reliability. In many areas, these
lower levels are still not adequate to meet the required emission levels.
The most common post combustion clean-up process is selective catalytic
reduction ("SCR"). SCR reduces NOx emissions by approximately 80%. For example,
a turbine with NOx emissions at 25 ppm can be reduced by 80%, to about 5 ppm,
with the addition of an SCR unit. Capital and operating costs of this approach
add significantly to the overall cost of producing power. In addition, the
natural gas turbine operator must store and handle large quantities of ammonia,
a toxic, hazardous substance.
18
Catalytica's Approach
In contrast to competitive combustion technologies, Combustion Systems'
product, marketed under the name XONON, is designed to reduce the high
temperatures created in conventional combustors to below 1500 degrees C at full
power generation, which results in less than 3 ppm formation of NOx, and
virtually no formation of carbon monoxide or unburned hydrocarbon emissions.
XONON uses a proprietary flameless process in which fuel and air react on the
surface of a catalyst in the turbine combustor to produce energy (the hot gases)
which drive the turbine.
Combustion Systems believes that the XONON system provides the lowest level of
emissions achievable with any emission prevention technology at gas turbine
operating conditions.* Combustion Systems has tested the durability of the XONON
catalytic combustion system for over 7,000 hours at atmospheric pressure and for
over 1,200 hours in an operating gas turbine with no degradation in system
performance. Turbine emissions levels obtained in Combustion Systems' tests of
the XONON system at full turbine operating conditions have been as low as 0.5
ppm for NOx, 0.8 ppm for carbon monoxide and 1.7 ppm for unburned hydrocarbons.
Emission results from two separate operating gas turbines, including the newly
commissioned turbine at the Silicon Valley Power utility, are consistent with
Combustion Systems' earlier tests. Results in a series of tests conducted by
GE, Solar, and AGC Manufacturing Services, Inc. ("AGC") have supported the
emissions results obtained by Combustion Systems.
Combustion Systems has demonstrated that the XONON system will provide
superior emissions reduction performance and competitive costs compared to
alternative technologies.* The XONON system is expected to have capital and
operating costs that are similar to DLN while offering significant advantages in
emissions.* Additionally, the XONON system is expected to provide significant
first cost and life cost advantages over SCR systems.* Once the technology is
commercially applied, Combustion Systems believes it will be accepted as best
available control technology ("BACT"), lowest achievable emissions rate ("LAER")
technology and reasonably available control technology ("RACT") for reduction of
NOx in natural gas turbines.* BACT, LAER and RACT are the benchmarks by which
the Environmental Protection Agency ("EPA"), and state and local regulatory
authorities decide which emissions control technologies will be required for
specific installations.
Commercialization Strategy
Combustion Systems' XONON product is designed to reduce NOx and other toxic
emissions to well below current required levels.* It is a replacement part that
is designed to fit inside each combustor on a turbine. Large turbines, such as
those used in the utility power generation market require an average of 10-18
combustors per turbine, while smaller industrial turbines require one or more
combustors. Combustion Systems expects to generate revenues from the manufacture
and initial sale of XONON products installed in each combustor of new turbines
and in existing turbines as well as the ongoing sale of XONON replacement units
based upon an average expected life of approximately 8,000 operating hours (one
year of full-time operation).*
19
To commercialize the XONON system, Combustion Systems is developing and
manufacturing products for the utility and distributed power generation markets
as well as the industrial applications markets through collaborative
relationships with leading manufacturers in these market segments.
In November 1998, GE and Combustion Systems signed a definitive agreement
under which GE and Combustion Systems expects to develop and market XONON for
use on GE turbines, including new turbines and for the retrofit of existing
turbines. In addition to GE, this agreement extends to GE's wholly owned
subsidiaries, including Nouvo Pignone, an Italian producer of small gas
turbines.
In January 1998, Enron, the largest customer of stationary gas turbines,
announced its intentions to use XONON extensively in their utility power
generation, distributed power generation and pipeline compressor applications.
At the initiation of the agreement, Enron also made an equity investment in
Combustion Systems.
Combustion Systems is also working with Kawasaki, PWC, Rolls-Royce, Allison,
and Solar, leading manufacturers of small- to medium-sized turbines. Combustion
Systems is conducting a development program to investigate the application of
Combustion Systems' catalytic combustion technology to these gas turbines.
Because of the large installed base of Solar, Kawasaki, and Allison turbines,
Combustion Systems believes there is a significant retrofit market opportunity
for many of these turbines used by gas processors and gas transmission companies
which face increasing emissions regulation in the United States.*
In the industrial applications area, Combustion Systems has completed testing
of its XONON system at AGC, a company that manufactures and markets small co-
generation systems to deliver power and steam to industrial users. In December
1997, these collaborative tests achieved a major milestone for XONON, and a
first for the power generation industry, by completing a 1,000 hour, successful
run on the Kawasaki turbine at low NOx emissions. In October 1998, Combustion
Systems announced the attainment of another major milestone when a Kawasaki
turbine with XONON was commissioned by a utility, Silicon Valley Power, to
produce power for the electric power grid.
Collaborative Relationships
Combustion Systems is pursuing the market opportunity in large turbines used
by electric utilities and independent power producers through working with
GE, the world's largest manufacturer of natural gas turbines. This collaboration
began in 1991 and has recently resulted in the aforementioned definitive
agreement between Combustion Systems and GE to develop and market XONON for use
on GE turbines. GE is continuing to fund the development of the XONON system for
application in GE turbines and this effort is expected to significantly increase
in light of the recent agreement.* Combustion Systems anticipates that one or
two additional years of development will be necessary to complete the design of
a commercial system for large turbines.*
20
In January 1998, Enron Ventures Corp. ("Enron Ventures"), a wholly owned
subsidiary of Enron Corp., purchased a 15 per cent minority interest in
Combustion Systems for $30 million. Enron also received a three-year option to
purchase an additional five per cent of Combustion Systems for $14.4 million in
cash. This relationship is an important piece of the Company's plans to
commercialize the XONON System. Enron Ventures is one of the world's largest
integrators of natural gas and electricity supply. Pursuant to the terms of the
investment, Thomas E. White, the Vice-Chairman of Enron Energy Services, was
appointed to the board of directors of Combustion Systems.
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 company, GENXON(TM) Power Systems, LLC, has focused on upgrading the
combustion systems of older installed turbines with XONON. Each company
contributed capital (in the form of a commitment payable over time) and a
limited license for use of their respective technologies. These licenses are
limited to cover only applications serving the retrofit of out-of-warranty
turbines not supported by original equipment manufacturers ("OEMs").
Regulatory Overview
In the United States, the Clean Air Act and amendments of 1970, 1979 and 1990
(collectively, the "Clean Air Act"), provide the regulatory guidelines for the
emissions of NOx, carbon monoxide and unburned hydrocarbons. The Clean Air Act
establishes the emission levels that must be met by power generation sources.
However, the emission requirements for specific sites are defined at the state
and local level.
Under the Clean Air Act, the EPA establishes ambient air quality standards.
Areas which meet these standards are considered "attainment areas," while areas
not meeting these standards are considered to be "non-attainment." In areas that
are considered to be non-attainment, the regulations require the emissions of a
new gas turbine to be "offset," i.e., if a new turbine is going to exceed a
specified emissions level, the user must offset the entire emissions of the
project so that the net increase of emissions for the area is zero. In many
cases there is a multiplier applied to the new emissions, so that the new
project combined with the "offset" must actually provide a net decrease in
emissions.
One of the ways to meet the offset requirements is to make contemporaneous
reductions of emissions at the same facility. As part of bringing a new project
on line, emission reductions at the facility are made by introducing controls on
existing equipment at the location or by taking existing equipment out of
service. If it is not possible to make sufficient contemporaneous reductions at
the facility, then the user must obtain Emission Reduction Credits ("ERC's")
from one of their own locations or from someone else's location to offset the
emissions from the project. There is a developing market for ERC's which
provides economic value to sources with credits available from their emission
reductions and establishes the cost for those who must acquire such credits.
In 1997, against a backdrop of continued strong public and political support
for clean air initiatives, the US EPA issued significantly more stringent
regulations for ground-level ozone
21
(smog), and particulate matter (soot). Since nitrogen oxide is both a principal
component of smog and a contributor to the formation of fine particulate matter,
NOx reduction moved to the forefront of the energy planning agenda. Towards the
end of the year, with the convening of the Kyoto conference on climate change,
the nations of the world agreed on the terms of a treaty for reducing emissions
of "greenhouse gases," which many scientists believe are contributing to the
warming of the global climate. The treaty mandates reductions in six greenhouse
gases, of which NOx is among the top three.
In addition to environmental requirements in the United States, there are
increasing regulatory requirements relating to emissions in many other
countries, particularly Japan and in Western Europe.
Tanaka Development Agreement
Catalytica has developed its catalytic combustion technology since 1988 under
a development agreement with Tanaka, Kikinzoku Kogyo ("Tanaka"), a major
Japanese precious metals company, under which Tanaka funded a significant amount
of the development effort until 1994. In January 1995, Catalytica and Tanaka
entered into a new agreement for further development and commercialization of
the catalytic combustion technology that supersedes their original agreement.
The new agreement divides commercialization rights to the technology between the
parties along market and geographic lines. Catalytica has exclusive rights to
manufacture and market catalytic combustion systems for large gas turbines
(greater than 25 megawatts power output) on a worldwide basis and for small- and
medium-sized gas turbines (25 megawatts power output or less) produced by OEMs
based in the Western Hemisphere and in Western Europe. Tanaka has reciprocal
exclusive rights to manufacture and market catalytic combustors for use in
automobiles on a worldwide basis and for OEMs of small- and medium- sized
turbines based in regions outside of Catalytica's area of exclusivity. In each
case, the manufacturing and marketing party will pay a royalty on net sales to
the other party. Under this new agreement, each party is responsible for its own
development expenses, and any invention made after May 1, 1995, is the sole
property of the party making the invention with the other party having a right
to obtain a royalty-bearing, nonexclusive license to use it in its areas of
exclusivity.
Combustion Systems Patents
Catalytica has an active patent program for its technology. A total of 15
patents have been issued in the United States and six United States patent
applications are pending for Combustion Systems' catalytic combustion
technology. Corresponding foreign applications have been filed in countries that
Combustion Systems believes represent significant markets throughout the world
pursuant to the PCT Patent Convention. These patents and patent applications
cover various aspects of the catalytic combustion technology, including catalyst
compositions, catalyst structure and design, multistage catalytic combustion
concepts, and certain modifications to gas turbine combustors.
22
Competition
Combustion Systems expects to compete in some markets with the DLN systems
being developed by the turbine manufacturers, including General Electric,
Allison, and Solar, for their own turbines.* Combustion Systems also competes
with manufacturers of SCR and other clean-up systems. All of its competitors
have substantially greater financial resources and larger research and
development staffs than Combustion Systems. The turbine manufacturers are also
potential customers of Combustion Systems and Combustion Systems expects to rely
on these customers to help commercialize its products.* If these turbine
manufacturers focus solely on their own solutions and products in these markets,
Combustion Systems' competitive position in the OEM market would be materially
adversely affected.
Combustion Systems' Management and Directors
As part of Combustion Systems' strategy to create focused business units,
Combustion Systems has assembled a management group that includes dedicated
senior executives and independent directors who provide relevant industry
experience. The directors and management of Combustion Systems include:
Name Age Position with Combustion Systems
- -------------------------- --- -------------------------------------
William B. Ellis 58 Director
Frederick O'Such 61 Director
Ricardo B. Levy 53 Director
John A. Urquhart 70 Director
Thomas E. White 55 Director
Dennis A. Orwig 52 President, CEO, and Director
Lawrence W. Briscoe 54 Chief Financial Officer and Director
Ralph Dalla Betta 53 Vice President and Chief Scientist
William B. Ellis joined the Board of Directors of Combustion Systems in
September 1995. Mr. Ellis is a Senior Fellow of the Yale University School of
Forestry and Environmental Studies. Mr. Ellis retired as chairman of Northeast
Utilities in 1995, where he also served as chief executive officer from 1983 to
1993. Mr. Ellis joined Northeast Utilities in 1976 as its Chief Financial
Officer. Mr. Ellis was a partner with McKinsey & Co. from 1969 to 1976. Mr.
Ellis serves on several other Boards of Directors, including the Connecticut
Mutual Life Insurance Company and Radian Corporation. He has a Ph.D. in chemical
engineering from the University of Maryland.
Frederick O'Such has served as a director of Combustion Systems since 1995. He
served as Group Vice President with Gulton Industries, Inc. from 1963 to 1970.
From 1970 to 1981, Mr. O'Such served as Group President and Vice President-
Corporate Development with Envirotech Corporation. From 1981 to 1986, Mr. O'Such
served as CEO of Xertex Corporation. Mr. O'Such currently is President and CEO
of Xertex Capital. Mr. O'Such is a member of several Boards of Directors, and
holds an MBA from Harvard University and a B.S. in Chemical Engineering from
Lehigh University.
23
John A. Urquhart has served as a director of Combustion Systems since April
1997. He was also elected to serve as a director of Catalytica in April 1997. He
was the Vice Chairman of Enron Corp., a global integrated natural gas company,
from 1990 to 1998, and currently serves as Senior Advisor to the Chairman.
He serves on a number of corporate Boards of Directors including TECO Energy,
Inc., Weir Group PLC, and Tampa Electric Co. He previously served as the Senior
Vice President of Industrial and Power Systems at General Electric.
Thomas E. White joined the board of Combustion Systems in January 1998. Mr.
White was named Chairman and Chief Executive Officer of Enron Power Corp., a
wholly owned subsidiary of Enron Corp. in 1991 and assumed the title of Vice
Chairman at Enron Operations Corp. in 1993 and Enron Energy Services in 1998.
Mr. White joined Enron Corp. in 1990 after retiring as a Brigadier General from
the United States Army, following 23 years of military service. Mr. White holds
a B.S. in engineering from the United States Military Academy and a Master's
degree in operations research from the United States Naval Post Graduate School.
Dennis A. Orwig joined Combustion Systems in April 1996 as Executive Vice
President, and was named President and Director of Combustion Systems in June
1996. Prior to Combustion Systems, he spent three years as an executive in the
Office-of-the-President of Elliott Company, a manufacturer of products for the
power generation and petrochemical industries. From 1989 to 1993, Mr. Orwig
served as President and Chief Executive Officer of ABB Power Generation, Inc. He
previously served as Vice-President and General Manager of Combustion
Engineering Corporation and in various executive positions at AccuRay
Corporation. Mr. Orwig holds B.S. degrees in Chemical Engineering and Pulp &
Paper Science from Miami University, and has an advanced degree from Duke
University.
Ralph A. Dalla Betta, Ph.D., joined Catalytica in 1976 and serves as the Chief
Scientist of Catalytica and Vice President of Combustion Systems. Dr. Dalla
Betta's major interests are in the design and synthesis of heterogeneous
catalysts, the detailed characterization of catalyst structure and surface
properties, and catalyst testing. Prior to joining Catalytica, Dr. Dalla Betta
spent 4 years at Ford Motor Company where he worked on emissions control
catalysis in the period when catalytic converters were first applied
commercially to automobiles. His development work has included catalytic
combustion systems that produce low NOx emissions, selective hydrogenation
catalyst systems and a rapid technique for measuring noble metal surface areas
for analyzing vehicle emissions control catalysts. Dr. Dalla Betta has a Ph.D.
in physical chemistry from Stanford University.
Ricardo B. Levy, Ph.D., who is a director of Combustion Systems, is also an
officer and director of Catalytica, Inc. For information on his business
background, see "--Catalytica, Inc.--Executive Officers."
Lawrence W. Briscoe, who is a director of Combustion Systems, is also an officer
of Catalytica, Inc. For information on his business background, see "--
Catalytica, Inc.--Executive Officers."
24
Advanced Technologies
Advanced Technologies is engaged in a number of research and development, new
business development, and special projects, primarily in the petroleum and
petrochemical field. Advanced Technologies' goal is to identify and develop new
commercial opportunities where application of the Company's core technology
expertise potentially contributes substantial and unique value.*
In 1998, Advanced Technologies advanced its program to supply
single-site organometallic catalysts and catalyst precursors for the polyolefin
industry. Advanced Technologies formed an equally owned joint venture with
United Catalysts, Inc., a subsidiary of the Sud-Chemie Group of Munich, Germany,
for the custom manufacturing, process development, and marketing of
organometallic catalysts. The new company, a Delaware limited liability company
named Single-Site Catalysts L.L.C., is focusing initially on a new class of
single-site catalysts employed in the manufacturer of polymers, using
proprietary synthesis technology previously developed by Catalytica. Sud-Chemie
Group Catalyst Companies, primarily through United Catalysts, is contributing
the initial capital as well as worldwide marketing and sales efforts to the new
venture to help expand and accelerate the commercialization activities. Advanced
Technologies has contributed its proprietary production technology in developing
and manufacturing single-site catalysts as well as its relationships with its
existing customers.
Single-Site Catalysts is assisting its customers, primarily polyolefin
manufacturers, with the development and commercialization of organometallic
single-site catalysts, a recently discovered class of chemical compounds that
produces highly controlled polymerization reactions. Organometallic single-site
catalysts are used in the development of new grades of plastics, such as
polyethylene and polypropylene, to impart desirable qualities such as increased
impact strength and toughness, better melt characteristics, and improved clarity
in films. Building on the work of Catalytica, the joint venture is providing
scaleable process development for these new catalysts enabling their manufacture
with high purity specifications which has provided enhanced catalysts
performance during customer evaluations. Commercial manufacture of single site
organometallic catalysts for the joint venture will continue at one of
Catalytica's manufacturing facilities.
As part of the goal to apply the Company's core expertise as broadly as
possible, Advanced Technologies is also pursuing opportunities to capitalize on
Combustion Systems' XOXON catalytic combustion technology in applications other
than gas turbines.*
Catalytica, Inc.
Human Resources
At December 31, 1998, Catalytica and its subsidiaries employed approximately
1,400 employees. The Company is not subject to any collective bargaining
agreements. Catalytica believes that it maintains good relations with its
employees.
25
Executive Officers
The executive officers of the Company are as follows:
Name Age Position
Ricardo B. Levy 53 President, Chief Executive Officer and
Director
James A. Cusumano 56 Chairman of the Board and Chief
Strategic Officer
Lawrence W. Briscoe 54 Vice President, Finance and
Administration, and Chief Financial
Officer
Ralph A. Dalla Betta 53 Vice President and Chief Scientist
John M. Hart 51 Vice President, Human Resources
At December 31, 1998, there were five individuals designated as executive
officers by the Board of Directors. The following sets forth certain information
with regard to the executive officers of Catalytica who are not Directors, with
the exception of Ricardo Levy and James Cusumano:
Ricardo B. Levy, a founder of Catalytica and a director since 1974, served as
Chief Operating Officer from the Company's inception in 1974 until August 1991,
when he became President and Chief Executive Officer. Prior to founding
Catalytica, Dr. Levy was a founding member of Exxon's Chemical Physics Research
Team. Dr. Levy is an alumnus of Princeton and Harvard University's Executive
Management Program, and has a Ph.D. in chemical engineering from Stanford
University.
James A. Cusumano, a founder of Catalytica and a director since 1974, served
as President of the Company from its inception in 1974 until 1985, when he
became Chairman of the Board and Chief Technical Officer. In 1998, Dr. Cusumano
became Chief Strategic Officer. From 1992 to 1998 he served as President and
Chief Executive Officer of Catalytica Pharmaceuticals. Dr. Cusumano served as
Director of Catalysis Research and Development at Exxon's Corporate Research
Laboratory from 1967 to 1974. Dr. Cusumano has a Ph.D. in physical chemistry
from Rutgers University.
Lawrence W. Briscoe joined Catalytica in July 1994 as Chief Financial Officer
and Vice President, Finance and Administration. Prior to joining the Company, he
held various executive and financial positions including President and Chief
Operating Officer and Director of Brae Corporation, Vice President of Corporate
Development at Transamerica Corp., and Chief Executive Officer of U.S.
Commercial Telephone Corp. Mr. Briscoe has an M.B.A. from Stanford University,
an M.S. in business from the University of Southern California, and a B.S. in
electrical engineering from the University of Missouri.
Ralph A. Dalla Betta has served as Vice President since 1979 and has been
Chief Scientist at Catalytica since 1976. From 1972 to 1976 Dr. Dalla Betta
worked at Ford Motor Company's Catalysis Group in the Fuel Sciences Department.
Dr. Dalla Betta has a Ph.D. in physical chemistry from Stanford University.
John M. Hart joined Catalytica in 1998 after serving as a consultant in human
resources strategic planning, management and organization development to several
major corporations. Prior to that,
26
Mr. Hart was Senior Vice President, Human Resources for USL Capital, Inc., the
financial services company of Ford Motor Company, and between 1991-93, he held a
similar position at U.S.F.& G. Corporation. Between 1984 -1991, Mr. Hart was
Senior Vice President at Heller International. Mr. Hart has a B.S. in Management
Science from Rensselaer Polytechnic Institute and an M.B.A. from Fairleigh
Dickenson University.
Risk Factors
For a discussion of various risk factors applicable to the Company and its
subsidiaries see "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations - Risk Factors."
27
Item 2. PROPERTIES
Catalytica's headquarters and research and development facilities, based in
Mountain View, California, occupy four buildings covering approximately 85,000
square feet. The Company's lease expires on December 31, 2003, with a five-year
option for renewal. The Company's research and development facility is adequate
for the Company's needs for the foreseeable future.*
Catalytica's Pharmaceuticals' manufacturing facilities are located in
Greenville, North Carolina and East Palo Alto, California. The pharmaceutical
manufacturing facility located in Greenville, North Carolina, ("Greenville
Facility") was purchased from Glaxo Wellcome on July 31, 1997. The site
comprises 584 acres of land, approximately 165 of which are occupied by 49
buildings totaling 1.77 million square feet of space. The site is used to
manufacture chemical intermediates and bulk drug products and formulate and
package those drugs into final dosage forms for shipment both domestically and
internationally. A key strategic advantage of this facility is the ability to
integrate the production and packaging in individual dosage form of the final
pharmaceutical product starting from relatively basic raw materials.*
There is contamination in the soil and groundwater of the pharmaceutical
manufacturing facility Catalytica Pharmaceuticals purchased from Glaxo Wellcome
in 1997. Glaxo Wellcome has been working with the EPA and the North Carolina
Department of Environment and Natural Resources to investigate, identify and
remediate contamination in the soil and groundwater at the Greenville Facility.
This investigation has identified 17 different areas of the Greenville Facility
where contamination has or may have occurred. Of these 17 areas, at least six
have been identified by the North Carolina Department of Environment and Natural
Resources as requiring further investigation and remediation. 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 is legally liable for such contamination. Glaxo Wellcome,
however, has agreed to be primarily liable for and to perform, at its cost, the
remediation that is required by law to cure the contamination of the soil and
groundwater that existed at the Greenville Facility on the date the Greenville
Facility was acquired by Catalytica Pharmaceuticals. The Company does not know
the cost or the extent of remediation that is required at the Greenville
Facility to cure the contamination.
In an effort to facilitate the remediation, the Company entered into an
agreement with Glaxo Wellcome that requires it to provide Glaxo Wellcome with
access to the Greenville Facility and certain facility services as required for
the remediation. Glaxo Wellcome has agreed to reimburse the Company for the
costs of such access. The Company, however, cannot assure you that its costs
will be reimbursed by Glaxo Wellcome or that it will not suffer any interference
with ongoing operations because of Glaxo Wellcome's remediation activities or
the existence of contamination at the Greenville 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.
Catalytica Pharmaceuticals' ongoing operations at the Greenville Facility may
also cause additional contamination. The determination of the existence and
cost of any such additional contamination contributed by Catalytica
Pharmaceuticals could involve costly and time-consuming
28
negotiations and litigation. Furthermore, any such contamination caused by
Catalytica Pharmaceuticals could materially adversely affect the business,
results of operations and financial condition of Catalytica Pharmaceuticals, and
consolidated results of operations and financial condition.
A moderate amount of asbestos containing material ("ACM") is present at the
Greenville Facility. The Company believes that the ACM, in its present
condition, does not require abatement. Abatement is only required if
renovations are performed in those areas containing ACM. The Company assumed
the liability associated with the abatement of the ACM present at the Greenville
Facility under the purchase agreement with Glaxo Wellcome. During 1998, the
Company began performing some asbestos abatement, and reduced the liability
accordingly.
The facility in East Palo Alto, California is on approximately five acres. The
Company owns the buildings, but leases the land at the site from Rhone Poulenc
Inc. The initial lease term is 15 years and expires on November 30, 2008, after
which the Company has options to extend for two five year periods, and one four-
year option to extend the lease term after expiration of the first two option
periods. See "Risk Factors Current and Potential Environmental Contamination
at Catalytica Pharmaceuticals' Two Facilities May Cause Disruption of
Manufacturing and Create Additional Liabilities."
Item 3. LEGAL PROCEEDINGS
From time to time the Company is subject to legal proceedings and claims in
the ordinary course of business. The Company is not currently aware of any
legal proceedings or claims that the Company believes will have, individually or
in the aggregate, a material adverse effect on the Company's business, results
of operations and financial condition.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the stockholders of the Company
during the fourth quarter of the fiscal year covered by this report.
29
Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Common Stock
Catalytica's Common Stock is traded in the NASDAQ National Market under the
symbol "CTAL." The following table shows the range of high and low closing
prices of Catalytica's Common Stock as reported by the NASDAQ National Market by
quarter for 1998 and 1997. Such prices represent interdealer prices and do not
include retail mark-ups or mark-downs or commissions and may not represent
actual transactions.
1998 1997
----------------------------------- ---------------------------------
High Low High Low
---------------- ----------------- ---------------- ---------------
Quarter ended 3/31 $13 15/32 $ 10 3/4 $11 3/4 $ 3 7/8
Quarter ended 6/30 19 5/8 12 13/16 13 5/8 7
Quarter ended 9/30 20 3/16 10 3/16 15 3/8 9 1/2
Quarter ended 12/31 18 7/8 13 3/4 13 7/8 10 1/8
At February 28, 1999, there were approximately 603 holders of record of the
Company's Common Stock.
The market price of the Common Stock has been and is likely to be highly
volatile. Factors such as the results of research and development and pilot
scale testing by Catalytica and its collaborative partners, the effectiveness
and commercial viability of products of Catalytica or its competitors, changes
in environmental regulations, announcements of technological innovations or new
products by the Company or its competitors, fluctuations in the Company's
operating results, including changes in the rate of growth and profitability of
its Pharmaceuticals business, and changes in recommendations by financial
analysts could have a significant impact on the future price of the Common
Stock. In addition, stock markets have experienced extreme price volatility in
recent years. This volatility has had a substantial effect on the market prices
of securities issued by many companies for reasons that may be unrelated to the
operating performance of the specific companies. These broad market
fluctuations may adversely affect the market price of the Common Stock.
During 1997, the Company issued 30,000,000 shares of Class A and B Common
Stock at $4.00 per share to Morgan Stanley Capital Partners III, L.P. and two
affiliates ("MSCP") in connection with the acquisition of the Glaxo Wellcome
manufacturing facility in Greenville, North Carolina. None of these shares are
publicly traded. In November of 1997, the Company repurchased 5,000,000 of the
Class B Common Stock from MSCP at $4.75 per share with the proceeds from the
issuance of a warrant dividend. See "Note 11 of Notes to Consolidated Financial
Statements."
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.
30
Item 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table presents selected financial data of Catalytica. This
historical data should be read in conjunction with the Consolidated Financial
Statements and the related Notes thereto in Item 8 and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" in Item 7. No
cash dividends were declared in any of the periods presented.
Year Ended December 31,
(In thousands, except per share amounts)
---------------------------------------------------------------------------------
1998 1997 1996 1995 1994
--------------- ---------------- -------------- -------------- -------------
Revenues:
Product sales $367,448 $174,347 $ 9,813 $ 8,858 $ 5,800
Research and development 7,708 6,599 6,501 4,766 6,395
-------- -------- ------- ------- -------
Total revenues 375,156 180,946 16,314 13,624 12,195
Net income (loss) before common stock
redemption 20,763 310 (5,192) (8,687) (9,145)
Premium paid on common stock
redemption -- (3,750) -- -- --
-------- -------- ------- ------- -------
Income (loss) attributable to common
shareholders $ 20,763 $ (3,440) $(5,192) $(8,687) $(9,145)
======== ======== ======= ======= =======
Basic earnings (loss) per share (1) $ 0.39 $ (0.10) $ (0.27) $ (0.55) $ (0.61)
Diluted earnings (loss) per share (1) $ 0.33 $ (0.10) $ (0.27) $ (0.55) $ (0.61)
Cash, cash equivalents, short-term, and
long-term investments $ 47,585 $ 47,067 $23,821 $20,902 $13,614
Total assets 347,396 328,873 41,003 31,239 22,186
Long-term debt 67,007 75,069 1,524 1,556 1,573
Stockholders' equity 76,577 52,110 17,263 22,029 15,779
(1) Net income (loss) per share in 1997 reflects a reduction in net income of
$3.75 million relating to the premium paid for the repurchase of five million
shares of Class B Common Stock with proceeds received from the exercise of
warrants issued to stockholders as a dividend.
31
ITEM 7. 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, which involve
risks and uncertainties including but not limited to those statements which have
been identified by an asterisk ("*") and other statements regarding the
Company's strategy, financial performance and revenue sources. The Company's
actual results could differ materially from the results anticipated in these
forward-looking statements as a result of certain factors including these set
forth under "Risk Factors" and elsewhere in this Report.
Catalytica, Inc. ("Catalytica" or "the Company") builds business in high
growth industries where the Company's technologies optimize manufacturing and
solve environmental problems.* To enhance its market focus, and increase
flexibility for strategic financial arrangements and business partnerships, the
Company has created three operating subsidiaries: Catalytica Pharmaceuticals,
Inc. ("Catalytica Pharmaceuticals"), Catalytica Combustion Systems, Inc.
("Combustion Systems"), and Catalytica Advanced Technologies, Inc. ("Advanced
Technologies").
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 "Greenville Facility") located
in Greenville, North Carolina (the "Acquisition"), in exchange for (i) $244.7
million in cash (after certain post closing adjustments); (ii) 250,000 shares of
Junior Preferred Stock of Catalytica Pharmaceuticals convertible into the
Company's common stock; (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 prior to July 31, 2007, in excess of an
aggregate cumulative amount of $10 million attributable to the Sterile
Production Operations ("SPO") portion of the Greenville Facility, up to an
aggregate cumulative payment to Glaxo Wellcome of an additional $25.0 million.
Upon consolidation of Catalytica Pharmaceuticals into Catalytica, Inc., the
Junior Preferred Stock issued to Glaxo Wellcome, Inc. is reflected as $3 million
of minority interest.
To raise the cash needed to complete the Acquisition, the Company used a
combination of equity and debt financing. With the closing of the Acquisition,
the Company completed the 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. The
Class A and B stock are convertible into common stock of the Company on a share
for share basis. In November of 1997, the Company repurchased 5,000,000 of the
Class B MSCP shares at $4.75 per share with the proceeds from the issuance of a
warrant dividend granted to its stockholders in connection with the financing of
the acquisition.
In addition to the equity investment by MSCP, the Company, The Chase Manhattan
Bank ("Chase") and Chase Securities Inc. ("CSI") entered into a Credit Agreement
pursuant to which a syndicate of banks led by Chase agreed to lend Catalytica
Pharmaceuticals an aggregate of up to
32
$200 million (the "Debt Facilities"). The Debt Facilities consisted of a senior
secured term loan facility (the "Term Debt Facility") in an aggregate principal
amount of $125 million and a senior secured revolving facility (the "Revolving
Debt Facility") in an aggregate principal amount of $75 million. In the quarter
ended June 30, 1998, this Credit Agreement was amended to increase the Revolving
Debt Facility from $75 million to $100 million. In addition, the Term Debt
Facility was reduced from its original balance of $125 million to $75 million.
In the second quarter of 1998, the Company also entered into an interest rate
swap, derivative transaction which fixed the LIBOR benchmark rate used to
calculate the Company's borrowing cost at 5.90% plus the spread in the Credit
Agreement for 4 years on $50 million of the Term Debt Facility. As of December
31, 1998, nothing was outstanding under the Revolving Debt Facility and $75
million was outstanding under the Term Debt Facility. (See Note 7 to
Consolidated Financial Statements).
The additional facilities, employees and business volumes resulting from the
Acquisition have substantially increased the Company's expenses and working
capital requirements and placed increased burdens on the Company's management
resources. Furthermore, the success of the Company's future results depends, in
significant part, on the levels of new manufacturing business developed by
Catalytica Pharmaceuticals.* In the event Catalytica Pharmaceuticals does not
continue to 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 Greenville Facility, and with servicing its
outstanding debt, 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 have a material affect on the consolidated results of operations
of the Company, and the results of operations of the Company's other businesses
are expected to only modestly impact consolidated results for fiscal year 1999.*
The anticipated revenues from the Supply Agreement with Glaxo Wellcome ("Supply
Agreement"), its subsequent amendments, and contracts with other pharmaceutical
customers are expected to allow the Company to achieve continued profitable
operations for Catalytica Pharmaceuticals throughout 1999, and the consolidated
parent Company as well, offsetting losses arising from continued investments in
the Company's Combustion Systems and Advanced Technologies businesses.* After
1999, Catalytica Pharmaceuticals' profitability will depend on its success and
timing in continuing to obtain additional new customers, including possible new
agreements with Glaxo Wellcome.* Profitability on a consolidated basis will
depend on the operating results of each of the Company's subsidiaries,
particularly the rate of commercial success of Catalytica Combustion Systems.*
Manufacturing at the Greenville Facility is conducted in three operations:
Chemical Manufacturing Operations ("CMO"), Pharmaceutical Production Operations
("PPO"), and Sterile Production Operations ("SPO"). There is underutilization
of manufacturing capacity at the PPO and SPO facilities, but because of the long
lead times required to obtain necessary regulatory approvals to manufacture
final dosage products at these facilities, Catalytica Pharmaceuticals does not
anticipate additional significant revenue from such facilities during 1999.* The
inability of Catalytica Pharmaceuticals 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 and
financial condition.
33
Catalytica Pharmaceuticals also owns and operates a flexible, multi-purpose,
commercial scale manufacturing plant in East Palo Alto, California, which has
approximately 12,000 gallons of reactor capacity set up in a wide range of
reactor sizes ("Bay View Facility"). The Bay View Facility includes a solids
handling facility that operates under current Good Manufacturing Practices
("cGMP"). This facility was acquired in 1993 from Novartis (formerly Sandoz).
On May 8, 1996, Pfizer Inc. ("Pfizer") infused $15 million in Catalytica
Pharmaceuticals. These funds originally provided Pfizer a 15% interest in
Catalytica Pharmaceuticals and a five-year, $7 million research and development
("R&D") commitment by Catalytica Pharmaceuticals to develop new processes and
technology for the manufacture of Pfizer products. In connection with the
investment, Pfizer was issued 150,000 shares of Series B Preferred Stock which
is convertible into the Company's common stock. Prior to this investment,
Catalytica Pharmaceuticals was a wholly-owned subsidiary of Catalytica, Inc.
Pursuant to the terms of the Greenville Acquisition, Glaxo Wellcome received
approximately a 1.5% equity interest in Catalytica Pharmaceuticals and the
Company purchased additional shares of Catalytica Pharmaceuticals, which
resulted in Pfizer's ownership interest decreasing to approximately 4.4%. The
Company owns the remaining 94.1% outstanding equity interest in Catalytica
Pharmaceuticals. Upon consolidation of Catalytica Pharmaceuticals into
Catalytica, Inc., the Series B Preferred Stock issued to Pfizer is reflected as
$8 million of minority interest.
On October 15, 1996 Catalytica's subsidiary Catalytica Combustion Systems Inc.
("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, was formed to upgrade the combustion systems of
installed turbines with XONON which is designed to reduce emissions and permit
greater asset utilization for both power generation and mechanical drive
markets.
Subsequent to the initial funding of $10 million ($2 million from Combustion
Systems and $8 million from Woodward Governor Company), which was completed
during the quarter ended September 30, 1997, continued funding of the joint
venture beyond the initial commitment has occurred on a 50/50 basis with each
joint venture partner contributing an equal amount quarterly. For the year ended
December 31, 1998, Combustion Systems contributed $4.4 million in cash, of which
$0.5 million was accrued by the Company in 1997 and paid in 1998, and Woodward
Governor Company contributed $4.4 million, bringing the total combined
investment in the joint venture to $22.6 million to date. Although the Company
believes that Combustion Systems and Woodward intend to continue the funding of
this joint venture, neither joint venture partner is contractually required to
make further capital infusions.*
On January 14, 1998, Enron Ventures Corporation, a wholly-owned subsidiary of
Enron Corporation ("Enron"), purchased a 15% minority interest in Catalytica
Combustion Systems for $30 million. The Company owns the remaining 85%
outstanding equity interest in Catalytica Combustion Systems. In addition, Enron
also received a three-year option to purchase an additional 5% of Combustion
Systems for $14.4 million. In connection with the Stock Purchase Agreement, the
Company entered into a Share Exchange agreement, providing Enron the right to
exchange the Series B Preferred Stock of Combustion Systems for Catalytica, Inc.
Common Stock. After the five year anniversary of the agreement, if Combustion
Systems has not undertaken a public offering, in
34
which Combustion Systems receives proceeds of at least $20 million, Enron shall
have the right to require the Company to exchange all of the outstanding shares
of Series B Preferred Stock for that number of shares of Catalytica, Inc. Common
Stock based upon a determined exchange rate. The exchange rate is based upon the
fair value of the Series B Preferred Stock and the market value of Catalytica's
Common Stock at the time of conversion. Upon consolidation of Combustion Systems
into Catalytica, Inc., the Series B Preferred Stock issued to Enron is reflected
as $30 million of minority interest.
The Company's business had not been profitable until the second half of 1997,
and as of December 31, 1998, the Company had an accumulated deficit of $27.1
million. To achieve continued profitable operations, the Company must
successfully manage the operations of its Greenville Facility and develop
additional business with other customers, 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 initiated efforts in
the pharmaceuticals development area in 1992 and began manufacturing, marketing
and selling pharmaceutical intermediates in 1994 with the acquisition of the Bay
View Facility, and substantially increased its manufacturing and marketing of
pharmaceutical products in 1997 with the acquisition of the Greenville Facility.
Results of Operations
For the year ended December 31, Annual % Change
--------------------------------------------------
1998 1997 1996 1998/1997 1997/1996
---------------- ---------------- -------------- ------------------- --------------------
Revenues:
- -------------------------------
(dollars in thousands)
Product Sales $367,448 $174,347 $ 9,813 111% 1,677%
Research and
Development Contracts 7,708 6,599 6,501 17% 2%
-------- -------- -------
Total Revenues $375,156 $180,946 $16,314 107% 1,009%
The significant increase in revenue of 107% from 1997 to 1998 is due to an
increase in product sales attributable to a full year of operations at the
Greenville Facility and the related Supply Agreement with Glaxo Wellcome. On
July 31, 1997, the Company purchased the Facility from Glaxo Wellcome. This
purchase including the related Supply Agreement and subsequent amendments
enabled the Company to substantially increase its product revenues beginning in
August 1997. As part of the Supply Agreement and its subsequent amendments,
Glaxo Wellcome guarantees a specified minimum level of revenues in each year of
the five year agreement.* To the extent the minimum level of revenues exceeds
revenues as a result of product shipments, the Company receives additional
payments from Glaxo Wellcome which help offset fixed manufacturing costs
associated with manufacturing capacity reserved for Glaxo Wellcome as required
in the long term Supply Agreement. (See Note 2 to Consolidated Financial
Statements). During 1998, $309.8 million of product revenues were covered by the
Glaxo Wellcome guaranteed revenue under the Supply Agreement and subsequent
amendments. Of the Company's product revenues, 88% were derived from sales to
Glaxo Wellcome. The remaining $11.5 million of product shipments to Glaxo
Welcome were sales related to new contracts not covered by the
35
original guaranteed revenue agreement. During 1998, the Company also used its
capacity at its Bay View facility to produce products for Glaxo Wellcome and
various other pharmaceutical and fine chemical customers including Novartis,
Pfizer, Merck, and Pharmacia & Upjohn. Product revenues for 1998 attributable to
customers other than Glaxo Wellcome were 12% of total revenue.
The purchase of the Greenville Facility and the related Supply Agreement also
enabled the Company to substantially increase its product revenue for the last
two quarters of 1997, and caused product sales to increase 1,677% from 1996 to
1997. In 1997, 90% of the Company's product revenues were derived from sales to
Glaxo Wellcome including $156.4 million which was part of the guaranteed revenue
contract and an additional $0.8 million outside the guaranteed revenue contract.
During 1997, the Company used its capacity at its Bay View facility to produce
products for various other pharmaceutical and fine chemical customers including
Pfizer, Novartis, and Bristol Myers Squibb. Product revenues for 1997
attributable to customers other than Glaxo Wellcome were 10% of total revenue.
Research and development contract revenue increased 17% from 1997 to 1998,
reflecting an increase in funded research associated with Advanced Technologies
and Combustion Systems including funding related to a project with General
Electric Power Systems ("GE"). There was a 2% increase in research and
development contract revenue from 1996 to 1997 that, to a large degree,
reflected a $0.5 million reimbursement from the GENXON joint venture in 1997
for R&D expenses incurred prior to the formation of the joint venture by
Combustion Systems. Research revenue in 1997 also benefited from a full year
of revenue under the Pfizer research agreement (See Note 2 to Consolidated
Financial Statements). This increase in research revenue, however, was partially
offset by a decrease in Combustion Systems research revenue over 1996.
For the year ended December 31, Annual % Change
--------------------------------------------------
1998 1997 1996 1998/1997 1997/1996
---------------- ---------------- -------------- ------------------- --------------------
Interest Income $2,894 $1,450 $1,179 100% 23%
- ---------------
(dollars in thousands)
Interest income increased 100% in 1998 due to increased cash balances related
to the Enron cash investment in Combustion Systems which has restrictions
related to its use such that these funds cannot be used to retire debt in other
Catalytica subsidiaries such as Catalytica Pharmaceuticals. (See Note 1 of
Notes to Consolidated Financial Statements).* Interest income increased 23% in
1997 when compared to 1996. Although balances in cash and short-term
investments were reduced during the first two quarters of 1997, as cash was used
to support the Company's operations, cash and investments increased in the
second half of the year due to increases in cash balances resulting from debt
and equity financing related to the Greenville acquisition and through increased
product sales. Interest income is expected to be moderately lower in 1999,
reflecting lower average cash balances in Combustion Systems as it continues to
invest its funds in research and development activities and capital acquisitions
needed to develop its manufacturing infrastructure.*
For the year ended December 31, Annual % Change
-----------------------------------------------
1998 1997 1996 1998/1997 1997/1996
--------------- --------------- ------------- ------------------- -------------------
Costs and Expenses:
- -------------------
36
(dollars in thousands)
Costs of goods sold $302,748 $155,092 $9,073 95% 1,609%
Research and development 22,598 9,556 9,707 136% (2%)
Selling, general and
administrative 16,875 7,302 4,452 131% 64%
Interest expense 8,931 5,422 353 65% 1,436%
Gain on sale of assets -- -- 900 -- --
Loss on joint ventures (3,827) (4,355) -- (12%) --
Cost of Goods Sold: The 95% increase in cost of sales in 1998 reflects a full
year of product sales attributable to the Greenville Facility and the related
Supply Agreement with Glaxo Wellcome and its subsequent amendments. In contrast,
the Greenville Facility acquisition contributed to five months of cost of sales
in 1997. In addition, operating margins in 1998 as compared to 1997 were
favorably influenced by product mix. Operating margins are highly dependent upon
the material content in sales covered by the guaranteed revenue contract as the
cost of materials is passed directly on to Glaxo Welcome. Therefore, any change
in material mix can significantly impact gross margins. The increase in cost
of goods sold for 1997 over 1996 reflects increased physical volume of product
sales of pharmaceutical products primarily due to an increase in sales
attributable to the Greenville Facility acquisition. Margins on the
pharmaceutical products are subject to fluctuations from quarter to quarter due
to various factors including the mix of products being manufactured,
manufacturing efficiencies achieved on production runs, the length of down-time
associated with setting up new productions runs, and numerous other variables
present in the chemical and dosage form manufacturing environment.
Research and Development: Research and development ("R&D") expenses increased
136% in 1998 over 1997. This increase is largely attributable to R&D expenses
associated with a full year of operations at the Greenville Facility coupled to
a lesser degree with increased R&D activity associated with Combustion Systems.
Although reported R&D expenses for 1997 were down slightly from the previous
years' level, the actual level of research activity occurring at the Company
increased during 1997. This increase in research activity is not reflected on
the Company's financial statements largely due to an allocation of certain
catalytic combustion research and development costs from the Company to the
GENXON joint venture beginning in the second half of 1996 (See Note 3 of Notes
to Consolidated Financial Statements). This transfer of R&D funding occurred
beginning August 1, 1996, and resulted in a shift of approximately $2.5 million
in 1998, $2.6 million in 1997, and $1.8 million in 1996 of R&D costs being
financed by the joint venture rather than the Company.
Of the Company's R&D expenses for 1998, approximately 21% were utilized to
develop the Company's combustion systems technology, approximately 60% were
spent on the Company's pharmaceuticals technologies, and approximately 19% were
spent on various other technologies, most of which were performed at the
specific request of, and funded by, third parties. The comparable division of
R&D expenditures among the Company's businesses for 1997 were approximately 22%
for combustion systems technology, approximately 38% for pharmaceuticals
technologies, and approximately 40% for various other technologies, also at the
specific request of, and funded by, third parties.
37
Selling, General and Administrative: Selling, general and administrative
("SG&A") expenses increased 131% for the year ended 1998 compared to 1997
largely due to SG&A costs incurred by a full year of operations at the
Greenville Facility. In addition, SG&A expenses have increased as the Company
has expanded its sales and marketing personnel to obtain new customers for
production of its products at the Greenville Facility to reduce the available
capacity in the Greenville Facility and to develop the market for its combustion
systems products.* SG&A expenses also increased during 1998 due to management
incentive accruals related to the Company's performance. SG&A expenses are
expected to level out somewhat in the future as the sales and marketing staff at
the Greenville Facility has reached the desired level. Future increases in SG&A
expenses will be tied to general salary increases and management incentive
payments which will dependent upon the Company's performance against plan.*
SG&A expenses increased from 1996 to 1997 by 64% primarily due to SG&A costs
incurred at the Greenville Facility starting on August 1, 1997.
Interest Expense: Net interest expense increased 65% for the year ended 1998
over 1997 due to a full year of interest payments on debt associated with the
July 31, 1997, acquisition of the Greenville Facility. In the quarter ended June
30, 1998, the Credit Agreement was amended to increase the Revolving Debt
Facility from $75 million to $100 million. In addition, the Term Debt Facility
was reduced from its original balance of $125 million to $75 million. In the
second quarter of 1998, the Company also entered into an interest rate swap,
derivative transaction. See "Overview." At the end of 1998, nothing was
outstanding on the Revolving Debt Facility, and $75 million was outstanding on
the Term Debt Facility. The Company expects to decrease its interest expense in
1999 due to lower average levels of outstanding indebtedness.*
The increase in interest expense in 1997 compared to 1996 was due to the
initiation of Chase Term Debt Facility for $125 million, and borrowings under
the Chase Manhattan Bank Revolving Debt Facility totaling $14.6 million both of
which occurred on July 31, 1997, as part of the Greenville Facility acquisition.
Under the terms of the Chase debt facilities, all of the Company's previous
outstanding debt was paid off prior to the funding of the Chase debt. By the end
of 1997, all of the Revolving Debt Facility was paid off leaving only the $125
million outstanding.
Gain on Sale of Assets: The $0.9 million gain on sale of assets in 1996
represents the net realized gain over book value on the sale of Advanced Sensor
Device's assets to Monitor Labs, Inc. on June 28, 1996 (See Note 3 of Notes to
Consolidated Financial Statements).
Loss on Joint Ventures: On January 3, 1997, Combustion Systems made its first
cash infusion of $1.0 million into the GENXON joint venture. Combustion Systems
has recognized its 50% share of GENXON losses of $3.7 million in 1998 and $4.4
million in 1997. Although the Company expects to make additional capital
contributions during 1999 which will result in the allocation of additional
losses to the Company,* neither joint venture partner is contractually required
to make further capital infusions. (See Note 3 of Notes to Consolidated
Financial Statements). The Company anticipates GENXON will continue to generate
losses during 1999, and accordingly the Company will record its share of these
losses to the extent of its capital contribution.*
On November 1, 1998, Advanced Technologies entered into an operating agreement
with United Catalysts, Inc. ("United Catalysts") to form Single-Site Catalysts,
L.L.C., a Delaware limited liability company ("Single-Site Catalysts").
Advanced Technologies was required to contribute
38
inventory and equipment valued at $150,000 and a License Agreement. United
Catalysts agreed to contribute a License Agreement and $5 million in capital to
be paid in varying installments over the next several years. Single-Site
Catalysts incurred a loss in 1998 and the Company anticipates that the joint
venture will continue to generate losses during 1999.* The Company has recorded
its share of these losses to the extent of its capital contribution of $150,000
in 1998. However, the operating agreement does not require any further capital
contributions by Advanced Technologies beyond its initial $150,000 contribution.
Therefore, no further losses will be recorded by the Company unless it decides
to invest additional capital beyond the initial $5 million commitment by its
joint venture partner.*
39
Net income (loss): For the year ended December 31,
-----------------------------------------------------
(dollars in thousands) Annual % Change
1998 1997 1996 1998/1997 1997/1996
----------------- ---------------- ---------------- ----------------- -----------------
Income (loss) before
income taxes $23,071 $ 669 $(5,192) 3,349% 1,129%
Provision for income
taxes (2,308) (359) -- 542% --
------- ------- ------- --------- ---------
Income (loss) before
stock redemption 20,763 310 (5,192) 6,598% 1,060%
Less premium paid on
stock redemption -- (3,750) -- -- --
------- ------- ------- --------- ---------
Income (loss) attributable to
common shareholders $20,763 $(3,440) $(5,192) 704% 34%
Basic earnings (loss)
per share $ 0.39 $ (.10) $ (.27) 490% 63%
Diluted earnings (loss)
per share $ 0.33 $ (.10) $ (.27) 430% 63%
In 1998, the Company reported income before adjustment for stock redemption of
$20.8 million as compared to income of $0.3 million and a loss of $5.2 million
in 1997 and 1996, respectively. The increase in income in 1998 and 1997 was
due to operations at the Greenville Facility and the related Supply Agreement
with Glaxo Wellcome. The increase in 1998 was also favorably impacted by
incremental new business with Glaxo Welcome beyond the original Supply Agreement
plus new business with other pharmaceutical companies. Although the Company was
at the break-even level for 1997 in total, the Company recorded a profit of $0.7
million and $3.7 million in the third and fourth quarters of 1997 due to the
August 1, 1997, acquisition of the Greenville Facility offsetting losses of
($2.3) million and ($1.8) million in the first and second quarters. The Company
expects continued profitability in 1999.* The extent of profitability will
depend on the operating results of Catalytica Pharmaceuticals, including the
ability to control operating expenses and the extent of losses arising from
continued investment in Combustion Systems, including GENXON, and to a lesser
extent Advanced Technologies.* Beyond 1999, profitability will largely be
dependent upon the Company's ability to continue to obtain new supply agreements
from new and/or existing customers to replace Glaxo Wellcome products that will
be phased out under the terms of the original Supply Agreement (See Note 2 of
Notes to Consolidated Financial Statements).* To a lesser degree, profitability
will also be dependent upon successfully developing the Company's catalytic
combustion processes.*
During the fourth quarter of 1997, the Company used $23.8 million of proceeds
from the exercise of warrants to repurchase 5,000,000 shares of Class B Common
Stock from MSCP. The stock was originally issued to MSCP at $4.00 per share.
The Company repurchased each share at $4.75. The Company recorded the
difference between the sale and repurchase prices of $0.75 as a premium paid on
common stock redemption, and reduced income available to common stockholders by
$3.75 million. When the common stock redemption premium is deducted from
income, the net income attributable to common stockholders is reduced to a loss
of $3.44 million. Consequently, the basic and diluted net loss per share for
the year is $0.10 per share. The
40
repurchase of these shares from MSCP is a one time transaction, and the Company
does not expect any similar transactions to take place in 1999.*
The provision for income taxes for the year ended December 31, 1998 as a
percentage of pre-tax income was approximately 10% as compared to 54% for 1997
and 0% in 1996. The increase in the estimated annual tax rate between 1996 and
1997 is due primarily to the Company's profitability at its Greenville Facility
resulting in franchise and state income tax expenses coupled with the federal
alternative minimum tax. In 1998 the percentage of tax decreased as a
percentage of pretax income due to prior net operating losses that have been
used to offset state and federal taxable income. The Company anticipates the
effective tax rate for 1999 will be significantly less than the combined state
and federal statutory rates due to the availability of net operating loss
carryforwards. In the years following, if the Company continues to be
profitable, the effective tax rate will increase.
Recently Issued Accounting Standards
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income." This Statement
requires that all items recognized under accounting standards as components of
comprehensive earnings be reported in an annual financial statement that is
displayed with the same prominence as other annual financial statements. This
Statement also requires that an entity classify items of other comprehensive
earnings by their nature in an annual financial statement. For example, other
comprehensive earnings may include foreign currency translation adjustments,
minimum pension liability adjustments, and unrealized gains and losses on
marketable securities classified as available-for-sale. Annual financial
statements for prior periods will be reclassified, as required. The Company has
no comprehensive earnings adjustments for the year ended December 31, 1998, thus
total comprehensive earnings is equal to net earnings (loss).
In June 1997, the Financial Accounting Standards Board issued Statement No.
131, "Disclosures about Segments of an Enterprise and Related Information" which
was adopted in fiscal 1998. This Statement establishes standards for the way
that public business enterprises report information about operating segments in
annual financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
stockholders. It also establishes standards for related disclosures about
products and services, geographic areas and major customers.
The Company operates primarily in the pharmaceuticals and combustion systems
industries. The Company has determined the operating segments based upon how
the business is managed and operated. Catalytica Pharmaceuticals and Combustion
Systems operate as independent subsidiaries of the Company with their own sales,
research and development and operations departments. (See Note 1 of Notes to
Consolidated Financial Statements)*.
Year 2000 Computer Systems Compliance
Many computer systems, software, and electronic products require valid dates
to work acceptably but are coded to accept only two-digit entries in the date
code field. These systems will need to be changed to distinguish 21st century
dates from 20th century dates. In addition, certain
41
systems and products do not correctly process "leap year" dates. As a result,
in the next 12 months, computer systems, software ("IT Systems"), and other
equipment, such as telephones, office equipment, and manufacturing equipment
used by the Company may need to be upgraded, repaired, or replaced to comply
with "Year 2000" and "leap year" requirements. The Company's existing systems
are not yet completely Year 2000 compliant. As a result, the company is
continuing to modify the systems.
The Company has conducted an internal review of most of our internal systems,
including inventory, manufacturing, planning, finance, human resources, payroll,
automation, laboratory, and embedded systems. The systems affected by the Year
2000 problem are divided into three categories. Business Information Technology
Systems are any mainframe, midrange, or PC based computer system used in
corporate operations. These systems generally involve application code
supported by internal staff. Manufacturing Automation Systems are specific
computer and process control systems used in production processes, including
programmable logic controllers. These systems generally involve application
code that is supported by internal staff or directly by the vendor. Embedded
Systems are systems or devices that include an intelligent processor or chip
that is not programmable or cannot be modified without hardware changes. These
systems are generally supported by the vendor and are not maintained by internal
staff, other than for routine calibration or adjustment (e.g. stand-alone
controllers, intelligent field devices, laboratory instruments,
telecommunications devices).
Set forth below is a chart showing the Company's present status of compliance
(at December 31, 1998) and internal target dates for compliance. The Company
has prioritized the remediation effort to fix critical business systems first,
non-critical systems second, and cosmetic changes to reports and displays last.
Key critical business systems, such as financial systems (General Ledger,
Purchasing, Accounts Payable, Accounts Receivable, and Fixed Assets) and
material requirements planning systems, are currently 100% compliant. Remaining
critical and non-critical business systems will be completed by mid-1999 and
cosmetic changes to reports and displays will be completed in the fourth quarter
of 1999.*
42
Present Year 2000 Status as of December 31, 1998
- ------------------------------------------------
Resolution Phases
Exposure Type Assessment Remediation Testing Implementation
- ----------------------------------------------------------------------------------------------
Business Information 100% 77% 69% 61%
- --------------------
Technology Systems Complete Complete Complete Complete
- --------------------
Expected Completion November November December
1999 1999 1999
- ----------------------------------------------------------------------------------------------
Manufacturing 100% 84% 84% 68%
- ------------------
Automation Systems Complete Complete Complete Complete
- ------------------
Expected Completion July July September
1999 1999 1999
- ----------------------------------------------------------------------------------------------
Embedded Systems 100% 98% 98% 96%
- ------------------ Complete Complete Complete Complete
Expected Completion September September September
1999 1999 1999
- ----------------------------------------------------------------------------------------------
Assessment of potential problems in business information technology systems is
complete; assessment of manufacturing automation systems and embedded systems
was completed in the fourth quarter of 1998. Testing and remediation of
business information technology systems, manufacturing automation systems, and
embedded systems is in progress. The Company anticipates successful completion
of all phases of these efforts during 1999.*
As part of the Company's review to assure Year 2000 compliance, it has formed
a task force (the "Task Force") to oversee Year 2000 and leap year issues.* The
Task Force has reviewed all IT Systems and Non-IT Systems that have not been
determined to be Year 2000 and leap year compliant and has identified and begun
implementation of solutions to ensure such compliance.* The Task Force has
evaluated the Company's systems for Year 2000 and leap year compliance.
Remediation of problems discovered will be accomplished through internal
efforts, vendor upgrades, replacement, or decommissioning of obsolete systems
and equipment.* External and internal costs associated with these efforts are
expected to reach $7 million.* In conjunction with the purchase of the
Greenville Facility, Glaxo Wellcome has agreed to reimburse the Company for $4
million of these costs. As of December 31, 1998, the Company has spent $4.7
million on costs associated with the Year 2000 effort of which $3.0 million has
been reimbursed by Glaxo Wellcome. Costs related to Year 2000 remediation are
not expected to have a material effect on the Company's results of operations or
financial condition.*
43
The Company has contacted its major customers, vendors, and service suppliers
whose systems failures potentially could have a significant impact on the
Company's operations, to verify their Year 2000 readiness to determine the
Company's potential exposure to Year 2000 issues. The Company has been informed
by 81% of its major customers, vendors, and service suppliers that such
suppliers expect to be Year 2000 compliant by the Year 2000.
Any failure of these third parties' systems to achieve timely Year 2000
compliance could have a material adverse effect on the Company's business,
financial condition, results of operation and prospects. Year 2000 problems
could affect many of the Company's production, distribution, plant equipment,
financial, and administrative operations. Systems critical to the business that
have been identified as non-Year 2000 compliant are either being replaced or
corrected through programming modifications.
As part of contingency planning, the Company is developing procedures for
those areas that are critical to its business. These plans will be designed to
mitigate serious disruptions to the business beyond the end of 1999.* The major
efforts in contingency planning will occur in the first half of 1999, with the
expectation that contingency plans will be in place by the end of the second
quarter of 1999.* Based on current plans and efforts to date, the Company does
not anticipate that Year 2000 problems will have a material effect on the
results of operations or financial condition.*
The state of compliance of certain of the Company's third-party suppliers of
services such as telephone companies, long distance carriers, financial
institutions, and electric companies has not been determined. The failure of any
one of such third party suppliers to be Year 2000 compliant could severely
disrupt the Company's ability to carry on its business as well as disrupt the
business of its customers.
Failure to provide Year 2000 and leap year compliant business solutions to
customers or to receive such business solutions from suppliers could result in
liability to the Company or otherwise have a material adverse effect on the
business, results of operations, financial condition and prospects. The Company
could be affected through disruptions in the operation of the enterprises with
which it interacts or from general widespread problems or an economic crisis
resulting from non-compliant Year 2000 systems. Despite the Company's efforts
to address the Year 2000 effect on its internal systems and business operations,
such effect could result in a material disruption of the business or have a
material adverse effect on business, results of operations or financial
condition. See "Risk Factors - Problems Related to "Year 2000 Issue" Could
Adversely Affect Our Business."
44
Future Results
This section contains certain forward-looking statements regarding the
Company's operating results which involve risks and uncertainties. Since
substantially all of this section involves forward-looking statements,
individual statements are not identified by an asterisk ("*") in this section.
The Company's actual results could differ materially from the results
anticipated in these forward-looking statements as a result of certain factors
set forth here under and under "Risk Factors."
A significant portion of the Company's product sales at its Greenville
Facility is generated through a Supply Agreement with Glaxo Wellcome. This
Supply Agreement including two subsequent amendments signed in 1998 and a third
amendment signed in the first quarter of 1999, calls for a generally declining
level of product shipments over the five year term of the agreement. As a
result, Catalytica Pharmaceuticals' 1999 total revenues are expected to be
somewhat below 1998 total revenues of $368.9 million. The anticipated revenues
from the Supply Agreement and its subsequent amendments and additional product
revenues from new business with new and/or existing customers are expected to be
sufficient to allow the Company to continue to achieve profitable operations for
1999. The associated cash flows coupled with an available credit line of $100
million will be sufficient to permit necessary capital expenditures, support
changes in working capital, and continue to reduce indebtedness incurred in
connection with the Acquisition. Profitability after 1999 will depend on its
success and timing in continuing to obtain new customers, including possible new
agreements with Glaxo Wellcome. There is excess manufacturing capacity
immediately available at the PPO and SPO facilities, but because of the long
lead times required to establish necessary regulatory approvals to manufacture
at these facilities, Catalytica Pharmaceuticals anticipates delayed recognition
of revenue from new business in these facilities. Catalytica Pharmaceuticals'
inability to fill the available capacity or to reduce costs commensurate with
lower levels of capacity utilization would have a material adverse effect on the
Company's consolidated results of operations .
Catalytica Pharmaceuticals estimates that aggregate payments (including the
cost of materials) by Glaxo Wellcome under the original Supply Agreement will
total approximately $800 million over the five-year life of the agreement.
Subsequent amendments to the original supply agreement may provide for
approximately $120 million in revenue over a two and one-half year period
commencing July 1998. A portion of this additional revenue has been guaranteed
by Glaxo Wellcome, however; the majority of this additional revenue is based on
forecasts by Glaxo Wellcome for production of product as defined in the amended
agreement. As such, the forecasted revenues are subject to fluctuations based
on production demands by Glaxo Wellcome. Under the original Supply Agreement
and certain amendments, Glaxo Wellcome has guaranteed that revenues paid to
Catalytica Pharmaceuticals will meet certain minimum levels through 2001,
("Minimum Revenues") and that Glaxo Wellcome will pay to Catalytica
Pharmaceuticals any difference between the specified minimum level and the
amount due for shipment of products at the prices set forth in the original
Supply Agreement. The Minimum Revenues, which include compensation for
transition services Catalytica Pharmaceuticals has agreed to provide Glaxo
Wellcome, and which exclude the cost of materials, in each of the five years are
as set forth below in millions of dollars.
45
August 1 -
December 31, 1998 1999 2000 2001 Total
------------ ----- ----- ----- ----- ------
1997
----
Supply Agreement $77.0 $173.4 $113.8 $72.6 $22.6 $459.4
and certain
amendments
The price for each product, excluding the cost of materials, is set forth in
the Supply Agreement and its subsequent amendments. The Supply Agreement and its
subsequent amendments require that Glaxo Wellcome reimburse Catalytica
Pharmaceuticals based on the invoice price of raw materials used in the
manufacture of products delivered to Glaxo Wellcome. This agreement states that
Minimum Revenues are to be calculated by comparing the amount billed for
products shipped during the year to the stipulated Minimum Revenue amount for
the specific year in agreement. The Minimum Revenue on an annual basis is not
subject to adjustment. The terms of the Supply Agreement and its subsequent
amendments provide for certain declines in prices over time. If during the term
of the Supply Agreement and its subsequent amendments Catalytica Pharmaceuticals
is unable to decrease its variable and fixed operating expenses commensurate
with the price declines or obtain new higher margin business to offset the
impact of such declines, Catalytica Pharmaceuticals' and the Company's results
of operations would be adversely affected. Under the terms of the Supply
Agreement and its subsequent amendments, Glaxo Wellcome is to provide periodic
forecasts of its future demand for certain products and Catalytica
Pharmaceuticals is committed to produce the products required, with certain
limitations, provided the required production capacity does not exceed the
capacity committed to Glaxo Wellcome. For production requests in excess of the
capacity committed to Glaxo Wellcome, Catalytica Pharmaceuticals has agreed to
undertake to accommodate Glaxo Wellcome's requests with pricing to be negotiated
on terms that reflect then market pricing.
The additional facilities, employees and business volumes at the Greenville
Facility substantially increased the expenses and working capital requirements
and placed substantial burdens on the Company's management resources on a
consolidated basis. The Company's research and development expenses, as well as
its selling, general and administrative expenses, increased significantly as the
Company established the necessary infrastructure for the operations.
Furthermore, the success of the Company's business depends, in a significant
part, on the levels of manufacturing business developed by Catalytica
Pharmaceuticals. In the event Catalytica Pharmaceuticals does not continue to
achieve additional new customers, which could involve additional business from
Glaxo Wellcome, on terms sufficient to offset the costs associated with
operating and maintaining the Greenville Facility, and with continuing to
service its outstanding debt, the Company's consolidated results of operations
and financial condition would be materially adversely affected.
Catalytica faces challenges in advancing its research and development programs
from bench and pilot scale to cost-effective commercial products and processes.
There can be no assurance that the Company will successfully address the
challenges that will arise during the development of each of its programs. The
Company expects to continue certain of its research and development programs,
46
which include the self-funding of expenditures that are not covered by payments
from collaborative partners. The Company believes its internally funded research
projects have the potential to lead to commercial sales in the next few years.
The Company anticipates that research that does not have the potential for near-
term commercialization will be conducted only when funded by collaborative
partners.
The Company expects that future operating results will fluctuate from quarter
to quarter, as a result of differences in the amount and timing of expenses
incurred and the revenues received. In particular, the Company's operating
results are affected by the size of and timing of receipt of orders for and
shipments of its pharmaceutical products, as well as the amount and timing of
payments and expenses under the Company's research and development contracts.
The Company has increasingly relied on product sales for its revenues. Continued
profitable operations, especially after 1999, will depend on the Company's
continued success and timing in obtaining new customers, including possible new
agreements with Glaxo Wellcome. To a lesser extent, profitability will also
depend on the Company's ability to successfully develop, manufacture, introduce,
and market or license its combustion systems technology. There can be no
assurance that the Company will be able to achieve profitability on a sustained
basis. The Company's operating results will continue to be substantially
dependent on the operating results of Catalytica Pharmaceuticals.
47
Liquidity and Capital Resources
For the year ended December 31,
-------------------------------
(dollars in thousands) 1998 1997 1996
----- ---- -----
Cash, cash equivalents, short
term investments $ 47,585 $ 47,067 $23,821
Working capital 113,186 87,425 23,904
Cash provided by (used in)
Operating activities 49,547 39,785 (778)
Investing activities (27,676) (262,290) 4,187
Financing activities (14,628) 242,114 7,110
-------- --------- -------
Net increase in cash and cash
equivalents 7,243 19,609 10,519
Current Ratio 2.78 1.97 3.61
Total cash and cash equivalents plus short-term investments increased slightly
in 1998 compared to 1997. Most of the cash generated from earnings net of
depreciation during 1998 ($32.3 million) was invested back into the business and
used for acquisition of plant and equipment ($31.4 million). The net increase
in cash can be attributed to the $30 million investment in Combustion Systems by
Enron Ventures Corporation for a 15% ownership in Combustion Systems coupled
with a net increase in various working capital items associated with the
pharmaceutical business, which was largely offset by payments of $50 million on
the Chase Term Debt Facility (See Note 7 to Consolidated Financial Statements).
Prior to 1997, the Company financed its operations through private placements
of equity securities, an initial public offering of its Common Stock on February
8, 1993, a secondary public offering on November 3, 1995, a $15 million cash
infusion from Pfizer on May 8, 1996, revenues from collaborative research
agreements, and starting in 1994, product revenues. During the past several
years, the Company has obtained various term loans and lines of credit to fund
capital purchases and working capital needs. On July 31, 1997 in conjunction
with the acquisition of the Greenville Facility, the Company and a syndicate of
Banks led by Chase Manhattan Bank ("Chase") entered into a Credit Agreement. In
the second quarter of 1998 this Credit Agreement was amended, pursuant to which
Catalytica Pharmaceuticals could borrow up to an aggregate of $175 million (the
"Debt Facilities"). The Debt Facilities consisted of a senior secured term loan
facility (the "Term Debt Facility") in an aggregate principal amount of $75
million and a senior secured revolving facility (the "Revolving Debt Facility")
in an aggregate principal amount of $100 million. The Term Debt Facility will
mature on December 31, 2002, and amortizes in quarterly installments commencing
on December 31, 1999 in aggregate annual amounts of (i) $10 million in the
fourth quarter of 1999, (ii) $15 million in the year 2000, (iii) $20 million in
the year 2001, and (iv) $30 million in the year 2002. The Revolving Debt
Facility matures on December 31, 2002. As of December 31, 1998, nothing was
outstanding under the Revolving Debt Facility and $75 million was outstanding
under the Term Debt Facility. In 1998, the Company made payments of $50 million
on the original Chase Term Debt Facility. As of December 31, 1998, the Company
was in compliance with various covenants and other restrictions contained in the
Chase Debt Agreement and believes that it will remain in compliance.*
48
In the second quarter of 1998 following the restructuring of the Credit
Agreement, the Company entered into a $50 million interest rate swap, derivative
transaction to reduce the Company's exposure to fluctuations in short-term
interest rates. This interest rate swap transaction effectively fixed the
LIBOR benchmark rate used to calculate the Company's borrowing cost at 5.90% for
4 years on $50 million of the Term Debt Facility. The Company accounts for this
interest rate swap as a hedge, and accrues the interest rate differential as
interest expense on a monthly basis. The Company does not hold or transact in
such financial instruments for purposes other than risk management.
The Company's operations to date have required substantial amounts of cash. As
part of the financing of the acquisition of the Greenville Facility, Catalytica
Pharmaceuticals incurred approximately $125 million of long-term indebtedness,
of which $75 million was outstanding as of December 31, 1998. The Company and
its subsidiary, Catalytica Advanced Technologies, have guaranteed this
indebtedness. As a result of this increased leverage, Catalytica
Pharmaceuticals' principal and interest obligations have increased
substantially. 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 and its subsequent amendments 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.* The Company expects to spend
approximately $30 to $35 million during 1999 for capital expenditures primarily
at Catalytica Pharmaceuticals.* Because of its cash position of $47.6 million
(including short-term investments) and its available line of credit of $100
million as of December 31, 1998, coupled with the anticipated cash flow from
operations in 1999, the Company believes that it has adequate funds to meet its
working capital needs and debt repayment obligations for at least the next 12
months.*
The increase in cash and cash equivalents in 1997 is largely due to an
increase in various working capital items associated with the Greenville
Acquisition. The Greenville Acquisition itself was financed with borrowings
against various credit facilities as discussed above, funds received from the
sale of common stock to MSCP, and through stock option and warrant exercises.
During 1996, the Company 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 $3.5 million at December 31, 1996.
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.
As discussed in the Overview, on July 31, 1997, the Company completed a stock
sale of 13,270,000 shares of its Class A Common Stock and 16,730,000 shares of
its Class B Common Stock to MSCP, at a price of $4.00 per share, for an
aggregate of $120 million.
49
The funds raised through the equity and debt financing were used to acquire
the Greenville Facility for $244.7 million in cash. This purchase also involved
other equity consideration, and potential future payments related to the SPO
facility. See Note 2 of Notes to Consolidated Financial Statements.
The Company distributed, at no cost, to each holder of Common Stock of record
as of August 22, 1997, one warrant for each three shares of Common Stock held by
the shareholder. The total number of warrants issued was 6,947,275. Of the
warrants issued to shareholders, 6,922,996 were exercised leaving 24,279 that
were not exercised when they expired on October 31, 1997.
The exercise of the warrants generated gross proceeds of $27.7 million. The
Company used $23.8 million of the proceeds to repurchase an aggregate of
5,000,000 shares of its Class B Common Stock issued to MSCP on July 31, 1997.
The premium paid for the repurchase is reflected in the Company's earnings per
share calculation for the period ending December 31, 1997. The Company's
earnings per share for the year ended December 31, 1997, were reduced by $0.10
due to this repurchase.
RISK FACTORS
The following Risk Factor section contains forward-looking statements within the
meaning of the federal securities laws relating to future events or our future
financial performance. The forward-looking statements involve risks and
uncertainties. We have identified most of the forward-looking statements with
an asterisk ("*"). Other forward-looking statements relate to our strategy,
financial performance and revenue sources. Our actual results could differ
materially from the results anticipated in these forward-looking statements as a
result of certain risk factors including those set forth below and elsewhere in
this report. In addition to the other information in this report, you are
encouraged to carefully review the following risk factors when evaluating us,
our financial performance, and our business.
Problems Related to "Year 2000 Issue" Could Adversely Affect Our Business.
Many computer systems, software, and electronic products require valid dates
to work acceptably but are coded to accept only two-digit entries in the date
code field. These systems will need to be changed to distinguish 21st century
dates from 20th century dates. In addition, certain systems and products do not
correctly process "leap year" dates. As a result, in the next 12 months,
computer systems, software ("IT Systems"), and other equipment, such as
elevators, phones, office equipment, and manufacturing equipment used by many
companies may need to be upgraded, repaired, or replaced to comply with "Year
2000" and "leap year" requirements. Our existing systems are not yet completely
Year 2000 compliant. As a result, we are continuing to modify the systems.
We have conducted an internal review of most of our internal systems,
including inventory, manufacturing, planning, finance, human resources, payroll,
automation, laboratory, and embedded systems. The systems affected by the Year
2000 problem are divided into the following three categories:
50
. Business Information Technology Systems, which comprise any mainframe,
midrange, or PC based computer system used in corporate operations.
These systems generally involve application code supported by internal
staff;
. Manufacturing Automation Systems, which are specific computer and
process control systems used in production processes, including
programmable logic controllers. These systems generally involve
application code that is supported by internal staff or directly by
the vendor; and
. Embedded Systems, which may comprise any system or device that includes
an intelligent processor or chip that is not programmable or cannot be
modified without hardware changes. These systems are generally
supported by the vendor and are not maintained by internal staff, other
than for routine calibration or adjustment (e.g. stand-alone
controllers, intelligent field devices, laboratory instruments,
telecommunications devices). See "Management's Discussion and
Analysis - Year 2000 Computer Systems Compliance".
Failure to provide Year 2000 and leap year compliant business solutions to
customers or to receive such business solutions from our suppliers could result
in liability to us or otherwise have a material adverse effect on our business,
results of operations, financial condition and prospects. We could be affected
through disruptions in the operation of the enterprises with which we interact
or from general widespread problems or an economic crisis resulting from non-
compliant Year 2000 systems. Despite our efforts to address the Year 2000
effect on our internal systems and business operations, such effect could result
in a material disruption of our business or have a material adverse effect on
our business, results of operations or financial condition.
Our Future Financial Results are Uncertain and Fluctuate.
Our business first achieved profitability in the quarter ended September 30,
1997. To achieve continued profitable operations, we must successfully:
. manage the operations of the pharmaceutical manufacturing facility
located in Greenville, North Carolina (the "Greenville Facility");
. continue and expand our business with our existing customers, and
develop new customers for our pharmaceuticals business; and
. to a lesser extent, successfully develop, manufacture, introduce and
market or license our combustion systems and catalytic processes.*
We initiated efforts in the pharmaceuticals development area in 1992 and began
manufacturing, marketing and selling pharmaceutical intermediates in 1994. As a
result of the acquisition of the Greenville Facility in 1997, we have
substantially increased our manufacturing of pharmaceutical products.
Manufacturing at the Greenville Facility is conducted in three distinct
operations: Chemical Manufacturing Operations ("CMO"), Pharmaceutical Production
Operations ("PPO") and Sterile Production Operations ("SPO"). Currently, there
is underutilization of manufacturing capacity at the PPO and SPO facilities.
The long lead times required to obtain necessary regulatory approvals
51
to manufacture pharmaceutical and sterile products at these facilities may
restrict the pace at which new business can be added to these facilities.
We anticipate fluctuation in our operating results from quarter to quarter
because of differences in the amount and timing of expenses incurred and
revenues received. In particular, the size and timing of receipt of orders for
and shipments of our pharmaceuticals products coupled with changes in product
mix, as well as the amount and timing of payments and expenses under our
research and development contracts affect our operating results.
A Material Portion of Our Revenues is Dependant on Our Relationship with Glaxo
Wellcome.
Our 1998 revenues were $375.2 million. The original Supply Agreement with
Glaxo Wellcome and its subsequent amendments accounted for approximately 83% of
total 1998 revenues, new contractual arrangements with Glaxo Wellcome accounted
for approximately 3%, and contracts with other customers accounted for
approximately 14%. Although the annual level of minimum payments under the
original Supply Agreement declines significantly after 1998, Glaxo Wellcome is
expected to continue to represent a significant source of revenue for Catalytica
Pharmaceuticals.* The Company amended the original Supply Agreement twice in
1998 and once in the beginning of 1999. The amendments increase over the
original Supply Agreement the amount of revenue to be received from Glaxo
Wellcome over the next several years.* Although new customer business is
expected to contribute to increased revenues, a material portion of Catalytica
Pharmaceuticals' business is expected to be derived from Glaxo Wellcome during
the next several years.* If Catalytica Pharmaceuticals is unsuccessful in the
performance of its obligations to service and provide materials to Glaxo
Wellcome then Glaxo Wellcome could possibly terminate the Supply Agreement
and/or its subsequent amendments.*
52
Our Executive Officers and Certain Key Personnel are Critical to Our Business
and Such Officers and Key Personnel May Not Remain with Catalytica or our
Subsidiaries in the Future.
Our success depends on the retention of principal members of our management
and scientific staff and on the ability to continue to attract, motivate and
retain additional key personnel.* We intensely compete for such key personnel,
and the loss of the services of key personnel or the failure to recruit
necessary additional personnel could materially and adversely affect our
operations and our research and development efforts.
Also, we have not entered into non-competition agreements with any of our key
employees, and the employment of all of our key officers is at will. Any
failure by us or our subsidiaries to attract or retain necessary personnel would
materially and adversely affect our consolidated results of operations.
Combustion Systems Business is Uncertain and Dependant Upon Its Relationships
with Certain Turbine Manufactures.
We, through our subsidiary, Catalytica Combustion Systems, Inc. ("Combustion
Systems") and the GENXON joint venture are conducting research and development
on our proprietary XOXON combustion system's technology. These XOXON combustion
system products are in their early stages of development and must undergo
rigorous testing in gas turbines prior to their commercialization. The
acceptance and use of XOXON by a limited number of turbine manufacturers and our
ability to enter into commercial relationships with these manufacturers will
determine the ultimate sales of our XOXON product.*
Combustion Systems has entered into agreements for the development of a
combustion system incorporating XOXON into the gas turbines of General Electric
Power Systems ("General Electric") and Pratt & Witney Canada, Inc. ("Pratt
Witney"). Combustion Systems' ability to complete research and development and
introduce commercial systems in the large turbine utility market is dependent on
its continued relationship with General Electric, the world leader in the
manufacture of large gas turbines. We are also working with other leading
turbine manufacturers to develop our combustor system products. Relationships
with gas turbine suppliers are expected to facilitate the completion of
Combustion Systems' research and development and the introduction of commercial
systems in the gas turbine market.* If major turbine manufacturers terminate
their relationship with Combustion Systems, then there is no assurance as to
whether Combustion Systems could enter into a similar relationship with other
manufacturers and Combustion Systems' ability to complete its research and
development and introduce commercial systems in the market could be adversely
affected.
Manufacturing and marketing capability for our combustion products is also
limited. To the extent that our existing facilities are inadequate, we must
develop or acquire additional manufacturing capability. In order to market any
of our combustion system products, we must develop marketing capability, either
on our own or in conjunction with others. We cannot assure that we will be able
to manufacture our products successfully or develop an effective marketing and
sales organization. In addition, our combustion systems are expected to be sold
as components of
53
large natural gas turbines for electric power plants.* Accordingly, the rate of
adoption of our systems and processes may depend in part on economic conditions
that affect capital investment decisions, as well as the regulatory
environment.* We cannot assure that our combustion products will be economically
attractive when compared to competitive products.
The GENXON Joint Venture May Fail to Become Economically Viable and Require
Additional Capital Investment.
In October 1996, Combustion Systems and Woodward Governor Company ("Woodward")
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"), was
formed to upgrade the combustion systems of installed turbines with XONON. XONON
is designed to reduce emissions and permit greater asset utilization for both
power generation and mechanical drive markets.* GENXON plans to deliver an
integrated product that includes Combustion Systems' technology for ultra low
NOx emissions and Woodward's control systems.* We cannot assure that GENXON and
its partners will be successful in developing new combustion systems that will
work in lieu of the current design that does not incorporate a catalyst. We also
cannot assure that GENXON's products will be economically attractive when
compared to competitive products.
GENXON entered into a technical services agreement with the City of Glendale,
California to retrofit an FT4 gas turbine engine which was provided by the City
of Glendale. Under the terms of the agreement, the retrofit was to include
adding the Company's proprietary XONON combustion system and a digital control
system for a total turnkey price of $700,000. GENXON did not complete the
agreed upon retrofit, and has returned the engine to the City of Glendale in its
original state. GENXON and the City of Glendale are in discussions regarding
alternatives to resolve any contractual issues relative to the retrofit project.
The Company does not believe such consequences will have a material adverse
effect on the Company's business, results of operations, and financial
condition.
The initial capital commitment of the GENXON joint venture partners was $10
million--$2 million from Combustion Systems and $8 million from Woodward--
payable over time as the funds were required by the joint venture. GENXON
reached this initial capital commitment of $10 million during the third quarter
of 1997. Continued funding of the joint venture beyond the initial $10 million
commitment has occurred on a 50/50 basis with Combustion Systems contributing
$4.4 million and Woodward Governor Company contributing $4.4 million, for the
year ended December 31, 1998. The total investment in the joint venture as of
the end of 1998 was $22.6 million. For the year ended December 31, 1998,
Combustion Systems recognized its 50% share of GENXON's $7.3 million in losses.
Such losses on the joint venture were recognized in the results of operations.
We will likely make additional capital contributions to the joint venture during
the remainder of fiscal 1999, and we anticipate GENXON will incur additional
losses.* We will record our share of these losses to the extent of our capital
contribution. Although Combustion Systems and Woodward intend to continue the
funding of this joint venture, neither joint venture partner is contractually
required to make further capital infusions. We could, however, be required to
fund the projects ourselves if Woodward decides not to make any additional
capital contributions to GENXON.* If such an event were to occur, our results
of operations and financial condition could be adversely
54
affected. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
Environmental Regulations May Influence the Rate of Commercialization of Our
Combustion Systems.
Current federal law governing air pollution generally does not mandate the
specific means for controlling emissions. Federal law, 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.
State and local authorities must also adopt performance standards for all major
new and modified sources of air pollution in all areas that do not meet ambient
air quality standards. The more polluted the air in a particular region
becomes, the more stringent the emission restrictions.
The enactment and enforcement of environmental regulations at the federal,
state and local levels will heavily influence the rate at which industrial
companies adopt the Company's catalytic combustion systems.* As a result, our
revenues will depend, in part, on the standards, permit requirements and
programs that these state and local authorities adopt for reducing emissions
(including emissions of NOx) addressed by our combustion and monitoring products
systems.* Demand for our systems and processes will be affected by how quickly
the standards are implemented and the level of reductions required.* For
instance, 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 our systems and processes. Moreover, new environmental regulations may
impose different requirements that may not be met by the systems and processes
being developed by us or that may require costly modifications of our products.
The United States Congress is currently reviewing existing environmental
regulations. Congress may amend or modify existing regulations in a manner that
could have an adverse effect on demand for our combustion system products.
We may be Liable to our Clients and Their Customers for Product and
Manufacturing Defects of Our Pharmaceutical Products.
Product liability claims may arise for products manufactured by Catalytica
Pharmaceuticals. We, however, regularly seek guarantees of indemnification from
our customers for any product liability claims that might result from the
pharmaceutical products we produce. We cannot assure you that Catalytica
Pharmaceuticals will not ultimately be found liable for any product liability
claims regarding products it manufactures. For example, manufacturing defects
of products that are manufactured by Catalytica Pharmaceuticals and that result
in injury to the consumer of the products will likely require Catalytica
Pharmaceuticals to indemnify its customers for product liability claims. We
cannot assure you that Catalytica Pharmaceuticals product liability insurance
will be obtainable or maintainable in the future with terms that are acceptable
to us or that provide us with adequate coverage against potential liabilities.
If Catalytica Pharmaceuticals is found liable in a product liability claim and
we do not have adequate product liability insurance or are not properly
indemnified, then our consolidated results of operations could be materially
adversely effected. Additionally, under the Supply Agreement, Catalytica
Pharmaceuticals is obligated to
55
maintain $100 million of product liability insurance. If Catalytica
Pharmaceuticals does not meet this requirement, we would be in default under the
Supply Agreement.
A Failure to Comply with Regulations Governing the Use of Hazardous Materials
and Environmental Matters Could Harm Our Business.
Our research and development activities and fine chemicals manufacturing
involve the use of many hazardous chemicals. Federal, state and local laws and
regulations extensively govern the use, manufacture, storage, handling and
disposal of such materials and associated waste products. Although we believe
that our use of our properties and operations comply in all material respects
with applicable environmental laws, our risk of substantial 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 us to comply with present
or future environmental laws could result in any of the following:
. the cessation of portions or all of our operations;
. the imposition of fines;
. restrictions on our ability to carry on or expand our operations;
. significant expenditures by us in order to comply with environmental
laws and regulations; or
. liabilities in excess of our resources.
To help mitigate our risk of at our facility in Greenville, North Carolina, we
have purchased environmental impairment insurance, which covers first party and
third party liability in the amount of $25 million (with a $1 million
deductible) with respect to the Greenville 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 capital expenditures may
be required at the Greenville Facility as a result of new environmental
regulations. The United States Environmental Protection Agency (the "EPA")
issued (September 21, 1998) new regulations for the pharmaceutical industry
under the authority of the federal Clean Air Act and Clean Water Act. These new
regulations require the installation of "Maximum Achievable Control Technology"
for certain hazardous air pollutant emissions sources ("Pharmaceutical MACT")
and the installation of additional pretreatment systems for wastewater
discharges. We are currently evaluating the new regulations to determine their
impact on future capital expenditures. The EPA is also considering changes to
its particulate matter emissions regulations as well as regulation of certain
ozone precursor emissions. 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
or adversely affected in the event such environmental laws or regulations
require Catalytica Pharmaceuticals to modify the current Greenville Facility
substantially or otherwise limit Catalytica Pharmaceuticals' ability to conduct
or expand its operations.
56
Current and Potential Environmental Contamination at Catalytica Pharmaceuticals'
Two Facilities May Cause Disruption of Manufacturing and Create Additional
Liabilities.
The Greenville Facility. There is contamination in the soil and groundwater
of the pharmaceutical manufacturing facility Catalytica Pharmaceuticals
purchased from Glaxo Wellcome in 1997. Glaxo Wellcome has been working with the
EPA and the North Carolina Department of Environment and Natural Resources to
investigate, identify and remediate contamination in the soil and groundwater at
the Greenville Facility. This investigation has identified 17 different areas
of the Greenville Facility where contamination has or may have occurred. Of
these 17 areas, at least six have been identified by the North Carolina
Department of Environment and Natural Resources as requiring further
investigation and remediation. 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 is legally liable for such
contamination. Glaxo Wellcome, however, has agreed to be primarily liable for
and to perform, at its cost, the remediation that is required by law to cure the
contamination of the soil and groundwater that existed at the Greenville
Facility on the date the Greenville Facility was acquired by Catalytica
Pharmaceuticals. We do not know the cost or the extent of remediation that is
required at the Greenville Facility to cure the contamination.
In an effort to facilitate the remediation, we have entered into an agreement
with Glaxo Wellcome that requires us to provide Glaxo Wellcome with access to
the Greenville Facility and certain facility services as required for the
remediation. Glaxo Wellcome has agreed to reimburse us for the costs of such
access. We, however, cannot assure you that our costs will be reimbursed by
Glaxo Wellcome or that we will not suffer any interference with ongoing
operations because of Glaxo Wellcome's remediation activities or the existence
of contamination at the Greenville Facility. In addition, our future
development of the facility may be limited by the existence of contamination or
Glaxo Wellcome's remediation activities.
Catalytica Pharmaceuticals' ongoing operations at the Greenville Facility may
also cause additional contamination. The determination of the existence and
cost of any such additional contamination contributed by Catalytica
Pharmaceuticals could involve costly and time-consuming negotiations and
litigation. Furthermore, any such contamination caused by us could materially
adversely affect the business, results of operations and financial condition of
Catalytica Pharmaceuticals and our consolidated results of operations and
financial condition.
The Bay View Facility. Our Bay View facility, located in East Palo Alto,
California and leased from Rhone Poulenc, Inc., has significant soil and
groundwater contamination caused by a predecessor to Rhone Poulenc and is
located in a down gradient area 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. The order currently requires
stabilization, containment and monitoring of the arsenic and volatile organic
contamination at the site and surrounding areas by Rhone Poulenc.
Our ground lease with Rhone Poulenc includes an indemnity by Rhone Poulenc
against any costs and liabilities that we might incur as a result of the
contamination addressed by the clean-up and abatement order. Novartis, the
immediately preceding owner/operator of the facility, has also
57
indemnified us against any costs and liabilities that we may incur with respect
to any contamination caused by Novartis' operations. Despite such indemnities,
there is risk that we may be held responsible for existing contamination or
named in an action brought by a governmental agency or a third party because of
such contamination. If we are determined to have contributed to the
contamination, we will be liable for any damage to third parties attributable to
our contamination, and will be required to indemnify Rhone Poulenc and Novartis
for any additional clean up costs or liability that they may incur because of
the contamination we caused. The determination of the existence and additional
cost of any such incremental contamination contribution by us could involve
costly and time-consuming negotiations and litigation. Further, any such
incremental contamination by us or the unenforceability of either of the
indemnity agreements described above could materially adversely affect our
business and results of operations.
Failure to Comply with Current Good Manufacturing Practices and other FDA
Regulations would Adversely Affect Our Business.
Catalytica Pharmaceuticals manufactures, or expects to manufacture, many
active pharmaceutical ingredients and advanced pharmaceutical intermediates
that are used in its customers' drug products. The final drug products in which
the pharmaceutical ingredients and advanced pharmaceutical intermediates are
used, however, are subject to regulation for safety and efficacy by the FDA and
foreign regulatory authorities. Such products must be approved by such agencies
before they 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'
product sales will be adversely affected.
Products manufactured by Catalytica Pharmaceuticals at the Greenville Facility
require Catalytica Pharmaceuticals to comply with the FDA's current Good
Manufacturing Practices ("cGMP") regulations. Additionally, certain of
Catalytica Pharmaceuticals' customers, including Glaxo Wellcome, also require
Catalytica Pharmaceuticals to adhere to cGMP regulations, even if not required
by the FDA. Compliance with cGMP regulations requires manufacturers to expend
time, money and effort in production, and to maintain precise records 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. If Catalytica
Pharmaceuticals fails to comply with cGMP requirements it may become subject to
possible FDA action and manufacturing at the facility could be suspended. The
FDA also may require the submission of any lot of a particular product for
inspection. If the lot or product fails to meet the FDA's requirements, then
the FDA could take any of the following actions:
. restrict the release of the product
. suspend of manufacture of the specific lot of the product,
. order a recall of the lot or product,
. order a seizure of the lot or product.
58
Failure of Catalytica Pharmaceuticals' customers to obtain and to maintain FDA
clearance for marketing of the products manufactured by Catalytica
Pharmaceuticals would have a material adverse effect on our results of
operations. Failure of Catalytica Pharmaceuticals to comply with cGMP
regulations as required by the FDA and its customers could have a material
adverse effect on our results of operations.
Our Market is Highly Competitive and Greatly influenced by Technological Change.
We have numerous competitors in a variety of industries in the United States,
Europe and Asia. Many of these competitors have commercialized and are working
on technologies that could be competitive with those under development by us,
including our catalytic and other technological approaches. Our competitors may
develop technologies and systems and processes that are more effective than
those being developed by us or that would render our technology and systems and
processes less competitive or obsolete.
In the market for intermediates and bulk actives used in pharmaceutical
products and in the market for final dosage form of pharmaceutical products, our
primary competition comes from pharmaceutical companies that manufacture their
own products and from other chemical manufacturers such as Lonza AG and DSM Fine
Chemicals.
In the combustion systems market, our primary competition comes from large gas
turbine power generation manufacturers, such as General Electric Co., Allison
Engine Company and Solar Turbines. Each of these competitors is developing
competing dry-low-NOx ("DLN") systems for their own turbines. Many of our
competitors in the combustion systems market are also our potential customers.
*We expect to rely on these potential customers to help commercialize our
products.*
Our research and development capabilities, financial resources, managerial
resources, marketing experience and manufacturing experience is not as great as
many of our competitors. If our competitors are successful in developing systems
and processes that are more effective than ours, then our ability to sell our
systems and processes would be materially adversely affected. Further, our
ability to gain market share may be limited because many of the our competitors
are existing or potential customers.*
We Face Risks Related to Patents and Intellectual Property Rights.
We actively pursue patents for our inventions in the United States and in
markets throughout the world relevant to our business areas. We have 37 United
States patents and 17 pending United States patent applications, and
approximately 115 foreign patents and patent applications. Our success depends
on the ability to continue to obtain patents, protect trade secrets and operate
without infringing the proprietary rights of others in the United States and
other countries. If we do not effectively protect our intellectual property,
our business could be materially harmed.
We cannot assure that our patent applications will result in the issuance of
any patent, that any of our 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 our technology, or
59
that any such patents will not be challenged, circumvented or invalidated. In
addition, it is possible that others may independently develop similar systems
or processes or design around patents issued to us.
We may be required to obtain licenses to patents or other proprietary rights.
We cannot assure that any licenses required under any such patents or
proprietary rights would be made available on terms acceptable to us, if at all.
If we require and do not obtain such licenses, we could encounter delays in
system or process introductions while we attempt to design around such patents,
or we could find that the development, manufacture, sale or licensing of systems
or processes requiring such licenses could be foreclosed.
We could incur substantial costs in defending ourselves or our licensees in
litigation brought by others or prosecuting infringement claims against third
parties. We could incur substantial costs in interference proceedings declared
by the United States Patent and Trademark Office in connection with one or more
of our or third parties' patents or patent applications, and those proceedings
could also result in an adverse decision as to the priority of our inventions.
We also protect our proprietary technology and processes in part by
confidentiality agreements with our collaborative partners, employees and
consultants. We cannot assure that these agreements will not be breached, that
we will have adequate remedies for any breach, or that our trade secrets will
not otherwise become known or be independently discovered by competitors.
There is a High Concentration of Ownership in Our Capital Stock.
As of December 31, 1998, Morgan Stanley Capital Partners III, L.P. and two
affiliated funds ("MSCP") beneficially owned approximately 32% of our voting
stock, and securities convertible into 40% of our voting stock, and 47% of our
total outstanding capital stock (voting and non-voting). As a result, MSCP can
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 our assets. In addition, we have granted to MSCP certain contractual
rights, including representation on our Board of Directors and committees of the
Board of Directors, that will give MSCP additional rights to participate in
certain actions that may be taken by us. Such concentration of ownership and
contractual rights may have the effect of delaying, deferring or preventing us
from entering into a change of control.
The sale by MSCP of shares of our capital stock could constitute a change of
control under our credit agreement, which would trigger a default of the
agreement. MSCP has agreed not to trigger a change of control under the credit
agreement.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Investment Portfolio
Interest Rate Swaps In the second quarter of 1998, following the
restructuring of the Chase Credit Agreement, the Company entered into a $50
million interest rate swap, derivative transaction
60
to reduce the Company's exposure to fluctuations in short-term interest rates.
This interest rate swap transaction effectively fixed the LIBOR benchmark rate
used to calculate the Company's borrowing cost at 5.90% for 4 years on $50
million of the Debt Facilities. The Company accounts for this interest rate swap
as a hedge, and accrues the interest rate differential as interest expense on a
monthly basis. In accordance with the accrual method of accounting, there is no
recognition in the financial statements for changes in the derivative's fair
value. In the event of the early extinguishment of a designated debt obligation,
any realized or unrealized gain or loss from the swap would be recognized in
income coincident with the extinguishment gain or loss. Any swap agreements that
are not designated with outstanding debt or notional amounts (or durations) of
interest-rate swap agreements in excess of the principal amounts (or maturities)
of the underlying debt obligations would be recorded as an asset or liability at
fair value, with changes in fair value recorded in other income or expense (the
fair value method). The Company does not hold or transact in such financial
instruments for purposes other than risk management.
The notional principal amount for the off-balance-sheet instrument provides
one measure of the transaction volume outstanding as of year end, and does not
represent the amount of the Company's exposure to credit or market loss. The
Company believes its gross exposure to potential accounting loss on this
transaction if all counterparties failed to perform according to the terms of
the contract, based on then-current interest rates at each respective date,
would have no material financial impact. The Company's exposure to credit loss
and market risk will vary over time as a function of interest rates.
The estimate of fair value is $1.3 million and is based on a price quote
obtained from a third party. Although the table above reflects the notional
principal, fair value, and credit risk amount of the Company's interest rate, it
does not reflect the gains or losses associated with the exposure and
transactions that the interest rate is intended to hedge. The amounts ultimately
realized upon settlement of the financial instrument, together with the gains
and losses on the underlying exposure, will depend on actual market conditions
during the remaining life of the instrument.
With the interest rate swap, which qualifies as an accounting hedge, the
Company either makes or receives payments on the interest rate differential
between 5.9% and the actual interest paid on its debt which has a floating
interest rate based on the three-month U.S. dollar LIBOR rate. As a result, the
swap effectively converts $50 million of the Company's floating-rate 4-year debt
to a 5.90% fixed-rate debt and generally qualifies for hedge accounting
treatment. The maturity date for the swap is June 10, 2002. As of December 31,
1998, the interest rate swap classified as receive-fixed swap had a weighted-
average receive rate of 5.90%. The weighted-average pay rate on the swap was
5.59% as of December 31, 1998. The gain or loss on the swap is recognized in net
interest expense in the same period as the hedged transaction. The actual
incurred loss totaled approximately $87,000 as of December 31, 1998.
Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's Consolidated Financial Statements and Schedules, the report of
the independent auditors, and the section entitled "Quarterly Financial Data
(Unaudited)" appear on pages 71 through 120 of this Form 10-K.
61
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Executive Officers and Directors
Certain information with respect to persons who are executive officers of the
Registrant is set forth under the caption "Executive Officers" in Part I of this
report. The section entitled "Election of Directors" appearing in the
Registrant's proxy statement for the annual meeting of stockholders sets forth
certain information with respect to the directors of the Registrant and is
incorporated herein by reference.
Item 11. EXECUTIVE COMPENSATION
The section entitled "Executive Compensation" appearing in the Registrant's
proxy statement for the annual meeting of stockholders sets forth certain
information with respect to the compensation of management of the Registrant and
is incorporated herein by reference.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The section entitled "Election of Directors" appearing in the Registrant's
Proxy Statement for the annual meeting of stockholders sets forth certain
information with respect to the ownership of the Registrant's Common Stock and
is incorporated herein by reference.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The section entitled "Transactions with Management" appearing in the
Registrant's Proxy Statement for the annual meeting of stockholders sets forth
certain information with respect to certain business relationships and
transactions between the Registrant and its directors and officers and is
incorporated herein by reference.
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES & REPORTS ON FORM 8-K
A. (1) Financial Statements:
The following financial statements of the Registrant are filed as part
of this Report
Page
----
Report of Ernst & Young LLP, Independent Auditors 69
Consolidated Statements of Operations for the three years ended
December 31, 1998, 1997, and 1996 70
Consolidated Balance Sheets at December 31, 1998, and December 31, 1997 71
Consolidated Statements of Cash Flows for the three years ended
December 31, 1998, 1997, and 1996 73
Consolidated Statement of Stockholders' Equity for the three years ended
December 31, 1998, 1997, and 1996 75
Notes to Consolidated Financial Statements 76
Separate Financial Statement of Subsidiaries Not Consolidated and Fifty
Percent-or-Less Owned Persons:
GENXON (tm) Power Systems, L.L.C. Financial Statements and Report of
Independent Accountants for the year ended September 30, 1998 and the
period from October 21, 1996 (date of inception) to September 30, 1997 109
Quarterly Financial Data (Unaudited) 119
(2) Financial Statement Schedules:
Valuation and Qualifying Accounts 120
(3) Exhibits
Exhibit
No. Notes Description
- ------- ----- --------------------------------------------------------------------------
3.1 (6) Corrected Fourth Amended and Restated Certificate of Incorporation.
3.2 (1) Bylaws of Registrant.
4.1(a) (1) Agreement of Shareholders Amending Registration Rights and Right of First
Refusal.
4.1(b) (1) Amended and Restated Registration Rights Agreement dated September 27, 1988.
4.1(c) (1) Amendment No. 1 to Amended and Restated Registration Rights Agreement.
Exhibit
No. Notes Description
- ------- ----- --------------------------------------------------------------------------
4.1(d) (1) Form of Amended and Restated Rights Agreement.
4.2 (1) Specimen of Common Stock Certificate.
4.3(a) (4) Preferred Shares Rights Agreement dated as of October 23, 1996, between
Catalytica, Inc. and Chase Mellon Shareholder Services, L.L.P., including the
form of Rights Certificate, the Certificate of Designation and the Summary of
Rights attached thereto as Exhibits A, B and C, respectively.
4.3(b) (5) Amendment No. 1, dated as of June 28, 1997, to Preferred Shares Rights
Agreement between Catalytica, Inc. and Chase Mellon Shareholder Services, L.L.C.
4.4 (6) Stock Purchase Warrant for 2,000,000 Shares of the Company's Common Stock dated
July 31, 1997.
10.1 (1) 1983 Incentive Stock Option Plan, as amended, with forms of agreements
thereunder.
10.2 (11) 1992 Stock Option Plan, as amended.
10.3 (11) 1992 Employee Stock Purchase Plan, as amended.
10.4 (1)** Agreement, dated as of July 18, 1988, between the Company and Tanaka Kikinzoku
Kogyo K.K.
10.7 (1)** Development Agreement, dated January 4, 1991 among the Company, Petro-Canada
Inc. And Techmocisco, Inc. (a subsidiary of Mitsubishi Oil), as amended.
10.11 (1) Form of Indemnification Agreement.
10.13 (1) Stock Purchase Agreement dated December 10, 1992 between the Company and
Mitsubishi Oil Co., Ltd.
10.15 (2)** Ground Lease Agreement, dated November 30, 1993, between the Company and
Rhone-Poulenc Inc.
10.16 (2)** Supply Agreement, dated September 28, 1993, between the Company and Novartis
Agro, Inc.
10.17 (2) Lease Agreement, dated January 1, 1993, between the Company and Jack Dymond
Associates.
10.19 (2)** Agreement, dated January 31, 1995, between the Company and Tanaka Kikinzoku
Kogyo K.K.
10.21 (10) Catalytica Pharmaceuticals, Inc. 1995 Stock Plan, with forms of agreements
thereunder.
10.22 (3) Catalytica Advanced Sensor Devices 1995 Stock Plan, with forms of agreements
thereunder.
Exhibit
No. Notes Description
- ------- ----- --------------------------------------------------------------------------
10.23 (3) Catalytica Advanced Technologies, Inc. 1995 Stock Plan, with forms of
agreements thereunder.
10.24 (10) Catalytica Combustion Systems, Inc. 1995 Stock Plan, with forms of agreements
thereunder.
10.25 (3) Catalytica, Inc. 1995 Director Stock Option Plan, with forms of agreements
thereunder.
10.26 (8) Limited Liability Operating Agreement of GENXON Power Systems, LLC, dated
October 21, 1996.
10.27 (12) Amendment No. 1, dated December 4, 1997, to the Operating Agreement of GENXON
Power Systems, L.L.C.
10.28 (6)** Asset Purchase Agreement among Glaxo Wellcome Inc. and Catalytica
Pharmaceuticals, Inc. and Catalytica, Inc., dated June 25, 1997.
10.29 (7)** Supply Agreement between Glaxo Wellcome Inc. and Catalytica Pharmaceuticals,
Inc., dated July 31, 1997.
10.30 (6) 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.
10.31 (6) $200,000,000 Credit Agreement dated July 31, 1997, by and among Catalytica,
Inc., Catalytica Pharmaceuticals, Inc. and The Chase Manhattan Bank.
10.32 (12) Amendment No. 1 and Consent, dated January 6, 1998, to $200,000,000 Credit
Agreement among Catalytica, Inc., Catalytica Pharmaceuticals, Inc. and The
Chase Manhattan Bank.
10.33 (6) Pledge Agreement
10.34 (6) Security Agreement
10.35 (9)* Amendment No. 1 to Supply Agreement between Glaxo Wellcome, Inc. and Catalytica
Pharmaceuticals, Inc. dated May 28, 1998.
10.36 (9) Effectiveness Agreement among Catalytica, Inc., Catalytica Pharmaceuticals,
Inc. and The Chase Manhattan Bank dated June 4, 1998, including Exhibit A,
$175,000,000 Amended and Restated Credit Agreement.
10.37 Form of Change of Control Severance Agreement entered into between the Company and
certain of its executive officers.
21.1 (1) Subsidiaries of Registrant
23.1 Consent of Ernst & Young LLP, Independent Auditors.
Exhibit
No. Notes Description
- ------- ----- --------------------------------------------------------------------------
23.2 Consent of Coopers & Lybrand LLP, Independent Accountants
24.1 Power of Attorney. (See page 122)
27.1 Financial Data Schedule
(1) Incorporated by reference to the exhibits filed with the Company's
Registration Statement on Form S-1 (Registration Statement No. 33-
55696).
(2) Incorporated by reference to the exhibits filed with the Company's
Form 10-K for the fiscal year ended December 31, 1994.
(3) Incorporated by reference to the exhibits filed with the Company's
Annual Report on Form 10-K for the year ended December 31, 1995.
(4) Incorporated by reference to the exhibits filed with the Company's
Registration Statement on Form 8-A as filed with the Commission on
November 29, 1996.
(5) Incorporated by reference to the exhibits filed with the Company's
Registration Statement on Form 8-A/A as filed with the Commission on
July 29, 1997.
(6) Incorporated by reference to the exhibits filed with the Company's
Form 10-Q for the quarter ended June 30, 1997.
(7) Incorporated by reference to exhibits filed with the Company's Form
10-Q/A for the quarter ended June 30, 1997.
(8) Incorporated by reference to the exhibits filed with the Company's
Form 10-K for the year ended December 31, 1996.
(9) Incorporated by reference to exhibits filed with the Company's Form
10-Q for the quarter ended June 30, 1998.
(10) Incorporated by reference to exhibits filed with the Company's Form
10-Q for the quarter ended September 30, 1998.
(11) Incorporated by reference to exhibits filed with the Company's
Registration Statement on Form S-8 (file No. 333-57809) as filed with
the commission on June 26, 1998.
(12) Incorporated by reference to exhibits filed with the Company's Form
10-K for the year ended December 31, 1997.
** Confidential treatment has been granted for portions of these
agreements.
(3) Exhibits (continued)
B. Reports on Form 8-K
No reports on Form 8-K were filed by the Registrant during the year ended
December 31, 1998.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors and Stockholders
Catalytica, Inc.
We have audited the accompanying consolidated balance sheets of Catalytica,
Inc. as of December 31, 1998 and December 31, 1997, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 1998. Our audits also included the
financial statement schedule listed in the Index at Item 14(a). These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Catalytica, Inc. at December 31, 1998 and December 31, 1997, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, present fairly in all material respects the
information set forth therein.
ERNST & YOUNG LLP
San Jose, California
January 29, 1999
CATALYTICA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
For the year ended December 31,
-----------------------------------------------------
1998 1997 1996
---------------- ---------------- -----------------
Revenues:
Product sales $367,448 $174,347 $ 9,813
Research and development contracts 7,708 6,599 6,501
-------- -------- -------
Total revenues 375,156 180,946 16,314
Costs and expenses:
Cost of product sales 302,748 155,092 9,073
Research and development 22,598 9,556 9,707
Selling, general and administrative 16,875 7,302 4,452
-------- -------- -------
Total costs and expenses 342,221 171,950 23,232
-------- -------- -------
Operating income (loss) 32,935 8,996 (6,918)
Interest income 2,894 1,450 1,179
Interest expense (8,931) (5,422) (353)
Gain on sale of assets -- -- 900
Loss on joint ventures (3,827) (4,355) --
-------- -------- -------
Income (loss) before income taxes 23,071 669 (5,192)
Provision for income taxes (2,308) (359) --
-------- -------- -------
Net income (loss) before common stock redemption 20,763 310 (5,192)
Less premium paid on redemption of Class B common stock -- (3,750) --
-------- -------- -------
Income (loss) attributable to common shareholders $ 20,763 $ (3,440) $(5,192)
======== ======== =======
Net income (loss) per share:
Basic $0.39 $(0.10) $(0.27)
======== ======== =======
Diluted $0.33 $(0.10) $(0.27)
======== ======== =======
Number of shares used in computing net income (loss) per share:
Basic 53,109 33,248 19,283
======== ======== =======
Diluted 59,196 33,248 19,283
======== ======== =======
The accompanying notes are an integral part of these statements.
CATALYTICA, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
December 31, December 31,
1998 1997
---------------- ----------------
ASSETS
Current assets:
Cash and cash equivalents $ 42,392 $ 35,149
Short-term investments 5,193 11,918
Accounts receivable, net of allowance for doubtful accounts of
$1,700 ($600 in 1997) 34,456 12,640
Accounts receivable from joint ventures, net of allowance for doubtful
accounts of $87 (none in 1997) 1,121 967
Notes receivable from employees, net of allowance for doubtful notes
of $25 (none in 1997) 282 405
Inventory:
Raw materials 38,614 52,648
Work in process 41,256 54,883
Finished goods 8,979 6,714
-------- --------
88,849 114,245
Deferred tax asset 2,867 166
Prepaid expenses and other assets 1,578 1,939
-------- --------
Total current assets 176,738 177,429
Property, plant and equipment:
Land 5,391 5,391
Equipment 124,735 99,744
Buildings and leasehold improvements 65,398 59,344
-------- --------
195,524 164,479
Less accumulated depreciation and amortization (27,882) (15,075)
-------- --------
167,642 149,404
Other assets 3,016 2,040
-------- --------
$347,396 $328,873
======== ========
The accompanying notes are an integral part of these statements.
CATALYTICA, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
December 31, December 31,
1998 1997
----------------- -----------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 19,984 $ 23,281
Accrued payroll and related expenses 16,497 5,768
Deferred revenue 4,479 1,848
Other accrued liabilities 8,116 8,250
Current portion of long-term debt 10,770 50,332
Income taxes payable 3,706 525
-------- --------
Total current liabilities 63,552 90,004
Long-term debt 67,007 75,069
Non-current deferred revenue 2,181 3,611
Minority interest 41,000 11,000
Commitments and Contingencies
Class A and B common stock subject to mandatory redemption:
Class A - 30,000,000 shares authorized, 13,270,000 issued and
outstanding in 1998 and 1997 51,452 51,452
Class B - 17,000,000 shares authorized, 11,730,000 issued and
outstanding in 1998 and 1997 45,627 45,627
Stockholders' equity:
Preferred Stock, $.001 par value; 5,000,000 shares authorized,
none issued and outstanding -- --
Common Stock, $.001 par value; 120,000,000 shares authorized including
30,000,000 Class A and 17,000,000 Class B, 28,406,087 shares of common
stock issued and outstanding in 1998; (27,941,729 shares in 1997).
See Class A and B common stock above 28 28
Additional paid-in capital 103,954 100,375
Deferred compensation (281) (406)
Accumulated deficit (27,124) (47,887)
-------- --------
Total stockholders' equity 76,577 52,110
-------- --------
$347,396 $328,873
======== ========
The accompanying notes are an integral part of these statements.
CATALYTICA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (decrease) in cash and cash equivalents
(In thousands)
Year ended December 31,
----------------------------------------------
1998 1997 1996
-------------- -------------- --------------
Cash flows from operating activities:
Net income (loss) $ 20,763 $ 310 $ (5,192)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activity:
Depreciation and amortization 11,491 5,754 944
Deferred income taxes (2,701) (166) ---
Losses in joint ventures 3,827 4,355 ---
Changes in:
Accounts receivable (21,816) (8,696) (387)
Accounts receivable from related party --- --- (865)
Accounts receivable from joint venture (154) (102) ---
Inventory 25,396 5,995 (2,563)
Prepaid expenses, and other current assets 1,061 136 (310)
Accounts payable (3,297) 21,226 716
Accrued payroll and related expenses 10,729 4,395 (20)
Deferred revenue 1,201 (1,248) 6,540
Other accrued liabilities 3,047 7,826 359
-------- --------- --------
Net cash provided by (used in) operating activities $ 49,547 $ 39,785 $ (778)
Cash flows from investing activities:
Purchases of investments (37,202) (25,099) (22,748)
Maturities of investments 44,431 21,532 30,500
Investment in joint ventures (3,827) (4,355) ---
Acquisition of property and equipment (31,357) (6,347) (3,565)
Disposition of property and equipment 272 -- --
Proceeds from sale of property and equipment 7 -- --
Acquisition of Glaxo Wellcome inventory -- (116,823) --
Acquisition of Glaxo Wellcome property, plant and equipment
-- (131,198) --
-------- --------- --------
Net cash provided by (used in) investing activities $(27,676) $(262,290) $ 4,187
The accompanying notes are an integral part of these statements.
CATALYTICA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Increase (decrease) in cash and cash equivalents
(In thousands)
Year ended December 31,
-----------------------------------------------
1998 1997 1996
-------------- --------------- --------------
Cash flows from financing activities:
Net receipts on (issuance of) notes receivable from employees (583) (92) (206)
Additions to debt obligations 2,700 137,726 4,213
Payments on debt obligations (50,324) (20,501) (5,278)
Minority investment 30,000 -- 8,000
Issuance of Class A and B common stock, net -- 117,679 --
Repurchase of Class B common stock -- (23,750) --
Issuance of common stock by exercise of warrant dividend -- 27,692 --
Issuance of common stock 3,579 3,360 381
-------- -------- -------
Net cash provided by (used in) financing activities $(14,628) $242,114 $ 7,110
-------- -------- -------
Net increase in cash and cash equivalents 7,243 19,609 10,519
Cash and cash equivalents at beginning of year 35,149 15,540 5,021
------- ------- -------
Cash and cash equivalents at end of year $42,392 $35,149 $15,540
======= ======= =======
Additional disclosure of non-cash financing and operating
activities:
Issuance of warrants in conjunction with the Glaxo
Wellcome facility acquisition --- 6,500 ---
======= ======= =======
Issuance of Catalytica Pharmaceutical's Junior Preferred
Stock in conjunction with the Glaxo Wellcome facility
acquisition --- 3,000 ---
======= ======= =======
Assumption of liability in conjunction with Glaxo Wellcome
facility acquisition --- 6,400 ---
======= ======= =======
Issuance of Catalytica common stock to Shearson Lehman for
services provided in conjunction with issuance of Class A
& B common stock --- 600 ---
======= ======= =======
Deferred Compensation --- 500 ---
======= ======= =======
Supplemental disclosure of cash flow information:
Interest paid $ 8,335 $ 4,667 $ 353
======= ======= =======
The accompanying notes are an integral part of these statements.
CATALYTICA, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(In thousands, except share amounts)
Common Stock Additional Total
------------ Paid-In Deferred Accumulated Stockholders'
Shares Amount Capital Compensation Deficit Equity
------------ ---------- ---------- ------------- -------------- ---------
Balance at December 31, 1995 19,190,222 $19 $ 65,101 $ (86) $(43,005) $22,029
Sale of common stock 206,852 -- 358 -- -- 358
Expense recorded from acceleration
of stock options -- -- 23 -- -- 23
Amortization of deferred
compensation -- -- -- 45 -- 45
Net loss -- -- -- -- (5,192) (5,192)
---------- --- -------- ----- -------- -------
Balance at December 31, 1996 19,397,074 $19 $ 65,482 $ (41) $(48,197) $17,263
Sale and issuance of common stock 1,413,506 2 3,958 -- -- 3,960
Issuance of warrants to Glaxo Wellcome -- -- 6,500 -- -- 6,500
Net exercise of warrants issued in
connection with public offering 208,153
Exercise of warrant dividends 6,922,996 7 27,685 -- -- 27,692
Premium paid in connection with repurchase
of Class B common stock (3,750) (3,750)
Issuance of below market stock
options -- -- 500 (500) --
Amortization of deferred
compensation -- -- -- 135 -- 135
Net income -- -- -- -- 310 310
---------- --- -------- ----- -------- -------
Balance at December 31, 1997 27,941,729 $28 $100,375 $(406) $(47,887) $52,110
Sale and issuance of common stock 464,358 -- 3,289 -- -- 3,289
Issuance of stock options to consultants -- -- 290 -- -- 290
Amortization of deferred
compensation -- -- -- 125 -- 125
Net income -- -- -- -- 20,763 20,763
---------- --- -------- ----- -------- -------
Balance at December 31, 1998 28,406,087 $28 $103,954 $(281) $(27,124) $76,577
========== === ======== ===== ======== =======
The accompanying notes are an integral part of these statements.
CATALYTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Description of Business and Significant Accounting Policies
Description of Business Catalytica, Inc. ("Catalytica" or "the Company")
builds business in high growth industries where the Company's technologies
sptimize manufacturing and solve environmental problems. To enhance its market
focus, and increase flexibility for strategic financial arrangements and
business partnerships, the Company has created three operating subsidiaries:
Catalytica Pharmaceuticals, Inc. ("Catalytica Pharmaceuticals"), Catalytica
Combustion Systems, Inc. ("Combustion Systems"), and Catalytica Advanced
Technologies, Inc. ("Advanced Technologies").
Basis of Presentation The accompanying consolidated financial statements
include the accounts of the Company and its wholly owned subsidiaries after
elimination of all significant intercompany accounts and transactions. Certain
amounts from 1997 and 1996 have been reclassified to reflect 1998 and 1997
presentation, respectively.
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.
Financial Instruments
Cash and Cash Equivalents Cash and cash equivalents consist of cash on
deposit with banks and money market instruments. As a result of a $30 million
investment by Enron Ventures Corporation in Combustion Systems (See Note 3), and
covenants associated with the Chase Credit Agreement (See Note 7), certain
restrictions have been placed on the use of the Company's cash and investments.
Of the Company's $42.4 million in cash and cash equivalents, $17.7 million may
only be used for Combustion Systems' operations, and the remaining $24.7 million
may be used for Catalytica Pharmaceuticals and other operations in the Company,
excluding Combustion Systems. These same restrictions apply to any short and
long term investments (See Investments below). The entire $5.2 million in short
term investments is associated with Combustion Systems, therefore, these funds
can also only be used within the Combustion Systems' operations.
Investments 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 (none at
December 31, 1998); investments with maturities of three months or less at the
date of purchase which are held-to-maturity ($5.2 million at December 31, 1998)
and investments with maturities greater than three months which are available-
for-sale (none at December 31, 1998) are considered to be short-term
investments; investments with
maturities greater than one year are considered to be long-term investments and
are available-for-sale (none at December 31, 1998). All investments at December
31, 1998, were carried at amortized cost, which approximated fair market value
(quoted market price). The classification of investments is made at the time of
purchase with classification for held-to-maturity made when the Company has the
positive intent and ability to hold the investments to maturity.
As of December 31, 1998, the average portfolio duration is approximately .85
months.
Interest Rate Swap In the second quarter of 1998 following the
restructuring of the Chase Credit Agreement (see Note 7), the Company entered
into a $50 million interest rate swap to reduce the Company's exposure to
fluctuations in short-term interest rates. This interest rate swap transaction
effectively fixed the LIBOR benchmark rate used to calculate the Company's
borrowing cost at 5.90% for 4 years on $50 million of the Term Debt Facility.
The Company accounts for this interest rate swap as a hedge, and accrues the
interest rate differential as an adjustment to interest expense on a monthly
basis. In accordance with the accrual method of accounting, there is no
recognition in the financial statements for changes in the derivative's fair
value. In the event of the early extinguishment of a designated debt
obligation, any realized or unrealized gain or loss from the swap would be
recognized in income coincident with the extinguishment gain or loss. Any swap
agreements that are not designated with outstanding debt or notional amounts (or
durations) of interest-rate swap agreements in excess of the principal amounts
(or maturities) of the underlying debt obligations would be recorded as an asset
or liability at fair value, with changes in fair value recorded in other income
or expense (the fair value method). The Company does not hold or transact in
such financial instruments for purposes other than risk management.
As of December 31, 1998, the interest rate swap classified as a receive-fixed
swap had a weighted-average receive rate of 5.90%. The weighted-average pay
rate on the swap was 5.59% as of December 31, 1998. The gain or loss on the swap
is recognized in net interest expense in the same period as the hedged
transaction. The actual incurred loss totaled approximately $87,000 as of
December 31, 1998.
Concentrations of Credit Risk Financial instruments that potentially subject
the Company to concentrations of credit risk consist principally of investments
in cash equivalents, short-term and long-term investments, and trade
receivables. The Company uses local banks and various investment firms to
invest its excess cash, principally in commercial paper and money market funds,
to provide a diversified portfolio of investments with strong credit ratings.
The Company is exposed to credit risks in the event of default by the financial
institutions or issuers of investments to the extent recorded on the balance
sheet. The Company performs ongoing credit evaluations of its customers and
generally does not require collateral.
Inventories All inventories are stated at the lower of cost (first-in, first-
out) or market. Inventory write-downs are based on the Company's best
estimates.
On July 31, 1997, Catalytica Pharmaceuticals purchased $116.8 million of
inventory as part of the acquisition of the pharmaceutical manufacturing
facility from Glaxo Wellcome Inc.
Property, Plant, and Equipment On July 31, 1997, Catalytica Pharmaceuticals
purchased from Glaxo Wellcome (i) all the land, buildings and improvements
thereon and certain rights relating thereto compromising the pharmaceutical
manufacturing facility of Glaxo Wellcome located in Greenville, North Carolina
("Greenville Facility"), containing approximately 584 acres of land, and (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 Greenville
Facility. The Company recorded $147.1 million of property, plant, and equipment
in connection with the acquisition of the Greenville Facility ("Acquisition").
Property and equipment are stated at cost. Depreciation and amortization are
provided on the straight-line basis over the lesser of the useful lives of the
respective assets or the lease term, if applicable (generally 3-15 years).
Expenditures for maintenance and repairs are generally charged to expense as
incurred. In 1998, $16.6 million was charged to repair and maintenance expense.
Advertising Advertising costs are expensed as incurred. Advertising costs
were $539,000, $165,000, and $49,000 for the years ended December 31, 1998,
1997, and 1996 respectively.
Revenues Revenues consist of both product sales and research revenues. All
product revenues are recognized upon shipment. Approximately 98% of revenues
are related to pharmaceutical product sales for the year ended December 31,
1998. During 1998, approximately 88% of the Company's product revenues were
derived from sales to Glaxo Wellcome. As of December 31, 1998, and December 31,
1997, respectively, a receivable in the amount of $16.1 million and $11.8
million was outstanding from Glaxo Wellcome. Glaxo Wellcome has guaranteed that
revenues paid to Catalytica Pharmaceuticals will meet a specified level or that
Glaxo Wellcome will pay to Catalytica Pharmaceuticals any shortfall. The
guaranteed revenues, which include compensation for transition services
Catalytica Pharmaceuticals has agreed to provide Glaxo Wellcome, and which
exclude the cost of materials, in the next several years are as set forth below
in millions of dollars:
August 1 -
December 31, 1998 1999 2000 2001 Total
----------- ------ ------ ----- ----- ------
1997
-----
Supply agreement and
certain amendments $77.0 $173.4 $113.8 $72.6 $22.6 $459.4
The Supply Agreement and certain subsequent amendments state that guaranteed
revenues are to be calculated by comparing the agreed upon product prices billed
on invoices for the year to the stipulated guaranteed revenue amount for the
specific year in agreement.
Approximately 2% of the Company's revenues in 1998 were derived from research
and development contracts. Most of the Company's research and development
contracts are subject to periodic review by the funding partner, which may
result in modifications, including reduction or termination of funding. There
can be no assurance that the Company will continue to receive research and
development funding, and the Company expects that it will rely increasingly on
product sales for its revenues.
Research revenues are earned as contractual services are performed in
connection with collaborative arrangements and are recognized in accordance with
contract terms, principally based on reimbursement of total costs and expenses
incurred. In return for funding development, collaborative partners receive
certain rights in the commercialization of the resulting technology. Costs of
$7.5 million, $6.3 million, and $6.2 million related to research revenues were
included in total costs and expenses for each of the three years ended December
31, 1998, 1997, and 1996, respectively. Unbilled revenues related to work
performed under collaborative arrangements were approximately $0.5 million at
December 31, 1998 ($1 million at December 31, 1997) and are included in accounts
receivable on the accompanying balance sheet. Most amounts unbilled at December
31, 1998, were billed in January 1999.
Major Customer Information Revenues from major customers from all sources of
revenue representing more than 10% of revenues in any of the past three years
are as follows:
Year ended December 31,
-----------------------------------------------------------
Customer 1998 1997 1996
- ------------------------------------------------------------ ------------------- ------------------- -----------------
Glaxo Wellcome 86% 87% --
Pharmacia Upjohn (formerly Upjohn) -- -- 17%
Merck & Co. -- 1% 13%
Novartis 1% 3% 11%
Pfizer, Inc. 3% 2% 11%
Research and Development All costs for research and development activities
are expensed in the year incurred. Such costs include proprietary research and
development expenses associated with revenues from research and development
agreements. Approximately 21% of the Company's 1998 research and development
expenses were spent to develop the Company's combustion systems technology,
approximately 60% were spent on pharmaceuticals technology, and approximately
19% were spent on other technologies, much of which was performed at the
specific request of, and funded by, third parties.
Income Taxes The Company accounts for income taxes under the liability
method in accordance with Statements of Financial Accounting Standards ("SFAS")
No. 109, "Accounting for Income Taxes"(see Note 8). Income taxes have been
provided and tax credits have been recognized based on tax laws in effect at the
dates of the financial statements.
Earnings (Loss) per Share Earnings (loss) per share is presented in
accordance with Financial Accounting Standards Board ("FASB") Statement of
Financial Accounting Standards
("SFAS") No. 128, "Earnings Per Share" ("EPS"). This statement requires the
presentation of EPS to reflect both "Basic EPS" and "Diluted EPS" on the face of
the statement of operations. In general, Basic EPS excludes dilution created by
common stock equivalents and is a function of the weighted average number of
common shares outstanding for the period. Diluted EPS reflects the potential
dilution created by common stock equivalents. For the periods ended December 31,
1997, and 1996, the inclusion of common stock equivalents and the reduction of
Catalytica Pharmaceuticals income due to holders of subsidiary stock options is
antidilutive, therefore loss per share is computed based on the weighted average
number of common shares outstanding excluding common stock equivalents. Weighted
average shares outstanding includes Class A and B common shares as the Company
considers Class A and B to be the equivalent of common stock. All periods
presented herein have been adjusted to reflect the calculation of EPS in
accordance with SFAS No. 128.
A reconciliation of the numerators and denominators for the Basic and Diluted
EPS calculations follows:
Earnings (Loss) per Share
(In thousands, except per share amounts)
The following table sets forth the computation of basic and diluted earnings
per share:
1998 1997 1996
---- ---- ----
Numerator:
Numerator for basic earnings per share: Income (loss)
available to common shareholders $20,763 $ 310 $(5,192)
Premium paid on common stock redemption (*) -- (3,750) --
------- ------- -------
20,763 (3,440) (5,192)
Less: Reduction of Catalytica Pharmaceuticals income
attributable to holders of subsidiary stock options
(1,380) -- --
------- ------- -------
Numerator for diluted earnings (loss) per share $19,383 $(3,440) $(5,192)
------- ------- -------
Denominator:
Denominator for basic earnings (loss) per share
Weighted-average shares 53,109 33,248 19,283
------- ------- -------
Effect of dilutive securities:
Catalytica, Inc. employee stock options 807 -- --
Catalytica Pharmaceuticals Convertible Preferred Stock 1,683 -- --
Catalytica Pharmaceuticals Convertible Junior Preferred Stock 568 -- --
Catalytica Combustion Systems, Inc. Convertible Preferred
Stock 2,651 -- --
Catalytica, Inc. warrants issued to Glaxo Wellcome, Inc. 378 --
------- ------- -------
Dilutive potential common shares 6,087 -- --
Denominator for diluted earnings (loss) per share
Adjusted weighted-average shares and assumed conversions 59,196 33,248 19,283
------- ------- -------
Basic earnings (loss) per share $0.39 $ (0.10) ($0.27)
======= ======= =======
Diluted earnings (loss) per share $0.33 $ (0.10) ($0.27)
======= ======= =======
* Income (loss) available to common shareholders reflects a reduction from
1997 net income of $3.75 million relating to the call premium paid for the
repurchase of five million shares of Series B common stock with proceeds
received from the exercise of warrants issued to shareholders as a dividend.
See Note 11.
81
For the years ended December 31, 1997, and 1996, potentially dilutive
securities of 2,649,000 and 2,286,000, respectively, were outstanding and not
included in the diluted earnings per share computation because they are
antidilutive.
Stock-Based Compensation In 1995, the FASB issued Statement No. 123,
Accounting for Stock-Based Compensation, which provides an alternative to APB
Opinion No. 25, Accounting for Stock Issued to Employees, in accounting for
stock-based compensation to employees. The Company has elected to account for
stock-based compensation to employees in accordance with APB Opinion 25,
providing only pro forma disclosures required by Statement 123. See Note 11.
Comprehensive Income Effective January 1, 1998, the Company adopted
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income." This Statement requires that all items recognized under accounting
standards as components of comprehensive earnings be reported in an annual
financial statement that is displayed with the same prominence as other annual
financial statements. This Statement also requires that an entity classify items
of other comprehensive earnings by their nature in an annual financial
statement. For example, other comprehensive earnings may include foreign
currency translation adjustments, minimum pension liability adjustments, and
unrealized gains and losses on marketable securities classified as available-
for-sale. As the Company has no components of other comprehensive income, there
are no disclosure requirements involved in the Company's adoption of this
Statement.
Segment Disclosures In June 1997, the Financial Accounting Standards Board
issued Statement No. 131, "Disclosures about Segments of an Enterprise and
Related Information" which was adopted by the Company in the first quarter of
fiscal 1998. This Statement establishes standards for the way that public
business enterprises report information about reportable operating segments in
annual financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
stockholders. It also establishes standards for related disclosures about
products and services, geographic areas and major customers.
The Company operates primarily in the pharmaceuticals and combustion systems
industries. The Company has determined the reportable operating segments based
upon how the business is managed and operated. Catalytica Pharmaceuticals and
Combustion Systems operate as independent subsidiaries of the Company with their
own sales, research and development and operations departments. Each subsidiary
manufactures and distributes distinct products with different production
processes. As such, the following table discloses revenues, operating income,
and identifiable assets for the above named operating segments. Advanced
Technologies is combined with Corporate as it does not meet the requirements for
separate disclosure.
(In thousands)
- --------------
1998 1997 1996
---- ---- ----
Revenues
82
Catalytica Pharmaceuticals $368,877 $175,807 $ 10,127
Combustion Systems 2,707 1,950 2,702
Corporate and other subsidiary 3,572 3,189 3,485
-------- -------- --------
Total Revenues $375,156 $180,946 $ 16,314
======== ======== ========
1998 1997 1996
---- ---- ----
Operating Income
Catalytica Pharmaceuticals $ 37,398 $ 9,258 $ (3,738)
Combustion Systems (3,014) (478) (2,216)
Corporate and other subsidiary (1,449) 216 (964)
-------- -------- --------
Total Operating Income $ 32,935 $ 8,996 $ (6,918)
======== ======== ========
1998 1997 1996
---- ---- ----
Identifiable Assets
Catalytica Pharmaceuticals $300,264 $305,565 $ 24,147
Combustion Systems 27,402 2,011 2,339
Corporate and other subsidiary 19,730 21,297 14,517
-------- -------- --------
Total Assets $347,396 $328,873 $ 41,003
======== ======== ========
Impact of Recently Issued Accounting Standards In June 1998, SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" was issued. SFAS
No. 133 establishes accounting and reporting standards for derivative
instruments, hedging activities, and exposure definition. SFAS No. 133 requires
that an entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. The
Statement is effective for all fiscal quarters of fiscal years beginning after
June 15, 1999. Earlier application of the Statement is permitted. The Company is
still in the process of assessing the impact that the Statement will have on the
Company's results of operations, consolidated financial position, and operating
policies.
Note 2. Catalytica Pharmaceuticals, Inc.
On July 31, 1997 the Company purchased from Glaxo Wellcome a pharmaceuticals
manufacturing facility in Greenville, North Carolina for (i) $244.7 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 for six years
after the closing of the acquisition ("Closing") 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 Greenville Facility
for a period of ten years following the Closing, up to an aggregate cumulative
payment to Glaxo Wellcome of an additional $25 million.
The cash purchase price reflects the parties' agreement to a reduction in the
cash consideration of approximately $6.4 million in exchange for the assumption
by the Company and Catalytica Pharmaceuticals of certain liability associated
with the abatement of asbestos or asbestos containing materials ("ACM") present
at the Greenville Facility and post-closing
83
employee workplace exposure. As a result of the Acquisition, Catalytica recorded
$116.8 million of inventory, $147.1 million of property, plant, and equipment,
and the assumption of the aforementioned asbestos liability of $6.4 million.
During 1998, the Company began performing some asbestos abatement, and the
asbestos liability was reduced by $0.6 million. See Note 5.
The Junior Preferred Stock of Catalytica Pharmaceuticals issued to Glaxo
Wellcome has the following rights: (a) a non-cumulative dividend preference and
a liquidation preference, both junior to the outstanding preferred stock of
Catalytica Pharmaceuticals and the Catalytica Pharmaceuticals Series C Preferred
Stock which was issued to the Company in connection with the Acquisition; (b)
the right to convert into shares of Catalytica Pharmaceuticals Common Stock on a
one-for-one basis (subject to adjustment in the case of stock splits,
reclassifications, stock dividends and rights offerings to existing holders of
Common Stock and similar events and in the event of Common Stock issuances below
the then fair market value except for issuances pursuant to Catalytica
Pharmaceuticals' employee benefit plans) at any time at the option of the holder
and automatically upon the closing of an underwritten public offering which
results in gross proceeds of at least $10 million to Catalytica Pharmaceuticals;
(c) each share of Junior Preferred Stock shall be entitled to the number of
votes equal to the number of shares of Common Stock into which such shares of
Junior Preferred Stock could then be converted; and (d) if Catalytica
Pharmaceuticals shall not have consummated an underwritten public offering which
results in gross proceeds of at least $10 million to Catalytica Pharmaceuticals
within five years of the consummation of the Acquisition, the Junior Preferred
Stock shall be exchangeable, at the option of Glaxo Wellcome, into shares of
Common Stock of the Company having a market value at that time equal to the
value of the preferred stock. Upon consolidation of Catalytica Pharmaceuticals
into Catalytica, Inc., the Junior Preferred Stock issued to Glaxo Wellcome is
reflected as $3 million of minority interest in Catalytica, Inc.
In connection with the sale of the Greenville Facility, Glaxo Wellcome entered
into a Supply Agreement under which Catalytica Pharmaceuticals manufactures
products for Glaxo Wellcome over the next several years. In 1998 the Company
signed two amendments to the original Supply Agreement, and a third amendment
was signed in the first quarter of 1999. Catalytica Pharmaceuticals estimates
that aggregate payments (including the cost of materials) by Glaxo Wellcome
under the original Supply Agreement will total approximately $800 million over a
five-year period. Subsequent amendments to the original supply agreement may
provide for approximately $120 million in revenue over a two and one-half year
period commencing July 1998. Glaxo Wellcome has guaranteed that revenues paid to
Catalytica Pharmaceuticals under the original Supply Agreement will meet a
specified level of minimum revenue or that Glaxo Wellcome will pay to Catalytica
Pharmaceuticals any shortfall. A portion of the $120 million additional revenue
has also been guaranteed by Glaxo Wellcome, however; the majority of this
additional revenue is based on forecasts by Glaxo Wellcome for production as
defined in the amended agreements. As such, the forecasted revenues are subject
to fluctuations based on production demand by Glaxo Wellcome. The minimum
revenues, which include compensation for transition services Catalytica
Pharmaceuticals has agreed to provide Glaxo Wellcome, and which exclude the cost
of materials, over the five years beginning in 1997, total $459.4 million. As of
December 31, 1998 and 1997, a receivable in the amount of $16.0 million and
$11.8 million, respectively, was outstanding from Glaxo Wellcome.
84
On May 8, 1996, Pfizer Inc. ("Pfizer") entered into a Collaborative Research
and License Agreement and a Stock Purchase Agreement with Catalytica
Pharmaceuticals, Inc. that included the purchase of 150,000 shares of Series B
Preferred Stock by Pfizer. The holders of the Series B Preferred Stock shall be
entitled to receive non-cumulative dividends at a rate of $6.00 per share, per
annum, when and if declared by the Board of Directors. In consideration of the
$15 million paid, Catalytica Pharmaceuticals is also obligated to perform
specified agreed upon research for a five year period. Accordingly, Catalytica
recognized Pfizer's minority interest in Catalytica Pharmaceuticals at $8
million and recorded deferred revenue of $7 million to be recognized as research
is performed. In 1998 and 1997, $1.4 million and $1.5 million, respectively, of
research was performed and recognized as revenue. The deferred revenue balance
pertaining to Pfizer is $3.6 and $5.0 million at December 31, 1998, and 1997,
respectively.
In conjunction with the Stock Purchase agreement, the Company entered into a
Share Exchange agreement, providing Pfizer the right to exchange the Series B
Preferred Stock of the Company for Catalytica, Inc. ("Catalytica") Common Stock.
After the three year anniversary of the agreement, Pfizer shall have the right
to require the Company to exchange all of the outstanding shares of Series B
Preferred Stock for that number of shares of Common Stock based upon a
determined exchange rate. The exchange rate is based upon the fair value of the
Preferred Stock and the market value of Catalytica's Common Stock at the time of
conversion. In the event of insolvency of the Catalytica Pharmaceuticals,
Pfizer may convert $4.2 million of Series B Preferred Shares into 700,000 shares
of Catalytica's Common Stock.
Note 3. Catalytica Combustion Systems, Inc.
On January 14, 1998, Enron Ventures Corporation, a wholly-owned subsidiary of
Enron Corporation ("Enron"), purchased a 15% minority interest in Combustion
Systems for $30 million in cash in which Enron received 1,339,286 shares of
Combustion Systems' Series B Preferred Stock. In addition, Enron also received
a three-year option to purchase an additional 5% of Combustion Systems for $14.4
million in cash. In conjunction with the Stock Purchase agreement, the Company
entered into a Share Exchange agreement, providing Enron the right to exchange
the Series B Preferred Stock of Combustion Systems for Catalytica, Inc. Common
Stock. After the five year anniversary of the agreement, if Combustion Systems
has not undertaken a public offering, in which Combustion Systems receives at
least $20 million in gross proceeds, Enron shall have the right to require the
Company to exchange all of the outstanding shares of Series B Preferred Stock
for that number of shares of Common Stock based upon a determined exchange rate.
The exchange rate is based upon the fair value of the Preferred Stock and the
market value of Catalytica's Common Stock at the time of conversion. Upon
consolidation of Combustion Systems into Catalytica, Inc., the Series B
Preferred Stock issued to Enron is reflected as $30 million of minority
interest.
Joint Venture (GENXON) On October 15, 1996, Catalytica's subsidiary 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, was formed to upgrade
85
the combustion systems of installed turbines with XONON, which is designed to
reduce emissions and permit greater asset utilization for both power generation
and mechanical drive markets.
The initial capital commitment of the GENXON joint venture partners was $10
million: $2 million from Combustion Systems, and $8 million from Woodward,
payable over time as the funds were required by the joint venture. In addition
to the initial capital commitment made by Combustion Systems and Woodward,
Combustion Systems has contributed to the joint venture an exclusive license for
the use of its catalytic combustion technologies valued at $8 million, and
Woodward contributed to the joint venture an exclusive license for the use of
its instrumentation and control systems for gas turbine catalytic combustion
valued at $2 million. The initial capital commitment of $10 million was reached
during the third quarter of 1997. Continued funding of the joint venture beyond
the initial $10 million commitment has occurred on a 50/50 basis with each joint
venture partner contributing an equal amount quarterly. For the year ended
December 31, 1998, Combustion Systems contributed $4.4 million in cash, of which
$0.5 million was accrued by the Company in 1997 and paid in 1998, and Woodward
Governor Company contributed $4.4 million, bringing the total combined
investment in the joint venture to $22.6 million to date. Combustion Systems
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. For the year ended December 31, 1998, the
Company recorded losses of $3.7 million on the joint venture.
Subsequent to the formation of the joint venture, the Company received
reimbursements for costs incurred by the Company on behalf of GENXON totaling $2
million. Accordingly, these costs have not been included in the consolidated
financial statements of Catalytica, Inc. As of December 31, 1998, accounts
receivable of $0.4 million were outstanding from GENXON.
The following information summarizes GENXON's financial position for the year
ended September 30, 1998, and the unaudited quarter ended December 31, 1998:
Year Ended Quarter Ended
September 30, 1998 December 31, 1998
------------------ -----------------
(in thousands) (Unaudited)
Total revenues $ 204 $ 386
======= =======
Net loss $(9,615) $(1,246)
======= =======
Current assets $ 1,077 $ 1,487
Long-term assets 1,018 968
------- -------
Total assets $ 2,095 $ 2,455
======= =======
Current liabilities $ 786 $ 1,243
Members' capital 1,309 1,212
------- -------
86
Total liabilities
and members' capital $ 2,095 $ 2,455
======= =======
Note 4. Catalytica Advanced Technologies, Inc.
Joint Venture (Single-Site Catalysts, L.L.C.) On November 1, 1998, Advanced
Technologies entered into an operating agreement with United Catalysts, Inc.
("United Catalysts") to form Single-Site Catalysts, L.L.C., a Delaware limited
liability company ("Single-Site Catalysts"). Advanced Technologies was required
to contribute inventory and equipment valued at $0.15 million and a License
Agreement. United Catalysts agreed to contribute a License Agreement and $5
million in capital to be paid in varying installments over the next several
years. Single-Site Catalysts incurred a loss in 1998 and the Company anticipates
that the joint venture will continue to generate losses during 1999. The
Company has recorded its share of these losses to the extent of its capital
contribution of $0.15 million in 1998. However, the operating agreement does not
require any further capital contributions by Advanced Technologies beyond it's
initial $0.15 million contribution. Therefore, no further losses will be
recorded by the Company unless it decides to invest additional capital.
Advanced Sensor Devices On June 28, 1996, Catalytica completed the sale of
substantially all the business of its wholly owned subsidiary, Advanced Sensor
Devices, Inc. ("ASD"), to Monitor Labs, Inc. 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, an additional $0.5 million paid upon certification
for the CEM product which occurred in December 1996, and a royalty stream based
on future revenues. For the year ended December 31, 1996, Catalytica realized a
$0.9 million gain on the sale of ASD's assets.
87
Note 5. Environmental Regulations
On November 30, 1993, the Company entered into a ground lease with Rhone
Poulenc, Inc. to lease the surface of the pharmaceuticals manufacturing facility
in East Palo Alto, California ("site"). Because there is significant soil and
groundwater contamination caused by past activities on the Site, Rhone Poulenc
Inc. is remediating the soil and groundwater of the Site pursuant to an order
from the Bay Area Regional Water Quality Control Board ("RWQCB"). Pursuant to
the ground lease with Rhone Poulenc Inc., the Company has received an indemnity
for the contamination that is the subject of the RWQCB's order.
A moderate amount of asbestos containing material ("ACM") is present at the
Greenville Facility. The Company believes that the ACM, in its present
condition, does not require abatement. Abatement is only required if
renovations are performed in those areas containing ACM. The Company assumed
the $6.4 million liability associated with the abatement of the ACM present at
the Greenville Facility under the purchase agreement with Glaxo Wellcome. During
1998, the Company began performing some asbestos abatement, and the asbestos
liability was reduced by $0.6 million. The Company had a reserve totaling $5.8
million and $6.4 million at December 31, 1998, and 1997, respectively, netted
against property, plant, and equipment which the Company believes is adequate to
cover the cost of remedial clean-up should further renovations ever be performed
in those areas containing ACM.
In connection with the sale of the pharmaceutical manufacturing facility in
Greenville, North Carolina to the Company (see Note 2), Glaxo Wellcome agreed to
perform, at its own cost, remediation required by law associated with soil and
groundwater contamination existing at the Greenville Facility as of the date of
the acquisition, July 31, 1997. Catalytica Pharmaceuticals is required to
provide access to the Greenville Facility and certain facility services required
by the remediation efforts, subject to reimbursement by Glaxo Wellcome.
Many of the pharmaceuticals products the Company manufactures, or will
manufacture in the future, and the final drug products in which they are used,
are subject to regulation for safety and efficacy by the FDA and foreign
regulatory authorities before such products can be commercially marketed. The
process of obtaining regulatory clearances for marketing is uncertain, costly,
and time-consuming. The Company cannot predict how long the necessary
regulatory approvals will take, or if its customers will ever obtain such
approval for their products. To the extent the Company's customers do not
obtain the necessary regulatory approvals for marketing new products, the
Company's pharmaceutical product sales will be adversely affected.
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. 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.
88
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 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. There can be no assurance that these regulations will ever
be adopted.
Note 6. Pension and Profit Sharing Plans
The Company has a defined contribution pension plan and a nonqualified pension
plan for employees meeting certain requirements, based on a defined percentage
of the employees' compensation and an employer match for the defined
contribution plan. Pension expense amounted to approximately $0.7 million,
$0.45 million, and $0.3 million, for each of the three years ended December 31,
1998, 1997, and 1996, respectively.
The Company has a qualified contributory savings plan as allowed under 401(k)
in the Internal Revenue Code. The plan permits participant contributions and
requires a minimum contribution from the Company based on the participant's
contribution. Participants may elect to defer up to 15% of their annual
compensation through participation in the plan. Total contribution expense was
$2.2 million in 1998, $0.9 million in 1997, and none in 1996.
Note 7. Debt
In conjunction with the acquisition of the Greenville Facility, the Company
entered into a Credit Agreement pursuant to which a syndicate of banks led by
Chase Securities, Inc. ("Chase") agreed to lend Catalytica Pharmaceuticals an
aggregate of up to $200 million (the "Debt Facilities"). The Debt Facilities
consisted of a senior secured term loan facility (the "Term Debt Facility") in
an aggregate principal amount of $125 million and a senior secured revolving
facility (the "Revolving Debt Facility") in an aggregate principal amount of $75
million. In the quarter ended June 30, 1998, this Credit Agreement was amended
to increase the Revolving Debt Facility from $75 million to $100 million. In
addition, the Term Debt Facility was reduced from its original balance of $125
million to $75 million. Up to $20 million of the Revolving Debt Facility is
available for the issuance of letters of credit. The Term Debt Facility, which
originally matured December 31, 2001, will now mature December 31, 2002, and
will amortize in quarterly installments commencing on December 31, 1999. The
Credit Agreement, which is guaranteed by the Company, requires that the Company
maintain certain financial ratios and levels of tangible net worth,
profitability, and liquidity and implements restrictions on the Company's
ability to declare and pay dividends. The senior secured facility interest rate
is a variable interest rate tied to LIBOR. This interest rate was 6.00% as of
December 31, 1998. As of December 31, 1998, nothing was outstanding under the
Revolving Debt Facility and $75 million was outstanding under the Term Debt
Facility.
In addition to the restrictions above, the Credit Agreement contains various
covenants restricting further indebtedness, issuance of preferred stock by the
Company or its subsidiaries,
89
liens, acquisitions, asset sales, and capital expenditures. At December 31,
1998, the Company and Catalytica Pharmaceuticals, Inc. were in compliance with
the covenants.
In the second quarter of 1998 following the restructuring of the Credit
Agreement, the Company entered into a $50 million interest rate swap, derivative
transaction to reduce the Company's exposure to fluctuations in short-term
interest rates. This interest rate swap transaction effectively fixed the LIBOR
benchmark rate used to calculate the Company's borrowing cost at 5.90% for 4
years on $50 million of the Debt Facilities. The Company accounts for this
interest rate swap as a hedge, and accrues the interest rate differential as an
adjustment to interest expense on a monthly basis. See Note 1.
During the second quarter of 1998, the Company received a $2.7 million non-
interest bearing loan from a customer to be used to finance special equipment
requirements. The loan is payable in aggregate annual amounts of (i) $0.7
million on December 31, 1999; (ii) $1 million on December 31, 2000; and (iii)
$ 1 million on December 31, 2001.
As of December 31, 1996, Catalytica Pharmaceuticals had a working capital line
of credit ($2.3 million outstanding at December 31, 1996) and two equipment
based term loans ($0.9 million and $0.5 million outstanding at December 31,
1996). On July 31, 1997, upon the acquisition of the Greenville Facility (See
Note 2), the working capital line of credit and the term loans were repaid at
the amounts outstanding on that date ($3.5 million, $0.8 million, and $0.5
million).
The fair value of debt is based on pricing models or securities with similar
terms, and approximates carrying value.
At December 31, 1998, future minimum principal payments on debt were as
follows (in thousands):
1999 10,770
2000 16,007
2001 21,000
2002 30,000
-------
$77,777
=======
90
Note 8. Income Taxes
The provision for income taxes in 1998 consists of the following (in
thousands):
1998 1997
---- ----
Current:
Federal $ 3,344 $ 41
State 1,665 484
------- -------
5,009 525
Deferred:
Federal (2,622) (19)
State (79) (147)
------- -------
(2,701) (166)
------- -------
Total Provision $ 2,308 $ 359
======= =======
The provision for income taxes reconciles to the amount computed by applying
the Federal statutory rate to income before provision for income taxes as
follows (in thousands):
1998 1997 1996
---- ---- ----
Income (loss) before provision for
income taxes $23,071 $ 669 $(5,192)
======= ======= =======
Federal statutory rate (35% in 1998,
34% in 1997 and 1996) $ 8,075 $ 227 $(1,765)
State taxes, net of federal benefit 1,268 330 --
Losses not currently benefited -- -- 1,765
Benefit of net operating losses (7,461) (198) --
Other 426 -- --
------- ------- -------
Provision for income taxes $ 2,308 $ 359 $ --
======= ======= =======
91
Deferred income taxes reflect the tax effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. Significant components of the net
deferred tax liability are as follows (in thousands):
1998 1997
---- ----
Deferred tax assets:
Capitalized R&D costs $ 114 $ 2,000
Net operating loss carryforwards 6,639 14,100
Credit carryforwards -- 200
Nondeductible reserves 3,749 1,300
Other, net 2,194 300
-------- --------
Total deferred tax assets $ 12,696 $ 17,900
Valuation allowance (9,829) (17,734)
-------- --------
Net deferred tax assets $ 2,867 $ 166
======== ========
The realization and amount of any tax benefit from the deferred tax asset of
$12.7 million is dependent upon the generation of future taxable income and the
tax rate in effect in such years. Accordingly, due to the uncertainty of
realizing future taxable earnings, a valuation allowance has been established
for a portion of the deferred tax asset. The valuation allowance decreased by
$7.9 million in 1998, and increased by $0.6 million during 1997. Approximately
$1.2 million of the valuation allowance for deferred tax assets relates to
benefits of stock option deductions which, when recognized, will be allocated
directly to contributed capital.
At December 31, 1998, for federal income tax purposes, the Company has net
operating loss carryforwards of approximately $19 million which expire in the
years 2009 through 2012. The net operating loss carryforwards differ from the
accumulated deficit as a result of temporary differences in the recognition of
certain revenue and expense items for financial and federal tax reporting
purposes, primarily consisting of expenses not currently deductible for tax
reporting purposes.
Note 9. Leases, Commitments, and Contingencies
Operating Leases
Catalytica leases its research and office facilities in Mountain View, Ca
under an operating lease agreement that expires on December 31, 2003, after
which the Company has the option for a five-year extension. The pharmaceuticals
manufacturing facility in East Palo Alto, Ca is owned by the Company; however,
the land at the facility is leased under a ground lease agreement commencing
November 30, 1993 for an initial term of 15 years. The lease expires on
November 30, 2008, after which the Company has two five-year options to extend
the lease term, and one four-year option to extend the lease term after
expiration of the first two option periods. All land and buildings at the
pharmaceuticals manufacturing facility in Greenville, North Carolina, are owned
by the Company.
92
The aggregate minimum annual commitments under all operating leases as of
December 31, 1998, are as follows (in thousands):
Fiscal Year
1999 4,661
2000 1,502
2001 1,193
2002 999
2003 986
and thereafter 189
------
$9,530
======
Rent expense, consisting of building and equipment rent, was $2.6 million,
$1.4 million, and $0.7 million for each of the three years ended December 31,
1998, 1997, and 1996, respectively.
Research Collaborations
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. See Note 2
for a description of the collaborative research and license agreement.
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.
The Company has entered into research collaborations with companies whereby
potential future payments may be due to selective collaborative partners if the
Company achieves certain commercial milestones as defined in the collaborative
agreements.
Supply Agreement
As mentioned in Note 2, in connection with the purchase of the Greenville
Facility, Glaxo Wellcome entered into a Supply Agreement under which Catalytica
Pharmaceuticals will manufacture products for Glaxo Wellcome over the next
several years. In 1998 the Company signed two amendments to the original Supply
Agreement, and a third amendment was signed in the first quarter of 1999.
93
Note 10. Related Party Transactions
Enron Ventures Corporation As discussed in Note 3, Enron purchased a 15%
minority interest in Combustion Systems for $30 million in cash. Enron also
received a three-year option to purchase an additional 5% of Combustion Systems
for $14.4 million in cash. In connection with the Stock Purchase Agreement, the
Company entered into a Share Exchange Agreement, providing Enron the right to
exchange the Series B Preferred Stock of Combustion Systems for Catalytica, Inc.
Common Stock.
Glaxo Wellcome As discussed in Note 2, Glaxo Wellcome holds 250,000 shares
of Junior Preferred Stock of Catalytica Pharmaceuticals (1.5% of Catalytica
Pharmaceuticals) and warrants to purchase 2,000,000 shares of Common Stock of
Catalytica. Under a Supply Agreement and its subsequent amendments, Catalytica
Pharmaceuticals currently manufactures products for Glaxo.
Morgan Stanley Capital Partners ("MSCP") In conjunction with the purchase
of the Greenville Facility, the Company issued 30,000,000 shares of Class A and
Class B Common Stock to MSCP for an aggregate purchase price of $120 million.
The Company subsequently repurchased 5,000,000 shares of Class B Common Stock
from MSCP at a price of $4.75 per share. At December 31, 1998, MSCP owned
approximately 32% of the Company's outstanding voting securities and
approximately 47% of the Company's outstanding securities (See Note 11).
Pursuant to this Investment Agreement, MSCP has certain rights to cause the
Company to include as nominees for the Company's Board of Directors, up to three
directors for so long as MSCP owns not less than 30% of the outstanding common
stock of the Company. MSCP has designated two MSCP nominees as directors and the
Company has increased the number of its directors from seven to nine. In the
event MSCP's beneficial ownership of outstanding common stock is less than 30%
but equal to or greater than 10%, MSCP shall be entitled to elect up to two
directors. In the event MSCP's beneficial ownership is less than 10% but equal
to or greater than 6%, MSCP shall be entitled to elect one director. The Company
has also agreed that MSCP will be represented on each committee of the Board of
Directors.
Pfizer Inc. As discussed in Note 2, Pfizer holds 150,000 shares of
Catalytica Pharmaceuticals Series B Preferred Stock (4.4% of Catalytica
Pharmaceuticals). Catalytica Pharmaceuticals currently manufactures
intermediates for Pfizer and performs research for Pfizer under a collaborative
research and license agreement.
GENXON(TM) Power Systems, LLC As discussed in Note 3, Catalytica Combustion
Systems Inc. ("Combustion Systems") and Woodward Governor Company ("Woodward")
have established GENXON, a joint venture, to serve the gas turbine retrofit
market. GENXON reimburses Catalytica and Woodward for work performed on its
behalf.
Single-Site Catalysts Catalytica Advanced Technologies formed an equally
owned joint venture with United Catalysts, Inc. for the custom manufacturing,
process development, and
94
marketing of organometallic catalysts. Single-Site Catalysts reimburses
Catalytica Advanced Technologies and United Catalysts for work performed on its
behalf.
Note 11. Capital Stock
Common Stock
On July 29, 1997, the shareholders of the Company approved an increase in the
authorized number of shares of the Company's Common Stock from 40,000,000 to
120,000,000 shares. 30,000,000 of those shares were approved as a new class of
Common Stock of the Company, to be designated Class A Common Stock at a par
value $0.001 per share. 17,000,000 of the shares were approved as a new class
of nonvoting Common Stock of the Company, to be designated Class B Common Stock,
par value $0.001 per share.
With the closing of the acquisition of the Greenville Facility as described in
Note 2, 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 MSCP (collectively,
the "Stock Sale"), at a price of $4.00 per share, for an aggregate of $120
million. As a result of the Stock Sale and subsequent stock repurchase, as of
December 31, 1998, MSCP beneficially own approximately 32% of the voting
control, and securities convertible into 40% of the voting control of the
Company, and 47% of the outstanding capital stock of the Company as of December
31, 1998.
Per the terms of the Acquisition, the Company had the option to redeem up to
5,000,000 shares of the Class B Common Stock at a price equal to $4.75 per share
during the period from closing through November 30, 1997, and $5.00 per share
during the period from December 1, 1997 through May 31, 1998, upon which the
redemption right expired. The optional redemption right provided the Company
with the flexibility to reduce the amount of equity issued to complete the
Acquisition if during the period between the closing of the Acquisition and May
31, 1998, the Company's financial performance during such period enabled the
Company to obtain capital on terms that reduced the equity dilution from the
Stock Sale. As further described in "Warrant Dividend" below, on November 30,
1997, the Company exercised its right of redemption for 5,000,000 shares of the
Class B Common Stock at $4.75 per share reflecting a call premium of $0.75 per
share. As such, 11,730,000 shares of Class B Common Stock remained outstanding
as of December 31, 1998.
At any time after July 1, 1998, MSCP has the right to request the Company to
effect a registration 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. 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
to have the Common Stock issuable upon conversion of the Class A and B Common
Stock included in such registration. At December 31, 1998, MSCP has not
effected a registration of shares of either Class A Common Stock or Class B
Common Stock.
95
At any time after July 1, 2005, the holders of the Class A Common Stock will
have the right to require the Company, upon six months written notice, to
repurchase during any annual period commencing July 1 and ending June 30 up to
one-third of the initial outstanding shares of Class A Common Stock and Class B
Common Stock for an amount in cash equal to the Liquidation Preference,
initially established at $4.00 per share subject to certain adjustments. In
addition, upon a change of control, MSCP shall have the right to cause the
Company to purchase all of the shares of Class A Common Stock and Class B Common
Stock initially acquired by MSCP at the Liquidation Preference.
Each share of Class A Common Stock may be converted at the option of the
holder into shares of Common Stock at the 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 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 have received in such liquidation had the Class A Common
Stock been converted to Common Stock in accordance with its terms.
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 to vote 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.
Common Stock Reserved for Future Issuance
Shares of Common Stock of the Company reserved for future issuance at December
31, 1998 are as follow:
1998
- ---------------------------------------------------------------- ----------
Employee Stock Purchase Plan 2,733,000
Stock Options 4,771,000
Pharmaceuticals Series B Preferred Stock (*) - held by Pfizer 1,700,000
Pharmaceuticals Junior Preferred Stock (*) - held by Glaxo Wellcome 600,000
96
Combustion Systems Series B Preferred Stock (*) - held by Enron 2,700,000
Warrants - held by Glaxo Wellcome 2,000,000
MSCP Class A and B Common Stock - held by MSCP 25,000,000
----------
39,504,000
==========
(*) Under terms of Shareholder Agreements with Pfizer, Glaxo Wellcome, and
Enron, stock held by these companies in Catalytica Pharmaceuticals and
Combustion Systems is convertible into Catalytica common stock if certain terms
and conditions are met. The minority interests held by Pfizer, Glaxo Wellcome,
and Enron are reflected as $8 million, $3 million, and $30 million,
respectively, ($41 million in total) as of December 31, 1998.
Preferred Stock
The Company has 5,000,000 shares of Preferred Stock authorized, all of which
are unissued and undesignated. The Board of Directors of the Company has the
authority, without further vote or action by the stockholders, to issue these
undesignated shares of Preferred Stock in one or more series and to fix the
rights, qualifications, preferences, privileges, limitations, and restrictions
of each such series, including dividend rights, terms or redemption, redemption
prices, liquidation preferences, and the number of shares constituting any
series or the designation of such series.
Warrant Dividend
The Company distributed, at no cost, to each holder of Common Stock of record
as of August 22, 1997, one warrant for each three shares of Common Stock held by
the shareholder. The warrants entitled each holder to purchase Common Stock at
$4.00 per share. The total number of warrants issued was 6,947,275. Of the
warrants issued to shareholders, 6,922,996 shares were exercised, and warrants
for 24,279 shares expired on October 31, 1997.
The exercise of 6,922,996 warrants generated gross proceeds of $27.7 million.
The Company used $23.75 million of the proceeds to repurchase an aggregate of
5,000,000 shares of its Class B Common Stock issued to MSCP on July 31, 1997.
The repurchase price was $4.75 per share, as such repurchase was consummated
prior to November 30, 1997. The premium paid in connection with the repurchase
is reflected in the Company's earnings per share calculation for the period
ended December 31, 1997, as a reduction of earnings available to common
shareholders. Accordingly, the Company's earnings per share for the year ending
December 31, 1997, were reduced by $0.10 due to this repurchase.
Warrants
In connection with the Acquisition of the Greenville Facility, the Company
issued warrants to Glaxo Wellcome to purchase 2,000,000 shares of the Company's
Common Stock at an exercise price of $12.00 per share. The warrants expire on
July 31, 2003. The value of the warrants was recorded in additional paid-in
capital as of December 31, 1997.
97
The Company issued a warrant to purchase 320,000 shares of Common Stock at a
price per share equal to $4.80 per share in connection with its financing in
November, 1995. As of December 31, 1998, 320,000 of the outstanding warrants
were exercised for 208,274 shares of common stock as per the terms of a cash-
less exercise agreement.
Catalytica Deferred Compensation
The Company granted to an officer options to purchase 100,000 shares of Common
Stock at an exercise price of $5.00 per share in 1997, for which the Company
recorded deferred compensation amounting to $0.5 million. The deferred
compensation is being amortized to expense ratably over the vesting period of
the option, four years.
Stockholders Rights Plan
On October 28, 1996, the Board of Directors adopted a Stockholders Rights Plan
providing a dividend of rights (which cannot be exercised until certain events
occur) to purchase shares of preferred stock of the Company. Each shareholder
of record receives one right for each share of common stock then owned. This
plan was adopted to ensure that all stockholders of the Company receive fair
value for their common stock in the event of any proposed takeover of the
Company and to guard against coercive tactics to gain control of the Company
without offering fair value to the Company's stockholders.
Stock Option and Stock Purchase Plans
The Company has elected to follow Accounting Principles Board No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") and related
Interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"), requires the use of option valuation models that
were not developed for use in valuing employee stock options. Under APB 25,
because the exercise price of the Company's stock options generally equals the
market price of the underlying stock on the date of grant, no compensation
expense is recognized.
Pro forma information regarding net income and earnings per share is required
by FAS 123 which also requires that the information be determined as if the
Company has accounted for its employee stock awards and those of its
subsidiaries granted subsequent to December 31, 1994, under the fair value
method of this Statement. The fair value for these options was estimated at the
date of grant using a Black-Scholes multiple option pricing model with the
following weighted average assumptions:
Weighted
Risk Free Dividend Volatility Average
Interest Rate Yield Factor Expected Life
---------------- -------- ------------------- ----------------
1998 1997 1996 1996-98 1998 1997 1996 1998 1997 1996
---- ---- ---- -------- ----- ----- ----- ---- ---- ----
98
Catalytica, Inc. Stock 5.19 6.15 6.42 0.0 .8602 .9089 .8852 5.1 3.6 3.5
Option Plans
Catalytica, Inc. 5.19 6.15 6.42 0.0 .8602 .9089 .8852 1.3 1.2 1.7
Stock Purchase Plan
Catalytica Advanced 5.55 5.95 6.67 0.0 .8602 .9089 .8852 7.0 7.0 7.0
Technologies, Inc.
Catalytica Combustion 5.48 6.01 6.57 0.0 .8602 .9089 .8852 5.0 5.0 5.0
Systems, Inc.
Catalytica 5.25 6.05 6.39 0.0 .8602 .9089 .8852 5.0 3.5 3.5
Pharmaceuticals, Inc.
Compensation
Expense
-------
1998 1997 1996
---- ---- ----
Catalytica, Inc. Stock Option Plans $ 4,621 $ 1,990 $ 470
Catalytica Stock Purchase Plan 2,405 1,439 74
Catalytica Advanced Technologies 10 12 25
Catalytica Combustion Systems 547 85 66
Catalytica Pharmaceuticals 3,511 1,000 44
-------------------------------------
$11,094 $4,526 $ 679
=====================================
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
Had compensation cost for the Company's stock-based compensation plans been
determined based on the fair value at the grant dates for awards under those
plans consistent with the method of FAS 123, the Company's net loss and loss per
share would have been increased to the pro forma amounts indicated below:
1998 1997 1996
---- ---- ----
(in thousands, except per share data)
Income/(Loss) attributable to common
shareholders $ 20,763 $ (3,440) $ (5,192)
Compensation expense $(11,094) $ (4,526) $ (679)
Pro forma net income/(loss) $ 9,669 $ (7,966) $ (5,871)
99
Pro forma income/(loss) per share - basic $ 0.18 $ (0.24) $ (0.30)
Pro forma income/(loss) per share - diluted $ 0.14 $ (0.24) $ (0.30)
Compensation expense resulting from the stock option and purchase plans
increased in fiscal 1998 significantly over prior years due to the full impact
of initial and annual option grants for employees at the Greenville Facility and
their participation in the employee stock purchase plan. 1997 only reflects
participation on both plans, Option Plans and Purchase Plan, by employees at the
Greenville Facility after the acquisition date of July 31, 1997.
Since compensation expense is recognized over the vesting period of the
related options, which are generally four years, and because pro forma
disclosure is only required commencing with 1995, the initial impact on pro
forma income may not be representative of compensation expense in future years.
Catalytica Inc.
1995 Catalytica Director Stock Option Plan In 1995, the Company adopted the
1995 Director Option Plan under which 200,000 shares have been reserved for
future issuance. Under the 1995 Director Option Plan, the Board of Directors is
authorized to grant nonqualified stock options to Outside Directors to provide
incentive to continue service on the Board. The nonqualified stock options may
be granted at a price of not less than 100% of the fair market value of Common
Stock on the date of grant. Options generally become exercisable ratably over
three years from the date of grant and expire no later than ten years from the
date of grant.
1992 Catalytica Stock Option Plan In 1992, the Company adopted the 1992
Stock Option Plan under which 5,050,000 shares have been reserved for future
issuance. Under the 1992 Stock Option Plan, the Board of Directors is authorized
to grant incentive stock options, or nonqualified stock options to eligible
employees and consultants, although incentive stock options may be granted only
to employees. Incentive stock options may be granted at an exercise price of not
less than 100% of the fair market value of Common Stock on the date of grant
while nonqualified stock options may be granted at a price not less than 50% of
the value of the Common Stock. Options generally become exercisable ratably over
five years and, effective 1998, 4 years from the date of grant and expire no
later than ten years from the date of grant.
1985 Catalytica Non-Qualified Stock Option Plan Since 1985, the Company has
granted to certain directors, officers, and consultants 438,800 nonqualified
stock options at an average price of $0.54 per share. As of December 31, 1998,
436,400 shares had been exercised, and 400 were exercisable. Of the amounts
disclosed, 400,000 options were granted in 1985 to an officer of the Company who
is now a director. All options were granted at the fair market value at the
date of grant.
1983 Catalytica Incentive Stock Option Plan The Company established an
incentive stock option plan in 1983 pursuant to which 1,240,000 shares were
reserved for future issuance to employees. The plan provided for full-time
employees to be granted options to purchase
100
common shares at fair value, as determined by the Board of Directors. The 1983
Incentive Stock Option Plan expired, in accordance with its terms, on May 16,
1993. While all future awards will be made under the 1992 Stock Option Plan,
awards made under the 1983 Incentive Stock Option Plan will continue to be
administered in accordance with that plan. All shares reserved but unissued
under that plan were canceled.
1983 Catalytica Restricted Stock Purchase Plan The Company has a 1983
restricted stock purchase plan pursuant to which 200,000 shares were reserved
for future issuance to employees. Under the 1983 Employee Restricted Stock
Purchase Plan, employees purchased 179,357 common shares at fair value, as
determined by the Board of Directors. The 1983 Restricted Stock Purchase Plan
expired, in accordance with its terms, on May 16, 1993. All shares reserved but
unissued under that plan were canceled. No shares were subject to repurchase.
In September, 1995, the Company implemented a stock exchange program whereby
certain option holders could exchange higher priced options for a reduced number
of new options at the current fair market value. Options canceled and
regranted are reflected in the table below.
101
The following table summarizes stock option plan activity for the 1995
Director Stock Option Plan, the 1992 Stock Option Plan, the 1985 Catalytica
Non-Qualified Plan, the 1983 Incentive Stock Option Plan, and the 1983
Restricted Stock Purchase Plan:
Outstanding Options
Shares ------------------------------------------------
Available Number Weighted Aggregate
for of Average Exercise
Grant Shares Exercise Price Price
--------- ------ -------------- ---------
Balance at December 31, 1995 177,024 1,502,065 $ 2.20 $ 3,305,943
Authorized 1,200,000 -- -- --
Granted (308,700) 308,700 $ 3.89 1,201,756
Exercised -- (124,095) $ 1.56 (194,102)
Canceled 37,017 (37,017) $ 3.63 (134,310)
Expired (4,200)
----------------------------------------------------------------
Balance at December 31, 1996 1,101,141 1,649,653 $ 2.53 $ 4,179,287
Authorized 1,200,000 -- -- --
Granted at Fair Value (1,218,420) 1,218,420 $10.48 12,764,792
Granted Below Fair Value (100,000) 100,000 $ 5.00 500,000
Exercised -- (1,060,660) $ 1.87 (1,979,072)
Canceled 29,044 (29,044) $ 7.40 (214,797)
Expired (3,200) -- -- --
----------------------------------------------------------------
Balance at December 31, 1997 1,008,565 1,878,369 $ 8.12 $15,250,210
Authorized 2,000,000 -- -- --
Granted (570,785) 570,785 $12.70 7,246,356
Exercised -- (115,550) $ 4.31 (498,294)
Canceled 91,609 (91,609) $10.68 (978,986)
Expired (750) -- -- --
----------------------------------------------------------------
Balance at December 31, 1998 2,528,639 2,241,995 $ 9.38 $21,019,286
================================================================
The weighted average fair value of options granted at fair value during 1998
is $8.90 as calculated in accordance with FASB 123.
102
A summary of the Company's stock option activity and related information for
the year ended December 31, 1998, is as follows:
Options Outstanding Options Exercisable
------------------------------------------------ --------------------------
Number Weighted Number Weighted
Outstanding Average Weighted Exercisable As Average
Range of December 31, Remaining Average of December 31, Exercise
Exercise Prices 1998 Contractual Exercise Price 1998 Price
- --------------- ------------ Life -------------- -------------- --------
-----------
$1.80 - $3.50 199,783 6.32 $ 3.16 75,983 $ 3.02
$3.88 - $3.88 226,410 7.51 $ 3.88 84,283 $ 3.88
$3.94 - $9.25 207,179 7.66 $ 6.01 99,387 $ 5.98
$10.50 - $10.50 909,233 8.65 $10.50 237,018 $10.50
$10.63 - $12.00 242,527 9.71 $11.24 59,614 $11.44
$12.19 - $12.81 366,386 9.46 $12.52 32,420 $12.81
$13.88 - $16.25 65,820 9.11 $14.56 13,283 $14.31
$16.38 - $16.38 750 9.86 $16.38 750 $16.38
$17.98 - $17.98 1,630 9.92 $17.98 0 $ 0.00
$18.00 -$18.00 22,277 10.00 $18.00 0 $ 0.00
------------------------------------------------ -------------------------
$1.80 - $18.00 2,241,995 8.51 $ 9.38 602,738 $ 8.19
1992 Catalytica Employee Stock Purchase Plan
In 1992, the Company adopted the 1992 Employee Stock Purchase Plan ("ESPP")
under which 3,500,000 shares have been reserved for future issuance. Under the
1992 Employee Stock Purchase Plan, employees of the Company are given an
opportunity to purchase Common Stock of the Company through accumulated payroll
deductions. Shares are purchased under the ESPP at 85% of the fair market value
at certain specified dates. Of the 3,500,000 shares authorized to be issued
under this plan, 2,733,440 are available for issuance at December 31, 1998. For
the year ended December 31, 1998, employees purchased 348,687 shares for $2.9
million. For the year ended December 31, 1997, employees purchased 201,390
shares for $1.4 million. For the year ended December 31, 1996, employees
purchased 82,757 shares for $0.2 million. The weighted average fair value of
those purchase rights granted in 1998 was $5.66.
Catalytica Advanced Technologies, Inc.
1995 Catalytica Advanced Technologies Stock Option Plan In 1995, the Company
adopted the 1995 Catalytica Advanced Technologies Stock Option Plan under which
949,624 shares have been reserved for future issuance. Under the 1995
Catalytica Advanced Technologies Stock Option Plan, the Catalytica Advanced
Technologies Board of Directors is authorized to grant incentive stock options,
or nonqualified stock options to eligible employees and consultants, although
incentive stock options may be granted only to employees. The incentive stock
options generally vest ratably over four years from the date of grant and expire
no later than ten years from the date of grant. Nonqualified stock options
offered to directors vest ratably over three years from the date of grant and
expire no later than ten years from the date of grant. These options become
exercisable upon an initial public offering of the subsidiary's
103
stock, acquisition of more than 50% of the subsidiary's outstanding securities
by a third party, or upon reaching the date January 1, 2004.
The following table summarizes stock option plan activity for the 1995
Catalytica Advanced Technologies Stock Option Plan:
Outstanding Options
Shares ------------------------------------------------
Available Number Weighted Aggregate
for of Average Exercise
Grant Shares Exercise Price Price
--------- ------ -------------- ---------
Balance at December 31, 1995 43,500 756,500 $0.10 $75,650
Authorized 100,000 -- -- --
Granted (80,000) 80,000 $0.10 8,000
Exercised -- -- -- --
Canceled 8,000 (8,000) $0.10 (800)
Expired -- -- -- --
------------------------------------------------------------
Balance at December 31, 1996 71,500 828,500 $0.10 $82,850
Authorized 19,624 -- -- --
Granted (172,000) 172,000 $0.10 17,200
Exercised -- -- -- --
Canceled 80,876 (80,876) $0.10 (8,088)
Expired -- -- -- --
------------------------------------------------------------
Balance at December 31, 1997 -- 919,624 $0.10 $91,962
Authorized 30,000 -- -- --
Granted (17,000) 17,000 $0.10 1,700
Exercised -- -- -- --
Canceled 15,000 (15,000) $0.10 (1,500)
Expired -- -- -- --
------------------------------------------------------------
Balance at December 31, 1998 28,000 921,624 $0.10 $92,162
============================================================
The weighted average fair value of options granted during 1998 was $0.08 as
calculated in accordance with FASB 123.
At December 31, 1998, options outstanding had a weighted average remaining
contractual life of 7.08 years and options to purchase approximately 772,328
shares of Catalytica Advanced Technologies common stock were vested with a
weighted average exercise price of $0.10/share.
Catalytica Combustion Systems, Inc.
1995 Catalytica Combustion Systems Stock Option Plan In 1995, The Company
adopted the 1995 Catalytica Combustion Systems Stock Option Plan under which
1,162,125 shares have been reserved for future issuance. Under the 1995
Catalytica Combustion Systems Stock Option Plan, the Catalytica Combustion
Systems Board of Directors is authorized to grant incentive stock options, or
nonqualified stock options to eligible employees and consultants, although
incentive stock options may be granted only to employees. The incentive stock
options generally vest ratably over four years from the date of grant and expire
no later than ten years from the date
104
of grant. Nonqualified stock options offered to directors vest ratably over
three years from the date of grant and expire no later than ten years from the
date of grant. These options become exercisable upon an initial public offering
of the subsidiary's stock, acquisition of more than 50% of the subsidiary's
outstanding securities by a third party, or upon reaching the date January 1,
2004. Effective August 4, 1998, all new option grants become exercisable ratably
over four years and expire no later than ten years from the date of grant.
The following table summarizes stock option plan activity for the 1995
Catalytica Combustion Systems Stock Option Plan:
Outstanding Options
Shares ------------------------------------------------
Available Number Weighted Aggregate
for of Average Exercise
Grant Shares Exercise Price Price
--------- ------ -------------- ---------
Balance at December 31, 1995 251,900 498,100 $0.40 $ 199,240
Granted (242,900) 242,900 $0.40 97,160
Exercised -- -- -- --
Canceled 72,292 (72,292) $0.40 (28,917)
Expired -- -- -- --
------------------------------------------------------------
Balance at December 31, 1996 81,292 668,708 $0.40 $ 267,483
Authorized 112,125 -- -- --
Granted (170,500) 170,500 $2.04 348,550
Exercised -- -- -- --
Canceled 4,750 (4,750) $0.40 (1,900)
Expired -- -- -- --
-------------------------------------------------------------
Balance at December 31, 1997 27,667 834,458 $0.74 $ 614,133
Authorized 300,000 -- -- --
Granted (187,950) 187,950 $9.69 1,821,665
Exercised -- -- -- --
Canceled 23,111 (23,111) $3.77 (87,244)
Expired -- -- -- --
-------------------------------------------------------------
Balance at December 31, 1998 162,828 999,297 $2.35 $2,348,554
=============================================================
The weighted average fair value of options granted during 1998 was $6.60 as
calculated in accordance with FASB 123.
105
A summary of Catalytica Combustion Systems' stock option activity for the year
ended December 31, 1998, is as follows:
Options Outstanding Options Exercisable
------------------------------------------------ --------------------------
Number Weighted Number Weighted
Outstanding Average Weighted Exercisable As Average
Range of December 31, Remaining Average of December 31, Exercise
Exercise Prices 1998 Contractual Exercise Price 1998 Price
- --------------- ----------- Life -------------- -------------- --------
-----------
$0.40-$0.40 692,847 7.02 $ 0.40 578,000 $ 0.40
$2.50-$2.50 133,500 8.75 $ 2.50 41,720 $ 2.50
$5.60-$5.60 64,900 9.12 $ 5.60 21,198 $ 5.60
$12.00-$12.00 80,000 9.30 $12.00 16,602 $12.00
$14.50-$14.50 23,050 9.93 $14.50 125 $14.50
$16.00-$16.00 5,000 9.63 $16.00 0 $ 0.00
----------------------------------------------------------------------------
$0.40-$16.00 999,297 7.65 $ 2.35 657,645 $ 1.00
Catalytica Pharmaceuticals, Inc.
1995 Pharmaceuticals Stock Option Plan In 1995, The Company adopted the 1995
Pharmaceuticals Stock Option Plan under which 2,947,025 shares have been
reserved for future issuance. Under the 1995 Pharmaceuticals Stock Option Plan,
the Catalytica Pharmaceuticals Board of Directors is authorized to grant
incentive stock options, or nonqualified stock options to eligible employees and
consultants, although incentive stock options may be granted only to employees.
The incentive stock options generally vest ratably over four years from the date
of grant and expire no later than ten years from the date of grant.
Nonqualified stock options offered to directors vest ratably over three years
from the date of grant and expire no later than ten years from the date of
grant. These options become exercisable upon an initial public offering of the
subsidiary's stock, acquisition of more than 50% of the subsidiary's outstanding
securities by a third party, or upon reaching the date January 1, 2004.
Effective August 4, 1998, all new option grants become exercisable ratably over
four years and expire no later than ten years from the date of grant.
106
The following table summarizes stock option plan activity for the 1995
Catalytica Pharmaceuticals Stock Option Plan:
Available Number Weighted Aggregate
for of Average Exercise
Grant Shares Exercise Price Price
--------- ------ -------------- ---------
Balance at December 31, 1995 900 377,100 $ 0.40 $ 150,840
Authorized 100,000 -- -- --
Granted (121,900) 121,900 $ 0.66 80,830
Exercised -- -- -- --
Canceled 23,000 (23,000) $ 0.40 (9,200)
Expired -- -- -- --
-------------------------------------------------------------------
Balance at December 31, 1996 2,000 476,000 $ 0.47 $ 222,470
Authorized 1,469,025 -- -- --
Granted (1,503,400) 1,503,400 $ 4.93 7,411,580
Exercised -- -- -- --
Canceled 32,375 (32,375) $ 5.13 (166,213)
Expired -- -- -- --
-------------------------------------------------------------------
Balance at December 31, 1997 -- 1,947,025 $ 3.84 $ 7,467,837
Authorized 1,000,000 -- -- --
Granted (492,255) 492,255 $19.06 9,384,793
Exercised -- -- -- --
Canceled 20,688 (20,688) $10.21 (211,281)
Expired -- -- -- --
-------------------------------------------------------------------
Balance at December 31, 1998 528,433 2,418,592 $ 6.88 $16,641,349
===================================================================
The weighted average fair value of options granted during 1998 was $13.09 as
calculated in accordance with FASB 123.
107
A summary of Catalytica Pharmaceuticals' stock option activity and related
information for the year ended December 31, 1998 is as follows:
Options Outstanding Options Exercisable
------------------------------------------------ --------------------------
Number Weighted Number Weighted
Outstanding Average Weighted Exercisable As Average
Range of December 31, Remaining Average of December 31, Exercise
Exercise Prices 1998 Contractual Exercise Price 1998 Price
- --------------- ----------- Life -------------- --------------- --------
-----------
$0.40 - $0.40 367,600 6.48 $ 0.40 356,650 $ 0.40
$0.70 - $0.70 110,425 7.54 $ 0.70 74,844 $ 0.70
$1.50 - $1.50 209,000 8.34 $ 1.50 105,286 $ 1.50
$5.50 - $5.50 1,254,312 8.64 $ 5.50 415,334 $ 5.50
$12.00-$12.00 18,500 9.25 $12.00 3,948 $12.00
$16.50 - $16.50 114,945 9.32 $16.50 32,973 $16.50
$20.00 - $20.00 238,810 9.63 $20.00 250 $20.00
$22.00 - $22.00 105,000 9.59 $22.00 11,250 $22.00
----------------------------------------------------- --------------------------
$0.40 - $5.50 2,418,592 8.41 $ 6.88 1,000,535 $ 3.48
108
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Managers and Members
Genxon Power Systems, L.L.C.:
In our opinion, the accompanying balance sheets and the related statements of
operations, of members' capital and of cash flows present fairly in all material
respects, the financial position of Genxon Power Systems L.L.C. at September 30,
1998 and 1997, and the results of its operations and its cash flows for the
year ended September 30, 1998 and for the period from October 21, 1996 (date of
inception) to September 30, 1997. These financials are the responsibility of
the Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. As discussed in Note 2 to the financial
statements, the Company has suffered losses from operations in both fiscal years
1998 and 1997, which raises substantial doubt about its ability to continue as a
going concern. Management's plans in regard to these matters are also described
in Note 2. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
PricewaterhouseCoopers LLP
San Jose, California
October 26, 1998
109
GENXON POWER SYSTEMS, L.L.C.
(a Delaware limited liability company)
BALANCE SHEETS
----------
September 30,
------------------
ASSETS 1998 1997
---- ----
Current assets:
Cash and cash equivalents $ 594,573 $ 54,366
Accounts receivable 204,233
Inventory 278,292 233,977
Prepaid expenses 358,482
----------- -----------
Total current assets 1,077,098 646,825
Property and equipment, net 897,876 557,362
Note receivable from employee 120,000
----------- -----------
Total assets $2,094,974 $ 1,204,187
=========== ===========
LIABILITIES AND MEMBERS' CAPITAL
Current liabilities:
Payable to Woodward Governor Company $ 9,060 $ 89,483
Payable to Catalytica Combustion Systems, Inc. 320,589 315,580
Accounts payable 199,480 1,852,014
Accrued liabilities 257,093 433,261
----------- -----------
Total current liabilities 786,222 2,690,338
Commitments and contingencies (Note 3)
Members' capital 1,308,752 (1,486,151)
----------- -----------
Total liabilities and members' capital $2,094,974 $ 1,204,187
=========== ===========
110
GENXON POWER SYSTEMS, L.L.C.
(a Delaware limited liability company)
STATEMENTS OF OPERATIONS
--------------
Period from
October 21,
1996 (date of
Year Ended inception) to
September 30, September 30,
1998 1997
------------- -------------
Revenues:
Research contract $ 204,233 $ 268,000
Operating expenses:
Research and development 8,137,903 8,656,442
Selling, general and administrative
expenses 1,709,337 2,147,797
------------ ------------
9,847,240 10,804,239
Loss from operations (9,643,007) (10,536,239)
Other income, net 27,910 50,088
------------ ------------
Net loss $(9,615,097) $(10,486,151)
111
GENXON POWER SYSTEMS, L.L.C.
(a Delaware limited liability company)
STATEMENTS OF MEMBERS' CAPITAL
------------
Woodward Catalytica
Governor Combustion
Company Systems, Inc. Total
------------ ------------- -------------
Capital contributions $ 7,100,000 $ 1,900,000 $ 9,000,000
Net loss (8,243,076) (2,243,075) (10,486,151)
Members' capital, September 30, 1997 (1,143,076) (343,075) (1,486,151)
Capital contributions 6,605,000 5,805,000 12,410,000
Net loss (4,807,548) (4,807,549) (9,615,097)
----------- ----------- -----------
Member's capital, September 30, 1998 $ 654,376 $ 654,376 $ 1,308,752
=========== =========== ===========
112
GENXON POWER SYSTEMS, L.L.C.
(a Delaware limited liability company)
STATEMENTS OF CASH FLOWS
------------
Period from
October 21,
1996 (date of
Year Ended inception) to
September 30, September 30,
1998 1997
------------ -------------
Cash flows from operating activities:
Net loss $ (9,615,097) $(10,486,151)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation expense 74,477
Changes in asset and liabilities:
Accounts receivable (204,233)
Inventory (44,315) (233,977)
Prepaid expenses 358,482 (358,482)
Note receivable from employee (120,000)
Payable to members (75,414) 405,063
Accounts payable (1,652,534) 1,852,014
Accrued liabilities (176,168) 433,261
Net cash used in operating activities (11,454,802) (8,388,272)
Cash flows from investing activities:
Acquisition of property and equipment (414,991) (557,362)
Cash flows from financing activities:
Member's capital contributions 12,410,000 9,000,000
Net increase in cash and cash equivalents 540,207 54,366
Cash and cash equivalents, beginning of
period 54,366 -
------------ ------------
Cash and cash equivalents, end of period $ 594,573 $ 54,366
============ ============
113
GENXON POWER SYSTEMS, L.L.C.
(a Delaware limited liability company)
NOTES TO FINANCIAL STATEMENTS
------------
1. Formation and Business of the Company:
-------------------------------------
GENXON Power Systems, L.L.C. (the Company), a Delaware limited liability
company, was formed on October 21, 1996 to develop and sell products and
services to a wide range of users of out-of-warranty gas turbines which require
reductions in emissions, overhaul or upgrade. Except as provided for in the
Limited Liability Operating Agreement, the existence of the Company will be
perpetual.
Investor members in GENXON Power Systems, L.L.C. received a percentage interest
in the Company based on the amount of cash and the agreed-upon fair value of
certain technology licenses contributed to the Company. There were two initial
investor members, each receiving a 50 percent interest in the Company. Their
initial capital commitments were as follows:
Cash Technology
Commitment Licenses Total
---------- ----------- -----------
Catalytica Combustion Systems, Inc. $2,000,000 $8,000,000 $10,000,000
(Catalytica)
Woodward Governor Company (Woodward) $8,000,000 $2,000,000 $10,000,000
At September 30, 1998, each member had contributed its agreed-upon technology
licenses and cash in the total amount of $21.4 million. Additional future cash
contributions will be at the discretion of each of the members, but will
generally be in proportion to their respective percentage interests in the
Company and will be governed by the terms of the Operating Agreement. For
financial statement purposes only, the fair value of the technology licenses has
not been recorded.
Continued
114
GENXON POWER SYSTEMS, L.L.C.
(a Delaware limited liability company)
NOTES TO FINANCIAL STATEMENTS
-------------
1. Formation and Business of the Company, continued:
-------------------------------------
The Operating Agreement generally provides that profits and losses in any fiscal
year, or other applicable period, shall be allocated to each member in
proportion to their respective percentage interest. In the event that a member's
cumulative capital account, including the fair value of the technology licenses
contributed, is reduced to zero, losses will be reallocated to members having
positive capital account balances until all members' capital accounts have been
reduced to zero. Thereafter, losses will again be allocated to the members
based on their respective percentage interests. Such "reallocated" losses shall
first be restored by an allocation of profits before any additional profits are
allocated to the members. Under the terms of the Operating Agreement, the
Company is required to make cash distributions to each member in the amount of
the estimated tax liability for the net taxable income and gains allocated to
such member during the fiscal year. Any additional distributions of cash or
property will be at the discretion of the Board of Managers as provided for in
the Operating Agreement. At September 30, 1998, cumulative capital account
balances determined in accordance with the Operating Agreement are as follows:
Catalytica Woodward Total
------------ ------------ ------------
Cash contributed $ 7,705,000 $ 13,705,000 $ 21,410,000
Technology licenses contributed 8,000,000 2,000,000 10,000,000
Allocation of cumulative net loss (10,050,624) (10,050,624) (20,101,248)
------------- ------------- -------------
Capital account balances $ 5,654,376 $ 5,654,376 $ 11,308,752
============= ============ ============
2. Summary of Significant Accounting Policies:
------------------------------------------
Basis of Presentation:
The Company's financial statements have been prepared on a basis of accounting
assuming that it is a going concern, which contemplates realization of assets
and satisfaction of liabilities in the normal course of business. The Company
has reported a net loss of $9.6 million for the year ended September 30, 1998
and a cumulative loss of $20.1 million for the period from October 21, 1996
(date of inception) through September 30, 1998. Management plans to obtain
additional capital contributions from its members or other additional investors
to meet its current and ongoing obligations. Continued existence of the Company
is dependent on the Company's ability to ensure the availability of adequate
funding and the establishment of profitable operations. The financial
statements do not include adjustments that might result from the outcome of this
uncertainty.
2. Summary of Significant Accounting Policies, continued:
------------------------------------------
Continued
115
GENXON POWER SYSTEMS, L.L.C.
(a Delaware limited liability company)
NOTES TO FINANCIAL STATEMENTS
-------------
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 amount of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Cash and Cash Equivalents:
The Company considers all highly liquid investments purchased with original or
remaining maturities of three months or less at the date of purchase to be cash
equivalents. Substantially all of the Company's excess cash is invested in
money market accounts with a major investment company.
Fair Value of Financial Instruments:
Carrying amounts of certain of the Company's financial instruments, including
cash and cash equivalents, accounts payable and other accrued liabilities
approximate fair value due to their short maturities.
Inventory:
Inventory, consisting of purchased and manufactured parts to be used in the
overhaul and upgrade of gas turbine engines, is stated at the lower of cost or
estimated selling price.
Property and Equipment:
Property and equipment are stated at cost and are depreciated using the
straight-line method over their estimated useful lives, generally 3 to 10 years.
Gains and losses from the disposal of property and equipment will be taken into
income in the year of disposition. At September 30, 1998, property and
equipment consists of tooling costs incurred in the construction of the
Company's manufacturing equipment.
Income Taxes:
The financial statements include no provision for income taxes since the
Company's income and losses are reported in the members' separate tax returns.
2. Summary of Significant Accounting Policies, continued:
------------------------------------------
Continued
116
GENXON POWER SYSTEMS, L.L.C.
(a Delaware limited liability company)
NOTES TO FINANCIAL STATEMENTS
-------------
Recent Accounting Pronouncements:
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 (SFAS 130), Reporting Comprehensive
Income. This statement establishes requirements for disclosure of comprehensive
income and becomes effective for the Company for its fiscal year 1999, with
reclassification of earlier financial statements for comparative purposes.
Comprehensive income generally represents all changes in members' capital except
those resulting from investments or contributions by members. The Company is
evaluating alternative formats for presenting this information, but does not
expect this pronouncement to materially impact the Company's results of
operations.
In June 1997, The Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131 (SFAS 131), Disclosures about Segments of
an Enterprise and Related Information. This statement establishes standards for
disclosure about operating segments in annual financial statements and selected
information in interim financial reports. It also establishes standards for
related disclosures about products and services, geographic areas and major
customers. This statement supersedes Statement of Financial Accounting
Standards No. 14, Financial Reporting for Segments of a Business Enterprise.
The new standard becomes effective for the Company's fiscal year 1999, and
requires that comparative information from earlier years be restated to conform
to the requirements of this standard. The Company is evaluating the
requirements of SFAS 131 and the effects, if any, on the Company's current
reporting and disclosures.
3. Commitments and Contingencies:
-----------------------------
The Company entered into an exclusive agreement with Agilis Group, Inc. (Agilis)
to provide assistance and advice in the development and design of the combustor
and combustor related hardware for the Company's proprietary catalytic
combustion technology. Under the terms of the agreement, Agilis has
responsibility as to the details, methods, and means of performing its services.
Subject to the Company's approval and on its behalf, Agilis may enter into
purchase commitments and contracts with outside vendors to provide materials and
services to complete the projects. At September 30, 1998, the Company has
approximately $0.7 million in open purchase commitments through Agilis. The
agreement will expire on the later of the completion of all services described
in the agreement or December 31, 1999, unless extended in writing and agreed to
by both parties.
Continued
117
GENXON POWER SYSTEMS, L.L.C.
(a Delaware limited liability company)
NOTES TO FINANCIAL STATEMENTS
-------------
3. Commitments and Contingencies, continued:
-----------------------------
The Company has entered into a technical services agreement with the City of
Glendale, California to retrofit an FT4 gas turbine engine which was provided
by the City. Under the terms of the agreement, the retrofit will include adding
the Company's proprietary XONON combustion system and a digital control system
for a total turnkey price of $0.7 million, and must be completed by December
1998. In the event that the Company is unable to complete the agreed upon
retrofit on time or damages the engine in the process, the agreement requires
the Company to return the engine to its original state or replace it with a
similar engine, for which the Company has recorded a reserve of $134,000. The
Company and the City of Glendale are in discussions regarding the ultimate
utilization of XONON technology on either existing or new gas turbines under
this agreement.
4. Related Party Transactions:
--------------------------
The Company has entered into a services agreement with Catalytica and Woodward
to provide the Company with management support, technical services support and
administrative services. Costs under these services agreements for the year
ended September 30, 1998 and for the period from October 21, 1996 (date of
inception) to September 30, 1997, are as follows:
1998 1997
---------- ----------
Catalytica:
Research and development $3,182,559 $3,450,077
General and administrative $ 816,163 $1,355,308
Woodward:
Research and development $ 552,690 $ 513,487
General and administrative $ 118,550 $ 65,192
The Company has also entered into supply agreements with both Catalytica and
Woodward to supply combustion system products and control system products to be
used by the Company in its business of retrofitting installed and operating gas
turbine engines.
118
CATALYTICA, INC.
Selected Quarterly Financial Data (Unaudited)
(In thousands, except per share amounts)
First Quarter Second Quarter Third Quarter Fourth Quarter
1998 1997 1998 1997 1998 1997 1998 1997 (1)
---- ----- ----- ----- ---- ----- ---- ----
Product Sales $90,280 $ 3,059 $93,766 $ 6,262 $86,072 $66,699 $97,330 $ 98,327
Research and Development Revenues 1,854 1,726 2,311 1,500 2,115 1,606 1,428 1,767
Total Revenues 92,134 4,785 96,077 7,762 88,187 68,305 98,758 100,094
Total Expenses 84,375 6,263 87,784 9,254 79,792 64,832 90,270 91,601
Gross Profit 7,759 (1,478) 8,293 (1,492) 8,395 3,473 8,488 8,493
Income (loss) before common stock
redemption 4,251 (2,325) 5,033 (1,828) 5,644 743 5,835 3,720
Net income (loss) attributable to common
shareholders $ 4,251 $(2,325) $ 5,033 $(1,828) $ 5,644 $ 743 $ 5,835 $ (30)
Basic earnings (loss) per share (1) $ 0.08 $ (.12) $ 0.09 $ (.09) $ 0.10 $ .02 $ 0.11 $ .00
Diluted earnings (loss) per share (1) $ 0.07 $ (.12) $ 0.08 $ (.09) $ 0.09 $ .02 $ 0.09 $ .00
(1) Net income (loss) per share in 1997 reflects a reduction in net income of
$3.75 million relating to the premium paid for the repurchase of five
million shares of Series B common stock with proceeds received from the
exercise of warrants issued to shareholders as a dividend.
119
CATALYTICA, INC.
Valuation and Qualifying Accounts
(In thousands)
Additions Deductions
Balance at Charged to From Bad Balance
Beginning Bad Debt Debt at End
Allowance for Doubtful Accounts: of Period Reserves Reserves of Period
Fiscal year ended December 31, 1996 $100,000 -- -- $ 100,000
Fiscal year ended December 31, 1997 $100,000 $ 500,000 -- $ 600,000
Fiscal year ended December 31, 1998 $600,000 $1,212,000 -- $1,812,000
120
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CATALYTICA, INC.
(Registrant)
Dated: March 30,1999 By:/s/ Ricardo B. Levy
------------- -------------------
Ricardo B. Levy
President and Chief Executive Officer
121
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Ricardo B. Levy, his attorney-in-fact,
for him in any and all capacities, to sign any amendments to this Report on Form
10-K, and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that said attorney-in-fact, or his substitute, may
do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the Registrant in
the capacities and on the date indicated.
Signature Title Date
--------- ----- -----
/s/ Ricardo B. Levy President, Chief Executive Officer (Principal March 30, 1999
- ---------------------------------------- Executive Officer), and Director --------------
Ricardo B. Levy
/s/ James A. Cusumano Chairman of the Board and Chief Strategic March 30 ,1999
- ---------------------------------------- Officer --------------
James A. Cusumano
/s/ Lawrence W. Briscoe Vice President, Finance and Administration, March 30 ,1999
- ---------------------------------------- and Chief Financial Officer (Principal --------------
Lawrence W. Briscoe Accounting and Financial Officer)
/s/ Richard Fleming Director March 30 ,1999
- ---------------------------------------- --------------
Richard Fleming
/s/ Alan Goldberg Director March 30 ,1999
- ---------------------------------------- --------------
Alan Goldberg
/s/ Howard Hoffen Director March 30 ,1999
- ---------------------------------------- --------------
Howard Hoffen
/s/ Ernest Mario Director March 30 ,1999
- ---------------------------------------- --------------
Ernest Mario
/s/ John A. Urquhart Director March 30 ,1999
- ---------------------------------------- --------------
John A. Urquhart
122
Exhibit
No. Notes Description
- ------- ----- --------------------------------------------------------------------------
3.1 (6) Corrected Fourth Amended and Restated Certificate of Incorporation.
3.2 (1) Bylaws of Registrant.
4.1(a) (1) Agreement of Shareholders Amending Registration Rights and Right of First
Refusal.
4.1(b) (1) Amended and Restated Registration Rights Agreement dated September 27, 1988.
4.1(c) (1) Amendment No. 1 to Amended and Restated Registration Rights Agreement.
4.1(d) (1) Form of Amended and Restated Rights Agreement.
4.2 (1) Specimen of Common Stock Certificate.
4.3(a) (4) Preferred Shares Rights Agreement dated as of October 23, 1996, between
Catalytica, Inc. and Chase Mellon Shareholder Services, L.L.P., including the
form of Rights Certificate, the Certificate of Designation and the Summary of
Rights attached thereto as Exhibits A, B and C, respectively.
4.3(b) (5) Amendment No. 1, dated as of June 28, 1997, to Preferred Shares Rights
Agreement between Catalytica, Inc. and Chase Mellon Shareholder Services, L.L.C.
4.4 (6) Stock Purchase Warrant for 2,000,000 Shares of the Company's Common Stock dated
July 31, 1997.
10.1 (1) 1983 Incentive Stock Option Plan, as amended, with forms of agreements
thereunder.
10.2 (11) 1992 Stock Option Plan, as amended.
10.3 (11) 1992 Employee Stock Purchase Plan, as amended.
10.4 (1)** Agreement, dated as of July 18, 1988, between the Company and Tanaka Kikinzoku
Kogyo K.K.
10.7 (1)** Development Agreement, dated January 4, 1991 among the Company, Petro-Canada
Inc. And Techmocisco, Inc. (a subsidiary of Mitsubishi Oil), as amended.
10.11 (1) Form of Indemnification Agreement.
10.13 (1) Stock Purchase Agreement dated December 10, 1992 between the Company and
Mitsubishi Oil Co., Ltd.
10.15 (2)** Ground Lease Agreement, dated November 30, 1993, between the Company and
Rhone-Poulenc Inc.
10.16 (2)** Supply Agreement, dated September 28, 1993, between the Company and Novartis
Agro, Inc.
10.17 (2) Lease Agreement, dated January 1, 1993, between the Company and Jack Dymond
Associates.
10.19 (2)** Agreement, dated January 31, 1995, between the Company and Tanaka Kikinzoku
Kogyo K.K.
10.21 (10) Catalytica Pharmaceuticals, Inc. 1995 Stock Plan, with forms of agreements
thereunder.
10.22 (3) Catalytica Advanced Sensor Devices 1995 Stock Plan, with forms of agreements
thereunder.
10.23 (3) Catalytica Advanced Technologies, Inc. 1995 Stock Plan, with forms of
agreements thereunder.
10.24 (10) Catalytica Combustion Systems, Inc. 1995 Stock Plan, with forms of agreements
thereunder.
10.25 (3) Catalytica, Inc. 1995 Director Stock Option Plan, with forms of agreements
thereunder.
10.26 (8) Limited Liability Operating Agreement of GENXON Power Systems, LLC, dated
October 21, 1996.
10.27 (12) Amendment No. 1, dated December 4, 1997, to the Operating Agreement of GENXON
Power Systems, L.L.C.
10.28 (6)** Asset Purchase Agreement among Glaxo Wellcome Inc. and Catalytica
Pharmaceuticals, Inc. and Catalytica, Inc., dated June 25, 1997.
10.29 (7)** Supply Agreement between Glaxo Wellcome Inc. and Catalytica Pharmaceuticals,
Inc., dated July 31, 1997.
10.30 (6) 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.
10.31 (6) $200,000,000 Credit Agreement dated July 31, 1997, by and among Catalytica,
Inc., Catalytica Pharmaceuticals, Inc. and The Chase Manhattan Bank.
10.32 (12) Amendment No. 1 and Consent, dated January 6, 1998, to $200,000,000 Credit
Agreement among Catalytica, Inc., Catalytica Pharmaceuticals, Inc. and The
Chase Manhattan Bank.
10.33 (6) Pledge Agreement
10.34 (6) Security Agreement
10.35 (9)* Amendment No. 1 to Supply Agreement between Glaxo Wellcome, Inc. and Catalytica
Pharmaceuticals, Inc. dated May 28, 1998.
10.36 (9) Effectiveness Agreement among Catalytica, Inc., Catalytica Pharmaceuticals,
Inc. and The Chase Manhattan Bank dated June 4, 1998, including Exhibit A,
$175,000,000 Amended and Restated Credit Agreement.
10.37 Form of Change of Control Severance Agreement entered into between the Company and
certain of its executive officers.
21.1 (1) Subsidiaries of Registrant
23.1 Consent of Ernst & Young LLP, Independent Auditors.
23.2 Consent of Coopers & Lybrand LLP, Independent Accountants
24.1 Power of Attorney. (See page 122)
27.1 Financial Data Schedule
(1) Incorporated by reference to the exhibits filed with the Company's
Registration Statement on Form S-1 (Registration Statement No. 33-
55696).
(2) Incorporated by reference to the exhibits filed with the Company's
Form 10-K for the fiscal year ended December 31, 1994.
(3) Incorporated by reference to the exhibits filed with the Company's
Annual Report on Form 10-K for the year ended December 31, 1995.
(4) Incorporated by reference to the exhibits filed with the Company's
Registration Statement on Form 8-A as filed with the Commission on
November 29, 1996.
(5) Incorporated by reference to the exhibits filed with the Company's
Registration Statement on Form 8-A/A as filed with the Commission on
July 29, 1997.
(6) Incorporated by reference to the exhibits filed with the Company's
Form 10-Q for the quarter ended June 30, 1997.
(7) Incorporated by reference to exhibits filed with the Company's Form
10-Q/A for the quarter ended June 30, 1997.
(8) Incorporated by reference to the exhibits filed with the Company's
Form 10-K for the year ended December 31, 1996.
(9) Incorporated by reference to exhibits filed with the Company's Form
10-Q for the quarter ended June 30, 1998.
(10) Incorporated by reference to exhibits filed with the Company's Form
10-Q for the quarter ended September 30, 1998.
(11) Incorporated by reference to exhibits filed with the Company's
Registration Statement on Form S-8 (file No. 333-57809) as filed with
the commission on June 26, 1998.
(12) Incorporated by reference to exhibits filed with the Company's Form
10-K for the year ended December 31, 1998.
** Confidential treatment has been granted for portions of these
agreements.
(3) Exhibits (continued)