UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 1999
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________________to ______________.
Commission File No. 0-20966
----------------------------
CATALYTICA, INC.
(Exact name of Registrant as specified in its charter)
Delaware 94-2262240
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
430 Ferguson Drive
Mountain View, California 94043
(Address of principal executive offices)
(650) 960-3000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes[x] No [ ]
As of May 7, 1999, on a fully diluted basis, reflecting the conversion of the
registrant's outstanding Class A and Class B Common Stock into Common Stock,
there were outstanding 53,462,821 shares of the registrant's Common Stock. As
of May 7, 1999, there were outstanding 28,462,821 shares of the registrant's
Common Stock, par value $.001, which is the only class of common stock of the
registrant registered under Section 12(g) of the Securities Act of 1933. The
Company also has outstanding 13,270,000 shares of Class A Common Stock and
11,730,000 shares of Class B Common Stock which are convertible into an equal
number of shares of Common Stock.
CATALYTICA, INC.
FORM 10-Q
TABLE OF CONTENTS
March 31, 1999
Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Unaudited Condensed Consolidated Balance Sheets as of March 31, 1999, and December 31, 1998 3
Unaudited Condensed Consolidated Statements of Operations for the three months ended March 31, 1999,
and March 31, 1998 4
Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 1999,
and March 31, 1998 5
Notes to Unaudited Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 21
2
PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
March 31, December 31,
1999 1998
---- ----
ASSETS
Current assets:
Cash and cash equivalents $ 36,934 $ 42,392
Short-term investments 5,273 5,193
Accounts receivable, net 20,286 34,456
Accounts receivable from joint venture 770 1,121
Notes receivable from employees 320 282
Inventory:
Raw materials 46,440 38,614
Work in process 51,492 41,256
Finished goods 2,269 8,979
-------- --------
100,201 88,849
Deferred tax asset 2,867 2,867
Prepaid expenses and other assets 2,032 1,578
-------- --------
Total current assets 168,683 176,738
Property, plant and equipment:
Land 5,391 5,391
Equipment 130,270 124,735
Buildings and leasehold improvements 66,128 65,398
-------- --------
201,789 195,524
Less accumulated depreciation and amortization (31,202) (27,882)
-------- --------
170,587 167,642
Other assets 2,493 3,016
-------- --------
$341,763 $347,396
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 20,827 $ 19,984
Accrued payroll and related expenses 8,497 16,497
Deferred revenue 2,063 4,479
Other accrued liabilities 8,076 8,116
Current portion of long-term debt 14,491 10,770
Income taxes payable 1,515 3,706
-------- --------
Total current liabilities 55,469 63,552
Long-term debt 63,254 67,007
Non-current deferred revenue 1,847 2,181
Minority interest 41,000 41,000
Class A and B common stock 97,079 97,079
Stockholders' equity:
Common stock 28 28
Additional paid-in capital 104,296 103,954
Deferred compensation (250) (281)
Accumulated deficit (20,960) (27,124)
-------- --------
Total stockholders' equity 83,114 76,577
-------- --------
$341,763 $347,396
======== ========
See accompanying notes.
3
CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Three Months Ended March 31,
1999 1998
---- ----
Revenues:
Product sales $82,751 $90,274
Research revenues 5,313 1,860
------- -------
Total Revenues 88,064 92,134
Costs and expenses:
Cost of sales 66,480 75,898
Research and development 8,056 5,050
Selling, general and administrative 4,648 3,427
------- -------
Total costs and expenses 79,184 84,375
Operating income 8,880 7,759
Interest income 654 909
Interest expense (1,854) (2,625)
Loss on joint ventures (512) (1,155)
------- -------
Income before income taxes 7,168 4,888
Provision for income taxes (1,004) (637)
------- -------
Net income $ 6,164 $ 4,251
======= =======
Net income per share:
Basic $ 0.12 $ 0.08
======= =======
Diluted $ 0.10 $ 0.07
======= =======
Number of shares used in computing net income per
share:
Basic 53,441 52,951
======= =======
Diluted 59,596 58,588
======= =======
See accompanying notes.
4
CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (decrease) in cash and cash equivalents
(in thousands)
Three Months Ended March 31,
1999 1998
---- ----
Cash flows from operating activities:
Net income $ 6,164 $ 4,251
Adjustments to reconcile net income to net cash provided by (used in) operating
activity:
Depreciation and amortization 3,111 4,567
Deferred income taxes -- (220)
Losses in joint ventures 512 1,154
Changes in:
Accounts receivable 14,170 (8,688)
Accounts receivable from joint venture 351 268
Inventory (11,352) (194)
Prepaid expenses, and other current assets 224 (1,866)
Accounts payable 843 (4,734)
Accrued payroll and related expenses (8,000) 10
Deferred revenue (2,750) (247)
Accrued acquisition costs -- (70)
Other accrued liabilities (2,231) 3,981
-------- --------
Net cash provided by (used in) operating activities 1,042 (1,788)
Cash flows from investing activities:
Purchases of investments (9,438) (16,797)
Maturities of investments 9,422 12,000
Investment in joint ventures (512) (1,154)
Disposition of property and equipment 76 --
Acquisition of property and equipment (6,368) (2,155)
Proceeds from sale of property and equipment 3 --
-------- --------
Net cash used in investing activities (6,817) (8,106)
Cash flows from financing activities:
Net receipts on (issuance of) notes receivable from employees 7 (1,046)
Payments on debt obligations (32) (20,028)
Minority investment -- 30,000
Issuance of stock, net of issuance costs 342 (21)
-------- --------
Net cash provided by financing activities 317 8,905
-------- --------
Net increase (decrease) in cash and cash equivalents (5,458) (989)
Cash and cash equivalents at beginning of period 42,392 35,149
-------- --------
Cash and cash equivalents at end of period $ 36,934 $ 34,160
======== ========
See accompanying notes.
5
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three-month period ended March 31,
1999, are not necessarily indicative of the results that may be expected for the
year ended December 31, 1999. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Catalytica, Inc.
Annual Report on Form 10-K for the year ended December 31, 1998.
2. Reclassification
To more clearly reflect its investment in research and development ("R&D")
activities, the Company reclassified approximately $1.2 million from cost of
sales to R&D costs for the quarter ended March 31, 1998, to conform to the
current period presentation. In addition, the Company has reclassified $7,000 of
related product sales to research revenues for the period ended March 31, 1999
to conform to the current period presentation.
3. Earnings per share
Earnings 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. Weighted average shares outstanding for the three
months ended March 31, 1999, includes Class A and B common shares as Catalytica,
Inc. considers Class A and B to be the equivalent of common stock. The periods
presented herein have been adjusted to reflect the calculation of EPS in
accordance with SFAS No. 128.
6
A reconciliation of the numerators and denominators for the Basic and Diluted
EPS calculations follows:
(in thousands, except per share amounts) Three months ended March 31,
1999 1998
---- ----
Numerator:
Numerator for basic earnings per share: Income available to
common shareholders $ 6,164 $ 4,251
Less: Reduction of Catalytica Pharmaceuticals income
attributable to holders of subsidiary stock options ------- -------
(405) (249)
------- -------
Numerator for diluted earnings per share $ 5,759 $ 4,002
------- -------
Denominator:
Denominator for basic earnings per share:
------- -------
Weighted-average shares 53,441 52,951
------- -------
Effect of dilutive securities:
Catalytica, Inc. employee stock options 749 579
Catalytica Pharmaceuticals, Inc. Convertible Preferred Stock 1,669 1,671
Catalytica Pharmaceuticals, Inc. Convertible Junior
Preferred Stock 563 564
Catalytica Combustion Systems, Inc. Convertible Preferred
Stock 2,820 2,823
Catalytica, Inc. warrants issued to Glaxo Wellcome, Inc. 354 --
------- -------
Dilutive potential common shares 6,155 5,637
Denominator for diluted earnings per share:
------- -------
Adjusted weighted-average shares and assumed conversions 59,596 58,588
------- -------
Basic earnings per share $ 0.12 $ 0.08
======= =======
Diluted earnings per share $ 0.10 $ 0.07
======= =======
4. Impact of recently issued accounting standards
Segment Disclosures The Company operates primarily in the pharmaceuticals
and combustion systems industries. The Company has determined its reportable
operating segments based upon how the business is managed and operated.
Catalytica Pharmaceuticals, Inc. ("Catalytica Pharmaceuticals") and Catalytica
Combustion Systems, Inc. ("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. Catalytica Advanced Technologies, Inc. (`Advanced
Technologies") is combined with Corporate operations as it does not meet the
requirements for separate disclosure.
7
(In thousands) Three months ended March 31,
---------------------------------------
1999 1998
---- ----
Revenues
Catalytica Pharmaceuticals $ 87,378 $ 90,696
Combustion Systems 293 419
Corporate and other subsidiary 393 1,019
-------- --------
Total Revenues $ 88,064 $ 92,134
======== ========
Three months ended March 31,
-----------------------------------------
1999 1998
---- ----
Operating Income
Catalytica Pharmaceuticals $ 10,166 $ 8,341
Combustion Systems (1,460) (424)
Corporate and other subsidiary 174 (158)
-------- --------
Total Operating Income $ 8,880 $ 7,759
======== ========
March 31, 1999 March 31, 1998
---------------- ---------------
Identifiable Assets
Catalytica Pharmaceuticals $305,965 $302,232
Combustion Systems 25,871 31,741
Corporate and other subsidiary 9,927 14,463
-------- --------
Total Assets $341,763 $348,436
======== ========
5. Financial instruments
For the purposes of the consolidated cash flows, all investments with
maturities of three months or less at the date of purchase held as available-
for-sale are considered to be cash and cash equivalents; instruments with
maturities of three months or less at the date of purchase that are planned to
be held-to-maturity ($5.3 million at March 31, 1999) and investments with
maturities greater than three months that are available-for-sale (none at March
31, 1999) are considered to be short-term investments; investments with
maturities greater than one year are considered to be long-term investments and
are available-for-sale (none at March 31, 1999). All investments at March 31,
1999, 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.
6. Use of estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
8
7. Revenue recognition
In connection with the purchase of the Glaxo Wellcome, Inc. ("Glaxo Wellcome")
facility, Glaxo Wellcome entered into a supply agreement under which Catalytica
Pharmaceuticals, a subsidiary of the Company, manufactures products for Glaxo
Wellcome over the next several years ("Supply Agreement"). In 1998, the Company
signed two amendments to the original Supply Agreement, and a third amendment
was signed in the first quarter of 1999. Under the original Supply Agreement
and certain amendments, Glaxo Wellcome has guaranteed that revenues paid to
Catalytica Pharmaceuticals will meet a specified level of minimum revenue or
that Glaxo Wellcome will pay Catalytica Pharmaceuticals any shortfall.
The Company recognizes revenue under the original Supply Agreement with Glaxo
Wellcome and certain amendments based upon the minimum revenues stipulated in
this agreement. All product revenues are recorded upon shipment. During the
three months ended March 31, 1999, and March 31, 1998, the Company recorded
$62.8 million and $83.3 million, respectively, of revenue derived from sales to
Glaxo Wellcome.
As of March 31, 1999, a receivable in the amount of $9.1 million was
outstanding from Glaxo Wellcome.
8. Debt
As of March 31, 1999, nothing was outstanding under the senior secured
revolving facility ("Revolving Debt Facility") and $75 million was outstanding
under the senior secured term loan facility ("Term Debt Facility").
This credit agreement, which is guaranteed by the Company, requires that the
Company maintain certain financial ratios and levels of tangible net worth,
profitability, and liquidity and implements restrictions on the Company's
ability to declare and pay dividends. In addition, the credit agreement
contains various covenants restricting further indebtedness, issuance of
preferred stock by the Company or its subsidiaries, liens, acquisitions, asset
sales, and capital expenditures. At March 31, 1999, the Company and Catalytica
Pharmaceuticals were in compliance with the covenants.
9. Joint ventures
GENXON Power Systems, LLC
Combustion Systems recognized its 50% share of GENXON losses of $1.0 million
or $0.5 million for the three months ended March 31, 1999. Accordingly, losses
on the joint venture were recognized in the results of operations.
9
As of March 31, 1999, an account receivable for $0.39 million existed from the
joint venture for costs incurred by Combustion Systems. Accordingly these costs
have not been included in the consolidated entity.
Single-Site Catalysts, LLC
Advanced Technologies recorded its share of losses to the extent of its
capital contribution of $0.15 million in the joint venture during 1998. 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.
As of March 31, 1999, an account receivable for $0.39 million existed from the
joint venture for costs incurred by Advanced Technologies. Accordingly these
costs have not been included in the consolidated entity.
10. Income taxes
The provision for income taxes for the three months ended March 31, 1999 was
approximately 14%, as compared with 13% for the corresponding period in 1998.
The increase in the estimated annual tax rate is due primarily to state income
taxes relating to the Greenville facility coupled with the federal alternative
minimum tax.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
This report contains forward-looking statements within the meaning of Section
27A of the Securities Act 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 those set
forth under "Risk Factors" and elsewhere in this Report. The Company undertakes
no obligation to update publicly any forward looking statements to reflect new
information, events or circumstances after the date of this release or to
reflect the incurrence of unanticipated events.
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").
Results of Operations
Net revenues for the three months ended March 31, 1999 decreased by 4.4%
compared with the revenues in the same quarter in fiscal 1998. Product sales
decreased by 8.3% during the period, when compared with the same period for
1998, primarily due to a decrease in product sales attributable to a scheduled
reduction in certain products under the original Glaxo Wellcome Supply Agreement
that was largely offset by continued expansion of sales to new customers.
During the three months ended March 31, 1999, 76% of the Company's
pharmaceutical product revenues were derived from sales to Glaxo Wellcome as
compared to 92% during the three months ended March 31, 1998. Approximately 50%
of product sales for the quarter ended March 31, 1999, were derived from sales
to Glaxo Wellcome under the original Supply Agreement. As part of the original
Supply Agreement and certain amendments, Glaxo Wellcome guarantees a specified
minimum level of revenues in each year of the agreement. To the extent the
minimum level of revenues exceeds amounts billed at the time 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 Supply Agreement (see Note 7 to
Unaudited Condensed Consolidated Financial Statements).
Research revenues increased by 186%, when compared with the same period for
1998, due to an increase in new research partners and related research revenues
at Catalytica Pharmaceuticals. However, the increase was partially offset by a
decrease in Advanced Technologies' research
11
revenue as it decreased its emphasis on contract research and focused its
efforts on new technologies.
Interest income decreased by 28% for the three months ended March 31, 1999,
when compared to the same period in 1998 due to lower average cash and
investment balances. Cash balances declined during the first quarter of 1999
due to payments of employee incentive bonuses coupled with quarterly estimated
tax payments. In addition, average cash and investment balances declined during
the second and third quarters of 1998 when the Company used $30 million of
available cash to retire some of the outstanding debt under the Chase Term and
Revolving Credit facilities. In the first quarter of 1998, Enron Ventures
Corporation invested $30.0 million in Combustion Systems. The Enron cash
investment has restrictions related to its use such that these funds cannot be
used by other Catalytica subsidiaries such as Catalytica Pharmaceuticals.
Cost of sales decreased 12% for the first three months of 1999 when compared
to cost of sales in the same period in 1998. The decrease in cost of sales
reflects lower product sales and a change in product mix. The change in product
mix coupled with improved manufacturing efficiencies are expected to continue to
favorably impact margins throughout 1999.* Margins on pharmaceutical products
are subject to fluctuations from quarter to quarter due to various factors,
including the mix of products being manufactured, manufacturing efficiencies
achieved on production runs, the length of down-time associated with setting up
new productions runs, and numerous other variables present in the pharmaceutical
manufacturing environment.
Research and development expenses ("R&D") increased 60% for the three months
ended March 31, 1999, as compared to R&D expenses in the same period in 1998.
This increase is largely attributable to increased R&D staffing and associated
R&D expenses at the Greenville Facility which is expanding the R&D services it
provides with respect to both chemical process and formulation development.
These activities are important for obtaining new customers and are becoming a
meaningful source of revenues. The increase in R&D expenses in the
pharmaceutical segment of our business was slightly offset by decreased R&D
expenses in Advanced Technologies. R&D expenses are expected to increase further
in 1999 as the Company continues to invest in its R&D capabilities.*
Selling, general and administrative expenses ("SG&A") increased 36% for the
three months ended March 31, 1999, compared with the same period in 1998 largely
due to SG&A costs incurred by the addition of SG&A employees at the Greenville
Facility. SG&A expenses have increased as the Company has expanded it's sales
and marketing personnel to sell the available capacity in the Greenville
Facility.* SG&A expenses have also increased as Combustion Systems hired
additional sales and marketing personnel as it nears commercialization. SG&A
expenses are expected to further increase in 1999.*
Interest expense decreased 29% for the quarter ended March 31, 1999, when
compared to the same period in 1998 due to a decrease of approximately $28
million in debt between the two quarters, which was related to the acquisition
of the Greenville Facility.
12
Combustion Systems recognized its 50% share of GENXON losses of $1.0 million
or $0.5 million for the three months ended March 31, 1999. During the
comparable period in 1998, Combustions System's 50% share of GENXON's losses of
$2.3 million amounted to $1.2 million. Accordingly, losses on the joint venture
during both periods were recognized in the results of operations. The reduction
in GENXON losses during the first quarter of 1999 is primarily due to a
reduction in KHI development costs as that program enters the test phase. The
reduced level of the Company's investment in GENXON will continue throughout
1999.*
Advanced Technologies recorded its share of losses to the extent of its
capital contribution of $0.15 million in the joint venture during 1998. 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 beyond the initial $5 million commitment by its joint venture
partner.*
The provision for income taxes for the three months ended March 31, 1999, was
14% compared with 13% for the corresponding periods in 1998. The slight increase
in the estimated annual tax rate is due primarily to the Company's recent
profitability, resulting in state income taxes relating to the Greenville
Facility coupled with the federal alternative minimum tax. The Company's
effective tax rate is expected to continue to be 14% throughout 1999.* In the
years following, if the Company continues to be profitable, the effective tax
rate will increase.*
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 systems and products do not
correctly process "leap year" dates. As a result, in the next 9 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
13
staff, other than for routine calibration or adjustment (e.g. stand-alone
controllers, intelligent field devices, laboratory instruments, and
telecommunications devices).
Set forth below is a chart showing the Company's present status of compliance at
March 31, 1999, 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.*
Present Year 2000 Status as of March 31, 1999
- ---------------------------------------------
Resolution Phases
Exposure Type Assessment Remediation Testing Implementation
- -----------------------------------------------------------------------------------------------------
Business Information 100% Complete 82% Complete 74% Complete 65% Complete
Technology Systems
Expected Completion November 1999 November 1999 December 1999
- -----------------------------------------------------------------------------------------------------
Manufacturing 100% Complete 86% Complete 86% Complete 70% Complete
Automation Systems
Expected Completion July 1999 August 1999 October 1999
- -----------------------------------------------------------------------------------------------------
Embedded Systems 100% Complete 99% Complete 99% Complete 98% Complete
Expected Completion September 1999 September 1999 October 1999
- -----------------------------------------------------------------------------------------------------
Assessment of all systems is complete. 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.
14
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 March 31, 1999, the Company has spent $5.1
million on costs associated with the Year 2000 effort of which $3.5 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.*
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
15
operations or financial condition. (See "Risk Factors - Problems Related to
"Year 2000 Issue" Could Adversely Affect Our Business.")
Liquidity and Capital Resources
Total cash and cash equivalents plus short-term investments decreased from
$47.6 million to $42.2 million for the three months ended March 31, 1999, when
compared with December 31, 1998, primarily due to payments of accrued year-end
payroll expenses and quarterly estimated tax payments coupled with a net
increase in fixed asset purchases. 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 $42.2 million (including
short-term investments) and its available line of credit of $100 million as of
March 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.*
In the second quarter of 1998, the Company entered into a $50 million interest
rate swap agreement to reduce the Company's exposure to fluctuations in short-
term interest rates. This agreement effectively fixed the LIBOR benchmark rate
used to calculate the Company's borrowing cost at 5.90% for 4 years on $50
million of the Term Debt Facility. The Company accounts for this agreement as a
hedge and accrues the interest rate differential as interest expense on a
monthly basis. The Company does not hold or transact in such financial
instruments for purposes other than risk management.
RISK FACTORS
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. The Company undertakes no
obligation to update publicly any forward looking statements to reflect new
information, events or circumstances after the date of this release or to
reflect the incurrence of unanticipated events.
Our Facilities Are Not Fully Utilized and Our Financial Results Fluctuate.
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
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approvals 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 Dependent on Our Relationship with Glaxo
Wellcome.
Our revenues in the first quarter of 1999 were $88 million. The original
Supply Agreement, its subsequent amendments, and new business with Glaxo
Wellcome accounted for approximately 71% of total revenues and 76% of Catalytica
Pharmaceutical's product revenues. Approximately 50% of product sales for the
quarter ending March 31, 1999, were derived from sales to Glaxo Wellcome under
the original Supply Agreement. 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.*
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 XONON combustion system technology. These XONON 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 XONON 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 XONON product.*
Combustion Systems has entered into agreements for the development of a
combustion system incorporating XONON 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 XONON combustion system. Relationships with
gas turbine suppliers are
17
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 Systems' 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 XONON combustion systems are
expected to be sold as components of 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 XONON
will be economically attractive when compared to competitive products.
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.
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.*
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There is a High Concentration of Ownership in Our Capital Stock.
As of March 31, 1999, 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, which 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.
Other Risks
Other risks associated with Catalytica's business, can be found on pages 48-58
of the Company's Form 10K for the year ended December 31, 1998, including
related Risks Factors.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's market risk disclosures set forth in the 1998 Form 10-K have
not changed significantly through the quarter ended March 31, 1999.
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PART II - OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
The Company filed no reports on Form 8-K during the quarter ended March 31,
1999.
All information required by other items in Part II is omitted because the
items are inapplicable, the answer is negative or substantially the same
information has been previously reported by the registrant.
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CATALYTICA, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: May 14, 1999
CATALYTICA, INC.
(Registrant)
By: /s/ Lawrence W. Briscoe
----------------------------
Lawrence W. Briscoe
Vice President and Chief
Financial Officer
Signing on behalf of the
registrant and as principal
financial officer
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