UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 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 August 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 53,608,298 shares of the registrant's Common Stock.
As of August 7, 1999, there were outstanding 28,608,298 shares of the
registrant's Common Stock, par value $.001, which is the only class of common
stock of the registrant registered under Section 12(g) of the Securities Act of
1933. The Company also has outstanding 13,270,000 shares of Class A Common
Stock and 11,730,000 shares of Class B Common Stock which are convertible into
an equal number of shares of Common Stock.
CATALYTICA, INC.
FORM 10-Q
TABLE OF CONTENTS
June 30, 1999
Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Unaudited Condensed Consolidated Balance Sheets as of June 30, 1999, and December 31, 1998 3
Unaudited Condensed Consolidated Statements of Operations for the three and six months ended June 30,
1999, and June 30, 1998 4
Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 1999, and
June 30, 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
Item 3. Quantitative and Qualitative Disclosures about Market Risk 30
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 32
Item 5. Other Information 32
Item 6. Exhibits and Reports on Form 8-K 32
Signatures 34
2
PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
June 30, December 31,
1999 1998
---- ----
ASSETS
Current assets:
Cash and cash equivalents $ 46,441 $ 42,392
Short-term investments 5,116 5,193
Accounts receivable, net 23,306 34,456
Accounts receivable from joint venture 572 1,121
Notes receivable from employees 305 282
Inventory:
Raw materials 38,230 38,614
Work in process 42,335 41,256
Finished goods 11,573 8,979
--------- --------
92,138 88,849
Deferred tax asset 2,867 2,867
Prepaid expenses and other assets 4,199 1,578
--------- --------
Total current assets 174,944 176,738
Property, plant and equipment:
Land 5,391 5,391
Equipment 135,785 124,735
Buildings and leasehold improvements 67,901 65,398
--------- --------
209,077 195,524
Less accumulated depreciation and amortization (34,770) (27,882)
--------- --------
174,307 167,642
Other assets 2,529 3,016
--------- --------
$ 351,780 $347,396
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 19,080 $ 19,984
Accrued payroll and related expenses 14,077 16,497
Deferred revenue 4,069 4,479
Other accrued liabilities 13,855 8,116
Current portion of long-term debt 8,201 10,770
Income taxes payable 438 3,706
--------- --------
Total current liabilities 59,720 63,552
Long-term debt 59,500 67,007
Non-current deferred revenue 1,414 2,181
Other long-term liabilities 1,125 --
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 105,810 103,954
Deferred compensation (219) (281)
Accumulated deficit (13,677) (27,124)
--------- --------
Total stockholders' equity 91,942 76,577
--------- --------
$ 351,780 $347,396
========= ========
See accompanying notes.
3
CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Three Months Ended June 30, Six Months Ended June 30,
1999 1998 1999 1998
---- ---- ---- ----
Revenues:
Product sales $ 99,418 $92,238 $ 182,169 $ 182,512
Research and development contracts 5,001 3,839 10,314 5,699
-------- ------- --------- ---------
Total revenues 104,419 96,077 192,483 188,211
Costs and expenses:
Cost of product sales 77,479 75,787 143,959 151,685
Research and development 10,049 8,168 18,105 13,218
Selling, general and administrative 5,823 3,829 10,471 7,256
-------- ------- --------- ---------
Total costs and expenses 93,351 87,784 172,535 172,159
Operating income 11,068 8,293 19,948 16,052
Interest income 668 646 1,322 1,555
Interest expense (2,042) (2,394) (3,896) (5,019)
Loss on joint ventures (463) (1,152) (975) (2,307)
-------- ------- --------- ---------
Income before income taxes 9,231 5,393 16,399 10,281
Provision for income taxes (1,948) (360) (2,952) (997)
-------- ------- --------- ---------
Net income $ 7,283 $ 5,033 $ 13,447 9,284
======== ======= ========= =========
Net income per share:
Basic $ 0.14 $ 0.09 $ 0.25 $ 0.18
======== ======= ========= =========
Diluted $ 0.11 $ 0.08 $ 0.21 $ 0.15
======== ======= ========= =========
Number of shares used in computing net
income per share:
Basic 53,513 53,035 53,477 52,993
======== ======= ========= =========
Diluted 58,942 59,305 59,178 58,936
======== ======= ========= =========
See accompanying notes.
4
CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (decrease) in cash and cash equivalents
(in thousands)
Six Months Ended June 30,
1999 1998
---- ----
Cash flows from operating activities:
Net income $ 13,447 $ 9,284
Adjustments to reconcile net income to net cash provided by operating activity:
Depreciation and amortization 7,447 7,078
Deferred income taxes -- --
Losses in joint ventures 975 2,308
Changes in:
Accounts receivable 11,150 (7,535)
Accounts receivable from joint venture 549 696
Inventory (3,289) 13,480
Prepaid expenses, and other current assets (2,367) (1,948)
Accounts payable (904) (5,967)
Accrued payroll and related expenses (2,420) 3,891
Deferred revenue (1,177) (787)
Other accrued liabilities 3,596 (2,055)
--------- ---------
Net cash provided by operating activities $ 27,007 $ 18,445
Cash flows from investing activities:
Purchases of investments $(15,112) $(23,762)
Maturities of investments 15,172 24,000
Investment in joint ventures (975) (2,308)
Disposition of property and equipment 85 125
Acquisition of property and equipment (13,668) (7,558)
Proceeds from sale of property and equipment 3 --
--------- --------
Net cash used in investing activities $ (14,495) $ (9,503)
Cash flows from financing activities:
Net receipts on (issuance of) notes receivable from employees $ (243) $ (1,067)
Additions to debt obligations -- 2,700
Payments on debt obligations (10,076) (40,058)
Minority investment -- 30,000
Issuance of stock, net of issuance costs 1,856 1,664
-------- ---------
Net cash used in financing activities $ (8,463) $ (6,761)
--------- ---------
Net increase in cash and cash equivalents 4,049 2,181
Cash and cash equivalents at beginning of period 42,392 35,149
-------- ---------
Cash and cash equivalents at end of period $ 46,441 $ 37,330
======== =========
See accompanying notes.
5
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the six-month period ended June 30, 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 $1.9 million and $3.1
million from cost of sales to R&D costs for the three and six months quarter
ended June 30, 1998, to conform to the current period presentation. In
addition, the Company has reclassified $1.5 million of related product sales
to research revenues for the three and six months ended June 30, 1998, 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 and
six months ended June 30, 1999, includes Class A and B common shares as Class A
and B common stock are convertible into an equal number of shares 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:
Three months ended Six months ended
(in thousands, except per share amounts) June 30, June 30,
1999 1998 1999 1998
---- ---- ---- ----
Numerator:
Numerator for basic earnings per share:
Income available to common shareholders $ 7,283 $ 5,033 $ 13,447 $ 9,284
Less: Reduction of Catalytica
Pharmaceuticals income attributable to
holders of subsidiary stock options (655) (312) (1,116) (561)
------- ------- -------- --------
Numerator for diluted earnings per share $ 6,628 $ 4,721 $ 12,331 $ 8,723
------- ------- -------- --------
Denominator:
Denominator for basic earnings per share:
Weighted-average shares 53,513 53,035 53,477 52,993
------- ------- -------- --------
Effect of dilutive securities:
Catalytica, Inc. employee stock options 500 879 625 745
Catalytica Pharmaceuticals, Inc. Convertible
Preferred Stock 1,657 1,691 1,654 1,691
Catalytica Pharmaceuticals, Inc.
Convertible Junior Preferred Stock 559 570 558 570
Catalytica Combustion Systems, Inc.
Convertible Preferred Stock 2,651 2,664 2,645 2,664
Catalytica, Inc. warrants issued to Glaxo
Wellcome, Inc. 62 466 219 273
------- ------- -------- --------
Dilutive potential common shares 5,429 6,270 5,701 5,943
Denominator for diluted earnings per share:
Adjusted weighted-average shares and
assumed conversions 58,942 59,305 59,178 58,936
------- ------- -------- ------
Basic earnings per share $ 0.14 $ 0.09 $ 0.25 $ 0.18
======= ======= ======== ========
Diluted earnings per share $ 0.11 $ 0.08 $ 0.21 $ 0.15
======= ======= ======== ========
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
7
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.
(In thousands) Three months ended June 30, Six months ended June 30,
--------------------------- -------------------------
1999 1998 1999 1998
---- ---- ---- ----
Revenues
Catalytica Pharmaceuticals $ 103,720 $ 94,085 $ 191,098 $ 184,781
Combustion Systems 218 905 511 1,324
Corporate and other subsidiary 481 1,087 874 2,106
--------- -------- --------- ---------
Total revenues $ 104,419 $ 96,077 $ 192,483 $ 188,211
========= ======== ========= =========
(In thousands) Three months ended June 30, Six months ended June 30,
--------------------------- -------------------------
1999 1998 1999 1998
---- ---- ---- ----
Operating Income
Catalytica Pharmaceuticals $ 13,820 $ 9,558 $ 23,986 $ 17,899
Combustion Systems (1,299) (848) (2,759) (1,272)
Corporate and other subsidiary (1,453) (417) (1,279) (575)
--------- -------- -------- ---------
Total operating income $ 11,068 $ 8,293 $ 19,948 $ 16,052
========= ======== ======== =========
(In thousands) June 30, 1999 December 31, 1998
------------- -----------------
Identifiable Assets
Catalytica Pharmaceuticals $ 318,372 $ 300,264
Combustion Systems 23,985 27,402
Corporate and other subsidiary 9,423 19,730
--------- ---------
Total assets $ 351,780 $ 347,396
========= =========
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 (none at June 30, 1999) 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 ($5.1 million at June 30, 1999)
and investments with maturities greater than three months that are
available-for-sale (none at June 30, 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 June 30, 1999). All
investments at June 30, 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 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
8
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
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, agreed to manufacture products for
Glaxo Wellcome over the next several years ("Original 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 these amendments, Glaxo Wellcome has guaranteed that
revenues paid to Catalytica Pharmaceuticals will meet a specified level of
minimum revenue or Glaxo Wellcome will be required to pay Catalytica
Pharmaceuticals any shortfall.
The Company recognizes revenue under the Original Supply Agreement with Glaxo
Wellcome and the amendments thereto based upon the minimum revenues stipulated.
All product revenues are recorded upon shipment. During the three and six months
ended June 30, 1999, the Company recorded $77.1 million and $139.9 million,
respectively, of revenue derived from sales to Glaxo Wellcome.
As of June 30, 1999, a receivable in the amount of $12.8 million was
outstanding from Glaxo Wellcome.
8. Debt
As of June 30, 1999, nothing was outstanding under the senior secured
revolving facility ("Revolving Debt Facility") and $65 million was outstanding
under the senior secured term loan facility ("Term Debt Facility").
The credit agreement covering the Revolving Debt Facility and the Term Debt
Facility, which is guaranteed by the Company, requires that the Company maintain
certain financial ratios and levels of tangible net worth, profitability, and
liquidity and implements restrictions on the Company's ability to declare and
pay dividends. In addition, the credit agreement contains various covenants
restricting further indebtedness, issuance of preferred stock by the Company or
its subsidiaries, liens, acquisitions, asset sales, and capital expenditures. At
June 30, 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 June 30, 1999, and $2.0 million or
$1.0 million for the six months ended June 30, 1999. Accordingly, losses on
the joint venture were recognized in the results of operations.
9
As of June 30, 1999, an account receivable for $0.4 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 its initial $0.15 million contribution.
Therefore, no further losses will be recorded by the Company unless it decides
to invest additional capital.
As of June 30, 1999, an account receivable for $0.2 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 and three and six months ended
June 30, 1999 was approximately 21% and 18%, respectively. For the three and six
months ended June 30, 1998 the provision for income taxes was 7% and 10%,
respectively. The increase in the estimated annual effective tax rate is
primarily due to the Company's increased profitability which is expected to
result in its income in the current year exceeding the limit of federal net
operating losses currently available from prior years.
11. Subsequent Event
On July 14, 1999, Catalytica, Inc. announced the signing of a definitive
agreement to acquire Wyckoff Chemical company, Inc. ("Wyckoff"), a leading
developer, manufacturer, and marketer of a broad range of active pharmaceutical
ingredients and advanced fine chemical ingredients. Under the terms of the
acquisition, which is expected to be accounted for as a pooling of interests,
the Company will exchange approximately 4,496,487 shares of Catalytica common
stock for all the outstanding shares of Wyckoff stock and applied towards
options and other rights to acquire Wyckoff stock. The acquisition is expected
to be completed in the fourth quarter of 1999 and is subject to certain
conditions, regulatory approval, and approval by Wyckoff shareholders. The
Company expects to record a one-time charge of approximately $1.0 million in the
third quarter of 1999 relating to expenses incurred with this transaction.
Wyckoff's operating results for the three and six months ended June 30, 1999
included revenues of approximately $13.7 million and $21.6 million,
respectively, and net income of approximately $2.2 million and $2.5 million,
respectively.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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 inccurence of unanticipated events.
Overview
Catalytica, Inc. ("Catalytica" or "the Company") builds business in high
growth industries where its 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 and six months ended June 30, 1999 increased by
8.7% and 2.3%, respectively, when compared with the revenues in the same periods
in fiscal 1998. Product sales increased by 7.8% and decreased by 0.2%,
respectively, during the three and six months ended June 30, 1999, when
compared with the same periods for 1998. For the three and six months ended
June 30, 1999, product sales attributable to Glaxo Wellcome declined in
accordance with scheduled volume reductions in certain products under the
Glaxo Wellcome supply agreement and some change in product mix. The decline in
product sales attributable to Glaxo Wellcome was largely offset by continued
expansion of sales to Warner Lambert and other new and existing customers,
particularly in the second quarter of 1999.
During the six months ended June 30, 1999, 73% of Catalytica's revenues were
derived from sales to Glaxo Wellcome, of which 42% was derived from sales to
Glaxo Wellcome under the original supply agreement. During the same period in
1998, 89% of Catalytica's revenues were derived from sales to Glaxo Wellcome, of
which 86% was derived from sales to Glaxo Wellcome under the original supply
agreement. During the quarter ended June 30, 1999, 74% of Catalytica's revenues
were derived from sales to Glaxo Wellcome, of which 36% was derived from sales
to Glaxo Wellcome under the original supply agreement. During the quarter ended
June 30, 1998, 87% of Catalytica's revenues were derived from sales to Glaxo
Wellcome, of which 85% was derived from sales to Glaxo Wellcome under the
original supply agreement. As part of the original supply agreement and
amendments to the original supply agreement, Glaxo Wellcome guarantees a
specified minimum level of revenues in each year of the agreement. If the
minimum level of
11
revenues exceeds amounts billed at the time of product shipments, Catalytica
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 Notes to
Catalytica's Consolidated Financial Statements.
Research revenues increased by 30% and 81%, respectively, for the three and
six months ended June 30, 1999, when compared with the same periods for 1998,
due to an increase in new research partners and related funded research
activities at Catalytica Pharmaceuticals. However, the increase was partially
offset by a decrease in Advanced Technologies' research revenue as it decreased
its emphasis on contract research and focused its efforts on development of new
technologies through joint ventures. The increase in research revenue was also
offset by a decrease in Combustion Systems' revenue for the three and six months
ended June 30, 1999, when compared to the same periods in 1998 primarily due to
a $0.5 million technology milestone payment from GENXON to Combustion Systems in
the second quarter of 1998, and a slight decrease in external research funding
in 1999. The Company's R&D revenues are expected to increase further in 1999 as
the Company continues to expands its research and development efforts and signs
new contracts with new and existing customers, especially in the Pharmaceutical
business.*
Cost of sales increased 2.2% for the second quarter of 1999 when compared to
the same period in 1998, which corresponds to a 7.8% increase in product sales.
Cost of sales increased less than product sales in the second quarter of 1999
due to a change in product mix and improved manufacturing efficiencies. Cost of
sales decreased 5% for the first six months of 1999, when compared to cost of
sales in the same period in 1998, which corresponds to a decrease of 0.2% of
product sales. This decrease in cost of sales reflects slightly lower product
sales, which was partially offset by a change in product mix and improved
manufacturing efficiencies. 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.
12
Research and development expenses increased 23% and 37%, respectively, for the
three and six months ended June 30, 1999, as compared to R&D expenses in the
same periods in 1998. This increase in R&D expenses directly corresponds to an
increase in R&D income attributable to increased 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 as the Company continues to obtain new R&D
customers who are becoming a meaningful source of revenues.* The increase in R&D
expenses in the pharmaceutical segment was offset slightly by lower R&D expenses
in Advanced Technologies due to a shift in emphasis from contract research to
development of new technologies through joint ventures. The Company's R&D
expenses are expected to increase further in 1999 as the Company continues to
invest in its R&D capabilities, especially in Catalytica Pharmaceutical.*
Selling, general and administrative expenses increased 52% and 44%,
respectively, for the three and six months ended June 30, 1999, compared with
the same periods in 1998. SG&A expenses increased due to higher expenditures on
sales and marketing personnel for the Greenville facility, higher employee
incentive costs related to Catalytica's performance and costs associated with
the Wyckoff merger. SG&A expenses have also increased in Combustion Systems as
it focuses on commercialization of the XONON technology. SG&A expenses are
expected to increase moderately in the remainder of 1999, due in part to costs
associated to the merger.*
Interest income increased by 3% and decreased 15%, respectively, for the three
and six months ended June 30, 1999, when compared to the same periods in 1998.
The decrease in interest income for the first six months of 1999 is primarily
due to lower average cash and investment balances in 1999 attributable to
payments on the Chase credit agreement, internal funding of Combustion System's
XONON technology, payments of employee incentive bonuses, and quarterly
estimated tax payments. However, average cash balances were slightly higher
during the second quarter of 1999 when compared to 1998, due to an increase in
working capital generated by Catalytica Pharmaceuticals, which was partially
offset by the above mentioned factors. 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.
Interest expense decreased 15% and 22%, respectively, for the three and six
months ended June 30, 1999, when compared to the same periods in 1998. The
decrease in interest expense at June 30, 1999, is attributable to a reduction of
approximately $20 million in debt, when compared to June 30, 1998. On June 7,
1999, the Company made an early debt payment on the Chase Credit Facility of
$10.0 million. Interest expense may increase slightly in the remainder of 1999
if the Wyckoff acquisition is consummated.*
During the three months ended June 30, 1999, Combustion Systems recognized its
50% share of GENXON losses of $1.0 million, which amounted to a $0.5 million
loss. In addition, for the six months ended June 30, 1999, Combustion Systems
recognized its 50% share of GENXON losses of $2.0 million, which amounted to a
loss of $1.0 million. During the three months ended June 30, 1998, Combustion
System's 50% share of GENXON's losses of $2.3 million amounted to a loss of
$1.15 million. During the six months ended June 30, 1998, Combustion System's
50% share of GENXON's losses of $4.6 million amounted to a loss of $2.3 million.
Accordingly, losses on the joint venture were recognized in the results of
operations. The reduction in GENXON losses during 1999 is primarily due to a
shift from development activities related to the retrofit of XONON to less
costly activities related to durability testing of XONON, and partially due to
an increase in research revenue related to a California Energy Commission grant.
The reduced level of the Company's investment in GENXON is expected to continue
throughout 1999.*
The provision for income taxes for the three and six months ended June 30,
1999, was 21% and 18%, respectively, compared with 7% and 10% for the
corresponding periods in 1998. The
13
increase in the estimated annual effective tax rate is primarily due to the
Company's increased profitability which is expected to result in its income in
the current year exceeding the limit of federal net operating losses currently
available from prior years.* The Company's effective tax rate is expected to
continue to be approximately 18% throughout 1999.* In the following year, if the
Company continues to be profitable, the effective tax rate will increase
further.*
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 21/st/ century dates
from 20/th/ century dates. In addition, certain systems and products do not
correctly process "leap year" dates. As a result, in the next six months,
computer systems, software ("IT Systems") and other equipment, such as
telephones, office equipment and manufacturing equipment used by Catalytica, may
need to be upgraded, repaired or replaced to comply with "Year 2000" and "leap
year" requirements. Catalytica's existing systems are not yet completely Year
2000 compliant. As a result, Catalytica is continuing to modify the systems.
Catalytica has conducted an internal review of most of its 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:
.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 generally are 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, and telecommunications devices).
The chart below shows Catalytica's status of compliance at June 30, 1999 and
internal target dates for compliance. Catalytica 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 in the
14
third quarter of 1999 and cosmetic changes to reports and displays will be
completed in the fourth quarter of 1999.*
Year 2000 Status as of June 30, 1999
Resolution Phases
Exposure Type Assessment Remediation Testing Implementation
- ----------------------------------------------------------------------------------------------------
Business Information 100% 88% 81% 74%
Technology Systems Complete Complete Complete Complete
Expected Completion* August November December
1999 1999 1999
- ------------------------------------------------------------------------------------------------------
Manufacturing 100% 98% 93% 86%
Automation Systems Complete Complete Complete Complete
Expected Completion* August September October
1999 1999 1999
- ------------------------------------------------------------------------------------------------------
Embedded Systems 100% 99% 99% 99%
Complete Complete Complete Complete
Expected Completion* September September October
1999 1999 1999
- ------------------------------------------------------------------------------------------------------
Assessment of potential problems in business information technology systems,
manufacturing automation systems, and embedded systems is complete. Testing and
remediation of business information technology systems, manufacturing automation
systems and embedded systems is in progress. Catalytica anticipates successful
completion of all phases of these efforts during 1999.*
As part of Catalytica's review to assure Year 2000 compliance, it has formed a
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 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 $7.0 million.* In
conjunction with the purchase of the Greenville facility, Glaxo Wellcome has
agreed to reimburse Catalytica for $4.0 million of these costs. As of June 30,
1999, Catalytica has spent $5.7 million on costs associated with the Year 2000
effort, of which $4.0 million has been reimbursed by Glaxo Wellcome. Costs
related to Year 2000 remediation are not expected to have a material effect on
Catalytica's results of operations or financial condition.*
15
Catalytica has contacted its major customers, vendors and service suppliers
whose systems failures potentially could have a significant impact on
Catalytica's operations, to verify their Year 2000 readiness to determine
Catalytica's potential exposure to Year 2000 issues. Catalytica has been
informed by 81% of its major customers, vendors and service suppliers that they
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 Catalytica's business,
financial condition, results of operation and prospects. Year 2000 problems
could affect many of Catalytica'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, Catalytica 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 occurred in the first half of 1999. Based on
current plans and efforts to date, Catalytica 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 Catalytica'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 Catalytica'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 business solutions from suppliers could result in
liability to Catalytica or otherwise have a material adverse effect on the
business, results of operations, financial condition and prospects. Catalytica
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 Catalytica'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-- If we, our suppliers or our customers do not
successfully address the Year 2000 issue, we could experience a significant
disruption of our financial management and control systems or a lengthy
interruption in our manufacturing operations."
Liquidity and Capital Resources
Total cash, cash equivalents and short-term investments increased from $47.6
million to $51.6 million for the six months ended June 30, 1999, when compared
with December 31, 1998. The increase largely reflects cash generated through
normal operating activities, partially offset by investments in property and
equipment and, a $10 million early payment on the Chase credit agreement. The
Company expects to spend approximately $30 million during 1999 for capital
expenditures, primarily at Catalytica Pharmaceuticals.* Because of its cash
position of $51.6 million (including short-term investments) its available line
of credit of $100 million as of June
16
30, 1999, and 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.
Agreement to Acquire Wyckoff Chemical Company, Inc.
On July 14, 1999, Catalytica, Pilot Acquisition Corporation, a wholly-owned
subsidiary of Catalytica ("Subsidiary") and Wyckoff Chemical Company, Inc.
("Wyckoff") entered into an Agreement and Plan and Reorganization (the "Merger
Agreement"), pursuant to which Subsidiary will merge with and into Wyckoff (the
"Merger"). Upon completion of the Merger, Wyckoff will become a wholly-owned
subsidiary of Catalytica. Under the terms of the Merger, 4,496,487 shares of
Catalytica common stock will be exchanged for all outstanding shares of Wyckoff
common stock and applied toward options and other rights to acquire Wyckoff
common stock. Catalytica and Wyckoff intend the Merger to be accounted for as a
pooling of interests and to qualify as a tax-free reorganization.* For
additional information on the Merger and for a copy of the Merger Agreement see
the Registration Statement on Form S-4 filed by Catalytica on August 6, 1999.
A copy of the press release regarding execution of the Merger Agreement issued
by Catalytica on July 15, 1999, is attached hereto as Exhibit 99.1.
Wyckoff develops, manufactures and markets a broad range of active
pharmaceutical ingredients and advanced fine chemical ingredients. Wyckoff
sells its products and custom synthesis services to pharmaceutical companies
that sell both branded and generic products, as well as to cosmetic companies
and other fine chemical end-users. Wyckoff's principal executive offices are
located in South Haven, Michigan.
17
RISK FACTORS
The following risk factor section contains forward-looking statements within
the meaning of the federal securities laws relating to future events or
Catalytica's 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. Catalytica's actual
results could differ materially from the results anticipated in these forward-
looking statements as a result of certain risks 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 an investment in our common stock. Catalytica 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.
The use of "we," "us," or "our" throughout this risk factor section is
intended to refer to Catalytica and Wyckoff. While the risk factors applicable
to Catalytica and Wyckoff relate to the combined company after the completion of
the Merger, each of these risk factors, unless the context requires otherwise,
should be read as applying to Catalytica prior to the consummation of the
Merger and in the event the Merger is not consummated.
Risks Related to the Proposed Merger
The proposed Merger may not be completed and Catalytica's stock trading price
and business may suffer as a result
The obligations of Catalytica and Wyckoff to complete the Merger are subject
to the satisfaction or waiver of certain conditions, including (a) the accuracy
of the other party's representations and warranties, (b) compliance by the other
party with its obligations under the Merger Agreement, (c) the absence of a
material adverse change with respect to the other party and (d) regulatory
approval. There is no guarantee that these and other conditions will be
satisfied or waived or that the Merger will be completed. Noncompletion of the
Merger could have a material adverse effect on the stock trading price of
Catalytica or on our business or prospects.
Integrating two companies is a difficult task and the expected benefits of the
Merger may not occur
The Merger will not achieve its anticipated benefits unless Catalytica and
Wyckoff successfully combine their operations and integrate their products and
services in a timely manner. Integrating Catalytica and Wyckoff will be a
complex, time consuming and expensive process and may result in disruptions to
the operations of the business. Before the Merger, Catalytica and Wyckoff
operated independently, each with its own business, business culture, customers,
employees and systems. Following the Merger, the combined company must use
common information communication systems, operating procedures, financial
controls and human resource practices, including benefit, training and
professional development programs. There may be substantial difficulties, costs
and delays involved in integrating Catalytica and Wyckoff, including:
18
. distractions to management from the business of the combined company
. potential incompatibility of business cultures
. perceived and potential adverse change in customer service standards,
business focus or service offerings available to customers
. potential inability to successfully coordinate research and development,
sales and marketing efforts
. costs and delays in implementing common systems and procedures, including
financial accounting systems
. costs and inefficiencies in delivering services to the customers of the
combined company
. inability to retain and integrate key management, technical sales and
customer support personnel
Any one or all of the factors identified above may cause increased operating
costs, lower than anticipated financial performance or the loss of key customers
and employees. The failure to integrate Catalytica and Wyckoff could harm the
business of the combined company.
We depend on retaining and integrating key personnel after the Merger
Wyckoff's contribution to the combined company's success depends upon the
continued service of Wyckoff's key management and technical personnel. While
Catalytica has agreed to assume the employment agreement of James B.
Friederichsen, Wyckoff's President and Chief Operating Officer, this agreement
does not require that Mr. Friederichsen continue his employment with Wyckoff for
a specified period. No other Wyckoff executive officer has entered into an
employment agreement providing for continued employment with the combined
company after the Merger. In addition, the competition to retain and motivate
qualified technical, sales and operations personnel is intense. We have at
times experienced, and continue to experience, difficulty retaining qualified
personnel. We might not be able to retain Wyckoff's key personnel after the
Merger. The loss of services of any of the key members of Wyckoff's management
team could harm the business of the combined company.
If the Merger does not qualify as a pooling of interests, Catalytica's reported
earnings could be lower in future periods
Catalytica and Wyckoff expect the Merger to be accounted for as a pooling of
interest transaction.* To qualify the Merger as a pooling of interests for
accounting purposes, Wyckoff, Catalytica and their respective affiliates must
meet the criteria for pooling of interests accounting established in opinions
published by the Accounting Principles Board and interpreted by the Financial
Accounting Standards Board and the SEC. These opinions are complex and the
interpretation of them is subject to change.
The availability of pooling of interests accounting treatment for the Merger
depends, in part, upon circumstances and events occurring after completion of
the Merger. For example, the business of the combined company cannot change in
a significant manner, including significant sales of assets, for a period of two
years following completion of the Merger. Further, affiliates
19
of Catalytica and Wyckoff must not sell, or otherwise reduce their risk with
respect to, any shares of either Catalytica or Wyckoff capital stock during the
period beginning on July 14, 1999 and continuing until two trading days after
Catalytica publicly announces financial results covering at least 30 days of
combined operations of Catalytica and Wyckoff. If completion of the Merger
occurs in October 1999, Catalytica expects that such combined financial results
would be published in the fourth quarter of 1999.* If affiliates of Catalytica
or Wyckoff sell their shares of Catalytica common stock before that time, the
Merger may not qualify for accounting as a pooling of interests for financial
reporting purposes. The failure of the Merger to qualify for pooling of
interests accounting treatment for any reason could materially reduce the
combined companys' future reported earnings.
Risks Related to the Combined Company
Our quarterly operating results may fluctuate and we may be unable to maintain
profitability
Catalytica first achieved profitability in the quarter ended September 30,
1997. Catalytica's operating results have fluctuated significantly in the past
and we expect that the results of the combined company will continue to vary
from quarter to quarter.* In particular, our quarterly results may fluctuate as
a result of:
. loss or reductions of orders from an important customer, such as Glaxo
Wellcome
. delays in availability or increases in costs of raw materials from our
suppliers
. increased price competition or reductions in the prices that we are able to
charge
. the amount and timing of payments and expenses under development and
production contracts
. changes in demand for the pharmaceuticals sold by our customers
. new product introductions or delays in product introductions by our
customers or their competitors
. size and timing of receipt of orders for and shipments of pharmaceutical
products
. changes in product mix
. operating efficiencies in manufacturing operations
. seasonality in demand for our products
. general business conditions in our markets, particularly in the
pharmaceutical sector
As a result of these and other factors, quarter-to-quarter comparisons of our
historical results of operations are not good indicators of future performance.
If our future operating results are below the expectations of stock market
analysts, or if we are unable to remain profitable, our stock price may decline.
We depend on a single customer for a large portion of our revenues, and a
reduction in the level of business with this customer could seriously harm our
business
A single customer, Glaxo Wellcome, accounts for a large percentage of
Catalytica's revenues. In 1998, Glaxo Wellcome accounted for approximately 86%
of Catalytica's total revenues. In the six months ended June 30, 1999, Glaxo
Wellcome accounted for approximately 73% of
20
Catalytica's total revenues, of which 42% related to business under the original
supply agreement and 31% related to new business Catalytica has negotiated with
Glaxo Wellcome since its acquisition of the Greenville facility. Catalytica's
top five customers collectively accounted for approximately 92% of its revenues
for the six months ended June 30, 1999. Even though the portion of our revenues
attributable to Glaxo Wellcome is expected to decline over time, we anticipate
that sales to Glaxo Wellcome will continue to account for a significant portion
of our revenues for the foreseeable future.* Our business would be seriously
harmed if we lost Glaxo Wellcome as a customer or suffered a large reduction in
orders from Glaxo Wellcome.
Our product sales depend on our customers to anticipate industry needs and
accurately forecast future demand for their products
We manufacture both intermediate products used in customers' finished products
and finished products for our customers. Typically, there is a relatively
lengthy lead-time between signing a production contract and the actual
production of products under that contract. Accordingly, we rely upon the
ability of our customers to anticipate changing customer needs, successfully
market the products and obtain necessary regulatory approval. A decrease in
demand for our customers' products would lower demand for our products. We
cannot guarantee that our customers' product development efforts will be
successful, that required regulatory approvals can be obtained on a timely
basis, if at all, that products can be manufactured at acceptable cost and with
appropriate quality or that any products, if approved, can be successfully
marketed. If our customers are not successful in this regard, they might reduce
or eliminate their orders and our results of operations likely would
deteriorate.
We may be held responsible for product liability claims and may be unable to
obtain sufficient product liability insurance
As a pharmaceutical and pharmaceutical intermediate manufacturer, we could
experience product liability claims for products we manufacture if we do not
meet customer specifications. Our customers generally agree to indemnify us
with respect to potential liability claims, other than claims related to our
failure to meet customer specifications.*
We have product liability insurance but cannot guarantee that we will be able
to obtain sufficient levels of product liability insurance on acceptable terms
in the future.* If we are held responsible for product liability and do not have
adequate insurance or are not properly indemnified, then our results of
operations could be harmed. Also, under the original Glaxo Wellcome supply
agreement, Catalytica Pharmaceuticals is obligated to maintain $100.0 million of
product liability insurance. If Catalytica Pharmaceuticals does not meet this
requirement, Glaxo Wellcome may terminate the supply agreement, which would have
a negative impact on our financial results.
21
Our operations must comply with environmental regulations, and any failure to
comply could result in extensive costs which would harm our business
Our research, development and manufacturing activities involve the use,
storage, transportation and disposal of many hazardous chemicals and are subject
to regulations governing air pollution and wastewater treatment. As a result,
our activities are subject to extensive federal, state and local laws and
regulations, some of which have recently changed. For example, in 1998, the
United States Environmental Protection Agency, or EPA, issued new regulations
for the pharmaceutical industry requiring the installation of "maximum
achievable control technology" for hazardous air pollution sources and
additional pretreatment systems for wastewater discharges. We currently are
evaluating the potential impact of these regulations on our operations and we
believe that these new regulations may require us to make large cash
expenditures. These and any other new regulatory changes could result in
renovations, improvements or other cash expenditures to bring our facilities and
operations into compliance. A failure to comply with present or future
environmental laws could result in:
. imposition of injunctions or orders to stop production and operations
. payment of fines, costs of remediation or damages
. restrictions on expansion of operations
. other expenditures as required to comply with environmental requirements
If our operations do not comply with environmental regulations for any reason,
any of these events could occur and the occurrence could harm our financial
condition.
Soil and groundwater contamination exists at our facilities, and the
contamination may result in large expenditures of cash and other resources
As the owner of the Greenville facility, Catalytica Pharmaceuticals is legally
liable for the existing contamination at the site. However, Glaxo Wellcome, the
previous owner, has agreed to pay the costs of remediation to the extent
contamination existed at the time it sold the property to Catalytica. Despite
its agreement with Glaxo Wellcome, Catalytica could be held responsible for the
contamination in an action brought by a governmental agency or a third party.
Catalytica's current operations and future expansion of the Greenville facility
could be slowed or prevented by required remediation activities at the site.
Catalytica Pharmaceuticals' ongoing operations at the Greenville facility also
may cause additional contamination. The determination of the existence and cost
of any such additional contamination contributed by Catalytica Pharmaceuticals
could involve costly and time-consuming negotiations and litigation. Additional
contamination could harm Catalytica's business, results of operations and
financial condition.
Similarly, Catalytica's Bay View facility has arsenic and volatile organic
compound contamination in the soil and groundwater. The site is subject to a
clean-up and abatement order issued by the Bay Area Regional Water Quality
Control Board. The order requires stabilization, containment and monitoring of
the contamination at the site and surrounding areas by the current
22
owner of the property, Rhone Poulenc, Inc. Although Catalytica has contractual
rights of indemnity from Rhone Poulenc and from Novartis, the prior
owners/operators of the facilities, Catalytica could be named in an action
brought by a governmental agency or a third party because of the contamination.
If Catalytica is determined to have contributed to the contamination, Catalytica
may be liable for any damage to third parties attributable to its contamination,
and may be required to indemnify Rhone Poulenc and Novartis for any clean up
costs or liability that they may incur as a result. Any litigation or
determination of the existence and cost of this contamination would likely be
costly and time-consuming.
The Wyckoff manufacturing site is listed under Michigan law as a site with
soil and groundwater contamination. Environmental assessments conducted on the
Wyckoff property have identified soil contamination by volatile organic
compounds and heavy metals. Wyckoff is legally liable under federal and state
law for the remediation of these areas of contamination. In addition, risks of
substantial environmental costs and liabilities are inherent in plant operations
and products produced by Wyckoff. Wyckoff's ongoing operations could cause
additional contamination which could harm Wyckoff's business, results of
operations and financial condition.
Environmental regulations may delay the commercialization of Catalytica's
catalytic combustion systems or increase the costs of bringing products to
market
The enactment and enforcement of environmental regulations at the federal,
state and local levels will strongly influence the demand for emissions
reduction systems, and thus will affect the rate at which industrial companies
adopt Catalytica's catalytic combustion systems.* As a result, Catalytica's
revenues will depend, in part, on the environmental standards that government
authorities adopt for reducing emissions (including emissions of nitrogen oxide)
addressed by its products.* Government authorities may revise existing
regulations in a manner that could diminish demand for Catalytica's products.
Moreover, new regulations may impose requirements that are not be met by
Catalytica's products or may necessitate costly redevelopment or modification of
its products. Also, certain industries or companies may seek to delay the
implementation of existing or new regulations, or acquire emissions credits from
other sources, which would delay or eliminate their need to purchase emissions
reduction products. If any of these circumstances arise, Catalytica may not
realize the expected returns on its investment in the catalytic combustion
business.
Some of Catalytica's manufacturing facilities are underutilized, and this
underutilization may harm our operating results
Currently, Catalytica's pharmaceutical production and sterile production
facilities at its Greenville, North Carolina facility are not fully utilized. To
utilize its manufacturing resources fully, Catalytica must continue to
successfully obtain new pharmaceuticals customers, expand business with existing
customers and obtain necessary regulatory approvals for production of new
products. As a result of reductions in the level of business attributable to
Glaxo Wellcome and the long lead times required to obtain regulatory approvals
to manufacture at our pharmaceutical and sterile production facilities, if we
are to fully utilize our pharmaceutical and sterile production facilities,
23
we must continue to enter agreements for additional business far enough in
advance of production to obtain required regulatory approvals.* If we are unable
to do these things, our pharmaceutical and sterile production facilities will
remain underutilized, and this may harm our operating results.
Our success depends on the ability of our customers to develop new
pharmaceutical products and obtain required regulatory approvals for those
products
The success of our pharmaceutical production operations depends on receiving
orders from our customers for the production of active ingredients,
intermediates, and pharmaceutical products in finished dosage form.* The
clinical development, testing and sales of these products is subject to
regulation by the FDA and other regulatory authorities in the United States
and abroad. As a result, we depend on our customers to both develop new
pharmaceutical products and obtain the required regulatory approvals. If our
customers are unable to develop new products or obtain required approvals, our
pharmaceutical production facilities may be underutilized and our results of
operations may be harmed.
Compliance with current Good Manufacturing Practices regulations is costly and
time-consuming, and our failure to comply could lead to delays in filling
product orders and loss of sales revenues
Our pharmaceutical production facilities must comply with the FDA's current
Good Manufacturing Practices ("cGMP") regulations. Additionally, some of our
customers, including Glaxo Wellcome, require us to adhere to certain additional
manufacturing standards specific to their companies. Compliance with cGMP
regulations and company specific requirements requires us to expend time, money
and effort in production, and to maintain precise records and quality control.
The FDA periodically inspects drug-manufacturing facilities to ensure compliance
with applicable cGMP requirements. If we fail to comply with cGMP requirements,
the FDA could take various actions, including:
. suspension of manufacturing at the facility
. inspection of any lot of a particular product
. restrictions or delays on the release of the product
. orders to recall the lot or product
Any of these actions could cause delays in meeting customer orders, which
could result in loss of customers, product orders and sales revenues.
Ownership of Catalytica's stock is concentrated in one owner, and this owner may
prevent or delay a change of control of Catalytica or otherwise make decisions
contrary to the interests of other stockholders
As of June 30, 1999, Morgan Stanley Dean Witter Capital Partners and its
affiliates held approximately 32% of Catalytica's voting stock and 47% of our
total outstanding voting and non-voting stock Morgan Stanley Dean Witter can
convert a portion of its non-voting stock into voting stock only if the
conversion results in Morgan Stanley Dean Witter holding 40% or less of
Catalytica's outstanding voting stock. As a result of its stock ownership and
contractual rights,
24
Morgan Stanley Dean Witter has significant influence over all matters requiring
stockholder approval, including the election of directors and approval of major
corporate transactions such as mergers, consolidations or sales of assets.
Morgan Stanley Dean Witter also has the right to designate three nominees for
election to Catalytica's board of directors and rights to a separate class vote
on certain merger and financing transactions. This concentration of ownership
and these contractual rights may allow Morgan Stanley Dean Witter to require us
to take actions, or delay or prevent us from taking actions, such as entering
into a change of control, that would otherwise be in the stockholders' interest.
The sale by Morgan Stanley Dean Witter of shares of Catalytica's capital stock
could constitute a change of control under Catalytica's credit agreement, which
would trigger a default under the agreement. Although Morgan Stanley Dean
Witter has agreed not to trigger a change of control under the credit agreement,
the sale of shares by Morgan Stanley Dean Witter in breach of this provision
could cause Catalytica to default under its credit agreement. In that event,
Catalytica might not be able to obtain sufficient credit in a timely fashion or
on acceptable terms. In such event, its operations could be adversely affected,
causing product delays, loss of customers and deterioration of financial
results.
Many of our competitors have greater financial resources, research and
development experience and marketing ability
The market in which we compete is characterized by extensive research efforts
and rapid technological progress.* We have numerous competitors in the United
States, Europe and Asia, many of whom have greater research and development
capabilities, financial resources, managerial resources, marketing experience
and manufacturing experience. Our primary competition comes from pharmaceutical
companies that manufacture their own products and from other chemical
manufacturers such as Chirex Inc, DSM Fine Chemicals and Lonza AG. If our
competitors are successful in developing systems and processes that are more
effective than our own, then our ability to sell our products, services, systems
and processes would be harmed. Our competitors may develop technologies,
systems and processes that are more effective than ours or that would render our
technology, systems and processes less competitive or obsolete. In addition,
our success depends in part on our ability to sell products to potential
customers at an early stage of product development, and there can be no
assurance that we will be successful in these efforts.
After the merger with Wyckoff, a small portion of the Company's business will
experience substantial competition in connection with the manufacture and sale
of pharmaceutical products for which patent protection has expired ("off-patent"
products). Wyckoff competes with off-patent drug manufacturers, brand-name
pharmaceutical companies that manufacture off-patent drugs and manufacturers of
new drugs that may compete with its off-patent drugs. Because selling prices of
off-patent drugs typically decline as competition intensifies, the maintenance
of profitable operations will depend on Wyckoff's ability to maintain efficient
production capabilities and to develop and introduce new products in a timely
manner.*
In the combustion systems market, Catalytica's competition comes from large
gas turbine power generation manufacturers, such as Allison Engine Company,
General Electric and Solar
25
Turbines as well as producers of post-combustion emission clean-up technologies
such as selective catalytic reduction systems. Gas turbine manufacturers are
developing competing dry-low-nitrogen oxide systems for their own turbines. Many
of Catalytica's competitors in the combustion systems market are also
Catalytica's potential customers.* Catalytica depends on its customers to help
commercialize its products, and would suffer loss of sales and revenues in the
if these customers withdraw their support or decide to pursue alternate
technologies. Catalytica's ability to gain market share may be limited because
many of its competitors are existing or potential customers.
If we are unable to protect and expand our intellectual property rights, our
competitive position will suffer
Our business depends on developing and maintaining a strong intellectual
property portfolio in the United States and abroad. We actively pursue patents
for our inventions in relevant business areas.* Catalytica has 37 patents and at
least 20 pending patent applications in the United States and approximately 145
patents and patent applications abroad. Wyckoff has three patents and one
pending patent application in the United States. Our patent applications might
not result in the issuance of patents. Further, our existing and future patents
might not provide enough protection to protect our technology and competitive
position.
The success of our current products, as well as development of additional
products, depends on our ability to protect our intellectual property portfolio
and obtain additional patents without infringing the proprietary rights of
others.* If we do not effectively protect our intellectual property, our
business could be materially harmed.
Even if we are able to obtain patents covering our technology, the patents may
be challenged, circumvented or invalidated. Competitors may develop
independently similar systems or processes or design around patents issued to
us. Also, patents issued in the United States may be unenforceable, or may not
provide as much protection, outside the United States. If any of our patents
are circumvented, invalidated or otherwise do not provide legal protection, our
competitors may be able to develop, manufacture and sell products which compete
directly with our products. In that case, our sales and financial results could
be harmed.
We also protect our proprietary technology and processes in part by
confidentiality agreements with our collaborative partners, employees and
consultants.* However, these agreements might be breached, and in that event, we
might not have adequate remedies for the breach. Further, our trade secrets
might otherwise become known or be independently discovered by competitors.
A third party claim of infringement of intellectual property could require us to
spend time and money to address the claim and could shut down some of our
operations
We could incur substantial costs in defending ourselves or our licensees in
litigation brought by others or in interference proceedings declared by the
United States Patent and Trademark Office. An adverse ruling, including an
adverse decision as to the priority of our inventions,
26
would undercut our intellectual property position and could ultimately have a
negative impact on our sales and financial position.
We may be required to obtain licenses to patents or other proprietary rights
held by third parties. However, these licenses might not be available on
acceptable terms, if at all. In that event, we could encounter delays in system
or process introductions while we attempt to design around the patents, or we
may be unable to continue product development in the particular field. In
either case, our competitive position would likely suffer, and our stock price
could decline as a result.
Catalytica Combustion Systems' products are in early stages of development and
its ability to develop an effective and commercially successful product depends
on the cooperative efforts of its strategic partners
Catalytica Combustion Systems' product XONON, is in the development stage and
must be thoroughly tested in gas turbines and integrated by original equipment
manufacturers into their gas turbine products before commercialization.*
Whether the XONON system will ultimately be commercially successful, and whether
Catalytica Combustion Systems will ultimately be profitable, will depend on a
number of factors, including:
. its ability to overcome technical hurdles associated with the incorporation
of XONON into particular gas turbines to provide an effective emissions
reduction system
. willingness of gas turbine manufacturers to incorporate the XONON system in
their products
. prices and effectiveness of alternative emissions reduction systems
. economic conditions in the utilities and power generation sector
. changes in regulatory requirements, particularly emissions standards
governing gas turbines and power generation
In particular, Catalytica Combustion Systems' ability to complete research and
development and introduce XONON systems in the large gas turbine market depends
on the continued efforts of General Electric, the world leader in the
manufacture of large gas turbines.* Catalytica also must develop and maintain
relationships with other gas turbine suppliers to commercially introduce XONON
systems in other gas turbine markets.* If any major turbine manufacturers
terminate their relationship with Catalytica Combustion Systems, then Catalytica
may not be able to complete the development and introduction of the XONON system
for that part of the market.
Catalytica Combustion Systems has limited manufacturing and marketing experience
and will need to develop these capabilities or find strategic partners to make
and sell its products
Catalytica currently has limited manufacturing capability for its XONON
products. Catalytica expects to expand its manufacturing capability, which will
require capital expenditures.* Further, to market any of our combustion system
products, we must develop marketing capability, either on our own or in
conjunction with others. Catalytica may not be able to develop an effective
marketing and sales organization or enter into marketing arrangements on
acceptable terms.
27
The GENXON joint venture may require additional funding and may not result in
successful products
Catalytica Combustion Systems' joint venture, GENXON, is not currently
profitable and may not become profitable in the future. GENXON might not
succeed in developing new combustion systems that will work effectively and
economically. Neither joint venture partner is contractually required to make
further capital infusions. If Catalytica's partner were to decide not to make
additional capital contributions, Catalytica would be faced with the possibility
of having to fund the joint venture on its own or find additional sources of
financing. In this event, additional financing might not be available on
acceptable terms, or at all. As a result, Catalytica's results of operations
and financial condition could be adversely affected.
Failure to develop new manufacturing processes will negatively impact Wyckoff's
revenues and profitability
Wyckoff's results of operations depend, to a significant extent, on its
ability to successfully develop new manufacturing processes for off-patent
products and for new products being developed by branded pharmaceutical
companies. After a product loses patent protection, its price tends to decrease
over time, which results in pressures on the prices which can be charged by
manufacturers of chemical intermediates and bulk actives. If Wyckoff is unable
to develop manufacturing processes soon after products are off-patent, or if
other manufacturers develop alternative manufacturing processes, Wyckoff would
be required to compete with multiple manufacturers and would experience
additional pricing pressures in its sale of products to the generic market. With
respect to the branded pharmaceutical companies, Wyckoff's ability to develop
new manufacturing processes is a competitive advantage which is important in
being awarded manufacturing business.* Failure to develop new manufacturing
processes in either of these markets may harm Wyckoff's gross margins and
financial results.
In October 1996, GENXON entered into a technical services agreement with the
City of Glendale in California for the retrofit of one of the City's gas
turbines with the XONON system for a total turnkey price of $700,000. GENXON did
not complete the agree upon retrofit and returned the engine to the City in its
original state. The parties are currently discussing alternatives to resolve
contractual issues related to the project, which resolution is not anticipated
to have a material adverse financial impact on Catalytica.*
Interruption of supply of key raw materials could cause delays in meeting
product orders, loss of customers and increased costs of production
We purchase raw materials, primarily chemicals, from suppliers throughout the
world. These chemicals range from basic commodities to more sophisticated
advanced intermediates. In many instances we use only one supplier to get a
volume discount and to ensure the chemicals meet our stringent quality
standards. If the supply of a key raw material is interrupted for any reason,
this could have an adverse impact on our ability to manufacture a particular
active pharmaceutical ingredient or advanced intermediate for our customers. In
most situations, there are alternate suppliers throughout the world of any
chemical that we require. If there was a significant delay in identifying and
qualifying a new supplier or if there are no alternate suppliers, there could be
a loss of sales and of customers, and ultimately an increase in the cost of
production. Any of these events could have a material adverse effect on our
results of operations.
28
We do not have a long-term supply agreement with most of our suppliers. We
purchase the chemicals on a purchase order basis and forecast our needs based on
our customers' requirements. There can be no assurance that such suppliers will
continue to make available to us the required raw materials on reasonable terms,
if at all. The availability and price of raw materials may be subject to
curtailment or change due to limitations that may be imposed under new
legislation or governmental regulations, suppliers' allocations to meet demand
of other purchasers, interruptions in production by suppliers and other
conditions. In addition, raw materials used by us may be subject to significant
price fluctuations.* A substantial increase in prices or a continued
interruption in supply would have a material adverse effect on our business and
results of operations.
If we, our suppliers or our customers do not successfully address the Year 2000
issue, we could experience a significant disruption of our financial management
and control systems or a lengthy interruption in our manufacturing operations
We use a significant number of computer software programs and operating
systems in our internal operations, including applications used in our
financial, product development, order management and manufacturing systems. The
inability of computer software programs to accurately recognize, interpret and
process date codes designating the year 2000 and beyond could cause systems to
yield inaccurate results or encounter operating problems resulting in the
interruption of the business operations which they control. This could
adversely affect our ability to process orders, forecast production requirements
or issue invoices. A significant failure of the computer integrated
manufacturing systems, which monitor and control factory equipment, would
disrupt manufacturing operations and cause a delay in completion and shipping of
products. Moreover, if our critical suppliers' or customers' systems or
products fail because of a Year 2000 malfunction, it could impact our operating
results.
Based on currently available information, our management does not believe that
the Year 2000 issues related to our internal systems will have a material impact
on our financial condition or overall trends in results of operations.*
However, we are uncertain to what extent we may be affected by these matters. A
significant disruption of our financial management and control systems or a
lengthy interruption in our manufacturing operations caused by a Year 2000
related issue could result in a material adverse impact on our operating results
and financial condition. In addition, it is possible that a supplier's failure
to ensure Year 2000 capability would have a negative effect on our results of
operations.
Catalytica's charter and bylaws have provisions that may deter or delay a change
of control of Catalytica
Catalytica's certificate of incorporation and bylaws contain certain
provisions that could make the acquisition of Catalytica more difficult. These
provisions include:
. advance notice procedures for stockholders to nominate candidates for
election as directors of Catalytica
. special voting requirements for removal of directors
29
. authorization of preferred stock of Catalytica, the powers, preferences and
rights of which may be fixed by its board of directors without stockholder
approval
In addition, Catalytica is subject to Section 203 of the Delaware General
Corporation Law, which limits transactions between a publicly-held company and
"interested stockholders." Interested stockholders generally are those
stockholders who, together with their affiliates and associates, own 10% or more
of a company's outstanding capital stock. This provision of Delaware law may
delay or deter potential acquisitions of Catalytica which may otherwise be in
the stockholders' interest.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the second quarter of 1998, following the restructuring of the Chase credit
agreement, Catalytica entered into a $50.0 million interest rate swap,
derivative transaction to reduce Catalytica's exposure to fluctuations in short-
term interest rates. This interest rate swap transaction effectively fixed the
LIBOR benchmark rate used to calculate Catalytica's borrowing cost at 5.9% for
four years on $50.0 million of the debt facilities. Catalytica accounts for this
interest rate swap as a hedge, and accrues the interest rate differential as
interest expense on a monthly basis. In accordance with the accrual method of
accounting, Catalytica does not recognize the changes in the derivative's fair
value in the financial statements. If the designated debt obligation is
extinguished early, 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). Catalytica does not
hold or transact in such financial instruments for purposes other than risk
management.
The notional principal amount for the off-balance-sheet instrument provides
one measure of the transaction volume outstanding as of year end, and does not
represent the amount of Catalytica's exposure to credit or market loss.
Catalytica believes its gross exposure to potential accounting loss on this
transaction if all counterparties failed to perform according to the terms of
the contract, based on then-current interest rates at each date, would have no
material financial impact. Catalytica's exposure to credit loss and market risk
will vary over time as a function of interest rates.
The estimate of fair market value of the Company's interest rate swap at
December 31, 1998 is $1.3 million based on a price quote obtained from a third
party. 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,
Catalytica either makes or receives payments on the interest rate differential
between 5.9% and the actual interest paid on its debt which has a floating
interest rate based on the three-month United States dollar LIBOR
30
rate. As a result, the swap effectively converts $50.0 million of Catalytica's
floating-rate debt to a four-year fixed-rate debt. The maturity date for the
swap is June 10, 2002. For the year ended December 31, 1998, the receive rate on
the swap hedging debt was 5.59%. The pay rate on the swap is 5.9%. The gain or
loss on the swap is recognized in net interest expense in the same period as the
hedged transaction. The actual incurred loss totaled approximately $87,000 as of
December 31, 1998.
The Company's market risk disclosures set forth above has not changed
significantly through the six months quarter ended June 30, 1999.
31
PART II - OTHER INFORMATION
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On June 24, 1999, at the annual stockholder's meeting, a quorum of
stockholders of the Company approved the following proposals: (1) the re-
election of the Board of Directors; (2) amendment to the Company's 1992
Employee Stock Purchase Plan to increase the number of shares of Common Stock
reserved for issuance thereunder by 1,500,000 shares; (3) amendment to the
Company's 1992 Stock Option Plan to increase the number of shares of Common
Stock reserved for issuance thereunder by 2,000,000 shares; and (4)
ratification of the appointment of Ernst & Young LLP to serve as the Company's
independent auditors for the ensuing year.
Proposal 1. Election of Directors
Director For Abstain
-------- --- -------
James A. Cusumano 38,700,824 102,236
Richard Fleming 38,690,579 112,481
Alan Goldberg 36,932,245 1,870,815
Howard I. Hoffen 38,689,727 113,333
Ricardo B. Levy 38,700,824 102,236
Ernest Mario 38,701,824 101,236
John A. Urquhart 38,693,293 109,767
Proposal 2. Ratification of Appointment of Independent Auditors
Broker
------
For Against Abstain Non-Vote
---- ------- ------- --------
38,724,055 33,113 45,892 0
Item 5. OTHER INFORMATION
Pursuant to the Company's Bylaws, stockholders who wish to bring matters or
propose nominees for directors at the Company's 2000 annual meeting of
stockholders must provide specified information in writing to the secretary of
the Company not less than the ninety (90) days nor more than one hundred twenty
(120) days prior to the first anniversary of the 1999 annual meeting (i.e., June
24, 2000), unless such matters are included in the Company's proxy statement
pursuant to Rule 14a-8 under the Securities Exchange Act, as amended.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule
99.1 Press release regarding definitive agreement to acquire Wyckoff
Chemical Inc. issued by Catalytica on July 15, 1999
32
(b) Reports on Form 8-K
The Company filed no reports on Form 8-K during the quarter ended June 30,
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.
33
CATALYTICA, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: August 13, 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
34