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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the fiscal year ended December 31, 1996
or
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period
from ____________ to ____________.
Commission File No. 0-20966
CATALYTICA, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 94-2262240
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
430 FERGUSON DRIVE
MOUNTAIN VIEW, CALIFORNIA 94043
(Address of principal executive offices)
(415) 960-3000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
Common Stock, $.001 par value NASDAQ
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
[X] Yes [_] No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
As of February 28, 1997, there were outstanding 19,880,549 shares of
the registrant's common stock, par value $.001, which is the only class of
common or voting stock of the registrant. As of that date, the aggregate market
value of the shares of common stock held by nonaffiliates of the registrant
(based on the closing price for the common stock on NASDAQ on February 28, 1997)
was $156,398,000. For purposes of this disclosure, shares of Common Stock held
by each officer and director of the Registrant and by each person who owns 5% or
more of the outstanding voting stock have been excluded in that such persons may
be deemed to be affiliates. This determination of affiliate status is not
necessarily a conclusive determination for other purposes.
DOCUMENTS INCORPORATED BY REFERENCE
The information called for by Part III is incorporated by reference to
the definitive Proxy Statement for the Annual Meeting of Stockholders of the
Company which will be filed with the Securities and Exchange Commission no
later than 120 days after December 31, 1996.
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CATALYTICA, INC.
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
DECEMBER 31, 1996
PAGE NO.
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PART I
Item 1. Business 2
Item 2. Properties 20
Item 3. Legal Proceedings 20
Item 4. Submission of Matters to a Vote of Security Holders 21
PART II
Item 5. Market for the Registrant's Common Stock and
Related Stockholder Matters 22
Item 6. Selected Financial Data 23
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 23
Item 8. Financial Statements and Supplementary Data 40
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 40
PART III
Item 10. Directors and Executive Officers of the Registrant 41
Item 11. Executive Compensation 41
Item 12. Security Ownership of Certain Beneficial Owners
and Management 41
Item 13. Certain Relationships and Related Transactions 41
PART IV
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K 42
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This report contains certain forward-looking statements which involve risks
and uncertainties including statements regarding the Company's strategy,
financial performance, and revenue sources. The Company's actual results could
differ materially from the results anticipated in these forward-looking
statements as a result of certain factors set forth under "Item 7, Management's
Discussion and Analysis of Financial Condition and Results of Operations - Risk
Factors" and elsewhere in this report.
PART I
ITEM 1. BUSINESS
OVERVIEW
Catalytica, Inc. ("Catalytica" or the "Company" and its subsidiaries) is
developing and offering to its customers advanced products that use the
Company's proprietary catalytic technologies to yield economic and environmental
benefits by lowering manufacturing costs and reducing hazardous byproducts.
Catalytica currently is focused on applying its technologies to two primary
areas: (i) improving production of pharmaceutical intermediates and bulk actives
and (ii) developing advanced combustion systems to reduce toxic emissions
generated by natural gas turbines. To pursue these opportunities, the Company
has created two operating subsidiaries, Catalytica Fine Chemicals, Inc. ("Fine
Chemicals") and Catalytica Combustion Systems, Inc. ("Combustion Systems"). In
addition to market focus, the formation of subsidiaries provides increased
flexibility for strategic financial arrangement and business partnerships.
A catalyst is a substance that initiates, accelerates and determines the
products of a chemical reaction. In a catalytic process, compounds are changed
or combined at the molecular level to create a desired product. Highly selective
catalysts can improve industrial process economics by making possible more
efficient use of raw materials, reducing energy requirements, increasing product
yields and eliminating or minimizing the formation or use of environmental
pollutants. As a result, catalyst design and performance can have a significant
impact on operating and capital costs across a variety of industries.
Fine Chemicals develops and uses its technology base to develop
proprietary manufacturing processes which it uses for the more cost-effective
and environmentally benign production of pharmaceutical intermediates. Fine
Chemicals manufactures products for several leading pharmaceutical companies,
including Pfizer, Inc. ("Pfizer") and Merck & Co. ("Merck"). Fine Chemicals also
is producing an intermediate for Novartis (formerly Sandoz) under a supply
agreement entered into at the time the Company purchased its manufacturing plant
from Novartis in 1993. Fine Chemicals is capitalizing on market opportunities
created by major changes that are occurring in the pharmaceutical industry, that
are causing pharmaceutical companies to outsource certain manufacturing
activities. These changes include increased pricing pressures on pharmaceutical
companies, the need to shorten drug development cycles and more stringent
environmental and FDA regulations.
The Company is currently negotiating with Glaxo Wellcome to purchase its
Greenville, North Carolina production facilities as part of Catalytica Fine
Chemicals' production expansion plans. See "Proposed Transaction with Glaxo
Wellcome", page 5.
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Combustion Systems is developing its XONON Flameless Combustion system
("XONON System") to reduce or eliminate certain toxic emissions produced by
natural gas turbines, including NOx, carbon monoxide and unburned hydrocarbons.
Combustion Systems' proprietary products are being developed for use by
utilities and other manufacturers and users of power generation systems.
Combustion Systems is currently working with leading turbine manufacturers,
including: General Electric in large turbines; Allison, a subsidiary of Rolls
Royce, and Solar, a subsidiary of Caterpillar, Inc., in medium size turbines;
and, through GENXON Power Systems, LLC, the Company's new joint venture company,
AGC, in small Kawasaki turbines for cogeneration applications.
CATALYTICA FINE CHEMICALS
INDUSTRY BACKGROUND
Chemicals are often grouped into three major categories - commodity
chemicals, specialty chemicals and fine chemicals. "Commodity chemicals" such as
methanol, ethylene, and ammonia, are low value-added products manufactured
according to specification in large volumes using well-established manufacturing
processes, and are sold to a wide range of customers. "Specialty chemicals,"
such as polymer additives, water treatment chemicals and lubricant additives,
are produced in smaller volumes and must satisfy well-defined performance
requirements. "Fine chemicals" are high value-added products often used as
intermediates in the production of a broad range of products, including
pharmaceuticals, agrochemicals, aroma chemicals, and food and feed additives.
Fine chemicals are usually produced to specification in lower volumes using
complex manufacturing processes and must satisfy well-defined chemical
specifications, which generally results in a closer relationship between the
fine chemical producer and the customer. Fine chemicals typically are sold for
higher prices than other chemicals. Rapid response to potential customers,
reliability of product supply and quality are important competitive factors.
Fine chemicals are an essential and costly component in the production
of pharmaceuticals. Based on industry sources, the Company believes the
pharmaceuticals sector of the fine chemicals market represents a $9 billion
market in the United States in 1996. The pharmaceutical industry currently is
facing significant competitive, manufacturing and regulatory challenges that are
resulting in the increasing outsourcing of certain activities, including the
manufacture of pharmaceutical intermediates and bulk actives. The challenges
facing the pharmaceutical industry include:
Increased Competitive Pressures. Increased penetration by
managed care companies and a continued focus on the cost of publicly
sponsored healthcare programs, such as Medicare and Medicaid, have
resulted in increasing pressure for lower priced drugs. This pricing
pressure, coupled with an increase in the acceptance of lower-priced
generic drugs, is putting pressure on pharmaceutical companies to reduce
their manufacturing costs in order to maintain margins. Over the next
few years a large number of branded drugs will lose patent exclusivity,
creating added competition from multiple generic alternatives.
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Efficient Use of Resources. Many pharmaceutical companies are
reevaluating their business models with a focus on drug discovery and
development, and sales and marketing. As a result, pharmaceutical
companies are increasingly outsourcing many of the activities that
traditionally were performed in-house, including the production of fine
chemicals used to produce pharmaceuticals.
Requirement to Meet More Stringent Environmental and FDA
Regulation. Increased environmental burdens are being imposed upon the
pharmaceutical industry which produces significant toxic waste as a
byproduct of the currently complex manufacturing processes. As a result,
manufacturing costs have increased due to higher waste-handling and
processing costs. Improvements in manufacturing processes are also
required as a result of FDA regulations that have increased demand for
higher levels of drug purity.
Need to Shorten Drug Development Cycles. To shorten the time
required to market a new drug, pharmaceutical companies are seeking to
outsource certain supply responsibilities to third parties that are able
to develop cost effective product manufacturing protocols as early as
possible in the drug development cycle. These suppliers must be capable
of providing the full spectrum of needs from small research quantities
to clinical trial samples and large commercial volumes.
STRATEGY
Fine Chemicals' strategy is to leverage its intellectual property base
and experience in commercial catalytic technology development to manufacture
pharmaceutical intermediates and bulk actives, and to become a "one-stop"
supplier to the pharmaceutical industry. Fine Chemicals initially targeted
intermediates because it believed its technology could be used to quickly
achieve improvements that reduce costs by streamlining manufacturing processes.
The Company planned to move to the manufacture of bulk actives and final dosage
products. The implementation of Fine Chemical's strategy will be accelerated if
Catalytica completes its proposed transaction with Glaxo Wellcome Inc., since it
will immediately commence manufacturing bulk actives for Glaxo Wellcome. See
"Item 1, Business - Proposed Transaction with Glaxo," "Item 2, Properties" and
"Item 7, Management's Discussion and Analysis of Financial Condition and Results
of Operations."
A key component of Fine Chemicals' strategy is to become involved with
its customers early in the design of the drug manufacturing process. Fine
Chemicals believes that its technology and expertise enables it to develop
efficient manufacturing processes at the research and clinical samples stage and
successfully scale-up such processes for the manufacture of commercial volumes.
These broad capabilities, coupled with its research, pilot and manufacturing
facilities, should enable it to develop close relationships with its customers
by becoming an integral part of their drug development process and a key
preferred supplier of the customer's commercial fine chemical requirements.
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TECHNOLOGY AND EXPERTISE
Fine Chemicals has an extensive intellectual property base and expertise
in catalytic science and engineering. Catalysis is an effective means to
streamline complex manufacturing processes and to reduce or eliminate toxic
materials and waste. The Company's staff draws on its experience of many years
of catalytic process development in the petroleum and petrochemical industry,
where high yields and efficient manufacturing represent important competitive
factors. As of December 31, 1996, Catalytica's technical staff included 37
chemists and 26 chemical engineers, of whom 29 hold Ph.D.'s. These scientists
have a broad background in the discovery, development and scale-up of novel
catalysts and catalytic processes that are relevant to developing efficient
manufacturing processes of pharmaceutical intermediates and bulk actives.
MANUFACTURING
Fine Chemicals owns and operates a flexible, multi-purpose, commercial
scale manufacturing plant in East Palo Alto, California, which has approximately
10,000 gallons of reactor capacity set up in a wide range of reactor sizes. A
new, 2,000 gallon reactor scheduled to go on-line in the second quarter of 1997
will increase the plant's total reactor capacity to 12,000 gallons. The facility
includes a pilot plant used for scaling up manufacturing processes and a solids
handling facility that operates under current Good Manufacturing Practices
("cGMP").
The facility is located on approximately five acres of land leased under
a long term lease which provides space for expansion if required. Fine Chemicals
believes that its current plant capacity will be sufficient to meet its
requirements through 1997. Fine Chemicals intends to increase its current
manufacturing capacity by acquiring additional manufacturing plants. See "Item
1, Business-Proposed Transaction with Glaxo," "Item 2, Properties" and "Item 7,
Management's Discussion and Analysis of Financial Condition and Results of
Operations."
The manufacturing facility was acquired from Novartis in December 1993
to provide Fine Chemicals with manufacturing capacity. As part of the
acquisition, Novartis entered into a five-year contract which expires in 1998
for the manufacture of a fine chemical intermediate. Under the terms of the
agreement, Novartis transferred certain equipment and technology relating to the
manufacture of a particular intermediate, and agreed to purchase all of its
requirements of the intermediate from Fine Chemicals subject to certain volume
limitations. The agreement may be terminated by either party upon 30 days prior
written notice for failure to perform a material provision of the agreement, if
such failure is not cured within 60 days after receipt of the notice.
PROPOSED TRANSACTION WITH GLAXO WELLCOME
The Company and Glaxo Wellcome Inc. ("Glaxo") signed a non-binding
letter of intent effective February 5, 1997 to enter into a series of
transactions pursuant to which the Company would acquire (the "Acquisition")
Glaxo's pharmaceutical production facility in Greenville, North Carolina (the
"Facility") as part of its expansion plans for Fine Chemicals.
The proposed agreement calls for the Company to purchase all of the
buildings and equipment at the 1.8 million-square-foot Facility, as well as the
approximately 600 acres of land on which it is
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situated. Under the agreement, the Company will enter into long term
manufacturing contracts to supply designated Glaxo Wellcome prescription
products with a potential revenue to the Company estimated at $800 million over
five years.
Under the terms of the proposed Acquisition, the Company will pay Glaxo
an undisclosed amount. The Acquisition is expected to be financed by a
combination of an equity investment in Catalytica by Morgan Stanley Capital
Partners and debt from a major global financial institution. In addition, Glaxo
will receive a small equity stake in Fine Chemicals. The agreement also provides
for Glaxo to receive a share of the profits from Catalytica's production of
products in the Greenville site's sterile products facility. Terms of the equity
financing are expected to be structured to reflect the valuation of the
Company's businesses prior to the announcement of the Acquisition. Terms of the
debt financing are expected to be structured to reflect cash flows generated by
supply contracts with Glaxo Wellcome and other parties.
No definitive agreements have been signed by the Company and Glaxo
relating to the proposed Acquisition. As a result, there can be no assurance,
and stockholders should not assume, that the proposed transactions will be
completed. The completion of the Acquisition is subject to a number of risks and
uncertainties, including the following: (i) completion of the negotiation of
definitive documents, including an asset purchase agreement and long term supply
contracts for chemical, final dosage and sterile products; (ii) completion of
the due diligence review by the Company and its equity and debt financing
sources; (iii) completion of the negotiation of the terms of the substantial
equity and debt financings required to consummate the Acquisition; and (iv)
receipt of certain regulatory approvals and consents, including stockholder
approval.
In addition, the proposed Acquisition, which is not expected to close
prior to the latter portion of the second quarter of 1997, will require
significant management time and legal, accounting and other expenditures,
whether or not the transactions are completed. In the event the Acquisition is
consummated, the additional facilities, employees and business volumes will
substantially increase the Company's expenses and working capital requirements
and place substantial burdens on the Company's management resources.
Furthermore, the success of the Acquisition depends, in part, on the levels of
additional manufacturing business developed by the Company, and the related
terms, including price. In the event the Company does not develop new business
sufficient to offset the costs and expenses associated with operating and
maintaining the new facilities, and with servicing the debt associated with the
acquisition of such facilities, the Company's results of operations would be
materially adversely affected. See "Item 2, Properties" and "Item 7,
Management's Discussion and Analysis of Financial Condition and Results of
Operations."
COMPETITION
Fine Chemicals believes that the key competitive factors in the fine
chemicals manufacturing industry include reliability of supply, product quality,
ability to comply with environmental and FDA regulations, capacity, price, and
the technical and manufacturing ability to produce a full range of quantities
from small batches for clinical samples to large commercial quantities. Fine
Chemicals believes it competes favorably with respect to these factors. Fine
Chemicals' primary competition is from pharmaceutical companies that produce
their own fine chemicals and to a lesser extent from
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other independent fine chemicals manufacturers such as Lonza AG and DSM Andeno
B.Z. Most of Fine Chemicals' competitors have substantially greater financial
resources than the Company.
FINE CHEMICALS' MANAGEMENT AND DIRECTORS
As part of the Company's strategy to create focused business units, Fine
Chemicals has assembled a management group that includes dedicated senior
executives and independent directors who provide relevant industry expertise.
The directors and management of Fine Chemicals include:
NAME POSITION WITH FINE CHEMICALS
- ---- ----------------------------
Barry M. Bloom........................ Director
Richard Fleming....................... Director
Thomas L. Gutshall.................... Director
Ricardo B. Levy....................... Director
Ernest Mario.......................... Director
James A. Cusumano..................... President and Director
Gary Hollingsworth.................... Senior Vice President, Business
Development
John H. Grate......................... Vice President, Research and
Development
Suresh Mahajan........................ Vice President, Process Engineering
Lawrence W. Briscoe................... Chief Financial Officer and Director
BARRY M. BLOOM has been a director of Fine Chemicals since February
1995. He retired in September 1993 from Pfizer Inc. where he was most recently
Executive Vice President, Research and Development since 1992, and a member of
the Board of Directors since 1971. Dr. Bloom was with Pfizer Inc. since 1952,
where he served in executive level positions since 1971. He is a member of
several corporate Board of Directors, including Cubist Pharmaceuticals, Inc.,
Neurogen Corp., Incyte Pharmaceuticals, Inc. and Vertex Pharmaceuticals, Inc.
Dr. Bloom was a member of the United States Congressional Commission on the
Federal Drug Approval Process and the Pharmaceutical Manufacturers Association
Commission on Drugs for Rare Diseases. He has a Ph.D. in organic chemistry from
the Massachusetts Institute of Technology.
RICHARD FLEMING has been a director of Fine Chemicals since 1995. Mr.
Fleming has been a director of Catalytica since 1985 and also serves as an
advisor and consultant to Catalytica. Mr. Fleming was President and Chief
Executive Officer of the Company from 1985 through August 1991. From 1969 to
1980, Mr. Fleming served at Air Products and Chemicals, most recently as
Executive Vice President, and from 1980 to 1981, he served as President and
Chief Operating Officer of GAF Corporation, a chemical company. He has served as
President and Chief Executive Officer of Richard Fleming Associates, Inc., a
consulting firm, since May 1981 and is Vice Chairman for Membership and Fiscal
Affairs of the Chemical Industry Institute of Toxicology. Mr. Fleming has an
M.S. in chemical engineering from New York University.
THOMAS L. GUTSHALL has been a director of Fine Chemicals since February
1995. He has been Chief Executive Officer and Chairman of Cephaid since August
16, 1996. Mr. Gutshall was President and Chief Operating Officer of CV
Therapeutics, Inc. from January 1995 to August 1996, and has 35 years of
experience in specialty chemicals, pharmaceuticals, and diagnostics. Mr.
Gutshall served in executive level positions with Syntex Corp. from 1981 to
1994, most recently as Executive Vice
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President since June 1989. He previously served with Mallinckrodt Inc., lastly
as Vice President and General Manager, Drug and Cosmetic Chemicals Division. Mr.
Gutshall has a B.S. in chemical engineering from the University of Delaware and
is an alumnus of the Harvard Executive Marketing Program.
ERNEST MARIO has been a director of Catalytica, Inc. since July, 1996.
Dr. Mario has been Co-Chairman and Chief Executive Officer of ALZA since August
1993. Prior to joining ALZA, Dr. Mario was Deputy Chairman and Chief Executive
Officer of Glaxo Holding p.l.c., having served in a variety of executive
positions with Glaxo, Inc., beginning in 1986. From 1977 to 1984, he held
various executive level positions with Squibb Corporation, ending as President
and Chief Executive Officer of Squibb Medical Products. Dr. Mario is a member of
the Board of Directors of several companies, including Advanced Technology Labs,
COR Therapeutics, and Pharmaceutical Product Development Co. Dr. Mario has a
Ph.D. and M.S. in physical sciences from the University of Rhode Island, and a
B.S. in pharmacy from Rutgers University. He is a licensed pharmacist in the
states of New York and Rhode Island, and an adjunct professor of pharmacy at
the University of Rhode Island.
JOHN H. GRATE joined Catalytica in 1981 and currently serves as the Vice
President of Research and Development for Catalytica Fine Chemicals. Prior to
helping found Catalytica's fine chemicals business, Dr. Grate led numerous
research and development projects, inventing and developing homogeneous
catalytic processes for the production of commercially valuable organic
chemicals. Dr. Grate holds a B.S. in chemistry from Miami University, Oxford,
Ohio and a Ph.D. from the University of California, San Diego. Dr. Grate is a
registered Patent Agent.
SURESH MAHAJAN joined Catalytica in 1986 and currently serves as the
Vice President of Process Engineering for Fine Chemicals. Dr. Mahajan previously
worked at Ethyl Corporation, Occidental Research Corporation and Novartis, where
he served as a senior chemical engineer and project leader developing commercial
processes for pharmaceuticals, agrochemicals, and chemicals. Dr. Mahajan
received a B.S. from the University of Delhi, an M.S. from Oklahoma State
University, and a Ph.D. in chemical engineering from Purdue University.
GARY D. HOLLINGSWORTH joined Catalytica in 1989 and currently serves as
Senior Vice President of Business Development for Catalytica Fine Chemicals. Mr.
Hollingsworth has more than fifteen years of business development experience
that includes serving as Marketing Manager and Director of Planning at Owens-
Corning Fiberglas, and as Director of Planning and Business Development and
International Business Manager for divisions of ICI. He has a B.S. in chemical
engineering from Oklahoma State University and an M.B.A. from Stanford Graduate
School of Business.
JAMES A. CUSUMANO, LAWRENCE W. BRISCOE AND RICARDO B. LEVY, who are also
directors of Fine Chemicals, are officers and/or directors of Catalytica, Inc.
For information on their business backgrounds, see "Executive Officers."
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CATALYTICA COMBUSTION SYSTEMS
INDUSTRY BACKGROUND
One of the critical issues facing the utilities and power generation
industry is the ability to satisfy economically the growing worldwide demand for
power while complying with environmental protection requirements. Natural gas
turbines are expected to meet the majority of this increasing demand because
natural gas burns more cleanly than other fossil fuels, and gas turbines have
shorter construction lead times and lower aggregate installation cost per
kilowatt than alternative power generation methods. However, all fuel
combustion, including natural gas, creates significant emissions of NOx, carbon
monoxide and unburned hydrocarbons, which are among the primary sources of air
pollution and result in smog and ground level ozone. There is significant
regulatory pressure in much of the industrialized world to reduce these
emissions from stationary and mobile power generation sources. Through its
Combustion Systems subsidiary, Catalytica is developing catalytic combustion
systems that are designed to significantly reduce emissions of pollutants from
turbines.
The gas turbine market encompasses a range of turbine sizes and
applications that are typically divided into two segments, utility power
generation and industrial applications. The installed base of natural gas
turbines in the United States is approximately 50,000 megawatts, which is
estimated to be less than one-half of the worldwide installed base. One megawatt
is sufficient energy to provide power to approximately 1,000 households.
Utility Power Generation. The utility power generation segment
is comprised principally of large turbines ranging from 50 to 250
megawatts, with an average size of approximately 100 megawatts, with 12
combustors. The principal users of these turbines are major electric
utilities and independent power producers. According to the North
American Electricity Reliance Council, demand for power is projected to
grow in the United States at an average rate of 6,000 megawatts per year
through at least 2003. Combustion Systems believes that the market in
the rest of the world, which is approximately twice as large as the
United States market, will grow more rapidly. General Electric and its
affiliates are estimated to have over a 60% share of the worldwide
utility power generation market.
Industrial Applications. The industrial applications segment is
comprised of small- and medium-size turbines generally ranging from one
to 25 megawatts, with an average turbine size of approximately 10
megawatts, with one or more combustors. The principal users of these
turbines are non-utility industrial power generators and mechanical
drive turbines such as those used for processing and transmission of
natural gas in pipelines. According to Forecast International, a market
information service, the world market for industrial power generation
and mechanical drive natural gas turbines is projected to grow at an
average rate of 10,000 megawatts per year. The United States market is
believed to represent approximately 25% of the world market. Allison and
Solar together have a majority of the worldwide market. Other suppliers
include European Gas Turbines and Kawasaki.
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CURRENT EMISSIONS CONTROL APPROACHES
Natural gas turbines currently utilize diffusion flame combustors that
operate at about 1800 degrees C (3270 degrees F). Without emissions controls or
clean-up processes, combustion at these temperatures results in NOx emissions of
between 75 and 200 parts per million ("ppm"). These levels generally are not
acceptable for turbines in most areas of the United States. For example, in
several metropolitan areas of the United States, new natural gas turbines have
been required to achieve NOx emission levels of 5 ppm or lower to obtain permits
for installation. Specifications for the next generation turbines being
developed under the United States government sponsored Advanced Turbine System
program require the achievement of less than 8 ppm of NOx without any post-
emissions clean-up system.
One current approach for reducing NOx is to reduce the combustor
temperature by using wet controls, which involves injecting water or steam into
the turbine combustor. NOx emission levels can be reduced to about 42 ppm with
water and about 25 ppm with steam injection. However, the use of water and steam
requires that purified water be available at the site location. Capital and
operating costs can significantly increase if sufficiently pure water is not
readily available and extensive water clean-up is required. Additionally,
corrosion induced by water impurities can cause serious turbine damage over a
relatively short time period.
A second approach currently used to reduce gas turbine emissions by
reducing temperature utilizes a control technology that is generally referred to
as lean pre-mix or dry-low-NOx ("DLN"). DLN is a combustion process in which
natural gas and air are premixed prior to entering the combustor, resulting in a
low fuel to air ratio. Turbine manufacturers utilizing this approach have
achieved emission levels of approximately 25 ppm, and are undertaking to achieve
emission levels in the 10 to 15 ppm range in the next product generation.
Compared to wet controls, DLN capital costs are moderate to high and operating
costs are low to moderate. Operating costs are expected to increase as emissions
are reduced below 25 ppm.
Maintaining an operating temperature in the combustors at 1500 degrees C
(2700 degrees F) or below virtually eliminates production of NOx. Wet controls
and DLN technologies are not able to operate at this temperature level, and
therefore these methods require post combustion process clean-up to achieve
lower emission levels.
The most common post combustion clean-up process is selective catalytic
reduction ("SCR"). SCR reduces NOx emissions by approximately 80%. For example,
a turbine with NOx emissions at 25 ppm can be reduced by 80%, to about 5 ppm,
with the addition of an SCR unit. Capital and operating costs of this approach
add significantly to the overall cost of producing power. In addition, the
natural gas turbine operator must store and handle large quantities of ammonia,
a toxic, hazardous substance.
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CATALYTICA'S APPROACH
In contrast to competitive combustion technologies, Combustion Systems'
technology, marketed under the name XONON, is designed to reduce the high
temperatures created in conventional combustors to below 1500 degrees C at full
power generation, which results in virtually no NOx emissions and significant
reductions in emissions of carbon monoxide and unburned hydrocarbons. XONON uses
a proprietary flameless process in which fuel and air react on the surface of a
catalyst in the turbine combustor to produce energy in the form of hot gases,
which drive the turbine.
Combustion Systems believes that the XONON system provides the lowest
level of emissions achieved with any control technology at natural gas turbine
operating conditions. Combustion Systems has tested the durability of the XONON
catalytic combustion system for over 7,000 hours at atmospheric pressure and for
over 1,000 hours at high pressure with no change in system performance for NOx,
carbon monoxide or unburned hydrocarbons emissions. Emissions levels obtained in
the Company's tests of the XONON system that simulate full turbine operating
conditions have been as low as 0.5 ppm for NOx, 0.8 ppm for carbon monoxide and
1.7 ppm for unburned hydrocarbons. Results in a series of tests conducted by
General Electric at its commercial-scale test facility have supported the
emissions results obtained by the Company's test results.
Combustion Systems believes the XONON system will provide superior
emissions reduction performance and competitive costs compared to alternative
technologies. The XONON system is expected to have capital and operating costs
that are similar to DLN while offering significant emissions performance and
cost advantages relative to water and steam control systems. Additionally, the
XONON system is expected to provide significant cost advantages over SCR
systems. Once the technology is commercially applied, the Company believes it
will be accepted as best available control technology ("BACT"), lowest
achievable emissions rate ("LAER") technology and reasonably available control
technology ("RACT") for reduction of NOx in natural gas turbines. BACT, LAER and
RACT are the benchmarks by which the Environmental Protection Agency ("EPA"),
and state and local regulatory authorities decide which emissions control
technologies will be required for specific installations.
The Company's XONON system is designed to fit inside each combustor on a
turbine. Large turbines, such as those used in the utility power generation
market require an average of 12 combustors per turbine, while smaller industrial
turbines require one or more combustors. Combustion Systems expects to generate
revenues from the sale of XONON systems installed in each combustor of new
turbines, the retrofit of combustors in existing turbines and the ongoing sale
of catalytic replacement units.
COMMERCIALIZATION STRATEGY
To commercialize the XONON system, Combustion Systems is developing
products for both the utility power generation and industrial applications
markets through collaborative relationships with leading manufacturers in both
of these market segments. Combustion Systems believes the earliest
commercialization opportunities are in small- and medium-sized turbines because
design and testing requirements are less extensive and the sales and
commercialization process are faster than for the
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larger natural gas turbines used in the utility power generation market.
Combustion Systems is also focused on out-of-warranty turbines that are not
currently supported by existing turbine manufacturers. These efforts are being
pursued by GENXON Power Systems, the Company's joint venture with Woodward
Governor.
Industrial Applications Market. In the industrial applications area,
Combustion Systems, through GENXON Power Systems, LLC, the Company's new joint
venture company, is working with AGC to install and test the XONON system in
AGC's unit that uses a 1.5 megawatt Kawasaki turbine unit. AGC funded the
initial development work on this project. AGC manufactures and markets small co-
generation systems to deliver power and steam to industrial users. The
engineering design for the installation of the XONON system in the AGC co-
generation unit currently is in progress. Combustion Systems and AGC negotiated
an amendment to their agreement whereby AGC will provide a turbine and technical
assistance, and Combustion Systems has assumed control of and responsibility for
funding, the completion of the development and construction of the catalytic
combustor and the operation of the turbine during the demonstration phase.
Combustion Systems commenced testing of the XONON system in the AGC unit in
December, 1996. See "Item 1, Business-Formation of GENXON Joint Venture."
Combustion Systems is also working with Allison and Solar, two of the
world's leading manufacturers of small- to medium-sized turbines. Combustion
Systems and Allison have completed a preliminary evaluation of the catalytic
combustion technology for one of Allison's principal commercial turbines and
have demonstrated in a test that ultra low emission targets can be met under
simulated turbine operating conditions. Based on these results, Allison is
continuing to fund the development effort. Combustion Systems is also conducting
a development program funded by Solar to investigate the application of
Combustion Systems' catalytic combustion technology to Solar's gas turbines.
Because of the large installed base of Allison and Solar turbines, Combustion
Systems believes there is a significant retrofit market opportunity for many of
these turbines used by gas processors and gas transmission companies which face
increasing emissions regulation in the United States. Both Allison and Solar are
participating in the United States government sponsored Advanced Turbine System
program and are utilizing the XONON system to meet the NOx emissions
specifications established for the program. If either Allison or Solar
terminated its relationship with Combustion Systems, there is no assurance as to
whether Combustion Systems could enter into a similar relationship with another
manufacturer, and the Company's ability to complete its research and development
and introduce commercial systems in these markets could be adversely affected.
Utility Power Generation Market. Combustion Systems is pursuing the
market opportunity in large turbines used by electric utilities and independent
power producers through a program with General Electric, the world's largest
manufacturer of natural gas turbines. This collaboration began in 1990 and
currently is in the second phase of testing at General Electric's commercial
scale test facility. General Electric is continuing to fund the development of
the XONON system for application in General Electric turbines. Catalytica
anticipates that several additional years of development will be necessary to
complete the design of a commercial system for large turbines. The Company's
ability to complete research and development and introduce commercial systems in
the large turbine utility market would be adversely affected if General Electric
terminated its
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relationship with Combustion Systems. If such a termination occurred, there is
no assurance Combustion Systems could enter into a similar relationship with
another manufacturer.
FORMATION OF GENXON/(TM)/JOINT VENTURE
In October 1996 Combustion Systems and Woodward Governor Company formed
a Delaware limited liability company in connection with a 50/50 joint venture to
serve the gas turbine retrofit market for installed, out-of-warranty engines.
The new company, GENXON/(TM)/ Power Systems, LLC, will initially provide gas
turbine fleet asset planning and utilization services for both power generation
and mechanical drive markets. These planning services will result in the
delivery of an integrated product portfolio which includes XONON Combustion
System for ultra low NOx emissions, Woodward's control systems, turbine overhaul
and upgrades, as well as contract maintenance and service.
The initial capital commitment of the GENXON joint venture partners is
$10 million - $2 million from Combustion Systems and $8 million from Woodward -
payable over time as the funds are required by the joint venture. These capital
infusions are predicated upon reaching certain milestones, and neither joint
venture partner is contractually required to make further capital infusions if
these milestones are not met. In addition to the capital commitment, Combustion
Systems has contributed to the joint venture an exclusive license for the use of
its catalytic combustion technologies and Woodward contributed to the joint
venture an exclusive license for the use of its instrumentation and control
systems for gas turbine catalytic combustion. These licenses only cover
applications serving the retrofit of out-of-warranty turbines not supported by
original equipment manufacturers. See "Item 7, Management's Discussion and
Analysis of Financial Condition and Results of Operations."
SALE OF ADVANCED SENSOR DEVICES, INC.
In June 1996 Catalytica completed the sale of substantially all the
assets of its wholly owned subsidiary Advanced Sensor Devices, Inc. (ASD) to
Monitor Labs, Inc. ASD produced continuous emission monitors (CEMs) based on
proprietary catalytic sensors. The terms for selling substantially all of ASD's
assets included an initial payment of approximately $1.1 million at the closing,
a second payment of $0.5 million at year end,) and a royalty stream based on
future revenues. See "Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations."
REGULATORY OVERVIEW
In the United States, the Clean Air Act and amendments of 1970, 1979 and
1990 (collectively, the "Clean Air Act"), provide the regulatory guidelines for
the emissions of NOx, carbon monoxide and unburned hydrocarbons. The Clean Air
Act establishes the emission levels that must be met by power generation
sources. However, the emission requirements for specific sites are defined at
the state and local level.
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Under the Clean Air Act, the EPA establishes ambient air quality
standards. Areas which meet these standards are considered "attainment areas",
while areas not meeting these standards are considered to be "non-attainment."
In areas that are considered to be non-attainment, the regulations require the
emissions of a new gas turbine to be "offset," i.e., if a new turbine is going
to exceed a specified emissions level, the user must offset the entire emissions
of the project so that the net increase of emissions for the area is zero. In
many cases there is a multiplier applied to the new emissions, so that the new
project combined with the "offset" must actually provide a net decrease in
emissions.
One of the ways to meet the offset requirements is to make
contemporaneous reductions of emissions at the same facility. As part of
bringing a new project on line, emission reductions at the facility are made by
introducing controls on existing equipment at the location or by taking existing
equipment out of service. If it is not possible to make sufficient
contemporaneous reductions at the facility, then the user must obtain Emission
Reduction Credits ("ERC's") from one of their own locations or from someone
else's location to offset the emissions from the project. There is a developing
market for ERC's which provides economic value to sources with credits available
from their emission reductions and establishes the cost for those who must
acquire such credits.
In addition to environmental requirements in the United States, there
are increasing regulatory requirements relating to emissions in many other
countries, particularly Japan and in Western Europe.
TANAKA DEVELOPMENT AGREEMENT
Catalytica has developed its catalytic combustion technology since 1988
under a development agreement with Tanaka, Kikinzoku Kogyo ("Tanaka"), a major
Japanese precious metals company, under which Tanaka funded a significant amount
of the development effort until 1994. In January 1995, Catalytica and Tanaka
entered into a new agreement for further development and commercialization of
the catalytic combustion technology that supersedes their original agreement.
The new agreement divides commercialization rights to the technology between the
parties along market and geographic lines. Catalytica has exclusive rights to
manufacture and market catalytic combustion systems for large gas turbines
(greater than 25 megawatts power output) on a worldwide basis and for small- and
medium-sized gas turbines (25 megawatts power output or less) in the Western
Hemisphere and in Western Europe. Genxon also has exclusive rights to
manufacture and market catalytic combustors for Kawasaki turbines in the one to
three megawatt range developed with AGC on a worldwide basis. Tanaka has
reciprocal exclusive rights to manufacture and market catalytic combustors for
use in automobiles on a worldwide basis and for small- and medium-sized turbines
in regions outside of Catalytica's area of exclusivity. In each case, the
manufacturing and marketing party will pay a royalty on net sales to the other
party. The agreement allows for sales by an international customer of one party
into the other party's exclusive area for an additional royalty payment. Under
this new agreement, each party is responsible for its own development expenses,
and any invention made after May 1, 1995, is the sole property of the party
making the invention with the other party having a right to obtain a royalty-
bearing, nonexclusive license to use it in its areas of exclusivity.
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COMBUSTION SYSTEMS PATENTS
Catalytica has an active patent program for its technology. A total of
15 patents have been issued in the United States and five United States patent
applications are pending for Combustion Systems' catalytic combustion
technology. Corresponding foreign applications have been filed in countries that
the Company believes represent significant markets throughout the world pursuant
to the PCT Patent Convention. These patents and patent applications cover
various aspects of the catalytic combustion technology, including catalyst
compositions, catalyst structure and design, multistage catalytic combustion
concepts, and certain modifications to gas turbine combustors. See "Item 7, Risk
Factors-Patents and Intellectual Property."
COMPETITION
Combustion Systems expects to compete with the DLN systems being
developed by the turbine manufacturers, including General Electric, Allison, and
Solar, for their own turbines. Combustion Systems also competes with
manufacturers of SCR systems, including Mitsubishi Heavy Industries, Babcock-
Hitachi, Engelhard Corp. and Johnson Mathey. All of these competitors have
substantially greater financial resources and larger research and development
staffs than Combustion Systems. The turbine manufacturers are also potential
customers of Combustion Systems and the Company expects to rely on these
customers to help commercialize its products. If these turbine manufacturers
focus solely on their own solutions and products, Combustion Systems competitive
position in the OEM market would be materially adversely affected.
COMBUSTION SYSTEMS' MANAGEMENT AND DIRECTORS
As part of the Company's strategy to create focused business units,
Combustion Systems has assembled a management group that includes dedicated
senior executives and independent directors who provide relevant industry
experience. The directors, special board advisor and management of Combustion
Systems include:
NAME POSITION WITH COMBUSTION SYSTEMS
---- --------------------------------
William B. Ellis...................... Director
William K. Reilly..................... Director
Fred O'Such........................... Director
Ricardo B. Levy....................... Director
John A. Urquhart...................... Special Board Advisor
Dennis A. Orwig....................... President and Director
Lawrence W. Briscoe................... Chief Financial Officer and
Director
Ralph Dalla Betta.................... Vice President
WILLIAM B. ELLIS joined the Board of Directors of Combustion Systems in
September 1995. Mr. Ellis is a Senior Fellow of the Yale University School of
Forestry and Environmental Studies. Mr. Ellis retired as chairman of Northeast
Utilities in 1995, where he also served as chief executive officer from 1983 to
1993. Mr. Ellis joined Northeast Utilities in 1976 as its Chief Financial
Officer. Mr. Ellis was a partner with McKinsey & Co. from 1969 to 1976. Mr.
Ellis serves on several other
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Boards of Directors, including the Connecticut Mutual Life Insurance Company and
Radian Corporation. He has a Ph.D. in chemical engineering from the University
of Maryland.
WILLIAM K. REILLY has served as a director of Combustion Systems since
July 1995. He served as the Administrator of the United States Environmental
Protection Agency from 1989 to 1993. Mr. Reilly is currently an associate with
the Texas Pacific Group, an international investment partnership, and a visiting
professor of international studies at Stanford University. He currently serves
as a director of a number of corporations and organizations including E.I.
DuPont de Nemours and Co., the World Wildlife Fund and Yale University. Mr.
Reilly holds a B.A. from Yale University, an M.S. from Columbia University and a
J.D. from Harvard University.
FRED O'SUCH has served as a director of Combustion Systems since 1995.
He served as Group Vice President with Gulton Industries, Inc. from 1963 to
1970. From 1970 to 1981, Mr. O'Such served as Group President and Vice
President-Corporate Development with Envirotech Corporation. From 1981 to 1986,
Mr. O'Such served as CEO of Xertex Corporation. Mr. O'Such currently is
President and CEO of Xertex Capital. Mr. O'Such is a member of several Boards of
Directors, and holds an MBA from Harvard University and a BS in Chemical
Engineering from Lehigh University.
JOHN A. URQUHART has served as a special board advisor to Combustion
Systems since July 1995. He is the Vice Chairman of Enron Corp., a global
integrated natural gas company, and also serves on a number of other corporate
Boards of Directors including TECO Energy, Inc., Weir Group PLC, and Tampa
Electric Co. He previously served as the Senior Vice President of Industrial and
Power Systems at General Electric.
DENNIS A. ORWIG joined Catalytica in April 1996 as Executive Vice
President, and was named President and Director in June 1996. Prior to
Catalytica, he spent three years as an executive in the Office-of-the-President
of Elliott Company, a manufacturer of goods for the power generation and
petrochemical industries. From 1989 to 1993, Mr. Orwig served as President and
Chief Executive Officer of ABB Power Generation, Inc. He previously served as
Vice-President and General Manager of Combustion Engineering Corporation and in
various executive positions at AccRay Corporation. Mr. Orwig holds B.S. degrees
in Chemical Engineering and Pulp & Paper Science from Miami University.
RALPH A. DALLA BETTA joined Catalytica in 1976 and serves as the Chief
Scientist of Catalytica and Vice President of Catalytica Combustion Systems. Dr.
Dalla Betta's major interests are in the design and synthesis of heterogeneous
catalysts, the detailed characterization of catalyst structure and surface
properties, and catalyst testing. His development work has included catalytic
combustion systems that produce low NOx emissions, selective hydrogenation
catalyst systems and a rapid technique for measuring noble metal surface areas
for analyzing vehicle emissions control catalysts. Dr. Dalla Betta has a Ph.D.
in physical chemistry from Stanford University.
RICARDO B. LEVY and LAWRENCE W. BRISCOE, who are also directors of
Combustion Systems, are officers and/or directors of Catalytica, Inc. For
information on their business backgrounds, see "Executive Officers."
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CATALYTICA, INC.
OTHER BUSINESS OPPORTUNITIES
In addition to Fine Chemicals and Combustion Systems, Catalytica is
engaged in a number of other research and development, consulting, and special
projects, primarily in the petroleum and petrochemical industries through its
subsidiary, Catalytica Advanced Technologies, Inc. Catalytica Advanced
Technologies is pursuing the use of nanoscale materials in catalysts with a
joint venture partner. The U.S. Department of Commerce's National Institute of
Standards and Technology is providing funding for this effort under a $2 million
grant awarded in 1994. Additional funding is being obtained from potential users
of the technology. Nanoscale technology has the potential to significantly lower
manufacturing costs and reduce byproduct waste by improving catalyst activity
and selectivity. During 1996, Catalytica Advanced Technologies successfully
scaled up this technology for a specific application for which a commercial
demonstration is being planned for 1997.
Commercial production in 1997 is the goal for an organometallic
synthesis project launched in 1996 by Catalytica Advanced Technologies.
Metallocenes are catalysts used in the production of plastics to impart improved
and more controlled properties. Catalytica has developed technology which
permits the manufacture of these specialized catalysts at lower production cost.
Early in 1997, one catalyst was qualified by the first customer, and commercial
production is planned for later this year.
Another program Catalytica Advanced Technologies is pursuing involves
the conversion of natural gas to liquid hydrocarbons. Catalytica has been
designing and implementing the natural gas conversion program and is currently
at the continuous bench-scale phase of this program. Mitsubishi Oil and Petro-
Canada have reimbursed Catalytica for most of the costs of this development
program. In early March of 1997, the subsidiary was awarded a $2 million grant
from the U.S. Department of Commerce to further develop this technology.
HUMAN RESOURCES
At February 28, 1997, Catalytica employed a total of 117 employees. The
Company is not subject to any collective bargaining agreements. Catalytica
believes that it maintains good relations with its employees.
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EXECUTIVE OFFICERS
The executive officers of the Company are as follows:
NAME AGE POSITION
- ---- --- --------
Ricardo B. Levy....... 51 President, Chief Executive Officer and Director
James A. Cusumano..... 54 Chairman of the Board and Chief Technical
Officer
Lawrence W. Briscoe... 52 Vice President, Finance and Administration, and
Chief Financial Officer
W. Robert Epperly*.... 61 Vice President, Engineering
Ralph A. Dalla Betta.. 51 Vice President and Chief Scientist
* W.R. Epperly resigned from the Company effective January 15, 1997.
At December 31, 1996, there were five individuals designated as
executive officers by the Board of Directors. The following sets forth certain
information with regard to the executive officers of Catalytica who are not
Directors with the exception of Ricardo Levy and James Cusumano:
RICARDO B. LEVY, a founder of Catalytica and a director since 1974,
served as Chief Operating Officer from the Company's inception in 1974 until
August 1991, when he became President and Chief Executive Officer. Prior to
founding Catalytica, Dr. Levy was a founding member of Exxon's Chemical Physics
Research Team. Dr. Levy is an alumnus of Princeton and Harvard University's
Executive Management Program, and has a Ph.D. in chemical engineering from
Stanford University.
JAMES A. CUSUMANO, a founder of Catalytica and a director since 1974,
served as President of the Company from its inception in 1974 until 1985, when
he became Chairman of the Board and Chief Technical Officer. Dr. Cusumano served
as Director of Catalysis Research and Development at Exxon's Corporate Research
Laboratory from 1967 to 1974. Dr. Cusumano has a Ph.D. in physical chemistry
from Rutgers University.
LAWRENCE W. BRISCOE joined Catalytica in July 1994 as Chief Financial
Officer and Vice President, Finance and Administration. Prior to joining the
Company, he held various executive and financial positions including President
and Chief Operating Officer and Director of Brae Corporation, Vice President of
Corporate Development at Transamerica Corp., and Chief Executive Officer of U.S.
Commercial Telephone Corp. Mr. Briscoe has an M.B.A. from Stanford University,
an M.S. in business from the University of Southern California, and a B.S. in
electrical engineering from the University of Missouri.
W. ROBERT EPPERLY joined Catalytica in March 1992 as Vice President,
Engineering. Mr. Epperly was named President, Catalytica Advanced Technologies
Inc. in September 1995. From April 1990 to March 1992, Mr. Epperly was an
independent consultant. From 1986 to 1990, Mr. Epperly served in various
positions at Fuel Tech N.V., a firm specializing in low-emission combustion
technology, most recently from 1989 to 1990 as Chief Executive Officer. From
1957 to 1986, he was with Exxon Research and Engineering Company, most recently
as General Manager
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of Corporate Research. Mr. Epperly has an M.S. in chemical engineering from
Virginia Polytechnic Institute.
RALPH A. DALLA BETTA has served as Vice President since 1979 and has
been a Chief Scientist at Catalytica since 1976. From 1972 to 1976 Dr. Dalla
Betta worked at Ford Motor Company's Catalysis Group in the Fuel Sciences
Department. Dr. Dalla Betta has a Ph.D. in physical chemistry from Stanford
University.
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ITEM 2. PROPERTIES
Catalytica's headquarters and research and development facilities, based
in Mountain View, California, occupy three buildings covering approximately
60,000 square feet. The Company's lease expires on December 31, 1998, with a
five-year option for renewal. The Company's research and development facility is
adequate for the Company's needs for the foreseeable future.
Catalytica's Fine Chemicals' manufacturing facility is located in East
Palo Alto, California, on approximately five acres. The Company owns the
buildings, but leases the land at the site from Rhone Poulenc Inc. The initial
lease term is 15 years and expires on November 30, 2008, after which the Company
has options to extend for an additional 14 years. The past activities of Rhone
Poulenc's predecessor caused significant soil and groundwater contamination of
the facility and a down gradient area located along the San Francisco Bay.
Consequently, the site is subject to a clean up and abatement order issued by
the Bay Area Regional Water Quality Control Board ("RWQCB") which currently
requires stabilization, containment and monitoring of the arsenic and volatile
organic contamination at the site and surrounding areas. The ground lease
between Rhone Poulenc and the Company includes an indemnity by Rhone Poulenc
against any costs and liabilities that the Company might incur to fulfill the
RWQCB order and to otherwise address the contamination that is the subject of
the order. The Company also has obtained an indemnification from Novartis (the
immediately preceding owner/operator of the facility) against any costs and
liability the Company may incur with respect to any contamination caused by
Novartis' operations. However, there can be no assurance that the Company will
not be held responsible with respect to the existing contamination or named in
an action brought by a governmental agency or a third party because of such
contamination. If the Company is held responsible and it has contributed to the
contamination, it will be liable for any damage to third parties, and will be
required to indemnify Rhone Poulenc and Novartis for any additional clean up
costs or liability they may incur, with respect to the contamination caused by
the Company. The determination of the existence and additional cost of any such
incremental contamination contribution by the Company could involve costly and
time-consuming negotiations and litigation. Further, any such incremental
contamination by the Company or the unenforceability of either of the indemnity
agreements described above could materially adversely affect the Company's
business and results of operations. Although there can be no assurance the
Company will obtain orders sufficient to fill the capacity by such time, the
Company's manufacturing facility for pharmaceutical intermediates is expected to
reach capacity in 1997. In order to augment its current pharmaceutical
intermediates manufacturing capacity, the Company entered into a non-binding
letter of intent with Glaxo Wellcome to acquire Glaxo's pharmaceutical
production facility in Greenville, North Carolina. See "Item 1, Business-
Proposed Transaction with Glaxo" and "Item 7, Management's Discussion and
Analysis of Financial Condition and Results of Operations."
ITEM 3. LEGAL PROCEEDINGS
None.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the stockholders of the
Company during the fourth quarter of the fiscal year covered by this report.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
COMMON STOCK
Catalytica's Common Stock is traded in the over-the-counter market under
the NASDAQ symbol "CTAL." The following table shows the range of high and low
closing prices of Catalytica's Common Stock as reported by the NASDAQ National
Market System by quarter for 1996 and 1995. Such prices represent interdealer
prices and do not include retail mark-ups or mark-downs or commissions and may
not represent actual transactions.
1996 1995
--------------- ---------------
High Low High Low
------ ------ ------ ------
Quarter ended 3/31 $4 3/8 $3 3/4 $4 3/4 $2
Quarter ended 6/30 5 3 3/4 4 5/8 3 1/8
Quarter ended 9/30 4 1/8 3 5/8 5 5/8 3 1/4
Quarter ended 12/31 4 1/4 3 5/8 5 5/8 3 3/4
At February 28, 1997, there were approximately 228 holders of record of
the Company's Common Stock.
The market price of the Common Stock is likely to be highly volatile.
Factors such as the results of research and development and pilot scale testing
by Catalytica and its collaborative partners, the effectiveness and commercial
viability of products of Catalytica or its competitors, changes in environmental
regulations, announcements of technological innovations or new products by the
Company or its competitors, fluctuations in the Company's operating results,
including changes in the rate of growth and profitability of its Fine Chemicals
business, and changes in recommendations by financial analysts could have a
significant impact on the future price of the Common Stock. In addition, stock
markets have experienced extreme price volatility in recent years. This
volatility has had a substantial effect on the market prices of securities
issued by many companies for reasons that may be unrelated to the operating
performance of the specific companies. These broad market fluctuations may
adversely affect the market price of the Common Stock.
Catalytica has never declared or paid cash dividends on its capital
stock. The Company currently intends to retain its earnings to finance the
operation and expansion of its business and therefore does not expect to pay any
cash dividends in the foreseeable future.
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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table presents selected financial data of Catalytica. This
historical data should be read in conjunction with the Consolidated Financial
Statements and the related Notes thereto in Item 8 and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" in Item 7. No
cash dividends were declared in any of the periods presented.
<TABLE>
<CAPTION>
Year Ended December 31,
(In thousands, except per share amounts)
------------------------------------------------------
1996 1995 1994 1993 1992
-------- ------- ------- -------- -------
<S> <C> <C> <C> <C> <C>
Revenues:
Product Sales......................... $ 9,813 $ 8,858 $ 5,800 $ - $ -
Research and development.............. 6,501 4,766 6,395 8,353 9,628
------- ------- ------- ------- ------
Total Revenues................ 16,314 13,624 12,195 8,353 9,628
Net loss.............................. (5,192) (8,687) (9,145) (9,003) (3,741)
Net loss per share.................... (0.27) (0.55) (0.61) (0.66) (0.83)
Cash, cash equivalents, short-term,
and long-term investments............. 23,821 20,902 13,614 23,987 3,268
Total assets.......................... 41,003 31,239 22,186 31,720 12,536
Long-term debt........................ 1,524 1,556 1,573 930 928
Stockholders' equity.................. 17,263 22,029 15,779 24,438 4,891
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results
of Operations contain certain forward-looking statements which involve risks and
uncertainties, including statements regarding the Company's strategy, financial
performance, 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 set forth under "Risk Factors" and elsewhere in this
report.
Catalytica is developing advanced products and manufacturing processes
which use the Company's proprietary chemical catalysis technologies. These
products and processes can yield economic and environmental benefits, including
lower manufacturing costs and reduced hazardous byproducts associated with
traditional manufacturing processes. The Company has developed significant
expertise in catalysis, an essential step in the production of many industrial
products. Approximately 98% of the Company's fiscal 1996 product sales are
derived from sales of fine chemicals products and its research and development
revenues are derived principally from the Company's Combustion Systems and
Advanced Technology businesses. In December 1993, the Company acquired a
manufacturing facility from Novartis to obtain fine chemicals manufacturing
capacity. As part of the acquisition, Novartis (formerly Sandoz) entered into a
five-year contract for the manufacture of a fine chemical intermediate. Under
the terms of the agreement, Novartis transferred certain equipment and
technology relating to the manufacture of the particular intermediate, and
agreed to purchase all of its requirements of such intermediate from the
Company, subject to certain volume limitations. These requirements represent
approximately $3.0 million of revenue per year. However,
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the timing of receipt of revenues under this contract varies, depending on the
timing of receipt of orders and shipment of products. During the years ended
December 31, 1996 and 1995, 18% and 49% respectively of the Company's fine
chemical product revenues were derived from sales to Novartis. The Company has
no contractual volume commitments from Novartis beyond May 31, 1998, and there
can be no assurance the Novartis contract will be renewed. The Company plans to
replace the Novartis contractual products with product sales to new customers in
the pharmaceutical industry. The agreement may be terminated by either party
upon 30 days prior written notice for failure to perform a material provision of
the agreement, if such failure is not cured within 60 days after receipt of the
notice.
The Company's business has not been profitable to date, and as of
December 31, 1996, the Company had an accumulated deficit of $48.2 million. The
Company had anticipated incurring additional losses for at least the next
several quarters. However, future results would be significantly impacted by the
completion of the acquisition of the Glaxo Wellcome facility (See Note 13 of
Notes to Financial Statements). The Company expects that future operating
results will fluctuate from quarter to quarter, as a result of differences in
the amount and timing of expenses incurred and the revenues received. In
particular, the Company's operating results are affected by the size of and
timing of receipt of orders for and shipments of its fine chemicals products, as
well as the amount and timing of payments and expenses under the Company's
research and development contracts. In 1994, the Company began deriving revenues
from the sale of fine chemicals products, and the Company expects that in the
future it will rely increasingly on product sales for its revenues. To achieve
profitable operations, Catalytica must increase significantly its commercial
sales of fine chemicals and successfully develop, manufacture, introduce, and
market or license its combustion systems. There can be no assurance that the
Company will be able to achieve profitability on a sustained basis.
On May 8, 1996, Catalytica Fine Chemicals, Inc., announced that Pfizer
Inc. had signed an agreement to infuse $15 million in Catalytica Fine Chemicals.
These funds give Pfizer a 15 percent interest in Catalytica Fine Chemicals Inc.
and a five-year R&D commitment by Catalytica Fine Chemicals to develop new
processes and technology for the manufacture of Pfizer products. Prior to this
investment, Catalytica Fine Chemicals was a wholly-owned subsidiary of
Catalytica, Inc. (See Note 2 of Notes to Financial Statements).
During the past four years, Catalytica Fine Chemicals and Pfizer have
collaborated on the development of proprietary processes for key intermediate
products for several of Pfizer's promising new pharmaceuticals. The Pfizer drugs
are at varying stages of approval by the Food and Drug administration, ranging
from Phase II clinical trials through the New Drug Application stage. In the
past, Catalytica Fine Chemicals has manufactured intermediates for certain
Pfizer drugs and anticipates becoming a supplier of intermediates to Pfizer for
other pharmaceutical products in the future. There can be no assurance, however,
that orders will be forthcoming from Pfizer.
On June 28, 1996 Catalytica completed the sale of substantially all the
assets of Advanced Sensor Devices, Inc. (ASD) to Monitor Labs, Inc. Prior to the
sale, ASD produced continuous emission monitors (CEMs) based on proprietary
catalytic sensors. The terms for selling substantially all of ASD's assets
included an initial payment of approximately $1.1 million at the closing, a
second payment of $0.5 million a year end, and a royalty stream based on future
revenues. The Company
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recorded a gain of $0.9 million on the sale of these assets (See Note 3 of Notes
to Financial Statements).
On October 15, 1996 Catalytica's wholly owned subsidiary Catalytica
Combustion Systems Inc. (CCSI) and Woodward Governor Company ("Woodward") formed
a Delaware limited liability company in connection with a 50/50 joint venture to
serve the gas turbine retrofit market for installed, out-of-warranty engines.
The new company, GENXON(TM) Power Systems, LLC, will initially provide gas
turbine fleet asset planning and utilization services for both power generation
and mechanical drive markets. These planning services will result in the
delivery of an integrated product portfolio which includes CCSI's XONON(TM)
system for ultra low NOx emissions, Woodward's control systems, turbine overhaul
and upgrades, as well as contract maintenance and service.
The initial capital commitment of the GENXON joint venture partners is
$10 million - $2 million from CCSI and $8 million from Woodward - payable over
time as the funds are required by the joint venture. These capital infusions are
predicated upon reaching certain milestones, and neither joint venture partner
is contractually required to make further capital infusions if these milestones
are not met. In addition to the capital commitment, CCSI has contributed to the
joint venture an exclusive license for the use of its catalytic combustion
technology, and Woodward contributed to the joint venture an exclusive license
for the use of its instrumentation and control systems for gas turbine catalytic
combustors. CCSI will account for its share of the joint venture gain or loss
upon the first cash infusion totaling $1.0 million which occurred on January 3,
1997 upon completion of a milestone. Prior to January 3, 1997, the joint venture
was being funded entirely by Woodward (See Note 3 of Notes to Financial
Statements).
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
Revenues were $16.3 million, $13.6 million, and $12.2 million for 1996,
1995, and 1994, respectively. The Company's overall revenues increased by
approximately 20% in 1996 and 12% in 1995, reflecting significant growth in fine
chemical product sales. While the Company's research and development revenues
declined somewhat in 1995, new funding from external partners including the
Pfizer research agreement signed earlier this year has led to an upturn in this
revenue category during 1996.
Prior to 1994, substantially all revenues for the Company were from
research agreements. In December, 1993, the Company acquired a manufacturing
facility from Novartis to obtain fine chemicals manufacturing capacity. As part
of the acquisition, Novartis entered into a five-year contract for the
manufacture of a fine chemical intermediate. During 1994, the first year of
operation of the new manufacturing facility, $5.6 million of revenues were
related to fine chemicals product sales -- much of it attributable to Novartis.
During 1995, the Company continued to focus on the commercialization of its
technologies. Fine chemicals product sales increased to $8.5 million, a 52%
increase over 1994. Most of this increase was due to shipments of pharmaceutical
intermediates products to new customers, which the Company expects to rely on
for an increasing portion of the Company's revenues. The remaining product
revenues for 1995 of $0.4 million was
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attributable to sensor sales and the first commercial shipments of the new
CEMcat(TM) continuous emissions monitor produced by the Company's wholly-owned
subsidiary Advanced Sensor Devices. Research revenue declined in 1995,
reflecting the full year impact of the cessation of funding on the gasoline
alkylation program which occurred in mid 1994, and the absence of contractual
payments related to the original agreement with Conoco and Neste.
During 1996, product sales continued their upward trend increasing 11%
due to increased shipments of fine chemical products to new and existing
customers. Sales in 1996 were negatively impacted in part by the timing of a
contractual shipment of product for Novartis which normally occurs in the fourth
quarter each year but this year was deferred at their request to the first
quarter of 1997. This in part explains the $1.3 million increase in finished
goods inventory over 1995. The 36% increase in research revenues reflects
initiation of the aforementioned new funded research commitment associated with
the five-year research and development agreement between Catalytica Fine
Chemicals and Pfizer plus increased funding of the Company's work on nanoscale
materials used in catalysts and related contract research activities. The
increase in research revenue was also aided by a $0.5 million reimbursement by
the newly formed GENXON joint venture for R&D expenses incurred prior to the
formation of the JV by Catalytica Combustion Systems, Inc. The increase in
research revenues and to a much lesser extent the increase in product sales were
partially offset by the discontinuation of the sensor business on June 28, 1996
following the sale of all the assets of Advanced Sensor Devices, Inc. (ASD) to
Monitor Labs, Inc. (See Overview above). ASD generated $0.5 million in research
revenues and $0.4 million in product sales in 1995 as compared to no research
revenues and $0.2 million in product sales in 1996.
In 1994, 1995, and 1996, a substantial amount of the Company's revenues
were derived from a few research agreements, the product supply agreement with
Novartis, and in 1996, the new five-year research and development agreement
between Catalytica Fine Chemicals and Pfizer. In the fiscal year ended December
31, 1996, revenue recognized from agreements and/or contracts with Upjohn,
Merck, Novartis, Pfizer and Mitsubishi Oil represented 17%, 13%, 11%, 11%, and
9% of total revenues, respectively. (See Note 1 of Notes to Financial
Statements).
The $9.1 million in cost of goods sold for 1996 represents a 9% increase
over 1995, and corresponds with the 11% product revenue increase for the same
period as noted above. The increases in 1995 over 1994 levels were much larger
as 1994 represented the first year of production at the new facility. Cost of
goods sold for 1995 were 51% higher than 1994 while product revenues were 53%
higher than in 1994. Gross margins were 8% in 1996, 6% in 1995, and 5% in 1994.
This trend reflects increasing utilization of the capacity that exists at the
facility. Full utilization of current capacity would occur at product revenues
in the $15 to $20 million range depending on product mix. Margins on the fine
chemical products are subject to fluctuations from year-to-year 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 production runs, and numerous other variables present in the
chemical manufacturing environment.
Research and development expenses were $9.7 million, $9.8 million, and
$13.0 million for the years ended December 31, 1996, 1995, and 1994,
respectively. Although research and development expenses for 1996 were down
slightly from the previous years level, the actual level of research
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activity occurring at Catalytica increased during 1996. This isn't reflected on
the Company's financial statements largely due to a shift of certain catalytic
combustion research and development costs from Catalytica to the newly formed
GENXON joint venture (See Note 3 of Notes to Financial Statements). This
transfer of R&D funding occurred beginning on August 1, 1996 and resulted in a
shift of approximately $1.8 million of research and development costs being
financed by the joint venture rather than Catalytica. It should be noted,
however, that without the funding provided by the joint venture, the level of
R&D spending on the retrofit technology would likely have been much lower if
Catalytica alone was funding this technology. On an absolute basis, i.e.,
excluding the $1.8 million transfer of R&D expenses, R&D spending on catalytic
combustion technology actually increased $1.9 Million over 1995 levels -although
all of that increase was funded and recorded on the books of the joint venture.
Cessation of all research activities of Advanced Sensor Devices (ASD) following
the sale of its assets (See Note 3 of Notes to Financial Statements) also
contributed approximately $0.8 million towards the reduction of R&D expenses.
This decrease in R&D funding during 1996 due to the formation of the joint
venture and sale of ASD was mostly offset by increases in R&D expenses elsewhere
in the Company reflecting new work on nanoscale materials used in catalysts and
related contract research activities, plus increased research activities
supporting the research commitment to Pfizer Inc. (See Note 2 of Notes to
Financial Statements).
Research and development expenses for 1995 decreased 25% as compared to
1994, reflecting the Company's continuing emphasis on commercialization of its
products, and a resulting shift of resources away from research and development
into sales and administration. The Company also realized the full-year impact of
reduced research and development expenses as a result of its restructuring in
the fourth quarter of 1994 (See Note 8 of Notes to Financial Statements).
Research and development expenses consist primarily of salaries and benefits for
scientific and research personnel, related support staff, consultants, supplies,
occupancy costs, and depreciation.
Of the Company's research and development expenses for 1996,
approximately 42% were utilized to develop the Company's advanced combustion
systems technology, approximately 24% was spent on the Company's fine chemicals
technologies, and the remaining approximately 34% was spent on various other
technologies, substantially all of which was done at the specific request of,
and funded by, third parties.
Selling, general, and administrative expenses (SG&A) were $4.5 million
for each of the years ended December 31, 1996, and 1995, and $3.1 million for
the year ended December 31, 1994. Selling, general, and administrative expenses
for 1995 increased 45% compared to 1994, primarily due to an increase in sales
personnel in the fine chemicals business and an increase in sales and
administrative expenses associated with Advanced Sensor Devices, a subsidiary of
Catalytica, and the shifting of certain resources from research and development.
Although the aggregate selling, general, and administrative expenses remained
flat for the full year 1996 as compared to 1995, there were changes in some of
the components. Increases in SG&A expense levels in some business units were
largely offset by two factors -- the discontinuation of the Advanced Sensor
devices subsidiary at the end of the second quarter and the formulation of the
new GENXON joint venture which resulted in a shift of some administrative
expenses to the joint venture as certain Catalytica employees spent time on
joint venture organization activities for which the Company was reimbursed by
the joint venture entity. Once the joint venture becomes fully staffed, these
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management activities being temporarily manned by Catalytica employees will be
taken over by full time GENXON employees. Thus, to the extent that Catalytica's
SG&A costs are being reimbursed by GENXON which amounted to $0.2 million in
1996, these reductions should be considered temporary. The reduction in SG&A
costs due to discontinuation of Advanced Sensor Devices, however, is a permanent
reduction. If the company does not consummate the proposed transaction with
Glaxo Wellcome, SG&A expense would increase significantly to reflect the
reclassification of acquisition costs which will be capitalized as part of the
acquisition costs starting in the first quarter of 1997. Prior to the first
quarter of 1997, these acquisition costs were recorded as SG&A expense as they
were incurred. See "Item 1, Business-Proposed Transaction with Glaxo Wellcome,"
as well as the description below.
In 1994, the Company took a restructuring charge of $499,000, primarily
related to costs associated with an 18% workforce reduction in the third quarter
of 1994.
The $0.9 million gain on sale of assets represents the net realized gain
over book value on the sale of ASD's assets to Monitor Labs, Inc. on June 28,
1996 (See Note 3 of Notes to Financial Statements).
Net interest income was $0.8 million, $0.3 million, and $0.8 million in
1996, 1995 and 1994, respectively. Net interest income decreased 56% in 1995
when compared to 1994 due to lower average balances of cash and short-term
investments as these funds were used to support the Company's operations, and
incremental interest expense associated with new loans that funded a portion of
capital improvements at the Fine Chemicals manufacturing facility. Interest
income was favorably impacted during the last two months of 1995 due to
significantly higher cash and short-term investment balances resulting from the
proceeds of the Company's secondary offering completed on November 3, 1995. This
trend continued into 1996 and was helped further by the $15 million cash
infusion by Pfizer on May 8, 1996. The higher cash balances resulted in a 144%
increase in net interest income in 1996 when compared to 1995. This increase in
interest income in 1996 was partially offset by increased interest expense on a
line of credit and other short-term working capital financing at the Catalytica
Fine Chemicals Bay View manufacturing facility.
The Company's net loss was $5.2 million, $8.7 million, and $9.1 million
in 1996, 1995, and 1994, respectively. The decrease in the net loss in 1996 as
compared to 1995 was largely due to the discontinuation of all activities at the
Advanced Sensors Devices Subsidiary upon its sale to Monitor Labs coupled with
the $0.9 million gain on the sale of the subsidiary's assets. The formation of
the GENXON joint venture also contributed significantly to the reduced net loss
in 1996. The decrease in the net loss in 1995 as compared to 1994 reflects
significant reductions in internal funding of research and development
activities coupled with a positive contribution of the fine chemicals product
sales, both partially offset with increased spending on general, sales, and
marketing activities. For discussion of the Company's net operating loss
carryforwards, see Note 9 of Notes to Financial Statements.
In 1995, the FASB issued Statement No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,
which requires impairment losses to be recorded on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying
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amount. The Company adopted Statement 121 in the first quarter of 1996 and the
impact was not material.
Also in 1995, the FASB issued Statement No. 123, Accounting for Stock
Based Compensation, which provides an alternative to APB Opinion No. 25,
Accounting for Stock Issued to Employees, in accounting for stock based
compensation to employees. The Company has elected to account for stock based
compensation to employees in accordance with Opinion 25, providing only pro
forma disclosures required by Statement 123.
FUTURE RESULTS
This Section contains certain forward-looking statements which involve
risks and uncertainties. The Company's actual results could differ materially
from the results anticipated in these forward-looking statements as a result of
certain factors set forth under "Risk Factors" and elsewhere in this report.
The Company expects to incur additional operating losses at least
through the next several quarters due to continued self-funding of research and
development expenditures coupled with higher sales, general and administrative
expenses. These losses, however, should decrease as the Company expands
the sales of its Fine Chemicals business and moves this unit toward
profitability. The expected increase in general and administrative expenses
reflect incremental sales and marketing efforts to support increased business at
Catalytica Fine Chemicals. The Company's future results would be significantly
impacted upon the completion of the acquisition of the Glaxo Wellcome facility.
See "Item 1, Business-Proposed Transaction with Glaxo," "Item 2, Properties," as
well as the description below.
In the past, losses have fluctuated from quarter to quarter due to the
seasonality of the fine chemical products manufactured for Novartis and
differences in the timing of expenses incurred and the revenues received from
collaborative agreements. Such fluctuations may be somewhat reduced in the
future as products that are planned to be manufactured in the Bay View facility
fill up excess capacity and even out production and as the Company continues its
shift from a research and development company to a commercial entity with
product sales.
The Company expects to continue certain of its research and development
programs, which include the self-funding of expenditures that are not covered by
payments from collaborative partners. The Company believes its internally funded
research projects have the potential to lead to commercial sales in the next few
years. The Company anticipates that in the future, research that does not have
the potential for near-term commercialization will be conducted only when funded
by collaborative partners.
As a result of the Company's acquisition of the Bay View manufacturing
facility in the fourth quarter of 1993, 1994 was the first year to include
significant revenues from fine chemicals product sales, incremental costs
associated with producing these products, and incremental fixed manufacturing
costs. During 1994, 1995 and 1996 a significant amount of the capacity at the
Bay View facility was underutilized. The Company is planning to use a
substantial portion of this
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capacity for the production of products utilizing proprietary technologies for
both the pharmaceutical and nonpharmaceutical markets. During 1997, the Company
plans additional capital expenditures in Bay View to expand its capacity for
certain types of products. Sales and marketing efforts increased significantly
in 1995, with much of that effort directed towards finding other fine chemical
products that can be manufactured under contract for new customers. From 1994 to
1995, these efforts resulted in a 52% increase in product sales, primarily to
new customers. From 1995 to 1996, product sales increased by 11%. Additional
incremental product sales are expected in the future as a result of these sales
and marketing efforts. There is no assurance, however, that additional revenues
from products under development, or from these sales efforts, will be achieved.
The Company's ability to increase revenues from its fine chemicals
business will also depend, in part, on the availability of manufacturing
capacity. Although there can be no assurance the Company will obtain orders
sufficient to fill the capacity by such time, the Company's manufacturing
facility for pharmaceutical intermediates is expected to reach capacity in 1997.
The Company's ability to increase its revenues from the fine chemicals business
could be constrained if the Company is unable to acquire additional plant
capacity. The Company could experience delays in manufacturing certain products,
which could result in the loss of contracts or customers. There can be no
assurance that the Company will be able to acquire additional plant capacity on
acceptable terms, if at all. In order to augment its current pharmaceutical
intermediates manufacturing capacity, the Company entered into a non-binding
letter of intent with Glaxo Wellcome to acquire Glaxo's pharmaceutical
production facility in Greenville, North Carolina. See "Item 1,
Business-Proposed Transaction with Glaxo", "Item 2, Properties", as well as the
description below.
Catalytica faces challenges in advancing its programs from bench and
pilot scale to cost-effective commercial products and processes. There can be no
assurance that the Company will successfully address the challenges that will
arise during the development of each of its programs.
PROPOSED TRANSACTION WITH GLAXO WELLCOME
The Company and Glaxo Wellcome Inc. ("Glaxo") signed a non-binding
letter of intent effective February 5, 1997 to enter into a series of
transactions pursuant to which the Company would acquire (the "Acquisition")
Glaxo's pharmaceutical production facility in Greenville, North Carolina (the
"Facility") as part of its expansion plans for Fine Chemicals.
The proposed agreement calls for the Company to purchase all of the
buildings and equipment at the 1.8 million-square-foot Facility, as well as the
approximately 600 acres of land on which it is situated. Under the agreement,
the Company will enter into long term manufacturing contracts to supply
designated Glaxo Wellcome products, including bulk active chemicals, final
dosage forms, and sterile products, with a potential revenue to the Company
estimated at $800 million over five years.
Under the terms of the proposed Acquisition, the Company will pay Glaxo
an undisclosed amount. The Acquisition will be financed by a combination of an
equity investment in Catalytica
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by Morgan Stanley Capital Partners and debt from a major global financial
institution. In addition, Glaxo will receive a small equity stake in Fine
Chemicals. The agreement also provides for Glaxo to receive a share of the
profits from Catalytica's production of products in the Greenville site's
sterile products facility. Terms of the equity financing are expected to be
structured to reflect the valuation of the Company's businesses prior to the
announcement of the Acquisition. Terms of the debt financing are expected to be
structured to reflect anticipated cash flows under the supply contracts with
Glaxo Wellcome and other parties.
No definitive agreements have been signed by the Company and Glaxo
relating to the proposed Acquisition. As a result, there can be no assurance,
and stockholders should not assume, that the proposed transactions will be
completed. The completion of the Acquisition is subject to a number of risks and
uncertainties, including the following: (i) completion of the negotiation of
definitive documents, including an asset purchase agreement and long term supply
contracts for chemical, final dosage and sterile products; (ii) completion of
the due diligence review by the Company and its equity and debt financing
sources; (iii) completion of the negotiation of the terms of the substantial
equity and debt financings required to consummate the Acquisition; and (iv)
receipt of certain regulatory approvals and consents, including stockholder
approval.
In addition, the proposed Acquisition, which is not expected to close
prior to the latter portion of the second quarter of 1997, will require
significant management time and legal, accounting and other expenditures,
whether or not the transactions are completed. In the event the Acquisition is
consummated, the additional facilities, employees and business volumes will
substantially increase the Company's expenses and working capital requirements
and place substantial burdens on the Company's management resources.
Furthermore, the success of the Acquisition depends on the levels of new
manufacturing business developed by the Company, and the related terms
negotiated by the parties. In the event the Company does not achieve additional
new business from Glaxo and other customers on terms sufficient to offset the
costs associated with operating and maintaining the new facilities, and with
servicing the debt associated with the acquisition of the new facilities, the
Company's results of operations would be materially adversely affected. See
"Item 1, Business-Proposed Transaction with Glaxo" and "Item 2, Properties."
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations through private placements of
equity securities, an initial public offering of its Common Stock on February 8,
1993, a secondary public offering on November 3, 1995, a $15 million cash
infusion from Pfizer on May 8, 1996, revenues from collaborative research
agreements, and starting in 1994, product revenues. At December 31, 1996, the
Company had cash, cash equivalents and short-term investments totaling $23.8
million.
Primarily as a result of the Company's self-funding of certain research
and development programs, the Company generated net operating losses for each of
the three years in the period ended December 31, 1996, and used $19.0 million of
cash for its operating activities. In addition, the Company expended $8.4
million of cash for capital expenditures and repaid approximately $6.1 million
of debt obligations during this same three-year period. The primary sources of
cash have been from financing activities, including $23.6 million received from
the sale of Common Stock in
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the parent corporation and its subsidiary Catalytica Fine Chemicals, Inc., plus
$9.7 million from debt issuances during the three years ended December 31, 1996.
In 1994, 1995 and 1996, the Company obtained various lines of credit to
fund capital purchases and future working capital needs (See Note 7 of Notes to
Financial Statements). One of these lines of credit collateralized with accounts
receivable was increased in 1995 to $2.0 million from $1.0 million in 1994. It
was further increased to $3.5 million in 1996. As of December 31, 1996, the
Company had approximately $2.3 million outstanding under this line of credit.
The loan includes a covenant that requires the Company's fine chemicals
manufacturing facility to achieve certain minimum levels of profitability. At
June 30, 1995, the Company was in violation of this covenant. During the quarter
ended June 30, 1995, the requirement was for break-even operations for such
facility. The actual loss with respect to such facility for the quarter amounted
to $72,000. The bank agreed to waive the covenant for the quarter ended June 30,
1995, and effective September 28, 1995, and further amended on November 30,
1995, the bank and the Company entered into an agreement which reduced certain
financial covenants, including the minimum profitability requirement. As a
result of this amendment as of September 30, 1995, the Company was not in
violation of the covenants contained in its line of credit. Accordingly, amounts
payable under the line of credit agreement due more than one year from the
balance sheet date continue to be classified as long-term. The company has not
been in violation of any bank covenants subsequent to the initial violation in
1995. To the extent the Company does not comply with the required financial
covenants in the future, there can be no assurance the bank will waive the
covenants. Failure to comply with the financial covenants could result in
acceleration of payment of the principal amount and interest due under the line
and termination of the line of credit.
The Company's operations to date have required substantial amounts of
cash. The Company anticipates that existing capital resources, product revenues,
and research and development revenues will enable the Company to maintain
current and planned operations for at least the next 12 months. The Company's
future capital requirements will depend on many factors, including rate of
commercialization of the Company's catalytic combustion systems, the need to
expand manufacturing capacity for both its fine chemicals and combustion systems
business, and the completion of the proposed transaction with Glaxo. However,
adequate funds for future operations, whether from the financial markets or from
collaborative or other arrangements, may not be available when needed or on
terms acceptable to the Company and, if available or acceptable to the Company,
may result in significant dilution to existing stockholders. If adequate funds
are not available, the Company may be required to delay, scale back or eliminate
some or all of its research and product development programs. Although there can
be no assurance the Company will obtain orders sufficient to fill the capacity
by such time, the Company's manufacturing facility for pharmaceutical
intermediates is expected to reach capacity in 1997. In order to augment its
current pharmaceutical intermediates manufacturing capacity, the Company entered
into a non-binding letter of intent with Glaxo Wellcome to acquire Glaxo's
pharmaceutical production facility in Greenville, North Carolina. See "Item 1,
Business-Proposed Transaction with Glaxo" and "Item 2, Properties," as well as
the description above.
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RISK FACTORS
History of Operating Losses and Uncertainty of Future Results
The Company's business has not been profitable to date, and as of
December 31, 1996, the Company had an accumulated deficit of $48.2 million. The
Company anticipates incurring additional losses for at least the next several
quarters. The Company expects that losses will fluctuate from quarter to quarter
as a result of differences in the amount and timing of expenses incurred and
revenues received. In particular, the Company's operating results are affected
by the size and timing of receipt of orders for and shipments of its fine
chemicals products, as well as the amount and timing of payments and expenses
under the Company's research and development contracts. Through 1993,
substantially all of the Company's revenues were derived from research and
development contracts. Most of the Company's research and development contracts
are subject to periodic review by the funding partner, which may result in
modifications, including reduction or termination of funding. The Company's
research and development revenues declined in 1995 and 1994 as certain research
projects were terminated. There can be no assurance the Company will continue to
receive research and development funding, and the Company expects that it will
increasingly rely on product sales for its revenues.
In 1994, the Company began deriving revenues from the sale of fine
chemicals products. During the past several years, a significant portion of the
Company's product revenues has been derived from sales to Novartis Agro, Inc.
("Novartis") under a five-year contract pursuant to which Novartis committed to
buy certain minimum volumes for the first four years and eight months. (See Note
1 of Notes to Financial Statements, "Major Customer Information") The Company
has no contractual volume commitment from Novartis beyond May 31, 1998. There
can be no assurance the Novartis contract will be renewed or replaced with new
business. The Novartis agreement may be terminated by either party upon 30 days
prior written notice for failure to perform a material provision of the
agreement, if such failure is not cured within 60 days after receipt of notice.
The Company expects that it will need to manufacture new products to increase
revenue. Typically, new products have lower gross margins during the initial
manufacturing phase, which could have an adverse effect on the Company's results
of operations. To achieve profitable operations, Catalytica must significantly
increase its commercial sales of fine chemicals and successfully develop,
manufacture, introduce and market or license its combustion systems and
catalytic processes. There can be no assurance that the Company will be able to
achieve profitability on a sustained basis, or at all.
Commercialization; Shift from Research and Development
The Company's success will depend on its ability to complete the
transition from emphasizing research and development to full commercialization
and sale of its products. The Company began manufacturing, marketing and selling
pharmaceutical intermediates in 1994. Success of the Company's fine chemicals
business is dependent upon development and commercialization of appropriate
catalytic processes for new customers and new fine chemicals products. There can
be no assurance the Company will be able to develop and commercialize such
processes. In addition, sales of certain of the Company's fine chemicals
intermediates are dependent upon the customer obtaining clearance from the
United States Food and Drug Administration ("FDA") for marketing of the
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customer's end-product. Failure of the Company's customers to obtain the
necessary FDA clearance would have an adverse affect on sales of certain fine
chemicals products.
The Company, through its subsidiary Catalytica Combustion Systems, Inc.
("CCSI"), and the GENXON joint venture, is still conducting research and
development on its combustion systems. Prior to commercialization of its
combustion systems, the Company's products will be required to undergo rigorous
testing by turbine manufacturers. Ultimate sales of the Company's combustion
system products will depend upon the acceptance and users of the Company's
technology by a limited number of turbine manufacturers and the Company's
ability to enter into commercial relationships with these manufacturers. The
Company's subsidiary, CCSI, is currently working with leading turbine
manufacturers, including: General Electric in large turbines, Allison Engine
Co., a subsidiary of Rolls Royce, and Solar, a subsidiary of Caterpillar, Inc.,
in medium size turbines. In addition, through its joint venture company GENXON,
the company is developing complete combustor systems for Affiliated Group of
Companies (AGC), to be used on small Kawasaki Heavy Industries turbines for
mobile cogeneration applications. GENXON is also developing complete combustor
systems utilizing Catalytica's combustion technology for end users to be "retro
fitted" on older "out-of-warranty" turbines no longer supported by OEM's.
Neither the Company, its subsidiary CCSI, nor the joint venture company GENXON
have formal long-term agreements in place with many of these companies. The
Company's ability to complete research and development and introduce commercial
systems for these markets would be adversely affected if any of these companies
terminated its relationship with the Company or GENXON. If such terminations
occurred, there is no assurance as to whether the Company could enter into a
similar relationship with another manufacturer. The Company currently has
limited manufacturing and marketing capability for its combustion products. The
Company's existing facilities are inadequate for commercial production of the
combustion products under development, and to the extent that the Company
chooses to produce commercial quantities of its products, the Company will be
required to develop or acquire manufacturing capability. In order to market any
of its combustion system products, the Company will be required to develop
marketing capability, either on its own or in conjunction with others. There can
be no assurance that the Company will be able to manufacture its products
successfully or develop an effective marketing and sales organization. In
addition, some of the Company's combustion systems and processes are expected to
be sold as components of large systems such as natural gas turbines for electric
power plants: accordingly, the rate of adoption of the Company's systems and
processes may depend in part on economic conditions which affect capital
investment decisions, as well as the regulatory environment. There can be no
assurance that the Company's products will be economically attractive when
compared to competitive products. See "Item 1, Business-Formation of GENXON
Joint Venture."
Proposed Transaction With Glaxo Wellcome
The Company and Glaxo Wellcome Inc. ("Glaxo") signed a non-binding
letter of intent effective February 5, 1997 to enter into a series of
transactions pursuant to which the Company would acquire (the "Acquisition")
Glaxo's pharmaceutical production facility in Greenville, North Carolina (the
"Facility") as part of its expansion plans for Fine Chemicals.
34
<PAGE>
The proposed agreement calls for the Company to purchase all of the
buildings and equipment at the 1.8 million-square-foot Facility, as well as the
approximately 600 acres of land on which it is situated. Under the agreement,
the Company will enter into long term manufacturing contracts to supply
designated Glaxo Wellcome proscription products with a potential revenue to the
Company estimated at $800 million over five years.
Under the terms of the proposed Acquisition, the Company will pay Glaxo
an undisclosed amount. The Acquisition will be financed by a combination of an
equity investment in Catalytica by Morgan Stanley Capital Partners and debt from
a major global financial institution. In addition, Glaxo will receive a small
equity stake in Fine Chemicals. The agreement also provides for Glaxo to receive
a share of the profits from Catalytica's production of medicines in the
Greenville site's sterile products facility. Terms of the equity financing are
expected to be structured to reflect the valuation of the Company's businesses
prior to the announcement of the Acquisition. Terms of the debt financing are
expected to be structured to reflect anticipated cash flows under supply
contracts with Glaxo Wellcome and other parties.
No definitive agreements have been signed by the Company and Glaxo
relating to the proposed Acquisition. As a result, there can be no assurance,
and stockholders should not assume, that the proposed transactions will be
completed. The completion of the Acquisition is subject to a number of risks and
uncertainties, including the following: (i) completion of the negotiation of
definitive documents, including an asset purchase agreement and long term supply
contracts for chemical, final dosage and sterile products; (ii) completion of
the due diligence review by the Company and its equity and debt financing
sources; (iii) completion of the negotiation of the terms of the substantial
equity and debt financings required to consummate the Acquisition; and (iv)
receipt of certain regulatory approvals and consents, including stockholder
approval.
In addition, the proposed Acquisition, which is not expected to close
prior to the latter portion of the second quarter of 1997, will require
significant management time and legal, accounting and other expenditures,
whether or not the transactions are completed. In the event the Acquisition is
consummated, the additional facilities, employees and business volumes will
substantially increase the Company's expenses and working capital requirements
and place substantial burdens on the Company's management resources.
Furthermore, the success of the Acquisition depends, in part, on the levels of
manufacturing business developed by the Company. In the event the Company does
not achieve additional new business from Glaxo and other customers on terms
sufficient to offset the costs associated with operating and maintaining the new
facilities, and with servicing the debt associated with acquisition of the new
facilities, the Company's results of operations would be materially adversely
affected. See "Item 1, Business--Proposed Transaction with Glaxo", "Item 2,
Properties", and "Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations".
Future Capital Requirements and Uncertainty of Additional Funding
See Management's Discussion and Analysis of Financial Condition and
Results of Operations -Liquidity and Capital Resources.
35
<PAGE>
Risks associated with GENXON Joint Venture
In October 1996 Combustion Systems and Woodward Governor Company formed
a Delaware limited liability company in connection with a 50/50 joint venture to
serve the gas turbine retrofit market for installed, out-of-warranty engines.
The new company, GENXON(TM) Power Systems, LLC, will initially provide gas
turbine fleet asset planning and utilization services for both power generation
and mechanical drive markets. The Company plans to deliver an integrated product
portfolio which includes Combustion Systems' system for ultra low NOx emissions,
Woodward's control systems, turbine overhaul and upgrades, as well as contract
maintenance and service.
The initial capital commitment of the GENXON joint venture partners is
$10 million - $2 million from Combustion Systems and $8 million from Woodward -
payable over time as the funds are required by the joint venture. These capital
infusions are predicated upon reaching certain milestones, and neither joint
venture partner is contractually required to make further capital infusions if
these milestones are not met. If the milestones are not met, and the Company
desired to complete any projects being developed by the joint venture, the
Company could be required to fund the projects itself if Woodward decides not to
make any additional capital contributions to GENXON. If such an event were to
occur, it could have a material adverse effect on the Company's results of
operations. See "Item 7, Management Discussion and Analysis of Financial
Conditions and Results of Operations."
Unlike Catalytica Combustion Systems' efforts to date which have focused
only on the design of the catalyst assembly, GENXON is developing entire
combustion systems. The development of complete combustion systems by GENXON to
serve the retrofit market will require the design of new combustion chambers to
be retrofitted on existing turbines. This new combustion chamber will
incorporate a XONON catalyst. There can be no assurance that GENXON will be
successful in developing new combustion chambers that will work in lieu of the
current design that does not incorporate a catalyst. There can be no assurance
that the Company's products will be economically attractive when compared to
competitive products. See "Item 1, Business-Formation of GENXON Joint Venture."
Influence of Environmental Regulations on Rate of Commercialization
The rate at which the Company's catalytic combustion systems are adopted
by industrial companies will be heavily influenced by the enactment and
enforcement of environmental regulations at the federal, state and local levels.
Current federal law governing air pollution generally does not mandate the
specific means for controlling emissions, but instead, creates ambient air
quality standards for individual geographic regions to attain through
individualized planning on a regional basis in light of the general level of air
pollution in the region. Federal law requires state and local authorities to
determine specific strategies for reducing emissions or specific pollutants.
Among other strategies, state and local authorities in all areas which do not
meet ambient air quality standards must adopt performance standards for all
major new and modified sources of air pollution. The more polluted the air in a
particular region has become, the more stringent such controls must be. The
Company's revenues will depend, in part, on the standards, permit requirements
and programs these state and local authorities promulgate for reducing emissions
36
<PAGE>
(including emissions of NOx) addressed by the Company's combustion and
monitoring products systems. Demand for the Company's systems and processes will
be affected by how quickly the standards are implemented and the level of
reductions required. Certain industries or companies may successfully delay the
implementation of existing or new regulations or purchase or acquire emissions
credits from other sources, which could delay or eliminate their need to
purchase the Company's systems and processes. Moreover, new environmental
regulations may impose different requirements which may not be met by the
systems and processes being developed by Catalytica or which may require costly
modifications of the Company's products. The United States Congress is currently
reviewing existing environmental regulations. There can be no certainty as to
whether Congress will amend or modify existing regulations in a manner that
could have an adverse effect on demand for the Company's combustion system
products.
Effect of FDA Regulations on Fine Chemicals Manufacturing
Many of the fine chemicals products the Company manufactures, or will
manufacture in the future, and the final drug products in which they are used
are subject to regulation for safety and efficacy by the FDA and foreign
regulatory authorities before such products can be commercially marketed. The
process of obtaining regulatory clearances for marketing is uncertain, costly
and time consuming. The Company cannot predict how long the necessary regulatory
approvals will take or if its customers will ever obtain such approval for their
products. To the extent the Company's customers do not obtain the necessary
regulatory approvals for marketing new products, the Company's fine chemicals
product sales will be adversely affected.
In the future, the Company intends to manufacture bulk actives. To do
so, the Company would be required to comply with the FDA's current Good
Manufacturing Practices ("cGMP") regulations, and certain of the Company's
customers may also require the Company to adhere to cGMP regulations, even if
not required by the FDA. In complying with cGMP regulations, manufacturers must
continue to expend time, money and effort in production, recordkeeping and
quality control to ensure that the product meets applicable specifications and
other requirements. The FDA periodically inspects drug manufacturing facilities
to ensure compliance with applicable cGMP requirements. Failure to comply
subjects the manufacturer to possible FDA action, such as suspension of
manufacturing. The FDA also may require the submission of any lot of the product
for inspection and may restrict the release of any lot that does not comply with
FDA regulations, or may otherwise order the suspension of manufacture, recall or
seizure. Failure of the Company's customers to obtain and to maintain FDA
clearance for marketing of the products manufactured by the Company, or failure
of the Company to comply with cGMP regulations as required by the FDA or the
Company's customers, would have a material adverse effect on the Company's
results of operations.
Competition and Technological Change
There are numerous competitors in a variety of industries in the United
States, Europe and Japan which have commercialized and are working on
technologies that could be competitive with those under development by the
Company, including both catalytic and other technological approaches. Some of
these competitive products are in more advanced stages of development and
testing. The
37
<PAGE>
Company's competitors may develop technologies and systems and processes that
are more effective than those being developed by the Company or that would
render the Company's technology and systems and processes less competitive or
obsolete. In the fine chemicals market, the Company faces its primary
competition from pharmaceutical companies that produce their own fine chemicals
and from other fine chemicals manufacturers such as Lonza AG and DSM Fine
Chemicals. In the combustion systems market, the Company faces its primary
competition from large gas turbine power generation manufacturers, such as
General Electric Co. ("General Electric"), Allison Engine Company ("Allison")
and Solar Turbines Incorporated ("Solar"), each of which is developing competing
DLN systems for their own turbines. Many of the Company's competitors in the
combustion systems market are also potential customers of the Company, and the
Company expects to rely on these potential customers to help commercialize its
products. Most of these competitors have greater research and development
capabilities, financial resources, managerial resources, marketing experience
and manufacturing experience than the Company. If these companies are successful
in developing such products, the Company's ability to sell its systems and
processes would be materially adversely affected. Further, since many of the
Company's competitors are existing or potential customers, the Company's ability
to gain market share may be limited.
Patents and Intellectual Property
The Company has an active program of pursuing patents for its inventions
in the United States and in markets throughout the world relevant to its
business areas. The Company has 38 United State patents and 13 pending United
States patent applications, plus 70 foreign patents and patent applications.
The Company's success will depend on the ability to continue to obtain
patents, protect trade secrets and operate without infringing on the proprietary
rights of others in the United States and other countries. There can be no
assurance that the Company's patent applications will result in the issuance of
any patent, that any of the Company's existing patents or any patents that may
be issued in the future will provide significant proprietary protection, that
any such patents will be sufficiently broad to protect the Company's technology,
or that any such patents will not be challenged, circumvented or invalidated.
There can also be no assurance that the patents of others will not have an
adverse effect on the Company. Others may independently develop similar systems
or processes or design around patents issued to the Company. In addition, the
Company may be required to obtain licenses to patents or other proprietary
rights. The Company cannot assure that any licenses required under any such
patents or proprietary rights would be made available on terms acceptable to the
Company, if at all. If Catalytica requires and does not obtain such licenses, it
could encounter delays in system or process introductions while it attempts to
design around such patents, or it could find that the development, manufacture,
sale or licensing of systems or processes requiring such licenses could be
foreclosed. The Company could incur substantial costs in defending itself or its
licensees in litigation brought by others or prosecuting infringement claims
against third parties. The Company could incur substantial costs in interference
proceedings declared by the United States Patent and Trademark Office in
connection with one or more of the Company's or third parties' patents or patent
applications, and those proceedings could also result in an adverse decision as
to the priority of the Company's inventions. The Company also protects its
proprietary technology and processes in part by confidentiality agreements with
its collaborative partners, employees and consultants. There can be no assurance
that these agreements will not be breached,
38
<PAGE>
that the Company will have adequate remedies for any breach, or that the
Company's trade secrets will not otherwise become known or be independently
discovered by competitors.
Dependence on Key Personnel
The Company's success is dependent on the retention of principal members
of its management and scientific staff and on the ability to continue to
attract, motivate and retain additional key personnel. Competition for such key
personnel is intense, and the loss of the services of key personnel or the
failure to recruit necessary additional personnel could have a material adverse
effect upon the Company's operations and on its research and development
efforts. The Company does not have non-competition agreements with any of its
key employees. The Company's anticipated expansion into areas and activities
requiring additional expertise, such as manufacturing, marketing and
distribution, are expected to place increased demands on the Company's
resources. These activities are expected to require the addition of new
personnel with expertise in these areas and the development of additional
expertise by existing personnel. The failure to acquire such personnel or to
develop such expertise could materially adversely affect prospects for the
Company's success.
Hazardous Materials and Environmental Matters
The Company's research and development activities and fine chemicals
manufacturing involve the use of many hazardous chemicals. The Company is
subject to extensive federal, state and local laws and regulations governing the
use, manufacture, storage, handling and disposal of such materials and
associated waste products. The Company believes that its properties and
operations comply in all material respects with applicable environmental laws;
however, the risk of environmental liabilities cannot be completely eliminated.
Public awareness of environmental issues has increased the impact of such laws
on the conduct of manufacturing operations and ownership of property. Any
failure by the Company to comply with present or future environmental laws could
result in cessation of portions or all of the Company's operations, impositions
of fines, restrictions on the Company's ability to carry on or expand its
operations, significant expenditures by the Company to comply with environmental
laws and regulations, and/or liabilities in excess of the resources of the
Company. The Company does not have environmental impairment liability insurance.
In 1992, the Company completed a renovation of its research and development
facilities at a cost of approximately $2.3 million to comply with environmental
laws and regulations. There can be no assurance, however, that the Company will
not be required to make additional renovations or improvements to comply with
environmental laws and regulations in the future. The Company's operations,
business or assets could be materially adversely affected in the event such
environmental laws or regulations require the Company to modify current
facilities substantially or otherwise limit the Company's ability to conduct or
expand its operations.
The Company leases the land on which its fine chemicals facility is
located from Rhone Poulenc, Inc., ("Rhone Poulenc"). The past activities of
Rhone Poulenc's predecessor caused significant soil and groundwater
contamination of the facility and a down gradient area located along the San
Francisco Bay. Consequently, the site is subject to a clean up and abatement
order issued by the Bay Area Regional Water Quality Control Board ("RWQCB")
which currently requires stabilization, containment and monitoring of the
arsenic and volatile organic contamination at the site and
39
<PAGE>
surrounding areas. The ground lease between Rhone Poulenc and the Company
includes an indemnity by Rhone Poulenc against any costs and liabilities that
the Company might incur to fulfill the RWQCB order and to otherwise address the
contamination that is the subject of the order. The Company also has obtained an
indemnification from Novartis (the immediately preceding owner/operator of the
facility) against any costs and liability the Company may incur with respect to
any contamination caused by Novartis' operations. However, there can be no
assurance that the Company will not be held responsible with respect to the
existing contamination or named in an action brought by a governmental agency or
a third party because of such contamination. If the Company is held responsible
and it has contributed to the contamination, it will be liable for any damage to
third parties, and will be required to indemnify Rhone Poulenc and Novartis for
any additional clean up costs or liability they may incur, with respect to the
contamination caused by the Company. The determination of the existence and
additional cost of any such incremental contamination contribution by the
Company could involve costly and time-consuming negotiations and litigation.
Further, any such incremental contamination by the Company or the
unenforceability of either of the indemnity agreements described above could
materially adversely affect the Company's business and results of operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's Financial Statements and Schedules, and the report of the
independent auditors appear on pages 45 through 68 of this Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
40
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Certain information with respect to persons who are executive officers
of the Registrant is set forth under the caption "Executive Officers" in Part I
of this report. The section entitled "Election of Directors" appearing in the
Registrant's proxy statement for the annual meeting of stockholders sets forth
certain information with respect to the directors of the Registrant and is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The section entitled "Executive Compensation" appearing in the
Registrant's proxy statement for the annual meeting of stockholders sets forth
certain information with respect to the compensation of management of the
Registrant and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The section entitled "Election of Directors" appearing in the
Registrant's proxy statement for the annual meeting of stockholders sets forth
certain information with respect to the ownership of the Registrant's Common
Stock and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The section entitled "Transactions with Management" appearing in the
Registrant's proxy statement for the annual meeting of stockholders sets forth
certain information with respect to certain business relationships and
transactions between the Registrant and its directors and officers and is
incorporated herein by reference.
41
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES & REPORTS ON FORM 8-K
A. (1) Financial Statements:
The following financial statements of the Registrant are filed as part
of this Report
PAGE
----
Report of Ernst & Young LLP, Independent Auditors........... 45
Consolidated Statements of Operations for the
fiscal years ended December 31, 1996, 1995, and 1994........ 46
Consolidated Balance Sheets at December 31,
1996, and December 31, 1995................................. 47
Consolidated Statements of Cash Flows for the
fiscal years ended December 31, 1996, 1995, and 1994........ 48
Consolidated Statement of Stockholders' Equity for
the fiscal years ended December 31, 1996, 1995, and 1994.... 49
Notes to Consolidated Financial Statements.................. 50
(2) Financial Statement Schedules:
All schedules have been omitted because they are not applicable or
because the required information is disclosed in the consolidated
financial statements or notes thereto.
(3) Exhibits
<TABLE>
<CAPTION>
Exhibit No. Notes/(x)/ Description
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
3.1 + Third Amended and Restated Certificate of
Incorporation.
3.2 + Bylaws of Registrant.
4.1(A) + Agreement of Shareholders Amending
Registration Rights and Right of First Refusal.
4.1(B) + Amended and Restated Registration Rights
Agreement dated September 27, 1988.
4.1(C) + Amendment No. 1 to Amended and Restated
Registration Rights Agreement.
4.1(D) + Form of Amended and Restated Rights Agreement.
4.2 + Specimen of Common Stock Certificate.
4.3 +++ Preferred Shares Rights Agreement dated as of
October 23, 1996, between Catalytica, Inc. and
Chase Mellon Shareholder Services, L.L.P,
including the form of Rights Certificate and
the Certificate of Designation, the Summary of
Rights Attached thereto as Exhibits A, B and
C, respectively.
10.1 + 1983 Incentive Stock Option Plan, as amended,
with forms of agreements thereunder.
</TABLE>
/(x)/See explanation of Notes on page 44.
42
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
10.2 + 1992 Stock Option Plan, with forms of
agreements thereunder.
10.3 + 1992 Employee Stock Purchase Plan.
10.4 + ** Agreement, dated as of July 18, 1988, between
the Company and Tanaka Kikinzoku Kogyo K.K.
10.5 + Joint Development Agreement, dated December
1, 1991 among the Company, Conoco Inc. and
Neste Oy.
10.7 + ** Development Agreement, dated January 4, 1991
among the Company, Petro-Canada Inc. and
Techmocisco, Inc. (a subsidiary of Mitsubishi
Oil), as amended.
10.8 + Series D and E Preferred Shares and Warrant
Purchase Agreement, dated September 27, 1988
between the Company and Koch Industries, Inc.
10.9 + Term Note, dated February 25, 1992 between
the Company and James A. Cusumano.
10.11 + Form of Indemnification Agreement.
10.12 + Agreement and Plan of Reorganization dated as
of September 27, 1988 among the Company,
Lubrizol Enterprises, Inc. and Catven, Inc.
10.13 + Stock Purchase Agreement dated December 10,
1992 between the Company and Mitsubishi Oil
Co., Ltd.
10.15 ++ ** Ground Lease Agreement, dated November 30,
1993 between the Company and Rhone-Poulenc
Inc.
10.16 ++ ** Supply Agreement, dated September 28, 1993
between the Company and Novartis Agro, Inc.
10.17 ++ Lease Agreement, dated January 1, 1993
between the Company and Jack Dymond
Associates.
10.18 ++ Loan and Security Agreement, dated November 18,
1994 between the Company and Silicon Valley Bank.
10.19 ++** Agreement, dated January 31, 1995 between the
Company and Tanaka Kikinzoku Kogyo K.K.
10.20 * Loan Modification Agreement, dated November
30, 1995
10.21 * Catalytica Fine Chemicals, Inc. 1995 Stock
Plan, with forms of agreements thereunder.
10.22 * Catalytica Advanced Sensor Devices 1995 Stock
Plan, with forms of agreements thereunder.
10.23 * Catalytica Advanced Technologies, Inc. 1995
Stock Plan, with forms of agreements
thereunder.
10.24 * Catalytica Combustion Systems, Inc. 1995 Stock
Plan, with forms of agreements thereunder.
10.25 * Catalytica, Inc. 1995 Director Stock Option
Plan, with forms of agreements thereunder.
10.26 Limited Liability Operating Agreement of
GENXON Power Systems, LLC, dated October 21,
1996.
21.1 + Subsidiaries of Registrant.
23.1 Consent of Ernst & Young LLP, Independent
Auditors.
24.1 Power of Attorney. (See page 69)
27.1 Financial Data Schedule.
</TABLE>
43
<PAGE>
* Incorporated by reference to the exhibits filed 10-K, for the year ended
December 31, 1996. with the Company's Annual Report on Form
** Confidential treatment has been granted for portions of these agreements.
+ Incorporated by reference to the exhibits filed Form S-1 (Registration
Statement No. 33-55696).
++ Incorporated by reference to the exhibits filed with the Company's Form
10-K for the fiscal year ended December 31, 1994 .
+++ Incorporated by reference to the exhibits filed with the Company's
Registration Statement on Form 8-A as filed with the Commission on
November 29, 1996.
B. Reports on Form 8-K:
No reports on Form 8-K were filed by the Registrant during the quarter
ended December 31, 1996.
44
<PAGE>
REPORT OF ERNST & YOUNG, LLP, INDEPENDENT AUDITORS
Board of Directors and Stockholders
Catalytica, Inc.
We have audited the accompanying consolidated balance sheets of
Catalytica, Inc. as of December 31, 1996 and December 31, 1995, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Catalytica, Inc. at December 31, 1996 and December 31, 1995, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended December 31, 1996, in conformity with generally
accepted accounting principles.
ERNST & YOUNG LLP
San Jose, California
January 28, 1997
45
<PAGE>
CATALYTICA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Revenues:
Product sales $ 9,813 $ 8,858 $ 5,800
Research and development contracts 6,501 4,766 6,395
------- ------- -------
Total revenues 16,314 13,624 12,195
Costs and expenses:
Cost of product sales 9,073 8,339 5,512
Research and development 9,707 9,818 13,012
General and administrative 4,452 4,492 3,091
Restructuring cost --- --- 499
------- ------- -------
Total costs and expenses 23,232 22,649 22,114
------- ------- -------
Operating loss (6,918) (9,025) (9,919)
Gain on sale of assets 900 --- ---
Interest income 1,179 616 860
Interest expense (353) (278) (86)
------- ------- -------
Net loss $(5,192) $ (8,687) $(9,145)
======= ======= =======
Net loss per share $(0.27) $(0.55) $(0.61)
======= ======= =======
Number of shares used in computing net loss per share 19,283 15,785 15,070
======= ======= =======
</TABLE>
The accompanying notes are an integral part of these statements.
46
<PAGE>
CATALYTICA, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
------------
ASSETS 1996 1995
-------- --------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 15,540 $ 5,021
Short-term investments 8,281 15,881
Accounts receivable, net of allowance for doubtful accounts of $100 3,944 3,557
Accounts receivable from joint venture 865 ---
Notes receivable from employees 328 72
Inventory:
Raw materials 1,689 498
Work in process 249 178
Finished goods 1,479 178
------- -------
3,417 854
Prepaid expenses and other current assets 681 371
------- -------
Total current assets 33,056 25,756
Property and equipment
Equipment 9,260 7,950
Leasehold improvements 8,173 6,059
------- -------
17,433 14,009
Less accumulated depreciation and amortization (9,536) (8,626)
------- -------
7,897 5,383
Notes receivable from employees 50 100
------- -------
$41,003 $31,239
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,055 $ 1,339
Accrued payroll and related expenses 1,372 1,392
Deferred revenue 1,643 167
Other accrued liabilities 949 590
Borrowings under line of credit 2,300 1,995
Current portion of long-term debt
($213 payable to related party in 1995 and 1996) 833 2,171
------- -------
Total current liabilities 9,152 7,654
Long-term debt ($213 payable to related party in 1995) 1,524 1,556
Non-current deferred revenue 5,064 ---
Minority interest 8,000 ---
Stockholders' equity:
Preferred Stock, $.001 par value; 5,000,000 shares
authorized, none issued and outstanding --- ---
Common Stock, $.001 par value; 40,000,000 shares
authorized, 19,397,074 shares issued and outstanding
in 1996; (19,190,222 shares in 1995) 19 19
Additional paid-in capital 65,482 65,101
Deferred compensation (41) (86)
Accumulated deficit (48,197) (43,005)
------- -------
Total stockholders' equity 17,263 22,029
------- -------
$41,003 $31,239
======= =======
</TABLE>
The accompanying notes are an integral part of these statements.
47
<PAGE>
CATALYTICA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (5,192) $ (8,687) $ (9,145)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activity:
Depreciation and amortization 944 1,547 1,474
Restructuring charges and other --- --- 252
Changes in:
Accounts receivable (387) (2,058) 875
Accounts receivable from related party (865) --- ---
Inventory (2,563) (275) (42)
Prepaid expenses, and other current assets (310) 387 (17)
Accounts payable 716 211 190
Accrued payroll and related expenses (20) (24) 188
Deferred revenue 6,540 --- (1,997)
Royalties payable to related party --- (622) 271
Other accrued liabilities 359 (407) (332)
------- ------ ------
NET CASH USED IN OPERATING ACTIVITIES (778) (9,928) (8,283)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments (22,748) (19,817) (14,295)
Maturities of investments 30,500 14,000 23,424
Acquisition of property and equipment (3,565) (1,645) (3,169)
------- ------ ------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES: 4,187 (7,462) 5,960
CASH FLOWS FROM FINANCING ACTIVITIES:
Net receipts on (issuance of) notes receivable from employees (206) 115 (36)
Additions to debt obligations 4,213 4,384 1,126
Payments on debt obligations (5,278) (618) (200)
Minority investment 8,000 --- ---
Sale of common stock 381 14,892 290
------- ------ ------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 7,110 18.773 1,180
------- ------ ------
Net increase (decrease) in cash and cash equivalents 10,519 1,383 (1,143)
Cash and cash equivalents at beginning of year 5,021 3,638 4,781
------- ------ ------
Cash and cash equivalents at end of year $ 15,540 $ 5,021 $ 3,638
======= ====== ======
</TABLE>
The accompanying notes are an integral part of these statements.
48
<PAGE>
CATALYTICA, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
Common Stock
------------
Additional Total
Paid-In Deferred Accumulated Stockholders'
Shares Amount Capital Compensation Deficit Equity
------ ------ ------- ------------ ------- ------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1993 14,844,423 15 49,771 (175) (25,173) 24,438
Sale of common stock 225,854 -- 290 -- -- 290
Expense recorded from acceleration of
stock options -- -- 152 -- -- 152
Amortization of deferred compensation -- -- -- 44 -- 44
Net loss -- -- -- -- (9,145) (9,145)
---------- ---- ------- ----------- -------- -------
Balance at December 31, 1994 15,070,277 15 50,213 (131) (34,318) 15,779
Sale of common stock 119,945 -- 218 -- -- 218
Public offering dated November 3,
1995, net of offering costs 4,000,000 4 14,667 -- -- 14,671
Exercise of warrants -- -- 3 -- -- 3
Amortization of deferred compensation -- -- -- 45 -- 45
Net loss -- -- -- -- (8,687) (8,687)
---------- ---- ------- ----------- -------- -------
Balance at December 31, 1995 19,190,222 $ 19 $65,101 $ (86) $(43,005) $22,029
Sale of common stock 206,852 -- 358 -- -- 358
Expense recorded from acceleration of
stock options -- -- 23 -- -- 23
Amortization of deferred compensation -- -- -- 45 -- 45
Net loss -- -- -- -- (5,192) (5,192)
---------- ---- ------- ----------- -------- -------
Balance at December 31, 1996 19,397,074 $ 19 $65,482 $ (41) $(48,197) $17,263
========== ==== ======= =========== ======== =======
</TABLE>
The accompanying notes are an integral part of these statements.
49
<PAGE>
CATALYTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ORGANIZATION AND BUSINESS
DESCRIPTION OF BUSINESS Catalytica, Inc. (the "Company"), was incorporated
in California in 1974 and is engaged in developing new manufacturing
technologies that intend to offer economic and environmental benefits. The
Company is applying its expertise in catalysis to create more efficient
production processes and to prevent pollution. In 1992, the stockholders
approved the reincorporation of the Company into Delaware. The Company has
formed various wholly-owned operating subsidiaries aligned with its various
technologies. These subsidiaries include Catalytica Fine Chemicals, Inc.,
Catalytica Combustion Systems, Inc., and Catalytica Advanced Technologies, Inc.
BASIS OF PRESENTATION The accompanying Consolidated Financial Statements
include the accounts of the Company and its wholly owned subsidiaries after
elimination of all significant intercompany accounts and transactions. Certain
amounts from 1995 have been reclassified to reflect 1996 presentation.
PUBLIC OFFERING In November, 1995, the Company sold 4,000,000 shares of
Common Stock at $4.00 per share in an offering filed on Form S-1, resulting in
net proceeds of approximately $14.7 million. In connection with the offering,
the Company issued a warrant to purchase 320,000 shares of common stock at a
price per share equal to 120% of the $4.00 per share offering price (See Note
11).
FINANCIAL INSTRUMENTS On November 15, 1995, the FASB staff issued a special
report, A Guide to Implementation of Statement 115 on Accounting for Certain
Investments in Debt and Equity Securities. In accordance with the provisions in
that special report, the Company chose to reclassify certain securities from
held-to-maturity to available-for-sale. At December 31, 1995, the carrying
value of those securities, which were corporate debt securities and carried in
short-term investments was $982,000, which approximated fair value.
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; investments with
maturities of three months or less at the date of purchase which are held-to-
maturity (none at December 31, 1996) and investments with maturities greater
than three months which are available-for-sale ($8,281,000 at December 31, 1996)
are considered to be short-term investments; investments with maturities
greater than one year are considered to be long-term investments and are
available-for-sale (none at December 31, 1996). All investments at December 31,
1996, were carried at amortized cost, which approximated fair market value
(quoted market price). The classification of investments is made at the time of
purchase with classification for held-to-maturity made when the Company has the
positive intent and ability to hold the investments to maturity.
As of December 31, 1996, the average portfolio duration is approximately 2.7
months.
50
<PAGE>
CONCENTRATIONS OF CREDIT RISK Financial instruments that potentially
subject the Company to concentrations of credit risk consist principally of
investments in cash equivalents, short-term and long-term investments and trade
receivables. The Company uses local banks and various investment firms to
invest its excess cash, principally in commercial paper and money market funds
from a diversified portfolio of investments with strong credit ratings. The
Company is exposed to credit risks in the event of default by the financial
institutions or issuers of investments to the extent recorded on the balance
sheet. The Company performs ongoing credit evaluations of its customers and
generally does not require collateral. There have been no provisions for
doubtful accounts in any of the periods presented in the accompanying
consolidated statements of operations.
REVENUES Revenues consist of both product sales and research revenues.
Approximately 98% of revenues related to product sales primarily represent the
sale of fine chemicals. Product revenues are recognized upon shipment. Through
December 31, 1996 and 1995, approximately 18% and 49% respectively of the
Company's fine chemicals product revenues have been derived from sales to
Novartis under a five-year contract pursuant to which Novartis committed to buy
certain minimum volumes for the first four years and eight months. The Company
has no contractual volume commitment from Novartis beyond May 31, 1998. There
can be no assurance that the Novartis contract will be renewed or replaced with
new business. The Novartis agreement may be terminated by either party upon 30
days prior written notice for failure to perform a material provision of the
agreement, if such failure is not cured within 60 days after receipt of notice.
Approximately 40% of the Company's revenues were derived from research and
development contracts. Most of the company's research and development contracts
are subject to periodic review by the funding partner, which may result in
modifications, including reduction or termination of funding. The Company
experienced a decline in research and development revenues during 1995 and
1994, as certain research projects were terminated and the Company began to
shift its focus to the sale of products. There can be no assurance that the
Company will continue to receive research and development funding, and the
Company expects that it will rely increasingly on product sales for its
revenues.
Research revenues are earned as contractual services are performed in
connection with collaborative arrangements and are recognized in accordance with
contract terms, principally based on reimbursement of total costs and expenses
incurred. In return for funding development, collaborative partners receive
certain rights in the commercialization of the resulting technology. Costs of
$6,235,000, $4,409,000, and $5,281,000 related to research revenues were
included in total costs and expenses for each of the three years ended December
31, 1996, 1995, and 1994, respectively. Unbilled revenues related to work
performed under collaborative arrangements were approximately $385,000 at
December 31, 1996 ($194,000 and $105,000 at December 31, 1995, and 1994,
respectively) and are included in accounts receivable on the accompanying
balance sheet. Most amounts unbilled at December 31, 1996, were billed in
January, 1997.
51
<PAGE>
MAJOR CUSTOMER INFORMATION Revenues from major collaborative partners
representing more than 10% of revenues in any of the past three years are as
follows:
Year ended December 31,
------------------------
Customer 1996 1995 1994
-------- ---- ---- ----
Upjohn...................................... 17% 0% 0%
Merck....................................... 13% 13% 0%
Novartis.................................... 11% 31% 38%
Pfizer...................................... 11% 4% 2%
Mitsubishi Oil Company, Ltd................. 9% 10% 6%
Conoco Inc./Neste Oy........................ 0% 0% 23%
In 1991, the Company entered into an agreement with Conoco Inc. and Neste Oy
to jointly develop the Company's gasoline alkylation technology. Under the
agreement, Conoco and Neste are entitled to reimbursement of approximately $5.8
million (at December 31, 1996) plus interest from the first 10% of the annual
pre-tax income, if any, realized from commercializing the technology.
RESEARCH AND DEVELOPMENT All costs for research and development activities
are expensed in the year incurred. Such costs include proprietary research and
development expenses associated with revenues from research and development
agreements. Approximately 42% of the company's 1996 research and development
expenses was spent to develop the company's advanced combustion systems
technology, approximately 24% was spent on fine chemicals technology, and
approximately 34% was spent on other technologies, substantially all of which
was performed at the specific request of, and funded by, third parties.
INVENTORIES Inventories are stated at the lower of cost (first-in, first-
out) or market.
PROPERTY AND EQUIPMENT Property and equipment are stated at cost.
Depreciation and amortization are provided on the straight-line basis over the
lesser of the useful lives of the respective assets or the lease term, if
applicable (generally 3-15 years). At December 31, 1996 the gross value of all
capital leases was $298,000, with accumulated depreciation of $43,000.
STOCK-BASED COMPENSATION In 1995, the FASB issued Statement No. 123,
Accounting for Stock-Based Compensation, which provides an alternative to APB
Opinion No. 25, Accounting for Stock Issued to Employees, in accounting for
stock-based compensation to employees. The Company has elected to account for
stock-based compensation to employees in accordance with Opinion 25, providing
only pro forma disclosures required by Statement 123.
NET LOSS PER SHARE Except as noted below, net loss per share is computed
using the weighted average number of shares of Common Stock outstanding. Common
equivalent shares from stock options are excluded from the computation as their
effect is antidilutive, except that, pursuant to the Securities and Exchange
Commission Staff Accounting Bulletins, common and common equivalent shares
issued at prices below the public offering price during the twelve-month period
prior to the
52
<PAGE>
offering have been included in the calculation as if they were outstanding for
all periods presented prior to the initial public offering (using the treasury
stock method).
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS In March, 1995, the FASB
issued Statement No. 121, Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed Of, which requires impairment losses to be
recorded on long-lived assets used in operations when indicators of impairment
are present and the undiscounted cash flows estimated to be generated by those
assets are less than the assets' carrying amount. The Company adopted Statement
No. 121 in the first quarter of 1996 and the impact of adoption was not
material. As of December 31, 1996, the Company has no long-lived assets in
operations that require impairment losses to be recorded as required by SFAS No.
121.
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.
NOTE 2. MINORITY INTEREST IN CATALYTICA FINE CHEMICALS, INC.
On May 8, 1996, Pfizer Inc. ("Pfizer") entered into a Collaborative Research
and License Agreement and a Stock Purchase Agreement with Catalytica Fine
Chemicals, Inc. ("CFC"), a subsidiary of Catalytica, Inc., that included the
purchase of 150,000 shares of Series B Preferred stock by Pfizer. The holders of
the Series B Preferred stock shall be entitled to receive non-cumulative
dividends at a rate of $6.00 per share, per annum, when and if declared by the
Board of Directors. In consideration of the $15 million paid, CFC is obligated
to perform specified agreed upon research for a five year period. Accordingly,
Catalytica recognized Pfizer's minority interest in CFC at $8 million and
recorded deferred revenue of $7 million to be recognized as research is
performed. As $536,000 of research was performed and recognized as revenue as
of December 31, 1996, the deferred revenue balance pertaining to Pfizer is $6.5
million at December 31, 1996.
In conjunction with the Stock Purchase agreement, the Company entered into a
Share Exchange agreement, providing Pfizer the right to exchange the Series B
preferred stock of the Company for Catalytica, Inc. (Catalytica) common stock.
After the three year anniversary of the agreement, Pfizer shall have the right
to require the Company to exchange all of the outstanding shares of Series B
preferred stock for that number of shares of common stock based upon a
determined exchange rate. The exchange rate is based upon the fair value of the
preferred stock and the market value of Catalytica's common stock at the time of
conversion. In the event of insolvency of the Company, Pfizer may convert
$4,200,000 of Series B preferred shares into 700,000 shares of Catalytica's
common stock.
NOTE 3. BUSINESS COMBINATIONS AND DISPOSALS
FORMATION OF JOINT VENTURE (GENXON) On October 15, 1996, Catalytica's
wholly owned subsidiary, Catalytica Combustion Systems Inc. (CCSI), and Woodward
Governor Company formed a Delaware limited liability company in connection with
a 50/50 joint venture to serve the gas turbine retrofit market for installed,
out-of-warranty engines. The new company, GENXON(TM)
53
<PAGE>
Power Systems, LLC, will initially provide gas turbine fleet asset planning and
utilization services for both power generation and mechanical drive markets.
The initial capital commitment of the GENXON joint venture partners is $10
million: $2 million from CCSI, and $8 million from Woodward, payable over time
as the funds are required by the joint venture. These capital infusions are
predicated upon reaching certain milestones, and neither joint venture partner
is contractually required to make further capital infusions if these milestones
are not met. CCSI will account for its share of the joint venture gain or loss
upon the first cash infusion totaling $1.0 million which occurred on January 3,
1997 upon completion of a milestone. Prior to January 3, 1997, the joint
venture was being funded entirely by Woodward Governor.
Research revenue in the amount of $.5 million was recorded from GENXON in
conjunction with the achievement of a milestone in December 1996. This
reimbursement was for costs incurred by the Company in the development of the
proprietary technology prior to the formation of the joint venture. Subsequent
to the formation of the joint venture, the Company received reimbursements for
cost incurred by the Company on behalf of GENXON totaling $1,996,000.
Accordingly, these costs have not been included in the consolidated entity.
As of December 31, 1996, accounts receivable of $865,000 were outstanding from
GENXON. This receivable was paid in full in January 1997.
ADVANCED SENSOR DEVICES On June 28, 1996, Catalyica completed the sale of
substantially all the business of its wholly owned subsidiary, Advanced Sensor
Devices, Inc. (ASD), to Monitor Labs, Inc. ASD produced continuous emission
monitors (CEMs) based on proprietary catalytic sensors. The terms for selling
substantially all of ASD's assets included an initial payment of approximately
$1.1 million at the closing, an additional $0.5 million paid upon certification
for the CEM product which occurred in December 1996, and a royalty stream based
on future revenues. For the year ended December 31, 1996, Catalytica realized a
$0.9 million gain on the sale of ASD's assets.
NOTE 4. PURCHASE OF FINE CHEMICALS MANUFACTURING FACILITY
On October 15, 1993, the Company signed an agreement with Novartis to
acquire a fine chemicals manufacturing facility including its existing buildings
and equipment located in East Palo Alto, California ("Site"). The facility,
located on five acres, is a multipurpose fine chemicals manufacturing plant with
several general purpose reactors totaling approximately 10,000 gallons in
capacity. Concurrent with the agreement to acquire the building and equipment,
the Company entered into a ground lease agreement with Rhone Poulenc Inc. to
lease the surface of the Site. The ground lease commenced on November 30, 1993
for an initial term of 15 years (see Note 10). The Company spent $1.0 million
and $1.6 million on leasehold improvements in 1996 and 1995, respectively at
this Site.
Because of significant soil and groundwater contamination caused by past
activities on the Site, Rhone Poulenc Inc. is remediating the soil and
groundwater of the Site pursuant to an order from the Bay Area Regional Water
Quality Control Board ("RWQCB"). Pursuant to the ground lease with Rhone
Poulenc Inc., the Company has received an indemnity for the contamination which
is the subject of the RWQCB's order.
54
<PAGE>
In addition to the facility purchase agreement, the Company signed a
separate agreement with Novartis to be the sole supplier of a fine chemicals
intermediate that is used in a proprietary product marketed by Novartis. The
supply agreement expires on May 31, 1998, but may be extended beyond the initial
term by mutual agreement of both parties. As security for the Company's
performance of all obligations under this agreement, Novartis holds a first lien
security interest in the equipment used to manufacture this proprietary product.
Should the Company fail to fully perform, this lien will provide Novartis the
right to recover the equipment during the life of the supply agreement. Once
the agreement expires, Novartis has no further rights to the equipment.
ENVIRONMENTAL REGULATIONS The rate at which the Company's catalytic
combustion systems are adopted by industrial companies will be heavily
influenced by the enactment and enforcement of environmental regulations at the
federal, state, and local levels. Federal law requires state and local
authorities to determine specific strategies for reducing emissions or specific
pollutants. Among other strategies, state and local authorities in all areas
which do not meet ambient air quality standards must adopt performance standards
for all major new and modified sources of air pollution. The more polluted the
air in a particular region has become, the more stringent such controls must be.
The Company's revenues will depend, in part, on the standards, permit
requirements, and programs these state and local authorities promulgate for
reducing emissions (including emissions of NOx) addressed by the Company's
combustion systems. Demand for the Company's systems and processes will be
affected by how quickly the standards are implemented and the level of
reductions required. There can be no assurance that these regulations will ever
be adopted.
Many of the fine chemicals products the Company manufactures, or will
manufacture in the future, and the final drug products in which they are used,
are subject to regulation for safety and efficacy by the FDA and foreign
regulatory authorities before such products can be commercially marketed. The
process of obtaining regulatory clearances for marketing is uncertain, costly,
and time-consuming. The Company cannot predict how long the necessary
regulatory approvals will take, or if its customers will ever obtain such
approval for their products. To the extent the Company's customers do not
obtain the necessary regulatory approvals for marketing new products, the
Company's fine chemicals product sales will be adversely affected.
NOTE 5. RELATED PARTY TRANSACTIONS
PFIZER INC. On May 8, 1996, Catalytica Fine Chemicals, Inc. ("CFC") entered
into a collaborative research and license agreement and a stock purchase
agreement with Pfizer Inc. ("Pfizer"). In consideration for the $15 million
paid, Pfizer received 150,000 shares of Catalytica Fine Chemicals Series B
Preferred stock and a five-year R&D commitment by Catalytica Fine Chemicals to
develop new processes and technology for the manufacture of Pfizer products.
The holders of the Series B Preferred stock shall be entitled to receive non-
cumulative dividends at a rate of $6.00 per share, per annum, when and if
declared by the Board of Directors. Catalytica recognized Pfizer's minority
interest in CFC at $8 million and recorded deferred revenue of $7 million to be
recognized as research is performed. As $536,000 of research was performed and
recognized as revenue as of December 31, 1996, the deferred revenue balance
pertaining to Pfizer is $6.5 million at December 31, 1996. Prior to this
investment, Catalytica Fine Chemicals was a wholly-owned subsidiary of
Catalytica, Inc. (See Note 2).
55
<PAGE>
KOCH INDUSTRIES, INC. In connection with certain agreements between the
company and Koch Industries entered into in 1991 and 1992, the Company is
required to reimburse Koch up to 15% of the future pre-tax income realized by
Catalytica, if any, associated with commercialization or licensing of several
technologies developed under research agreements with Koch. On December 22,
1995, rights to the Naphthalene Alkylation technology were sold to Koch in
return for $50,000 and future royalty payments should Koch commercialize the
technology. At December 31, 1996 and 1995, the amounts which could be required
to be paid out of pretax profits realized from activities related to these
technologies and which accrue interest from December 1991 total $15,258,000 and
$14,092,000 respectively. The Company is not currently developing or marketing
any of these technologies.
Subject to the terms of this agreement, the Company owes Koch $213,000 in
royalties payable as of December 31, 1996, for license fees realized on the
gasoline alkylation project related to funding received from Conoco and Neste
(See Note 1). This obligation, which originally totaled $640,000 at December 31,
1994, was converted to a promissory note payable in quarterly installments
amortized over three years with interest accruing at the prime rate compounded
annually (See Note 7).
GENXON(TM) POWER SYSTEMS, LLC As discussed in Note 3, on October 15, 1996,
Catalytica's wholly owned subsidiary, Catalytica Combustion Systems Inc. (CCSI)
and Woodward Governor Company formed a Delaware limited liability company in
connection with a 50/50 joint venture to serve the gas turbine retrofit market
for installed, out-of-warranty engines. The new company, GENXON(TM) Power
Systems, LLC, will develop and sell XONON combustion systems to be retrofitted
on existing turbines in the power generation and mechanical drive markets.
Research revenue in the amount of $.5 million was recorded from GENXON in
conjunction with the achievement of a milestone in December 1996. This amount
was a reimbursement for costs incurred by the Company in the development of the
proprietary technology prior to the formation of the joint venture. As of
December 31, 1996, accounts receivable of $865,000 were outstanding from GENXON.
This receivable was paid in full in January 1997. Subsequent to the formation of
the joint venture, the Company received reimbursements for cost incurred by the
Company on behalf of GENXON totaling $1,996,000. Accordingly, these costs have
not been included in the consolidated entity.
NOTE 6. PENSION AND PROFIT SHARING PLANS
The Company has a defined contribution pension plan and a nonqualified
pension plan for employees meeting certain requirements, based on a defined
percentage of the employees' compensation. Pension expense amounted to
approximately $324,000, $297,000, and $270,000, for each of the three years
ended December 31, 1996, 1995, and 1994, respectively.
NOTE 7. DEBT
During fiscal 1991, the Company borrowed $830,000 from a collaborative
partner to partially fund improvements to its facilities. Per the note
agreement, the Company made annual interest payments based on the outstanding
loan balance from 1992 through 1994. Commencing in
56
<PAGE>
December, 1995, the Company made the first of four annual principal payments,
which extend through 1998. This loan, which bears interest at 7% per year, is
unsecured. The balance of the loan was $415,000 at December 31, 1996.
In November 1995, the Company's Fine Chemicals subsidiary obtained a line of
credit which was guaranteed by Catalytica, Inc. The working capital line of
credit agreement limited the Company's borrowings to the lesser of $2,000,000 or
the eligible portion of the Company's accounts receivable and contract rights.
The line of credit was paid off in full June 30, 1996. For the six months this
loan was outstanding in 1996, the average interest rate and the average amount
outstanding were 9.79% and $875,000 respectively.
The Company's Fine Chemicals subsidiary renewed and increased its working
capital line of credit in September 1996. Under the current agreement, the
Company's total borrowings are limited to the lesser of $3,500,000, or $500,000
plus 80% of the Company's eligible accounts receivable (which were $2,499,000 at
December 31, 1996). The agreement is secured by Fine Chemicals' current and
future assets. Borrowings under this arrangement bear interest at the prime
rate plus 1 1/2%. As of December 31, 1996, the outstanding balance on this loan
was $2,300,000, with an interest rate of 9.75%. This line of credit agreement
expires in September, 1997.
The Fine Chemicals subsidiary had another credit agreement representing a
promissory note of $1,500,000 for the purpose of refinancing the subsidiary's
outstanding subordinated debt to Catalytica, Inc. The note was paid in full
June 30, 1996. For the six months this loan was outstanding in 1996, the
average interest rate and the average amount outstanding were 10.29% and
$1,500,000 respectively.
The Fine Chemicals subsidiary also has two term loans from the same
lender, both of which are restricted to purchases of equipment. Under the first
loan, the Company had an outstanding balance of $930,000 at December 31, 1996,
and $1,167,000 at December 31, 1995. Borrowings under this credit agreement
have converted to five-year term loans maturing through June 30, 2000, are
secured by the Company's current and future assets, and bear interest ranging
from 9.71% to 11.82%. The average interest rate and the average amount
outstanding on this loan during 1996 were 11.52% and $1,061,000 respectively.
The second credit agreement, funded October 1996, authorizes borrowings up
to $500,000. Once the draw down period expires in June 1997, it will convert to
a fully amortized, five year term loan. This agreement originally carried a
variable interest rate of the prime rate plus 1 3/4%. In December 1996, this
loan was converted to a fixed rate of 9.95%. For the three months this loan was
outstanding in 1996, the average interest rate was 10.00%. As of December 31,
1996, total outstanding borrowings on this credit agreement were $500,000.
The three credit facilities discussed above contain various covenants. At
June 30, 1995, the Company was in violation of one of these covenants. The
loan includes a covenant that requires the Bay View Facility to achieve certain
minimum profitability requirements. During the quarter ended June 30, 1995, the
requirement was for break-even operations. The actual loss for the quarter
amounted to $72,000. The bank agreed to waive the covenant for the quarter
ended June 30, 1995. On September 28, 1995, and on November 30, 1995, the bank
agreed to redefine certain financial covenants. As a result of these amendments
to the original line of credit agreement, the Company
57
<PAGE>
was in compliance with the covenants contained in its line of credit agreement,
and believes that it will remain in compliance throughout the remaining term of
the agreement. Accordingly, amounts payable under the credit facilities due more
than one year from the balance sheet date continue to be classified as long-
term. The Company has not been in violation of any bank covenants subsequent to
the initial violation in 1995.
When the working capital line of credit was renewed on September 24, 1996,
the original note, which included the two term loans, was amended to release any
and all guarantees by Catalytica. The notes and line of credit are now solely
the responsibility of Fine Chemicals, which is required to maintain a tangible
net worth plus subordinated debt of at least $6.0 million.
As discussed in Note 5, the Company owed Koch $213,000 in royalties payable
as of December 31, 1996, for license fees. The average interest rate and the
average amount outstanding on this loan during 1996 were 8.27% and $347,000
respectively. This note is also unsecured.
In 1996, the Company entered into a capital lease to purchase two
compressors for its Combustion Systems subsidiary. The minimum principal
payments due on the lease, which has a three-year term, are approximately
$254,000 at December 31, 1996.
In 1995 and 1996, the Company entered into two capital leases to purchase
office trailers for use at its Bay View facility. The minimum principal
payments on the leases, which both have three-year terms, amount to
approximately $14,000 at December 31, 1996.
In 1996, the Company entered into a capital lease to purchase a telephone
system for its Bay View facility. The minimum principal payments on the lease,
which has a five-year term, are $29,000 at December 31, 1996.
Fair value of debt is based on pricing models or securities with similar
terms, and approximates carrying value.
At December 31, 1996, future minimum principal payments on debt were as follows:
1997................... $ 3,133,000
1998................... 696,000
1999................... 499,000
2000................... 140,000
2001................... 122,000
----------
$ 4,590,000
===========
Cash paid for interest for each of the three years ended December 31, 1996,
1995 and 1994, amounted to approximately $354,000, $278,000, and $86,000,
respectively.
NOTE 8. RESTRUCTURING OF OPERATIONS
During the third quarter of fiscal 1994, the Company incurred a
restructuring charge of $499,000 related to streamlining certain operations to
reduce expenses and to focus on the commercialization of the Company's
technologies. The charge primarily related to severance costs
58
<PAGE>
associated with reducing the Company's workforce by 18%, or 20 people. All such
severance obligations have been paid.
NOTE 9. INCOME TAXES
A reconciliation between the Company's effective tax rate and the U.S. statutory
rate is as follows (in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
-------- --------- ---------
<S> <C> <C> <C>
Tax at federal statutory rate................................................. $(1,765) $ (2,954) $ (3,109)
Losses not currently benefited................................................ 1,765 2,954 3,109
------- -------- --------
Provision for income taxes.................................................... $ ---- $ ---- $ ----
</TABLE>
The components of deferred income taxes consist of the following at
December 31 (in thousands):
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Deferred tax assets:
Capitalized R&D costs..................................................................... $ 1,022 $ 923
Net operating loss carryforwards.......................................................... 14,561 12,982
Credit carryforwards...................................................................... 184 184
Other, net................................................................................ 1,384 2,722
-------- --------
Total deferred tax assets................................................................... $ 17,151 $ 16,811
Valuation allowance......................................................................... (17,151) (16,811)
-------- --------
Net deferred tax assets..................................................................... $ ---- $ ----
======== ========
</TABLE>
The realization and amount of any tax benefit from the deferred tax asset
of $17,151,000 is dependent upon the generation of future taxable income and the
tax rate in effect in such years. Accordingly, due to the uncertainty of
realizing future taxable earnings, a valuation allowance has been established
for the deferred tax asset. The valuation allowance increased by $340,000 and
$4,283,000 during 1996 and 1995 respectively.
At December 31, 1996, for federal income tax purposes, the Company has net
operating loss carryforwards of approximately $42,600,000 which expire in the
years 1998 through 2011. The net operating loss carryforwards differ from the
accumulated deficit as a result of temporary differences in the recognition of
certain revenue and expense items for financial and federal tax reporting
purposes, primarily consisting of expenses not currently deductible for tax
reporting purposes.
The Company also has approximately $184,000 of investment and research and
development credit carryforwards that will expire in years 1997 through 2000.
Investment tax credits will be accounted for under the flow-through method when
utilized.
The Company also has net operating loss carryforwards for California income
tax purposes of approximately $1,100,000 that will expire in years 1997 through
2000. The net operating loss carryforwards differ from the accumulated deficit
as a result of the 50% limitation for net operating loss carryforwards, the
expiration of previous years' state net operating losses, capitalized research
59
<PAGE>
and development costs, and as a result of temporary differences in the
recognition of certain revenue and expense items for financial and state tax
reporting purposes.
An initial public offering of the Company's Common Stock was completed by
the Company during fiscal 1993. The utilization of federal net operating loss
and the deduction equivalent of federal tax credit carryforwards incurred prior
to the offering of approximately $14,163,000 will be subject to an annual
limitation of approximately $4,150,000 per year. Future changes in ownership
may result in additional limitations.
NOTE 10. COMMITMENTS
Catalytica leases its research and office facilities in Mountain View under
an operating lease agreement that expires on December 31, 1998, after which the
Company has the option for a five-year extension. The fine chemicals
manufacturing facility in East Palo Alto is owned by the Company; however, the
land at the facility is leased under a ground lease agreement commencing
November 30, 1993 (see Note 4). The lease expires on November 30, 2008, after
which the Company has two five-year options to extend the lease term, and one
four-year option to extend the lease term after expiration of the first two
option periods.
Annual minimum rental payments which principally relate to the research and
office facilities through 1998 are $707,000 per year. Rent expense was
$732,000, $707,000, and $713,000 for each of the three years ended December 31,
1996, 1995, and 1994, respectively.
The aggregate minimum annual commitments under all operating leases as of
December 31, 1996, are as follows:
FISCAL YEAR
1997.................... 707,000
1998.................... 707,000
1999.................... 38,000
2000.................... 38,000
2001.................... 38,000
and thereafter.......... 266,000
----------
$1,794,000
==========
NOTE 11. STOCKHOLDERS' EQUITY
STOCKHOLDERS RIGHTS PLAN
On October 28, 1996 the Board of Directors adopted a Stockholders
Rights Plan providing a dividend of rights (which cannot be exercised until
certain events occur) to purchase shares of preferred stock of the Company.
Each shareholder of record receives one right for each share of common stock
then owned. This plan was adopted to ensure that all stockholders of the
Company receive fair value for their common stock in the event of any proposed
takeover of the Company and to guard against coercive tactics to gain control
of the Company without offering fair value to the Company's stockholders.
60
<PAGE>
PREFERRED STOCK
The Company has 5,000,000 shares of Preferred Stock authorized, all of
which are unissued and undesignated. The Board of Directors of the Company has
the authority, without further vote or action by the stockholders, to issue
these undesignated shares of Preferred Stock in one or more series and to fix
the rights, qualifications, preferences, privileges, limitations, and
restrictions of each such series, including dividend rights, terms or
redemption, redemption prices, liquidation preferences, and the number of shares
constituting any series or the designation of such series.
STOCK OPTION AND STOCK PURCHASE PLANS
The Company has elected to follow Accounting Principles Board No. 25,
"Accounting for Stock Issued to Employees" (APB 25) and related Interpretations
in accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS
123), requires the use of option valuation models that were not developed for
use in valuing employee stock options. Under APB 25, because the exercise price
of the Company's stock options generally equals the market price of the
underlying stock on the date of grant, no compensation expense is recognized.
Pro forma information regarding net income and earnings per share is
required by FAS 123 which also requires that the information be determined as if
the Company has accounted for its employee stock awards and those of its
subsidiaries granted subsequent to December 31, 1994, under the fair value
method of this Statement. The fair value for these options was estimated at the
date of grant using a Black-Scholes multiple option pricing model with the
following weighted average assumptions:
<TABLE>
<CAPTION>
WEIGHTED
RISK FREE AVERAGE COMPENSATION
INTEREST RATE EXPECTED LIFE EXPENSE
--------------------- DIVIDEND VOLATILITY ----------------------------------
1996 1995 YIELD FACTOR 1996 1995 1996 1995
---- ---- ----- ------ ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Catalytica, Inc. Stock Option Plans 6.42 6.03 0.0 .8852 3.5 3.0 $ 470 $ 295
Catalytica Employee Stock Purchase Plan 6.03 6.03 0.0 .8852 1.7 1.4 74 180
Catalytica Advanced Technologies, Inc. 6.67 6.47 0.0 .8852 7.0 8.0 25 22
Catalytica Combustion Systems, Inc. 6.57 6.26 0.0 .8852 5.0 6.0 66 49
Catalytica Fine Chemicals, Inc. 6.39 6.11 0.0 .8852 3.5 4.1 44 36
------------
Total $ 679 $ 582
</TABLE>
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option models require the input of
highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
Had compensation cost for the Company's stock-based compensation plans been
determined based on the fair value at the grant dates for awards under those
plans consistent with the method of
61
<PAGE>
FAS 123, the Company's net loss and loss per share would have been increased to
the pro forma amounts indicated below:
1996 1995
---- ----
(in thousands, except per share data)
Actual net loss........................................ $(5,192) $(8,687)
Compensation expense................................... $ (679) $ (582)
Pro forma net loss..................................... $(5,871) $(9,269)
Pro forma loss per share............................... $ (0.30) $ (0.59)
Since compensation expense is recognized over the vesting period of the
related options, which are generally five years, and because pro forma
disclosure is only required commencing with 1995, the initial impact on pro
forma income may not be representative of compensation expense in future years.
CATALYTICA INC.
1995 CATALYTICA DIRECTOR STOCK OPTION PLAN In 1995, the Company adopted
the 1995 Director Option Plan under which 100,000 shares were reserved for
future issuance. Under the 1995 Director Option Plan, the Board of Directors is
authorized to grant nonqualified stock options to Outside Directors to provide
incentive to continue service on the Board. The nonqualified stock options may
be granted at a price of not less than 100% of the fair market value of Common
Stock on the date of grant. Options generally become exercisable ratably over
three years from the date of grant and expire no later than ten years from the
date of grant.
1992 CATALYTICA STOCK OPTION PLAN In 1992, the Company adopted the 1992
Stock Option Plan under which 1,950,000 shares have been reserved for future
issuance. Under the 1992 Stock Option Plan, the Board of Directors is
authorized to grant incentive stock options, or nonqualified stock options to
eligible employees and consultants, although incentive stock options may be
granted only to employees. Incentive stock options may be granted at an
exercise price of not less than 100% of the fair market value of Common Stock on
the date of grant while nonqualified stock options may be granted at a price not
less than 50% of the value of the Common Stock. Options generally become
exercisable ratably over five years from the date of grant and expire no later
than ten years from the date of grant.
CATALYTICA NON-QUALIFIED STOCK OPTION PLAN Since 1985, the Company has
granted to certain directors, officers, and consultants 438,800 nonqualified
stock options at an average price of $0.51 per share. As of December 31, 1996,
8,000 shares had been exercised, and 428,400 were exercisable. Of the amounts
disclosed, 400,000 options were granted in 1985 to an officer of the Company who
is now a director. All options were granted at the fair market value at the
date of grant.
1983 CATALYTICA INCENTIVE STOCK OPTION PLAN The Company established an
incentive stock option plan in 1983 pursuant to which 1,240,000 shares were
reserved for future issuance to employees. The plan provided for full-time
employees to be granted options to purchase common shares at fair value, as
determined by the Board of Directors. The 1983 Incentive Stock Option Plan
expired, in accordance with its terms, on May 16, 1993. While all future awards
will be made under the 1992 Stock Option Plan, awards made under the 1983
Incentive Stock Option Plan will continue
62
<PAGE>
to be administered in accordance with that plan. All shares reserved but
unissued under that plan were canceled.
1983 CATALYTICA RESTRICTED STOCK PURCHASE PLAN The Company has a 1983
restricted stock purchase plan pursuant to which 200,000 shares were reserved
for future issuance to employees. Under the 1983 Employee Restricted Stock
Purchase Plan, employees purchased 179,357 common shares at fair value, as
determined by the Board of Directors. The 1983 Restricted Stock Purchase Plan
expired, in accordance with its terms, on May 16, 1993. All shares reserved but
unissued under that plan were canceled. No shares were subject to repurchase.
In September, 1995, the Company implemented a stock exchange program
whereby certain option holders could exchange higher priced options for a
reduced number of new options at the current fair market value. Options
canceled and regranted are reflected in the table below.
The following table summarizes stock option plan activity for the 1995
Director Stock Option Plan, the 1992 Stock Option Plan, the 1985 Catalytica Non-
Qualified Plan, the 1983 Incentive Stock Option Plan, and the 1983 Restricted
Stock Purchase Plan:
<TABLE>
<CAPTION>
Outstanding Options
Shares --------------------------------------------------
Available Number Weighted Aggregate
for of Average Exercise
Grant Shares Exercise Price Price
--------- ------------------- -------------- -----------
<S> <C> <C> <C> <C>
Balance at December 31, 1993.................................... 587,680 1,259,650 $1.44 $ 1,814,610
Granted..................................................... (261,726) 261,726 $6.27 1,640,969
Exercised................................................... --- (192,892) $0.81 (155,790)
Canceled.................................................... 46,030 (46,030) $3.87 (177,948)
Expired..................................................... (22,009) --- --- ---
------------------------------------------------------------------
Balance at December 31, 1994.................................... 349,975 1,282,454 $2.43 $ 3,121,841
Authorized.................................................. 100,000 --- --- ---
Granted..................................................... (534,659) 534,659 $3.38 1,807,002
Exercised................................................... --- (49,575) $0.76 (37,866)
Canceled.................................................... 265,473 (265,473) $5.97 (1,585,034)
Expired..................................................... (3,765) --- --- ---
------------------------------------------------------------------
Balance at December 31, 1995 177,024 1,502,065 $2.20 $ 3,305,943
Authorized.................................................. 1,200,000 --- --- ---
Granted..................................................... (308,700) 308,700 $3.89 1,201,756
Exercised................................................... --- (124,095) $1.56 (194,102)
Canceled.................................................... 37,017 (37,017) $3.63 (134,310)
Expired..................................................... (4,200) --- --- ---
------------------------------------------------------------------
Balance at December 31, 1996 1,101,141 1,649,653 $2.53 $ 4,179,287
</TABLE>
The weighted average fair value of options granted during 1996 is $2.33
63
<PAGE>
A summary of the Company's stock option activity and related information for
the year ended December 31, 1996 is as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------------ --------------------------
WEIGHTED NUMBER OF WEIGHTED
RANGE OF NUMBER AVERAGE WEIGHTED EXERCISABLE AS AVERAGE
EXERCISE OUTSTANDING REMAINING AVERAGE OF DECEMBER 31, EXERCISE
PRICES DECEMBER 31, 1996 CONTRACTUAL LIFE EXERCISE PRICE 1996 PRICE
- -------------------- ------------------- ---------------- ------------------- --------------- --------
<S> <C> <C> <C> <C> <C>
$0.4500 - $0.6000 486,700 7.02 $0.4684 486,700 $0.4684
$0.9000 - $0.9000 124,969 4.18 $0.9000 124,969 $0.9000
$1.8000 - $1.8000 122,890 5.31 $1.8000 96,160 $1.8000
$3.2500 - $3.8800 734,181 8.93 $3.5080 138,721 $3.2621
$4.3800 - $5.3800 51,000 8.51 $4.8853 21,700 $4.8542
$5.7500 - $6.5000 129,913 6.81 $6.1038 65,866 $6.0312
-----------------------------------------------------------------------------------------
$0.4500 - $6.5000 1,649,653 7.55 $2.5334 934,115 $1.5722
</TABLE>
1992 CATALYTICA EMPLOYEE STOCK PURCHASE PLAN
In 1992, the Company adopted the 1992 Employee Stock Purchase Plan ("ESPP")
under which 500,000 shares have been reserved for future issuance. Under the
1992 Employee Stock Purchase Plan, employees of the Company are given an
opportunity to purchase Common Stock of the Company through accumulated payroll
deductions. Shares are purchased under the ESPP at 85% of the fair market value
at certain specified dates. Of the 500,000 shares authorized to be issued under
this plan, 283,517 are available for issuance at December 31, 1996. For the
year ended December 31, 1996, employees purchased 82,757 shares for $214,606.
For the year ended December 31, 1995, employees purchased 70,370 shares for
$181,000. For the year ended December 31, 1994, employees purchased 33,955
shares for $141,000. The weighted average fair value of those purchase rights
granted in January 1996 and January 1995 were 1.86 and 1.65, respectively.
CATALYTICA DEFERRED COMPENSATION
The Company granted to an officer, certain employees, and consultants
options to purchase 36,910 shares of Common Stock at an exercise price of $1.80
per share in 1992, for which the Company recorded deferred compensation
amounting to approximately $234,000. The deferred compensation is being
amortized into earnings ratably over the vesting period of the option, five
years.
WARRANTS
The Company issued a warrant to purchase 320,000 shares of Common Stock at
a price per share equal to $4.80 per share in connection with its financing in
November, 1995. This warrant expires on November 3, 2000.
ADVANCED SENSOR DEVICES INC.
1995 Advanced Sensor Devices Stock Option Plan In 1995, The Company
adopted the 1995 Advanced Sensor Devices Stock Option Plan under which 400,000
shares were reserved for future issuance and 312,600 shares were granted in
1995. The company believes the stock underlying these options has no value as a
result of the sale of Advanced Sensor Devices' assets. Therefore, these options
have not been valued in accordance with the provisions of FASB 123. (See Note
3).
64
<PAGE>
CATALYTICA ADVANCED TECHNOLOGIES, INC.
1995 CATALYTICA ADVANCED TECHNOLOGIES STOCK OPTION PLAN In 1995, The
Company adopted the 1995 Catalytica Advanced Technologies Stock Option Plan
under which 900,000 shares have been reserved for future issuance. Under the
1995 Catalytica Advanced Technologies Stock Option Plan, the Catalytica Advanced
Technologies Board of Directors is authorized to grant incentive stock options,
or nonqualified stock options to eligible employees and consultants, although
incentive stock options may be granted only to employees. The incentive stock
options generally vest ratably over four years from the date of grant and expire
no later than ten years from the date of grant. Nonqualified stock options vest
ratably over three years from the date of grant and expire no later than ten
years from the date of grant. These options become exercisable upon an initial
public offering of the subsidiary's stock, acquisition of more than 50% of the
subsidiary's outstanding securities by a third party, or upon reaching the date
January 1, 2004.
The following table summarizes stock option plan activity for the 1995
Catalytica Advanced Technologies Stock Option Plan:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
SHARES ---------------------------------------------------
AVAILABLE NUMBER WEIGHTED AGGREGATE
FOR OF AVERAGE EXERCISE
GRANT SHARES EXERCISE PRICE PRICE
--------- ------------------- -------------- ---------
<S> <C> <C> <C> <C>
Balance at December 31, 1994.................................... --- --- --- ---
Authorized.................................................... 800,000 --- --- ---
Granted....................................................... (756,500) 756,500 $0.1000 $75,650
Exercised..................................................... --- --- --- ---
Canceled...................................................... --- --- --- ---
Expired....................................................... --- --- --- ---
-------------------------------------------------------------
Balance at December 31, 1995.................................... 43,500 756,500 $0.1000 $75,650
Authorized.................................................... 100,000 --- --- ---
Granted....................................................... (80,000) 80,000 $0.1000 8,000
Exercised..................................................... --- --- --- ---
Canceled...................................................... 8,000 (8,000) $0.1000 (800)
Expired....................................................... --- --- --- ---
-------------------------------------------------------------
Balance at December 31, 1996 71,500 828,500 $0.1000 $82,850
=============================================================
</TABLE>
The weighted average fair value of options granted during 1996 was $0.08.
At December 31, 1996, options outstanding had a weighted average remaining
contractual life of 8.74 years and options to purchase approximately 360,737
shares of Catalytica Advanced Technologies common stock were vested with a
weighted average exercise price of $.10/share.
65
<PAGE>
CATALYTICA COMBUSTION SYSTEMS, INC.
1995 CATALYTICA COMBUSTION SYSTEMS STOCK OPTION PLAN In 1995, The Company
adopted the 1995 Catalytica Combustion Systems Stock Option Plan under which
750,000 shares were reserved for future issuance. Under the 1995 Catalytica
Combustion Systems Stock Option Plan, the Catalytica Combustion Systems Board of
Directors is authorized to grant incentive stock options, or nonqualified stock
options to eligible employees and consultants, although incentive stock options
may be granted only to employees. The incentive stock options generally vest
ratably over four years from the date of grant and expire no later than ten
years from the date of grant. Nonqualified stock options vest ratably over
three years from the date of grant and expire no later than ten years from the
date of grant. These options become exercisable upon an initial public offering
of the subsidiary's stock, acquisition of more than 50% of the subsidiary's
outstanding securities by a third party, or upon reaching the date January 1,
2004.
The following table summarizes stock option plan activity for the 1995
Catalytica Combustion Systems Stock Option Plan:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
SHARES ---------------------------------------------------
AVAILABLE NUMBER WEIGHTED AGGREGATE
FOR OF AVERAGE EXERCISE
GRANT SHARES EXERCISE PRICE PRICE
--------- ------------------- -------------- ---------
<S> <C> <C> <C> <C>
Balance at December 31, 1994.................................... --- --- --- ---
Authorized.................................................... 750,000 --- --- ---
Granted....................................................... (498,100) 498,100 $0.4000 $199,240
Exercised..................................................... --- --- --- ---
Canceled...................................................... --- --- --- ---
Expired....................................................... --- --- --- ---
-------------------------------------------------------------
Balance at December 31, 1995.................................... 251,900 498,100 $0.4000 $199,240
Granted....................................................... (242,900) 242,900 $0.4000 97,160
Exercised..................................................... --- --- --- ---
Canceled...................................................... 72,292 (72,292) $0.4000 (28,917)
Expired....................................................... --- --- --- ---
-------------------------------------------------------------
Balance at December 31, 1996 81,292 688,707 $0.4000 $267,483
=============================================================
</TABLE>
The weighted average fair value of options granted during 1996 was $0.29.
At December 31, 1996, options outstanding has a weighted average remaining
contractual life of 8.95 years and options to purchase approximately 234,028
shares of Catalytica Combustion Systems common stock were vested with a weighted
average exercise price of $.40/share.
66
<PAGE>
CATALYTICA FINE CHEMICALS, INC.
1995 FINE CHEMICALS STOCK OPTION PLAN In 1995, The Company adopted the 1995
Fine Chemicals Stock Option Plan under which 478,000 shares have been reserved
for future issuance. Under the 1995 Fine Chemicals Stock Option Plan, the
Catalytica Fine Chemicals Board of Directors is authorized to grant incentive
stock options, or nonqualified stock options to eligible employees and
consultants, although incentive stock options may be granted only to employees.
The incentive stock options generally vest ratably over four years from the date
of grant and expire no later than ten years from the date of grant.
Nonqualified stock options vest ratably over three years from the date of grant
and expire no later than ten years from the date of grant. These options become
exercisable upon an initial public offering of the subsidiary's stock,
acquisition of more than 50% of the subsidiary's outstanding securities by a
third party, or upon reaching the date January 1, 2004.
The following table summarizes stock option plan activity for the 1995 Fine
Chemicals Stock Option Plan:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
SHARES ---------------------------------------------------
AVAILABLE NUMBER WEIGHTED AGGREGATE
FOR OF AVERAGE EXERCISE
GRANT SHARES EXERCISE PRICE PRICE
--------- ------------------- -------------- ---------
<S> <C> <C> <C> <C>
Balance at December 31, 1994.................................... --- --- --- ---
Authorized.................................................... 378,000 --- --- ---
Granted....................................................... (377,100) 377,100 $0.4000 $150,840
Exercised..................................................... --- --- --- ---
Canceled...................................................... --- --- --- ---
Expired....................................................... --- --- --- ---
-------------------------------------------------------------
Balance at December 31, 1995.................................... 900 377,100 $0.4000 $150,840
Authorized.................................................... 100,000 --- --- ---
Granted....................................................... (121,900) 121,900 $0.6631 80,830
Exercised..................................................... --- --- --- ---
Canceled...................................................... 23,000 (23,000) $0.4000 (9,200)
Expired....................................................... --- --- --- ---
-------------------------------------------------------------
Balance at December 31, 1996 2,000 476,000 $0.4674 $222,470
=============================================================
</TABLE>
The weighted average fair value of options granted during 1996 was $0.40.
At December 31, 1996, options to purchase approximately 181,996 shares of
Catalytica Fine Chemicals common stock were vested with a weighted average
exercise price of $.40/share.
A summary of Catalytica Fine Chemicals' stock option activity and related
information for the year ended December 31, 1996 is as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------------ --------------------------
WEIGHTED NUMBER OF WEIGHTED
RANGE OF NUMBER AVERAGE WEIGHTED EXERCISABLE AS AVERAGE
EXERCISE OUTSTANDING REMAINING AVERAGE OF DECEMBER 31, EXERCISE
PRICES DECEMBER 31, 1996 CONTRACTUAL LIFE EXERCISE PRICE 1996 PRICE
- -------------------- ------------------- ---------------- ------------------- -------------- --------
<S> <C> <C> <C> <C> <C>
$0.4000 - $0.4000 369,100 8.48 $0.4000 181,996 $0.4000
$0.7000 - $0.7000 106,900 9.52 $0.7000 0 $0.0000
$0.4000 - $0.7000 476,000 8.71 $0.4674 181,996 $0.4000
</TABLE>
67
<PAGE>
NOTE 13. SUBSEQUENT EVENT
On February 5, 1997, the Company signed a letter of intent with Glaxo
Wellcome Inc. to acquire its pharmaceutical production facility in Greenville,
North Carolina. The proposed agreement requires Catalytica to purchase all of
the land, buildings and equipment at the 1.8 million-square-foot facility. In
addition to the asset purchase agreement, Catalytica will enter into a
manufacturing contract to supply designated Glaxo Wellcome prescription
products.
Under the terms of the proposed transaction, Catalytica will pay Glaxo
Wellcome certain cash consideration. In addition, Glaxo Wellcome will receive a
small equity stake in Catalytica Fine Chemicals. The agreement also provides
for Glaxo Wellcome to receive a share of the profits from Catalytica's
production in the Greenville site's sterile products facility. Determination of
the total purchase price will be based upon the completion of due diligence with
respect to the assets acquired and liabilities assumed.
68
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CATALYTICA, INC.
(Registrant)
Dated: March 28, 1997 By: /s/ Ricardo B. Levy
-------------------
Ricardo B. Levy
President and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Ricardo B. Levy, his attorney-in-fact,
for him in any and all capacities, to sign any amendments to this Report on Form
10-K, and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that said attorney-in-fact, or his substitute, may
do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the Registrant in
the capacities and on the date indicated.
<TABLE>
<CAPTION>
<S> <C> <C>
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Ricardo B. Levy President, Chief Executive Officer March 28, 1997
- --------------------------- (Principal Executive Officer), and Director
Ricardo B. Levy
/s/ James A. Cusumano Chairman of the Board and Chief Technical March 28 ,1997
- --------------------------- Officer
James A. Cusumano
/s/ Lawrence W. Briscoe Vice President, Finance and Administration, March 28 ,199
- --------------------------- and Chief Financial Officer (Principal
Lawrence W. Briscoe Accounting and Financial Officer)
/s/ Ralph A. Dalla Betta Vice President and Chief Scientist March 28 ,1997
- ---------------------------
Ralph A. Dalla Betta
/s/ Utz Felcht Director March 28 ,1997
- ---------------------------
Utz Felcht
/s/ Richard Fleming Director March 28 ,1997
- ---------------------------
Richard Fleming
</TABLE>
69
<PAGE>
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Ernest Mario Director March 28 ,1997
- ---------------------------
Ernest Mario
/s/ Yoshindo Tomoi Director March 28 ,1997
- ---------------------------
Yoshindo Tomoi
</TABLE>
70
<PAGE>
EXHIBIT 10.26
---------------------------------------
LIMITED LIABILITY OPERATING AGREEMENT
OF
GENXON POWER SYSTEMS, LLC
A DELAWARE LIMITED LIABILITY COMPANY
OCTOBER 21, 1996
---------------------------------------
<PAGE>
TABLE OF CONTENTS
PAGE
----
SECTION 1 DEFINITIONS .................................................... 1
SECTION 2 FORMATION ...................................................... 5
2.1 Formation and Name............................................ 5
2.2 Term.......................................................... 6
2.3 Purpose and Scope............................................. 6
2.4 Principal Office.............................................. 6
2.5 Delaware Registered Office and Agent for Service of Process... 6
2.6 Members, Additional Members and Assignees..................... 6
2.7 Required Documents............................................ 7
2.8 Title to Property............................................. 7
SECTION 3 CAPITALIZATION OF THE COMPANY .................................. 7
3.1 Members' Interests; Units..................................... 7
3.2 Capital Commitments........................................... 7
3.3 Capital Contributions......................................... 8
3.4 Capital Commitment Termination................................ 9
3.5 Capital Requirements Above $10 million........................ 9
3.6 Remedies for Failure to Fund.................................. 9
3.7 Withdrawal and Return of Capital.............................. 10
3.8 Loans to the Company.......................................... 10
3.9 Interest on Capital........................................... 10
3.10 Limitation of Liability; Return of Certain Distributions...... 10
SECTION 4 ALLOCATION OF PROFITS AND LOSSES ............................... 11
4.1 Allocations of Profits and Losses............................. 11
4.2 Modifications to Preserve Underlying Economic Objectives...... 13
4.3 Withholding Taxes............................................. 14
SECTION 5 DISTRIBUTIONS .................................................. 15
5.1 Tax Distributions............................................. 15
5.2 Operating Distributions....................................... 15
5.3 True Up Contribution and Distributions........................ 15
5.4 Liquidating Distributions..................................... 16
5.5 Distributions upon Withdrawal or Removal...................... 16
5.6 Limitation on Distributions................................... 16
5.7 Return of Distributions....................................... 16
<PAGE>
TABLE OF CONTENTS
(CONTINUED)
PAGE
----
SECTION 6 ADMINISTRATIVE PROVISIONS ...................................... 16
6.1 Meetings of Members........................................... 16
6.2 Board of Managers............................................. 18
6.3 Meetings of the Board of Managers............................. 19
6.4 Major Decisions............................................... 20
6.5 Interested Managers........................................... 21
6.6 Officers 22
6.7 Reimbursements................................................ 22
6.8 Reliance by Third Parties..................................... 23
6.9 Outside Businesses............................................ 23
6.10 Services of Affiliates........................................ 24
6.11 Business Plan, Budget and Financial Reports................... 24
6.12 Confidentiality............................................... 25
6.13 Disclosures 25
6.14 Tax Matters Partner........................................... 25
SECTION 7 TRANSFERS OF COMPANY INTERESTS; WITHDRAWALS AND REMOVALS ....... 26
7.1 General Provisions Regarding Transfers........................ 26
7.2 Withdrawal by a Member........................................ 27
7.3 Removal of a Member........................................... 28
7.4 Status of Assignees........................................... 28
SECTION 8 DISSOLUTION AND LIQUIDATION .................................... 30
8.1 Dissolving Events............................................. 30
8.2 Winding Up of the Company..................................... 30
SECTION 9 LIABILITY PROVISIONS ........................................... 31
9.1 Liability..................................................... 31
9.2 Indemnification............................................... 31
SECTION 10 GENERAL PROVISIONS ............................................ 32
10.1 Status Under the Act.......................................... 32
10.2 Entire Agreement.............................................. 32
10.3 Amendments.................................................... 32
(ii)
<PAGE>
TABLE OF CONTENTS
(CONTINUED)
PAGE
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10.4 Governing Law................................................. 33
10.5 Severability.................................................. 33
10.6 Counterparts; Binding upon Members and Assignees.............. 33
10.7 Survival of Rights............................................ 34
10.8 Survival of Obligations....................................... 34
10.9 No Third Party Beneficiaries.................................. 34
10.10 Notices....................................................... 34
10.11 Partnership for Tax Purposes Only............................. 35
10.12 Avoidance of Publicly Traded Partnership Status............... 35
10.13 Dispute Resolution............................................ 36
10.14 Penalty Provisions............................................ 36
EXHIBIT A Schedule of Members
EXHIBIT B-1 CCSI Technology License
EXHIBIT B-2 WGC Technology License
EXHIBIT C Services Agreement
EXHIBIT D Supply Agreement
(iii)
<PAGE>
THIS OPERATING AGREEMENT of GENXON Power Systems, LLC, a Delaware
limited liability company, is entered into as of October 21, 1996.
-----------------------------------
SECTION 1
DEFINITIONS
-----------------------------------
As used in this Agreement:
ACT shall mean the Delaware Limited Liability Company Act, as amended.
ADDITIONAL MEMBER shall mean any Person, other than a Substitute Member,
admitted to the Company as a Member after the date first above written.
AFFILIATE shall mean, with respect to any Person, any other Person with
regard to which the Person is controlling, controlled or commonly controlled.
For purposes of the preceding sentence, "control" shall mean the power to direct
the principal business management and activities of a Person, whether through
ownership of voting securities, by agreement, or otherwise.
AGREEMENT shall mean this Operating Agreement of GENXON Power Systems, LLC,
a Delaware limited liability company.
ANCILLARY AGREEMENT shall have the meaning set forth in Section 3.6(c).
ANNUAL BUDGET shall have the meaning set forth in Section 6.11(b).
ASSIGNEE shall mean a Person that has acquired an interest in the Company
(including, without limitation, a Person that has acquired such interest by
means of a Transfer permitted under Section 7), but that has not been admitted
as a Member.
BANKRUPTCY shall, with respect to a Member, have the meaning set forth in
Section 18-304 of the Act.
BENEFICIAL OWNER shall mean, with respect to a Member, any Person that
holds an equity interest in such Member, either directly or indirectly through a
nominee or agent or through one or more intervening entities qualifying as
partnerships, grantor trusts or S corporations, in each case as determined for
Federal income tax purposes.
BOARD OF MANAGERS shall have the meaning set forth in Section 6.2.
BUSINESS PLAN shall have the meaning set forth in Section 6.11(a).
<PAGE>
CAPITAL ACCOUNT shall mean, for each Member, a separate account that is:
(a) Increased by: (i) the amount of such Member's Capital
Contribution and (ii) allocations of Profit to such Member pursuant to
Section 4;
(b) Decreased by: (i) the amount of cash distributed to such Member
by the Company, (ii) the fair market value of any other property distributed to
such Member by the Company (determined as of the time of distribution, without
regard to Section 7701(g) of the Code, and net of liabilities secured by such
property that the Member assumes or to which the Member's ownership of the
property is subject) and (iii) allocations of Loss to such Member pursuant to
Section 4;
(c) Revalued in connection with any event described in Treasury
Regulation Section 1.704-1(b)(2)(iv)(f); and
(d) Otherwise adjusted so as to conform to the requirements of
Sections 704(b) and (c) of the Code and the Treasury Regulations issued
thereunder.
CAPITAL COMMITMENT shall mean, for any Member, the total amount of cash
and/or property required to be contributed by such Member to the capital of the
Company pursuant to Section 3. The Capital Commitment of a Member shall be set
forth on Exhibit A and shall be adjusted as required under this Agreement.
CAPITAL CONTRIBUTION shall mean, for any Member, the sum of the net amount
of cash and the fair market value of any other property (determined as of the
time of contribution, without regard to Section 7701(g) of the Code, and net of
liabilities secured by such property that the Company assumes or to which the
Company's ownership of the property is subject) contributed by such Member to
the capital of the Company. The term "capital contribution" (where not
capitalized) shall mean any contribution to the capital of the Company valued in
accordance with the rules set forth in the preceding sentence.
CCSI shall mean Catalytica Combustion Systems, Inc., a Delaware company.
CERTIFICATE OF FORMATION shall mean the Certificate of Formation of the
Company filed in the Office of the Secretary of State of Delaware, as such may
be amended from time to time in accordance with Section 10.5.
CLOSE OF BUSINESS shall mean 5:00 p.m., local time, in San Francisco,
California.
CODE shall mean the United States Internal Revenue Code of 1986, as
amended.
COMPANY shall mean GENXON Power Systems, LLC, a Delaware limited liability
company.
DEFAULT shall have the meaning set forth in Section 3.6(c).
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<PAGE>
DEFAULTING MEMBER shall have the meaning set forth in Section 3.6.
FISCAL YEAR shall mean the period from October 1 through September 30 of
each year (unless otherwise required by law).
FAIR MARKET VALUE shall mean the fair market value of the Company's Units
as determined by the procedure set forth in Section 7.1(c).
FUNDING DEFAULT shall have the meaning set forth in Section 3.6.
GAAP shall mean United States generally accepted accounting principles,
consistently applied.
INDEMNIFIED PERSON shall mean each Member and each equity holder, member,
director, officer, employee, or agent of a Member. In addition, "Indemnified
Person" shall mean any Member of the Board of Managers, any employee or any
agent of the Company to the extent determined by the Board of Managers in their
reasonable discretion. A Person that has ceased to hold a position that
previously qualified such Person as an Indemnified Person shall be deemed to
continue as an Indemnified Person with regard to all matters arising or
attributable to the period during which such Person held such position.
INITIAL UNITS shall have the meaning set forth in Section 3.1.
INTEREST shall mean a Member's interest in the Company.
MAJOR DECISIONS shall have the meaning set forth in Section 6.4.
MAJORITY IN INTEREST OF THE MEMBERS shall mean a group of Members whose
aggregate Percentage Interests equal more than 50% of the total Percentage
Interests of all the Members as of the time of such determination.
MANAGEMENT shall mean the executive officers of the Company.
MATERIAL MISCONDUCT shall mean, with respect to an Indemnified Person,
gross negligence, a willful and material breach of this Agreement, fraud, breach
of a fiduciary duty arising under this Agreement, or commission of a felony.
For purposes of the preceding sentence: (i) an Indemnified Person that consults
with legal counsel, an accountant or other expert in respect of Company affairs
shall be deemed to have acted in good faith and without negligence with regard
to any action or inaction that is taken in accordance with the advice or opinion
of such advisor so long as such advisor was selected with reasonable care; and
(ii) an Indemnified Person's reliance upon the truth and accuracy of any written
statement, representation or warranty of a Member shall be deemed to have been
reasonable and in good faith absent such Indemnified Person's actual knowledge
that such statement, representation or warranty was not, in fact, true and
accurate.
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<PAGE>
MEMBER shall mean any Person (i) listed on Exhibit A as a Member or (ii)
admitted to the Company pursuant to the terms of this Agreement as an Additional
Member or a Substitute Member, but only if such Person has not withdrawn or been
removed from the Company within the meaning of Section 7.2 or 7.3 or Transferred
its entire membership interest to one or more Members and/or Persons admitted to
the Company as Substitute Members pursuant to Section 7.4. Without limiting the
foregoing, a Member shall not cease to be a Member or lose its non-economic
rights in respect of the Company solely by virtue of having transferred to one
or more Persons its entire economic interest in the Company. Except where the
context requires otherwise, a reference in this Agreement to "the Members" shall
mean all of the Members (taken together or acting unanimously, as appropriate).
MEMBER NONRECOURSE DEDUCTION shall mean an item of loss, expense or
deduction attributable to a nonrecourse liability of the Company for which a
Member bears the economic risk of loss within the meaning of Treasury Regulation
Section 1.704-2(i).
MINIMUM GAIN of the Company shall, as provided in Treasury Regulation
Section 1.704-2, mean the total amount of gain the Company would realize for
Federal income tax purposes if it disposed of all assets subject to a
nonrecourse liability for no consideration other than full satisfaction thereof.
NONRECOURSE DEDUCTION shall mean an item of loss, expense or deduction
(other than a Member Nonrecourse Deduction) attributable to a nonrecourse
liability of the Company within the meaning of Treasury Regulation Section
1.704-2(b).
PERCENTAGE INTEREST shall mean, for each Member, such Members percentage
ownership of the Company as determined by dividing the number of Units owned by
such Member by the total outstanding Units of the Company.
PERSON shall mean an individual, partnership, corporation, limited
liability company, unincorporated organization, trust, joint venture,
governmental agency, or other entity, whether domestic or foreign.
PRINCIPAL OFFICE shall have the meaning set forth in Section 2.4.
PROFITS AND LOSSES shall mean, for any period, the Company's items of
income and gain (including, without limitation, items not subject to Federal
income tax) as well as items of loss, expense and deduction (including, without
limitation, items not deductible, depreciable, amortizable or otherwise
excludable from income for Federal income tax purposes), respectively, as
determined under Federal income tax principles; provided, however, that Profits
and Losses attributable to assets with a book value that differs from tax basis
(as determined under Federal income tax rules) shall be determined with regard
to such book value in the manner required under Treasury Regulation Section
1.704-1(b).
SERVICES AGREEMENT shall have the meaning set forth in Section 6.10(b).
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<PAGE>
STATE shall mean any constituent state of the United States.
SUBSTITUTE MEMBER shall mean an Assignee of all or a portion of a Member's
interest in the Company that becomes a Member and succeeds, to the extent of the
interest assigned, to the rights and powers and becomes subject to the
restrictions and liabilities of the assignor Member.
SUPPLY AGREEMENT shall have the meaning set forth in Section 6.10(c).
TAX MATTERS PARTNER shall have the meaning set forth in Section 6.14(a).
TRANSFER shall mean any sale, exchange, transfer, gift, encumbrance,
assignment, pledge, mortgage, hypothecation or other disposition, whether
voluntary or involuntary.
TREASURY REGULATION shall mean a regulation issued by the United States
Treasury Department and relating to a matter arising under the Code.
TRUE UP DATE shall mean the earlier of (i) the first date after March 31,
1997 on which additional Capital Contributions are required under Section 3.3(d)
or (ii) December 31, 1999.
UNIT shall mean a unit of interest in the Company.
UNITED STATES shall mean the United States of America.
WGC shall mean Woodward Governor Company, a Delaware company.
WORKING CAPITAL shall mean current assets less current liabilities
(excluding deferred revenues associated with order prepayments).
-----------------------------------
SECTION 2
FORMATION
-----------------------------------
2.1 FORMATION AND NAME.
(a) The Members hereby enter into and form the Company as a limited
liability company governed by the Act for the limited purpose and scope set
forth in this Agreement.
(b) The name of the Company shall be "GENXON Power Systems, LLC".
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<PAGE>
2.2 TERM. The term of the Company shall commence upon the later of: (i)
the filing of the Company's Certificate of Formation with the office of the
Delaware Secretary of State or (ii) the execution of this Agreement by two or
more Members. Except as specifically provided in Section 8, the existence of the
Company shall be perpetual.
2.3 PURPOSE AND SCOPE. The purpose and scope of the Company shall be to
develop and sell products and services to users of out of warranty gas turbines
which require reductions in emissions, overhaul or upgrade, and in connection
therewith, to develop catalytic combustion systems and associated products, and
any other lawful purpose which the Board of Managers may determine in the
future.
2.4 PRINCIPAL OFFICE. The Principal Office initially shall be located at
430 Ferguson Drive, Mountain View, CA 94043, and may thereafter be changed from
time to time by a Majority in Interest of the Members.
2.5 DELAWARE REGISTERED OFFICE AND AGENT FOR SERVICE OF PROCESS. The
Company shall maintain a Delaware registered office and agent for service of
process as required by the Act. In the event the registered agent ceases to act
as such for any reason or the registered office shall change, the Board of
Managers shall promptly designate a replacement registered agent or file a
notice of change of address, as the case may be. If the Board of Managers shall
fail to promptly designate a replacement registered agent or file a notice of
change of address of the registered office, any Member may designate a
replacement registered agent or file a notice of change of address of the
registered office.
2.6 MEMBERS, ADDITIONAL MEMBERS AND ASSIGNEES.
(a) Each Person whose name is listed on Exhibit A is hereby admitted
as a Member.
(b) Set forth below the name of each Member on Exhibit A shall be
appropriate contact information for such Member (including, without limitation,
such Member's mailing address, telephone number, and telecopy number as well as,
in the case of a Member that is an entity, the name or title of an individual to
whom correspondence should be directed). Each Member shall promptly provide the
Company with the contact information required to be set forth for such Member on
Exhibit A and shall thereafter promptly notify the Company of any change to such
information.
(c) Additional Members may be admitted to the Company only with the
consent of a Majority in Interest of the Members.
(d) The Company shall not issue Assignee interests.
(e) Notwithstanding Sections 2.6(c) and (d), the provisions of
Section 7 shall apply with regard to the admission of Substitute Members and the
Transfer of Assignee interests by Members and Assignees.
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<PAGE>
2.7 REQUIRED DOCUMENTS.
(a) COMPANY DOCUMENTS. The Members shall cause to be executed,
filed, recorded, or amended, as necessary, the Certificate of Formation and any
other documents required or desirable, as determined by the Board of Managers in
their reasonable discretion, to be executed, filed, recorded or amended in
connection with the formation, operation or dissolution of the Company pursuant
to the laws of the State of Delaware or any other jurisdiction in which the
Company's business is conducted. The terms and provisions of each document
described in the preceding sentence shall be initially established and shall be
amended as necessary to cause such terms and provisions to be consistent with
the terms and provisions of this Agreement.
(b) OTHER DOCUMENTS. The Members shall execute and acknowledge such
other documents as may be necessary or desirable, as determined by the Board of
Managers in their reasonable discretion, to give effect to the terms of this
Agreement.
2.8 TITLE TO PROPERTY. Title to all Company property shall be held in the
name of the Company. No Member shall have any interest in any specific property
of the Company. Except as otherwise permitted by this Agreement, no Member shall
have the right, and each Member does hereby agree that it shall not seek, to
cause a partition of the Company's property whether by court action or
otherwise.
-----------------------------------
SECTION 3
CAPITALIZATION OF THE COMPANY
-----------------------------------
3.1 MEMBERS' INTERESTS; UNITS. The Interests of the Members in the Company
shall be represented by Units, as set forth opposite each Member's name on
Appendix A, and as adjusted pursuant to the provisions of this Agreement. The
Company is authorized to issue up to 200,000 Units. Each Unit shall on the date
of this Agreement shall represent $200 in value of Capital Commitments ("Initial
Units"). The Initial Units for CCSI shall be 50,000 Units and the Initial Units
for WGC shall be 50,000 Units.
3.2 CAPITAL COMMITMENTS. The Capital Commitment of each Member shall be as
set forth opposite such Member's name on Exhibit A, as adjusted under Sections
---------
3.4 and 3.5 below. Unless provided otherwise in this Agreement, the Capital
Commitment installments of each Member to the Company shall be due at such times
and in such amounts as are requested by the Board of Managers. To the maximum
extent permitted by the Act, no third party shall be entitled to rely on the
Capital Commitment obligations set forth herein or to demand that the Board of
Managers make any capital call.
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<PAGE>
3.3 CAPITAL CONTRIBUTIONS.
(a) Except as provided in Section 3.3(b)(i) and (iii), all Capital
Contributions shall be paid in cash unless agreed otherwise by the contributing
Member and the Board of Managers. The capital contribution obligations provided
for in this Section 3.3(a) are for the benefit of the Company and the Members.
(b) INITIAL CAPITAL CONTRIBUTIONS; TECHNOLOGY LICENSES.
(i) The initial cash Capital Contribution for CCSI on the
date of the Agreement shall be equal to the costs incurred by CCSI, and agreed
to by WGC, between January 1, 1996 and August 1, 1996, to develop catalytic
combustion systems for the 1.5 MW KHI and PW FT4 gas turbines and any cash or
other amounts contributed to the Company (and not previously reimbursed) as of
such date.
(ii) The initial cash Capital Contribution for WGC on the
date of this Agreement shall be equal to $2.5 million cash.
(iii) In addition to the Capital Contributions to be made
under paragraphs (i) and (ii) above, CCSI and WGC shall each contribute the
technology licenses described in subclauses (A) and (B) below.
(A) CCSI shall contribute the technology licensed to
the Company pursuant to the terms as substantially set forth in Exhibit B-1
-----------
hereto (the "CCSI License"). The Members hereby agree that the value of such
contribution is equal to $8 million.
(B) WGC shall contribute the technology licensed to
the Company pursuant to the terms as substantially set forth in Exhibit B-2
-----------
hereto (the "WGC License"). The Members hereby agree that the value of such
contribution is equal to $2 million.
(c) POST JANUARY 1, 1997 INCREASE TO CAPITAL COMMITMENTS. At such
time after January 1, 1997, as the Company's preliminary design of the catalytic
combustion system and related controls for the PW FT4 gas turbine is completed
in a manner satisfactory to the Board of Managers, CCSI and WGC shall each make
a Capital Contribution of $1 million.
(d) SUBSEQUENT CAPITAL CALLS. Subsequent to the date of the
fulfillment of Section 3.3(c), if (i) the Company shall have operated the KHI
gas turbine for a cumulative total of one hundred hours, (ii) the Working
Capital of the Company is less than $1,000,000 (the "Threshold Funding Level")
and (iii) the management of the Company notifies the Board of Managers that its
Working Capital is below the Threshold Funding Level, then CCSI and WGC shall be
required to make an additional Capital Contribution to the Company. The amount
of any such additional Capital Contribution pursuant to this Section 3.3(d)
shall be equal to the lesser of (a) $1,000,000 or (b) the aggregate balance of
the remaining CCSI and WGC Capital Commitments, respectively. Such additional
Capital Contributions shall be made solely by WGC until the aggregate Capital
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<PAGE>
Contributions of CCSI and WGC are in the ratio of 1:4, respectively, and
thereafter shall be made in proportion to the remaining Capital Commitments of
the two parties.
3.4 CAPITAL COMMITMENT TERMINATION. If GENXON is able to conduct its
business as directed by the Board of Managers and after a period of five years
from the date of this Agreement has not made capital calls which fully utilize
the aggregate Capital Commitments of CCSI and WGC then the unutilized Capital
Commitments of CCSI and/or WGC as of such date shall terminate.
3.5 CAPITAL REQUIREMENTS ABOVE $10 MILLION. If, after notification by the
President of the Company, the Board of Managers determines that the Company
requires capital in excess of CCSI and WGC's initial $10 million of Capital
Commitments in order to continue to operate, the Board of Managers shall
promptly notify the Members of the Company's excess capital requirements. Each
Member shall have the right to contribute its pro rata share of such excess
capital requirement, based on relative Percentage Interests, and shall have ten
(10) days from the date it receives such excess capital requirements notice to
both notify the Board of Managers of its desire to exercise such right and make
such capital contributions as are necessary to exercise such right. If any of
the Member's fails to exercise such rights within the ten (10) day period, each
exercising Member shall have the right to assume a pro rata portion of such non-
exercising Member's share, based on relative Percentage Interests, and shall
thereafter have an additional five (5) days to both notify the Board of Managers
of its desire to exercise such right and make such capital contributions as are
necessary to exercise such right. Members exercising their rights under this
Section shall be issued additional Units for their respective contributions to
the Company, amounts to be based on the Fair Market Value of Company Units as of
the date of the excess capital requirement notice, and the Member's Percentage
Interests in the Company shall be adjusted thereafter accordingly. For purposes
of the preceding sentence, the Fair Market Value of Units shall be determined
under the valuation procedures set forth in Section 7.1(c).
3.6 REMEDIES FOR FAILURE TO FUND. If any Member defaults on its
obligations to make the capital contributions provided for under Sections 3.3,
or 3.4 (a "Defaulting Member") and has failed to cure such default within ten
(10) days after the receipt of the initial written funding call (a "Funding
Default"), the Company, acting through the non-Defaulting Members'
representatives on the Board of Managers, in its discretion may elect (but is
not limited to) any one or more of the following alternatives.
(a) The Company shall issue additional Units upon a Capital
Contribution by the Non-Defaulting Members such that the Defaulting Member's
Percentage Interest in future Profits and Losses of the Company is reduced to
1%;
(b) The Company shall receive the right to a perpetual and exclusive
license to the technology granted under the CCSI License in the case where CCSI
is the Defaulting Member, and to the technology granted under the WGC License in
the case where WGC is the Defaulting Member; and
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<PAGE>
(c) If a Member fails to make a Capital Contribution such that the
Member becomes a Defaulting Member (a "Default"), such Defaulting Member's
obligation to sell or otherwise supply any products or services to the Company
as may be required under any agreement entered into by the parties in connection
with this Agreement (an "Ancillary Agreement") shall continue under the terms of
such Ancillary Agreement and shall in no way be affected by such Default.
Notwithstanding the foregoing, in the case of a Default by a Member as described
by this Section 3.6(c), the obligations of the Company to such Defaulting Member
under any Ancillary Agreement shall continue at the discretion of the Board of
Managers, as determined by the representatives on the Board of Managers of the
non-defaulting Members.
3.7 WITHDRAWAL AND RETURN OF CAPITAL. No Member may withdraw any portion
of its Capital Contribution or Capital Account balance. Except as provided in
Section 5 or 8, no Member shall be entitled to the return of such Member's
Capital Contribution or to a distribution in respect of such Member's Capital
Account balance.
3.8 LOANS TO THE COMPANY. No Member shall be required to lend any money to
the Company or to guarantee any Company indebtedness.
3.9 INTEREST ON CAPITAL. No Member shall be entitled to interest on such
Member's Capital Contribution or Capital Account balance.
3.10 LIMITATION OF LIABILITY; RETURN OF CERTAIN DISTRIBUTIONS
(a) Except as otherwise required by the Act or this Section 3.10, a
Member shall have no personal liability for the debts and obligations of the
Company and shall not be required to return any distributions received from the
Company. Without limiting the foregoing, the failure to observe any formalities
relating to the management or administration of the Company shall not be grounds
for imposing upon any Member personal liability to third parties for the
Company's debts and obligations.
(b) A Member that receives a distribution (i) in violation of this
Agreement or (ii) that is required to be returned to the Company under the Act
shall return such distribution immediately upon demand therefor by any Member.
(c) The Company may, in its sole and absolute discretion, elect to
withhold from any distributions otherwise payable to a Member amounts due to the
Company from such Member.
(d) Nothing in this Section 3.10 shall be applied to release any
Member from (i) its obligation to make capital contributions pursuant to this
Section 3 or other payments specifically required under this Agreement or (ii)
its obligations pursuant to any relationship between the Company and such Member
acting in a capacity other than as a Member (including, for example, as a
borrower or independent contractor).
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-----------------------------------
SECTION 4
ALLOCATION OF PROFITS AND LOSSES
----------------------------------
4.1 ALLOCATIONS OF PROFITS AND LOSSES.
(a) GENERAL. Except as otherwise provided in this Section 4.1,
Profits and Losses of the Company shall be allocated as follows:
(i) Profits shall be allocated:
(A) First, as necessary to offset in reverse order
any items of Loss allocated pursuant to Section 4.1(b)(i) and not previously
offset under this Section 4.1(a)(i)(A);
(B) Next, as necessary to offset in reverse order
any items of Loss allocated pursuant to Section 4.1(a)(ii) and not previously
offset under this Section 4.1(a)(i)(B); and
(C) Thereafter, to CCSI and WGC in proportion to
their respective Percentage Interests.
(ii) Losses shall be allocated:
(A) First, as necessary to offset in reverse order
any items of Profit allocated pursuant to Section 4.1(b)(ii) and not previously
offset under this Section 4.1(a)(ii)(A); and
(B) First, as necessary to offset in reverse order
any items of Profit allocated pursuant to Section 4.1(a)(i) and not previously
offset under this Section 4.1(a)(ii)(B); and
(C) Thereafter, to CCSI and WGC in proportion to
their respective Percentage Interests.
(b) PRE- TRUE UP DATE ALLOCATIONS. Notwithstanding Section 4.1(a),
prior to the True Up Date Losses and Profits of the Company shall be allocated
as follows.
(i) Losses shall be allocated:
(A) First, to CCSI and WGC in proportion to their
respective Percentage Interests until the Capital Account balance of WGC is
equal to zero;
(B) Next, to CCSI until its Capital Account balance
is equal to (x) the aggregate cash Capital Contributions of CCSI minus (y) 25%
of the aggregate cash Capital Contributions of WGC; and
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<PAGE>
(C) Thereafter, 100% to WGC.
(ii) Profits shall be allocated:
(A) First, as necessary to offset in reverse order
any items of Loss allocated pursuant to Section 4.1(b)(i) and not previously
offset under this Section 4.1(b)(ii)(A); and
(B) Thereafter, to CCSI and WGC in proportion to
their respective Percentage Interests.
(c) MEMBER NONRECOURSE DEDUCTIONS. In accordance with the provisions
of Treasury Regulation Section 1.704-2(i), each item of Member Nonrecourse
Deduction shall be allocated among the Members in proportion to the economic
risk of loss that the Members bear with respect to the nonrecourse liability of
the Company to which such item of Member Nonrecourse Deduction is attributable.
(d) EXCESS LOSSES OTHERWISE ALLOCABLE TO A MEMBER. If and to the
extent that any items of net Loss otherwise allocable to a Member under Section
4.1(a) or (b) would create a negative balance in the Capital Account of such
Member (or increase the amount by which such Capital Account balance is
negative), the items shall not be allocated to such Member pursuant to Section
4.1(a) or (b), as applicable, but shall instead be allocated as follows:
(i) First, to the Members as a group, in proportion to their
respective positive Capital Account balances, until the Capital Account balance
of each Member has been reduced to (but not less than) zero; and
(ii) Next, to the Members as a group in proportion to their
respective Percentage Interests.
To the extent that there have been allocations of Loss away from a Member under
this Section 4.1(d) that have not subsequently been reversed pursuant to this
sentence or Section 4.1(i), the next available items of Profit otherwise
allocable to such Member pursuant to Section 4.1(a) or (b), as applicable, shall
be allocated to the Members to whom such items of Loss had been allocated under
this Section 4.1(d) so as to first offset in reverse order such allocations of
Loss.
(e) BOOK - TAX ACCOUNTING DISPARITIES. Solely for Federal income tax
purposes, if Company property is reflected in the Capital Accounts of the
Members at a book value (i.e., the property's basis for purposes of determining
Profit and Loss with respect thereto as determined in accordance with the
principles set forth in the definition of Profits and Losses in Section 1) that
differs from the adjusted tax basis of such property, allocations of
depreciation, amortization, income, gain or loss with respect to such property
shall be made among the Members in a manner which takes such difference into
account in accordance with Section 704(c) of the Code and Section 1.704-3(b) of
the Treasury Regulations issued thereunder. The Members shall, within 30 days
after the date first above written, agree upon an equitable method that complies
with the requirements of Section 704(c)
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of the Code to allocate actual and/or constructive amortization deductions
attributable to property contributed by the Members to the Company in connection
with the Company's formation.
(f) ADJUSTMENT TO CAPITAL ACCOUNTS FOR DISTRIBUTIONS OF PROPERTY. If
property distributed in kind is reflected in the Capital Accounts of the Members
at a book value (i.e., the property's basis for purposes of determining Profit
and Loss with respect thereto as determined in accordance with the principles
set forth in the definition of Profits and Losses in Section 1) that differs
from the Fair Market Value of the property at the time of distribution, the
difference shall be treated as Profit or Loss on the sale of the property and
shall be allocated among the Members in accordance with the provisions of this
Section 4.1.
(g) ALLOCATIONS IN EVENT OF TRANSFER. If an interest in the Company
is Transferred in accordance with this Agreement, allocations of Profits and
Losses as between the transferor and transferee shall be made pursuant to any
method chosen by the Board of Managers that is permitted under Section 706 of
the Code.
(h) TAX ALLOCATIONS. Taking into account the requirements of Section
4.1(e), items of Company income, gain, loss, deduction or credit recognized for
Federal income tax purposes shall be allocated among the Members for Federal
income tax purposes in a manner that is consistent with the requirements of the
Code and the Treasury Regulations.
(i) REALLOCATION OF CERTAIN LOSSES. To the extent that: (i) Losses
which otherwise would have been allocated to a Member under this Section 4.1
were allocated to one or more other Members under Section 4.1(d); (ii) such
allocation has not been reversed pursuant to the subsequent operation of Section
4.1(d) or this Section 4.1(i); and (iii) the Member thereafter returns a
distributed amount as required under Section 3.7 or otherwise makes a
contribution to the capital of the Company, the Capital Accounts of the Members
shall be adjusted in connection with such return or contribution (to the extent
of the value thereof) to effect a reallocation of such Losses to the Member.
4.2 MODIFICATIONS TO PRESERVE UNDERLYING ECONOMIC OBJECTIVES.
(a) CHANGE IN LAW. If, in the opinion of counsel to the Company,
there is a change in the Federal income tax law (including the Code as well as
the Treasury Regulations, rulings, and administrative practices thereunder)
which makes it necessary or prudent to modify the allocation provisions of this
Section 4 in order to preserve the underlying economic objectives of the Members
as reflected in this Agreement, the Members shall make the minimum modification
necessary to achieve such purpose.
(b) BORROWING. In the event the Company borrows money or property,
the Members shall modify the allocation provisions of this Section 4 to the
minimum extent necessary to ensure that allocations relating to such borrowing
are respected for Federal income tax purposes while, to the maximum extent
possible, preserving the underlying economic objectives of the Members as
reflected in this Agreement.
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(c) SECTION 754 ELECTION. In the event the Company makes an election
to adjust the basis of the Company's assets under Section 754 of the Code, the
Members shall modify the allocation provisions of this Section 4 to the minimum
extent necessary to ensure that subsequent allocations relating to such adjusted
basis are respected for Federal income tax purposes while, to the maximum extent
possible, preserving the underlying economic objectives of the Members as
reflected in this Agreement.
4.3 WITHHOLDING TAXES.
(a) The Company shall withhold taxes from distributions to, and
allocations among, the Members to the extent required by law (as determined by
the Members in their reasonable discretion). Except as otherwise provided in
this Section 4.3, any amount so withheld by the Company with regard to a Member
shall be treated for purposes of this Agreement as an amount actually
distributed to such Member pursuant to Section 5.1(a). An amount shall be
considered withheld by the Company if, and at the time, remitted to a
governmental agency without regard to whether such remittance occurs at the same
time as the distribution or allocation to which it relates; provided, however,
that an amount actually withheld from a specific distribution or designated by
the Members as withheld from a specific allocation shall be treated as if
distributed at the time such distribution or allocation occurs.
(b) To the extent that operation of Section 4.3(a) would create a
negative balance in a Member's Capital Account or increase the amount by which
such Capital Account balance is negative (in each case determined as if,
immediately prior to the deemed distribution of the withheld amount, all of the
Company's assets had been valued pursuant to Section 7.1(c) and any previously
unallocated Profits or Losses allocated pursuant to this Section 4), the amount
of the deemed distribution shall instead be treated as a loan by the Company to
such Member, which loan shall be payable upon demand by the Members and shall
bear interest at a floating rate equal to the prime rate as announced from time
to time by the Bank, compounded daily.
(c) Each Member hereby agrees to indemnify the Company and the other
Members for any liability they may incur for failure to properly withhold taxes
in respect of such Member; moreover, each Member hereby agrees that neither the
Company nor any other Member shall be liable for any excess taxes withheld in
respect of such Member's interest in the Company and that, in the event of
overwithholding, a Member's sole recourse shall be to apply for a refund from
the appropriate governmental authority.
(d) Taxes withheld by third parties from payments to the Company
shall be treated as if withheld by the Company for purposes of this Section 4.3.
Such withholding shall be deemed to have been made in respect of all the Members
in proportion to their respective allocative shares under Section 4.1 of the
underlying items of Profit to which such third party payments are attributable
unless, and to the extent that, the Members select a different apportionment
method in respect of a specific withholding tax following a determination by the
Members in their reasonable discretion that such method is necessary, in light
of the nature of such tax, to achieve a fair and equitable apportionment among
the Members. In the event that the Company receives a refund of taxes previously
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withheld by a third party from one or more payments to the Company, the economic
benefit of such refund shall be apportioned among the Members in a manner
reasonably determined by the Members to offset the prior operation of this
Section 4.3(d) in respect of such withheld taxes.
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SECTION 5
DISTRIBUTIONS
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5.1 TAX DISTRIBUTIONS.
(a) The Company shall distribute to each Member, not later than
ninety (90) days after the close of each Fiscal Year, an amount of cash equal to
the product of: (x) the Tax Rate and (y) the net taxable income and gain
allocated to such Member for such Fiscal Year (as shown on the Company's Federal
income tax return). For purposes of this Agreement, "Tax Rate" shall mean the
highest blended Federal and appropriate state for the Members marginal statutory
income tax rate (determined for the fiscal year in question without regard to
phaseouts of deductions or similar adjustments) applicable to ordinary income
recognized by a corporation resident in such states.
(b) Solely for purposes of determining whether the Company has
satisfied its distribution obligation under Section 5.1(a), all cash
distributions made during a Fiscal Year shall be treated as tax distributions
made pursuant to Section 5.1(a) in respect of such Fiscal Year except to the
extent that such distributions were required to satisfy the obligations of the
Company under Section 5.1(a) in respect of one or more prior Fiscal Years and
the Company shall not be obligated to make a Tax Distribution for any Fiscal
Year in which the Company's taxable income for such period does not exceed
$250,000.
5.2 OPERATING DISTRIBUTIONS. Subject to Section 5.7, operating
distributions of cash or property shall be made at such times and in such
amounts as shall be determined by the Board of Managers. Each operating
distribution shall be made to the Members in proportion to their respective
positive Capital Account balances, except that a Member may elect to forego some
or all of its share of any distribution. No Member shall be entitled to a pro
rata portion of any particular asset of the Company distributed in kind, and the
Board of Managers may require a Member to accept more than such Member's pro
rata portion of any particular asset distributed.
5.3 TRUE UP CONTRIBUTION AND DISTRIBUTIONS. Immediately following the True
Up Date, if the aggregate cash Capital Contributions of CCSI and WGC,
respectively, are not in the ratio of 1:4, WGC shall make sufficient additional
cash Capital Contributions to permit GENXON to make, and GENXON shall make, a
capital distribution from CCSI's Capital Account to CCSI in order to achieve
such ratio (i.e. True Up).
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5.4 LIQUIDATING DISTRIBUTIONS. Notwithstanding Sections 5.1, 5.2 and 5.3,
cash and property of the Company available for distribution upon the dissolution
of the Company (including cash or property received upon the sale or other
disposition of assets in anticipation of or in connection with such dissolution)
shall be distributed in accordance with Section 8.2.
5.5 DISTRIBUTIONS UPON WITHDRAWAL OR REMOVAL. A withdrawn or removed
Member shall not be entitled to receive any distribution under Section 18-604 of
the Act or otherwise in connection with such withdrawal or removal, except as
provided in Section 7.3 or as may be determined in the discretion of the Board
of Managers.
5.6 LIMITATION ON DISTRIBUTIONS. No distribution shall be made to a Member
to the extent that such distribution would be in violation of the Act, would
render the Company insolvent, would render the receiving Member liable for a
return of such distribution under the Act, or to the extent that such
distribution would exceed the amount of the Member's positive Capital Account
balance determined as if, immediately prior to such distribution, all of the
Company's assets had been sold for fair market value (as determined in
accordance with Section 7701(g) of the Code), and the Profit and Loss
attributable thereto had been allocated among the Members in accordance with
Section 4.1.
5.7 RETURN OF DISTRIBUTIONS. Any Member receiving a distribution in
violation of the terms of this Agreement shall return such distribution (or cash
equal to the net fair value of any property so distributed, determined as of the
date of the distribution) promptly following the Member's receipt of a request
therefor from the Board of Managers. The obligation of a Member to return a
distribution may be compromised upon the approval of the Board of Managers. The
obligations to return distributions provided for in this Section 5.7 are for the
benefit of the Company and the Members; to the maximum extent permitted by the
Act. No third party shall be entitled to rely on the obligations to return
distributions set forth herein or to demand that the Board of Managers make any
request for any such return.
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SECTION 6
ADMINISTRATIVE PROVISIONS
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6.1 MEETINGS OF MEMBERS.
(a) Annual meetings of the Members shall be held at such time in
such place or places as the Board of Managers may determine. Special meetings of
the Members, as provided in Section 6.1(c), may be called by any Member.
(b) Members shall be entitled to receive notice of and to attend all
meetings of the Members of the Company. At any such meeting each Member shall
have one vote for each Unit held by such Member.
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(c) The Company shall deliver, by mail or telecopy written notice
stating the date, time and place of any meeting of Members and, in the case of a
special Members' meeting or when otherwise required by law, a description of the
purposes for which the meeting is called, to each Member of record entitled to
vote at the meeting, at such address as appears in the records of the Company,
such notice to be mailed at least seven (7) days, but not more than sixty (60)
days, before the date and time of the meeting. A Member may waive notice of any
meeting, before or after the date of the meeting, by delivering a signed waiver
to the Company for inclusion in the minutes of the Company. A Member's
attendance at any meeting, in person or by proxy: (i) waives objection to lack
of notice or defective notice of the meeting, unless the Member at the beginning
of the meeting objects to holding the meeting or transacting business at the
meeting and (ii) waives objection to consideration of a particular matter at the
meeting that is not within the purposes described in the meeting notice, unless
the Member objects to considering the matter when it is presented.
(d) The record date for the purpose of determining the Members
entitled to notice of a Members' meeting, for demanding a special meeting, for
voting or for taking any other action shall be the seventh (7th) day prior to
the date of the notice of such meeting or other action.
(e) A Member may appoint a proxy to vote or otherwise act for the
Member pursuant to a written appointment form executed by the Member or the
Member's duly authorized attorney-in-fact. An appointment of a proxy is
effective when received by the Board of Managers. The general proxy of a
fiduciary is given the same effect as the general proxy of any other Member. A
proxy appointment is valid for eleven (11) months unless otherwise expressly
stated in the appointment form.
(f) At any meeting of Members, the presence of Members constituting
a Majority in Interest of the Members shall constitute a quorum. Action on a
matter is approved if it receives approval from a Majority in Interest of the
Members or such greater number as may be required by law or the for the
particular matter under consideration.
(g) Whenever Members of the Company are required or permitted to
take any action by vote, such action may be taken without a meeting, without
prior notice and without a vote, if a consent or consents in writing, setting
forth the action so taken, shall be signed by the Members who hold the voting
interests having not less than the minimum number of votes that would be
necessary to authorize such action at a meeting at which all of the Members
entitled to vote therein were present and voted and shall be delivered to the
office of the Company by hand or by certified or registered mail, return receipt
requested. Notice of the taking of action without a meeting by less than
unanimous written consent shall be given to those Members who have not consented
in writing but who would have been entitled to vote thereon had such action been
taken at a meeting.
(h) Any or all Members may participate in any annual or special
Members' meeting by means of conference telephone or similar communications
equipment by means of which all Members participating may simultaneously hear
each other during the meeting. A Member so participating is deemed to be present
in person at the meeting.
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(i) At any annual or special Members' meeting, the Members shall
appoint a person to preside at the meeting and a person to act as secretary of
the meeting. The secretary of the meeting shall prepare minutes of the meeting
which shall be placed in the minute books of the Company.
6.2 BOARD OF MANAGERS.
(a) All powers of the Company shall be exercised by or under the
authority of, and the business and affairs of the Company shall be managed under
the direction of, a board of managers (the "Board of Managers"), unless
otherwise provided in the Act, the Certificate of Formation or this Agreement.
The Board of Managers shall, until the first anniversary of this Agreement, be
comprised of six members, three of whom shall be the nominees of CCSI and three
of whom shall be the nominees of WGC, thereafter the Board of Managers shall be
comprised of four members, two of whom shall be the nominees of CCSI and two of
whom shall be the nominees of WGC. One member of the Board of Managers shall be
elected annually as Chairman and shall be responsible for administering the
affairs of the Board of Managers. The Chairman shall rotate annually between the
CCSI and WGC representatives.
(b) Each of the Members holding Units will take such actions as may
be necessary and appropriate, including without limitation the voting of the
Units held or controlled by such Member, to elect as members of the Board of
Managers:
(i) the individuals designated in writing by CCSI to WGC;
and
(ii) the individuals designated in writing by WGC to CCSI.
Each of CCSI and WGC will take such actions as may be necessary and appropriate,
including without limitation the voting of the Units held by such Member, to (i)
remove as members of the Board of Managers, upon written notice from CCSI to
WGC, any member of the Board of Managers designated by CCSI pursuant to Section
6.2(b)(i) and (ii) remove as members of the Board of Managers, upon written
notice from WGC to CCSI, any member of the Board of Managers designated by WGC
pursuant to Section 6.2(b)(ii). In the event of a vacancy on the Board of
Managers of a member appointed pursuant to Section 6.2(b)(i), CCSI will have the
immediate right to designate a successor to fill that vacancy and, in the event
of a vacancy on the Board of Managers of a member appointed pursuant to Section
6.2(b)(ii), WGC will have the immediate right to designate a successor to fill
that vacancy. In such event, each of CCSI and WGC will immediately take all
necessary action, including, without limitation, the voting of the Units held or
controlled by them, to cause such designees to be elected.
(c) Each member of the Board of Managers shall be elected by the
Members and shall serve until a successor is appointed and qualifies. Members of
the Board of Managers may resign at any time by giving written notice to the
Company and the Board of Managers and such resignation shall be effective at the
time such notice is given or, if a later date is provided in the
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notice, on such later date. Acceptance of such notice by the Members is not
required to make the resignation effective.
(d) The initial members of the Board of Managers shall be:
CCSI designees: Ricardo B. Levy
Dennis A. Orwig
Lawrence W. Briscoe
WGC designees: John A. Halbrook
Stephen P. Carter
Terry A. Shetler
(e) Notwithstanding the foregoing provisions of Sections 6.2(a), (b)
and (c), in the event of a default by a Member under Section 3.6 as a result of
which such Defaulting Member's Percentage Interest in Future Profits and Losses
of the Company is reduced to 1%, then thereafter (i) if such Defaulting Member
is CCSI all members of the Board of Managers shall be nominated by WGC and (ii)
if such Defaulting Member is WGC all members of the Board of Managers shall be
nominated by CCSI.
(f) Each Member hereby agrees that any member of the Board of
Managers may, without violating any fiduciary duty, duty of loyalty or duty of
care owed by such member to the Company or any Member, vote or abstain from the
vote on any matter involving one or more of the Members or members of the Board
of Managers or a contract or other transaction between the Company and any other
Person in which one or more of the Members or members of the Board of Managers
are managers, directors or officers or have a substantial financial interest.
6.3 MEETINGS OF THE BOARD OF MANAGERS.
(a) The first meeting of the Board of Managers shall be held at such
time and place as shall be fixed by the vote of the Members and no notice of
such meeting shall be necessary to the newly elected managers in order to
legally constitute the meeting, provided a quorum shall be present. In the event
of the failure of the Members to fix the time or place of such first meeting of
the newly elected Board of Managers, or in the event such meeting is not held at
the time and place so fixed by the Members, the meeting may be held at such time
and place as shall be specified in a notice given as hereinafter provided for
special meetings of the Board of Managers, or as shall be specified in a written
waiver signed by all members of the Board of Managers.
(b) Regular meetings of the Board of Managers may be held without
notice at such time and such place as from time to time shall be determined by
the Board of Managers, but in any event shall be held at least annually.
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(c) Special meetings of the Board of Managers may be called by the
president or any Member on two hours notice to each member of the Board of
Managers, either personally or by mail, electronic mail, by telegram or by
facsimile.
(d) At all meetings of the Board of Managers an equal number of
representatives of CCSI and WGC (which could be one representative of each of
CCSI and WGC) shall constitute a quorum for the transaction of business and the
act of a majority of the Board of Managers present at any meeting at which there
is a quorum shall be the act of the Board of Managers. If there is an unequal
number of representatives present, one or more representative may abstain so as
to create any equal number.
(e) Unless otherwise restricted by the Certificate of Formation or
this Agreement, any action required or permitted to be taken at any meeting of
the Board of Managers may be taken without a meeting if all members of the Board
of Managers consent thereto in writing and the writing or writings are filed
with the minutes of the Company.
(f) Unless otherwise restricted by the Certificate of Formation or
this Agreement, members of the Board of Managers may participate in a meeting of
the Board of Managers by means of conference telephone or similar communications
equipment by means of which all persons participating in the meeting can hear
each other, and such participation in a meeting shall constitute presence in
person at the meeting.
6.4 MAJOR DECISIONS. No act shall be taken, or sum expended, or obligation
incurred by any member of the Board of Managers or any officer of the Company
with respect to any matters within the scope of any of the major decisions
affecting the Company as set out below (the "Major Decisions"), unless such
Major Decision has been approved in concept and all the essential terms and
conditions approved by the Board of Managers. The Major Decisions shall be the
following:
(a) making, executing or delivering any promissory note, deed of
trust or mortgage, or otherwise incurring indebtedness (absolute or
contingent);
(b) acquiring, purchasing or agreeing to acquire or purchase any
real estate or any other assets (tangible or intangible) unless such item is
specifically contemplated by an Annual Budget, or is within the discretionary
spending level, approved by the Board of Managers;
(c) making an assignment for the benefit of creditors or filing a
voluntary petition under applicable Bankruptcy laws;
(d) approving disbursements to be made on behalf of the Company
unless such item is specifically contemplated by an Annual Budget or is within
the discretionary spending level, approved by the Board of Managers;
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(e) appointing and determining the remuneration of any employee of
the Company unless such employee's annual compensation is less than $100,000
or such compensation is specifically contemplated by an Annual Budget approved
by the Board of Managers;
(f) selling any assets of the Company (tangible or intangible)
except goods and services in the ordinary course of business;
(g) conducting any other transaction which is not set forth in the
Company's Annual Budget approved by the Board of Managers or otherwise outside
the normal course of business;
(h) determining the amount, manner of payment and date of any
distributions to be made to the Members;
(i) establishing additional bank accounts, provided that the
President shall be authorized to establish initial bank accounts upon
formation; and
(j) increasing the number of Units which the Company shall be
authorized to issue.
6.5 INTERESTED MANAGERS.
(a) No contract or other transaction between the Company and one or
more of the Members or members of the Board of Managers or between the Company
and any other Person in which one or more of the Members or members of the Board
of Managers are managers, directors or officers or have a substantial financial
interest, shall be either void or voidable for this reason alone or by reason
alone that such Member or member of the Board of Managers were present at a
meeting of the Members or the Board of Managers which approved such contract or
transaction, or that his or her or their votes were counted for such purposes:
(i) if the material facts as to such Person's interest in
such contract or transaction and as to any such common managership,
directorship, officership or financial interest are disclosed in good faith
or known to the other members of the Board of Managers, and the Board of
Managers approves such contract or transaction by a vote sufficient for
such purpose without counting the vote of such interested member of the
Board of Managers or, if the votes of the disinterested members of the
Board of Managers are insufficient to constitute an act of the Board of
Managers pursuant to the terms hereof, by unanimous vote of the
disinterested members of the Board of Managers, as the case may be; or
(ii) if the material facts as to such Person's interest in
such contract or transaction and as to any such common managership,
directorship, officership or financial interest are disclosed in good faith
or known to the Members entitled to vote thereon, and
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such contract or transaction is approved by the unanimous vote of the
Members entitled to vote thereon.
(b) Common or interested members of the Board of Managers or Members
may be counted in determining the presence of a quorum at a meeting of the Board
of Managers or Members that approves any such contract or transaction.
6.6 OFFICERS.
(a) The day-to-day operations of the Company shall be under the
control of the officers of the Company duly appointed from time to time by the
Board of Managers, subject to the supervision and direction of the Board of
Managers. The officers of the Company, if deemed necessary by the Board of
Managers, shall include a president, one or more vice-presidents, a treasurer
and a secretary and such other officers as the Board of Managers may from time
to time consider appropriate. Such officers shall exercise such duties as
customarily pertain to such offices as determined by the Board of Managers.
(b) The officers of the Company shall hold office until their
successors are chosen by the Board of Managers and qualify. Any officer may be
removed at any time by the Board of Managers. Any vacancy occurring in any
office of the Company shall be filled by the Board of Managers.
(c) Any officer of the Company may be an employee of a Member or a
Member of the Board of Managers.
6.7 REIMBURSEMENTS.
(a) The Company shall reimburse the Members for all ordinary and
necessary out-of-pocket expenses incurred by the Members on behalf of the
Company, including the reasonable legal costs and expenses incurred by CCSI and
WGC in connection with the formation of the Company. The Board of Managers shall
determine which other expenses may be reimbursed to a Member and the amount
of such expenses.
(b) Expenses incurred prior to the date of this Agreement shall be
reimbursed as follows:
(i) To the extent CCSI and WGC have made expenditures to
develop the market for the 1.5 MW KHI and PW FT4 retrofits, subsequent to
August 1, 1996, such expenditures shall be appropriately verified and
reimbursed by the Company.
(ii) At such time as the Company achieves successful startup
of the 1.5MW KHI gas turbine with a catalytic combustion system, CCSI shall
be reimbursed for $500,000 of the expenses it incurred, and WGC shall be
reimbursed for the expenses it incurred (currently estimated at $150,000),
during the period from January 1, 1996, through
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August 1, 1996, in development of the catalytic combustion and control
systems for the KHI and PW FT4 gas turbines.
(iii) At such time as the Company is successful in arranging
external funding from third parties in excess of $1 million, CCSI shall be
reimbursed for an additional $500,000 of the expenses it incurred during
the period from January 1, 1996, through August 1, 1996, in development of
catalytic combustion systems for the 1.5 MW KHI and PW FT4 gas turbines.
(c) Any reimbursement pursuant to Section 6.7(a) and (b)(i) shall be
treated as an expense of the Company and shall not be deemed to constitute a
distributive share of Profits or a distribution or return of capital to any
Member.
6.8 RELIANCE BY THIRD PARTIES.
Any Person dealing with the Company, the Board of Managers or any officer of
the Company may rely upon a certificate signed by two or more officers of the
Company as to:
(a) the identity or any officer, member of the Board of Managers or
Member hereof:
(b) the existence or non-existence of any fact or facts which
constitute a condition precedent to acts by the officer, the Board of Managers
or in any other manner germane to the affairs of the Company;
(c) the Persons who are authorized to execute and deliver any
instrument or document of or on behalf of the Company; or
(d) any act or failure to act by the Company or as to any other
matter whatsoever involving the Company or any Member.
6.9 OUTSIDE BUSINESSES. Any Member or Affiliate thereof or member of the
Board of Managers may engage in or possess an interest in other business
ventures of any nature or description, independently or with others, similar or
dissimilar to the business of the Company, and the Company and the Members shall
have no rights by virtue of this Agreement in and to such independent ventures
or the income or profits derived therefrom, and the pursuit of any such venture,
shall not be deemed wrongful or improper. No Member of Affiliate thereof or
member of the Board of Managers shall be obligated to present any particular
business opportunity to the Company even if such opportunity is of a character
that, if presented to the Company, could be taken by the Company, and any Member
or Affiliate thereof or member of the Board of Managers shall have the
right to take for its own account (individually or as a partner or
fiduciary) or to recommend to others any such particular business opportunity.
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6.10 SERVICES OF AFFILIATES.
(a) In the event that the management of the Company retains any Member
or its Affiliate to provide services to the Company, such services shall be
provided on arms' length terms and at a cost to the Company not in excess of the
fair market value of such services (i.e., the price at which such services would
be provided by a third party).
(b) Notwithstanding anything to the contrary in this Agreement, CCSI
and WGC will each enter a services agreement with the Company in substantially
the form attached hereto as Exhibit C (the "Services Agreement"), whereby the
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Company may secure services to operate its business. These services shall be
provided on the basis of the fully burdened cost of providing such services. The
provider shall provide the Company an estimate of the costs of requested
services in advance if the Company so requests. The Company shall have the right
to use third party services or develop the capability to perform such services
itself should it choose to do so.
(c) Notwithstanding anything to the contrary in this Agreement, the
Company shall buy all of its requirements for combustion systems from CCSI and
all its requirements for control systems from WGC as provided in the supply
agreement attached as Exhibit D (the "Supply Agreement").
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6.11 BUSINESS PLAN, BUDGET AND FINANCIAL REPORTS.
(a) On an annual basis, the President of the Company shall prepare
or cause to be prepared and present to the Board of Managers for its approval a
business plan (the "Business Plan") for the upcoming Fiscal Year of the Company.
Such Business Plan for the remainder of the 1996/1997 Fiscal Year shall be
presented to the Board of Managers fifteen business days after the date of this
Agreement. The Business Plan for each subsequent Fiscal Year shall be presented
to the Board of Managers on or prior to August 31 of the year preceding such
fiscal year.
(b) Each Business Plan will include an annual budget (an "Annual
Budget"), which will include monthly balance sheets and related income
statements and cash flows for such year.
(c) Within ten (10) business days of the beginning of each month,
the President of the Company shall prepare or caused to be prepared and deliver
to the Board of Managers (i) a balance sheet and related income statements and
cash flows for the immediately preceding month and (ii) a year to date income
statement and cash flows through and including the immediately preceding month.
Such statements will include a comparison to the Annual Budget for such periods,
as well as a comparison to the previous year (if such information is available).
(d) The Company shall have its financial statements prepared in
accordance with generally accepted accounting principles audited after the close
of each fiscal year by an audit firm of national standing. Such firm may be the
firm utilized by CCSI or WGC provided the other party does not object.
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6.12 CONFIDENTIALITY. The Members hereby acknowledge that the Company will
be in possession of confidential information the improper use or disclosure of
which could have a material adverse effect upon the Company or upon one or more
Members.
(a) The Members acknowledge and agree that all information provided
to them by or on behalf of the Company or any Member concerning the business of
the Company or any Member shall be deemed strictly confidential and shall not,
without the prior consent of the Member whose confidential information is
proposed to be disclosed, be (i) disclosed to any Person (other than a Member)
or (ii) used by a Member other than for a Company purpose. The Members hereby
consent to the disclosure by each Member of Company information to such Member's
accountants, attorneys and similar advisors bound by a duty of confidentiality;
moreover, the foregoing requirements of this Section 6.12(a) shall not apply to
a Member with regard to any information that is currently or becomes: (i)
required to be disclosed pursuant to applicable law (but only to the extent of
such legal requirement); (ii) publicly known or available in the absence of any
improper or unlawful action on the part of such Member; or (iii) independently
developed or known or available to such Member other than through or on behalf
of the Company or any Member (acting in its capacity as such).
(b) Except that the Company and the Board of Managers may disclose
any information to the extent necessary or convenient for the formation,
operation, dissolution or liquidation of the Company, the Company and the Board
of Managers shall similarly refrain from disclosing any confidential information
furnished by a Member pursuant to Section 6.13.
6.13 DISCLOSURES. Each Member shall furnish to the Company upon request
any information with respect to such Member reasonably determined by the Board
of Managers to be necessary or convenient for the formation, operation,
dissolution or liquidation of the Company.
6.14 TAX MATTERS PARTNER.
(a) GENERAL. WGC is hereby designated the "Tax Matters Partner" of
the Company within the meaning of Section 6231(a)(7) of the Code. Except to the
extent specifically provided in the Code or the Treasury Regulations (or the
laws of other relevant taxing jurisdictions), the Tax Matters Partner, acting
with the approval of the Board of Managers, shall have the exclusive authority
to act for or on behalf of the Company with regard to tax matters, including,
without limitation, the authority to make (or decline to make ) any available
tax elections.
(b) NOTICE OF INCONSISTENT TREATMENT OF COMPANY ITEM. No Member
shall file a notice with the United States Internal Revenue Service under
Section 6222(b) of the Code in connection with such Member's intention to treat
an item on such Member's Federal income tax return in a manner which is
inconsistent with the treatment of such item on the Company's Federal income tax
return unless such Member has, not less than thirty (30) days prior to the
filing of such notice, provided the Tax Matters Partner with a copy of the
notice and thereafter in a timely manner provides such other information related
thereto as the Tax Matters Partner shall reasonably request.
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(c) NOTICE OF SETTLEMENT AGREEMENT. Any Member entering into a
settlement agreement with the United States Department of the Treasury which
concerns a Company item shall notify the Tax Matters Partner of such settlement
agreement and its terms within sixty (60) days after the date thereof.
----------------------------------
SECTION 7
TRANSFERS OF COMPANY INTERESTS;
WITHDRAWALS AND REMOVALS
-----------------------------------
7.1 GENERAL PROVISIONS REGARDING TRANSFERS.
(a) No Transfer of all or any portion of an Interest in the Company
shall be permitted unless such Transfer will not: (i) violate Federal or State
securities laws or any other law, regulation or other governmental rule
applicable to such Transfer; (ii) effect a termination of the Company under
Section 708 of the Code; (iii) cause the Company to be a "publicly traded
partnership" within the meaning of Section 7704 of the Code or otherwise cause
the Company to be taxable as a corporation for Federal income tax purposes; (iv)
subject the Company or any Member to additional regulatory requirements under
Federal, State, local or foreign law, compliance with which would subject the
Company or such other Person to material expense or burden (unless each such
affected Person consents to such Transfer); or (v) violate the terms of this
Agreement.
(b) No Member may sell, assign, transfer or otherwise dispose of
more than eighty percent (80%) of its Interest without the prior written consent
of a majority in interest of the other Members, which consent may be withheld in
their sole and absolute discretion.
(c) Prior to the fifth (5th) anniversary of this Agreement no Member
may make a voluntary Transfer of its Interest to a third party. Subsequent to
the fifth (5th) anniversary of this Agreement, but subject to Section 7.1(b), in
the case of a voluntary Transfer to a third party, the transferring Member shall
provide to the other Members notice that it wishes to make a Transfer of its
Interest and the non-transferring Members shall have a right of first
opportunity to buy such Interest at its Fair Market Value. Fair Market Value for
purposes of this Section 7.1 shall be determined as follows. Each of the Members
shall make an independent determination of the Company's fair market value. If
the values so determined are within 10% of each other, the Fair Market Value
shall be deemed to be the mean of the two values. If the difference in the
values is greater than 10%, an independent third party of national standing,
experienced in business valuations, and agreed to by the parties shall be
retained to determine which of the values determined by the parties most closely
approximates the Fair Market Value. The non-transferring Members will then have
the option to purchase the Interest of the transferring Member at the Fair
Market Value. Unless agreed to otherwise by the transferring Member, such
payment must be made in cash. If the non-transferring Members do not arrange to
acquire the Interest of the transferring Member within
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sixty (60) days of the final determination of the Company's Fair Market Value
pursuant to this Section 7.1, then the non-transferring Members shall have a
period of 120 days from the date of the notice of the non-transferring Member
that it is not acquiring such Interest, to arrange for a third party to make
such purchase at the Fair Market Value. If the non-transferring Members do not
arrange to acquire the Interest of the transferring Members or arrange for a
third party to make such purchase, then the transferring member shall have 120
days from the expiration of the 120 day period of the non-transferring Member to
arrange for a third party to make such purchase at the Fair Market Value.
(d) Any attempted Transfer in violation of the terms of this
Agreement: (i) shall be null and void as against the Company and the other
Members; and (ii) shall not be recognized or permitted by, or duly reflected in
the official books and records of, the Company. The preceding sentence shall not
be applied to prevent the Company from enforcing any rights it may have in
respect of a transferee arising under this Agreement or otherwise (including,
without limitation, any rights arising under Section 10.6). In the event of any
Transfer or attempted Transfer of a Company interest in violation of this
Agreement, without limiting any other rights of the Company, the non-
transferring Members shall have the right, in their sole and absolute
discretion, to require the withdrawal of the transferring Member (or its
successor(s) in interest) from the Company.
(e) In connection with each Transfer pursuant to this Section 7: (i)
the transferor and transferee shall execute and deliver to the Company a written
instrument of transfer in form and substance reasonably satisfactory to the
Board of Managers; and (ii) the transferee shall execute and deliver to the
Company a written instrument pursuant to which the transferee assumes all
obligations of the transferor associated with the transferred interest and
otherwise agrees to comply with the terms and provisions of this Agreement.
(f) In the event that a Member Transfers (or proposes to Transfer)
all or any portion of its interest in the Company, all reasonable legal and
other out-of-pocket expenses incurred by the Company on account of the Transfer
(or proposed Transfer) shall be paid by such Member. Following the effective
date of any Transfer, the transferor and transferee shall be jointly and
severally liable for all such expenses.
(g) Except as otherwise specifically provided in this Agreement or
with the consent of the Majority in Interest of the Members, all economic
attributes of a transferor Member's interest in the Company (such as the
Member's Capital Commitment, Capital Contribution and Capital Account balance)
shall carry over to a transferee in proportion to the percentage of the interest
so transferred.
7.2 WITHDRAWAL BY A MEMBER.
(a) Except as provided in this Section 7.2 or pursuant to the
Transfer of a Member's entire interest to one or more Members or Substitute
Members pursuant to this Section 7, a Member shall not withdraw all or any
portion of its interest in the Company or otherwise cease to
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be a Member without the unanimous prior consent of the other Members, which
consent may be withheld in such Members' sole and absolute discretion.
(b) A Member may be required to withdraw from the Company as
provided in Section 7.1(d).
(c) The Bankruptcy, Dissolution or termination of a Member shall be
deemed to be a non-permitted withdrawal of the Member unless the resulting
Transfer of the Member's interest in the Company has been authorized in
accordance with the provisions of this Section 7. If a Person would otherwise
become an Assignee of all or a portion of a Member's interest pursuant to the
non-permitted withdrawal of the Member or any other Transfer not expressly
permitted in accordance with this Section 7, the Company may elect to: (i)
disregard the Transfer for all purposes under this Agreement; (ii) treat the
transferee as an Assignee; and/or (iii) pursue any available remedies in
accordance with the provisions of Section 10.13. The withdrawal of a Member
shall not give rise to any rights on the part of such Member or its successor(s)
in interest to distributions or a return of capital other than as specifically
provided in this Agreement.
7.3 REMOVAL OF A MEMBER. Except as otherwise provided in this Agreement, a
Member shall not be removed from the Company without its consent.
7.4 STATUS OF ASSIGNEES.
(a) The transferee of all or any portion of a Member's interest in
the Company, unless previously admitted as a Member pursuant to this Agreement
or admitted as a Substitute Member in accordance with this Section 7.4(a), shall
be an Assignee subject to the provisions of this Section 7.4. Notwithstanding
any provision of this Agreement to the contrary, an Assignee shall not be
admitted as a Substitute Member without the consent of non-transferring Members
holding a majority of the Units held by the non-transferring Members, which
consent may be withheld in such non-transferring Members' sole and absolute
discretion. For purposes of the preceding sentence, a Member shall be deemed to
be the "transferor Member" of an Assignee's Units if the Assignee's interest in
such Units has arisen in whole or in part by a direct or indirect assignment
from such Member (including, without limitation, through the intervening
assignment of another Assignee, but not through the intervening assignment of
another Member).
(b) Notwithstanding any provision of this Agreement to the contrary:
(i) all rights and privileges associated with an Assignee interest in the
Company shall be derived solely from the Member Interest of which such rights
and privileges were previously a component part and (ii) no Assignee shall hold,
by virtue of such Assignee's interest in the Company, any rights and privileges
that were not specifically transferred to such Assignee by the prior holder of
such interest.
(c) Subject to Section 4.1(d), an Assignee that holds an interest in
the Company shall be entitled to receive the allocations attributable to such
interest pursuant to Section 4, to receive the distributions attributable to
such interest pursuant to Sections 5 and 8, and to Transfer such interest in
accordance with the terms of this Section 7. Notwithstanding the foregoing, the
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Company and the Members shall incur no liability for allocations and
distributions made in good faith to a transferor until a valid written
instrument of assignment has been received by the Company and recorded on its
books and the effective date of the assignment has passed.
(d) An Assignee that holds an interest in the Company shall be
responsible for any unpaid Capital Commitment, obligation to contribute
services, and obligation to return distributions or make other payments to the
Company associated with such interest; provided, however, that the transferor of
such interest, if a Member, shall also continue to be responsible for the
satisfaction of such Capital Commitment and other obligations until such time as
a Substitute Member is admitted in respect of such interest. To the extent
otherwise applicable to the interest in the Company that has been transferred to
an Assignee, the Assignee shall be subject to, and bound by, all of the terms
and provisions of this Agreement that inure to the benefit of the Company and/or
other Members (including, without limitation, the provisions of this Agreement
concerning penalties for breach of this Agreement, confidentiality of Company
information, Transfers of Company interests, and resolution of disputes). The
foregoing provisions of this Section 7.4(d) shall apply to any Assignee that
becomes bound by this Agreement pursuant to Section 10.8 without regard to
whether such Assignee has executed a written instrument of assignment as
described in Section 7.4(c).
(e) Solely to the extent necessary to give effect to the Assignee
rights and obligations set forth in Sections 7.4(c) and (d), an Assignee shall
be treated as a Member for purposes of this Agreement.
(f) An Assignee shall not, solely by virtue of its status as such,
hold any non-economic rights in respect of the Company. Without limiting the
preceding sentence, an Assignee's interest in the Company shall not entitle such
Assignee to participate in the management of the Company, vote on any Company
matters or bind the Company under agreements with third parties. An Assignee
shall not hold itself out as a Member in any forum or for any purpose; provided,
however, that, to the extent necessary to maintain consistency with the
Company's income tax returns, reports, and other filings, an Assignee shall take
the position that it is a Member solely for income tax purposes.
(g) Provided that none of the consequences described in Section
7.1(a) shall result, the Company may, at any time and in the sole and absolute
discretion of the Majority in Interest of the Members, redeem (or cause the sale
of) the Company interest of any Assignee for cash equal to the Fair Market
Value of such interest.
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-----------------------------------
SECTION 8
DISSOLUTION AND LIQUIDATION
-----------------------------------
8.1 DISSOLVING EVENTS. The Company shall be dissolved upon the occurrence
of any of the following events:
(a) Issuance of an order by a court of competent jurisdiction
requiring the dissolution of the Company;
(b) Failure of the Company to have at least two Members;
(c) Permanent cessation of the Company's business;
(d) An election to dissolve the Company executed by the Majority in
Interest of the Members; or
(e) Any other event which results in a mandatory dissolution of the
Company under the Act.
8.2 WINDING UP OF THE COMPANY.
(a) Upon dissolution of the Company, the Board of Managers shall
promptly wind up the affairs of the Company in accordance with the provisions of
this Section 8.2. In furtherance thereof, the Board of Managers shall: (i) have
the power to bind the Company and (ii) be reimbursed for any reasonable out-of-
pocket expenses on behalf of the Company. Following dissolution, the Company
shall sell or otherwise dispose of assets determined by the Board of Managers to
be unsuitable for distribution to the Members, but shall engage in no other
business activities except as may be necessary, in the reasonable discretion of
the Board of Managers, to preserve the value of the Company's assets during the
period of dissolution and liquidation. In any event, the Board of Managers shall
use its reasonable best efforts to prevent the period of dissolution and
liquidation of the Company from extending beyond the date which is two years
from the Company's date of dissolution.
(b) Distributions to the Members in liquidation may be made in cash
or in kind, or partly in cash and partly in kind, as determined by the Board of
Managers. Distributions in kind shall be valued at fair market value and shall
be subject to such conditions and restrictions as may be necessary or advisable
in the reasonable discretion of the Board of Managers to preserve the value of
the property so distributed or to comply with applicable law.
(c) The Profits and Losses of the Company during the period of
dissolution and liquidation shall be allocated among the Members in accordance
with the provisions of Section 4.1.
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If any property is to be distributed in kind, the Capital Accounts of the
Members shall be adjusted with regard to such property in accordance with the
provisions of Section 4.1(e).
(d) The assets of the Company (including, without limitation,
proceeds from the sale or other disposition of any assets during the period of
dissolution and liquidation) shall be applied as follows:
(i) First, to repay any indebtedness of the Company, whether
to third parties or the Members, in the order of priority required by law;
(ii) Next, to any reserves which the Board of Managers
reasonably deems necessary for contingent or unforeseen liabilities or
obligations of the Company (which reserves when they become unnecessary shall be
distributed in accordance with the provisions of clause (iii), below); and
(iii) Next, to the Members in proportion to their respective
positive Capital Account balances (after taking into account all adjustments to
the Members' Capital Accounts required under Section 8.2(c)).
-----------------------------------
SECTION 9
LIABILITY PROVISIONS
-----------------------------------
9.1 LIABILITY. Except as otherwise specifically provided in this
Agreement, no Indemnified Person shall be liable for the return of any
contributions made to the capital of the Company by the Members. In the absence
of Material Misconduct (which misconduct shall have given rise to the matter at
issue) on the part of an Indemnified Person, such Indemnified Person shall not
be liable to the Company or the Members for any act or omission concerning the
Company. An Indemnified Person shall not be liable to the Company or the Members
for losses due to the fraud, bad faith, willful misconduct or negligence,
whether of omission or commission, of any independent contractor, employee or
other agent of the Company unless such Indemnified Person was or should have
been directly involved with the selection, engagement or supervision of such
Person and failed to exercise reasonable care in connection therewith.
9.2 INDEMNIFICATION.
(a) In the absence of Material Misconduct (which misconduct shall
have given rise to the matter at issue) on the part of an Indemnified Person,
the Company shall indemnify and hold such Indemnified Person harmless from and
against any loss, expense, damage or injury suffered or sustained by such
Indemnified Person by reason of any actual or threatened claim, demand, action,
suit or proceeding (civil, criminal, administrative, or investigative) in which
such Indemnified Person
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may be involved, as a party or otherwise, by reason of its actual or alleged
management of, or involvement in, the affairs of the Company. This
indemnification shall include, but not be limited to: (i) payment of reasonable
attorneys fees and other expenses as incurred in investigating or settling any
claim or threatened action (where, in the case of a settlement, such settlement
is approved by the Board of Managers), or incurred in preparing for, or
conducting a defense pursuant to, any proceeding up to and including a final
non-appealable adjudication; (ii) payment of fines, damages or similar amounts
required to be paid by an Indemnified Person; and (iii) the removal of liens
affecting the property of an Indemnified Person.
(b) Indemnification payments shall be made pursuant to this Section
9.2 only to the extent that the Indemnified Person is not entitled to receive
(or will not in any event receive) from a third party equal or greater
indemnification payments in respect of the same loss, expense, damage or injury.
(c) If a Person receives an indemnification payment pursuant to this
Section 9.2 and it is subsequently determined that such Person was not entitled
to receive such payment (whether by virtue of such Person's Material Misconduct
or otherwise), such Person shall return such payment to the Company promptly
upon demand therefor by any Member.
(d) Notwithstanding the foregoing provisions of this Section 9.2,
the Company shall be under no obligation to indemnify an Indemnified Person from
and against any reduction in the value of such Person's interest in the Company
that is attributable to losses, expenses, damages or injuries suffered by the
Company or to any other decline in the value of the Company's assets.
(e) The indemnification provided by this Section 9.2 shall not be
deemed to be exclusive of any other rights to which any Indemnified Person may
be entitled under any agreement, as a matter of law, in equity or otherwise.
-----------------------------------
SECTION 10
GENERAL PROVISIONS
-----------------------------------
10.1 STATUS UNDER THE ACT. This Agreement is the "operating agreement" of
the Company within the meaning of Section 18-101(7) of the Act.
10.2 ENTIRE AGREEMENT. This Agreement contains the entire understanding
among the Members and supersedes any prior written or oral agreement between
them respecting the Company. There are no representations, agreements,
arrangements, or understandings, oral or written, among the Members relating to
the Company which are not fully expressed in this Agreement.
10.3 AMENDMENTS.
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(a) Except as otherwise provided in this Section 10.3, this
Agreement may be amended only through a written amendment executed by Members
holding a majority of the outstanding Units.
(b) An amendment to any provision of this Agreement that calls for a
higher level of approval of the Members or the approval of certain specified
Members shall require the same form of approval as is set forth in such
provision.
(c) Notwithstanding the foregoing provisions of this Section 10.3,
the Board of Managers may, without the consent of the other Members, amend this
Agreement in any manner determined by the Board of Managers to be necessary or
convenient to reflect the admission of an Additional Member, comply with
applicable law, supply a missing term or provision, or resolve an ambiguity in
the existing terms and provisions of this Agreement. The Board of Managers shall
not have the authority under this Section 10.3(c) to amend this Agreement in a
manner that is materially adverse to any Member; provided, however, that a
Member's right to object to an amendment pursuant to this Section 10.3(c) on the
grounds that such amendment is materially adverse to such Member shall expire at
the Close of Business on the 30th day following notice to such Member of such
amendment.
(d) Each Member shall be promptly notified of any amendment to this
Agreement made pursuant to this Section 10.3.
10.4 GOVERNING LAW. All questions with respect to the interpretation of
this Agreement and the rights and liabilities of the Members shall be governed
by the laws of the State of Delaware as they are applied to contracts entered
into and wholly performed upon in Delaware solely by residents of Delaware. To
the extent permitted by the Act and other applicable law, the provisions of this
Agreement governing the rights and obligations of the Members shall supersede
any contrary provisions of the Act or other applicable law.
10.5 SEVERABILITY. In the event that any provision of this Agreement is
determined to be invalid or unenforceable, such provision shall be deemed
severed from the remainder of this Agreement and replaced with a valid and
enforceable provision as similar in intent as reasonably possible to the
provision so severed, and shall not cause the invalidity or unenforceability of
the remainder of this Agreement.
10.6 COUNTERPARTS; BINDING UPON MEMBERS AND ASSIGNEES. This Agreement may
be executed in any number of counterparts and, when so executed, all of such
counterparts shall constitute a single instrument binding upon all parties
notwithstanding the fact that all parties are not a signatory to the original or
to the same counterpart. In addition, to the maximum extent permitted by
applicable law, a Person shall become bound in accordance with the terms of this
Agreement as an Assignee or Member if such Person (or a representative
authorized by such Person orally, in writing or by other action such as payment
for an interest in the Company) executes any other writing evidencing the intent
of such Person to become a Member or Assignee or if such Person or
representative complies with the conditions for becoming a Member or Assignee as
set forth in this
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Agreement or any other writing and requests (orally, in writing or by other
action such as payment for an interest in the Company or acceptance of
distributions from the Company) that the records of the Company reflect such
admission or assignment.
10.7 SURVIVAL OF RIGHTS. Except as otherwise specifically set forth in this
Agreement, the provisions of this Agreement shall inure to the benefit of and be
binding upon each Member and Assignee and such Member's or Assignee's heirs,
devises, legatees, personal representatives, successors, and assigns.
10.8 SURVIVAL OF OBLIGATIONS. The following obligations of the Members
shall survive the dissolution and termination of the Company:
(a) The obligation to maintain the confidentiality of another
Member's information pursuant to Section 6.12;
(b) The obligation to return certain indemnification payments as set
forth in Section 9.2(c); and
(c) Any obligation arising from a breach of this Agreement.
10.9 NO THIRD PARTY BENEFICIARIES. Except as otherwise provided in Section
10.6, the provisions of this Agreement are not intended to be for the benefit of
or enforceable by any third party. Without limiting the foregoing, no third
party shall have any right to (i) enforce or demand enforcement of a Member's
Capital Commitment, obligation to return distributions, or obligation to make
other payments to the Company as set forth in this Agreement or (ii) demand that
the Company issue any capital call.
10.10 NOTICES. Any notice required or permitted to be given under this
Agreement or applicable law shall be in writing.
(a) NOTICE TO MEMBERS. Notice to a Member shall be deemed duly
given: (i) when personally delivered to such Member; (ii) at the Close of
Business on the third day after being deposited in the United States mail,
registered or certified, postage prepaid and addressed to the address set forth
on Exhibit A for such Member, or to any other address of which the Company is
notified by such Member in writing; (iii) at the Close of Business on the first
day after being deposited in the United States with a nationally recognized
overnight delivery service, with delivery charges prepaid and addressed as
provided in the preceding clause; or (iv) when actually received by such Member
via public or private mail, telecopy, telex or telegram.
(b) NOTICE TO THE COMPANY. Notice to the Company shall be deemed
duly given or when actually received at the Principal Office, in accordance with
the same procedures set forth in Section 10.10(a).
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10.11 PARTNERSHIP FOR TAX PURPOSES ONLY. As set forth in Section 2.1, the
Members hereby form the Company as a limited liability company under the Act.
The Members expressly do not intend hereby to form a partnership even though the
Company may be treated as a partnership solely for tax purposes.
10.12 AVOIDANCE OF PUBLICLY TRADED PARTNERSHIP STATUS.
(a) Except to the extent otherwise approved by the Members, each
Member hereby represents that at least one of the following statements with
respect to such Member is true and will continue to be true throughout the
period during which such Member holds an interest in the Company:
(i) Such Member is not a partnership, grantor trust or S
corporation for Federal income tax purposes;
(ii) With regard to each Beneficial Owner of such Member, the
principal purposes for the establishment and/or use of such Member do not
include avoidance of the 100 partner limitation set forth in Treasury Regulation
Section 1.7704-1(h)(1)(ii); or
(iii) With regard to each Beneficial Owner of such Member, not
more than seventy-five percent (75%) of the value of such Beneficial Owner's
interest in such Member is attributable to such Member's interest in the
Company.
(iv) In the event that a Member's representation pursuant to
Section 10.12(a) shall at any time fail to be true, such Member shall promptly
(and in any event within 10 days) notify the Board of Managers of such fact and
shall promptly thereafter deliver to the Board of Managers any information
regarding such Member and its Beneficial Owners reasonably requested by counsel
to the Company for purposes of determining the number of the Company's
"partners" within the meaning of Treasury Regulation Section 1.7704-1(h).
(v) A Member that, with the approval of the Board of
Managers, is not required to make the full representation set forth in Section
10.12(a) shall promptly deliver to the Board of Managers any information
regarding such Member and its Beneficial Owners reasonably requested by counsel
to the Company for purposes of determining the number of the Company's
"partners" within the meaning of Treasury Regulation Section 1.7704-1(h) and
shall promptly (and in any event within ten (10) days) notify the Board of
Managers of any change in the status of such Member or its Beneficial Owners
that may be relevant to such determination.
(vi) Each Member hereby acknowledges that the Board of
Managers will rely upon such Member's representations, notices and other
information as set forth in this Section 10.12 for purposes of determining
whether proposed Transfers of Company interests may cause the Company to be
treated as a "publicly traded partnership" within the meaning of Section 7704 of
the Code and that failure by a Member to satisfy its obligations under this
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Section 10.12 may cause the Company to be treated as a corporation for Federal,
State and local tax purposes.
10.13 DISPUTE RESOLUTION.
(a) The potential for disputes between the parties is to be
minimized through continuing communication on developments in the Company
programs at the working level and periodic Board of Managers meetings. To the
extent disputes develop which can not be resolved at the working level, any
Member may give written notice to the other Members invoking the dispute
resolution procedures as provided in this Section 10.13.
(b) Within ten (10) working days of written notice invoking dispute
resolution procedures pursuant to this Section 10.13, each of the parties shall
name a designated representative to resolve the dispute. Such designated
representatives shall negotiate in good faith for ten (10) working days to
resolve the dispute. If such designated representatives are unable to resolve
the dispute, then within ten (10) additional working days the parties shall
submit the matter to binding arbitration.
(c) Any dispute or claim submitted to arbitration pursuant to this
Section 10.13, shall be settled in accordance with the rules of the American
Arbitration Association by a panel of three (3) arbitrators, and judgment upon
an award arising in connection therewith will be binding on the parties without
right of appeal and may be entered in any court of competent jurisdiction.
(d) To the extent permitted by applicable law, any arbitration,
mediation, court action, or other adjudicative proceeding arising out of or
relating to this Agreement shall be held in Santa Clara County, California if
initiated by WGC and in Denver, Colorado if initiated by CCSI or, if such
proceeding cannot be lawfully held in such location, as near thereto as
applicable law permits.
(e) The prevailing party or parties in any arbitration, mediation,
court action, or other adjudicative proceeding arising out of or relating to
this Agreement shall be reimbursed by the party or parties who do not prevail
for their reasonable attorneys, accountants and experts fees and for the costs
of such proceeding. In the event that two or more parties are deemed liable for
a specific amount payable or reimbursable under this Section 10.13(e), such
parties shall be jointly and severally liable therefor.
10.14 PENALTY PROVISIONS. Each Member hereby acknowledges that certain
provisions of this Agreement (including without limitation Sections 3.6 and
7.1(d)) provide for specified penalties in the event of a breach of this
Agreement by a Member. Each Member hereby agrees that the penalty provisions of
this Agreement are fair and reasonable and, in light of the difficulty of
determining actual damages, represent a prior agreement among the Members as to
appropriate liquidated damages.
-36-
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Agreement as of the date
first above written.
Catalytica Combustion Systems, Inc.
By: /s/ LAWRENCE W. BRISCOE
-----------------------
Its: Chief Financial Officer
-----------------------
Woodward Governor Company
By: /s/ STEPHEN P. CARTER
---------------------
Its: Vice President and Treasurer
----------------------------
-38-
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
date first above written.
Catalytica Combustion Systems, Inc.
By: ________________________________________
Its: _______________________________________
Woodward Governor Company
By: ________________________________________
Its: _______________________________________
-37-
<PAGE>
EXHIBIT A
SCHEDULE OF MEMBERS
<TABLE>
<CAPTION>
Name and Contact Information Capital Commitment Units
- ---------------------------- ------------------ -----
<S> <C> <C>
Catalytic Combustion Systems, Inc. $2 million and delivery of an 50,000
430 Ferguson Drive exclusive license as provided in
Mountain View, California 94043 Exhibit B-1
Attn: Lawrence W. Briscoe
Chief Financial Officer
Telephone: (415) 960-3000
Facsimile: (415) 968-7129
Woodward Governor Company $8 million and delivery of an 50,000
5001 North Second Street exclusive license as provided in
Rockford, IL 61111 Exhibit B-2
Attn: Stephen P. Carter
Vice President and Treasurer
Telephone: (815) 639-6800
Facsimile: (815) 636-6018
</TABLE>
<PAGE>
EXHIBIT 23.1
CATALYTICA, INC.
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Form S-8's No. 33-62964 and No. 333-09533) pertaining to the 1992 Stock Option
Plan, the 1992 Employee Stock Purchase Plan, and the 1995 Director Option Plan
of Catalytica, Inc. of our report dated January 28, 1997, with respect to the
consolidated financial statements of Catalytica, Inc., included in this Annual
Report (Form 10-K) for the year ended December 31, 1996.
ERNST & YOUNG LLP
San Jose, California
March 28, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1995
<PERIOD-START> JAN-01-1996 JAN-01-1995
<PERIOD-END> DEC-31-1996 DEC-31-1995
<CASH> 15,540 5,021
<SECURITIES> 8,281 15,881
<RECEIVABLES> 5,237 3,729
<ALLOWANCES> 100 100
<INVENTORY> 3,417 854
<CURRENT-ASSETS> 33,056 25,756
<PP&E> 17,433 14,009
<DEPRECIATION> 9,536 8,626
<TOTAL-ASSETS> 41,003 31,239
<CURRENT-LIABILITIES> 9,152 7,654
<BONDS> 1,524 1,556
0 0
0 0
<COMMON> 65,501 65,120
<OTHER-SE> (48,238) (43,091)
<TOTAL-LIABILITY-AND-EQUITY> 41,003 31,239
<SALES> 9,813 8,858
<TOTAL-REVENUES> 16,314 13,624
<CGS> 9,073 8,339
<TOTAL-COSTS> 23,232 22,649
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 353 278
<INCOME-PRETAX> (5,192) (8,687)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (5,192) (8,687)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (5,192) (8,687)
<EPS-PRIMARY> (.27) (.55)
<EPS-DILUTED> (.27) (.55)
</TABLE>
