<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended MARCH 31, 1998
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________________to ______________.
Commission File No. 0-20966
---------------
CATALYTICA, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 94-2262240
(State or other jurisdiction of (IRS EMPLOYER
incorporation or organization) IDENTIFICATION NUMBER)
430 Ferguson Drive
MOUNTAIN VIEW, CALIFORNIA 94043
(Address of principal executive offices)
(415) 960-3000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
As of May 7, 1998, there were outstanding 27,972,391 shares of the
registrant's Common Stock, par value $.001, which is the only class of common
stock of the registrant registered under Section 12(g) of the Securities Act of
1933. The Company also has outstanding 13,270,000 shares of Class A Common
Stock and 11,730,000 shares of Class B Common Stock which are convertible into
an equal number of shares of Common Stock.
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CATALYTICA, INC.
FORM 10-Q
TABLE OF CONTENTS
March 31, 1998
<TABLE>
<CAPTION>
PAGE NO.
<S> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidated Balance Sheets as of March 31, 1998 and December 31, 1997 3
Condensed Consolidated Statements of Operations for the three months ended March 31,
1998 and March 31, 1997 5
Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 1998
and March 31, 1997 6
Notes to Condensed Consolidated Financial Statements 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS 11
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 23
SIGNATURES 24
</TABLE>
2
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PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
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<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 34,160 $ 35,149
Short-term investments 16,863 11,918
Accounts receivable, net 21,328 12,640
Accounts receivable from joint venture 699 967
Notes receivable from employees 1,451 405
Inventory:
Raw materials 49,333 52,648
Work in process 57,255 54,883
Finished goods 7,851 6,714
-------- --------
114,439 114,245
Deferred tax asset 386 166
Prepaid expenses and other assets 2,536 1,939
-------- --------
Total current assets 191,862 177,429
Property, plant and equipment:
Land 5,391 5,391
Equipment 101,433 99,744
Buildings and leasehold improvements 66,210 65,744
-------- --------
173,034 170,879
Less accumulated depreciation and amortization (18,238) (15,075)
-------- --------
154,796 155,804
Other assets 1,778 2,040
-------- --------
$348,436 $335,273
======== ========
</TABLE>
See accompanying notes.
3
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CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
------------------ ------------------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 18,547 $ 23,281
Accrued payroll and related expenses 5,778 5,768
Deferred revenue 2,018 1,848
Other accrued liabilities 11,400 8,250
Current portion of long-term debt 39,707 50,332
Income taxes payable 669 525
Interest Payable 617 --
-------- --------
Total current liabilities 78,736 90,004
Long-term debt 65,666 75,069
Non-current deferred revenue 3,194 3,611
Other accrued liabilities 6,400 6,400
Minority interest 41,000 11,000
Class A and B common stock 97,079 97,079
Stockholders' equity:
Common Stock 30 28
Additional paid-in capital 100,352 100,375
Deferred compensation (385) (406)
Accumulated deficit (43,636) (47,887)
-------- --------
Total stockholders' equity 56,361 52,110
-------- --------
$348,436 $335,273
======== ========
</TABLE>
See accompanying notes.
4
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CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Three MONTHS ENDED MARCH 31,
1998 1997
------------------ -------------------
<S> <C> <C>
Revenues:
Product sales $90,280 $ 3,059
Research revenues 1,854 1,726
------- -------
92,134 4,785
Costs and expenses:
Cost of sales 77,112 3,074
Research and development 3,836 2,199
Selling, general and administrative 3,427 990
------- -------
Total costs and expenses 84,375 6,263
Operating income (loss) 7,759 (1,478)
Interest income 909 266
Interest expense (2,625) (113)
Loss on joint venture (1,155) (1,000)
------- -------
Income (loss) before income taxes 4,888 (2,325)
Provision for income taxes (637) --
------- -------
Net income (loss) $ 4,251 $(2,325)
======= =======
Net income (loss) per share:
Basic $0.08 $(0.12)
======= =======
Diluted $0.07 $(0.12)
======= =======
Number of shares used in computing net income (loss) per share:
Basic 52,951 19,855
======= =======
Diluted 58,588 19,855
======= =======
</TABLE>
See accompanying notes.
5
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CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Three MONTHS ENDED MARCH 31,
1998 1997
------------------- -------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 4,251 $(2,325)
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activity:
Depreciation and amortization 4,567 275
Deferred income taxes (220)
Losses in affiliated company 1,154 --
Changes in:
Accounts receivable (8,688) (581)
Accounts receivable from joint venture 268 606
Inventory (194) 332
Prepaid expenses and other current assets (1,866) (450)
Accounts payable (4,734) (444)
Accrued payroll and related expenses 10 132
Deferred revenue (247) (19)
Accrued acquisition costs (70) --
Other accrued liabilities 3,981 (217)
-------- -------
Net cash used in operating activities (1,788) (2,691)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments (16,797) (7,353)
Maturities of investments 12,000 7,200
Investment in affiliate company (1,154) --
Acquisition of property and equipment (2,155) (2,160)
-------- -------
Net cash used in investing activities (8,106) (2,313)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net receipts on (issuance of) notes receivable from employees (1,046) 30
Additions to debt obligations -- 785
Payments on debt obligations (20,028) (473)
Minority investment 30,000 --
Issuance of stock, net of issuance costs (21) 350
-------- -------
Net cash provided by financing activities 8,905 692
-------- -------
Net increase (decrease) in cash and cash equivalents (989) (4,312)
Cash and cash equivalents at beginning of period 35,149 15,540
-------- -------
Cash and cash equivalents at end of period $ 34,160 $11,228
======== =======
</TABLE>
See accompanying notes.
6
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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three-month period ended March 31,
1998, are not necessarily indicative of the results that may be expected for the
year ended December 31, 1998. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Catalytica, Inc.
Annual Report on Form 10-K for the year ended December 31, 1997.
2. EARNINGS (LOSS) PER SHARE
Earnings (loss) per share is presented in accordance with Financial Accounting
Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No.
128, "Earnings Per Share" (EPS). This statement requires the presentation of EPS
to reflect both "Basic EPS" and "Diluted EPS" on the face of the statement of
operations. For the period ended March 31, 1998, the inclusion of common stock
equivalents is antidilutive, therefore loss per share is computed based on the
weighted average number of common shares outstanding excluding common stock
equivalents for this period. Weighted average shares outstanding includes Class
A and B common shares as the Company considers Class A and B to be the
equivalent of common stock. The periods presented herein have been adjusted to
reflect the calculation of EPS in accordance with SFAS No. 128.
A reconciliation of the numerators and denominators for the Basic and Diluted
EPS calculations follows:
<TABLE>
<CAPTION>
Three MONTHS ENDED MARCH 31,
1998 1997
------------------- ------------------
<S> <C> <C>
Numerator:
Numerator for basic earnings per share: Income available to common
shareholders $ 4,251 $(2,325)
Less: Reduction of Catalytica Pharmaceuticals income attributable to
holders of subsidiary stock options (249) --
------- -------
Numerator for diluted earnings per share 4,002 (2,325)
DENOMINATOR:
Denominator for basic earnings per share
Weighted-average shares 52,951 19,855
------- -------
Effect of dilutive securities:
Catalytica, Inc. employee stock options 579 --
Catalytica Pharmaceuticals Convertible Preferred Stock 1,671 --
Catalytica Pharmaceuticals Convertible Junior Preferred Stock 564 --
Catalytica Combustion Systems, Inc. Convertible Preferred Stock 2,823 --
------- -------
Dilutive potential common shares 5,637 --
Denominator for diluted earnings per share
Adjusted weighted-average shares and assumed conversions 58,588 19,855
------- -------
Basic earnings per share $ 0.08 $ (0.12)
======= =======
Diluted earnings per share $ 0.07 $ (0.12)
======= =======
</TABLE>
7
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3. IMPACT OF STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 130
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income." This Statement
requires that all items recognized under accounting standards as components of
comprehensive earnings be reported in an annual financial statement that is
displayed with the same prominence as other annual financial statements. This
Statement also requires that an entity classify items of other comprehensive
earnings by their nature in an annual financial statement. For example, other
comprehensive earnings may include foreign currency translation adjustments,
minimum pension liability adjustments, and unrealized gains and losses on
marketable securities classified as available-for-sale. Annual financial
statements for prior periods will be reclassified, as required. The Company has
no comprehensive earnings adjustments for the three months ended March 31, 1998
and 1997, thus total comprehensive earnings is equal to net earnings (loss).
4. FINANCIAL INSTRUMENTS
For the purposes of the consolidated cash flows, all investments with
maturities of three months or less at the date of purchase held as available-
for-sale are considered to be cash and cash equivalents; instruments with
maturities of three months or less at the date of purchase which are held-to-
maturity ($11,902,000 at March 31, 1998) and investments with maturities greater
than three months which are available-for-sale ($4,961,000 at March 31, 1998)
are considered to be short-term investments; investments with maturities greater
than one year are considered to be long-term investments and are available-for-
sale (none at March 31, 1998). All investments at March 31, 1998, were carried
at amortized cost, which approximated fair market value (quoted market price).
The classification of investments is made at the time of purchase with
classification for held-to-maturity made when the Company has the positive
intent and ability to hold the investments to maturity.
5. USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
6. REVENUE RECOGNITION
In connection with the purchase of the Glaxo Wellcome, Inc. ("Glaxo Wellcome")
facility in Greenville, North Carolina ("Greenville Facility") by the Company on
July 31, 1997, Glaxo Wellcome entered into a Supply Agreement under which
Catalytica Pharmaceuticals has been and will continue to manufacture products
for Glaxo Wellcome. Glaxo Wellcome has guaranteed that revenues paid to
Catalytica Pharmaceuticals will meet a specified level of minimum revenue or
that Glaxo Wellcome will pay Catalytica Pharmaceuticals any shortfall.
The Company recognizes revenue under the Supply Agreement with Glaxo Wellcome
based upon the minimum revenues under this agreement. All other product
revenues are recorded upon shipment. During the three months ended March 31,
1998, the Company recorded $74 million of product revenue under the Supply
Agreement.
As of March 31, 1998, a receivable in the amount of $13.5 million was
outstanding from Glaxo Wellcome.
8
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7. DEBT
In conjunction with the acquisition of the Greenville Facility, the Company,
and The Chase Manhattan Bank ("Chase") entered into a Credit Agreement pursuant
to which a syndicate of banks led by Chase agreed to lend Catalytica
Pharmaceuticals an aggregate of up to $200,000,000 (the "Debt Facilities"). The
Debt Facilities consist of a senior secured term loan facility (the "Term Debt
Facility") in an aggregate principal amount of $125,000,000 and a senior secured
revolving facility (the "Revolving Debt Facility") in an aggregate principal
amount of $75,000,000. Up to $20,000,000 of the Revolving Debt Facility is
available for the issuance of letters of credit. The Term Debt Facility will
mature December 31, 2001 and will amortize in quarterly installments commencing
on the last day of the third fiscal quarter of 1998. The Credit Agreement, which
is guaranteed by Catalytica, Inc., requires that the Company maintain certain
financial ratios and levels of tangible net worth, profitability, and liquidity
as well as restrictions on the Company's ability to declare and pay dividends.
The senior secured facility interest rate is a variable interest rate tied to
LIBOR. This interest rate was 6.94% as of March 31, 1998. As of March 31,
1998, nothing was outstanding under the Revolving Debt Facility and $105,000,000
was outstanding under the senior secured term facility. On February 2, 1998,
the Company made an early payment of $20 million on the Term Debt Facility. On
April 1, 1998, the Company made an additional early payment of $5 million on the
Term Debt Facility. These early payments reduced the remaining amount owed in
1998 to $25 million.
In addition to the restrictions above, the Chase Credit Agreement contains
various covenants restricting further indebtedness, issuance of preferred stock
by the Company or its subsidiaries, liens, acquisitions, asset sales, capital
expenditures. At March 31, 1998, the Company was in compliance with the
covenants.
8. FORMATION OF GENXON/(TM)/ JOINT VENTURE WITH WOODWARD GOVERNOR COMPANY
On October 15, 1996 Catalytica's subsidiary Catalytica Combustion Systems,
Inc. ("Combustion Systems") and Woodward Governor Company formed a Delaware
limited liability company in connection with a 50/50 joint venture to serve the
gas turbine retrofit market for installed, out-of-warranty engines. The new
company, GENXON/(TM)/ Power Systems, LLC, will initially upgrade the combustion
systems of installed turbines with XONON which is designed to reduce emissions
and permit greater asset utilization for both power generation and mechanical
drive markets.
Subsequent to the initial funding of $10 million, which was completed during
the quarter ended September 30, 1997, continued funding of the joint venture
beyond the initial commitment has occurred on a 50/50 basis with each joint
venture partner contributing an equal amount quarterly. For the quarter ended
March 31, 1998, each partner contributed $1.2 million, bringing the total
combined investment in the joint venture to $17.15 million to date. Although the
Company believes that Combustion Systems and Woodward intend to continue the
funding of this joint venture, neither joint venture partner is contractually
required to make further capital infusions exclusive of some required capital
infusions that are predicated upon reaching certain milestones.
Combustion Systems recognized its 50% share of GENXON losses of $2.3 million,
or $1.15 million, for the three months ending March 31, 1998. Accordingly,
losses on the joint venture were recognized in the results of operations.
As of March 31, 1998, an account receivable for $699,000 existed from the
joint venture for costs incurred by Combustion Systems. Accordingly these costs
have not been included in the consolidated entity.
9
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9. ENRON INVESTMENT
On January 14, 1998, Enron Ventures Corporation, a wholly-owned subsidiary of
Enron Corporation ("Enron"), purchased a 15% minority interest in Combustion
Systems for $30 million in cash. Enron also received a three-year option to
purchase an additional 5% of Combustion Systems for $14.4 million in cash. In
connection with the Stock Purchase Agreement, the Company entered into a Share
Exchange Agreement, providing Enron the right to exchange the Series B Preferred
Stock of Combustion Systems for Catalytica, Inc. Common Stock. After the five
year anniversary of the agreement, if Combustion Systems has not undertaken a
public offering, in which Combustion Systems receives at least $20 million,
Enron shall have the right to require Catalytica, Inc. to exchange all of the
outstanding shares of Series B Preferred Stock for that number of shares of
Catalytica, Inc. Common Stock based upon a determined exchange rate. The
exchange rate is based upon the fair value of the Series B Preferred Stock and
the market value of Catalytica's Common Stock at the time of conversion. Upon
consolidation of Combustion Systems into Catalytica, Inc., the Series B
Preferred Stock issued to Enron is reflected as $30 million of minority interest
in Catalytica, Inc.
NOTE 10. INCOME TAXES
The provision for income taxes for the three months ended March 31, 1998 was
approximately 13% as compared to 0% for the corresponding period in 1997. The
increase in the estimated annual tax rate is due primarily to state income taxes
relating to the Greenville facility coupled with the federal alternative minimum
tax.
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act and Section 21E of the Exchange Act, which
involve risks and uncertainties including but not limited to those statements
which have been identified by an asterisk ("*") and other statements regarding
the Company's strategy, financial performance and revenue sources. The Company's
actual results could differ materially from the results anticipated in these
forward-looking statements as a result of certain factors including these set
forth under "Risk Factors" and elsewhere in this Report.
The Company is creating new businesses that leverage 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 capabilities to two primary areas: (i)
production of pharmaceutical components 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 Pharmaceuticals, Inc. ("Catalytica Pharmaceuticals") and Catalytica
Combustion Systems, Inc. ("Combustion Systems"). In addition to market focus,
the formation of subsidiaries provides greater flexibility for strategic
financial arrangements and business partnerships. A third subsidiary,
Catalytica Advanced Technologies ("Advanced Technologies"), is exploring new
business opportunities and markets for the Company's technologies.
On July 31, 1997, Catalytica Pharmaceuticals, Inc. (formerly Catalytica
Fine Chemicals, Inc.), a subsidiary of the Company, acquired from Glaxo
Wellcome, Inc. a pharmaceutical manufacturing facility (the "Greenville
Facility") located in Greenville, North Carolina (the "Acquisition"), in
exchange for (i) $244.7 million in cash (after certain post closing
adjustments); (ii) 250,000 shares of Junior Preferred Stock of Catalytica
Pharmaceuticals; (iii) warrants to purchase 2,000,000 shares of the Company's
Common Stock at an exercise price of $12.00 per share and (iv) 10% of the
earnings before interest and taxes prior to July 31, 2007, in excess of an
aggregate cumulative amount of $10 million attributable to the Sterile Product
Operations ("SPO") portion of the Greenville Facility, up to an aggregate
cumulative payment to Glaxo Wellcome of an additional $25.0 million.
To raise the cash needed to complete the Acquisition, the Company used a
combination of equity and debt financing. With the closing of the Acquisition,
the Company completed the sale of 13,270,000 shares of its Class A Common Stock
and 16,730,000 shares of its Class B Common Stock to Morgan Stanley Capital
Partners III, L.P. and two affiliated funds ("MSCP") (collectively, the "Stock
Sale"), at a price of $4.00 per share, for an aggregate of $120,000,000. The
Class A and B stock are convertible into common stock of the Company on a share
for share basis. In November of 1997, the Company repurchased 5,000,000 of the
Class B MSCP shares at $4.75 per share with the proceeds from the issuance of a
warrant dividend granted to its shareholders in connection with the financing of
the acquisition.
In addition to the equity investment by MSCP, the Company, The Chase
Manhattan Bank ("Chase") and Chase Securities Inc. ("CSI") entered into a Credit
Agreement pursuant to which a syndicate of banks led by Chase agreed to lend
Catalytica Pharmaceuticals an aggregate of up to $200,000,000 (the "Debt
Facilities"). The Debt Facilities consist of a senior secured term loan facility
(the "Term Debt Facility") in an aggregate principal amount of $125,000,000 and
a senior secured revolving facility (the "Revolving Debt Facility") in an
aggregate principal amount of $75,000,000. As of March 31, 1998, nothing was
outstanding under the revolving debt facility and $105,000,000 was outstanding
under the senior secured term facility. (See Note 7 to Unaudited Condensed
Consolidated Financial Statements).
The additional facilities, employees and business volumes resulting from
the Acquisition have substantially increased the expenses and working capital
requirements and placed increased burdens on the Company's management resources.
Furthermore, the success of the Company's future results depends, in significant
part, on the levels of new manufacturing business developed by Catalytica
Pharmaceuticals.* In the event Catalytica
11
<PAGE>
Pharmaceuticals does not obtain additional new customers, which could involve
additional business from Glaxo Wellcome, on terms sufficient to offset the costs
associated with operating and maintaining the Greenville Facility, and with
servicing the debt incurred in connection with the acquisition of the Greenville
Facility, the Company's consolidated results of operations and financial
condition would be materially adversely affected.
Due to the size of the Acquisition, the results of operations of Catalytica
Pharmaceuticals have a material effect on the consolidated results of operations
of the Company, and the results of operations of the Company's other businesses
are expected to only modestly impact consolidated results for fiscal year 1998.*
The anticipated revenues from the Supply Agreement with Glaxo Wellcome are
expected to allow the Company to achieve continued profitable operations for
Catalytica Pharmaceuticals throughout 1998, and the consolidated parent Company
as well, offsetting losses arising from continued investments in the Company's
Combustion Systems and Advanced Technologies businesses.* After 1998, Catalytica
Pharmaceuticals' profitability will depend on its success and timing in
obtaining new customers, including possible new agreements with Glaxo Wellcome.*
Profitability on a consolidated basis will depend on the operating results of
each of the Company's subsidiaries, particularly the rate of commercial success
of Catalytica Combustion Systems, Inc.*
Manufacturing at the Greenville Facility is conducted in three district
operations: Chemical Manufacturing Operations ("CMO"), Pharmaceutical Product
Operations ("PPO") and Sterile Product Operations ("SPO"). There is substantial
excess manufacturing capacity immediately available at the PPO and SPO
facilities, but because of the long lead times required to obtain necessary
regulatory approvals to manufacture final dosage products at these facilities,
Catalytica Pharmaceuticals does not anticipate additional significant revenue
from such facilities until later in 1998 or 1999 at the earliest.* The inability
of Catalytica Pharmaceuticals to fill additional available capacity or to reduce
costs in conjunction with lower levels of capacity utilization would have a
material adverse effect on the Company's results of operations and financial
condition.
Catalytica Pharmaceuticals also owns and operates a flexible, multi-
purpose, commercial scale manufacturing plant in East Palo Alto, California,
which has approximately 12,000 gallons of reactor capacity set up in a wide
range of reactor sizes ("Bayview Facility"). The Bayview Facility includes a
pilot plant used for scaling up manufacturing processes and a solids handling
facility that operates under current Good Manufacturing Practices ("cGMP").
This facility was acquired in 1993 from Novartis (formerly Sandoz).
On May 8, 1996, Catalytica Pharmaceuticals, announced that Pfizer Inc. had
signed an agreement to invest $15 million in Catalytica Pharmaceuticals. These
funds originally provided Pfizer a 15% interest in Catalytica Pharmaceuticals
and a five-year research and development ("R&D") commitment by Catalytica
Pharmaceuticals to develop new processes and technology for the manufacture of
Pfizer products. Prior to this investment, Catalytica Pharmaceuticals was a
wholly-owned subsidiary of Catalytica, Inc. Pursuant to the terms of the
Greenville Acquisition, Glaxo Wellcome received approximately a 1.5% equity
interest in Catalytica Pharmaceuticals and the Company purchased additional
shares of Catalytica Pharmaceuticals, which resulted in Pfizer's ownership
interest decreasing to approximately 4.4%. The Company owns the remaining 94.1%
outstanding equity interest in Catalytica Pharmaceuticals.
During the past four years, Catalytica Pharmaceuticals and Pfizer have
collaborated on the development of proprietary processes for key intermediate
products for several of Pfizer's promising new pharmaceuticals. During the first
quarter of 1998, Catalytica Pharmaceuticals and Pfizer signed a new
collaborative agreement to begin research and development into new drug
formulations. Under the new agreement, Catalytica Pharmaceuticals through it's
Greenville Facility, will now provide expertise in development of innovative
processes for the manufacture of tablets, capsules, injectable products, and
other formulations for releasing medications internally. The new agreement with
Pfizer extends the aforementioned existing R&D relationship between the two
companies, established in 1996, under which Catalytica Pharmaceuticals has
focused on the development of new processes for synthesizing chemical compounds
for the production of Pfizer drugs. The Pfizer drugs are at varying stages of
approval by the Food and Drug Administration ("FDA"), ranging from Phase II
clinical trials through the New Drug Application stage. Catalytica
Pharmaceuticals currently manufactures intermediates for certain Pfizer drugs
and anticipates becoming a supplier of intermediates to Pfizer for other
pharmaceutical products in the future.* There can be no assurance, however, that
orders will be forthcoming from Pfizer.
12
<PAGE>
On October 15, 1996 Catalytica's subsidiary Catalytica Combustion Systems
Inc. ("Combustion Systems") and Woodward Governor Company formed a Delaware
limited liability company in connection with a 50/50 joint venture to serve the
gas turbine retrofit market for installed, out-of-warranty engines. The new
company, GENXON/(TM)/ Power Systems, LLC, will initially upgrade the combustion
systems of installed turbines with XONON which is designed to reduce emissions
and permit greater asset utilization for both power generation and mechanical
drive markets.
Subsequent to the initial funding of $10 million which was completed during
the quarter ended September 30, 1997, continued funding of the joint venture
beyond the initial commitment has occurred on a 50/50 basis with each joint
venture partner contributing an equal amount quarterly. For the quarter ended
March 31, 1998, each partner contributed $1.2 million, bringing the total
combined investment in the joint venture to $17.15 million to date. Although the
Company believes that Combustion Systems and Woodward intend to continue the
funding of this joint venture, neither joint venture partner is contractually
required to make further capital infusions exclusive of some required capital
infusions that are predicated upon reaching certain milestones.*
On January 14, 1998, Enron Ventures Corporation, a wholly-owned subsidiary
of Enron Corporation ("Enron"), purchased a 15% minority interest in Catalytica
Combustion Systems for $30 million in cash. The Company owns the remaining 85%
outstanding equity interest in Catalytica Combustion Systems. In addition, Enron
also received a three-year option to purchase an additional 5% of Combustion
Systems for $14.4 million in cash. In connection with the Stock Purchase
agreement, the Company entered into a Share Exchange agreement, providing Enron
the right to exchange the Series B Preferred Stock of Combustion Systems for
Catalytica, Inc. Common Stock. After the five year anniversary of the
agreement, if Combustion Systems has not undertaken a public offering, in which
Combustion Systems receives proceeds of at least $20 million, Enron shall have
the right to require the Company to exchange all of the outstanding shares of
Series B Preferred Stock for that number of shares of Common Stock based upon a
determined exchange rate. The exchange rate is based upon the fair value of the
Series B Preferred Stock and the market value of Catalytica's Common Stock at
the time of conversion. Upon consolidation of Combustion Systems into
Catalytica, Inc., the Series B Preferred Stock issued to Enron is reflected as
$30 million of minority interest.
The Company's business had not been profitable until the second half of
1997, and as of March 31, 1998, the Company had an accumulated deficit of $43.6
million. To achieve continued profitable operations, the Company must
successfully manage the operations of the new Greenville Facility, and, to a
lesser extent, successfully develop, manufacture, introduce and market or
license its combustion systems and catalytic processes.* The Company's success
will depend on its ability to complete the transition from emphasizing research
and development to full commercialization and sale of its products.* The Company
began manufacturing, marketing and selling pharmaceutical intermediates in 1994
and, with the Acquisition of the Facility, substantially increased its
manufacturing of pharmaceutical products.
RESULTS OF OPERATIONS
Net revenues for the three months ended March 31, 1998 increased by 1,825%
compared to the same quarter in fiscal 1997 due to an increase in product sales
attributable to the Greenville Facility and the related Supply Agreement with
Glaxo Wellcome. During the three months ended March 31, 1998, 92% of the
Company's pharmaceutical product revenues were derived from sales to Glaxo
Wellcome under the Supply Agreement. As part of the Supply Agreement, Glaxo
Wellcome guarantees a specified minimum level of revenues in each year of the
agreement. To the extent the minimum level of revenues exceeds revenues due as
a result of product shipments, the Company receives additional payments from
Glaxo Wellcome which help offset fixed manufacturing costs associated with
manufacturing capacity reserved for Glaxo Wellcome as required in the long term
Supply Agreement (See Note 6 to Unaudited Condensed Consolidated Financial
Statements). There was a 7% increase in research revenues for the first quarter
of 1998 reflecting a funded research commitment associated with the five-year
R&D agreement between Catalytica Pharmaceuticals and Pfizer to develop new
processes and technology for
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the manufacture of Pfizer products, and expansion of the Company's research and
development to support the higher level of manufacturing at its Greenville
facility.
Interest income increased 241% for the first quarter of 1998 when compared
to the same period in 1997. Cash and investments increased due to increases in
cash balances resulting from debt and equity financing related to the
acquisition of the Greenville Facility and through increased product sales. Cash
balances also increased significantly due to the Enron cash investment in
Catalytica Combustion Systems (See Note 9 to Unaudited Condensed Consolidated
Financial Statements). The Enron cash investment has restrictions related to
its use such that these funds cannot be used to retire debt in other Catalytica
subsidiaries such as Catalytica Pharmaceuticals (See Note 9 to Unaudited
Condensed Consolidated Financial Statements).
Cost of goods sold increased 2,408% for the first quarter of 1998. The
increase in cost of goods sold for the three month period reflects increased
physical volume of product sales primarily due to an increase in sales
attributable to the Facility and the related Supply Agreement with Glaxo
Wellcome. Margins on the pharmaceutical products are subject to fluctuations
from quarter to quarter due to various factors including the mix of products
being manufactured, manufacturing efficiencies achieved on production runs, the
length of down-time associated with setting up new productions runs, and
numerous other variables present in the chemical manufacturing environment.
Research and development expenses increased 74% for the three months ended
March 31,1998, as compared to the same periods in 1997. This increase is
attributable to research and development expenses associated with the Facility
coupled with increased R&D activity associated with the Pfizer research
agreements. Research and development expenses may fluctuate from quarter to
quarter.
Selling, general and administrative expenses ("SG&A") increased 246% for
the first quarter of 1998 compared to the same period of 1997 largely due to
SG&A costs incurred at the Greenville Facility. SG&A expenses are expected to
increase further in the future as the Company expands it's sales and marketing
personnel to sell the available capacity in the Facility.*
Net interest expense increased 2,214% for the first quarter of 1998 when
compared to the same periods last year due to debt incurred to complete the
acquisition of the Greenville Facility.
Combustion Systems recognized its 50% share of GENXON losses, of $2.3
million, or $1.15 million for the first quarter of 1998. The Company's capital
contribution for the first quarter of 1998 was $1.2 million. The Company
estimates it may make additional capital contributions to the joint venture
during the remainder of 1998.* The Company anticipates GENXON will continue to
generate losses during this time frame, and accordingly the Company will record
its share of these losses to the extent of its capital contribution.* However,
these losses may be partially offset by reimbursements for past R&D expenses if
certain GENXON milestones are achieved.
The provision for income taxes for the three months ended March 31, 1998
was approximately 13% as compared to 0% for the corresponding period in 1997.
The increase in the estimated annual tax rate is due primarily to state income
taxes relating to the Greenville Facility coupled with the federal alternative
minimum tax.
Liquidity and Capital Resources
Total cash and cash equivalents plus short-term investments increased to
$51 million at March 31, 1998, compared to $47 million at December 31, 1997. The
increase in cash was due to a $30 million investment in Combustion Systems by
Enron Ventures Corporation for a 15% ownership in Combustion Systems (See Note 9
to Unaudited Condensed Consolidated Financial Statements). This increase was
largely offset by an early payment of $20 million on the Chase Term Debt
Facility (See Note 7 to Unaudited Condensed Consolidated Financial Statements),
coupled with a net increase in various working capital items associated with the
Pharmaceutical business. On April 1, 1998, the Company made an additional early
payment of $5 million on the Chase Term Debt Facility.
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During the past several years, the Company has obtained various term loans
and lines of credit to fund capital purchases and working capital needs. On July
31, 1997 in conjunction with the Acquisition of the Greenville Facility, the
Company, a syndicate of Banks led by Chase Manhattan Bank ("Chase") entered into
a Credit Agreement pursuant to which Catalytica Pharmaceuticals could borrow up
to an aggregate of $200,000,000 (the "Debt Facilities"). The Debt Facilities
consist of a senior secured term loan facility (the "Term Debt Facility") in an
aggregate principal amount of $125,000,000 and a senior secured revolving
facility (the "Revolving Debt Facility") in an aggregate principal amount of
$75,000,000. The Term Debt Facility will mature on December 31, 2001, and
amortizes in quarterly installments commencing on the last day of the third
fiscal quarter of 1998 in aggregate annual amounts of (i) $50,000,000 in the
year 1998, (ii) $37,500,000 in the year 1999, (iii) $20,000,000 in the year
2000, and (iv) $17,500,000 in the year 2001. The Revolving Debt Facility matures
four and one-half years after consummation of the Acquisition. As of March 31,
1998, nothing was outstanding under the revolving debt facility and $105,000,000
was outstanding under the senior secured term facility. On February 2, 1998,
the Company made an early payment of $20 million on the Chase Term Debt
Facility. On April 1, 1998, the Company made an additional early payment of $5
million on the Chase Term Debt Facility. These early payments reduced the
remaining amount owed in 1998 to $25 million. As of March 31, 1998, the Company
was in compliance with various covenants and other restrictions contained in the
Chase Debt Agreement and believes that it will remain in compliance.*
The Company's operations to date have required substantial amounts of cash.
As part of the financing of the Acquisition of the Greenville Facility,
Catalytica Pharmaceuticals incurred approximately $125 million of long-term
indebtedness, of which $105 million was outstanding as of March 31, 1998. The
Company and its subsidiary Catalytica Advanced Technology have guaranteed this
indebtedness. As a result of this increased leverage, Catalytica
Pharmaceuticals' principal and interest obligations have increased
substantially. The degree to which Catalytica Pharmaceuticals is leveraged could
adversely affect Catalytica Pharmaceuticals' and the Company's ability to obtain
additional financing for working capital, acquisitions or other purposes and
could make Catalytica Pharmaceuticals and the Company more vulnerable to
economic downturns and competitive pressures. The Company's future capital
requirements will depend on many factors, including Catalytica Pharmaceuticals
level of business beyond the Supply Agreement with Glaxo Wellcome, the rate of
commercialization of the Company's catalytic combustion systems, and the need to
expand manufacturing capacity for pharmaceutical or combustion systems
business.* The Company expects to spend approximately $30 million to $40
million during 1998 for capital expenditures primarily at Catalytica
Pharmaceuticals.* As of March 31, 1998, the Company believes that with its cash
position of $51.0 million (including short-term investments) plus its available
line of credit of $75 million coupled with the anticipated cash flow from
operations in 1998, the Company has adequate funds to meet its working capital
needs and debt repayment obligations, for at least the next 12 months.*
RISK FACTORS
HISTORY OF OPERATING LOSSES AND UNCERTAINTY OF FUTURE RESULTS. The
Company's business had not been profitable until the quarter ended September 30,
1997. As of March 31, 1998, the Company had an accumulated deficit of $43.6
million. To achieve continued profitable operations, Catalytica must
successfully manage the operations of the pharmaceutical manufacturing facility
located in Greenville, North Carolina (the "Greenville Facility"), and, to a
lesser extent, successfully develop, manufacture, introduce and market or
license its combustion systems and catalytic processes.* The Company's success
will depend on its ability to complete the transition from emphasizing research
and development to full commercialization and sale of its products.* The
Company began manufacturing, marketing and selling pharmaceutical intermediates
in 1994, with the acquisition of the Greenville Facility, will substantially
increase its manufacturing of pharmaceutical products in 1998.
The additional facilities, employees and business volumes resulting from
the acquisition of the Greenville Facility from Glaxo Wellcome in the third
quarter of Fiscal 1997 (the "Acquisition") substantially increased the expenses
and working capital requirements and placed substantial burdens on the Company's
management resources. Furthermore, the success of the Acquisition and the
Company's future results depend, in significant part, on the levels of
manufacturing business developed by Catalytica Pharmaceuticals.* In the event
Catalytica Pharmaceuticals does not obtain additional new customers, which could
involve additional business from Glaxo Wellcome, on terms sufficient to offset
the costs associated with operating and maintaining the Greenville Facility,
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and with servicing the debt incurred in connection with the acquisition of the
Greenville Facility, the Company's consolidated results of operations and
financial condition would be materially adversely affected.
Due to the size of the Acquisition, the results of operations of Catalytica
Pharmaceuticals have a material effect on the consolidated results of operations
of the Company, and the results of operations of the Company's other businesses
will be insignificant for 1998.* The anticipated revenues from the Supply
Agreement entered into with Glaxo Wellcome are expected to allow the Company to
achieve profitable operations for Catalytica Pharmaceuticals for 1998.* After
1998, Catalytica Pharmaceuticals' profitability will depend on its success and
timing in obtaining new customers, including possible new agreements with Glaxo
Wellcome.* Manufacturing at the Greenville Facility is conducted in three
district operations: Chemical Manufacturing Operations ("CMO"), Pharmaceutical
Product Operations ("PPO") and Sterile Product Operations ("SPO"). Excess
manufacturing capacity will be available at the CMO facility beginning in mid-
1998, and based on marketing efforts to date Catalytica Pharmaceuticals expects
it will have one or more customers for some or all of the unused CMO facility
beginning in mid-1998.* There is substantial excess manufacturing capacity
immediately available at the PPO and SPO facilities, but because of the long
lead times required to obtain necessary regulatory approvals to manufacture
pharmaceutical and sterile products at these facilities, Catalytica
Pharmaceuticals does not anticipate additional significant revenue from such
facilities until 1998 or 1999 at the earliest.* Catalytica Pharmaceuticals'
inability to fill additional available capacity or to reduce costs in
conjunction with lower levels of capacity utilization would have a material
adverse effect on the Company's results of operations. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
The Company anticipates its operating results 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 pharmaceuticals products, as well as the amount and timing of payments and
expenses under the Company's research and development contracts.
MANAGEMENT OF GROWTH; LIMITATION OF EXISTING INFORMATION SYSTEMS. The
Company's business is currently experiencing a period of growth that has placed
and is expected to continue to place a significant strain on the Company's
personnel and resources. The Company's ability to manage future growth, if any,
will depend on its ability to continue to implement and improve operational,
financial and management information and control systems on a timely basis,
together with maintaining effective cost controls. In particular the Company's
existing information system is not yet completely Year 2000 compliant, as a
result, the Company is continuing to modify the system. To support any future
growth, the Company will need to hire more sales, marketing, support and
administrative personnel, and expand customer service capabilities.*
Competition for the necessary personnel in the Company's industry is intense.
There can be no assurance that the Company will be able to attract and retain
the necessary personnel or that it will be able to satisfy customer demand in a
timely fashion and satisfactorily support its customers and operations.
RELIANCE ON RELATIONSHIP WITH GLAXO WELLCOME. Catalytica Pharmaceuticals
estimates that aggregate payments by Glaxo Wellcome under the Supply Agreement,
which commenced on August 1, 1997, will total approximately $800 million, which
include guaranteed minimum payments plus the cost of raw materials.* The annual
level of minimum payments declines significantly after 1998, but is expected to
continue to represent a significant source of revenue for Catalytica
Pharmaceuticals.* Results for Catalytica Pharmaceuticals business is
substantially dependent on its Supply Agreement with Glaxo Wellcome during 1998
and 1999, and will continue to be dependent on Glaxo Wellcome in part thereafter
until the end of the term of the Supply Agreement. Catalytica Pharmaceuticals'
business and the Company's consolidated results of operations would be adversely
affected if Catalytica Pharmaceuticals does not successfully perform its
obligations under the Supply Agreement. This could result in increased costs to
the Company or in possible termination of the Supply Agreement by Glaxo
Wellcome.
DEPENDENCE ON KEY PERSONNEL. The Company's success is dependent on the
retention of principal members of its management and scientific staff and on the
ability to continue to attract, motivate and retain additional key personnel.
Competition for such key personnel is intense, and the loss of the services of
key personnel or the failure to recruit necessary additional personnel could
have a material adverse effect on the
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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 expansion into areas and activities requiring additional expertise,
such as manufacturing, marketing and distribution, have placed increased demands
on the Company's resources. These activities require the addition of new
personnel with expertise in these areas and the development of additional
expertise by existing personnel. The successful integration of the Greenville
Facility with the operations of Catalytica Pharmaceuticals will be significantly
dependent upon Catalytica Pharmaceuticals' ability to attract and retain the
personnel (including former Glaxo Wellcome employees) necessary to effectively
integrate, and thereafter operate, the combined businesses.* In this regard,
Catalytica Pharmaceuticals has hired certain key managers of the Greenville
Facility, and needs to hire additional personnel particularly sales and
marketing and research and development personnel. Any failure on the part of
Catalytica Pharmaceuticals to attract or retain necessary personnel would have a
material adverse effect on the Company's consolidated results of operations.
UNCERTAINTIES RELATED TO COMBUSTION SYSTEMS BUSINESS. The Company, through
its subsidiary Catalytica Combustion Systems, Inc. ("Combustion Systems"), 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 use of the Company's technology by a limited
number of turbine manufacturers and the Company's ability to enter into
commercial relationships with these manufacturers.* The Company's subsidiary,
Combustion Systems, is currently working with leading turbine manufacturers,
including: Pratt & Whitney Canada, Inc., General Electric, Allison Engine Co., a
subsidiary of Rolls Royce, and Solar, a subsidiary of Caterpillar, Inc. In
addition, through its joint venture company GENXON, Combustion Systems is
developing complete combustor systems for 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 retrofitted on older out-of-warranty turbines no
longer supported by OEM's. Neither the Company, its subsidiary Combustion
Systems, 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
could 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, and to the extent that the Company's existing
facilities are inadequate , 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 that affect capital investment decisions, as well as the
regulatory environment.* There can be no assurance that the Company's
combustion products will be economically attractive when compared to competitive
products.
In October 1996 Combustion Systems and Woodward Governor Company formed a
Delaware limited liability company in connection with a 50/50 joint venture to
serve the gas turbine retrofit market for installed, out-of-warranty engines.
The new company, GENXON/(TM)/ Power Systems, LLC ("GENXON"), will initially
upgrade the combustion systems of installed turbines with XONON which is
designed to reduce emissions and permit greater asset utilization for both power
generation and mechanical drive markets. GENXON plans to deliver an integrated
product which includes Combustion Systems' system for ultra low NOx emissions
and Woodward's control systems.* 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
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lieu of the current design that does not incorporate a catalyst. There can be no
assurance that GENXON's products will be economically attractive when compared
to competitive products.
The initial capital commitment of the GENXON joint venture partners was $10
million--$2 million from Combustion Systems and $8 million from Woodward--
payable over time as the funds were required by the joint venture. This initial
capital commitment of $10 million was reached during the third quarter of 1997.
Continued funding of the joint venture beyond the initial $10 million commitment
has occurred on a 50/50 basis with each joint venture partner contributing $1.2
million during the first quarter of 1998, bringing the total investment in the
joint venture to $17.15 million to date. Combustion Systems recognized its 50%
share of GENXON losses of $1.15 million for the quarter ended March 31, 1998.
Accordingly, a $1.15 million loss on the joint venture was recognized in the
results of operations. The Company expects to make additional capital
contributions to the joint venture during the remainder of fiscal 1998 and
anticipates GENXON will incur additional losses.* The Company will record its
share of these losses to the extent of its capital contribution. These losses
may be partially offset by reimbursements for past R&D expenses if certain
GENXON milestones are achieved. Although Combustion Systems and Woodward intend
to continue the funding of this joint venture, neither joint venture partner is
contractually required to make further capital infusions exclusive of some
required capital infusions which are predicated upon reaching certain
milestones. If the milestones are not met, and the Company desired to complete
any projects being developed by the joint venture, the Company could be required
to fund the projects itself if Woodward decides not to make any additional
capital contributions to GENXON. * If such an event were to occur, it could
have a material adverse effect on the Company's results of operations and
financial condition. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
FUTURE CAPITAL REQUIREMENTS AND UNCERTAINTY OF ADDITIONAL FUNDING;
INCREASED LEVERAGE. The Company's operations to date have required substantial
amounts of cash. As part of the financing of the Acquisition, Catalytica
Pharmaceuticals incurred approximately $125 million of short and long-term
indebtedness of which $105 million was outstanding as of March 31, 1998. The
Company and its subsidiary, Advanced Technology, have guaranteed this
indebtedness. As a result of this increased leverage, Catalytica
Pharmaceuticals' principal and interest obligations have increased
substantially. The degree to which Catalytica Pharmaceuticals is leveraged
could adversely affect Catalytica Pharmaceuticals' and the Company's ability to
obtain additional financing for working capital, acquisitions or other purposes
and could make Catalytica Pharmaceuticals and the Company more vulnerable to
economic downturns and competitive pressures. The Company's future capital
requirements will depend on many factors, including Catalytica Pharmaceuticals
level of business beyond the Supply Agreement with Glaxo Wellcome, the rate of
commercialization of the Company's catalytic combustion systems, and the need to
expand manufacturing capacity for pharmaceutical or combustion systems business.
The Company believes that with the anticipated cash flow from its business and
its quarter-end cash position of $51 million (including short-term investments)
plus its available line of credit of $75 million, coupled with the anticipated
cash flow from operations in 1998, it will have adequate funds to meet its
working capital needs and debt repayment obligations, for at least the next 12
months.* However, there are no assurances that adequate funds for future
operations, whether from the cash flow, financial markets or from collaborative
or other arrangements, will be available when needed or on terms acceptable to
the Company. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Liquidity and Capital Resources."
RISK OF PRODUCT LIABILITY. Although Catalytica Pharmaceuticals intends to
seek indemnification from its customers for any product liability claims that
may result from the pharmaceutical products it produces, there can be no
assurance that Catalytica Pharmaceuticals will not ultimately be found liable
for any product liability claims regarding products it manufactures. Catalytica
Pharmaceuticals expects it will be required to indemnify its customers for
product liability claims if a manufacturing defect results in injury. There can
be no assurance that Catalytica Pharmaceuticals will be able to obtain or
maintain product liability insurance in the future on acceptable terms or with
adequate coverage against potential liabilities. If Catalytica Pharmaceuticals
is found liable in a product liability claim and the Company does not have
adequate product liability insurance or indemnification, the Company's
consolidated results of operations could be materially adversely effected.
Additionally, under the Supply Agreement, Catalytica Pharmaceuticals is
obligated to maintain $100,000,000 of product liability insurance. If
Catalytica Pharmaceuticals does not meet this requirement, it would be
considered a default under the Supply Agreement.
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HAZARDOUS MATERIALS AND ENVIRONMENTAL MATTERS. The Company's research and
development activities and fine chemicals manufacturing involve the use of many
hazardous chemicals. The use of such chemicals has significantly increased as a
result of the acquisition of the Greenville Facility. 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 has
environmental impairment insurance with regard to first party and third party
liability in the amount of $25,000,000 (with a $1,000,000 retention) with
respect to the Greenville Facility only. There can be no assurance that the
Company will not be required to make renovations or improvements to comply with
environmental laws and regulations in the future. The Company's operations,
business or assets could be materially adversely affected in the event such
environmental laws or regulations require the Company to modify current
facilities substantially or otherwise limit the Company's ability to conduct or
expand its operations.
Catalytica Pharmaceuticals expects that significant expenditures may be
incurred at the Greenville Facility as a result of new environmental regulations
currently under consideration. The United States Environmental Protection
Agency (the "EPA") is considering new regulations for the pharmaceutical
industry under the authority of the federal Clean Air Act and Clean Water Act.
These proposed regulations would require the installation of "Maximum Achievable
Control Technology" for certain hazardous air pollutant emissions sources
("Pharmaceutical MACT") and could potentially require the installation of
additional pretreatment systems for wastewater discharges.* The EPA is also
considering changes to its particulate matter emissions regulations as well as
regulation of certain ozone precursor emissions. As these rules are in the
early stages of consideration by the EPA, and as there can be no assurance of
their adoption, the additional cost of complying with such regulations cannot be
determined at this time. There can be no assurance that Catalytica
Pharmaceuticals will not be required to make additional renovations or
improvements to comply with environmental laws and regulations in the future.
Catalytica Pharmaceuticals' operations, business and assets could be materially
adversely affected in the event such environmental laws or regulations require
Catalytica Pharmaceuticals to modify the current Greenville Facility
substantially or otherwise limit Catalytica Pharmaceuticals' ability to conduct
or expand its operations.
CURRENT AND POTENTIAL ENVIRONMENTAL CONTAMINATION AT CATALYTICA
PHARMACEUTICALS' TWO SITES. Glaxo Wellcome has been working with the EPA and
the North Carolina Department of Environment and Natural Resources (the
"NCDENR") to investigate, identify and remediate contamination in the soil and
groundwater at the Greenville Facility now owned by Catalytica Pharmaceuticals.
This investigation, carried out pursuant to the federal Resource Conservation
and Recovery Act, has identified 17 different areas of the Greenville Facility
where contamination has or may have occurred. Of these 17 areas, at least six
have been identified as requiring further investigation and remediation by
NCDENR ("Site Contamination"). Contaminants found in the soil and groundwater
at the Greenville Facility include solvents, petroleum hydrocarbons and
pesticides. As the new owner of the Greenville Facility, Catalytica
Pharmaceuticals has become legally liable for such contamination.
Notwithstanding such legal liability, Glaxo Wellcome has agreed to be primarily
liable for and to perform, at its cost, the remediation required by law for
contamination of the soil and groundwater existing at the Greenville Facility as
of the Closing. The cost and extent of remediation to be required at the
Greenville Facility is currently unknown. The Environmental Agreement with
Glaxo Wellcome also requires Catalytica Pharmaceuticals to provide access to the
Greenville Facility and certain facility services as required for the
remediation, subject to reimbursement by Glaxo Wellcome. However, there can be
no assurance that the Company or Catalytica Pharmaceuticals will not incur
unreimbursed costs or suffer an interference with ongoing operations as a result
of Glaxo Wellcome's remediation activities or the existence of contamination at
the Greenville Facility. In addition, the Company's future development of the
Greenville Facility may be limited by the existence of contamination or Glaxo
Wellcome's remediation activities. There also can be no assurance that
Catalytica Pharmaceuticals' ongoing
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operations at the Greenville Facility will not cause additional contamination.
The determination of the existence and cost of any such additional contamination
contributed by Catalytica Pharmaceuticals of the Company could involve costly
and time-consuming negotiations and litigation. Furthermore, any such
contamination caused by Catalytica Pharmaceuticals or the Company could
materially adversely affect the business, results of operations and financial
condition of Catalytica Pharmaceuticals and the consolidated results of
operations and financial condition of the Company.
In addition, a moderate amount of asbestos containing material ("ACM") is
present at the Greenville Facility. Catalytica Pharmaceuticals believes that
the ACM, in its present condition, does not require abatement. Abatement will
only be required if and as renovations are performed in those areas containing
ACM. Catalytica Pharmaceuticals cannot presently predict whether, when or to
what extent it may need or desire to renovate areas of the Greenville Facility
containing ACM. However, should such renovations be necessary, the additional
costs could be substantial.
The Company through a subsidiary leases the land on which its Bayview
facility in East Palo Alto, California is located from Rhone Poulenc, Inc.,
("Rhone Poulenc"). The past activities of Rhone Poulenc's predecessor caused
significant soil and groundwater contamination of the facility and a down
gradient area located along the San Francisco Bay. Consequently, the site is
subject to a clean up and abatement order issued by the Bay Area Regional Water
Quality Control Board ("RWQCB") which currently requires stabilization,
containment and monitoring of the arsenic and volatile organic contamination at
the site and surrounding areas. The ground lease between Rhone Poulenc and the
Company includes an indemnity by Rhone Poulenc against any costs and liabilities
that the Company might incur to fulfill the RWQCB order and to otherwise address
the contamination that is the subject of the order. The Company also has
obtained an indemnification from Novartis (the immediately preceding
owner/operator of the facility) against any costs and liability the Company may
incur with respect to any contamination caused by Novartis' operations.
However, there can be no assurance that the Company will not be held responsible
with respect to the existing contamination or named in an action brought by a
governmental agency or a third party because of such contamination. If the
Company is held responsible and it has contributed to the contamination, it will
be liable for any damage to third parties, and will be required to indemnify
Rhone Poulenc and Novartis for any additional clean up costs or liability they
may incur, with respect to the contamination caused by the Company. The
determination of the existence and additional cost of any such incremental
contamination contribution by the Company could involve costly and time-
consuming negotiations and litigation. Further, any such incremental
contamination by the Company or the unenforceability of either of the indemnity
agreements described above could materially adversely affect the Company's
business and results of operations.
CATALYTICA PHARMACEUTICALS' COMPLIANCE WITH FDA REGULATIONS. Many of the
fine chemicals products Catalytica Pharmaceuticals manufactures, or will
manufacture in the future, and the final drug products in which they are used
are subject to regulation for safety and efficacy by the FDA and foreign
regulatory authorities before such products can be commercially marketed. The
process of obtaining regulatory clearances for marketing is uncertain, costly
and time consuming. Catalytica Pharmaceuticals cannot predict how long the
necessary regulatory approvals will take or if its customers will ever obtain
such approval for their products. To the extent Catalytica Pharmaceuticals'
customers do not obtain the necessary regulatory approvals for marketing new
products, Catalytica Pharmaceuticals' fine chemicals product sales will be
adversely affected.
Products manufactured by Catalytica Pharmaceuticals at the Greenville
Facility require Catalytica Pharmaceuticals to comply with the FDA's current
Good Manufacturing Practices ("cGMP") regulations, and certain of Catalytica
Pharmaceuticals' customers, including Glaxo Wellcome, also require Catalytica
Pharmaceuticals to adhere to cGMP regulations, even if not required by the FDA.
In complying with cGMP regulations, manufacturers must continue to expend time,
money and effort in production, record keeping and quality control to ensure
that the product meets applicable specifications and other requirements. The
FDA periodically inspects drug-manufacturing facilities to ensure compliance
with applicable cGMP requirements. Failure to comply subjects the manufacturer
to possible FDA action, such as suspension of manufacturing. The FDA also may
require the submission of any lot of the product for inspection and may restrict
the release of any lot that does not comply with FDA regulations, or may
otherwise order the suspension of manufacture, recall or seizure. Failure of
Catalytica Pharmaceuticals' customers to obtain and to maintain FDA clearance
for marketing of the products manufactured by Catalytica Pharmaceuticals,
20
<PAGE>
or failure of Catalytica Pharmaceuticals to comply with cGMP regulations as
required by the FDA or Catalytica Pharmaceuticals' customers, would have a
material adverse effect on the Company's results of operations.
INFLUENCE OF ENVIRONMENTAL REGULATIONS ON RATE OF COMMERCIALIZATION. The
rate at which industrial companies adopt the Company's catalytic combustion
systems will be heavily influenced by the enactment and enforcement of
environmental regulations at the federal, state and local levels.* Current
federal law governing air pollution generally does not mandate the specific
means for controlling emissions, but instead, creates ambient air quality
standards for individual geographic regions to attain through individualized
planning on a regional basis in light of the general level of air pollution in
the region. Federal law requires state and local authorities to determine
specific strategies for reducing emissions or specific pollutants. Among other
strategies, state and local authorities in all areas which do not meet ambient
air quality standards must adopt performance standards for all major new and
modified sources of air pollution. The more polluted the air in a particular
region has become, the more stringent such controls must be. The Company's
revenues will depend, in part, on the standards, permit requirements and
programs these state and local authorities promulgate for reducing emissions
(including emissions of NOx) addressed by the Company's combustion and
monitoring products systems.* Demand for the Company's systems and processes
will be affected by how quickly the standards are implemented and the level of
reductions required.* Certain industries or companies may successfully delay
the implementation of existing or new regulations or purchase or acquire
emissions credits from other sources, which could delay or eliminate their need
to purchase the Company's systems and processes. Moreover, new environmental
regulations may impose different requirements which may not be met by the
systems and processes being developed by Catalytica or which may require costly
modifications of the Company's products. The United States Congress is
currently reviewing existing environmental regulations. There can be no
certainty as to whether Congress will amend or modify existing regulations in a
manner that could have an adverse effect on demand for the Company's combustion
system products.
COMPETITION AND TECHNOLOGICAL CHANGE. There are numerous competitors in a
variety of industries in the United States, Europe and Japan that have
commercialized and are working on technologies that could be competitive with
those under development by the Company, including both catalytic and other
technological approaches. Some of these competitive products are in more
advanced stages of development and testing. The Company's competitors may
develop technologies and systems and processes that are more effective than
those being developed by the Company or that would render the Company's
technology and systems and processes less competitive or obsolete. In the fine
chemicals market, the Company faces its primary competition from pharmaceutical
companies that produce their own fine chemicals and from other fine chemicals
manufacturers such as Lonza AG and DSM Fine Chemicals. In the combustion
systems market, the Company faces its primary competition from large gas turbine
power generation manufacturers, such as General Electric Co. ("General
Electric"), Allison Engine Company ("Allison") and Solar Turbines Incorporated
("Solar"), each of which is developing competing DLN systems for their own
turbines. Many of the Company's competitors in the combustion systems market
are also potential customers of the Company, and the Company expects to rely on
these potential customers to help commercialize its products.* Most of these
competitors have greater research and development capabilities, financial
resources, managerial resources, marketing experience and manufacturing
experience than the Company. If these companies are successful in developing
such products, the Company's ability to sell its systems and processes would be
materially adversely affected. Further, since many of the Company's competitors
are existing or potential customers, the Company's ability to gain market share
may be limited.
PATENTS AND INTELLECTUAL PROPERTY. The Company has an active program of
pursuing patents for its inventions in the United States and in markets
throughout the world relevant to its business areas. The Company has at least
37 United States patents and 14 pending United States patent applications, and
at least 91 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
21
<PAGE>
patents will not be challenged, circumvented or invalidated. There can also be
no assurance that the patents of others will not have an adverse effect on the
Company. Others may independently develop similar systems or processes or design
around patents issued to the Company. In addition, the Company may be required
to obtain licenses to patents or other proprietary rights. The Company cannot
assure that any licenses required under any such patents or proprietary rights
would be made available on terms acceptable to the Company, if at all. If
Catalytica requires and does not obtain such licenses, it could encounter delays
in system or process introductions while it attempts to design around such
patents, or it could find that the development, manufacture, sale or licensing
of systems or processes requiring such licenses could be foreclosed. The Company
could incur substantial costs in defending itself or its licensees in litigation
brought by others or prosecuting infringement claims against third parties. The
Company could incur substantial costs in interference proceedings declared by
the United States Patent and Trademark Office in connection with one or more of
the Company's or third parties' patents or patent applications, and those
proceedings could also result in an adverse decision as to the priority of the
Company's inventions. The Company also protects its proprietary technology and
processes in part by confidentiality agreements with its collaborative partners,
employees and consultants. There can be no assurance that these agreements will
not be breached, that the Company will have adequate remedies for any breach, or
that the Company's trade secrets will not otherwise become known or be
independently discovered by competitors.
CONCENTRATION OF OWNERSHIP. Morgan Stanley Capital Partners III, L.P. and
two affiliated funds (collectively, "MSCP") beneficially own approximately 32%
of the voting control of the Company and 47% of the outstanding capital stock of
the Company as of March 31, 1998. As a result, MSCP is able to exercise
significant influence over all matters requiring stockholder approval, including
the election of directors and approval of all significant corporate transactions
such as any merger, consolidation or sale of all or substantially all of the
Company's assets. The Company has granted to MSCP certain contractual rights,
including representation on the Company's Board of Directors and committees of
the Board of Directors, that will give MSCP additional rights to participate in
certain actions to be taken by the Company. Such concentration of ownership and
contractual rights may have the effect of delaying, deferring or preventing a
change of control of the Company. The sale by MSCP of shares of the Company's
capital stock could constitute a change of control under the Company's credit
agreement, which would trigger a default of the agreement. MSCP has agreed not
to trigger a change of control under the credit agreement. In addition, such
concentration of ownership and contractual rights could allow MSCP to prevent
significant corporate transactions.
22
<PAGE>
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27.1 Financial Data Schedule.
(b) Reports on Form 8-K
The Company filed no reports on Form 8-K during the quarter ended March 31,
1998.
All information required by other items in Part II is omitted because the
items are inapplicable, the answer is negative or substantially the same
information has been previously reported by the registrant.
23
<PAGE>
CATALYTICA, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: May 14, 1998
CATALYTICA, INC.
(Registrant)
By: /s/ Lawrence W. Briscoe
------------------------
Lawrence W. Briscoe
Vice President and Chief
Financial Officer
Signing on behalf of the
registrant and as principal
financial officer
24
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