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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-K
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(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, 1997
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
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CATALYTICA, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 94-2262240
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NUMBER)
INCORPORATION OR ORGANIZATION)
430 FERGUSON DRIVE
MOUNTAIN VIEW, CALIFORNIA 94043
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
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(650) 960-3000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.001 PAR VALUE
(TITLE OF CLASS)
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
[X] Yes [_] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
As of February 28, 1997, there were outstanding 27,949,029 shares of the
registrant's Common Stock, par value $.001, which is the only class of common
stock of the registrant registered under Section 12(g) of the Securities Act
of 1933. As of that date, the aggregate market value of the shares of common
stock held by nonaffiliates of the registrant (based on the closing price for
the common stock on NASDAQ on February 27, 1997) was $330,161,880. For
purposes of this disclosure, shares of Common Stock held by each officer and
director of the Registrant and by each person who owns 5% or more of the
outstanding voting stock have been excluded in that such persons may be deemed
to be affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes. The Company also has outstanding
13,270,000 shares of Class A Common Stock and 11,730,000 shares of Class B
Common Stock which are convertible into an equal number of shares of Common
Stock.
DOCUMENTS INCORPORATED BY REFERENCE
The information called for by Part III is incorporated by reference to the
definitive Proxy Statement for the Annual Meeting of Stockholders of the
Company which will be filed with the Securities and Exchange Commission no
later than 120 days after December 31, 1997.
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CATALYTICA, INC.
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
DECEMBER 31, 1997
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NO. PAGE
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PART I
<S> <C> <C>
Item 1. Business............................................................................... 2
Item 2. Properties............................................................................. 18
Item 3. Legal Proceedings...................................................................... 19
Item 4. Submission of Matters to a Vote of Security Holders.................................... 19
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters............... 20
Item 6. Selected Consolidated Financial Data................................................... 21
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.. 21
Item 8. Consolidated 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..................................... 40
Item 11. Executive Compensation................................................................. 40
Item 12. Security Ownership of Certain Beneficial Owners and Management......................... 40
Item 13. Certain Relationships and Related Transactions......................................... 40
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K........................ 41
</TABLE>
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COMPANY INFORMATION
This report contains certain forward-looking statements within the meaning
of Section 27A of the Securities Exchange Act of 1933 and Section 21E of the
Securities Exchange Act of 1934 which involve risks and uncertainties,
including statements regarding the Company's strategy, financial performance,
and revenue sources. The Company's actual results could differ materially from
the results anticipated in these forward-looking statements as a result of
certain factors including those set forth under "Item 7, Management's
Discussion and Analysis of Financial Condition and Results of Operations--Risk
Factors" and elsewhere in this report. Forward-looking statements include but
are not limited to, those Statements that are indicated by an asterisk (*).
References to "Catalytica" and the "Company" refer to Catalytica, Inc. and its
Subsidiaries.
ITEM 1. BUSINESS
OVERVIEW
Catalytica, Inc. ("Catalytica" or "the Company") 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 increased 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.
The Company's technology is based on new and improved catalytic systems. A
catalyst is a substance that initiates, accelerates and determines the
products of a chemical reaction. In a catalytic process, compounds are changed
or combined at the molecular level to create a desired product. Highly
selective catalysts can improve industrial process economics by making
possible more efficient use of raw materials, reducing energy requirements,
increasing manufacturing yields and eliminating or minimizing the formation or
use of environmental pollutants. As a result, catalyst design and performance
can have a significant impact on operating and capital costs across a variety
of industries.
Catalytica Pharmaceuticals manufactures the full range of products used by
the pharmaceutical industry. Customers include several leading pharmaceutical
companies, including Glaxo Wellcome, Pharmacia & Upjohn, Inc. ("Pharmacia &
Upjohn"), Merck & Co. ("Merck") and Pfizer, Inc. ("Pfizer"). Catalytica
Pharmaceuticals is undertaking to capitalize on market opportunities created
by major changes that are occurring in the pharmaceutical industry that are
causing pharmaceutical companies to outsource certain chemical development and
manufacturing activities. These changes include increased pricing pressures on
pharmaceutical companies, the need to shorten drug development cycles and more
stringent environmental and FDA regulations.
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 users of power generation systems. Combustion
Systems is currently working with leading turbine manufacturers, including:
General Electric, Allison Engine Company, a subsidiary of Rolls Royce, and
Solar Turbines, a subsidiary of Caterpillar, Inc.
CATALYTICA PHARMACEUTICALS
INDUSTRY BACKGROUND
The pharmaceutical industry has been undergoing significant change over the
last few years. As part of that change, many of the larger participants have
recognized that their competitive differentiation comes from two key elements
of their business: drug discovery and final product marketing. These are the
core competencies in
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which successful pharmaceutical companies excel and are the ones that are
increasingly defining the leaders in the industry. With this recognition has
come increasing pressure on many pharmaceutical companies to focus their
resources on these two facets of their business. As a result, these industry
participants are looking to outsource to other companies with specialized
expertise some of the other essential parts of the business, especially the
development of manufacturing processes and the manufacturing of the drug
products themselves. These factors have resulted in an increasing outsourcing
trend in the pharmaceutical industry, impacting the full breadth of the
manufacturing cycle, from the starting chemical entities to the final product
form sold to the consumer. The market drivers for the outsourcing trend
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 causing 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.
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 chemical development and 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 to large commercial volumes.
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 development of chemical processes and pharmaceutical products.
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 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.
STRATEGY
Catalytica Pharmaceuticals recognized these changes in the pharmaceutical
industry several years ago. Catalytica Pharmaceuticals believed it could
address this market opportunity by combining a strong technological capability
to develop manufacturing methods for pharmaceuticals that involve fewer
chemical reaction steps, require less equipment, utilize raw materials more
efficiently and that are environmentally cleaner, with a manufacturing
operation that can make products for the industry in a cost-effective,
reliable, responsive and high quality manner. Catalytica Pharmaceuticals
acquired a manufacturing facility in California in December 1993 as a first
step to serve this growing market opportunity. Together with Catalytica
Pharmaceuticals' established chemical research and development capabilities,
this acquisition permitted Catalytica Pharmaceuticals to begin serving major
pharmaceutical customers and to establish itself as a viable and attractive
supplier of drug substances and pharmaceutical products.
Many pharmaceutical companies have recognized that to implement outsourcing
successfully they would significantly benefit from selecting "preferred
manufacturing partners." Such partnerships permit a tighter integration
between the supplier and the customer and significantly facilitate the
outsourcing operations. A number of pharmaceutical companies have started to
choose a few such manufacturing partners. Catalytica Pharmaceuticals'
objective is to become one of the preferred partners of the major
international pharmaceutical companies, by becoming involved with its
customers early in the design of the drug manufacturing process. Catalytica
Pharmaceuticals believes that its technology and expertise enable it to
develop efficient manufacturing
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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 and formulated products
requirements. Consistent with this strategy, in early 1996 Catalytica
Pharmaceuticals entered into a five-year cooperative process research and
development program with Pfizer Inc. ("Pfizer"), which also made an equity
investment in Catalytica Pharmaceuticals. This activity with Pfizer was
expanded in 1998 to include the development of new drug formulations.
In furtherance of its Strategy, on July 31, 1997, Catalytica Pharmaceuticals
acquired the pharmaceutical manufacturing facility of Glaxo Wellcome located
in Greenville, North Carolina, (collectively, the "Greenville Facility"). The
Greenville Facility is engaged in contract development and manufacturing for
the pharmaceutical and biotechnology industry. The Greenville Facility was
purchased as a fully operating facility with three to five year contracts for
continuing manufacture of important Glaxo Wellcome products. In addition to
this business base, the site offers additional capacity that can be used to
manufacture additional products for other customers as those opportunities are
developed, which could include additional products for Glaxo Wellcome.
Another important aspect of Catalytica Pharmaceuticals' 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.
The Greenville Facility enables Catalytica Pharmaceuticals to combine
technological excellence and innovation with expanded manufacturing scale and
state of the art facilities. With the acquisition of the Greenville Facility
Catalytica Pharmaceuticals has an integrated capability to produce
intermediate chemicals, to synthesize bulk active drugs, and to formulate and
package the final dosage form. The Greenville Facility also includes a state-
of-the-art sterile products facility capable of producing injectable
formulations. The Company believes that the Greenville Facility will permit
Catalytica Pharmaceuticals to offer a "one-stop" supply capability that is
unique among outsourcing operations, and offers important advantages to
potential customers.*
TECHNOLOGY AND EXPERTISE
Catalytica Pharmaceuticals has an extensive intellectual property base and
expertise in catalytic science and engineering, and through the Greenville
acquisition, in product development and formulation. The Company's staff draws
on its experience of many years of catalytic process development in the
petroleum and petrochemical industry, where high yields and efficient
manufacturing represent important competitive factors. Catalytica's technical
staff includes chemists, and chemical engineers, many of whom hold Ph.D.'s.
These scientists have a broad background in the discovery, development and
scale-up of novel catalysts and catalytic processes that are relevant to
developing efficient manufacturing processes of pharmaceutical intermediates
and bulk actives and in the formulation and manufacturing of pharmaceutical
dosage forms.
MANUFACTURING--THE GREENVILLE FACILITY
Catalytica acquired the Greenville Facility in July 1997 from Glaxo Wellcome
Inc., a company formed as a result of the 1995 merger of Glaxo plc and
Wellcome plc. The site was originally developed by Burroughs Wellcome Company
from a green field site in 1969 to its current state through a series of
construction programs over the years. The latest and most advanced part of the
facility, the sterile manufacturing complex, was completed in 1995. The site
comprises 582 acres of land, approximately 165 of which are occupied by 38
buildings totaling 1.76 million square feet of space. The site has
approximately 1,165 full time employees and 150 other personnel employed on a
temporary basis. The employees are not represented by a labor union.
The site is used to manufacture chemical intermediates and bulk drug
products and to formulate and to package those drugs into individual dosage
forms for shipment both domestically and internationally. Manufacturing at the
site is conducted in three distinct operations: chemical, pharmaceutical and
sterile
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manufacturing. One of the potential advantages of the Greenville Facility is
the ability to integrate the production and packaging in individual dosage form
of the final pharmaceutical product starting from relatively basic raw
materials.*
Chemical Manufacturing Operations ("CMO") involves the basic preparation of
the desired drug substance, in bulk form, primarily by chemical synthesis,
although one product, digoxin, is prepared by solvent extraction from leaves of
digitalis plants grown commercially for this purpose. Carefully selected and
purified raw materials are processed through complex chemical reactions under
tightly prescribed and controlled conditions. Each step typically involves
separation and purification of a derived intermediate chemical which then
proceeds to the next reaction step. The final reaction produces the desired
drug which then is separated, purified, dried, sometimes ground to appropriate
particle size, and then delivered to bulk storage. This bulk product may be
shipped as such to another site for further processing, passed to the
pharmaceutical product manufacturing plant for compounding into non-sterile
dosage forms and packaging, or delivered to the Sterile Product Operations
("SPO") plant for further processing and ultimately sterile packaging.
The chemical reactions involved in CMO manufacturing are carried out in
batches in closed, pressurized reaction vessels, generally 500-2,000 gallons in
capacity, in a liquid medium at carefully regulated temperature and pressure.
Depending on the reaction, such vessels may be glass lined, stainless steel or
another alloy material. Each such reactor is equipped with appropriate pumps,
condensers, separation equipment or other equipment as required by the process.
There is a high degree of automation and in many cases all important operating
variables are monitored and recorded by computer systems. Carefully documented
and approved quality control testing procedures are followed, results recorded,
and samples retained for future reference. The collection of equipment,
instrumentation, utilities, supplies and other services necessary to carry out
any particular reaction are considered a production module. Because of the
differences in specific reaction requirements, such modules may be well adapted
for certain reactions but not for others. Although modules are built to be
reasonably general purpose, there are certain limitations on their flexibility.
Pharmaceutical Product Operations ("PPO") involves the conversion of bulk
drug materials into final dosage form pharmaceuticals and the packaging of
these products for distribution. Such dosage forms may be solids, liquids,
creams or ointments. Solid forms may be tablets, caplets and capsules and in
all cases the formulated dose will contain other ingredients required to
provide a readily usable, recognizable, effective and stable product. Any
particular drug can be made into a variety of dosage forms, active ingredient
dosages, package types and sizes for institutional or personal use, and
distribution packaging. The packaged product may be intended for prescription
use or over-the-counter sales and must be dated and carefully tracked through
the distribution system by batch and/or lot number.
Processing in pharmaceutical manufacturing includes a variety of granulation
techniques, compression methods, sugar and film coating, printing,
encapsulating, polishing and other operations throughout which the product must
be carefully monitored and protected. Packaging can be in hospital unit dose
packs, samples, blister packages, plastic or glass bottles, pouches, tubes or
foil packs. These multiple forms require sophisticated equipment and inventory
tracking systems.
Formulating the finished pharmaceutical to successfully withstand such
processing and provide appropriate bioavailability, efficacy, stability,
appearance and identification at the point of administration with the required
reliability involves careful development of processes and ingredients suitable
both to the specific drug and the equipment through which it is processed.
Careful selection of the other ingredients of the formulation and tight quality
control are essential elements of these operations. Computer systems are used
to properly track and record the processing and distribution of these products
according to drug, form, dose, personal package, distribution package and
destination.
Sterile Product Operations ("SPO") involves the production of those products
which, by reason of their mode of administration, must be aseptic to avoid
microbial contamination. These products are specifically processed to establish
aseptic conditions according to rigid standards in a production facility that
is isolated from
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other portions of the plant and especially maintained for this purpose. The
sterile manufacturing plant at the Greenville Facility includes a state-of-
the-art building dedicated to sterile products which was completed in 1995.
The sterile facilities are characterized by high levels of isolation of
processing areas, significant automation, closed operating systems, limited
personnel access, specialized heating, ventilating and air conditioning
systems, and very high levels of data acquisition and recording.
SUPPLY AGREEMENT. In connection with the purchase of the Greenville
Facility, Glaxo Wellcome entered into a Supply Agreement under which
Catalytica Pharmaceuticals has agreed to manufacture products for Glaxo
Wellcome over the next year, in the case of pharmaceutical products, and the
next four years in the case of chemical and sterile products. This arrangement
is allowing Catalytica Pharmaceuticals the time required to develop new
customers and comply with regulatory requirements before commencing production
of new products under new contracts. Catalytica Pharmaceuticals estimates that
aggregate payments (including the cost of materials) by Glaxo Wellcome under
the Supply Agreement will total approximately $800 million.*
Glaxo Wellcome has guaranteed that revenues paid to Catalytica
Pharmaceuticals will meet a minimum level or Glaxo Wellcome will pay to
Catalytica Pharmaceuticals any shortfall. The minimum revenues, which include
compensation for transition services that Catalytica Pharmaceuticals has
agreed to provide Glaxo Wellcome and which exclude the cost of materials in
each of the next five years, are as set forth below in millions of dollars.*
<TABLE>
<CAPTION>
AUGUST 1-
DECEMBER 31, 1997 1998 1999 2000 2001 TOTAL
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$77.0 $166.4* $94.0* $72.6* $22.6* $432.6*
</TABLE>
The price for each product, excluding the cost of materials, is set forth in
the Supply Agreement. The terms of the Supply Agreement provide for reductions
in prices for certain products over time. Pursuant to the Supply Agreement,
Glaxo Wellcome also reimburses Catalytica Pharmaceuticals for the actual costs
of materials used in the production of products delivered to Glaxo Wellcome.
Under the terms of the Supply Agreement, Glaxo Wellcome is to provide periodic
forecasts of its future demand for various products and Catalytica
Pharmaceuticals is committed to produce the products required, with certain
limitations, provided the required production capacity does not exceed the
capacity committed to Glaxo Wellcome. For production requests in excess of the
capacity committed to Glaxo Wellcome, Catalytica Pharmaceuticals has agreed to
undertake to accommodate Glaxo Wellcome's requests with pricing to be
negotiated on terms that reflect then market pricing.
In addition, Catalytica Pharmaceuticals has agreed to produce certain
specialty products for Glaxo Wellcome during the period June 30, 2001 to June
30, 2002 at prices to be negotiated prior to February 2001.
In addition to the minimum revenues set forth above, Glaxo Wellcome will
reimburse to Catalytica Pharmaceuticals an aggregate of $4.0 million for
certain software upgrades necessary to achieve Year 2000 compliance at the
Greenville Facility.
The provisions of the Supply Agreement related to the production of chemical
and sterile products may only be terminated with two years prior written
notice. Notice of termination may only be given on or after the second
anniversary of the date of Supply Agreement with respect to the provisions
related to the chemical products. In addition, Glaxo Wellcome has a right to
extend the term of the agreement with respect to one or more pharmaceutical
products for up to an additional twelve months and with respect to one or more
of the sterile products for up to four consecutive quarterly periods. The
agreement may be terminated immediately by the affected party upon a material
uncured default by the other party. A change in control of Catalytica or
Catalytica Pharmaceuticals may also result in the right of Glaxo Wellcome to
terminate the agreement. Catalytica has guaranteed Catalytica Pharmaceuticals'
obligations under the Supply Agreement.
Chemical Manufacturing Operations. The CMO facility manufactures bulk
chemicals for formulation into final dosage form. The facility has 33,900
gallons of reactor capacity. Glaxo Wellcome has committed under the
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Supply Agreement to a specified level of reactor capacity at the chemical
facility for each calendar year and has agreed to pay certain guaranteed
revenues whether or not it utilizes this capacity. In addition, beginning in
the second half of 1998, Glaxo Wellcome has reserved 1,500 reactor gallons for
each calendar year through the first half of 2001. However, Glaxo Wellcome is
required to give three calendar quarters notice of its intention to utilize
this reserved capacity and, if it chooses to use the capacity, to pay a
specified amount that Catalytica Pharmaceuticals believes reflects then
current market conditions. The percentage of the current capacity to which
Glaxo Wellcome is firmly committed and has reserved is as set forth below.
<TABLE>
<CAPTION>
2ND 1ST 2ND 1ST 2ND
HALF HALF HALF HALF HALF
1997 1998 1998 1999 2000 2001 2001
---- ---- ---- ---- ---- ---- ----
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Committed.................................... 100% 100% 66% 58% 56% 52% 4%
Reserved..................................... -- -- 4% 4% 4% 4% --
</TABLE>
Catalytica Pharmaceuticals is marketing the portion of its Greenville and
Bayview chemical facilities unused capacity to one or more pharmaceutical
customers. Catalytica Pharmaceuticals is discussing with prospective customers
possible new business for 1998 and subsequent years.* It believes the pricing
it can achieve for this capacity and reduction in operating costs may mitigate
the impact of certain declines in prices over time provided for in the Supply
Agreement.*
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. 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").
Pharmaceutical Product Operations. The PPO facility converts bulk drug
materials into final dosage forms, which include tablets and capsules as well
as creams, ointments and liquids. In addition to manufacturing products for
Glaxo Wellcome, the facility manufactures products for several other
customers. Production for the largest customer extends to December 31, 1998.
Catalytica Pharmaceuticals is acting as a subcontractor of Glaxo Wellcome for
such customer. Contracts with the other existing third party customers of the
Greenville Facility were assigned or subcontracted to Catalytica
Pharmaceuticals upon the closing of the acquisition of the Greenville Facility
from Glaxo Wellcome.
The obligation under the Supply Agreement with Glaxo Wellcome for
pharmaceutical products is in effect until December 31, 1998, for products
other than cytotoxics and certain specialty products, and December 2000, for
cytotoxics and certain specialty products. The approximate levels of
utilization of the pharmaceutical products facility required to fulfill the
production requirements of this agreement, which include the requirements for
third parties, are as follows:
<TABLE>
<CAPTION>
1997 1998 1999 2000
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<S> <C> <C> <C> <C>
Solid Dose(1).............................................. 32% 27%* 2%* 2%*
Ointments, creams and liquids(1)........................... 17% 16%* 4%* 4%*
</TABLE>
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(1) Based on estimated machine hours for the forecast product mix and 50 week
per year, 24 hour per day operations.
Pharmaceutical production of cytotoxic and certain specialty products are
conducted in areas of the Greenville Facility dedicated to the production of
these types of products. Catalytica Pharmaceuticals is discussing with
prospective customers possible new business for 1998 and subsequent years.*
Continued operation of the pharmaceutical facility at current operating levels
will depend on Catalytica Pharmaceuticals success in obtaining substantial new
business.*
Sterile Product Operations. The new SPO facility, which is in a separate
building, is used for the manufacture of aseptic products used predominately
for injectable formulations. The new facility was approved
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by the FDA in 1995 and is producing certain Glaxo Wellcome and third party
products. The Supply Agreement with Glaxo Wellcome is effective through
December 2000. The approximate levels of utilization of the sterile facility
required to fulfill the production requirements of this agreement are as
follows:
<TABLE>
<CAPTION>
1997 1998 1999 2000
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<S> <C> <C> <C> <C>
Sterile(1).................................................. 26% 33%* 22%* 13%*
</TABLE>
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(1) Based on estimated machine hours for the forecast product mix and 50 week
per year, 24 hour per day operations.
Catalytica Pharmaceuticals believes there is considerable interest in the
manufacturing capabilities provided by its sterile facilities and has signed
agreements with a number of biotechnology and pharmaceutical companies,
including Amgen, Inc., Monarch Pharmaceuticals, Inc., and ASTRA.* Because of
the long lead-times for regulatory approvals, the manufacture of new products
is not expected to commence until late 1998 at the earliest, except for
clinical trial materials.* Catalytica Pharmaceuticals believes the time
necessary to build and receive regulatory certification of a new SPO facility
creates a significant barrier to entry by new competitors.*
There is excess manufacturing capacity available at the chemical facility
beginning in the second half of 1998. There is also substantial excess
manufacturing capacity immediately available at the pharmaceutical and sterile
facilities, but because of the long lead times required to establish necessary
regulatory approvals to manufacture at these facilities, Catalytica
Pharmaceuticals does not anticipate additional revenue from such facilities
until late 1998 at the earliest, except for clinical trial materials.* If
Catalytica Pharmaceuticals' is unable to use the available capacity or to
reduce costs commensurate with lower levels of capacity utilization, it would
have an adverse effect on the Company's consolidated results of operations.
Employment Matters. On July 31, 1997 Catalytica Pharmaceuticals hired the
vast majority of the Greenville Facility's employees and supplemented its
management team and employee base with experienced personnel where
appropriate. As of December 31, 1997, there were approximately 1,165 employees
at the Greenville Facility. Catalytica Pharmaceuticals has hired personnel to
perform marketing, sales, research and development, contract support and
administration functions. With the combination of the management teams and
employee base of Catalytica Pharmaceuticals at the Bay View facility, plus
selective additions, Catalytica Pharmaceuticals believes it can continue to
effectively operate the Greenville Facility and develop new business as the
level of business with Glaxo Wellcome declines.*
Environmental Matters. Glaxo Wellcome has been working with the U.S. EPA and
the North Carolina Department of Environmental and Natural Resources
("NCDENR") to investigate, identify and remediate contamination in the soil
and groundwater at the Greenville Facility now owned by Catalytica
Pharmaceuticals. This investigation, carried out pursuant to the federal
Resource Conservation and Recovery Act, has identified 17 different areas of
the Greenville Facility where contamination has or may have occurred. Of these
17 areas, at least six have been identified as requiring further investigation
and remediation ("Site Contamination"). Contaminants found in the soil and
groundwater at the Greenville Facility include solvents, petroleum
hydrocarbons and pesticides. While the new owner of the Greenville Facility,
Catalytica Pharmaceuticals, has become legally liable for such contamination.
Notwithstanding, such legal liability, Glaxo Wellcome has agreed to be
primarily liable for and to perform, at its cost, the remediation required by
law for contamination of the soil and groundwater existing at the Greenville
Facility as of the date Catalytica purchased the facility. It is unknown at
this time what further remediation will be required at the Greenville Facility
and the cost of such remediation. Catalytica Pharmaceuticals is also required,
pursuant to an environmental agreement between Catalytica Pharmaceutical and
Glaxo Wellcome, to provide access to the Greenville Facility and certain
facility services as required for the remediation, subject to reimbursement by
Glaxo Wellcome. However, there can be no assurance that the Company or
Catalytica Pharmaceuticals will not incur unreimbursed costs or suffer an
interference with ongoing operations as a result of Glaxo Wellcome's
remediation activities or the existence of contamination at the Greenville
Facility. In addition, the Company's future development of the Greenville
Facility may be limited by the existence of contamination or Glaxo Wellcome's
remediation activities. There
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also can be no assurance that Catalytica Pharmaceuticals' ongoing operations
at the Greenville Facility will not cause additional contamination. The
determination of the existence and cost of any such additional contamination
contributed by Catalytica Pharmaceuticals or the Company could involve costly
and time-consuming negotiations and litigation. Furthermore, any such
contamination caused by Catalytica Pharmaceuticals or the Company could
materially adversely affect the business, results of operations and financial
condition of Catalytica Pharmaceuticals and the consolidated results of
operations and financial condition of the Company.
Commensurate with the closing of the acquisition of the Greenville Facility,
Catalytica Pharmaceuticals and Glaxo Wellcome entered into additional
agreements regarding certain environmental matters including a release of
Glaxo Wellcome from certain liabilities relating to asbestos containing
materials and a memorandum of understanding between Catalytica Pharmaceuticals
and Glaxo Wellcome indicating to NCDENR that Glaxo Wellcome will be primarily
liable for any pre-closing site contamination. See "Item 2. Properties."
COMPETITION
Catalytica Pharmaceuticals believes that the key competitive factors in the
pharmaceuticals manufacturing industry include reliability of supply, product
quality, ability to comply with environmental and FDA regulations, capacity,
price, and the technical and manufacturing ability to produce a full range of
quantities from small batches for clinical trials to large commercial
quantities. Catalytica Pharmaceuticals believes it competes favorably with
respect to these factors. Catalytica Pharmaceuticals' primary competition is
from pharmaceutical companies that produce their own fine chemicals and to a
lesser extent from other independent fine chemicals manufacturers such as
Lonza AG and DSM Andeno B.Z. Many of Catalytica Pharmaceuticals' competitors
have substantially greater financial resources than Catalytica
Pharmaceuticals.
CATALYTICA PHARMACEUTICALS' MANAGEMENT AND DIRECTORS
As part of the Company's strategy to create focused business units,
Catalytica Pharmaceuticals has assembled a management group that includes
dedicated senior executives and independent directors who provide relevant
industry expertise. The directors and management of Catalytica Pharmaceuticals
include:
<TABLE>
<CAPTION>
NAME AGE POSITION WITH CATALYTICA PHARMACEUTICALS
---- --- ----------------------------------------
<S> <C> <C>
Barry M. Bloom.................. 68 Director
Richard Fleming................. 72 Director
Thomas L. Gutshall.............. 59 Director
Ricardo B. Levy................. 52 Director
Ernest Mario.................... 58 Director
James A. Cusumano............... 55 Chief Executive Officer and Chairman of the
Board
Gabriel R. Cipau................ 56 President, Chief Operating Officer and
Director
Lawrence W. Briscoe............. 53 Chief Financial Officer and Director
</TABLE>
BARRY M. BLOOM has been a director of Catalytica Pharmaceuticals since
February 1995. He retired in September 1993 from Pfizer Inc. where he was most
recently Executive Vice President, Research and Development since 1992, and a
member of the Board of Directors since 1971. Dr. Bloom was with Pfizer Inc.
since 1952, where he served in executive level positions since 1971. He is a
member of several corporate Board of Directors, including Cubist
Pharmaceuticals, Inc., Neurogen Corp., Incyte Pharmaceuticals, Inc. and Vertex
Pharmaceuticals, Inc. Dr. Bloom was a member of the United States
Congressional Commission on the Federal Drug Approval Process and the
Pharmaceutical Manufacturers Association Commission on Drugs for Rare
Diseases. He has a Ph.D. in organic chemistry from the Massachusetts Institute
of Technology.
RICHARD FLEMING has been a director of Catalytica Pharmaceuticals since
1995. Mr. Fleming has been a director of Catalytica since 1985 and also serves
as an advisor and consultant to Catalytica. Mr. Fleming was President and
Chief Executive Officer of the Company from 1985 through August 1991. From
1969 to 1980, Mr. Fleming served at Air Products and Chemicals, most recently
as Executive Vice President, and from 1980 to
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<PAGE>
1981, he served as President and Chief Operating Officer of GAF Corporation, a
chemical company. He has served as President and Chief Executive Officer of
Richard Fleming Associates, Inc., a consulting firm, since May 1981 and is
past Vice Chairman for Membership and Fiscal Affairs of the Chemical Industry
Institute of Toxicology. Mr. Fleming has an M.S. in chemical engineering from
New York University.
THOMAS L. GUTSHALL has been a director of Catalytica Pharmaceuticals since
February 1995. He has been Chief Executive Officer and Chairman of 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 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 Pharmaceuticals and
Catalytica, Inc. since July, 1996. Dr. Mario has been Co-Chairman and Chief
Executive Officer of ALZA since August 1993. Prior to joining ALZA, Dr. Mario
was Deputy Chairman and Chief Executive Officer of Glaxo Holding p.l.c.,
having served in a variety of executive positions with Glaxo, Inc., beginning
in 1986. From 1977 to 1984, he held various executive level positions with
Squibb Corporation, ending as President and Chief Executive Officer of Squibb
Medical Products. Dr. Mario is a member of the Board of Directors of several
companies, including Advanced Technology Labs, COR Therapeutics, and
Pharmaceutical Product Development Co. Dr. Mario has a Ph.D. and M.S. in
physical sciences from the University of Rhode Island, and a B.S. in pharmacy
from Rutgers University. He is a licensed pharmacist in the states of New York
and Rhode Island, and an adjunct professor of pharmacy at the University of
Rhode Island.
GABRIEL R. CIPAU joined Catalytica in August 1996 as a consultant, and in
August 1997 he became President and COO of Catalytica Pharmaceuticals, Inc.,
and a member of the Catalytica Pharmaceuticals, Inc. Board of Directors.
Previously, Dr. Cipau was President and CEO of Copley Pharmaceutical, Inc.
from July 1995 until August 1996, and President and CEO of Nippon Wellcome
K.K. from September 1993 until July 1995, and Executive director of Wellcome
plc. From 1970 until 1993, he held various positions at Burroughs Wellcome
Co., including Sr. Vice President Production and Engineering. Dr. Cipau holds
Ph.D. and B.S. degrees in Chemical Engineering and Physics from Polytechnic
Institute, Timisoara, Romania, an MBA degree from Duke University, and an M.S.
in Chemistry from East Carolina University.
JAMES A. CUSUMANO, LAWRENCE W. BRISCOE AND RICARDO B. LEVY, who are
directors of Catalytica Pharmaceuticals, are also officers and/or directors of
Catalytica, Inc. For information on the business backgrounds of Messrs.
Cusumano and Levy, see "Proposal No. 1--Election of Directors--Nominees." For
information on the business background of Mr. Briscoe, see "--Catalytica,
Inc.--Executive Officers."
CATALYTICA COMBUSTION SYSTEMS
INDUSTRY BACKGROUND
One of the critical issues facing the 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. Following the Kyoto
conference on global warming, there are significant new regulatory pressures
in much of the world to reduce these emissions from stationary and mobile
power generation sources. Through its Combustion Systems subsidiary,
Catalytica is
10
<PAGE>
developing XONON 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 40% of the worldwide installed base. One megawatt is sufficient energy to
provide power to approximately 1,000 households or to power two 350,000 square
foot commercial buildings.
Utility Power Generation. 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, and utilizing 10-12 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 2005.*
Combustion Systems believes that the market in the rest of the world, which is
more than 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 less than one to 25
megawatts, with an average turbine size of approximately 10 megawatts,
utilizing 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 traditional suppliers include European Gas Turbines and
Kawasaki.
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 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
development to achieve emission levels in the 10 to 15 ppm range in the next
product generation. Compared to wet controls, DLN capital costs are moderate
to high and operating costs are low to moderate. Operating costs are projected
to increase as emissions are reduced below 25 ppm.
11
<PAGE>
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.
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 in an operating gas turbine with no change in system
performance for NOx, carbon monoxide or unburned hydrocarbons emissions.
Emissions levels obtained in Combustion Systems' tests of the XONON system in
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, Solar, and AGC Manufacturing Services,
Inc. ("AGC") have supported the emissions results obtained by Combustion
Systems.
Combustion Systems has demonstrated that the XONON system will provide
superior emissions reduction performance and competitive costs compared to
alternative technologies. The XONON system is expected to have capital and
operating costs that are similar to DLN while offering significant advantages
in emissions performance and cost relative to water and steam control
systems.* Additionally, the XONON system is expected to provide significant
first cost and life cost advantages over SCR systems.* Once the technology is
commercially applied, Combustion Systems believes it will be accepted as best
available control technology ("BACT"), lowest achievable emissions rate
("LAER") technology and reasonably available control technology ("RACT") for
reduction of NOx in natural gas turbines.* BACT, LAER and RACT are the
benchmarks by which the Environmental Protection Agency ("EPA"), and state and
local regulatory authorities decide which emissions control technologies will
be required for specific installations.
Combustion Systems' XONON product is designed to fit inside each combustor
on a turbine. Large turbines, such as those used in the utility power
generation market require an average of 10-12 combustors per turbine, while
smaller industrial turbines require one or more combustors. Combustion Systems
expects to generate revenues from the sale of XONON products 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 will achieve the earliest
commercialization opportunities 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 larger natural gas turbines
used in the utility
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<PAGE>
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, Combustion Systems'
joint venture with Woodward Governor.
In January 1998, Enron Ventures Corp. ("Enron Ventures"), a wholly owned
subsidiary of Enron Corp., purchased a 15 per cent minority interest in
Combustion Systems for $30 million. Enron also received a three-year option to
purchase an additional five per cent of Combustion Systems for $14.4 million
in cash. This relationship is an important piece of the Company's plans to
commercialize the XONON System. Enron Corp. is one of the world's largest
integrater natural gas and electricity companies. Pursuant to the terms of the
investment, Thomas E. White, the Chairman and CEO of Enron Ventures was
appointed to the board of directors of Combustion Systems.
Industrial Applications Market. In the industrial applications area,
Combustion Systems, through GENXON Power Systems, LLC, Combustion Systems'
joint venture company, has completed testing of its XONON system at AGC, a
company that manufactures and markets small co-generation systems to deliver
power and steam to industrial users. In December 1997, these collaborative
tests achieved a major milestone for XONON, and a first for the power
generation industry, by completing a 1,000 hour, successful run on the
Kawasaki turbine at low Nox emissions. See "--Formation of GENXON(TM) Joint
Venture," below.
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. Based upon the success of the XONON tests, Solar announced in
December of 1997 that catalytic combustions will be the design feature option
in their Advanced Turbine Systems ("ATS") (Mercury 50 engine). 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 Combustion Systems' 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 third 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. Combustion
Systems anticipates that one or two additional years of development will be
necessary to complete the design of a commercial system for large turbines.
Combustion Systems' 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 relationship with Combustion
Systems. If such a termination occurred, there is no assurance Combustion
Systems could enter into a similar relationship with another manufacturer and
Combustion Systems' ability to complete its research and development and
introduce commercial systems in these markets could be adversely affected.
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,
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<PAGE>
out-of-warranty engines. The new company, GENXON(TM) Power Systems, LLC, will
initially upgrade the combustion systems of installed turbines with XONON
which will reduce emissions on these older installed turbine engines.
The initial capital commitment of the GENXON joint venture partners was $10
million, $2 million from Combustion Systems and $8 million from Woodward. The
capital commitment was payable over time as the funds were required by the
joint venture. These capital infusions were 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 a limited exclusive license for the use of its catalytic combustion
technologies and Woodward contributed to the joint venture a limited exclusive
license for the use of its instrumentation and control systems for gas turbine
catalytic combustion. These licenses are limited to cover only applications
serving the retrofit of out-of-warranty turbines not supported by original
equipment manufacturers. See "Company Information--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.
Under the Clean Air Act, the EPA establishes ambient air quality standards.
Areas which meet these standards are considered "attainment areas," while
areas not meeting these standards are considered to be "non-attainment." In
areas that are considered to be non-attainment, the regulations require the
emissions of a new gas turbine to be "offset," i.e., if a new turbine is going
to exceed a specified emissions level, the user must offset the entire
emissions of the project so that the net increase of emissions for the area is
zero. In many cases there is a multiplier applied to the new emissions, so
that the new project combined with the "offset" must actually provide a net
decrease in emissions.
One of the ways to meet the offset requirements is to make contemporaneous
reductions of emissions at the same facility. As part of bringing a new
project on line, emission reductions at the facility are made by introducing
controls on existing equipment at the location or by taking existing equipment
out of service. If it is not possible to make sufficient contemporaneous
reductions at the facility, then the user must obtain Emission Reduction
Credits ("ERC's") from one of their own locations or from someone else's
location to offset the emissions from the project. There is a developing
market for ERC's which provides economic value to sources with credits
available from their emission reductions and establishes the cost for those
who must acquire such credits.
In 1997, against a backdrop of continued strong public and political support
for clean air initiatives, the US EPA issued significantly more stringent
regulations for ground-level ozone (smog), and particulate matter (soot).
Since nitrogen oxide is both a principal component of smog and a contributor
to the formation of fine particulate matter, NOx reduction moved to the
forefront of the energy planning agenda. Towards the end of the year, with the
convening of the Kyoto conference on climate change, the nations of the world
agreed on the terms of a treaty for reducing emissions of "greenhouse gases,"
which many scientists believe are contributing to the warming of the global
climate. The treaty mandates reductions in six greenhouse gases, of which NOx
is among the top three.
In addition to environmental requirements in the United States, there are
increasing regulatory requirements relating to emissions in many other
countries, particularly Japan and in Western Europe.
TANAKA DEVELOPMENT AGREEMENT
Catalytica has developed its catalytic combustion technology since 1988
under a development agreement with Tanaka, Kikinzoku Kogyo ("Tanaka"), a major
Japanese precious metals company, under which Tanaka
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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. 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. Under this new agreement, each party
is responsible for its own development expenses, and any invention made after
May 1, 1995, is the sole property of the party making the invention with the
other party having a right to obtain a royalty-bearing, nonexclusive license
to use it in its areas of exclusivity.
COMBUSTION SYSTEMS PATENTS
Catalytica has an active patent program for its technology. A total of 15
patents have been issued in the United States and five United States patent
applications are pending for Combustion Systems' catalytic combustion
technology. Corresponding foreign applications have been filed in countries
that Combustion Systems believes represent significant markets throughout the
world pursuant to the PCT Patent Convention. These patents and patent
applications cover various aspects of the catalytic combustion technology,
including catalyst compositions, catalyst structure and design, multistage
catalytic combustion concepts, and certain modifications to gas turbine
combustors.
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 Combustion Systems expects to rely on these customers to help
commercialize its products. If these turbine manufacturers focus solely on
their own solutions and products, Combustion Systems' competitive position in
the OEM market would be materially adversely affected.
COMBUSTION SYSTEMS' MANAGEMENT AND DIRECTORS
As part of Combustion Systems' strategy to create focused business units,
Combustion Systems has assembled a management group that includes dedicated
senior executives and independent directors who provide relevant industry
experience. The directors and management of Combustion Systems include:
<TABLE>
<CAPTION>
NAME AGE POSITION WITH COMBUSTION SYSTEMS
---- --- --------------------------------
<S> <C> <C>
William B. Ellis....................... 57 Director
Frederick O'Such....................... 60 Director
Ricardo B. Levy........................ 52 Director
John A. Urquhart....................... 69 Director
Thomas E. White........................ 54 Director
Dennis A. Orwig........................ 51 President, CEO, and Director
Lawrence W. Briscoe.................... 53 Chief Financial Officer and Director
Ralph Dalla Betta...................... 52 Vice President and Chief Scientist
</TABLE>
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
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<PAGE>
Northeast Utilities in 1976 as its Chief Financial Officer. Mr. Ellis was a
partner with McKinsey & Co. from 1969 to 1976. Mr. Ellis serves on several
other Boards of Directors, including the Connecticut Mutual Life Insurance
Company and Radian Corporation. He has a Ph.D. in chemical engineering from
the University of Maryland.
FREDERICK O'SUCH has served as a director of Combustion Systems since 1995.
He served as Group Vice President with Gulton Industries, Inc. from 1963 to
1970. From 1970 to 1981, Mr. O'Such served as Group President and Vice
President-Corporate Development with Envirotech Corporation. From 1981 to
1986, Mr. O'Such served as CEO of Xertex Corporation. Mr. O'Such currently is
President and CEO of Xertex Capital. Mr. O'Such is a member of several Boards
of Directors, and holds an MBA from Harvard University and a B.S. in Chemical
Engineering from Lehigh University.
JOHN A. URQUHART has served as a director of Combustion Systems since April
1997. He was also elected to serve as a director of Catalytica in April 1997.
He 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.
THOMAS E. WHITE joined the board of Combustion Systems in January 1998. Mr.
White was named Chairman and Chief Executive Officer of Enron Power Corp., a
wholly owned subsidiary of Enron Corp. in 1991 and assumed the same titles at
Enron Operations Corp. in 1993 and Enron Ventures Corporation in 1996. Mr.
White joined Enron Corp. in 1990 after retiring as a Brigadier General from
the United States Army, following 23 years of military service. Mr. White
holds a B.S. in engineering from the United States Military Academy and a
Master's degree in operations research from the United States Naval Post
Graduate School.
DENNIS A. ORWIG joined Combustion Systems in April 1996 as Executive Vice
President, and was named President and Director of Combustion Systems in June
1996. Prior to Combustion Systems, he spent three years as an executive in the
Office-of-the-President of Elliott Company, a manufacturer of products for the
power generation and petrochemical industries. From 1989 to 1993, Mr. Orwig
served as President and Chief Executive Officer of ABB Power Generation, Inc.
He previously served as Vice-President and General Manager of Combustion
Engineering Corporation and in various executive positions at AccuRay
Corporation. Mr. Orwig holds B.S. degrees in Chemical Engineering and Pulp &
Paper Science from Miami University, and has an advanced degree from Duke
University.
RALPH A. DALLA BETTA joined Catalytica in 1976 and serves as the Chief
Scientist of Catalytica and Vice President of Combustion Systems. Dr. Dalla
Betta's major interests are in the design and synthesis of heterogeneous
catalysts, the detailed characterization of catalyst structure and surface
properties, and catalyst testing. 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 directors of Combustion
Systems, are also officers and/or directors of Catalytica, Inc. For
information on their business backgrounds. See "--Catalytica, Inc.--Executive
Officers."
CATALYTICA, INC.
OTHER BUSINESS OPPORTUNITIES
In addition to Catalytica Pharmaceuticals 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. Advanced
Technologies' goal is to
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identify and develop new commercial opportunities where application of the
Company's core expertise contributes substantial and unique value.
Catalytica Advanced Technologies is developing a new class of catalysts for
the direct oxidation of methane into methanol or other liquid hydrocarbons
including fuels such as gasoline and methanol. This process could be
complementary to, and potentially less expensive than some current Fischer-
Tropsch technologies. Because liquids can be transported more efficiently than
gas, development of gas to liquid technologies for methane conversion would
make it more economical for energy producers to recover natural gas in remote
areas. Catalytica has designed and executed this longer-range R&D program with
reimbursement of most of the costs by partners Mitsubishi Oil and Petro-
Canada. In March of 1997, the subsidiary was awarded a $2 million grant from
the U.S. Department of Commerce's National Institute of Standards and
Technology, and in February of 1998 announced additional funding by Syntroleum
Corporation, to further develop this technology. Advanced Technologies is now
proceeding to examine other potential applications of the technology.
As part of the goal to apply the Company's core expertise as broadly as
possible, Advanced Technologies is cooperating with Catalytica Combustion
Systems to leverage XONON technology into other, non-gas turbine applications.
The charter of this effort involves prevention, clean-up, and waste reduction.
In 1996 Catalytica Advanced Technologies launched an initiative to supply
single-site organometallic catalysts and catalyst precursors for the
polyolefin industry. These catalysts, known as "metallocenes", are used in new
polymer production technology which imparts improved and better-controlled
properties to the product. Catalytica focused on developing proprietary
technology which permits the manufacture of these specialized catalysts at a
significantly increased cost/benefit ratio. Early in 1997, one catalyst was
qualified by the first customer, and commercial production commenced in early
1998 using one of Catalytica's manufacturing facilities. Initial feedback from
major polyolefin producers confirms the expected performance improvements.
Complementing the Company's effort in single-site catalysts, Catalytica
Advanced Technologies is also pursuing nanoscale technology which has the
potential to significantly lower manufacturing costs and reduce byproduct
waste by improving catalyst activity and selectivity. Catalytica Advanced
Technologies is pursuing this technology with its joint venture partner,
Microfluidics International, under the three-year, $2 million grant initiated
in 1995 from the U.S. Department of Commerce's National Institute of Standards
and Technology. During 1997, Catalytica Advanced Technologies successfully
scaled up this technology to semi-commercial size batches producing product
used for market development.
HUMAN RESOURCES
At December 31, 1997, Catalytica and its subsidiaries employed a total of
1,300 employees. The Company is not subject to any collective bargaining
agreements. Catalytica believes that it maintains good relations with its
employees.
EXECUTIVE OFFICERS
The executive officers of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Ricardo B. Levy............. 52 President, Chief Executive Officer and Director
James A. Cusumano........... 55 Chairman of the Board and Chief Technical
Officer
Lawrence W. Briscoe......... 53 Vice President, Finance and Administration, and
Chief Financial Officer
Ralph A. Dalla Betta........ 52 Vice President and Chief Scientist
</TABLE>
At December 31, 1997, there were four 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:
17
<PAGE>
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.
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.
RISK FACTORS
For a discussion of various risk factors applicable to the Company and its
subsidiaries see "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations--Risk Factors."
ITEM 2. PROPERTIES
Catalytica's headquarters and research and development facilities, based in
Mountain View, California, occupy four buildings covering approximately 85,000
square feet. The Company's lease expires on December 31, 2003, with a five-
year option for renewal. The Company's research and development facility is
adequate for the Company's needs for the foreseeable future.
Catalytica's Pharmaceuticals' manufacturing facilities are located in
Greenville, North Carolina and East Palo Alto, California. The facility in
Greenville was purchased from Glaxo Wellcome on July 31, 1997. The site
comprises 582 acres of land, approximately 165 of which are occupied by 38
buildings totaling 1.76 million square feet of space. The site is used to
manufacture chemical intermediates and bulk drug products and formulate and
package those drugs into final dosage forms for shipment both domestically and
internationally. A key strategic advantage of this facility is the ability to
integrate the production and packaging in individual dosage form of the final
pharmaceutical product starting from relatively basic raw materials.
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
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 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
Facility include solvents, petroleum hydrocarbons and pesticides. As the new
owner of the 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 Facility as of the Closing. The cost
18
<PAGE>
and extent of remediation to be required at the facility is currently unknown.
The Environmental Agreement with Glaxo Wellcome also requires Catalytica
Pharmaceuticals to provide access to the 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 Facility. In addition, the Company's
future development of the Facility may be limited by the existence of
contamination or Glaxo Wellcome's remediation activities. There also can be no
assurance that Catalytica Pharmaceuticals' ongoing operations at the 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.
A moderate amount of asbestos containing material ("ACM") is present at the
Greenville facility. The Company believes that the ACM, in its present
condition, does not require abatement. Abatement will only be required if and
as renovations are performed in those areas containing ACM. The Company
assumed the liability associated with the abatement of the ACM present at the
Facility under the purchase agreement with Glaxo Wellcome.
The facility in East Palo Alto, California is on approximately five acres.
The Company owns the buildings, but leases the land at the site from Rhone
Poulenc Inc. The initial lease term is 15 years and expires on November 30,
2008, after which the Company has options to extend for two five year periods,
and one four-year option to extend the lease term after expiration of the
first two option periods. 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, results of operations and financial condition.
ITEM 3. LEGAL PROCEEDINGS
From time to time the Company is subject to legal proceedings and claims in
the ordinary course of business. The Company is not currently aware of any
legal proceedings or claims that the Company believes will have, individually
or in the aggregate, a material adverse effect on the Company's business,
results of operations and financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the stockholders of the Company
during the fourth quarter of the fiscal year covered by this report.
19
<PAGE>
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 1997 and 1996. Such prices represent interdealer
prices and do not include retail mark-ups or mark-downs or commissions and may
not represent actual transactions.
<TABLE>
<CAPTION>
1997 1996
--------------- -------------
HIGH LOW HIGH LOW
------- ------- ------ ------
<S> <C> <C> <C> <C>
Quarter ended 3/31.......................... $11 3/4 $ 3 7/8 $4 3/8 $3 3/4
Quarter ended 6/30.......................... 13 5/8 7 5 3 3/4
Quarter ended 9/30.......................... 15 3/8 9 1/2 4 1/8 3 5/8
Quarter ended 12/31......................... 13 7/8 10 1/8 4 1/4 3 5/8
</TABLE>
At February 28, 1998, there were approximately 783 holders of record of the
Company's Common Stock.
The market price of the Common Stock has been and is likely to be highly
volatile. Factors such as the results of research and development and pilot
scale testing by Catalytica and its collaborative partners, the effectiveness
and commercial viability of products of Catalytica or its competitors, changes
in environmental regulations, announcements of technological innovations or
new products by the Company or its competitors, fluctuations in the Company's
operating results, including changes in the rate of growth and profitability
of its Pharmaceuticals business, and changes in recommendations by financial
analysts could have a significant impact on the future price of the Common
Stock. In addition, stock markets have experienced extreme price volatility in
recent years. This volatility has had a substantial effect on the market
prices of securities issued by many companies for reasons that may be
unrelated to the operating performance of the specific companies. These broad
market fluctuations may adversely affect the market price of the Common Stock.
During 1997, the Company issued 30,000,000 shares of Class A and B Common
Stock at $4.00 per share to Morgan Stanley Capital Partners III, L.P. and two
affiliates ("MSCP") in connection with the acquisition of the Glaxo Wellcome
manufacturing facility in Greenville, North Carolina. None of these shares are
publicly traded. In November of 1997, the Company repurchased 5,000,000 of the
Class B MSCP shares at $4.75 per share with the proceeds from the issuance of
a warrant dividend. See "Note 10 of Notes to Consolidated Financial
Statements."
On August 22, 1997, the Company distributed to each shareholder one warrant
for each three shares of Common Stock held by the shareholder. Shareholders
were entitled to exercise the warrant at a price of $4.00 per share. Of the
6,947,275 warrants issued to shareholders, 6,922,996 were exercised, leaving
24,279 that were not exercised when they expired on October 31, 1997.
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.
20
<PAGE>
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,
---------------------------------------------
1997 1996 1995 1994 1993
-------- ------- ------- ------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
Revenues:
Product sales................ $174,347 $ 9,813 $ 8,858 $ 5,800 $ --
Research and development..... 6,599 6,501 4,766 6,395 8,353
-------- ------- ------- ------- --------
Total revenues............. 180,946 16,314 13,624 12,195 8,353
Net income before common stock
redemption.................... 310 (5,192) (8,687) (9,145) (9,003)
Premium paid on common stock
redemption.................... (3,750) -- -- -- --
-------- ------- ------- ------- --------
Loss attributable to common
shareholders.................. $ (3,440) $(5,192) $(8,687) $(9,145) $ (9,003)
Basic and diluted earnings per
share(1)...................... $ (0.10) $ (0.27) $ (0.55) $ (0.61) $ (0.66)
Cash, cash equivalents, short-
term, and long-term
investments................... $ 47,067 $23,821 $20,902 $13,614 $ 23,987
Total assets................... 335,273 41,003 31,239 22,186 31,720
Long-term debt................. 75,069 1,524 1,556 1,573 930
Stockholders' equity........... 52,110 17,263 22,029 15,779 24,438
</TABLE>
- --------
(1) Net income (loss) per share reflects a reduction in net income of
$3,750,000 relating to the premium paid for the repurchase of five million
shares of Class B Common Stock with proceeds received from the exercise of
warrants issued to stockholders as a dividend.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act and Section 21E of the Exchange Act, which
involve risks and uncertainties including but not limited to those statements
which have been identified by an asterisk ("*") and other statements regarding
the Company's strategy, financial performance and revenue sources. The
Company's actual results could differ materially from the results anticipated
in these forward-looking statements as a result of certain factors including
these set forth under "Risk Factors" and elsewhere in this Report.
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 increased 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 "Facility") located in
Greenville, North Carolina (the "Acquisition"), in exchange for (i) $244.7
million in cash; (ii)
21
<PAGE>
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 in excess of an aggregate cumulative amount of $10 million
attributable to the Sterile Product Operations ("SPO") portion of the
Facility, up to an aggregate cumulative payment to Glaxo Wellcome of an
additional $25.0 million. As a result of the Acquisition, Catalytica recorded
$116.8 million of inventory and $147.1 million of property, plant and
equipment. During the twelve months ended December 31, 1997, 90.1% of the
Company's pharmaceutical product revenues were derived from sales to Glaxo
Wellcome under a Supply Agreement entered into at the time of the Acquisition.
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. 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. As a result of the
Stock Sale and subsequent stock repurchase, as of December 31, 1997, MSCP
owned approximately 32% of the Company's outstanding voting securities and
approximately 47% of the Company's outstanding securities. See Notes 2 and 9
of Notes to Consolidated Financial Statements.
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. Up to $20,000,000
of the Revolving Debt Facility will be available for the issuance of letters
of credit. As of December 31, 1997, no amount was outstanding under the
revolving debt facility and $125,000,000 was outstanding under the senior
secured term facility. On February 2, 1998, the Company made an early payment
of $20 million which left an outstanding balance of $105 million under the
term facility. This early payment reduces the remaining amount owed in 1998 to
$30 million.
The additional facilities, employees and business volumes resulting from the
Acquisition have 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 Facility, and with
servicing the debt incurred in connection with the acquisition of the
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 were insignificant for 1997 and are not expected to be
significant in 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 for 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. The Company's earnings per share were reduced by $0.10 for the year ended
December 31, 1997, as it had repurchased 5,000,000 shares of its Class B
Common Stock from MSCP at a premium with the proceeds from a warrant issuance
which occurred during the third fiscal quarter of 1997.
22
<PAGE>
Manufacturing at the Facility is conducted in three district operations:
Chemical Manufacturing Operations ("CMO"), Pharmaceutical Product Operations
("PPO") and Sterile Product Operations ("SPO"). There is excess manufacturing
capacity that will be available at the CMO facility beginning in mid-1998.
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
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. 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"). 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 infuse $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
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. 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.
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.
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 at year end, and a royalty stream
based on future revenues. The Company recorded a total gain of $0.9 million on
the sale of these assets.
On October 15, 1996, Catalytica's 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 initially upgrade the combustion
systems of installed turbines with XONON which will reduce emissions and
permit greater asset utilization for both power generation and mechanical
drive markets. The joint venture is expected to result in the delivery of an
integrated product portfolio which includes CCSI's XONON(TM) technology for
ultra low NOx emissions, and Woodward's NetCon(R) control systems.*
The initial capital commitment of the GENXON joint venture partners was $10
million--$2 million from CCSI 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
23
<PAGE>
joint venture beyond the initial $10 million commitment has occurred on a
50/50 basis with each joint venture partner contributing $1.9 million during
the last quarter of 1997, bringing the total combined investment in the joint
venture to $13.8 million to date. Although CCSI and Woodward intend to
continue the funding of this joint venture which will result in the allocation
of additional losses to the Company in 1998*, 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. CCSI has contributed to the joint venture a limited exclusive
license for the use of its catalytic combustion technology, and Woodward
contributed to the joint venture a limited exclusive license for the use of
its instrumentation and control systems for gas turbine catalytic combustors.
CCSI began accounting for its share of the joint venture gain or loss upon its
first cash infusion totaling $1.0 million which occurred on January 3, 1997
upon completion of a milestone. Prior to January 3, 1997, the joint venture
was being funded entirely by Woodward Governor. For the year ended December
31, 1997, the Company has recorded losses of $4.4 million on the joint
venture.
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 CCSI
for $14.4 million in cash. In conjunction with the Stock Purchase agreement,
the Company entered into a Share Exchange agreement, providing Enron the right
to exchange the Series B preferred stock of Combustion Systems for Catalytica,
Inc. (Catalytica) 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 Company's business had not been profitable until the second half of
1997, and as of December 31, 1997, the Company had an accumulated deficit of
$47.9 million. To achieve continued profitable operations, the Company must
successfully manage the operations of the new 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, has substantially increased
its manufacturing of pharmaceutical products in 1997.
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
ANNUAL % CHANGE
-------------------
1997 1996 1995 1997/1996 1996/1995
-------- ------- ------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
REVENUES:
Product Sales.................... $174,347 $ 9,813 $ 8,858 1,677% 11%
Research and Development
Contracts....................... 6,599 6,501 4,766 2% 36%
-------- ------- -------
Total Revenues................. $180,946 $16,314 $13,624 1,009% 20%
</TABLE>
The significant increase in 1997 revenue is due to an increase in product
sales attributable to the Greenville facility and the related Supply Agreement
with Glaxo Wellcome. During 1997, 90% of the Company's product revenues were
derived from sales to Glaxo Wellcome under the Supply Agreement. The increase
in 1996 revenue compared to 1995 is primarily due to an increase in research
revenues. The increase in research and development revenues during 1997 and
1996 to a large degree reflect a funded research commitment associated with
the five-year R&D agreement between Catalytica Pharmaceuticals and Pfizer to
develop new processes and technology for the manufacture of Pfizer products
(See overview above).
Prior to 1994, substantially all revenues for the Company were from research
agreements. During 1995, The Company focused on the commercialization of its
technologies of which fine chemical product sales were
24
<PAGE>
$8.5 million. This revenue was primarily due to shipments of pharmaceutical
intermediates products to new customers. The remaining product revenues for
1995 were attributable to a wholly-owned subsidiary Advanced Sensor Devices,
the assets of which have since been sold (See overview above).
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 was deferred at their request to the first
quarter of 1997. 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 Pharmaceuticals 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.
On July 31, 1997, the Company purchased the Facility from Glaxo Wellcome.
This purchase and additional Supply Agreement enabled the Company to
substantially increase its product revenue for the last two quarters of 1997,
and caused product sales to increase 1,677% from 1996 to 1997. Specified
levels of product revenues under the Supply Agreement with Glaxo Wellcome are
guaranteed over a period of five years. Product revenues for 1997 included
$77.0 million (excluding the cost of materials) from the Glaxo Wellcome Supply
Agreement. As a 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 "Overview" above. During 1997, the Company used its
capacity at its Bay View facility to produce products for various other
pharmaceutical customers including Pfizer, Novartis, Bristol Myers Squibb, and
others. Product revenues for 1997 attributable to customers other than Glaxo
Wellcome were 10% of total revenue.
Research and development contract revenue increased 2% from 1996 to 1997. In
1997 as well as in 1996, the Company received a $0.5 million reimbursement
from the GENXON joint venture for R&D expenses incurred prior to the formation
of the joint venture by Combustion Systems. Research revenue in 1997 also
benefited from a full year of revenue under the Pfizer research agreement (See
Overview above). This increase in research revenue, however, was partially
offset by a decrease in CCSI revenue over 1996.
<TABLE>
<CAPTION>
ANNUAL % CHANGE
-------------------
1997 1996 1995 1997/1996 1996/1995
------ ------ ---- --------- ---------
(DOLLARS IN
THOUSANDS)
<S> <C> <C> <C> <C> <C>
INTEREST INCOME.......................... $1,450 $1,179 $616 23% 91%
</TABLE>
Interest income increased 23% during 1997 when compared to 1996. Although
balances in cash and short-term investments were reduced during the first two
quarters of 1997 as cash was used to support the Company's operations, cash
and investments increased in the second half of the year due to increases in
cash balances resulting from debt and equity financing related to the
Greenville acquisition and through increased product sales. Interest income
increased 91% from 1995 to 1996 due to the $15 million investment by Pfizer.
(See Overview above). Interest income is expected to increase again in 1998
due to increased cash balances related to the Enron cash investment in
Catalytica Combustion Systems which has restrictions related to its use such
that these funds cannot be used to retire debt in other Catalytica
subsidiaries such as Catalytica Pharmaceuticals. (See Note 11 of Notes to
Consolidated Financial Statements)*.
25
<PAGE>
<TABLE>
<CAPTION>
ANNUAL % CHANGE
-------------------
1997 1996 1995 1997/1996 1996/1995
-------- ------ ------ --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
COSTS AND EXPENSES:
Costs of goods sold............... $155,092 $9,073 $8,339 1,609% 9%
Research and development.......... 9,556 9,707 9,818 (2%) (1%)
Selling, general and
administrative................... 7,302 4,452 4,492 64% (1%)
Interest expense.................. 5,422 353 278 1,436% 27%
Gain on sale of assets............ -- 900 -- -- --
Loss on joint venture............. (4,355) -- -- -- --
</TABLE>
Cost of Goods Sold: The increase in cost of goods sold for 1997 reflects
increased physical volume of product sales of pharmaceutical products
primarily due to an increase in sales attributable to the Greenville Facility.
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 1996. 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 production runs, and
numerous other variables present in the chemical manufacturing environment.
Research and Development: Although reported research and development
expenses ("R&D") for 1997 and 1996 were down slightly from the previous years'
level, the actual level of research activity occurring at the Company
increased during 1997 and 1996. This increase in research activity is not
reflected on the Company's financial statements largely due to an allocation
of certain catalytic combustion research and development costs from the
Company to the GENXON joint venture beginning in the second half of 1996 (See
Note 3 of Notes to Consolidated Financial Statements). This transfer of R&D
funding occurred beginning August 1, 1996 and resulted in a shift of
approximately $2.6 million in 1997 and $1.8 million in 1996 of research and
development costs being financed by the joint venture rather than the Company.
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 the Company alone was funding this technology.
Cessation of all research activities of Advanced Sensor Devices (ASD)
following the sale of its assets (See Note 3 of Notes to Consolidated
Financial Statements) also contributed approximately $.3 and $0.8 million in
1997 and 1996, respectively, towards the reduction of R&D expenses.
This decrease in R&D funding during the last two years due to the formation
of the GENXON joint venture and the sale of ASD was mostly offset by increases
in R&D expenses elsewhere in the Company, most of which occurred at Catalytica
Pharmaceuticals. Starting in mid 1996, R&D activities at Catalytica
Pharmaceuticals started an upward trend reflecting increased research
activities supporting the research commitment to Pfizer Inc. (See Note 2 of
Notes to Consolidated Financial Statements). On August 1, 1997, another
increase in R&D spending occurred following the acquisition of the Greenville
facility and its associated R&D support activities. Total Company R&D expenses
are expected to increase significantly in 1998 reflecting the full year impact
of the Greenville acquisition and expansion of R&D activities to support the
increased level of production activity for both existing and new products.*
Of the Company's research and development expenses for 1997, approximately
22% were utilized to develop the Company's combustion systems technology,
approximately 38% were spent on the Company's pharmaceuticals technologies,
and the remaining approximately 40% were spent on various other technologies,
substantially all of which were done at the specific request of, and funded
by, third parties.
Selling, General and Administrative: Selling, general, and administrative
("SG&A") expenses increased from 1996 to 1997 by 64% primarily due to SG&A
costs incurred at the Greenville facility starting on August 1, 1997. SG&A
expenses are expected to increase significantly again in 1998 reflecting the
full year impact of the Greenville acquisition*.
26
<PAGE>
Although the aggregate selling, general, and administrative expenses
remained flat for the full year of 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 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 ($.7
million in 1997 and $0.2 million in 1996), these reductions should be
considered temporary.
Interest Expense: The increase in interest expense in 1997 is due to the
initiation of The Chase Manhattan Bank ("Chase") "Term Debt Facility" for
$125,000,000, and borrowings under the Chase Manhattan Bank "Revolving Debt
Facility" totaling $14,600,000 both of which occurred on July 31, 1997 as part
of the Greenville acquisition. Under the terms of the Chase debt facilities,
all of the Company's outstanding debt was paid off prior to the funding of the
Chase debt. By the end of 1997, all of the "Revolving Debt Facility" was paid
off leaving only the $125,000,000 outstanding. Interest expense increased from
1995 to 1996 due to increased borrowing on a line of credit and other short-
term working capital financing at the Catalytica Pharmaceuticals Bay View
manufacturing facility. The Company expects to incur significant interest
expense in 1998 due to outstanding indebtedness.*
Gain on Sale of Assets: 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 Consolidated Financial
Statements).
Loss on Joint Venture: On January 3, 1997, Combustion Systems made its first
cash infusion of $1.0 million into the GENXON joint venture. CCSI has
recognized its 50% share of GENXON losses totaling $4.4 million during 1997
which represents its capital contribution to-date. Although the Company
expects to make additional capital contributions during 1998 which will result
in the allocation of additional losses to the Company,* neither joint venture
partner is contractually required to make further capital infusions. (See Note
3 of Notes to Consolidated Financial Statements). Any future losses the
Company recognizes as part of its 50% share of GENXON may be partially offset
by reimbursements for past R&D expenses if certain GENXON milestones are
achieved.
<TABLE>
<CAPTION>
ANNUAL % CHANGE
-------------------
1997 1996 1995 1997/1996 1996/1995
------- ------- ------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
NET INCOME (LOSS):
Income (loss) before income
taxes......................... $ 669 $(5,192) $(8,687) 1,129% 40%
Provision for income taxes..... (359) -- -- -- --
------- ------- ------- ----- ---
Income (loss) before stock
redemption.................... 310 (5,192) (8,687) 1,060% 40%
Less premium paid on stock
redemption.................... (3,750) -- -- -- --
------- ------- ------- ----- ---
Loss attributable to common
shareholders.................. $(3,440) $(5,192) $(8,687) 34% 40%
Basic and Dilated loss per
share......................... $ (.10) $ (.27) $ (.55) 63% 51%
</TABLE>
In 1997, the Company reported income of $0.3 million as compared to net
losses of $5.2 million and $8.7 million in 1996 and 1995, respectively. The
positive income was entirely due to the acquisition of the Greenville facility
effective August 1, 1997, and the Supply Agreement with Glaxo Wellcome.
Although the Company was basically at the break-even level for 1997 in total,
the Company recorded a profit of $0.7 million and $3.7 million in the third
and fourth quarters of 1997--offsetting losses of ($2.3) million and ($1.8)
million in the first and second quarters. The Company expects continued
profitability in 1998.* The extent of profitability will depend on the
operating results of Catalytica Pharmaceuticals, including the ability to
control operating expenses and
27
<PAGE>
the extent of losses arising from continued investment in CCSI, including
GENXON, and to a lesser extent Advanced Technologies.* Beyond 1998,
profitability will largely be dependent upon obtaining new supply agreements
from new and/or existing customers to replace Glaxo Wellcome products that
will be phased out under the terms of the Supply Agreement (See Note 2 of
Notes to Consolidated Financial Statements)*.
During the fourth quarter of 1997, the Company used $23,750,000 of proceeds
from exercise of warrants to repurchase 5,000,000 shares of Class B Common
Stock from MSCP. The stock was originally issued to MSCP at $4.00 per share.
The Company repurchased each share at $4.75. The Company recorded the
difference between the sale and repurchase prices of $.75 as a premium paid on
common stock redemption, and reduced income available to common stockholders
by $3.75 million. When the common stock redemption premium is deducted from
income, the net income attributable to common stockholders is reduced to a
loss of $3.44 million. Consequently, the basic and diluted net loss per share
for the year is $0.10 per share. The repurchase of these shares from MSCP is a
one time transaction, and the Company does not expect any similar transactions
to take place in 1998.
The decrease in 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 as certain research
and development costs were funded by the joint venture. For discussion of the
Company's net operating loss carryforwards, see Note 7 of Notes to
Consolidated Financial Statements.
Year 2000 Date Conversion
In 1997, the Company began the process of identifying, evaluating and
implementing changes to computer programs necessary to address the year 2000
issue. This issue affects computer systems that have time-sensitive programs
that may not properly recognize the year 2000. This could result in major
system failures or miscalculations. The Company is currently addressing its
internal year 2000 issue with modifications to existing programs and
conversions to new programs. Glaxo Wellcome will reimburse to Catalytica
Pharmaceuticals an aggregate of $4.0 million for certain software upgrades
necessary to achieve Year 2000 compliance at the Greenville Facility. The
Company is also communicating with suppliers, financial institutions, and
others with which it conducts business to help them identify and resolve the
year 2000 issue. If necessary modifications and conversions by the Company and
those with which it conducts business are not completed in a timely manner,
the year 2000 issue may have a material adverse effect on the Company's
consolidated results of operations based on the Company's current estimation.
The total cost associated with the required modification and conversions is
not expected to be material to the Company's consolidated results of
operations and financial position and is being expensed as incurred.* However,
such estimates could prove to be too low and the Company could incur expenses
resulting from Year 2000 compliance which are not currently anticipated.
Recently Issued Accounting Standards
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," effective for fiscal years beginning after December 15, 1997. This
Statement requires that all items that are required to be recognized under
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. This Statement further requires that an entity display
an amount representing total comprehensive income for the period in that
financial statement. This Statement also requires that an entity classifies
items of other comprehensive income by their nature in a financial statement.
For example, other comprehensive income may include foreign currency items,
minimum pension liability adjustments, and unrealized gains and losses on
certain investments in debt and equity securities. Reclassification of
financial statements for earlier periods, provided for comparative purposes,
is required. Based on current accounting standards, this Statement is not
expected to have a material impact on the Company's consolidated financial
statements. The Company will adopt this accounting standard effective January
1, 1998, as required.
28
<PAGE>
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," effective for fiscal years beginning
after December 15, 1997. This Statement establishes standards for reporting
information about operating segments in annual financial statements and
require selected information about operating segments in interim financial
reports issued to shareholders. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
Operating segments are defined as components of an enterprise about which
separate financial information is available that is evaluated regularly by the
chief operating decision maker in deciding how to allocate resources and in
assessing performance. This Statement requires reporting segment profit or
loss, certain specific revenue and expense items and segment assets. It also
requires reconciliations of total segment revenues, total segment profit or
loss, total segment assets, and other amounts disclosed for segments to
corresponding amounts reported in the consolidated financial statements.
Restatement of comparative information for earlier periods presented is
required in the initial year of application. Interim information is not
required until the second year of application, at which time comparative
information is required. The Company has not determined the impact that the
adoption of this new accounting standard will have on its consolidated
financial statement disclosures. The Company will adopt this accounting
standard effective January 1, 1998, as required.
FUTURE RESULTS
This section contains certain forward-looking statements regarding the
Company's operating results which involve risks and uncertainties. Since
substantially all of this section involves forward-looking statements,
individual statements are not identified by an asterisk (*) in this section.
The Company's actual results could differ materially from the results
anticipated in these forward-looking statements as a result of certain factors
set forth here under and under "Risk Factors".
As a result of the Company's acquisition of the Greenville Facility and the
associated Supply Agreement effective August 1, 1997, Catalytica
Pharmaceuticals' product revenues are expected to expand from $174.3 million
during 1997 to an annualized product revenue rate in excess of $300 million in
calendar year 1998. The anticipated revenues from the Supply Agreement are
expected to be sufficient to allow the Company to continue to achieve
profitable operations for 1998 and the associated cash flows will be
sufficient to permit necessary capital expenditures, support changes in
working capital, and reduce indebtedness incurred in connection with the
Acquisition. Profitability after 1998 will depend on its success and timing in
obtaining new customers, including possible new agreements with Glaxo
Wellcome. There is excess manufacturing capacity available at the CMO
facilities beginning in the second half of 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 facilities beginning in mid 1998. There is
also substantial excess manufacturing capacity immediately available at the
PPO and SPO facilities, but because of the long lead times required to
establish necessary regulatory approvals to manufacture at these facilities,
Catalytica Pharmaceuticals does not anticipate additional revenue from such
facilities until 1998 or 1999 at the earliest, except for clinical trial
materials. Catalytica Pharmaceuticals' inability to fill the available
capacity or to reduce costs commensurate with lower levels of capacity
utilization would have a material adverse effect on the Company's consolidated
results of operations.
Catalytica Pharmaceuticals estimates that aggregate payments (including the
cost of materials) by Glaxo Wellcome under the Supply Agreement will total
approximately $800 million over a five-year period, including a guaranteed
minimum payment of approximately $432.6 million, and, based on current
expectations of product mix, approximately $356.2 million for reimbursed
actual costs of materials.
29
<PAGE>
Glaxo Wellcome has guaranteed that revenues paid to Catalytica
Pharmaceuticals will meet certain minimum levels through 2001, ("Minimum
Revenues") and that Glaxo Wellcome will pay to Catalytica Pharmaceuticals any
difference between the specified minimum level and the amount due for shipment
of products at the prices set forth in the Supply Agreement. The Minimum
Revenues, which include compensation for transition services Catalytica
Pharmaceuticals has agreed to provide Glaxo Wellcome, and which exclude the
cost of materials, in each of the next five years are as set forth below.
<TABLE>
<CAPTION>
AUGUST 1-DECEMBER 31
----------------------------------------------------------------------------------------------
1997 1998 1999 2000 2001 TOTAL
------ ------ ----- ----- ----- ------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
$77.0 $166.4 $94.0 $72.6 $22.6 $432.6
</TABLE>
The price for each product, excluding the cost of materials, is set forth in
the Supply Agreement. The Supply Agreement requires that Glaxo Wellcome
reimburse Catalytica Pharmaceuticals based on the invoice price of raw
materials used in the manufacture of products delivered to Glaxo Wellcome.
This agreement states that minimum revenues are to be calculated by comparing
the amount billed for products shipped during the year to the stipulated
minimum revenue amount for the specific year in agreement. Total revenue under
this agreement equaled $77.0 million, which is considered a full year in the
agreement. The minimum revenue on an annual basis is not subject to
adjustment. The terms of the Supply Agreement provide for certain declines in
prices over time. If during the term of the Supply Agreement Catalytica
Pharmaceuticals is unable to decrease its variable and fixed operating
expenses commensurate with the price declines or obtain new higher margin
business to offset the impact of such declines, Catalytica Pharmaceuticals'
and the Company's results of operations should be adversely affected. Under
the terms of the Supply Agreement, Glaxo Wellcome is to provide periodic
forecasts of its future demand for certain products and Catalytica
Pharmaceuticals is committed to produce the products required, with certain
limitations, provided the required production capacity does not exceed the
capacity committed to Glaxo Wellcome. For production requests in excess of the
capacity committed to Glaxo Wellcome, Catalytica Pharmaceuticals has agreed to
undertake to accommodate Glaxo Wellcome's requests with pricing to be
negotiated on terms that reflect then market pricing.
The additional facilities, employees and business volumes at the Facility
have substantially increased the expenses and working capital requirements and
placed substantial burdens on the Company's management resources on a
consolidated basis. The Company's research and development expenses, as well
as its selling, general and administrative expenses, have increased
significantly as the Company establishes the necessary infrastructure for the
operations. Furthermore, the success of the Acquisition depends, in a
significant part, on the levels of manufacturing business developed by
Catalytica Pharmaceuticals. In the event Catalytica Pharmaceuticals does not
achieve additional new customers, which could involve additional business from
Glaxo Wellcome, on terms sufficient to offset the costs associated with
operating and maintaining the Facility, and with servicing the debt associated
with acquisition of the Facility, the Company's consolidated results of
operations and financial condition would be materially adversely affected.
Catalytica faces challenges in advancing its research and development
programs from bench and pilot scale to cost-effective commercial products and
processes. There can be no assurance that the Company will successfully
address the challenges that will arise during the development of each of its
programs. The Company expects to continue certain of its research and
development programs, which include the self-funding of expenditures that are
not covered by payments from collaborative partners. The Company believes its
internally funded research projects have the potential to lead to commercial
sales in the next few years. The Company anticipates that research that does
not have the potential for near-term commercialization will be conducted only
when funded by collaborative partners.
The Company expects that future operating results will fluctuate from
quarter to quarter, as a result of differences in the amount and timing of
expenses incurred and the revenues received. In particular, the Company's
operating results are affected by the size of and timing of receipt of orders
for and shipments of its pharmaceutical products, as well as the amount and
timing of payments and expenses under the Company's
30
<PAGE>
research and development contracts. The Company expects to increasingly rely
on product sales for its revenues. Continued profitable operations, especially
after 1998, will depend on the Company's success and timing in obtaining new
customers, including possible new agreements with Glaxo Wellcome. To a lesser
extent, profitability will also depend on the Company's ability to
successfully develop, manufacture, introduce, and market or license its
combustion systems technology. There can be no assurance that the Company will
be able to achieve profitability on a sustained basis. The Company's operating
results will be substantially dependent on the operating results of Catalytica
Pharmaceuticals.
LIQUIDITY AND CAPITAL RESOURCES
<TABLE>
<CAPTION>
1997 1996 1995
--------- ------- -------
<S> <C> <C> <C>
Cash, cash equivalents, short term investments.... $ 47,067 $23,821 $20,902
Working capital................................... 87,425 23,904 18,102
Cash provided by (used in)
Operating activities............................ 39,785 (778) (9,928)
Investing activities............................ (262,290) 4,187 (7,462)
Financing activities............................ 242,114 7,110 18,773
Net increase in cash and cash equivalents......... 19,609 10,519 1,383
Current Ratio..................................... 1.97 3.61 3.37
</TABLE>
Prior to 1997, the Company financed its operations through private
placements of equity securities, an initial public offering of its Common
Stock on February 8, 1993, a secondary public offering on November 3, 1995, a
$15 million cash infusion from Pfizer on May 8, 1996, revenues from
collaborative research agreements, and starting in 1994, product revenues. The
increase in cash and cash equivalents in 1997 is largely due to an increase in
various working capital items associated with the Greenville acquisition. The
acquisition itself was financed with borrowings against various credit
facilities, funds received from the sale of common stock to MSCP, and through
stock option and warrant exercises. The more modest increase in cash and cash
equivalents in 1996 over 1995 reflects a $15 million infusion in cash from
Pfizer which was significantly offset with cash consumed by the net loss in
1996 and investments in plant and equipment.
During 1995 and 1996, the Company obtained various lines of credit to fund
capital purchases and future working capital needs. One of these lines of
credit collateralized with accounts receivable was $2.0 in 1995 and increased
to $3.5 million in 1996. On July 31, 1997, this line of credit was repaid with
borrowings under a credit facility with a syndicate of banks led by The Chase
Manhattan Bank entered into in connection with the Acquisition.
As discussed in the Overview, the Company completed a sale of 13,270,000
shares of its Class A Common Stock and 16,730,000 shares of its Class B Common
Stock to 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.
In addition to the equity investment by MSCP, the Company, The Chase
Manhattan Bank ("Chase") and Chase Securities Inc. ("CSI") have entered into a
Credit Agreement pursuant to which a syndicate of banks led by Chase has
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 December 31,
1997, no amount was outstanding under the revolving debt facility and
$125,000,000 was outstanding under the senior secured term facility. On
February 2, 1998, the Company made an early payment of $20 million which left
an outstanding balance of $105 million under the term facility. This early
payment reduces the remaining amount owed in 1998 to $30 million.
31
<PAGE>
The funds raised through the equity financing and debt were used to acquire
the Greenville manufacturing facility for $244.7 million in cash. This
purchase also involved other equity consideration, and potential future
payments related to the SPO facility. See Note 2 of Notes to Consolidated
Financial Statements.
The Company distributed, at no cost, to each holder of Common Stock of
record as of August 22, 1997, one Warrant for each three shares of Common
Stock held by the shareholder. The total number of warrants issued was
6,947,275. Of the warrants issued to shareholders, 6,922,996 were exercised
leaving 24,279 that were not exercised when they expired on October 31, 1997.
The exercise of the Warrants generated gross proceeds of $27,691,984. The
Company used $23,750,000 of the proceeds to repurchase an aggregate of
5,000,000 shares of its Class B Common Stock issued to MSCP on July 31, 1997.
The premium paid for the repurchase is reflected in the Company's earnings per
share calculation for the period ending December 31, 1997. The Company's
earnings per share for the year ended December 31, 1997 were reduced by $.10
due to this repurchase.
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 long-term indebtedness--of which $105
million was outstanding as of February 2, 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 Company anticipates that cash
flows from the operation of its business will be sufficient to meet its debt
repayment obligations. 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
$25 million to $30 million during 1998 for capital expenditures primarily at
Catalytica Pharmaceuticals.* As of December 31, 1997, the Company believes
that with its cash position of $47.1 million plus its available line of credit
of $75 million coupled with the $30 million cash investment by Enron on
January 14, 1998, into Combustion Systems, and anticipated cash flow from
operations in 1998, the Company has adequate funds to meet its working capital
needs and debt repayment obligations during the next 12 months.*
RISK FACTORS
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 the risk factors including
those set forth below and elsewhere in this report. In addition to the other
information in this report, the following factors should be carefully
considered in evaluating the Company and its business.
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 December 31, 1997, the Company had an accumulated deficit of $47.9
million. To achieve continued profitable operations, Catalytica must
successfully manage the operations of the pharmaceutical manufacturing
facility located in Greenville, North Carolina (the "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, will
substantially increase its manufacturing of pharmaceutical products in 1998.
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The additional facilities, employees and business volumes resulting from the
acquisition of the 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 Facility, and
with servicing the debt incurred in connection with the acquisition of the
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 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 and 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
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.* Catalytica
Pharmaceuticals is substantially dependent on Glaxo Wellcome for the next two
and one half years 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
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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 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 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 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. ("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 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,
CCSI, is currently working with leading turbine manufacturers, including:
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, CCSI 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 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, 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,
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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 will 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 that 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
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 CCSI 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 $600,000 during the third quarter and $1.9 million during the
fourth quarter of 1997, bringing the total investment in the joint venture to
$13.8 million to date. CCSI recognized its 50% share of GENXON losses of $4.4
million for the year ended December 31, 1997 which was equal to the Company's
capital contribution. Accordingly, a $4.4 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 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 CCSI 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 February 2, 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 Company anticipates that cash flows from the operation of
its business will be sufficient to reduce indebtedness incurred in connection
with the Acquisition to a level supportable by the current assets of the
Company.* 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 year end cash position of $47.1 million
plus its available line of credit of $75 million, coupled with the $30 million
cash investment by Enron on January 14, 1998 into Combustion Systems, 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.
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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.
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 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
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 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 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
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Resources (the "NCDENR") to investigate, identify and remediate contamination
in the soil and groundwater at the 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 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 Facility include solvents, petroleum hydrocarbons and
pesticides. As the new owner of the 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 Facility as of the Closing. The cost and
extent of remediation to be required at the facility is currently unknown. The
Environmental Agreement with Glaxo Wellcome also requires Catalytica
Pharmaceuticals to provide access to the 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 Facility. In addition, the Company's
future development of the Facility may be limited by the existence of
contamination or Glaxo Wellcome's remediation activities. There also can be no
assurance that Catalytica Pharmaceuticals' ongoing operations at the 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 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 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
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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 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, 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
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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 37 United
States patents and 14 pending United States patent applications, plus 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 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 December 31, 1997. 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.
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ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's Consolidated Financial Statements and Schedules, the report of
the independent auditors, and the section entitled "Quarterly Financial Data
(Unaudited)" appear on pages 67 through 100 of this Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
EXECUTIVE OFFICERS AND DIRECTORS
Certain information with respect to persons who are executive officers of
the Registrant is set forth under the caption "Executive Officers" in Part I
of this report. The section entitled "Election of Directors" appearing in the
Registrant's proxy statement for the annual meeting of stockholders sets forth
certain information with respect to the directors of the Registrant and is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The section entitled "Executive Compensation" appearing in the Registrant's
proxy statement for the annual meeting of stockholders sets forth certain
information with respect to the compensation of management of the Registrant
and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The section entitled "Election of Directors" appearing in the Registrant's
Proxy Statement for the annual meeting of stockholders sets forth certain
information with respect to the ownership of the Registrant's Common Stock and
is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The section entitled "Transactions with Management" appearing in the
Registrant's Proxy Statement for the annual meeting of stockholders sets forth
certain information with respect to certain business relationships and
transactions between the Registrant and its directors and officers and is
incorporated herein by reference.
40
<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
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Ernst & Young LLP, Independent Auditors...................... 44
Consolidated Statements of Operations for the three years ended
December 31, 1997, 1996, and 1995..................................... 45
Consolidated Balance Sheets at December 31, 1997, and December 31,
1996.................................................................. 46
Consolidated Statements of Cash Flows for the three years ended
December 31, 1997, 1996, and 1995..................................... 48
Consolidated Statement of Stockholders' Equity for the three years
ended December 31, 1997, 1996, and 1995............................... 49
Notes to Consolidated Financial Statements............................. 50
Separate Financial Statement of Subsidiaries Not Consolidated and Fifty
Percent-or-Less Owned Persons:
GENXON(TM) Power Systems, L.L.C. Financial Statements and Report of
Independent Accountants for the period from October 21, 1996 (date of
inception) to September 30, 1997...................................... 72
Quarterly Financial Data (Unaudited)................................... 80
(2) Financial Statement Schedules:
Valuation and Qualifying Accounts...................................... 81
</TABLE>
(3) Exhibits
<TABLE>
<CAPTION>
EXHIBIT NO. NOTES DESCRIPTION
----------- ----- -----------
<C> <C> <S>
Corrected Fourth Amended and Restated Certificate of
3.1 +++++ Incorporation.
3.2 + Bylaws of Registrant.
Agreement of Shareholders Amending Registration Rights and
4.1(A) + Right of First Refusal.
Amended and Restated Registration Rights Agreement dated
4.1(B) + September 27, 1988.
Amendment No. 1 to Amended and Restated Registration Rights
4.1(C) + Agreement.
4.1(D) + Form of Amended and Restated Rights Agreement.
4.2 + Specimen of Common Stock Certificate.
4.3(A) +++ Preferred Shares Rights Agreement dated as of October 23,
1996, between Catalytica, Inc. and ChaseMellon Shareholder
Services, L.L.P., including the form of Rights Certificate,
the Certificate of Designation and the Summary of Rights
attached thereto as Exhibits A, B and C, respectively.
4.3(B) ++++ Amendment No. 1, dated as of June 28, 1997, to Preferred
Shares Rights Agreement between Catalytica, Inc. and
ChaseMellon Shareholder Services, L.L.C.
4.4 +++++ Stock Purchase Warrant for 2,000,000 Shares of the Company's
Common Stock dated July 31, 1997.
1983 Incentive Stock Option Plan, as amended, with forms of
10.1 + agreements thereunder.
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.
10.7 +** Development Agreement, dated January 4, 1991 among the
Company, Petro-Canada Inc. And Techmocisco, Inc. (a
subsidiary of Mitsubishi Oil), as amended.
</TABLE>
41
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NO. NOTES DESCRIPTION
----------- -------- -----------
<C> <C> <S>
10.11 + Form of Indemnification Agreement.
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.
10.19 ++** Agreement, dated January 31, 1995 between the Company and
Tanaka Kikinzoku Kogyo K.K.
10.21 * Catalytica Pharmaceuticals, 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.
Catalytica, Inc. 1995 Director Stock Option Plan, with
10.25 * forms of agreements thereunder.
10.26 ++++++ Limited Liability Operating Agreement of GENXON Power
Systems, LLC, dated October 21, 1996.
10.27 Amendment No. 1, dated December 4, 1997, to the Operating
Agreement of GENXON Power Systems, L.L.C.
10.28 +++++*** Asset Purchase Agreement among Glaxo Wellcome Inc. and
Catalytica Pharmaceuticals, Inc. and Catalytica, Inc.,
dated June 25, 1997.
10.29 +++++*** Supply Agreement between Glaxo Wellcome Inc. and
Catalytica Pharmaceuticals, Inc., dated July 31, 1997.
10.30 +++++ Investment Agreement dated as of June 25, 1997 among
Morgan Stanley Capital Partners III, L.P., Morgan
Stanley Capital Investors, L.P., MSCP III 892 Investors,
L.P. and Catalytica, Inc.
10.31 +++++ $200,000,000 Credit Agreement dated July 31, 1997, by and
among Catalytica, Inc., Catalytica Pharmaceuticals, Inc.
and The Chase Manhattan Bank
10.32 Amendment No. 1 and Consent, dated January 6, 1998, to
$200,000,000 Credit Agreement among Catalytica, Inc.,
Catalytica Pharmaceuticals, Inc. and The Chase Manhattan
Bank.
10.33 +++++ Pledge Agreement
10.34 +++++ Security Agreement
21.1 + Subsidiaries of Registrant
23.1 Consent of Ernst & Young LLP, Independent Auditors.
23.2 Consent of Coopers & Lybrand LLP, Independent Accountants
24.1 Power of Attorney. (See page 83)
27.1 Financial Data Schedule
</TABLE>
42
<PAGE>
- --------
* Incorporated by reference to the exhibits filed with the Company's
Annual Report on Form 10-K for the year ended December 31, 1995.
** Confidential treatment has been granted for portions of these
agreements.
*** Confidential treatment has been requested for portions of these
agreements.
+ Incorporated by reference to the exhibits filed with the Company's
Registration Statement on 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.
++++ Incorporated by reference to the exhibits filed with the Company's
Registration Statement on Form 8-A/A as filed with the Commission on
July 29, 1997.
+++++ Incorporated by reference to the exhibits filed with the Company's Form
10-Q for the quarter ended June 30, 1997.
++++++ Incorporated by reference to the exhibits filed with the Company's Form
10-K for the year ended December 31, 1996.
B. Reports on Form 8-K
No reports on Form 8-K were filed by the Registrant during the quarter
ended December 31, 1997.
43
<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, 1997 and December 31, 1996, and the related
consolidated statements of operations, stockholders' equity, and cash flows
for each of the three years in the period ended December 31, 1997. Our audit
also included the financial statement schedule listed in the Index at Item
14(a). These financial statements and schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Catalytica, Inc. at December 31, 1997 and December 31, 1996, and the
consolidated results of its operations and its cash flows for each of the
three years in the period ended December 31, 1997, in conformity with
generally accepted accounting principles. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, present fairly in all material respects
the information set forth therein.
Ernst & Young LLP
San Jose, California
January 27, 1998
44
<PAGE>
CATALYTICA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Revenues:
Product sales........................... $174,347 $ 9,813 $ 8,858
Research and development contracts...... 6,599 6,501 4,766
---------- ---------- ----------
Total revenues........................ 180,946 16,314 13,624
Costs and expenses:
Cost of product sales................... 155,092 9,073 8,339
Research and development................ 9,556 9,707 9,818
Selling, general and administrative..... 7,302 4,452 4,492
---------- ---------- ----------
Total costs and expenses.............. 171,950 23,232 22,649
---------- ---------- ----------
Operating income (loss)................... 8,996 (6,918) (9,025)
Interest income........................... 1,450 1,179 616
Interest expense.......................... (5,422) (353) (278)
Gain on sale of assets.................... -- 900 --
Loss on joint venture..................... (4,355) -- --
---------- ---------- ----------
Income (loss) before income taxes......... 669 (5,192) (8,687)
Provision for income taxes................ (359) -- --
---------- ---------- ----------
Net income (loss) before common stock re-
demption................................. 310 (5,192) (8,687)
Less premium paid on redemption of Class B
common stock ............................ (3,750) -- --
---------- ---------- ----------
Loss attributable to common shareholders.. $ (3,440) $ (5,192) $ (8,687)
========== ========== ==========
Net loss per share:
Basic and Diluted....................... $ (0.10) $ (0.27) $ (0.55)
========== ========== ==========
Number of shares used in computing net
loss per share:
Basic and Diluted....................... 33,248 19,283 15,785
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these statements.
45
<PAGE>
CATALYTICA, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.......................... $ 35,149 $15,540
Short-term investments............................. 11,918 8,281
Accounts receivable, net of allowance for doubtful
accounts of $600 ($100 in 1996)................... 12,640 3,944
Accounts receivable from joint venture............. 967 865
Notes receivable from employees.................... 405 328
Inventory:
Raw materials.................................... 52,648 1,689
Work in process.................................. 54,883 249
Finished goods................................... 6,714 1,479
-------- -------
114,245 3,417
Deferred tax asset................................. 166 --
Prepaid expenses and other assets.................. 1,939 681
-------- -------
Total current assets........................... 177,429 33,056
Property, plant and equipment:
Land............................................... 5,391 --
Equipment.......................................... 99,744 9,260
Buildings and leasehold improvements............... 65,744 8,173
-------- -------
170,879 17,433
Less accumulated depreciation and amortization..... (15,075) (9,536)
-------- -------
155,804 7,897
Other assets......................................... 2,040 50
-------- -------
$335,273 $41,003
======== =======
</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, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................... $ 23,281 $ 2,055
Accrued payroll and related expenses............... 5,768 1,372
Deferred revenue................................... 1,848 1,643
Other accrued liabilities.......................... 8,250 949
Borrowings under line of credit.................... -- 2,300
Current portion of long-term debt.................. 50,332 833
Income taxes payable............................... 525 --
-------- --------
Total current liabilities........................ 90,004 9,152
Long-term debt....................................... 75,069 1,524
Non-current deferred revenue......................... 3,611 5,064
Other accrued liabilities............................ 6,400 --
Minority interest.................................... 11,000 8,000
Class A and B common stock subject to mandatory re-
demption:
Class A--30,000,000 shares authorized, 13,270,000
issued and outstanding in 1997.................... 51,452 --
Class B--17,000,000 shares authorized, 11,730,000
issued and outstanding in 1997.................... 45,627 --
Stockholders' equity:
Preferred Stock, $.001 par value; 5,000,000 shares
authorized, none issued and outstanding........... -- --
Common Stock, $.001 par value; 120,000,000 shares
authorized including 30,000,000 Class A and
17,000,000 Class B, 27,941,729 shares of common
stock issued and outstanding in 1997; (19,397,074
shares in 1996). See Class A and B common stock
above............................................. 28 19
Additional paid-in capital......................... 100,375 65,482
Deferred compensation.............................. (406) (41)
Accumulated deficit................................ (47,887) (48,197)
-------- --------
Total stockholders' equity....................... 52,110 17,263
-------- --------
$335,273 $ 41,003
======== ========
</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,
-----------------------------
1997 1996 1995
--------- -------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).............................. $ 310 $ (5,192) $ (8,687)
Adjustments to reconcile net income (loss) to
net cash provided by(used in) operating activ-
ity:
Depreciation and amortization.................. 5,754 944 1,547
Deferred Income Taxes.......................... (166) -- --
Losses in affiliated company................... 4,355 -- --
Changes in:
Accounts receivable........................... (8,696) (387) (2,058)
Accounts receivable from related party........ -- (865) --
Accounts receivable from joint venture........ (102) -- --
Inventory..................................... 5,995 (2,563) (275)
Prepaid expenses, and other current assets.... 136 (310) 387
Accounts payable.............................. 21,226 716 211
Accrued payroll and related expenses.......... 4,395 (20) (24)
Deferred revenue.............................. (1,248) 6,540 --
Royalties payable to related party............ -- -- (622)
Other accrued liabilities..................... 7,826 359 (407)
--------- -------- --------
Net cash provided by (used in) operating
activities.................................. 39,785 (778) (9,928)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments....................... (25,099) (22,748) (19,817)
Maturities of investments...................... 21,532 30,500 14,000
Investment in affiliate company................ (4,355) -- --
Acquisition of property and equipment.......... (6,347) (3,565) (1,645)
Acquisition of Glaxo Wellcome inventory........ (116,823) -- --
Acquisition of Glaxo Wellcome property, plant
and equipment................................. (131,198) -- --
--------- -------- --------
Net cash provided by (used in) investing
activities.................................. (262,290) 4,187 (7,462)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net receipts on (issuance of) notes receivable
from employees................................ (92) (206) 115
Additions to debt obligations.................. 137,726 4,213 4,384
Payments on debt obligations................... (20,501) (5,278) (618)
Minority investment............................ -- 8,000 --
Issuance of Class A and B common stock, net.... 117,679 -- --
Repurchase of Class B common stock............. (23,750) -- --
Issuance of common stock by exercise of warrant
dividend ..................................... 27,692 -- --
Issuance of common stock....................... 3,360 381 14,892
--------- -------- --------
Net cash provided by financing activities.... 242,114 7,110 18,773
--------- -------- --------
Net increase in cash and cash equivalents....... 19,609 10,519 1,383
Cash and cash equivalents at beginning of year.. 15,540 5,021 3,638
--------- -------- --------
Cash and cash equivalents at end of year........ $ 35,149 $ 15,540 $ 5,021
========= ======== ========
Additional disclosure of non-cash financing and
operating activities:
Issuance of warrants in conjunction with the
Glaxo Wellcome facility acquisition........... 6,500 -- --
========= ======== ========
Issuance of Catalytica Pharmaceutical's Junior
Preferred Stock in conjunction with the Glaxo
Wellcome facility acquisition................. 3,000 -- --
========= ======== ========
Assumption of liability in conjunction with
Glaxo Wellcome facility acquisition........... 6,400 -- --
========= ======== ========
Issuance of Catalytica common stock to Shearson
Lehman for services provided in conjunction
with issuance of Class A & B common stock..... 600 -- --
========= ======== ========
Deferred Compensation.......................... 500 -- --
========= ======== ========
Supplemental disclosure of cash flow
information:
Interest paid.................................. 4,667 353 278
========= ======== ========
</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,
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
Sale and issuance of
common stock.......... 1,413,506 2 3,958 -- -- 3,960
Issuance of warrants to
Glaxo Wellcome........ -- -- 6,500 -- -- 6,500
Net exercise of
warrants issued in
connection with public
offering.............. 208,153
Exercise of warrant
dividends............. 6,922,996 7 27,685 -- -- 27,692
Premium paid in connec-
tion with repurchase
of Class B common
stock................. (3,750) (3,750)
Issuance of below
market stock options.. -- -- 500 (500) --
Amortization of
deferred
compensation.......... -- -- -- 135 -- 135
Net income............. -- -- -- -- 310 310
---------- --- -------- ----- -------- -------
Balance at December 31,
1997................... 27,941,729 $28 $100,375 $(406) $(47,887) $52,110
========== === ======== ===== ======== =======
</TABLE>
The accompanying notes are an integral part of these statements.
49
<PAGE>
CATALYTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS 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
increased 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.
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 1996 have been reclassified to reflect 1997 presentation.
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.
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
10).
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;
investments with maturities of three months or less at the date of purchase
which are held-to-maturity ($11,918,000 at December 31, 1997) and investments
with maturities greater than three months which are available-for-sale (none
at December 31, 1997) 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, 1997). All
investments at December 31, 1997, 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, 1997, the average portfolio duration is approximately
1.46 months.
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. The Company recorded an
allowance for doubtful accounts of $600,000 in 1997 and $100,000 in 1996.
50
<PAGE>
CATALYTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
INVENTORIES All inventories are stated at the lower of cost (first-in,
first-out) or market. Inventory write-downs are based on the Company's best
estimates.
On July 31, 1997, Catalytica Pharmaceuticals purchased $116.8 million of
inventory as part of the acquisition of the pharmaceutical manufacturing
facility from Glaxo Wellcome Inc.
PROPERTY AND EQUIPMENT On July 31, 1997, Catalytica Pharmaceuticals
purchased from Glaxo Wellcome (i) all the land, buildings and improvements
thereon and certain rights relating thereto compromising the pharmaceutical
manufacturing facility of Glaxo Wellcome located in Greenville, North
Carolina, containing approximately 582 acres of land, and (ii) substantially
all of the machinery, equipment, furniture, fixtures, transportation and
distribution equipment, waste treatment facilities, computers, analytical
equipment, instruments, communication equipment, control systems, spare parts,
supplies, materials and all other items of tangible personal property owned by
Glaxo Wellcome and located at the Facility. The Company recorded $147.1
million of property, plant, and equipment in connection with the Acquisition.
Property and equipment are stated at cost. Depreciation and amortization are
provided on the straight-line basis over the lesser of the useful lives of the
respective assets or the lease term, if applicable (generally 3-15 years).
Expenditures for maintenance and repairs are generally charged to expense as
incurred. In 1997, $9.1 million was charged to repair and maintenance expense.
REVENUES Revenues consist of both product sales and research revenues. All
product revenues are recognized upon shipment. Approximately 96% of revenues
are related to pharmaceutical product sales for the year ended December 31,
1997. Through December 31, 1997, approximately 90% of the Company's product
revenues have been derived from sales to Glaxo Wellcome under a Supply
Agreement entered into on July 31, 1997. As of December 31, 1997, a receivable
in the amount of $11,770,000 was outstanding from Glaxo Wellcome. Glaxo
Wellcome has guaranteed that revenues paid to Catalytica Pharmaceuticals will
meet a specified level or that Glaxo Wellcome will pay to Catalytica
Pharmaceuticals any shortfall. The guaranteed revenues, which include
compensation for transition services Catalytica Pharmaceuticals has agreed to
provide Glaxo Wellcome, and which exclude the cost of materials, in each of
the next five years are as set forth below:
<TABLE>
<CAPTION>
AUGUST 1-
DECEMBER 31
1997 1998 1999 2000 2001 TOTAL
----------- ------ ----- ----- ----- ------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
$77.0 $166.4 $94.0 $72.6 $22.6 $432.6
</TABLE>
This agreement states that guaranteed revenues are to be calculated by
comparing the agreed upon product prices billed on invoices for the year to
the stipulated guaranteed revenue amount for the specific year in agreement.
For the two years ended December 31, 1997 and 1996, approximately 3%, and
18%, respectively, of the Company's pharmaceutical product revenues have been
derived from sales to Novartis by the Company's manufacturing facility in
California under a five-year contract pursuant to which Novartis committed to
buy certain minimum annual volumes. 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 4% of the Company's revenues in 1997 were derived from
research and development contracts. Most of the company's research and
development contracts are subject to periodic review by the
51
<PAGE>
CATALYTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
funding partner, which may result in modifications, including reduction or
termination of funding. There can be no assurance that the Company will
continue to receive research and development funding, and the Company expects
that it will rely increasingly on product sales for its revenues.
Research revenues are earned as contractual services are performed in
connection with collaborative arrangements and are recognized in accordance
with contract terms, principally based on reimbursement of total costs and
expenses incurred. In return for funding development, collaborative partners
receive certain rights in the commercialization of the resulting technology.
Costs of $6,290,000, $6,235,000, and $4,409,000 related to research revenues
were included in total costs and expenses for each of the three years ended
December 31, 1997, 1996, and 1995, respectively. Unbilled revenues related to
work performed under collaborative arrangements were approximately $996,572 at
December 31, 1997 ($385,000 at December 31, 1996) and are included in accounts
receivable on the accompanying balance sheet. Most amounts unbilled at
December 31, 1997, were billed in January, 1998.
MAJOR CUSTOMER INFORMATION Revenues from major customers from all sources of
revenue representing more than 10% of revenues in any of the past three years
are as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
--------------
CUSTOMER 1997 1996 1995
-------- ---- ---- ----
<S> <C> <C> <C>
Glaxo Wellcome................................................ 87% -- --
Upjohn........................................................ 0% 17% 0%
Merck......................................................... 1% 13% 13%
Novartis...................................................... 3% 11% 31%
Pfizer........................................................ 2% 11% 4%
Mitsubishi Oil Company, Ltd. ................................. 1% 9% 10%
</TABLE>
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 22% of the company's 1997 research and development
expenses was spent to develop the company's combustion systems technology,
approximately 38% was spent on pharmaceuticals technology, and approximately
40% was spent on other technologies, much of which was performed at the
specific request of, and funded by, third parties.
INCOME TAXES The Company accounts for income taxes under the liability
method in accordance with Statements of Financial Accounting Standards
("SFAS") No. 109, "Accounting for Income Taxes", see Note 7. Income taxes have
been provided and tax credits have been recognized based on tax laws in effect
at the dates of the financial statements.
EARNINGS (LOSS) PER SHARE Earnings (loss) per share is presented in
accordance with Financial Accounting Standards Board (FASB) Statement of
Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share" (EPS).
This statement requires the presentation of EPS to reflect both "Basic EPS"
and "Diluted EPS" on the face of the statement of operations. In general,
Basic EPS excludes dilution created by common stock equivalents and is a
function of the weighted average number of common shares outstanding for the
period. Diluted EPS reflects the potential dilution created by common stock
equivalents. For the periods ended December 31, 1997, 1996, and 1995, 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. Weighted average shares
outstanding includes Class A and B common shares as the Company considers
Class A and B to be the equivalent of common stock. All periods presented
herein have been adjusted to reflect the calculation of EPS in accordance with
SFAS No. 128.
52
<PAGE>
CATALYTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
A reconciliation of the numerators and denominators for the Basic and
Diluted EPS calculations follows:
EARNINGS (LOSS) PER SHARE
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The following table sets forth the computation of basic and diluted earnings
per share:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Numerator:
Net income before common stock redemption pre-
mium......................................... $ 310 $(5,192) $(8,687)
Premium paid on common stock redemption (*)... (3,750) -- --
------- ------- -------
Numerator for earnings per share--income
available to common shareholders............. (3,440) (5,192) (8,687)
Denominator:
Denominator for basic and diluted earnings per
share--weighted-average shares............... 33,248 19,283 15,785
Basic and Diluted loss per share................ $ (0.10) $ (0.27) $ (0.55)
======= ======= =======
</TABLE>
- --------
* Income (loss) available to common shareholders reflects a reduction from net
income of $3.75 million relating to the call premium paid for the repurchase
of five million shares of Series B common stock with proceeds received from
the exercise of warrants issued to shareholders as a dividend. See Note 10.
For the years ended December 31, 1997, 1996, and 1995, potentially dilutive
securities of 2,649,000, 2,286,000, and 604,000, respectively, were
outstanding and not included in the diluted earnings per share computation
because they are antidilutive.
STOCK-BASED COMPENSATION In 1995, the FASB issued Statement No. 123,
Accounting for Stock-Based Compensation, which provides an alternative to APB
Opinion No. 25, Accounting for Stock Issued to Employees, in accounting for
stock-based compensation to employees. The Company has elected to account for
stock-based compensation to employees in accordance with Opinion 25, providing
only pro forma disclosures required by Statement 123.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS The Company intends to adopt
SFAS No. 130. "Reporting Comprehensive Income," and SFAS 131, "Disclosures
about Segments of an Enterprise and Related Information," in fiscal 1998. SFAS
No. 130 contains requirements for the reporting and display of comprehensive
income and is expected to first be reflected in the Company's first quarter of
1998 interim financial statements. Components of comprehensive income for the
Company include items such as net income and changes in the value of
available-for-sale securities. SFAS No. 131 changes the way companies report
segment information and requires segments to be determined based on how
management measures performance and makes decisions about allocating
resources. SFAS No. 131 will first be reflected in the Company's 1998 Annual
Report.
NOTE 2. CATALYTICA PHARMACEUTICALS, INC.
On July 31, 1997, The Company purchased from Glaxo Wellcome a
pharmaceuticals manufacturing facility in Greenville, North Carolina for (i)
$244.7 million in cash; (ii) 250,000 shares of Junior Preferred Stock of
Catalytica Pharmaceuticals; (iii) warrants to purchase 2,000,000 shares of
Common Stock of Catalytica at an exercise price of $12.00 per share
exercisable for six years after the closing of the acquisition ("Closing") and
(iv) 10% of the earnings before interest and taxes in excess of an aggregate
cumulative amount of $10 million
53
<PAGE>
CATALYTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
attributable to the sterile products portion of the Facility for a period of
ten years following the Closing, up to an aggregate cumulative payment to
Glaxo Wellcome of an additional $25 million. The cash purchase price reflects
the parties' agreement to a reduction in the cash consideration of
approximately $6,400,000 in exchange for the assumption by the Company and
Catalytica Pharmaceuticals of certain liability associated with the abatement
of asbestos or asbestos containing materials ("ACM") present at the Facility
and post-closing employee workplace exposure. As a result of the Acquisition,
Catalytica recorded $116.8 million of inventory, $147.1 million of property,
plant, and equipment, and the assumption of the aforementioned asbestos
liability of $6.4 million. See Note 4.
The Junior Preferred Stock of Catalytica Pharmaceuticals issued to Glaxo
Wellcome has the following rights: (a) a non-cumulative dividend preference
and a liquidation preference, both junior to the outstanding preferred stock
of Catalytica Pharmaceuticals and the Catalytica Pharmaceuticals Series C
Preferred Stock which was issued to the Company in connection with the
Acquisition; (b) the right to convert into shares of Catalytica
Pharmaceuticals Common Stock on a one-for-one basis (subject to adjustment in
the case of stock splits, reclassifications, stock dividends and rights
offerings to existing holders of Common Stock and similar events and in the
event of Common Stock issuances below the then fair market value except for
issuances pursuant to Catalytica Pharmaceuticals' employee benefit plans) at
any time at the option of the holder and automatically upon the closing of an
underwritten public offering which results in gross proceeds of at least
$10,000,000 to Catalytica Pharmaceuticals; (c) each share of Junior Preferred
Stock shall be entitled to the number of votes equal to the number of shares
of Common Stock into which such shares of Junior Preferred Stock could then be
converted; and (d) if Catalytica Pharmaceuticals shall not have consummated an
underwritten public offering which results in gross proceeds of at least $10
million to Catalytica Pharmaceuticals within five years of the consummation of
the Acquisition, the Junior Preferred Stock shall be exchangeable, at the
option of Glaxo Wellcome, into shares of Common Stock of the Company having a
market value at that time equal to the value of the preferred stock. Upon
consolidation of Catalytica Pharmaceuticals into Catalytica, Inc. the Junior
Preferred Stock issued to Glaxo Wellcome is reflected as $3 million in
minority interest in Catalytica, Inc.
In connection with the sale of the Facility, Glaxo Wellcome entered into a
Supply Agreement under which Catalytica Pharmaceuticals will manufacture
products for Glaxo Wellcome over the next year, in the case of Pharmaceutical
Product Operations ("PPO"), and the next four and one-half years in the case
of Chemical Manufacturing Operations ("CMO") and Sterile Product Operations
("SPO"). Catalytica Pharmaceuticals estimates that aggregate payments
(including the cost of materials) by Glaxo Wellcome under the Supply Agreement
will total approximately $800 million over a five-year period. Glaxo Wellcome
has guaranteed that revenues paid to Catalytica Pharmaceuticals will meet a
specified level of minimum revenue or that Glaxo Wellcome will pay to
Catalytica Pharmaceuticals any shortfall. The minimum revenues, which include
compensation for transition services Catalytica Pharmaceuticals has agreed to
provide Glaxo Wellcome, and which exclude the cost of materials, over the five
years total $432.6 million. Total minimum revenue excluding the cost of
materials recognized under the Supply Agreement was $77.0 million during 1997.
As of December 31, 1997, a receivable in the amount of $11,770,000 was
outstanding from Glaxo Wellcome.
On May 8, 1996, Pfizer Inc. ("Pfizer") entered into a Collaborative Research
and License Agreement and a Stock Purchase Agreement with Catalytica
Pharmaceuticals, Inc., that included the purchase of 150,000 shares of Series
B Preferred stock by Pfizer. The holders of the Series B Preferred stock shall
be entitled to receive non-cumulative dividends at a rate of $6.00 per share,
per annum, when and if declared by the Board of Directors. In consideration of
the $15 million paid, Catalytica Pharmaceuticals is also obligated to perform
specified agreed upon research for a five year period. Accordingly, Catalytica
recognized Pfizer's minority interest in Catalytica Pharmaceuticals at $8
million and recorded deferred revenue of $7 million to be recognized as
research is performed. In 1997 and 1996, $1,454,000 and $536,000,
respectively, of research was performed and recognized as revenue. The
deferred revenue balance pertaining to Pfizer is $5.0 million and $6.5 million
at December 31, 1997 and 1996, respectively.
54
<PAGE>
CATALYTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In conjunction with the Stock Purchase agreement, the Company entered into a
Share Exchange agreement, providing Pfizer the right to exchange the Series B
preferred stock of the Company for Catalytica, Inc. ("Catalytica") common
stock. After the three year anniversary of the agreement, Pfizer shall have
the right to require the Company to exchange all of the outstanding shares of
Series B preferred stock for that number of shares of common stock based upon
a determined exchange rate. The exchange rate is based upon the fair value of
the preferred stock and the market value of Catalytica's common stock at the
time of conversion. In the event of insolvency of the Catalytica
Pharmaceuticals, Pfizer may convert $4,200,000 of Series B preferred shares
into 700,000 shares of Catalytica's common stock.
NOTE 3. JOINT VENTURE AND DISPOSAL
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 Power Systems, LLC, will initially
upgrade the combustion systems of installed turbines with XONON which will
reduce emissions and permit greater asset utilization for both power
generation and mechanical drive markets.
The initial capital commitment of the GENXON joint venture partners was $10
million: $2 million from CCSI, and $8 million from Woodward, payable over time
as the funds are required by the joint venture. In addition to the initial
capital commitment made by CCSI and Woodward, CCSI has contributed to the
joint venture an exclusive license for the use of its catalytic combustion
technologies valued at $8.0 million, and Woodward contributed to the joint
venture an exclusive license for the use of its instrumentation and control
systems for gas turbine catalytic combustion valued at $2.0 million.
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 $1.9 million during the last quarter of 1997, bringing
the total investment in the joint venture to $13.8 million to date. CCSI began
accounting for its share of the joint venture gain or loss upon the first cash
infusion totaling $1.0 million which occurred on January 3, 1997 upon
completion of a milestone. Prior to January 3, 1997, the joint venture was
being funded entirely by Woodward Governor. For the year ended December 31,
1997, the Company has recorded losses of $4.4 million on 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 financial statements of Catalytica. Inc. As of December 31, 1997,
accounts receivable of $967,000 were outstanding from GENXON.
The following information summarizes GENXON's financial position for the
year ended September 30, 1997 and the unaudited quarter ended December 31,
1997:
<TABLE>
<CAPTION>
YEAR ENDED QUARTER ENDED
SEPTEMBER 30, 1997 DECEMBER 31, 1997
------------------ -----------------
(UNAUDITED)
<S> <C> <C>
Total Revenues........................ $ 268,000 $ 0
============ ===========
Net loss.............................. (10,486,000) (1,959,000)
============ ===========
Current assets........................ $ 647,000 $ 1,046,000
Long-term assets...................... 557,000 1,224,000
------------ -----------
Total assets........................ $ 1,204,000 $ 2,270,000
============ ===========
Current liabilities................... $ 2,690,000 $ 2,467,000
Members' capital...................... (1,486,000) (197,000)
------------ -----------
Total liabilities and members' capi-
tal................................ $ 1,204,000 $ 2,270,000
============ ===========
</TABLE>
55
<PAGE>
CATALYTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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. ENVIRONMENTAL REGULATIONS
On November 30, 1993, the Company entered into a ground lease with Rhone
Poulenc, Inc. to lease the surface of the pharmaceuticals manufacturing
facility in East Palo Alto, California. Because there is significant soil and
groundwater contamination caused by past activities on the Site, Rhone Poulenc
Inc. is remediating the soil and groundwater of the Site pursuant to an order
from the Bay Area Regional Water Quality Control Board ("RWQCB"). Pursuant to
the ground lease with Rhone Poulenc Inc., the Company has received an
indemnity for the contamination which is the subject of the RWQCB's order.
A moderate amount of asbestos containing material ("ACM") is present at the
Greenville facility. The Company believes that the ACM, in its present
condition, does not require abatement. Abatement will only be required if and
as renovations are performed in those areas containing ACM. The Company
assumed the liability associated with the abatement of the ACM present at the
Facility under the purchase agreement with Glaxo Wellcome. The Company has a
reserve totaling $6.4 million at December 31, 1997, which it believes is
adequate to cover the cost of remedial clean-up should renovations ever be
performed in those areas containing ACM.
In connection with the sale of the pharmaceutical manufacturing facility in
Greenville, North Carolina to the Company (see Note 2), Glaxo Wellcome agreed
to perform, at its own cost, remediation required by law associated with soil
and groundwater contamination existing at the facility as of the date of the
acquisition, July 31, 1997. Catalytica Pharmaceuticals is required to provide
access to the facility and certain facility services required by the
remediation efforts, subject to reimbursement by Glaxo Wellcome.
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 pharmaceuticals products the Company manufactures, or will
manufacture in the future, and the final drug products in which they are used,
are subject to regulation for safety and efficacy by the FDA and foreign
regulatory authorities before such products can be commercially marketed. The
process of obtaining regulatory clearances for marketing is uncertain, costly,
and time-consuming. The Company cannot predict how long the necessary
regulatory approvals will take, or if its customers will ever obtain such
approval for their products. To the extent the Company's customers do not
obtain the necessary regulatory approvals for marketing new products, the
Company's pharmaceuticals product sales will be adversely affected.
56
<PAGE>
CATALYTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 5. PENSION AND PROFIT SHARING PLANS
The Company has a defined contribution pension plan and a nonqualified
pension plan for employees meeting certain requirements, based on a defined
percentage of the employees' compensation and an employer match for the
defined contribution plan. Pension expense amounted to approximately
$1,315,000, $324,000, and $297,000, for each of the three years ended December
31, 1997, 1996, and 1995, respectively.
NOTE 6. DEBT
In conjunction with the acquisition of the Greenville Facility and the
related equity investment by Morgan Stanley Capital Partners III, L.P.
("MSCP"), 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 will be available for the issuance of letters
of credit. The Term Debt Facility will mature four and one-half years after
consummation of the Acquisition 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 7.25% as of
December 31, 1997. As of December 31, 1997, nothing was outstanding under the
revolving debt facility and $125,000,000 was outstanding under the senior
secured term facility.
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. In addition,
compliance with leverage ratios and interest expense coverage ratios are
required. At December 31, 1997, the Company was in compliance with the
covenants, and believes that it will remain in compliance.
As of December 31, 1997, Catalytica owed $207,500 to a previous research and
development collaborative partner. This note, originating in fiscal 1991, will
be fully repaid in fiscal 1998.
As of December 31, 1996, Catalytica Pharmaceuticals had a working capital
line of credit ($2,300,000 outstanding at December 31, 1996) and two equipment
based term loans ($930,000 and $500,000 outstanding at December 31, 1996). On
July 31, 1997, upon the acquisition of the Greenville manufacturing facility
(See Note 2), the working capital line of credit and the term loans were
repaid at the amounts outstanding on that date ($3,497,000, $799,000, and
$500,000).
Fair value of debt is based on pricing models or securities with similar
terms, and approximates carrying value.
At December 31, 1997, future minimum principal payments on debt were as
follows:
<TABLE>
<S> <C>
1998........................ $ 50,332,000
1999........................ 37,569,000
2000........................ 20,000,000
2001........................ 17,500,000
------------
$125,401,000
============
</TABLE>
57
<PAGE>
CATALYTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 7. INCOME TAXES
The provision for income taxes in 1997 consists of the following (in
thousands):
<TABLE>
<CAPTION>
1997
----
<S> <C>
Current:
Federal.......................... $ 41
State............................ 484
----
525
Deferred:
Federal.......................... (19)
State............................ (147)
----
(166)
----
Total Provision................ $359
</TABLE>
The provision for income taxes reconciles to the amount computed by applying
the Federal statutory rate to income before provision for income taxes as
follows (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
----- ------- -------
<S> <C> <C> <C>
Income (loss) before provision for income taxes... $ 669 $(5,192) $(8,687)
===== ======= =======
Federal statutory rate............................ $ 227 $(1,765) $(2,954)
State taxes, net of federal benefit............... 330 -- --
Benefit of prior year losses not currently bene-
fited............................................ (198) 1,765 2,954
----- ------- -------
Provision for income taxes........................ $ 359 $ -- $ --
===== ======= =======
</TABLE>
Deferred income taxes reflect the tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the net deferred tax liability are as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards....................... $ 14,100 $ 14,561
Capitalized R&D costs.................................. 2,000 1,022
Net operating loss carryforwards....................... 14,100 14,561
Credit carryforwards................................... 200 184
Nondeductible reserves................................. 1,300 --
Other, net............................................. 500 1,384
-------- --------
Total deferred tax assets................................ $ 18,100 $ 17,151
Valuation allowance...................................... (17,934) (17,151)
-------- --------
Net deferred tax assets.................................. $ 166 $ --
======== ========
</TABLE>
The net deferred tax assets of $166,000 consists primarily of temporary
differences for North Carolina state taxes.
The realization and amount of any tax benefit from the deferred tax asset of
$18.1 million is dependent upon the generation of future taxable income and
the tax rate in effect in such years. Accordingly, due to the uncertainty of
realizing future taxable earnings, a valuation allowance has been established
for the deferred tax asset. The valuation allowance increased by $783,000 and
$340,000 during 1997 and 1996 respectively.
58
<PAGE>
CATALYTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
At December 31, 1997, for federal income tax purposes, the Company has net
operating loss carryforwards of approximately $41,300,000 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 $200,000 of investment and research and
development credit carryforwards that will expire in years 1998 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 $1,300,000 that will expire in years 1998
through 2001. 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 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.
As a result of the stock offering completed by the Company during fiscal
1997, the utilization of federal net operating loss and the deduction
equivalent of federal tax credit carryforwards incurred prior to July 1997 of
approximately $42,700,000 will be subject to an annual limitation of
approximately $16,000,000 per year. Future changes in ownership may result in
additional limitations.
NOTE 8. LEASES, COMMITMENTS, AND CONTINGENCIES
LEASES
Catalytica leases its research and office facilities in Mountain View under
an operating lease agreement that expires on December 31, 2003, after which
the Company has the option for a five-year extension. The pharmaceuticals
manufacturing facility in East Palo Alto is owned by the Company; however, the
land at the facility is leased under a ground lease agreement commencing
November 30, 1993 for an initial term of 15 years. The lease expires on
November 30, 2008, after which the Company has two five-year options to extend
the lease term, and one four-year option to extend the lease term after
expiration of the first two option periods. All land and buildings at the
pharmaceuticals manufacturing facility in Greenville, North Carolina, are
owned by the Company.
RENT
The aggregate minimum annual commitments under all operating leases as of
December 31, 1997, are as follows:
<TABLE>
<CAPTION>
FISCAL YEAR
<S> <C>
1998......................... 2,440,000
1999......................... 2,060,000
2000......................... 1,653,000
2001......................... 1,662,000
2002......................... 1,651,000
and thereafter............... 4,242,000
-----------
$13,708,000
===========
</TABLE>
Rent expense was $1,425,000, $732,000, and $707,000 for each of the three
years ended December 31, 1997, 1996, and 1995, respectively.
59
<PAGE>
CATALYTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
RESEARCH COLLABORATIONS
During the past four years, Catalytica Pharmaceuticals and Pfizer have
collaborated on the development of proprietary processes for key intermediate
products for several of Pfizer's promising new pharmaceuticals. The Pfizer
drugs are at varying stages of approval by the Food and Drug Administration,
ranging from Phase II clinical trials through the New Drug Application stage.
See Note 2 for a description of the collaborative research and license
agreement. Catalytica Pharmaceuticals currently manufactures intermediates for
certain Pfizer drugs and anticipates becoming a supplier of intermediates to
Pfizer for other pharmaceutical products in the future.
The Company has entered into research collaborations with companies whereby
potential future payments may be due to selective collaborative partners if
the partners achieve certain milestones as defined in the collaborative
agreements.
In 1991, the Company entered into an agreement with Conoco Inc. (Conoco) and
Neste Oy (Neste) 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, 1997) plus
interest from the first 10% of the annual pre-tax income, if any, realized
from commercializing the technology.
In connection with certain agreements between the Company and Koch
Industries (Koch) 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, 1997, 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 $16,545,000,
$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, as of December 31, 1997, the Company
paid Koch in full for outstanding royalties payable for license fees realized
on the gasoline alkylation project related to funding received from Conoco and
Neste. 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 6).
SUPPLY AGREEMENT
As mentioned in Note 2, in connection with the purchase of the Facility,
Glaxo Wellcome entered into a Supply Agreement under which Catalytica
Pharmaceuticals will manufacture products for Glaxo Wellcome over the next
year, in the case of PPO products, and the next four and one-half years in the
case of CMO and SPO products.
NOTE 9. RELATED PARTY TRANSACTIONS
GLAXO WELLCOME As discussed in Note 2, Glaxo Wellcome holds 250,000 shares
of Junior Preferred Stock of Catalytica Pharmaceuticals (1.5% of Catalytica
Pharmaceuticals) and warrants to purchase 2,000,000 shares of Common Stock of
Catalytica. Under a Supply Agreement, Catalytica Pharmaceuticals currently
manufactures products for Glaxo.
MORGAN STANLEY CAPITAL PARTNERS ("MSCP") In conjunction with the purchase of
the North Carolina Facility, the Company issued 30,000,000 shares of Class A
and Class B Common Stock to MSCP for an
60
<PAGE>
CATALYTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
aggregate purchase price of $120,000,000. The Company subsequently repurchased
5,000,000 shares of Class B Common Stock from MSCP at a price of $4.75 per
share. At December 31, 1997, MSCP owned approximately 32% of the Company's
outstanding voting securities and approximately 47% of the Company's
outstanding securities (See Note 10). Pursuant to this Investment Agreement,
MSCP has certain rights to cause the Company to include as nominees for the
Company's Board of Directors, up to three directors for so long as MSCP owns
not less than 30% of the outstanding common stock of the Company. MSCP has
designated two MSCP nominees as directors and the Company has increased the
number of its directors from seven to nine. In the event MSCP's beneficial
ownership of outstanding common stock is less than 30% but equal to or greater
than 10%, MSCP shall be entitled to elect up to two directors. In the event
MSCP's beneficial ownership is less than 10% but equal to or greater than 6%,
MSCP shall be entitled to elect one director. The Company has also agreed that
MSCP will be represented on each committee of the Board of Directors.
PFIZER INC. As discussed in Note 2, Pfizer holds 150,000 shares of
Catalytica Pharmaceuticals Series B Preferred Stock (4.4% of Catalytica
Pharmaceuticals). Catalytica Pharmaceuticals currently manufactures
intermediates for Pfizer and performs research for Pfizer under a
collaborative research and license agreement.
GENXON(TM) POWER SYSTEMS, LLC As discussed in Note 3, Catalytica Combustion
Systems Inc. (CCSI) and Woodward Governor Company ("Woodward") have
established GENXON, a joint venture, to serve the gas turbine retrofit market.
GENXON reimburses Catalytica and Woodward for work performed on its behalf.
NOTE 10. CAPITAL STOCK
Common Stock
On July 29, 1997, the shareholders of the Company approved an increase in
the authorized number of shares of the Company's Common Stock from 40,000,000
to 120,000,000 shares. 30,000,000 of those shares were approved as a new class
of Common Stock of the Company, to be designated Class A Common Stock at a par
value $0.001 per share. 17,000,000 of the shares were approved as a new class
of nonvoting Common Stock of the Company, to be designated Class B Common
Stock, par value $0.001 per share.
With the closing of the acquisition of the Glaxo Wellcome facility as
described in Note 2, the Company closed a sale of 13,270,000 shares of its
Class A Common Stock and 16,730,000 shares of its Class B Common Stock to
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. As a result of the Stock Sale and subsequent stock
repurchase, as of December 31, 1997, MSCP owned approximately 32% of the
Company's outstanding voting securities and approximately 47% of the Company's
outstanding securities.
Per the terms of the Acquisition, the Company had the option to redeem up to
5,000,000 shares of the Class B Common Stock at a price equal to $4.75 per
share during the period from closing through November 30, 1997, and $5.00 per
share during the period from December 1, 1997 through May 31, 1998, upon which
the redemption right expires. The optional redemption right provided the
Company with the flexibility to reduce the amount of equity issued to complete
the Acquisition if during the period between the closing of the Acquisition
and May 31, 1998, the Company's financial performance during such period
enabled the Company to obtain capital on terms that reduce the equity dilution
from the Stock Sale. As further described in "Warrant Dividend" below, on
November 30, 1997, the Company exercised its right of redemption for 5,000,000
shares of the Class B Common Stock at $4.75 per share reflecting a call
premium of $0.75 per share. As such, 11,730,000 shares of Class B Common Stock
remained outstanding as of December 31, 1997.
At any time after July 1, 1998, MSCP has the right to request the Company to
effect a registration of shares of Common Stock issuable upon conversion of
the Class A Common Stock and Class B Common Stock held by
61
<PAGE>
CATALYTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
it with an aggregate offering price of at least $15 million. In addition, in
the event the Company proposes to register any of its securities for its own
account or the account of any of its stockholders (other than certain
registrations relating solely to a stock option or other similar employee
benefit plan), MSCP will have the right to have the Common Stock issuable upon
conversion of the Class A and B Common Stock included in such registration.
At any time after July 1, 2005, the holders of the Class A Common Stock will
have the right to require the Company, upon six months written notice, to
repurchase during any annual period commencing July 1 and ending June 30 up to
one-third of the initial outstanding shares of Class A Common Stock and Class
B Common Stock for an amount in cash equal to the Liquidation Preference,
initially established at $4.00 per share subject to certain adjustments. In
addition, upon a change of control, MSCP shall have the right to cause the
Company to purchase all of the shares of Class A Common Stock and Class B
Common Stock initially acquired by MSCP at the Liquidation Preference.
Each share of Class A Common Stock may be converted at the option of the
holder into shares of Common Stock at the effective conversion price. Each
share of Class A Common Stock shall automatically convert into Common Stock
(i) upon any transfer by MSCP, including any distribution to its partners or
affiliated entities, or (ii) if less than 10% of the shares of Class A Common
Stock initially issued are outstanding. The conversion price initially shall
be $4.00 per share and shall be subject to adjustment in certain cases as
described below. The Company may issue up to $25,000,000 of aggregate amount
of capital stock or warrants to stockholders of the Company prior to May 31,
1998 without triggering an adjustment to the additional $2,500,000 of capital
stock or warrants to stockholders of the Company without triggering an
adjustment to the conversion price of the Class A Common Stock provided that
such additional capital stock is issued in connection with the exercise of the
warrants from the Warrant Issuance.
The liquidation preference of the Class A Common Stock ranks senior to all
other common stock and preferred stock at any time outstanding of the Company
unless agreed to by MSCP. The liquidation preference of the Class A Common
Stock will be equal to the greater of (i) $4.00 per share plus any accrued and
unpaid dividends, (the "Liquidation Preference") and (ii) the amount that
holders thereof would have received in such liquidation had the Class A Common
Stock been converted to Common Stock in accordance with its terms.
The Class B Common Stock has the same powers, preferences and rights
described above as the Class A Common Stock, except that the Class B Common
Stock is convertible into Class A Common Stock, has no voting rights (except
as required by Delaware law) and has no right to vote for the election of
directors.
The shares of Class B Common Stock will, upon any transfer of such shares by
MSCP, be automatically converted into a like number of shares of Common Stock,
subject to adjustment upon certain events with respect to the Common Stock.
The shares of Class B Common Stock are convertible at the option of MSCP into
Common Stock or Class A Common Stock so long as such conversion results in
MSCP holding 40% or less of the Company's outstanding voting securities.
62
<PAGE>
CATALYTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Common Stock Reserved for Future Issuance
Shares of Common Stock of the Company reserved for future issuance at
December 31, 1997 are as follow:
<TABLE>
<CAPTION>
1997
--------------
(IN THOUSANDS)
<S> <C>
Employee Stock Purchase Plan.................................. 1,582,127
Stock Options................................................. 2,886,934
Series B Preferred Stock (*).................................. 1,500,000
Junior Preferred Stock (*).................................... 250,000
Warrants...................................................... 2,000,000
---------
8,219,061
=========
</TABLE>
- --------
(*) Under terms of Shareholder Agreements with Pfizer and Glaxo Wellcome,
stock held by these companies in Catalytica Pharmaceuticals is convertible
into Catalytica common stock if certain terms and conditions are met.
Preferred Stock
The Company has 5,000,000 shares of Preferred Stock authorized, all of which
are unissued and undesignated. The Board of Directors of the Company has the
authority, without further vote or action by the stockholders, to issue these
undesignated shares of Preferred Stock in one or more series and to fix the
rights, qualifications, preferences, privileges, limitations, and restrictions
of each such series, including dividend rights, terms or redemption,
redemption prices, liquidation preferences, and the number of shares
constituting any series or the designation of such series.
Warrant Dividend
The Company distributed, at no cost, to each holder of Common Stock of
record as of August 22, 1997, one Warrant for each three shares of Common
Stock held by the shareholder. The warrants entitled each holder to purchase
Common Stock at $4.00 per share. The total number of warrants issued was
6,947,275. Of the warrants issued to shareholders, 6,922,996 shares were
exercised, and warrants for 24,279 shares expired on October 31, 1997.
The exercise of 6,922,996 warrants generated gross proceeds of $27,691,984.
The Company used $23,750,000 of the proceeds to repurchase an aggregate of
5,000,000 shares of its Class B Common Stock issued to MSCP on July 31, 1997.
The repurchase price was $4.75 per share, as such repurchase was consummated
prior to November 30, 1997. The premium paid in connection with the repurchase
is reflected in the Company's earnings per share calculation for the period
ended December 31, 1997 as a reduction of earnings available to common
shareholders. Accordingly, the Company's earnings per share for the year
ending December 31, 1997 were reduced by $.10 due to this repurchase.
Warrants
In connection with the Acquisition of the Glaxo Wellcome facility, the
Company issued warrants to Glaxo Wellcome to purchase 2,000,000 shares of the
Company's Common Stock at an exercise price of $12.00 per share. This warrant
expires on July 31, 2003. The value of the warrants has been recorded in
additional paid-in capital as of December 31, 1997.
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. During the year ended December 31, 1997, a total of 319,822
warrants were exercised for 208,153 shares of common stock.
63
<PAGE>
CATALYTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Catalytica Deferred Compensation
The Company granted to an officer options to purchase 100,000 shares of
Common Stock at an exercise price of $5.00 per share in 1997, for which the
Company recorded deferred compensation amounting to $500,000. The deferred
compensation is being amortized to expense ratably over the vesting period of
the option, four years.
Stockholders Rights Plan
On October 28, 1996 the Board of Directors adopted a Stockholders Rights
Plan providing a dividend of rights (which cannot be exercised until certain
events occur) to purchase shares of preferred stock of the Company. Each
shareholder of record receives one right for each share of common stock then
owned. This plan was adopted to ensure that all stockholders of the Company
receive fair value for their common stock in the event of any proposed
takeover of the Company and to guard against coercive tactics to gain control
of the Company without offering fair value to the Company's stockholders.
Stock Option and Stock Purchase Plans
The Company has elected to follow Accounting Principles Board No. 25,
"Accounting for Stock Issued to Employees" (APB 25) and related
Interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-
Based Compensation" (SFAS 123), requires the use of option valuation models
that were not developed for use in valuing employee stock options. Under APB
25, because the exercise price of the Company's stock options generally equals
the market price of the underlying stock on the date of grant, no compensation
expense is recognized.
Pro forma information regarding net income and earnings per share is
required by FAS 123 which also requires that the information be determined as
if the Company has accounted for its employee stock awards and those of its
subsidiaries granted subsequent to December 31, 1994, under the fair value
method of this Statement. The fair value for these options was estimated at
the date of grant using a Black-Scholes multiple option pricing model with the
following weighted average assumptions:
<TABLE>
<CAPTION>
WEIGHTED
RISK FREE DIVIDEND VOLATILITY AVERAGE
INTEREST RATE YIELD FACTOR EXPECTED LIFE
-------------- -------- ------------- --------------
1997 1996 1995 1995-97 1997 1995-96 1997 1996 1995
---- ---- ---- -------- ----- ------- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Catalytica, Inc. Stock
Option Plans........... 6.15 6.42 6.03 0.0 .9089 .8852 3.6 3.5 3.0
Catalytica Stock Pur-
chase Plan............. 6.15 6.42 6.03 0.0 .9089 .8852 1.2 1.7 1.4
Catalytica Advanced
Technologies........... 5.95 6.67 6.47 0.0 .9089 .8852 7.0 7.0 8.0
Catalytica Combustion
Systems................ 6.01 6.57 6.26 0.0 .9089 .8852 5.0 5.0 6.0
Catalytica Pharmaceuti-
cals................... 6.05 6.39 6.11 0.0 .9089 .8852 3.5 3.5 4.1
</TABLE>
<TABLE>
<CAPTION>
COMPENSATION
EXPENSE
----------------
1997 1996 1995
------ ---- ----
<S> <C> <C> <C>
Catalytica, Inc. Stock Option Plans........................ $1,990 $470 $295
Catalytica Stock Purchase Plan............................. 1,439 74 180
Catalytica Advanced Technologies........................... 12 25 22
Catalytica Combustion Systems.............................. 85 66 49
Catalytica Pharmaceuticals................................. 1,000 44 36
------ ---- ----
$4,526 $679 $582
====== ==== ====
</TABLE>
64
<PAGE>
CATALYTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
Had compensation cost for the Company's stock-based compensation plans been
determined based on the fair value at the grant dates for awards under those
plans consistent with the method of FAS 123, the Company's net loss and loss
per share would have been increased to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Loss attributable to common shareholders......... $(3,440) $(5,192) $(8,687)
Compensation expense............................. $(4,526) $ (679) $ (582)
Pro forma net loss............................... $(7,966) $(5,871) $(9,269)
Pro forma loss per share......................... $ (0.24) $ (0.30) $ (0.59)
</TABLE>
Compensation expense resulting from the stock option and purchase plans
increased in fiscal 1997 significantly over prior years due to the impact of
initial option grants for the new Greenville employees and their participation
in the employee stock purchase plan.
Since compensation expense is recognized over the vesting period of the
related options, which are generally five years for Catalytica options and
four years for subsidiary options, and because pro forma disclosure is only
required commencing with 1995, the initial impact on pro forma income may not
be representative of compensation expense in future years.
CATALYTICA INC.
1995 CATALYTICA DIRECTOR STOCK OPTION PLAN In 1995, the Company adopted the
1995 Director Option Plan under which 200,000 shares have been reserved for
future issuance. Under the 1995 Director Option Plan, the Board of Directors
is authorized to grant nonqualified stock options to Outside Directors to
provide incentive to continue service on the Board. The nonqualified stock
options may be granted at a price of not less than 100% of the fair market
value of Common Stock on the date of grant. Options generally become
exercisable ratably over three years from the date of grant and expire no
later than ten years from the date of grant.
1992 CATALYTICA STOCK OPTION PLAN In 1992, the Company adopted the 1992
Stock Option Plan under which 3,050,000 shares have been reserved for future
issuance. Under the 1992 Stock Option Plan, the Board of Directors is
authorized to grant incentive stock options, or nonqualified stock options to
eligible employees and consultants, although incentive stock options may be
granted only to employees. Incentive stock options may be granted at an
exercise price of not less than 100% of the fair market value of Common Stock
on the date of grant while nonqualified stock options may be granted at a
price not less than 50% of the value of the Common Stock. Options generally
become exercisable ratably over five years from the date of grant and expire
no later than ten years from the date of grant.
1985 CATALYTICA NON-QUALIFIED STOCK OPTION PLAN Since 1985, the Company has
granted to certain directors, officers, and consultants 438,800 nonqualified
stock options at an average price of $0.54 per share. As of December 31, 1997,
427,600 shares had been exercised, and 9,200 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.
65
<PAGE>
CATALYTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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 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,
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
Authorized............ 1,200,000 -- -- --
Granted at Fair
Value................ (1,218,420) 1,218,420 $10.48 12,764,792
Granted Below Fair
Value................ (100,000) 100,000 $ 5.00 500,000
Exercised............. -- (1,060,660) $ 1.87 (1,979,072)
Canceled.............. 29,044 (29,044) $ 7.40 (214,797)
Expired............... (3,200) -- -- --
---------- ---------- ------ ------------
Balance at December 31,
1997................... 1,008,565 1,878,369 $ 8.12 $ 15,250,210
</TABLE>
The weighted average fair value of options granted at fair value during 1997
is $6.68 as calculated in accordance with FASB 123. The weighted average fair
value of options granted below fair value during 1997 is $7.19.
66
<PAGE>
CATALYTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
A summary of the Company's stock option activity and related information for
the year ended December 31, 1997 is as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------- ------------------------
NUMBER WEIGHTED NUMBER WEIGHTED
OUTSTANDING AVERAGE WEIGHTED EXERCISABLE AS AVERAGE
RANGE OF DECEMBER 31, REMAINING AVERAGE OF DECEMBER 31, EXERCISE
EXRCISE PRICESE 1997 CONTRACTUAL LIFE EXERCISE PRICE 1997 PRICE
- --------------- ------------ ---------------- -------------- --------------- --------
<S> <C> <C> <C> <C> <C>
$ 0.60-$ 0.90........... 19,000 2.32 $ 0.79 19,000 $0.79
$ 1.80-$ 1.80........... 14,310 4.28 $ 1.80 14,310 $1.80
$ 3.25-$ 3.88........... 473,952 8.03 $ 3.58 56,422 $3.67
$ 3.94-$ 5.38........... 126,823 9.28 $ 4.93 25,391 $4.84
$ 5.75-$ 6.50........... 56,164 5.92 $ 6.19 19,306 $6.11
$ 7.63-$ 9.25........... 55,000 9.29 $ 8.19 9,111 $8.18
$10.50-$13.88........... 1,133,120 9.66 $10.67 0 $0.00
--------- ---- ------ ------- -----
$ 0.60-$13.88........... 1,878,369 8.99 $ 8.12 143,540 $3.92
</TABLE>
1992 Catalytica Employee Stock Purchase Plan
In 1992, the Company adopted the 1992 Employee Stock Purchase Plan ("ESPP")
under which 2,000,000 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 2,000,000 shares authorized to
be issued under this plan, 1,582,127 are available for issuance at December
31, 1997. For the year ended December 31, 1997, employees purchased 201,390
shares for $1,365,200. For the year ended December 31, 1996, employees
purchased 82,757 shares for $214,600. For the year ended December 31, 1995,
employees purchased 70,370 shares for $181,000. The weighted average fair
value of those purchase rights granted in 1997 was $5.75.
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.
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 919,624 shares have been reserved for future issuance. Under the
1995 Catalytica Advanced Technologies Stock Option Plan, the Catalytica
Advanced Technologies Board of Directors is authorized to grant incentive
stock options, or nonqualified stock options to eligible employees and
consultants, although incentive stock options may be granted only to
employees. The incentive stock options generally vest ratably over four years
from the date of grant and expire no later than ten years from the date of
grant. Nonqualified stock options offered to directors vest ratably over three
years from the date of grant and expire no later than ten years from the date
of grant. These options become exercisable upon an initial public offering of
the subsidiary's stock, acquisition of more than 50% of the subsidiary's
outstanding securities by a third party, or upon reaching the date January 1,
2004.
67
<PAGE>
CATALYTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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 $0.10 $75,650
Exercised............... -- -- -- --
Canceled................ -- -- -- --
Expired................. -- -- -- --
-------- ------- ----- -------
Balance at December 31,
1995..................... 43,500 756,500 $0.10 $75,650
Authorized.............. 100,000 -- -- --
Granted................. (80,000) 80,000 $0.10 8,000
Exercised............... -- -- -- --
Canceled................ 8,000 (8,000) $0.10 (800)
Expired................. -- -- -- --
-------- ------- ----- -------
Balance at December 31,
1996..................... 71,500 828,500 $0.10 $82,850
Authorized.............. 19,624 -- -- --
Granted................. (172,000) 172,000 $0.10 17,200
Exercised............... -- -- -- --
Canceled................ 80,876 (80,876) $0.10 (8,088)
Expired................. -- -- -- --
-------- ------- ----- -------
Balance at December 31,
1997..................... -- 919,624 $0.10 $91,962
======== ======= ===== =======
</TABLE>
At December 31, 1997, options outstanding had a weighted average remaining
contractual life of 8.08 years and options to purchase approximately 541,757
shares of Catalytica Advanced Technologies common stock were vested with a
weighted average exercise price of $.10/share.
CATALYTICA COMBUSTION SYSTEMS, INC.
1995 CATALYTICA COMBUSTION SYSTEMS STOCK OPTION PLAN In 1995, The Company
adopted the 1995 Catalytica Combustion Systems Stock Option Plan under which
862,125 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
offered to directors vest ratably over three years from the date of grant and
expire no later than ten years from the date of grant. These options become
exercisable upon an initial public offering of the subsidiary's stock,
acquisition of more than 50% of the subsidiary's outstanding securities by a
third party, or upon reaching the date January 1, 2004.
68
<PAGE>
CATALYTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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 $0.40 $199,240
Exercised.................. -- -- -- --
Canceled................... -- -- -- --
Expired.................... -- -- -- --
-------- ------- ----- --------
Balance at December 31,
1995........................ 251,900 498,100 $0.40 $199,240
Granted.................... (242,900) 242,900 $0.40 97,160
Exercised.................. -- -- -- --
Canceled................... 72,292 (72,292) $0.40 (28,917)
Expired.................... -- -- -- --
-------- ------- ----- --------
Balance at December 31,
1996........................ 81,292 668,708 $0.40 $267,483
Authorized................. 112,125 -- -- --
Granted.................... (170,500) 170,500 $2.04 348,550
Exercised.................. -- -- -- --
Canceled................... 4,750 (4,750) $0.40 (1,900)
Expired.................... -- -- -- --
-------- ------- ----- --------
Balance at December 31,
1997........................ 27,667 834,458 $0.74 $614,133
-------- ------- ----- --------
</TABLE>
The weighted average fair value of options granted during 1997 was $0.08 as
calculated in accordance with FASB 123.
A summary of Catalytica Combustion Systems' stock option activity for the
year ended December 31, 1997 is as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------- ------------------------
WEIGHTED NUMBER WEIGHTED
NUMBER AVERAGE WEIGHTED EXERCISABLE AS AVERAGE
RANGE OF OUTSTANDING REMAINING AVERAGE OF DECEMBER 31, EXERCISE
EXERCISE PRICES DECEMBER 31, 1997 CONTRACTUAL LIFE EXERCISE PRICE 1997 PRICE
--------------- ----------------- ---------------- -------------- --------------- --------
<S> <C> <C> <C> <C> <C>
$0.40-$0.40............. 700,958 8.03 $0.40 416,908 $0.40
$2.50-$2.50............. 133,500 9.75 $2.50 0 $0.00
------- ---- ----- ------- -----
$0.40-$2.50............. 834,458 8.30 $0.74 416,908 $0.40
</TABLE>
CATALYTICA PHARMACEUTICALS, INC.
1995 PHARMACEUTICALS STOCK OPTION PLAN In 1995, The Company adopted the 1995
Pharmaceuticals Stock Option Plan under which 1,947,025 shares have been
reserved for future issuance. Under the 1995 Pharmaceuticals Stock Option
Plan, the Catalytica Pharmaceuticals Board of Directors is authorized to grant
incentive stock options, or nonqualified stock options to eligible employees
and consultants, although incentive stock options may be granted only to
employees. The incentive stock options generally vest ratably over four years
from the date of grant and expire no later than ten years from the date of
grant. Nonqualified stock options
69
<PAGE>
CATALYTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
offered to directors vest ratably over three years from the date of grant and
expire no later than ten years from the date of grant. These options become
exercisable upon an initial public offering of the subsidiary's stock,
acquisition of more than 50% of the subsidiary's outstanding securities by a
third party, or upon reaching the date January 1, 2004.
The following table summarizes stock option plan activity for the 1995
Catalytica Pharmaceuticals Stock Option Plan:
<TABLE>
<CAPTION>
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 $0.40 $ 150,840
Exercised............. -- -- -- --
Canceled.............. -- -- -- --
Expired............... -- -- -- --
---------- --------- ----- ----------
Balance at December 31,
1995................... 900 377,100 $0.40 $ 150,840
Authorized............ 100,000 -- -- --
Granted............... (121,900) 121,900 $0.66 80,830
Exercised............. -- -- -- --
Canceled.............. 23,000 (23,000) $0.40 (9,200)
Expired............... -- -- -- --
---------- --------- ----- ----------
Balance at December 31,
1996................... 2,000 476,000 $0.47 $ 222,470
Authorized............ 1,469,025 -- -- --
Granted............... (1,503,400) 1,503,400 $4.93 7,411,580
Exercised............. -- -- -- --
Canceled.............. 32,375 (32,375) $5.13 (166,213)
Expired............... -- -- -- --
---------- --------- ----- ----------
Balance at December 31,
1997................... -- 1,947,025 $3.84 7,467,837
========== ========= ===== ==========
</TABLE>
The weighted average fair value of options granted during 1997 was $3.06 as
calculated in accordance with FASB 123.
A summary of Catalytica Pharmaceuticals' stock option activity and related
information for the year ended December 31, 1997 is as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------- ------------------------
WEIGHTED NUMBER WEIGHTED
NUMBER AVERAGE WEIGHTED EXERCISABLE AS AVERAGE
RANGE OF OUTSTANDING REMAINING AVERAGE OF DECEMBER 31, EXERCISE
EXERCISE PRICES DECEMBER 31, 1997 CONTRACTUAL LIFE EXERCISE PRICE 1997 PRICE
--------------- ----------------- ---------------- -------------- --------------- --------
<S> <C> <C> <C> <C> <C>
$0.40-$0.40............. 367,600 7.48 $0.40 276,458 $0.40
$0.70-$0.70............. 110,425 8.54 $0.70 42,822 $0.70
$1.50-$1.50............. 209,000 9.34 $1.50 56,667 $1.50
$5.50-$5.50............. 1,260,000 9.64 $5.50 0 $0.00
--------- ---- ----- ------- -----
$0.40-$5.50............. 1,947,025 9.14 $3.84 375,947 $0.60
</TABLE>
70
<PAGE>
CATALYTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 11. SUBSEQUENT EVENTS
On January 14, 1998, Enron Ventures Corporation, a wholly-owned subsidiary
of Enron Corporation (Enron), purchased a 15% minority interest in Combustion
Systems for $30 million in cash. In addition, Enron also received a three-year
option to purchase an additional 5% of Combustion Systems for $14.4 million in
cash. In conjunction with the Stock Purchase agreement, the Company entered
into a Share Exchange agreement, providing Enron the right to exchange the
Series B preferred stock of Combustion Systems for Catalytica, Inc. common
stock. After the five year anniversary of the agreement, if Combustion Systems
has not undertaken a public offering, in which Combustion Systems receives at
least $20 million, Enron shall have the right to require the Company to
exchange all of the outstanding shares of Series B preferred stock for that
number of shares of common stock based upon a determined exchange rate. The
exchange rate is based upon the fair value of the preferred stock and the
market value of Catalytica's common stock at the time of conversion.
On February 2, 1998, the Company made an early payment of $20 million on the
Chase Term Debt Facility which left an outstanding balance of $105 million
under this debt facility. This early payment reduces the remaining amount owed
in 1998 to $30 million.
71
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Managers and Members
GENXON Power Systems, L.L.C.:
We have audited the accompanying balance sheet of GENXON Power Systems,
L.L.C. ("the Company"), a Delaware limited liability company, as of September
30, 1997, and the related statements of operations, members' capital and cash
flows for the period from October 21, 1996 (date of inception) to September
30, 1997. 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 audit.
We conducted our audit 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 audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of GENXON Power Systems,
L.L.C. as of September 30, 1997, and the results of its operations and its
cash flows for the period from October 21, 1996 (date of inception) to
September 30, 1997 in conformity with generally accepted accounting
principles.
The accompanying financial statements have been prepared assuming the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company has suffered losses from operations and has
a net capital deficiency that raise substantial doubt about its ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note 2. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
San Jose, California
October 17, 1997
72
<PAGE>
GENXON POWER SYSTEMS, L.L.C.
(A DELAWARE LIMITED LIABILITY COMPANY)
BALANCE SHEET, SEPTEMBER 30, 1997
<TABLE>
<S> <C>
ASSETS
Current assets:
Cash and cash equivalents........................................ $ 54,366
Inventory........................................................ 233,977
Prepaid expenses................................................. 358,482
-----------
Total current assets........................................... 646,825
Property and equipment............................................. 557,362
-----------
Total assets................................................. $ 1,204,187
===========
LIABILITIES AND MEMBERS' CAPITAL
Current liabilities:
Payable to Woodward Governor Company............................. $ 89,483
Payable to Catalytica Combustion Systems, Inc. .................. 315,580
Accounts payable................................................. 1,852,014
Accrued liabilities.............................................. 433,261
-----------
Total current liabilities...................................... 2,690,338
Commitments and contingencies (Note 3)
Members' capital................................................... (1,486,151)
Total liabilities and members' capital....................... $ 1,204,187
===========
</TABLE>
The accompanying notes are an integral part of these statements.
73
<PAGE>
GENXON POWER SYSTEMS, L.L.C.
(A DELAWARE LIMITED LIABILITY COMPANY)
STATEMENT OF OPERATIONS
FOR THE PERIOD FROM OCTOBER 21, 1996
(DATE OF INCEPTION) TO SEPTEMBER 30, 1997
<TABLE>
<S> <C>
Revenues:
Research contract.............................................. $ 268,000
------------
Operating expenses:
Research and development....................................... 8,656,442
Selling, general and administrative expenses................... 2,147,797
------------
10,804,239
------------
Loss from operations......................................... (10,536,239)
Other income (expense):
Interest income, net........................................... 50,088
------------
Net loss..................................................... $(10,486,151)
============
</TABLE>
The accompanying notes are an integral part of these statements.
74
<PAGE>
GENXON POWER SYSTEMS, L.L.C.
(A DELAWARE LIMITED LIABILITY COMPANY)
STATEMENT OF MEMBERS' CAPITAL
FOR THE PERIOD FROM OCTOBER 21, 1996
(DATE OF INCEPTION) TO SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
WOODWARD CATALYTICA
GOVERNOR COMBUSTION
COMPANY SYSTEMS, INC. TOTAL
----------- ------------- ------------
<S> <C> <C> <C>
Capital contributions................ $ 7,100,000 $ 1,900,000 $ 9,000,000
Net loss............................. (8,243,076) (2,243,075) (10,486,151)
Members' capital, September 30,
1997................................ $(1,143,076) $ (343,075) $ (1,486,151)
=========== =========== ============
</TABLE>
The accompanying notes are an integral part of these statements.
75
<PAGE>
GENXON POWER SYSTEMS, L.L.C.
(A DELAWARE LIMITED LIABILITY COMPANY)
STATEMENT OF CASH FLOWS
FOR THE PERIOD FROM OCTOBER 21, 1996
(DATE OF INCEPTION) TO SEPTEMBER 30, 1997
<TABLE>
<S> <C>
Cash flows from operating activities:
Net loss........................................................ $(10,486,151)
Adjustments to reconcile net loss to net cash used in operating
activities:
Changes in assets and liabilities:
Inventory..................................................... (233,977)
Prepaid expenses.............................................. (358,482)
Payable to members............................................ 405,063
Accounts payable.............................................. 1,852,014
Accrued liabilities........................................... 433,261
------------
Net cash used in operating activities........................ (8,388,272)
------------
Cash flows from investing activities:
Acquisition of property and equipment........................... (557,362)
------------
Cash flows from financing activities:
Members' capital contributions.................................. 9,000,000
------------
Net increase in cash and cash equivalents........................ 54,366
Cash and cash equivalents, beginning of period................... --
------------
Cash and cash equivalents, end of period......................... $ 54,366
============
</TABLE>
The accompanying notes are an integral part of these statements.
76
<PAGE>
GENXON POWER SYSTEMS, L.L.C.
(A DELAWARE LIMITED LIABILITY COMPANY)
NOTES TO FINANCIAL STATEMENTS
1. FORMATION AND BUSINESS OF THE COMPANY:
GENXON Power Systems, L.L.C. (the Company), a Delaware limited liability
company, was formed on October 21, 1996 to develop and sell products and
services to a wide range of users of out-of-warranty gas turbines which
require reductions in emissions, overhaul or upgrade. Except as provided for
in the Limited Liability Operating Agreement, the existence of the Company
will be perpetual.
Investor members in GENXON Power Systems, L.L.C. received a percentage
interest in the Company based on the amount of cash and the agreed-upon fair
value of certain technology licenses contributed to the Company. There were
two initial investor members, each receiving a 50 percent interest in the
Company. Their initial capital commitments were as follows:
<TABLE>
<CAPTION>
CASH TECHNOLOGY
COMMITMENT LICENSES TOTAL
---------- ---------- -----------
<S> <C> <C> <C>
Catalytica Combustion Systems, Inc.
(Catalytica)........................... $2,000,000 $8,000,000 $10,000,000
Woodward Governor Company (Woodward).... $8,000,000 $2,000,000 $10,000,000
</TABLE>
At September 30, 1997, each member had contributed its agreed-upon
technology licenses and cash in the total amount of $9 million. Subsequent to
year-end, the members contributed the balance of their initial cash commitment
and an additional $1,200,000 in cash. Additional future cash contributions
will be at the discretion of each of the members, but will generally be in
proportion to their respective percentage interests in the Company and will be
governed by the terms of the Operating Agreement. For financial statement
purposes only, the fair value of the technology licenses has not been
recorded.
The Operating Agreement generally provides that profits and losses in any
fiscal year, or other applicable period, shall be allocated to each member in
proportion to their respective percentage interest. In the event that a
member's cumulative capital account, including the fair value of the
technology licenses contributed, is reduced to zero, losses will be
reallocated to members having positive capital account balances until all
members' capital accounts have been reduced to zero. Thereafter, losses will
again be allocated to the members based on their respective percentage
interests. Such "reallocated" losses shall first be restored by an allocation
of profits before any additional profits are allocated to the members. Under
the terms of the Operating Agreement, the Company is required to make cash
distributions to each member in the amount of the estimated tax liability for
the net taxable income and gains allocated to such member during the fiscal
year. Any additional distributions of cash or property will be at the
discretion of the Board of Managers as provided for in the Operating
Agreement. At September 30, 1997, cumulative capital account balances
determined in accordance with the Operating Agreement are as follows:
<TABLE>
<CAPTION>
CATALYTICA WOODWARD TOTAL
----------- ----------- ------------
<S> <C> <C> <C>
Cash contributed..................... $ 1,900,000 $ 7,100,000 $ 9,000,000
Technology licenses contributed...... 8,000,000 2,000,000 10,000,000
Allocation of net loss............... (5,243,075) (5,243,076) (10,486,151)
----------- ----------- ------------
Capital account balances............. $ 4,656,925 $ 3,856,924 $ 8,513,849
=========== =========== ============
</TABLE>
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Basis of Presentation:
The Company's financial statements have been prepared on a basis of
accounting assuming that it is a going concern, which contemplates realization
of assets and satisfaction of liabilities in the normal course of business.
77
<PAGE>
GENXON POWER SYSTEMS, L.L.C.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
The Company has reported a net loss for the period from October 21, 1996 (date
of inception) to September 30, 1997 in the amount of $10,486,151. Management
plans to obtain additional capital contributions from its members or other
additional investors to meet its current and ongoing obligations. Continued
existence of the Company is dependent on the Company's ability to ensure the
availability of adequate funding and the establishment of profitable
operations. The financial statements do not include adjustments that might
result from the outcome of this uncertainty.
Use of Estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents:
The Company considers all highly liquid investments purchased with original
or remaining maturities of three months or less at the date of purchase to be
cash equivalents. Substantially all of the Company's excess cash is invested
in money market accounts with a major investment company.
Fair Value of Financial Instruments:
Carrying amounts of certain of the Company's financial instruments,
including cash and cash equivalents, accounts payable and other accrued
liabilities approximate fair value due to their short maturities.
Inventory:
Inventory, consisting of purchased and manufactured parts to be used in the
overhaul and upgrade of gas turbine engines, is stated at the lower of cost or
market.
Property and Equipment:
Property and equipment are stated at cost and will be depreciated using the
straight-line method over their estimated useful lives, generally 3 to 10
years. Gains and losses from the disposal of property and equipment will be
taken into income in the year of disposition. At September 30, 1997, property
and equipment consists solely of tooling costs incurred in the construction of
the Company's manufacturing equipment. As this equipment has not yet been
completed or placed in service, no depreciation costs have been recorded.
Income Taxes:
The financial statements include no provision for income taxes since the
Company's income and losses are reported in the members' separate tax returns.
Recent Accounting Pronouncements:
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 (SFAS 130), Reporting Comprehensive
Income. This statement establishes requirements for disclosure of
comprehensive income and becomes effective for the Company for its fiscal year
1999, with reclassification of earlier financial statements for comparative
purposes. Comprehensive income generally represents all changes in members'
capital except those resulting from investments or contributions by members.
The Company is evaluating alternative formats for presenting this information,
but does not expect this pronouncement to materially impact the Company's
results of operations.
78
<PAGE>
GENXON POWER SYSTEMS, L.L.C.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
In June 1997, The Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131 (SFAS 131), Disclosures about Segments
of an Enterprise and Related Information. This statement establishes standards
for disclosure about operating segments in annual financial statements and
selected information in interim financial reports. It also establishes
standards for related disclosures about products and services, geographic
areas and major customers. This statement supersedes Statement of Financial
Accounting Standards No. 14, Financial Reporting for Segments of a Business
Enterprise. The new standard becomes effective for the Company's fiscal year
1999, and requires that comparative information from earlier years be restated
to conform to the requirements of this standard. The Company is evaluating the
requirements of SFAS 131 and the effects, if any, on the Company's current
reporting and disclosures.
3. COMMITMENTS AND CONTINGENCIES
The Company entered into an exclusive agreement with Agilis Group, Inc.
(Agilis) to provide assistance and advice in the development and design of the
combustor and combustor related hardware for the Company's proprietary
catalytic combustion technology. Under the terms of the agreement, Agilis has
responsibility as to the details, methods, and means of performing its
services. Subject to the Company's approval and on its behalf, Agilis may
enter into purchase commitments and contracts with outside vendors to provide
materials and services to complete the projects. At September 30, 1997, the
Company has approximately $2.3 million in open purchase commitments through
Agilis. The agreement will expire on the later of the completion of all
services described in the agreement or December 31, 1999, unless extended in
writing and agreed to by both parties.
The Company has entered into a technical services agreement with the City of
Glendale, California to retrofit an FT4 gas turbine engine which was provided
by the City. Under the terms of the agreement, the retrofit will include
adding the Company's proprietary combustion system and a digital control
system for a total turnkey price of $700,000, and must be completed by
December 1998. In the event that the Company is unable to complete the agreed
upon retrofit on time or damages the engine in the process, the agreement
requires the Company to return the engine to its original state or replace it
with a similar engine, for which the Company has recorded a reserve of
$134,000.
4. RELATED PARTY TRANSACTIONS:
The Company has entered into a services agreement with Catalytica and
Woodward to provide the Company with management support, technical services
support and administrative services. For the period from October 21, 1996
(date of inception) through September 30, 1997, the Company incurred general
and administrative support costs from Catalytica in the amount of $1,355,308
and research and development costs totaling $3,450,077. For the same period,
the Company incurred $65,192 of general and administrative support costs from
Woodward and $513,487 for research and development services.
The Company has also entered into supply agreements with both Catalytica and
Woodward to supply combustion system products and control system products to
be used by the Company in its business of retrofitting installed and operating
gas turbine engines.
79
<PAGE>
CATALYTICA, INC.
SELECTED QUARTERLY FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER
---------------- ---------------- --------------- ----------------
1997 1996 1997 1996 1997 1996 1997(2) 1996
------- ------- ------- ------- ------- ------- -------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Product Sales........... $ 3,059 $ 2,017 $ 6,262 $ 2,685 $66,699 $ 1,922 $ 98,327 $3,189
Research and Development
Revenues............... 1,726 1,323 1,500 1,424 1,606 1,693 1,767 2,061
Total Revenues........ 4,785 3,340 7,762 4,109 68,305 3,615 100,094 5,250
Total Expenses........ 6,263 5,827 9,254 6,619 64,832 4,870 91,601 5,916
Gross Profit.......... (1,478) (2,487) (1,492) (2,510) 3,473 (1,255) 8,493 (666)
Income (loss) before
common stock
redemption........... (2,325) (2,370) (1,828) (1,810) 743 (972) 3,720 (40)
Net income (loss)
attributable to
common shareholders.. $(2,325) $(2,370) $(1,828) $(1,810) $ 743 $ (972) $ (30) $ (40)
Basic and diluted
earnings (loss) per
share(1)(2).......... $ (.12) $ (.12) $ (.09) $ (.09) $ .02 $ (.05) $ .00 $ .00
</TABLE>
- --------
(1) Earnings per share ("EPS") amounts have been restated to reflect the
adoption of Statement of Financial Accounting Standards No. 128, "Earnings
per Share," which replaces the presentation of primary EPS and fully
diluted EPS with a presentation of basic EPS and diluted EPS,
respectively.
(2) Net income (loss) per share reflects a reduction in net income of
$3,750,000 relating to the premium paid for the repurchase of five million
shares of Series B common stock with proceeds received from the exercise
of warrants issued to shareholders as a dividend.
80
<PAGE>
CATALYTICA, INC.
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONS DEDUCTIONS
BALANCE AT CHARGED TO FROM BAD BALANCE
BEGINNING BAD DEBT DEBT AT END
OF PERIOD RESERVES RESERVES OF PERIOD
---------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
ALLOWANCE FOR DOUBTFUL ACCOUNTS:
Fiscal year ended December 31,
1995........................... $100,000 -- -- $100,000
Fiscal year ended December 31,
1996........................... $100,000 -- -- $100,000
Fiscal year ended December 31,
1997........................... $100,000 $500,000 -- $600,000
</TABLE>
81
<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 30, 1998
/s/ Ricardo B. Levy
By: _________________________________
Ricardo B. Levy
President and Chief Executive
Officer
82
<PAGE>
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Ricardo B. Levy, his attorney-in-fact, for him
in any and all capacities, to sign any amendments to this Report on Form 10-K,
and to file the same, with exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, hereby ratifying and
confirming all that said attorney-in-fact, or his substitute, may do or cause
to be done by virtue hereof.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT IN THE CAPACITIES AND ON THE DATE INDICATED.
SIGNATURE TITLE DATE
/s/ Ricardo B. Levy President, Chief March 30, 1998
- ------------------------------------ Executive Officer
RICARDO B. LEVY (Principal
Executive
Officer), and
Director
/s/ James A. Cusumano Chairman of the March 30, 1998
- ------------------------------------ Board and Chief
JAMES A. CUSUMANO Technical Officer
/s/ Lawrence W. Briscoe Vice President, March 30, 1998
- ------------------------------------ Finance and
LAWRENCE W. BRISCOE Administration,
and Chief
Financial Officer
(Principal
Accounting and
Financial Officer)
/s/ Utz Felcht Director March 30, 1998
- ------------------------------------
UTZ FELCHT
/s/ Richard Fleming Director March 30, 1998
- ------------------------------------
RICHARD FLEMING
/s/ Alan Goldberg Director March 30, 1998
- ------------------------------------
ALAN GOLDBERG
/s/ Howard Hoffen Director March 30, 1998
- ------------------------------------
HOWARD HOFFEN
/s/ Ernest Mario Director March 30, 1998
- ------------------------------------
ERNEST MARIO
/s/ Yoshindo Tomoi Director March 30, 1998
- ------------------------------------
YOSHINDO TOMOI
/s/ John A. Urquhart Director March 30, 1998
- ------------------------------------
JOHN A. URQUHART
83
<PAGE>
EXHIBIT 10.27
AMENDMENT NO. 1 TO THE
OPERATING AGREEMENT OF
GENXON POWER SYSTEMS, LLC,
A DELAWARE LIMITED LIABILITY COMPANY
THIS AMENDMENT NO. 1 (this "Amendment") to the Operating Agreement of
Genxon Power Systems, LLC, a Delaware Limited Liability Company, entered into
and effective as of October 21, 1996 (the "Operating Agreement"), is entered
into and effective as of December 4, 1997.
Capitalized terms not otherwise defined herein have the same meaning as in
the Operating Agreement.
RECITALS
WHEREAS, the undersigned are all of the constituent Members of Genxon Power
Systems, LLC, a Delaware limited liability company (the "Company"); and
WHEREAS, Section 6.2 of the Operating Agreement provides in relevant part
that until the first anniversary of the Operating Agreement the Board of
Managers shall be comprised of six members and thereafter the Board of Managers
shall be comprised of four members; and
WHEREAS, the Members desire that the Board of Managers be comprised of six
members for an additional year.
NOW, THEREFORE, in consideration of the mutual covenants contained herein
and in accordance with Section 10.3 of the Operating Agreement, the Members do
hereby amend and revise the Operating Agreement as follows.
1. Section 6.2(a) of the Operating Agreement is hereby amended in its
entirety to read as follows:
"(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 be comprised of six members, three
of whom shall be the nominees of CCSI and three of whom shall be the
nominees of WGC. One member of the Board
<PAGE>
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."
2. Miscellaneous.
-------------
(a) Except as specifically amended hereby, the Operating Agreement
shall continue in full force and effect.
(b) This Amendment shall not itself be amended. Any future amendment
to the Operating Agreement shall be effected in accordance with the terms
thereof.
(c) This Amendment may be executed in several counterparts, each of
which may be executed by fewer than all of the Members, and as so executed shall
constitute one Amendment which shall be binding on all the Members.
[Remainder of Page Intentionally Left Blank]
2
<PAGE>
IN WITNESS WHEREOF, the Members have executed this Amendment as of the date
first written above.
CATALYTICA COMBUSTION SYSTEMS, INC.
By: /s/ Dennis Orwig
---------------------
Dennis Orwig, President
WOODWARD GOVERNOR COMPANY
By: /s/ John Halbrook
----------------------
John Halbrook, Chief Executive Officer
[Amendment No. 1 to Genxon Operating Agreement]
<PAGE>
EXHIBIT 10.32
CONFORMED COPY
AMENDMENT NO. 1 AND CONSENT dated as of January 6, 1998
(this "Amendment"), to the Credit Agreement dated as of July 31,
1997 (the "Credit Agreement"), among Catalytica, Inc., a Delaware
corporation ("Catalytica"); Catalytica Pharmaceuticals, Inc., a
Delaware corporation (the "Borrower"); the financial institutions
party thereto as Lenders (the "Lenders"); The Chase Manhattan
Bank, a New York banking corporation, as administrative agent (in
such capacity, the "Administrative Agent") for the Lenders, as
collateral agent for the Lenders, as Documentation Agent for the
Lenders and as issuing bank (in such capacity, the "Issuing
Bank").
A. The Lenders and the Issuing Bank have extended credit to the
Borrower, and have agreed to extend credit to the Borrower, in each case
pursuant to the terms and subject to the conditions set forth in the Credit
Agreement.
B. Catalytica Combustion intends to enter into a stock purchase
agreement with Enron Ventures Corp. ("Enron") on or before January 31, 1998,
pursuant to which Catalytica Combustion will issue approximately 15% of its
capital stock in exchange for $30,000,000 in cash (the "Equity Issuance").
C. In connection with the Equity Issuance, Catalytica has agreed to
contribute on or after the Catalytica Combustion Release Date additional
capital to Catalytica Combustion in the form of notes that evidence
approximately $12,500,000 of intercompany loans made by Catalytica to Catalytica
Combustion and its subsidiaries (the "Conversion", and together with the Equity
Issuance, the "Transactions").
D. In connection with the Transactions, the Borrower has requested
that (a) the requisite Lenders consent to the Transactions, and (b) the Credit
Agreement be amended as set forth herein. The requisite Lenders are willing to
grant such consent and so to amend the Credit Agreement pursuant to the terms
and subject to the conditions set forth herein.
E. Capitalized terms used but not defined herein have the meanings
assigned to them in the Credit Agreement.
Accordingly, in consideration of the mutual agreements herein
contained and other good and valuable consideration, the sufficiency and receipt
of which are hereby acknowledged, the parties hereto agree as follows:
SECTION 1. Amendment to Article I of the Credit Agreement. Article I
-----------------------------------------------
of the Credit Agreement is hereby amended by (a) deleting the word "Subsidiary"
wherever such word appears in such Article (other than (i) in the fourth line of
the definition of the term "Environmental Liability", (ii) in the definition of
the term "Foreign Subsidiary", (iii) in the definition of the term "Inactive
Subsidiary", (iv) in the definition of the term "Non-Borrower Subsidiary", (v)
in the definition of the term "Subsidiary", (vi) in the definition of the term
"Subsidiary Loan Party" and (vii) in the phrases "Subsidiary Loan Party" and
"Subsidiary Loan Parties") and inserting in lieu thereof the phrase "Restricted
Subsidiary" and (b) deleting the word "Subsidiaries" wherever such word appears
in Article I and inserting in lieu thereof the phrase "Restricted Subsidiaries".
SECTION 2. Amendment to Section 1.01 of the Credit Agreement. (a)
--------------------------------------------------
The definition of the term "Adjusted Consolidated EBITDA" set forth in Section
1.01 of the Credit Agreement is hereby amended by inserting the word
"Restricted" before the word "Subsidiary's" in the fourth and ninth lines of
such definition.
(b) The definition of the term "Capital Expenditures" set forth in
Section 1.01 of the Credit Agreement is hereby amended by deleting the words
"and its consolidated subsidiaries"
<PAGE>
2
from the third and seventh lines of such definition and inserting in lieu
thereof the following phrase: ", the Borrower and the Restricted Subsidiaries".
(c) The definition of the term "Catalytica Combustion Release Date"
set forth in Section 1.01 of the Credit Agreement is hereby amended by inserting
after the phrase "subsidiaries)" in the tenth line of such definition, the
following phrase:
", provided that Catalytica may instead contribute on or after the
--------
Catalytica Combustion Release Date additional capital to Catalytica
Combustion in the form of notes that evidence up to $4,250,000 in the
aggregate of intercompany loans made by Catalytica to Catalytica
Combustion and its subsidiaries after the date of this Agreement."
(d) The definition of the term "Consolidated EBITDA" set forth in
Section 1.01 of the Credit Agreement is hereby amended by deleting the phrase
"and (e)" from the seventh line of such definition and inserting in lieu thereof
the following phrase: ", (e) the amount of dividends and distributions (other
than loans, advances or tax sharing payments) actually received in cash by
Catalytica, the Borrower or any of the Restricted Subsidiaries from any
Unrestricted Subsidiary during such period and (f)".
(e) The definition of the term "Consolidated Net Income" set forth in
Section 1.01 of the Credit Agreement is hereby amended by deleting the words "or
any of its subsidiaries" from the last line of such definition and inserting in
lieu thereof the following phrase ", the Borrower or any of the Restricted
Subsidiaries".
(f) The definition of the term "Excess Cash Flow" set forth in Section
1.01 of the Credit Agreement is hereby amended by (i) deleting the phrase "and
its consolidated subsidiaries" from the third line of clause (c), the fourth
through fifth lines of clause (d) and the second line of clause (f) of such
definition and inserting in lieu thereof the phrase ", the Borrower and the
Restricted Subsidiaries" and (ii) inserting the phrase "plus (iv) the amount, if
any, of dividends and distributions (other than loans, advances or tax sharing
payments) actually received in cash by Catalytica or the Restricted Subsidiaries
from any Unrestricted Subsidiary during such period" before the semicolon in the
seventh line of clause (c) of such definition.
(g) The definition of the term "Net Working Capital" set forth in
Section 1.01 of the Credit Agreement is hereby amended by deleting the phrase
"and its consolidated subsidiaries" from the second and third through fourth
lines of such definition and inserting in lieu thereof the phrase ", the
Borrower and the Restricted Subsidiaries".
(h) Section 1.01 of the Credit Agreement is hereby amended by
inserting, in appropriate alphabetical order, the following definitions:
"Restricted Subsidiary" means (a) prior to the Catalytica
---------------------
Combustion Release Date, any Subsidiary and (b) after the Catalytica
Combustion Release Date, any Subsidiary that is not an Unrestricted
Subsidiary.
"Unrestricted Subsidiary" means, after the Catalytica Combustion
-----------------------
Release Date, Catalytica Combustion and each of its subsidiaries.
SECTION 3. Amendment to Section 2.10 of the Credit Agreement.
--------------------------------------------------
Section 2.10(b) of the Credit Agreement is hereby amended by inserting the word
"Restricted" before the word "Subsidiary" in the second line of such Section.
SECTION 4. Amendment to Article III of the Credit Agreement.
-------------------------------------------------
Article III of the Credit Agreement is hereby amended by (a) deleting the word
"Subsidiary" wherever such word appears in such Article (other than in the
phrases "Inactive Subsidiary", "Non-Borrower
<PAGE>
3
Subsidiary", "Subsidiary Loan Party" and "Subsidiary Loan Parties") and
inserting in lieu thereof the phrase "Restricted Subsidiary" and (b) deleting
the word "Subsidiaries" wherever such word appears in such Article (other than
in Sections 3.04(b), 3.06(a) and 3.06(b)) and inserting in lieu thereof the
phrase "Restricted Subsidiaries".
SECTION 5. Amendment to Article V of the Credit Agreement. Article V
-----------------------------------------------
of the Credit Agreement is hereby amended by (a) deleting the word "Subsidiary"
wherever such word appears in such Article (other than (i) in the third line of
Section 5.01(g), (ii) in the third line of Section 5.01(h), (iii) in the third
line of Section 5.02 and (iv) in the phrases "Inactive Subsidiary", "Foreign
Subsidiary", "Subsidiary Loan Party" and "Subsidiary Loan Parties") and
inserting in lieu thereof the phrase "Restricted Subsidiary" and (b) deleting
the word "Subsidiaries" wherever such word appears in Article V and inserting in
lieu thereof the phrase "Restricted Subsidiaries".
SECTION 6. Amendment to Section 5.01 of the Credit Agreement.
--------------------------------------------------
Section 5.01 of the Credit Agreement is hereby amended by deleting paragraphs
(a), (b) and (c) thereof and inserting in lieu thereof the following:
"(a) within 90 days after the end of each fiscal year of
Catalytica, (i) the audited consolidated and unaudited consolidating
balance sheet and related statements of operations, stockholders' equity
and cash flows of Catalytica, the Borrower and the Subsidiaries as of the
end of and for such year and (ii) the unaudited consolidating balance sheet
and related statements of operations, stockholders' equity and cash flows
of Catalytica, the Borrower and the Restricted Subsidiaries as of the end
of and for such year, setting forth in each case in comparative form the
figures for the previous fiscal year, in the case of such consolidated
financial statements, reported on by Ernest & Young LLP or other
independent public accountants of recognized national standing (without a
"going concern" or like qualification or exception and without any
qualification or exception as to the scope of such audit) to the effect
that such consolidated financial statements present fairly in all material
respects the financial condition and results of operations of Catalytica
and its consolidated subsidiaries on a consolidated basis in accordance
with GAAP consistently applied;
(b) within 45 days after the end of each of the first three
fiscal quarters of each fiscal year of Catalytica, (i) the consolidated and
consolidating balance sheet and related statements of operations,
stockholders' equity and cash flows of Catalytica, the Borrower and the
Subsidiaries as of the end of and for such fiscal quarter and the then
elapsed portion of the fiscal year and (ii) the unaudited consolidating
balance sheet and related statements of operations, stockholders' equity
and cash flows of Catalytica, the Borrower and the Restricted Subsidiaries
as of the end of and for such fiscal quarter and the then elapsed portion
of the fiscal year, setting forth in each case in comparative form the
figures for the corresponding period or periods of (or, in the case of the
balance sheet, as of the end of) the previous fiscal year, all certified by
one of its Financial Officers as presenting fairly in all material respects
the financial condition and results of operations of Catalytica and its
consolidated subsidiaries on a consolidated basis in accordance with GAAP
consistently applied, subject to normal year-end audit adjustments and the
absence of footnotes;
(c) within 30 days after the end of each of the first two fiscal
months of each fiscal quarter of Catalytica, (i) the consolidated and
consolidating balance sheet and related statements of operations,
stockholders' equity and cash flows of Catalytica, the Borrower and the
Subsidiaries as of the end of and for such fiscal month and then elapsed
portion of the fiscal year, and (ii) the unaudited consolidating balance
sheet and related statements of operations, stockholders' equity and cash
flows of Catalytica, the Borrower and the Restricted Subsidiaries as of the
end of and for such fiscal month and the then elapsed
<PAGE>
4
portion of the fiscal year, all certified by one of its Financial Officers
as presenting in all material respects the financial condition and results
of operations of Catalytica and its consolidated subsidiaries on a
consolidated basis in accordance with GAAP consistently applied, subject to
normal year-end audit adjustments and the absence of footnotes;"
SECTION 7. Amendment to Section 5.08 of the Credit Agreement.
--------------------------------------------------
Section 5.08 of the Credit Agreement is hereby amended by inserting, before the
word "whether" in the second line in clause (b) of such Section, the following
phrase:
"determined for purposes of this Section 5.08 without regard to the
final proviso in the definition of the term "Net Proceeds" and".
SECTION 8. Amendment to Article VI of the Credit Agreement. Article
------------------------------------------------
VI of the Credit Agreement is hereby amended by (a) deleting the word
"Subsidiary" wherever such word appears in such Article (other than (i) in the
fifth line of Section 6.01(b), (ii) in the second line of Section 6.05(c) and
(iii) in the phrases "Foreign Subsidiary", "Subsidiary Loan Party", "Subsidiary
Loan Parties" and "Non-Borrower Subsidiary") and inserting in lieu thereof the
phrase "Restricted Subsidiary" and (b) deleting the word "Subsidiaries" wherever
such word appears in such Article (other than in the phrase "Non-Borrower
Subsidiaries") and inserting in lieu thereof the phrase "Restricted
Subsidiaries".
SECTION 9. Amendment to Section 6.01 of the Credit Agreement.
--------------------------------------------------
Section 6.01(a) of the Credit Agreement is hereby amended by (a) inserting the
word "and" after the semicolon in the last line of clause (vi) of such Section,
(b) deleting the phrase "; and" from the last line of clause (vii) of such
Section and inserting in lieu thereof a period and (c) deleting paragraph (viii)
of such Section. Section 6.01(b) of the Credit Agreement is hereby amended by
inserting the phrase "6.04(d), 6.04(i) or" after the word "Section" in the third
line of such Section.
SECTION 10. Amendment to Section 6.02 of the Credit Agreement.
--------------------------------------------------
Section 6.02 of the Credit Agreement is hereby amended by (a) inserting the word
"and" after the semicolon in the last line of clause (e) of such Section, (b)
deleting the phrase "; and" from the last line of clause (f) of such Section and
inserting in lieu thereof a period and (c) deleting paragraph (g) of such
Section.
SECTION 11. Amendment to Section 6.04 of the Credit Agreement. (a)
--------------------------------------------------
Section 6.04 of the Credit Agreement is hereby amended by (a) deleting the words
"its subsidiaries" in the second line of clause (h) of such Section and
inserting in lieu thereof the phrase ", the Borrower and the Restricted
Subsidiaries", (b) deleting the word "and" from the last line of clause (h) of
such Section, (c) deleting the number "15,000,000" in the third line of clause
(i) of such Section and inserting in lieu thereof the number "10,000,000", (d)
deleting the period from the last line of clause (i) of such Section and
inserting in lieu thereof the phrase "; and", (e) inserting after clause (i) of
such Section the phrase "(j) payments to Catalytica Combustion and its
subsidiaries permitted by Section 6.09(e).", (f) inserting the phrase "and
except as otherwise provided in Section 6.04(i)" after the phrase "(f)" in the
first line in the last paragraph of such Section, (g) deleting the word
"subsidiaries" from the third line in the last paragraph of such Section and
inserting in lieu thereof the phrase "Restricted Subsidiaries" and (h) deleting
clauses (e) and (f) of the last paragraph of such Section and inserting in lieu
thereof the following:
"(e) Advanced Technologies and its subsidiaries shall not make after
the Effective Date any investment in or loan or advance to or
Guarantee any Indebtedness of any other Non-Borrower Subsidiaries
other than their respective subsidiaries, (f) prior to the Catalytica
Combustion Release Date, neither Catalytica Combustion nor any of its
subsidiaries shall make after the Effective Date any investment in or
loan or advance to or Guarantee any Indebtedness of any Non-Borrower
Subsidiaries other than Catalytica Combustion and its subsidiaries and
(g) on and after the Catalytica Combustion Release Date, none of
Catalytica, the
<PAGE>
5
Borrower or any Restricted Subsidiary shall make any investment in or
loan or advance to or Guarantee any Indebtedness of Catalytica
Combustion or any of its subsidiaries".
SECTION 12. Amendment to Section 6.05 of the Credit Agreement.
--------------------------------------------------
Section 6.05(c) of the Credit Agreement is hereby amended by deleting the phrase
"and its subsidiaries" from the eighth and ninth lines of such Section and
inserting in lieu thereof the phrase ", the Borrower and the Restricted
Subsidiaries".
SECTION 13. Amendment to Section 6.06 of the Credit Agreement.
--------------------------------------------------
Section 6.06 of the Credit Agreement is hereby amended by deleting the word
"Enter" from the first line of such Section and inserting in lieu thereof the
phrase "Catalytica and the Borrower will not, and will not permit any of the
Restricted Subsidiaries to, enter".
SECTION 14. Amendment to Section 6.08 of the Credit Agreement.
--------------------------------------------------
Section 6.08 of the Credit Agreement is hereby amended by (a) deleting clause
(c) of such Section, (b) deleting the phrase "(d)" in the eighth line of such
Section and inserting in lieu thereof the phrase ", (c)" and (c) deleting the
phrase "(e)" in the ninth line of such Section and inserting in lieu thereof the
phrase "(d)".
SECTION 15. Amendment to Section 6.09 of the Credit Agreement.
--------------------------------------------------
Section 6.09 of the Credit Agreement is hereby amended by (a) deleting the word
"and" from the tenth line of such Section and inserting a comma in lieu thereof
and (b) inserting after the word "Catalytica" in the eleventh line of such
Section the following phrase:
"and (e) payments made by Catalytica to Catalytica Combustion or its
subsidiaries in the amount of the actual reduction in the amount of
Taxes that would have been paid by Catalytica that is directly
attributable to the net operating losses or similar tax benefits
provided by the Unrestricted Subsidiaries."
SECTION 16. Amendment to Section 6.15 of the Credit Agreement.
--------------------------------------------------
Section 6.15 of the Credit Agreement is hereby amended by deleting the phrase
"of Catalytica and the Subsidiaries" from the second and third lines of such
Section.
SECTION 17. Amendment to Article VII of the Credit Agreement.
-------------------------------------------------
Article VII of the Credit Agreement is hereby amended by (a) deleting the word
"Subsidiary" wherever such word appears in such Article (other than (i) in the
third and seventh lines of paragraph (i) of such Article, (ii) in the first and
eighth lines of paragraph (j) of such Article and (iii) in the first line of
paragraph (k) of such Article) and inserting in lieu thereof the phrase
"Restricted Subsidiary" and (b) deleting the word "Subsidiaries" wherever such
word appears in such Article and inserting in lieu thereof the phrase
"Restricted Subsidiaries".
SECTION 18. Consent. The Required Lenders hereby consent to (a) the
--------
Equity Issuance and (b) the Conversion.
SECTION 19. Representations and Warranties. Each of Catalytica and
-------------------------------
the Borrower represents and warrants to the Administrative Agent and to each of
the Lenders that:
(a) This Amendment has been duly authorized, executed and delivered
by it and constitutes the legal, valid and binding obligation of each Loan
Party hereto, enforceable against such Loan Party in accordance with its
terms subject to applicable bankruptcy, insolvency, reorganization,
moratorium or other laws affecting creditors' rights generally and subject
to general principles of equity, regardless of whether considered in a
proceeding in equity or at law.
(b) On and as of the date of this Amendment, the representations and
warranties set forth in Article III of the Credit Agreement are true and
correct in all material respects
<PAGE>
6
with the same effect as if made on the date hereof, except to the extent
such representations and warranties expressly relate to an earlier date.
(c) At the time of and immediately after giving effect to this
Amendment, no Event of Default or Default has occurred and is continuing.
SECTION 20. Conditions to Effectiveness. This Amendment shall become
----------------------------
effective as of the date first above written when the Administrative Agent shall
have received counterparts of this Amendment that, when taken together, bear the
signatures of Catalytica, the Borrower, the Required Lenders and Term Loan
Lenders holding a majority in interest of the outstanding Term Loans.
SECTION 21. Credit Agreement. Except as specifically amended hereby,
-----------------
the Credit Agreement shall continue in full force and effect in accordance with
the provisions thereof as in existence on the date hereof. After the date
hereof, any reference to the Credit Agreement shall mean the Credit Agreement as
amended hereby. This Amendment shall constitute a "Loan Document" for all
purposes of the Credit Agreement and the other Loan Documents.
SECTION 22. Acknowledgment. Each Lender acknowledges that on the
---------------
Catalytica Combustion Release Date (a) Catalytica Combustion and each other
Guarantor that, as of the Catalytica Combustion Release Date, is a subsidiary of
Catalytica Combustion shall be automatically released from their obligations
under the Guarantee Agreement in accordance with Section 10 of the Guarantee
Agreement, (b) Catalytica Combustion and each other Guarantor that, as of the
Catalytica Combustion Release Date, is a subsidiary of Catalytica Combustion
shall be automatically released from their obligations under the Indemnity,
Subrogation and Contribution Agreement in accordance with Section 8 of the
Indemnity, Subrogation and Contribution Agreement, (c) Catalytica Combustion and
each other Guarantor that, as of the Catalytica Combustion Release Date, is a
subsidiary of Catalytica Combustion shall be automatically released from their
obligations under the Pledge Agreement in accordance with Section 14 of the
Pledge Agreement, (d) the security interest in the Collateral (as defined in the
Pledge Agreement) granted by Catalytica Combustion and each other Guarantor
that, as of the Catalytica Combustion Release Date, is a subsidiary of
Catalytica Combustion shall be automatically released in accordance with Section
14 of the Pledge Agreement and (e) the security interest in the notes that
evidence the intercompany loans that will be subject to the Conversion granted
by Catalytica shall be automatically released in accordance with Section 14 of
the Pledge Agreement. The Collateral Agent further acknowledges that (a) as
soon as reasonably practicable after the Catalytica Combustion Release Date, the
Collateral (as defined in the Pledge Agreement) pledged to the Collateral Agent
for the benefit of the Secured Parties by Catalytica Combustion and each of its
subsidiaries and in the physical possession of the Collateral Agent shall be
returned to Catalytica Combustion and (b) as soon as reasonably practicable
after the Catalytica Combustion Release Date, the Collateral Agent shall release
the intercompany notes that evidence the intercompany loans that will be subject
to the Conversion and return such notes to Catalytica.
SECTION 23. APPLICABLE LAW. THIS AMENDMENT SHALL BE GOVERNED BY, AND
---------------
CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF NEW YORK.
SECTION 24. Counterparts. This Amendment may be executed in two or
-------------
more counterparts, each of which shall constitute an original but all of which
when taken together shall constitute but one agreement. Delivery of an executed
signature page to this Amendment by facsimile shall be effective as delivery of
a manually executed counterpart hereof.
<PAGE>
7
SECTION 25. Expenses. The Borrower agrees to reimburse the
---------
Administrative Agent for its out-of-pocket expenses in connection with this
Amendment, including the reasonable fees, charges and disbursements of Cravath,
Swaine & Moore, counsel for the Administrative Agent.
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to
be duly executed by their respective authorized officers as of the day and year
first written above.
CATALYTICA, INC.,
by
/s/ Lawrence W. Briscoe
----------------------------------------
Name: Lawrence W. Briscoe
Title: CFO
CATALYTICA PHARMACEUTICALS, INC.,
by
/s/ Lawrence W. Briscoe
----------------------------------------
Name: Lawrence W. Briscoe
Title: CFO
THE CHASE MANHATTAN BANK, individually and as
Administrative Agent,
by
/s/ Joan F. Garvin
----------------------------------------
Name: Joan F. Garvin
Title: Managing Director
BANK OF TOKYO-MITSUBISHI TRUST COMPANY,
by
/s/ Nicholas J. Campbell
----------------------------------------
Name: Nicholas J. Campbell
Title: Vice President
BANQUE PARIBAS,
by
/s/ Don L. Unruh
----------------------------------------
Name: Don L. Unruh
Title: Assistant Vice President
<PAGE>
8
by
/s/ Stanley P. Berkman
----------------------------------------
Name: Stanley P. Berkman
Title: Managing Director/ Western Region
COMERICA BANK,
by
/s/ Emmanuel M. Skevofilax
----------------------------------------
Name: Emmanuel M. Skevofilax
Title: Assistant Vice President
COOPERATIVE CENTRALE
RAIFFEISEN-BOERENLEENBANK B.A., "RABOBANK
NEDERLAND", NEW YORK BRANCH,
by
/s/ Dana W. Hemenway
----------------------------------------
Name: Dana W. Hemenway
Title: Vice President
by
/s/ W. Pieter C. Kodde
----------------------------------------
Name: W. Pieter C. Kodde
Title: Vice President
DRESDNER BANK AG, New York Branch and Grand
Cayman Branch,
by
/s/ Christopher E. Sarisky
----------------------------------------
Name: Christopher E. Sarisky
Title: Assistant Treasurer
by
/s/ John W. Sweeney
----------------------------------------
Name: John W. Sweeney
Title: Assistant Vice President
FIRST UNION NATIONAL BANK,
by
/s/ Tom Cambern
----------------------------------------
Name: Tom Cambern
Title: Senior Vice President
<PAGE>
9
FLEET NATIONAL BANK,
by
/s/ Dorothy E. Bambach
----------------------------------------
Name: Dorothy E. Bambach
Title: Senior Vice President
NATEXIS BANQUE (previously known as Banque
Francaise Du Commerce Exterieur),
by
/s/ Iain A. Whyte
----------------------------------------
Name: Iain A. Whyte
Title: Vice President
by
/s/ Bennett C. Pozil
----------------------------------------
Name: Bennett C. Pozil
Title: Vice President
THE BANK OF NOVA SCOTIA,
by
/s/ John Quick
----------------------------------------
Name: John Quick
Title: Senior Relationship Manager
THE INDUSTRIAL BANK OF JAPAN, LIMITED,
by
/s/ Takahide Akiyama
----------------------------------------
Name: Takahide Akiyama
Title: General Manager
THE MITSUBISHI TRUST AND BANKING CORPORATION,
by
/s/ Beatrice Kossodo
----------------------------------------
Name: Beatrice Kossodo
Title: Senior Vice President
THE ROYAL BANK OF SCOTLAND PLC,
by
/s/ Derek Bonnar
----------------------------------------
Name: Derek Bonnar
Title: Vice President
<PAGE>
10
UNION BANK OF CALIFORNIA, N.A.,
by
/s/ Wanda Headrick
----------------------------------------
Name: Wanda Headrick
Title: Vice President
WACHOVIA BANK, N.A.,
by
/s/ Charles S. Zimmerman
----------------------------------------
Name: Charles S. Zimmerman
Title: Vice President
<PAGE>
EXHIBIT 23.1
CATALYTICA, INC.
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, No. 333-09533, and No. 333-33681) 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 27, 1998,
with respect to the consolidated financial statements and schedule of
Catalytica, Inc., included in this Annual Report (Form 10-K) for the year
ended December 31, 1997.
Ernst & Young LLP
San Jose, California
March 30, 1998
<PAGE>
EXHIBIT 23.2
CATALYTICA, INC.
CONSENT OF COOPERS & LYBRAND LLP, INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the Registration Statements
of Catalytica, Inc. (Form S-8's No. 33-62964, No. 333-09533, and No. 333-
33681) 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 October 17, 1997, which included an explanatory paragraph
regarding GENXON Power Systems, L.L.C.'s ability to continue as a going
concern, on our audit of GENXON Power Systems, L.L.C. as of September 30, 1997
and for the period from October 21, 1996 (date of inception) to September 30,
1997, which report is included in this Annual Report (Form 10-K) for the year
ended December 31, 1997.
Coopers & Lybrand LLP
San Jose, California
March 30, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1996
<PERIOD-START> JAN-01-1997 JAN-01-1996
<PERIOD-END> DEC-31-1997 DEC-31-1996
<CASH> 35,149 15,540
<SECURITIES> 11,918 8,281
<RECEIVABLES> 14,012 5,137
<ALLOWANCES> 600 100
<INVENTORY> 114,245 3,417
<CURRENT-ASSETS> 177,429 33,056
<PP&E> 155,804 7,897
<DEPRECIATION> (15,075) (9,536)
<TOTAL-ASSETS> 335,273 41,003
<CURRENT-LIABILITIES> 90,004 9,152
<BONDS> 0 0
0 0
0 0
<COMMON> 100,403 65,501
<OTHER-SE> (47,887) (48,197)
<TOTAL-LIABILITY-AND-EQUITY> 335,273 41,003
<SALES> 174,347 9,813
<TOTAL-REVENUES> 180,946 16,314
<CGS> 155,092 9,073
<TOTAL-COSTS> 171,950 23,232
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> (5,422) (353)
<INCOME-PRETAX> 669 (5,192)
<INCOME-TAX> (359) 0
<INCOME-CONTINUING> 310 (5,192)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> (3,750) 0
<NET-INCOME> (3,440) (5,192)
<EPS-PRIMARY> (.10) (.27)
<EPS-DILUTED> (.10) (.27)
</TABLE>
