<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2000
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________________to ______________.
Commission File No. 0-20966
_________________
CATALYTICA, INC.
(Exact name of Registrant as specified in its charter)
Delaware 94-2262240
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
430 Ferguson Drive
Mountain View, California 94043
(Address of principal executive offices)
(650) 960-3000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No[_]
As of November 7, 2000, on a fully diluted basis, reflecting the conversion
of the registrant's outstanding Class A and Class B Common Stock into Common
Stock, there were outstanding 58,320,252 shares of the registrant's Common
Stock. As of November 7, 2000, there were outstanding 33,320,252 shares of the
registrant's Common Stock, par value $.001, which is the only class of common
stock of the registrant registered under Section 12(g) of the Securities Act of
1933. The Company also has outstanding 13,270,000 shares of Class A Common Stock
and 11,730,000 shares of Class B Common Stock which are convertible into an
equal number of shares of Common Stock.
<PAGE>
CATALYTICA, INC.
FORM 10-Q
TABLE OF CONTENTS
September 30, 2000
<TABLE>
<CAPTION>
Page No.
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Unaudited Condensed Consolidated Balance Sheets as of September 30, 2000, and December 31, 1999 3
Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended
September 30, 2000, and September 30, 1999 4
Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30,
2000, and September 30, 1999 5
Notes to Unaudited Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures about Market Risk 29
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 30
Item 6. Exhibits and Reports on Form 8-K 30
Signatures 32
</TABLE>
2
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PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
---- ----
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 14,774 $ 34,876
Short-term investments 4,980 5,470
Accounts receivable, net 32,164 41,985
Accounts receivable from joint venture 154 177
Notes receivable from employees 75 158
Inventory:
Raw materials 54,957 64,836
Work in process 37,662 27,938
Finished goods 18,135 12,745
-------- --------
110,754 105,519
Deferred taxes 12,951 12,951
Prepaid expenses and other assets 2,990 4,060
-------- --------
Total current assets 178,842 205,196
Property, plant and equipment:
Land 6,646 6,533
Equipment 232,633 194,097
Buildings and leasehold improvements 87,198 82,273
-------- --------
326,477 282,903
Less accumulated depreciation and amortization (77,888) (61,772)
-------- --------
248,589 221,131
Notes receivable from employees 470 978
Other assets 595 1,203
-------- --------
$428,496 $428,508
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 29,051 $ 38,508
Accrued payroll and related expenses 14,496 18,126
Deferred revenue 10,091 6,771
Other accrued liabilities 8,897 9,184
Current portion of long-term debt 19,750 12,948
Income taxes payable 4,737 1,162
-------- --------
Total current liabilities 87,022 86,699
Long-term debt 36,000 51,000
Non-current deferred revenue 6,338 6,992
Deferred taxes 16,031 16,031
Other long-term liabilities 958 959
Minority interest 41,000 41,000
Class A and B common stock 97,079 97,079
Stockholders' equity:
Common stock 33 33
Additional paid-in capital 116,267 112,021
Deferred compensation (62) (156)
Accumulated earnings 27,830 16,850
-------- --------
Total stockholders' equity 144,068 128,748
-------- --------
$428,496 $428,508
======== ========
</TABLE>
See accompanying notes.
3
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CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Product sales $67,608 $92,031 $243,315 $295,747
Research and development contracts 9,616 6,434 29,863 16,748
------- ------- -------- --------
Total revenues 77,224 98,465 273,178 312,495
Costs and expenses:
Cost of product sales 56,458 77,594 195,686 235,457
Research and development 13,277 11,200 36,024 30,140
Selling, general and administrative 7,423 6,781 19,629 20,283
------- ------- -------- --------
Total costs and expenses 77,158 95,575 251,339 285,880
Operating income 66 2,890 21,839 26,615
Interest income 644 769 1,731 2,106
Interest expense (1,773) (2,230) (5,362) (6,404)
Loss on joint ventures (236) (158) (236) (1,132)
------- ------- -------- --------
Income (loss) before income taxes (1,299) 1,271 17,972 21,185
Provision for income taxes 524 167 (6,992) (3,849)
------- ------- -------- --------
Net (loss) income $ (775) $ 1,438 $ 10,980 $ 17,336
======= ======= ======== ========
Net income (loss) per share:
Basic $(0.01) $0.02 $0.19 $0.30
======= ======= ======== ========
Diluted $(0.01) $0.02 $0.15 $0.25
======= ======= ======== ========
Number of shares used in computing net
income (loss) per share:
Basic 58,234 57,639 58,089 57,544
======= ======= ======== ========
Diluted 58,234 64,067 64,269 63,867
======= ======= ======== ========
</TABLE>
See accompanying notes.
4
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CATALYTICA, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (decrease) in cash and cash equivalents
(in thousands)
<TABLE>
<CAPTION>
Nine Months Ended June 30,
2000 1999
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $ 10,980 $ 17,336
Adjustments to reconcile net income to net cash provided by operating activity:
Depreciation and amortization 17,359 13,495
Deferred income taxes -- 3,560
Losses in joint ventures 236 1,133
Stock compensation associated with employee retirement 1,060 --
Stock compensation associated with options issuance to consultant 207 --
Forgiveness of note receivable to former officer of subsidiary 620 --
Changes in:
Accounts receivable 9,821 10,791
Accounts receivable from joint venture 23 898
Inventory (5,235) 146
Prepaid expenses, and other current assets 1,071 (2,115)
Accounts payable (9,457) (5,852)
Accrued payroll and related expenses (3,630) 1,495
Deferred revenue 2,666 3,483
Income taxes payable 3,575 (6,923)
Other accrued liabilities (288) 13,301
-------- --------
Net cash provided by operating activities 29,008 50,748
Cash flows from investing activities:
Purchases of investments (10,500) (19,714)
Maturities of investments 11,000 19,781
Investment in joint ventures (236) (1,133)
Disposition of property and equipment 773 137
Acquisition of property and equipment (44,842) (30,527)
Dividends paid -- (170)
-------- --------
Net cash used in investing activities (43,805) (31,626)
Cash flows from financing activities:
Net receipts on (issuance of) notes receivable from employees (86) (343)
Additions to debt obligations -- 7,247
Payments on debt obligations (8,198) (17,019)
Issuance of stock, net of issuance costs 2,975 2,195
-------- --------
Net cash used in financing activities $ (5,305) $ (7,920)
-------- --------
Net increase (decrease) in cash and cash equivalents (20,102) 11,202
Cash and cash equivalents at beginning of period 34,876 41,269
-------- --------
Cash and cash equivalents at end of period $ 14,774 $ 52,471
======== ========
</TABLE>
See accompanying notes.
5
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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three and nine-month periods ended
September 30, 2000, are not necessarily indicative of the results that may be
expected for the year ended December 31, 2000. For further information, refer to
the consolidated financial statements and footnotes thereto included in the
Catalytica, Inc. Annual Report on Form 10-K for the year ended December 31,
1999.
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2. Earnings per share
A reconciliation of the numerators and denominators for the Basic and Diluted
EPS calculations follows:
<TABLE>
<CAPTION>
Three months ended Nine months ended
(in thousands, except per share amounts) September 30, September 30,
2000(1) 1999 2000 1999
------- ---- ---- ----
<S> <C> <C> <C> <C>
Numerator:
Numerator for basic earnings per share:
Income (loss) available to common shareholders $ (775) $ 1,438 $10,980 $17,336
Less: Reduction of Catalytica
Pharmaceuticals income attributable to
holders of subsidiary stock options
(237) (181) (1,299) (1,297)
------- ------- ------- -------
Numerator for diluted earnings (loss) per share $(1,012) $ 1,257 $ 9,681 $16,039
------- ------- ------- -------
Denominator:
Denominator for basic earnings (loss) per share:
Weighted-average shares 58,234 57,639 58,089 57,544
------- ------- ------- -------
Effect of dilutive securities:
Catalytica, Inc. employee stock options - 901 492 871
Catalytica Pharmaceuticals, Inc.
Convertible Preferred Stock - 1,794 1,918 1,775
Catalytica Pharmaceuticals, Inc.
Convertible Junior Preferred Stock - 605 647 599
Catalytica Energy Systems, Inc.
Convertible Preferred Stock - 2,853 3,108 2,837
Catalytica, Inc. warrants issued to Glaxo
Wellcome, Inc. - 275 15 241
------- ------- ------- -------
Dilutive potential common shares - 6,428 6,180 6,323
Denominator for diluted earnings (loss) per share:
Adjusted weighted-average shares and
assumed conversions 58,234 64,067 64,269 63,867
------- ------- ------- -------
Basic earnings (loss) per share $ (0.01) $ 0.02 $ 0.19 $ 0.30
------- ------- ------- -------
Diluted earnings (loss) per share $ (0.01) $ 0.02 $ 0.15 $ 0.25
======= ======= ======= =======
</TABLE>
Weighted average shares outstanding for the three and nine months ended
September 30, 2000, includes Class A and B common shares as Catalytica considers
Class A and B to be the equivalent of common stock.
(1) For the three months ended September 30, 2000, potentially dilutive
Securities of 6,354 were outstanding and are not included in the diluted
earnings per share computation because they are anti-dilutive.
7
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3. Segment Disclosures
The Company operates primarily in the pharmaceuticals and combustion
systems businesses. The Company has determined its reportable operating segments
based upon how the business is managed and operated. Catalytica Pharmaceuticals,
Inc. ("Catalytica Pharmaceuticals") and Catalytica Energy Systems, Inc.,
formerly known as Catalytica Combustion Systems, Inc. ("Energy Systems") operate
as independent businesses with their own sales, research and development, and
operations departments. Each manufactures and distributes distinct products with
different production processes. As such, the following table discloses their
revenues, operating income (loss), and identifiable assets for the above named
operating segments. Catalytica Advanced Technologies, Inc. ("Advanced
Technologies") is combined with Catalytica's corporate operations as it does not
meet the requirements for separate disclosure. Sales to countries outside of the
United States are less than 10% of total revenues for all periods presented.
<TABLE>
<CAPTION>
(In thousands) Three months ended Sept 30, Nine months ended Sept 30,
----------------------------- ----------------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues
Catalytica Pharmaceuticals $75,790 $97,684 $269,334 $310,329
Energy Systems 1,279 549 2,688 1,060
Corporate and other subsidiary 155 232 1,156 1,106
------- ------- -------- --------
Total revenues $77,224 $98,465 $273,178 $312,495
</TABLE>
<TABLE>
<CAPTION>
(In thousands) Three months ended Sept 30, Nine months ended Sept 30,
----------------------------- ----------------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Operating Income (Loss)
Catalytica Pharmaceuticals $ 4,299 $ 5,425 $ 29,058 $ 33,189
Energy Systems (4,052) (2,202) (7,060) (4,961)
Corporate and other subsidiary (181) (333) (159 (1,613)
------- ------- -------- --------
Total operating income (loss) $ 66 $ 2,890 $21,839 $ 26,615
======= ======= ======== ========
</TABLE>
(In thousands)
<TABLE>
<CAPTION>
September 30, 2000 December 31, 1999
------------------------ -----------------------
<S> <C> <C>
Identifiable Assets
Catalytica Pharmaceuticals $397,486 $389,902
Energy Systems 13,419 19,335
Corporate and other subsidiary 18,054 19,271
-------- --------
Total assets $428,959 $428,508
======== ========
</TABLE>
4. Financial instruments
For the purposes of the consolidated cash flows, all investments with
maturities of three months or less at the date of purchase held as available-
for-sale (none at September 30, 2000) are considered to be cash and cash
equivalents; instruments with maturities of three months or less at the date of
purchase that are planned to be held-to-maturity ($5.0 million at September 30,
2000) and investments with maturities greater than three months that are
available-for-sale (none at September 30, 2000) 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 September 30,
2000). All investments at September 30, 2000, were carried at amortized cost,
8
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which approximated fair market value (quoted market price). The classification
of investments is made at the time of purchase with classification for held-to-
maturity made when the Company has the intent and ability to hold the
investments to maturity.
5. Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
6. Debt
As of September 30, 2000, nothing was outstanding under the senior secured
revolving facility ("Revolving Debt Facility") and $53.8 million was outstanding
under the senior secured term loan facility ("Term Debt Facility").
The credit agreement, which is guaranteed by the Company, requires that the
Company maintain certain financial ratios and levels of tangible net worth,
profitability, liquidity and implements restrictions on the Company's ability to
declare and pay dividends. In addition, the credit agreement contains various
covenants restricting further indebtedness, issuance of preferred stock by the
Company or its subsidiaries, liens, acquisitions, asset sales, and capital
expenditures. At September 30, 2000, the Company and Catalytica Pharmaceuticals
were in compliance with the covenants.
7. Income taxes
The Company recorded an income tax benefit for the three months ended
September 30, 2000, at an effective tax rate equal to 40% of pretax income. The
provision for income taxes for the nine months ended September 30, 2000, was an
effective tax rate of 39%. For the three months ended September 30, 1999, the
Company recorded an income tax benefit of 13% of pretax income. The provision
for income taxes for the nine months ended September 30, 1999, was an effective
tax rate of 18%. The 2000 effective tax rate differs from the federal statutory
tax rate primarily due to state income taxes. The 1999 effective tax rate
differed from the federal statutory tax rate primarily due to the utilization of
tax net operating loss carry forwards and the elimination of the valuation
allowance for deferred tax assets.
8. Change in Agreement with Enron
In December of 1999, an affiliate of the holder of a minority interest in
Energy Systems, Enron North America ("Enron"), announced that Energy Systems'
Xonon combustion system had been specified as the preferred emissions control
system with GE 7FA turbines that have been ordered for the proposed Pastoria
Energy Facility. The Pastoria Energy Facility is a project proposed by
affiliates of Enron, and is expected to begin construction in 2001 and enter
9
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commercial operations by the summer of 2003.
Effective March 31, 2000, Energy Systems and Enron amended this agreement
such that all funds were repaid by Enron in the period ended September 30, 2000.
Accordingly, approximately $1.0 million of the previously recorded provision was
eliminated and included in the results of operations as a reduction of research
and development expenses in the three months ended March 31, 2000.
9. Litigation
On August 4, 2000, a purported class action complaint Sims et al. v.
Cusumano et al., Civil Action No. 18197NC, was filed in the Chancery Court of
the State of Delaware against Catalytica and certain of its directors. The
complaint alleges that defendants breached their fiduciary duties by agreeing to
a transaction that contemplates the distribution of Energy Systems shares to
Catalytica stockholders and in which Catalytica would be acquired by DSM. The
plaintiffs contend the transaction is unfair to the Catalytica shareholders and
they seek to, among other things, enjoin the transaction. Defendants have not
yet responded to the complaint. Based on the facts known to date, Catalytica
believes that the claims are without merit and intends to vigorously defend this
suit. Catalytica further believes that the outcome of this litigation will not
have a material adverse effect on Catalytica's financial condition or results of
operations.
On August 14, 2000, the City of Glendale filed a complaint against Energy
Systems, Catalytica and Genxon Power Systems, Inc. in Los Angeles County
Superior Court, Case No. EC029841. The action has been transferred to the
Superior Court for Orange County, California. The complaint asserts claims
against all defendants for breach of contract, breach of the covenant of good
faith and fair dealing, fraud and negligent misrepresentation arising out of
defendants' failure to complete its performance under a Technical Services
Agreement between the City of Glendale and Catalytica providing for the retrofit
of the FT4 engine with the FT4 Xonon Combustion System. The City of Glendale
seeks compensatory damages in excess of $7,500,000 and punitive damages. The
defendants believe they have meritorious defenses to the claims asserted and
intend to defend the action vigorously.
On April 12, 2000, a complaint was filed with the District Court for the
Southern District of the State of New York by an individual (the "Plaintiff")
against Catalytica Pharmaceuticals and Glaxo Wellcome, alleging Zyban, a product
manufactured by Catalytica Pharmaceuticals and distributed by Glaxo Wellcome,
was dangerous and defective. The Plaintiff alleges that she suffered an adverse
reaction after using Zyban and undergoing anesthesia, including symptoms of
cognitive dysfunction and memory loss. The Plaintiff has requested a judgement
in the sum of $10,000,000. On July 17, 2000, Catalytica Pharmaceuticals and
Glaxo Wellcome responded by denying all allegations in the Plaintiff's complaint
and asking for a judgement to dismiss her complaint. Since this case is in the
early phase of discovery no documents have been exchanged nor has deposition
testimony be obtained. While the outcome of this case is uncertain, Catalytica
believes the complaint is without merit and intends to defend the action
vigorously.
10
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10. Merger Transaction
On August 2, 2000, Catalytica entered into an Agreement and Plan of Merger
by and among Synotex Company, Inc. ("Synotex"), a Delaware corporation and
wholly owned subsidiary of DSM, N.V., Synotex Acquisition Corporation
("Acquisition Corp."), a Delaware corporation and wholly owned subsidiary of
Synotex, and Catalytica, pursuant to which Acquisition Corp. will merge with and
into Catalytica and Catalytica will become a wholly owned subsidiary of Synotex
(the "Merger"). Immediately prior to the consummation of the Merger, Energy
Systems and Advanced Technologies will be combined to form Catalytica Energy
Systems, Inc. and all of the shares of the combined company owned by Catalytica
will be distributed on a pro rata basis to the Catalytica stockholders (the
"Spin-Off"). If the Merger is consummated, Catalytica's stockholders will be
entitled to receive an aggregate of $750 million (the "Merger Consideration") in
cash subject to certain adjustments, including a reduction in the Merger
Consideration for the tax liability incurred by Catalytica with respect to the
Spin-Off. The tax liability, which is expected to be a material amount, will be
based on the value of Catalytica Energy Systems, Inc. as determined by the
weighted average trading price of Catalytica Energy Systems, Inc. on the first
full day of trading. In addition, the Merger Consideration will be reduced by
$50 million, the amount of capital that Catalytica is expected to provide to
Catalytica Energy Systems through the purchase of stock to ensure that the
company has adequate operating capital. These reductions will be partially
offset by proceeds from any exercises of options and warrants to purchase
Catalytica common stock prior to the consummation of the Merger. The
consummation of the Merger is subject to the satisfaction of numerous
conditions, including the approval of the Merger by Catalytica stockholders,
applicable regulatory clearances and the consummation of the Spin-Off. No
assurance can be given that the Merger or Spin-Off will be consummated.
11. Subsequent Events
Restructuring In November 2000, Catalytica announced plans to restructure
Catalytica Pharmaceuticals. Catalytica will close its Bay View chemical
manufacturing operation in East Palo Alto, California in early 2001.
Additionally, Catalytica will reorganize its Greenville and South Haven
facilities. As a result of the facility closure and reorganization, Catalytica
expects to incur a pre-tax charge of approximately $12-14 million in the fourth
quarter, of which $3-4 million will require cash payments and the remainder will
represent non-cash write-offs of fixed assets.
Name Change In October 2000, Catalytica Combustion Systems, Inc.
changed its name to Catalytica Energy Systems, Inc.
11
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
This Report contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934, including, without limitation, statements regarding the Company's
expectations, beliefs, intentions or future strategies that are signified by the
words "expects", "anticipates", "intends", "believes", or similar language. All
forward-looking statements included in this document are based on information
available to the Company on the date hereof, and the Company assumes no
obligation to update any such forward-looking statements. Actual results could
differ materially from those projected in the forward-looking statements. In
evaluating the Company's business, prospective investors should carefully
consider the information set forth below under the caption "Risk Factors" set
forth herein. The Company cautions investors that its business and financial
performance are subject to substantial risks and uncertainties.
Catalytica, Inc. ("Catalytica") finds new pathways to improve processes -
reducing time, waste, and costs. Catalytica applies its innovative and patented
catalytic technologies and other scientific processes to the pharmaceutical and
power generation industries. For the pharmaceutical industry, Catalytica
improves the steps for manufacturing pharmaceutical products and also finds
better, more efficient ways to produce them in commercial scale quantities. For
the power generation industry, Catalytica's unique application of a catalyst and
proprietary technology enables gas turbines to produce essentially pollution-
free power.
In addition, Catalytica continues to explore other business opportunities that
capitalize on its rich 25-year history of discovery and effective application of
catalysts. Projects include high throughput screening of catalysts and
processes for rapid analysis of optimum production of products, unique
applications of catalysts to enhance fuel conversion for fuel cells and
production of better catalysts for the manufacture of plastics. Catalytica
operates through three subsidiaries: Catalytica Pharmaceuticals, Inc.
("Catalytica Pharmaceuticals"), Catalytica Energy Systems, Inc., formerly known
as Catalytica Combustion Systems, Inc., (''Energy Systems"), and Catalytica
Advanced Technologies, Inc. ("Advanced Technologies").
On September 20, 1999, the Company acquired Wyckoff Chemical Company
("Wyckoff"), which develops, manufactures and markets a broad range of active
pharmaceutical and advanced fine chemical ingredients. At the completion of the
acquisition, Wyckoff became a wholly owned subsidiary of the Company and now
markets its services as the Wyckoff Division of Catalytica Pharmaceuticals.
The acquisition was accounted for as a pooling of interests. The consolidated
financial statements were restated to reflect the Company's financial position
and the results of operations as if Wyckoff was a wholly owned subsidiary of the
Company since inception.
12
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The Merger
On August 2, 2000, Catalytica entered into an Agreement and Plan of Merger by
and among Synotex Company, Inc. ("Synotex"), a Delaware corporation and wholly
owned subsidiary of DSM, N.V., Synotex Acquisition Corporation ("Acquisition
Corp."), a Delaware corporation and wholly owned subsidiary of Synotex, and
Catalytica, pursuant to which Acquisition Corp. will merge with and into
Catalytica and Catalytica will become a wholly owned subsidiary of Synotex (the
"Merger"). Immediately prior to the consummation of the Merger, Energy Systems
and Advanced Technologies will be combined to form Catalytica Energy Systems,
Inc. and all of the shares of the combined company owned by Catalytica will be
distributed on a pro rata basis to the Catalytica stockholders (the "Spin-Off").
If the Merger is consummated, Catalytica's stockholders will be entitled to
receive an aggregate of $750 million (the "Merger Consideration") in cash
subject to certain adjustments, including a reduction in the Merger
Consideration for the tax liability incurred by Catalytica with respect to the
Spin-Off. The tax liability, which is expected to be a material amount, will be
based on the value of Catalytica Energy Systems, Inc. as determined by the
weighted average trading price of Catalytica Energy Systems, Inc. on the first
full day of trading. In addition, the Merger Consideration will be reduced by
$50 million, the amount of capital that Catalytica is expected to provide to
Catalytica Energy Systems through the purchase of stock to ensure that the
company has adequate operating capital. These reductions will be partially
offset by proceeds from any exercises of options and warrants to purchase
Catalytica common stock prior to the consummation of the Merger. The
consummation of the Merger is subject to the satisfaction of numerous
conditions, including the approval of the Merger by Catalytica stockholders,
applicable regulatory clearances and the consummation of the Spin-Off. No
assurance can be given that the Merger or Spin-Off will be consummated.
Results of Operations
Net revenues for the three and nine months ended September 30, 2000, decreased
by 21.6% and 12.6%, respectively when compared with the revenues in the same
periods in 1999, primarily due to a scheduled decrease in product sales to Glaxo
Wellcome under the original supply agreement and subsequent amendments. Product
sales decreased by 26.5% and 17.7%, respectively during the three and nine
months ended September 30, 2000, when compared with the same periods in 1999,
due to a scheduled decrease in sales to Warner Lambert for products which were
produced under the original Glaxo Wellcome Supply Agreement, a shift in product
demand as a result of Y2K concerns that created higher product demand in the
fourth quarter of 1999 and subsequently reduced product demand in the first
quarter of 2000, as well as a reduction in product sales to Pfizer. This decline
in product revenues was partially offset by a significant growth in research
revenues during these periods.
During the nine months ended September 30, 2000, 64% of Catalytica's revenues
were derived from sales to Glaxo Wellcome. During the same period in 1999, 66%
of Catalytica's revenues were derived from sales to Glaxo Wellcome. During the
quarter ended September 30, 2000, 64% of Catalytica's revenues were derived from
sales to Glaxo Wellcome. During the same quarter in 1999, 69% of Catalytica's
revenues were derived from sales to Glaxo Wellcome. As part of the original
supply agreement and amendments to the original supply agreement,
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Glaxo Wellcome guarantees a specified minimum level of revenues in each year of
the agreement. Product shipments to Glaxo Wellcome have exceeded the levels
associated with the aggregate annual minimum payments provided for in the
original Supply Agreement and related amendments. Therefore, Glaxo Wellcome has
made no shortfall payments to Catalytica.
Under terms of the original Glaxo Wellcome supply agreement and certain
amendments, there are scheduled reductions in product sales to Glaxo Welcome.
Revenues from Glaxo and others customers are expected to increase in the fourth
quarter of 2000 as compared to the third quarter of 2000. However, no assurance
of this growth in revenues for the fourth quarter can be provided.
Research and development ("R&D") revenues increased by 49.5% and 78.3% for the
three and nine months ended September 30, 2000, respectively, when compared with
the same periods in 1999, primarily due to a significant increase in new R&D
partners and related funded R&D activities at Catalytica Pharmaceuticals. In
addition, Energy Systems' R&D revenue increased over the same periods primarily
due to an increase in cost reimbursement by gas turbine manufacturers and other
research institutes related to the development of Xonon technology. The
Company's R&D revenues are expected to increase in fiscal 2000 when compared
with fiscal 1999, as the Company continues to expands its R&D efforts and signs
new contracts with new and existing customers, especially in the pharmaceutical
business.
Cost of sales decreased 27.2% and 16.9% for the three and nine months ended
September 30, 2000, respectively, when compared with the same periods in 1999,
which corresponds to a respective 26.5% and 20.8% decrease in product sales
during these periods. This decrease in cost of sales reflects the lower product
sales, as well as a change in product mix. Additionally, Catalytica
Pharmaceuticals received a $2.5 million settlement through its business
interruption insurance as a partial settlement of the lost production incurred
following Hurricane Floyd during the third quarter of 1999. This payment was
included as a reduction in cost of goods sold in the second quarter of 2000.
The gross margin for the three and nine months ended September 30, 2000,
decreased by 0.8% and 3.9%, respectively, compared with the same periods in
1999, primarily due to lower capacity utilization as a result of lower sales,
and a change in product mix during the respective periods. Margins on
pharmaceutical products are subject to fluctuations from quarter to quarter due
to various factors, including the mix of products being manufactured,
manufacturing efficiencies achieved on production runs, the length of down-time
associated with setting up new production runs, and numerous other variables
present in the pharmaceutical manufacturing environment.
Research and development ("R&D") expenses increased 18.5% and 19.5%,
respectively, for the three and nine months ended September 30, 2000, as
compared with R&D expenses in the same periods in 1999. This increase in R&D
expenses directly corresponds to increased demand for the Company's
pharmaceutical development services, and is attributable to increased staffing
and associated R&D expenses at Catalytica Pharmaceuticals which is expanding the
R&D services it provides with respect to both chemical process and formulation
development. These
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activities are important as the Company continues to obtain new customers for
its R&D services which are becoming a meaningful source of revenues, and are
expected to lead to new manufacturing business in the future. In addition,
Energy Systems' R&D expense increased over the same periods in 1999. In December
1999, we entered into an agreement with Enron, the purpose of which was to
accelerate the development of Energy Systems' Xonon technology. In connection
with this agreement, we recorded a $1.2 million provision. In March, the
agreement was amended and Enron reimbursed Catalytica for approximately $1.0
million of the previous advance. Accordingly, that amount was recorded in the
first quarter of 2000 as a reduction of related research and development
activities. Additionally, through the end of the second quarter of 1999, a
significant portion of Energy Systems' research activity was conducted on behalf
of the GENXON joint venture. Upon the completion of the GENXON prototype
development program in June 1999, the engineering efforts relating to additional
catalyst system testing and development were conducted principally by Energy
Systems and consequently are reflected in R&D costs. The Company's R&D expenses
are expected to grow in the future as the Company continues to invest in its R&D
capabilities, especially in Catalytica Pharmaceuticals.
Selling, general and administrative expenses increased 9.5% and decreased
3.2%, respectively, for the three and nine months ended September 30, 2000,
compared with the same periods in 1999. Selling, general and administrative has
increased for the three months ended September 30, 2000 principally due to costs
associated with the planned spin-off of the Company's combustion business. For
the nine months ended September 30, 2000 selling, general and administrative
expenses decreased relative to the same period in 1999, due to charges in the
second and third quarters of 1999 for expenses related to the acquisition of
Wyckoff as well as a reduction in reserves for incentive bonuses during the
first nine months of 2000.
Interest income decreased 16.3% and 17.8%, respectively, for the three and
nine months ended September 30, 2000, when compared to the same periods in 1999.
This decrease in interest income is primarily due to lower average cash balances
in the three and nine months ended September 30, 2000, when compared to the same
periods in 1999. This decrease in cash is primarily due to lower average cash
balances related to Energy Systems, as it continues to invest its funds in
research and development activities. Interest income is expected to continue to
be moderately lower in the remainder of 2000 as the Company intends to utilize a
portion of its cash to finance capital expenditures.
Interest expense decreased 20.5% and 16.3%, respectively for the three and
nine months ended September 30, 2000, when compared to the same periods in 1999
due to a reduction in the Company's overall debt, which reflects payments on the
Chase Credit Facility as well as repayment of $16.1 million of Wyckoff's current
and long-term debt in the fourth quarter of 1999.
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Energy Systems incurred losses in its GENXON joint venture of $0.2 million for
the three and nine months ended September 30, 2000. During the three and nine
months ended September 30, 1999, Energy Systems' share of GENXON's losses was
$0.2 million and $1.1 million, respectively, which represented its capital
contribution during this period. Losses on the joint venture are recognized in
the results of operations. In the third quarter of 1999, GENXON completed its
prototype development of the Kawasaki combustor unit, and subsequent testing
programs were conducted by Energy Systems. The reduced level of the Company's
investment in GENXON is expected to continue throughout 2000.
The Company recorded an income tax benefit for the three months ended
September 30, 2000, at an effective tax rate equal to 40% of pretax income. The
provision for income taxes for the nine months ended September 30, 2000, was an
effective tax rate of 39%. For the three months ended September 30, 1999, the
Company recorded an income tax benefit of 13% of pretax income. The provision
for income taxes for the nine months ended September 30, 1999, was an effective
tax rate of 18%. The 2000 effective tax rate differs from the federal statutory
tax rate primarily due to state income taxes. The 1999 effective tax rate
differed from the federal statutory tax rate primarily due to the utilization of
tax net operating loss carry forwards and the elimination of the valuation
allowance for deferred tax assets. The Company's effective tax rate will
approximate the federal statutory rate in 2000.
Liquidity and Capital Resources
Total cash, cash equivalents, and short-term investments decreased from $40.3
million as of December 31, 1999 to $19.8 million as of September 30, 2000,
primarily due to quarterly estimated tax payments, payments of incentive
bonuses, an increase in investment in capital expenditures and the operating
loss incurred during the third quarter. The Company expects to spend
approximately $60.0 million to $70.0 million during 2000 for capital
expenditures primarily at Catalytica Pharmaceuticals which includes funds for
expansion of the Greenville Sterile facility. Because of its cash position of
$19.8 million (including short-term investments) and its available line of
credit of $100.0 million as of September 30, 2000, coupled with the anticipated
cash flow from operations in 2000, the Company believes that it has adequate
funds to meet its working capital needs and debt repayment obligations for the
near and longer term.
In the second quarter of 1998, the Company entered into a $50.0 million
interest rate swap agreement to reduce the Company's exposure to fluctuations in
short-term interest rates. This agreement effectively fixed the LIBOR
benchmark rate used to calculate the Company's borrowing cost at 5.90% for 4
years on $50.0 million of the Term Debt Facility. The Company accounts for this
agreement as a hedge and accrues the interest rate differential as interest
expense on a monthly basis. The Company does not hold or transact in such
financial instruments for purposes other than risk management.
RISK FACTORS
Failure to complete the Merger could negatively impact Catalytica's stock price,
future business or operations.
On August 2, 2000, Catalytica entered into an Agreement and Plan of Merger by
and among Synotex Company, Inc. ("Synotex"), a Delaware corporation and wholly
owned subsidiary of DSM, N.V., a corporation organized under the laws of the
Netherlands, Synotex Acquisition Corporation ("Acquisition Corp."), a Delaware
corporation and wholly owned subsidiary of Synotex, and Catalytica, pursuant to
which Acquisition Corp. will merge with and into Catalytica and Catalytica will
become a wholly owned subsidiary of Synotex (the "Merger"). Immediately prior to
the consummation of the Merger, Catalytica will distribute to its stockholders
on a pro rata basis all of the shares owned by Catalytica of the combined
business of Catalytica's Energy Systems and Advanced Technologies. No assurances
can be given that the Merger will be consummated.
The consummation of the Merger is subject to the satisfaction or waiver of
numerous conditions, including the approval of the Merger by Catalytica
stockholders, the receipt of applicable regulatory clearances and the
consummation of the Spin-Off. Furthermore, on August 4, 2000, a purported class
action complaint was filed in Delaware Chancery Court in Wilmington, Delaware
against Catalytica, Morgan Stanley Dean Witter and each of the directors of
Catalytica by certain of Catalytica's stockholders on behalf of themselves and
all other stockholders of Catalytica. The complaint alleges generally that the
proposed merger transaction involving Catalytica and certain subsidiaries of
DSM, N.V. is unfair. The complaint further alleges conflicts of interest and
breaches of fiduciary duties by the directors. The plaintiffs claim to be
seeking preliminary and permanent injunctions against the proposed merger
transaction and unspecified damages and costs. Catalytica believes this
complaint is without merit and intends to defend itself vigorously.
If the Merger is not completed for any reason, Catalytica may be subject to a
number of material risks, including the following:
. Catalytica may be required under certain circumstances to pay Synotex a
termination fee of $20 million and expenses of up to $5 million;
. the price of Catalytica's common stock may decline to the extent that the
relevant current market price reflects a market assumption that the Merger
will be completed; and
. costs related to the Merger, such as legal, accounting, certain financial
advisory and financial printing fees, must be paid even if the Merger is
not completed.
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Our quarterly operating results may fluctuate and we may be unable to maintain
profitability
Catalytica's operating results have fluctuated significantly in the past and
we expect that results will continue to vary from quarter to quarter. In
particular, our quarterly results may fluctuate and our profitability may suffer
as a result of:
. loss or reductions of orders from an important customer, such as Glaxo
Wellcome
. delays in availability or increases in costs of raw materials from our
suppliers
. increased price competition or reductions in the prices that we are able to
charge
. the amount and timing of payments and expenses under development and
production contracts
. changes in demand for the pharmaceuticals sold by our customers
. new product introductions or delays in product introductions by our
customers or their competitors
. size and timing of receipt of orders for and shipments of pharmaceutical
products
. changes in product mix
. operating efficiencies in manufacturing operations
. seasonality in demand for our products
. costs associated with the merger and spin-off of the energy business
. general business conditions in our markets, particularly in the
pharmaceutical sector
As a result of these and other factors, quarter-to-quarter comparisons of our
historical results of operations are not good indicators of future performance.
If our future operating results are below the expectations of stock market
analysts, or if we are unable to remain profitable, our stock price may decline.
We depend on a single customer for a large portion of our revenues, and a
reduction in the level of business with this customer could seriously harm our
business
A single customer, Glaxo Wellcome, accounts for a large percentage of
Catalytica's revenues. During the nine months ended September 30, 2000, 64% of
Catalytica's revenues were derived from sales to Glaxo Wellcome. During the same
period in 1999, 66% of Catalytica's revenues were derived from sales to Glaxo
Wellcome. During the quarter ended September 30, 2000, 64% of Catalytica's
revenues were derived from sales to Glaxo Wellcome. During the same quarter in
1999, 69% of Catalytica's revenues were derived from sales to Glaxo Wellcome.
Catalytica's top five customers collectively accounted for approximately 78% of
its revenues for the nine months ended September 30, 2000. Even though the
portion of our revenues attributable to Glaxo Wellcome is expected to decline
over time, we anticipate that sales to Glaxo Wellcome will continue to account
for a significant portion of our revenues for the foreseeable future. Our
business would be seriously harmed if we lost Glaxo Wellcome as a customer or
suffered a large reduction in orders from Glaxo Wellcome.
Under terms of the original Glaxo Wellcome supply agreement and certain
amendments, there are scheduled reductions in product sales to Glaxo Welcome.
Revenues from Glaxo and others customers are expected to increase in the fourth
quarter of 2000 as compared to the third
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quarter of 2000. However, no assurance of this growth in revenues for the fourth
quarter can be provided.
Our product sales depend on our customers to anticipate industry needs and
accurately forecast future demand for their products
We manufacture both intermediate products used in customers' finished products
and finished products for our customers. Typically, there is a relatively
lengthy lead-time between signing a production contract and the actual
production of products under that contract. Accordingly, we rely upon the
ability of our customers to anticipate changing customer needs, successfully
market the products and obtain necessary regulatory approval. A decrease in
demand for our customers' products would lower demand for our products. We
cannot guarantee that our customers' product development efforts will be
successful, that required regulatory approvals can be obtained on a timely
basis, if at all, that products can be manufactured at acceptable cost and with
appropriate quality or that any products, if approved, can be successfully
marketed. If our customers are not successful in this regard, they might reduce
or eliminate their orders and our results of operations likely would
deteriorate.
We may be held responsible for product liability claims and may be unable to
obtain sufficient product liability insurance
As a pharmaceutical and pharmaceutical intermediate manufacturer, we could
experience product liability claims for products we manufacture if they do not
meet customer specifications. Our customers generally agree to indemnify us
with respect to potential liability claims, other than claims related to our
failure to meet their specifications.
We have product liability insurance but cannot guarantee that we will be able
to obtain sufficient levels of product liability insurance on acceptable terms
in the future. If we are held responsible for product liability and do not have
adequate insurance or are not properly indemnified, then our results of
operations could be harmed. Also, under the original Glaxo Wellcome Supply
Agreement, Catalytica Pharmaceuticals is obligated to maintain $100.0 million of
product liability insurance. If Catalytica Pharmaceuticals does not meet this
requirement, Glaxo Wellcome may terminate the Supply Agreement, which would have
a negative impact on our financial results.
On April 12, 2000, a complaint was filed with the District Court for the
Southern District of the State of New York by an individual (the "Plaintiff")
against Catalytica Pharmaceuticals and Glaxo Wellcome, alleging Zyban, a product
manufactured by Catalytica Pharmaceuticals and distributed by Glaxo Wellcome,
was dangerous and defective. The Plaintiff alleges that she suffered an adverse
reaction after using Zyban and undergoing anesthesia, including symptoms of
cognitive dysfunction and memory loss. The Plaintiff has requested a judgement
in the sum of $10,000,000. On July 17, 2000, Catalytica Pharmaceuticals and
Glaxo Wellcome responded by denying all allegations in the Plaintiff's complaint
and asking for a judgement to dismiss her complaint. Since this case is in the
early phase of discovery no documents have been exchanged nor has deposition
testimony be obtained. While the outcome of this case is uncertain, Catalytica
believes the complaint is without merit and intends to defend the action
vigorously.
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Our pharmaceutical production facilities must comply with the FDA's current
Good Manufacturing Practices ("cGMP") regulations as well as international
regulatory requirements. Additionally, some of our customers require us to
adhere to certain additional manufacturing standards specific to their
companies. Compliance with cGMP regulations as well as other company-specific
specifications requires us to expend time, money and effort to maintain precise
records and quality assurance. Failure to maintain satisfactory cGMP compliance
could have a significant adverse effect on our ability to continue to
manufacture and sell our products and, in the most serious cases, could result
in the seizure or recall of products, injunction and/or civil fines, and such
action could be taken with little or no notice.
Our facilities are subject to routine inspection by the FDA and other
international regulatory authorities for compliance with cGMP requirements and
other applicable regulations. As such, the Greenville Facility has had a total
of four regulatory inspections in 1999. Three of the inspections resulted in a
satisfactory assessment by the regulatory agency. One of the inspections, of
our chemical manufacturing facility, which took place during the week of June
28, 1999, resulted in the issuance by the FDA of an FDA Form 483 followed by a
letter, which detailed specific areas where the FDA inspectors observed that we
were not in full compliance with certain regulatory requirements. Corrective
actions addressing all identified observations were initiated immediately, and a
re-inspection conducted by the FDA within one month of our receipt of the letter
resulted in concurrence by the FDA that all issues had been addressed to their
satisfaction.
Our operations must comply with environmental regulations, and any failure to
comply could result in extensive costs, which would harm our business
Our research, development and manufacturing activities involve the use,
storage, transportation and disposal of many hazardous chemicals and are subject
to regulations governing air pollution and wastewater treatment. As a result,
our activities are subject to extensive federal, state and local laws and
regulations, some of which have recently changed. For example, in 1998, the
United States Environmental Protection Agency, or EPA, issued new regulations
for the pharmaceutical industry requiring the installation of "maximum
achievable control technology" for hazardous air pollution sources and
additional pretreatment systems for wastewater discharges. We currently are
evaluating the potential impact of these regulations on our operations and we
believe that these new regulations may require us to make large cash
expenditures. These and any other new regulatory changes could result in
renovations, improvements or other cash expenditures to bring our facilities and
operations into compliance. A failure to comply with present or future
environmental laws could result in:
. imposition of injunctions or orders to stop production and operations
. payment of fines, costs of remediation or damages
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. restrictions on expansion of operations
. other expenditures as required to comply with environmental requirements
If our operations do not comply with environmental regulations for any reason,
any of these events could occur and the occurrence could harm our financial
condition.
For example, in 1999, Catalytica's Greenville Facility experienced a chemical
release as a result of a broken pipeline. Shortly thereafter, Catalytica, the
North Carolina Occupational Health and Safety Agency and the North Carolina Air
Quality Division investigated this incident. The investigation was resolved in
February 2000.
Soil and groundwater contamination exists at our facilities, and the
contamination may result in large expenditures of cash and other resources
As the owner of the Greenville Facility, Catalytica Pharmaceuticals is legally
liable for the existing contamination at the site. However, Glaxo Wellcome, the
previous owner, has agreed to pay the costs of remediation to the extent
contamination existed at the time it sold the property to Catalytica. Despite
its agreement with Glaxo Wellcome, Catalytica could be held responsible for the
contamination in an action brought by a governmental agency or a third party.
Catalytica's current operations and future expansion of the Greenville Facility
could be slowed or prevented by required remediation activities at the site.
Catalytica Pharmaceuticals' ongoing operations at the Greenville Facility also
may cause additional contamination. The determination of the existence and cost
of any such additional contamination contributed by Catalytica Pharmaceuticals
could involve costly and time-consuming negotiations and litigation. Additional
contamination could harm Catalytica's business, results of operations and
financial condition.
Similarly, Catalytica's Bay View facility has arsenic and volatile organic
compound contamination in the soil and groundwater. The site is subject to a
clean-up and abatement order issued by the Bay Area Regional Water Quality
Control Board. The order requires stabilization, containment and monitoring of
the contamination at the site and surrounding areas by the current owner of the
property, Aventis, formerly Rhone Poulenc, Inc. Although Catalytica has
contractual rights of indemnity from Aventis and from Novartis, the prior
owners/operators of the facilities, Catalytica could be named in an action
brought by a governmental agency or a third party because of the contamination.
If Catalytica is determined to have contributed to the contamination, Catalytica
may be liable for any damage to third parties attributable to its contamination,
and may be required to indemnify Aventis and Novartis for any clean up costs or
liability that they may incur as a result. Any litigation or determination of
the existence and cost of this contamination would likely be costly and time-
consuming. Catalytica recently announced plans to close the Bay View facility.
If the facility does not continue operation in some capacity, regulatory
agencies will require environmental closure of the Bayview Facility, which could
result in Catalytica incurring significant costs to address facility shutdown
and de-contamination.
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The Wyckoff manufacturing site is listed under Michigan law as a site with
soil and groundwater contamination. Environmental assessments conducted on the
Wyckoff property have identified soil contamination by volatile organic
compounds and heavy metals. We are legally liable under federal and state law
for the remediation of these areas of contamination. In addition, risks of
environmental costs and liabilities are inherent in plant operations and
products produced by Wyckoff. Wyckoff's ongoing operations could cause
additional contamination, which could harm our business, results of operations
and financial condition.
Environmental regulations may delay the commercialization of Catalytica's
catalytic energy systems or increase the costs of bringing products to market
The enactment and enforcement of environmental regulations at the federal,
state and local levels will strongly influence the demand for emissions
reduction systems, and thus will affect the rate at which industrial companies
adopt Energy Systems' catalytic combustion systems. As a result, Energy Systems'
revenues will depend, in part, on the environmental standards that government
authorities adopt for reducing emissions (including emissions of nitrogen oxide)
addressed by its products. Government authorities may revise existing
regulations in a manner that could diminish demand for Energy Systems' products.
Moreover, new regulations may impose requirements that are not met by Energy
Systems' products or may necessitate costly redevelopment or modification of its
products. Also, certain industries or companies may seek to delay the
implementation of existing or new regulations, or acquire emissions credits from
other sources, which would delay or eliminate their need to purchase emissions
reduction products. If any of these circumstances arise, Energy Systems may not
realize the expected returns on its investment in the catalytic combustion
business.
Some of Catalytica's manufacturing facilities are underutilized, and this
underutilization may harm our operating results
Currently, Catalytica's pharmaceutical production and sterile production
facilities at its Greenville Facility are not fully utilized. To utilize its
manufacturing resources fully, Catalytica must continue to successfully obtain
new pharmaceuticals customers, expand business with existing customers and
obtain necessary regulatory approvals for production of new products. As a
result of reductions in the level of business attributable to Glaxo Wellcome and
the long lead times required to obtain regulatory approvals to manufacture at
our pharmaceutical and sterile production facilities, if we are to fully utilize
our pharmaceutical and sterile production facilities, we must continue to enter
into agreements for additional business far enough in advance of production to
obtain required regulatory approvals. If we are unable to do these things, our
pharmaceutical and sterile production facilities will remain underutilized, and
this may harm our operating results.
Our success depends on the ability of our customers to develop new
pharmaceutical products and obtain required regulatory approvals for those
products
The success of our pharmaceutical production operations depends on receiving
orders from our customers for the production of active ingredients,
intermediates, and pharmaceutical
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products in finished dosage form. The clinical development, testing and sales of
these products is subject to regulation by the FDA and other regulatory
authorities in the United States and abroad. As a result, we depend on our
customers to both develop new pharmaceutical products and obtain the required
regulatory approvals. If our customers are unable to develop new products or
obtain required approvals, our pharmaceutical production facilities may be
underutilized and our results of operations may be harmed.
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Ownership of Catalytica's stock is concentrated in one owner, and this owner may
make decisions contrary to the interests of other stockholders
As of September 30, 2000, Morgan Stanley Capital Partners and its affiliates
held approximately 29% of Catalytica's voting stock and 43% of our total
outstanding voting and non-voting stock. Morgan Stanley can convert a portion of
its non-voting stock into voting stock only if the conversion results in Morgan
Stanley holding 40% or less of Catalytica's outstanding voting stock. On
November 13, 2000, Morgan Stanley and its affiliates converted 6,344,598 shares
of its non-voting stock into shares of voting stock resulting in Morgan Stanley
and its affiliates holding approximately 37% of Catalytica's voting stock. As a
result of its stock ownership and contractual rights, Morgan Stanley has
significant influence over all matters requiring stockholder approval, including
the election of directors and approval of major corporate transactions such as
mergers, consolidations or sales of assets, including the Merger. Morgan Stanley
also has the right to designate three nominees for election to Catalytica's
board of directors and rights to a separate class vote on certain merger and
financing transactions. This concentration of ownership and these contractual
rights may allow Morgan Stanley to require us to take actions, or delay or
prevent us from taking actions that would otherwise be in the stockholders'
interest. In connection with the Merger, Morgan Stanley and certain other
stockholders of Catalytica have entered into a Voting Agreement pursuant to
which Morgan Stanley and such other stockholders have agreed to vote in favor of
the acquisition and against certain other matters. This Voting Agreement is
filed as an exhibit to the report on Form 8-K filed by Catalytica on August 10,
2000.
The sale by Morgan Stanley of shares of Catalytica's capital stock could
constitute a change of control under Catalytica's credit agreement, which would
trigger a default under the agreement. Although Morgan Stanley has agreed not to
trigger a change of control under the credit agreement, the sale of shares by
Morgan Stanley in breach of this provision could cause Catalytica to default
under its credit agreement. In that event, Catalytica might not be able to
obtain sufficient credit in a timely fashion or on acceptable terms. In such
event, its operations could be adversely affected, causing product delays, loss
of customers and deterioration of financial results.
If the Acquisition of Wyckoff does not qualify as a pooling of interests,
Catalytica's reported earnings could be lower in future periods
Catalytica expects the acquisition of Wyckoff to be accounted for as a pooling
of interest transaction. To qualify the acquisition as a pooling of interests
for accounting purposes, Wyckoff, Catalytica and their respective affiliates
must meet the criteria for pooling of interests accounting established in
opinions published by the Accounting Principles Board and interpreted by the
Financial Accounting Standards Board and the SEC. These opinions are complex
and the interpretation of them is subject to change.
The availability of pooling of interests accounting treatment for the
acquisition depends, in part, upon circumstances and events occurring after
completion of the acquisition. For example,
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the business of the combined company cannot change in a significant manner,
including significant sales of assets, for a period of two years following
completion of the acquisition. The failure of the acquisition to qualify for
pooling of interests accounting treatment for any reason could materially reduce
Catalytica's future reported earnings.
Many of our competitors have greater financial resources, research and
development experience and marketing ability
The market in which we compete is characterized by extensive research efforts
and rapid technological change. We have numerous competitors in the United
States, Europe and Asia, many of whom have greater research and development
capabilities, financial resources, managerial resources, marketing experience
and manufacturing experience. Our primary competition comes from pharmaceutical
companies that manufacture their own products and from other chemical
manufacturers such as Lonza AG, Bayer, Chirex, Cambrex, Great Lakes, Dow and
until the merger is completed, DSM Fine Chemicals. If our competitors are
successful in developing systems and processes that are more effective than our
own, then our ability to sell our products, services, systems and processes
would be harmed. Our competitors may develop technologies, systems and processes
that are more effective than ours or that would render our technology, systems
and processes less competitive or obsolete. In addition, our success depends in
part on our ability to sell products to potential customers at an early stage of
product development, and there can be no assurance that we will be successful in
these efforts.
A small portion of our business experiences substantial competition in
connection with the manufacture and sale of pharmaceutical products for which
patent protection has expired ("off-patent" products). We compete with off-
patent drug manufacturers, brand-name pharmaceutical companies that manufacture
off-patent drugs, and manufacturers of new drugs that may compete with our off-
patent drugs. Because selling prices of off-patent drugs typically decline as
competition intensifies, the maintenance of profitable operations will depend on
our ability to maintain efficient production capabilities and to develop and
introduce new products in a timely manner. If we are unable to develop
manufacturing processes soon after products are off-patent, or if other
manufacturers develop alternative manufacturing processes, we would be required
to compete with multiple manufacturers and would experience additional pricing
pressures in its sale of products to the generic market.
In the combustion systems market, our competition comes from large gas turbine
power generation manufacturers, such as Allison Engine Company, General Electric
and Solar Turbines as well as producers of post-combustion emission clean-up
technologies such as selective catalytic reduction systems. Gas turbine
manufacturers are developing competing dry-low-nitrogen oxide systems for their
own turbines. Many of our competitors in the combustion systems market are also
potential customers. We depend on our customers to help commercialize our
products, and would suffer loss of sales and revenues if these customers
withdraw their support or decide to pursue alternate technologies. Our ability
to gain market share may be limited because many of our competitors are existing
or potential customers.
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If we are unable to protect and expand our intellectual property rights, our
competitive position will suffer
Our business depends on developing and maintaining a strong intellectual
property portfolio in the United States and abroad. We actively pursue patents
for our inventions in relevant business areas. We have approximately 40 patents
and at least 21 pending patent applications in the United States and
approximately 145 patents and patent applications abroad. Our patent
applications might not result in the issuance of patents. Further, our existing
and future patents might not provide enough protection to protect our technology
and competitive position.
The success of our current products, as well as development of additional
products, depends on our ability to protect our intellectual property portfolio
and obtain additional patents without infringing the proprietary rights of
others. If we do not effectively protect our intellectual property, our
business could be materially harmed.
Even if we are able to obtain patents covering our technology, the patents may
be challenged, circumvented or invalidated. Competitors may develop
independently similar systems or processes or design around patents issued to
us. Also, patents issued in the United States may be unenforceable, or may not
provide as much protection, outside the United States. If any of our patents
are circumvented, invalidated or otherwise do not provide legal protection, our
competitors may be able to develop, manufacture and sell products which compete
directly with our products. In that case, our sales and financial results could
be harmed.
We also protect our proprietary technology and processes in part by
confidentiality agreements with our collaborative partners, employees and
consultants. However, these agreements might be breached, and in that event, we
might not have adequate remedies for the breach. Further, our trade secrets
might otherwise become known or be independently discovered by competitors.
A third party claim of infringement of intellectual property could require us to
spend time and money to address the claim and could shut down some of our
operations
We could incur substantial costs in defending ourselves or our licensees in
litigation brought by others or in interference proceedings declared by the
United States Patent and Trademark Office. An adverse ruling, including an
adverse decision as to the priority of our inventions, would undercut our
intellectual property position and could ultimately have a negative impact on
our sales and financial position.
We may be required to obtain licenses to patents or other proprietary rights
held by third parties. However, these licenses might not be available on
acceptable terms, if at all. In that event, we could encounter delays in system
or process introductions while we attempt to design around the patents, or we
may be unable to continue product development in the particular field. In
either case, our competitive position would likely suffer, and our stock price
could decline as a result.
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Energy Systems' product is in early stages of development and its ability to
develop an effective and commercially successful product depends on whether it
and its strategic partners can complete development and integration work
Energy Systems' product, Xonon Cool Combustion system, is in the development
stage and must be thoroughly tested in gas turbines and integrated by original
equipment manufacturers into their gas turbine products before
commercialization. Additional development work may also be required in order to
integrate our product into any particular gas turbine. Whether the Xonon system
will ultimately be commercially successful, and whether Energy Systems will
ultimately be profitable, will depend on a number of factors, including:
. its ability to overcome technical hurdles associated with the incorporation
of Xonon into particular gas turbines to provide an effective emissions
reduction system
. willingness of gas turbine manufacturers to incorporate the Xonon system in
their products
. prices and effectiveness of alternative emissions reduction systems
. economic conditions in the utilities and power generation sector
. changes in regulatory requirements, particularly emissions standards
governing gas turbines and power generation
In particular, Energy Systems' ability to complete research and development
and introduce Xonon systems in the large gas turbine market depends on the
continued efforts of General Electric, the world leader in the manufacture of
large gas turbines. Catalytica also must develop and maintain relationships
with other gas turbine suppliers to commercially introduce Xonon systems in
other gas turbine markets. If any major turbine manufacturers terminate their
relationship with Energy Systems, then Catalytica may not be able to complete
the development and introduction of the Xonon system for that part of the
market.
Energy Systems has limited manufacturing and marketing experience and will need
to develop these capabilities or find strategic partners to make and sell its
products
Catalytica currently has limited manufacturing capability for its Xonon
products. Catalytica expects to expand its manufacturing capability, which will
require capital expenditures. Further, to market any of our combustion system
products, we must develop marketing capability, either on our own or in
conjunction with others. Catalytica may not be able to develop an effective
marketing and sales organization or enter into marketing arrangements on
acceptable terms.
The GENXON joint venture may require additional funding and may not result in
successful products
Energy Systems' joint venture, GENXON, is not currently profitable and may not
become profitable in the future. GENXON might not succeed in developing new
combustion systems that will work effectively and economically. Neither joint
venture partner is contractually required to make further capital infusions. If
Catalytica's partner were to decide not to make additional capital
contributions, Catalytica would be faced with the possibility of having to fund
the joint venture on its own or find additional sources of financing. In this
event, additional
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financing might not be available on acceptable terms, or at all. As a result,
Catalytica's results of operations and financial condition could be adversely
affected.
In October 1996, GENXON entered into a technical services agreement with the
City of Glendale in California for the retrofit of one of the City's gas
turbines with the Xonon system for a total turnkey price of $700,000. GENXON
did not complete the agreed-upon retrofit and returned the engine to the City in
its original state. On August 14, 2000, the City of Glendale filed a complaint
against Catalytica and GENXON. The complaint asserts claims against all
defendants for breach of contract, breach of the covenant of good faith and fair
dealing, fraud and negligent misrepresentation arising out of defendants'
failure to complete irs performance under a Technical Services Agreement between
the City of Glendale and Catalytica providing for the retrofit of the FT4 engine
with the FT4 Xonon Combustion System. The City of Glendale seeks compensatory
damages in excess of $7,500,000 and punitive damages. While the outcome of this
case is uncertain, Catalytica believes the complaint is without merit and
intends to defend the action vigorously.
Interruption of supply of key raw materials could cause delays in meeting
product orders, loss of customers and increased costs of production
We purchase raw materials, primarily chemicals, from suppliers throughout the
world. These chemicals range from basic commodities to more sophisticated
advanced intermediates. In many instances we use only one supplier to get a
volume discount and to ensure the chemicals meet our stringent quality
standards. If the supply of a key raw material is interrupted for any reason,
this could have an adverse impact on our ability to manufacture a particular
active pharmaceutical ingredient or advanced intermediate for our customers. In
most situations, there are alternate suppliers throughout the world of any
chemical that we require. If there was a significant delay in identifying and
qualifying a new supplier or if there are no alternate suppliers, there could be
a loss of sales and of customers, and ultimately an increase in the cost of
production. Any of these events could have a material adverse effect on our
results of operations.
We do not have a long-term supply agreement with most of our suppliers. We
purchase the chemicals on a purchase order basis and forecast our needs based on
our customers' requirements. There can be no assurance that such suppliers will
continue to make available to us the required raw materials on reasonable terms,
if at all. The availability and price of raw materials may be subject to
curtailment or change due to limitations that may be imposed under new
legislation or governmental regulations, suppliers' allocations to meet demand
of other purchasers, interruptions in production by suppliers and other
conditions. In addition, raw materials used by us may be subject to significant
price fluctuations. A substantial increase in prices or a continued
interruption in supply would have a material adverse effect on our business and
results of operations.
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FORWARD-LOOKING STATEMENTS MAY PROVE INACCURATE
The statements contained in this quarterly report that are not historical
facts are "forward-looking statements" within the "safe harbor" provisions of
the Private Securities Litigation Reform Act of 1995. These statements involve
risks and uncertainties and can be identified by the use of forward-looking
terminology such as "estimates," "projects," "anticipates," "plans," "future,"
"may," "will," "should," "predicts," "potential," "continue," "expects,"
"intends," "believes" and similar expressions. Examples of these forward-looking
statements include:
. the timing and likelihood of the consummation of the merger with Synotex
and the spin-off of the Energy Systems and Advanced Technologies businesses
. our expectations regarding ongoing litigation
. our expectations regarding the amounts of future sales revenues from Glaxo
Wellcome and other pharmaceutical customers
. our estimates of future operating results and our ability to remain
profitable
. statements regarding the development of our business and products,
including our ability to develop new pharmaceutical business and
commercialize our Xonon product
. our ability to develop technologies for efficient manufacturing processes
and solve environmental problems
. our expectations regarding our R&D efforts, including our expectations
regarding future R&D reserves
. opportunities for the use and commercialization of our technologies
. the amounts of any future expenditures which may be necessary to comply
with environmental, health and safety regulations and to remediate
environmental contamination
. our expectations regarding our future investment in GENXON
. Year 2000 compliance, including expected costs and timing of ongoing Year
2000 compliance efforts and expectations regarding the potential effects of
non-compliance
. our ability to account for our acquisition of Wyckoff Chemical Company as a
pooling of interests
. our anticipated capital expenditures and future financial condition
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. other statements contained in this quarterly report regarding matters that
are not historical facts
These and other forward-looking statements in this quarterly report are only
estimates or predictions. While we believe that the expectations reflected in
the forward-looking statements are reasonable, we can give you no assurance that
future results will be achieved. Forward-looking statements are subject to known
and unknown risks, uncertainties and other factors that may cause our actual
operating results, levels of activity, financial performance, achievements and
prospects to be materially different from those expressed or implied by the
forward-looking statements. These risks, uncertainties and other factors
include, among others, those identified in the "Risk Factors" section and
elsewhere in this quarterly report. We disclaim any obligation to update
information contained in any forward-looking statement.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to financial market risks, including changes in
interest rates. In the second quarter of 1998, following the restructuring of
the Chase credit agreement, Catalytica entered into a $50.0 million interest
rate swap transaction to reduce Catalytica's exposure to fluctuations in short-
term interest rates. This interest rate swap transaction effectively fixed the
LIBOR benchmark rate used to calculate Catalytica's borrowing cost at 5.9% for
four years on $50.0 million of the debt facilities. Catalytica accounts for this
interest rate swap as a hedge, and accrues the interest rate differential as
interest expense on a monthly basis. If the designated debt obligation is
extinguished early, any realized or unrealized gain or loss from the swap would
be recognized in income coincident with the extinguishment gain or loss.
Catalytica does not hold or transact in such financial instruments for purposes
other than risk management.
The notional principal amount for the off-balance-sheet instrument provides
one measure of the transaction volume outstanding as of year end, and does not
represent the amount of Catalytica's exposure to credit or market loss.
Catalytica believes its gross exposure to potential accounting loss on this
transaction if all counterparties failed to perform according to the terms of
the contract, based on then-current interest rates at each date, would have no
material financial impact. Catalytica's exposure to credit loss and market risk
will vary over time as a function of interest rates.
With the interest rate swap, Catalytica either makes or receives payments on
the interest rate differential between 5.9% and the actual interest paid on its
debt which has a floating interest rate based on the three-month United States
dollar LIBOR rate. As a result, the swap effectively converts $50.0 million of
Catalytica's floating- rate debt to a four-year fixed-rate debt. The maturity
date for the swap is June 10, 2002. For the year ended December 31, 1999, the
receive rate on the swap hedging debt was 5.3%. The pay rate on the swap is
5.9%. The gain or loss on the swap is recognized in net interest expense in the
same period as the hedged transaction. Given the above agreement, approximately
22% of Catalytica's outstanding debt was variable at December 31, 1999. A
hypothetical increase of 100 basis points in interest rates would not result in
a material exposure to the Company.
The Company's market risk disclosures set forth have not changed significantly
through the nine months ended September 30, 2000.
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PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
On April 12, 2000, a complaint was filed with the District Court for the
Southern District of the State of New York by an individual (the "Plaintiff")
against Catalytica Pharmaceuticals and Glaxo Wellcome, alleging Zyban, a
product manufactured by Catalytica Pharmaceuticals and distributed by Glaxo
Wellcome, was dangerous and defective. The Plaintiff alleges that she suffered
an adverse reaction after using Zyban and undergoing anesthesia, including
symptoms of cognitive dysfunction and memory loss. The Plaintiff has requested
a judgement in the sum of $10,000,000. On July 17, 2000, Catalytica
Pharmaceuticals and Glaxo Wellcome responded by denying all allegations in the
Plaintiff's complaint and asking for a judgement to dismiss her complaint.
Since this case is in the early phase of discovery no documents have been
exchanged nor has deposition testimony been obtained. While the outcome of
this case is uncertain, Catalytica believes the complaint is without merit and
intends to defend the action vigorously.
On August 4, 2000, a purported class action complaint was filed in Delaware
Chancery Court in Wilmington, Delaware against Catalytica, Morgan Stanley Dean
Witter and each of the directors of Catalytica by two of Catalytica's
stockholders on behalf of themselves and all other stockholders of Catalytica.
The complaint alleges generally that the proposed merger transaction involving
Catalytica and certain subsidiaries of DSM, N.V. is unfair. The complaint
further alleges conflicts of interest and breaches of fiduciary duties by the
directors. The plaintiffs claim to be seeking preliminary and permanent
injunctions against the proposed merger transaction and unspecified damages and
costs. Catalytica believes this complaint is without merit and intends to defend
itself vigorously.
On August 14, 2000, the City of Glendale filed a complaint against Energy
Systems, Catalytica and Genxon Power Systems, Inc. in Los Angeles County
Superior Court, Case No. EC029841. The action has been transferred to the
Superior Court for Orange County, California. The complaint asserts claims
against all defendants for breach of contract, breach of the covenant of good
faith and fair dealing, fraud and negligent misrepresentation arising out of
defendants' failure to complete its performance under a Technical Services
Agreement between the City of Glendale and Catalytica providing for the retrofit
of the FT4 engine with the FT4 Xonon Combustion System. The City of Glendale
seeks compensatory damages in excess of $7,500,000 and punitive damages. The
defendants believe they have meritorious defenses to the claims asserted and
intend to defend the action vigorously.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
2.1* Agreement and Plan of Merger by and among Synotex Company, Inc.
Synotex Acquisition Corporation and Catalytica, Inc. dated August 2, 2000
4.9(1) Amendment No. 2, dated as of August 2, 2000, to the Preferred Shares
Rights Agreement between Catalytica, Inc. and Chase Mellon Shareholder
Services, L.L.C.
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9.1* Voting Agreement by and among Synotex Company, Inc., Catalytica, Inc.
and certain stockholders of Catalytica dated August 2, 2000.
27.1 Financial Data Schedule
* Incorporated by reference to the exhibit of the same number contained in
the Company's report on Form 8-K filed on August 10, 2000.
(1) Incorporated by reference to exhibits filed with Catalytica, Inc.'s Form
10-Q for the quarter ended June 30, 2000 (Commission File No. 0-20966).
(b) Reports on Form 8-K
The Company filed no reports on Form 8-K during the quarter ended September
30, 2000.
All information required by other items in Part II is omitted because the
items are inapplicable, the answer is negative or substantially the same
information has been previously reported by the registrant.
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CATALYTICA, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 14, 2000
CATALYTICA, INC.
(Registrant)
/s/ Lawrence W. Briscoe
By: ------------------------------
Lawrence W. Briscoe
Vice President and Chief
Financial Officer
Signing on behalf of the
registrant and as principal
financial officer
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