Back to GetFilings.com
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the fiscal year ended December 31, 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 ENERGY SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
Delaware 77-0410420
(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)
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)
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 26, 2001, there were outstanding 12,324,095 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 The Nasdaq National Market on February 26, 2001) was
$199,057,708. For purposes of this disclosure, shares of common stock held by
each officer and director of the Registrant and by each person who owns 5% or
more of the outstanding voting stock have been excluded in that such persons may
be deemed to be affiliates. This determination of affiliate status is not
necessarily a conclusive determination for other purposes.
Documents Incorporated by Reference
The information called for by Part III is incorporated by reference to the
definitive Proxy Statement for the Annual Meeting of Stockholders of the Company
which will be filed with the Securities and Exchange Commission no later than
120 days after December 31, 2000.
================================================================================
CATALYTICA ENERGY SYSTEMS, INC.
Annual Report on Form 10-K
Table of Contents
December 31, 2000
Page No.
--------
PART I
Item 1. Business 2
Item 2. Properties 18
Item 3. Legal Proceedings 18
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 19
Item 6. Selected Financial Data 19
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 21
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 33
Item 8. Financial Statements and Supplementary Data 33
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 33
PART III
Item 10. Directors and Executive Officers of the Registrant 34
Item 11. Executive Compensation 34
Item 12. Security Ownership of Certain Beneficial Owners and Management 34
Item 13. Certain Relationships and Related Transactions 34
PART IV
Item 14. Exhibits and Reports on Form 8-K 35
1
ITEM 1. BUSINESS
Overview
Catalytica Energy Systems, Inc. ("Catalytica Energy") designs and develops
advanced products for more effective energy production. Our first product, the
Xonon(TM) Cool Combustion system, prevents the formation of air pollutants in
stationary gas turbines that are primarily used for electric power generation.
Our Xonon system is the only commercially available pollution prevention
technology that enables ultra low emissions in gas turbine power generation.
We have been generating essentially pollution-free electric power for Silicon
Valley residents for more than 7400 hours with a Xonon-equipped 1.4 megawatt
("MW") gas turbine. Both GE Power Systems ("GE") and Kawasaki Motors Corp.,
U.S.A. ("Kawasaki") have received initial orders for Xonon-equipped gas turbines
and we are working with each of them under collaborative commercialization
agreements to incorporate Xonon into the combustor of their gas turbines. In
addition, we have development work underway with other gas turbine original
equipment manufacturers ("OEMs") to incorporate the Xonon system into their
turbines.
The Xonon Cool Combustion system consists of the Xonon module and proprietary
technology to incorporate it into the combustor of a gas turbine. The module is
designed to be replaced in accordance with the routine maintenance schedule for
the gas turbine. We expect to derive revenue from the sale of both new and
replacement Xonon modules.
By essentially preventing the formation of pollution, our Xonon Cool Combustion
system provides a more efficient, cost-effective solution for enabling ultra low
emissions in power generation and other gas turbine applications. Post-
emissions cleanup systems, like selective catalytic reduction ("SCR"), can
achieve ultra low emissions in some gas turbine configurations but typically
require the use of toxic ammonia and add considerably to the square footage and
operating cost of the power generation facility. Additionally, conventional
exhaust cleanup systems cannot be used in all gas turbine applications. Simple-
cycle gas turbines that do not employ heat recovery systems, for example, have
exhaust temperatures too high for conventional exhaust cleanup systems to be
effective, while high-temperature SCR systems have not been adequately proven in
high temperature exhaust configurations and are more costly than conventional
SCR. As such, we believe that Xonon may expand the use of gas turbines by
enabling the production of power in areas in which it was previously difficult
to obtain a permit to do so or in which operation was limited due to the
inability of existing technology to control unacceptably high emissions levels.
In addition to our Xonon Cool Combustion system, we are also focused on
technology development efforts for the energy industry, including early stage
development work on fuel processing for fuel cells, as well as adaptation of our
Xonon technology to microturbines, hybrid gas turbine fuel cells, and diesel
applications.
History and Background
We became a publicly traded company on NASDAQ on December 18, 2000. Prior to
that, we operated as a subsidiary of Catalytica, Inc. under the name Catalytica
Combustion Systems, Inc. In October 2000, we changed our name to Catalytica
Energy Systems, Inc. When Catalytica, Inc. was acquired on December 15, 2000 by
Synotex Company, Inc., a U.S. subsidiary of DSM, N.V., its two subsidiaries
Catalytica Energy Systems and Catalytica Advanced Technologies were merged and
spun off as a single new public entity, Catalytica Energy Systems. Much of our
early work and proprietary technologies held today are the product of our
discovering and developing catalytic technologies at Catalytica, Inc. For
example, we discovered our breakthrough Xonon Cool Combustion technology in the
late 80's and were issued our first patents on the technology in 1993.
Our Product
How Xonon Cool Combustion Works
A gas turbine operates by compressing incoming air, combining it with fuel, and
combusting the mixture. The combustion process releases the fuel's energy,
forming hot gases that power the turbine. In conventional combustion systems, a
flame is used to combust the fuel. The temperature required to sustain a stable
flame is significantly higher than the temperature at which the gas turbine is
designed to operate. This excessive temperature causes the nitrogen and oxygen
in the air to react, forming nitrogen oxides ("NOx"), a major contributor to air
pollution.
2
We have developed Xonon Cool Combustion, a catalytic technology that combusts
fuel flamelessly. This system provides the same amount of output energy as
flame-based combustion systems but at a lower peak temperature. Importantly,
this lower temperature is below the threshold at which NOx is formed. The Xonon
combustion system is the only gas turbine combustion system demonstrated to
achieve ultra low emissions.
How Xonon Cool Combustion is Integrated into the Gas Turbine
We collaborate with gas turbine OEMs to adapt their combustion systems to
incorporate the Xonon Cool Combustion system. Together with the OEMs, we
believe that we can design the Xonon combustion system to suit any size and type
of gas turbine. For each turbine model that an OEM agrees to pursue, we design a
catalytic Xonon module, the key component of the Xonon system, to fit directly
into the turbine combustor(s).
We then manufacture the custom-designed Xonon modules and sell the Xonon modules
to OEMs to incorporate them as an integral part of their product. At present,
the Xonon modules have an expected life of 8000 hours (equivalent to
approximately one year of continuous operation) and are designed to be replaced
during regular, scheduled maintenance over the 15 to 20-year life of the
turbine.
Key Benefits of Xonon Cool Combustion
We have developed and are marketing the Xonon Cool Combustion system for gas
turbines used primarily in electric power generation. Integration of the Xonon
Cool Combustion system has several key benefits when compared to conventional
gas turbine combustion and emissions reduction systems:
. Essentially Eliminates the Formation of NOx. High temperatures in
conventional gas turbine combustion systems result in the formation of NOx, a
harmful pollutant. The Xonon Cool Combustion system allows combustion to
occur at lower temperatures, avoiding the formation of NOx and achieving
ultra low emissions.
. Reduces Emissions of Carbon Monoxide and Unburned Hydrocarbons. In
traditional flame-based combustion, measures used to reduce emissions of NOx
often increase emissions of carbon monoxide and unburned hydrocarbons. Since
the Xonon Cool Combustion system uses catalytic combustion rather than flame-
based combustion, carbon monoxide and the hydrocarbon fuel are more
thoroughly combusted. As a result, only trace amounts of carbon monoxide and
unburned hydrocarbons remain in the exhaust.
. Avoids Costly Exhaust Cleanup. Gas turbines using flame-based combustion can
achieve ultra low emissions only in some applications and only through the
combination of lean pre-mix combustion and exhaust cleanup systems. Gas
turbine exhaust cleanup systems, however, add significant capital and
operating costs, reduce system efficiency, take up space, and in many cases
require the use of toxic chemicals. Xonon enables gas turbines in essentially
all applications to achieve ultra low emissions, without the use of exhaust
cleanup systems.
. Maintains Gas Turbine Efficiency. Flame-based combustion and the Xonon Cool
Combustion system release the same energy from the fuel and therefore achieve
the same combustion efficiency required for optimal operation of the turbine.
. Reduces Potential for Premature Component Failure. The Xonon combustion
system avoids the combustor vibration or "noise" that can occur when a
conventional flame is modified to reduce NOx formation. We believe that this
may result in more stable combustion operating conditions, reduced stress and
wear-and-tear on expensive combustion parts, and less potential for premature
component failure.
. Broadens Gas Turbine Applicability. To date, conventional exhaust cleanup
systems cannot be applied cost-effectively to all applications and sizes of
gas turbines. For example, simple cycle turbines, or turbines without heat
recovery systems, cannot use conventional exhaust cleanup systems.
Additionally, it can be cost-prohibitive for smaller gas turbines to use
exhaust cleanup systems. As a result, these facilities cannot achieve ultra
low emissions. We believe Xonon will enable essentially all applications and
sizes of gas turbines to achieve ultra low emissions, thus broadening their
range of uses.
. Expands Gas Turbine Use in Urban Areas. Xonon-equipped turbines can be put
into service in densely populated areas where environmental concerns may have
previously prevented gas turbines from being used.
3
With all these benefits, Xonon should significantly increase flexibility in
siting, permitting, and operating new and installed gas turbines.
Key Milestones Achieved
The following is a summary of our key milestones since initial development of
Xonon in 1988:
Date Key Dates and Milestones
- ---- ------------------------
1988 Discovered Xonon technology and initiated development
1989 Q4 Demonstrated viability of Xonon technology under laboratory
conditions
1991 Q1 Completed test of pilot-scale Xonon module with GE
1992 Q1 Initiated full-scale Xonon module test with GE
1994 Q4 Completed 7000-hour catalyst durability test
1996 Q1 Began joint development program with Rolls-Royce plc
1996 Q2 Began joint development program with Solar Turbines
1997 Q2 Published joint research paper with GE reporting ultra low
emissions in Xonon tests
1997 Q3 Completed 1000+ hour prototype gas turbine demonstration
1998 Q1 Obtained $30 million equity investment from Enron Ventures
1998 Q4 Signed Collaborative Commercialization & License Agreement
with GE Power Systems
1999 Q2 Commenced operation of Xonon-equipped turbine connected to
electric utility grid at Silicon Valley Power in Santa
Clara, California
1999 Q4 Obtained ISO 9001 registration for design, installation,
manufacturing and service of Xonon modules
1999 Q4 Announced that Enron specified the Xonon combustion system
as the preferred emissions control system on Frame 7FA (170
MW) gas turbines that it ordered from GE
1999 Q4 Completed 4,000 hours of operation of Xonon-equipped turbine
at Silicon Valley Power
2000 Q1 Announced satisfaction of all EPA guidelines for an
"achieved in practice" technology
2000 Q2 Agreed with GE to commercialize the Xonon-equipped GE10
(11MW) gas turbine (formerly the Nuovo Pignone PGT 10
turbine)
2000 Q2 Announced GE's and Alliance Power's preliminary agreement to
order six Xonon-equipped GE10 gas turbines
2000 Q2 Announced Enron Energy Services' order for three Xonon-
equipped Kawasaki M1A-13X (1.4 MW) gas turbines
2000 Q3 Received distributed power generation research award from
the U.S. Department of Energy ("DOE"), which provided for
additional R&D funding
2000 Q3 Announced that Xonon Cool Combustion won the EPA's first
Clean Air Excellence Award in the Clean Air Technology
category for its impact, innovation, and replicability
2000 Q3 Catalytica Inc. announced its intention to spin off
Catalytica Combustion Systems and Catalytica Advanced
Technologies as a single new public entity
2000 Q4 Unveiled Catalytica Energy Systems as new name for
Catalytica Combustion Systems
2000 Q4 First day of trading of Catalytica Energy Systems on the
Nasdaq National Market as a new public entity - (Nasdaq:
CESI)
2000 Q4 Entered into commercialization agreement with Kawasaki to
supply Xonon-equipped Kawasaki turbines to the distributed
generation market
4
2001 Q1 Received third party confirmation for Xonon's ultra low
emissions capabilities through the U.S. Environmental
Protection Agency's ("EPA") Environmental Technology
Verification ("ETV") Program.
The Changing Electric Power Industry
Three major forces are reshaping the electric power industry today:
. A broad restructuring initiative seeking to solve the shortcomings of the
old regulated system;
. A continued focus on the environmental consequences associated with the
generation of electric power; and
. An increased demand for very high levels of power reliability and quality
to support the strict power tolerances of digital electronics.
These forces will alter the way electricity will be provided in the future which
we believe will ultimately result in significantly increased demand for the
benefits offered by Xonon combustion systems.
Restructuring of the Utility Industry
The electric power industry is undergoing fundamental changes both domestically
and internationally. Governments around the world have recognized the
inefficiencies inherent in providing electricity through heavily regulated
monopoly systems. While the pace and extent of the restructuring activities vary
geographically, several themes have emerged:
. The customer's right to choose a power supplier;
. The separation of the generation, transmission and distribution segments of
the business; and
. Market-based pricing for electricity.
The industry transition to a competitive generation environment is changing the
context in which power producers operate existing facilities and evaluate new
projects. Competition has heightened attention on all elements of cost,
including fuel and environmental compliance. Producers are seeking to identify
market opportunities where, whether driven by temporary or chronic imbalances in
supply, they can capture premium pricing. They place particular value on the
ability to site quickly and operate non-controversial, clean generating units
designed to meet periods of peak demand. Other market participants, including
public utilities, independent power producers, end-users and independent
transmission operators are also seeking new, more responsive alternatives to
building additional transmission and distribution lines to serve growing urban
loads. These participants are driving demand towards distributed generation,
peaking plants, and new technologies that are both economically and
environmentally sound.
Continued Environmental Awareness
The second force affecting the electric power generation industry is the
continued public focus on environmental issues. Electric power production
results in significant emissions of certain environmentally harmful pollutants,
including NOx, carbon monoxide, unburned hydrocarbons and particulate matter. In
the United States, the Clean Air Act creates the National Ambient Air Quality
Standards ("NAAQS"), which are the basis for regulations that limit emissions on
a facility-by-facility basis. These restrictions vary geographically and are
most stringent in areas where existing pollution levels are high, such as in
urban areas and in California, the Northeast states and Texas. Air quality
regulations in the United States encourage the use of more effective emissions-
control technologies by requiring the use of the "Best Available Control
Technology," and they provide an economic incentive to achieve lower emissions
through requirements to offset emissions of new sources with reductions from
existing sources in areas that do not meet air quality standards.
5
The cost of emissions control systems alone does not capture the full impact of
environmental issues on the power producer. Public opinion and permitting issues
often prevent power producers from siting plants near population centers, even
if they can meet emissions standards. As a result, the availability of cost-
effective emissions technologies that surpass regulatory requirements can be
extremely valuable to power producers. Beyond reducing costs, these technologies
can actually enable projects which otherwise would not have been possible.
Increased Quality and Reliability Requirements
The third force reshaping the electric power industry is the new digital
economy's need for reliable, high quality power. The rapid growth in the use of
computers, the Internet and telecommunications products has significantly
increased the demand for high quality power to run computer equipment, cellular
base stations and many other components and devices that depend on a reliable
electricity supply. Unlike traditional electrical loads, such as lights and
motor-operated equipment, sophisticated digital devices cannot tolerate voltage
instabilities, such as surges and sags, without a serious negative impact on
their operations. These increased quality and reliability requirements are
creating demands for new supplies of cost-effective and reliable electric power
that can be located in populated areas, close to loads, where they can provide
the highest-quality service.
Limitations of Existing Technology
Gas turbines have emerged as the solution of choice for new power generation
throughout the world where natural gas is available, due primarily to their
inherent operating flexibility, high efficiency, relatively low capital and
operating costs and overall cleanliness relative to other generation
alternatives. Gas fueled generation as a percent of total installed capacity is
expected to rise significantly over the next two decades. The DOE estimates that
gas-fired generation, which accounted for 16% of total United States electricity
generation in 1999, will represent 36% of total generation by 2020.
Additionally, the DOE projects that gas-fired generation will account for 92% of
all U.S. electricity generation capacity additions between 1999 and 2020.
Despite the advantages of gas-fired generation, emissions remain a concern for
both air quality regulators and wholesale generators who have sought to
emphasize their use of clean power generation technologies. In order to reduce
emissions, gas turbine manufacturers have developed improved flame-based
combustion systems. The most advanced of the modified flame-based combustion
systems are the lean pre-mix systems such as dry-low NOx, or DLN. These measures
have, however, in some cases contributed to premature component failure and
reduced gas turbine reliability. Furthermore, even the most effective lean pre-
mix systems cannot achieve the required ultra low emissions levels.
For baseload, or nearly continuous operation, gas turbine generating plants that
operate in combined cycle (with a heat recovery system) for added efficiency,
exhaust cleanup systems are required to achieve ultra low emissions. The most
common conventional exhaust cleanup system is selective catalytic reduction, or
SCR. While this technology has become commonplace, it adds significant capital
and operating costs, reduces overall project performance and efficiency and can
create incremental health risks through secondary emissions and the
transportation and storage of toxic reagents. Operators of baseload generating
plants are particularly sensitive to the costs of exhaust cleanup due to the
competitive pricing nature of the markets they serve.
Furthermore, exhaust cleanup systems cannot be used in all gas turbine
applications. Gas turbines that operate in simple cycle (without a heat
recovery system) for added operating flexibility, such as peaking turbines and
gas pipeline compressors, have exhaust temperatures that are too hot for
conventional exhaust cleanup systems. For small gas turbines with heat recovery
systems used in distributed generation applications, the addition of SCR can be
cost-prohibitive.
The limitations associated with existing emissions control technologies prevent
power producers from cost-effectively achieving ultra low emissions across all
gas turbine applications. As a result, producers have been limited in their
ability to respond to the changing needs of the power industry. Power producers
seeking to develop flexible peaking plants in capacity-constrained regions have
faced more lengthy permitting processes and/or operating restrictions due to
concerns over the plants' inability to achieve ultra low emissions. Power
producers have also been unable to offer distributed generation on a wide scale
because technologies that can achieve ultra low emissions, such as fuel cells,
remain prohibitively expensive while cost-effective alternatives, such as gas
turbines, produce harmful emissions that limit their use in distributed
generation applications.
6
The limitations associated with existing emissions control technologies have
also adversely impacted gas pipeline operators. Gas turbine pipeline compressors
cannot use conventional exhaust cleanup systems. As a result, they cannot
achieve ultra low emissions and operators are often required to install more
expensive electric motor drives in emissions sensitive areas.
The Xonon Cool Combustion Solution
We believe that the introduction of a technology that can cost-effectively
achieve ultra low emissions in all gas turbine applications will create
significant value for users of gas turbines by enabling them to better respond
to the changing needs of the energy industry. Furthermore, we believe:
. Xonon Cool Combustion offers a cost-effective, ultra low emissions solution
for baseload gas turbine generating plants.
. Xonon enables simple cycle gas turbines to achieve ultra low emissions. As
a result, we believe Xonon will facilitate the siting and permitting of
peaking turbines and enhance their value by eliminating emissions-related
operating restrictions.
. Small Xonon-equipped gas turbines represent the first distributed
generation alternative that is cost-effective, achieves ultra low
emissions, is based on proven technology and is currently available on a
commercial basis. We believe the implementation of Xonon-equipped gas
turbines in these applications will accelerate the acceptance of
distributed generation in the changing electric power industry.
. Xonon enables turbines to be used in pipeline compressor applications in
the most emissions-sensitive areas and avoids the use of more expensive
electric motor drives.
Our Strategy
Our goal is to make Xonon the preferred combustion system for all gas turbines
and for other applications. Our strategy for achieving this goal is as follows:
. Develop Our OEM Relationships. We intend to develop and sell Xonon
combustion systems through gas turbine OEMs. We have entered into
collaborative development agreements with a number of leading turbine
manufacturers for the joint design and application of Xonon Cool Combustion
technology to their turbines. Upon completion of these development
programs, we expect them to commercialize Xonon-equipped turbines.
We believe offering Xonon on their gas turbines could give OEMs a
competitive advantage in new equipment sales. We also believe Xonon module
replacement services and the availability of Xonon as an upgrade for
existing gas turbines could enhance the OEMs' service businesses. Once an
OEM adopts Xonon combustion technology on one of its gas turbines, we will
work to extend the Xonon combustion technology to other gas turbines in its
product lines. We believe our collaborative relationships with OEMs place
us at a considerable competitive advantage relative to other potential
developers of catalytic combustion and competing technologies.
. Market Currently Offered Xonon-equipped Gas Turbines. During the early
stages of commercialization, we are working with our OEM partners and are
actively seeking out prospective users of Xonon-equipped gas turbines. We
are participating in the initial stages of discussions relating to their
gas turbine orders. We are also working with the OEMs to identify
situations where project circumstances are well suited for early adoption
of Xonon.
. Establish and Promote Xonon Brand Awareness. We believe that increased
awareness of the Xonon combustion system and its benefits among end-users
will accelerate OEMs' incorporation of Xonon combustion systems across
their product lines. We expect to actively promote awareness of Xonon
combustion systems among a broad audience through peer-reviewed technical
articles, advertisements in trade journals, presentations at trade shows
and other promotional activities. We will establish brand awareness by
7
targeting our marketing and product development activities to demonstrate
the range of Xonon's benefits. We expect that the OEMs will market the
Xonon combustion system under our Xonon brand.
. Aggressively Defend Our Intellectual Property and Broaden Our Technology
Base. Our Xonon Cool Combustion technology is a proprietary technology
protected by patents. Our intellectual property base and our accumulated
experience in applying catalytic combustion to operating systems place us
at a considerable advantage relative to other potential developers of
catalytic combustion and competing technologies. We intend to continue
technological development of Xonon to further extend catalyst life, gain
experience with a wider set of gas turbine operating conditions and develop
component design approaches for gas turbines under different operating
conditions and combustion configurations. In addition, we plan to
vigorously defend our intellectual property.
. Expand the Applications of Our Technology. We believe our technology is
applicable to other types of gas turbines, such as microturbines and
turbines incorporated in fuel cell-gas turbine hybrid power systems. We
also believe our technology can be used in combustion systems other than
gas turbines such as diesel engines. We expect to continue research and
development in these areas where technical and commercial factors appear
encouraging.
. Participate in the Development of Regulations. Federal, state and local air
agencies are continually developing regulations and guidance affecting the
permitting and operation of gas turbines. We participate in these
development efforts by attending workshops and hearings, providing written
comments to draft documents, and participating in public forums, such as
trade associations, as well as meeting with key individuals in regulatory
agencies. This is to ensure that the agencies are aware of Xonon's
capabilities and limitations when creating regulations.
Market for Xonon
We believe that Xonon combustion systems offer distinct advantages in all gas
turbine markets within the power generation and gas pipeline compression
industries. We divide our potential market into three segments based on gas
turbine size, OEM participants and end-user applications. These segments include
small, medium and large gas turbines for electric power generation.
Small Gas Turbines (less than 15 MW)
Due to their earlier shipping dates, we expect that Xonon modules for small gas
turbines will compose a majority of our product revenue over the next few years.
The small gas turbine segment includes turbines that generate less than 15 MW of
electric power. Turbines in this segment serve light industrial, commercial and
institutional loads in power only and combined heat and power, or cogeneration,
applications. With the restructuring of the utility industry, the desire to site
near users has become a key driver of demand for these turbines. Electricity
supplied by distributed generation in the residential and commercial sectors is
projected by the DOE to increase by more than 50% over the forecast period 2000
to 2020. Such units sited at the point of use can avoid the need to expand
transmission and distribution capacity and enhance power quality and
reliability.
We believe that the small gas turbine market sector is poised for dramatic
growth. According to Diesel & Gas Turbine Worldwide, orders for gas turbines
between 1 and 15 MW used for power generation were 486 for the year ending May
2000. According to Power Engineering, distributed generation in this size range
is predicted to reach a 20%-40% share of total power generation capacity
additions over the next ten years.
Gas turbine OEMs in this segment include Honeywell (formerly AlliedSignal),
Alstom Power, Kawasaki Heavy Industries, Ltd., GE's Nuovo Pignone subsidiary,
Pratt & Whitney Canada Corp., Rolls-Royce plc, and Caterpillar Inc.'s Solar
Turbines unit. According to PowerData Group, Solar, Kawasaki, Rolls-Royce and
Alstom Power are the dominant participants.
We are operating a 1.4 MW Xonon-equipped Kawasaki Heavy Industries, Ltd. gas
turbine on the electric utility grid at Silicon Valley Power, a municipal power
provider for the City of Santa Clara, California. This turbine has accumulated
over 7400 hours of operation, supplying essentially pollution-free power to
Santa Clara residents, with NOx levels averaging under 2.5 ppm.
8
In May 2000, Kawasaki and Enron Energy Services ("Enron") announced their intent
to furnish three Xonon-equipped 1.4 MW Kawasaki M1A-13X gas turbines for a
distributed power generation project in Massachusetts at a healthcare facility
of a U.S. Government agency. We plan to deliver the production units in 2001 for
these turbines. Following receipt of this first order for Xonon-equipped
Kawasaki turbines, the Company announced in December 2000 that it had entered
into a collaborative commercialization agreement enabling Kawasaki to market and
sell a generator package, known as the GPB15X, that includes the 1.4 MW Kawasaki
M1A-13X gas turbine incorporating Xonon Cool Combustion.
We are also working with GE to develop and commercialize the Xonon Cool
Combustion system for its GE10 (11 MW) gas turbine. In April 2000, GE entered
into a preliminary agreement to supply Alliance Power with six Xonon-equipped
GE10 gas turbines, subject to successful completion of the development work on
this Xonon system. We expect to deliver commercial Xonon modules for these gas
turbines beginning in mid-2002.
Additionally, we are engaged with other OEMs in adapting Xonon for gas turbines
they manufacture in this size range.
Medium Gas Turbines (15 to 60 MW)
The medium gas turbine segment includes turbines that generate between 15 and 60
MW of electric power. These units are used in energy intensive industrial
facilities for power generation and cogeneration.
According to Diesel & Gas Turbine Worldwide, global orders of gas turbines
between 15 and 60 MW were 302 for the year ending May 2000. Alstom Power, GE,
Rolls-Royce and Siemens Westinghouse are players in this market with GE as the
dominant participant, according to PowerData Group.
We are currently discussing the incorporation of our Xonon Cool Combustion
system into the gas turbines of several OEM products in the mid-size turbine
market.
Large Gas Turbines (greater than 60 MW)
Due to longer turbine lead times, we expect that Xonon modules for large gas
turbines will not compose a significant portion of our revenue until after 2003.
The large gas turbine segment includes turbines that generate more than 60 MW of
electric power. These turbines are presently used by public utilities and
wholesale generating companies to provide large quantities of power to serve
utility loads or for resale in wholesale markets. The majority of gas turbines
in this market are used in combined cycle configuration for base load power
generation.
The market for large gas turbines has recently demonstrated very high growth
with turbine manufacturers reporting significant sales increases and backlogs.
According to Diesel & Gas Turbine Worldwide, global orders of gas turbines
greater than 60 MW were 415 for the year ending May 2000, compared with 160 for
the year ending May 1998.
According to PowerData Group, Alstom Power, GE, and Siemens Westinghouse
together represent nearly all of this market on a unit basis, with GE as the
market leader in this sector.
In November 1998, we signed a collaborative agreement with GE to develop the
Xonon combustion system components for incorporation into GE's model 7EA and 7FA
gas turbines. In December 1999, GE accepted an order from Enron specifying Xonon
as the preferred emissions control system on GE 7FA gas turbines, with GE and
Enron maintaining the right to substitute alternative emissions control
technology for any reason, including if the Xonon combustion system cannot be
developed or has not been developed in time to meet delivery requirements. We
are also engaged in discussions at various stages with other manufacturers
serving this sector.
Relationships with Enron
In January 1998, Enron announced that it would evaluate the use of the Xonon
combustion system in certain of its future wholesale power generation,
distributed power generation and pipeline compressor projects. At the same time,
Enron Ventures, a wholly owned subsidiary of Enron, purchased an equity interest
in us for $30.0 million, resulting in Enron's owning approximately 1.3 million
shares of our Series B preferred stock. Enron Ventures also received a three-
year option to purchase up to an additional 535,715 shares for approximately
$14.4 million. In conjunction with our spin-off completed on December 15, 2000,
the Series B preferred stock was converted to our common stock. Enron's current
equity ownership in us is approximately 11%. On January 14, 2001, Enron's
option to purchase up to
9
an additional 535,715 shares of common stock expired unexercised.
As part of Enron's original investment, Thomas E. White, then an officer of
Enron Ventures and currently Vice Chairman of Enron Energy Services, joined our
board of directors. JSB Asset, LLC, successor to Sundance Assets, L.P. and Enron
Ventures, has the right to nominate one member of our board so long as it owns
at least 5% of our voting stock. See "Related-Party Transactions-Relationship
with Enron."
In December 1999, an Enron North America order for GE 7FA gas turbines specified
the Xonon combustion system as the preferred emissions control system for the
gas turbines. Enron and GE have the right to substitute alternative emissions
control technology for any of these gas turbines for any reason, including in
the event the Xonon combustion system has not been developed or cannot be
developed in time to support Enron North America's project schedule.
In December 1999, Enron North America also agreed to contribute to the funding
of the development of the Xonon combustion system for use in GE 7FA gas
turbines. GE agreed to use commercially reasonable efforts to complete, in
collaboration with us, development, design, and on-engine testing of the Xonon
combustion system for 7FA gas turbines. GE's collaborative effort for
development, design and testing of Xonon for 7FA gas turbines is not limited by
the future selection of the emissions control technology used in Enron's
December 1999 order for GE 7FA gas turbines.
Collaborations
To date, we have entered into the following collaborative relationships with
leading industry participants to produce and sell gas turbines equipped with
Xonon combustion systems.
. General Electric. GE is the leading manufacturer of gas turbines in the
world. We have been working with GE on the application of the Xonon system
to gas turbines under a series of development program agreements since
1991. In November 1998, we signed an agreement with GE for the development,
design and commercialization of the Xonon Cool Combustion system in
selected models of new and existing GE gas turbines. The agreement requires
that GE market the Xonon Cool Combustion system only under the Xonon brand.
The agreement also includes provisions for the development and supply of
Xonon modules to satisfy GE's requirements for initial installation and
periodic replacement. This agreement prohibits us from selling or field
testing our products in gas turbines equal to or greater than 70 MW
provided that development proceeds in accordance with the agreed upon
timetable. We are not, however, prohibited from engaging in other
activities to develop and test the Xonon technology with other OEMs. Based
on the schedule for development with GE, we expect that our ability to sell
and field test in the large gas turbine market will not be impacted by our
agreement with GE. In December 1999, GE accepted from Enron North America
the first order for GE 7FA gas turbines specifying Xonon combustion systems
as the preferred emissions control system. Concurrent with this gas turbine
order, GE agreed to use commercially reasonable efforts to complete, in
collaboration with us, development, design and testing of the Xonon
combustion system for the 7FA gas turbines. The Enron order provides that
the 7FA gas turbines will be equipped with Xonon unless Enron or GE elects
to substitute alternative emissions control technology. The agreement
provides that GE may terminate the agreement at any time if it determines
that there are significant technical issues which indicate that the
technical objectives of the Xonon commercialization program are not
achievable or cannot be achieved within the timetable established for the
program.
. Kawasaki. In May 2000, Kawasaki and Enron announced their intent to furnish
three Xonon-equipped 1.4 MW Kawasaki M1A-13X gas turbines for a distributed
power generation project in Massachusetts at a healthcare facility of a
U.S. government agency. We plan to deliver the production units for these
turbines in 2001. Following receipt of this first order for Xonon-equipped
Kawasaki turbines, we announced in December 2000 that we had entered into a
collaborative commercialization agreement enabling Kawasaki to market and
sell a generator package, known as the GPB15X, that includes the 1.4 MW
Kawasaki M1A-13X gas turbine incorporating Xonon Cool Combustion.
. Nuovo Pignone. We and GE are working to develop and commercialize the Xonon
combustion system for the GE10 gas turbine manufactured by GE's Nuovo
Pignone subsidiary. This gas turbine is used for distributed generation and
gas pipeline compression applications. In April 2000, GE entered into a
preliminary agreement with Alliance Power for the purchase of six GE10 gas
turbines equipped with the Xonon combustion system. Subject to successful
completion of the development work on this Xonon system, we expect to
deliver commercial Xonon modules for these gas turbines beginning in mid-
2002.
10
. Solar Turbines. In the second quarter of 1996, we and Solar Turbines, a
wholly-owned subsidiary of Caterpillar Inc., began a joint design and
development program for the inclusion of Xonon into Solar's new Advanced
Technology System gas turbine being co-funded by the DOE. Xonon full-scale
testing is in process at Solar on the Solar Mercury 50 (5 MW) gas turbine,
which has resulted from this program. We are also investigating application
of the Xonon technology in other Solar gas turbines.
. Rolls-Royce. In the first quarter of 1996, we began a joint development
program with the Allison Engine division of Rolls-Royce for the design of
Xonon as an integral part of their new Advanced Technology System gas
turbine, which was co-funded by the DOE. Development and testing is
continuing.
Development of the Xonon technology has been supported in part by government
agencies and research institutions, including the DOE, The EPA, The California
Energy Commission PIER program, the California Air Resources Board, EPRI
("Electric Power Research Institute") and GTI, formerly known as the Gas
Research Institute. In connection with some of these funding arrangements, some
of these parties may receive certain financial rights in the commercialization
of the resulting technology.
Manufacturing and Testing
We plan to initially manufacture commercial quantities of Xonon modules at our
facility in Mountain View, California. We believe that our current manufacturing
facilities will require only modest capital expenditures to expand our
capabilities to supply a sufficient number of both prototype and production
Xonon modules to satisfy our near-term needs. We plan to retain all proprietary
manufacturing within our facilities and outsource the non-critical components to
third party suppliers having OEM gas turbine component manufacturing expertise.
For internal production we plan to use manufacturing cells. Manufacturing cells
are a sequence of manufacturing equipment arranged in a manner to allow the
continuous production of a set of similar products, such as Xonon modules. Our
manufacturing cells occupy approximately 3,000 square feet and are designed to
produce all varieties of Xonon modules. These cells are scaleable to capacity
needs and can be located near customer facilities or distribution nodes as
appropriate. During 1999, we constructed the first manufacturing cell at our
Mountain View facility and have achieved start-up and initial production of
commercial-quality modules. Due to the long lead times for delivery of gas
turbines and the relatively short production time for a Xonon module, we believe
that we can adequately predict and accommodate our manufacturing needs in
advance of demand for our Xonon module.
In the fourth quarter of 1999, we earned ISO 9001 Registration from Underwriters
Laboratories, Inc. ("UL") for the design and manufacture of Xonon modules. The
ISO series standards are internationally recognized quality management system
requirements developed by the International Organization of Standardization
("ISO"). ISO 9001 is the most comprehensive standard in the ISO 9000 series.
We anticipate achieving production efficiencies as commercial production volume
ramps up over the next three years. Overall capacity growth will be achieved
through a combination of these efficiency improvements and the start-up of
additional manufacturing cells, both at our current facility and at additional
sites, as appropriate. Because of the modular design of these cells, our
capacity can grow in cell-sized increments in line with increasing demand. Our
manufacturing process lead-time is much shorter than the production lead-time of
the gas turbines into which our modules fit. Based on our commercialization
plan, we anticipate that our existing facilities will provide sufficient
capacity through 2002. Our long-term manufacturing needs will be satisfied by
our plans to build out a full-scale, high-volume, commercial production facility
at our second site in Scottsdale, Arizona.
Pursuant to our arrangements with the gas turbine manufacturers, Xonon modules
will be returned to us at the end of their useful life. We expect to reclaim,
reuse or recycle most components of the module, including the precious metals
palladium and platinum. Because we can recover and reuse these metals in our
modules, we can protect against the volatility of precious metal prices.
Our sourcing strategy is designed to take advantage of existing suppliers and
production infrastructure and to ensure the supply of critical materials and
components. We will ensure supply of critical materials by a combination of dual
sourcing, strategic inventory control and identification of substitute
materials. We expect to outsource metal fabrication components to suppliers
already supplying similar components to the turbine OEMs. Other materials
required for Xonon module production will be sourced from the specialty
chemicals and specialty metals industries. We expect
11
these components and materials to have lead times of under four months at full
production quantities. In the case of all of our components and materials, we
have identified either alternative suppliers or substitute materials, with the
exception of one, a high temperature steel alloy. In this case, this material's
primary use is in the jet aircraft and turbine industries, and our requirements
would represent less than 5% of the present demand. We believe the continuing
supply of this material will be ensured by its demand in its primary market. We
are also evaluating substitute materials for this alloy.
In addition to our manufacturing facilities, we own and operate facilities used
for testing and developing our technologies. We have catalyst test facilities,
including two combustion test rigs, at our site in Mountain View, California.
These facilities are capable of testing catalysts at a range of gas turbine
operating conditions representative of most gas turbines that are presently
manufactured. We have additional facilities that allow for the testing of
critical combustor components such as preburners and mixers.
We also own a Kawasaki Heavy Industries, Ltd. 1.4 MW M1A-13A gas turbine
equipped with the Xonon combustion system that is operating on the electric
utility grid in Santa Clara, California. This turbine provides electric power
under contract to Silicon Valley Power. In addition to power production, this
unit serves as our on-engine test and demonstration facility for the Xonon
combustion system for gas turbines.
Regulatory
In the United States, federal air quality regulations include standards for
ground-level ozone (a primary component of smog) and particulate matter (soot).
Since NOx is both a precursor to ground-level ozone and a contributor to the
formation of fine particulate matter, reducing NOx emissions at power generation
facilities is important to meeting air quality standards. Federal air quality
regulations also include standards for emissions of carbon monoxide and unburned
hydrocarbons, two other common byproducts of electric power generation. The
federal regulations governing air quality create National Ambient Air Quality
Standards ("NAAQS"). Areas that meet the NAAQS are designated as "attainment
areas," while areas not meeting the standards are designated as "non-attainment
areas." State and local authorities determine specific strategies to be applied
in each area in order to meet the federal air quality standards. Generally
speaking, emissions restrictions applied in the most severe non-attainment areas
are the most stringent.
Federal law requires that major new and modified sources of air pollution in
attainment areas use the most effective emissions control technology that has
been demonstrated in practice and is commercially available, unless it can be
shown not to be cost-effective. This requirement is referred to as the "Best
Available Control Technology," or BACT. State and local authorities determine
what BACT will be on a case-by-case basis when assessing new power projects.
In areas that do not meet ambient air quality standards, authorities assessing
new facilities are not permitted to consider the cost-effectiveness of
technology alternatives. This more stringent technology determination is
referred to as the "Lowest Achievable Emissions Rate," or LAER. Furthermore, in
non-attainment areas, the permitted emissions of major new or modified sources
of air pollution must also be offset by emissions reductions elsewhere such that
there is a net decrease in overall emissions as a result of the new source. In
order to satisfy this requirement, project developers may demonstrate emissions
reductions or, in some markets, purchase credits for emissions reductions.
To facilitate the control technology assessments in BACT/LAER determinations,
some state and local authorities have published guidance documents for
applicants that identify desired emissions levels for different types of
sources. For example, the California Air Resources Board ("CARB") and the South
Coast Air Quality Management District ("SCAQMD") covering the Los Angeles Basin
have adopted guidance NOx emissions levels for gas turbines of 2.5 parts per
million ("ppm"). The Xonon Cool Combustion system operating on the gas turbine
at Silicon Valley Power has satisfied federal EPA guidelines for an emissions
control technology that is "achieved in practice" and has demonstrated emissions
levels that would satisfy the CARB and SCAQMD guidelines for gas turbines. We
believe that Xonon is the only gas turbine combustion system demonstrated to
meet these guidelines without requiring a costly exhaust cleanup system.
Furthermore, in February 2001, we successfully completed an evaluation process
by the EPA, which verified the ultra low emissions performance of a Xonon-
equipped gas turbine operating at Silicon Valley Power.
12
While U.S. regulations do not directly force the adoption of new control
technologies or mandate lower emissions levels, they do provide an economic
incentive to achieve lower emissions, and, through BACT/LAER determinations,
require consideration of newly introduced control technologies that are more
cost-effective and/or achieve lower emissions levels. We believe the Xonon
combustion system for gas turbines achieves desired ultra low emissions levels
more cost-effectively than post-combustion exhaust cleanup systems, and enables
gas turbines to achieve ultra low emissions in situations where these exhaust
cleanup systems cannot be used. As a result, we believe Xonon will enhance the
value of gas turbine projects by reducing emissions compliance costs and
contributing to regulatory and community acceptance, thus improving the siting
and operating flexibility of gas turbines.
In addition to environmental requirements in the United States, there are
increasing restrictions on emissions abroad, particularly in Japan and Western
Europe. Furthermore, lending agencies such as the World Bank and public pressure
are expected to force host countries to adopt proven emissions control
technologies on power plants in developing countries.
Our Intellectual Property
Xonon Cool Combustion is a proprietary technology with extensive intellectual
property protection. Our intellectual property strategy is to identify key
intellectual property developed by us in order to protect it in a timely and
effective manner, and to use and assert such intellectual property to our
competitive advantage in the catalytic combustion business. Intellectual
property includes proprietary technology, know-how, business strategies and
market information. An objective of our intellectual property strategy is to
enable us to be first to market with proprietary technology and to sustain a
long-term technological lead in the market. We rely on a combination of patents,
trade secrets, trademarks, copyrights and contracts to protect our proprietary
technology.
We use patents as the primary means of protecting our technological advances and
innovations, such as our proprietary Xonon Cool Combustion system designs,
catalyst compositions, new materials, manufacturing processes, operating
techniques, combustor components and combustor system designs. We have adopted a
proactive approach to identifying patentable inventions and securing patent
protection through the timely filing and aggressive prosecution of patent
applications. Our employees participate in a comprehensive invention disclosure
program involving preparation of written invention memoranda and preservation of
supporting laboratory records. Patent applications are filed in various
jurisdictions internationally, which are carefully chosen based on the likely
value and enforceability of intellectual property rights in those jurisdictions,
and to strategically reflect our anticipated major markets. Patents provide us
with the right to exclude others from incorporating these technical innovations
into their products and processes. We also use patents, along with publications
and, where appropriate, licensing-in of third party technology to provide us
with the flexibility to adopt preferred technologies.
As of December 31, 2000, we (a) owned, either exclusively or jointly, (b) held
exclusive license rights from third parties for, or (c) held license rights from
affiliates, in 17 U.S. patents issued, 2 U.S. patents pending, 10 International
Patent Treaties, and 43 international registered patents. An additional 5
patent applications are currently in preparation.
We believe we have developed a significant international patent portfolio. We
have filed an increasing number of patent applications each year and we
anticipate that this trend will continue. We actively monitor the patent
position, technical developments and market activities of our competitors. We
expect that our growing patent portfolio, especially when coupled with a strong
enforcement program, will provide us with a significant advantage over our
competitors.
Portions of our know-how are protected as trade secrets and supported through
contractual agreements with our employees, suppliers, partners and customers. We
aggressively protect our intellectual property rights in our collaboration
agreements with a view to capturing maximum value from our products in our
markets and ensuring a competitive advantage.
Competition
We expect Xonon-equipped gas turbines to compete with turbines outfitted with
traditional emissions reduction technologies, including lean pre-mix combustion
and conventional exhaust cleanup systems.
We believe Xonon is unique in its abilities to allow gas turbines to achieve
ultra low emissions in simple cycle gas
13
turbines and to achieve ultra low emissions without the use of exhaust cleanup
systems. Lean pre-mix combustion systems cannot achieve ultra low emissions, and
the applicability of conventional exhaust cleanup systems is limited. Exhaust
cleanup used in combination with lean pre-mix combustion can reach ultra low
emissions in some applications. As Xonon is applied to gas turbine models, these
benefits will enhance the value of those gas turbines. We expect Xonon-equipped
gas turbines to be priced to end-users by the OEMs to capture a share of that
value.
Lean pre-mix combustion systems are manufactured and provided by gas turbine
OEMs as part of their turbine product line. These gas turbine OEMs represent the
potential customer base for our Xonon modules, and we expect to rely upon them
to distribute Xonon-equipped turbines to end-users.
Third parties, including Cormatech, Engelhard, Goal Line, Mitsubishi and Siemens
Westinghouse, manufacture conventional exhaust cleanup systems. End-users
generally purchase these systems directly from the manufacturers, through
packagers, or from vendors of heat recovery steam generation equipment. Gas
turbine OEMs do not function as intermediaries in these transactions and do not
receive any economic value from the sale of exhaust systems.
We expect that gas turbine OEMs will choose to purchase Xonon modules and
distribute Xonon-equipped turbines despite the fact that Xonon represents a
direct competitive challenge to their existing emissions control products. We
believe this will be the case for two reasons. First, Xonon combustion systems
achieve ultra low emissions at lower costs than competing technologies. Based on
this cost differential, turbines that incorporate Xonon Cool Combustion
technology offer a significant competitive advantage over turbines equipped with
conventional emissions technology. Incorporation of Xonon Cool Combustion
technology, therefore, enhances the OEM's product line and offers the potential
for the turbine OEM to gain market share from competitors whose turbines do not
incorporate Xonon Cool Combustion technology. Second, incorporating Xonon into
its turbines allows the OEM to capture a larger portion of the economics
associated with pollution control. Currently, OEMs only capture the portion of
emissions reduction economics associated with lean pre-mix, while third parties
capture the portion of economics associated with exhaust cleanup systems.
Because Xonon replaces lean pre-mix technology and eliminates the need for
exhaust cleanup systems, its incorporation in the turbine allows OEMs to capture
a larger portion of the economic value associated with emissions reduction.
Over time, the Xonon combustion system may also face competition from new
entrants to the market for emissions reduction. New entrants may eventually
develop competing technologies, catalytic or otherwise, that also achieve ultra
low emissions on a cost-effective basis. For example, Precision Combustion, Inc.
("PCI") has indicated on its web site that it has a long-term business agreement
with Siemens Westinghouse Power Corporation to develop, manufacture and sell
low, single digit NOx catalytic combustors for certain of Westinghouse's gas
turbines. PCI also states that it is working with other gas turbine
manufacturers under shorter term agreements. PCI has not characterized these
agreements as exclusive.
We believe, based on a review of public reports, that we are the only company to
have demonstrated catalytic combustion in full-scale combustion systems at
actual gas turbine conditions and to have achieved operation of catalytic
combustion on a gas turbine with the durability required for commercial success.
Further, we believe the technology that has enabled us to achieve these
milestones is proprietary to us.
We believe that the measures we have taken to protect our intellectual property
provide a significant barrier to entry for future competing technologies. We
also believe that even if current efforts to create competing technologies could
circumvent our intellectual property protections, these efforts are several
years away from commercial development.
Subsidiaries
Sud-Chemie Catalytica, L.L.C.
Sud-Chemie Catalytica, L.L.C. is a 50/50 joint venture originally formed in 1998
between Catalytica Advanced Technologies and the Sud-Chemie Group to custom
manufacture organometallic catalysts. Sud-Chemie Catalytica is focused on
supported and unsupported single-site catalysts and boron co-catalysts, a
recently discovered class of chemical compounds that allow highly controlled
polymerization reactions. Organometallic single-site catalysts are used to
produce new grades of plastics, such as polyethylene and polypropylene. They
impart desirable qualities such as increased impact strength and toughness,
better melt characteristics, and improved clarity in films. Scale-up and cost-
effective manufacture of commercial quantities of single-site catalysts
especially metallocenes for the polyolefin industry, is the primary focus.
Formerly named Single-Site Catalysts, the name was changed to Sud-Chemie
Catalytica
14
in March 2000 to more closely identify the company with the parents of the joint
venture.
Beginning in early 2001, the Sud-Chemie Group will provide 100% of the funding
for the current year activity of Sud-Chemie Catalytica. In exchange for this
commitment, Sud-Chemie will receive an increased equity ownership in the joint
venture. We will continue to assess our position in the joint venture and can
resume funding at any time under the current operating agreement.
Catalytica NovoTec, Inc.
Catalytica NovoTec ("NovoTec") was formed by us in July 2000 to rapidly improve
chemical and petrochemical manufacturing processes using proprietary high speed
testing and computer learning technologies for the discovery and development of
new catalysts.
Shortly after the spin-off transaction, we conducted a strategic assessment of
our non-energy technology businesses. As a result of that review, we decided in
January 2001 to discontinue all operations within the NovoTec subsidiary.
In March 2001, we sold substantially all of the assets formerly used in
NovoTec's operations to NovoDynamics, Inc., a corporation founded by members of
NovoTec's prior management.
Human Resources
As of December 31, 2000, we employed 85 persons. None of our employees is
represented by a labor union. We believe our relations with our employees are
good.
Directors, Executive Officers and Key Employees
Our directors, executive officers and key employees are as follows:
Name Age Position with Catalytica Energy Systems
---- --- ---------------------------------------
Ricardo B. Levy.......... 56 Chairman of the Board and Director
Craig N. Kitchen......... 50 President and Chief Executive Officer and Director
Ralph A. Dalla Betta..... 56 Chief Technology Officer and Vice President, Technology
Dennis Riebe............. 58 Chief Financial Officer
Carl Schopfer............ 54 Senior Vice President, Engineering
Patrick T. Conroy........ 55 Senior Vice President, Product Development
Steven J. Oliva.......... 42 Vice President, Operations
Richard Buchanan......... 37 Vice President, Business Leader
Jacqueline Cossmon....... 45 Vice President, Investor Relations
Ronald L. Alto........... 51 Vice President, Sales and Service
Lawrence W. Briscoe...... 56 Director
William B. Ellis......... 60 Director
Frederick M. O'Such...... 63 Director
John A. Urquhart......... 72 Director
15
Thomas E. White.......... 57 Director
Ernest Mario............. 62 Director
Howard I. Hoffen......... 37 Director
Ricardo B. Levy, Ph.D. joined our board of directors in June 1995 as chairman of
the board. He was a founder of Catalytica, Inc., and was a director of
Catalytica, Inc. from 1974 to December 2000. He served as chief operating
officer from Catalytica, Inc.'s inception in 1974 until August 1991. He served
as president and chief executive officer of Catalytica, Inc. from August 1991
until December 2000. Before founding Catalytica, Inc., Dr. Levy was a founding
member of Exxon's chemical physics research team. Dr. Levy also serves on the
board of directors of the public company, Pharmacopeia, Inc. Dr. Levy has an
M.S. from Princeton University and a Ph.D. in chemical engineering from Stanford
University. Dr. Levy is an alumnus of Princeton and Harvard University's
Executive Management Program.
Craig N. Kitchen has served as our president, chief executive officer, and
director since July 2000. Prior to that Mr. Kitchen was a corporate vice
president at Triumph Group, a manufacturer of major airframe, structural and
aircraft engine components, where he most recently directed business for the
aerospace companies. From October 1994 to July 1997, Mr. Kitchen was a partner
at Stolper-Fabralloy, a supplier of combustors for aerospace and industrial gas
turbines, and led the business development efforts for new combustors such as GE
Aircraft Engines, Rolls Royce, Allison Engine and Solar Gas Turbines. From 1982
to 1994, Mr. Kitchen served in several senior management positions and was vice
president, repairs and overhaul/business development for AlliedSignal. Mr.
Kitchen holds a B.S.M.E. from the U.S. Air Force Academy and an M.B.A. from the
University of Northern Colorado.
Ralph A. Dalla Betta, Ph.D. has served as our chief technology officer and vice
president, technology since June 1995. From 1976 until the spin-off of
Catalytica Energy Systems, Inc., Dr. Dalla Betta was employed by Catalytica,
Inc. most recently as chief scientist. Prior to joining Catalytica, Inc., Dr.
Dalla Betta was a senior scientist at the Ford Motor Company. He has authored
over 40 scientific papers, holds 12 patents and is co-author of one book. He
holds a B.S. degree from the Colorado College and a Ph.D. in physical chemistry
from Stanford University.
Dennis S. Riebe has served as our chief financial officer since September 2000.
Prior to that, Mr. Riebe spent 34 years with AlliedSignal (now Honeywell), in a
variety of positions including both Finance and Operations. He served as the CFO
for an AlliedSignal Engines acquisition in Stratford, Connecticut, and has been
the Director of Cost Management and Director of Financial Planning and Analysis
for the AlliedSignal Engine business. Prior to that he was the Corporate
Controller for The Garrett Corporation, and served as an officer and member of
the Board of Directors for an international joint venture with the Republic of
China (Taiwan). Mr. Riebe is a graduate of Purdue University and has completed
graduate studies in business administration at Arizona State University.
Carl Schopfer has served as our senior vice president, engineering since April
2000. Prior to that, Mr. Schopfer spent over 20 years at AlliedSignal Engines
(formerly Garrett Turbine Engine Company), most recently as vice president,
engineering and technology. Prior to that he was AlliedSignal Engines' vice
president, strategic planning and business development. From 1968 to 1976, Mr.
Schopfer worked as a development engineer at the Allison Gas Turbine Division of
General Motors Corporation. Mr. Schopfer holds a B.S. in mechanical engineering
from the University of Missouri-Rolla and an M.B.A. from Butler University.
Patrick T. Conroy has served as our senior vice president, product development
since September 1998. Since October 1997, Mr. Conroy has served as president and
chief executive officer of GENXON Power Systems LLC, a joint venture we entered
into with Woodward Governor Company. From 1971 until February 1997, Mr. Conroy
was employed by Westinghouse Electric Corporation in the nuclear energy and
power generation businesses. Significant positions during his tenure at
Westinghouse included four years as operations manager of the nuclear service
business and six years as general manager of the power generation service
business. He was also the senior sales executive for Westinghouse's power
generation business in Europe, the Middle East and Africa and president of a
joint venture with Rolls Royce Industrial Power. Mr. Conroy holds a B.S. in
marine engineering from the US Merchant Marine Academy (Kings Point) and has
completed graduate work in business administration at Widener University.
Stephen J. Oliva has served as our vice president, operations since June 1998,
when he was promoted from director of operations, a position he had held since
joining us in May 1995. From March 1990 to May 1995, Mr. Oliva was with
16
the consulting firm of Pittiglio, Rabin, Todd & McGrath, a leader in operations
and product development consulting to high technology companies, where he served
in a number of roles, including director of materials and director of operations
for various clients. Prior to that, Mr. Oliva held technical and management
positions in operations with DuPont, Hewlett Packard and Genentech. Mr. Oliva
holds a B.S. in chemical engineering from M.I.T. and an M.B.A. from Stanford.
Richard Buchanan has served as our vice president, business leader since October
2000. Prior to that, Mr. Buchanan spent 15 years with Allied Signal (now
Honeywell) in a variety of positions in Customer Support and was most recently
the Manager of Regional Turbofan, New Business Development. Mr. Buchanan holds a
B.S. in Business Management and an Associate of Applied Science Degree in
Aviation Management from Southern Illinois University.
Jacqueline Cossmon has served as our vice president, investor relations since
February 2001. Prior to that, Ms. Cossmon was vice president of investor
relations of Catalytica, Inc. from late 1998 to December 2000. Before joining
Catalytica, Inc. she spent over 18 years in the healthcare industry, with a
focus in the last nine years on investor and public relations. She has headed
the investor relation's efforts for Applied Biosystems and Applied Immune
Sciences. Prior to that, Cossmon held various management positions including
national sales manager and national accounts manager for biochemical and
bioseparation products at Applied Biosystems. She holds an MBA with an emphasis
in finance from Santa Clara University and is an active member of the National
Investor Relations Institute.
Ronald L. Alto joined us as our vice president, sales and services in March
2001. Prior to that, Mr. Alto was vice president of global marketing of Cytec
Industries, Inc. from 1999 to March 2001. Mr. Alto held various positions
including regional director Australasia and director of marketing, sales,
service and new business development at Honeywell from 1982 through 1998.
Before joining Honeywell, he held various management and engineering positions
at General Electric, Inc. from 1972 until 1981. He was an officer in the USAF,
and holds an Aeronautical Engineering degree from Arizona State University and
is an alumnus of management, marketing and business development programs at the
University of Southern California, University of Michigan, Thunderbird Graduate
School of International Management, and GE, Crotonville, Executive Business
Management Program.
Lawrence W. Briscoe has served as our director since our inception in 1995. Mr.
Briscoe has been the chief financial officer of Maxygen since January 2001.
Mr. Briscoe served as our chief financial officer from our inception until
September 2000. From July 1994 to December 2000, Mr. Briscoe served as the chief
financial officer and vice president, finance and administration of Catalytica,
Inc. Before joining Catalytica, Inc., 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 United States Commercial Telephone Corp. Mr. Briscoe
holds a B.S. in electrical engineering from the University of Missouri, an M.S.
in business from the University of Southern California and an M.B.A. from
Stanford University.
William B. Ellis joined our board of directors in September 1995. Mr. Ellis is a
senior fellow of the Yale University School of Forestry and Environmental
Studies. Mr. Ellis retired as chairman of Northeast Utilities in 1995, where he
also served as chief executive officer from 1983 to 1993. Mr. Ellis joined
Northeast Utilities in 1976 as its chief financial officer. Mr. Ellis was a
consultant with McKinsey & Co. from 1969 to 1976 and was a principal in that
firm from 1975 to 1976. Mr. Ellis serves on the board of directors of
Massachusetts Mutual Life Insurance Company and the Pew Center on Global Climate
Change. He has a Ph.D. in chemical engineering from the University of Maryland.
Frederick M. O'Such joined our board of directors in 1995. Mr. O'Such is
currently president and chief executive officer of Xertex Capital. From 1981 to
1986, Mr. O'Such served as chief executive officer of Xertex Corporation. From
1970 to 1981, Mr. O'Such served as group president and vice president, corporate
development with Envirotech Corporation. He served as group vice president with
Gulton Industries, Inc. from 1963 to 1970. Mr. O'Such is a member of several
boards of directors, including Herrick-Pacific Corporation, a public company.
Mr. O'Such holds a B.S. in chemical engineering from Lehigh University and an
M.B.A. from Harvard University.
John A. Urquhart joined our board of directors in April 1997. He currently
serves as senior advisor to the chairman of Enron Corp. and also served as the
vice chairman of Enron from 1990 to 1998. Mr. Urquhart also serves on a number
of other boards of directors, including those of the following public companies:
Enron, Hubbell Incorporated, TECO Energy, Inc., Weir Group PLC and Tampa
Electric Co. He previously served as the senior vice president/executive vice
president of industrial and power systems at General Electric. In addition, he
served five years as a committee member on the board of the United States
Council for Energy Awareness. Mr. Urquhart holds a B.S. in engineering from the
Virginia Polytechnic Institute.
17
Thomas E. White joined our board of directors in January 1998. Mr. White has
been designated by Enron Energy Services to serve as one of our directors
pursuant to Enron Ventures' right to nominate a director under its Series B
Preferred Stock Purchase Agreement and Omnibus Agreement. Mr. White was named
chairman and chief executive officer of Enron Power Corp., a wholly-owned
subsidiary of Enron, in 1991 and assumed the titles of Chairman and Chief
Executive Officer of Enron Operations Corp. in 1993, Chairman and Chief
Executive Officer of Enron Ventures Corp. in 1996, and Vice Chairman of Enron
Energy Services in 1998. Mr. White joined Enron 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 an M.S. in operations research from the United States Naval Post
Graduate School.
Ernest Mario, Ph.D. joined our board of directors in September 2000. Dr. Mario
is currently chairman and chief executive officer of ALZA. Before joining ALZA
in August 1993 Dr. Mario served as 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 the following public companies:
SonoSite, COR Therapeutics, Cepheid, Orchid BioSciences, Inc. and Pharmaceutical
Product Development Co. Dr. Mario has a Ph.D. and an M.S. in physical sciences
from the University of Rhode Island and a B.S. in pharmacy from Rutgers
University.
Howard I. Hoffen joined our board of directors in September 2000. Mr. Hoffen is
currently the Chairman and Chief Executive Officer of Morgan Stanley Dean Witter
Private Equity, and has been a Managing Director of Morgan Stanley & Co.,
Incorporated since 1997. He joined Morgan Stanley & Co., Incorporated in 1985
and Morgan Stanley Dean Witter Private Equity in 1986. Mr. Hoffen also serves on
a number of boards of directors, including the board of the public company,
Allegiance Telecom, Inc., and is a director of several privately held companies.
Mr. Hoffen has a B.S. from Columbia University and an M.B.A. from the Harvard
Business School.
Item 2. PROPERTIES
Our research and development facility is based in Mountain View, California,
occupying four buildings covering approximately 85,000 square feet. Our lease
expires on December 31, 2003, with a five-year option for renewal. Our research
and development facility is adequate for the Company's needs for the foreseeable
future.
We lease an additional 5,200 square foot facility in Scottsdale, Arizona, which
is used primarily for sales and engineering support functions. This lease
expires in August 2003.
Item 3. LEGAL PROCEEDINGS
On August 14, 2000, the City of Glendale filed a complaint against us,
Catalytica, Inc. and GENXON Power Systems, Inc. in Los Angeles County Superior
Court. The case has been transferred to the Orange County Superior Court, Case
No. 00CC13002. 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, Inc. 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. On January 16, 2001, the court
granted, with leave to amend, Catalytica, Inc.'s motion to dismiss the causes of
action for fraud and negligent misrepresentation asserted in the complaint. The
defendants believe they have meritorious defenses to the remaining claims
asserted and intend to defend the action vigorously. While it is not possible to
predict with certainty the outcome of this matter, and while we do not believe
an adverse result would have a material effect on our financial position, it
could be material to the results of operations and cash flows for a fiscal year.
We have agreed to indemnify Catalytica, Inc. for any costs associated with this
matter.
18
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.
Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Common Stock
Our common stock is listed on the Nasdaq National Market under the symbol
"CESI." The following table sets forth high and low trading prices per share for
our common stock as quoted on the Nasdaq National Market from the effective date
of our spin-off, December 18, 2000 until December 31, 2000. Such prices
represent interdealer prices and do not include retail mark-ups or mark-downs or
commissions and may not represent actual transactions.
December 18, 2000
through
December 31, 2000
Common stock price
per share:
High $19 1/2
Low 12 5/8
As of February 23, 2001, there were approximately 784 holders of record of our
common stock, as shown on the records of our transfer agent. The number of
record holders does not include shares held in "street name" through brokers.
We have never paid cash dividends on our common stock or any other securities.
We anticipate that we will retain any future earnings for use in the expansion
and operation of our business and do not anticipate paying cash dividends in the
foreseeable future.
Item 6. SELECTED FINANCIAL DATA
The following tables contain selected financial data as of and for each of the
four years ended December 31, 1997, 1998, 1999 and 2000 and have been derived
from combined financial statements, which have been audited by Ernst & Young
LLP, independent auditors. The selected financial data relating to 1996 has been
derived from unaudited financial statements. The selected financial data are
qualified by reference to, and should be read in conjunction with, our financial
statements and the notes to those financial statements and Management's
Discussion and Analysis of Financial Condition and Results of Operations. No
cash dividends were declared in any of the periods presented.
19
Years ended December 31,
--------------------------------------------------
1996 1997 1998 1999 2000
------- -------- ------- ------- --------
(in thousands, except per share data)
Statement of Operations Data:
Research and development
contracts........................ $ 5,934 $ 5,139 $ 6,279 $ 3,053 $ 5,487
------- -------- ------- -------- --------
Costs and expenses:
Research and development(1)..... 6,451 6,009 9,313 9,627 11,277
Costs associated with
discontinued product line..... 268 -- -- -- --
Selling general and
administrative................ 708 671 1,269 4,786 10,660
------- -------- ------- -------- --------
Total costs and expenses....... 7,427 6,680 10,582 14,413 21,937
------- -------- ------- -------- --------
Operating loss.................... (1,493) (1,541) (4,303) (11,360) (16,450)
Loss on joint venture............. -- (4,355) (3,826) (1,133) (236)
Interest income................... -- -- 1,409 1,041 886
Interest expense.................. (114) (374) (177) (278) (110)
------- -------- ------- -------- --------
Net loss $(1,607) $ (6,270) $(6,897) $(11,730) $(15,910)
======= ======== ======= ======== ========
Basic and diluted
net loss per share(2) -- -- -- -- $ (15.91)
======= ======== ======= ======== ========
Weighted average shares used for
above calculation -- -- -- -- 1,000
======= ======== ======= ======== ========
December 31
-------------------------------------------------
1996 1997 1998 1999 2000
------- -------- ------- ------- --------
Combined Balance Sheet Data:
Cash, cash equivalents
and short term investments....... $ -- $ -- $ 22,847 $ 16,032 $ 58,713
Total assets...................... 2,767 2,871 28,520 19,840 67,772
Total stockholders'
equity (deficit).................. (8,928) (15,198) 24,137 12,552 57,470
(1) See Note 2 to the financial statements.
(2) Since we did not have a formal capital structure until December 2000, loss
per share information prior to that date has not been presented.
20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This report contains forward-looking statements within the meaning of Section
27A of the Securities Act and Section 21E of the Exchange Act, which involve
risks and uncertainties including but not limited to those statements containing
the words "believes", "anticipates", "estimates", "expects", and words of
similar import, regarding the Company's strategy, financial performance and
revenue sources. The Company's actual results could differ materially from the
results anticipated in these forward-looking statements as a result of certain
factors including those set forth under "Risk That Could Affect Our Financial
Condition and Results of Operations" and elsewhere in this report. The Company
undertakes no obligation to update publicly any forward looking statements to
reflect new information, events or circumstances after the date of this release
or to reflect the incurrence of unanticipated events. See "Forward-Looking
Statements".
Overview
We develop proprietary technologies that use catalysts to essentially eliminate
the formation of harmful pollutants and improve the performance of hydrocarbon
combustion systems such as gas turbines. We have developed Xonon Cool
Combustion, a breakthrough combustion technology that reduces temperatures in
combustion systems to avoid the formation of chemical pollutants without
diminishing combustion efficiency. We are developing and marketing Xonon Cool
Combustion technology for use in gas turbines in power generation and gas
pipeline compression applications.
In December 2000, we and Catalytica Advanced Technologies, Inc. were combined,
and all of the shares of the combined company were distributed on a pro rata
basis by Catalytica, Inc. to its stockholders.
In our early stage of development we were engaged in developing, manufacturing
and marketing technologies that use catalysts to measure the existence of
harmful pollutants. In 1995, we ceased efforts to develop measurement products
and disposed of related assets in 1996. Cumulative net costs associated with
this discontinued product line were $9.3 million. Prior to our combination with
Catalytica Advanced Technologies, as described above, new technologies were
developed through Catalytica Advanced Technologies. In July 2000, we formed
Catalytica NovoTec Inc. ("NovoTec") to develop improved catalytic processes
employing proprietary high speed testing and computer learning technologies.
In January 2001, all operations in NovoTec were ceased.
Our costs to date, excluding costs associated with the discontinued product
line, have primarily consisted of expenses to support Xonon development. We
expect to significantly increase our research and development expenses to
further commercialize Xonon. As we begin to fulfill commercial orders, we will
incur cost of goods sold expenses. Costs associated with Catalytica Advanced
Technologies to date have primarily consisted of expenses to support contracted
research.
All of our revenue has consisted of revenue from research and development
contracts funded either from gas turbine manufacturers, government sources or
research institutions, as well as contracted and collaborative research. We do
not anticipate product sales until at least 2001. These sales may require future
royalty payments to others. We expect to incur operating losses through at least
2003.
Results of Operations
Comparison of the years ended December 31, 1998, December 31, 1999, and December
31, 2000.
Revenue
For the year ended
December 31, Annual % Change
--------------------- ---------------------------
1998 1999 2000 1999/1998 2000/1999
----- ------ ------ --------- ---------
(in thousands)
Total revenue.. $6,279 $3,053 $5,487 (51)% 80%
21
Our revenue has consisted entirely of research and development revenues that are
derived from cost reimbursement contracts with gas turbine manufacturers,
government agencies and research institutions, as well as contracted and
collaborative research. Reimbursement contracts provide for partial recovery of
our direct and indirect costs. The timing of these reimbursements varies from
year to year, and from contract to contract, based on the terms agreed upon by
us and the funding party.
Revenue increased 80% for the twelve months ended December 31, 2000, compared
with the twelve months ended December 31, 1999. This increase was principally
due to securing $2.7 million of additional external development funding for
Xonon development programs. During 2000 we received $2.9 million of new revenue
related to GE programs. This increase was slightly offset by a $0.3 million
decrease in external funding related to Catalytica Advanced Technologies'
revenues as it decreased its emphasis on contract research and focused its
efforts on development of new business opportunities.
Revenue decreased 51% for the twelve months ended December 31, 1999, compared
with the twelve months ended December 31, 1998. This reduction was principally
due to a $1.2 million decrease in external research funding received by us
during 1999, as well as a $2.0 million decrease in Catalytica Advanced
Technologies' R&D revenue as it decreased its emphasis on contract research and
focused its efforts on development of new technologies through joint ventures.
Most of our research and development contracts are subject to periodic review by
the funding partner, which may result in modifications, termination of funding
or schedule delays. We cannot assure that we will continue to receive research
and development funding. In return for funding development, collaborative
partners receive certain rights in the commercialization of the resulting
technology. We expect to continue to pursue funded research programs. These may
not, however, be a continual source of revenue. Due to the nature of our
operating history, period comparisons of revenues are not necessarily meaningful
and should not be relied upon as indications of future performance.
Costs and Expenses
For the year ended
December 31, Annual % Change
---------------------- ---------------------------
1998 1999 2000 1999/1998 2000/1999
----- ----- ---- --------- ---------
(in thousands)
Research and development (includes
allocated costs from Catalytica, Inc. of
$1,938, $2,045 and $ 1,678 for the
years ended December 31,
1998, 1999, and 2000, respectively)................... $9,313 $9,627 $11,277 3% 17%
Selling, general and administrative
(includes allocated costs from
Catalytica, Inc. of $1,049, $1,052 and
$ 875 for the years ended
December 31, 1998, 1999, and 2000,
respectively)......................................... 1,269 4,786 10,660 277% 123%
Research and Development ("R&D"). R&D expense includes compensation and benefits
for engineering staff, expenses for contract engineers, materials to build
prototype units, fees paid to outside suppliers for subcontracted components and
services, supplies used and facility-related costs. We expense all R&D costs as
incurred.
R&D expense increased 17% for the twelve months ended December 31, 2000,
compared with the twelve months ended December 31, 1999. Once the prototype
development program of our 50% owned GENXON joint venture was completed in June
1999, the engineering efforts relating to additional catalyst system testing and
development were conducted principally by us and consequently resulted in our
having increased R&D costs of $2.0 million in 2000 over 1999. The increase in
R&D expenditures was also attributable to an increase of $2.0 million from Xonon
development programs. We expect to continue our R&D efforts, and we expect R&D
expense to increase in the future. The R&D expense increase was partially offset
by a net reimbursement of advances made by us to Enron totaling approximately
22
$1.1 million. In December 1999, we agreed to advance cash to Enron in order to
accelerate the development of Xonon cool combustion applications for turbines.
In exchange, Enron obligated itself to repay any advances at the end of nine
months in either cash or "turbine credits". Under the arrangement, if certain
conditions were met, Enron could gain the unilateral right to select whether it
would repay our advances with cash or settle them through turbine credits. The
turbine credits entitle the holder to a dollar-for-dollar credit on the purchase
of certain turbines that specify the use of our Xonon process. Because Enron
could gain the right to use the turbine credits to settle the advances and
because we were unable to reasonably estimate the amount we would ultimately
realize if Enron used turbine credits to settle the advances, we recorded a $1.2
million provision, which was equal to the amount advanced by us to Enron at
December 31, 1999. In March 2000, the agreement was amended and Enron reimbursed
us for approximately $1.1 million of the previous advance. Accordingly, that
amount was recorded in the first quarter of 2000 as a reduction of related R&D
expense.
R&D expense increased 3% for the twelve months ended December 31, 1999, compared
with the twelve months ended December 31, 1998. Although the total amount of R&D
expense remained relatively flat in 1999, R&D expense was impacted by a shift in
R&D spending from the GENXON joint venture back to us and a decrease in
Catalytica Advanced Technologies' R&D expense due to commencement of their joint
venture with Sud-Chemie. Beginning in the second half of 1996 through the end of
the second quarter of 1999, a significant portion of our research activity was
financed through and allocated to the GENXON joint venture. Once the prototype
development of the Kawasaki development program was completed in June 1999, we
assumed primary funding of additional catalyst system testing and development
which resulted in an increase in R&D costs of $0.9 million in 1999. In addition,
$1.2 million of costs incurred to accelerate the development of Xonon technology
also contributed to the increase in R&D expense in 1999. Lastly, the increase in
R&D expenses was partially offset by lower R&D expenses by Catalytica Advanced
Technologies in the amount of $1.7 million due to a shift in emphasis from
contract research to development of new technologies primarily through its 50/50
joint venture, Sud-Chemie Catalytica, which was formed in July of 1998. R&D
expenses that were previously incurred by Catalytica Advanced Technologies were
transferred to the Sud-Chemie Catalytica joint venture, which accounted for a
reduction of Catalytica Advanced Technologies' R&D expenses of $1.1 million in
the twelve months ended December 31, 1999 when compared to 1998. Catalytica
Advanced Technologies formed this joint venture to share development costs with
its joint venture partner.
Through the end of the second quarter of 1999, a significant portion of our
research activity was conducted on behalf of the GENXON joint venture (see "Loss
on Joint Venture"). As a result, some R&D costs were incurred by the joint
venture rather than by us. The following amounts of R&D expenses were incurred
by us (under our contract with GENXON) and charged to the GENXON joint venture:
none in 2000, $2.0 million in 1999, and $2.5 million in 1998. Additionally, the
GENXON joint venture incurred other significant R&D costs reflected in the
GENXON financial statements. Once GENXON completed its final program in June
1999, all further R&D efforts were conducted principally by us and consequently
are reflected in our R&D costs. We account for losses of our joint ventures
under the equity method of accounting.
Selling, General and Administrative ("SG&A") expenses include compensation,
benefits and related costs in support of corporate functions, which include
management, business development, marketing, sales and finance. Additionally,
SG&A expenses include charges by Catalytica, Inc. for various costs paid by
Catalytica, Inc. on our behalf, including facilities, finance, legal, human
resources, pension and other expenses. Charges for these services have been
allocated based upon square footage, usage, headcount and other methods that
management believes to be reasonable.
SG&A expenses increased 123% for the twelve months ended December 31, 2000,
compared with the twelve months ended December 31, 1999. This increase was
primarily due to $5.3 million in transaction costs recorded in the third and
fourth quarters which related to our spin-off and $0.9 million in severance
costs associated with the resignation of our former President and Chief
Executive Officer. In addition, $1.0 million of the increase was due to
increased staffing and administration costs of which $0.3 million was related to
the commercialization of Xonon and $0.7 million was related to NovoTec, our
subsidiary, which was formed in June 2000. The increases in 2000 in SG&A were
partially offset by a one-time charge of $1.3 million reserve for contingencies
which we incurred in 1999. We expect SG&A expenses to increase in the future as
we enter later stages of commercialization.
SG&A expenses increased 277% for the twelve months ended December 31, 1999 when
compared to the twelve months ended December 31, 1998. As we move toward
commercialization, we have developed a need to increase our marketing and other
SG&A activities. Related to this transition, our costs increased $2.2 million
between 1998 and 1999. Additionally, in 1999, we recorded a charge of $1.3
million for contingencies.
23
Loss on Joint Ventures
For the year ended
December 31, Annual % Change
-------------------- -----------------------
1998 1999 2000 1999/1998 2000/1999
---- ---- ---- --------- ---------
(in thousands)
Loss on joint ventures... $3,826 $1,133 $236 (70)% (79)%
In 1996, we formed a Delaware limited liability company, GENXON LLC, as a 50/50
joint venture with Woodward Governor to develop the potential market for
upgrading out-of-warranty turbines with new systems to improve emissions and
operating performance. We account for losses of our joint ventures under the
equity method of accounting. Under the equity method of accounting, we are
required to record losses in the joint venture because we made a capital
contribution in an equal amount during this period. We recognized 50% of the
loss of the joint venture to the extent of our capital contribution, which
resulted in losses of $0.2 million in 2000, $1.1 million in 1999, and $3.7
million in 1998. In the third quarter of 1999, GENXON completed its prototype
development of the Kawasaki combustion unit, and we began conducting subsequent
catalyst system testing programs. Although we expect to make further reduced
capital contributions during 2001, which will result in the recognition of
additional pro rata losses, neither joint venture partner is contractually
required to make such capital infusions. Our reduced level of investment in
GENXON is expected to continue throughout 2001.
In 1998, Catalytica Advanced Technologies formed a joint venture with United
Catalysts, Inc., a division Sud-Chemie Group, to form Sud-Chemie Catalytica. No
losses were recorded by Catalytica Advanced Technologies in 2000 and 1999
related to Sud-Chemie Catalytica, because it had recorded its share of losses to
the extent of its capital contribution of $0.15 million in 1998. The operating
agreement does not require any further capital contributions by Catalytica
Advanced Technologies or us beyond its initial $0.15 million contribution.
Therefore, we do not expect to incur further losses unless we decide to invest
additional capital beyond the initial $5 million commitment by the joint venture
partner.
Interest Income
For the year ended
December 31, Annual % Change
------------------- ---------------------
1998 1999 2000 1999/1998 2000/1999
---- ---- ---- --------- ---------
(in thousands)
Interest income... $1,409 $1,041 $ 886 (26)% (15)%
Our interest income consists of interest earned on cash, cash equivalents and
short-term investments. Interest income decreased for the twelve months ended
December 31, 2000, compared with the twelve months ended December 31, 1999, due
to reduced average cash balances attributable to the funding of operations.
Interest income in 2001 is expected to be higher than in previous years as a
result of higher cash balances related to $50.0 million of cash Catalytica, Inc.
invested in us in December 2000, immediately before the close of the
distribution of our common stock by Catalytica, Inc.
Interest income decreased 26% for the twelve months ended December 31, 1999 when
compared to the previous period, due to reduced average cash balances
attributable to the funding of operations. In January 1998, Enron Ventures
invested $30.0 million in our company. Prior to the Enron Ventures investment,
we had no interest income.
24
Interest Expense
For the year ended
December 31, Annual % Change
---------------------- ---------------------
1998 1999 2000 1999/1998 2000/1999
---- ---- ---- --------- ---------
(in thousands)
Interest expense........ $ 177 $ 278 $ 110 57% (60)%
Interest expense decreased 60% for the twelve months ended December 31, 2000,
compared with the twelve months ended December 31, 1999, due to Catalytica, Inc.
discontinuing charging Catalytica Advanced Technologies interest related to
intercompany debt owed to Catalytica, Inc. Catalytica Energy incurred a $0.1
million one-time interest cost in the first quarter of 2000 related to the
recovery of $1.1 million of the $1.2 million advance paid by us to Enron and
incurred to develop Xonon technology. Interest expense is expected to be
minimal for the next few years.
Interest expense increased 57% for the twelve months ended December 31, 1999
when compared to the previous period due to an increase of $0.1 million of
interest expense attributable to an increase of approximately $2.0 million of
intercompany debt balance between Catalytica Advanced Technologies and
Catalytica, Inc. Catalytica Advanced Technologies used borrowings from
Catalytica, Inc. to fund operations. Catalytica, Inc. charged Catalytica
Advanced Technologies interest of $0.2 million and $0.3 million for the twelve
months ended December 31, 1998 and 1999, respectively. In January 1998, we
received a $30.0 million investment by Enron Ventures. Prior to the Enron
investment, we used borrowings from Catalytica, Inc. to fund our operations. We
incurred interest expense to Catalytica, Inc. at an annual interest rate of 7%
on these borrowings.
Income Taxes
No benefit for federal and state income tax is reported in the financial
statements because of our Tax Sharing Agreement with Catalytica, Inc. In
accordance with this agreement, we are not reimbursed for the tax benefit of our
past losses and any net operating losses generated by us prior to our separation
with Catalytica, Inc. in December 2000.
Liquidity and Capital Resources
Year ended
December 31,
---------------------------------
1998 1999 2000
-------- ------- --------
(in thousands)
Cash, cash equivalents, and short-term
investments.............................. $ 22,847 $16,032 $ 58,713
Working capital........................... 22,424 10,653 51,552
Cash provided by (used in)
Operating activities...................... (3,784) (7,367) (10,740)
Investing activities...................... (10,017) (1,488) 66
Financing activities...................... 31,455 1,763 54,334
-------- ------- --------
Net increase (decrease) in cash and cash
equivalents.............................. 17,654 (7,092) 43,660
Current Ratio............................. 7.14 2.62 6.05
Prior to the spin-out transaction, Catalytica, Inc. made a $50.0 million cash
investment in us. At December 31, 2000, we had cash, cash equivalents, and
short term investments totaling approximately $58.7 million. We believe that
our current cash resources are adequate to fund currently contemplated
operations through at least 2002. Our cash requirements depend on numerous
factors, including completion of our product development activities, ability to
25
commercialize Xonon Cool Combustion technology, market acceptance of our systems
and other factors. We expect to devote substantial capital resources to further
commercialize Xonon Cool Combustion technology, hire and train our production
staff, develop and expand our manufacturing capacity, begin production
activities and expand our research and development activities.
Other Commitments
In December 2000, in connection with DSM's merger with Catalytica, Inc., we
agreed to indemnify DSM Catalytica for all liabilities related to us and
Catalytica Advanced Technologies incurred prior and subsequent to our spin-off
from Catalytica, Inc. Additionally, we agreed to indemnify DSM for any costs
associated with the merger, which were not reduced from the merger consideration
distributed to shareholders of Catalytica, Inc. in connection with the merger.
We entered into research collaboration arrangements that may require us to make
future royalty payments. These payments would generally be due once specified
milestones, such as the commencement of commercial sales of a product
incorporating the funded technology are achieved. Currently, we have three such
arrangements with Tanaka Kikinzoku Kogyo ("Tanaka"), Gas Research Institute
("GRI") and the California Energy Commission ("CEC").
We have developed our catalytic combustion technology under a development
agreement with Tanaka, a major Japanese precious metals company. Under this
agreement, Tanaka funded a significant amount of the development effort related
to this technology. In January 1995, we entered into a new agreement, for which
further development and commercialization of the catalytic combustion
technology, which superseded the original agreement. The new agreement divides
commercialization rights to the technology between the parties along market and
geographic lines. We have exclusive rights to manufacture and market catalytic
combustion systems for large gas turbines (greater than 25 MW power output) on a
worldwide basis and for small- and medium-sized gas turbines (25 MW 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 our area of exclusivity. In each case, the manufacturing and
marketing party will pay a royalty on net sales to the other party, and an
additional royalty on net sales if the sale occurs in the other party's area of
exclusivity. 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, while the other party has a right to obtain a royalty-bearing,
nonexclusive license to use the invention in its areas of exclusivity.
We entered into a funding arrangement with GRI to fund the next generation Xonon
combustor and demonstrate its performance. We will be required to make royalty
payments to GRI of $243,000 per year beginning with the sale, lease or other
transfer of the twenty-fifth catalyst module for gas turbines rated greater than
1MW, for seven years, up to a maximum of $1.7 million.
We entered into a funding arrangement with the CEC in which they agreed to fund
a portion of our Xonon-engine test and demonstration facility located in Santa
Clara, California. Under this agreement, we are required to pay a royalty of
1.5% of the sales price on the sale of each product or right related to this
project for fifteen years. We have the right to choose an early buyout option
for an amount equal to $2.6 million, without a pre-payment penalty, provided the
payment occurs within two years from the date at which royalties are first due
to the CEC.
We have never paid cash dividends on our common stock or any other securities.
We anticipate that we will retain any future earnings for use in the expansion
and operation of our business and do not anticipate paying cash dividends in the
foreseeable future.
Impact of Inflation
The effect of inflation and changing prices on our operations was not
significant during the periods presented.
Impact of Recently Issued Accounting Standards
FAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", is
effective for the fiscal year ending on or about December 31, 2001. It
establishes accounting and reporting standards requiring that every derivative
instrument be recorded on the balance sheet as either an asset or liability
measured at its fair value. We do not believe that adopting this statement will
have a material effect on our financial position or results of operations. In
December
26
1999, the Securities and Exchange Commission issued SAB 101, "Revenue
Recognition in Financial Statements". Adoption of this statement did not have a
material effect on our financial position or results of operations.
We have operated primarily in the United States and all sales to date have been
made in U.S. dollars. Accordingly, we have not had any material exposure to
foreign currency rate fluctuations.
RISKS THAT COULD AFFECT OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should carefully consider the risks described below before you decide to
hold or sell our common stock. If any of the following risks were to occur, our
business, financial condition or results of operations could suffer. In that
event, the trading price of our common stock could decline, and you may lose all
or part of your investment.
This annual report on Form 10K contains forward-looking statements based on our
current expectations, assumptions, estimates and projections about our company
and our industry. These forward-looking statements involve risks and
uncertainties. Our actual results may differ materially from those anticipated
in these forward-looking statements as a result of various factors, as more
fully described below.
Risks Related to Our Business
We are an early stage company and your basis for evaluating us is limited
Our activity to date has consisted of developing the Xonon Cool Combustion
technology and designing products for its commercialization. We do not expect to
ship our Xonon modules until at least 2001. Accordingly, there is only a
limited basis upon which you can evaluate our business and prospects. Since we
are an early stage company, our revenues will initially be low relative to the
size of likely orders and may therefore vary significantly from quarter to
quarter. You should consider the challenges, expenses and difficulties that we
will face as an early stage company seeking to develop, manufacture and sell a
new product.
We have incurred losses and anticipate continued operating losses through at
least 2003
As of December 31, 2000, we had an accumulated deficit of $59.9 million. We have
not achieved profitability and expect to continue to incur net losses until we
can produce sufficient revenues to cover our costs. Our current cash resources
are expected to finance operations through 2002. We expect to incur operating
losses through at least 2003, and we expect that we will need to raise
additional capital before we become profitable. Even if we do achieve
profitability, we may be unable to sustain or increase our profitability in the
future.
We must successfully complete further development work before Xonon-equipped gas
turbines can be shipped. Delays in completing this work could result in the loss
of orders, and the emergence of significant technical issues could result in
termination by OEMs of certain agreements to adapt Xonon to their gas turbines
Incorporating our technology in each gas turbine model will require adaptation
work by us and the OEM, such as additional engineering work and, for some
turbines, technology development. In most cases, that work has not yet been
completed. For example, we have not yet completed the development of Xonon
required to integrate it into the GE 7FA gas turbine. The GE 7FA gas turbine
operates at a higher firing temperature than other gas turbine models for which
we and GE have done more extensive adaptation work. The remaining work for the
7FA and possibly other gas turbine models may involve significant technical
risks and may extend over several years. We are, however, currently performing
within the timetables established for completion of these programs. We may not
be successful in adapting Xonon technology to particular gas turbine models, and
even if we are successful, the development work may result in delays in
commercial shipment. Under the terms of our collaborative commercialization and
license agreement with GE, GE may terminate the agreement at any time if it
determines that there are significant technical issues which indicate that the
technical objectives of the Xonon commercialization program are not achievable
or cannot be achieved within the timetable established for the program.
We will incur significant costs developing our technology with OEMs. If any OEM
fails to complete development for any reason, we will not be able to recover the
costs incurred for the development with that OEM
27
Given the long lead times for gas turbine orders, we expect that OEMs will take
initial orders for Xonon-equipment turbines prior to completion of the
development work, and that these initial orders will take into account the
attendant risks. For example, for Enron North America's December 1999 7FA order
specifying Xonon as the preferred emissions control system, GE and Enron have
the right to substitute alternative emissions control technology for any of
these gas turbines for any reason, including in the event the Xonon combustion
system cannot be developed or has not been developed in time to support Enron
North America's project schedule. In that case, we would lose the revenue
associated with these orders.
We are heavily dependent on our relationships with OEMs and their commitment to
adopt and market Xonon technology on their gas turbines
Substantially all of our revenue for the foreseeable future will be derived from
sales of Xonon modules to manufacturers of gas turbines for use in their new and
installed turbines. We have ongoing programs with several OEMs, which are in
various stages of incorporating our Xonon technology into, or evaluating our
Xonon technology for incorporation into, their gas turbine product lines. These
and future OEMs may decide not to continue the development and commercialization
of Xonon combustion systems for their gas turbines.
Our agreements with OEMs generally provide the OEM with the right to be the sole
market channel for distribution of Xonon combustion systems in that OEM's gas
turbines under contract. A decision by an OEM not to continue with the
commercialization of Xonon combustion systems in its product line could
significantly limit our access to the market for that OEM's turbines.
Our ability to sell Xonon modules for those gas turbines for which Xonon
combustion systems become commercially available is heavily dependent upon the
OEMs' marketing and sales strategies for Xonon combustion systems and their
worldwide sales and distribution networks and service capabilities. Any decision
on their part to limit, constrain or otherwise fail to aggressively market and
sell Xonon combustion systems, including limiting their availability or pricing
them uncompetitively, could harm our potential earnings by depriving us of full
access to their market.
If the initial orders for Xonon-equipped turbines do not ship, our reputation
could be harmed and future sales could be adversely affected
Although our OEM customers have received initial orders for Xonon-equipped gas
turbines, we cannot assure you that these orders will ultimately be shipped.
There are many reasons why these orders might not ship, including:
. A failure by us and the OEM to complete necessary development, design and
adaptive work;
. A decision by the OEM not to include Xonon-based systems in its turbines, or
in a particular turbine model, for commercial or other reasons; and
. Cancellation of the OEM's turbine order by the end-user, due to its inability
to obtain permitting, or for commercial or other reasons.
If the initial announced orders for Xonon-equipped turbines do not ultimately
ship, then, depending on the stated reasons for cancellation and market
perceptions of the cancellation, our reputation could be harmed and our sales
could be adversely affected.
Xonon-equipped gas turbines may never attain market acceptance
Xonon-equipped gas turbines represent an emerging market. If Xonon Cool
Combustion technology does not attain market acceptance, end-users may not want
to purchase turbines equipped with Xonon modules. If a significant commercial
market fails to develop or develops more slowly than we anticipate, we may be
unable to recover the losses incurred to develop our product and may be unable
to achieve profitability. The development of a commercial market for our systems
may be impacted by factors which are out of our control, including:
. The cost competitiveness of the Xonon combustion system;
. A significant drop in demand for new gas turbines;
28
. The future costs of natural gas and other fuels;
. Changing regulatory requirements;
. The emergence of more effective technologies and products; and
. Changes in federal, state or local environmental regulations.
We have not yet developed Xonon systems for "dual fuel" turbines, which may
account for a portion of our market
We believe that a portion of new electric generation projects may require
turbines powered by natural gas and an alternative liquid fuel. These turbines
are known as "dual fuel." We do not know what portion of the market dual fuel
turbines may represent in the future. Xonon is in the development stage for use
in dual fuel turbines, and we have not undertaken the adaptation work for any
particular turbine models. The necessary adaptation work for specific turbine
models may delay availability, or even be unsuccessful, which could adversely
affect our sales.
We have no experience manufacturing Xonon modules on a commercial basis
To date, we have focused primarily on research and development and have no
experience manufacturing Xonon modules on a commercial basis. We have
constructed a 3,000 square foot manufacturing facility, and we are continuing to
develop our manufacturing processes. We may not be able to develop efficient,
low-cost manufacturing capability and processes that will enable us to meet the
quality, price, engineering, design and production standards or production
volumes required to manufacture Xonon modules on a commercial scale. We may also
encounter difficulty purchasing components and materials, particularly those
with long lead times. Even if we are successful in developing our manufacturing
capability and processes, we do not know whether we will do so in time to meet
our product commercialization schedule or to satisfy the requirements of our
customers.
We are dependent on third party suppliers for the development and supply of key
components for our products
We have recently entered into commercial arrangements with suppliers of the key
components of our systems. We do not know, however, when or whether we will
secure arrangements with suppliers of other required materials and components
for our Xonon modules, or whether these arrangements will be on terms that will
allow us to achieve our objectives. If we fail to obtain suppliers of all the
required materials and components for our systems, our business could be harmed.
A supplier's failure to supply materials or components in a timely manner, or to
supply materials or components that meet our quality, quantity or cost
requirements, or our inability to obtain substitute sources of these materials
and components on a timely basis or on terms acceptable to us, could harm our
ability to manufacture our Xonon modules.
A number of our components are provided by a single supplier and our purchase
volumes are not yet at the point where we can secure agreements ensuring long-
term supplies at attractive prices given the alternative of maintaining a
strategic inventory reserve. Some of our suppliers use proprietary processes to
manufacture components. Although alternative suppliers are available, a switch
in suppliers could be costly and could take up to one year to accomplish.
Significant price increases in key materials may reduce our gross margins and
profitability
The prices of palladium and platinum, which are used in the production of Xonon
modules, can be volatile. For example, during the period from January 1, 1999 to
December 31, 2000, the price of palladium ranged from $284 to $972 per troy
ounce. During that period, the price of platinum ranged from $342 to $625 per
troy ounce. If the long-term costs of these materials were to significantly
increase we would, in addition to recycling materials from returned modules,
attempt to reduce material usage or find substitute materials. If these efforts
were not successful and if these cost increases could not be passed onto the
customers of Xonon modules, then our gross margins and profitability would be
reduced.
Our success depends on the continued demand for gas turbines
29
A significant portion of the market for Xonon combustion systems will result
from the purchase and installation of new Xonon-equipped gas turbines. If the
market for gas turbines significantly declines, the demand for Xonon combustion
systems could be reduced. The market for new gas turbines has historically been
cyclical in nature. If this pattern continues in the future, then during periods
of low demand, the portion of our business derived from new turbine sales will
decline.
Competition from alternative technologies may adversely affect our profitability
The market for emissions reduction is intensely competitive. There are
alternative technologies which, when used in combination, could reduce gas
turbine emissions to levels comparable to or lower than Xonon-equipped gas
turbines. These technologies include lean pre-mix combustion systems, which are
used in conjunction with gas turbine exhaust cleanup systems such as selective
catalytic reduction. Lean pre-mix systems are offered by several gas turbine
OEMs, some of which have much greater financial resources than we do.
There are also a number of companies, universities, research institutions and
governments engaged in the development of emissions reduction technologies that
could compete with the Xonon technology. Many of these entities have
substantially greater resources than we do.
Xonon combustion systems will be deployed in complex and varied operating
environments, and they may have limitations or defects that we find only after
full deployment
Gas turbines equipped with Xonon combustion systems are expected to be subjected
to a variety of operating conditions and to be deployed in a number of extremely
demanding environments. For example, gas turbines will be deployed in a wide
range of temperature conditions, in the presence of atmospheric or other
contaminants, under a wide range of operating requirements and with varying
maintenance practices. As a result, technical limitations may only become
apparent in the field after many Xonon-equipped gas turbines have been deployed.
These limitations could require correction, and the corrections could be
expensive. In addition, the need to develop and implement these corrections
could temporarily delay the sale of new Xonon- equipped gas turbines.
Any failure of gas turbines incorporating our technology could damage our
reputation, reduce our revenues or otherwise harm our business
The Xonon combustion system includes components, that are located in a critical
section of the gas turbine. A mechanical failure of a Xonon-equipped gas turbine
may be attributed to the Xonon combustion system, even if the immediate cause is
not clear. If this occurs, the reputation of the Xonon combustion system and its
acceptability in the marketplace could be negatively impacted.
We may be unable to raise additional capital to complete our product development
and commercialization plans
Our product development and commercialization schedule could be delayed if we
are unable to fund our research and development activities or the continuing
development of our manufacturing capabilities. We expect that our current cash
resources will be sufficient to fund our operations through at least 2002.
However, we may need to raise additional funds to achieve full commercialization
of the Xonon combustion systems and other potential products. We do not know
whether we will be able to secure additional funding on terms acceptable to us
to pursue our commercialization plans.
We may have difficulty managing the expansion of our operations
We are undergoing and expect to continue to undergo growth in the number of our
employees, the size of our physical plant and the scope of our operations. We
must also integrate the operations of Catalytica Advanced Technologies, a
subsidiary of Catalytica, Inc. which was combined with us prior to the spin-off.
This expansion is likely to place a significant strain on our management team
and other resources. Our business could be harmed if we encounter difficulties
in effectively managing the budgeting, forecasting and other process control
issues presented by such a rapid expansion.
30
If we are unable to protect our intellectual property, others may duplicate our
technology
We rely on a combination of patent, copyright and trade secret laws and
restrictions on disclosure to protect our intellectual property rights. Our
ability to compete effectively will depend, in part, on our ability to protect
our proprietary technology, systems designs and manufacturing processes. The
ability of others to use our intellectual property could allow them to duplicate
the benefits of our product and reduce our competitive advantage. We do not know
whether any of our pending patent applications will issue or, in the case of
patents issued or to be issued, that the claims allowed are or will be
sufficiently broad to protect our technology or processes. Even if all our
patent applications are issued and are sufficiently broad, they may be
challenged or invalidated. We could incur substantial costs in prosecuting or
defending patent infringement suits. While we have attempted to safeguard and
maintain our proprietary rights, we do not know whether we have been or will be
completely successful in doing so.
Further, our competitors may independently develop or patent technologies or
processes that are substantially equivalent or superior to ours. If we are found
to be infringing on third party patents, we do not know whether we will be able
to obtain licenses to use such patents on acceptable terms, if at all. Failure
to obtain needed licenses could delay or prevent the development, manufacture or
sale of our systems.
We rely, in part, on contractual provisions to protect our trade secrets and
proprietary knowledge. These agreements may be breached, and we may not have
adequate remedies for any breach. Our trade secrets may also be known without
breach of such agreements or may be independently developed by competitors. Our
inability to maintain the proprietary nature of our technology and processes
could allow our competitors to limit or eliminate any competitive advantages we
may have and prevent us from fully commercializing Xonon technology. If we do
not fully commercialize Xonon, we will not be profitable.
If we are unable to attract or retain key personnel, our ability to adapt our
technology to gas turbines, to continue to develop our technology, to
effectively market our product and to manage our business could be harmed
Our business requires a highly skilled management team and specialized
workforce, including scientists, engineers, researchers, and manufacturing and
marketing professionals who have developed essential proprietary skills. Based
on our planned expansion, we will need to increase the number of our employees
and outside contractors. Our future success will therefore depend on attracting
and retaining additional qualified management and technical personnel. We do not
know whether we will be successful in hiring or retaining qualified personnel.
Our inability to hire qualified personnel on a timely basis, or the departure of
key employees, could harm our expansion and commercialization plans.
The GENXON joint venture may require additional funding or subject us to
liability in connection with litigation
Our joint venture, GENXON, has completed its prototype development, but could
incur additional costs. Neither joint venture partner is contractually required
to make further capital infusions. If our partner decides not to make additional
capital contributions, we would be faced with the possibility of having to fund
the joint venture on our own or find additional sources of financing. In this
event, additional financing might not be available on acceptable terms, or at
all.
On August 14, 2000, the City of Glendale filed a complaint against us,
Catalytica, Inc. and GENXON Power Systems, Inc. in Los Angeles County Superior
Court. The case has been transferred to the Orange County Superior Court, Case
No. 00CC13002. 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, Inc. 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. On January 16, 2001, the court
granted, with leave to amend, our motion to dismiss the causes of action for
fraud and negligent misrepresentation asserted in the complaint. The defendants
believe they have meritorious defenses to the remaining claims asserted and
intend to defend the action vigorously. While it is not possible to predict with
certainty the outcome of this matter, and while we do not believe an adverse
result would have a material effect on our financial position, it could be
material to the results of operations and cash flows for a fiscal year.
Moreover, we have indemnified Catalytica, Inc. pursuant to our indemnification
agreement with Catalytica, Inc. for liabilities incurred by Catalytica, Inc. in
connection with the operations of GENXON or litigation involving GENXON.
31
Morgan Stanley Dean Witter Capital Partners owns a significant amount of our
common stock and has significant influence over our business
As of December 31, 2000, Morgan Stanley Dean Witter Capital Partners and its
affiliates own approximately 34% of our outstanding common stock. Morgan Stanley
also has shareholder rights, including rights to appoint directors, and
registration rights. As a result, Morgan Stanley and its affiliates hold a
substantial voting position in us and may be able to significantly influence our
business.
Liabilities incurred by us as a result of the spin-off may have a negative
effect on our financial results
We incurred additional liabilities as a result of the spin-off. For example,
when the business of Catalytica Advanced Technologies was combined with ours, we
became responsible for the liabilities of Catalytica Advanced Technologies.
Additionally, we have obligations under the separation agreements we entered
into with Catalytica, Inc., Synotex and DSM. For example, we indemnified DSM
Catalytica, Inc. for liabilities arising out of our business, the business of
Catalytica Advanced Technologies and other liabilities of DSM Catalytica, Inc.
not associated with the pharmaceuticals business. We are also responsible for
liabilities arising out of the distribution of our common stock by Catalytica,
Inc. The nature and amount of these potential liabilities cannot be estimated.
If we incur these liabilities, our financial results could be harmed.
A large number of our shares may be sold in the market, which may depress the
market price of our common stock
Sales of a substantial number of shares of our common stock in the public market
could cause the market price of our common stock to decline. JSB Asset, LLC, an
affiliate of Enron, and Morgan Stanley together own approximately 45% of our
outstanding shares of common stock, and we have granted to JSB Asset, LLC and
have agreed to grant to Morgan Stanley, the right to have their shares
registered with the SEC immediately after the distribution. Neither Morgan
Stanley nor JSB Asset, LLC has exercised this right.
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, the effectiveness and
commercial viability of products of us or our competitors, changes in
environmental regulations, announcements of technological innovations or new
products by us or our competitors, fluctuations in our operating results,
including 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.
Provisions in our charter documents may delay or prevent our acquisition, which
could decrease the value of your shares
Our certificate of incorporation and bylaws and Delaware law contain provisions
that could make it harder for a third party to acquire us without the consent of
our board of directors. These provisions include a classified board of
directors. In addition, our board of directors has the right to issue preferred
stock without stockholder approval, which could be used to dilute the stock
ownership of a potential hostile acquirer. Although we believe these provisions
provide for an opportunity to receive a higher bid by requiring potential
acquirers to negotiate with our board of directors, these provisions apply even
if the offer may be considered beneficial by some stockholders.
FORWARD-LOOKING STATEMENTS
This annual report on Form 10K contains forward-looking statements within the
meaning of the federal securities laws that relate to future events or our
future financial performance. In some cases, you can identify forward-looking
statements by terminology such as "may," "will," "should," "expects," "plans,"
"anticipates," "believes," "estimates," "predicts," "intend," "potential" or
"continue" or the negative of such terms or other comparable terminology. In
addition, these forward-looking statements include, but are not limited to,
statements regarding the following: (1) our combustion systems, (2) our ability
to adapt our technology to particular gas turbine models, (3) our intellectual
property portfolio, and (4) our business strategies and plans. These statements
are only predictions. These forward-
32
looking statements are subject to certain risks and uncertainties that could
cause actual results to different materially from those reflected in these
forward-looking statements. Factors that might cause actual results to differ
include, but are not limited to, those discussed in the sections entitled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Risks That Could Affect Our Financial Condition and Results of
Operations."
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Moreover, neither we nor any other person
assume responsibility for the accuracy and completeness of these statements. We
are under no duty to update any of these forward-looking statements or to
conform these statements to actual results.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The primary objective of our investment activities is to preserve principal
while at the same time maximizing the income we receive from our investments
without significantly increasing risk. Some of the securities that we invest in
may have market risk. This means that a change in prevailing interest rates may
cause the principal amount of the investment to fluctuate. For example, if we
hold a security that was issued with a fixed interest rate at the then-
prevailing rate and the prevailing interest rate later rises, the principal
amount of our investment will probably decline. To minimize this risk in the
future, we intend to maintain our portfolio of cash equivalents and short-term
investments in a variety of securities, including commercial paper, money market
funds, government and non-government debt securities. The average duration of
all of our investments in 2000 was less than one year. Due to the short term
nature of these investments, we believe we have no material exposure to interest
rate risk arising from our investments. Therefore, no quantitative tabular
disclosure is required.
Item 8. Financial Statements and Supplementary Data
Our Financial Statements and the report of the independent auditors appear on
pages 37 through 74 of this Form 10-K.
Item 9. Changes in and Disagreements with Accountants and Accounting and
Financial Disclosure
None.
33
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.
34
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES & REPORTS ON FORM 8-K
A. (1) Financial Statements:
The following financial statements of the Registrant are filed as part of
this Report
Page
----
Report of Ernst & Young LLP, Independent Auditors 37
Statements of Operations for the years ended
December 31, 1998, 1999 and 2000 38
Balance Sheets at December 31, 1999 and 2000 39
Statements of Stockholders' Equity for the years
ended December 31, 1996, 1997, 1998, 1999 and 2000 40
Statements of Cash Flows for the years ended December 31, 1998, 1999 and
2000 42
Notes to Financial Statements 43
(2) Financial Statement Schedules:
None. Schedules not listed above have been omitted because the
information required to be set forth therein is not applicable or is
shown in the financial statements or notes thereto .
(3) Exhibits
Exhibit
Number Description
- ------ -----------
2.1(2) Assignment and Assumption Agreement between Catalytica, Inc. and
the registrant effective as of July 25, 1995.
2.2(1) Employee Matters Agreement between Catalytica, Inc. and the
registrant.
2.3(1) Master Trademark Ownership and License Agreement between
Catalytica, Inc. and the registrant.
2.4(1) Tax Sharing Agreement between Catalytica, Inc., Synotex, Inc. and
the registrant.
2.5(1) Master Confidential Disclosure Agreement between Catalytica, Inc.
and the registrant.
2.6(2) Cross-License Agreement between Catalytica, Inc. and the
registrant effective as of July 1995.
2.7(2) Cross-License Agreement between Catalytica Advanced Technologies,
Inc. and Catalytica, Inc. dated July 1995.
2.8(1) Indemnification Agreement among Catalytica, Inc. and the
registrant.
2.9(1) Master Transitional Services Agreement between Catalytica, Inc.
and the registrant.
2.10(1) Real Estate Matters Agreement between Catalytica, Inc. and the
registrant.
2.11(1) Master Separation Agreement between Catalytica, Inc. and the
registrant.
3.1(1) Amended and Restated Certificate of Incorporation to be effective
upon completion of the distribution of the Registrant's Common
Stock.
3.2(2) Amended and Restated Bylaws to be effective upon completion of
the distribution of the Registrant's Common Stock.
4.1(1) Stock Certificate specimen of the Registrant.
10.1(3) 1995 Catalytica Combustion Systems, Inc. Stock Option Plan with
agreements thereunder.
10.2(2) Promissory Notes and security documents issued to registrant from
Dennis A. Orwig.
10.3(2) Promissory Note from Patrick T. Conroy issued to GENXON Power
Systems LLC dated November 1997.
35
10.4(2) Promissory Notes from Peter B. Evans issued to registrant both
dated July 20, 1999.
10.5(2) Form of Change of Control Severance Agreements between Ralph A.
Dalla Betta and Catalytica, Inc. dated May 26, 1999, Ricardo B.
Levy and Catalytica, Inc. dated April 30, 1999, between Lawrence
W. Briscoe and Catalytica, Inc. dated May 5, 1999, and between
Dennis A. Orwig and Catalytica, Inc. dated April 15, 1999.
10.6(4) Limited Liability Company Operating Agreement of GENXON Power
Systems, LLC, dated October 21, 1996.
10.7(5) Amendment No. 1, dated December 4, 1997, to the Operating
Agreement of GENXON Power Systems, LLC.
10.8(6)+ Agreement, dated as of July 18, 1988, between Catalytica, Inc.
and Tanaka Kikinzoku Kogyo K.K.
10.9(7)+ Agreement, dated as of January 31, 1995, between Catalytica, Inc.
and Tanaka Kikinzoku Kogyo K.K.
10.10(2) Series B Preferred Stock Purchase Agreement, dated December 9,
1997, between Catalytica, Inc., Enron Ventures Corp. and the
registrant.
10.11(2) Omnibus Agreement, dated August 29, 2000, by and among
Catalytica, Inc., Sundance Assets, L.P., Enron North America
Corp. and the registrant.
10.12(1)+ Collaborative Commercialization and License Agreement among
General Electric Co., GENXON Power System, LLC and the registrant
dated as of November 19, 1998.
10.13(2) Letter Agreement with Craig N. Kitchen dated June 6, 2000.
10.14(2) Letter Agreement with Peter B. Evans dated March 26, 1999.
10.15(2) Letter Agreement with Lawrence W. Briscoe dated June 3, 1994.
10.16(2) Form of Indemnification Agreement for directors of the
registrant.
10.17(2) Registration Rights Agreement between Morgan Stanley Dean Witter
Capital Partners and its affiliates and the registrant.
10.18(2) Employee Stock Purchase Plan of the Registrant.
10.19(2) Letter Agreement with Dennis S. Riebe dated August 29, 2000.
10.20(2) Catalytica Energy Systems, Inc. 1995 Stock Plan (as amended and
restated October 26, 2000).
10.21 Letter Agreement with Ronald L. Alto dated February 16, 2001.
10.22 Consulting Agreement with Jackie Cossmon dated December 16, 2000.
10.23 Share Transfer Agreement between the Registrant and JSB Asset,
LLC dated December 15, 2000.
10.24 Stock Purchase Warrant Agreement between the Registrant and Glaxo
Wellcome, Inc. dated December 15, 2000.
21.1(2) Subsidiaries of registrant.
23.1 Independent Auditors' Consent of Ernst & Young LLP.
23.2 Independent Accountants' Consent of PricewaterhouseCoopers, LLP.
24.1 Power of Attorney (contained on page 76).
- -------------
+ Confidential treatment has been granted for portions of these agreements.
(1) Incorporated by reference to exhibits filed with our Post Effective
Amendment No. 1 to Form S-1 (Commission File No. 333-44772).
(2) Incorporated by reference to exhibits filed with our registration statement
on Form S-1 (Commission File No. 333-44772).
(3) Incorporated by reference to exhibits filed with Catalytica, Inc.'s Form 10-
Q for the quarter ended September 30, 1998 (Commission File No. 0-20966).
(4) Incorporated by reference to exhibits filed with Catalytica, Inc.'s Form 10-
K for the year ended December 31, 1996 (Commission File No. 0-20966).
(5) Incorporated by reference to exhibits filed with Catalytica, Inc.'s Form 10-
K for the year ended December 31, 1997 (Commission File No. 0-20966).
(6) Incorporated by reference to exhibits filed with Catalytica, Inc.'s
Registration Statement on Form S-1 (Registration Statement No. 33-55696).
(7) Incorporated by reference to exhibits filed with Catalytica, Inc.'s Form 10-
K for the year ended December 31, 1994 (Commission File No. 0-20966).
36
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors and Stockholders
Catalytica Energy Systems, Inc.
We have audited the accompanying combined balance sheets of Catalytica Energy
Systems, Inc. and Catalytica Advanced Technologies, Inc. (a combined company in
the development stage) as of December 31, 1998 and 1999, and the related
combined statements of operations, stockholders' equity, and cash flows for each
of the two years in the period ended December 31, 1999. We have also audited the
accompanying balance sheet of Catalytica Energy Systems, Inc. (a company in the
development stage) as of December 31, 2000, and the related statements of
operations, stockholders' equity, and cash flows for the year then ended and for
the period August 1, 1995 (inception) through December 31, 2000. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits. We did not audit the financial statements of Genxon Power Systems,
LLC a joint venture in which Catalytica Energy Systems, Inc. has a 50% interest
and for which this Company recognized losses of $ 4,355,000, $3,676,000, and
$1,133,000 as of December 31, 1997, 1998 and 1999, respectively. Those
statements were audited by other auditors whose reports have been furnished to
us and included an explanatory paragraph that is discussed in note 3 to the
financial statements. Our opinion, insofar as it relates to data included for
Genxon Power Systems, LLC, is based solely on the reports of other auditors.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. 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 and the reports of other auditors
provide a reasonable basis for our opinion.
In our opinion, based on our audits and the reports of other auditors, the 1998
and 1999 financial statements referred to above present fairly, in all material
respects, the combined financial position of Catalytica Energy Systems, Inc. and
Catalytica Advanced Technologies, Inc. at December 31, 1998 and 1999, and the
combined results of their operations and their cash flows for each of the two
years in the period ended December 31, 1999, in conformity with accounting
principles generally accepted in the United States. Also, in our opinion, based
on our audits and the reports of other auditors, the 2000 financial statements
referred to above present fairly, in all material respects, the financial
position of Catalytica Energy Systems, Inc. at December 31, 2000, and the
results of its operations and its cash flows for the year ended December 31,
2000, and for the period August 1, 1995 (inception) through December 31, 2000,
in conformity with accounting principles generally accepted in the United
States.
/s/ Ernst & Young LLP
San Jose, California
February 14, 2001
37
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
(a combined company in the development stage)
COMBINED STATEMENTS OF OPERATIONS
for the years ended December 31, 1998 and 1999
and
CATALYTICA ENERGY SYSTEMS, INC. (a company in the development stage)
STATEMENT OF OPERATIONS
for the year ended December 31, 2000
(In thousands, except per share amounts)
Cumulative Amounts
from Inception
For the year ended December 31, through December 31,
-------------------------------------- --------------------
1998 1999 2000 2000
------- -------- -------- ----
Revenues:
Research and development contracts $ 6,279 $ 3,053 $ 5,487 $ 48,517
------- -------- -------- --------
Costs and expenses:
Research and development 9,313 9,627 11,277 69,165
Selling, general and administrative 1,269 4,786 5,356 17,324
Spin-off and related transaction costs -- -- 5,304 5,304
Costs associated with discontinued product line -- -- -- 9,299
------- -------- -------- --------
Total costs and expenses 10,582 14,413 21,937 101,092
------- -------- -------- --------
Operating loss (4,303) (11,360) (16,450) (52,575)
Loss on joint ventures (3,826) (1,133) (236) (9,551)
Interest income 1,409 1,041 886 3,336
Interest expense (177) (278) (110) (1,095)
------- -------- -------- --------
Net loss $(6,897) $(11,730) $(15,910) $(59,885)
======= ======== ======== ========
Basic and diluted net loss per share (1): $ (15.91)
========
Weighted average shares used in computing basic
and diluted net loss per share: 1,000
========
(1) See Note 1, Net Loss per Share.
The accompanying notes are an integral part of these statements.
38
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
(a combined company in the development stage)
COMBINED BALANCE SHEET at December 31, 1999
and
CATALYTICA ENERGY SYSTEMS, INC. (a company in the development stage)
BALANCE SHEET at December 31, 2000
(In thousands, except per share data)
December 31,
1999 2000
-------- --------
ASSETS
Current assets:
Cash and cash equivalents $ 10,562 $ 54,222
Short-term investments 5,470 4,490
Accounts receivable:
Trade, less allowance of $100 in 2000 and 1999 736 2,190
Joint venture 176 158
Notes receivable from employees 182 --
Inventory 56 180
Prepaid expenses and other assets 29 524
-------- --------
Total current assets 17,211 61,764
Property, plant and equipment:
Leasehold improvements and equipment 2,680 13,592
Less accumulated depreciation and amortization (964) (8,062)
-------- --------
1,716 5,530
Notes receivable from employees and others, less allowance of $225 in 2000 and none in 1999 913 478
-------- --------
Total assets $ 19,840 $ 67,772
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Payable to Catalytica, Inc. $ 5,026 $ 602
Liabilities related to spin-off from Catalytica, Inc. -- 4,090
Accounts payable 1,532 1,364
Accrued payroll -- 1,305
Accrued liabilities -- 2,478
Deferred revenue -- 219
Current portion of capital lease obligation -- 155
-------- --------
Total current liabilities 6,558 10,213
Capital lease obligation -- 89
Notes payable to Catalytica, Inc. 730 --
-------- --------
Total liabilities 7,288 10,302
Commitments and contingencies
Stockholders' equity:
Catalytica Energy Systems, Inc.:
Convertible preferred stock, $0.001 par value; authorized - 9,000 shares in 1999 and 5,000
shares in 2000, issuable in Series:
Series A: authorized, issued and outstanding shares - 7,000 in 1999 and none in 2000 7 --
Series B: authorized - 2,000 shares in 1999, none in 2000; issued and outstanding - 1,339
shares in 1999 and none in 2000 1 --
Common stock, $0.001 par value; authorized - 10,250 shares in 1999 and 70,000 shares in 2000;
issued and outstanding - 500 shares in 1999 and 12,198 shares in 2000 1 12
Advanced Technologies, Inc.:
Convertible preferred stock, $0.001 par value; authorized - 3,000 shares in 1999 and none in
2000, issuable in Series:
Series A: authorized, issued and outstanding shares - 3,000 in 1999 and none in 2000 3 --
Common stock, $0.001 par value; authorized - 4,800 shares in 1999 and none in 2000; issued and
outstanding - 1,000 shares in 1999 and none shares in 2000 1 --
Additional paid-in capital 56,718 117,606
Deferred compensation (204) (263)
Deficit accumulated during the development stage (43,975) (59,885)
-------- --------
Total stockholders' equity 12,552 57,470
-------- --------
Total liabilities and stockholders' equity $ 19,840 $ 67,772
======== ========
The accompanying notes are an integral part of these statements.
39
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
(a combined company in the development stage)
COMBINED STATEMENTS OF STOCKHOLDERS' EQUITY for the years ended December 31,
1996, 1997, 1998 and 1999
and
CATALYTICA ENERGY SYSTEMS, INC. (a company in the development stage)
STATEMENT OF STOCKHOLDERS' EQUITY
for the year ended December 31, 2000
(In thousands)
Catalytica Energy Systems, Inc.
----------------------------------------------------------------------
Preferred Stock
----------------------------------------------
Series A Series B Common Stock
-------- -------- ------------
Shares Amount Shares Amount Shares Amount
---------- -------- ---------- ------------ -------- ------------
Capital contributions (August 1, 1995) 7,000 $7 -- -- 500 $1
Net loss from Nov. 1, 1994 (inception)
to Dec. 31, 1996 -- -- -- -- -- --
---------- -------- ---------- ------------ -------- ------------
Bal. at Dec. 31, 1996 7,000 7 -- -- 500 1
Net loss -- -- -- -- -- --
---------- -------- ---------- ------------ -------- ------------
Bal. at Dec. 31, 1997 7,000 7 -- -- 500 1
Issuance of preferred stock to Enron
in January 1998 -- -- 1,339 1 -- --
Forgiveness of Catalytica, Inc. notes
in January 1998 -- -- -- -- -- --
Issuance of stock options at various
dates in 1998 -- -- -- -- -- --
Net loss -- -- -- -- -- --
---------- -------- ---------- ------------ -------- ------------
Bal. at Dec. 31, 1998 7,000 7 1,339 1 500 1
Issuance of stock options at various
dates in 1999 -- -- -- -- -- --
Issuance of stock options at various
dates in 1999 -- -- -- -- -- --
Acceleration of stock option vesting
at various dates in 1999 -- -- -- -- -- --
Amortization of deferred compensation -- -- -- -- -- --
Net loss -- -- -- -- -- --
---------- -------- ---------- ------------ -------- ------------
Bal. at Dec. 31, 1999 (carried forward) 7,000 7 1,339 1 500 1
Advanced Technologies, Inc.
------------------------------------------------
Preferred Stock
---------------------
Series A Common Stock Paid-In Deferred
-------- ------------
Shares Amount Shares Amount Capital Compensation
---------- -------- ----------- ------------- ------- -------------
Capital contributions (August 1, 1995) 3,000 $3 1,000 $1 $10,138 $ --
Net loss from Nov. 1, 1994 (inception)
to Dec. 31, 1996 -- -- -- -- -- --
---------- -------- ----------- ------------- ------- ------------
Bal. at Dec. 31, 1996 3,000 3 1,000 1 10,138 --
Net loss -- -- -- -- -- --
---------- -------- ----------- ------------- ------- ------------
Bal. at Dec. 31, 1997 3,000 3 1,000 1 10,138 --
Issuance of preferred stock to Enron
in January 1998 -- -- -- -- 29,921 --
Forgiveness of Catalytica, Inc. notes
in January 1998 -- -- -- -- 16,222 --
Issuance of stock options at various
dates in 1998 -- -- -- -- 88 --
Net loss -- -- -- -- -- --
---------- -------- ----------- ------------- ------- ------------
Bal. at Dec. 31, 1998 3,000 3 1,000 1 56,369 --
Issuance of stock options at various
dates in 1999 -- -- -- -- 82 --
Issuance of stock options at various
dates in 1999 -- -- -- -- 256 --
Acceleration of stock option vesting
at various dates in 1999 -- -- -- -- -- 11
Amortization of deferred compensation -- -- -- -- -- 52
Net loss -- -- -- -- -- --
---------- -------- ----------- ------------- ------- ------------
Bal. at Dec. 31, 1999 (carried forward) 3,000 3 1,000 1 56,718 (204)
Deficit During
the Development Stockholders'
Stage Equity
--------------- -------------
Capital contributions (August 1, 1995) $ -- $ 10,150
Net loss from Nov. 1, 1994 (inception)
to Dec. 31, 1996 (19,078) (19,078)
---------- ----------
Bal. at Dec. 31, 1996 (19,078) (8,928)
Net loss (6,270) (6,270)
---------- ----------
Bal. at Dec. 31, 1997 (25,348) (15,198)
Issuance of preferred stock to Enron
in January 1998 -- 29,922
Forgiveness of Catalytica, Inc. notes
in January 1998 -- 16,222
Issuance of stock options at various
dates in 1998 -- 88
Net loss (6,897) (6,897)
---------- ----------
Bal. at Dec. 31, 1998 (32,245) 24,137
Issuance of stock options at various
dates in 1999 -- 82
Issuance of stock options at various
dates in 1999 -- --
Acceleration of stock option vesting
at various dates in 1999 -- 11
Amortization of deferred compensation -- 52
Net loss (11,730) (11,730)
---------- ----------
Bal. at Dec. 31, 1999 (carried forward) (43,975) 12,552
The accompanying notes are an integral part of these statements.
40
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
(a combined company in the development stage)
COMBINED STATEMENTS OF STOCKHOLDERS' EQUITY for the years ended December 31,
1996, 1997, 1998 and 1999
and
CATALYTICA ENERGY SYSTEMS, INC. (a company in the development stage)
STATEMENT OF STOCKHOLDERS' EQUITY
for the year ended December 31, 2000
(In thousands)
(Continued)
Catalytica Energy Systems, Inc.
----------------------------------------------------------------------------
Preferred Stock
-------------------------------------------------
Series A Series B Common Stock
-------- -------- ------------
Shares Amount Shares Amount Shares Amount
----------- --------- ----------- ------------- --------- -------------
Bal. at Dec. 31, 1999(brought forward) 7,000 7 1,339 1 500 1
Cancellation of common stock and
Series A preferred held by
Catalytica, Inc. (7,000) (7) -- -- (500) (1)
Purchase of $50,000,000 of common
stock by Catalytica, Inc. and
distribution to Catalytica Energy
shareholders on December 15, 2000 -- -- -- -- 3,828 4
Distribution of remaining Catalytica
Energy common stock to shareholders
in connection with the spin-off from
Catalytica, Inc. on December 15, 2000 -- -- -- -- 6,999 7
Cancellation of CAT common and Series
A preferred stock in connection with
its merger with Catalytica Energy in
December 2000 -- -- -- -- -- --
Conversion of Series B preferred stock
to Catalytica Energy common stock by
Enron in December 2000 -- -- (1,339) (1) 1,343 1
Forgiveness of Catalytica, Inc.
intercompany debt in December 2000 -- -- -- -- -- --
Carrying value of assets contributed
by Catalytica, Inc. to Catalytica
Energy in December 2000 -- -- -- -- -- --
Exercise of stock options at various
dates in 2000 -- -- -- -- 28 --
Issuance of stock options at various
dates in 2000 -- -- -- -- -- --
Acceleration of stock option vesting
at various dates in 2000 -- -- -- -- -- --
Amortization of deferred compensation -- -- -- -- -- --
Net loss -- -- -- -- -- --
---------- -------- ---------- ------------ ------ ------------
Bal. at Dec. 31, 2000 -- $ -- -- $ -- 12,198 $ 12
========== ======== ========== ============ ====== ============
Advanced Technologies, Inc.
--------------------------------------------------------
Series A Common Stock Paid-In Deferred
-------- ------------
Shares Amount Shares Amount Capital Compensation
----------- --------- ------------ -------------- -------- -------------
Bal. at Dec. 31, 1999(brought forward) 3,000 3 1,000 1 56,718 (204)
Cancellation of common stock and
Series A preferred held by
Catalytica, Inc. -- -- -- -- 8 --
Purchase of $50,000,000 of common
stock by Catalytica, Inc. and
distribution to Catalytica Energy
shareholders on December 15, 2000 -- -- -- -- 49,996 --
Distribution of remaining Catalytica
Energy common stock to shareholders
in connection with the spin-off from
Catalytica, Inc. on December 15, 2000 -- -- -- -- (7) --
Cancellation of CAT common and Series
A preferred stock in connection with
its merger with Catalytica Energy in
December 2000 (3,000) (3) (1,000) (1) 4 --
Conversion of Series B preferred stock
to Catalytica Energy common stock by
Enron in December 2000 -- -- -- -- -- --
Forgiveness of Catalytica, Inc.
intercompany debt in December 2000 -- -- -- -- 7,263 --
Carrying value of assets contributed
by Catalytica, Inc. to Catalytica
Energy in December 2000 -- -- -- -- 3,185 --
Exercise of stock options at various
dates in 2000 -- -- -- -- 15 --
Issuance of stock options at various
dates in 2000 -- -- -- -- 225 (176)
Acceleration of stock option vesting
at various dates in 2000 -- -- -- -- 199 --
Amortization of deferred compensation -- -- -- -- -- 117
Net loss -- -- -- -- -- --
---------- -------- ----------- ------------- -------- ------------
Bal. at Dec. 31, 2000 -- $ -- -- $ -- $117,606 $(263)
========== ======== =========== ============= ======== ============
Deficit During
the Development Stockholders'
Stage Equity
-------------- ------------
Bal. at Dec. 31, 1999(brought forward) (43,975) 12,552
Cancellation of common stock and
Series A preferred held by
Catalytica, Inc. -- --
Purchase of $50,000,000 of common
stock by Catalytica, Inc. and
distribution to Catalytica Energy
shareholders on December 15, 2000 -- 50,000
Distribution of remaining Catalytica
Energy common stock to shareholders
in connection with the spin-off from
Catalytica, Inc. on December 15, 2000 -- --
Cancellation of CAT common and Series
A preferred stock in connection with
its merger with Catalytica Energy in
December 2000 -- --
Conversion of Series B preferred stock
to Catalytica Energy common stock by
Enron in December 2000 -- --
Forgiveness of Catalytica, Inc.
intercompany debt in December 2000 -- 7,263
Carrying value of assets contributed
by Catalytica, Inc. to Catalytica
Energy in December 2000 -- 3,185
Exercise of stock options at various
dates in 2000 -- 15
Issuance of stock options at various
dates in 2000 -- 49
Acceleration of stock option vesting
at various dates in 2000 -- 199
Amortization of deferred compensation -- 117
Net loss (15,910) (15,910)
-------- --------
Bal. at Dec. 31, 2000 $(59,885) $ 57,470
======== ========
The accompanying notes are an integral part of these statements.
41
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
(a combined company in the development stage)
COMBINED STATEMENTS OF CASH FLOWS
for the years ended December 31, 1998 and 1999
and
CATALYTICA ENERGY SYSTEMS, INC. (a company in the development stage)
STATEMENT OF CASH FLOWS
for the year ended December 31, 2000
(In thousands)
Cumulative
Amounts from
Inception
Year ended December 31, through December 31,
---------------------------------
1998 1999 2000 2000
-------- -------- -------- ----
Cash flows from operating activities:
Net loss $ (6,897) $(11,730) $(15,910) $(59,885)
Adjustments to reconcile net loss to net cash used in
operating activity:
Depreciation and amortization (114) 230 235 636
Forgiveness of note receivable to former officer -- -- 623 623
Provision for uncollectable accounts -- 100 100 200
Losses in joint ventures 3,826 1,133 236 9,551
Inventory charged to research and development -- -- 63 63
Acceleration of stock option vesting -- 94 199 293
Stock based compensation 89 51 166 306
Changes in:
Accounts and notes receivable (770) 1,893 (1,701) (2,713)
Inventory 81 (31) (187) (243)
Accounts payable 404 (404) 1,364 1,364
Prepaid expenses, and other current assets -- (29) (389) (418)
Deferred revenue 41 (44) 219 219
Other accrued liabilities (444) 1,370 4,242 5,773
-------- -------- -------- --------
Net cash used in operating activities (3,784) (7,367) (10,740) (44,231)
Cash flows from investing activities:
Purchases of investments (37,202) (26,635) (35,688) (99,525)
Maturities of investments 32,431 26,624 37,000 96,055
Investment in joint ventures (4,075) (883) (236) (9,551)
Purchase of property and equipment (1,171) (594) (1,010) (3,690)
-------- -------- -------- --------
Net cash provided by (used in) investing activities (10,017) (1,488) 66 (16,711)
Cash flows from financing activities:
Net issuance of notes receivable to employees (1,001) (219) (42) (1,262)
Net payments on capital lease obligations (105) (56) 244 244
Advances from Catalytica, Inc. 8,306 4,867 11,560 41,934
Payments to Catalytica, Inc. (5,667) (2,829) (7,443) (15,839)
Proceeds from stock options -- -- 15 15
Proceeds from issuance of common and Series A preferred stock
at inception -- -- -- 10,150
Proceeds from issuance of Series B preferred stock and option
to Enron 29,922 -- -- 29,922
Issuance of common stock in connection with spin-off from
Catalytica, Inc. -- -- 50,000 50,000
-------- -------- -------- --------
Net cash provided by financing activities 31,455 1,763 54,334 115,164
-------- -------- -------- --------
Net increase (decrease) in cash and cash equivalents 17,654 (7,092) 43,660 54,222
Cash and cash equivalents at beginning of year -- 17,654 10,562 --
-------- -------- -------- --------
Cash and cash equivalents at end of year $ 17,654 $ 10,562 $ 54,222 $ 54,222
======== ======== ======== ========
Additional disclosure of cash flow information:
Conversion of Catalytica, Inc. payable to additional paid in capital $ 16,222 $ -- $ 7,263 $ 23,485
======== ======== ======== ========
Assets contributed from Catalytica, Inc. $ -- $ -- $ 3,185 $ 3,185
======== ======== ======== ========
Liabilities transferred from Catalytica, Inc. $ -- $ -- $ 2,224 $ 2,224
======== ======== ======== ========
Forgiveness of notes receivable to employees $ 58 $ 67 $ 76 $ 201
======== ======== ======== ========
Interest paid $ 13 $ 3 $ 110 $ 167
======== ======== ======== ========
Deferred compensation for issuance of stock options to non-employees
in March 1999 $ -- $ 227 $ -- $ 227
======== ======== ======== ========
Deferred compensation for issuance of stock options to directors
below market value in July 1999 $ -- $ 28 $ -- $ 28
======== ======== ======== ========
Deferred compensation for issuance of stock options to non-employees
in March 2000
$ -- $ -- $ 176 $ 176
======== ======== ======== ========
The accompanying notes are an integral part of these statements.
42
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
(a combined company in the development stage)
for the years ended December 31, 1998 and 1999
and
CATALYTICA ENERGY SYSTEMS, INC. (a company in the development stage)
for the year ended December 31, 2000
NOTES TO FINANCIAL STATEMENTS
Note 1. Description of Business and Significant Accounting Policies
Spin Out Transaction On August 2, 2000, Catalytica, Inc. entered into an
Agreement and Plan of Merger by and among Synotex Company, Inc. ("Synotex"),
pursuant to which a subsidiary of Synotex merged with and into Catalytica, Inc.
Immediately prior to the consummation of the Merger, Catalytica Energy
("Catalytica Energy") and Catalytica Advanced Technologies, Inc. ("CAT") were
merged, Catalytica, Inc. contributed $50 million in exchange for shares of
Catalytica Energy common stock and all of the common shares of Catalytica Energy
were distributed on a pro rata basis to the Catalytica, Inc. stockholders.
Catalytica Energy agreed to indemnify Catalytica Inc. for all Catalytica Energy
and CAT liabilities incurred prior and subsequent to the spin-off.
Additionally, Catalytica Energy agreed to indemnify Synotex for any costs
associated with the merger ("deal costs") which were not reduced from the merger
consideration distributed to shareholders of Catalytica, Inc.
Description of Business Catalytica Energy operated as an element of
Catalytica, Inc.'s research and development activities from inception through
the date of its incorporation as a separate division. In 1995, it was
incorporated and became a subsidiary of Catalytica, Inc. Catalytica Energy is
engaged in developing, manufacturing and marketing of technologies that use
catalysts to measure and prevent the formation of harmful pollutants. In 1995,
Catalytica Energy ceased efforts to develop measurement related products and
disposed of related net assets in 1996. Cumulative net costs associated with the
discontinued product line were $9.3 million. Beginning in 1996, development
efforts were focused on Xonon technology. Advanced Sensor Devices ("ASD"), an
inactive subsidiary of Catalytica Energy, was merged into Catalytica Energy in
December 2000. In July 2000, Catalytica Energy formed Catalytica NovoTec Inc.
("NovoTec") as a subsidiary. NovoTec was formed to develop improved catalytic
processes employing proprietary high speed testing and computer learning
technologies. In January 2001, all operations in NovoTec were ceased.
CAT was incorporated in 1995. CAT conducted in-house and contract research and
development. In December 2000, CAT merged into Catalytica Energy. In 1998, CAT
and United Catalysts, Inc. formed Sud-Chemie Catalytica L.L.C., a 50/50 joint
venture. In that year, CAT recognized losses of $0.15 million relating to this
operation to the extent of its investment. Since that year, no further capital
contributions were made to this business therefore no additional losses have
been recognized.
Basis of Presentation Catalytica Energy and CAT were commonly controlled
subsidiaries of Catalytica, Inc. The 1998 and 1999 financial statements present
the combined balance sheets and combined statements of operations, stockholders'
equity, and cash flows. In December 2000, Catalytica, Inc. completed its spin-
out and merger of Catalytica Energy and CAT to its stockholders. Catalytica
Energy is in the development stage. Accordingly, cumulative losses and cash
flows from inception through December 31, 2000 are presented on the statements
of operations and cash flows.
Cash Equivalents Catalytica Energy considers all highly liquid investments
with an original maturity of three months or less from the date of purchase to
be cash equivalents.
Investments Catalytica Energy's investments consist of commercial paper with
maturities of three months or less and are classified as held to maturity. They
are carried at cost, which approximates their fair market value.
Investments in joint ventures where Catalytica Energy has a 20% to 50% ownership
interest are accounted for under the equity method. Under this method,
Catalytica Energy records its pro rata share of the investee's net earnings or
losses. Investee's net losses are recorded until Catalytica Energy's net
investment and obligation, if any, to pay down debt are reduced to zero.
Concentrations of Credit Risk Assets subject to concentrations of credit
risk consist principally of cash equivalents, investments, and receivables.
Catalytica Energy 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
43
ratings. Related credit risk would result from a default by the financial
institutions or issuers of investments to the extent of the recorded carrying
value of these assets. Catalytica Energy performs ongoing credit evaluations of
its customers and generally does not require collateral.
Allowance for Doubtful Accounts Below is a summary of the activity for all
accounts and notes receivable:
Amount
transferred
from
Beginning Catalytica, Ending
Year ended December 31, Balance Provision Inc. Balance
1998 $ -- $ -- $ -- $ --
1999 $ -- $100,000 $ -- $100,000
2000 $ 100,000 $100,000 $125,000 $325,000
Inventory Catalytica Energy's inventory consists of raw materials and is
stated at the lower of cost (first-in, first-out) or market.
Property and Equipment These assets 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. In accordance with
Financial Accounting Standards ("FAS") No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," Catalytica
Energy reviews long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of such assets may not be fully
recoverable. To date, no such impairment has been indicated. If this review
indicates the carrying value of these assets will not be recoverable, as
measured based on estimated undiscounted cash flows over their remaining life,
the carrying amount would be adjusted to fair value. The cash flow estimates
that will be used will contain management's best estimates, using appropriate
and customary assumptions and projections at the time.
Comprehensive Income Catalytica Energy has no components of other
comprehensive income.
Research and Development Revenues Catalytica Energy recognizes revenue when
persuasive evidence of an arrangement exists, delivery has occurred or services
have been rendered, the selling price is fixed or determinable and collection is
reasonably assured. These revenues are derived entirely from research and
development contracts. They are earned as contractual services are performed and
are recognized in accordance with contract terms, principally based on
reimbursement of total costs and expenses incurred. No amounts recognized as
revenue are refundable. In return for funding, collaborative partners receive
certain rights in the commercialization of the resulting technology. The
contracts are also subject to periodic review by the funding partner, which may
result in modifications, including reduction or termination of funding.
Customer advances and customer billings in excess of recognized revenues are
recorded as deferred revenue until earned.
Use of Estimates The preparation of financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts in
the financial statements and accompanying notes. Actual results for Catalytica
Energy could differ from those estimates and such differences may be material to
the financial statements.
Research and Development Activities Related costs are expensed as incurred.
Stock-Based Compensation Catalytica Energy accounts for stock-based
compensation using the intrinsic value method prescribed in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25") and has adopted the disclosure only alternative of Statement of
Accounting Standards No. 123, "Accounting for Stock-based Compensation" ("FAS
123").
Any deferred stock compensation calculated under APB 25 is amortized over the
vesting period of the individual options, generally four years, using the graded
vesting method. The graded vesting method provides for vesting of portions of
the overall awards at interim dates and results in greater vesting in earlier
years than the straight-line method of amortization.
All stock-based awards to non-employees are accounted for at fair value, as
calculated using the Black-Scholes model, in accordance with FAS 123 and
Emerging Task Force Consensus No. 96-18. Related options are subject to periodic
re-valuations over their vesting terms.
44
Income Taxes Catalytica Energy accounts for income taxes under the asset and
liability method in accordance with FAS No. 109, "Accounting for Income Taxes".
Under the asset and liability method, deferred income tax assets and liabilities
are determined based on the differences between the financial reporting and tax
bases of assets and liabilities and are measured using the currently enacted tax
rates and laws.
Net Loss per Share Earnings (loss) per share is presented in accordance
with FAS No. 128, "Earnings Per Share" ("EPS"). For the year ended December 31,
2000, the inclusion of potentially dilutive securities of 989,029 are
antidilutive, and therefore are excluded from the computation of diluted loss
per share. Prior to the merger of Catalytica Energy and CAT in late December
2000, the companies were commonly controlled by Catalytica, Inc. and did not
have a formal combined capital structure. Accordingly, no earnings per share
information for those years is presented.
The following table sets forth the computation of basic and diluted earnings
attributable to common shareholders per share (in thousands, except per share
amounts):
Year ended
----------
December 31,
------------
2000
----
Numerator for basic and diluted loss per share $(15,910)
--------
Denominator for basic and diluted loss per share -
Weighted-average shares outstanding 1,000
--------
Basic and diluted loss per share $ (15.91)
========
Impact of Recently Issued Accounting Standards FAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities" (and related subsequent
amendment), is effective for the fiscal year ending on or about December 31,
2001. It establishes accounting and reporting standards requiring that every
derivative instrument be recorded on the balance sheet as either an asset or
liability measured at its fair value. Adoption of this statement is not
expected to have a material effect on the Company's financial position or
results of operations. In December 1999, the Securities and Exchange Commission
issued SAB 101, "Revenue Recognition in Financial Statements". Adoption of this
statement did not have a material effect on Catalytica Energy's financial
position or results of operations.
Note 2. Transactions with Related Parties
Catalytica, Inc. Prior to the spin-off, the financial statements include
allocations from Catalytica, Inc. for the cost of functions and services
provided. These allocations include charges for facilities, finance, legal,
human resources, and other employee benefit costs and totaled $3.0 million, $3.1
million, and $2.6 million, respectively, for the years ended December 31, 1998,
1999, and 2000. Charges for these services have been allocated based upon square
footage, usage, headcount and other methods that management believes to be
reasonable.
Prior to the Enron Ventures Corporation ("Enron") investment, Catalytica Energy
used borrowings from Catalytica, Inc. to fund its operations. In January 1998,
when Enron invested in Catalytica Energy, all of Catalytica Energy's
intercompany debt was forgiven and Catalytica Energy incurred no further
intercompany debt. CAT continued to borrow from Catalytica, Inc. and incurred
interest expense on these borrowings through December 31, 1999. Catalytica, Inc.
charged interest at a rate of 7%. Related interest charged was $0.2 million,
$0.3 million, and none for the twelve months ended December 31, 1998, 1999, and
2000, respectively.
In December 2000, in accordance with the merger agreement between DSM and
Catalytica, Inc., $7.3 million of intercompany debt owed to Catalytica, Inc. by
CAT was forgiven.
Investment By Enron On January 14, 1998, Enron, purchased a 15% minority
interest in Catalytica Energy for $30.0 million in cash. Enron also received a
three-year option to purchase an additional 535,715 shares of Catalytica Energy
for $14.4 million in cash. This option expired unexercised on January 14, 2001.
In connection with the Enron Stock Purchase Agreement, Catalytica Energy entered
into a Share Exchange Agreement, providing Enron the right to exchange the
Series B Preferred Stock of Catalytica Energy for Catalytica, Inc. common stock.
After the five year anniversary of the agreement, if Catalytica Energy had not
undertaken a public offering, in which Catalytica Energy received at least $20.0
million, Enron had the right to require Catalytica, Inc. to exchange all of the
outstanding shares of Series B Preferred Stock for that number of shares of
Catalytica, Inc. common stock based upon a determined
45
exchange rate. The exchange rate was based upon the fair value of the Series B
Preferred Stock and the market value of Catalytica, Inc.'s common stock at the
time of conversion. In conjunction with the Enron Stock Purchase Agreement,
$16.2 million of indebtedness owed to Catalytica, Inc. by Catalytica Energy was
contributed to Catalytica Energy's capital. In December 2000, Enron converted
all of its Series B Preferred Stock and received 1,342,889 shares of Catalytica
Energy common stock.
Transaction With An Affiliate of Enron In December 1999, an affiliate of
Enron, the holder of a minority interest in Catalytica Energy, specified
Catalytica Energy's Xonon combustion system as the preferred emissions control
system for certain turbine orders from GE Power Systems ("GE"). In connection
therewith, Catalytica Energy and this affiliate of Enron signed an agreement
which provided, among other things, that Catalytica Energy agreed to advance the
affiliate up to $9.9 million to accelerate the development of the Xonon-equipped
GE gas turbines, and the affiliate had the right to elect to repay the advances
to Catalytica Energy in cash or turbine credits. Turbine credits entitle the
holder to a dollar-for-dollar credit on the purchase of certain turbines (in the
case of these specific credits, those that specify the use of Catalytica
Energy's Xonon process). Repayment in cash or other consideration was required
by September 30, 2000. Catalytica Energy advanced the Enron affiliate $1.2
million at December 31, 1999 under this arrangement. Since the Enron affiliate
had the option of repaying the advance in cash or turbine credits and the fair
market value of the latter was not reasonably estimatable and because: 1)
Catalytica Energy is not in the business of buying turbines, 2) Catalytica
Energy is not in the business of exchanging turbine credits with those that buy
turbines, and 3) in our particular case, the turbine credits Catalytica Energy
would receive specified they could only be used on purchases of turbines that
specify the use of Catalytica Energy's Xonon process, and Xonon is a relatively
new technology, and there can be no assurance that it will be specified by
sufficient buyers of turbines to create a market for these turbine credits,
Catalytica Energy, therefore, recorded a provision equal to the advance as
research and development expense. In 2000, the arrangement between Catalytica
Energy and the Enron affiliate was amended and all previous advances through
that date of $2.8 million from Catalytica Energy were refunded, less certain
costs, and the related provision was eliminated and reduced research and
development expense in this period.
Transactions With An Officer In July 2000, the President and Chief Executive
Officer of Catalytica Energy resigned. His separation agreement provides for
severance of approximately $18,000 a month for twelve months and a one-time
payment of $18,900. Catalytica Energy recorded a one-time charge in the third
quarter of 2000 for $234,900 related to the officer's severance. If he remains
unemployed after the twelve months, payments of $18,000 will continue for an
additional six months or until he is employed, whichever comes first. These
payments will be expensed when and if they become probable. In addition,
previous loans and accrued interest of $620,000 will be forgiven in equal
installments over a twelve month period. Catalytica Energy recorded a one-time
charge in the third quarter of 2000 for $620,000 related to the forgiveness of
the officer's loans and interest. Additionally, vesting of his options to
purchase common stock was accelerated. Catalytica Energy recorded compensation
expense totaling $0.1 million in the third quarter of 2000 associated with the
acceleration of vesting of these options.
Advances to Nonlinear Dynamics, Inc. on Behalf of Novotec In November 2000,
Catalytica Energy advanced $0.2 million to Nonlinear Dynamics, Inc. in order to
accelerate a contemplated merger between NovoTec and Nonlinear Dynamics, Inc.
Because repayment was not probable at the time of the advance, the entire
advance was charged to operations in the same period the advance was made.
Note 3. Joint Venture
Joint Venture ("GENXON") In October 1996, Catalytica Energy and Woodward
Governor Company formed a Delaware limited liability company in connection with
a 50/50 joint venture to serve the gas turbine retrofit market for installed,
out-of-warranty engines. The new company, GENXON(TM) Power Systems, LLC
("GENXON"), was formed to upgrade the combustion systems of installed turbines
with Xonon, which is designed to reduce emissions and permit greater asset
utilization for both power generation and mechanical drive markets. The initial
capital commitment of the GENXON joint venture partners was $10.0 million: $2.0
million from Catalytica Energy and $8.0 million from Woodward. In addition,
Catalytica Energy contributed an exclusive license for the use of its catalytic
combustion technologies, and Woodward contributed an exclusive license for the
use of its instrumentation and control systems for gas turbine catalytic
combustion.
The initial funding of the capital commitment of $10.0 million was made by the
third quarter of 1997. Continued funding of the joint venture beyond the initial
commitment is voluntary and has occurred on a 50/50 basis with each joint
venture partner contributing an equal amount quarterly. Catalytica Energy has
recorded its share of losses on the joint venture of $3.7 million, $1.1 million,
and $0.2 million for the years ended December 31, 1998, 1999 and 2000,
respectively. In the third quarter of 1999, GENXON completed its prototype
development. All further funding of the durability testing was assumed by
Catalytica Energy and is no longer being charged to the joint venture. All R & D
46
costs related to the durability testing are expensed directly by Catalytica
Energy. Because the carrying value of our net investment in GENXON is zero and
Catalytica Energy is not obligated in anyway to pay down GENXON's debts,
Catalytica Energy ceased recognizing its pro rata share of its losses in the
first half of 2000.
The following information summarizes GENXON's financial position for the twelve
months ended September 30, 1998, 1999, and 2000:
Twelve Months Ended
September 30, 1999 September 30, 1998 September 30, 2000
------------------ ------------------ ------------------
(unaudited)
(in thousands)
Total revenues........... $ 204 $ 887 $ 7
======= ======= =====
Net loss................. $(9,615) $(4,157) $(504)
======= ======= =====
Current assets........... $ 1,077 $ 338 $ 678
Long-term assets......... 1,018 270 --
------- ------- -----
Total assets........... $ 2,095 $ 608 $ 678
======= ======= =====
Current liabilities...... $ 786 $ 646 $ 641
Members' earnings
(deficit)............... 1,309 (38) 37
------- ------- -----
Total liabilities and
members' capital...... $ 2,095 $ 608 $ 678
======= ======= =====
The 1998 and 1999 reports of GENXON's independent auditors included an
explanatory paragraph indicating that GENXON's financial statements have been
prepared on the 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. GENXON has reported a net loss of $0.2 million for its year
ended September 30, 2000 and a cumulative loss of $25.0 million through that
same date. Its management plans to obtain additional capital contributions from
its members or other additional investors to meet its current and ongoing
obligations. GENXON's continued existence is dependent on its ability to obtain
adequate additional funding. This matter is not material in relation to the
financial statements of Catalytica Energy because: (1) Catalytica Energy has no
obligation to make any further cash contributions to GENXON and; (2) the
financial statements of Catalytica Energy at December 31, 2000 have no
significant amounts due from GENXON or any recorded carrying value of its
investment in GENXON at that same date.
Catalytica Energy has entered into an agreement with GENXON to provide
management, technical and administrative support services. These costs are
incurred by Catalytica Energy and then billed to GENXON. Related amounts (both
the costs and the amounts billed to GENXON) are recorded net as a element of
research and development costs (none in 2000; $2.0 million in 1999; and $2.9
million in 1998, while amounts actually billed are recorded as accounts
receivable from joint venture on our balance sheet.
Note 4. Income Taxes
Catalytica Energy and CAT were included in the consolidated federal and combined
California franchise tax returns of Catalytica, Inc. through the date of the
merger discussed in Note 1. Prior to the merger, both companies entered into a
tax sharing agreement pursuant to which they computed hypothetical tax returns
(with certain modifications) as if they were not joined in consolidated or
combined returns with Catalytica, Inc. Under this agreement, Catalytica Energy
and CAT were not reimbursed for the tax benefits of their net operating losses,
but would not be required to pay taxes on any future profits up to the amount of
their net operating losses utilized by Catalytica, Inc.
In connection with the merger discussed in Note 1, Catalytica Energy and CAT
entered into a new tax sharing agreement with Synotex canceling Catalytica
Energy's and CAT's right of offset for the benefit of any net operating losses
utilized by Catalytica, Inc. through the date of the merger. As a result,
Catalytica Energy and CAT reduced the tax benefit associated with the right of
offset for losses utilized by Catalytica, Inc. by approximately $9.4 million in
2000.
47
Recorded income tax benefit differs from the expected benefit determined by
applying the U.S. federal statutory rate to the net loss as follows:
Year Ended December 31,
---------------------------
1998 1999 2000
------- ------- -------
(in thousands)
Income tax benefit at U.S. statutory rate............. $ 2,340 $ 3,987 $ 5,409
Pre-merger operating losses canceled right of offset.. -- -- (3,996)
Valuation allowance for deferred tax assets........... (2,340) (3,987) (1,413)
-------
Income tax benefit.................................... $ -- $ -- $ --
======= ======= =======
Based on a proforma separate return basis, Catalytica Energy would not be able
to record an income tax benefit for the net loss incurred in 2000, because the
expected benefit computed by applying the U.S. federal statutory rate to the net
loss is offset by an increase in the valuation allowance for deferred tax
assets.
Deferred income taxes reflect the net 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. They include the
following:
December 31,
-----------------------
1999 2000
-------- --------
(in thousands)
Deferred tax assets:
Net operating loss carryforwards............................ $ 392 $ 185
Other accruals.............................................. 491 1,228
Right of offset for losses utilized by Catalytica, Inc. in
consolidated tax returns................................... 9,406 --
-------- -------
Total gross deferred tax assets............................. 10,289 1,413
Less valuation allowance.................................... (10,289) (1,413)
-------- -------
Net deferred tax assets................................... $ -- $ --
======== =======
Realization of the deferred tax assets is dependent on future earnings, the
timing and amount of which are uncertain. Accordingly, a valuation allowance, in
an amount equal to the related deferred tax assets has been established to
reflect these uncertainties. The valuation allowance increased by approximately
$4.8 million in 1999 and decreased by approximately $8.9 million in 2000.
As of December 31, 2000, Catalytica Energy's federal and state net operating
loss carryforwards were approximately $0.5 million and $0.25 million,
respectively. The federal net operating loss carryforward will expire in 2020
and the state net operating loss carryforward will expire in 2005 if not used to
offset future taxable income. Utilization of the net operating loss
carryforwards may be subject to a substantial annual limitation due to the
ownership change limitations provided by the Internal Revenue Code of 1986, as
amended, and a similar state provision. The annual limitation may result in the
expiration of net operating loss carryforwards before utilization.
48
Note 5. Capital Stock
Catalytica Energy
Shares of common stock reserved for future issuance are as follows:
December 31, 2000
-----------------
Employee stock purchase plan 1,500,000
Stock options 1,971,546
Enron option (expired January 14, 2001) 535,715
Glaxo Wellcome warrant 330,940
---------
4,338,201
=========
Convertible Preferred Stock Prior to Catalytica Energy's spin-off from
Catalytica, Inc., Catalytica Energy had 9,000,000 shares of preferred stock, par
value of $0.001, authorized, of which 660,714 was subject to future issuance in
one or more classes or series of preferred stock and options as determined by
the Board of Directors. On December 15, 2000, all issued and outstanding shares
of the Company's preferred stock was cancelled. The Company had 8,339,286 shares
of preferred stock issued and outstanding prior to December 15, 2000, consisting
of the following classes:
Series A Preferred Stock The Company had 7,000,000 shares of Series A preferred
stock issued and outstanding prior to December 15, 2000 held by Catalytica, Inc.
The Series A preferred stock had the following rights: (a) the right to receive
a dividend of $0.06 per annum, per share, when and if declared by the Company's
Board of Directors; (b) dividends paid prior to dividends declared and paid on
the common stock; (c) In the event of liquidation, Catalytica, Inc. would have
been entitled to distributions amounting to $1.00 per share plus all declared
and unpaid dividends paid in preference to liquidation distributions to common
stock; (d) the right to convert into a single share of common stock at any time
after the date of issuance. The conversion rate was subject to change based upon
future dilutive transactions.
Upon the closing of an underwritten public offering of the Company's securities
at an aggregate gross offering price of not less than $20.0 million, these
shares would have automatically converted into common stock at the then
effective conversion price. The holder of each share would have been entitled to
the number of votes equal to the number of shares of common stock into which
such share of preferred stock could have been converted at the record date for
determining the stockholders entitled to vote on such matters. On December 15,
2000, all shares of Series A preferred stock were cancelled in connection with
Catalytica Energy's spin-off from Catalytica, Inc.
Series B Preferred Stock As discussed in Note 2, on January 14, 1998, the
Company entered into a Stock Purchase Agreement with Enron and issued 1,339,286
shares of Series B preferred stock. This stock had the following rights: (a) the
right to receive a dividend of $1.34 when and if declared by the Company's Board
of Directors and prior to any dividends declared and paid on Series A preferred
stock and common stock; (b) in the event of liquidation, any shares that
remained outstanding had a liquidation preference over Series A preferred stock
and common stock amounting to $22.40 per share plus all declared and unpaid
dividends; (c) the right to convert into shares of 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, except for issuances pursuant to employee benefit plans) at any
time at the option of the holder and automatically upon the closing of an
underwritten public offering, which resulted in gross proceeds to the Company of
at least $20.0 million. The holder of each share would have been entitled to the
number of votes equal to the number of shares of common stock into which such
shares of preferred stock could have been converted at the record date for
determining the stockholders entitled to vote on such matters. On December 15,
2000, all shares of Series B preferred stock were converted into 1,342,889
shares of Catalytica Energy's common stock in connection with Catalytica
Energy's spin-off from Catalytica, Inc.
In addition, if the Company had not consummated an underwritten public offering,
which resulted in gross proceeds to the Company of at least $20.0 million within
five years of the consummation of the acquisition of Series B preferred stock,
the Series B preferred stock would have been exchangeable, at the option of
Enron, into shares of common stock of Catalytica, Inc., as determined by the
Exchange Rate. The Exchange Rate was the quotient of (a) the value per share of
the Company's Series B preferred stock, on an as converted basis, and (b) the
average of the Price Per Share of the Catalytica, Inc. common stock over the
twenty business days prior to notice of conversion from Enron. Enron was granted
an option in accordance with the Stock Purchase Agreement to purchase 535,715
shares of Series B preferred
49
stock, provided Enron's ownership interest did not increase to more than 19.9%
of the Company's total outstanding capital stock, for $26.88 per share.
Beginning on the tenth day after the distribution pursuant to the spin-off, the
option was exercisable on a cashless basis. Enron's right to purchase these
shares expired unexercised on January 14, 2001.
Glaxo Wellcome, Inc. Warrant On July 31, 1997, Catalytica, Inc. issued a
warrant for 2,000,000 shares of Catalytica, Inc, common stock at $12.00 per
share to Glaxo Wellcome. On December 15, 2000, in connection with the spin-off
of Catalytica Energy, the warrant was converted into a warrant for 330,940
shares of Catalytica Energy common stock at $11.23 per share, which expires on
July 31, 2003.
CAT
Series A Preferred Stock CAT had 3,000,000 shares of Series A preferred stock
authorized, issued and outstanding prior to its merger with Catalytica Energy in
December 2000. The Series A preferred stock had the following rights: (a) the
right to receive a dividend of $0.06 per annum, per share, when and if declared
by the Company's Board of Directors, (b) dividends would have been paid prior to
dividends declared and paid on the common stock, (c) in the event of
liquidation, holders would have been entitled to distributions amounting to
$0.67 per share plus all declared and unpaid dividends paid in preference to
liquidation distributions to common stock, (d) the right to convert into a
single share of common stock at any time after the date of issuance (the
conversion rate would have been subject to change based upon future dilutive
transactions).
Upon the closing of an underwritten public offering of the Company's securities
at an aggregate gross offering price of not less than $20.0 million, these
shares would have automatically converted into common stock at the then
effective conversion price. The holder of each share of Series A preferred stock
would have been entitled to the number of votes equal to the number of shares of
common stock into which such share of preferred stock could have been converted
at the record date for determining the stockholders entitled to vote on such
matters.
Note 6. Employee Benefit Plans
The Company's 1995 Stock Option Plan (as amended and restated October 26, 2000)
Under this plan, the Company's Board of Directors is authorized to grant
incentive stock options to eligible employees and nonqualified stock options to
eligible employees, consultants, and directors. 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. Effective August 4, 1998, all new
option grants to employees were exercisable ratably over four years and expire
no later than ten years from the date of grant.
Prior to becoming a public company in December 2000, Catalytica Energy's Board
of Directors established the estimated fair value of its common stock for
purposes of applying APB No. 25, prior to the granting of stock awards, after
considering the following: 1) the implied fair value of the underlying
businesses, based on the sale its convertible preferred stock to Enron, in
relation to the then total estimated market capitalization of its publicly-owned
parent, Catalytica, Inc., and 2) other developments that the Board of Directors,
in its judgment, considered relevant to fair value.
50
The following table summarizes related stock option plan activity:
Outstanding Options
---------------------------------
Weighted
Shares Average Aggregate
Available Number of Exercise Exercise
for Grant Shares Price Price
--------- -------- ---------- ---------
Balance at December 31, 1997................... 27,667 834,458 0.74 614,133
Authorized.................................... 300,000 -- -- --
Granted....................................... (187,950) 187,950 9.69 1,821,665
Canceled...................................... 23,111 (23,111) 3.77 (87,244)
--------- --------- ----------
Balance at December 31, 1998................... 162,828 999,297 2.35 2,348,554
Granted....................................... (90,220) 90,220 21.17 1,910,352
Canceled...................................... 17,474 (17,474) 3.44 (60,095)
--------- --------- ----------
Balance at December 31, 1999................... 90,082 1,072,043 3.92 4,198,811
Authorized.................................... 837,875 -- -- --
Granted ...................................... (222,580) 222,580 24.60 5,475,468
Canceled...................................... 41,755 (41,755) 13.20 (551,166)
Exercised..................................... -- (28,454) 0.54 (15,365)
--------- --------- ----------
Balance at December 31, 2000................... 747,132 1,224,414 7.43 $9,107,748
========= ========= ==========
The weighted average fair value of options granted during 1998, 1999 and 2000,
was $6.60, $10.68, and $17.67, respectively as calculated in accordance with FAS
123. A summary of Catalytica Energy's stock option activity for the year ended
December 31, 2000 is as follows:
Options Outstanding Options Exercisable
------------------------------------------------------------ --------------------------------------
Range of Weighted Average Number Exercisable
Exercise Number Outstanding Remaining Weighted Average As of December 31, Weighted Average
Prices December 31, 2000 Contractual Life Exercise Price 2000 Exercise Price
- -------------- ------------------ ---------------- ---------------- ------------------- ----------------
$ 0.40 - $0.40 652,248 5.00 $ 0.40 651,311 $ 0.40
$ 2.50 - $5.60 181,221 6.88 3.59 159,465 3.50
$ 12.00-$14.50 96,547 7.45 12.58 77,736 12.65
$ 15.75-$15.75 6,000 8.50 15.75 6,000 15.75
$ 16.00-$16.00 2,042 7.63 16.00 1,625 16.00
$ 20.50-$20.50 2,188 8.89 20.50 813 20.50
$ 21.00-$21.00 67,681 9.16 21.00 21,404 21.00
$ 21.60-$21.60 73,537 8.19 21.60 39,230 21.60
$ 26.50-$26.50 141,950 9.49 26.50 11,036 26.50
$ 30.00-$30.00 1,000 9.58 30.00 0 30.00
--------- -------
$ 0.40 -$30.00 1,224,414 6.45 $ 7.43 968,620 $ 3.64
========= =======
Pro forma information regarding net loss is required by FAS 123, which also
requires that the information be determined as if the Company has accounted for
its employee stock awards 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:
Risk Free Risk Free Dividend Volatility Volatility Volatility
Interest Rate Interest Rate Yield Factor Factor Factor
1998/1999 2000 All years 1998 1999 2000
------------- ------------- --------- ---------- ---------- ----------
5.48 6.43 0.0 .8602 .8238 .8814
Weighted Average Weighted Average Weighted Average
Expected Life Expected Life Expected Life
1998 1999 2000
---------------- ---------------- ----------------
5.0 2.6 4.3
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 Catalytica
Energy's employee stock options have characteristics significantly different
from those of traded options, and because changes in the subjective assumptions
51
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 Catalytica Energy's stock-based compensation plan
been determined based on the fair value at the grant dates for awards under this
plan consistent with the method of FAS 123, the Catalytica Energy's net for the
combined entity loss would have been increased to the pro forma amounts
indicated below:
1998 1999 2000
-------- -------- --------
(in thousands)
Net loss...................................... $(6,897) $(11,730) $(15,910)
Compensation expense.......................... (547) (826) (1,714)
------- -------- --------
Pro forma net loss............................ $(7,444) $(12,556) $(17,624)
======= ======== ========
Pro forma basic and diluted net
loss per share: $ -- $ -- $ (17.62)
======= ======== ========
Since compensation expense is recognized over the vesting period of the related
options, which is generally four years, and because pro forma disclosure is only
required commencing with 1995, the initial impact on pro forma loss may not be
representative of compensation expense in future years.
Stock Options Granted to Non Employees In March 1999, Catalytica Energy granted
certain employees of Catalytica Inc. and its subsidiaries options to purchase
10,500 shares of its common stock at a price of $21.60 per share. The ownership
of these options vests over a four-year period. Since the recipients of these
options are not employees of Catalytica Energy, Catalytica Energy recorded a
deferred compensation obligation of $227,000, of which $47,000 and $56,700 was
earned and charged to operations in the year ended December 31, 1999 and
December 31, 2000, respectively. This obligation was remeasured at December 31,
2000, and no additional deferred compensation was recorded. In each subsequent
reporting period (through the vesting period) this obligation will be
remeasured.
In July 1999, Catalytica Energy granted 6,000 options to directors at $4.74
below market value. These options vest over a one year period. Since the
recipients of these options received options below their fair market value,
Catalytica Energy recorded a deferred compensation obligation of $28,000, of
which $5,000 and $23,000 was earned and charged to operations in the years ended
December 31, 1999 and December 31, 2000, respectively. This obligation has been
fully amortized over the vesting period of the options and will not be
remeasured in future reporting periods.
In March 2000, Catalytica Energy granted certain employees of Catalytica Inc.
and its subsidiaries options to purchase 8,400 shares of its common stock at a
price of $21.00 per share. These options vest over a four-year period. Since the
recipients of these options are not employees of Catalytica Energy, Catalytica
Energy recorded a deferred compensation obligation of $176,000, of which $37,000
was charged to operations in the year ended December 31, 2000. This obligation
was remeasured at December 31, 2000, and no additional deferred compensation was
recorded. In each subsequent reporting period (through the vesting period) this
obligation will be remeasured.
Compensation Expense Related to Stock Options The Company has occasionally
granted options to non-employees and accelerated vesting of options for
terminated employees. Compensation expense of $89,000, $94,000, and $214,000 was
recorded in the twelve months ended December 31, 1998, December 31, 1999, and
December 31, 2000, respectively. The resulting additional charges were recorded
as additional paid-in capital with the offset expensed as compensation.
2000 Employee Stock Purchase Plan In 2000, the Company adopted the 2000
Employee Stock Purchase Plan (the Plan) under which employees will be eligible
to purchase shares of the Company's common stock at a discount through periodic
payroll deductions. The Plan is intended to meet the requirements of Section 423
of the Internal Revenue Code. After the initial period, purchases will occur at
the end of six month offering periods at a purchase price equal to 85% of the
market value of the Company's common stock at either the beginning of the
offering period or the end of the offering period, whichever is lower. The first
offering period under the plan will begin on December 18, 2000 and will end on
June 30, 2001. Participants may elect to have up to 10% of their pay withheld
for purchase of common stock at the end of the offering period, up to a maximum
of $25,000 per calendar year. The Company has reserved 1,500,000 shares of
common stock for issuance under the Plan. At December 31, 2000, the Company had
not issued any shares under the Plan.
52
401(k) Savings & Retirement Plan The Company offers a 401(k) Savings &
Retirement Plan to eligible employees meeting certain age and service
requirements. This plan permits participants to contribute up to 15% of their
salary, up to the maximum allowable by the Internal Revenue Service regulations.
The plan provides for both a bi-monthly Company match and a discretionary annual
contribution. Participants are immediately vested in their voluntary
contributions plus actual earnings and in the Company's matching contributions.
The Company's expense for this plan was $162,000 for the month ending December
31, 2000.
Note 7. Major Customers and Geographic Revenues
Major customers are as follows:
Year ended
December 31,
-------------------
1998 1999 2000
-------------------
Department of Energy................................................ 5% 26% 2%
Pratt & Whitney Canada.............................................. 6% 12% --
McDermott........................................................... 2% 21% 20%
Mitsubishi.......................................................... 14% 9% --
NIST................................................................ 16% 8% 1%
General Electric -- -- 52%
Gas Research Institute -- -- 14%
Unbilled revenues related to work performed was approximately $289,000,
$497,000, and $26,000 in 1998, 1999, and 2000, respectively. These amounts were
included in accounts receivable.
Research revenue by geographic region is as follows:
For the year
ended
December 31,
-----------------------------
1998 1999 2000
-----------------------------
United States................................................................ 80% 79% 82%
Canada....................................................................... 5% 12% --
Japan........................................................................ 14% 9% --
Europe....................................................................... 1% -- 18%
--------------------------
Total....................................................................... 100% 100% 100%
====== ==== =====
Note 8. Leases, Commitments and Contingencies
Capital leases In 1996, Catalytica Energy entered into a three-year capital
lease to purchase a compressor. In 1999, Catalytica Energy completed the
scheduled payments required under the lease, exercised its bargain purchase
option, and received title to the compressor. In the fourth quarter of 2000,
Catalytica Energy entered into three, three-year leases for furniture and
computer equipment. These leases expire in the fourth quarter of 2003.
Operating leases Catalytica Energy leases its research and office facilities in
Mountain View, CA under an operating lease agreement that expires on December
31, 2003, after which time the Company has the option for a five-year extension.
Catalytica Energy leases an office facility in Scottsdale, AZ under an operating
lease agreement that expires on August 31, 2003, after which time, Catalytica
Energy has the option for a six-month extension. Additionally, Catalytica Energy
leases computers and furniture under lease agreements, which generally expire
throughout 2003.
The aggregate minimum annual commitments under all leases as of December 31,
2000, are as follows (in thousands):
Year
----
2001 $1,015
2002 1,024
2003 996
and thereafter --
------
$3,035
======
53
Rent expense consisting of building and equipment rent was none in 1998 and 1999
and $218,000 in 2000.
Catalytica Energy subleases a portion of its Mountain View, CA facilities to two
companies. Under the subleases, rental income is generated as follows (in
thousands):
Year
----
2001 $1,332
2002 1,203
2003 1,204
and thereafter --
------
$3,739
======
Rental income was none in 1998 and 1999, and $47,000 in 2000.
Commitments Catalytica Energy has developed its catalytic combustion technology
under a development agreement with Tanaka, Kikinzoku Kogyo ("Tanaka"), a major
Japanese precious metals company. In January 1995, Catalytica Energy and Tanaka
entered into a new agreement for further development and commercialization of
the catalytic combustion technology. The new agreement provides
commercialization rights to the technology between the parties along market and
geographic lines. Catalytica Energy 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 Energy'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 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.
Catalytica Energy has entered into certain research collaboration arrangements
whereby potential future royalty payments may be required. Such payments would
generally be due once specified milestones such as commencement of commercial
sales of products incorporating the funded technology are achieved. Related
royalty payments for certain technologies would range from 1.5% to 5.0% of
product sales during the period covered by the royalty agreement.
Contingencies On August 14, 2000, the City of Glendale filed a complaint
against Catalytica Energy, Catalytica, Inc. and GENXON Power Systems, Inc. in
Los Angeles County Superior Court. The case has been transferred to the Orange
County Superior Court, Case No. 00CC13002. 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, Inc. 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. On January
16, 2001, the court granted, with leave to amend, Catalytica, Inc.'s motion to
dismiss the causes of action for fraud and negligent misrepresentation asserted
in the complaint. The defendants believe they have meritorious defenses to the
remaining claims asserted and intend to defend the action vigorously. While it
is not possible to predict with certainty the outcome of this matter, and while
Catalytica Energy does not believe an adverse result would have a material
effect on its financial position, it could be material to the results of
operations and cash flows for a fiscal year. Catalytica Energy has agreed to
indemnify Catalytica, Inc. for any costs associated with this matter.
On December 13, 2000 AGC Manufacturing Service, Inc. served a demand letter on
Catalytica, Inc. seeking payment of $5,751,178 to settle a dispute concerning
the interpretation of the Collaboration Agreement, dated November 2, 1993
between AES Project Development, Inc. and Catalytica, Inc., as amended through
Amendment 3, dated October 12, 1995. Under this agreement, AGC claims to have
rights to the Xonon 2 Combustor technology manufactured by Catalytica, Inc. The
Company believes that the technology is distinct and that the development of the
Xonon 2 Combustor was outside of the scope of the Collaboration Agreement. Thus,
the Company believes that it has meritorious defenses to any claim that AGC may
bring with respect to this technology. The Company intends to negotiate in good
faith, and absent an informal resolution, will vigorously defend any litigation
that may be filed.
Note 9. Segment Disclosures
Catalytica Energy operates primarily in two businesses: Catalytica Energy, which
is in the business of developing and commercializing Xonon technology and CAT,
which conducts in-house and contract research and development. The Company has
determined the reportable operating segments based upon how the businesses are
managed and operated.
54
As such, the following table discloses their revenues, operating income, and
identifiable assets for the above named operating segments.
Year ended December 31,
------------------------------
1998 1999 2000
-------- -------- --------
Revenues
Catalytica Energy.............................. $ 2,707 $ 1,552 $ 4,282
CAT............................................ 3,572 1,501 1,205
-------- -------- -------
Total revenues................................. $ 6,279 $ 3,053 $ 5,487
======== ======== =======
Year ended December 31,
------------------------------
1998 1999 2000
-------- -------- --------
Operating loss
Catalytica Energy................... $ (3,014) $ (9,670) $ (13,688)
CAT................................. (1,289) (1,690) (2,762)
-------- -------- --------
Total operating loss.............. $ (4,303) $(11,360) $ (16,450)
======== ======== ========
Year ended December 31,
-----------------------
1999 2000
-------- --------
Identifiable assets
Catalytica Energy................... $ 19,335 $ 66,748
CAT............................................ 505 1,024
-------- --------
Total assets.................... $ 19,840 $ 67,772
======== ========
Note 10. Selected Quarterly Financial Data (Unaudited) (In thousands, except
per share amounts)
First Quarter Second Quarter Third Quarter Fourth Quarter
1999 2000 1999 2000 1999 2000 1999 2000
------- ------ ------- ------- ------- ------- ------- -------
Research and development $ 686 $1,275 $ 699 $ 1,158 $ 781 $ 1,456 $ 887 $ 1,598
revenues
Total expenses 2,615 2,235 2,235 4,096 3,587 6,339 5,976 9,267
Operating loss (1,929) (960) (1,536) (2,938) (2,806) (4,883) (5,089) (7,669)
Net loss $(2,227) $ (953) $(1,801) $(2,650) $(2,781) $(4,923) $(4,921) $(7,384)
Basic and diluted net loss
per share -- $(1.89) -- $ (5.14) -- $ (9.53) -- $ (2.99)
For the twelve months ended December 31, 1999, Catalytica Energy did not have a
formal capital structure. Accordingly, no earnings per share for the 1999
quarters is presented.
Note 11. Subsequent Events (Unaudited)
NovoDynamics, Inc.
In November 2000, Catalytica Energy advanced $0.2 million to NonLinear Dynamics,
Inc. ("NonLinear Dynamics") in order to accelerate a contemplated merger between
NovoDynamics, Inc., a Delaware corporation ("NovoDynamics") and NonLinear
Dynamics. NovoDynamics is engaged in the development of data mining, informatics
discovery and high throughput synthesis and testing technologies. Because
repayment of the advance was not probable at the time it was made, the entire
amount was charged to operations in November 2000.
In March 2001, Catalytica Energy entered into agreements to invest $2.0 million
in cash and $0.4 million in assets into NovoDynamics. In accordance with these
agreements, when our full investment is completed in April 2001, Catalytica
55
Energy will own shares of Series A preferred stock representing 31% of
NovoDynamics' outstanding equity. Additionally, Catalytica Energy agreed to loan
NovoDynamics up to $1.5 million if certain milestones are met.
Separation Costs
In January 2001, NovoTec ceased operations. Related wind up and separation costs
approximated $0.4 million.
In January 2001, CESI's Senior Vice President of Business Development resigned.
CESI is currently negotiating a severance arrangement with this officer which is
expected to be approximately $0.3 million.
56
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Members of Genxon Power Systems, LLC:
In our opinion, the accompanying balance sheets and the related statements of
operations and of cash flows present fairly, in all material respects, the
financial position of Genxon Power Systems, LLC (a company in the development
stage) at September 30, 1999 and 1998, and the results of its operations and its
cash flows for the years ended September 30, 1999 and 1998, and for the period
from October 21, 1996 (date of inception) to September 30, 1999, in conformity
with accounting principles generally accepted in the United States. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States, which 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, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statements presentation. We believe that our audits provide a reasonable basis
for the opinion expressed above.
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 in both fiscal years
1999 and 1998, which raises 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.
/s/ PricewaterhouseCoopers LLP
San Jose, CA October 17, 1999, except for second paragraph of note 4 as to which
the date is August 28, 2000
57
GENXON POWER SYSTEMS, L.L.C. (a company in the development stage)
BALANCE SHEETS
September 30,
--------------------
1999 1998
-------- ----------
ASSETS
Current assets:
Cash and cash equivalents......................... $162,832 $ 594,573
Accounts receivable............................... 175,321 204,233
Inventory......................................... -- 278,292
-------- ----------
Total current assets............................. 338,153 1,077,098
Property and equipment, net........................ 179,558 897,876
Note receivable from employee...................... 90,000 120,000
-------- ----------
Total assets..................................... $607,711 $2,094,974
======== ==========
LIABILITIES AND MEMBERS' CAPITAL
Current Liabilities:
Payable to Woodward Governor Company.............. $ -- $ 9,060
Payable to Catalytica Combustion Systems, Inc..... 53,857 320,589
Accounts payable.................................. -- 199,480
Accrued liabilities............................... 592,518 257,093
-------- ----------
Total current liabilities........................ 646,375 786,222
-------- ----------
Commitments and contingencies (Note 4)
Members' capital................................... (38,664) 1,308,752
-------- ----------
Total liabilities and members' capital........... $607,711 $2,094,974
======== ==========
The accompanying notes are an integral part of these financial statements.
58
GENXON POWER SYSTEMS, L.L.C. (a company in the development stage)
STATEMENTS OF OPERATIONS
Period from
October 21,
1996 (date of
Year ended Year ended inception) to
September 30, September 30, September 30,
1999 1998 1999
----------- ----------- ------------
Revenues:
Research contract..................... $ 887,224 $ 204,233 $ 1,359,457
----------- ----------- ------------
Operating expenses:
Research and development.............. 3,964,331 8,137,903 20,758,676
Selling, general and
Administrative expenses.............. 1,095,602 1,709,337 4,952,736
----------- ----------- ------------
5,059,933 9,847,240 25,711,412
----------- ----------- ------------
Loss from operations................... (4,172,709) (9,643,007) (24,351,955)
Other income, net...................... 15,293 27,910 93,291
----------- ----------- ------------
Net loss............................... $(4,157,416) $(9,615,097) $(24,258,664)
=========== =========== ============
The accompanying notes are an integral part of these financial statements.
59
GENXON POWER SYSTEMS, L.L.C. (a company in the development stage)
STATEMENTS OF MEMBERS' CAPITAL
Catalytica
Woodward Combustion Total
Governor Systems, Members'
Company Inc. Capital
------------ ------------ -------------
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)
Capital contributions................ 6,605,000 5,805,000 12,410,000
Net loss............................. (4,807,548) (4,807,549) (9,615,097)
----------- ----------- ------------
Members' capital, September 30, 1998.. 654,376 654,376 1,308,752
Capital contributions................ 1,405,000 1,405,000 2,810,000
Net loss............................. (2,078,708) (2,078,708) (4,157,416)
----------- ----------- ------------
Members' capital, September 30, 1999.. $ (19,332) $ (19,332) $ (38,664)
=========== =========== ============
The accompanying notes are an integral part of these financial statements.
60
GENXON POWER SYSTEMS, L.L.C. (a company in the development stage)
STATEMENTS OF CASH FLOWS
Period from
October 21,
1996 (date of
Year ended Year ended inception) to
September 30, September 30, September 30,
1999 1998 1999
------------ ------------ ------------
Cash flows from operating activities:
Net loss................................. $(4,157,416) $ (9,615,097) $(24,258,664)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation expense.................... 215,181 74,477 289,658
Changes in assets and liabilities:
Accounts receivable.................... 28,912 (204,233) (175,321)
Inventory.............................. 278,292 (44,315) --
Prepaid expenses....................... -- 358,482 --
Note receivable from employee.......... 30,000 (120,000) (90,000)
Payable to members..................... (275,792) (75,414) 53,857
Accounts payable....................... (199,480) (1,652,534) --
Accrued liabilities.................... 335,425 (176,168) 592,518
Loss on disposal of fixed assets....... 503,137 -- 503,137
----------- ------------ ------------
Net cash used in operating
activities........................... (3,241,741) (11,454,802) (23,084,815)
----------- ------------ ------------
Cash flows from investing activities:
Acquisition of property and
equipment............................... -- (414,991) (972,353)
----------- ------------ ------------
Cash flows from financing activities:
Members' capital contributions........... 2,810,000 12,410,000 24,220,000
----------- ------------ ------------
Net decrease in cash and cash
equivalents.............................. (431,741) 540,207 162,832
Cash and cash equivalents, beginning
of period................................ 594,573 54,366 --
----------- ------------ ------------
Cash and cash equivalents, end of
period................................... $ 162,832 $ 594,573 $ 162,832
=========== ============ ============
The accompanying notes are an integral part of these financial statements.
61
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:
Cash Technology
Commitment Licenses Total
---------- ---------- -----------
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
At September 30, 1999, each member had contributed its agreed-upon technology
licenses and cash in the total amount of $34.3 million. 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, 1999, cumulative capital account
balances determined in accordance with the Operating Agreement are as follows:
Catalytica Woodward Total
------------- ------------- -------------
Cash contributed................. $ 9,110,000 $ 15,110,000 $ 24,220,000
Technology licenses contributed.. 8,000,000 2,000,000 10,000,000
Allocation of cumulative net
loss............................ (12,129,332) (12,129,332) (24,258,664)
------------ ------------ ------------
Capital account balances......... $ 4,980,668 $ 4,980,668 $ 9,961,336
============ ============ ============
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. The Company
has reported a net loss of $4.2 million for the year ended September 30, 1999
and a cumulative loss of $24.3 million for the period from October 21, 1996
(date of inception) through September 30, 1999. Management
62
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.
Revenue recognition
The Company revenue is derived from government research funding related to the
prototype development of the Kawasaki program. The Company performs services
under time and materials contracts in which revenue is recognized as services
are performed.
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.
Concentrations
At September 30, 1999 and 1998 one customer accounted for 100% of the Company's
accounts receivable.
One customer comprised 100% of the revenue for the years ended, September 30,
1999 and 1998.
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
estimated selling price.
Property and equipment
Property and equipment are stated at cost and are 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.
Impairment of long-lived assets
In 1998 Genxon entered into a technical services agreement with the City of
Glendale (City) (Note 4) for the retrofit of the City's gas turbine. In 1999,
the Company returned the turbine in its original state to the City as allowed in
the contract. Related to the contract, the Company had acquired certain
equipment to support the Company's performance under the contract. Since the
contract has been terminated the Company has no alternative use for the
equipment and at September 30, 1999 disposed of the equipment. Accordingly, the
carrying value of the equipment is not recoverable and an impairment loss has
been recognized. The effect of this statement for the year ended
63
September 30, 1999 was a write-down of equipment of approximately $503,000,
which has been included in the Statement of Operations within the caption
"Research and Development."
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.
3. Property and Equipment
Property and equipment consist of the following:
September 30,
-------------
1999 1998
--------- ----------
Laboratory equipment............ $ 344,235 $498,712
Less: Accumulated depreciation.. (164,677) (74,477)
--------- --------
179,558 424,235
Construction in progress........ -- 473,641
--------- --------
$ 179,558 $897,876
========= ========
4. 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, 1999, the Company has no
open purchase commitments through Agilis. The agreement was extended in
September 1999 and will expire on the later of the completion of all services
described in the agreement or December 31, 2000, unless extended in writing and
agreed to by both parties.
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 turnkey price of $700,000 GENXON did not
complete the agree-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 Combustion Systems, Inc., Catalytica, Inc., and Genxon Power
Systems, Inc. in Los Angeles County Superior Court, Case No. EC029841 (the
"Complaint"). The Complaint asserts claims against all defendants for breach of
contract, breach of 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 one FT4 engine with the FT4 Xonon
Combustion System ("FT4 XCS"). 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.
5. 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. Costs under these services agreements for the year
ended September 30, 1999, September 30, 1998 and for the period from October 21,
1996 (date of inception) to September 30, 1999, are as follows:
64
Period from
October 21,
1996 (date of inception) to
September 30,
1999 1998 1999
---------- ---------- ----------
Catalytica:
Research and development.... $2,454,940 $3,182,559 $9,087,576
General and administrative.. $ 685,777 $ 816,163 $2,857,248
Woodward:
Research and development.... $ -- $ 552,690 $1,066,177
General and administrative.. $ -- $ 118,550 $ 183,742
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.
65
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Members of Genxon Power Systems, L.L.C. (a company
in the development stage):
In our opinion, the accompanying balance sheets and the related statements of
operations, of members' capital and of cash flows present fairly in all material
respects, the financial position of Genxon Power Systems L.L.C. at September 30,
1998 and 1997, and the results of its operations and its cash flows for the year
ended September 30, 1998 and for the period from October 21, 1996 (date of
inception) to September 30, 1997. These financials are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
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 in both fiscal years
1998 and 1997, which raises 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.
/s/ PricewaterhouseCoopers LLP
San Jose, California October 26, 1998
66
GENXON POWER SYSTEMS, L.L.C. (a company in the development stage)
BALANCE SHEETS
September 30,
-----------------
1998 1997
---------- -----------
ASSETS
Current assets:
Cash and cash equivalents.............................. $ 594,573 $ 54,366
Accounts receivable.................................... 204,233 --
Inventory.............................................. 278,292 233,977
Prepaid expenses....................................... -- 358,482
---------- -----------
Total current assets.................................. 1,077,098 646,825
---------- -----------
Property and equipment, net............................. 897,876 557,362
Note receivable from employee........................... 120,000 --
---------- -----------
Total assets.......................................... $2,094,974 $ 1,204,187
========== ===========
LIABILITIES AND MEMBERS' CAPITAL
Current liabilities:
Payable to Woodward Governor Company................... $ 9,060 $ 89,483
Payable to Catalytica Combustion Systems, Inc. ........ 320,589 315,580
Accounts payable....................................... 199,480 1,852,014
Accrued liabilities.................................... 257,093 433,261
---------- -----------
Total current liabilities............................. 786,222 2,690,338
Commitments and contingencies (Note 3)
Members' capital........................................ 1,308,752 (1,486,151)
---------- -----------
Total liabilities and members' capital................ $2,094,974 $ 1,204,187
========== ===========
The accompanying notes are an integral part of these financial statements.
67
GENXON POWER SYSTEMS, L.L.C. (a company in the development stage)
STATEMENTS OF OPERATIONS
Period from
October 21,
1996 (date of
Year Ended inception) to
September 30, September 30,
1998 1997
------------- -------------
Revenues:
Research contract......... $ 204,233 $ 268,000
----------- ------------
Operating expenses:
Research and development.. 8,137,903 8,656,442
Selling, general and
administrative expenses.... 1,709,337 2,147,797
----------- ------------
9,847,240 10,804,239
----------- ------------
Loss from operations....... (9,643,007) (10,536,239)
Other income, net.......... 27,910 50,088
----------- ------------
Net loss................... $(9,615,097) $(10,486,151)
=========== ============
The accompanying notes are an integral part of these financial statements.
68
GENXON POWER SYSTEMS, L.L.C. (a company in the development stage)
STATEMENTS OF MEMBERS' CAPITAL
Catalytica
Woodward Combustion
Governor Systems,
Company Inc. Total
------------ ------------ -------------
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)
Capital contributions.. 6,605,000 5,805,000 12,410,000
Net loss............... (4,807,548) (4,807,549) (9,615,097)
----------- ----------- ------------
Members' capital,
September 30, 1998...... $ 654,376 $ 654,376 $ 1,308,752
=========== =========== ============
The accompanying notes are an integral part of these financial statements.
69
GENXON POWER SYSTEMS, L.L.C. (a company in the development stage)
STATEMENTS OF CASH FLOWS
Period from
October 21,
1996 (date of
Year ended Inception) to
September 30, September 30,
1998 1997
-------------- --------------
Cash flows from operating activities:
Net loss............................................ $ (9,615,097) $(10,486,151)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation expense............................... 74,447 --
Changes in assets and liabilities:
Accounts receivable............................... (204,233) --
Inventory......................................... (44,315) (233,977)
Prepaid expenses.................................. 358,482 (358,482)
Note receivable from employee..................... (120,000) --
Payable to members................................ (75,414) 405,063
Accounts payable.................................. (1,652,534) 1,852,014
Accrued liabilities............................... (176,168) 433,261
------------ ------------
Net cash used in operating activities............ (11,454,832) (8,388,272)
------------ ------------
Cash flows from investing activities:
Acquisition of property and equipment............... (414,991) (557,362)
------------ ------------
Cash flows from financing activities:
Members' capital contributions...................... 12,410,000 9,000,000
------------ ------------
Net increase in cash and cash equivalents............ 540,207 54,366
Cash and cash equivalents, beginning of period....... 54,366 --
------------ ------------
Cash and cash equivalents, end of period............. $ 594,573 $ 54,366
============ ============
The accompanying notes are an integral part of these financial statements.
70
1. Formation and Business of the Company:
GENXON Power Systems, L.L.C., 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 "Operating Agreement"), the existence of GENXON will be
perpetual.
Investor members in GENXON Power Systems, L.L.C. received a percentage interest
in GEXNON amount of cash and the agreed-upon fair value of certain technology
licenses contributed to GENXON. There were two initial investor members, each
receiving a 50 percent interest in GENXON. Their initial capital commitments
were as follows:
Cash Technology
Commitment Licenses Total
----------- ----------- ------------
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
At September 30, 1998, each member had contributed its agreed-upon technology
licenses and cash in the total amount of $21.4 million. 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 GENXON
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, GENXON 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, 1998, cumulative capital account balances
determined in accordance with the Operating Agreement are as follows:
Catalytica Woodward Total
------------- ------------- -------------
Cash contributed................... $ 7,705,000 $ 13,705,000 $ 21,410,000
Technology licenses contributed.... 8,000,000 2,000,000 10,000,000
Allocation of cumulative net loss.. (10,050,624) (10,050,624) (20,101,248)
------------ ------------ ------------
Capital account balances........... $ 5,654,376 $ 5,654,376 $ 11,308,752
============ ============ ============
2. Summary of Significant Accounting Policies:
Basis of Presentation:
GENXON'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. GENXON has
reported a net loss of $9.6 million for the year ended September 30, 1998 and a
cumulative loss of $20.1 million for the period from October 21, 1996 (date of
inception) through September 30, 1998. Management plans to obtain
71
additional capital contributions from its members or other additional investors
to meet its current and ongoing obligations. Continued existence of GENXON is
dependent on GENXON'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:
GENXON 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 GENXON's excess cash is invested in money
market accounts with a major investment company.
Concentrations:
At September 30, 1998 one customer accounted for 100% of the Company's accounts
receivable.
One customer comprised 100% of the revenue for the year ended, September 30,
1998 and for the period from October 21, 1996 (date of inception) to September
30, 1997.
Fair Value of Financial Instruments:
Carrying amounts of certain of GENXON'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
estimated selling price.
Property and Equipment:
Property and equipment are stated at cost and are depreciated using the
straight-line method over their estimated useful lives, generally three 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, 1998, property
and equipment consisted of tooling costs incurred in the construction of
GENXON's manufacturing equipment.
Income Taxes:
The financial statements include no provision for income taxes since GENXON's
income and losses are reported in the members' separate tax returns.
Revenue Recognition:
The Company revenue is derived from government research funding related to the
prototype development of the Kawasaki program. The Company performs services
under time and materials contracts in which revenue is recognized as services
are performed.
72
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 GENXON 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. GENXON is
evaluating alternative formats for presenting this information, but does not
expect this pronouncement to materially impact its results of operations.
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 GENXON's fiscal year 1999, and requires that
comparative information from earlier years be restated to conform to the
requirements of this standard. GENXON is evaluating the requirements of SFAS 131
and the effects, if any, on GENXON's current reporting and disclosures.
3. Commitments and Contingencies:
GENXON entered into an exclusive agreement with Agilis Group, Inc. to provide
assistance and advice in the development and design of the combustor and
combustor related hardware for GENXON'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 GENXON'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, 1998, GENXON had approximately $0.7 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, 2000,
unless extended in writing and agreed to by both parties.
GENXON 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
GENXON's proprietary XONON combustion system and a digital control system for a
total turnkey price of $0.7 million, and must be completed by December 1998. In
the event that GENXON is unable to complete the agreed upon retrofit on time or
damages the engine in the process, the agreement requires GENXON to return the
engine to its original state or replace it with a similar engine, for which
GENXON has recorded a reserve of $134,000. GENXON and the City of Glendale are
in discussions regarding the ultimate utilization of XONON technology on either
existing or new gas turbines under this agreement.
4. Related Party Transactions:
GENXON has entered into a services agreement with Catalytica and Woodward to
provide GENXON with management support, technical services support and
administrative services. Costs under these services agreements for the year
ended September 30, 1998 and for the period from October 21, 1996 (date of
inception) to September 30, 1997, are as follows:
1998 1997
---------- ----------
Catalytica:
Research and development.... $3,182,559 $3,450,077
General and administrative.. $ 816,163 $1,355,308
Woodward:
Research and development.... $ 552,690 $ 513,487
General and administrative.. $ 118,550 $ 65,192
73
GENXON has also entered into supply agreements with both Catalytica and Woodward
to supply combustion system products and control system products to be used by
GENXON in its business of retrofitting installed and operating gas turbine
engines.
74
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 ENERGY SYSTEMS, INC.
(Registrant)
Dated: March 15, 2001 By: /s/ Craig N. Kitchen
--------------- --------------------
Craig N. Kitchen
President and Chief Executive Officer
75
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Craig N. Kitchen, 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/ Craig N. Kitchen President, Chief Executive Officer (Principal March 15, 2001
- ------------------------------------------ --------------
Craig N. Kitchen Executive Officer) and Director
/s/ Ricardo B. Levy Chairman of the Board March 15, 2001
- ------------------------------------------ --------------
Ricardo B. Levy
/s/ Dennis Riebe Chief Financial Officer (Principal Accounting and March 15, 2001
- ------------------------------------------ --------------
Dennis Riebe Financial Officer)
/s/ Lawrence W. Briscoe Director March 15, 2001
- ------------------------------------------ --------------
Lawrence W. Briscoe
/s/ William B. Ellis Director March 15, 2001
- ------------------------------------------ --------------
William B. Ellis
/s/ Frederick M. O'Such Director March 15, 2001
- ------------------------------------------ --------------
Frederick M. O'Such
/s/ John A. Urquhart Director March 15, 2001
- ------------------------------------------ --------------
John A. Urquhart
/s/ Thomas E. White Director March 15, 2001
- ------------------------------------------ --------------
Thomas E. White
/s/ Ernest Mario Director March 15, 2001
- ------------------------------------------ --------------
Ernest Mario
/s/ Howard I. Hoffen Director March 15, 2001
- ------------------------------------------ --------------
Howard I. Hoffen
76