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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, 2001
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, CA 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, $0.001 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 March 20, 2002, there were outstanding 11,606,135 shares of the
registrant's common stock, par value $0.001, 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 March 20, 2002) was $42,246,331.
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, 2001.
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CATALYTICA ENERGY SYSTEMS, INC.
Annual Report on Form 10-K
Table of Contents
December 31, 2001
Page No.
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PART I
Item 1. Business............................................................................. 2
Item 2. Properties........................................................................... 17
Item 3. Legal Proceedings.................................................................... 17
Item 4. Submission of Matters to a Vote of Security Holders.................................. 17
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters............ 18
Item 6. Selected Financial Data.............................................................. 20
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 21
Item 7A. Quantitative and Qualitative Disclosures about Market Risk........................... 40
Item 8. Financial Statements and Supplementary Data.......................................... 40
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. 40
PART III
Item 10. Directors and Executive Officers of the Registrant................................... 41
Item 11. Executive Compensation............................................................... 41
Item 12. Security Ownership of Certain Beneficial Owners and Management....................... 41
Item 13. Certain Relationships and Related Transactions....................................... 41
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K...................... 42
1
PART I
Item 1. BUSINESS
Overview
We are responding to a growing demand in the energy industry for
cost-effective solutions for cleaner power through our commitment to the
discovery, development, and manufacture of advanced products that ease the
environmental impact of power production. Our first product, Xonon(R) Cool
Combustion, prevents the formation of nitrogen oxides (NOx) in stationary gas
turbines that are used primarily for electric power generation. Additionally,
we believe that our proprietary catalytic technology has significant market
opportunities in energy production applications outside of gas turbines. In
order to pursue these opportunities, we are currently conducting several
technology development efforts including early stage development work on fuel
processing for fuel cells in automotive applications and adaptation of our
Xonon technology to microturbines, hybrid gas turbine fuel cells and diesel
applications.
Our Xonon system is the only commercially available pollution prevention
technology proven to achieve ultra-low emissions (less than 5 parts per million
("ppm")) during combustion. We believe that our Xonon system achieves ultra-low
emissions of NOx more efficiently and cost-effectively than current systems
that remove this pollutant from the turbine exhaust. In addition, we believe
that our Xonon system can be broadly deployed across turbine applications where
current systems may not be economically or technically viable. Further, we
believe that the environmental and operational benefits offered by Xonon will
expand the use and broaden the application of gas turbines.
For over 24 months, we have been using a Xonon-equipped 1.4 MW gas turbine
to successfully generate power with ultra-low emissions for Silicon Valley
residents and to test our technology in field conditions. The turbine, which
functions as part of the Silicon Valley Power grid, has served alternately as a
demonstration of Xonon's performance and reliability during unattended
full-load operation, and as a development and test engine in support of
commercial program initiatives for customers. Since its installation, the
Xonon-equipped turbine has run for over 8,600 hours. The system has satisfied
federal Environmental Protection Agency, or EPA, guidelines for an emissions
control technology that is "achieved in practice" and has demonstrated
emissions levels that would satisfy the California and South Coast Air Quality
Management District, or 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
through its Environmental Technology Verification program, which confirmed the
ultra-low emissions performance of our turbine.
We have been working actively with gas turbine original equipment
manufacturers, or OEMs, to adapt our technology as part of their stationary gas
turbine product lines. We currently have collaborative commercialization
agreements in place with General Electric Power Systems, or GE, and Kawasaki
Motors Corp., U.S.A., or Kawasaki. Both companies have already received initial
orders for Xonon-equipped gas turbines, and in the third quarter of 2001, we
shipped our first three commercial Xonon units to Kawasaki. We also have
development work underway with Solar Turbines, or Solar, to incorporate the
Xonon system into its turbines. Our development of the Xonon technology has
been supported by government agencies and research institutions, including the
Federal Department of Energy, the EPA, the California Energy Commission Public
Interest Energy Research program, the California Air Resources Board and others.
The Market Opportunity
Three major factors are reshaping today's electric power generation industry:
. An ongoing need for new generating capacity in the United States to avoid
supply/demand imbalances;
. A continued focus on the environmental consequences associated with the
generation of electric power; and
2
. An increased demand for distributed power sources due to growing
transmission and distribution constraints and to assure very high levels
of power reliability and quality to support the requirements of our
digital economy.
Together, these forces are creating a significant need for more
environmentally friendly power generation sources. We believe that our Xonon
Cool Combustion system is an enabling technology that addresses this growing
market need.
Need for Increased Generating Capacity
Driven by an economic boom and population growth, the demand for electricity
in the United States grew dramatically during the 1990s. However, growth in the
supply of electricity failed to keep pace. Over the ten-year period from 1990
to 1999, the increase in the peak demand for power was approximately four times
as large as the increase in generation capacity. Consequently, several regions
of the country suffered significant supply/demand imbalances.
For example, in California, residents were subjected to repeated rolling
blackouts and significant increases in retail electric rates during 2000 and
2001. Fortunately, mild weather conditions, newly installed capacity, and
economic factors across the country in the latter half of 2001 avoided a more
widespread problem. Nevertheless, the President's National Energy Policy
Development Group, or NEPDG, projects that the demand for electricity in the
United States will rise 45% from 2000 to 2020. Accordingly, the Department of
Energy, or DOE, estimates that the United States will need 355,000 MW of new
generating capacity, or the equivalent of 1,300 new large power plants, to meet
growing demand and to replace retiring units. According to the DOE, 88% of this
growth in capacity will come from gas-fired generation, and a large percentage
of these capacity additions will be in densely populated areas where air
quality and environmental concerns are the most severe.
Gas turbines are increasingly the choice for new power generation, due
primarily to their inherent operating flexibility, high efficiency, relatively
low capital investment, shorter installation time, lower operating costs, and
lower emissions. Gas-fueled generation, which includes gas turbines and other
generation technologies, 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 2000, will represent 32% of total generation by 2020.
We believe that the environmental and operational benefits of our Xonon
technology will expand the use and broaden the applicability of gas turbines,
thereby enabling a more rapid and comprehensive response to the need for
additional generation capacity.
Continued Environmental Awareness
One barrier to adding this additional generation capacity is the continued
public focus on environmental issues. Electricity production can result in
emissions of certain environmentally harmful pollutants, including NOx, carbon
monoxide, volatile organic compounds and particulate matter. In the United
States, the Clean Air Act creates the National Ambient Air Quality Standards,
or NAAQS, which are the basis for regulations that limit these emissions. The
NAAQS encourage the use of more effective emissions control technology in two
ways. First, they require the use of the best available control technology, or
BACT. Second, they provide an economic incentive by requiring that emissions
from new sources be offset by emissions reductions from existing sources in
areas that do not meet air quality standards. Although permits are issued on a
facility-by-facility basis, regulators often issue regulatory guidance setting
forth permissible emissions for new and upgraded facilities. These emission
standards vary geographically and are most stringent in areas where existing
pollution levels are high, including California, the Northeastern states, East
Texas, and other urban areas.
3
A representative sample of high population density areas and their
corresponding permissible emissions includes:
. California (California Air Resource Board)--2.5 ppm, for all units
regardless of size;
. Los Angeles Basin (SCAQMD)--2.5 ppm for units greater than 3 MW;
. Eastern Texas, including Dallas, Austin and San Antonio (Texas Natural
Resources Conservation Commission)--3 ppm for units greater than 10 MW
(and will apply to smaller units after 2004);
. Connecticut, Massachusetts, New York and New Jersey--no specific guidance
has been issued, however several permits have been issued in the past
three years requiring less than 2.5 ppm.
The increased permitting requirements associated with meeting more stringent
emissions requirements, as well as community concerns surrounding construction
of new plants near population centers, have significantly increased the time
and cost associated with siting and permitting new power plants. These
difficulties, combined with other uncertainties surrounding deregulation, have
resulted in a situation where only a fraction of planned generation additions
have actually been brought on-line. For example, according to the NEPDG, of the
approximately 43,000 MW of new generating capacity that power companies planned
in 1994 for construction from 1995 to 1999, only about 18,000 MW of capacity
were actually built. Completion statistics are even lower in areas with more
severe environmental problems and more stringent emissions regulations. The
NEPDG found that, in California where emissions restrictions are the strictest
in the nation, lengthy and costly siting and permitting issues had prevented
the addition of even one single major new power plant between 1991 and 2000.
Significant capacity additions, however, have finally been completed since the
beginning of 2001and more additions are expected in the next few years.
Currently available emissions control technologies fail to cost-effectively
satisfy the most stringent environmental requirements in gas turbine
applications. In order to reduce emissions, gas turbine manufacturers have
developed improved flame-based combustion systems. These measures have, in some
cases, contributed to shorter component lives. Furthermore, even the most
effective of these systems has been unable to achieve ultra-low emissions
levels that are required today without add-on exhaust gas cleanup systems. For
baseload, or nearly continuous operation, virtually all new gas turbine
generating plants that operate in combined cycle (with a heat recovery system)
require exhaust cleanup systems 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
creates incremental health risks through secondary emissions and through the
transportation and storage of hazardous and toxic reagents. In addition,
exhaust cleanup systems cannot be used in all gas turbine applications. For
small gas turbines with heat recovery systems used in distributed generation
applications, the addition of SCR can be cost-prohibitive. Gas turbines that
operate in simple cycle (without a heat recovery system), such as peaking
turbines and gas pipeline compressors, have exhaust temperatures that are too
hot for conventional exhaust cleanup systems. However, there is an emerging
technology generically called high-temperature SCR that can be used in some
simple cycle applications. At least one high-temperature application has been
demonstrated to meet the EPA definition of "achieved in practice" with 8 ppm
NOx, and some units are now operating at less than 5 ppm. However, these
systems are even more expensive to acquire and operate than traditional SCRs
and carry the same attendant risks.
We believe that the role that environmental protection requirements have
played and may continue to play in delaying or ultimately limiting the supply
of new generation capacity highlights the need for a cost-effective,
widely-applicable emissions technology, like Xonon, that permits turbines to
meet the most stringent existing emissions guidelines. We believe that Xonon
will not only reduce the operating costs associated with complying with
environmental standards, but may create additional value by enabling rapid
siting and permitting of projects that otherwise may not have been possible.
4
Increased Demand for Distributed Power Sources
The third factor impacting the electric power industry is the emerging
demand for distributed power sources, or distributed generation. The DOE
projects that about 19,000 megawatts of gas-fired distributed generation
capacity will be added by 2020. Two market drivers are contributing to the
increased demand for on-site power generation:
1. Growing transmission and distribution constraints, and
2. The digital economy's need for high-quality, highly reliable power.
The electric utility grid in the U.S. is faced with growing transmission and
distribution constraints as the result of a lack of investment in an aging,
outdated infrastructure. While net generation of electricity has grown 26% over
the past decade, the number of transmission miles has remained virtually
constant. This lack of investment is creating an electricity bottleneck, which
is impacting transmission grid reliability. A recent report published by the
North American Electric Reliability Council, or NERC, highlights this growing
problem:
"In the near term, transmission congestion is expected to continue. Demand
growth, new generation additions, and the increasing number of energy
transactions continue to outstrip the proposed expansion of transmission
systems The reliability of the interconnected transmission systems in the
long term will be highly dependent upon the location of new generating
resources. Unless mechanisms are developed to encourage investment in new
transmission facilities and siting issues are addressed, few new
transmission facilities and reinforcements will be constructed. This lack of
additional transmission facilities and reinforcements will require either
that new technologies be developed to alleviate transmission congestion or
that generating facilities be located and dispatched in a manner to minimize
the use of constrained transmission corridors."(1)
At the same time, the new digital economy is faced with a 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 highly
reliable power. The electric power grid in the United States was designed to
achieve reliability targets for delivery to traditional electric loads, such as
lights and motor-operated equipment. Sophisticated digital devices require
higher levels of reliability. In addition, brief and sustained outages exact
high costs on all types of businesses in terms of lost data, materials and
productivity. Sandia National Laboratories, a DOE national security laboratory,
estimates that power quality and reliability problems cost U.S. businesses
approximately $150 billion annually. Several businesses have sought to avoid
the costs associated with poor grid quality and reliability by placing
generation sources at or near their point of demand.
To date, power producers have been unable to offer distributed generation
solutions 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 unacceptable levels
of emissions that limit their use in densely populated areas requiring
distributed applications. We believe that the low-cost, ultra-low emissions
solution offered by our Xonon technology will enable the widespread use of
distributed generation.
Our Solution
How Xonon Cool Combustion Is Unique
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, so most of the air is used to cool the combustion process
to the level the turbine requires. The high temperature required for a stable
flame causes the nitrogen and oxygen in the air to react, forming NOx, a major
contributor to air pollution.
- --------
(1) Reliability Assessment 2001-2010: The Reliability of Bulk Electric Systems
in North America; NERC--October 16, 2001
5
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 at a lower peak temperature.
Importantly, this lower temperature is below the threshold at which significant
amounts of NOx are formed. The Xonon combustion system is the only commercially
available gas turbine combustion system demonstrated to achieve ultra-low
emissions without add-on exhaust gas cleanup systems.
How Xonon Cool Combustion Is Integrated into the Gas Turbine
We collaborate with gas turbine OEMs, to adapt their combustion systems to
incorporate our Xonon technology. We believe that, together with the OEMs, we
can design the Xonon combustion system to suit essentially all sizes and types
of gas turbines in land-based applications. For each turbine model that an OEM
agrees to pursue, we design a catalytic Xonon module, the key component of the
Xonon system, to be incorporated into the design of the turbine combustors.
We then manufacture the custom-designed Xonon modules and sell the Xonon
modules to the OEM to incorporate as an integral part of its product. At
present, the Xonon modules have an expected life of 8,000 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. We expect to derive revenue from the sale of both new and replacement
Xonon modules.
Key Benefits of Xonon Cool Combustion
We believe that Xonon can achieve ultra-low NOx emissions levels more
efficiently and cost-effectively than current emissions control technologies
across a broader range of gas turbine applications. As a result, we believe
Xonon will enable the power generation industry to address the significant need
for additional, high-quality power supply while simultaneously protecting the
environment and mitigating community concerns about air quality, the
environment, aesthetics and public safety. In addition, our Xonon system is
designed to operate with low carbon monoxide and volatile organic compound
emissions, which are other pollutants associated with power generation. Xonon's
role as an enabling technology is the product of several key benefits that it
offers relative to current emissions control technologies. Xonon:
. Significantly Reduces the Formation of NOx. High temperatures in
conventional gas turbine combustion systems result in the formation of
NOx. The Xonon Cool Combustion system allows combustion to occur at lower
temperatures, which significantly reduces the formation of NOx without
affecting turbine performance.
. Avoids Costly and Burdensome 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, require considerable additional space, and in many cases
require the use of hazardous and toxic reagents. Xonon enables gas
turbines in essentially all applications to achieve ultra-low emissions,
without the use of exhaust cleanup systems.
. Maintains Combustion 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.
. 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 cannot use
conventional exhaust cleanup systems except for high temperature SCRs,
which are not yet proven at ultra-low emissions levels and which are more
costly than conventional SCRs. In addition, it can be cost-prohibitive
for smaller gas turbines to use any exhaust cleanup systems. As a result,
these facilities cannot in some cases achieve ultra-low emissions. We
believe Xonon will enable almost all applications and sizes of gas
turbines to achieve ultra-low emissions, thus broadening their range of
use.
6
. Expands Gas Turbine Use in Urban Areas. Xonon-equipped turbines can be
put into service in densely populated areas where community,
environmental, health, and safety concerns may have previously prevented
gas turbines from being used.
Market for Xonon
We believe that Xonon combustion systems offer distinct advantages in all
gas turbine markets. We divide our potential market into three sectors based on
gas turbine size: small, medium and large gas turbines.
Small Gas Turbines
Market Description. The small gas turbine sector includes turbines that
generate between 1 and 15 MW of electric power. Turbines in this sector serve
industrial, commercial and institutional loads in power only and combined heat
and power, or cogeneration, applications. The desire to site generation
facilities near users for quality and reliability reasons has driven demand for
these turbines. Units sited at or near the point of use can enhance power
quality and reliability while avoiding the need to expand transmission and
distribution capacity.
We believe that the small gas turbine market sector is poised for growth.
According to Diesel & Gas Turbine Worldwide, 327 power generation gas turbines
between 1 and 15 MW were ordered during the year ended May 2001. According to
the DOE's Strategic Plan for Distributed Energy Resources, its goal for
distributed generation, which includes small gas turbines in this size range
and other technologies, is to reach 20% of the total power generation capacity
additions by 2010. Gas turbine OEMs in this sector include Alstom Power,
Kawasaki Heavy Industries, Ltd., GE's Nuovo Pignone subsidiary, Pratt & Whitney
Canada Corp., Rolls Royce Allison, and Caterpillar Inc.'s Solar Turbines unit.
Products. Due to their earlier shipping dates, we expect that Xonon modules
for small gas turbines will comprise a majority of our product revenue through
2005. We are currently engaged with OEMs in adapting Xonon for gas turbines
they manufacture in this size range.
. Kawasaki M1A-13X Turbine (1.4 MW). In May 2000, Kawasaki and Enron
Energy Services jointly agreed to furnish three Xonon-equipped 1.4 MW
Kawasaki gas turbines for a distributed power generation project at a
United States government agency healthcare facility located in
Massachusetts. Following the receipt of this order, in December 2000, we
entered into a collaborative commercialization agreement enabling
Kawasaki to market and sell a generator package comprised of a 1.4 MW
Kawasaki gas turbine outfitted with the Xonon Cool Combustion system.
Kawasaki is currently accepting commercial orders for this generator
package. We shipped our first commercial Xonon modules to Kawasaki in the
third quarter of 2001.
. GE-10 Turbine (11 MW). In May 2000, Alliance Power Inc. entered into a
preliminary agreement with GE for the purchase of up to six 11 MW GE gas
turbines equipped with the Xonon Cool Combustion system. Pre-delivery
testing of Xonon-equipped GE turbines began in the second quarter of
2001, with the shipment of two pre-commercial Xonon modules to GE.
Subject to successful completion of the development work on this Xonon
system, we expect that GE could begin accepting commercial orders for
Xonon-equipped GE turbines in the second half of 2002, for delivery
commencing in the first half of 2003.
. Taurus 60 (5 MW). In October 2001, we entered into an agreement with
Solar, a wholly owned subsidiary of Caterpillar, for the development and
adaptation of the Xonon Cool Combustion system to Solar's Taurus 60, a 5
MW turbine. The 24-month development effort commenced in the first
quarter of 2002, and will culminate in full-scale testing on a
demonstration engine at Solar's facility.
. Small, multi-can development ((less than)15 MW). In September 2001, the
California Energy Commission, or CEC, notified us that it would award us
$3.0 million to help fund application of the Xonon Cool Combustion system
to a multi-combustor gas turbine. The development effort for this program
commenced in the first quarter of 2002. We expect to partner with an OEM
in this effort, with the objective of completing an engine test under
full-scale operating conditions, followed by commercialization.
7
Medium Gas Turbines
Market Description. The medium gas turbine sector includes turbines that
generate between 15 and 60 MW of electric power. These units are generally used
for meeting power requirements during periods of peak demand and in energy
intensive industrial facilities for power generation and cogeneration.
According to Diesel & Gas Turbine Worldwide, 401 power generation gas
turbines between 15 and 60 MW were ordered during the year ended May 2001. A
February 2002 forecast by Forecast International estimates that the global
market for this class of unit will remain in excess of 400 units per year over
the next ten years. The majority of these units are expected to be used for
peaking applications, with the bulk of the remainder used for base load duty.
Alstom Power, GE and Rolls Royce Allison manufacture turbines for this market.
Products. We are in active discussions with OEMs to incorporate the Xonon
system into medium-sized gas turbines. However, we expect our revenues from
this sector to be smaller than from the small and large gas turbine sectors.
Large Gas Turbines
Market Description. The large gas turbine sector is comprised of turbines
that generate more than 60 MW of electric power. These turbines are used by
public utilities and wholesale generating companies to provide large quantities
of power to serve utility loads or for resale in wholesale markets.
In the last couple of years, the market for large gas turbines has
demonstrated very high growth, with turbine manufacturers reporting significant
sales increases and backlogs. According to Diesel & Gas Turbine Worldwide,
there were 629 global orders for gas turbines greater than 60 MW during the
year ended May 2001. While the market for large gas turbines has experienced a
recent slowdown, due largely to economic factors in the U.S. in the second half
of 2001, a February 2002 forecast by Forecast International estimates that the
global market will remain in excess of 600 units per year between 2002 and
2011, suggesting continued long-term demand. The continuation of these high
order levels is predicated on several factors including the need to replace
aging generating plants, continued growth in the U.S. economy, and the
environmental attractiveness of natural gas as a fuel when utilized to power
highly efficient and clean gas turbine combined-cycle power plants. According
to PowerData Group, Alstom Power, GE and Siemens Westinghouse together
represent nearly all of this market on a unit basis.
Products. Due to longer lead times required to apply Xonon to large gas
turbines, we expect that Xonon modules for large gas turbines will not comprise
a significant portion of our revenue until after 2005. We are working with GE
to adapt Xonon for gas turbines it manufactures in this size range.
. GE 7FA Turbine (170 MW). In November 1998, we signed a collaborative
agreement with GE to develop the Xonon Cool 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 for three GE 7FA gas turbines intended for the
Pastoria project in central California. Concurrent with this order, GE
agreed to use commercially reasonable efforts to complete development,
design and testing of the Xonon Cool Combustion system for GE 7FA
turbines. As part of this order, Enron and GE had the right to substitute
alternative emissions controls for any reason. In January 2001, we
shipped Xonon modules to GE for rig testing in support of our 7FA program
effort. Initial tests were promising and confirmed Xonon's ability to
reduce NOx to ultra low levels in a high-firing temperature environment.
Despite the positive test results, in the spring of 2001, we and GE
decided that the delivery date of January 2003 selected for these
turbines was too early to ensure that Xonon could be ready to meet the
strict commercial warranties required under this contract, and GE
exercised the option to substitute alternative emissions control
technology. Since this substitution, we have continued Xonon development
for the GE 7FA gas turbine.
8
Our Strategy
Our goal is to make Xonon an industry standard as the preferred combustion
system for all gas turbines and for similar applications. Our strategy for
achieving this goal is as follows:
. Continue to Develop Our OEM Relationships. We develop and sell Xonon
combustion modules to gas turbine OEMs. We have entered into
collaborative development and commercialization agreements with leading
turbine manufacturers for the joint design and application of Xonon Cool
Combustion technology to their turbines.
We believe offering Xonon on their gas turbines gives OEMs a competitive
advantage in new equipment sales. We also believe that Xonon module
replacement services and the availability of Xonon as an upgrade for
existing gas turbines will 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 existing collaborative relationships
with OEMs place us at a considerable competitive advantage over other
potential developers of catalytic combustion and competing technologies.
. Market Currently Offered Xonon-Equipped Gas Turbines. During the early
stages of commercialization, we work with our OEM partners and actively
seek prospective users of Xonon-equipped gas turbines. We participate in
the initial stages of discussions relating to their gas turbine orders.
We also work with 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 our Xonon Cool Combustion technology and its benefits among
end-users will increase OEMs' incorporation of Xonon combustion systems
across their product lines. We 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 establish brand awareness by
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.
. Develop and Defend Our Intellectual Property and Broaden Our Technology
Base. Our Xonon Cool Combustion technology is a proprietary technology
protected by patents. We believe 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.
. 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. We do this to ensure that the agencies are aware of
Xonon's capabilities and limitations when creating regulations.
9
Recent Milestones Achieved
The following is a summary of milestones that we have recently achieved.
Date Recent Milestones
---- -----------------
Q1 2000 Announced satisfaction of all EPA guidelines for an "achieved in practice" technology
Q2 2000 Agreed to pursue an amendment to our collaborative commercialization and license agreement with
GE in order to commercialize the Xonon--equipped GE-10 gas turbine (formerly the Nuovo
Pignone PGT10 turbine)
Q2 2000 Alliance Power signed preliminary agreement with GE to order up to six Xonon-equipped GE-10 gas
turbines
Q2 2000 Enron Energy Services ordered three Xonon-equipped Kawasaki M1A-13X gas turbines
Q3 2000 Received distributed power generation research award from the DOE, which provided for additional
R&D funding
Q3 2000 Received the EPA's first Clean Air Excellence Award in the Clean Air Technology category for
impact, innovation and replicability
Q4 2000 Catalytica Energy Systems spun off as a new public entity from Catalytica, Inc.
Q4 2000 Entered into commercialization agreement with Kawasaki to supply Xonon-equipped Kawasaki
turbines to the distributed generation market
Q1 2001 Received third party confirmation of Xonon's ultra-low emissions capabilities from the EPA's
Environmental Technology Verification Program
Q2 2001 Achieved 8,000 hours of power production with a Xonon-equipped gas turbine operating at Silicon
Valley Power
Q2 2001 Awarded a research and development cost sharing contract by the DOE to fund development of fuel
reforming and fuel processing technology for use in transportation applications, which was increased
to an aggregate $11.7 million
Q3 2001 Shipped first commercial Xonon units for incorporation into Kawasaki M1A-13X
Q3 2001 Completed follow-on public offering, raising $47.6 million in net proceeds to us through sale of
4,250,000 shares
Q3 2001 Received notification of $3.0 million award from the CEC for expanded application of Xonon to a
small, multi-can gas turbine
Q4 2001 Finalized agreement with Solar Turbines to develop Xonon-Equipped Taurus 60 gas turbines
Q4 2001 Opened new facility in Arizona to house dedicated commercial manufacturing operations
Manufacturing
We currently manufacture both prototype and production Xonon modules at our
facility in Mountain View, California. We believe that, with modest capital
expenditures, we can expand our capabilities in Mountain View to supply a
sufficient number of both development and production Xonon modules to satisfy
our short-term needs. We plan to retain all proprietary manufacturing within
our facilities and outsource the manufacturing of non-critical components to
third party suppliers.
We plan to use manufacturing cells for internal production. Our
manufacturing cells consist of a sequence of manufacturing equipment arranged
in a manner to allow the simultaneous production of three different varieties
of Xonon modules on three separate coating lines. Certain equipment is common
to all coating lines, such as ovens, rollers and other support equipment. Our
cells are designed to produce all varieties of Xonon modules. Our first
manufacturing cell located at our Mountain View facility was developed in 1999
with a single coating
10
line, and has demonstrated initial production of commercial-quality modules.
Since we are able to manufacture our Xonon modules much more quickly than gas
turbines are manufactured, we anticipate that we will be able to accommodate
demand for our modules.
Based on our commercialization plan, we anticipate that our existing
facilities will provide sufficient capacity through 2002. We anticipate
achieving production efficiencies as commercial production volume increases
over the next three years. In addition, we will expand our production
capabilities at our new facility in the Phoenix metropolitan area, which is
expected to come on-line by the end of 2002. Upon initiation of production in
our new facility, our focus will be manufacturing commercial modules at our
Phoenix area facility, with the Mountain View facility serving primarily for
the manufacture of prototype and development modules, and as a back-up site for
commercial manufacturing. Over the long term, we intend to manufacture our
modules in high commercial volumes at our production facility in Arizona.
We manage our supply of critical materials through dual-sourcing
procurement, strategic inventory control and identification of substitute
materials. We purchase metal fabrication components from suppliers already
supplying similar components to the turbine OEMs. Other materials required for
Xonon module production are sourced from the specialty chemicals and specialty
metals industries. We expect 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, with the exception of one, a high temperature steel
alloy, we have identified either alternative suppliers or substitute materials.
The alloy's primary use is in the jet aircraft and turbine industries, and we
believe that at full production levels our requirements would represent less
than 5% of our supplier's 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.
We expect the Xonon modules to be returned to us at the end of their useful
life. We expect to reclaim, reuse or recycle most components of the module,
particularly the precious metals palladium and platinum, in order to reduce our
costs and protect ourselves against the volatility of precious metal prices.
In the fourth quarter of 1999, we earned ISO 9001 Registration from
Underwriters Laboratories, Inc. 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, or ISO. ISO 9001 is the most comprehensive standard in the ISO
9000 series.
In addition to our manufacturing facilities, we 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 for the testing of critical
combustor components such as preburners and mixers.
Technology
In a gas turbine system, a fuel, often natural gas but also other
hydrocarbons, is burned in a chamber with air compressed by the gas turbine's
compressor. This heat energy is then converted to mechanical energy in the
turbine section to drive an electric generator or other device.
In a conventional gas turbine combustion system, fuel is injected into a
combustion chamber that is filled with compressed air. The fuel-air mixture
burns at a high temperature. NOx is formed when the nitrogen present in the air
is exposed to very high temperatures, such as those in a flame. As a result,
NOx concentrations reach over 100 ppm in the gas turbine exhaust. Over the past
twenty years systems have been developed which reduce the temperature at which
the fuel is burned by altering the composition of the fuel; most often by using
water, steam or air to dilute the concentration of fuel in the combustor before
it is mixed with the compressed air and burned. As the fuel-air mixture becomes
leaner, the combustion temperature lowers, thus reducing the NOx
11
emissions. These systems are generically called "lean pre-mix" combustion
systems. Today most gas turbines are manufactured with a version of this type
of system that uses air to dilute the mixture and are known as "dry low NOx"
systems.
However, the combustion temperature must be sufficiently hot to prevent the
flame from flickering or being extinguished. In practice this has limited the
lean pre-mix systems to operating at NOx levels no lower than approximately 9
ppm for the very best commercial systems using air and approximately 25 ppm for
those using steam or water.
The Xonon system combusts the fuel using a different principle. Instead of
heating the fuel-air mixture in a flame until it is hot enough to burn, Xonon
passes this mixture over a chemical catalyst that causes the combustion
reaction to take place at much lower temperatures. About half the fuel is
combusted in the catalyst. The remaining fuel is combusted downstream of the
catalyst in a homogeneous reaction, also at a temperature low enough to prevent
formation of significant amounts of NOx. The resulting concentration of NOx in
the gas turbine exhaust will be in the range of 1 to 5 ppm and below 3 ppm in
most gas turbines built today.
Competition
We expect Xonon-equipped gas turbines to compete with turbines outfitted
with current emissions reduction technologies, including lean pre-mix
combustion and conventional exhaust cleanup systems. 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. We expect that OEMs will continue to
develop technologies that may compete with ours.
Third parties, including Cormatech, Engelhard, EmeraChem, Mitsubishi and
Siemens, 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 should offer a significant competitive advantage over turbines
equipped with conventional emissions control 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 should allow the OEM to capture a larger
portion of the economics associated with pollution control. Currently, most
OEMs do not 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., or PCI, has indicated on its web site that it is working with
Siemens Westinghouse, Honeywell and Solar Turbines.
12
New Technology Development
We believe that our proprietary catalytic technology has significant market
opportunities in energy production applications outside of gas turbines. As a
result, we are pursuing new product development efforts, which leverage our
proprietary Xonon catalyst technology.
In July 2001, we were selected by the DOE for an $11.2 million cost-shared
contract to help fund the development of a compact fuel processor capable of
operating on multiple fuels for use with fuel cells in transportation
applications. In September 2001, this contract amount was increased to $11.7
million. The 48-month development effort commenced in October 2001 in
association with the National Fuel Cell Research Center, whom we have engaged
as a sub-contractor. The program will focus on delivering a compact
fuel-flexible fuel processor prototype to be used with Proton Exchange Membrane
("PEM") fuel cells in an automotive application. The availability of a
cost-effective, compact system that can convert conventional fuels, such as
gasoline, to hydrogen to power fuel cells remains one of the barriers to
widespread commercialization of fuel cell use in automobiles. We believe that
the low volume and weight enabled by our technology, combined with our
technology's high efficiencies and rapid transient response, could provide a
solution to this problem.
We are also pursuing the application of our Xonon technology for diesel
engines. In 2001, we commenced development of a prototype reductant generator
designed to enable over-the-road diesel trucks to meet the stringent 2007 EPA
emission requirements by significantly improving NOx storage and release
technology. While current NOx trap technology has been proven to reduce NOx
emissions in diesel engines, certain operating constraints persist. These
operating issues include significant performance limitations and a negative
impact on fuel economy. We believe that the use of our technology will solve
these issues by enabling enhanced regeneration of NOx traps for improved
performance and fuel efficiency. The goal of the combined system is to reduce
NOx by 90 to 95%.
In 2001, we spent $14.6 million on research and development activities of
which approximately $11.7 million was related to customer and government
sponsored programs in which we received $5.5 million of cost reimbursement.
Intellectual Property
We rely on a combination of patents, trade secrets, trademarks, copyrights
and contracts to protect our proprietary technology, including the Xonon Cool
Combustion system. 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 use patents as the primary means of protecting our technological advances
and innovations. 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.
As of December 31, 2001, we either owned (exclusively or jointly), held
exclusive license rights from third parties for, or held license rights from
affiliates for 24 U.S. patents and 49 international registered patents.
Additional domestic and international patent applications are currently in
preparation. Among other things, our patents cover our proprietary Xonon Cool
Combustion system designs, catalyst compositions, new materials,
13
manufacturing processes, operating techniques, methods of control, combustor
components and combustor system designs.
We believe that 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. We plan to vigorously defend our intellectual property.
Portions of our know-how are also 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.
Other Businesses
NovoDynamics, Inc.
In July 2000, we formed Catalytica NovoTec Inc. ("NovoTec") as a wholly
owned 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 and assets contributed to
NovoTec were used to purchase equity in NovoDynamics, Inc. ("NovoDynamics"). We
currently own approximately 34.4% of NovoDynamics' outstanding equity.
Sud-Chemie Catalytica, L.L.C.
In 1998, Catalytica Advanced Technologies, which was merged into us in
December 2000, formed a joint venture with United Catalysts, Inc., a division
of Sud-Chemie Group, to form Sud-Chemie Catalytica. The joint venture was
formed to custom manufacture organometallic catalysts. Formerly named
Single-Site Catalysts, the name was changed to Sud-Chemie Catalytica in March
2000 to more closely identify the company with the parents of the joint
venture. This joint venture is currently winding down. The operating agreement
for this joint venture does not require any further capital contributions by
Catalytica Advanced Technologies or us beyond the initial $0.15 million
contribution. We do not expect to incur further losses as we do not intend to
make any additional capital contributions.
Facilities
We lease approximately 85,000 square feet in Mountain View, California
pursuant to a lease that expires in December 2003, with a five-year option for
renewal. We currently sublease approximately 20,000 square feet at this site.
In 2001, we expanded our manufacturing facilities and initiated relocation
of our headquarters to Gilbert, Arizona under a lease for approximately 43,000
square feet. In December 2001, we entered into an option agreement to purchase
this site. In March 2002, we completed the purchase of this facility.
We lease an additional 5,300 square foot facility in Scottsdale, Arizona,
which is entirely subleased. This lease expires in August 2003.
Human Resources
As of December 31, 2001, we employed 96 persons. None of our employees is
represented by a labor union. We believe our relations with our employees are
good.
14
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..... 57 Chairman of the Board and Director
Craig N. Kitchen.... 51 President and Chief Executive Officer and Director
Ralph A. Dalla Betta 57 Chief Technology Officer and Vice President, Technology
Dennis S. Riebe..... 59 Chief Financial Officer
Patrick T. Conroy... 56 Senior Vice President, Product Development
William B. Ellis.... 61 Director
Frederick M. O'Such. 64 Director
John A. Urquhart.... 73 Director
Ernest Mario........ 63 Director
Howard I. Hoffen.... 38 Director
Susan F. Tierney.... 50 Director
Peter Cartwright.... 72 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 companies, Pharmacopeia, Inc. and StemCells,
Inc., and is a director of a privately held company. 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.
15
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. 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.
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 the
Massachusetts Mutual Life Insurance Company and on 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. From 1986 until
2001, Mr. O'Such served as 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. 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. Mr. Urquhart
serves on a number of other boards of directors, including those of the
following public companies: Hubbell Incorporated, TECO Energy, Inc., and Tampa
Electric Co. He served as a senior advisor to the chairman of Enron Corp. from
1998 until 2001, and also served as the vice chairman of Enron from 1990 to
1998. 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.
Ernest Mario, Ph.D. joined our board of directors in September 2000. Dr.
Mario is currently Chairman and Chief Executive Officer of Apothogen, Inc.
Prior to joining Apothogen, Inc. in January 2002, Dr. Mario was Chairman and
Chief Executive Officer of ALZA Corp. until July 1993. From July 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, 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 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 Private Equity in 1986. Mr. Hoffen also serves on a number of boards of
directors, including the boards of the public companies, Allegiance Telecom,
Inc. and Choice One Communications, 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.
16
Susan F. Tierney, Ph.D. joined our board of directors in December 2000. Dr.
Tierney is currently the Senior Vice President of Lexecon Inc. Dr. Tierney is
chairman of the board of directors of The Energy Foundation and the Energy
Innovations Institute, non-profit organizations. Additionally, she is a
director of the following non-profit organizations: Electric Power Research
Institute, Clean Air-Cool Planet, and the Northeast States Clean Air
Foundation. Before joining Lexecon (and its predecessor company, the Economics
Resource Group) in November 1995, Dr. Tierney served in senior positions in
federal and state government from 1983 until 1995. Previously, she was an
assistant professor at the University of California, Irvine from 1978 until
1982. Dr. Tierney has a Ph.D. in public policy and planning, a Masters degree
in regional planning from Cornell University, and a bachelor's degree from
Scripps College.
Peter Cartwright joined our board of directors in December 2001. Mr.
Cartwright currently serves as a director as well as the President and Chief
Executive Officer of Calpine, Inc., which he founded in 1984. From 1979 to
1984, Mr. Cartwright was Vice President and General Manager of Gibbs & Hill,
Inc.'s Western Regional Office. From 1960 to 1979, Mr. Cartwright worked for
General Electric Corporation's Nuclear Energy Division. Mr. Cartwright obtained
a Master of Science Degree in Civil Engineering from Columbia University in
1953 and a Bachelor of Science Degree in Geological Engineering from Princeton
University in 1952.
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. We currently
sublease approximately 20,000 square feet at this site.
In 2001, we initiated relocation of our headquarters to Gilbert, Arizona and
expanded our future manufacturing facilities under a seven-year lease for
approximately 43,000 square feet. In December 2001, we entered into an option
agreement to purchase this site. In March 2002, we completed the purchase of
this facility. We believe that our existing facilities are adequate for the
Company's present needs.
We lease an additional 5,300 square foot facility in Scottsdale, Arizona,
which is entirely subleased. 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. a then 50/50 joint venture
between us and Woodward Governor Company ("WGC"), in Los Angeles County
Superior Court. The case has been transferred to the Orange County Superior
Court, Case No. 00CC13002. The first amended 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 May 31,
2001, we filed an answer to the first amended complaint. We have agreed to
indemnify Catalytica, Inc. for any costs associated with this matter.
In March 2002, the parties entered into a settlement agreement with respect
to this matter. Under the terms of the settlement agreement, we will pay the
City of Glendale $3.0 million, and all parties will dismiss and release all
claims. Under the terms of an agreement with WGC, WGC is obligated to reimburse
us for $1.5 million of this amount. On March 27, 2002, we were notified by WGC
that it was disputing the amount of its reimbursement obligation to us. We
believe that we are entitled to reimbursement of the entire $1.5 million
pursuant to the terms of our agreement with WGC and intend to pursue such
reimbursement.
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.
17
PART II
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 for the period
from December 18, 2000 (the effective date of our spin-off) until December 31,
2000 and for each quarter of 2001. 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, Quarter Quarter Quarter Quarter
2000 through ended ended ended ended
December 31, March 31, June 30, September 30, December 31,
2000 2001 2001 2001 2001
------------ --------- -------- ------------- ------------
Common stock price per share:
High...................... $19.500 $20.937 $24.00 $20.57 $9.15
Low....................... 12.625 12.125 14.35 5.40 4.00
As of March 20, 2002, there were approximately 661 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.
Dividend Policy
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.
Use of Proceeds from Registered Securities
On August 8, 2001, we and a selling stockholder offered an aggregate
5,000,000 shares of our common stock, par value $0.001 per share, at a per
share price to the public of $12.18 in a firm commitment underwritten public
offering. Of these shares, 4,250,000 were sold by us and 750,000 were sold by
an existing stockholder. The offering was effected pursuant to a Registration
Statement on Form S-1 (Registration No.333-64682), which the Securities and
Exchange Commission declared effective on August 7, 2001. Goldman, Sachs & Co.,
Merrill Lynch & Co. and Credit Suisse First Boston were the lead underwriters
for the offering.
Of the $60.9 million in aggregate proceeds raised in connection with the
offering, $51.8 million was paid to us and $9.1 million was paid to the selling
stockholder. Of our aggregate proceeds, we paid (i) $2.7 million to
underwriters in connection with underwriting discounts, and (ii) approximately
$1.5 million in connection with offering expenses, printing fees, filing fees
and legal fees. The net offering proceeds to us after deducting the foregoing
expenses were approximately $47.6 million.
From the date of receipt through December 31, 2001, our net proceeds from
this offering were used to develop and commercialize our Xonon Cool Combustion
technology, establish our commercial manufacturing facility in the Phoenix
metropolitan area, and for general corporate purposes.
Shareholder Rights Plan
On January 29, 2002, our Board of Directors adopted a Shareholder Rights
Plan. Under this plan, we will distribute Preferred Stock Purchase Rights as a
dividend at the rate of one Right for each share of our common
18
stock held by stockholders of record as of February 20, 2002 (the "Record
Date"). The Board of Directors also authorized the issuance of Rights for each
share of common stock issued after the Record Date, until the occurrence of
certain specified events. The Shareholder Rights Plan was adopted to provide
protection to stockholders in the event of an unsolicited attempt to acquire
us. Each Right will entitle the registered holder to purchase from us one
one-thousandth of a share of Series A Preferred stock at an exercise price of
$45, subject to adjustment.
The Rights are not exercisable until triggered by certain conditions
including the acquisition of beneficial ownership of 15% of our common stock.
However, Morgan Stanley Capital Partners III, L.P. ("MSCP"), and its affiliates
may acquire up to 21.5% of our common stock without triggering the Rights. If
the Rights are triggered then each holder of a Right which has not been
exercised (other than Rights beneficially owned by the Acquiring Person) will
have the right to receive, upon exercise, voting Common Shares having a value
equal to two times the Purchase Price.
We are entitled to redeem the Rights, for $0.001 per Right, at the
discretion of our Board of Directors, until certain specified times. We may
also require the exchange of Rights, under certain additional circumstances. We
also have the ability to amend the Rights, subject to certain limitations.
19
Item 6. SELECTED FINANCIAL DATA
The following tables contain selected financial data as of and for each of
the five years ended December 31, 1997, 1998, 1999, 2000 and 2001 derived from
our 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.
Years ended December 31,
-----------------------------------------------
1997 1998 1999 2000 2001
-------- ------- -------- -------- --------
(in thousands, except per share data)
Statement of Operations Data:
Research and development contracts....... $ 5,139 $ 6,279 $ 3,053 $ 5,487 $ 5,523
-------- ------- -------- -------- --------
Costs and expenses:
Research and development(1).............. 6,009 9,313 9,627 11,277 14,622
Selling general and administrative....... 671 1,269 3,536 5,356 7,017
Spin-off and related transaction
costs.................................. -- -- -- 5,304 --
Legal settlements........................ -- -- 1,250 -- 3,250
-------- ------- -------- -------- --------
Total costs and expenses............. 6,680 10,582 14,413 21,937 24,889
-------- ------- -------- -------- --------
Operating loss.............................. (1,541) (4,303) (11,360) (16,450) (19,366)
Loss on equity investments.................. (4,355) (3,826) (1,133) (236) (707)
Impairment charge to implied goodwill
of an equity investment................... -- -- -- -- (2,145)
Interest income............................. -- 1,409 1,041 886 2,672
Interest expense............................ (374) (177) (278) (110) (43)
-------- ------- -------- -------- --------
Net loss.................................... $ (6,270) $(6,897) $(11,730) $(15,910) $(19,589)
======== ======= ======== ======== ========
Basic and diluted net loss per share(2)..... -- -- -- $ (15.91) $ (1.33)
======== ======= ======== ======== ========
Weighted average shares used for above
calculation............................... -- -- -- 1,000 14,747
======== ======= ======== ======== ========
December 31,
-----------------------------------------------
1997 1998 1999 2000 2001
-------- ------- -------- -------- --------
Combined Balance Sheet Data:
Cash, cash equivalents and short term
investments............................ $ -- $22,847 $ 16,032 $ 58,712 $ 87,647
Total assets......................... 2,871 28,520 19,840 67,772 95,140
Total stockholders' equity
(deficit).......................... (15,198) 24,137 12,552 57,470 86,722
- --------
(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 "Risks 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 occurrence of unanticipated events.
See "Forward-Looking Statements".
Overview
We design and develop advanced products for cleaner energy production. Our
first product, the Xonon Cool Combustion system, prevents the formation
nitrogen oxides (NOx), a significant air pollutant in stationary gas turbines
that are used primarily for electric power generation. Our Xonon system is the
only commercially available pollution prevention technology proven to achieve
ultra-low emissions during combustion.
In December 2000, we and Catalytica Advanced Technologies, Inc. ("CAT") 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. Prior to our
combination with Catalytica Advanced Technologies, 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 of Advanced Sensor Devices ("ASD"), an inactive subsidiary of Catalytica
Energy, have primarily consisted of expenses to support Xonon development. We
expect to 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.
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.
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 ensure 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.
We shipped our first commercial products in July 2001. Our sales will
require royalty payments to others.
21
Results of Operations
Comparison of the years ended December 31, 1999, December 31, 2000, and
December 31, 2001.
Revenue
For the year ended
December 31, Annual % Change
-------------------- ------------------
1999 2000 2001 2000/1999 2001/2000
------ ------ ------ --------- ---------
(in thousands)
Total revenue.......................... $3,053 $5,487 $5,523 80% 0.7%
Revenue remained relatively flat for the twelve months ended December 31,
2001, compared with the twelve months ended December 31, 2000. Revenue of
funded external research related to Catalytica Advanced Technologies decreased,
as anticipated, due to the merger with us and subsequent elimination of most of
Catalytica Advanced Technologies' efforts. This decrease was entirely offset by
increased research funding of Xonon efforts through the DOE.
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 in 2000. During 2000 we received $2.9
million of 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.
Costs and Expenses
For the year ended
December 31, Annual % Change
---------------------- ------------------
1999 2000 2001 2000/1999 2001/2000
------ ------- ------- --------- ---------
(in thousands)
Research and development (includes allocated
costs from Catalytica, Inc. of $2,045, $1,678,
and $0 for the years ended December 31, 1999,
2000, and 2001, respectively)................... $9,627 $11,277 $14,622 17% 30%
Selling, general and administrative (includes
allocated costs from Catalytica, Inc. of $1,052,
$875, and $0 for the years ended December 31,
1999, 2000, and 2001, respectively)............. 3,536 5,356 7,017 51% 31%
Spin-off and related transaction costs............ -- 5,304 -- -- --
Legal settlements................................. 1,250 -- 3,250 -- --
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.
For the twelve months ended December 31, 2001, R&D expenses increased $3.3
million or 30% compared to the same period of 2000. This increase includes $1.4
million related to increased R&D staffing, $0.5 million of additional material
costs incurred to accelerate the development of Xonon technology, and $0.3
million related to the production of development units. R&D expenses are
expected to grow in the future as we continue to invest in our R&D capabilities
and participate in cost reimbursable government funded programs. In 2001, we
spent $14.6 million on R&D activities of which approximately $11.7 million was
related to customer and government sponsored programs in which we received $5.5
million of cost reimbursement.
22
In December 1999, we agreed to advance cash to an affiliate of Enron
Corporation ("Enron") in order to accelerate the development of Xonon Cool
Combustion applications for gas 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 system. 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 in cash 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 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 then 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 approximately $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.
Through the end of the second quarter of 1999, a significant portion of our
research activity was conducted on behalf of GENXON (see "Loss on Equity
Investments"). As a result, some R&D costs were incurred by GENXON rather than
by us. The following amounts of R&D expenses were incurred by us (under our
contract with GENXON) and charged to GENXON: none in 2001 and 2000, and $2.0
million in 1999. Additionally, GENXON 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. Until December 2001, we
accounted for losses of our equity investments in GENXON under the equity
method of accounting, at which time we obtained 100% ownership in GENXON and
consolidated GENXON in our financial statements.
Selling, General and Administrative ("SG&A") expenses include compensation,
benefits and related costs in support of corporate functions, which include
management, business development, marketing, human resources, sales, finance,
and allocated facilities costs. Prior to December 15, 2000, SG&A expenses
included 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 those services had been allocated based upon
square footage, usage, headcount and other methods that management believes to
be reasonable.
For the twelve months ended December 31, 2001, the increase of 31% in SG&A
primarily resulted from a payment of $0.9 million of severance and loan
forgiveness to a former officer in the third quarter of 2000, offset by $0.4
million in severance costs associated with the resignation of two officers in
2001, $0.2 million associated with the discontinuation of NovoTec's operations,
$0.8 million associated with the expansion of our Arizona office, $0.4 million
of restructuring costs, and $1.7 million of increased marketing, finance and
administration costs related to the commercialization of Xonon and operations
as a new stand alone company in 2001. We expect SG&A expenses to increase in
the future as we enter later stages of commercialization of our products.
In the third quarter of 2000, we incurred $1.2 million of expenses
associated with our spin-off from Catalytica, Inc. on December 15, 2000. During
December 2000, we incurred additional spin-off related transaction costs of
$4.1 million. In the third quarter of 2001, a related credit of $0.9 million,
negotiated pursuant to an agreement with our investment bankers to provide
service for our follow-on offering, was recorded as a reduction of SG&A costs.
SG&A expenses increased 51% for the twelve months ended December 31, 2000,
compared with the twelve months ended December 31, 1999. This increase resulted
from $0.9 million in severance costs associated with
23
the resignation of our former President and Chief Executive Officer. In
addition, $0.9 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 $0.6 million was related to NovoTec, our subsidiary, which was
formed in June 2000. Additionally, we recorded $5.3 million in transaction
costs in the third and fourth quarters of 2000, related to our spin-off.
In March 2002, we entered into a settlement agreement to settle a matter
between us and the City of Glendale. Under the terms of the settlement
agreement, we will pay the City of Glendale $3.0 million, and all parties will
dismiss and release all claims. Under the terms of an agreement with Woodward
Governor Company ("WGC"), WGC is obligated to reimburse us for $1.5 million of
this amount. We have recorded a net reserve of $1.5 million as of December 31,
2001, to accrue for the settlement of this matter of which $0.25 million was
reserved in 2001 and $1.25 million was reserved in 1999. On March 27, 2002, we
were notified by WGC that it was disputing the amount of its reimbursement
obligation to us. We believe that we are entitled to reimbursement of the
entire $1.5 million pursuant to the terms of our agreement with WGC and intend
to pursue such reimbursement.
In September 2001, we signed a $3.0 million cash settlement with AGC
Manufacturing Services, Inc. and AGC Project Development, Inc. (collectively
referred to as "AGC") to be paid over a 22-month period in connection with a
demand for arbitration filed by AGC with respect to a contract dispute. We
recorded the $3.0 million settlement amount in our financial statements for the
quarter ended September 30, 2001. The first $1.5 million settlement installment
was paid to AGC during the twelve months ended December 31, 2001. The $1.5
million balance will be paid to AGC in quarterly installments through June 30,
2003.
Loss on Equity Investments
For the year ended
December 31, Annual % Change
------------------ ------------------
1999 2000 2001 2000/1999 2001/2000
------ ---- ---- --------- ---------
(in thousands)
Loss on equity investments....................... $1,133 $236 $707 (79)% 200%
NovoDynamics. In March 2001, we entered into agreements to invest $2.3
million in NovoDynamics. This amount consisted of $1.8 million in cash,
forgiveness of a $0.2 million advance made to Nonlinear Dynamics, which was to
be payable to NovoTec, and investment of $0.3 million in assets formerly used
by NovoTec. In accordance with these agreements, our full investment was
completed in April 2001. We originally purchased shares of Series A voting
preferred stock representing approximately 38.4% of Novo Dynamics' outstanding
equity. Additionally, we agreed to loan NovoDynamics up to $1.5 million if
certain milestones are met. We accounted for losses in NovoDynamics under the
equity method of accounting until the fourth quarter of 2001. Under the equity
method of accounting, we are required to record losses to the extent of our
capital contribution and debt incurred, if any. We currently own approximately
34.4% of NovoDynamics' outstanding equity.
We periodically evaluate our equity investments for impairment. On December
31, 2001, we evaluated our investment in NovoDynamics under Accounting
Principles Board Opinion No. 18, The Equity Method of Accounting for
Investments in Common Stock ("APB 18") and determined that a loss in the
carrying value of the investment had occurred which was other than temporary
based on NovoDynamics' financial history and projected future losses. At that
time, we determined that the estimated fair value of our investment in
NovoDynamics was zero. The carrying value of the investment at December 31,
2001 had been $1.6 million, and based on our evaluation of the investment, that
entire amount was charged as an impairment to implied goodwill of an equity
investment on December 31, 2001. As of December 31, 2001, as a result of the
carrying value of this investment being zero, we discontinued applying the
equity method. In 2001, prior to the suspension of the equity method treatment
of this investment, we recorded losses of $0.6 million on this investment.
In December 2001, we committed to loan $0.5 million of the above described
$1.5 million aggregate loan to NovoDynamics to be made available on January 7,
2002. As of December 31, 2001, we recorded a note payable
24
for the $0.5 million and a receivable of $0.5 million on our balance sheet.
Because repayment of the note was not certain at the time it was made, an
allowance of $0.5 million was recorded against the loan and $0.5 million was
charged as an impairment to implied goodwill of an equity investment on
December 31, 2001.
GENXON On December 19, 2001, we purchased WGC's equity interest in GENXON
for $10,000 making us the sole equity owner of GENXON, which had, up until that
date, been a 50/50 joint venture between us and WGC. At that time, GENXON
became a wholly owned subsidiary of us. We recorded our loss in our equity
interest in GENXON through December 19, 2001. Prior to this date, GENXON was a
50/50 joint venture with WGC to develop the potential market for upgrading
out-of-warranty turbines with new systems to improve emissions and operating
performance. Because the carrying value of the net investment in GENXON is zero
and we were not obligated to pay down GENXON's debts, we ceased recognizing our
pro rata share of GENXON's losses in the first half of 2000. Under the equity
method of accounting, we were 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 $0.1 million, $0.2 million, and $1.1 million of
loss in the twelve months ended December 31, 2001, 2000, and 1999,
respectively. The financial statements of us and GENXON were consolidated as of
December 31, 2001.
Sud-Chemie Catalytica, Inc. In 1998, Catalytica Advanced Technologies,
which was subquently merged into us, formed a joint venture with United
Catalysts, Inc., a division of Sud-Chemie Group, to form Sud-Chemie Catalytica.
No losses were recorded by Catalytica Advanced Technologies or us in 2001, 2000
and 1999 related to Sud-Chemie Catalytica, because we had recorded its share of
losses to the extent of our capital contribution of $0.15 million in 1998. This
joint venture is currently winding down. The operating agreement for this joint
venture does not require any further capital contributions by Catalytica
Advanced Technologies or us beyond the initial $0.15 million contribution. We
do not expect to incur further losses as we do not intend to make any
additional capital contributions.
Interest Income
For the year ended
December 31, Annual % Change
------------------ ------------------
1999 2000 2001 2000/1999 2001/2000
------ ---- ------ --------- ---------
(in thousands)
Interest income........................ $1,041 $886 $2,672 (15)% 202%
Our interest income consists of interest earned on cash, cash equivalents
and short-term investments. Interest income increased for the twelve months
ended December 31, 2001, compared with the twelve months ended December 31,
2000, due to higher average 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. Additionally, in
August 2001, we completed a follow-on offering which generated approximately
$47.6 million of cash. All interest income is generated from money market and
short-term investments. Interest income is expected to decrease as we use cash
to fund operations and the commercialization of Xonon.
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 Expense
For the year ended
December 31, Annual % Change
------------------ -----------------
1999 2000 2001 2000/1999 2001/2000
---- ---- ---- --------- ---------
(in thousands)
Interest expense....................... $278 $110 $43 (60)% (61%)
25
Interest expense decreased 61% for the twelve months ended December 31, 2001
compared with the twelve months ended December 31, 2000, due to $0.1 million of
interest cost in 2000 related to a repayment of an advance by Enron, which was
partially offset by interest expense related to office equipment leases.
Interest expense is expected to be minimal for the next few years.
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 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.
Income Taxes
No benefit from income taxes is recorded in 2001 due to our inability to
recognize the benefit from our losses. No benefit for federal and state income
tax is reported in 1999 and 2000 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.
Restructuring and Related Activities
In the fourth quarter of 2001, our management approved a restructuring plan
to move the Company's finance department to Gilbert, Arizona and to realign two
additional functions within its corporate structure. Accordingly, we plan to
eliminate 7 employee positions in connection with this plan. Restructuring and
related charges of $0.36 million were expensed during the fourth quarter of
2001. As of December 31, 2001, we had not yet completed any of the planned
employee separations under the 2001 restructuring plan. We expect to
substantially complete the initiatives contemplated under the restructuring
plan by July 1, 2002. Components of accrued restructuring costs and amounts
charged against the accrual as of December 31, 2001 were as follows:
Beginning Adjustments and December 31,
accrual expenditures 2001
--------- --------------- ------------
(in thousands)
Employee separation costs............... $359 -- $359
Critical Accounting Policies and Estimates
Our discussion and analysis of the financial condition and results of
operations are based upon our financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and related disclosure of contingent liabilities. On an on-going
basis, we evaluate our estimates and judgments, including those related to
contract terms, equity investments, bad debts, inventories, investments,
intangible assets, income taxes, financing operations, restructuring,
contingencies and litigation. We base our estimates and judgments on historical
experience and on various other factors that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our financial
statements. We recognize revenue from our funded research and development
contracts as work is performed and billable hours are incurred by us, in
accordance with each contract. Since these programs are subject to government
audits, we maintain a revenue cost reserve for our government-funded programs
in the event any of these funded costs, including overhead, are disallowed. We
maintain an allowance for doubtful accounts for estimated losses resulting from
the inability of our customers to
26
make required payments. If the financial condition of any of our customers were
to deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required. We maintain a reserve for employee and
related party notes in the event repayment of a note is uncertain. We
frequently review the repayment ability of employees and related parties. If
the financial condition of any employee or related party were to deteriorate,
resulting in an impairment of their ability to make payments, additional
allowances or write- offs would be required. We write down our inventory based
on market prices of precious metals equal to the difference between the cost of
inventory and their estimated realizable value. If actual market conditions
become less favorable, additional inventory write-downs may be required. We
currently hold equity interests in NovoDynamics and Sud-Chemie Catalytica. We
record an investment impairment charge against the carrying value of these
investment when we believe the investment has experienced a decline in value
that is other than temporary based on adverse changes in market conditions or
poor operating results of the underlying investment which could result in
losses or an inability to recover the carrying value of the investment that may
not be reflected in the investment's current carrying value. We record a
valuation allowance to reduce our deferred tax assets to the amount that is
more likely than not to be realized. We record a reserve for contingencies
including litigation settlements when a liability becomes probable.
Related Party Transactions
NovoDynamics, Inc. In March 2001, we entered into agreements to invest $2.3
million in NovoDynamics. This amount consisted of $1.8 million in cash,
forgiveness of a $0.2 million advance made to NonLinear Dynamics, which was to
be payable to NovoTec, a subsidiary of us, and investment of $0.3 million in
assets formerly used by NovoTec. In accordance with these agreements, this full
investment was completed in April 2001. In 2001, we owned shares of Series A
voting preferred stock representing approximately 38.4% of NovoDynamics'
outstanding equity. Subsequent to December 31, 2001, we owned approximately
34.4% of NovoDynamics' outstanding equity as a result of NovoDynamics issuing
an additional approximately $0.7 million of Series B preferred stock. We
recorded our investment at cost and recorded its share of pro rata losses under
the equity method in the period from March 2001 through December 31, 2001. The
investment was accounted for as implied goodwill.
Additionally, in March 2001, we agreed to loan NovoDynamics up to $1.5
million if certain milestones were met. On December 31, 2001, we committed to
loan $0.5 million of the $1.5 million to NovoDynamics on January 7, 2002. As of
December 31, 2001, we recorded a note payable for the $0.5 million and a
receivable of $0.5 million on its balance sheet. Because repayment of the note
was not certain at the time it was made, an allowance of $0.5 million was
recorded against the loan and this amount was charged as impairment to implied
goodwill of an equity investment on December 31, 2001.
We periodically evaluate our equity investments. On December 31, 2001, we
evaluated our investment in NovoDynamics under Accounting Principles Board
Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock
("APB 18") and determined that an impairment in the carrying value of the
investment had occurred which was other than temporary. At that time, we
determined that the estimated fair value of our investment in NovoDynamics was
zero. The carrying value of the investment at December 31, 2001 had been $1.6
million, and the entire amount was charged as impairment to implied goodwill in
non-operating expenses on December 31, 2001. At that time, we discontinued
applying the equity method because our net investment was zero.
As of December 31, 2001, two of our directors held a direct investment in
NovoDynamics Series B voting preferred stock, which represented slightly less
than 1% of NovoDynamics' outstanding stock.
Catalytica, Inc. Prior to the spin-off, the financial statements include
allocations from Catalytica, Inc. for the cost of functions and services
provided by them to us. These allocations include charges for facilities,
finance, legal, human resources, and other employee benefit costs and totaled
$3.1 million, $2.6 million, and none respectively, for the years ended December
31, 1999, 2000, and 2001. Charges for these services have been allocated based
upon square footage, usage, headcount and other methods that management
believes to be reasonable.
27
Prior to Enron Ventures Corporation's investment, we used borrowings from
Catalytica, Inc. to fund our operations. In January 1998, when Enron invested
in us, all of our intercompany debt was forgiven and we 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 $0.3
million for the year ended December 31, 1999, and none for the years ended
December 31, 2000 and 2001.
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 us for $30.0 million in cash. Enron also received a three-year
option to purchase an additional 535,715 shares of us for $14.4 million in
cash. This option expired unexercised on January 14, 2001. In connection with
the Enron Stock Purchase Agreement, we entered into a Share Exchange Agreement,
providing Enron the right to exchange the Series B Preferred Stock of us for
Catalytica, Inc. common stock. After the five year anniversary of the
agreement, if we had not undertaken a public offering, in which we 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
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 us was contributed to
our capital. In December 2000, Enron converted all of its Series B Preferred
Stock and received 1,342,889 shares of our common stock. In November 2001,
Enron sold all of its shares of our common stock to a third party and did not
assign any of its rights under the Share Exchange Agreement.
Transaction With An Affiliate of Enron In December 1999, an affiliate of
Enron ("the Affiliate"), the holder of a minority interest in us, specified our
Xonon combustion system as the preferred emissions control system for certain
turbine orders from GE Power Systems ("GE"). In connection therewith, we and
this Affiliate of Enron signed an agreement, which provided, among other
things, that we 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 us 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 our Xonon process). Repayment in cash or other
consideration was required by September 30, 2000. We 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) we are not in the business of buying turbines, (2) we are not
in the business of exchanging turbine credits with those that buy turbines, and
(3) in our particular case, the turbine credits we would receive specified they
could only be used on purchases of turbines that specify the use of our 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, we, therefore, recorded a provision equal
to the advance as research and development expense. In February 2000, we
advanced the Enron affiliate an additional $1.8 million. In March 2000, the
arrangement between us and the Affiliate was amended and all previous advances
through that date of $2.9 million from us were refunded, less certain costs,
and the related provision was eliminated and reduced research and development
expense in this period.
Transactions With Officers In July 2000, our President and Chief Executive
Officer resigned. His separation agreement provided for severance of
approximately $18,000 a month for twelve months and a payment of $18,900. We
recorded a charge in the third quarter of 2000 for $234,900 related to the
officer's severance. If he remained unemployed after the twelve months,
payments of $18,000 would continue for an additional six months or until he was
employed, whichever came first. These payments were expensed when they became
probable, through November 2001 when the arrangement ended. In addition,
previous loans and accrued interest of $620,000 were forgiven and we recorded a
charge in the third quarter of 2000 for this amount.
28
Additionally, vesting of his options to purchase common stock was accelerated.
We recorded compensation expense totaling $0.1 million in the third quarter of
2000 associated with the acceleration of vesting of these options.
In January 2001, our Senior Vice President of Business Development resigned.
His separation agreement provided for a severance payment totaling
approximately $0.18 million. In addition, a previous loan of $0.1 million was
immediately forgiven. We recorded a charge in the first quarter of 2001 for
$0.3 million related to the forgiveness of the officer's loan and severance.
The former officer is currently indebted to us for approximately $0.17 million
which is payable in installments through March 31, 2005. Interest accrues on
this note at an annual rate of 6%.
In August 2001, our Vice President of Operations resigned. His separation
agreement provided for a severance payment totaling approximately $82,000.
Investments As of December 31, 2001, we had invested approximately $25.0
million with Morgan Stanley Private Wealth Management. This amount is invested
primarily in a money market account and commercial and government short-term
paper. We have a board member who is the Chairman and Chief Executive Officer
of Morgan Stanley Private Equity, and is a Managing Director of Morgan Stanley
& Co., Incorporated.
Liquidity and Capital Resources
Year ended December 31,
---------------------------
1999 2000 2001
------- -------- --------
(in thousands)
---------------------------
Cash, cash equivalents, and short-term investments.. $16,032 $ 58,712 $ 87,647
Working capital..................................... 10,653 51,552 81,330
Cash provided by (used in)
Operating activities............................. $(7,367) $(10,740) $(15,313)
Investing activities............................. (1,488) 66 (16,658)
Financing activities............................. 1,763 54,334 47,813
------- -------- --------
Net increase (decrease) in cash and cash equivalents $(7,092) $ 43,660 $ 15,842
======= ======== ========
Current Ratio....................................... 2.62 6.05 10.73
======= ======== ========
Prior to our spin-off, Catalytica, Inc. made a $50.0 million cash investment
in us. Additionally, in August 2001, we received net proceeds of approximately
$47.6 million from a follow-on offering. At December 31, 2001, we had cash and
cash equivalents totaling approximately $87.6 million. Based on our current
plans, we believe that our current cash resources will be adequate to fund our
operations through our cash break-even point. The preceding sentence contains a
forward-looking statement regarding our expectations about our ability to reach
cash break-even operations. Our cash requirements, and therefore, our ability
to reach cash break-even, depend on numerous factors, including completion of
our product development activities, our ability to successfully expand
commercialization of Xonon Cool Combustion technology, market acceptance of our
products 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. We
face substantial uncertainties with our business operations and may not be able
to achieve the cash flows that we currently predict. We cannot assure you that
our current cash resources will be sufficient to enable us to reach our cash
break-even point.
In December 2001, we purchased a $0.1 million non-refundable option to enter
into an agreement to purchase a 43,000 square foot manufacturing facility and
administrative building in Gilbert, Arizona which had
29
been leased by us. In 2002, we purchased an additional $0.3 million option to
extend the purchase date of the building. These options totaling $0.4 million
were applied toward the purchase price of the facility. In March 2002, we
completed our purchase of this site. The building was purchased for $4.1
million, and 75% of the building purchase was financed through a five-year term
loan agreement with the Arizona State Compensation Fund at a 7.375% annual rate
of interest with a twenty-five year amortization. Prior to March 2002, we had
leased this facility under a seven-year lease commitment that expired on
October 31, 2008. The committed future lease payments associated with this
facility, which totalled approximately $2.0 million, were cancelled upon
completion of the purchase of the facility in March 2002.
There are no other significant contractual obligations or commercial
commitments as of December 31, 2001.
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 four such
arrangements with Tanaka Kikinzoku Kogyo ("Tanaka"), Gas Technology Institute
("GTI")(formally known as Gas Research Institute), the California Energy
Commission ("CEC") and WGC.
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
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 non-exclusive rights for small- and medium-sized gas
turbines (25 MW power output or less) worldwide. Tanaka has reciprocal
exclusive rights to manufacture and market catalytic combustors for use in
automobiles on a worldwide basis and non-exclusive rights for small- and
medium- sized turbines worldwide. In each case, the manufacturing and marketing
party will pay a royalty on net sales to the other party. 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. As commercialized, the Xonon Cool
Combustion System contains significant technology developed by us after May 1,
1995 and no technology developed by Tanaka after this date. Our development
agreement with Tanaka expires in 2005, and we have no further royalty
obligations with Tanaka after 2005.
We entered into a funding arrangement with GTI to fund the next generation
Xonon combustor and demonstrate its performance. We will be required to make
royalty payments to GTI 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 upon initiation of the first Xonon commercial sale of
a Xonon- equipped engine greater than 1MW.
30
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.
On December 19, 2001, we purchased WGC's equity interest in GENXON making us
the sole equity owner of GENXON, which had up to that date, been a 50/50 joint
venture between us and WGC. As part of the purchase agreement, we also obtained
a commitment from WGC to pay 50% of the first $3,000,000 and 30% of any amount
above that of any settlement or judgment against the defendants in the then
pending City of Glendale lawsuit, except for damages specified to have been
awarded due to fraud or misrepresentation by Catalytica, Inc., Catalytica
Combustion Systems, Inc., or us.
Also, on December 19, 2001, we entered into an agreement with WGC pursuant
to which WGC assigned a patent to us, and we and WGC cross-licensed certain
intellectual property to each other. Under this agreement, we must pay WGC
between $5,000 and $15,000 upon each shipment of a Xonon commercial unit. The
agreement also provides that, each time we sublicense the WGC technology
licensed to us to a gas turbine manufacturer or third party control
manufacturer, we will pay WGC a control technology license fee of $50,000, as
well as a $3,000 additional license fee for each sale of a Xonon control system
sold by such manufacturer. We are obligated to make these payments through
December 31, 2014 or until our cumulative payments and license fees to WGC
totals $15.0 million, whichever occurs first.
In addition, WGC must pay us a fee of one percent of the sale price of each
WGC control system installed in conjunction with Xonon catalytic modules for
new and retrofit turbines. WGC is obligated to make these payments through
December 31, 2014 or until we have received total payments of $2.0 million,
whichever occurs first.
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 and Foreign Currency Fluctuation
The effect of inflation and changing prices on our operations was not
significant during the periods presented.
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.
Impact of Recently Issued Accounting Standards
In June 2001, the FASB issued Statement of Financial Accounting Standards
No. 141, Business Combinations ("SFAS 141"). SFAS 141 establishes new standards
for accounting and reporting for business combinations and will require that
the purchase method of accounting be used for all business combinations
initiated after September 30, 2001. Use of the pooling-of-interests method will
be prohibited. We expect to adopt this statement during the first quarter of
fiscal 2002 and we do not believe that SFAS 141 will have a material effect on
our operating results or financial position.
In June 2001, the FASB issued Statement of Financial Accounting Standards
No. 142, Goodwill and Other Intangible Assets ("SFAS 142"), which supersedes
APB Opinion No. 17, Intangible Assets. SFAS 142 establishes new standards for
goodwill, including the elimination of goodwill amortization to be replaced
with methods of periodically evaluating goodwill for impairment. We expect to
adopt this statement during the first quarter of fiscal 2002, and we do not
believe that SFAS 142 will have a material effect on our operating results or
financial position.
In August 2001, the FASB issued Statement of Financial Accounting Standard
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS
144"), which is effective for fiscal periods beginning after
31
December 15, 2001 and supersedes SFAS 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of. SFAS 144
provides a single model for accounting and reporting for the impairment and
disposal of long-lived assets. The statement also sets new criteria for the
classification of assets held-for-sale and changes the reporting of
discontinued operations. We expect to adopt this statement during the first
quarter of fiscal 2002, and we do not believe that SFAS 144 will have a
material effect on our operating results or financial position.
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 shipped our
first commercial Xonon modules in July 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.
As of December 31, 2001, we had an accumulated deficit of $79.5 million. We
have not achieved profitability and expect to continue to incur net losses for
the next several years. 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 and adaptation work before
Xonon-equipped gas turbines can be shipped.
Incorporating our technology in each gas turbine model requires adaptation
work by us and the original equipment manufacturer ("OEM"), such as additional
engineering work and, for some turbines, technology development. Except for the
Kawasaki 1.4 MW gas turbine, that work has not yet been completed. 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. 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.
We are heavily dependent on our relationships with OEMs and their commitment
to adopt and market Xonon technology on their gas turbines.
Aside from revenues earned under research and development contracts,
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
32
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. Our OEM agreements generally provide that either party can
terminate the agreement if technical issues arise that cannot be resolved. A
decision by an OEM to discontinue the commercialization of Xonon combustion
systems in its product line could significantly limit our access to the market
for that OEM's turbines.
Some of our agreements provide the OEM limited exclusivity, which prevents
us from entering into agreements with other OEMs regarding the application of
Xonon to some of their competing 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, we would lose
the revenues associated with these orders and our reputation could be
adversely affected. In addition, we would have lost the opportunity to pursue
development for other sales.
Although our OEM customers have received initial orders for Xonon-equipped
gas turbines, we cannot ensure 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.
For example, in December 1999, GE accepted an order from Enron specifying
Xonon as the preferred emissions control system for three GE 7FA gas turbines
intended for the Pastoria project in central California. Concurrent with this
order, GE agreed to use commercially reasonable efforts to complete
development, design and testing of the Xonon Cool Combustion system for GE 7FA
turbines. As part of this order, Enron and GE had the right to substitute
alternative emissions controls for any reason. In the spring of 2001, we and GE
decided that the delivery date of January 2003 selected for these turbines was
too early to ensure that this Xonon system could be ready to meet the strict
commercial warranties required under this contract, and GE exercised the option
to substitute alternative emissions control technology.
If the initial announced orders for Xonon-equipped turbines do not
ultimately ship, we would lose the revenues associated with these orders, and,
depending on the stated reasons for cancellation and market perceptions of the
cancellation, our reputation could be adversely affected. In addition, we would
have lost the opportunity to pursue development for other sales.
33
We will incur significant costs developing our technology with OEMs. If any
OEM does not complete development for any reason, we may not be able to
recover costs incurred for the development with that OEM.
We incur significant costs in developing our technology with OEMs. We
recover a substantial portion of these costs through contractual reimbursement
with the OEMs. However, we bear some of the development costs ourselves. If
OEMs do not complete development work for any reason, we will not be able to
recover our share of development costs through product sales.
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 that are not within our control, including:
. The cost competitiveness of the Xonon combustion system;
. A significant drop in demand for new gas turbines;
. The future costs of natural gas and other fuels;
. Changing regulatory requirements;
. The emergence of alternative technologies and products; and
. Changes in federal, state or local environmental regulations.
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.
Continuing to expand our manufacturing operations at our new commercial
facility in Arizona will require significant management attention. 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.
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 limited experience manufacturing Xonon modules on a commercial basis.
To date, we have focused primarily on research and development and have
limited experience manufacturing Xonon modules on a commercial basis. We have
constructed a 3,000 square foot manufacturing facility in Mountain View, CA,
and we are continuing to develop our manufacturing processes, which include our
new facility in the Phoenix metropolitan area. 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
34
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. One of our components is
provided by a single supplier and is not currently available from any other
supplier. Additionally, 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,
2001 to December 31, 2001, the price of palladium ranged from $315 to $1,090
per troy ounce. During that period, the price of platinum ranged from $415 to
$633 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 are not successful and if these cost increases
cannot be passed onto the customers of Xonon modules, then our gross margins
and profitability will be reduced.
Our success depends on the continued demand for gas turbines.
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 and experienced a slowdown due to economic factors in the
second half of 2001. If this cyclical 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 technologies 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, each of whom may prefer to use technology internally
developed rather than our technology. 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.
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
35
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. Based on current plans, we
expect that our current cash resources will be sufficient to fund our
operations through our anticipated cash break-even point. The preceding
sentence contains a forward-looking statement regarding our expectations about
our ability to reach cash break-even operations. Despite our current
expectations, we may need to raise additional funds to achieve full
commercialization of the Xonon combustion systems and other potential products
in the event our current plans prove insufficient. We do not know whether we
will be able to secure such additional funding on terms acceptable to us to
pursue our commercialization plans. We face substantial uncertainties with our
business operations and may not be able to achieve the cash flows that we
currently predict. Thus, we cannot assure you that our current cash resources
will be sufficient to enable us to reach our cash break-even point.
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 may be unable to obtain
licenses to use those patents on acceptable terms, or 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.
36
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.
GENXON may subject us to liability in connection with litigation.
On December 19, 2001, we purchased WGC's equity interest in GENXON making us
the sole equity owner of GENXON, which had, up to that date, been a 50/50 joint
venture between us and WGC. As part of the purchase agreement, we also obtained
a commitment from WGC to pay 50% of the first $3,000,000 and 30% of any amount
above that of any settlement or judgment against the defendants in the pending
City of Glendale lawsuit, except for damages specified to have been awarded due
to fraud or misrepresentation by Catalytica, Inc., Catalytica Combustion
Systems, Inc., or us.
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 first amended 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(R) Combustion System. The City of Glendale
seeks compensatory damages in excess of $7,500,000 and punitive damages. On May
31, 2001, we filed an answer to the first amended complaint. We have agreed to
indemnify Catalytica, Inc. for any costs associated with this matter.
In March 2002, the parties entered into a settlement agreement with respect
to this matter. Under the terms of the settlement agreement, we will pay the
City of Glendale $3.0 million, and all parties will dismiss and release all
claims. Under the terms of an agreement with WGC, WGC is obligated to reimburse
us for $1.5 million of this amount. We have recorded a net reserve of $1.5
million as of December 31, 2001, to accrue for the settlement of this matter.
On March 27, 2002, we were notified by WGC that it was disputing the amount of
its reimbursement obligation to us. We believe that we are entitled to
reimbursement of the entire $1.5 million pursuant to the terms of our agreement
with WGC and intend to pursue such reimbursement.
Liabilities incurred by us as a result of our spin-off may have a negative
effect on our financial results.
We incurred additional liabilities as a result of our spin-off from
Catalytica, Inc. For example, when the business of Advanced Technologies was
combined with ours, we became responsible for the liabilities of Advanced
Technologies. Additionally, we have obligations under the separation agreements
we entered into with Catalytica, Inc., Synotex and DSM. For example, we agreed
to indemnify DSM Catalytica, Inc., the successor corporation to Catalytica,
Inc., for liabilities arising out of our business, the business of Advanced
Technologies and other liabilities of DSM Catalytica, Inc. not associated with
the pharmaceuticals business it purchased from Catalytica, Inc.
We are also responsible for specified 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 these additional
liabilities materialize, our financial results could be harmed.
37
Provisions in our charter documents and our adoption of a rights plan may
delay or prevent our acquisition, which could decrease the value of shares of
our common stock.
Our certificate of incorporation and bylaws and Delaware law contain
provisions that could make it more difficult 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.
In addition, we have adopted a shareowner rights plan. The rights are not
intended to prevent a takeover of us. However, the rights may have the effect
of rendering more difficult or discouraging an acquisition of us deemed
undesirable by our board of directors. The rights will cause substantial
dilution to a person or group that attempts to acquire us on terms or in a
manner not approved by our board of directors, except pursuant to an offer
conditioned upon redemption of the rights.
As a Delaware corporation, we are also subject to provisions of Delaware
law, including Section 203 of the Delaware General Corporation law, which
prevents some shareowners from engaging in certain business combinations
without approval of the holders of substantially all of our outstanding common
stock.
Any provision of our certificate of incorporation, bylaws, our shareowner
rights plan or Delaware law that has the effect of delaying or deterring a
change in control could limit the opportunity for our shareowners to receive a
premium for their shares of our common stock, and could also affect the price
that some investors are willing to pay for our common stock.
Subsequent to our follow-on public offering, a large number of shares of our
common stock became available, which may adversely affect the market price of
our common stock.
The market price of our common stock could decline as a result of sales of a
large number of shares in the market or the perception that these sales could
occur. These factors also could make it more difficult for us to raise funds
through future offerings of our common stock. Funds managed by Morgan Stanley
Capital Partners III, Inc., or "Morgan Stanley Private Equity", currently own
approximately 19.3% of our outstanding shares of common stock. The Morgan
Stanley Private Equity funds have the right to have their remaining shares
registered under the Securities Act.
There are 17,510,198 shares of common stock outstanding as of March 20,
2002, all of which are freely transferable without restriction or further
registration under the Securities Act, except for any shares held or purchased
by our affiliates, sales of which will be limited by Rule 144 under the
Securities Act.
The holders of approximately 3,386,748 shares of common stock have
registration rights. If those registration rights are exercised, shares covered
by a registration statement can be sold in the public market. Additionally,
shares issued upon exercise of stock options to persons other than affiliates
will be eligible for resale in the public market without restriction, which
could adversely affect our stock price. Sales by affiliates could also occur,
subject to limitations, under Rule 144 of the Securities Act.
The market price of our common stock is highly volatile and may decline.
The market price of our common stock is highly volatile. Factors that could
cause fluctuation in our stock price may include, among other things:
. announcements or cancellations of orders;
. changes in financial estimates by securities analysts;
38
. conditions or trends in our industry;
. changes in the market valuations of other companies in our industry;
. the effectiveness and commercial viability of products offered by us or
our competitors;
. the results of our research and development;
. announcements by us or our competitors of technological innovations, new
products, significant acquisitions, strategic partnerships, divestitures,
joint ventures or other strategic initiatives;
. changes in environmental regulations;
. additions or departures of key personnel; and
. sales of our common stock.
Many of these factors are beyond our control. These factors may cause the
market price of our common stock to decline, regardless of our operating
performance. 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 our common stock.
Because a small number of stockholders own a significant percentage of our
common stock, they may control all major corporate decisions, and our other
stockholders may not be able to influence these corporate decisions.
As of March 20, 2002, our executive officers, directors and greater than 5%
stockholders controlled approximately 33.4% of our outstanding common stock. If
these parties act together, they can significantly influence the election of
directors and the approval of actions requiring the approval of a majority of
our stockholders. The interests of our management or these investors could
conflict with the interests of our other stockholders.
Based on shares outstanding as of March 20, 2001, the funds managed by
Morgan Stanley Private Equity and their affiliates own approximately 19.3% of
our outstanding common stock. The Morgan Stanley Private Equity funds also have
stockholder rights, including rights to appoint directors and registration
rights. As a result, Morgan Stanley Private Equity and its affiliates hold a
substantial voting position in us and may be able to significantly influence
our business.
39
FORWARD-LOOKING STATEMENTS
This annual report on Form 10-K 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 our market opportunities and the growth of the market for
our solutions, the applicability of our solutions across turbine applications,
the efficiency of our solutions, the limits on current generation capacity due
to environmental concerns, the cost of ultra-low emissions technology and its
effects, the uniqueness of Xonon, our ability to design Xonon for different
turbine models, our future sales, our ability to broaden the range of uses of
turbines, sources of our revenues, delivery of our first commercial modules,
our ability to create an industry standard, our competitive advantage in the
marketplace, the value or our intellectual property and effectiveness of our
patent portfolio, availability and expense of resources and raw materials
necessary for production and manufacturing, our ability to recycle parts, the
level of research and development by OEMs, our commitments to joint ventures,
our relations with employees, the liquidity and sufficiency of existing cash
and cash equivalents, our use of earnings, our investment in research and
development, our commitment to funded research programs, the impact of interest
income and expense, critical accounting policies, our ability to generate cash
and achieve cash break-even operations and our business strategies and plan of
operations. These statements are only predictions. These forward-looking
statements are subject to certain risks and uncertainties that could cause
actual results to differ 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 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 2001 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 45 through 71 of this Form 10-K.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
40
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.
41
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
A. (1) Financial Statements:
The following financial statements of the Registrant are filed as part of
this Report
Page
----
Report of Ernst & Young LLP, Independent Auditors.................... 45
Statements of Operations for the years ended December 31, 1999, 2000,
and 2001........................................................... 46
Balance Sheets at December 31, 2000 and 2001......................... 47
Statements of Stockholders' Equity for the years ended December 31,
1996, 1997, 1998, 1999, 2000, and 2001............................. 48
Statements of Cash Flows for the years ended December 31, 1999, 2000,
and 2001........................................................... 51
Notes to Financial Statements........................................ 52
(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 Notes Description
- ------ ----- -----------
2.1 (5) Assignment and Assumption Agreement between Catalytica, Inc. and the registrant effective
as of July 25, 1995.
2.2 (4) Employee Matters Agreement between Catalytica, Inc. and the registrant.
2.3 (4) Master Trademark Ownership and License Agreement between Catalytica, Inc. and the
registrant.
2.4 (4) Tax Sharing Agreement between Catalytica, Inc., Synotex, Inc. and the registrant.
2.5 (4) Master Confidential Disclosure Agreement between Catalytica, Inc. and the registrant.
2.6 (5) Cross-License Agreement between Catalytica, Inc. and the registrant effective as of July
1995.
2.7 (5) Cross-License Agreement between Catalytica Advanced Technologies, Inc. and Catalytica,
Inc. dated July 1995.
2.8 (4) Indemnification Agreement among Catalytica, Inc. and the registrant.
2.9 (4) Master Transitional Services Agreement between Catalytica, Inc. and the registrant.
2.10 (4) Real Estate Matters Agreement between Catalytica, Inc. and the registrant.
2.11 (4) Master Separation Agreement between Catalytica, Inc. and the registrant.
3.1 (4) Amended and Restated Certificate of Incorporation to be effective upon completion of the
distribution of the Registrant's Common Stock.
3.2 (5) Amended and Restated Bylaws to be effective upon completion of the distribution of the
Registrant's Common Stock.
3.3 (2) Audit Committee Charter.
42
Exhibit
Number Notes Description
- ------ ----- -----------
4.1 (4) Stock Certificate specimen of the Registrant.
4.2 (1) Preferred Stock Rights Agreement, dated as of January 29, 2002, between the Registrant and
Mellon Investor Services LLC, including the Certificate of Designation, the form of Rights
Certificate and the Summary of Rights attached thereto as Exhibits A, B, and C,
respectively.
10.1 (6) 1995 Catalytica Combustion Systems, Inc. Stock Option Plan with agreements there under.
10.3 (5) Promissory Note from Patrick T. Conroy issued to GENXON Power Systems LLC dated
November 1997.
10.4 (5) Promissory Notes from Peter B. Evans issued to registrant both dated July 20, 1999.
10.8 (7)+ Agreement, dated as of July 18, 1988, between Catalytica, Inc. and Tanaka Kikinzoku
Kogyo K.K.
10.9 (8)+ Agreement, dated as of January 31, 1995, between Catalytica, Inc. and Tanaka Kikinzoku
Kogyo K.K.
10.12 (4)+ Collaborative Commercialization and License Agreement among General Electric Co.,
GENXON Power System, LLC and the registrant dated as of November 19, 1998.
10.13 (5) Letter Agreement with Craig N. Kitchen dated June 6, 2000.
10.16 (5) Form of Indemnification Agreement for directors of the registrant.
10.17 (5) Registration Rights Agreement between Morgan Stanley Dean Witter Capital Partners and its
affiliates and the registrant.
10.18 (5) Employee Stock Purchase Plan of the Registrant.
10.19 (5) Letter Agreement with Dennis S. Riebe dated August 29, 2000.
10.20 (5) Catalytica Energy Systems, Inc. 1995 Stock Plan (as amended and restated October 26, 2000).
10.21 (3) Letter Agreement with Ronald L. Alto dated February 16, 2001.
10.24 (3) Stock Purchase Warrant Agreement between the Registrant and Glaxo Wellcome, Inc. dated
December 15, 2000.
10.26 (5)+ Technology Development and Transfer Agreement between Kawasaki Heavy Industries, Ltd.
and Registrant dated December 13, 2000.
10.27 (5)+ Xonon Module Supply Agreement, dated December 13, 2000, by and among Kawasaki
Heavy Industries, Ltd and Registrant.
10.28 (5) Form of Change of Control Severance Agreements between Patrick T. Conroy and the
Registrant dated April 5, 2001, Dennis S. Riebe and the Registrant dated April 5, 2001,
Craig N. Kitchen and the Registrant dated April 5, 2001, and Ralph A. Dalla Betta and the
Registrant dated April 17, 2001.
10.29 (5) Lease Agreement between GH Tech I L.L.C. and the Registrant dated June 22, 2001.
10.30 ++ Amendment No. 1 to the Collaborative Commercialization and License Agreement between
Catalytica Combustion Systems, Inc. and Genxon Power Systems, L.L.C. and General
Electric Company dated January 3, 2002.
10.31 Consulting Agreement with John A. Urquhart dated January 1, 2002.
10.32 GENXON Membership Transfer and Settlement Agreement dated December 19, 2001,
between the Registrant, Woodward Governor Company, and GENXON Power Systems.
43
Exhibit
Number Notes Description
- ------ ----- -----------
10.33 Control Patent Assignment and Cross-License Agreement between the Registrant and Woodward
Governor Company dated December 19, 2001.
10.34 Loan Agreement between the Arizona State Compensation Fund and the Registrant dated
March 18, 2002.
21.1 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 73).
- --------
+ Confidential treatment has been granted for portions of these agreements.
++ Confidential treatment has been requested for portions of these agreements.
(1) Incorporated by reference to exhibits filed with our registration
statement on Form 8-A (Commission File No. 000-31953).
(2) Appendix A to the Proxy Statement filed on Schedule 14A dated April 24,
2001 "Commission File No. 000-31953."
(3) Incorporated by reference to exhibits filed with our Form 10-K for the
year ended December 31, 2000 (Commission File No. 000-31953).
(4) Incorporated by reference to exhibits filed with our Post Effective
Amendment No. 1 to Form S-1 (Commission File No. 333-44772).
(5) Incorporated by reference to exhibits filed with our registration
statement on Form S-1 (Commission File No. 333-44772).
(6) 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).
(7) Incorporated by reference to exhibits filed with Catalytica, Inc.'s
Registration Statement on Form S-1 (Registration Statement No. 33-55696).
(8) 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).
"Xonon" is s registered trademark and "cool combustion", "Catalytica Energy
Systems" and the stylized Catalytica logo are trademarks of Catalytica Energy
Systems, Inc.
44
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors and Stockholders
Catalytica Energy Systems, Inc.
We have audited the accompanying consolidated balance sheets of Catalytica
Energy Systems, Inc. (a company in the development stage) as of December 31,
2000 and 2001, and the related consolidated statements of operations,
stockholders' equity and cash flows for the years then ended and for the period
from August 1, 1995 (inception) through December 31, 2001. We have also audited
the accompanying combined statements of operations, stockholders' equity and
cash flows of Catalytica Energy Systems, Inc. and Catalytica Advanced
Technologies, Inc. (a combined company in the development stage) for the year
ended December 31, 1999. 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, formerly a joint venture in which
Catalytica Energy Systems, Inc. had 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
financial statements referred to above present fairly, in all material
respects, the consolidated financial position of Catalytica Energy Systems,
Inc. (a company in the development stage) at December 31, 2000 and 2001, and
the consolidated results of its operations and its cash flows for the years
then ended and for the period from August 1, 1995 (inception) through December
31, 2001, in conformity with accounting principles generally accepted in the
United States. Also, in our opinion, based on our audit and the reports of
other auditors, the combined financial statements of Catalytica Energy Systems,
Inc. and Catalytica Advanced Technologies, Inc. (a combined company in the
development stage) for the year ended December 31, 1999 referred to above
presents fairly, in all material respects, the combined results of its
operations and its cash flows for the year then ended, in conformity with
accounting principles generally accepted in the United States.
/s/ ERNST & YOUNG LLP
San Jose, California
January 25, 2002
45
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
(a combined company in the development stage)
COMBINED STATEMENT OF OPERATIONS
for the year ended December 31, 1999
and
CATALYTICA ENERGY SYSTEMS, INC.
(a company in the development stage)
CONSOLIDATED STATEMENTS OF OPERATIONS
for the years ended December 31, 2000 and 2001
and for the period from inception through December 31, 2001
(In thousands, except per share amounts)
Cumulative
Amounts
from
Inception
For the year ended December 31, through
------------------------------ December 31,
1999 2000 2001 2001
-------- -------- -------- ------------
Revenues:
Research and development contracts........................ $ 3,053 $ 5,487 $ 5,523 $ 54,040
-------- -------- -------- --------
Costs and expenses:
Research and development.................................. 9,627 11,277 14,622 83,787
Selling, general and administrative....................... 3,536 5,356 7,017 23,091
Spin-off and related transaction costs.................... -- 5,304 -- 5,304
Legal settlements......................................... 1,250 -- 3,250 4,500
Costs associated with discontinued product line........... -- -- -- 9,299
-------- -------- -------- --------
Total costs and expenses.............................. 14,413 21,937 24,889 125,981
-------- -------- -------- --------
Operating loss............................................... (11,360) (16,450) (19,366) (71,941)
Loss on equity investments................................... (1,133) (236) (707) (10,258)
Impairment charge to implied goodwill of an equity investment -- -- (2,145) (2,145)
Interest income.............................................. 1,041 886 2,672 6,008
Interest expense............................................. (278) (110) (43) (1,138)
-------- -------- -------- --------
Net loss..................................................... $(11,730) $(15,910) $(19,589) $(79,474)
======== ======== ======== ========
Basic and diluted net loss per share(1)...................... $ (15.91) $ (1.33)
======== ========
Weighted average shares used in computing basic and diluted
net loss per share......................................... 1,000 14,747
======== ========
- --------
(1) See Note 1, Net Loss per Share.
See accompanying notes.
46
CATALYTICA ENERGY SYSTEMS, INC. (a company in the development stage)
CONSOLIDATED BALANCE SHEETS
at December 31, 2000 and 2001
(In thousands, except per share amounts)
December 31,
------------------
2000 2001
-------- --------
ASSETS
------
Current assets:
Cash and cash equivalents........................................................... $ 54,222 $ 70,064
Short-term investments.............................................................. 4,490 17,583
Accounts receivable:
Trade, less allowance of $100 in 2001 and 2000.................................. 2,190 1,208
Joint venture................................................................... 158 116
Inventory........................................................................... 180 178
Prepaid expenses and other assets................................................... 524 536
-------- --------
Total current assets......................................................... 61,764 89,685
Property and equipment:
Leasehold improvements and equipment................................................ 13,592 14,682
Less accumulated depreciation and amortization...................................... (8,062) (9,905)
-------- --------
5,530 4,777
Long term deposit...................................................................... -- 300
Notes receivable from employees and related party, less allowance of $525 in 2001 and
$225 in 2000......................................................................... 478 378
-------- --------
Total assets................................................................. $ 67,772 $ 95,140
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Payable to Catalytica, Inc.......................................................... $ 602 $ --
Liabilities related to spin-off from Catalytica, Inc................................ 4,090 --
Accounts payable.................................................................... 1,364 829
Accrued payroll..................................................................... 1,305 2,432
Accrued liabilities................................................................. 2,478 4,758
Deferred revenue, net............................................................... 219 276
Current portion of capital lease obligation......................................... 155 60
-------- --------
Total current liabilities.................................................... 10,213 8,355
Capital lease obligation............................................................... 89 63
-------- --------
Total liabilities............................................................ 10,302 8,418
Commitments and contingencies
Stockholders' equity:
Convertible preferred stock, $0.001 par value; authorized--5,000 shares in 2000 and
2001, none issued in 2000 and 2001................................................ -- --
Common stock, $0.001 par value; authorized--70,000 shares in 2000 and 2001;
issued and outstanding--12,698 shares in 2000 and 17,463 in 2001.................. 13 17
Additional paid-in capital.......................................................... 117,605 166,439
Deferred compensation............................................................... (263) (260)
Deficit accumulated during the development stage.................................... (59,885) (79,474)
-------- --------
Total stockholders' equity................................................... 57,470 86,722
-------- --------
Total liabilities and stockholders' equity................................... $ 67,772 $ 95,140
======== ========
See accompanying notes.
47
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
(a combined company in the development stage)
COMBINED STATEMENTS OF STOCKHOLDERS' EQUITY
for the year ended December 31, 1999
and
CATALYTICA ENERGY SYSTEMS, INC. (a company in the development stage)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
for the years ended December 31, 2000 and 2001 and for the period from
inception through December 31, 2001
(In thousands)
Catalytica Energy Systems, Inc. Advanced Technologies, Inc.
----------------------------------------- -----------------------------
Preferred Stock Preferred Stock
--------------------------- ---------------
Series A Series B Common Stock Series A Common Stock
------------- ------------- ------------- --------------- -------------
Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Capital contributions (August 1, 1995)............ 7,000 $ 7 -- $-- 500 $ 1 3,000 $ 3 1,000 $ 1
Net loss from Nov. 1, 1994 (inception) to
Dec. 31, 1996.................................... -- -- -- -- -- -- -- -- -- --
----- --- ----- --- --- --- ----- --- ----- ---
Balance at Dec. 31, 1996.......................... 7,000 7 -- -- 500 1 3,000 3 1,000 1
Net loss.......................................... -- -- -- -- -- -- -- -- -- --
----- --- ----- --- --- --- ----- --- ----- ---
Bal. at Dec. 31, 1997............................. 7,000 7 -- -- 500 1 3,000 3 1,000 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 3,000 3 1,000 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 3,000 3 1,000 1
Deficit
During the
Paid-In Deferred Development Stockholders'
Capital Compensation Stage Equity
------- ------------ ----------- -------------
Capital contributions (August 1, 1995)............ $10,138 $ -- $ -- $ 10,150
Net loss from Nov. 1, 1994 (inception) to
Dec. 31, 1996.................................... -- -- (19,078) (19,078)
------- ----- -------- --------
Balance at Dec. 31, 1996.......................... 10,138 -- (19,078) (8,928)
Net loss.......................................... -- -- (6,270) (6,270)
------- ----- -------- --------
Bal. at Dec. 31, 1997............................. 10,138 -- (25,348) (15,198)
Issuance of preferred stock to Enron in January
1998............................................. 29,921 -- -- 29,922
Forgiveness of Catalytica, Inc. notes in January
1998............................................. 16,222 -- -- 16,222
Issuance of stock options at various dates in 1998 88 -- -- 88
Net loss.......................................... -- -- (6,897) (6,897)
------- ----- -------- --------
Bal. at Dec. 31, 1998............................. 56,369 -- (32,245) 24,137
Issuance of stock options at various dates in 1999 82 -- -- 82
Issuance of stock options at various dates in 1999 256 (256) -- --
Acceleration of stock option vesting at various
dates in 1999.................................... 11 -- -- 11
Amortization of deferred compensation............. -- 52 -- 52
Net loss.......................................... -- -- (11,730) (11,730)
------- ----- -------- --------
Bal. at Dec. 31, 1999 (carried forward)........... 56,718 (204) (43,975) 12,552
See accompanying notes.
48
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
(a combined company in the development stage)
COMBINED STATEMENTS OF STOCKHOLDERS' EQUITY
for the year ended December 31, 1999
and
CATALYTICA ENERGY SYSTEMS, INC. (a company in the development stage)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
for the years ended December 31, 2000 and 2001 and for the period from
inception through December 31, 2001
(In thousands)
(Continued)
Catalytica Energy Systems, Inc. Advanced Technologies, Inc.
------------------------------------------- -----------------------------
Preferred Stock Preferred Stock
---------------------------- --------------
Series A Series B Common Stock Series A Common Stock
------------- ------------- ------------- -------------- -------------
Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Bal. at Dec. 31, 1999 (brought forward)......... 7,000 $ 7 1,339 $ 1 500 $ 1 3,000 $ 3 1,000 $ 1
Cancellation of common stock and Series A
preferred held by Catalytica, Inc.............. (7,000) (7) -- -- (500) (1) -- -- -- --
Purchase of $50,000 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.............................. -- -- -- -- 7,499 8 -- -- -- --
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)
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 (carried forward)......... -- -- -- -- 12,698 13 -- -- -- --
Deficit
During the
Paid-In Deferred Development Stockholders'
Capital Compensation Stage Equity
-------- ------------ ----------- -------------
Bal. at Dec. 31, 1999 (brought forward)......... $ 56,718 $(204) $(43,975) $ 12,552
Cancellation of common stock and Series A
preferred held by Catalytica, Inc.............. 8 -- -- --
Purchase of $50,000 of common stock by
Catalytica, Inc. and distribution to Catalytica
Energy shareholders on December 15, 2000....... 49,996 -- -- 50,000
Distribution of remaining Catalytica Energy
common stock to shareholders in connection
with the spin-off from Catalytica, Inc. on
December 15, 2000.............................. (8) -- -- --
Cancellation of CAT common and Series A
preferred stock in connection with its merger
with Catalytica Energy in December 2000........ 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 -- -- 7,263
Carrying value of assets contributed by
Catalytica, Inc. to Catalytica Energy in
December 2000.................................. 3,185 -- -- 3,185
Exercise of stock options at various dates
in 2000........................................ 15 -- -- 15
Issuance of stock options at various dates
in 2000........................................ 225 (176) -- 49
Acceleration of stock option vesting at various
dates in 2000.................................. 199 -- -- 199
Amortization of deferred compensation........... -- 117 -- 117
Net loss........................................ -- -- (15,910) (15,910)
-------- ----- -------- --------
Bal. at Dec. 31, 2000 (carried forward)......... 117,605 (263) (59,885) 57,470
See accompanying notes.
49
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
(a combined company in the development stage)
COMBINED STATEMENTS OF STOCKHOLDERS' EQUITY
for the year ended December 31, 1999
and
CATALYTICA ENERGY SYSTEMS, INC. (a company in the development stage)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
for the years ended December 31, 2000 and 2001 and for the period from
inception through December 31, 2001
(In thousands)
(Continued)
Catalytica Energy Systems, Inc. Advanced Technologies, Inc.
----------------------------------------- -----------------------------
Preferred Stock Preferred Stock
--------------------------- ---------------
Series A Series B Common Stock Series A Common Stock
------------- ------------- ------------- --------------- ------------- Paid-In
Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount Capital
------ ------ ------ ------ ------ ------ ------ ------ ------ ------ --------
Bal. at Dec. 31, 2000 (brought forward)....... -- $-- -- $-- 12,698 $13 -- $-- -- $-- $117,605
Exercise of stock options at various dates
in 2001...................................... -- -- -- -- 498 -- -- -- -- -- 767
Purchase of shares through employee stock
purchase plan at July 1, 2001................ -- -- -- -- 17 -- -- -- -- -- 200
Sale of Catalytica Energy common stock through
follow-on offering, net of $4,025 of issuance
costs, on August 2, 2001..................... -- -- -- -- 4,250 4 -- -- -- -- 47,638
Issuance of stock options at various dates
in 2001...................................... -- -- -- -- -- -- -- -- -- -- 229
Amortization of deferred compensation......... -- -- -- -- -- -- -- -- -- -- --
Net loss...................................... -- -- -- -- -- -- -- -- -- -- --
--- --- -- --- ------ --- -- --- -- --- --------
Bal. at Dec. 31, 2001......................... -- $-- -- $-- 17,463 $17 -- $-- -- $-- $166,439
=== === == === ====== === == === == === ========
Deficit
During the
Deferred Development Stockholders'
Compensation Stage Equity
------------ ----------- -------------
Bal. at Dec. 31, 2000 (brought forward)....... $(263) $(59,885) $ 57,470
Exercise of stock options at various dates
in 2001...................................... -- -- 767
Purchase of shares through employee stock
purchase plan at July 1, 2001................ -- -- 200
Sale of Catalytica Energy common stock through
follow-on offering, net of $4,025 of issuance
costs, on August 2, 2001..................... -- -- 47,642
Issuance of stock options at various dates
in 2001...................................... (155) -- 74
Amortization of deferred compensation......... 158 -- 158
Net loss...................................... -- (19,589) (19,589)
----- -------- --------
Bal. at Dec. 31, 2001......................... $(260) $ 79,474 $ 86,722
===== ======== ========
See accompanying notes.
50
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
(a combined company in the development stage)
COMBINED STATEMENT OF CASH FLOWS
for the year ended December 31, 1999
and
CATALYTICA ENERGY SYSTEMS, INC. (a company in the development stage)
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the years ended December 31, 2000 and 2001
and for the period from inception through December 31, 2001
(In thousands)
Cumulative
Amounts from
Year ended December 31, Inception through
---------------------------- December 31,
1999 2000 2001 2001
-------- -------- -------- -----------------
Cash flows from operating activities:
Net loss...................................................................... $(11,730) $(15,910) $(19,589) $ (79,474)
Adjustments to reconcile net loss to net cash used in operating activity:
Depreciation and amortization................................................ 230 235 1,854 2,490
Forgiveness of note receivable to former officer............................. -- 623 100 723
Provision for uncollectable accounts......................................... 100 100 300 500
Losses in equity investments................................................. 1,133 236 707 10,258
Acceleration of stock option vesting......................................... 94 199 -- 293
Stock based compensation..................................................... 51 166 233 539
Impairment charge to implied goodwill of an equity investment................ -- -- 1,645 1,645
Changes in:
Accounts and notes receivable.............................................. 1,893 (1,701) 1,008 (1,705)
Inventory.................................................................. (31) (124) (124) (304)
Accounts payable........................................................... (404) 1,364 (535) 829
Prepaid expenses and other current assets.................................. (29) (389) 88 (330)
Deferred revenue........................................................... (44) 219 183 402
Accrued liabilities........................................................ 1,370 4,242 (1,183) 4,590
-------- -------- -------- ---------
Net cash used in operating activities.......................................... (7,367) (10,740) (15,313) (59,544)
-------- -------- -------- ---------
Cash flows from investing activities:
Purchases of investments...................................................... (26,635) (35,688) (22,500) (122,025)
Maturities of investments..................................................... 26,624 37,000 9,500 105,555
Deposit on facilities......................................................... -- -- (400) (400)
Contributions in equity investments........................................... (883) (236) (1,894) (11,445)
Purchase of property and equipment, net....................................... (594) (1,010 ) (1,364) (5,054)
-------- -------- -------- ---------
Net cash provided by (used in) investing activities............................ (1,488) 66 (16,658) (33,369)
-------- -------- -------- ---------
Cash flows from financing activities:
Net issuance of notes receivable to employees and related party............... (219) (42) (189) (1,451)
Net payments on capital lease obligations..................................... (56) 244 (5) 239
Advances from Catalytica, Inc................................................. 4,867 11,560 -- 41,934
Payments to Catalytica, Inc................................................... (2,829) (7,443) (602) (16,441)
Proceeds from stock options................................................... -- 15 767 782
Proceeds from issuance of shares through employee stock purchase plan......... -- -- 200 200
Proceeds from follow-on offering, net......................................... -- -- 47,642 47,642
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
Issuance of common stock in connection with spin-off from Catalytica, Inc..... -- 50,000 -- 50,000
-------- -------- -------- ---------
Net cash provided by financing activities...................................... 1,763 54,334 47,813 162,977
-------- -------- -------- ---------
Net increase (decrease) in cash and cash equivalents.......................... (7,092) 43,660 15,842 70,064
Cash and cash equivalents at beginning of year................................ 17,654 10,562 54,222 --
-------- -------- -------- ---------
Cash and cash equivalents at end of year...................................... $ 10,562 $ 54,222 $ 70,064 $ 70,064
======== ======== ======== =========
Additional disclosure of cash flow information:
Conversion of Catalytica, Inc. payable to additional paid in capital......... $ -- $ 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................................. $ 67 $ 76 $ 188 $ 389
======== ======== ======== =========
Interest paid................................................................ $ 3 $ 110 $ 43 $ 210
======== ======== ======== =========
Deferred compensation for issuance and revaluation of stock options to
non-employees.............................................................. $ 255 $ 176 $ 158 $ 589
======== ======== ======== =========
Assets invested in NovoDynamics, Inc......................................... $ -- $ -- $ 567 $ 567
======== ======== ======== =========
See accompanying notes.
51
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
(a combined company in the development stage)
for the year ended December 31, 1999
and
CATALYTICA ENERGY SYSTEMS, INC. (a company in the development stage)
for the years ended December 31, 2000 and 2001
NOTES TO FINANCIAL STATEMENTS
Note 1. Description of Business and Significant Accounting Policies
Description of Business Catalytica Energy Systems, Inc. ("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, Catalytica Energy was incorporated and became a subsidiary
of Catalytica, Inc. Catalytica Energy is engaged in developing, manufacturing
and marketing technologies that use catalysts to 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 wholly owned 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 and assets contributed to NovoTec were used to purchase
equity in NovoDynamics, Inc. ("NovoDynamics").
Catalytica Advanced Technologies, Inc. ("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.
On December 19, 2001, Catalytica Energy purchased Woodward Governor
Company's ("WGC") equity interest in GENXON making it the sole equity owner of
GENXON, which had been a 50/50 joint venture between Catalytica Energy and WGC.
The Company recorded its loss in the equity interest in GENXON through December
19, 2001. The financial statements of Catalytica Energy and GENXON were
consolidated as of December 31, 2001. Prior to December 19, 2001, GENXON had
been a 50/50 joint venture between Catalytica Energy and WGC to serve the gas
turbine retrofit market for installed, out-of-warranty engines.
Follow-on Offering In August 2001, Catalytica Energy registered 5,000,000
shares of its common stock in a follow-on public offering, of which 4,250,000
shares were sold by the Company and 750,000 shares were sold by an existing
stockholder, at a price to the public of $12.18 per share for net proceeds of
$47.6 million.
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 and 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.
52
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Basis of Presentation Catalytica Energy and CAT were commonly controlled
subsidiaries of Catalytica, Inc. until December 15, 2000. The 1999 financial
statements present the combined statement of operations, stockholders' equity,
and cash flows. In December 2000, Catalytica, Inc. completed its merger of CAT
and Catalytica Energy and spin-out of Catalytica Energy to its stockholders.
Catalytica Energy is in the development stage. Accordingly, cumulative losses
and cash flows from inception through December 31, 2001 are presented on the
statements of operations and cash flows.
Reclassifications Prior period amounts have been reclassified where
necessary to conform to the 2001 presentation.
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 principally of
commercial paper with maturities of twelve months or less and are classified as
held to maturity. They are carried at cost, which approximates their fair
market value.
Investments in Equity Investments and Joint Ventures Investments in equity
investments and 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. The company reviews its equity investments for impairment whenever events
or changes in circumstances indicate that the carrying amount of an equity
investment may not be recoverable.
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 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:
Impairment
Amount charge to
transferred loan in
Year ended Beginning from equity Ending
December 31, Balance Provision Catalytica, Inc. investment Balance
------------ --------- --------- ---------------- ---------- --------
1999 $ -- 100,000 -- -- $100,000
2000 $100,000 100,000 125,000 -- $325,000
2001 $325,000 (200,000) -- 500,000 $625,000
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, which range from three to seven years, 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
53
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
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 may 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 significant 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"). In March 2000, the FASB issued FASB Interpretation No. 44, "Accounting
for Certain Transactions Involving Stock Compensation--an Interpretation of APB
Opinion No. 25" ("FIN 44"). FIN 44 clarifies the application of APB Opinion No.
25 and among other issues clarifies the following: the definition of an
employee for purposes of applying APB Opinion No. 25, the criteria for
determining whether a plan qualifies as a noncompensatory plan, and the
accounting consequences of various modifications to the terms of previously
fixed stock options or awards. FIN 44 was effective as of July 1, 2000, but
certain conclusions in FIN 44 cover specific events that occurred after either
December 15, 1998 or January 12, 2000. The Company adopted FIN 44 in the first
quarter of fiscal 2001 with no material effect on the Company's consolidated
financial position, results of operations or cash flows.
Any deferred stock compensation calculated under APB 25 and FIN 44 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.
Stock-based awards to non-employees are accounted for at fair value, as
generally 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.
54
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
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 years ended December
31, 2000 and 2001, the inclusion of potentially dilutive securities of 989,029
shares and 582,464 shares, respectively, 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 Year ended
December 31, December 31,
2000 2001
------------ ------------
Numerator for basic and diluted loss per share.................... $(15,910) $(19,589)
======== ========
Denominator for basic and diluted loss per share--Weighted-average
shares outstanding.............................................. 1,000 14,747
======== ========
Basic and diluted loss per share.................................. $ (15.91) $ (1.33)
======== ========
Impact of Recently Issued Accounting Standards
In June 2001, the FASB issued SFAS No. 141, "Business Combinations," and
SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 provides new
guidance on the accounting for a business combination at the date a business
combination is completed. Specifically, it requires use of the purchase method
of accounting for all business combinations initiated after June 30, 2001,
thereby eliminating use of the pooling-of-interests method. SFAS No. 142
establishes new guidance on how to account for goodwill and intangible assets
after a business combination is completed. Among other things, it requires that
goodwill and certain other intangible assets will no longer be amortized and
will be tested for impairment at least annually and written down only when
impaired. This statement will apply to existing goodwill and intangible assets,
beginning with fiscal years starting after December 15, 2001. The Company is
currently evaluating these statements but does not expect that they will have a
material impact on the Company's financial position, results of operations, or
cash flows.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets." This statement supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed of." Although retaining many of the fundamental recognition and
measurement provisions of SFAS 121, the new rules significantly change the
criteria that would have to be met to classify an asset as held-for-sale. The
statement also supersedes certain provisions of Accounting Principles Board
Opinion No. 30, "Reporting the Results of Operations--Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions," and will require expected
future operating losses from discontinued operations to be displayed in
discontinued operations in the period(s) in which the losses are incurred
rather than as of the measurement date, as presently required. As required by
SFAS No. 144, the Company will adopt this new statement on June 1, 2002. The
Company is currently evaluating this statement but does not expect that it will
have a material impact on the Company's financial position, results of
operations, or cash flows.
55
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Note 2. Transactions with Related Parties
NovoDynamics, Inc. In November 2000, Catalytica Energy advanced $0.2
million to NonLinear Dynamics, Inc. ("NonLinear Dynamics") in order to
accelerate a contemplated business combination between NovoTec, a Delaware
corporation and wholly-owned subsidiary of Catalytica Energy and NonLinear
Dynamics. NovoTec was 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 $2.3
million in NovoDynamics. This amount consisted of $1.8 million in cash,
forgiveness of the $0.2 million advance made to NonLinear Dynamics, which was
to be payable to NovoTec, and investment of $0.3 million in assets formerly
used by NovoTec. In accordance with these agreements, this full investment was
completed in April 2001. In 2001, Catalytica Energy owned shares of Series A
voting preferred stock representing approximately 38.4% of NovoDynamics'
outstanding equity. Subsequent to December 31, 2001, Catalytica Energy owned
approximately 34.4% of NovoDynamics' outstanding equity as a result of
NovoDynamics issuing an additional approximately $0.7 million of Series B
preferred stock. Catalytica Energy recorded its investment at cost and recorded
its share of pro rata losses under the equity method in the period from March
2001 through December 31, 2001. The investment was accounted for as implied
goodwill.
Additionally, in March 2001, Catalytica Energy agreed to loan NovoDynamics
up to $1.5 million if certain milestones were met. On December 31, 2001,
Catalytica Energy committed to loan $0.5 million of the $1.5 million to
NovoDynamics on January 7, 2002. As of December 31, 2001, Catalytica Energy
recorded a note payable for the $0.5 million and a receivable of $0.5 million
on its balance sheet. Because repayment of the note was not certain at the time
it was made, an allowance of $0.5 million was recorded against the loan and
this amount was charged as impairment to implied goodwill of an equity
investment on December 31, 2001.
Catalytica Energy periodically evaluates its equity investments. On December
31, 2001, Catalytica Energy evaluated its investment in NovoDynamics under
Accounting Principles Board Opinion No. 18, The Equity Method of Accounting for
Investments in Common Stock ("APB 18") and determined that an impairment in the
carrying value of the investment had occurred which was other than temporary
based on NovoDynamics' financial history and projected future losses. At that
time, Catalytica Energy determined that the estimated fair value of our
investment in NovoDynamics was zero. The carrying value of the investment at
December 31, 2001 had been $1.6 million, and the entire amount was charged as
impairment to implied goodwill in non-operating expenses on December 31, 2001.
At that time, the Company discontinued applying the equity method because its
net investment was zero.
As of December 31, 2001, two of Catalytica Energy's directors held a direct
investment in NovoDynamics Series B voting preferred stock, which represented
slightly less than 1% of NovoDynamics' outstanding stock.
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 $3.1 million,
$2.6 million, and none respectively, for the years ended December 31, 1999,
2000, and 2001. Charges for these services have been allocated based upon
square footage, usage, headcount and other methods that management believes to
be reasonable.
Prior to Enron Ventures Corporation's 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
56
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
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 $0.3 million for the year ended December 31, 1999,
and none for the years ended December 31, 2000 and 2001.
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
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. In November 2001, Enron sold all of its shares of
Catalytica Energy common stock to a third party and did not assign any of its
rights under the Share Exchange Agreement.
Transaction With An Affiliate of Enron In December 1999, an affiliate of
Enron ("the Affiliate"), 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 February
2000, Catalytica Energy advanced the Enron affiliate an additional
$1.8 million. In March 2000, the arrangement between Catalytica Energy and the
Affiliate was amended and all previous advances through that date of $2.9
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 Officers In July 2000, the President and Chief Executive
Officer of Catalytica Energy resigned. His separation agreement provided for
severance of approximately $18,000 a month for twelve months and a payment of
$18,900. Catalytica Energy recorded a charge in the third quarter of 2000 for
$234,900 related to the officer's severance. If he remained unemployed after
the twelve months, payments of $18,000 would
57
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
continue for an additional six months or until he was employed, whichever came
first. These payments were expensed when they became probable, through November
2001 when the arrangement ended. In addition, previous loans and accrued
interest of $620,000 were forgiven and the Company recorded a charge in the
third quarter of 2000 for this amount. 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.
In January 2001, Catalytica Energy's Senior Vice President of Business
Development resigned. His separation agreement provided for a severance payment
totaling approximately $0.18 million. In addition, a previous loan of $0.1
million was immediately forgiven. Catalytica Energy recorded a charge in the
first quarter of 2001 for $0.3 million related to the forgiveness of the
officer's loan and severance. The former officer is currently indebted to
Catalytica Energy for approximately $0.17 million which is payable in
installments through March 31, 2005. Interest accrues on this note at an annual
rate of 6%.
In August 2001, Catalytica Energy's Vice President of Operations resigned.
His separation agreement provided for a severance payment totaling
approximately $82,000.
Investments As of December 31, 2001, Catalytica Energy had invested
approximately $25.0 million with Morgan Stanley Private Wealth Management. This
amount is invested primarily in a money market account and commercial and
government short-term paper. Catalytica Energy has a board member who is the
Chairman and Chief Executive Officer of Morgan Stanley Private Equity, and is a
Managing Director of Morgan Stanley & Co., Incorporated.
Note 3. GENXON
GENXON In October 1996, Catalytica Energy and WGC 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, 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 members was
$10.0 million: $2.0 million from Catalytica Energy and $8.0 million from WGC.
In addition, Catalytica Energy contributed an exclusive license for the use of
its catalytic combustion technologies, and WGC 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 occurred on a 50/50 basis with each joint
venture member contributing an equal amount quarterly. Catalytica Energy
recorded its share of losses on the joint venture of $1.1 million, $0.2
million, and $0.1 million for the years ended December 31, 1999, 2000, and
2001, 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 costs related to the durability testing are expensed directly
by Catalytica Energy. Because the carrying value of the 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.
58
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The following information summarizes GENXON's financial position for the
twelve months ended September 30, 1999, 2000, and 2001:
Twelve Months
ended
September 30, September 30, September 30,
1999 2000 2001
------------- ------------- -------------
(unaudited) (unaudited)
(in thousands)
Total revenues........................ $ 887 $ 7 $ 27
======= ===== =====
Net loss.............................. $(4,157) $(504) $(488)
======= ===== =====
Current assets........................ $ 338 $ 678 $ 418
Long-term assets...................... 270 -- --
------- ----- -----
Total assets.......................... $ 608 $ 678 $ 418
======= ===== =====
Current liabilities................... $ 646 $ 641 $ 680
Members' earnings (deficit)........... (38) 37 (262)
------- ----- -----
Total liabilities and members' capital $ 608 $ 678 $ 418
======= ===== =====
The 1998 and 1999 reports of GENXON's independent accountants 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 cumulative loss of $25.3
million through September 30, 2001. Catalytica Energy has no obligation to make
any further cash contributions to GENXON and the financial statements of
Catalytica Energy at December 31, 2001 have no significant amounts due from
GENXON or any recorded carrying value of its investment in GENXON at that same
date.
Catalytica Energy had entered into an agreement with GENXON to provide
management, technical and administrative support services. These costs were
incurred by Catalytica Energy and then billed to GENXON. Related amounts (both
the costs and the amounts billed to GENXON) were recorded net as an element of
research and development costs (none in 2000 and 2001; and $2.0 million in
1999), while amounts actually billed were recorded as accounts receivable from
joint venture on the Company's balance sheet.
On December 19, 2001, Catalytica Energy purchased WGC's equity interest in
GENXON for $10,000 making it the sole equity owner of GENXON, which had been a
50/50 joint venture between Catalytica Energy and WGC. As part of the purchase
agreement, Catalytica Energy also obtained a commitment from WGC to pay 50% of
the first $3.0 million and 30% of any amount above $3.0 million, of any
settlement or judgment against the defendants in the pending City of Glendale
lawsuit, except for damages specified to have been awarded due to fraud or
misrepresentation by Catalytica, Inc., Catalytica Combustion Systems, Inc., or
Catalytica Energy. Also on December 19, 2001, Catalytica Energy entered into an
agreement with WGC, which assigned a patent held by WGC to Catalytica Energy in
exchange for royalty and license arrangements between WGC and Catalytica
Energy. The Company recorded its loss in the equity interest in GENXON through
December 19, 2001. The financial statements of Catalytica Energy and GENXON
were consolidated as of December 31, 2001.
59
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Note 4. Income Taxes
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,
-------------------------
1999 2000 2001
------- ------- -------
(in thousands)
Income tax benefit at U.S. statutory rate........... $ 3,987 $ 5,409 $ 6,660
Pre-merger operating losses canceled right of offset -- (3,996) --
Valuation allowance for deferred tax assets......... (3,987) (1,413) (6,660)
------- ------- -------
Income tax benefit.................................. $ -- $ -- $ --
======= ======= =======
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.
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 1999 and
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,
-----------------
2000 2001
------- --------
(in thousands)
Deferred tax assets:
Net operating loss carryforwards.............. $ 185 $ 6,900
Tax credit carryforwards...................... 0 520
Accruals and reserves not currently deductible 1,228 4,340
------- --------
Total gross deferred tax assets............... 1,413 11,760
Less valuation allowance...................... (1,413) (11,760)
------- --------
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 approximately
$4.8 million in 1999, decreased by approximately $8.9 million in 2000 and
increased by approximately $10.3 million in 2001.
60
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
As of December 31, 2001, Catalytica Energy's federal and state net operating
loss carryforwards were approximately $20 million and $3 million, respectively.
The federal net operating loss carryforward will expire in the years 2020
through 2021 and the state net operating loss carryforward will expire in the
years 2005 through 2006 if not used to offset future taxable income. The
Company also had federal and state research and development credit
carryforwards of approximately $0.4 million and $0.3 million, respectively. The
federal research and development tax credits will expire in the year 2021 and
the state research and development tax credits carryforward indefinitely.
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.
Note 5. Capital Stock
Shares of Catalytica Energy common stock reserved for future issuance are as
follows:
December 31,
2001
------------
Employee stock purchase plan................................ 1,482,897
Stock options............................................... 2,985,311
Glaxo Wellcome warrant...................................... 330,940
---------
4,799,148
=========
Follow-on Offering In August 2001, Catalytica Energy registered 5,000,000
shares of its common stock in a follow-on public offering, of which 4,250,000
shares were sold by the Company and 750,000 shares were sold by an existing
stockholder, at a price to the public of $12.18 per share. The gross proceeds
to the Company from the follow-on public stock offering were $51.8 million and
the Company incurred approximately $4.025 million in costs in connection with
the offering.
Catalytica Energy
Preferred Stock The Company has 5,000,000 shares of Preferred Stock
authorized, all of which are unissued and undesignated. The Board of Directors
of the Company has the authority, without further vote or action by the
stockholders, to issue these undesignated shares of Preferred Stock in one or
more series and to fix the rights, qualifications, preferences, privileges,
limitations, and restrictions of each such series, including dividend rights,
terms or redemption, redemption prices, liquidation preferences, and the number
of shares constituting any series or the designation of such series.
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 and 5,000,000 shares of perferred stock
was newly authorized. 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
61
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
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 November
2001, Enron sold all of its shares of Catalytica Energy common stock to a third
party and did not assign any of its rights under the Share Exchange Agreement.
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 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 to purchase 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 to
purchase 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
62
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
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. In December 2000, all shares of CAT Series A preferred stock
were cancelled in connection with its merger into Catalytica Energy.
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 one to four years from the date of grant 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.
The following table summarizes related stock option plan activity:
Outstanding Options
Weighted --------------------------------
Shares Average Aggregate
Available Number Exercise Exercise
for Grant of Shares Price Price
--------- --------- --------- -----------
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
Authorized.............. 1,500,000 -- -- --
Granted................. (793,268) 793,268 14.13 11,212,402
Canceled................ 174,134 (174,134) 16.74 (2,914,349)
Exercised............... -- (486,235) 1.58 (767,061)
--------- --------- ------ -----------
Balance at December 31, 2001 1,627,998 1,357,313 $12.26 $16,638,740
========= ========= ====== ===========
63
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The weighted average fair value of options granted during 1999, 2000 and
2001, was $10.68, $17.67, and $8.91 respectively as calculated in accordance
with FAS 123. A summary of Catalytica Energy's stock option activity for the
year ended December 31, 2001 is as follows:
Options Outstanding Options Exercisable
---------------------------------- -----------------------------------
Number of Weighted Weighted
Weighted Number Average Average Exercisable Average
Range of Outstanding Remaining Exercise As of Exercise
Exercise Price December 31, 2001 Contractual Life Price December 31, 2001 Price
- -------------- ----------------- ---------------- -------- ----------------- --------
$0.40 277,225 3.96 $ 0.40 277,225 $ 0.40
$2.50-$6.14 153,923 7.85 4.42 85,264 3.98
$6.32-$12.00 131,816 8.31 9.67 60,944 11.67
$14.31 268,679 9.07 14.31 81,657 14.31
$14.50-$16.50 14,623 8.11 15.81 9,009 15.55
$16.94 235,244 9.15 16.94 52,675 16.94
$19.25-$21.00 97,768 8.78 20.45 45,693 20.45
$21.60 42,397 7.17 21.60 30,795 21.60
$26.50 134,638 8.50 26.50 52,313 26.50
$30.00 1,000 8.58 30.00 354 30.00
--------- -------
$0.40-$30.00 1,357,313 7.68 $12.26 695,929 $ 9.14
========= =======
Stock Option and Stock Purchase Plans
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 Risk Free
Interest Rate Interest Rate Interest Rate
1999 2000 2001
------------- ------------- -------------
Stock Option Plan....................... 5.48 6.43 4.51
Employee Stock Purchase Plan............ -- -- 4.51
Dividend Volatility Volatility Volatility
Yield Factor Factor Factor
All Years 1999 2000 2001
--------- ---------- ---------- ----------
Stock Option Plan...................... 0.0 .8236 .8814 .7217
Employee Stock Purchase Plan........... 0.0 -- -- .7217
Weighted Weighted Weighted
Average Average Average
Expected Expected Expected
Life Life Life
1999 2000 2001
-------- -------- --------
Stock Option Plan...................................... 2.6 4.3 4.97
Employee Stock Purchase Plan........................... -- -- 1.04
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
64
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
employee stock options have characteristics significantly different from those
of traded options, and because changes in the subjective assumptions can
materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the
fair value of its employee stock options.
For pro forma purposes, the estimated fair value of the Company's
stock-based awards to employees is amortized over the options' vesting period
(for options) and the six-month purchase method (for stock purchased under
ESPP). The weighted average fair value of stock options during 1999 and 2000
was $10.68 and $17.67 per share, respectively. The weighted average fair value
of stock options and employee stock purchase rights granted during 2001 was
$8.91 and $5.75 per share, respectively.
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:
Compensation Expense
----------------------------
1999 2000 2001
-------- -------- --------
(in thousands)
Net loss...................................... $(11,730) $(15,910) $(19,589)
Stock option plan............................. (826) (1,714) (4,103)
Employee stock purchase plan.................. -- -- (105)
-------- -------- --------
Pro forma net loss............................ $(12,556) $(17,624) $(23,797)
======== ======== ========
Pro forma basic and diluted net loss per share $ -- $ (17.62) $ (1.61)
======== ======== ========
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 $56,700 and
$56,800 was earned and charged to operations in the year ended December 31,
2000 and December 31, 2001, respectively. This obligation was remeasured at
December 31, 2000 and at December 31, 2001, 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
65
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
a deferred compensation obligation of $176,000, of which $37,000 and $44,600
was charged to operations in the years ended December 31, 2000 and December 31,
2001, respectively. This obligation was remeasured at December 31, 2000 and
December 31, 2001, and no additional deferred compensation was recorded. In
each subsequent reporting period (through the vesting period) this obligation
will be remeasured.
In the first quarter of 2001, Catalytica Energy granted a consultant options
to purchase 5,558 shares of its common stock at prices between $14.31 and
$16.44 per share. The options vest up to four years. Since the recipient of
these options is not an employee of Catalytica Energy, Catalytica Energy
recorded a deferred compensation obligation of $64,000, of which $56,100 was
charged to operations in the year ended December 31, 2001. This obligation was
remeasured at December 31, 2001, and no additional deferred compensation was
recorded. In each subsequent reporting period (through the vesting period) this
obligation will be remeasured.
In the fourth quarter of 2001, Catalytica Energy granted a charitable
foundation options to purchase 20,000 shares of its common stock at $4.55 per
share. The options were granted to the foundation at the request of a member of
the Company's board of directors who otherwise would have received the options
for his board service. The options vest over four years. Since the recipient of
these options is not an employee of Catalytica Energy, Catalytica Energy
recorded a deferred compensation obligation of $91,000, of which none was
charged to operations in the year ended December 31, 2001. Catalytica Energy
will begin recording a deferred compensation charge associated with this option
grant in January 2002. This obligation was remeasured at December 31, 2001, 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 $94,000, $214,000, and $70,000
was recorded in the twelve months ended December 31, 1999, December 31, 2000,
and December 31, 2001, 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 began on December 18, 2000 and ended 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, 2001, the Company had
issued 17,103 shares under the Plan. For the year ended December 31, 2001,
employees purchased 17,103 shares for $200,000. The weighted average fair value
of those purchased shares granted in 2001 was $5.75.
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 and $246,000 for the year ended December 31, 2001.
66
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Note 7. Major Customers and Geographic Revenues
Major customers are as follows:
Year ended December 31,
-------------------------
1999 2000 2001
------- ------- -------
General Electric............................ -- 52% 48%
Department of Energy........................ 26% 2% 35%
McDermott................................... 21% 20% 9%
Gas Research Institute...................... -- 14% --
NIST........................................ 8% 1% --
Pratt & Whitney Canada...................... 12% -- --
Mitsubishi.................................. 9% -- --
Unbilled revenues related to work performed were approximately $497,000,
$26,000, and $343,000 in 1999, 2000, and 2001, respectively. These amounts were
included in accounts receivable.
Research revenue by geographic region is as follows:
For the year ended
December 31,
-------------------------
1999 2000 2001
------- ------- -------
United States............................... 79% 82% 59%
Europe...................................... -- 18% 41%
Canada...................................... 12% -- --
Japan....................................... 9% -- --
------- ------- -------
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 and
the first quarter of 2001, Catalytica Energy entered into five, three-year
leases for furniture and computer equipment. These leases expire in the fourth
quarter of 2003 and the first quarter of 2004.
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 currently subleases approximately 20,000
square feet at the Mountain View, CA site.
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. This facility has
been entirely subleased. Additionally, Catalytica Energy leases copiers and
office equipment under lease agreements, which generally expire throughout 2003.
In 2001, Catalytica Energy leased manufacturing facilities in Gilbert,
Arizona under a seven-year lease for approximately 43,000 square feet that
expires on October 31, 2008. In 2002, Catalytica Energy completed the purchase
of this facility for $4.1 million. See Note 12 Subsequent Events.
67
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The aggregate minimum annual commitments under all leases as of December 31,
2001, are as follows (in thousands):
Year
----
2002....................................................... $1,442
2003....................................................... 1,415
2004....................................................... 407
2005....................................................... 404
2006....................................................... 404
------
$4,072
======
Rent expense consisting of building and equipment rent was none in 1999,
$218,000 in 2000, and $1,219,000 in 2001.
Catalytica Energy subleases a portion of its Mountain View, CA facilities as
well as the entire portion of its Scottsdale, AZ office to two companies. Under
the subleases, rental income is generated as follows (in thousands):
Year
----
2002....................................................... $1,190
2003....................................................... 1,163
------
$2,353
======
Rental income was none in 1999, $47,000 in 2000, and $1,864,000 in 2001.
Commitments Catalytica Energy has entered into research collaboration
arrangements that may require it 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, Catalytica Energy has four such
arrangements with Tanaka Kikinzoku Kogyo ("Tanaka"), Gas Technology Institute
("GTI") (formally known as Gas Research Institute), the California Energy
Commission ("CEC") and WGC. In certain cases these royalty payments are
contingent upon the number of units sold during the period covered by the
applicable 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 first amended 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 $7.5 million and punitive
damages. On May 31, 2001, the Company filed an answer to the first amended
complaint. Catalytica Energy has agreed to indemnify Catalytica, Inc. for any
costs associated with this matter.
On July 16, 2001, AGC Manufacturing Services, Inc. and AGC Project
Development, Inc. (collectively referred to as "AGC") filed a demand for
arbitration against Catalytica, Inc. and Catalytica Energy. The arbitration
demand asserted claims for breach of contract, fraud, conversion/unjust
enrichment, restitution, determination of commercial arrangement terms and an
accounting. These claims arose out of a dispute concerning the interpretation
of the Collaboration Agreement, dated November 2, 1993, between AES Project
68
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Development, Inc. and Catalytica, Inc., as amended through Amendment 3, dated
October 12, 1995. AGC sought compensatory damages in excess of $5.0 million,
punitive damages and declaratory relief establishing ownership in certain
Catalytica technology. Catalytica Energy agreed to indemnify Catalytica, Inc.
for any costs associated with this matter. In September 2001, Catalytica Energy
signed a $3.0 million cash settlement with AGC to be paid over a 22-month
period in connection with these claims. Catalytica Energy recorded the $3.0
million settlement amount in its financial statements as of December 31, 2001.
Catalytica Energy paid $1.5 million of settlement installments to AGC during
the year ended December 31, 2001. The $1.5 million balance will be paid to AGC
in quarterly installments through June 30, 2003.
Note 9. Segment Disclosures
Catalytica Energy operates as one business segment. Consequently, segment
disclosure for the twelve months ended December 31, 2001 is not provided. Prior
to December 31, 2000, Catalytica Energy operated primarily in two businesses:
Catalytica Energy, which is in the business of developing and commercializing
Xonon technology and Advanced Technologies, which conducted in-house and
contract research and development. The Company determined these reportable
operating segments based upon how the businesses were managed and operated. As
such, the following table discloses their revenues and operating income for the
above named operating segments for the twelve months ended December 31, 1999
and December 31, 2000, as well as identifiable assets as of December 31, 1999
and December 31, 2000.
Year ended
December 31,
------------------
1999 2000
-------- --------
Revenues
Catalytica Energy............................. $ 1,552 $ 4,282
CAT........................................... 1,501 1,205
-------- --------
Total revenues............................ $ 3,053 $ 5,487
======== ========
Year ended
December 31,
------------------
1999 2000
-------- --------
Operating loss
Catalytica Energy............................. $ (9,670) $(13,688)
CAT........................................... (1,690) (2,762)
-------- --------
Total operating loss...................... $(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
======== ========
69
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Note 10. Restructuring and Related Activities
In the fourth quarter of 2001, Catalytica Energy's management approved a
restructuring plan to move its finance department to Gilbert, Arizona and to
realign two additional functions within its corporate structure. Accordingly,
the Company planned to eliminate 7 employee positions in connection with this
plan. Restructuring and related charges of $0.36 million were expensed during
the fourth quarter of 2001. As of December 31, 2001, Catalytica Energy had not
yet completed any of the planned employee separations under the 2001 plan. The
Company expects to substantially complete the initiatives contemplated under
the restructuring plan by July 1, 2002. Components of accrued restructuring
costs and amounts charged against the 2001 restructuring plan as of December
31, 2001 were as follows:
Beginning Adjustments and December 31,
accrual expenditures 2001
--------- --------------- ------------
(in thousands)
Employee separation costs.......... $359 -- $359
Note 11. Selected Quarterly Financial Data (Unaudited) (In thousands, except
per share amounts)
First Quarter Second Quarter Third Quarter Fourth Quarter
--------------- ---------------- ---------------- ----------------
2000 2001 2000 2001 2000 2001 2000 2001
------ ------- ------- ------- ------- ------- ------- -------
Research and development
revenues.................... $1,275 $ 1,446 $ 1,158 $ 2,212 $ 1,457 $ 1,177 $ 1,597 $ 688
Total expenses................ 2,235 5,836 4,096 5,453 6,339 7,465 9,267 6,135
Operating loss................ (960) (4,390) (2,938) (3,241) (4,882) (6,288) (7,670) (5,447)
Net loss...................... $ (953) $(3,725) $(2,650) $(2,871) $(4,923) $(5,860) $(7,384) $(7,133)
Basic and diluted net loss per
share....................... $(1.89) $ (0.29) $ (5.14) $ (0.22) $ (9.53) $ (0.37) $ (2.99) $ (0.41)
Note 12. Subsequent Events (Unaudited)
Shareholder Rights Plan
On January 29, 2002, the Board of Directors of Catalytica Energy adopted a
Shareholder Rights Plan. Pursuant to the Shareholder Rights Plan, the Company
will distribute Preferred Stock Purchase Rights as a dividend at the rate of
one Right for each share of the Company's common stock held by stockholders of
record as of February 20, 2002 (the "Record Date"). The Board of Directors also
authorized the issuance of Rights for each share of common stock issued after
the Record Date, until the occurrence of certain specified events. The
Shareholder Rights Plan was adopted to provide protection to stockholders in
the event of an unsolicited attempt to acquire the Company. Each Right will
entitle the registered holder to purchase from the Company one one-thousandth
of a share of Series A Preferred stock at an exercise price of $45, subject to
adjustment.
The Rights are not exercisable until the earlier of (i) ten business days
(or such later date as may be determined by the Board of Directors) following
an announcement that a person or group has acquired beneficial ownership of 15%
of the Company's common stock or (ii) ten days (or such later date as may be
determined by the Board of Directors) following the announcement of a tender
offer which would result in a person or group obtaining beneficial ownership of
15% or more of the Company's outstanding common stock, subject to certain
exceptions (the earlier of such dates being called the "Distribution Date.").
However, with respect to the shares of the Company's common stock held or
acquired by Morgan Stanley Capital Partners III, L.P. ("MSCP"), no Distribution
Date shall occur until MSCP acquires 21.5% or more of the Company's common
stock then outstanding or announces a tender offer to acquire 21.5% or more of
the Company's common stock then
70
CATALYTICA ENERGY SYSTEMS, INC. and CATALYTICA ADVANCED TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
outstanding (the "Limitations"). The Rights are initially exercisable for
one-one thousandth of a share of the Company's Series A Preferred stock at a
price of $45 per one-one thousandth share, subject to adjustment. However, if
(i) after the Distribution Date the Company is acquired in certain types of
transactions, or (ii) any person or group (with certain exceptions) acquires
beneficial ownership of 15% of the Company's common stock, then holders of
Rights (other than the 15% holder) will be entitled to receive upon exercise of
the Right, common stock of the Company (or in the case of acquisition of the
Company, common stock of the acquirer) having a market value of two times the
exercise price of the Right.
The Company is entitled to redeem the Rights, for $0.001 per Right, at the
discretion of the Board of Directors, until certain specified times. The
Company may also require the exchange of Rights, under certain additional
circumstances. The Company also has the ability to amend the Rights, subject to
certain limitations.
If the Rights are triggered then each holder of a Right which has not been
exercised (other than Rights beneficially owned by the Acquiring Person) will
have the right to receive, upon exercise, voting Common Shares having a value
equal to two times the Purchase Price.
Purchase of Arizona Facility
In March 2002, Catalytica Energy completed its purchase of a 43,000 square
foot manufacturing facility and administrative building in Gilbert, Arizona. In
December 2001, Catalytica Energy had purchased a $0.1 million non-refundable
option to enter into an agreement to purchase this site. In 2002, the Company
purchased an additional $0.3 million option to extend the purchase date of the
building. These options totaling $0.4 million were applied toward the purchase
price of the facility. The building was purchased for $4.1 million, and 75% of
the building purchase was financed through a five-year term loan agreement with
the Arizona State Compensation Fund. Prior to March 2002, the Company had
leased this facility under a seven-year lease commitment, which was due to
expire on October 31, 2008. In connection with the purchase of this building,
the lease agreement was cancelled and Catalytica Energy has no further lease
obligation. Approximately $2.0 million of the operating lease commitments in
Note 8 are lease payments associated with rent under the Company's prior lease
of this facility, which was cancelled upon completion of the purchase of the
facility in March 2002.
Legal Settlement
In March 2002, the parties entered into a settlement agreement with respect
to this matter. Under the terms of the settlement agreement, Catalytica Energy
will pay the City of Glendale $3.0 million, and all parties will dismiss and
release all claims. Under the terms of an agreement with WGC, WGC is obligated
to reimburse Catalytica Energy for $1.5 million of this amount. Catalytica
Energy has accrued a net reserve of $1.5 million as of December 31, 2001, to
accrue for the net settlement of this matter, of which $0.25 million was
recorded in 2001. On March 27, 2002, Catalytica Energy was notified by WGC that
WGC was disputing the amount of its reimbursement obligation to Catalytica
Energy. Catalytica Energy believes that they are entitled to reimbursement of
the entire $1.5 million pursuant to the terms of an agreement with WGC and
intend to pursue such reimbursement.
71
Exhibit F
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.
PRICEWATERHOUSECOOPERS LLP
San Jose, California
October 17, 1999, except for the second paragraph of note 4 as to which
the date is August 28, 2000
72
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.
73
GENXON POWER SYSTEMS, L.L.C.
(a company in the development stage)
STATEMENTS OF OPERATIONS
Period from
October 21, 1996
Year ended Year ended (date of inception)
September 30, September 30, to 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.
74
GENXON POWER SYSTEMS, L.L.C.
(a company in the development stage)
STATEMENTS OF MEMBERS' CAPITAL
Woodward Catalytica Total
Governor Combustion Members'
Company Systems 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.
75
GENXON POWER SYSTEMS, L.L.C.
(a company in the development stage)
STATEMENTS OF CASH FLOWS
Period from
October 21, 1996
Year ended Year ended (date of inception)
September 30, September 30, to 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.
76
GENXON POWER SYSTEMS, L.L.C.
(a company in the development stage)
NOTES TO FINANCIAL STATEMENTS
1. Formation and Business of the Company
GENXON Power Systems, L.L.C. (the "Company"), a Delaware limited liability
company, was formed on October 21, 1996 to develop and sell products and
services to a wide range of users of out-of-warranty gas turbines which require
reductions in emissions, overhaul or upgrade. Except as provided for in the
Limited Liability Operating Agreement, the existence of the Company will be
perpetual.
Investor members in GENXON Power Systems, L.L.C. received a percentage
interest in the Company based on the amount of cash and the agreed-upon fair
value of certain technology licenses contributed to the Company. There were two
initial investor members, each receiving a 50 percent interest in the Company.
Their initial capital commitments were as follows:
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.
77
GENXON POWER SYSTEMS, L.L.C.
(a company in the development stage)
NOTES TO FINANCIAL STATEMENTS--(Continued)
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
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.
78
GENXON POWER SYSTEMS, L.L.C.
(a company in the development stage)
NOTES TO FINANCIAL STATEMENTS--(Continued)
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 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 agreed-upon retrofit and returned the engine to the city in its
original state. On August 14, 2000, the City of Glendale filed a complaint
against Catalytica 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
79
GENXON POWER SYSTEMS, L.L.C.
(a company in the development stage)
NOTES TO FINANCIAL STATEMENTS--(Continued)
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:
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.
6. Subsequent Event (Unaudited)
On December 19, 2001, Catalytica Energy Systems, Inc. (formerly Catalytica
Combustion Systems, Inc.) purchased Woodward Governer Company's equity interest
in the Company for $10,000 making Catalytica Energy Systems, Inc. the sole
owner of the Company.
In March 2002, Catalytica Energy Systems, Inc. (formerly Catalytica
Combustion Systems, Inc.) and the City of Glendale entered into a settlement
agreement with respect to the complaint the City of Glendale filed against the
Company on August 14, 2000. Under the terms of the settlement, Catalytica
Energy Systems, Inc. will pay the City of Glendale $3.0 million, and all
parties will dismiss and release all claims.
80
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)
/s/ CRAIG N. KITCHEN
By: _______________________________
Craig N. Kitchen
President and Chief Executive Officer
Dated: March 29, 2002
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 March 29, 2002
- ----------------------------- Officer (Principal
Craig N. Kitchen Executive Officer) and
Director
/s/ RICARDO B. LEVY Chairman of the Board March 29, 2002
- -----------------------------
Ricardo B. Levy
/s/ DENNIS RIEBE Chief Financial Officer March 29, 2002
- ----------------------------- (Principal Accounting and
Dennis Riebe Financial Officer)
/s/ HOWARD I. HOFFEN Director March 29, 2002
- -----------------------------
Howard I. Hoffen
/s/ WILLIAM B. ELLIS Director March 29, 2002
- -----------------------------
William B. Ellis
/s/ FREDERICK M. O'SUCH Director March 29, 2002
- -----------------------------
Frederick M. O'Such
/s/ JOHN A. URQUHART Director March 29, 2002
- -----------------------------
John A. Urquhart
/s/ ERNEST MARIO Director March 29, 2002
- -----------------------------
Ernest Mario
/s/ PETER CARTWRIGHT Director March 29, 2002
- -----------------------------
Peter Cartwright
/s/ SUSAN F. TIERNEY Director March 29, 2002
- -----------------------------
Susan F. Tierney
81