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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

OR

Commission File No. 000-31953

CATALYTICA ENERGY SYSTEMS, INC.

(Exact name of Registrant as specified in its charter)

1388 North Tech Boulevard

Gilbert, Arizona 85233

(Address of principal executive offices)

(480) 556-5555

(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes  x  No  ¨

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes  ¨  No  x

As of August 5, 2003, there were outstanding 17,695,324 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.

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CATALYTICA ENERGY SYSTEMS, INC.

FORM 10-Q

TABLE OF CONTENTS

June 30, 2003

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PART I—FINANCIAL INFORMATION

CATALYTICA ENERGY SYSTEMS, INC. (a development stage company)

CONSOLIDATED STATEMENTS OF OPERATIONS

for the three and six-month periods ended June 30, 2003 and 2002

and for the period from January 1, 1988 (inception) through June 30, 2003

(In thousands, except per share amounts)

(Unaudited)

See accompanying notes.

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CATALYTICA ENERGY SYSTEMS, INC. (a development stage company)

CONSOLIDATED BALANCE SHEETS

(In thousands)

See accompanying notes.

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CATALYTICA ENERGY SYSTEMS, INC. (a development stage company)

CONSOLIDATED STATEMENTS OF CASH FLOWS

for the six-month periods ended June 30, 2003 and 2002

and for the period from January 1, 1988 (inception) through June 30, 2003

(In thousands)

(Unaudited)

See accompanying notes.

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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. Description of Business and Significant Accounting Policies

Description of Business. Catalytica Energy Systems, Inc. (“Catalytica Energy,” “the Company” or “we”) designs, develops and manufactures advanced products for the energy and transportation industries with a focus on cost-effective solutions for improved performance and reduced emissions from combustion sources. Catalytica Energy was operated as part of Catalytica, Inc.’s research and development activities from its inception through the date of its creation as a separate subsidiary. In 1995, Catalytica Energy (then known as Catalytica Combustion Systems, Inc.) was incorporated and became a subsidiary of Catalytica, Inc. In December 2000, Catalytica Energy was combined with Catalytica Advanced Technologies, Inc., was spun off from Catalytica, Inc. and initiated operations as a stand-alone public entity. Catalytica Energy is in the development stage.

Unaudited Interim Financial Information. The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles for interim financial information generally accepted in the United States and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six-month periods ended June 30, 2003 are not necessarily indicative of the results that may be expected for the full fiscal year ending December 31, 2003. Certain amounts for prior periods have been reclassified to conform to the current presentation. For further information, refer to the financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2002 filed with the Securities and Exchange Commission on March 31, 2003.

Catalytica Energy operates as one business segment. Consequently, segment disclosure as of and for the three and six-month periods ended June 30, 2003 and 2002 is not provided.

Use of Estimates. The preparation of consolidated 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 consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Stock-Based Compensation. The Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and has adopted the disclosure-only alternative of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-based Compensation,” and SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure.” Any deferred stock compensation calculated under APB Opinion No. 25 and related interpretations is amortized over the vesting period of the individual options, generally four years, using 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 SFAS No. 123 and Emerging Issues Task Force Consensus No. 96-18, “Accounting for Equity Instruments that are Issued to other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services” (“EITF 96-18”). Related options are subject to re-measurements over their vesting terms at the end of each reporting period.

Had compensation cost for Catalytica Energy’s stock-based compensation plan been determined based on the fair value at the grant dates for employee and director stock option awards consistent with the method of SFAS No. 123, the Company’s net loss would have been increased or decreased to the pro forma amounts indicated below:

During the quarter ended June 30, 2003, the SFAS No. 123 impact was a benefit of $186,000 due to a reduction in the Company’s workforce which had the effect of reversing $779,000 of pro forma expense that had been presented in previous periods.

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2. Net Loss per Share

Basic and diluted net loss per share is presented in accordance with SFAS No. 128, “Earnings Per Share.” The Company’s potentially dilutive securities (stock options and warrants) were anti-dilutive for the three and six-month periods ended June 30, 2003 and 2002 because the Company incurred a net loss for each of those periods, and therefore, such potentially dilutive securities have been excluded from the computation of weighted-average shares outstanding used in computing diluted net loss per share. Total stock options and warrants outstanding as of June 30, 2003 and 2002 were approximately 3,162,000 and 2,299,000, respectively. The following table sets forth the computation of basic and diluted net loss attributable to common shareholders per share:

3. Contract Settlement Agreement

On August 14, 2000, the City of Glendale, California filed a complaint against Catalytica Energy, Catalytica, Inc. and GENXON Power Systems, LLC (“GENXON”), then a 50/50 joint venture between Catalytica Energy and Woodward Governor Company (“WGC”), asserting claims for breach of contract, breach of the covenants of good faith and fair dealing, fraud and negligent misrepresentation arising out of defendants’ termination of a September 16, 1996 Technical Services Agreement between the City of Glendale and Catalytica, Inc. On March 22, 2002, the parties entered into a settlement agreement with respect to this litigation. Under the terms of the settlement agreement, Catalytica Energy paid the City of Glendale $3,000,000 in April 2002, and all parties dismissed and released all claims arising out of the action.

Based on an agreement between WGC and Catalytica Energy entered into effective December 2001 (the “GENXON Membership Transfer and Settlement Agreement”), Catalytica Energy believed that WGC would provide reimbursement for 50% of the settlement amount, or $1,500,000. As of December 31, 2001, a reserve of $1,500,000 had been established to account for Catalytica Energy’s net settlement payment. In March 2002, WGC disputed the amount owed to Catalytica Energy as reimbursement of the settlement payment.

In April 2002, Catalytica Energy and WGC entered into a settlement and release of claims (the “Settlement Agreement”) with respect to the GENXON Membership Transfer and Settlement Agreement the parties had entered into in December 2001 pursuant to which WGC paid Catalytica Energy $1,500,000 in April 2002 as reimbursement of its portion of the settlement payment to the City of Glendale. In return, Catalytica Energy agreed to the amendment of certain provisions of the Control Patent Assignment and Cross License Agreement (“Patent Assignment Agreement”) entered into between Catalytica Energy and WGC on December 19, 2001 and also agreed to pay certain amounts to WGC. The amendments to the Patent Assignment Agreement increased the royalties owed by Catalytica Energy to WGC by $250,000 and required $50,000 of these royalties to be guaranteed and paid in advance. In accordance with the Settlement Agreement, Catalytica Energy paid WGC $250,000 in April 2002, which was a $50,000 prepayment of royalties under the Patent Assignment Agreement as well as a prepayment of $200,000 of nonrefundable control technology license fees for Catalytica Energy’s first four $50,000 sublicenses of the WGC control technology licensed to the Company. Catalytica Energy paid WGC $100,000 in January 2003 and owes WGC an additional $100,000 of guaranteed royalties, evidenced by a non-interest bearing promissory note which is due and payable in January 2004 if such amount has not previously been paid in accordance with the terms of the Patent Assignment Agreement.

In March 2002, Catalytica Energy recorded a general and administrative expense of $450,000 for the royalties and license fees payable to WGC pursuant to the Settlement Agreement.

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4. Impact of Recently Issued Accounting Standards

In November 2002, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 45 (“FIN No. 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN No. 45 elaborates on the existing disclosure requirements for most guarantees, including residual value guarantees issued in conjunction with operating lease agreements. It also clarifies that at the time a company issues a guarantee, the company must recognize an initial liability for the fair value of the obligation it assumes under that guarantee and must disclose that information in its interim and annual financial statements. The initial recognition and measurement provisions apply on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. The Company’s adoption of FIN No. 45 did not have a material impact on our results of operations or financial position.

In January 2003, the FASB issued Interpretation No. 46 (“FIN No. 46”), “Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51.” FIN No. 46 requires certain variable interest entities (“VIEs”) to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN No. 46 is effective for all VIEs created or acquired after January 31, 2003. For VIEs created or acquired prior to February 1, 2003, the provisions of FIN No. 46 must be applied for the first interim or annual period beginning after June 15, 2003. The Company currently has no contractual relationship or other business relationship with a variable interest entity and therefore the adoption of FIN No. 46 did not have a material effect on our results of operations or financial position.

In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity” (“SFAS No. 150”). SFAS No. 150 establishes standards on the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. The provisions of SFAS No. 150 are effective for financial instruments entered into or modified after May 31, 2003 and to all other instruments that exist as of the beginning of the first interim financial reporting period beginning after June 15, 2003. The Company does not believe that the adoption of SFAS No. 150 will have a material impact on its results of operations or financial position.

This Management’s Discussion and Analysis of Financial Condition and Results of Operations and other parts of this Report on Form 10-Q contain forward-looking statements that involve risks and uncertainties. The words “anticipates,” “believes,” “expects,” “intends,” “will” and similar expressions identify forward-looking statements, which are based on information available to us on the date hereof. These forward-looking statements include predictions regarding our future results of operations; revenues, including the availability of research and development funding from government agencies and original equipment manufacturing (“OEM”) partners; research and development expenses; selling, general and administrative expenses; interest income and interest expense; expenditure of capital resources; liquidity and sufficiency of existing cash, cash equivalents and short-term investments for near-term requirements; retention of future earnings; and the effect of recent accounting pronouncements on our results of operations and financial condition. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth in “Risks That Could Affect Our Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2002 and elsewhere in this Quarterly Report on Form 10-Q. We assume no obligation to update any forward-looking statements contained in this report.

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Overview

Catalytica Energy Systems, Inc. (“Catalytica Energy,” “the Company” or “we”) designs, develops and manufactures advanced products for the energy and transportation industries with a focus on cost-effective solutions for improved performance and reduced emissions from combustion sources. We were operated as part of Catalytica, Inc.’s research and development activities from our inception through the date of our creation as a separate subsidiary. In 1995, Catalytica Energy (then known as Catalytica Combustion Systems, Inc.) was incorporated and became a subsidiary of Catalytica, Inc. In December 2000, Catalytica Advanced Technologies, Inc., another subsidiary of Catalytica, Inc., was merged into Catalytica Energy and the combined entity was spun-out from Catalytica, Inc. as a separate, stand-alone public company.

Our proprietary technologies include the application of catalysts to combustion systems and next-generation fuel processors to mitigate the environmental impact of power generation and transportation systems. We are marketing our first commercial product, Xonon Cool Combustion^™, a pollution prevention technology that enables natural gas-fired turbines to achieve ultra-low emission power production. Xonon^® reduces the formation of nitrogen oxides (“NOx”), a primary contributor to air pollution, through a proprietary catalytic combustion process. We are also conducting technology development efforts related to fuel processing for fuel cells and are actively pursuing adaptation of our core Xonon technology to mobile, off-road and stationary diesel applications.

Results of Operations

Revenue. Revenue primarily consists of research and development contracts funded by gas turbine manufacturers, government sources and research institutions, the timing of which may vary from period to period based on the terms agreed upon by us and the funding party. We expect to continue to pursue funded research programs, however, these may not be a continual source of revenue. 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. Due to the nature of our operating history, period comparisons of revenue are not necessarily meaningful and should not be relied upon as indications of future performance. In return for funding development, collaborative partners may receive certain rights in the commercialization of any resulting technology, including royalty payments on future sales (see “Other Commitments” below).

The decline in revenue during the three and six-month periods ended June 30, 2003 compared to the corresponding periods of 2002 reflects the completion of a research program funded by the U.S. Department of Energy in August 2002. Revenue recorded from this program to enhance the performance of combustion systems using Xonon technology was $473,000 during the three and six-month periods ended June 30, 2002. Partially offsetting the decline in revenue from termination of this program was funding from a state governmental agency for a research program which commenced in August 2002. Revenue recorded from this program to apply Xonon technology to multi-combustor gas turbine engines during the three and six-month periods ended June 30, 2003 was $156,000 and $171,000, respectively.

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We expect that revenue during the full fiscal year ending December 31, 2003 will be less than that during fiscal 2002 due to reduced availability of funding from governmental agencies and OEM partners as a result of the weak economic environment and challenging market conditions in the gas turbine industry.

Research and Development Expenses (“R&D”). R&D includes compensation and benefits for engineering and manufacturing staff, fees for contract engineers, materials to build prototype units, amounts paid to outside suppliers for subcontracted components and services, supplies used and facilities and information technology costs. We expense all R&D costs as incurred. As we begin to fulfill commercial orders, we will incur cost of goods sold expenses.

The decline in R&D during the three and six-month periods ended June 30, 2003 compared to the corresponding periods of 2002 reflects reduced salaries and benefits following a February 2003 restructuring in which certain administrative and support positions were eliminated from our engineering and manufacturing departments. Additionally, amounts paid to outside suppliers and consultants for subcontracted components and services have been reduced during 2003 as a result of a reduction in the work required for funded research programs.

We expect that R&D during the full fiscal year ending December 31, 2003 will be less than that during fiscal 2002 due to a planned reduction in spending on funded research projects. However, we continue to focus our research efforts on those programs that we believe may result in commercial product opportunities.

Selling, General and Administrative Expenses (“SG&A”). SG&A includes compensation and benefits, facilities and information technology costs and professional fees for corporate functions which include management, business development, marketing, human resources, sales and finance.

The decline in SG&A during the three and six-month periods ended June 30, 2003 compared to the corresponding periods of 2002 reflects reduced salaries and benefits following a February 2003 restructuring in which certain positions were eliminated from our accounting, human resources, marketing and information technology departments. Employee relocation costs were also lower in 2003 due to costs incurred in 2002 to move personnel to a new manufacturing and administrative facility in Gilbert, Arizona. In addition, included in SG&A during the six months ended June 30, 2002 was a charge of $450,000 related to an April 2002 settlement agreement with Woodward Governor Company (“WGC”) with respect to the GENXON Membership Transfer and Settlement Agreement the parties had originally entered into in December 2001 (see “Other Commitments”). Legal fees were higher during the three and six-month periods ended June 30, 2002 than during the corresponding periods of 2003 as a result of this matter and certain other legal issues which did not recur during 2003.

We expect that SG&A during the full fiscal year ending December 31, 2003 will be less than that during fiscal 2002 due to continued efforts to streamline operations and the non-recurrence of the $450,000 WGC settlement and employee relocation costs.

Interest Income and Expense. Our interest income consists of interest earned on cash, cash equivalents and short-term investments. Interest expense reflects amounts accrued under long-term debt and capital lease obligations.

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Interest income during 2003 was significantly lower than that during 2002 due to lower average cash and short-term investments balances and lower average market interest rates during 2003. We expect that interest income will decline during the full fiscal year ending December 31, 2003 compared to that during fiscal 2002 as we use cash to fund operations and commercialize our technology.

Interest expense during the six months ended June 30, 2003 was higher than the corresponding period of 2002 due to the funding of a $3,010,000 loan in March 2002 to finance the purchase of a manufacturing and administrative facility in Gilbert, Arizona. It is anticipated that this loan will be outstanding during all twelve months of the fiscal year ending December 31, 2003 and, therefore, we expect that interest expense will be higher than that during fiscal 2002.

Income Taxes. No benefit from income taxes was recorded on the losses incurred during the three and six-month periods ended June 30, 2003 and 2002 because the expected benefit, computed by applying statutory tax rates to the net loss, was offset by an increase in the valuation allowance for deferred tax assets.

Critical Accounting Policies and Estimates

Our discussion and analysis of financial condition and results of operations are based upon our unaudited interim consolidated financial statements, which have been prepared in accordance with accounting principles for interim financial information 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 we believe to be reasonable under the circumstances, the results of which form the basis of our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results would differ from these estimates under different assumptions or conditions.

Our significant accounting policies are disclosed in Note 1 to the consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2002 filed with the Securities and Exchange Commission on March 31, 2003. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated 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. If we underestimate the amount of disallowed funding for a particular program, we will have to reduce our revenue in a subsequent period by the amount by which actual disallowed funding exceeds our estimate. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers or funding partners to make required payments. If the financial condition of any of our customers or funding partners were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances would be required. We maintain a reserve for notes receivable in the event repayment of a note is uncertain. If the financial condition of any of our debtors were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances or write-offs would be required. Based on changes in market prices, we periodically write down our inventory of certain precious metals used in our products by an amount equal to the difference between the cost of inventory and its estimated realizable value. If actual market conditions become less favorable, additional inventory write-downs would be required. We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. We maintain a reserve for the costs to repair or replace our products being used in commercial applications during the applicable warranty period. Given our status as a development stage company, the estimate of such costs is subject to adjustment as the rate of defects and cost of related repairs are established over time. We record a reserve for contingencies, including litigation settlements, when a liability becomes probable and estimable. The amount we record for litigation reserves is based upon our best estimate at the time and is subject to change as facts we are aware of change or ultimate determinations or settlements are made.

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Liquidity and Capital Resources

Prior to our spin-off in December 2000, Catalytica, Inc. made a $50,000,000 cash investment in us. Additionally, in August 2001, we received net proceeds of $47,642,000 from a public offering of our common stock. At June 30, 2003, we had cash, cash equivalents and short-term investments totaling $58,589,000.

Our capital requirements depend on numerous factors including, but not limited to, product development and commercialization activities, the timing and level of research and development funding, market acceptance of our products and our rate of sales growth. We expect to devote substantial capital resources to further commercialize our technology, hire and train our production staff, develop and expand our manufacturing capacity, begin production activities and expand our research and development activities. We may enter into acquisitions or strategic arrangements which could require the use of cash or additional equity or debt financing. In this regard, as part of our growth strategy, we have in the past and may continue to enter into discussions with third parties regarding potential acquisitions of businesses or technologies that would complement our current products, expand the breadth of our markets or enhance our technical capabilities. In addition, a principal repayment of our long-term debt totaling $2,844,000 is due in April 2007. We believe that our available cash, cash equivalents and short-term investments as of June 30, 2003 will provide sufficient capital to fund operations as presently planned for at least the next twelve months.

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.

Other Commitments

In December 2000, we agreed to indemnify DSM Catalytica, Inc. (“DSM”), the successor corporation to Catalytica, Inc., for liabilities related to us and Catalytica Advanced Technologies, Inc. incurred prior and subsequent to our spin-off from Catalytica, Inc. To date, no claims have been made against us pursuant to this indemnification and, as of June 30, 2003, we believe that the likelihood of any material claim being made against us is remote.

We have 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 K.K. (“Tanaka”), Gas Technology Institute (“GTI”) (formerly known as Gas Research Institute), the California Energy Commission (“CEC”) and WGC.

A significant amount of the development effort related to our catalytic combustion technology was funded by Tanaka under a January 1995 development agreement which divides commercialization rights to the technology between the parties along product market lines. We have exclusive rights to manufacture and market catalytic combustion systems for gas turbines of greater than 25 mega-watt (“MW”) power output and non-exclusive rights for gas turbines of 25 MW power output or less. Tanaka has reciprocal exclusive rights to manufacture and market catalytic combustors for use in automobiles and non-exclusive rights for gas turbines of 25 MW power output or less. In each case, the manufacturing and marketing party will pay a royalty of 5% of 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, non-exclusive license to use the invention in its areas of exclusivity. As commercialized, the Xonon 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 to Tanaka after 2005. Through June 30, 2003, we have made payments totaling $7,600 to Tanaka under this agreement.

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In January 2000, we entered into a funding arrangement with GTI to fund the development of our Xonon combustor and to demonstrate its performance. We will be required to make royalty payments to GTI of $243,000 per year for seven years beginning with the sale, lease or other transfer of the twenty-fifth catalyst module for gas turbines rated greater than 1 MW, up to a maximum of $1,701,000. No royalties have accrued or been paid on this agreement to date.

In September 1998, we entered into a funding arrangement with the CEC under 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 developed under this project for fifteen years upon initiation of the first commercial sale of a Xonon-equipped engine greater than 1MW. We have the right to choose an early buyout option for an amount equal to $2,633,000 provided that the payment occurs within two years from the date upon which royalties are first due to the CEC. No royalties have accrued or been paid on this agreement to date.

On December 19, 2001, we entered into a Control Patent Assignment and Cross License Agreement (“Patent Assignment 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 the Patent Assignment Agreement, we must pay WGC between $5,000 and $15,000 upon each shipment of a Xonon commercial unit. Additionally, as part of an April 2002 settlement agreement with WGC (the “Settlement Agreement”), we agreed to increase royalties by $2,500 per unit on our shipment of the first 100 gas turbines greater than 10MW. These increased royalties are guaranteed, and we must pay them on 100 units even if we do not ship any units of this size. We prepaid $50,000 of these royalties to WGC in April 2002. We paid WGC $100,000 in January 2003 and will pay WGC $100,000 in January 2004, if we have not paid such amounts sooner through sales of units in accordance with the Patent Assignment Agreement. These guaranteed payments totaling $250,000 were recorded as a component of selling, general and administrative expenses in March 2002 and are in addition to the $5,000 we must pay to WGC under the Patent Assignment Agreement upon each shipment of a Xonon commercial unit in a gas turbine of this size.

The Patent Assignment Agreement also provides that each time we sublicense the WGC technology 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. As a part of the Settlement Agreement, we paid $200,000 in April 2002 representing a pre-payment of the control technology license fees for our first four $50,000 sublicenses of the WGC control technology. This payment was recorded as a component of selling, general and administrative expenses in March 2002. We are obligated to make the foregoing license payments to WGC through December 31, 2014 or until our cumulative payments and license fees to WGC total $15,250,000, whichever occurs first.

WGC must pay us a fee of 1% 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 $2,000,000, whichever occurs first.

RISKS THAT COULD AFFECT OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should carefully consider the risks described in our Annual Report on Form 10-K for the year ended December 31, 2002 before you decide to buy, hold or sell our common stock. The listed risk factors could materially and adversely affect our future operating results and could cause actual events to differ materially from those predicted in any forward-looking statements we make about our business.

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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 in which we invest have market risk. This means that a change in prevailing interest rates would 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 decline. In an effort to minimize this risk, 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 our investments in 2003 and 2002 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.

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 revenue recognized to date has been in U.S. dollars. Accordingly, we have not had any material exposure to foreign currency rate fluctuations.

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PART II—OTHER INFORMATION

On June 6, 2003, at the annual stockholder’s meeting, a quorum of stockholders of the Company approved the following proposals: (1) the election of three Class III Directors to each serve a three-year term and (2) ratification of the appointment of Ernst & Young LLP to serve as the Company’s independent accountants for the 2003 fiscal year.

The Board of Directors is divided into three classes, with Directors in each class serving for three-year terms. Accordingly, not all Directors are elected at each annual meeting of stockholders. Michael J. Murry, Frederick M. O’Such and John A. Urquhart were elected Directors at the meeting. The Directors whose terms of office continued after the meeting are Peter Cartwright, William B. Ellis, Susan F. Tierney, Howard I. Hoffen and Ricardo B. Levy.

The matters described below were voted on at the Annual Meeting of Stockholders, and the number of votes cast with respect to each matter and, with respect to the election of a director, were as indicated.

Proposal 1. Election of Class III Directors:

Proposal 2. Ratification of Appointment of Independent Accountants:

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

(b) Reports on Form 8-K

The Company filed the following report on Form 8-K during the quarter ended June 30, 2003:

Current Report on Form 8-K dated May 1, 2003.

All information required by other items in Part II is omitted because the items are inapplicable, the answer is negative or substantially the same information has been previously reported by the Registrant.

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CATALYTICA ENERGY SYSTEMS, INC.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: August 5, 2003

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