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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, 2000
or
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ____________ to
____________.
Commission File No. 0-20966
CATALYTICA ENERGY SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
Delaware 77-0410420
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
430 Ferguson Drive
Mountain View, California 94043
(Address of principal executive offices)
(650) 960-3000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
[X] Yes [_] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
As of February 26, 2001, there were outstanding 12,324,095 shares of the
registrant's common stock, par value $.001, which is the only class of common
stock of the registrant registered under Section 12(g) of the Securities Act of
1933. As of that date, the aggregate market value of the shares of common stock
held by nonaffiliates of the registrant (based on the closing price for the
common stock on The Nasdaq National Market on February 26, 2001) was
$199,057,708. For purposes of this disclosure, shares of common stock held by
each officer and director of the Registrant and by each person who owns 5% or
more of the outstanding voting stock have been excluded in that such persons may
be deemed to be affiliates. This determination of affiliate status is not
necessarily a conclusive determination for other purposes.
Documents Incorporated by Reference
The information called for by Part III is incorporated by reference to the
definitive Proxy Statement for the Annual Meeting of Stockholders of the Company
which will be filed with the Securities and Exchange Commission no later than
120 days after December 31, 2000.
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CATALYTICA ENERGY SYSTEMS, INC.
Annual Report on Form 10-K
Table of Contents
December 31, 2000
Page No.
--------
PART I
Item 1. Business 2
Item 2. Properties 18
Item 3. Legal Proceedings 18
Item 4. Submission of Matters to a Vote of Security Holders 19
PART II
Item 5. Market for the Registrant's Common Stock and
Related Stockholder Matters 19
Item 6. Selected Financial Data 19
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 21
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 33
Item 8. Financial Statements and Supplementary Data 33
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 33
PART III
Item 10. Directors and Executive Officers of the Registrant 34
Item 11. Executive Compensation 34
Item 12. Security Ownership of Certain Beneficial Owners and Management 34
Item 13. Certain Relationships and Related Transactions 34
PART IV
Item 14. Exhibits and Reports on Form 8-K 35
1
ITEM 1. BUSINESS
Overview
Catalytica Energy Systems, Inc. ("Catalytica Energy") designs and develops
advanced products for more effective energy production. Our first product, the
Xonon(TM) Cool Combustion system, prevents the formation of air pollutants in
stationary gas turbines that are primarily used for electric power generation.
Our Xonon system is the only commercially available pollution prevention
technology that enables ultra low emissions in gas turbine power generation.
We have been generating essentially pollution-free electric power for Silicon
Valley residents for more than 7400 hours with a Xonon-equipped 1.4 megawatt
("MW") gas turbine. Both GE Power Systems ("GE") and Kawasaki Motors Corp.,
U.S.A. ("Kawasaki") have received initial orders for Xonon-equipped gas turbines
and we are working with each of them under collaborative commercialization
agreements to incorporate Xonon into the combustor of their gas turbines. In
addition, we have development work underway with other gas turbine original
equipment manufacturers ("OEMs") to incorporate the Xonon system into their
turbines.
The Xonon Cool Combustion system consists of the Xonon module and proprietary
technology to incorporate it into the combustor of a gas turbine. The module is
designed to be replaced in accordance with the routine maintenance schedule for
the gas turbine. We expect to derive revenue from the sale of both new and
replacement Xonon modules.
By essentially preventing the formation of pollution, our Xonon Cool Combustion
system provides a more efficient, cost-effective solution for enabling ultra low
emissions in power generation and other gas turbine applications. Post-
emissions cleanup systems, like selective catalytic reduction ("SCR"), can
achieve ultra low emissions in some gas turbine configurations but typically
require the use of toxic ammonia and add considerably to the square footage and
operating cost of the power generation facility. Additionally, conventional
exhaust cleanup systems cannot be used in all gas turbine applications. Simple-
cycle gas turbines that do not employ heat recovery systems, for example, have
exhaust temperatures too high for conventional exhaust cleanup systems to be
effective, while high-temperature SCR systems have not been adequately proven in
high temperature exhaust configurations and are more costly than conventional
SCR. As such, we believe that Xonon may expand the use of gas turbines by
enabling the production of power in areas in which it was previously difficult
to obtain a permit to do so or in which operation was limited due to the
inability of existing technology to control unacceptably high emissions levels.
In addition to our Xonon Cool Combustion system, we are also focused on
technology development efforts for the energy industry, including early stage
development work on fuel processing for fuel cells, as well as adaptation of our
Xonon technology to microturbines, hybrid gas turbine fuel cells, and diesel
applications.
History and Background
We became a publicly traded company on NASDAQ on December 18, 2000. Prior to
that, we operated as a subsidiary of Catalytica, Inc. under the name Catalytica
Combustion Systems, Inc. In October 2000, we changed our name to Catalytica
Energy Systems, Inc. When Catalytica, Inc. was acquired on December 15, 2000 by
Synotex Company, Inc., a U.S. subsidiary of DSM, N.V., its two subsidiaries
Catalytica Energy Systems and Catalytica Advanced Technologies were merged and
spun off as a single new public entity, Catalytica Energy Systems. Much of our
early work and proprietary technologies held today are the product of our
discovering and developing catalytic technologies at Catalytica, Inc. For
example, we discovered our breakthrough Xonon Cool Combustion technology in the
late 80's and were issued our first patents on the technology in 1993.
Our Product
How Xonon Cool Combustion Works
A gas turbine operates by compressing incoming air, combining it with fuel, and
combusting the mixture. The combustion process releases the fuel's energy,
forming hot gases that power the turbine. In conventional combustion systems, a
flame is used to combust the fuel. The temperature required to sustain a stable
flame is significantly higher than the temperature at which the gas turbine is
designed to operate. This excessive temperature causes the nitrogen and oxygen
in the air to react, forming nitrogen oxides ("NOx"), a major contributor to air
pollution.
2
We have developed Xonon Cool Combustion, a catalytic technology that combusts
fuel flamelessly. This system provides the same amount of output energy as
flame-based combustion systems but at a lower peak temperature. Importantly,
this lower temperature is below the threshold at which NOx is formed. The Xonon
combustion system is the only gas turbine combustion system demonstrated to
achieve ultra low emissions.
How Xonon Cool Combustion is Integrated into the Gas Turbine
We collaborate with gas turbine OEMs to adapt their combustion systems to
incorporate the Xonon Cool Combustion system. Together with the OEMs, we
believe that we can design the Xonon combustion system to suit any size and type
of gas turbine. For each turbine model that an OEM agrees to pursue, we design a
catalytic Xonon module, the key component of the Xonon system, to fit directly
into the turbine combustor(s).
We then manufacture the custom-designed Xonon modules and sell the Xonon modules
to OEMs to incorporate them as an integral part of their product. At present,
the Xonon modules have an expected life of 8000 hours (equivalent to
approximately one year of continuous operation) and are designed to be replaced
during regular, scheduled maintenance over the 15 to 20-year life of the
turbine.
Key Benefits of Xonon Cool Combustion
We have developed and are marketing the Xonon Cool Combustion system for gas
turbines used primarily in electric power generation. Integration of the Xonon
Cool Combustion system has several key benefits when compared to conventional
gas turbine combustion and emissions reduction systems:
. Essentially Eliminates the Formation of NOx. High temperatures in
conventional gas turbine combustion systems result in the formation of NOx, a
harmful pollutant. The Xonon Cool Combustion system allows combustion to
occur at lower temperatures, avoiding the formation of NOx and achieving
ultra low emissions.
. Reduces Emissions of Carbon Monoxide and Unburned Hydrocarbons. In
traditional flame-based combustion, measures used to reduce emissions of NOx
often increase emissions of carbon monoxide and unburned hydrocarbons. Since
the Xonon Cool Combustion system uses catalytic combustion rather than flame-
based combustion, carbon monoxide and the hydrocarbon fuel are more
thoroughly combusted. As a result, only trace amounts of carbon monoxide and
unburned hydrocarbons remain in the exhaust.
. Avoids Costly Exhaust Cleanup. Gas turbines using flame-based combustion can
achieve ultra low emissions only in some applications and only through the
combination of lean pre-mix combustion and exhaust cleanup systems. Gas
turbine exhaust cleanup systems, however, add significant capital and
operating costs, reduce system efficiency, take up space, and in many cases
require the use of toxic chemicals. Xonon enables gas turbines in essentially
all applications to achieve ultra low emissions, without the use of exhaust
cleanup systems.
. Maintains Gas Turbine Efficiency. Flame-based combustion and the Xonon Cool
Combustion system release the same energy from the fuel and therefore achieve
the same combustion efficiency required for optimal operation of the turbine.
. Reduces Potential for Premature Component Failure. The Xonon combustion
system avoids the combustor vibration or "noise" that can occur when a
conventional flame is modified to reduce NOx formation. We believe that this
may result in more stable combustion operating conditions, reduced stress and
wear-and-tear on expensive combustion parts, and less potential for premature
component failure.
. Broadens Gas Turbine Applicability. To date, conventional exhaust cleanup
systems cannot be applied cost-effectively to all applications and sizes of
gas turbines. For example, simple cycle turbines, or turbines without heat
recovery systems, cannot use conventional exhaust cleanup systems.
Additionally, it can be cost-prohibitive for smaller gas turbines to use
exhaust cleanup systems. As a result, these facilities cannot achieve ultra
low emissions. We believe Xonon will enable essentially all applications and
sizes of gas turbines to achieve ultra low emissions, thus broadening their
range of uses.
. Expands Gas Turbine Use in Urban Areas. Xonon-equipped turbines can be put
into service in densely populated areas where environmental concerns may have
previously prevented gas turbines from being used.
3
With all these benefits, Xonon should significantly increase flexibility in
siting, permitting, and operating new and installed gas turbines.
Key Milestones Achieved
The following is a summary of our key milestones since initial development of
Xonon in 1988:
Date Key Dates and Milestones
- ---- ------------------------
1988 Discovered Xonon technology and initiated development
1989 Q4 Demonstrated viability of Xonon technology under laboratory
conditions
1991 Q1 Completed test of pilot-scale Xonon module with GE
1992 Q1 Initiated full-scale Xonon module test with GE
1994 Q4 Completed 7000-hour catalyst durability test
1996 Q1 Began joint development program with Rolls-Royce plc
1996 Q2 Began joint development program with Solar Turbines
1997 Q2 Published joint research paper with GE reporting ultra low
emissions in Xonon tests
1997 Q3 Completed 1000+ hour prototype gas turbine demonstration
1998 Q1 Obtained $30 million equity investment from Enron Ventures
1998 Q4 Signed Collaborative Commercialization & License Agreement
with GE Power Systems
1999 Q2 Commenced operation of Xonon-equipped turbine connected to
electric utility grid at Silicon Valley Power in Santa
Clara, California
1999 Q4 Obtained ISO 9001 registration for design, installation,
manufacturing and service of Xonon modules
1999 Q4 Announced that Enron specified the Xonon combustion system
as the preferred emissions control system on Frame 7FA (170
MW) gas turbines that it ordered from GE
1999 Q4 Completed 4,000 hours of operation of Xonon-equipped turbine
at Silicon Valley Power
2000 Q1 Announced satisfaction of all EPA guidelines for an
"achieved in practice" technology
2000 Q2 Agreed with GE to commercialize the Xonon-equipped GE10
(11MW) gas turbine (formerly the Nuovo Pignone PGT 10
turbine)
2000 Q2 Announced GE's and Alliance Power's preliminary agreement to
order six Xonon-equipped GE10 gas turbines
2000 Q2 Announced Enron Energy Services' order for three Xonon-
equipped Kawasaki M1A-13X (1.4 MW) gas turbines
2000 Q3 Received distributed power generation research award from
the U.S. Department of Energy ("DOE"), which provided for
additional R&D funding
2000 Q3 Announced that Xonon Cool Combustion won the EPA's first
Clean Air Excellence Award in the Clean Air Technology
category for its impact, innovation, and replicability
2000 Q3 Catalytica Inc. announced its intention to spin off
Catalytica Combustion Systems and Catalytica Advanced
Technologies as a single new public entity
2000 Q4 Unveiled Catalytica Energy Systems as new name for
Catalytica Combustion Systems
2000 Q4 First day of trading of Catalytica Energy Systems on the
Nasdaq National Market as a new public entity - (Nasdaq:
CESI)
2000 Q4 Entered into commercialization agreement with Kawasaki to
supply Xonon-equipped Kawasaki turbines to the distributed
generation market
4
2001 Q1 Received third party confirmation for Xonon's ultra low
emissions capabilities through the U.S. Environmental
Protection Agency's ("EPA") Environmental Technology
Verification ("ETV") Program.
The Changing Electric Power Industry
Three major forces are reshaping the electric power industry today:
. A broad restructuring initiative seeking to solve the shortcomings of the
old regulated system;
. A continued focus on the environmental consequences associated with the
generation of electric power; and
. An increased demand for very high levels of power reliability and quality
to support the strict power tolerances of digital electronics.
These forces will alter the way electricity will be provided in the future which
we believe will ultimately result in significantly increased demand for the
benefits offered by Xonon combustion systems.
Restructuring of the Utility Industry
The electric power industry is undergoing fundamental changes both domestically
and internationally. Governments around the world have recognized the
inefficiencies inherent in providing electricity through heavily regulated
monopoly systems. While the pace and extent of the restructuring activities vary
geographically, several themes have emerged:
. The customer's right to choose a power supplier;
. The separation of the generation, transmission and distribution segments of
the business; and
. Market-based pricing for electricity.
The industry transition to a competitive generation environment is changing the
context in which power producers operate existing facilities and evaluate new
projects. Competition has heightened attention on all elements of cost,
including fuel and environmental compliance. Producers are seeking to identify
market opportunities where, whether driven by temporary or chronic imbalances in
supply, they can capture premium pricing. They place particular value on the
ability to site quickly and operate non-controversial, clean generating units
designed to meet periods of peak demand. Other market participants, including
public utilities, independent power producers, end-users and independent
transmission operators are also seeking new, more responsive alternatives to
building additional transmission and distribution lines to serve growing urban
loads. These participants are driving demand towards distributed generation,
peaking plants, and new technologies that are both economically and
environmentally sound.
Continued Environmental Awareness
The second force affecting the electric power generation industry is the
continued public focus on environmental issues. Electric power production
results in significant emissions of certain environmentally harmful pollutants,
including NOx, carbon monoxide, unburned hydrocarbons and particulate matter. In
the United States, the Clean Air Act creates the National Ambient Air Quality
Standards ("NAAQS"), which are the basis for regulations that limit emissions on
a facility-by-facility basis. These restrictions vary geographically and are
most stringent in areas where existing pollution levels are high, such as in
urban areas and in California, the Northeast states and Texas. Air quality
regulations in the United States encourage the use of more effective emissions-
control technologies by requiring the use of the "Best Available Control
Technology," and they provide an economic incentive to achieve lower emissions
through requirements to offset emissions of new sources with reductions from
existing sources in areas that do not meet air quality standards.
5
The cost of emissions control systems alone does not capture the full impact of
environmental issues on the power producer. Public opinion and permitting issues
often prevent power producers from siting plants near population centers, even
if they can meet emissions standards. As a result, the availability of cost-
effective emissions technologies that surpass regulatory requirements can be
extremely valuable to power producers. Beyond reducing costs, these technologies
can actually enable projects which otherwise would not have been possible.
Increased Quality and Reliability Requirements
The third force reshaping the electric power industry is the new digital
economy's need for reliable, high quality power. The rapid growth in the use of
computers, the Internet and telecommunications products has significantly
increased the demand for high quality power to run computer equipment, cellular
base stations and many other components and devices that depend on a reliable
electricity supply. Unlike traditional electrical loads, such as lights and
motor-operated equipment, sophisticated digital devices cannot tolerate voltage
instabilities, such as surges and sags, without a serious negative impact on
their operations. These increased quality and reliability requirements are
creating demands for new supplies of cost-effective and reliable electric power
that can be located in populated areas, close to loads, where they can provide
the highest-quality service.
Limitations of Existing Technology
Gas turbines have emerged as the solution of choice for new power generation
throughout the world where natural gas is available, due primarily to their
inherent operating flexibility, high efficiency, relatively low capital and
operating costs and overall cleanliness relative to other generation
alternatives. Gas fueled generation as a percent of total installed capacity is
expected to rise significantly over the next two decades. The DOE estimates that
gas-fired generation, which accounted for 16% of total United States electricity
generation in 1999, will represent 36% of total generation by 2020.
Additionally, the DOE projects that gas-fired generation will account for 92% of
all U.S. electricity generation capacity additions between 1999 and 2020.
Despite the advantages of gas-fired generation, emissions remain a concern for
both air quality regulators and wholesale generators who have sought to
emphasize their use of clean power generation technologies. In order to reduce
emissions, gas turbine manufacturers have developed improved flame-based
combustion systems. The most advanced of the modified flame-based combustion
systems are the lean pre-mix systems such as dry-low NOx, or DLN. These measures
have, however, in some cases contributed to premature component failure and
reduced gas turbine reliability. Furthermore, even the most effective lean pre-
mix systems cannot achieve the required ultra low emissions levels.
For baseload, or nearly continuous operation, gas turbine generating plants that
operate in combined cycle (with a heat recovery system) for added efficiency,
exhaust cleanup systems are required to achieve ultra low emissions. The most
common conventional exhaust cleanup system is selective catalytic reduction, or
SCR. While this technology has become commonplace, it adds significant capital
and operating costs, reduces overall project performance and efficiency and can
create incremental health risks through secondary emissions and the
transportation and storage of toxic reagents. Operators of baseload generating
plants are particularly sensitive to the costs of exhaust cleanup due to the
competitive pricing nature of the markets they serve.
Furthermore, exhaust cleanup systems cannot be used in all gas turbine
applications. Gas turbines that operate in simple cycle (without a heat
recovery system) for added operating flexibility, such as peaking turbines and
gas pipeline compressors, have exhaust temperatures that are too hot for
conventional exhaust cleanup systems. For small gas turbines with heat recovery
systems used in distributed generation applications, the addition of SCR can be
cost-prohibitive.
The limitations associated with existing emissions control technologies prevent
power producers from cost-effectively achieving ultra low emissions across all
gas turbine applications. As a result, producers have been limited in their
ability to respond to the changing needs of the power industry. Power producers
seeking to develop flexible peaking plants in capacity-constrained regions have
faced more lengthy permitting processes and/or operating restrictions due to
concerns over the plants' inability to achieve ultra low emissions. Power
producers have also been unable to offer distributed generation on a wide scale
because technologies that can achieve ultra low emissions, such as fuel cells,
remain prohibitively expensive while cost-effective alternatives, such as gas
turbines, produce harmful emissions that limit their use in distributed
generation applications.
6
The limitations associated with existing emissions control technologies have
also adversely impacted gas pipeline operators. Gas turbine pipeline compressors
cannot use conventional exhaust cleanup systems. As a result, they cannot
achieve ultra low emissions and operators are often required to install more
expensive electric motor drives in emissions sensitive areas.
The Xonon Cool Combustion Solution
We believe that the introduction of a technology that can cost-effectively
achieve ultra low emissions in all gas turbine applications will create
significant value for users of gas turbines by enabling them to better respond
to the changing needs of the energy industry. Furthermore, we believe:
. Xonon Cool Combustion offers a cost-effective, ultra low emissions solution
for baseload gas turbine generating plants.
. Xonon enables simple cycle gas turbines to achieve ultra low emissions. As
a result, we believe Xonon will facilitate the siting and permitting of
peaking turbines and enhance their value by eliminating emissions-related
operating restrictions.
. Small Xonon-equipped gas turbines represent the first distributed
generation alternative that is cost-effective, achieves ultra low
emissions, is based on proven technology and is currently available on a
commercial basis. We believe the implementation of Xonon-equipped gas
turbines in these applications will accelerate the acceptance of
distributed generation in the changing electric power industry.
. Xonon enables turbines to be used in pipeline compressor applications in
the most emissions-sensitive areas and avoids the use of more expensive
electric motor drives.
Our Strategy
Our goal is to make Xonon the preferred combustion system for all gas turbines
and for other applications. Our strategy for achieving this goal is as follows:
. Develop Our OEM Relationships. We intend to develop and sell Xonon
combustion systems through gas turbine OEMs. We have entered into
collaborative development agreements with a number of leading turbine
manufacturers for the joint design and application of Xonon Cool Combustion
technology to their turbines. Upon completion of these development
programs, we expect them to commercialize Xonon-equipped turbines.
We believe offering Xonon on their gas turbines could give OEMs a
competitive advantage in new equipment sales. We also believe Xonon module
replacement services and the availability of Xonon as an upgrade for
existing gas turbines could enhance the OEMs' service businesses. Once an
OEM adopts Xonon combustion technology on one of its gas turbines, we will
work to extend the Xonon combustion technology to other gas turbines in its
product lines. We believe our collaborative relationships with OEMs place
us at a considerable competitive advantage relative to other potential
developers of catalytic combustion and competing technologies.
. Market Currently Offered Xonon-equipped Gas Turbines. During the early
stages of commercialization, we are working with our OEM partners and are
actively seeking out prospective users of Xonon-equipped gas turbines. We
are participating in the initial stages of discussions relating to their
gas turbine orders. We are also working with the OEMs to identify
situations where project circumstances are well suited for early adoption
of Xonon.
. Establish and Promote Xonon Brand Awareness. We believe that increased
awareness of the Xonon combustion system and its benefits among end-users
will accelerate OEMs' incorporation of Xonon combustion systems across
their product lines. We expect to actively promote awareness of Xonon
combustion systems among a broad audience through peer-reviewed technical
articles, advertisements in trade journals, presentations at trade shows
and other promotional activities. We will establish brand awareness by
7
targeting our marketing and product development activities to demonstrate
the range of Xonon's benefits. We expect that the OEMs will market the
Xonon combustion system under our Xonon brand.
. Aggressively Defend Our Intellectual Property and Broaden Our Technology
Base. Our Xonon Cool Combustion technology is a proprietary technology
protected by patents. Our intellectual property base and our accumulated
experience in applying catalytic combustion to operating systems place us
at a considerable advantage relative to other potential developers of
catalytic combustion and competing technologies. We intend to continue
technological development of Xonon to further extend catalyst life, gain
experience with a wider set of gas turbine operating conditions and develop
component design approaches for gas turbines under different operating
conditions and combustion configurations. In addition, we plan to
vigorously defend our intellectual property.
. Expand the Applications of Our Technology. We believe our technology is
applicable to other types of gas turbines, such as microturbines and
turbines incorporated in fuel cell-gas turbine hybrid power systems. We
also believe our technology can be used in combustion systems other than
gas turbines such as diesel engines. We expect to continue research and
development in these areas where technical and commercial factors appear
encouraging.
. Participate in the Development of Regulations. Federal, state and local air
agencies are continually developing regulations and guidance affecting the
permitting and operation of gas turbines. We participate in these
development efforts by attending workshops and hearings, providing written
comments to draft documents, and participating in public forums, such as
trade associations, as well as meeting with key individuals in regulatory
agencies. This is to ensure that the agencies are aware of Xonon's
capabilities and limitations when creating regulations.
Market for Xonon
We believe that Xonon combustion systems offer distinct advantages in all gas
turbine markets within the power generation and gas pipeline compression
industries. We divide our potential market into three segments based on gas
turbine size, OEM participants and end-user applications. These segments include
small, medium and large gas turbines for electric power generation.
Small Gas Turbines (less than 15 MW)
Due to their earlier shipping dates, we expect that Xonon modules for small gas
turbines will compose a majority of our product revenue over the next few years.
The small gas turbine segment includes turbines that generate less than 15 MW of
electric power. Turbines in this segment serve light industrial, commercial and
institutional loads in power only and combined heat and power, or cogeneration,
applications. With the restructuring of the utility industry, the desire to site
near users has become a key driver of demand for these turbines. Electricity
supplied by distributed generation in the residential and commercial sectors is
projected by the DOE to increase by more than 50% over the forecast period 2000
to 2020. Such units sited at the point of use can avoid the need to expand
transmission and distribution capacity and enhance power quality and
reliability.
We believe that the small gas turbine market sector is poised for dramatic
growth. According to Diesel & Gas Turbine Worldwide, orders for gas turbines
between 1 and 15 MW used for power generation were 486 for the year ending May
2000. According to Power Engineering, distributed generation in this size range
is predicted to reach a 20%-40% share of total power generation capacity
additions over the next ten years.
Gas turbine OEMs in this segment include Honeywell (formerly AlliedSignal),
Alstom Power, Kawasaki Heavy Industries, Ltd., GE's Nuovo Pignone subsidiary,
Pratt & Whitney Canada Corp., Rolls-Royce plc, and Caterpillar Inc.'s Solar
Turbines unit. According to PowerData Group, Solar, Kawasaki, Rolls-Royce and
Alstom Power are the dominant participants.
We are operating a 1.4 MW Xonon-equipped Kawasaki Heavy Industries, Ltd. gas
turbine on the electric utility grid at Silicon Valley Power, a municipal power
provider for the City of Santa Clara, California. This turbine has accumulated
over 7400 hours of operation, supplying essentially pollution-free power to
Santa Clara residents, with NOx levels averaging under 2.5 ppm.
8
In May 2000, Kawasaki and Enron Energy Services ("Enron") announced their intent
to furnish three Xonon-equipped 1.4 MW Kawasaki M1A-13X gas turbines for a
distributed power generation project in Massachusetts at a healthcare facility
of a U.S. Government agency. We plan to deliver the production units in 2001 for
these turbines. Following receipt of this first order for Xonon-equipped
Kawasaki turbines, the Company announced in December 2000 that it had entered
into a collaborative commercialization agreement enabling Kawasaki to market and
sell a generator package, known as the GPB15X, that includes the 1.4 MW Kawasaki
M1A-13X gas turbine incorporating Xonon Cool Combustion.
We are also working with GE to develop and commercialize the Xonon Cool
Combustion system for its GE10 (11 MW) gas turbine. In April 2000, GE entered
into a preliminary agreement to supply Alliance Power with six Xonon-equipped
GE10 gas turbines, subject to successful completion of the development work on
this Xonon system. We expect to deliver commercial Xonon modules for these gas
turbines beginning in mid-2002.
Additionally, we are engaged with other OEMs in adapting Xonon for gas turbines
they manufacture in this size range.
Medium Gas Turbines (15 to 60 MW)
The medium gas turbine segment includes turbines that generate between 15 and 60
MW of electric power. These units are used in energy intensive industrial
facilities for power generation and cogeneration.
According to Diesel & Gas Turbine Worldwide, global orders of gas turbines
between 15 and 60 MW were 302 for the year ending May 2000. Alstom Power, GE,
Rolls-Royce and Siemens Westinghouse are players in this market with GE as the
dominant participant, according to PowerData Group.
We are currently discussing the incorporation of our Xonon Cool Combustion
system into the gas turbines of several OEM products in the mid-size turbine
market.
Large Gas Turbines (greater than 60 MW)
Due to longer turbine lead times, we expect that Xonon modules for large gas
turbines will not compose a significant portion of our revenue until after 2003.
The large gas turbine segment includes turbines that generate more than 60 MW of
electric power. These turbines are presently used by public utilities and
wholesale generating companies to provide large quantities of power to serve
utility loads or for resale in wholesale markets. The majority of gas turbines
in this market are used in combined cycle configuration for base load power
generation.
The market for large gas turbines has recently demonstrated very high growth
with turbine manufacturers reporting significant sales increases and backlogs.
According to Diesel & Gas Turbine Worldwide, global orders of gas turbines
greater than 60 MW were 415 for the year ending May 2000, compared with 160 for
the year ending May 1998.
According to PowerData Group, Alstom Power, GE, and Siemens Westinghouse
together represent nearly all of this market on a unit basis, with GE as the
market leader in this sector.
In November 1998, we signed a collaborative agreement with GE to develop the
Xonon combustion system components for incorporation into GE's model 7EA and 7FA
gas turbines. In December 1999, GE accepted an order from Enron specifying Xonon
as the preferred emissions control system on GE 7FA gas turbines, with GE and
Enron maintaining the right to substitute alternative emissions control
technology for any reason, including if the Xonon combustion system cannot be
developed or has not been developed in time to meet delivery requirements. We
are also engaged in discussions at various stages with other manufacturers
serving this sector.
Relationships with Enron
In January 1998, Enron announced that it would evaluate the use of the Xonon
combustion system in certain of its future wholesale power generation,
distributed power generation and pipeline compressor projects. At the same time,
Enron Ventures, a wholly owned subsidiary of Enron, purchased an equity interest
in us for $30.0 million, resulting in Enron's owning approximately 1.3 million
shares of our Series B preferred stock. Enron Ventures also received a three-
year option to purchase up to an additional 535,715 shares for approximately
$14.4 million. In conjunction with our spin-off completed on December 15, 2000,
the Series B preferred stock was converted to our common stock. Enron's current
equity ownership in us is approximately 11%. On January 14, 2001, Enron's
option to purchase up to
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an additional 535,715 shares of common stock expired unexercised.
As part of Enron's original investment, Thomas E. White, then an officer of
Enron Ventures and currently Vice Chairman of Enron Energy Services, joined our
board of directors. JSB Asset, LLC, successor to Sundance Assets, L.P. and Enron
Ventures, has the right to nominate one member of our board so long as it owns
at least 5% of our voting stock. See "Related-Party Transactions-Relationship
with Enron."
In December 1999, an Enron North America order for GE 7FA gas turbines specified
the Xonon combustion system as the preferred emissions control system for the
gas turbines. Enron and GE have the right to substitute alternative emissions
control technology for any of these gas turbines for any reason, including in
the event the Xonon combustion system has not been developed or cannot be
developed in time to support Enron North America's project schedule.
In December 1999, Enron North America also agreed to contribute to the funding
of the development of the Xonon combustion system for use in GE 7FA gas
turbines. GE agreed to use commercially reasonable efforts to complete, in
collaboration with us, development, design, and on-engine testing of the Xonon
combustion system for 7FA gas turbines. GE's collaborative effort for
development, design and testing of Xonon for 7FA gas turbines is not limited by
the future selection of the emissions control technology used in Enron's
December 1999 order for GE 7FA gas turbines.
Collaborations
To date, we have entered into the following collaborative relationships with
leading industry participants to produce and sell gas turbines equipped with
Xonon combustion systems.
. General Electric. GE is the leading manufacturer of gas turbines in the
world. We have been working with GE on the application of the Xonon system
to gas turbines under a series of development program agreements since
1991. In November 1998, we signed an agreement with GE for the development,
design and commercialization of the Xonon Cool Combustion system in
selected models of new and existing GE gas turbines. The agreement requires
that GE market the Xonon Cool Combustion system only under the Xonon brand.
The agreement also includes provisions for the development and supply of
Xonon modules to satisfy GE's requirements for initial installation and
periodic replacement. This agreement prohibits us from selling or field
testing our products in gas turbines equal to or greater than 70 MW
provided that development proceeds in accordance with the agreed upon
timetable. We are not, however, prohibited from engaging in other
activities to develop and test the Xonon technology with other OEMs. Based
on the schedule for development with GE, we expect that our ability to sell
and field test in the large gas turbine market will not be impacted by our
agreement with GE. In December 1999, GE accepted from Enron North America
the first order for GE 7FA gas turbines specifying Xonon combustion systems
as the preferred emissions control system. Concurrent with this gas turbine
order, GE agreed to use commercially reasonable efforts to complete, in
collaboration with us, development, design and testing of the Xonon
combustion system for the 7FA gas turbines. The Enron order provides that
the 7FA gas turbines will be equipped with Xonon unless Enron or GE elects
to substitute alternative emissions control technology. The agreement
provides that GE may terminate the agreement at any time if it determines
that there are significant technical issues which indicate that the
technical objectives of the Xonon commercialization program are not
achievable or cannot be achieved within the timetable established for the
program.
. Kawasaki. In May 2000, Kawasaki and Enron announced their intent to furnish
three Xonon-equipped 1.4 MW Kawasaki M1A-13X gas turbines for a distributed
power generation project in Massachusetts at a healthcare facility of a
U.S. government agency. We plan to deliver the production units for these
turbines in 2001. Following receipt of this first order for Xonon-equipped
Kawasaki turbines, we announced in December 2000 that we had entered into a
collaborative commercialization agreement enabling Kawasaki to market and
sell a generator package, known as the GPB15X, that includes the 1.4 MW
Kawasaki M1A-13X gas turbine incorporating Xonon Cool Combustion.
. Nuovo Pignone. We and GE are working to develop and commercialize the Xonon
combustion system for the GE10 gas turbine manufactured by GE's Nuovo
Pignone subsidiary. This gas turbine is used for distributed generation and
gas pipeline compression applications. In April 2000, GE entered into a
preliminary agreement with Alliance Power for the purchase of six GE10 gas
turbines equipped with the Xonon combustion system. Subject to successful
completion of the development work on this Xonon system, we expect to
deliver commercial Xonon modules for these gas turbines beginning in mid-
2002.
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. Solar Turbines. In the second quarter of 1996, we and Solar Turbines, a
wholly-owned subsidiary of Caterpillar Inc., began a joint design and
development program for the inclusion of Xonon into Solar's new Advanced
Technology System gas turbine being co-funded by the DOE. Xonon full-scale
testing is in process at Solar on the Solar Mercury 50 (5 MW) gas turbine,
which has resulted from this program. We are also investigating application
of the Xonon technology in other Solar gas turbines.
. Rolls-Royce. In the first quarter of 1996, we began a joint development
program with the Allison Engine division of Rolls-Royce for the design of
Xonon as an integral part of their new Advanced Technology System gas
turbine, which was co-funded by the DOE. Development and testing is
continuing.
Development of the Xonon technology has been supported in part by government
agencies and research institutions, including the DOE, The EPA, The California
Energy Commission PIER program, the California Air Resources Board, EPRI
("Electric Power Research Institute") and GTI, formerly known as the Gas
Research Institute. In connection with some of these funding arrangements, some
of these parties may receive certain financial rights in the commercialization
of the resulting technology.
Manufacturing and Testing
We plan to initially manufacture commercial quantities of Xonon modules at our
facility in Mountain View, California. We believe that our current manufacturing
facilities will require only modest capital expenditures to expand our
capabilities to supply a sufficient number of both prototype and production
Xonon modules to satisfy our near-term needs. We plan to retain all proprietary
manufacturing within our facilities and outsource the non-critical components to
third party suppliers having OEM gas turbine component manufacturing expertise.
For internal production we plan to use manufacturing cells. Manufacturing cells
are a sequence of manufacturing equipment arranged in a manner to allow the
continuous production of a set of similar products, such as Xonon modules. Our
manufacturing cells occupy approximately 3,000 square feet and are designed to
produce all varieties of Xonon modules. These cells are scaleable to capacity
needs and can be located near customer facilities or distribution nodes as
appropriate. During 1999, we constructed the first manufacturing cell at our
Mountain View facility and have achieved start-up and initial production of
commercial-quality modules. Due to the long lead times for delivery of gas
turbines and the relatively short production time for a Xonon module, we believe
that we can adequately predict and accommodate our manufacturing needs in
advance of demand for our Xonon module.
In the fourth quarter of 1999, we earned ISO 9001 Registration from Underwriters
Laboratories, Inc. ("UL") for the design and manufacture of Xonon modules. The
ISO series standards are internationally recognized quality management system
requirements developed by the International Organization of Standardization
("ISO"). ISO 9001 is the most comprehensive standard in the ISO 9000 series.
We anticipate achieving production efficiencies as commercial production volume
ramps up over the next three years. Overall capacity growth will be achieved
through a combination of these efficiency improvements and the start-up of
additional manufacturing cells, both at our current facility and at additional
sites, as appropriate. Because of the modular design of these cells, our
capacity can grow in cell-sized increments in line with increasing demand. Our
manufacturing process lead-time is much shorter than the production lead-time of
the gas turbines into which our modules fit. Based on our commercialization
plan, we anticipate that our existing facilities will provide sufficient
capacity through 2002. Our long-term manufacturing needs will be satisfied by
our plans to build out a full-scale, high-volume, commercial production facility
at our second site in Scottsdale, Arizona.
Pursuant to our arrangements with the gas turbine manufacturers, Xonon modules
will be returned to us at the end of their useful life. We expect to reclaim,
reuse or recycle most components of the module, including the precious metals
palladium and platinum. Because we can recover and reuse these metals in our
modules, we can protect against the volatility of precious metal prices.
Our sourcing strategy is designed to take advantage of existing suppliers and
production infrastructure and to ensure the supply of critical materials and
components. We will ensure supply of critical materials by a combination of dual
sourcing, strategic inventory control and identification of substitute
materials. We expect to outsource metal fabrication components to suppliers
already supplying similar components to the turbine OEMs. Other materials
required for Xonon module production will be sourced from the specialty
chemicals and specialty metals industries. We expect
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these components and materials to have lead times of under four months at full
production quantities. In the case of all of our components and materials, we
have identified either alternative suppliers or substitute materials, with the
exception of one, a high temperature steel alloy. In this case, this material's
primary use is in the jet aircraft and turbine industries, and our requirements
would represent less than 5% of the present demand. We believe the continuing
supply of this material will be ensured by its demand in its primary market. We
are also evaluating substitute materials for this alloy.
In addition to our manufacturing facilities, we own and operate facilities used
for testing and developing our technologies. We have catalyst test facilities,
including two combustion test rigs, at our site in Mountain View, California.
These facilities are capable of testing catalysts at a range of gas turbine
operating conditions representative of most gas turbines that are presently
manufactured. We have additional facilities that allow for the testing of
critical combustor components such as preburners and mixers.
We also own a Kawasaki Heavy Industries, Ltd. 1.4 MW M1A-13A gas turbine
equipped with the Xonon combustion system that is operating on the electric
utility grid in Santa Clara, California. This turbine provides electric power
under contract to Silicon Valley Power. In addition to power production, this
unit serves as our on-engine test and demonstration facility for the Xonon
combustion system for gas turbines.
Regulatory
In the United States, federal air quality regulations include standards for
ground-level ozone (a primary component of smog) and particulate matter (soot).
Since NOx is both a precursor to ground-level ozone and a contributor to the
formation of fine particulate matter, reducing NOx emissions at power generation
facilities is important to meeting air quality standards. Federal air quality
regulations also include standards for emissions of carbon monoxide and unburned
hydrocarbons, two other common byproducts of electric power generation. The
federal regulations governing air quality create National Ambient Air Quality
Standards ("NAAQS"). Areas that meet the NAAQS are designated as "attainment
areas," while areas not meeting the standards are designated as "non-attainment
areas." State and local authorities determine specific strategies to be applied
in each area in order to meet the federal air quality standards. Generally
speaking, emissions restrictions applied in the most severe non-attainment areas
are the most stringent.
Federal law requires that major new and modified sources of air pollution in
attainment areas use the most effective emissions control technology that has
been demonstrated in practice and is commercially available, unless it can be
shown not to be cost-effective. This requirement is referred to as the "Best
Available Control Technology," or BACT. State and local authorities determine
what BACT will be on a case-by-case basis when assessing new power projects.
In areas that do not meet ambient air quality standards, authorities assessing
new facilities are not permitted to consider the cost-effectiveness of
technology alternatives. This more stringent technology determination is
referred to as the "Lowest Achievable Emissions Rate," or LAER. Furthermore, in
non-attainment areas, the permitted emissions of major new or modified sources
of air pollution must also be offset by emissions reductions elsewhere such that
there is a net decrease in overall emissions as a result of the new source. In
order to satisfy this requirement, project developers may demonstrate emissions
reductions or, in some markets, purchase credits for emissions reductions.
To facilitate the control technology assessments in BACT/LAER determinations,
some state and local authorities have published guidance documents for
applicants that identify desired emissions levels for different types of
sources. For example, the California Air Resources Board ("CARB") and the South
Coast Air Quality Management District ("SCAQMD") covering the Los Angeles Basin
have adopted guidance NOx emissions levels for gas turbines of 2.5 parts per
million ("ppm"). The Xonon Cool Combustion system operating on the gas turbine
at Silicon Valley Power has satisfied federal EPA guidelines for an emissions
control technology that is "achieved in practice" and has demonstrated emissions
levels that would satisfy the CARB and SCAQMD guidelines for gas turbines. We
believe that Xonon is the only gas turbine combustion system demonstrated to
meet these guidelines without requiring a costly exhaust cleanup system.
Furthermore, in February 2001, we successfully completed an evaluation process
by the EPA, which verified the ultra low emissions performance of a Xonon-
equipped gas turbine operating at Silicon Valley Power.
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While U.S. regulations do not directly force the adoption of new control
technologies or mandate lower emissions levels, they do provide an economic
incentive to achieve lower emissions, and, through BACT/LAER determinations,
require consideration of newly introduced control technologies that are more
cost-effective and/or achieve lower emissions levels. We believe the Xonon
combustion system for gas turbines achieves desired ultra low emissions levels
more cost-effectively than post-combustion exhaust cleanup systems, and enables
gas turbines to achieve ultra low emissions in situations where these exhaust
cleanup systems cannot be used. As a result, we believe Xonon will enhance the
value of gas turbine projects by reducing emissions compliance costs and
contributing to regulatory and community acceptance, thus improving the siting
and operating flexibility of gas turbines.
In addition to environmental requirements in the United States, there are
increasing restrictions on emissions abroad, particularly in Japan and Western
Europe. Furthermore, lending agencies such as the World Bank and public pressure
are expected to force host countries to adopt proven emissions control
technologies on power plants in developing countries.
Our Intellectual Property
Xonon Cool Combustion is a proprietary technology with extensive intellectual
property protection. Our intellectual property strategy is to identify key
intellectual property developed by us in order to protect it in a timely and
effective manner, and to use and assert such intellectual property to our
competitive advantage in the catalytic combustion business. Intellectual
property includes proprietary technology, know-how, business strategies and
market information. An objective of our intellectual property strategy is to
enable us to be first to market with proprietary technology and to sustain a
long-term technological lead in the market. We rely on a combination of patents,
trade secrets, trademarks, copyrights and contracts to protect our proprietary
technology.
We use patents as the primary means of protecting our technological advances and
innovations, such as our proprietary Xonon Cool Combustion system designs,
catalyst compositions, new materials, manufacturing processes, operating
techniques, combustor components and combustor system designs. We have adopted a
proactive approach to identifying patentable inventions and securing patent
protection through the timely filing and aggressive prosecution of patent
applications. Our employees participate in a comprehensive invention disclosure
program involving preparation of written invention memoranda and preservation of
supporting laboratory records. Patent applications are filed in various
jurisdictions internationally, which are carefully chosen based on the likely
value and enforceability of intellectual property rights in those jurisdictions,
and to strategically reflect our anticipated major markets. Patents provide us
with the right to exclude others from incorporating these technical innovations
into their products and processes. We also use patents, along with publications
and, where appropriate, licensing-in of third party technology to provide us
with the flexibility to adopt preferred technologies.
As of December 31, 2000, we (a) owned, either exclusively or jointly, (b) held
exclusive license rights from third parties for, or (c) held license rights from
affiliates, in 17 U.S. patents issued, 2 U.S. patents pending, 10 International
Patent Treaties, and 43 international registered patents. An additional 5
patent applications are currently in preparation.
We believe we have developed a significant international patent portfolio. We
have filed an increasing number of patent applications each year and we
anticipate that this trend will continue. We actively monitor the patent
position, technical developments and market activities of our competitors. We
expect that our growing patent portfolio, especially when coupled with a strong
enforcement program, will provide us with a significant advantage over our
competitors.
Portions of our know-how are protected as trade secrets and supported through
contractual agreements with our employees, suppliers, partners and customers. We
aggressively protect our intellectual property rights in our collaboration
agreements with a view to capturing maximum value from our products in our
markets and ensuring a competitive advantage.
Competition
We expect Xonon-equipped gas turbines to compete with turbines outfitted with
traditional emissions reduction technologies, including lean pre-mix combustion
and conventional exhaust cleanup systems.
We believe Xonon is unique in its abilities to allow gas turbines to achieve
ultra low emissions in simple cycle gas
13
turbines and to achieve ultra low emissions without the use of exhaust cleanup
systems. Lean pre-mix combustion systems cannot achieve ultra low emissions, and
the applicability of conventional exhaust cleanup systems is limited. Exhaust
cleanup used in combination with lean pre-mix combustion can reach ultra low
emissions in some applications. As Xonon is applied to gas turbine models, these
benefits will enhance the value of those gas turbines. We expect Xonon-equipped
gas turbines to be priced to end-users by the OEMs to capture a share of that
value.
Lean pre-mix combustion systems are manufactured and provided by gas turbine
OEMs as part of their turbine product line. These gas turbine OEMs represent the
potential customer base for our Xonon modules, and we expect to rely upon them
to distribute Xonon-equipped turbines to end-users.
Third parties, including Cormatech, Engelhard, Goal Line, Mitsubishi and Siemens
Westinghouse, manufacture conventional exhaust cleanup systems. End-users
generally purchase these systems directly from the manufacturers, through
packagers, or from vendors of heat recovery steam generation equipment. Gas
turbine OEMs do not function as intermediaries in these transactions and do not
receive any economic value from the sale of exhaust systems.
We expect that gas turbine OEMs will choose to purchase Xonon modules and
distribute Xonon-equipped turbines despite the fact that Xonon represents a
direct competitive challenge to their existing emissions control products. We
believe this will be the case for two reasons. First, Xonon combustion systems
achieve ultra low emissions at lower costs than competing technologies. Based on
this cost differential, turbines that incorporate Xonon Cool Combustion
technology offer a significant competitive advantage over turbines equipped with
conventional emissions technology. Incorporation of Xonon Cool Combustion
technology, therefore, enhances the OEM's product line and offers the potential
for the turbine OEM to gain market share from competitors whose turbines do not
incorporate Xonon Cool Combustion technology. Second, incorporating Xonon into
its turbines allows the OEM to capture a larger portion of the economics
associated with pollution control. Currently, OEMs only capture the portion of
emissions reduction economics associated with lean pre-mix, while third parties
capture the portion of economics associated with exhaust cleanup systems.
Because Xonon replaces lean pre-mix technology and eliminates the need for
exhaust cleanup systems, its incorporation in the turbine allows OEMs to capture
a larger portion of the economic value associated with emissions reduction.
Over time, the Xonon combustion system may also face competition from new
entrants to the market for emissions reduction. New entrants may eventually
develop competing technologies, catalytic or otherwise, that also achieve ultra
low emissions on a cost-effective basis. For example, Precision Combustion, Inc.
("PCI") has indicated on its web site that it has a long-term business agreement
with Siemens Westinghouse Power Corporation to develop, manufacture and sell
low, single digit NOx catalytic combustors for certain of Westinghouse's gas
turbines. PCI also states that it is working with other gas turbine
manufacturers under shorter term agreements. PCI has not characterized these
agreements as exclusive.
We believe, based on a review of public reports, that we are the only company to
have demonstrated catalytic combustion in full-scale combustion systems at
actual gas turbine conditions and to have achieved operation of catalytic
combustion on a gas turbine with the durability required for commercial success.
Further, we believe the technology that has enabled us to achieve these
milestones is proprietary to us.
We believe that the measures we have taken to protect our intellectual property
provide a significant barrier to entry for future competing technologies. We
also believe that even if current efforts to create competing technologies could
circumvent our intellectual property protections, these efforts are several
years away from commercial development.
Subsidiaries
Sud-Chemie Catalytica, L.L.C.
Sud-Chemie Catalytica, L.L.C. is a 50/50 joint venture originally formed in 1998
between Catalytica Advanced Technologies and the Sud-Chemie Group to custom
manufacture organometallic catalysts. Sud-Chemie Catalytica is focused on
supported and unsupported single-site catalysts and boron co-catalysts, a
recently discovered class of chemical compounds that allow highly controlled
polymerization reactions. Organometallic single-site catalysts are used to
produce new grades of plastics, such as polyethylene and polypropylene. They
impart desirable qualities such as increased impact strength and toughness,
better melt characteristics, and improved clarity in films. Scale-up and cost-
effective manufacture of commercial quantities of single-site catalysts
especially metallocenes for the polyolefin industry, is the primary focus.
Formerly named Single-Site Catalysts, the name was changed to Sud-Chemie
Catalytica
14
in March 2000 to more closely identify the company with the parents of the joint
venture.
Beginning in early 2001, the Sud-Chemie Group will provide 100% of the funding
for the current year activity of Sud-Chemie Catalytica. In exchange for this
commitment, Sud-Chemie will receive an increased equity ownership in the joint
venture. We will continue to assess our position in the joint venture and can
resume funding at any time under the current operating agreement.
Catalytica NovoTec, Inc.
Catalytica NovoTec ("NovoTec") was formed by us in July 2000 to rapidly improve
chemical and petrochemical manufacturing processes using proprietary high speed
testing and computer learning technologies for the discovery and development of
new catalysts.
Shortly after the spin-off transaction, we conducted a strategic assessment of
our non-energy technology businesses. As a result of that review, we decided in
January 2001 to discontinue all operations within the NovoTec subsidiary.
In March 2001, we sold substantially all of the assets formerly used in
NovoTec's operations to NovoDynamics, Inc., a corporation founded by members of
NovoTec's prior management.
Human Resources
As of December 31, 2000, we employed 85 persons. None of our employees is
represented by a labor union. We believe our relations with our employees are
good.
Directors, Executive Officers and Key Employees
Our directors, executive officers and key employees are as follows:
Name Age Position with Catalytica Energy Systems
---- --- ---------------------------------------
Ricardo B. Levy.......... 56 Chairman of the Board and Director
Craig N. Kitchen......... 50 President and Chief Executive Officer and Director
Ralph A. Dalla Betta..... 56 Chief Technology Officer and Vice President, Technology
Dennis Riebe............. 58 Chief Financial Officer
Carl Schopfer............ 54 Senior Vice President, Engineering
Patrick T. Conroy........ 55 Senior Vice President, Product Development
Steven J. Oliva.......... 42 Vice President, Operations
Richard Buchanan......... 37 Vice President, Business Leader
Jacqueline Cossmon....... 45 Vice President, Investor Relations
Ronald L. Alto........... 51 Vice President, Sales and Service
Lawrence W. Briscoe...... 56 Director
William B. Ellis......... 60 Director
Frederick M. O'Such...... 63 Director
John A. Urquhart......... 72 Director
15
Thomas E. White.......... 57 Director
Ernest Mario............. 62 Director
Howard I. Hoffen......... 37 Director
Ricardo B. Levy, Ph.D. joined our board of directors in June 1995 as chairman of
the board. He was a founder of Catalytica, Inc., and was a director of
Catalytica, Inc. from 1974 to December 2000. He served as chief operating
officer from Catalytica, Inc.'s inception in 1974 until August 1991. He served
as president and chief executive officer of Catalytica, Inc. from August 1991
until December 2000. Before founding Catalytica, Inc., Dr. Levy was a founding
member of Exxon's chemical physics research team. Dr. Levy also serves on the
board of directors of the public company, Pharmacopeia, Inc. Dr. Levy has an
M.S. from Princeton University and a Ph.D. in chemical engineering from Stanford
University. Dr. Levy is an alumnus of Princeton and Harvard University's
Executive Management Program.
Craig N. Kitchen has served as our president, chief executive officer, and
director since July 2000. Prior to that Mr. Kitchen was a corporate vice
president at Triumph Group, a manufacturer of major airframe, structural and
aircraft engine components, where he most recently directed business for the
aerospace companies. From October 1994 to July 1997, Mr. Kitchen was a partner
at Stolper-Fabralloy, a supplier of combustors for aerospace and industrial gas
turbines, and led the business development efforts for new combustors such as GE
Aircraft Engines, Rolls Royce, Allison Engine and Solar Gas Turbines. From 1982
to 1994, Mr. Kitchen served in several senior management positions and was vice
president, repairs and overhaul/business development for AlliedSignal. Mr.
Kitchen holds a B.S.M.E. from the U.S. Air Force Academy and an M.B.A. from the
University of Northern Colorado.
Ralph A. Dalla Betta, Ph.D. has served as our chief technology officer and vice
president, technology since June 1995. From 1976 until the spin-off of
Catalytica Energy Systems, Inc., Dr. Dalla Betta was employed by Catalytica,
Inc. most recently as chief scientist. Prior to joining Catalytica, Inc., Dr.
Dalla Betta was a senior scientist at the Ford Motor Company. He has authored
over 40 scientific papers, holds 12 patents and is co-author of one book. He
holds a B.S. degree from the Colorado College and a Ph.D. in physical chemistry
from Stanford University.
Dennis S. Riebe has served as our chief financial officer since September 2000.
Prior to that, Mr. Riebe spent 34 years with AlliedSignal (now Honeywell), in a
variety of positions including both Finance and Operations. He served as the CFO
for an AlliedSignal Engines acquisition in Stratford, Connecticut, and has been
the Director of Cost Management and Director of Financial Planning and Analysis
for the AlliedSignal Engine business. Prior to that he was the Corporate
Controller for The Garrett Corporation, and served as an officer and member of
the Board of Directors for an international joint venture with the Republic of
China (Taiwan). Mr. Riebe is a graduate of Purdue University and has completed
graduate studies in business administration at Arizona State University.
Carl Schopfer has served as our senior vice president, engineering since April
2000. Prior to that, Mr. Schopfer spent over 20 years at AlliedSignal Engines
(formerly Garrett Turbine Engine Company), most recently as vice president,
engineering and technology. Prior to that he was AlliedSignal Engines' vice
president, strategic planning and business development. From 1968 to 1976, Mr.
Schopfer worked as a development engineer at the Allison Gas Turbine Division of
General Motors Corporation. Mr. Schopfer holds a B.S. in mechanical engineering
from the University of Missouri-Rolla and an M.B.A. from Butler University.
Patrick T. Conroy has served as our senior vice president, product development
since September 1998. Since October 1997, Mr. Conroy has served as president and
chief executive officer of GENXON Power Systems LLC, a joint venture we entered
into with Woodward Governor Company. From 1971 until February 1997, Mr. Conroy
was employed by Westinghouse Electric Corporation in the nuclear energy and
power generation businesses. Significant positions during his tenure at
Westinghouse included four years as operations manager of the nuclear service
business and six years as general manager of the power generation service
business. He was also the senior sales executive for Westinghouse's power
generation business in Europe, the Middle East and Africa and president of a
joint venture with Rolls Royce Industrial Power. Mr. Conroy holds a B.S. in
marine engineering from the US Merchant Marine Academy (Kings Point) and has
completed graduate work in business administration at Widener University.
Stephen J. Oliva has served as our vice president, operations since June 1998,
when he was promoted from director of operations, a position he had held since
joining us in May 1995. From March 1990 to May 1995, Mr. Oliva was with
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the consulting firm of Pittiglio, Rabin, Todd & McGrath, a leader in operations
and product development consulting to high technology companies, where he served
in a number of roles, including director of materials and director of operations
for various clients. Prior to that, Mr. Oliva held technical and management
positions in operations with DuPont, Hewlett Packard and Genentech. Mr. Oliva
holds a B.S. in chemical engineering from M.I.T. and an M.B.A. from Stanford.
Richard Buchanan has served as our vice president, business leader since October
2000. Prior to that, Mr. Buchanan spent 15 years with Allied Signal (now
Honeywell) in a variety of positions in Customer Support and was most recently
the Manager of Regional Turbofan, New Business Development. Mr. Buchanan holds a
B.S. in Business Management and an Associate of Applied Science Degree in
Aviation Management from Southern Illinois University.
Jacqueline Cossmon has served as our vice president, investor relations since
February 2001. Prior to that, Ms. Cossmon was vice president of investor
relations of Catalytica, Inc. from late 1998 to December 2000. Before joining
Catalytica, Inc. she spent over 18 years in the healthcare industry, with a
focus in the last nine years on investor and public relations. She has headed
the investor relation's efforts for Applied Biosystems and Applied Immune
Sciences. Prior to that, Cossmon held various management positions including
national sales manager and national accounts manager for biochemical and
bioseparation products at Applied Biosystems. She holds an MBA with an emphasis
in finance from Santa Clara University and is an active member of the National
Investor Relations Institute.
Ronald L. Alto joined us as our vice president, sales and services in March
2001. Prior to that, Mr. Alto was vice president of global marketing of Cytec
Industries, Inc. from 1999 to March 2001. Mr. Alto held various positions
including regional director Australasia and director of marketing, sales,
service and new business development at Honeywell from 1982 through 1998.
Before joining Honeywell, he held various management and engineering positions
at General Electric, Inc. from 1972 until 1981. He was an officer in the USAF,
and holds an Aeronautical Engineering degree from Arizona State University and
is an alumnus of management, marketing and business development programs at the
University of Southern California, University of Michigan, Thunderbird Graduate
School of International Management, and GE, Crotonville, Executive Business
Management Program.
Lawrence W. Briscoe has served as our director since our inception in 1995. Mr.
Briscoe has been the chief financial officer of Maxygen since January 2001.
Mr. Briscoe served as our chief financial officer from our inception until
September 2000. From July 1994 to December 2000, Mr. Briscoe served as the chief
financial officer and vice president, finance and administration of Catalytica,
Inc. Before joining Catalytica, Inc., he held various executive and financial
positions including president and chief operating officer and director of Brae
Corporation, vice president of corporate development at Transamerica Corp. and
chief executive officer of United States Commercial Telephone Corp. Mr. Briscoe
holds a B.S. in electrical engineering from the University of Missouri, an M.S.
in business from the University of Southern California and an M.B.A. from
Stanford University.
William B. Ellis joined our board of directors in September 1995. Mr. Ellis is a
senior fellow of the Yale University School of Forestry and Environmental
Studies. Mr. Ellis retired as chairman of Northeast Utilities in 1995, where he
also served as chief executive officer from 1983 to 1993. Mr. Ellis joined
Northeast Utilities in 1976 as its chief financial officer. Mr. Ellis was a
consultant with McKinsey & Co. from 1969 to 1976 and was a principal in that
firm from 1975 to 1976. Mr. Ellis serves on the board of directors of
Massachusetts Mutual Life Insurance Company and the Pew Center on Global Climate
Change. He has a Ph.D. in chemical engineering from the University of Maryland.
Frederick M. O'Such joined our board of directors in 1995. Mr. O'Such is
currently president and chief executive officer of Xertex Capital. From 1981 to
1986, Mr. O'Such served as chief executive officer of Xertex Corporation. From
1970 to 1981, Mr. O'Such served as group president and vice president, corporate
development with Envirotech Corporation. He served as group vice president with
Gulton Industries, Inc. from 1963 to 1970. Mr. O'Such is a member of several
boards of directors, including Herrick-Pacific Corporation, a public company.
Mr. O'Such holds a B.S. in chemical engineering from Lehigh University and an
M.B.A. from Harvard University.
John A. Urquhart joined our board of directors in April 1997. He currently
serves as senior advisor to the chairman of Enron Corp. and also served as the
vice chairman of Enron from 1990 to 1998. Mr. Urquhart also serves on a number
of other boards of directors, including those of the following public companies:
Enron, Hubbell Incorporated, TECO Energy, Inc., Weir Group PLC and Tampa
Electric Co. He previously served as the senior vice president/executive vice
president of industrial and power systems at General Electric. In addition, he
served five years as a committee member on the board of the United States
Council for Energy Awareness. Mr. Urquhart holds a B.S. in engineering from the
Virginia Polytechnic Institute.
17
Thomas E. White joined our board of directors in January 1998. Mr. White has
been designated by Enron Energy Services to serve as one of our directors
pursuant to Enron Ventures' right to nominate a director under its Series B
Preferred Stock Purchase Agreement and Omnibus Agreement. Mr. White was named
chairman and chief executive officer of Enron Power Corp., a wholly-owned
subsidiary of Enron, in 1991 and assumed the titles of Chairman and Chief
Executive Officer of Enron Operations Corp. in 1993, Chairman and Chief
Executive Officer of Enron Ventures Corp. in 1996, and Vice Chairman of Enron
Energy Services in 1998. Mr. White joined Enron in 1990 after retiring as a
brigadier general from the United States Army, following 23 years of military
service. Mr. White holds a B.S. in engineering from the United States Military
Academy and an M.S. in operations research from the United States Naval Post
Graduate School.
Ernest Mario, Ph.D. joined our board of directors in September 2000. Dr. Mario
is currently chairman and chief executive officer of ALZA. Before joining ALZA
in August 1993 Dr. Mario served as deputy chairman and chief executive officer
of Glaxo Holding p.l.c., having served in a variety of executive positions with
Glaxo, Inc. beginning in 1986. From 1977 to 1984, he held various executive
level positions with Squibb Corporation, ending as president and chief executive
officer of Squibb Medical Products. Dr. Mario is a member of the board of
directors of several companies, including the following public companies:
SonoSite, COR Therapeutics, Cepheid, Orchid BioSciences, Inc. and Pharmaceutical
Product Development Co. Dr. Mario has a Ph.D. and an M.S. in physical sciences
from the University of Rhode Island and a B.S. in pharmacy from Rutgers
University.
Howard I. Hoffen joined our board of directors in September 2000. Mr. Hoffen is
currently the Chairman and Chief Executive Officer of Morgan Stanley Dean Witter
Private Equity, and has been a Managing Director of Morgan Stanley & Co.,
Incorporated since 1997. He joined Morgan Stanley & Co., Incorporated in 1985
and Morgan Stanley Dean Witter Private Equity in 1986. Mr. Hoffen also serves on
a number of boards of directors, including the board of the public company,
Allegiance Telecom, Inc., and is a director of several privately held companies.
Mr. Hoffen has a B.S. from Columbia University and an M.B.A. from the Harvard
Business School.
Item 2. PROPERTIES
Our research and development facility is based in Mountain View, California,
occupying four buildings covering approximately 85,000 square feet. Our lease
expires on December 31, 2003, with a five-year option for renewal. Our research
and development facility is adequate for the Company's needs for the foreseeable
future.
We lease an additional 5,200 square foot facility in Scottsdale, Arizona, which
is used primarily for sales and engineering support functions. This lease
expires in August 2003.
Item 3. LEGAL PROCEEDINGS
On August 14, 2000, the City of Glendale filed a complaint against us,
Catalytica, Inc. and GENXON Power Systems, Inc. in Los Angeles County Superior
Court. The case has been transferred to the Orange County Superior Court, Case
No. 00CC13002. The complaint asserts claims against all defendants for breach
of contract, breach of the covenant of good faith and fair dealing, fraud and
negligent misrepresentation arising out of defendants' failure to complete its
performance under a Technical Services Agreement between the City of Glendale
and Catalytica, Inc. providing for the retrofit of the FT4 engine with the FT4
Xonon Combustion System. The City of Glendale seeks compensatory damages in
excess of $7,500,000 and punitive damages. On January 16, 2001, the court
granted, with leave to amend, Catalytica, Inc.'s motion to dismiss the causes of
action for fraud and negligent misrepresentation asserted in the complaint. The
defendants believe they have meritorious defenses to the remaining claims
asserted and intend to defend the action vigorously. While it is not possible to
predict with certainty the outcome of this matter, and while we do not believe
an adverse result would have a material effect on our financial position, it
could be material to the results of operations and cash flows for a fiscal year.
We have agreed to indemnify Catalytica, Inc. for any costs associated with this
matter.
18
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the stockholders of the Company
during the fourth quarter of the fiscal year covered by this report.
Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Common Stock
Our common stock is listed on the Nasdaq National Market under the symbol
"CESI." The following table sets forth high and low trading prices per share for
our common stock as quoted on the Nasdaq National Market from the effective date
of our spin-off, December 18, 2000 until December 31, 2000. Such prices
represent interdealer prices and do not include retail mark-ups or mark-downs or
commissions and may not represent actual transactions.
December 18, 2000
through
December 31, 2000
Common stock price
per share:
High $19 1/2
Low 12 5/8
As of February 23, 2001, there were approximately 784 holders of record of our
common stock, as shown on the records of our transfer agent. The number of
record holders does not include shares held in "street name" through brokers.
We have never paid cash dividends on our common stock or any other securities.
We anticipate that we will retain any future earnings for use in the expansion
and operation of our business and do not anticipate paying cash dividends in the
foreseeable future.
Item 6. SELECTED FINANCIAL DATA
The following tables contain selected financial data as of and for each of the
four years ended December 31, 1997, 1998, 1999 and 2000 and have been derived
from combined financial statements, which have been audited by Ernst & Young
LLP, independent auditors. The selected financial data relating to 1996 has been
derived from unaudited financial statements. The selected financial data are
qualified by reference to, and should be read in conjunction with, our financial
statements and the notes to those financial statements and Management's
Discussion and Analysis of Financial Condition and Results of Operations. No
cash dividends were declared in any of the periods presented.
19
Years ended December 31,
--------------------------------------------------
1996 1997 1998 1999 2000
------- -------- ------- ------- --------
(in thousands, except per share data)
Statement of Operations Data:
Research and development
contracts........................ $ 5,934 $ 5,139 $ 6,279 $ 3,053 $ 5,487
------- -------- ------- -------- --------
Costs and expenses:
Research and development(1)..... 6,451 6,009 9,313 9,627 11,277
Costs associated with
discontinued product line..... 268 -- -- -- --
Selling general and
administrative................ 708 671 1,269 4,786 10,660
------- -------- ------- -------- --------
Total costs and expenses....... 7,427 6,680 10,582 14,413 21,937
------- -------- ------- -------- --------
Operating loss.................... (1,493) (1,541) (4,303) (11,360) (16,450)
Loss on joint venture............. -- (4,355) (3,826) (1,133) (236)
Interest income................... -- -- 1,409 1,041 886
Interest expense.................. (114) (374) (177) (278) (110)
------- -------- ------- -------- --------
Net loss $(1,607) $ (6,270) $(6,897) $(11,730) $(15,910)
======= ======== ======= ======== ========
Basic and diluted
net loss per share(2) -- -- -- -- $ (15.91)
======= ======== ======= ======== ========
Weighted average shares used for
above calculation -- -- -- -- 1,000
======= ======== ======= ======== ========
December 31
-------------------------------------------------
1996 1997 1998 1999 2000
------- -------- ------- ------- --------
Combined Balance Sheet Data:
Cash, cash equivalents
and short term investments....... $ -- $ -- $ 22,847 $ 16,032 $ 58,713
Total assets...................... 2,767 2,871 28,520 19,840 67,772
Total stockholders'
equity (deficit).................. (8,928) (15,198) 24,137 12,552 57,470
(1) See Note 2 to the financial statements.
(2) Since we did not have a formal capital structure until December 2000, loss
per share information prior to that date has not been presented.
20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This report contains forward-looking statements within the meaning of Section
27A of the Securities Act and Section 21E of the Exchange Act, which involve
risks and uncertainties including but not limited to those statements containing
the words "believes", "anticipates", "estimates", "expects", and words of
similar import, regarding the Company's strategy, financial performance and
revenue sources. The Company's actual results could differ materially from the
results anticipated in these forward-looking statements as a result of certain
factors including those set forth under "Risk That Could Affect Our Financial
Condition and Results of Operations" and elsewhere in this report. The Company
undertakes no obligation to update publicly any forward looking statements to
reflect new information, events or circumstances after the date of this release
or to reflect the incurrence of unanticipated events. See "Forward-Looking
Statements".
Overview
We develop proprietary technologies that use catalysts to essentially eliminate
the formation of harmful pollutants and improve the performance of hydrocarbon
combustion systems such as gas turbines. We have developed Xonon Cool
Combustion, a breakthrough combustion technology that reduces temperatures in
combustion systems to avoid the formation of chemical pollutants without
diminishing combustion efficiency. We are developing and marketing Xonon Cool
Combustion technology for use in gas turbines in power generation and gas
pipeline compression applications.
In December 2000, we and Catalytica Advanced Technologies, Inc. were combined,
and all of the shares of the combined company were distributed on a pro rata
basis by Catalytica, Inc. to its stockholders.
In our early stage of development we were engaged in developing, manufacturing
and marketing technologies that use catalysts to measure the existence of
harmful pollutants. In 1995, we ceased efforts to develop measurement products
and disposed of related assets in 1996. Cumulative net costs associated with
this discontinued product line were $9.3 million. Prior to our combination with
Catalytica Advanced Technologies, as described above, new technologies were
developed through Catalytica Advanced Technologies. In July 2000, we formed
Catalytica NovoTec Inc. ("NovoTec") to develop improved catalytic processes
employing proprietary high speed testing and computer learning technologies.
In January 2001, all operations in NovoTec were ceased.
Our costs to date, excluding costs associated with the discontinued product
line, have primarily consisted of expenses to support Xonon development. We
expect to significantly increase our research and development expenses to
further commercialize Xonon. As we begin to fulfill commercial orders, we will
incur cost of goods sold expenses. Costs associated with Catalytica Advanced
Technologies to date have primarily consisted of expenses to support contracted
research.
All of our revenue has consisted of revenue from research and development
contracts funded either from gas turbine manufacturers, government sources or
research institutions, as well as contracted and collaborative research. We do
not anticipate product sales until at least 2001. These sales may require future
royalty payments to others. We expect to incur operating losses through at least
2003.
Results of Operations
Comparison of the years ended December 31, 1998, December 31, 1999, and December
31, 2000.
Revenue
For the year ended
December 31, Annual % Change
--------------------- ---------------------------
1998 1999 2000 1999/1998 2000/1999
----- ------ ------ --------- ---------
(in thousands)
Total revenue.. $6,279 $3,053 $5,487 (51)% 80%
21
Our revenue has consisted entirely of research and development revenues that are
derived from cost reimbursement contracts with gas turbine manufacturers,
government agencies and research institutions, as well as contracted and
collaborative research. Reimbursement contracts provide for partial recovery of
our direct and indirect costs. The timing of these reimbursements varies from
year to year, and from contract to contract, based on the terms agreed upon by
us and the funding party.
Revenue increased 80% for the twelve months ended December 31, 2000, compared
with the twelve months ended December 31, 1999. This increase was principally
due to securing $2.7 million of additional external development funding for
Xonon development programs. During 2000 we received $2.9 million of new revenue
related to GE programs. This increase was slightly offset by a $0.3 million
decrease in external funding related to Catalytica Advanced Technologies'
revenues as it decreased its emphasis on contract research and focused its
efforts on development of new business opportunities.
Revenue decreased 51% for the twelve months ended December 31, 1999, compared
with the twelve months ended December 31, 1998. This reduction was principally
due to a $1.2 million decrease in external research funding received by us
during 1999, as well as a $2.0 million decrease in Catalytica Advanced
Technologies' R&D revenue as it decreased its emphasis on contract research and
focused its efforts on development of new technologies through joint ventures.
Most of our research and development contracts are subject to periodic review by
the funding partner, which may result in modifications, termination of funding
or schedule delays. We cannot assure that we will continue to receive research
and development funding. In return for funding development, collaborative
partners receive certain rights in the commercialization of the resulting
technology. We expect to continue to pursue funded research programs. These may
not, however, be a continual source of revenue. Due to the nature of our
operating history, period comparisons of revenues are not necessarily meaningful
and should not be relied upon as indications of future performance.
Costs and Expenses
For the year ended
December 31, Annual % Change
---------------------- ---------------------------
1998 1999 2000 1999/1998 2000/1999
----- ----- ---- --------- ---------
(in thousands)
Research and development (includes
allocated costs from Catalytica, Inc. of
$1,938, $2,045 and $ 1,678 for the
years ended December 31,
1998, 1999, and 2000, respectively)................... $9,313 $9,627 $11,277 3% 17%
Selling, general and administrative
(includes allocated costs from
Catalytica, Inc. of $1,049, $1,052 and
$ 875 for the years ended
December 31, 1998, 1999, and 2000,
respectively)......................................... 1,269 4,786 10,660 277% 123%
Research and Development ("R&D"). R&D expense includes compensation and benefits
for engineering staff, expenses for contract engineers, materials to build
prototype units, fees paid to outside suppliers for subcontracted components and
services, supplies used and facility-related costs. We expense all R&D costs as
incurred.
R&D expense increased 17% for the twelve months ended December 31, 2000,
compared with the twelve months ended December 31, 1999. Once the prototype
development program of our 50% owned GENXON joint venture was completed in June
1999, the engineering efforts relating to additional catalyst system testing and
development were conducted principally by us and consequently resulted in our
having increased R&D costs of $2.0 million in 2000 over 1999. The increase in
R&D expenditures was also attributable to an increase of $2.0 million from Xonon
development programs. We expect to continue our R&D efforts, and we expect R&D
expense to increase in the future. The R&D expense increase was partially offset
by a net reimbursement of advances made by us to Enron totaling approximately
22
$1.1 million. In December 1999, we agreed to advance cash to Enron in order to
accelerate the development of Xonon cool combustion applications for turbines.
In exchange, Enron obligated itself to repay any advances at the end of nine
months in either cash or "turbine credits". Under the arrangement, if certain
conditions were met, Enron could gain the unilateral right to select whether it
would repay our advances with cash or settle them through turbine credits. The
turbine credits entitle the holder to a dollar-for-dollar credit on the purchase
of certain turbines that specify the use of our Xonon process. Because Enron
could gain the right to use the turbine credits to settle the advances and
because we were unable to reasonably estimate the amount we would ultimately
realize if Enron used turbine credits to settle the advances, we recorded a $1.2
million provision, which was equal to the amount advanced by us to Enron at
December 31, 1999. In March 2000, the agreement was amended and Enron reimbursed
us for approximately $1.1 million of the previous advance. Accordingly, that
amount was recorded in the first quarter of 2000 as a reduction of related R&D
expense.
R&D expense increased 3% for the twelve months ended December 31, 1999, compared
with the twelve months ended December 31, 1998. Although the total amount of R&D
expense remained relatively flat in 1999, R&D expense was impacted by a shift in
R&D spending from the GENXON joint venture back to us and a decrease in
Catalytica Advanced Technologies' R&D expense due to commencement of their joint
venture with Sud-Chemie. Beginning in the second half of 1996 through the end of
the second quarter of 1999, a significant portion of our research activity was
financed through and allocated to the GENXON joint venture. Once the prototype
development of the Kawasaki development program was completed in June 1999, we
assumed primary funding of additional catalyst system testing and development
which resulted in an increase in R&D costs of $0.9 million in 1999. In addition,
$1.2 million of costs incurred to accelerate the development of Xonon technology
also contributed to the increase in R&D expense in 1999. Lastly, the increase in
R&D expenses was partially offset by lower R&D expenses by Catalytica Advanced
Technologies in the amount of $1.7 million due to a shift in emphasis from
contract research to development of new technologies primarily through its 50/50
joint venture, Sud-Chemie Catalytica, which was formed in July of 1998. R&D
expenses that were previously incurred by Catalytica Advanced Technologies were
transferred to the Sud-Chemie Catalytica joint venture, which accounted for a
reduction of Catalytica Advanced Technologies' R&D expenses of $1.1 million in
the twelve months ended December 31, 1999 when compared to 1998. Catalytica
Advanced Technologies formed this joint venture to share development costs with
its joint venture partner.
Through the end of the second quarter of 1999, a significant portion of our
research activity was conducted on behalf of the GENXON joint venture (see "Loss
on Joint Venture"). As a result, some R&D costs were incurred by the joint
venture rather than by us. The following amounts of R&D expenses were incurred
by us (under our contract with GENXON) and charged to the GENXON joint venture:
none in 2000, $2.0 million in 1999, and $2.5 million in 1998. Additionally, the
GENXON joint venture incurred other significant R&D costs reflected in the
GENXON financial statements. Once GENXON completed its final program in June
1999, all further R&D efforts were conducted principally by us and consequently
are reflected in our R&D costs. We account for losses of our joint ventures
under the equity method of accounting.
Selling, General and Administrative ("SG&A") expenses include compensation,
benefits and related costs in support of corporate functions, which include
management, business development, marketing, sales and finance. Additionally,
SG&A expenses include charges by Catalytica, Inc. for various costs paid by
Catalytica, Inc. on our behalf, including facilities, finance, legal, human
resources, pension and other expenses. Charges for these services have been
allocated based upon square footage, usage, headcount and other methods that
management believes to be reasonable.
SG&A expenses increased 123% for the twelve months ended December 31, 2000,
compared with the twelve months ended December 31, 1999. This increase was
primarily due to $5.3 million in transaction costs recorded in the third and
fourth quarters which related to our spin-off and $0.9 million in severance
costs associated with the resignation of our former President and Chief
Executive Officer. In addition, $1.0 million of the increase was due to
increased staffing and administration costs of which $0.3 million was related to
the commercialization of Xonon and $0.7 million was related to NovoTec, our
subsidiary, which was formed in June 2000. The increases in 2000 in SG&A were
partially offset by a one-time charge of $1.3 million reserve for contingencies
which we incurred in 1999. We expect SG&A expenses to increase in the future as
we enter later stages of commercialization.
SG&A expenses increased 277% for the twelve months ended December 31, 1999 when
compared to the twelve months ended December 31, 1998. As we move toward
commercialization, we have developed a need to increase our marketing and other
SG&A activities. Related to this transition, our costs increased $2.2 million
between 1998 and 1999. Additionally, in 1999, we recorded a charge of $1.3
million for contingencies.
23
Loss on Joint Ventures
For the year ended
December 31, Annual % Change
-------------------- -----------------------
1998 1999 2000 1999/1998 2000/1999
---- ---- ---- --------- ---------
(in thousands)
Loss on joint ventures... $3,826 $1,133 $236 (70)% (79)%
In 1996, we formed a Delaware limited liability company, GENXON LLC, as a 50/50
joint venture with Woodward Governor to develop the potential market for
upgrading out-of-warranty turbines with new systems to improve emissions and
operating performance. We account for losses of our joint ventures under the
equity method of accounting. Under the equity method of accounting, we are
required to record losses in the joint venture because we made a capital
contribution in an equal amount during this period. We recognized 50% of the
loss of the joint venture to the extent of our capital contribution, which
resulted in losses of $0.2 million in 2000, $1.1 million in 1999, and $3.7
million in 1998. In the third quarter of 1999, GENXON completed its prototype
development of the Kawasaki combustion unit, and we began conducting subsequent
catalyst system testing programs. Although we expect to make further reduced
capital contributions during 2001, which will result in the recognition of
additional pro rata losses, neither joint venture partner is contractually
required to make such capital infusions. Our reduced level of investment in
GENXON is expected to continue throughout 2001.
In 1998, Catalytica Advanced Technologies formed a joint venture with United
Catalysts, Inc., a division Sud-Chemie Group, to form Sud-Chemie Catalytica. No
losses were recorded by Catalytica Advanced Technologies in 2000 and 1999
related to Sud-Chemie Catalytica, because it had recorded its share of losses to
the extent of its capital contribution of $0.15 million in 1998. The operating
agreement does not require any further capital contributions by Catalytica
Advanced Technologies or us beyond its initial $0.15 million contribution.
Therefore, we do not expect to incur further losses unless we decide to invest
additional capital beyond the initial $5 million commitment by the joint venture
partner.
Interest Income
For the year ended
December 31, Annual % Change
------------------- ---------------------
1998 1999 2000 1999/1998 2000/1999
---- ---- ---- --------- ---------
(in thousands)
Interest income... $1,409 $1,041 $ 886 (26)% (15)%
Our interest income consists of interest earned on cash, cash equivalents and
short-term investments. Interest income decreased for the twelve months ended
December 31, 2000, compared with the twelve months ended December 31, 1999, due
to reduced average cash balances attributable to the funding of operations.
Interest income in 2001 is expected to be higher than in previous years as a
result of higher cash balances related to $50.0 million of cash Catalytica, Inc.
invested in us in December 2000, immediately before the close of the
distribution of our common stock by Catalytica, Inc.
Interest income decreased 26% for the twelve months ended December 31, 1999 when
compared to the previous period, due to reduced average cash balances
attributable to the funding of operations. In January 1998, Enron Ventures
invested $30.0 million in our company. Prior to the Enron Ventures investment,
we had no interest income.
24
Interest Expense
For the year ended
December 31, Annual % Change
---------------------- ---------------------
1998 1999 2000 1999/1998 2000/1999
---- ---- ---- --------- ---------
(in thousands)
Interest expense........ $ 177 $ 278 $ 110 57% (60)%
Interest expense decreased 60% for the twelve months ended December 31, 2000,
compared with the twelve months ended December 31, 1999, due to Catalytica, Inc.
discontinuing charging Catalytica Advanced Technologies interest related to
intercompany debt owed to Catalytica, Inc. Catalytica Energy incurred a $0.1
million one-time interest cost in the first quarter of 2000 related to the
recovery of $1.1 million of the $1.2 million advance paid by us to Enron and
incurred to develop Xonon technology. Interest expense is expected to be
minimal for the next few years.
Interest expense increased 57% for the twelve months ended December 31, 1999
when compared to the previous period due to an increase of $0.1 million of
interest expense attributable to an increase of approximately $2.0 million of
intercompany debt balance between Catalytica Advanced Technologies and
Catalytica, Inc. Catalytica Advanced Technologies used borrowings from
Catalytica, Inc. to fund operations. Catalytica, Inc. charged Catalytica
Advanced Technologies interest of $0.2 million and $0.3 million for the twelve
months ended December 31, 1998 and 1999, respectively. In January 1998, we
received a $30.0 million investment by Enron Ventures. Prior to the Enron
investment, we used borrowings from Catalytica, Inc. to fund our operations. We
incurred interest expense to Catalytica, Inc. at an annual interest rate of 7%
on these borrowings.
Income Taxes
No benefit for federal and state income tax is reported in the financial
statements because of our Tax Sharing Agreement with Catalytica, Inc. In
accordance with this agreement, we are not reimbursed for the tax benefit of our
past losses and any net operating losses generated by us prior to our separation
with Catalytica, Inc. in December 2000.
Liquidity and Capital Resources
Year ended
December 31,
---------------------------------
1998 1999 2000
-------- ------- --------
(in thousands)
Cash, cash equivalents, and short-term
investments.............................. $ 22,847 $16,032 $ 58,713
Working capital........................... 22,424 10,653 51,552
Cash provided by (used in)
Operating activities...................... (3,784) (7,367) (10,740)
Investing activities...................... (10,017) (1,488) 66
Financing activities...................... 31,455 1,763 54,334
-------- ------- --------
Net increase (decrease) in cash and cash
equivalents.............................. 17,654 (7,092) 43,660
Current Ratio............................. 7.14 2.62 6.05
Prior to the spin-out transaction, Catalytica, Inc. made a $50.0 million cash
investment in us. At December 31, 2000, we had cash, cash equivalents, and
short term investments totaling approximately $58.7 million. We believe that
our current cash resources are adequate to fund currently contemplated
operations through at least 2002. Our cash requirements depend on numerous
factors, including completion of our product development activities, ability to
25
commercialize Xonon Cool Combustion technology, market acceptance of our systems
and other factors. We expect to devote substantial capital resources to further
commercialize Xonon Cool Combustion technology, hire and train our production
staff, develop and expand our manufacturing capacity, begin production
activities and expand our research and development activities.
Other Commitments
In December 2000, in connection with DSM's merger with Catalytica, Inc., we
agreed to indemnify DSM Catalytica for all liabilities related to us and
Catalytica Advanced Technologies incurred prior and subsequent to our spin-off
from Catalytica, Inc. Additionally, we agreed to indemnify DSM for any costs
associated with the merger, which were not reduced from the merger consideration
distributed to shareholders of Catalytica, Inc. in connection with the merger.
We entered into research collaboration arrangements that may require us to make
future royalty payments. These payments would generally be due once specified
milestones, such as the commencement of commercial sales of a product
incorporating the funded technology are achieved. Currently, we have three such
arrangements with Tanaka Kikinzoku Kogyo ("Tanaka"), Gas Research Institute
("GRI") and the California Energy Commission ("CEC").
We have developed our catalytic combustion technology under a development
agreement with Tanaka, a major Japanese precious metals company. Under this
agreement, Tanaka funded a significant amount of the development effort related
to this technology. In January 1995, we entered into a new agreement, for which
further development and commercialization of the catalytic combustion
technology, which superseded the original agreement. The new agreement divides
commercialization rights to the technology between the parties along market and
geographic lines. We have exclusive rights to manufacture and market catalytic
combustion systems for large gas turbines (greater than 25 MW power output) on a
worldwide basis and for small- and medium-sized gas turbines (25 MW power output
or less) in the Western Hemisphere and in Western Europe. Tanaka has reciprocal
exclusive rights to manufacture and market catalytic combustors for use in
automobiles on a worldwide basis and for small- and medium- sized turbines in
regions outside of our area of exclusivity. In each case, the manufacturing and
marketing party will pay a royalty on net sales to the other party, and an
additional royalty on net sales if the sale occurs in the other party's area of
exclusivity. Each party is responsible for its own development expenses, and any
invention made after May 1, 1995 is the sole property of the party making the
invention, while the other party has a right to obtain a royalty-bearing,
nonexclusive license to use the invention in its areas of exclusivity.
We entered into a funding arrangement with GRI to fund the next generation Xonon
combustor and demonstrate its performance. We will be required to make royalty
payments to GRI of $243,000 per year beginning with the sale, lease or other
transfer of the twenty-fifth catalyst module for gas turbines rated greater than
1MW, for seven years, up to a maximum of $1.7 million.
We entered into a funding arrangement with the CEC in which they agreed to fund
a portion of our Xonon-engine test and demonstration facility located in Santa
Clara, California. Under this agreement, we are required to pay a royalty of
1.5% of the sales price on the sale of each product or right related to this
project for fifteen years. We have the right to choose an early buyout option
for an amount equal to $2.6 million, without a pre-payment penalty, provided the
payment occurs within two years from the date at which royalties are first due
to the CEC.
We have never paid cash dividends on our common stock or any other securities.
We anticipate that we will retain any future earnings for use in the expansion
and operation of our business and do not anticipate paying cash dividends in the
foreseeable future.
Impact of Inflation
The effect of inflation and changing prices on our operations was not
significant during the periods presented.
Impact of Recently Issued Accounting Standards
FAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", is
effective for the fiscal year ending on or about December 31, 2001. It
establishes accounting and reporting standards requiring that every derivative
instrument be recorded on the balance sheet as either an asset or liability
measured at its fair value. We do not believe that adopting this statement will
have a material effect on our financial position or results of operations. In
December
26
1999, the Securities and Exchange Commission issued SAB 101, "Revenue
Recognition in Financial Statements". Adoption of this statement did not have a
material effect on our financial position or results of operations.
We have operated primarily in the United States and all sales to date have been
made in U.S. dollars. Accordingly, we have not had any material exposure to
foreign currency rate fluctuations.
RISKS THAT COULD AFFECT OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should carefully consider the risks described below before you decide to
hold or sell our common stock. If any of the following risks were to occur, our
business, financial condition or results of operations could suffer. In that
event, the trading price of our common stock could decline, and you may lose all
or part of your investment.
This annual report on Form 10K contains forward-looking statements based on our
current expectations, assumptions, estimates and projections about our company
and our industry. These forward-looking statements involve risks and
uncertainties. Our actual results may differ materially from those anticipated
in these forward-looking statements as a result of various factors, as more
fully described below.
Risks Related to Our Business
We are an early stage company and your basis for evaluating us is limited
Our activity to date has consisted of developing the Xonon Cool Combustion
technology and designing products for its commercialization. We do not expect to
ship our Xonon modules until at least 2001. Accordingly, there is only a
limited basis upon which you can evaluate our business and prospects. Since we
are an early stage company, our revenues will initially be low relative to the
size of likely orders and may therefore vary significantly from quarter to
quarter. You should consider the challenges, expenses and difficulties that we
will face as an early stage company seeking to develop, manufacture and sell a
new product.
We have incurred losses and anticipate continued operating losses through at
least 2003
As of December 31, 2000, we had an accumulated deficit of $59.9 million. We have
not achieved profitability and expect to continue to incur net losses until we
can produce sufficient revenues to cover our costs. Our current cash resources
are expected to finance operations through 2002. We expect to incur operating
losses through at least 2003, and we expect that we will need to raise
additional capital before we become profitable. Even if we do achieve
profitability, we may be unable to sustain or increase our profitability in the
future.
We must successfully complete further development work before Xonon-equipped gas
turbines can be shipped. Delays in completing this work could result in the loss
of orders, and the emergence of significant technical issues could result in
termination by OEMs of certain agreements to adapt Xonon to their gas turbines
Incorporating our technolog