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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-K

(Mark One)

or

Commission File No. 000-31953

CATALYTICA ENERGY SYSTEMS, INC.

(Exact name of Registrant as specified in its charter)

1388 North Tech Boulevard

Gilbert, Arizona 85233

(Address of principal executive offices)

(480) 556-5555

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.001 par value

(Title of Class)

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

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

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.    x

As of March 19, 2004, there were outstanding 17,827,312 shares of the Registrant’s common stock, par value $0.001, which is the only class of common stock of the Registrant registered under Section 12(g) of the Securities Act of 1933.

As of June 30, 2003, the aggregate market value of the shares of common stock held by non-affiliates of the Registrant (based on the last sale price for the common stock on The NASDAQ Stock Market on such date) was $25,868,665. For purposes of this computation, all officers, directors and 5% beneficial owners of the Registrant’s common stock are deemed to be affiliates. Such determination should not be deemed to be an admission or representation that such officers, directors or 5% beneficial owners are, in fact, affiliates of the Registrant.

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, 2003.

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CATALYTICA ENERGY SYSTEMS, INC.

Annual Report on Form 10-K

December 31, 2003

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FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan” and similar expressions identify such forward-looking statements.

The forward-looking statements in this report include, but are not limited to:

These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in these forward-looking statements. Factors that might cause actual results to differ include, but are not limited to, those discussed in the sections entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risks that Could Affect Our Financial Condition and Results of Operations.”

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We undertake no responsibility to update any of these forward-looking statements or to conform these statements to actual results.

“Xonon” is a registered trademark and “Cool Combustion,” “Catalytica Energy Systems” and the stylized Catalytica logo are trademarks of Catalytica Energy Systems, Inc.

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PART I

Overview

Catalytica Energy Systems, Inc. (“Catalytica Energy,” the “Company,” “we” or “us”) was incorporated in Delaware in 1995 as a subsidiary of Catalytica, Inc. Catalytica Energy operated as part of Catalytica, Inc.’s research and development activities from inception through the date of its incorporation as a separate entity. In December 2000, Catalytica Advanced Technologies, Inc., another subsidiary of Catalytica Inc., was merged into us, and the combined entity was spun out from Catalytica, Inc. as Catalytica Energy Systems, Inc., a separate, stand-alone public company.

We provide innovative emissions solutions to ease the environmental impact of combustion-related applications in the power generation and transportation industries. Since our inception, our business activities have included designing, developing and manufacturing advanced products based on our proprietary catalyst and fuel processing technologies to offer cost-effective solutions for reducing nitrogen oxides (“NOx”) emissions. We have commercialized and are marketing Xonon Cool Combustion^™, a breakthrough pollution prevention technology that enables natural gas-fired turbines to achieve ultra-low emissions power production through a proprietary catalytic combustion process. We are also pursuing the development of NOx reduction solutions for mobile, stationary and off-road diesel engines. In addition, we continue to conduct development efforts related to fuel processing systems for Proton Exchange Membrane (“PEM”) fuel cells used in vehicular applications.

We are focused on growing our business through a product and market diversification strategy in the area of NOx control. Increasingly stringent air quality regulations have resulted in tighter emissions restrictions being imposed on a variety of combustion-related applications. NOx emissions, which are a precursor to smog formation, have become a primary target of government-imposed emissions regulations, creating a significant opportunity for innovative, cost-effective NOx control solutions. According to a May 2003 study published by The McIlvaine Company, the market for NOx control in the power generation industry alone is estimated to reach $25 billion in worldwide sales over the next decade.

As a result of ongoing challenging conditions in the gas turbine industry, a slow to emerge distributed generation market and the pace of gas turbine original equipment manufacturer (“OEM”) commercialization activities, we completed a rigorous exercise in 2003 to realign our strategic direction and build a stronger business. This has been accomplished through broadening our product and service offerings in the area of NOx control beyond our Xonon Cool Combustion product for gas turbines. Accordingly, we have sharpened our focus on the pursuit of new business activity and expanding our portfolio of NOx-related products and services across new and growing markets. We are committed to solving NOx-related problems by providing the most economically compelling and most effective solutions available, whether it is through prevention or through some form of after-treatment. In addition to intensifying our development of NOx control after-treatment systems for diesel engines, which leverage our core Xonon^® technology, over the past year we have become more active in identifying strategic opportunities, including business acquisitions that complement our current products, expand the breadth of our markets or build upon our technical capabilities. In particular, we continue to focus on opportunities that offer near-term, profitable product and service offerings.

As part of this strategic initiative, in February 2004 we acquired SCR-Tech, LLC (“SCR-Tech”), the North American leader in catalyst regeneration technologies and management services for selective catalytic reduction (“SCR”) systems used by coal-fired power plants and other utility-scale power generating facilities to reduce NOx emissions. The addition of SCR-Tech strategically broadens and diversifies our product and service offerings to the growing emissions control market for coal-fired power plants and accelerates our penetration into the NOx control marketplace. We believe the acquisition of SCR-Tech has created a solid foundation for future growth and has strengthened our ability to continue pursuing development and commercialization efforts in other areas of our business, while also targeting additional business opportunities in the area of NOx control.

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NOx Control Solutions for Gas Turbines

Our Xonon Cool Combustion product is the only commercially available pollution prevention technology proven to achieve ultra-low NOx emissions of less than 3 parts per million (“ppm”) during combustion. Our Xonon^® system is integrated within a gas turbine, replacing the conventional flame-based combustion system with a catalytic process that combusts fuel at temperatures below the threshold at which NOx forms. This revolutionary approach to reducing emissions is a significant departure from traditional methods of achieving ultra-low NOx levels in gas turbine power generation, which involve cleaning up downstream the pollution produced in the combustion process through costly, add-on exhaust cleanup systems. Through pollution prevention instead of cleanup, we believe our Xonon system offers an efficient and cost-effective means for gas turbine operators to meet increasingly stringent Federal and State-imposed NOx regulations.

Industry Background and Market Opportunity

A gas turbine operates by compressing incoming air, combining it with fuel and combusting the mixture. The combustion process releases the fuel’s energy, forming hot gases that power the turbine. In conventional combustion systems, a flame is used to combust the fuel. The temperature required to sustain a stable flame is significantly higher than the temperature at which the gas turbine is designed to operate, so most of the incoming air is used to cool the combustion process to the level the turbine requires. The high temperature required for a stable flame causes the nitrogen and oxygen in the air to react, forming NOx, a major contributor to air pollution. Over the past twenty years, advanced flame-based systems have been developed which reduce the temperature at which the fuel is burned by altering the composition of the fuel—most often by using water, steam or air to dilute the concentration of fuel in the combustor before it is mixed with the compressed air and burned. As the fuel-air mixture becomes leaner, the combustion temperature lowers, thus reducing the NOx emissions. These systems are generically called “lean pre-mix” combustion systems. Today, most gas turbines are manufactured with a version of this type of system that uses air to dilute the mixture and are known as “dry low NOx” systems. Other than one gas turbine OEM that offers a 5 ppm NOx guarantee on one of its small gas turbine models, the most advanced flame-based combustion systems today are limited to achieving NOx levels of approximately 9 ppm for certain newer commercial lean pre-mix or dry low NOx systems, which are limited in application, and approximately 25 ppm for less sophisticated systems. Historically, the only alternative for meeting increasingly stringent ultra-low NOx emissions requirements has been to add a downstream exhaust cleanup system.

An ongoing barrier to adding new power generation capacity is the continued public focus on environmental issues. In the United States, the Clean Air Act creates the National Ambient Air Quality Standards, or NAAQS, which are the basis for regulations that limit emissions of certain harmful pollutants such as NOx. Today, U.S. emissions regulations generally require new installations of gas turbines to meet NOx emissions levels of 2.5 to 25 ppm, depending on the location and size of the installation. The general trend is toward the lower end of this range, with all areas of the U.S. today generally requiring ultra-low NOx emissions (less than 5 ppm) for new installations of gas turbines greater than 50 MW in size. In certain areas where air quality is currently unacceptable, smaller turbines (<50 MW) are also being required to achieve ultra-low NOx levels. According to the U.S. Environmental Protection Agency (“EPA”), it has been estimated that approximately 40% of the U.S. population lives in areas where the most stringent emissions requirements are being enforced. New EPA regulations targeted for 2006 are expected to increase to more than 60% the portion of the U.S. population living in areas imposing the most stringent emissions requirements.

We believe the role of environmental protection requirements in the permitting of new power generation capacity highlights the need for a cost-effective, widely-applicable emissions technology, like Xonon, that enables turbines to meet the most stringent existing emissions guidelines. We believe Xonon will not only reduce the operating costs associated with complying with environmental standards, but could also create additional value by enabling rapid siting and permitting of projects that otherwise may not have been possible.

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Xonon Cool Combustion

Our Xonon system combusts the fuel in a gas turbine using a different principle than conventional flame-based combustion systems. Instead of heating the fuel-air mixture in a flame until it is hot enough to burn, Xonon passes this mixture over a chemical catalyst that allows the combustion reaction to take place at much lower temperatures. A portion of the fuel is combusted in the catalyst. The remaining fuel is combusted downstream of the catalyst in a homogeneous reaction, also at a temperature low enough to prevent formation of significant amounts of NOx. The resulting concentration of NOx in the gas turbine exhaust will be in the range of 1 to 5 ppm and below 3 ppm in most gas turbines built today. Importantly, our flameless catalytic combustion approach provides the same amount of output energy as flame-based combustion systems while achieving ultra-low NOx emissions without add-on exhaust cleanup systems.

We are focused on bringing the benefits of Xonon Cool Combustion to the power generation market through our strategic relationships with leading gas turbine manufacturers. To gain market share and penetrate new markets, OEMs seek to differentiate their products with technological advances that benefit their customers. The ultra-low emissions capabilities and economic benefits offered by Xonon-equipped gas turbines could greatly enhance an OEM’s product line and offer significant competitive advantages.

Development and Commercialization

We have been working actively with gas turbine OEMs to adapt our technology as part of their stationary gas turbine product lines. We currently have collaborative commercialization agreements in place with Kawasaki Heavy Industries, Ltd. and Kawasaki Gas Turbines-Americas, a division of Kawasaki Motors Corp., U.S.A. (“Kawasaki”), and General Electric Power Systems (“GE”). We also have development work underway with Solar Turbines (“Solar”), to incorporate the Xonon system into its gas turbine line. Our development of the Xonon technology has been supported by government agencies and research institutions, including the U.S. Department of Energy (“DOE”), the EPA, the California Energy Commission (“CEC”) Public Interest Energy Research program, California Air Resources Board (“CARB”) and others.

For each turbine model that an OEM agrees to pursue, we design a catalytic Xonon module, the key component of the Xonon system, to be incorporated into the design of the turbine combustion system. At present, we guarantee our Xonon modules for 8,000 hours (equivalent to approximately one year of continuous operation), and are designed to be replaced during regularly scheduled maintenance over the 15- to 20-year life of the turbine. We expect future revenues to be generated from the sale of both new and replacement Xonon modules.

Since 1999, we have been conducting a field demonstration of our Xonon Cool Combustion system on a 1.4 megawatt (“MW”) Kawasaki gas turbine at Silicon Valley Power, a municipally-owned utility site, located in Santa Clara, California. The Company-owned turbine functions as part of the local power grid. Since its installation, the turbine has served as a demonstration of Xonon’s performance and reliability during unattended full-load operation and as a development and test engine in support of commercial program initiatives for customers. Since initiating the field demonstration, the Xonon-equipped turbine has run for more than 18,000 hours with NOx emissions consistently well below 3 ppm. The system has satisfied federal EPA guidelines for an emissions control technology that is “achieved in practice” and has demonstrated emissions levels that satisfy California’s South Coast Air Quality Management District (“SCAQMD”) guidelines for gas turbines. We believe Xonon is the only gas turbine combustion system demonstrated to meet these guidelines without requiring a downstream exhaust cleanup system. Furthermore, we have successfully completed evaluations by the EPA, through its Environmental Technology Verification program, and by CARB through its technology precertification program, both of which confirmed the ultra-low emissions performance of our technology while operating on a gas turbine.

In partnership with Kawasaki, we installed the first commercial Xonon-equipped gas turbine in November 2002, marking the world’s first commercial operation of a catalytic combustion system in a gas turbine and a

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major milestone in gas turbine innovation. The 1.4 MW Kawasaki gas turbine operating at Sonoma Developmental Center in Eldridge, California is also the first commercial gas turbine to generate ultra-low emissions power without the use of a downstream exhaust cleanup system.

Our initial product offerings target the small gas turbine sector, which includes turbines that generate between one and approximately 15 MW of power. According to Forecast International, the worldwide production of gas turbines in this size class is projected to average 312 units annually over the next 10 years. In North America, orders for gas turbines between one and 15 MW have averaged 40 units annually over the past three years according to Diesel & Gas Turbine Worldwide. Turbines in this sector serve industrial, commercial and institutional loads in both power only and combined heat and power, or cogeneration, applications and can help meet power requirements during periods of peak demand at base-load power facilities. Small gas turbines are also used in the pipeline industry to transport oil and gas.

Distributed generation applications, or power sources located at or near the point of use, can enhance power quality and reliability while avoiding the need to expand transmission and distribution capacity. We believe the distributed generation concept has the potential to address a number of ongoing problems in the power industry, including limitations in the bulk power transmission grids, environmental and community opposition surrounding the construction of new power lines, concerns about the vulnerability of the power infrastructure, and the need for high quality, reliable power. While the distributed generation market has proven slow to emerge, we believe there is a substantial, long-term market opportunity in constrained transmission pockets in certain areas of the U.S., whereby installations of small and medium-sized distributed power units, such as Xonon-equipped gas turbines, can serve to alleviate bottlenecks. The Los Angeles basin and certain areas of New York are examples of regions we believe could benefit from such a solution.

We are currently engaged with leading gas turbine manufacturers in adapting and marketing Xonon for the following gas turbines within the one to 15 MW size range:

Kawasaki M1A-13X (1.4 MW)—In December 2000, we entered into a collaborative commercialization agreement whereby Kawasaki could market and sell our Xonon Cool Combustion system as part of its GPB15X generator package, which features a 1.4 MW M1A-13X Kawasaki gas turbine. Kawasaki is actively marketing and accepting commercial orders for this generator package. The first commercial Xonon-equipped M1A-13X gas turbine entered operation at Sonoma Developmental Center in Eldridge, California in November 2002. This unit continues to operate as part of a cogeneration system, which is providing supplemental heat and power for a 120-building campus. A second commercial Xonon-equipped M1A-13X gas turbine entered service in December 2003 at Plains Exploration and Production Company’s oil field in San Luis Obispo, California. Kawasaki has shipped a third commercial Xonon-equipped M1A-13X for installation at the Reader’s Digest Association Headquarters in Pleasantville, New York, which is scheduled to enter service in the second quarter of 2004. We and Kawasaki are working on additional projects for the Xonon-equipped M1A-13X which could also enter service in 2004.

As part of our joint marketing and sales activities, we and Kawasaki continue to pursue initiatives to expand the penetration of Xonon-equipped gas turbines in the market. In February 2002, Kawasaki successfully petitioned the California Public Utilities Commission to expand qualification for self-generation financial incentives to include generating technologies up to 1.5 MW. As a result, California power projects considering installation of the Xonon-equipped M1A-13X may now qualify for a subsidy of up to 30 percent of project costs. Additionally, Kawasaki entered into a distribution agreement with Cummins Power Generation in December 2002, whereby Cummins will market, sell and service Kawasaki generator sets and power systems. This agreement creates an additional distribution channel for Xonon-equipped Kawasaki products.

GE10 (~10 MW)—We and GE continue to pursue adaptation of Xonon for the GE10 under a collaborative commercialization agreement signed in May 2000. As part of our ongoing development of a Xonon-equipped GE10, we and GE have performed a series of rig tests followed by the completion of an initial

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round of full-scale engine tests in the fourth quarter of 2003. These most recent test activities revealed the need for additional modifications of the catalyst and other combustion system hardware to better match the catalyst to the turbine characteristics and to achieve optimal performance within a commercial GE10 gas turbine environment. This has resulted in a delay in the commercialization prospects for a Xonon-equipped GE10. We and GE have agreed to pursue additional engine tests scheduled to commence in the third quarter of 2004 following our completion of catalyst modifications that are currently underway. The completion of these test activities will provide a basis for determining the future direction of our GE10 program.

Solar Taurus 70 (7.5 MW)—In October 2001, we entered into an agreement with Solar for the development and adaptation of the Xonon Cool Combustion system to Solar’s Taurus 70 gas turbine. The scope of our work in this joint development effort, which commenced in the first quarter of 2002, includes the design of supplementary combustor components in addition to the Xonon module for the catalytic combustion system. In January 2004, Solar commenced an initial round of full-scale rig testing associated with our jointly designed catalytic combustion system. We anticipate this testing to be completed by the summer of 2004.

Multi-combustor development (<15 MW)—In September 2001, the CEC granted us an award to help fund application of the Xonon Cool Combustion system to a small, multi-combustor gas turbine. The development effort for this program commenced in the first quarter of 2002. During 2003, we completed the technology development phase and are assessing ongoing plans for the program.

We also believe Xonon combustion systems can be applied to larger gas turbine sizes. Larger gas turbines are used by public utilities and wholesale generating companies in base-load power generating facilities, as well as for meeting power requirements during periods of peak demand and in energy intensive industrial facilities for power generation and cogeneration. OEMs who manufacture gas turbines larger than 15 MW include Alstom Power, GE, Mitsubishi Heavy Industries, Pratt & Whitney Canada and Siemens Westinghouse.

We have performed initial development work and testing of Xonon for large gas turbines. Preliminary tests conducted with GE and another large gas turbine manufacturer have confirmed Xonon’s ability to reduce NOx to ultra-low levels in the high temperature and high pressure operating conditions of a large, industrial-type gas turbine.

As a result of the weak economic environment and challenging market conditions in the gas turbine industry, particularly for large gas turbines, our current focus is to complete commercial deployment of Xonon on small gas turbines. We do not expect Xonon modules for large gas turbines to comprise a significant portion of our revenue in the foreseeable future.

Competition

We expect Xonon-equipped gas turbines to compete with turbines outfitted with current emissions reduction technologies, including advanced flame-based combustion systems and downstream exhaust cleanup systems. Advanced flame-based combustion systems, such as lean pre-mix or dry low NOx systems, are manufactured and provided by gas turbine OEMs as part of their turbine product line. These gas turbine OEMs also represent the potential customer base for our Xonon modules, and we expect to rely upon them to distribute Xonon-equipped turbines to end-users. While even the most effective of these systems have been unable to achieve today’s required ultra-low emissions levels without add-on exhaust cleanup systems, we expect that OEMs will continue to develop technologies that may compete with ours.

Various companies, including Cormetech, Engelhard, Mitsubishi and Siemens, manufacture conventional exhaust cleanup systems. End-users generally purchase these systems directly from the manufacturers, through packagers, or from vendors of heat recovery steam generation equipment. Gas turbine OEMs generally do not function as intermediaries in these transactions and do not receive any economic value from the sale of exhaust cleanup systems.

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The deployment of exhaust cleanup systems involves the combination of a gas turbine equipped with an advanced flame-based combustion system and the addition of downstream cleanup equipment, which is fitted onto the turbine to clean the exhaust. While cleanup systems have been proven to reduce NOx to ultra-low levels in most gas turbine applications, they add considerably to the square footage of the power generating facility, and can be costly to install and operate. For most downstream cleanup systems, other drawbacks may include a negative impact on turbine efficiency and the use of toxic substances, such as ammonia, to clean up the pollution after it has formed.

Through pollution prevention instead of cleanup, we believe our Xonon Cool Combustion system presents a more practical and cost-effective approach to reducing NOx to ultra-low levels in the form of a compact system integrated within the gas turbine itself. The installation of a Xonon-equipped turbine offers power producers an environmentally friendly, one-step approach to reducing NOx that requires no additional labor or space. Xonon can be widely applied and requires no toxic chemicals. As a result, we believe Xonon could ease the challenges associated with siting, permitting, and operating new power sources, enabling broader deployment of gas turbines in densely populated areas.

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. We are aware of other companies pursuing the development of ultra-low NOx technologies with gas turbine OEMs, including Precision Combustion, Inc., ALZETA Corporation and Cheng Power Systems.

We are also aware of companies developing NOx reduction solutions approaching ultra-low NOx emissions. Solar Turbines, a leading gas turbine manufacturer of small gas turbines in the one to 14 MW range, and also one of our development partners, recently announced that it has commercialized a 4.6 MW gas turbine with a 5 ppm NOx guarantee. We expect that other gas turbine OEMs may continue to advance their lean pre-mix or dry low NOx technologies and could eventually develop a system that achieves NOx emissions approaching the levels achieved by our Xonon system. We are also aware of one company, Power Systems Manufacturing (“PSM”) that has commercialized a 5 ppm retrofit NOx system for certain large gas turbine models greater than 60 MW in size.

We believe our Xonon system has a competitive advantage over competing emissions control alternatives as a result of our unique pollution prevention approach for achieving ultra-low emissions that has been proven in commercial installations. Further, we believe our significant investment in the technology, combined with our established OEM relationships and substantial intellectual property base will continue to yield an advantage over new entrants to the market.

Emissions Control Solutions for Diesel Engines

We are leveraging our decades of catalyst technology expertise with a proven fuel processing competency to offer innovative new engine and retrofit diesel emissions reduction solutions, targeted at helping diesel OEMs and government agencies meet the growing diesel emissions challenge.

Industry Background and Market Opportunity

In October 1997, the EPA adopted new NOx emissions standards for heavy-duty diesel truck and bus engines to be phased in through 2010. The first phase of these stricter limits took effect in October 2002 when the requirements for NOx were reduced from 4.0 grams per brake horsepower-hr (“g/bhp-hr”) to 2.5 g/bhp-hr. Non-compliance with the October 2002 deadline resulted in steep fines imposed by the EPA of as much as $12,000 per engine. The most stringent of the EPA’s new emissions standards requires a phased-in 50% to 90% NOx reduction over the current standards between 2007 and 2010, resulting in a 0.2 g/bhp-hr limit by the end of the decade for all heavy-duty diesel trucks and buses. The significant 90% reduction in NOx required by 2010, in

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particular, has created a major technological hurdle for diesel engine OEMs for which a single technology path has yet to be adopted. Lighter-duty diesel passenger cars, trucks and passenger vans in the U.S. are also facing tighter NOx emissions standards to be phased in during 2004 through 2009, dependent on vehicle type, with full compliance expected to be required by 2009.

Increasingly stringent emissions standards are also being imposed on diesel engine markets in the European Union (“EU”) and Japan. For example, in 2005 Japan will impose the world’s strictest emissions standards for urban heavy-duty trucks and buses, requiring a 41% reduction in NOx emissions from 3.38 grams per kilowatt-hour (“g/kWh”) to 2.0 g/kWh (or 1.49 g/bhp-hr). While current U.S., EU and Japanese emissions reduction mandates remain fragmented, there is a growing demand for the harmonization of tighter standards throughout these markets. The following chart details current global HDD NOx requirements and the year(s) that tighter standards are scheduled to take effect.

At the same time, mobile, stationary and off-road diesel engines in service today are coming under increasingly intense scrutiny by government officials in an attempt to reduce urban smog in emissions-sensitive areas across the country. According to the EPA, existing diesel sources contribute as much as 50% of NOx emitted in many U.S. urban areas, making them a prime target for emissions controls. Accordingly, government agency funding for diesel retrofits continues to develop in an effort to meet air quality objectives, and, in some cases, to avoid severe EPA sanctions or the loss of Federal Highway Administration funds. In addition, a growing number of federal and state programs to fund school bus retrofits have emerged over the past year in an effort to reduce asthma and other pediatric respiratory disorders associated with diesel exhaust.

The new engine market includes more than 1.2 million light, medium and heavy-duty trucks produced annually in the U.S. by diesel OEMs. Diesel OEMs continue to seek enabling solutions to meet increasingly stringent global emissions standards. U.S. heavy duty diesel (“HDD”) engine manufacturers have recently decided to pursue in-house engine modifications similar to those used in their 2002 complaint engines to meet the initial 2007 step-down in emissions requirements. However, the most severe NOx reduction requirements, which will be phased into various segments of the U.S. HDD market between 2008 and 2010, remain a difficult challenge that we believe will require some form of advanced NOx after-treatment or significant advances in diesel engine technology. We are also exploring opportunities in markets outside of the U.S., including Japan, which produces approximately 200,000 diesel bus and truck engines annually. Other global markets in Europe and Asia, which are considering more stringent emissions regulations similar to those being imposed in the U.S., could offer promising additional markets for our emissions solutions.

We believe that the retrofit diesel engine market in the U.S. offers a more near-term opportunity for us than the new engine market. The EPA estimated in 2001 that as many as 10 million sources of diesel emissions were in service in the U.S., many operating in emissions-sensitive areas of the country.

Funding sources for diesel retrofits are building on both the state and federal level. As a result of a recent growth in funding sources, the total addressable market for diesel retrofits is expanding. On the federal level, a variety of programs have been proposed to reduce emissions from a variety of diesel sources. The Congestion Mitigation and Air Quality (“CMAQ”) Program, sponsored by the Department of Transportation, and administered by the Federal Highway and Federal Transit Administrations, is providing funds totaling more than $1.75 billion per year for states to invest in air quality improvement projects, with diesel retrofit recently added as an acceptable candidate for appropriations. In 2003, for example, $13.8 million in CMAQ funding was provided for the retrofit of 1,700 diesel buses in the San Francisco Bay Area. In January 2004, the EPA called for the nation’s fleet of 444,000 school buses to install pollution control devices in an effort to combat rising health concerns associated with diesel exhaust fumes.

According to the Diesel Technology Forum’s Diesel Retrofit Funding Directory, a growing number of state agencies are now funding retrofit programs. Programs to retrofit diesel engines are in place today in Arizona, California, Georgia, Illinois, Massachusetts, New Jersey, New York, Pennsylvania, Texas and Washington.

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Texas alone is offering $100 to $150 million per year between 2003 and 2008 to help fund the deployment of retrofit solutions to achieve a significant reduction in air pollution and reach compliance with its State Implementation Plan (“SIP”) by 2007. According to industry reports, retrofit programs are also now emerging in Canada, Japan and in the European Union to address approximately five million HDD engines, as estimated by the 2003 Transportation Industry Data Book.

New Engine and Retrofit Applications Development

We are focused on bringing the benefits of our diesel NOx control systems to the growing diesel emissions reduction market by partnering with diesel OEMs, Tier 1 suppliers, system integrators, and other significant players within the diesel industry.

We have developed and are now refining a proprietary diesel fuel processor technology for new engine applications as a means for diesel OEMs to meet the most stringent impending NOx emissions regulations. Our Xonon fuel processor, or XFP, technology is designed to enable a 90% reduction in NOx by improving the performance of NOx traps. NOx trap systems, also referred to as NOx adsorbers, along with diesel SCR systems, Clean Diesel Combustion (“CDC”), and Low-Temperature Combustion (“LTC”), including Homogeneous Charge Compression Ignition (“HCCI”) solutions represent the most likely approaches believed to have the greatest potential to meet the EPA’s 2010 emissions mandate.

NOx traps adsorb NOx from the exhaust and convert the NOx to non-polluting nitrogen during a regeneration cycle. NOx trap technology today offers considerable NOx reduction capabilities, but performance issues related to durability, operating range and fuel economy have limited their real-world viability. In most cases, diesel fuel injected at the engine or in the exhaust system upstream of the NOx trap is used for the regeneration cycle. This process can give good performance at high exhaust temperatures, but historically has demonstrated poor performance at lower exhaust temperatures. Low exhaust temperatures represent a large portion of vehicle operating time, particularly for medium and light duty diesel engine applications used in urban areas and for automobiles, light trucks and SUVs. Our XFP is designed to deliver rapid, low-temperature NOx trap regeneration with improved fuel utilization and efficient desulfation (elimination of sulfur within the NOx trap associated with the sulfur naturally occurring within diesel fuel) to significantly improve NOx trap performance and durability. We believe the combination of our XFP with a NOx trap can enable diesel OEM implementation of a durable, deployable, reasonably sized NOx reduction solution that enables compliance with the most stringent emissions requirements with minimal fuel penalty.

In July 2003, we announced successful completion of a full-scale test of our prototype XFP on a 7+ liter HDD engine, which demonstrated the rapid regeneration capabilities of our technology and its potential to significantly improve the performance of NOx traps. The tests, which were conducted with a HDD engine manufacturer, focused on verifying the performance of our XFP at low exhaust temperatures. Test results demonstrated highly efficient, rapid NOx trap regeneration, resulting in NOx conversion in line with the EPA’s mandated emissions requirements for 2010. Importantly, our XFP demonstrated an ability to minimize the fuel penalty typically associated with regeneration of NOx traps, yielding up to a 50% improvement in fuel economy at critical low load points when compared to similar OEM tests using other regeneration methods.

These tests have provided us with valuable data that we are using to further enhance the operating range and fuel economy of our XFP system. While this first round of full-scale engine tests focused specifically on evaluating temperature and fuel economy performance, future development tests will also explore our XFP’s capability to enhance NOx trap durability. According to the EPA, improving the durability of NOx traps, especially as it relates to desulfation, remains a fundamental hurdle to commercial NOx trap deployment in HDD applications. We are committed to addressing these limitations and believe that further refinements to our XFP have the potential to significantly improve the durability, temperature range and desulfation issues associated with NOx traps.

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For new engine applications, we are committed to working with diesel OEMs, NOx trap providers and emissions system integrators to jointly develop and commercialize robust NOx control systems to meet the most stringent U.S. and international emissions requirements. To gain market share and penetrate new markets while maintaining compliance with new emissions standards, OEMs and Tier 1 suppliers (direct suppliers to OEMs) seek to differentiate their products with technological advances that benefit their customers. We believe that the combination of our XFP and a third party NOx trap has the potential to offer a cost-effective NOx reduction solution with minimal fuel penalty to enhance an OEM’s product line and offer significant competitive advantages.

We are also developing a retrofit solution for mobile, stationary and off-road diesel engine applications as a means for government agencies to address growing urban smog issues in emissions-sensitive areas. Our retrofit solution combines a derivative of our XFP technology with a proprietary lean-NOx catalyst and is being designed to offer a scalable, easily integrated solution for diesel engines currently in service. While still in early-stage development, our after-treatment approach is designed to offer a continuous production of a reactive reductant across a broad operating range to enable a 50% reduction in NOx.

If we are successful in developing this solution, there are three main benefits that could differentiate our technology from current retrofit solutions on the market today:

Subscale, in-house rig tests of our retrofit solution in 2003 demonstrated 50% NOx reduction while operating on standard U.S. highway diesel fuel with 500 ppm sulfur content. We have since completed the assembly of full-scale prototypes, which we are currently undergoing in-house engine tests to further develop the technology. We still have various technical hurdles to address before achieving a full-scale prototype solution that fully meets our design specifications. If we are successful, we then must complete a variety of integration activities before we can advance its development to a CARB verification-ready retrofit solution. We continue to evaluate our progress in developing a commercially viable retrofit solution and our ability to capitalize on the limited near-term diesel retrofit market.

For retrofit applications, we are focused on partnering with system integrators and field service providers to jointly develop and commercialize our product. We believe the scalable, viable integration retrofit solution that we are developing could have the potential to achieve maximum NOx reduction in a cost-effective manner to enhance a partner’s product line and offer significant competitive advantages.

In line with our objective to secure partners to further develop and commercialize our diesel NOx control systems for new engine and retrofit applications, we have taken an active role over the past year in establishing several prospective partner relationships within the diesel industry, both in the U.S. and internationally. As a result, we are in active discussions today with a number of OEMs, Tier 1 suppliers and retrofit integrators relating to testing and joint development opportunities in North America and Asia.

In the fall of 2003, we completed the construction of a diesel test facility in an effort to further advance the cost-effective development of our diesel NOx reduction solutions, and we have initiated in-house, full-scale engine tests. These tests are providing us with valuable data that we are using to further optimize our technology solutions for commercial application. This test facility will also enable us to simulate EPA certification and CARB verification protocols as well as advanced durability testing for a broad diesel engine population as we work to accelerate the product development path of our solutions for both new engine and retrofit applications.

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Competition

We expect our solutions to compete with current emissions reduction technologies under development by diesel OEMs, Tier 1 suppliers and systems integrators, which also represent the potential customer base for our NOx reduction solutions. While even the most effective of these systems has limitations relating to the amount of NOx reduction that can be achieved, we expect these diesel industry players will continue to develop technologies that may compete with ours.

For new engine applications, leading diesel engine manufacturers such as Cummins, Caterpillar, Detroit Diesel Corporation, Navistar-ITEC and Volvo are currently developing and exploring a variety of NOx control solutions, ranging from advanced fuel systems, cooled exhaust gas recirculation (“EGR”), NOx catalysts, advanced engine controls and SCR systems. Most of these diesel OEMs completed in-house engine modifications to achieve the October 2002 EPA mandate, and are now pursuing refinements to their engine designs to meet the next phase of U.S. emissions requirements that will take effect in 2007. However, diesel OEMs have indicated that further engine modifications will not be able to achieve the 2010 U.S. mandated 90% reduction in NOx without some form of advanced NOx after-treatment or significant advances in CDC or HDDI/LTC solutions.

While a variety of after-treatment technology paths are currently being evaluated in the U.S. to meet the 2010 EPA mandate, the solutions considered to have the greatest potential to meet the 0.2 g/bhp-hr target are NOx traps and SCR systems. With respect to SCR systems there are some significant downsides, associated with their use in mobile diesels, which have created concerns over their widespread use. SCR requires urea or ammonia to neutralize NOx in the exhaust, raising environmental concerns and requiring the creation of an infrastructure to house urea or ammonia tanks at filling stations across the country as well as associated compliance issues when tanks run dry.

NOx traps, on the other hand, use onboard diesel fuel in the NOx reduction process, eliminating both the need for a costly new infrastructure and the risk of noncompliance by truck operators. We believe that through the use of our XFP technology in combination with a NOx trap, we can enable a robust, cost-effective and practical commercial solution to meet the most stringent NOx requirements in the U.S. and select global markets. Accordingly, a growing number of diesel OEMs are inquiring about our ability to support their next phase of emissions control needs as NOx traps continue to be a favored technology path to comply with stringent environmental standards.

Over time, our XFP may also face competition from new entrants to the market for diesel emissions reduction. New entrants may eventually develop competing technologies that achieve a similar level of emissions reduction on a cost-effective and practical basis. We are aware of one other company, HydrogenSource LLC, which is pursuing the development of a diesel fuel reformer technology similar to ours that is designed to work in conjunction with a lean NOx trap to enable emissions reduction in line with the 2010 EPA mandate.

With respect to retrofit applications, we are aware of one company, Cleaire, which is marketing a catalyst-based retrofit solution offering a 25% reduction in NOx for mobile diesel applications. There are other companies currently offering or developing alternate NOx control options that may compete with retrofit solutions. These technologies include EGR, engine “repowers” or replacements, compressed natural gas, or CNG, and others. These alternatives may result in NOx reductions in excess of 50%, but we believe they are also more costly than retrofit solutions. Our retrofit solution may also face competition from new entrants to the market that may eventually develop competing retrofit technologies, catalytic or otherwise, that achieve a similar reduction in NOx as our technology on a cost-effective basis. Cleaire, for example, is currently developing a catalyst-based retrofit solution targeting a 40% reduction in NOx.

We believe that the successful development of our retrofit solution could offer a significant competitive advantage over alternate NOx retrofit solutions on the market today or currently under development. In addition

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to a NOx reduction potential of 50%, compared with the 25% NOx reduction currently being offered by another supplier, our solution is designed to be compatible with both ULSD and standard diesel fuels and to operate across a broader temperature range, possibly including low temperatures encountered while idling.

Fuel Processing for Vehicular Fuel Cell Applications

In 2001, we were selected by the DOE for an $11,658,000 cost-shared contract for the development of a compact fuel processor capable of operating on multiple fuels for use with fuel cells in transportation applications. The objective of the 48-month development program is to deliver a compact fuel-flexible fuel processor prototype to be used with PEM fuel cells in an automotive application. The lack of availability of a cost-effective, compact system that can convert conventional fuels, such as gasoline, to hydrogen to power fuel cells remains one of the barriers to widespread commercialization of fuel cell use in automobiles.

Since initiation of the program in October 2001, significant progress has been made in developing highly active, cost-effective and durable fuel reforming, water-gas-shift and preferential oxidation catalysts. Individual catalytic reactor components of the fuel processing system have been modeled and designed to achieve the targeted 60-second start-up time. Subscale prototype fabrication and demonstration tests of individual reactor components are expected to commence this year.

SCR Catalyst and Management Services

Our SCR-Tech subsidiary, which was acquired in February 2004, is based in Charlotte, North Carolina and offers catalyst cleaning, rejuvenation and regeneration as well as SCR system management and consulting services (collectively “SCR catalyst and management services”), to help power plant operators optimize their SCR system operation while reducing operating and maintenance (“O&M”) costs. SCR-Tech’s customer base includes some of the largest utilities and independent power producers (“IPPs”) in the U.S.

SCR Tech provides catalyst regeneration services by means of two patented processes that can fully restore the activity level of used SCR catalyst for significantly less cost than purchasing new catalyst. SCR-Tech is the only company in North America currently operating a commercial catalyst regeneration facility and offering catalyst regeneration in addition to cleaning and rejuvenation.

SCR-Tech also provides SCR system management and consulting services relating to system design and tuning, efficiency optimization, O&M cost reduction, catalyst specification and performance testing.

History of SCR-Tech

SCR-Tech’s roots go back to the mid-90’s when one of the founders of SCR-Tech, ENVICA GmbH, created a method for cleaning, rejuvenating and regenerating SCR catalyst in Germany. Meanwhile, EnBW, Germany’s third largest energy company and one of SCR-Tech’s former owners, was independently developing an innovative “in-situ” cleaning and rejuvenation process.

In 1997, ENVICA, in partnership with one of Germany’s largest utilities, Hamburgische Electricitätswerke AG (“HEW”), began developing an off-site regeneration process based on ENVICA’s core technology, which not only physically cleaned but also chemically regenerated SCR catalyst. The successful test results achieved with this process led to the decision to jointly market SCR catalyst regeneration services to other SCR plant operators in Germany and the construction of the world’s first full-scale commercial SCR catalyst regenerating facility. This process is marketed in Germany by ENVICA under the ENVICA Kat name. Both HEW and EnBW continue to use ENVICA’s regeneration processes in their coal-fired plants throughout Germany.

In March 2001, ENVICA and Energy & Environmental Consultants GmbH (“E&EC”), a German consulting company, formed SCR-Tech GmbH in Germany for marketing the regeneration process worldwide. In March

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2002, EnBW Energy Solutions GmbH became a shareholder of SCR-Tech GmbH together with the two founders ENVICA and E&EC. EnBW Energy Solutions granted an exclusive license to SCR-Tech for its proprietary and patented in-situ cleaning process that it had independently developed in 1995.

For the past six years, these technologies have been successfully applied commercially throughout Germany by SCR-Tech’s founding owners, leading to the creation of SCR-Tech LLC in the U.S. in 2001 to begin marketing the technology in the NAFTA regions. SCR-Tech subsequently initiated commercial operations in its Charlotte regeneration facility in early 2003.

Industry Background and Market Opportunity

SCR systems are used most commonly in large coal-fired and natural gas-fired power plants. SCR technology is based on catalysts that remove NOx from the power plant exhaust by reducing it with ammonia to elemental nitrogen and water vapor. Over time, ash buildup can cause physical clogging or blinding of the catalyst, which can negatively impact the performance of both the SCR system and the power generating asset. In addition, the NOx removal efficiency of SCR systems gradually declines as a result of catalyst deactivation caused by various catalyst poisons present in the flue gas, resulting in the need for some form of catalyst exchange. Historically, the spent catalyst has been replaced with new catalyst, a costly proposition. Because utilities and IPPs have been facing increasing pressure to lower their O&M costs, plant operators are seeking more cost-effective SCR catalyst management solutions.

NOx is considered to be one of the principal contributors to secondary, ground level ozone, or smog, and energy producers and other industries operating large power plants, particularly in the Eastern half of the U.S, have been required to reduce their NOx emissions by at least 85 percent by 2007 as part of the EPA’s NOx SIP Call. The NOx SIP Call requires major NOx reductions during the “ozone season” (May 1-September 30) in 19 Midwestern and Eastern states¹ and the District of Columbia to mitigate the regional transport of ozone, which is contributing to the poor air quality of downwind states. As a result, these areas are required to revise their SIPs, outlining measures they intend to make to reduce NOx emissions to a statewide limit determined by the EPA for each affected state. As part of the NOx SIP Call, these areas are required to begin implementing new controls by April 2004 to reduce NOx emissions in an effort to reach compliance with EPA established limits by September 2007. In general, during non-ozone season periods, most operators will not have any requirements to run their SCR systems unless regulations are further tightened.

Coal-fired plants currently account for more than half of the nation’s power generating capacity. With NOx removal efficiencies of up to 95 percent, we believe that SCR systems are the most effective and most widely used technology by power plant operators to comply with increasingly stringent U.S. emissions regulations. As a result, the installed base of SCR systems has increased dramatically in recent years. It is projected that by the end of 2005, approximately 100 gigawatts of coal-fired generating capacity will have been retrofitted with SCR systems to comply with the EPA’s NOx SIP Call. As a result of the growing base of SCR system installations, the market for SCR catalyst services is expected to more fully develop in the 2006-2007 timeframe. Furthermore, it is projected that the available market for catalyst replacement could reach $100 million by 2010. We believe that catalyst regeneration has the potential to play a significant role in this market, as it offers a more cost-effective approach than the replacement of deactivated catalysts.

SCR-Tech’s Service Offerings

SCR-Tech offers proprietary and patented processes based on highly sophisticated and advanced technologies that can extend the useful life of installed SCR catalyst and offer a compelling economic alternative to catalyst replacement.

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SCR-Tech’s processes are capable of not only physically cleaning and rejuvenating the most severely plugged, blinded or poisoned catalyst, but of also chemically reactivating deactivated catalyst. SCR-Tech’s off-site regeneration process restores deactivated SCR catalyst back to its original specifications and catalytic activity with no physical damage to the catalyst. In this process, the customer removes the deactivated catalyst modules from the SCR unit and ships them to SCR-Tech’s regeneration facility. Once regenerated, SCR-Tech returns the catalyst modules to the customer for reinstallation in the SCR unit. Upon reinstallation, the regenerated catalyst delivers the same level of performance and deactivation rate as the original catalyst. Catalyst regeneration provides SCR operators a significantly lower cost alternative to catalyst replacement and essentially eliminates the need to dispose of deactivated catalysts, which can be considered hazardous waste.

For lightly plugged or blinded catalyst that has not yet fully deactivated from catalyst poisons, SCR-Tech offers an “in-situ” cleaning process that can be performed on catalyst while the catalyst remains in the SCR unit at the customer’s plant site. This process offers the advantage of extending the life of SCR catalyst and significantly improving its NOx removal efficiency without requiring removal of the catalyst from the SCR unit.

SCR-Tech’s cleaning, rejuvenation and regeneration services are expected to represent the majority of SCR-Tech’s projected future revenues.

SCR-Tech also provides SCR system management services including ammonia injection grid (“AIG”) tuning to optimize efficiency and reduce overall O&M costs, and consulting services related to the management and design of SCR systems, including catalyst specification, selection and initial performance testing for guarantee verification.

Customers

Since its founding in May 2001, SCR-Tech has secured contracts with some of the largest utilities and IPPs in the U.S., including AES, Duke Energy, Mirant, National Energy & Gas Transmission, and Southern Company’s subsidiaries, Alabama Power and Georgia Power. In March 2003, SCR-Tech greatly expanded its service offerings when it commenced commercial operation in its regeneration facility. SCR-Tech completed orders in 2003 totaling approximately $3.0 million.

As part of an ongoing commercialization strategy, SCR-Tech is actively targeting SCR operators throughout North America to broaden its established customer base and is in active negotiations today with several potential new customers.

In the fourth quarter of 2003, SCR-Tech signed a service contract with AES relating to its entire installed base of SCR systems after having worked with one of AES’ plants for two years under a management and consulting agreement. As part of this agreement, SCR-Tech will now provide SCR system management and catalyst regeneration services to AES’ entire installed base of more than 25 fossil fuel-fired units equipped with SCR systems.

Competition

We expect SCR-Tech’s cleaning and rejuvenation processes to compete with alternate cleaning and rejuvenation processes currently in the marketplace. We are aware of two companies that offer on-site cleaning and washing of SCR catalyst; however we believe that SCR-Tech’s patent-protected cleaning process offers several competitive advantages, including both an off-site process and an “in-situ” process that does not require the removal of the catalyst from the SCR system.

While there is some competition for catalyst cleaning and rejuvenation, we are not aware of any other company in North America offering a regeneration process that can chemically reactivate SCR catalyst back to its original specifications. Accordingly, new catalyst remains the primary competition for SCR-Tech’s

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regeneration process. The leading SCR catalyst suppliers to the U.S. coal-fired power generation market include Cormetech, Haldor Topsøe and Hitachi America. While we believe that SCR-Tech’s regeneration process offers a significant cost advantage over the purchase of replacement catalyst and essentially eliminates hazardous waste disposal issues associated with spent catalyst, it is possible that these companies and others could eventually develop a solution that may compete with ours. Nonetheless, we believe the strength of SCR-Tech’s intellectual property and patent protection creates a significant barrier for new entrants to the market. In addition, we believe that our first mover advantage in the regeneration marketplace will help us maintain our leading market position.

Facilities

In the summer of 2002, after having leased 46,000 square feet of industrial processing, warehouse and office space on an existing chemical production site in Charlotte, North Carolina owned by Clariant, Corp., SCR-Tech commenced modification of the production building and installation of the process equipment to build out its regeneration facility.

In March 2003, SCR-Tech completed its modification of and brought on-line the first regeneration facility in North America. The facility’s current capacity is expected to be sufficient for the near future. When necessary, the existing facility can be expanded to accommodate a doubling of capacity with minimal incremental costs. Any expansion costs are anticipated to be funded through the growth of the business.

SCR-Tech is fully licensed, permitted and in compliance with all relevant local and federal regulations required for or related to its business operations in its Charlotte facility. The site owner is also fully licensed, permitted and equipped for the removal and treatment of the waste water created by SCR-Tech’s cleaning and regeneration processes, which does not generate any hazardous waste.

For a more detailed discussion of the environmental risks that may be associated with the operation of SCR-Tech’s business and the nature of its assets, see “Additional Risks Relating to SCR Catalyst and Management Services.”

Manufacturing

In October 2002, we brought on-line a commercial manufacturing facility in our Gilbert, Arizona location, which is being used to manufacture both prototype and production Xonon modules for gas turbine applications as well as prototypes of our diesel NOx reduction solutions. In the second quarter of 2003, we implemented an advanced product quality assurance system and installed a new, more robust coating line in our Gilbert facility, enabling us to further enhance our manufacturing operations. We also have manufacturing capability in our Mountain View, California facility, which is used primarily for the manufacture of prototypes as part of our ongoing research, development and test activities.

We have sufficient capacity in our Gilbert facility to build both development and production Xonon modules for gas turbines to satisfy our needs for the near future. We plan to retain all proprietary manufacturing within our facilities and to outsource the manufacturing of non-critical components to third party suppliers. We expect the Xonon modules to be returned to us at the end of their useful life. We plan to reclaim, reuse or recycle most components of the module, particularly the precious metals palladium and platinum, in order to reduce our costs and protect ourselves against the volatility of precious metal prices.

While we are currently manufacturing prototypes of our diesel emissions solutions in both of our facilities, we plan to outsource portions of our future commercial production to leverage the expertise of high-volume manufacturers and achieve our goal of producing cost-effective diesel emissions reduction solutions.

In the fourth quarter of 1999, we earned ISO 9001 Registration from Underwriters Laboratories, Inc. for the design and manufacture of Xonon modules at our Mountain View, California facility. In the fourth quarter of

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2002 we also earned IS0 9001 Registration for our Gilbert, Arizona commercial manufacturing operations and subsequently completed the transition to the ISO 9001:2000 standards in October 2003 following an audit of our quality system. In addition to being awarded ISO 9001:2000 certification from Underwriters Laboratories, Inc., we received commendations of excellent system processes for our Integrated Product Development System and Manufacturing Control, further demonstrating our commitment to high quality standards and customer satisfaction.

Intellectual Property

We rely on a combination of patents, trade secrets, trademarks, copyrights and contracts to protect our proprietary technology. Our intellectual property strategy is to identify key intellectual property developed or acquired by us in order to protect it in a timely and effective manner, and to use such intellectual property to our competitive advantage in the NOx control marketplace. 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. As of the date of this filing, we either owned (exclusively or jointly), held exclusive license rights from third parties for, or held license rights from affiliates for 28 U.S. patents and 22 pending applications and the international counterparts associated with some of them.

We use patents as the primary means of protecting our technological advances and innovations. We have adopted a proactive approach to identifying patentable inventions and securing patent protection through the timely filing and aggressive prosecution of patent applications. Our employees participate in a comprehensive invention disclosure program involving preparation of written invention memoranda and preservation of supporting laboratory records. Patent applications are filed in various jurisdictions internationally, which are carefully chosen based on the likely value and enforceability of intellectual property rights in those jurisdictions and to strategically reflect our anticipated major markets.

We actively monitor our patent position, technical developments and market activities of our competitors. We believe that our growing patent portfolio, especially when coupled with a strong enforcement program, can provide us with a significant advantage over our competitors. We plan to vigorously defend our intellectual property.

Portions of our know-how are also protec