Catalytica Energy Systems, Inc.

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Catalytica Energy Systems, Inc.

430 Ferguson Drive
Mountain View, California 94043
U.S.A.
Telephone: (650) 960-3000
Fax: (650) 965-4345
Web site: http://www.catalyticaenergy.com

Public Company
Incorporated: 2000
Employees: 85
Total Assets: $67.77 million (2000)
Stock Exchanges: NASDAQ
Ticker Symbol: CESI
NAIC: 54171 Research and Development in the Physical, Engineering, and Life Sciences; 335314 Relay and Industrial Control Manufacturing; 325188 All Other Basic Inorganic Chemical Manufacturing

Catalytica Energy Systems, Inc. is one of the world leaders in developing and marketing technologies related to the catalytic combustion of fossil fuels. The patented process and materials Catalytica has created—in particular its Xonon catalytic technology—will make possible the production of electrical energy by gas-fired turbines with virtually no polluting emissions. With General Electric (GE), Catalytica operates a large gas turbine equipped with Xonon technology at the Silicon Valley Power Plant near San Francisco. Catalytica is working on similar catalytic systems for motor vehicles and fuel cells. Catalytica plans to ship Xonon to its first commercial customers in late 2001.

1970s–80s: Origins

While Catalytica Energy Systems was founded in 1995 as Catalytica Combustion Systems, and not incorporated as a public company until 2000, its history may be traced to the formation of its former parent, Catalytica Inc. This company was founded in 1974 by Ricardo B. Levy and James A. Cusumano. Until Catalytica began making its breakthroughs in catalytic technology,

Cusumano was perhaps best known as the precocious teenage singer who fronted the Royal Teens when they had their 1950s hit record, “Who Wears Short Shorts?” In the early 1970s Cusumano and Levy were Ph.D. chemists at the Exxon laboratories in New Jersey who shared an interest in catalytic processes. In December 1974 they left Exxon, and with Michele Boudart, a professor of chemical engineering at Stanford University, anted up $10,000 each and founded Catalytica Associates, Inc. Catalytica was a consulting company that served the petrochemical industry. It operated at first out of Levy’s small basement but later moved to real offices in Silicon Valley.

By 1980 the company had a staff of 30 and had clients throughout the world. Cusumano and Levy were beginning to gravitate away from pure consulting toward research and development. They hoped to develop catalytic agents that would make possible more efficient energy production with lower pollution, for example in automotive engines and power plant turbines. However, they intended to approach their R&D work differently from other labs. Rather than slow and costly trial and error experiments with various substances, they planned to engineer made-to-order catalysts at the molecular level.

In the early 1980s a Catalytica board member introduced the partners to Tommy Davis, a legendary Silicon Valley-based venture capitalist who founded the Palo Alto-based Mayfield Fund. Davis made a series of investments in Catalytica, about $3 million in 1983 and another $2 million the following year. In October 1984 he helped broker a limited partnership, with Lu-brizol Corporation’s Catven unit that brought another $20 million to Catalytica. Those investments were meant to finance Catalytica for approximately five years while the company worked on developing marketable technologies.

By 1985, the company was known as Catalytica Inc. and employed 50 people, about half of whom held Ph.D. degrees. In 1988 it stopped consulting altogether to focus entirely on research and development (R&D). It would be some time before Catalytica was able to develop a commercially viable product, but the petrochemical and energy industries expressed interest in its work from the start. In 1989, Catalytica signed an agreement with Koch Industries, a chemical and petroleum refining company. In exchange for a minority interest in Catalytica, Koch invested $10 million and agreed to sponsor specific research projects. Successful technologies would be brought to market jointly by the two partners. Koch’s executive vice-president David Koch was given a seat on Catalytica’s board of directors.

Helping to fuel interest in Catalytica were the more demanding environmental laws of the late 1980s and early 1990s. Those laws called for significantly lower emissions by electrical power plants of the chemical nitrogen oxide, the primary component of smog and acid rain. Nitrogen oxide is created when fossil fuels are burned at high temperatures. Catalytica was developing processes that would enable plants to generate power by burning fuels at lower temperatures. “Environmental regulations are going to get nothing but more stringent,” James Cusumano told Alex Barnum of the Colorado Springs Gazette Telegraph. ”Besides, we have a moral responsibility to create technology that is cleaner and cleaner.”

By 1991, Catalytica’s work force had grown to 130, and the company was reporting revenues of approximately $13 million. The company was involved in 14 research ventures with ten different firms. Among its projects was the development of a component of plastics and petroleum refining that would eliminate the use of hazardous chemicals. A 1991 company backgrounder described Catalytica’s “three-pronged approach”: licensing out the technologies it developed; working with established companies on the production and marketing of those technologies; and, manufacturing and marketing products in Catalytica’s own facilities.

Breakthroughs in the 1990s

The year 1992 was significant for Catalytica. In February the company began working with Conoco Inc.,a subsidiary of E.I. du Pont de Nemours & Co., and Neste Oy, a Finnish oil company, developing a process to produce gasoline that met the standards of the Clean Air Act without the use of dangerous liquid acids. In July of the same year, the company announced the completion of a pilot program to recover bromine from hydrobromic acid waste. In December it signed a major deal with Japan’s Tanaka Kikinzoku Kogyo KK and the General Electric Company to develop processes to eliminate nitrogen oxide emissions in the generation of electricity by gas-fired turbines. Since March 1991 Catalytica had been working on the project with Tanaka, a company that produces and sells products for industrial use in electronics, automotive, catalysis and other applications. The December 1992 agreement brought in the giant GE, whose interest in the new technology stemmed from its position as a leading producer of gas-powered turbines. GE agreed first to fund turbine research at both Catalytica and Tanaka, and then to test any systems that were developed under normal operating conditions. The research on the technology, which Catalytica called Xonon, moved forward rapidly, and the agreement was extended in June 1993.

Catalytica announced another novel production process in January 1993. As part of a project that also involved Petro-Canada and Techmocisco Inc., a Mitsubishi Oil Co. Ltd. subsidiary, a process for making methanol directly from methane was developed. Methanol can be converted into a low-pollution fuel that powers cars, tractors and other motor vehicles. Earlier methods for converting methane to methanol were beset with problems. Highly reactive chemicals used in older processes led to unwanted and hard-to-control reactions. Catalytica’s new process utilized methyl bisulfate, a compound more easily controlled. In addition, Catalytica’s process was able to convert 43 percent of the methane to methanol compared with a meager 3 percent for other methods.

In late 1993 Catalytica received a patent for one of its Xonon processes. Around that time, Fortune reported that Catalytica was closer to creating non-polluting turbine processes than large competitors such as Exxon, Mobil, ICI, or Hoechst. A GE vice president told the magazine “We’ve been looking for a possibility of clean catalytic combustion with several companies in the past ten years, and Catalytica is the only one that seems to have really strong potential.”

1993: Catalytica Goes Public

In December 1992 Catalytica announced an initial public offering of three million shares. The stock first sold in February 1993, was priced at $7 a share, lower than the $9 to $11 Catalytica had hoped for. The company raised just over $28 million, some $10 million of which came from the Mitsubishi Oil Company, Ltd. Despite remarkable progress in its research, none of Catalytica’s projects had moved beyond the testing stage to commercial viability. In October 1993 it announced that revenues of $9 million for the previous year had been offset by losses of $7 million; what’s more, it predicted even greater losses for the two coming years. Most analysts did not regard this news as a cause for alarm. Based mainly on Catalytica’s progress in reducing nitrogen oxide emissions in gas-turbines, they predicted that the company would start showing profits around the 1995-96 fiscal year, and that significant earnings would be achieved in the years following.

Company Perspectives:

Catalytica Energy Systems develops catalytic systems that satisfy the growing demand for clean energy and high quality uninterrupted power for the energy market and is a leader in the field of catalytic combustion of hydrocarbon fossil fuels with over 19 patents issued and pending. Our Xonon Cool Combustion system is a breakthrough technology that essentially prevents pollution in power production. We are initially applying our Xonon catalytic technology in gas turbines used for electric power generation and gas pipeline compression applications. We are also discovering proprietary catalytic systems for power production from fuel cells.

By 1993 Catalytica was working on pharmaceutical intermediates, special chemicals used in the manufacture of pharmaceuticals. Catalytica hoped to develop processes that resulted in fewer polluting by-products than standard processes. In the fall of 1993 it was looking for a production facility where it could produce chemicals for drug companies. It found one in December 1993 in East Palo Alto, not far from Catalytica’s Mountain View, California headquarters. It purchased the plant from Sandoz Agro, Inc. and began supplying chemicals to Sandoz. Eventually some 40 workers were employed at the facility.

As expected, Catalytica reported large losses again in 1993, with $8.4 million in revenues, and $9 million in net losses. However, while its financials continued to languish, it continued its progress on both the production and the R&D fronts. It made its first commercial sales ever, $5 million in chemicals produced at its new Palo Alto plant, a success that led the company to look for other strategic partners in the drug industry. In April 1994, it was awarded a patent for its methanol conversion process. Later the same year, Advanced Sensor Devices, a Catalytica subsidiary, had developed a device that continuously monitored nitrogen oxide emissions. The sensor could be mounted directly on exhaust pipes and was not affected by weather conditions. Another sensor developed by Advanced Sensor Devices in 1994 was able to monitor hot wet samples for nitrous oxide or nitrogen oxide and needed only low maintenance.

By the end of 1994, Catalytica took another step toward commercial exploitation of its new technologies. The first was an 18 percent reduction in the company’s workforce—approximately 20 workers from throughout the company. “The streamlining was prompted by our desire to focus our financial resources on those programs that promise commercialization in the shortest possible time frame,” company president Ricardo B. Levy said in a company statement, “and is part of our transition from a research and development organization to a technology-based commercial business.” The reaction of the markets to the layoffs was initially negative. The day after Catalytica stock dropped a full point to three-and-three-quarters. However, less than three weeks later the company’s stock seemed to have recovered completely, its price rebounding by more than 18 percent.

By the mid-1990s, Catalytica’s research began to attract money from various granting organizations. In 1994 the Department of Commerce’s Advanced Technology Program awarded the company a grant of $2 million for work on the commercial feasibility of nanoscale catalysts—catalysts one-billionth of a meter and smaller—for petroleum and chemical industries. In November 1994 Catalytica’s Advanced Sensor Devices division received a three-year grant of $1.2 from the Gas Research Institute in Chicago to develop devices to continuously monitor nitrogen oxide emissions. In August 1996, another Catalytica unit, Catalytica Combustion Systems Inc., was awarded a $3.5 million contract from the Department of Energy’s Advanced Turbine System program to fund its research into cleaner, more cost-efficient gas turbines.

Reorganizing in the Late 1990s

Catalytica raised more money in May 1996 when it sold a 15 percent share of its Catalytica Fine Chemicals unit to Pfizer Inc. for $15 million. Catalytica agreed to perform research for Pfizer and to continue to supply chemicals to Pfizer’s production division. Just over a month later, Catalytica sold Advanced Sensor Devices to Monitor Labs Inc. for approximately $1 million up front, an undisclosed amount once the company’s monitors received final government certification, and royalties once the monitors went into regular production.

With the sale of its sensor division, Catalytica was able to concentrate most of its attention on developing its Xonon turbine systems. In September 1996 it announced the successful conclusion of initial tests on a turbine at General Electric. A spokesman for GE characterized the results as better than expected and expressed the expectation that the technology could be successfully incorporated into GE’s line of turbines. At the same time, Catalytica modified the process so it could be used on older turbines. In September 1996, the company, with Woodward Governor Company, formed a joint company called GENXON Power Systems. GENXON retrofitted otherwise unusable turbines with Catalytica technology. Prospects for the new company were good because of plans to deregulate the power industry.

Catalytica was able to sell its Xonon technology for the first time in November 1996. The city of Glendale, California, contracted Catalytica to retrofit an old turbine that, because of pollution restrictions, it was only permitted to run 200 hours a year. The job was experimental in some respects; it would demonstrate whether Catalytica turbines were able to operate under normal conditions on a long-term basis. The contract was an important one for the company. If all went well, Catalytica believed it could look forward to sales to thousands of electric companies throughout the world.

Key Dates:

1974:: James A. Cusumano, Ricardo Levy, and Michele Boudart found consulting firm Catalytica Associates, Inc.
1983:: Catalytica receives first $3 million in venture capital.
1988:: With first work on Xonon technology, Catalytica switches focus from consulting to research and development.
1989:: Catalytica signs a $10 million agreement with Koch Industries.
1991:: Catalytica begins working with Tanaka Kikinzoku Kogyo KK to develop Xonon technology.
1993:: Catalytica receives first Xonon-related patent; makes initial public offering; begins manufacturing ingredients for pharmaceuticals.
1994:: Catalytica receives $2 million grant from the Department of Commerce’s Advanced Technology Program.
1996:: Catalytica makes first sale of Xonon technology to city of Glendale, California.
1999:: Turbine equipped with Xonon technology produces a full gigawatt hour of virtually pollution-free energy.
2000:: Catalytica Inc. is purchased by DSM N.V.; Catalytica Combustion Systems spun off and renamed Catalytica Energy Systems.
2001:: The Environmental Protection Agency announces in February that tests it conducted verified the low emission rates in gas turbines equipped with Xonon.

In February 1997, Catalytica Fine Chemicals bought a chemical plant in Greenville, North Carolina, for about $247 million from Glaxo Wellcome. The purchase, and an accompanying $800 million pharmaceutical intermediates production contract with Glaxo, pushed Catalytica’s work force up to 1,400 and made it the third largest company in the San Francisco Bay Area. By 1999, Catalytica was producing drug-related products for Glaxo, Warner-Lambert Co., and Eli Lilly & Co.

In another major deal in June 1997 GE agreed to incorporate Catalytica’s technology into its line of gas-fired turbines. For Catalytica the news was a sign that its technology would become the industry standard. The market apparently agreed. A definitive deal with GE was signed in November 1998. In April 1998 Pratt & Whitney Canada Inc.’s United Technologies Corp unit placed an order for the Xonon combustion system, the first Catalytica received from an original equipment manufacturer and the first real indication that Xonon was commercially viable. Further evidence came in August 1999 when the company announced that a turbine equipped with Xonon technology had produced a full gigawatt hour of energy with virtually no pollution. In December 1999, Xonon was named the preferred emissions control system in the Pastoria Energy Facility, a power plant Enron Corp. proposed to build on Tejon Ranch land north of Los Angeles. Work on the facility was scheduled to begin sometime in 2001. The Environmental Protection Agency announced in February 2001 that tests it conducted verified the low emission rates in gas turbines equipped with Xonon.

In the summer of 2000, Catalytica took steps to refocus itself on what it saw as its core business, its energy technologies. In August it announced that the Dutch chemical company DSM N.V. would acquire most of its businesses for around $750 million and the assumption of $50 million in debt. DSM retained Catalytica’s profitable pharmaceutical-related units, including their production facilities. Catalytica’s energy-related operations, Catalytica Combustion Systems and Catalytica Advanced Technologies, were then spun off to form an independent company, Catalytica Energy Systems Inc. Catalytica shareholders received shares in the new company, along with a cash payment from the sale. An advantage of the spin-off for Catalytica was it created an independent company without an initial public offering. Some 85 percent of the shares of Catalytica Energy Systems remained in the hands of the company itself. The deal was approved by Catalytica shareholders in December 2000 and went into effect shortly thereafter.

As Catalytica Energy Systems, the company continued to develop its Xonon Cool Combustion technology. In August 2001 the company made a public offering of five million shares of stock, and in November it opened a new facility in Gilbert, Arizona. With over 40,000 square feet of space, the new plant would house a commercial manufacturing operation expected to begin in 2002.