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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
Annual Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the fiscal year ended March 31, 1996 Commission file 0-146-02
CYANOTECH CORPORATION
(Exact name of Registrant as specified in its charter)
NEVADA 91-1206026
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
73-4460 Queen Kaahumanu Hwy., Suite 102, Kailua-Kona, HI 96740
(Address of principal executive offices)
(808) 326-1353
(Registrant's telephone number)
Securities registered pursuant to Section 12(b) of the Exchange Act:
NONE
Securities registered pursuant to Section 12(g) of the Exchange Act:
Title of class
--------------
Common Stock, Par value $.005 per share
Check 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 past 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
-- --
Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B is not contained in this form and will not be contained, to the best of the
registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendments to
this Form 10-KSB. ____
The registrant's revenues for the fiscal year ended March 31, 1996 were
$8,081,000.
At June 24, 1996, the aggregate market value of the registrant's Common
Stock held by non-affiliates of the registrant was approximately $71,060,898.
At June 24, 1996, the number of shares outstanding of registrant's Common
Stock was 12,657,270.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement to be filed with the Securities and
Exchange Commission on or prior to July 26, 1996 and to be used in connection
with the Annual Meeting of Shareholders expected to be held September 19, 1996
are incorporated by reference in Part III of this Form 10-KSB.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
Except for historical information contained herein, the matters discussed
in this report contain forward looking statements that involve risks and
uncertainties that could cause results to differ materially.
GENERAL
Cyanotech develops and commercializes natural products from microalgae. The
Company is currently producing microalgae products for the nutritional
supplement and immunological diagnostics markets and is also developing
microalgae-based products for the aquaculture feed/pigments, biopesticide and
food coloring markets. Microalgae are a diverse group of over 30,000 species of
microscopic plants which have a wide range of physiological and biochemical
characteristics and naturally contain high levels of nutrients. Microalgae
represent a largely unexplored and unexploited renewable natural resource, which
grow much faster than land-based plants. Under favorable growing conditions,
certain microalgae produce a new crop every week. Cyanotech has designed,
developed and implemented proprietary production and harvesting technologies,
systems and processes which eliminate many of the stability and contamination
problems frequently encountered in the production of microalgae. The Company
believes its technologies, systems, processes and favorable growing location
permit year-round harvesting of its microalgal products in a cost effective
manner. The Company believes that these accomplishments have not been equaled by
any other company, university or research institute.
Cyanotech's principal revenues are derived from sales of microalgae-based
"Spirulina" products for the vitamin and supplement market. SPIRULINA PACIFICA
is a unique strain of Spirulina developed by Cyanotech which provides a
vegetable-based, highly absorbable source of natural beta carotene, mixed
carotenoids and other phytonutrients, B vitamins, gamma linolenic acid ("GLA"),
protein and essential amino acids. The Company believes its Hawaiian SPIRULINA
PACIFICA has achieved high brand identity among both wholesale and retail
customers, and that the Company's products have better taste, more consistent
color and greater concentrations of natural beta carotene than competing
Spirulina products. Cyanotech currently markets its products in the United
States and twelve other countries through a combination of retail, wholesale,
and private label channels, and plans to market new products either directly or
through strategic alliances where appropriate.
Cyanotech maintains an environmentally responsible philosophy in the
development and production of its products, using natural production methods and
resources which employ extensive recycling of raw materials and nutrients. The
Company believes that these recycling methods result in substantially lower
operating costs. The Company's production system operates without the use of
pesticides and herbicides, and does not create erosion, fertilizer runoff or
water pollution. The Company believes that it is the only producer of microalgae
to receive organic certification.
The Company is incorporated in Nevada. Its principal executive offices are
located at 73-4460 Queen Kaahumanu Highway, Suite 102, Kailua-Kona, Hawaii
96740, and its telephone number is (808) 326-1353. Unless otherwise indicated,
all references in this report to the "Company" and "Cyanotech" refer to
Cyanotech Corporation, a Nevada corporation, and its wholly owned subsidiary,
Nutrex, Inc.
SPIRULINA PACIFICA-TM-, OCEAN-CHILL DRYING-TM-, HAWAIIAN ENERGIZER-TM- and
NUTREX-TM- are trademarks of the Company. SPIRULINA PACIFICA is a registered
trademark of the Company in Japan. The SPIRULINA PACIFICA logo is a registered
trademark of the Company in the United States.
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INDUSTRY BACKGROUND
Microalgae are a diverse group of microscopic plants that have a wide range
of physiological and biochemical characteristics and naturally contain, among
other things, high levels of proteins, amino acids, vitamins, pigments and
enzymes. Microalgae grow extremely fast, making it possible to harvest a new
crop every week utilizing optimal culture and processing technologies. The raw
materials required for microalgae growth are abundant and include sunlight,
carbon dioxide and agricultural fertilizers.
Research on potential uses of microalgae began in the early 1900s and
intensified after World War II. One of the first comprehensive reviews on
applications of microalgae and methods to grow microalgae was in ALGAL CULTURE
FROM LABORATORY TO PILOT PLANT, published by the Carnegie Institute in 1953.
Most early work centered on microalgae as a food and this theme was carried into
recent work by NASA, which continues to examine microalgae as a source of food
as well as a means to remove carbon dioxide and generate oxygen in outer space.
Current industry and university research is directed at identifying unique
compounds produced by microalgae for the fine chemical and pharmaceutical
markets.
Over 30,000 species of microalgae are known to exist and represent a
largely unexplored and unexploited renewable natural resource. Microalgae has
the following properties that make commercial production attractive:
(1) microalgae grow much faster than land grown plants; (2) microalgae have a
uniform cell structure with no bark, stems, branches or leaves, which permits
easier extraction of products and higher utilization of the microalgae cells;
(3) cellular uniformity also makes it practical to manipulate and control
growing conditions in order to optimize a particular cell characteristic;
(4) microalgae contain a wide array of vitamins and other important nutrients;
and (5) microalgae contain natural pigments and are a potential source of
medical products.
Commercial applications for these microscopic plants include nutritional
products, diagnostic products, aquaculture feed/pigments, natural food colorings
and research grade chemicals. The Company believes that microalgae could
potentially be used for other commercial applications, including genetically
engineered products for the biopesticide and pharmaceutical industries. The most
significant microalgae products produced today are algae utilized as food
supplements. These include forms of Spirulina, Chlorella, lake grown blue green
algae and natural beta carotene from DUNALIELLA SALINA. These microalgae food
supplements contain, in varying degrees, highly absorbable sources of
phytonutrients including mixed carotenoids, B vitamins, GLA, protein and
essential amino acids. Published scientific animal studies suggest that
increased levels of some of these natural compounds in the diet may reduce the
risk of many types of cancer and strengthen the immune system. The Company
believes that demand for these microalgae products has increased as the benefits
of plant-based nutrients, commonly known as "green superfoods," are beginning to
receive promotion in retail markets outside the health food community.
While many unique compounds have been identified in microalgae, the
efficient and cost effective commercial production of microalgae is elusive.
Many microalgae culture systems have been designed and tested and failed over
the last 20 years. Because microalgae produced for food supplements is
typically cultivated and harvested outdoors, production is affected
significantly by climate, weather conditions and the chemical composition of the
culture media. Without consistent sunlight, warm temperature, low rainfall and
proper chemical balance, microalgae will not grow as quickly, resulting in
longer harvesting cycles, decreased pond utilization and increased cost.
Furthermore, microalgal growth requires a nutrient rich environment. The high
nutrient levels in the ponds promote the growth of unwanted organisms, or
"weeds," if the chemical composition of the ponds changes from its required
balance. Once contamination occurs, a pond must be emptied, cleaned and
restarted, a process that further decreases pond utilization and increases
production costs.
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Microalgae producers also face relatively high harvesting and processing
costs, particularly with respect to the energy costs required to dry the
microalgae prior to packaging and the labor required throughout the harvesting
and processing cycles. Once harvested, microalgal cells contain from 85% to 95%
water. The high water content is due to internal water in the cells that cannot
be removed by mechanical means. The Company estimates that the cost of
conventional heat-based microalgae drying processes represents approximately 30%
of total production cost. Most drying systems also damage or destroy oxygen
sensitive nutrients in the finished microalgae products.
TECHNOLOGY
Cyanotech has designed, developed and implemented proprietary production
and harvesting technologies, systems and processes which reduce many of the
stability and contamination problems frequently encountered in the production of
microalgae. This proprietary production system is known as Integrated Culture
Biology Management ("ICBM"). Through the application of this technology,
Cyanotech's ponds are in production year-round without any significant loss in
productivity due to contamination. The Company believes that such an
accomplishment remains unique to Cyanotech. Certain aspects of the ICBM
technology are also applicable to producing other microalgae products which the
Company currently has under development. The Company believes that its ICBM
technology combined with the climate conditions at its production facility in
Hawaii make it a cost-effective producer of premium Spirulina products.
In addition to the advantages of its ICBM technology, Cyanotech has
developed a patented system for the recovery of carbon dioxide from its drying
system exhaust gas, called OCEAN-CHILL DRYING. Since microalgae are essentially
microscopic "plants," they require sunlight, water, carbon dioxide and nutrients
for optimal growth. By recovering carbon dioxide that would otherwise be
released into the atmosphere, the Company is able to divert the recovered carbon
dioxide back to the algae cultures to nourish the growing algae. The Company
believes that this process provides it with a significant cost advantage over
other microalgae producers who must purchase carbon dioxide. OCEAN-CHILL DRYING
also dries microalgal products in a low oxygen environment which protects oxygen
sensitive nutrients. In addition, Cyanotech has developed an automated Spirulina
processing system, which enables a single operator to harvest and produce dried
Spirulina powder.
Another major advantage for the Company is the location of its production
facility at the Hawaii Ocean Science and Technology ("HOST") Park at Keahole
Point, Hawaii. The Company believes that the combination of consistent warm
temperature, abundant sunlight, and low rainfall at this facility makes this a
favorable location for economically cultivating microalgae on a large scale. The
Company believes that in contrast to its facility, other microalgae production
facilities located in areas lacking these characteristics stop producing
microalgae for up to four months a year because of unfavorable climate or
weather conditions.
At the HOST Park, the Company has access to cold, clean, deep sea water
that is pumped up from a depth of 2,000 feet. This sea water is used both as a
source of nutrients for microalgae culture and as a cooling agent in the
OCEAN-CHILL DRYING process. Additionally, Cyanotech's facility has access to a
complete industrial infrastructure and is located 30 miles from a deep water
port and adjacent to an airport. The Company believes that the combination of
its ICBM technology, favorable growing location, year-round production
capability, OCEAN-CHILL DRYING process and automated processing system can be
successfully applied to the large-scale cultivation of other species of
microalgae that may be identified for commercial applications. The Company is
currently conducting pilot production work on natural
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astaxanthin, a red pigment used primarily in the aquaculture industry to impart
pink color to the flesh of pen-raised fish and shrimp. Among the Company's other
microalgae products under development are a genetically engineered mosquitocide.
See "Patents, Licenses and Trademarks."
STRATEGY
The Company's objective is to be the leading developer and producer of
microalgal products in its existing and future markets. The Company seeks to
achieve this objective through the following strategies:
- INCREASE THE COMPANY'S SPIRULINA MARKET SHARE. The Company intends to
increase its world market share for Spirulina by expanding channels of
distribution, expanding geographically and locating new potential markets for
Spirulina. The Company plans to expand domestic sales and marketing efforts for
its Nutrex products and private label packaged products, and to explore mass
marketing opportunities for Spirulina based products. The Company's products are
sold in twelve foreign countries and the Company is investigating ways to expand
the global presence of its products, including through the addition of foreign
distributors. The Company is investigating potential additional uses for
Spirulina. To this end, the Company intends to fund limited clinical trials on
the effects of Spirulina on arthritis and the immune system, and to fund studies
for the use of Spirulina as a premium animal feed.
- PROMOTE BRAND UNIQUENESS AND PACKAGED PRODUCTS. Cyanotech is the only
Hawaiian producer of Spirulina and has developed a unique strain of Spirulina
marketed as "SPIRULINA PACIFICA." The private label customers also promote the
brand uniqueness of Hawaiian Spirulina, which the Company believes provides
competitive differentiation in the marketplace. The Company plans to increase
marketing emphasis on packaged products, which generally have higher associated
gross profit per pound than bulk products. The Company believes that it is the
only producer of microalgae to receive organic certification.
- INCREASE BREADTH OF PRODUCT OFFERINGS. The Company is developing and
plans to develop other products from microalgae, utilizing, in part, its current
production technologies. These products include aquaculture feed/pigments and
biopesticides. The Company is currently conducting pilot production work on
natural astaxanthin, a red pigment used primarily in the aquaculture industry to
impart pink color to the flesh of pen-raised fish and shrimp. Among the
Company's other products under development are a genetically engineered
mosquitocide.
- ESTABLISH STRATEGIC ALLIANCES. The Company intends to market new and
existing products through strategic alliances where appropriate. The Company
believes that these alliances will allow it to focus on its core business as a
microalgal producer and to gain access to broader markets. For example, the
Company is currently discussing a strategic alliance for its proposed natural
astaxanthin product with a major aquaculture feed formulator.
- CONTINUE IMPROVEMENT UPON PRODUCTION METHODOLOGIES. Cyanotech intends
to continue to improve upon its ICBM proprietary production system and
OCEAN-CHILL DRYING system and apply certain of those technologies in the
development of additional microalgae-based products for the aquaculture
feed/pigments, biopesticide, food coloring and nutrition markets, as well as
other potential commercial uses.
- PROMOTE ENVIRONMENTAL RESPONSIBILITY. Cyanotech has a strong
commitment to the environment. The Company's production system recovers carbon
dioxide from its drying system exhaust
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gas, recycles 100% of the growing media, operates without the use of pesticides
or herbicides, and does not create erosion, fertilizer runoff or water
pollution. The Company believes that these recycling methods result in
significantly lower operating costs.
PRODUCTS AND PRODUCT CANDIDATES
The following table summarizes the market applications and current status
of the Company's current products and products under development.
<TABLE>
<CAPTION>
MARKET APPLICATION STATUS
<S> <C> <C>
CURRENT PRODUCTS:
SPIRULINA PACIFICA Powder Health and nutrition Domestic and international
wholesale and retail sales
SPIRULINA PACIFICA Tablets Health and nutrition Domestic and international
wholesale and retail sales
SPIRULINA PACIFICA Flakes Health and nutrition Domestic retail sales
HAWAIIAN ENERGIZER Sports Health and nutrition Domestic retail sales
Drink Powder
HAWAIIAN ENERGIZER Tablets Health and nutrition Domestic retail sales
Phycobiliproteins Immunological diagnostics Domestic and international sales
PRODUCTS UNDER DEVELOPMENT:
Natural Astaxanthin Aquaculture pigment Pilot production in process
Genetically Engineered Pesticide Production system
Mosquitocide development work expected
to start by Mid-1996
</TABLE>
PRODUCTS
SPIRULINA
Cyanotech's principal product is a nutritional microalgae marketed as
SPIRULINA PACIFICA, a unique strain of Spirulina developed by Cyanotech and sold
worldwide to the health and natural foods market. SPIRULINA PACIFICA is a
vegetable microalgae that is a highly absorbable source of natural beta
carotene, mixed carotenoids and other phytonutrients, B vitamins, GLA, protein
and essential amino acids. The Company believes SPIRULINA PACIFICA has greater
concentrations of natural beta carotene, better taste and more consistent color
than competing Spirulina products. The Company believes that it is the only
Spirulina producer to have its products and processes certified organic.
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Spirulina is a naturally occurring microscopic plant which has been used
for thousands of years as a food. Today, Spirulina is used by the health
conscious consumer for a variety of immediate and long term effects. Spirulina
is a good source of natural phytonutrients, including carotenoids and
phycocyanin, among others. Published scientific animal studies suggest that
increased levels of some of these natural compounds in the diet may reduce the
risk of many types of cancer and strengthen the immune system.
The Company produces SPIRULINA PACIFICA in three forms: powder, flake and
tablets. Powder is used as an ingredient in health food drinks while flakes are
used as a seasoning on salads and pasta. Tablets are consumed daily as a food
supplement.
The Company also produces and markets two products under the HAWAIIAN
ENERGIZER name. HAWAIIAN ENERGIZER sports drink contains complex carbohydrates
and vegetarian protein in combination with SPIRULINA PACIFICA, Bee Pollen and
Siberian Ginseng. HAWAIIAN ENERGIZER tablets contain SPIRULINA PACIFICA, Bee
Pollen and Siberian Ginseng.
Since 1992, substantially all of the Company's net sales have been
attributable to its SPIRULINA PACIFICA products. Sales of SPIRULINA PACIFICA
products accounted for approximately 98% and 97% of the Company's net sales in
each of the years ended March 31, 1996 and 1995 respectively. The Company
believes that SPIRULINA PACIFICA products will continue to constitute a
substantial portion of net sales. The Company plans to increase production of
Spirulina products substantially in fiscal 1997 by using a portion of the net
proceeds from a recent public offering of common stock to construct more
Spirulina ponds and related Spirulina processing facilities. There can be no
assurance that the market for Spirulina products in general, or the Company's
SPIRULINA PACIFICA products in particular, will support the increased output
anticipated from the Company's planned expansion. Any decrease in the overall
level of sales of, or the prices for, the Company's SPIRULINA PACIFICA products,
whether as a result of competition, change in consumer demand, increased
worldwide supply of Spirulina or any other factors, would have a material
adverse effect on the Company's business, financial condition and results of
operations. The Company's Spirulina products are rich in natural beta carotene.
Two large scale studies released in January 1996 on synthetic beta carotene
indicated that certain health benefits previously associated with beta carotene
generally do not exist in synthetic beta carotene. Although synthetic beta
carotene has different properties from natural beta carotene, consumers'
perception of beta carotene generally may be adversely affected by these and
other studies. If consumer perceptions of the negative effects of synthetic
beta carotene are extended to the Company's products which contain natural beta
carotene, the Company's business, financial condition and results of operation
could be materially adversely affected. See "Management's Discussions and
Analysis of Financial Condition and Results of Operations" and "Competition."
PHYCOBILIPROTEINS
Cyanotech also produces phycobiliproteins which are sold to the medical and
biotechnology research industry. Phycobiliproteins are highly fluorescent
pigments purified from microalgae. Their spectral properties make them useful as
tags or markers in many kinds of biological assays, such as flow cytometry,
fluorescence immunoassays and fluorescence microscopy.
The Company produces a line of four phycobiliprotein products with various
spectral properties. R-phycoerythrin (RPE) is a red pigment used primarily in
flow cytometry. Allo-phycocyanin (APC) is a blue pigment also used in flow
cytometry, but typically in combination with RPE to form a fluorescent tandem
phycobiliprotein conjugate which improves sensitivity. Cross-linked
allo-phycocyanin (XL-APC) is a stabilized form of APC which can be used in very
diluted solution without problems of degradation. C-phycocyanin (CPC) is also a
blue pigment and, although not used extensively in cytometry, has potential
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applications in food and cosmetics coloring. Sales of phycobiliproteins
accounted for less than 2% of the Company's net sales for the fiscal year ended
March 31, 1996. The Company anticipates that sales of phycobiliproteins will not
be material in future periods.
PRODUCTS UNDER DEVELOPMENT
Two products are under active development by Cyanotech: natural astaxanthin
and a genetically engineered mosquitocide.
NATURAL ASTAXANTHIN
Astaxanthin is a red pigment used primarily in the aquaculture industry to
impart pink color to the flesh of pen-raised fish and shrimp. For example,
without astaxanthin in their diet, the flesh of pen-raised salmon is white and
has a limited market. The astaxanthin market currently is dominated by synthetic
astaxanthin produced from petrochemicals.
The Company is currently discussing a strategic alliance for its natural
astaxanthin with a major aquaculture feed formulator. The Company has also been
working with this feed formulator to schedule feeding tests at a major salmon
production facility. The Company began delivering limited amounts of natural
astaxanthin product in March 1996.
The Company plans to begin construction of a natural astaxanthin production
facility by August of 1996. Natural astaxanthin is a new product for the Company
and many production issues must be resolved prior to commercial production.
There can be no assurance that the Company will resolve production issues or
that the Company will successfully complete its pilot production scale studies
of natural astaxanthin.
GENETICALLY ENGINEERED MOSQUITOCIDE
A genetically engineered mosquitocide was developed at the University of
Memphis by a team under the direction of Professor Edward Stevens, Jr., who
successfully cloned the toxin gene from BACILLUS THURINGINSIS VAR, ISRAELENSIS
(Bti) into the blue-green algae SYNECHOCOCCUS. The bacterial toxin of Bti is
very specific to mosquitoes and black flies, while the blue-green algae is a
food for mosquito larvae. The Company believes that when applied to a
mosquito-infested body of water, the algae could act as an effective and
environmentally safe means of control.
In June 1995, Cyanotech signed an exclusive worldwide license agreement
with the University of Memphis to manufacture and sell the genetically
engineered mosquitocide. Development of a commercial production system is
scheduled to start by mid-1996. In addition to being a nuisance, mosquitoes are
carriers for viral encephalitis in the United States, and major carriers for a
number of diseases throughout the world including malaria, yellow fever, dengue
fever and filariasis. The Company is currently investigating the possible
application of this technology to other biopesticides.
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NATURAL FOOD COLORINGS
Natural beta carotene, a fat soluable pigment found in many plants, can be
used as a yellow/orange coloring agent for margarine, cake mixes, soft drinks
and other products. The Company believes that there are no other natural
yellow/orange food colorings available today.
In August 1994, Cyanotech and Hauser formed a joint venture partnership,
BetaPharm International, to develop, produce and sell products derived from
DUNALIELLA SALINA (natural beta carotene). If the results of the project
warrant and market conditions dictate, the joint venture will proceed to obtain
funding to commercialize the product.
OTHER POTENTIAL PRODUCTS
Many potential commercial substances have been identified in microalgae
including amino acids, vitamins, fatty acids, pigments, enzymes, anti-bacterial
agents and anti-viral agents. Cyanotech believes that it has, and is further
developing, technology which will allow the Company to produce a variety of
products from microalgae. Of particular interest to the Company is the
production of natural colorants for use in foods and cosmetics and an expanded
line of biopesticides through genetic manipulation of microalgae. Cyanotech
believes that a large market may exist for these products, and that while
government approval for such products is likely to be required, Cyanotech
believes approval may be obtained in a shorter time period and with less expense
than for pharmaceutical products. The Company believes that as new potential
products are either identified in microalgae or genetically engineered into
microalgae, it will be in a unique position to employ its proprietary and
commercially proven technology for the cost effective production of these
potential products.
Other than its Spirulina and phycobiliprotein products, the Company currently
has no products available for commercial sale. The Company believes that its
future success is substantially dependent on the expansion of the worldwide
Spirulina market and the Company's ability to successfully develop and
commercialize new products and penetrate new markets. There can be no assurance
that the Company can successfully develop the foregoing products or any other
additional products, that any such products will be capable of being produced in
commercial quantities at reasonable cost, or that any such products will achieve
market acceptance. The Company has little experience marketing its products
directly and is generally dependent on the marketing skills and efforts of third
parties. There can be no assurances as to whether the marketing efforts of such
third parties will be successful or whether such third parties will eventually
compete with the Company or assist the Company's competitors. Many other
companies have significantly greater marketing and product development
experience and resources to devote to marketing and product development than the
Company. The Company has entered into, and expects to enter into additional,
selected strategic alliances with third parties for product development and
marketing. There can be no assurances regarding the performance of such third
parties, or the overall success, if any, of such strategic alliances. The
inability of the Company to successfully develop or commercialize these or any
additional products would have a material adverse effect on the Company's
business, financial condition and results of operations.
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MANUFACTURING
SPIRULINA
Cyanotech began culturing SPIRULINA PACIFICA in 1985 at its present
facility at the HOST Park. SPIRULINA PACIFICA is cultured in shallow, open ponds
adjacent to the Pacific Ocean. Paddlewheels agitate the water, permitting even
exposure of the algae to the sun. A combination of fresh water and nutrient-rich
deep ocean water, drawn from a depth of 2,000 feet, is used to fill the
Spirulina ponds. Ninety-six trace elements are supplied by deep ocean water. The
other major components required for growing Spirulina are food-grade baking soda
(sodium bicarbonate) and carbon dioxide.
SPIRULINA PACIFICA is pumped from the culture ponds through underground
pipes to a process building where it is screened for particulate matter and then
separated by stainless steel screens from the culture medium. It is then washed
three times with fresh water and vacuum filtered. SPIRULINA PACIFICA intended
for use in powder and tablets is dried by a patented OCEAN-CHILL DRYING process.
The Company uses deep ocean water in its OCEAN-CHILL DRYING process. The Company
obtains the cold water from the HOST Park at a cost substantially less than the
cost of generating the same cooling effect by refrigeration. The drying process
takes approximately three seconds and results in a dark green powder with a
consistency similar to flour. SPIRULINA PACIFICA prepared in flake form is dried
in a more conventional proprietary process. Bulk SPIRULINA PACIFICA powder,
tablets and flakes are packaged in foil laminate heat-sealed bags with an oxygen
absorbing pack sealed in each bag. This packaging ensures product freshness and
extends the shelf life of bulk SPIRULINA PACIFICA.
Carbon dioxide is recovered as a result of the OCEAN-CHILL DRYING process
and fed back to the culture ponds as a nutrient. By use of ICBM, all culture
media from the harvest are recycled to culture ponds and additional nutrients
are added to support the next growth phase. Active culture remaining in the
ponds after harvest serves to inoculate the next batch. The algae reproduces
rapidly, and, on average, approximately one week is required before the culture
pond is again harvested. Spirulina production with ICBM has proven to be an
extremely stable operating environment, permitting the Company to grow and
harvest Spirulina without any significant problems of contamination by unwanted
algae and associated loss of productivity. The Company believes that its
Spirulina competitors continue to experience problems of culture contamination
by unwanted algae, requiring that culture ponds be emptied, cleaned and
restarted. The Company is presently pursuing certification under the
international quality management system ISO 9000.
Spirulina powder is difficult to tablet and most tablet manufacturers
overcome this difficulty by either adding high amounts (from 10% to 30%) of
excipients to "glue" the tablet together or by using a heat granulation process
that destroys nutrients. SPIRULINA PACIFICA tablets are produced by the Company
by blending SPIRULINA PACIFICA powder with a minimum amount of excipients
(maximum of 2%) and tableting in a cold press compression tablet-making machine.
SPIRULINA PACIFICA flakes are produced by blending SPIRULINA PACIFICA powder
with food-grade lecithin and drying this in a proprietary drying system. The
Company's packaged consumer products are bottled and labeled by two
subcontractors in California, both of which are certified cGMP manufacturers and
undergo regular governmental inspections.
A sample from each lot of SPIRULINA PACIFICA is subjected to quality
assurance testing. Quality assurance testing includes bulk density, moisture,
particulate matter, color and taste. In addition, each lot of SPIRULINA PACIFICA
is subjected to a prescribed set of microbiological tests for food products,
including total aerobic bacteria, coliform bacteria and E. coli. SPIRULINA
PACIFICA powder is certified free of pesticides and herbicides, and certified
Kosher.
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All of the Company's production capacity is located at its Kailua-Kona,
Hawaii facility, on property leased from the State of Hawaii and which is
situated on a 200-year-old lava flow adjacent to a dormant volcano. In the
event that production at or transportation from such facility were interrupted
by fire, volcanic eruption, earthquake, tidal wave, hurricane, or other natural
disaster, work stoppage, termination or suspension of the Company's facility
lease by the State of Hawaii for public use or similar purposes, other
regulatory actions or any other cause, the Company would be unable to continue
to produce its products at such facility. Such an interruption would materially
and adversely affect the Company's business, financial condition and results of
operations.
Due to the importance of sunlight and a consistent warm temperature for
Spirulina growth, the Company's Spirulina production is significantly affected
by weather patterns and seasonal weather changes. For example, the Company
estimates that its ponds are up to approximately 20% less productive between the
months of November and February due to fewer daylight hours and lower
temperatures than during other months of the year. Any unseasonably cool or
cloudy weather would adversely impact the Company's production and could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
NATURAL ASTAXANTHIN
Cyanotech is conducting pilot production work to develop a commercial
production system for natural astaxanthin. HAEMATOCOCCUS, the microalgae which
produces astaxanthin, grows in neutral conditions and is susceptible to
contamination by unwanted algae. Cyanotech is developing a proprietary system
which it believes will solve this problem. The Company employs a closed culture
system during the initial stage of algal growth, after which the algae is
transferred to open ponds for astaxanthin production. An additional advantage of
the Company's pilot system is the ability to control the temperature of algal
cultures by the use of cold seawater. Natural astaxanthin is a new product for
the Company and many production issues must be resolved prior to commercial
production. There can be no assurance that the Company will resolve production
issues or that the Company will successfully complete its pilot production scale
studies of natural astaxanthin.
RESEARCH & DEVELOPMENT
Cyanotech's expertise is in the development of efficient, stable and
cost-effective production systems for microalgal products. The Company does not
conduct basic scientific research to identify new microalgal products or develop
new microalgal products through genetic engineering. Rather, the Company
investigates specific microalgae identified in scientific literature for
potentially marketable products. When necessary, the Company will license
specific organisms and/or basic science technology for pilot-studies.
MARKETING AND SALES
The Company believes that its present bulk customers could consume a
significant portion of the increased production of Spirulina from the facilities
expansion currently underway. However, it is the Company's strategy to first
emphasize sales of higher priced packaged consumer products through its own
Nutrex brand and private label customers, since sales of packaged consumer
products carry higher associated gross profit than sales of bulk products.
Cyanotech intends to form strategic alliances with established mass market sales
and distribution companies to sell Spirulina products into mass markets. The
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Company also intends to take certain efforts targeted at expanding the bulk
market for Spirulina and to continue to differentiate its products based on
quality, taste and color consistency.
- PRODUCT IDENTITY AND BRAND UNIQUENESS. Cyanotech is the only Hawaiian
producer of Spirulina and has developed a unique strain of Spirulina
marketed as "SPIRULINA PACIFICA." Manufacturers who market Cyanotech's
brand generally identify and promote Hawaiian Spirulina as a superior
product. The private label customers also promote the brand uniqueness
of Hawaiian Spirulina, which the Company believes provides competitive
differentiation in the marketplace.
- EXPAND SALES OF CONSUMER PACKAGED PRODUCTS.
PRIVATE LABEL CONSUMER PACKAGED PRODUCTS. The Company has achieved
significant sales of private label products in certain Pacific Rim
countries. Cyanotech plans to capitalize upon its unique Hawaiian
brand to increase the number of both domestic and international
private label customers.
NUTREX BRAND PRODUCTS. The Company believes that a substantial
opportunity exists to increase domestic sales of its Nutrex brand
products. Nutrex packaged consumer products and certain of the
Company's private label products currently are the only organic
certified microalgal products, which the Company believes is
important to health and natural food consumers. The Company has
launched a new label and is starting an intensified retail marketing
program. The initial thrust of this program will be to focus
resources on high volume, large natural food store chains such as
Whole Foods, Mrs. Gooches, Alfalfas, Wild Oats, Bread and Circus,
and Puget Consumers Cooperatives.
- DEVELOP STRATEGIC ALLIANCES. The Company is seeking strategic
alliances with sales and distribution companies that have proven track
records in mass market sales and distribution outside the health food
industry. The objective is to generate sales of consumer packaged
products in chain drug stores and discount stores. Cyanotech
anticipates coordinating this program with media advertising.
- EXPAND BULK SALES. The Company intends to focus marketing efforts on
its existing bulk customers in order to increase bulk sales. Cyanotech
develops product literature and marketing materials for bulk
customers, sponsors cooperative advertising, participates in trade
shows and provides speakers for product forums and press interviews.
The Company plans to sponsor feed studies on the benefits of
incorporating SPIRULINA PACIFICA in feed formulations for poultry,
pets and fish in an effort to expand the bulk market for Spirulina
products.
- DIFFERENTIATE PRODUCTS ON QUALITY ADVANTAGES. Cyanotech believes it
has established a quality advantage for its SPIRULINA PACIFICA in the
health food and nutrition industry. The Company plans on maintaining
its premium status through (i) continued education of customers about
the Company's product quality and (ii) consistent improvement of
product quality through improved processing and handling of finished
goods.
DISTRIBUTION
The majority of Cyanotech's bulk Spirulina sales are to companies with
their own Spirulina product lines. Many of these companies identify and promote
Cyanotech's Hawaiian Spirulina in their products. In the United States, the
Company sells directly to manufacturers and health food formulators. Packaged
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consumer products sell in the domestic market through an established health food
distribution network and via mail order. Orders for packaged consumer products
are taken at the store level by one of 34 regional broker representatives and
shipped through one of 22 distributors. In the foreign markets the Company has
appointed exclusive sales distributors for both bulk Spirulina and packaged
consumer products. The Company now has exclusive sales distributors for the
following regions: (i) Japan, Korea, Taiwan and Singapore; (ii) Canada;
(iii) the Benelux Countries; (iv) Australia; (v) Hong Kong and China; and
(vi) France.
In the years ended March 31, 1996 and 1995, international sales accounted
for approximately 55% and 42%, respectively, of the Company's net sales. The
Company expects that international sales will continue to represent a
significant portion of its net sales. The Company's business, financial
condition and results of operations may be materially adversely affected by any
difficulties associated with managing accounts receivable from international
customers, tariff regulations, imposition of governmental controls, political
and economic instability or other trade restrictions. Although the Company's
international sales are currently denominated in United States dollars,
fluctuations in currency exchange rates could cause the Company's products to
become relatively more expensive to customers in the affected country, leading
to a reduction in sales in that country. Additionally, the Company's largest
customer resells the Company's products principally in mainland China, and thus
the Company is exposed to political, legal, economic and other risks and
uncertainties associated with doing business in China.
CUSTOMERS
Cyanotech markets and sells its Spirulina products to health food
manufacturers, private label customers, retail distributors, natural products
distributors and direct to certain natural food stores. The Company's customers
range in size from large enterprises with over $500 million in annual sales to
small neighborhood retail stores. Several of the Company's major customers are
businesses that were established exclusively to market and sell Spirulina
products. The Company cooperates closely with these customers to develop product
labeling and advertising designed to educate the consumer about the health
benefits of using a "green superfood" such as Spirulina and, more specifically,
SPIRULINA PACIFICA products.
Approximately 48.7% and 32.3% of the Company's net sales in the years ended
March 31, 1996 and 1995, respectively, were derived from sales to the Company's
top three customers during those periods. The Company's largest customer, a Hong
Kong-based natural products marketing and distribution company, accounted for
approximately 29.4% and 3.0% of Cyanotech's net sales in the years ended
March 31, 1996 and 1995, respectively. The Hong Kong-based company is a
multilevel marketing organization which purchases the Company's packaged
consumer products and sells them under a private label. The Company's second
largest customer, a Canadian Spirulina marketing and distribution company,
accounted for approximately 11.1% and 16.8% of Cyanotech's net sales in the
years ended March 31, 1996 and 1995, respectively. The Company's third largest
customer, a Dutch-based Spirulina marketing and distribution company, accounted
for approximately 8.2% and 12.5% of Cyanotech's net sales in the years ended
March 31, 1996 and 1995, respectively. The loss of, or significant adverse
change in, the relationship between the Company and its largest customer or any
other major customer would have a material adverse effect on the Company's
business, financial condition and results of operations. The loss of, or
reduction in orders from, any significant customer, losses arising from customer
disputes regarding shipments, fees, product condition or related matters, or the
Company's inability to collect accounts receivable from any major customer could
have a material adverse effect on the Company's business, financial condition
and results of operations. Although there can be no assurance in this regard,
based on discussions with the Company's largest customers, the Company
anticipates that sales to its largest
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customers should continue to represent a significant portion of the Company's
total net sales in the year ending March 31, 1997.
HEALTH FOOD MANUFACTURERS. Health food manufacturers use the Company's
products as the key ingredient in Spirulina products, or as an ingredient in
health food formulations, which they manufacture for sale. These customers
purchase bulk powder or bulk tablets and package the products under their brand
label for sale to the health and natural food markets. In some instances, these
customers produce products under private-labeling arrangements with third
parties. Many of the products produced by these customers are often marketed and
sold in direct competition with the Nutrex line of retail consumer products.
However, the Company differentiates its products from those of its bulk
customers by reserving the certified organic line of products for sale
exclusively under the Nutrex label and certain private labels.
PRIVATE LABEL CUSTOMERS. The Company currently provides private label retail
consumer products to two international customers. Using Spirulina tablets
produced by the Company, the products are packaged by one of the Company's two
bottling subcontractors in Southern California, using product labels supplied by
the customer. Products for these customers are manufactured only upon receipt of
an order; finished product inventories are not maintained by the Company.
RETAIL DISTRIBUTORS. Retail distributors act as product wholesalers to
independent and chain retailers. The majority of domestic Nutrex sales in the
year ended March 31, 1996 were to 22 distributors.
NATURAL PRODUCTS DISTRIBUTORS. In the year ended March 31, 1996, the Company
sold to three U.S. customers engaged in the business of distributing natural raw
materials to health and natural food manufacturers. These distributors provide
their customers with standardized quality control, warehousing and distribution
services, and charge a mark-up on the products for providing these services.
These distributors may differentiate the products they sell, but they generally
treat the products as commodities, with price being the major determining factor
in their purchasing decision.
NATURAL FOOD STORES. Less than 5% of the Company's sales in the year ended
March 31, 1996, were direct sales to independent or chain natural food retail
stores. The Company believes that most natural food retail stores prefer to
purchase products from retail distributors.
COMPETITION
SPIRULINA
The Company's SPIRULINA PACIFICA products compete with a variety of
vitamins, dietary supplements, other algal products and similar nutritional
products available to consumers. The nutritional products market is highly
competitive. It includes international, national, regional and local producers
and distributors, many of whom have greater resources than the Company, and many
of whom offer a greater variety of products. The Company believes that its
direct competition in the Spirulina market currently is from Dainippon Ink and
Chemical's Earthrise Farms facility in California and several farms in China. To
a lesser extent, the Company competes with numerous smaller farms in India,
Thailand, Brazil and South Africa. The Company's packaged consumer products
marketed under its Nutrex brand also compete with products marketed by health
food manufacturing customers of the Company who purchase bulk Spirulina from the
Company and package it for retail sales. A large Spirulina production facility
in Mexico, which has been closed since 1993 may reopen. Should this facility
resume production in substantial quantities, the Company would encounter
increased competition.
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In addition to other Spirulina based products, SPIRULINA PACIFICA competes
in certain markets with other "green superfoods," such as Chlorella (a green
microalgae with sales primarily in Japan), APHAMIZOMENON (a blue-green algae
harvested from an eutrophic lake in Oregon with sales primarily through
multilevel marketing) and cereal grasses such as barley, wheat and kamut. In
addition, major food and beverage companies may become more active in the
nutritional products business, either directly or through the acquisition of
smaller companies. A decision by another company to focus on the Company's
existing or target markets or a substantial increase in the overall supply of
Spirulina could have a material adverse effect on the Company's business,
financial condition and results of operations. While the Company believes that
it competes favorably on factors such as quality, brand name recognition and
loyalty, the Company's SPIRULINA PACIFICA products have typically been sold at
prices higher than other Spirulina products. There can be no assurance that the
Company will not experience competitive pressure, particularly with respect to
pricing, that could adversely affect its business, financial condition and
results of operations.
PHYCOBILIPROTEINS
There are four major competitors which manufacture phycobiliprotein
products for sale, including Molecular Probes, Inc., Quantify Inc., Martek
Biosciences Corporation and Prozyme Inc. Cyanotech competes with these companies
on the basis of price and quality. In addition, one large potential user of
phycobiliproteins, Coulter, Inc., manufactures phycobiliproteins for its
internal use. New synthetic fluorescent compounds have been developed by a third
party which are superior to phycobiliproteins in some applications. The
advantage of the synthetic compounds is their lower molecular weight and, in
some cases, their lower cost. While the Company's phycobiliprotein products may
not be able to compete effectively against synthetic compounds in some
applications, Cyanotech's phycobiliproteins have gained a reputation for high
quality at a competitive price.
PRODUCTS UNDER DEVELOPMENT
The products being developed by Cyanotech will compete with both synthetic
and natural products on the basis of price and quality. The Company's future
competitors may include major chemical and specialized biotechnology companies,
many of which have financial, technical and marketing resources significantly
greater than those of Cyanotech. Cyanotech believes that its proprietary
technology combined with the metabolic diversity and high productivity of
microalgae will allow the Company to compete in large market areas against large
companies, although there can be no assurance in this regard.
There can be no assurance that the Company can successfully develop the
foregoing products or any other additional products, that any such products will
be capable of being produced in commercial quantities at reasonable cost, or
that any such products will achieve market acceptance. The Company has little
experience marketing its products directly and is generally dependent on the
marketing skills and efforts of third parties. There can be no assurances as to
whether the marketing efforts of such third parties will be successful or
whether such third parties will eventually compete with the Company or assist
the Company's competitors. Many other companies have significantly greater
marketing and product development experience and resources to devote to
marketing and product development than the Company. The Company has entered
into, and expects to enter into additional, selected strategic alliances with
third parties for product development and marketing. There can be no assurances
regarding the performance of such third parties, or the overall success, if any,
of such strategic alliances. The inability of the Company to successfully
develop or commercialize these or any additional products would have a material
adverse effect on the Company's business, financial condition and results of
operations.
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The Company's natural astaxanthin product, if successfully developed, will
compete directly against synthetic astaxanthin produced and marketed worldwide
by one company. The Company believes that there are no other significant
producers of natural astaxanthin. Although the Company is unaware of any studies
indicating that natural astaxanthin has any benefits not otherwise provided by
synthetic astaxanthin, it believes there is consumer demand for a natural
astaxanthin product.
Cyanotech's proposed mosquitocide product may, if successfully developed,
compete with chemical pesticides as well as other biopesticides. Three companies
currently manufacture a mosquito biopesticide based on the bacterial Bti toxin.
There can be no assurance that Cyanotech's proposed product, if successfully
developed, can or would compete favorably with the other Bti products currently
available.
GOVERNMENT REGULATION
The Company's products, potential products and its manufacturing and
research activities are subject to varying degrees of regulation by a number of
government authorities in the United States and in other countries, including
the Food and Drug Administration (the "FDA") pursuant to the Federal Food, Drug
and Cosmetic Act and by the Environmental Protection Agency ("EPA") under the
Federal Insecticide, Fungicide, and Rodenticide Act ("FIFRA"). The FDA
regulates, to varying degrees and in different ways, dietary supplements, other
food products, and diagnostic medical device and pharmaceutical products,
including their manufacture, testing, exportation, labeling, and, in some cases,
advertising. Generally, prescription pharmaceuticals and certain types of
diagnostic products, as medical devices, are regulated more rigorously than
foods, such as dietary supplements. The EPA rigorously regulates pesticides,
among other types of products.
The Company is also subject to other federal, state and foreign laws,
regulations and policies with respect to labeling of its products, importation
of organisms, and occupational safety, among others. Federal, state and foreign
laws, regulations and policies are always subject to change and depend heavily
on administrative policies and interpretations. The Company works with foreign
distributors in its compliance with foreign laws, regulations and policies.
There can be no assurance that any changes with respect to federal, state and
foreign laws, regulations and policies, and, particularly with respect to the
FDA and EPA or other such regulatory bodies, with possible retroactive effect,
will not have a material adverse effect on the Company's business, financial
condition and results of operations. There can be no assurance that any of the
Company's potential products will satisfy applicable regulatory requirements.
The Federal Dietary Supplement Health and Education Act ("DSHEA") regulates
the use and marketing of dietary supplements, including vitamin products. The
DSHEA covers only dietary supplements and contains a number of provisions that
differentiate dietary supplements from other foods. The DSHEA also sets forth
standards for adulteration of dietary supplements or ingredients thereof and
establishes current food Good Manufacturing Practices ("cGMP") requirements for
dietary supplements. It also provides detailed requirements for the labeling of
dietary supplements, including nutrition and ingredient labeling. The Company
currently believes that its SPIRULINA PACIFICA, marketed as a dietary
supplement, is exempt from FDA regulation as a food additive.
The Company's Spirulina manufacturing processes and the Company's contract
bottlers are required to adhere to cGMP as prescribed by the FDA. The Company
believes that it is currently in compliance with all applicable cGMP and other
food regulations. Such regulations specify component and product testing
standards, quality assurance requirements, and records and other documentation
controls. Compliance with relevant cGMP requirements can be onerous and time
consuming, and there can be no
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assurance that the Company can continue to meet relevant FDA manufacturing
requirements for existing products or meet such requirements for any future
products. Ongoing compliance with food cGMP and other applicable regulatory
requirements are monitored through periodic inspections by state and federal
agencies, including the FDA, the Hawaii Department of Health and comparable
agencies in other countries. The Company's processing facility is also inspected
annually for organic certification by Quality Assurance International and for
Kosher certification by the Kosher Overseers Association. The use of Spirulina
as a food additive for seasoning on salads or pasta or for such other food uses
has not been cleared by the FDA. The Company currently markets the product for
these food uses on the basis of its belief that its use in these food
applications is generally recognized as safe and therefore is not subject to FDA
premarket clearances as a food additive. A determination that the Company is in
violation of the FDA's food cGMP and other food regulations including food
additive requirements, could lead to the imposition of civil penalties,
including fines, product recalls or product seizures, and potentially criminal
sanctions.
As IN VITRO diagnostic medical device components, phycobiliprotein products
do not currently require premarket clearances by the FDA. However, as a
component of a medical device, they can nonetheless still be subject to other
various medical device requirements, including cGMP requirements.
All new color additives require premarket clearances from the FDA.
Therefore, the Company's potential natural food color products will require FDA
clearances, unless they meet the requirements of current color additive
regulations. The Company's proposed natural astaxanthin product will need FDA
clearance for use as a color additive in the United States. The Company believes
that no regulatory approval is required for use of astaxanthin as a colorant in
foods in major markets outside the United States. The process of obtaining
clearances for a new color additive is expensive and time consuming. Extensive
information is required on the toxicity of the additive, including
carcinogenicity studies and other animal testing. No assurances can be given
that any of the Company's proposed products intended for use in coloring foods
will be cleared by the FDA as color additives on a timely basis, if at all.
FIFRA requires the registration of most pesticides, including the Company's
proposed genetically engineered mosquitocide. The EPA also regulates under FIFRA
the experimental testing of pesticides, facility inspections, records and
exports of pesticides. The registration of a new pesticide must usually contain
different types of supporting data, including product chemistry, environmental
fate, toxicology, and fish and wildlife studies. Although biochemical and
microbial pesticides are sometimes treated differently from conventional
chemical pesticides because of their unique modes of action, low volumes, target
species specificity or natural occurrence, there can be no assurance that EPA
registration of the Company's mosquitocide can be obtained on a timely basis, if
at all.
PATENTS, LICENSES AND TRADEMARKS
Although the Company regards its proprietary technology, trade secrets,
trademarks and similar intellectual property as critical to its success and
relies on a combination of trade secret, contract, patent, copyright and
trademark law to establish and protect its rights in its products and
technology, there can be no assurance that the Company will be able to protect
its technology adequately or that competitors will not be able to develop
similar technology independently. In addition, the laws of certain foreign
countries may not protect the Company's intellectual property rights to the same
extent as the laws of the United States. Cyanotech has had one United States
patent issued to it. Litigation in the United States or abroad may be necessary
to enforce the Company's patent or other intellectual property rights, to
protect the Company's trade secrets, to determine the validity and scope of the
proprietary rights of others or to defend against claims of infringement. Such
litigation, even if successful, could result in substantial costs and
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diversion of resources and could have a material adverse effect on the Company's
business, results of operations and financial condition. Additionally, although
currently there are no pending claims or lawsuits that have been brought against
the Company, if any such claims are asserted against the Company, the Company
may seek to obtain a license under the third party's intellectual property
rights. There can be no assurance, however, that a license would be available on
terms acceptable or favorable to the Company, if at all.
While the disclosure and use of Cyanotech's know-how and trade secrets are
generally controlled under agreements with the parties involved, there can be no
assurance that all confidentiality agreements will be honored, that others will
not independently develop equivalent technology, that disputes will not arise
concerning the ownership of intellectual property, or that dissemination of the
Company's trade secrets will not occur. The Company anticipates that it may in
the future apply for additional patents on certain aspects of its technology. No
assurance can be given that its patent applications will issue as patents or
that any patent now or to be issued will provide the Company with preferred
positions with respect to the covered technology. Additionally, there can be no
assurance that any patent issued to the Company will not be challenged,
invalidated or circumvented or that the rights granted thereunder will provide
adequate protection to the Company's products. Furthermore, there can be no
assurance that others will not independently develop similar products, duplicate
the Company's products or, if patents are issued to the Company, design around
the patents issued to the Company.
ASSOCIATES
The Company employed 54 associates as of March 31, 1996, of which 50 are
full-time. Approximately 22 associates are involved in the harvesting and
production process, 7 are involved in research and product development, and the
remainder are involved in sales, administration and support. Management believes
that its relations with its associates are good. The Company has not experienced
difficulty in attracting personnel. None of the Company's associates are
represented by a labor union.
Effective April 1, 1995, the Company implemented a profit sharing plan for
all associates not covered under a separate management incentive plan. Under the
profit sharing plan, 5% of pre-tax profits are allocated based on gross wages to
non-management associates on a quarterly basis. Fifty percent of each
associate's profit sharing bonus is distributed in cash on an after- tax basis,
the remainder is deposited in each associate's 401(k) account on a pre-tax basis
with a six year vesting schedule, based on years of service with the Company.
The Company's success depends to a significant extent upon the continued
service of Dr. Gerald R. Cysewski, its President and Chief Executive Officer,
and other members of the Company's executive management and the loss of any of
such key executives could have a material adverse effect on the Company's
business, financial condition or results of operations. Furthermore, the
Company's future performance depends on its ability to identify, recruit and
retain key management personnel. The competition for such personnel is intense,
and there can be no assurance the Company will be successful in such efforts.
The Company is also dependent on its ability to continue to attract, retain and
motivate production, distribution, sales and other personnel, of which there can
be no assurance. The failure to attract and retain such personnel could have a
material adverse effect on the Company's business, financial condition and
results of operations.
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ITEM 2. DESCRIPTION OF PROPERTIES
The Company is located in Kailua-Kona, Hawaii, at the HOST Park. The
facility in Kailua-Kona consists of approximately 77 leased acres containing
production ponds, a processing facility, a laboratory, administrative offices
and additional space for production ponds. All products are produced at this
facility. The property is leased from the State of Hawaii under a 30-year
commercial lease expiring in 2025. Cyanotech has obtained an option to lease an
additional 160 acres at the HOST Park. The Company believes that there is
sufficient available land at the HOST Park to meet its currently planned needs.
The Company has no production facilities or offices outside the State of Hawaii.
ITEM 3. LEGAL PROCEEDINGS
Cyanotech is not currently subject to any legal proceedings. The Company
may from time to time become a party to various legal proceedings arising in the
normal course of its business. These actions could include employee-related
issues and disputes with vendors or customers. Use of the Company's products
and potential products in human consumption may expose the Company to liability
claims from the use of such products, although the Company has not been subject
to any such claims to date. As part of its quality control procedures the
Company conducts regular quality assurance tests on its products, however, there
can be no assurance that the Company's products will not suffer contamination at
the Company's facilities or in the distribution channel, which could in turn
cause injury to consumers. In addition, the Company may experience product
recalls, although no such recalls have been required to date. A contamination
problem, product liability claim or recall of products could have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company maintains product liability insurance in limited amounts for
products involving human consumption. In the opinion of management, broader
product liability insurance coverage is prohibitively expensive at this time.
Nevertheless, any future claims are subject to the uncertainties related to
litigation and the ultimate outcome of any such proceedings or claims cannot be
predicted. There can be no assurance that the Company's insurance is adequate
or will remain available to cover any such claims arising from use of the
Company's current or future products.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the stockholders during the fourth
quarter of fiscal 1996.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Until February 17, 1996, the Company's Common Stock was quoted on The
Nasdaq SmallCap Market. On such date, the Company's Common Stock began trading
on the Nasdaq National Market under the symbol "CYAN." The following table sets
forth the high and low bid quotation per share of the Company's Common Stock on
The Nasdaq SmallCap Market and the Nasdaq National Market, as the case may be,
for the periods indicated. Quotations from The Nasdaq SmallCap Market are from
the Nasdaq Monthly Statistical Summary Report, and reflect inter-dealer prices,
without retail mark-up or commission, and may not represent actual transactions.
<TABLE>
<CAPTION>
THREE MONTHS ENDED HIGH LOW HIGH LOW
- - ------------------ ------ ------- ------- -------
<S> <C> <C> <C> <C>
June 30, 1995 and 1994.......... $ 3-3/8 $ 1-1/8 $ 1-1/8 $ 13/16
September 30, 1995 and 1994..... $ 6-5/8 $ 2-11/16 $ 1-5/8 $ 15/16
December 31, 1995 and 1994...... $ 14-7/8 $ 5-1/8 $ 1-1/2 $ 1-1/4
March 31, 1996 and 1995......... $ 11-3/8 $ 6-1/4 $ 1-3/8 $ 1-1/16
</TABLE>
The company has never declared or paid cash dividends on its Common Stock.
Holders of Series C Preferred Stock are entitled to cumulative annual dividends
at the rate of $.40 per share if and when declared by the Board of Directors.
The Company may not pay dividends on the Common Stock until it has paid
accumulated dividends on the Series C Preferred Stock. Cumulative dividends in
arrears on the Series C Preferred Stock as of March 31, 1996 amounted to
$1,957,000 ($2.663 per share). The Company currently intends to retain all of
its earnings for use in its business and does not anticipate paying any cash
dividends on its Series C Preferred Stock or Common Stock in the foreseeable
future.
The Company's stock price has been, and is likely to continue to be, highly
volatile. The market price of the Common Stock has fluctuated substantially in
recent periods, rising from $1 1/8 on March 24, 1995 to a high of $14 7/8 at
November 27, 1995, to $7 3/8 at June 24, 1996. Future announcements concerning
the Company or its competitors, quarterly variations in operating results,
introduction of new products or changes in product pricing policies by the
Company or its competitors, changes in market demand for Spirulina, acquisition
or loss of significant customers, weather patterns and other acts of nature that
may affect or be perceived to affect the Company's production capability, or
changes in earnings estimates by analysts, among other factors, could cause the
market price of the Common Stock to fluctuate substantially. In addition, stock
markets have experienced extreme price and volume volatility in recent years.
This volatility has had a substantial effect on the market prices of securities
of many smaller public companies for reasons frequently unrelated to the
operating performance of the specific companies. These broad market
fluctuations may adversely affect the market price of the Common Stock. There
can be no assurance that the market price of the Common Stock will not decline
below the current price.
20
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Substantially all of the Company's resources are currently dedicated to the
production of SPIRULINA PACIFICA, a nutritional microalgae. The Company sells
SPIRULINA PACIFICA to health food manufacturers, health food distributors and
retail consumers on a worldwide basis. Through the application of its Integrated
Culture Biology Management ("ICBM") technology, the Company maintains continuous
algae cultures and produces a new crop from each of its 51 algal culture ponds
(aggregating approximately 40 acres) approximately every week on average.
Since 1993 the Company has been capacity-constrained, with demand for its
bulk SPIRULINA PACIFICA products exceeding the Company's production
capabilities. Historically, a majority of the Company's net sales have been
derived from the Company's bulk SPIRULINA PACIFICA products, which have lower
associated gross profit (measured in dollars) but higher associated gross margin
(measured as a percentage of net sales) than the Company's packaged consumer
products. Accordingly, an increase in the percentage of net sales attributable
to bulk products would increase the Company's gross margin. Conversely, an
increase in the percentage of the Company's net sales attributable to the
Company's packaged consumer products would decrease its gross margin but likely
increase gross profit. The Company expects that its product mix will vary from
period to period, and a decrease in orders from a customer such as the Company's
largest current customer which purchases only packaged consumer products could
require the Company to reallocate greater portions of its production capacity to
its lower gross profit bulk products.
The Company is currently producing SPIRULINA PACIFICA at full capacity and
is planning to significantly increase the rate of production by late 1996. There
can be no assurance that the favorable supply/demand characteristics of the
market for SPIRULINA PACIFICA will continue. In order to meet the increasing
demand for the Company's Spirulina products, the Company completed construction
of six additional 36,000 square foot algal culture ponds during May 1995, six
additional 36,000 square foot algal culture ponds during September 1995, six
additional 36,000 square foot algal culture ponds during December 1995 and six
additional 36,000 square foot algal culture ponds during February 1996, bringing
the total number of ponds to 51. The Company has begun a substantial pond
expansion project that is currently scheduled to be completed in late 1996.
Since 1992 the Company has experienced substantial growth in its revenues
and operations, and has undergone substantial changes in its business that have
placed significant demands on the Company's management, working capital and
financial and management control systems. The Company's current expansion plans
also may place a significant strain on the Company's management, working capital
and financial control systems. Failure to upgrade the Company's operating,
management and financial control systems or difficulties encountered during such
upgrades could adversely affect the Company's business, financial condition and
results of operations. Although the Company believes that its systems and
controls are adequate to address its current needs, there can be no assurance
that such systems will be adequate to address future expansion of the Company's
business. The Company's results of operations will be adversely affected if
revenues do not increase sufficiently to compensate for the increase in
operating expenses resulting from any expansion and there can be no assurance
that any expansion will be profitable or that it will not adversely affect the
Company's results of operations. In addition, the success of any future
expansion plans will depend in part upon the Company's ability to continue to
improve and expand its management and financial control systems, to attract,
retain and motivate key personnel, and to raise additional required capital.
There can be no assurance that the Company will be successful in these regards.
21
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth certain consolidated statement of income
data as a percentage of net sales for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
--------------------
1996 1995
---- ----
<S> <C> <C>
Net sales. . . . . . . . . . . . . . . . . 100.0% 100.0%
Cost of sales . . . . . . . . . . . . . 43.5 54.8
------------- -------------
Gross profit . . . . . . . . . . . . . . . 56.5 45.2
------------- -------------
Operating expenses:
Research and development. . . . . . . . 4.4 4.1
General and administrative. . . . . . . 14.8 16.5
Sales and marketing . . . . . . . . . . 5.5 7.3
------------- -------------
Total operating expenses. . . . . . . 24.7 27.9
------------- -------------
Income from operations. . . . . . . . 31.8 17.3
------------- -------------
Other income (expense):
Interest income . . . . . . . . . . . . 0.3 0.4
Interest expense. . . . . . . . . . . . (1.1) (0.7)
Other income, net . . . . . . . . . . . - 2.4
Proportionate share of loss of joint venture - (0.9)
------------- -------------
Total other income (expense). . . . . (0.8) 1.2
------------- -------------
Net income. . . . . . . . . . . . . . 31.0% 18.5%
------------- -------------
------------- -------------
</TABLE>
NET SALES
Net sales for the year ended March 31, 1996 were $8,081,000, a 95% increase
over net sales of $4,150,000 for the year ended March 31, 1995. The increase in
net sales during the year ended March 31, 1996 is attributable to price
increases, significantly higher production and sales of bulk Spirulina powder
and tablets and increased sales of packaged consumer products which carry a
higher sales price than bulk Spirulina Pacifica products. The increased
production is the result of Spirulina production expansions that were completed
in May, September and December of 1995 and February of 1996.
International sales represented 55% and 42% of total net sales for the
years ended March 31, 1996 and 1995, respectively. This increase reflects the
Company's increasing emphasis on developing international markets and higher
sales of packaged consumer products into Asian retail markets. The Company's
largest customer, a Hong Kong-based natural products marketing and distribution
company, accounted for approximately 29% and 3% of Cyanotech's net sales in the
years ended March 31, 1996 and 1995, respectively. The Hong Kong-based company
is a multilevel marketing organization which purchases the Company's packaged
consumer products and sells them under a private label.
22
<PAGE>
GROSS PROFIT
Gross profit represents net sales less the cost of goods sold, which
includes the cost of materials, manufacturing overhead costs, direct labor
expenses and depreciation and amortization. The Company's gross profit
increased to 56.5% of net sales for the year ended March 31, 1996 from 45.2% of
net sales for the year ended March 31, 1995. The increase in gross profit is
attributable to higher prices and higher production levels resulting in the
absorbtion of fixed manufacturing overhead costs over a significantly increased
sales volume during the fiscal year.
OPERATING EXPENSES
Operating expenses decreased to 24.7% of net sales for the year ended
March 31, 1996, from 27.9% of net sales for the year ended March 31, 1995.
RESEARCH AND DEVELOPMENT. Expenditures for research and development increased
to 4.4% of net sales for the year ended March 31, 1996, from 4.1% of net sales
for the year ended March 31, 1995. The increase from the prior year is
primarily the result of the research work done on beta carotene for the joint
venture partnership with Hauser Chemical Research, Inc. ("Hauser") and on the
astaxanthin product.
GENERAL AND ADMINISTRATIVE. General and administrative expenses decreased to
14.8% of net sales for the year ended March 31, 1996, from 16.5% of net sales
for the year ended March 31, 1995. The increase in absolute dollars is due to
the payment of associate incentive bonuses indexed to the Company's
profitability during the year ended March 31, 1996, higher insurance costs, and
payroll compensation expense associated with grants of Common Stock to non-
employee directors.
SALES AND MARKETING. Sales and marketing expenses increased 48% to $445,000,
or 5.5% of net sales, for the year ended March 31, 1996, from $301,000, or 7.3%
of net sales, for the year ended March 31, 1995. The increase from the prior
year is primarily due to expenses related to the increasing domestic and
international marketing efforts and higher payroll related expenditures.
PROPORTIONATE SHARE OF LOSS OF JOINT VENTURE. Proportionate share of loss of
joint venture represents the Company's 50% ownership interest in a joint venture
with Aquasearch, Inc. for the development of astaxanthin. The loss in the year
ended March 31, 1995 represents services, and facilities and equipment use that
was contributed to the joint venture by the Company. The joint venture was
terminated in November 1994 by mutual consent and the Company has no further
obligation under the joint venture arrangement.
Inflation during the years ended March 31, 1996 and 1995 did not have a
material impact on the Company's operations.
VARIABILITY OF RESULTS
The Company was formed in 1983 and did not become profitable on an annual
basis until fiscal 1992. As of March 31, 1996, the Company's accumulated
deficit was $4.6 million. There can be no assurance that the Company will be
consistently profitable on either a quarterly or an annual basis. The Company
has experienced quarterly fluctuations in operating results and anticipates that
these fluctuations may continue in future periods. Future operating results may
fluctuate as a result of changes in sales levels to the Company's largest
customers, new product introductions, weather patterns, the mix between sales
23
<PAGE>
of bulk products and packaged consumer products, start-up costs associated with
new facilities, expansion into new markets, sales promotions, competition,
increased energy costs, the announcement or introduction of new products by the
Company's competitors, changes in the Company's customer mix, and overall trends
in the market for Spirulina products. While a significant portion of the
Company's expense levels are relatively fixed, and the timing of increases in
expense levels is based in large part on the Company's forecasts of future
sales, if net sales are below expectations in any given period, the adverse
impact on results of operations may be magnified by the Company's inability to
adjust spending quickly enough to compensate for the sales shortfall. The
Company may also choose to reduce prices or increase spending in response to
market conditions, which may have a material adverse effect on the Company's
results of operations.
LIQUIDITY AND CAPITAL RESOURCES
In prior years, the Company met its operating and capital requirements from
cash flow from operating activities, additional borrowings and proceeds from the
exercise of warrants and stock options. On March 27, 1996, the Company completed
a fully underwritten public offering of 1,500,000 shares of common stock at a
price of $7.00 per share. The Company agreed to sell up to an additional
225,000 shares in the offering upon exercise of an over-allotment option granted
to the underwriters. The underwriters exercised the over-allotment option on
April 22, 1996. The Company's cash and cash equivalent balance increased by
$8,913,000 during the fiscal year ended March 31, 1996. The increase was
primarily due to the aforementioned public offering, increased profit levels,
borrowings from two customers and proceeds from the exercise of warrants and
stock options. Major uses of cash during the fiscal year ended March 31, 1996
included $640,000 in additional accounts receivable to support the higher sales
level and $3,910,000 in additional investment in culture ponds and equipment to
increase Spirulina production capacity. Largely as a result of the increases in
cash and accounts receivable, working capital increased $9,149,000 during the
fiscal year ended March 31, 1996. The Company presently estimates that its
existing capital resources and expected cash flow from operations will be
sufficient to fund its current and planned operations and capital expenditures.
The Company currently has a $1,000,000 bank line of credit which is
collateralized by a certificate of deposit.
As of March 31, 1996, the Company had construction commitments totaling
$1,556,000, which the Company intends to fund from cash reserves and cash flow
from operations. In addition, the Company intends to use approximately $7.5
million of the net proceeds from the completed public offering for the
construction of (i) additional culture ponds and related processing facilities,
(ii) a facility and culture ponds for the production of natural astaxanthin,
(iii) a laboratory/warehouse, and (iv) a cogeneration facility.
NEW ACCOUNTING STANDARDS
In March 1995, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of."
SFAS No. 121 requires that long-lived assets and certain identifiable
intangibles held and used by an entity be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. If the sum of the expected future cash flows
(undiscounted and without interest charges) is less than the carrying amount of
the asset, an impairment loss is recognized. Measurement of that loss would be
based on the fair value of the asset. Generally, SFAS No. 121 requires that
long-lived assets and certain identifiable intangibles to be disposed of be
reported at the lower of carrying amount or fair value less cost to sell. The
Company
24
<PAGE>
adopted the provisions of SFAS No. 121 effective April 1, 1996. The adoption
of SFAS No. 121 did not have a material effect on the Company's financial
condition or results of operations.
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation." SFAS No. 123 establishes a fair value based method of accounting
for stock-based compensation, but does not require an entity to adopt the new
method for preparing its basic financial statements. For entities not adopting
the new method, SFAS No. 123 requires footnote disclosure of pro forma net
income and earnings per share information as if the fair value based method had
been adopted. The disclosure requirements of SFAS No. 123 are effective for
financial statements for fiscal years beginning after December 31, 1995. The
Company will comply with the disclosure requirements of SFAS No. 123 in its
financial statements as of and for the year ending March 31, 1997.
ITEM 7. FINANCIAL STATEMENTS
The financial statements required to be filed herewith begin on page F-1.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
25
<PAGE>
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(a) OF THE EXCHANGE ACT
IDENTIFICATION OF DIRECTORS
The information required by this Item is incorporated by reference from the
Sections captioned "Proposal One: Election of Directors," " Security Ownership
of Certain Beneficial Owners and Management" and "Compliance with Section 16(a)
of the Exchange Act" contained in Cyanotech's definitive 1996 Proxy Statement.
IDENTIFICATION OF EXECUTIVE OFFICERS
The executive officers of the Company and their ages and positions as of March
31, 1996 are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<C> <C> <C>
Gerald R. Cysewski, Ph.D. . . . 47 Chairman of the Board, President and
Chief Executive Officer
Glenn D. Jensen . . . . . . . . 37 Vice President - Operations
Kelly J. Moorhead . . . . . . . 40 Vice President - Sales and Marketing
and President, Nutrex, Inc.
Ronald P. Scott . . . . . . . . 41 Executive Vice President - Finance and
Administration, Secretary, Treasurer and
Director
</TABLE>
DR. CYSEWSKI co-founded the Company in 1983 and has served as a director of the
Company and as its Scientific Director since that time. Since March 1990,
Dr. Cysewski has served as President and Chief Executive Officer of the Company
and in October 1990 was also appointed to the position of Chairman of the Board.
From 1988 to November 1990, he served as Vice Chairman of the Company. From 1980
to 1982 Dr. Cysewski was group leader of microalgae research and development at
Battelle Northwest, a major contract research and development firm. From 1976 to
1980 Dr. Cysewski was an assistant professor in the Department of Chemical and
Nuclear Engineering at the University of California, Santa Barbara, where he
received a two-year grant from the National Science Foundation to develop a
culture system for blue-green algae. Dr. Cysewski received his doctorate in
Chemical Engineering from the University of California at Berkeley.
MR. JENSEN has served as Vice President - Operations since May 1993. He joined
the Company in 1984 as Process Manager and was promoted to Production Manager in
1991, in which position he served until his promotion to Vice President -
Operations. Prior to joining Cyanotech, Mr. Jensen worked for three years as a
plant engineer at a Spirulina production facility, Cal-Alga near Fresno,
California, which ceased to do business in 1983. Mr. Jensen holds a B.S. degree
in Health Science from California State University, Fresno.
MR. MOORHEAD has served as Vice President - Sales and Marketing and President
of Nutrex, Inc. since December 1991. From August 1987 to December 1991, he
served as Vice President - Production. Mr. Moorhead joined the Company as
Production Biologist in December 1984. Prior to joining Cyanotech, Mr. Moorhead
worked at the Oceanic Institute in Honolulu, Hawaii where he conducted research
on
26
<PAGE>
production of Spirulina from agricultural wastes. Mr. Moorhead holds a B.S.
degree in Aquatic Biology from the University of California, Santa Barbara.
MR. SCOTT was appointed to the Board of Directors of the Company in
November 1995, has served as Executive Vice President - Finance and
Administration since August 1995, and has served as Secretary and Treasurer
since November 1990 and June 1990, respectively. From December 1990 until
August 1995 Mr. Scott served as Vice President - Finance and Administration.
From September 1990 to December 1990, Mr. Scott served as Controller. From 1989
to 1990, he was Assistant Controller for PRIAM Corporation, a manufacturer of
Winchester disk drives. From 1980 to 1989, he served in various accounting
management positions with Measurex Corporation, a manufacturer of industrial
process control systems. Mr. Scott holds a B.S. degree in Finance and Management
from California University, San Jose, and an M.B.A. degree from the University
of Santa Clara.
ITEM 10. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference from the
section captioned "Executive Compensation and Other Information" and "Director
Renumeration" contained in Cyanotech's definitive 1996 Proxy Statement.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference from the
section captioned "Security Ownership of Certain Beneficial Owners and
Management" contained in Cyanotech's definitive 1996 Proxy Statement.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference from the
section captioned "Certain Transactions" contained in Cyanotech's definitive
1996 Proxy Statement.
27
<PAGE>
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBIT NUMBER DOCUMENT DESCRIPTION
- - -------------- --------------------
3.1 Restated Articles of Incorporation. (Incorporated by reference to
Exhibit 3.3 to the Company's Quarterly Report on Form 10-Q for
the quarter ended March 31, 1991, file no. 0-14602.)
3.2 Bylaws of the Registrant, as amended. (Incorporated by reference to
Exhibit 3.1 to the Company's Quarterly Report on Form 10-QSB for the
quarter ended December 31, 1995, file no. 0-14602.)
4.1 Specimen Common Stock Certificate. (Incorporated by reference to
Exhibit 4.1 to the Company's Registration Statement on Form SB-2 filed
on February 28, 1996, file no. 333-00951.)
4.2 Terms of the Series C Preferred Stock as Revised 1991. (Incorporated
by reference to Exhibit 4.1 to the Annual Report on Form 10-K for the
fiscal year ended December 31, 1990, file no. 0-14602.)
10.1 1985 Incentive Stock Option Plan dated March 18, 1985, as amended.
(Incorporated by reference to to the Company's Registration Statement
on Form S-8 filed on December 3, 1992, file no. 33-55310.)
10.2 Stockholders Agreement dated as of May 17, 1993. (Incorporated
by reference to Exhibit 10.8 to the Company's Annual Report on
Form 10-KSB for the fiscal year ended March 31, 1994, file no.
0-14602.)
10.3 1994 Non-Employee Directors Stock Option and Stock Grant Plan.
(Incorporated by reference to Exhibit 10.7 to the Company's Annual
Report on Form 10-KSB for the year ended March 31, 1994, file no.
0-14602.)
10.4 Supply and Exclusive Marketing Agreement between the Company and
Nutrition Gandalf dated July 8, 1994. Confidential portions of
this exhibit have been omitted and filed separately with the
Commission. (Incorporated by reference to Exhibit 10.2 to the
Company's Quarterly Report on Form 10-QSB for the quarter ended
December 31, 1995, file no. 0-14602.)
10.5 Joint Venture Agreement dated as of August 31, 1994 between Hauser
Chemical Research, Inc. and the Company. Confidential portions of this
exhibit have been omitted and filed separately with the Commission.
(Incorporated by reference to Exhibit 10.9 to the Company's Quarterly
Report on Form 10-QSB for the quarter ended September 30, 1994, file
no. 0-14602.)
10.6 Letter and Registration Rights Agreement dated August 31, 1994 between
Hauser Chemical Research, Inc. and the Company. (Incorporated by
reference to Exhibit 10.10 to the Company's Quarterly Report on Form
10-QSB for the quarter ended September 30, 1994, file no. 0-14602.)
10.7 Facilities Rental Agreement dated November 1, 1994 between the
Company and Natural Energy Laboratory of Hawaii Authority.
(Superseded by Exhibit 10.13.) (Incorporated by reference to Exhibit
10.11 to the Company's Annual Report on Form 10-KSB for the fiscal
year ended March 31, 1995, file no. 0-14602.)
28
<PAGE>
10.8 Facilities Rental Agreement dated December 2, 1994 between the
Company and Natural Energy Laboratory of Hawaii Authority.
(Superseded by Exhibit 10.13.) (Incorporated by reference to Exhibit
10.12 to the Company's Annual Report on Form 10-KSB for the fiscal
year ended March 31, 1995, file no. 0-14602.)
10.9 Term Loan Agreement dated April 1, 1995 between Spirulina
International B.V. and the Company. (Incorporated by reference to
Exhibit 10.13 to the Company's Annual Report on Form 10-KSB for the
fiscal year ended March 31, 1995, file no. 0-14602.)
10.10 License Agreement by and between The University of Memphis and the
Company dated June 19, 1995. (Incorporated by reference to Exhibit
10.14 to the Company's Annual Report on Form 10-KSB for the fiscal
year ended March 31, 1995, file no. 0-14602.)
10.11 Term Loan Agreement dated July 11, 1995 between the Company and
Satoshi Sakurada. (Incorporated by reference to Exhibit 10.3 to the
Company's Quarterly Report on Form 10-QSB for the quarter ended
December 31, 1995, file no. 0-14602)
10.12 1995 Stock Option Plan for Cyanotech Corporation dated August 9, 1995,
as amended. (Incorporated by reference to Exhibit 4(c) to the
Company's Registration Statement on Form S-8 filed on October 27,
1995, file no. 33-63789.)
10.13 Sub-Lease Agreement between the Company and Natural Energy
Laboratory of Hawaii Authority dated December 29, 1995. (Incorporated
by reference to Exhibit 10.1 to the Company's Quarterly Report on Form
10-QSB for the quarter ended December 31, 1995, file no. 0-14602.)
10.14 Preferred Stock Conversion and Registration Rights Agreement by and
between the Company and Firemen's Insurance Company of Newark, New
Jersey, dated as of February 20, 1996. (Incorporated by reference to
Exhibit 10.16 to the Company's Registration Statement on Form SB-2 as
filed on February 28, 1996, file no. 333-00951.)
10.15 Registration Rights Agreement by and between the Company and American
Cynamid Company dated as of February 20, 1996. (Incorporated by
reference to Exhibit 10.17 to the Company's Registration Statement on
Form SB-2 as filed on February 28, 1996, file no 333-00951.)
10.16 Management Incentive Plan dated May 18, 1995. Confidential portions of
this exhibit have been omitted and filed separately with the
Commission. (Incorporated by reference to Exhibit 10.4 to the
Company's Quarterly Report on Form 10-QSB for the quarter ended
December 31, 1995, file no. 0-14602.)
11.1 Statement re: Computation of Earnings Per Share.
13.1 1996 Annual Report to Stockholders (President's Letter to
Stockholders)
21.1 Subsidiaries of the Company.
_____________________
(b) REPORTS ON FORM 8-K
The Registrant did not file any reports on Form 8-K during the fourth
quarter of the 1996 fiscal year.
29
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has duly caused this report on Form 10-KSB to be signed on
its behalf by the undersigned, thereunto duly authorized, on the 26th day of
June, 1996.
CYANOTECH CORPORATION
By: /s/ Gerald R. Cysewski
------------------------------
Gerald R. Cysewski, Ph.D
Chairman of the Board,
President and Chief
Executive Officer
In accordance with the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the Registrant and in
the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
<S> <C> <C>
/s/ Gerald R. Cysewski Chairman of the Board, President June 26, 1996
- - ----------------------------- and Chief Executive Officer
Gerald R. Cysewski, Ph.D (Principal Executive Officer)
/s/ Ronald P. Scott Executive Vice President - Finance June 26, 1996
- - ----------------------------- and Administration, Secretary and
Ronald P. Scott Treasurer (Principal Financial and
Accounting Officer)
/s/ Julian C. Baker Director June 24, 1996
- - -----------------------------
Julian C. Baker
/s/ Eva R. Reichl Director June 13, 1996
- - -----------------------------
Eva R. Reichl
/s/ John T. Ushijima Director June 24, 1996
- - -----------------------------
John T. Ushijima
/s/ Paul C. Yuen Director June 24, 1996
- - -----------------------------
Paul C. Yuen
</TABLE>
30
<PAGE>
CYANOTECH CORPORATION
Index to Financial Statements
Page
----
Independent Auditors' Report F-2
Consolidated Balance Sheets F-3
Consolidated Statements of Income F-4
Consolidated Statements of Stockholders' Equity F-5
Consolidated Statements of Cash Flows F-6
Notes to Consolidated Financial Statements F-7 to F-18
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Cyanotech Corporation:
We have audited the accompanying consolidated balance sheets of Cyanotech
Corporation and subsidiary as of March 31, 1996 and 1995, and the related
consolidated statements of income, stockholders' equity and cash flows for the
years then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Cyanotech
Corporation and subsidiary as of March 31, 1996 and 1995, and the results of
their operations and their cash flows for the years then ended in conformity
with generally accepted accounting principles.
KPMG Peat Marwick, LLP
Honolulu, Hawaii
April 26, 1996
F-2
<PAGE>
CYANOTECH CORPORATION
Consolidated Balance Sheets
March 31, 1996 and 1995
(in thousands, except share data)
<TABLE>
<CAPTION>
ASSETS (NOTE 4) 1996 1995
------- -------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 9,409 $ 496
Accounts receivable 1,288 648
Inventories (note 2) 494 375
Prepaid expenses 120 5
------- -------
Total current assets 11,311 1,524
Equipment and leasehold improvements, net (note 3) 8,349 4,635
Other assets 56 53
------- -------
Total assets $19,716 $ 6,212
------- -------
------- -------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt (note 4) $ 150 $ 7
Current maturities of capital lease obligations (note 5) 126 58
Accounts payable 852 629
Accrued expenses and other (note 7) 434 230
------- -------
Total current liabilities 1,562 924
Long-term debt, excluding current maturities (note 4) 513 --
Obligations under capital lease, excluding current
maturities (note 5) 325 184
------- -------
Total liabilities 2,400 1,108
------- -------
Stockholders' equity:
Preferred stock (note 8) 1 2
Common stock of $.005 par value, authorized
18,000,000 shares; issued and outstanding
11,755,650 shares at March 31, 1996 and issued
9,051,325 shares at March 31, 1995 59 45
Additional paid-in capital 21,876 12,216
Accumulated deficit (4,620) (7,129)
------- -------
17,316 5,134
Less - treasury stock, 30,000 common shares at cost at
March 31, 1995 -- 30
------- -------
Total stockholders' equity 17,316 5,104
------- -------
Commitments and contingencies (notes 5, 8 and 13)
Total liabilities and stockholders' equity $19,716 $ 6,212
------- -------
------- -------
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
CYANOTECH CORPORATION
Consolidated Statements of Income
Years ended March 31, 1996 and 1995
(in thousands, except per-share data)
<TABLE>
<CAPTION>
1996 1995
------- -------
<S> <C> <C>
Net sales (note 10) $ 8,081 $ 4,150
Cost of sales 3,518 2,275
------- -------
Gross profit 4,563 1,875
------- -------
Operating expenses:
Research and development 351 171
General and administrative 1,196 685
Sales and marketing 445 301
------- -------
Total operating expenses 1,992 1,157
------- -------
Income from operations 2,571 718
------- -------
Other income (expense):
Interest income 32 17
Interest expense (90) (27)
Other income (expense), net (4) 98
Proportionate share of loss of joint venture -- (37)
------- -------
Total other income (expense) (62) 51
------- -------
Net income $ 2,509 $ 769
------- -------
------- -------
Net income per common share $ 0.17 $ 0.05
------- -------
------- -------
Weighted average number of common shares and common share
equivalents 14,548 13,589
------- -------
------- -------
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
CYANOTECH CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years ended March 31, 1996 and 1995
(in thousands, except share data)
<TABLE>
<CAPTION>
PREFERRED STOCK
(NOTE 8) COMMON STOCK
----------------- ---------------- ADDITIONAL TOTAL
PAR PAR PAID-IN ACCUMULATED TREASURY STOCKHOLDERS'
SHARES VALUE SHARES VALUE CAPITAL DEFICIT STOCK EQUITY
---------- ----- ---------- ----- ---------- ----------- -------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balances at March 31, 1994 2,118,507 $2 8,736,506 $44 $12,042 $(7,898) $(30) $ 4,160
Common stock issued for cash, net of
costs of $6 -- -- 146,969 1 144 -- -- 145
Exercise of warrants for cash -- -- 38,400 -- 24 -- -- 24
Exercise of stock options for cash -- -- 4,300 -- 3 -- -- 3
Conversion of 21,030 shares of Series C
preferred stock to 105,150 shares of
common stock (note 8) (21,030) -- 105,150 -- -- -- -- --
Conversion of 100,000 shares of Series E
preferred stock to 20,000 shares of
common stock (note 8) (100,000) -- 20,000 -- -- -- -- --
Issuance of common stock warrants for
services -- -- -- -- 3 -- -- 3
Net income -- -- -- -- -- 769 -- 769
---------- ----- ---------- ----- ---------- ----------- -------- -------------
Balances at March 31, 1995 1,997,477 2 9,051,325 45 12,216 (7,129) (30) 5,104
Exercise of warrants for cash -- -- 891,200 5 507 -- -- 312
Exercise of stock options for cash -- -- 82,625 -- 76 -- -- 76
Issuance of common stock to nonemployee
directors for services -- -- 8,000 -- 40 -- -- 40
Exchange of Series A preferred stock for
common stock (1,250,000) (1) 250,000 1 -- -- -- --
Exchange of Series B preferred stock for
common stock (12,500) -- 2,500 -- -- -- -- --
Retirement of treasury stock -- -- (30,000) -- (30) -- 30 --
Common Stock issued for cash, net of
costs of $556 -- -- 1,500,000 8 9,067 -- -- 9,075
Net income -- -- -- -- -- 2,509 -- 2,509
---------- ----- ---------- ----- ---------- ----------- -------- -------------
Balances at March 31, 1996 734,977 $ 1 11,755,650 $59 $21,876 $(4,620) $ -- $17,316
---------- ----- ---------- ----- ---------- ----------- -------- -------------
---------- ----- ---------- ----- ---------- ----------- -------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
CYANOTECH CORPORATION
Consolidated Statements of Cash Flows
Years ended March 31, 1996 and 1995
(in thousands)
<TABLE>
<CAPTION>
1996 1995
------- -------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 2,509 $ 769
Adjustments to reconcile net income to net cash provided by
operating activities:
Proportionate share of loss of joint venture -- 37
Depreciation and amortization 499 338
Increase in accounts receivable (640) (186)
(Increase) decrease in inventories (119) 23
Increase in prepaid expenses and other assets (118) (17)
Increase in accounts payable 223 63
Increase (decrease) in accrued expenses and other 204 (28)
Other 40 --
------- -------
Net cash provided by operating activities 2,598 999
------- -------
Cash flows from investing activities:
Investment in equipment and leasehold improvements (3,910) (1,442)
Investment in joint venture -- (37)
------- -------
Net cash used in investing activities (3,910) (1,479)
------- -------
Cash flows from financing activities:
Net proceeds from issuance of common stock and exercise of
stock options and warrants 9,663 175
Proceeds from issuance of long-term debt 750 --
Principal payments on long-term debt (94) (13)
Principal payments on capital lease obligations (94) (52)
------- -------
Net cash provided by financing activities 10,225 110
------- -------
Net increase (decrease) in cash and cash
equivalents 8,913 (370)
Cash and cash equivalents at beginning of year 496 866
------- -------
Cash and cash equivalents at end of year $ 9,409 $ 496
------- -------
------- -------
Supplemental disclosure of cash flow information:
Cash paid during the year for interest $ 73 $ 26
------- -------
------- -------
Non-cash investing and financing activities:
Equipment leased under capital lease obligations $ 303 $ 166
------- -------
------- -------
Issuance of common stock to non-employee directors for
services $ 40 --
------- -------
------- -------
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
CYANOTECH CORPORATION
Notes to Consolidated Financial Statements
Years ended March 31, 1996 and 1995
(all amounts in thousands, except share data)
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF ACCOUNTING POLICIES
(a) Description of Business
Cyanotech Corporation (Company) develops and commercializes
natural products from microalgae. The Company is currently
producing microalgae products for the nutritional supplement and
immunological diagnostics markets and is also developing
microalgae-based products for the aquaculture feed/pigments,
biopesticide and food coloring markets.
Substantially all of the Company's net sales have been
attributable to its SPIRULINA PACIFICA products. Sales of
SPIRULINA PACIFICA products accounted for approximately 98% and
97% of the Company's net sales for the year ended March 31, 1996
and 1995, respectively.
(b) Principles of Consolidation
The Company consolidates enterprises in which it has a
controlling financial interest. The accompanying consolidated
financial statements include the accounts of Cyanotech
Corporation and its wholly owned subsidiary, Nutrex, Inc. All
significant intercompany balances and transactions have been
eliminated in consolidation.
(c) Cash Equivalents
For purposes of the consolidated statements of cash flows, the
Company considers all highly liquid debt investments purchased
with original maturities of three months or less to be cash
equivalents.
(d) Inventories
Inventories are stated at the lower of cost (which approximates
first-in, first-out) or market.
(e) Equipment and Leasehold Improvements
Owned equipment and leasehold improvements are stated at cost.
Equipment under capital lease is stated at the lower of the
present value of minimum lease payments or fair value of the
equipment at the inception of the lease. Depreciation and
amortization are provided using the straight-line method over the
following estimated useful lives:
<TABLE>
<CAPTION>
ESTIMATED
USEFUL LIVES
-------------
<S> <C>
Equipment 3 to 10 years
Leasehold improvements lease term
Furniture and fixtures 7 years
Equipment under capital lease lease term
</TABLE>
Amortization of equipment under capital lease is included in
depreciation and amortization expense in the accompanying
consolidated financial statements.
F-7
<PAGE>
CYANOTECH CORPORATION
Notes to Consolidated Financial Statements, Continued
(f) Investments in Joint Ventures
Investments in joint ventures and other investments for which the
Company has the ability to exercise significant influence over
the operating and financing policies of the enterprise are
accounted for under the equity method.
(g) Net Income Per Common Share
Net income per common share is computed based on net income after
preferred stock dividend requirements and the weighted average
number of common shares outstanding during the year, adjusted to
reflect the assumed exercise of outstanding stock options and
warrants and the conversion of preferred stock to the extent such
items have a dilutive effect on the computation. Fully diluted
net income per common share is not materially different from
primary net income per common share.
(h) Income Taxes
Deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and
liabilities and their tax bases and operating loss carryforwards.
Deferred tax assets and liabilities are measured using enacted
income tax rates applicable to the period in which the deferred
tax assets or liabilities are expected to be realized or settled.
As changes in tax laws or rates are enacted, deferred tax assets
and liabilities are adjusted through the provision for income
taxes.
(i) Research and Development
Research and development costs are expensed as incurred.
(j) Accounting Changes
LONG-LIVED ASSETS
In March 1995, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards (SFAS) No.
121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of." SFAS No. 121 requires that
long-lived assets and certain identifiable intangibles held and
used by an entity be reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. If the sum of the expected future
cash flows (undiscounted and without interest charges) is less
than the carrying amount of the asset, an impairment loss is
recognized. Measurement of that loss would be based on the fair
value of the asset.
Generally, SFAS No. 121 requires that long-lived assets and
certain identifiable intangibles to be disposed of be reported at
the lower of carrying amount or fair value less cost to sell.
The Company adopted the provisions of SFAS No. 121 effective
April 1, 1996. The adoption of SFAS No. 121 did not have a
material effect on the Company's financial condition or results
of operations.
F-8
<PAGE>
CYANOTECH CORPORATION
Notes to Consolidated Financial Statements, Continued
STOCK-BASED COMPENSATION
In October 1995, the FASB issued SFAS No. 123, "Accounting for
Stock-Based Compensation." SFAS No. 123 establishes a fair value
based method of accounting for stock-based compensation, but does
not require an entity to adopt the new method for purposes of
preparing its basic financial statements. For entities not
adopting the new method, SFAS No. 123 requires footnote
disclosure of proforma net income and earnings per share
information as if the fair value based method had been adopted.
The disclosure requirements of SFAS No. 123 are effective for
financial statements for fiscal years beginning after December
15, 1995. The Company will comply with the disclosure
requirements of SFAS No. 123 in its consolidated financial
statements as of and for the year ending March 31, 1997.
(k) Use of Estimates
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements, and the
reported amounts of revenues and expenses during the reporting
period. Actual results could differ significantly from those
estimates.
(l) Reclassifications
Certain 1995 amounts were reclassified to conform with 1996
presentations. Such reclassifications had no effect on the
previously reported results of operations.
(2) INVENTORIES
Inventories consists of the following as of March 31, 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Raw materials $ 73 $ 29
Work in process 200 105
Finished goods 105 171
Supplies 116 70
---- ----
$494 $375
---- ----
---- ----
</TABLE>
F-9
<PAGE>
CYANOTECH CORPORATION
Notes to Consolidated Financial Statements, Continued
(3) EQUIPMENT AND LEASEHOLD IMPROVEMENTS, NET
Equipment and leasehold improvements consists of the following as of
March 31, 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
------- -------
<S> <C> <C>
Equipment $ 3,538 $ 2,622
Leasehold improvements 6,815 3,648
Furniture and fixtures 36 31
Equipment under capital lease (note 5) 602 299
------- -------
10,991 6,600
Less accumulated depreciation and amortization (3,038) (2,539)
Construction in-progress 396 574
------- -------
Equipment and leasehold improvements, net $ 8,349 $ 4,635
------- -------
------- -------
</TABLE>
(4) LONG-TERM DEBT
Long-term debt consists of the following as of March 31, 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
------- -------
<S> <C> <C>
Note payable at 5% to the State of Hawaii,
Department of Agriculture, secured by all
Company assets, paid in September 1995 $ -- $ 7
Notes payable at the London Interbank
Offered Rate (LIBOR) plus 2%, adjusted
quarterly; principal payments of $37.5
due quarterly, plus interest 663 --
Less current maturities of long-term debt (150) (7)
------- -------
Long-term debt, excluding current
maturities $ 513 $ --
------- -------
------- -------
</TABLE>
On April 1, 1995, the Company executed a $250 note, payable in
principal installments of $12.5 each quarter, plus interest, with
principal and interest payments satisfied by delivering to the
lender an equivalent market value amount of salable product or
cash (at the lender's option). The note payable bears interest
at LIBOR plus 2%, adjusted quarterly, and is secured by certain
Company assets.
On July 11, 1995, the Company executed a $500 note, payable in
principal installments of $25 each quarter, plus interest, with
principal and interest payments satisfied by delivering to the
lender an equivalent market value amount of salable product or
cash (at the lender's option). The note payable bears interest
at LIBOR plus 2%, adjusted quarterly, and is secured by certain
Company assets.
F-10
<PAGE>
CYANOTECH CORPORATION
Notes to Consolidated Financial Statements, Continued
(5) LEASES
The Company leases certain of its equipment and a building
under capital leases expiring between 1998 and 2000, and leases
facilities, equipment and land under operating leases expiring
between 1997 and 2025. At March 31, 1996, the net book value of
equipment under the capital leases amounted to $523.
Future minimum lease payments under non-cancelable operating
leases and the present value of future minimum capital lease
payments as of March 31, 1996 are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
------- ----------
<S> <C> <C>
Year ending March 31:
1997 $160 $ 127
1998 152 117
1999 142 114
2000 38 112
2001 -- 112
Thereafter, through 2025 -- 2,771
---- ------
Total minimum lease payments 492 $3,353
------
------
Less amount representing interest at 8.1% 41
----
Present value of minimum capital lease
payments 451
Less current maturities of capital lease obligations 126
----
Obligations under capital lease, excluding
current maturities $325
----
----
</TABLE>
Total rent expense under operating leases amounted to $89
and $48 for the years ended March 31, 1996 and 1995.
(6) INVESTMENT IN JOINT VENTURES
In March 1993, the Company formed a joint venture
corporation, OceanColor, Inc., with an unrelated entity,
Aquasearch, Inc., to develop commercial systems for producing a
natural red pigment from microalgae, called astaxanthin, for use
as a natural feed ingredient by the acquaculture industry. On
November 18, 1994, the joint venture agreement was terminated by
mutual consent. Under the terms of the joint venture agreement,
the Company owned a 50% interest in OceanColor, Inc., and was
committed to contribute, subject to certain conditions, services
and facilities and equipment use and technology valued at $423.
As of the termination date, $63 of services and facilities and
equipment use had been contributed and the Company has no further
obligation under the joint venture arrangement. The Company
plans to continue, on its own, development of commercial systems
for the production of astaxanthin.
F-11
<PAGE>
CYANOTECH CORPORATION
Notes to Consolidated Financial Statements, Continued
On August 31, 1994, the Company formed a joint venture
partnership with Hauser Chemical Research, Inc. (Hauser) to
develop, produce, and market natural beta carotene. Under the
terms of the partnership agreement, Hauser owns a 60% interest
and the Company owns a 40% interest in the joint venture.
Development work is expected to be completed in 1996 with the
total cost to the Company for its share of development costs not
expected to exceed $400 (as of March 31, 1996 and 1995,
approximately $324 and $125, respectively, had been incurred).
Funding for the construction of the commercial production
facility would be arranged by the joint venture partnership.
(7) ACCRUED EXPENSES AND OTHER
Accrued expenses and other consists of the following as of
March 31, 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Accrued payroll and related benefits $341 $126
Accrued directors' fees 30 35
Deposits -- 26
Other accrued liabilities 63 43
---- ----
$434 $230
---- ----
---- ----
</TABLE>
(8) PREFERRED STOCK
Series A and B convertible preferred stock were non-voting
(except for the right of Series A preferred stockholders to elect
one director, as described below) and were convertible into
common stock at the rate of five shares of preferred stock for
one share of common stock through February 28, 1995 for Series A
preferred stock and February 28, 1993 for Series B preferred
stock. Holders of Series A and B preferred stock were entitled
to 12% cumulative annual dividends at the rate of $.048 per
share. Series A preferred stockholders also had certain
preemptive rights, anti-dilution privileges and the right to
elect one member of the board of directors. The consent of
Series A preferred stockholders was also required to alter their
present rights, issue additional shares of preferred stock, sell
the Company, or sell or assign the Company's proprietary
technical information.
On December 27, 1995, the Company exchanged 2,500 shares of
restricted common stock for the remaining 12,500 shares of Series
B preferred stock. On March 27, 1996, the Company exchanged
250,000 shares of restricted common stock for all 1,250,000
shares of Series A preferred stock. The amount of cumulative
dividends foregone due to conversion during the year ended March
31, 1996 was $655 and $6 for Series A and Series B preferred
stock, respectively.
F-12
<PAGE>
CYANOTECH CORPORATION
Notes to Consolidated Financial Statements, Continued
Series C convertible preferred stock is convertible into common
stock at the rate of one share of preferred stock for five shares
of common stock through February 23, 2000, after which date the
conversion feature is no longer applicable. Holders of 21,030
shares of Series C preferred stock elected to convert such shares
into 105,150 shares of common stock during the year ended March
31, 1995. Series C preferred stock has voting rights equal to
the number of shares of common stock into which it is convertible
and has a preference in liquidation over all other series of
preferred stock of $5 per share plus any accumulated but unpaid
dividends. Holders of Series C preferred stock are entitled to
8% cumulative annual dividends at the rate of $.40 per share;
cumulative dividends in arrears as of March 31, 1996 amount to
$1,957 ($2.663 per share). Upon conversion of Series C preferred
stock, cumulative dividends in arrears on converted shares are no
longer payable. The amount of cumulative dividends foregone due
to conversion during the year ended March 31, 1995 was $36. The
consent of Series C preferred stockholders is required to change
their present rights or sell all or substantially all of the
Company's assets.
The Series C convertible preferred stock was originally issued
with a redemption feature. Terms of the Series C preferred stock
were modified in February 1991 to eliminate such redemption
feature.
Series E convertible preferred stock was convertible at the
holder's option into common stock at the rate of five shares of
preferred stock for one share of common or for such number of
common shares as have a market value of $.75, through September
26, 1994. Series E convertible preferred stock was converted by
the holder into 20,000 shares of common stock on September 21,
1994. Upon conversion of Series E preferred stock, cumulative
dividends in arrears on converted shares are no longer payable.
The amount of cumulative dividends foregone due to conversion
during the year ended March 31, 1995 was $38.
Preferred stock as of March 31, 1996 and 1995 consists of the
following:
<TABLE>
<CAPTION>
1996 1995
------ -----
<S> <C> <C>
Preferred stock, authorized 5,000,000 shares;
$.001 par value, issued and outstanding:
Series A, 12% cumulative; 1,250,000 shares
at March 31, 1995 (nil at March 31, 1996);
liquidation value $.40 per share plus
unpaid accumulated dividends $ -- $ 1
Series B, 12% cumulative, 12,500 shares at
March 31, 1995 (nil at March 31, 1996);
liquidation value $.40 per share plus
unpaid accumulated dividends -- --*
Series C, 8% cumulative, convertible;
734,977 shares; liquidation value
$5.00 per share plus unpaid accumulated
dividends 1 1
----- -----
$ 1 $ 2
----- -----
----- -----
</TABLE>
*Amount is less than $.5
F-13
<PAGE>
CYANOTECH CORPORATION
Notes to Consolidated Financial Statements, Continued
(9) STOCK OPTIONS AND WARRANTS
STOCK OPTIONS
At the Company's annual meeting held on August 9, 1995, the
stockholders of the Company approved the Company's 1995 Stock
Option Plan (Plan), reserving a total of 400,000 shares of common
stock for issuance under the Plan. The Plan provides for the
issuance of both incentive and non-qualified stock options.
Options are to be granted at or above the fair market value of
the Company's common stock at the date of grant and generally
become exercisable over a five-year period.
The Company also has a Non-employee Director Stock Option and
Stock Grant Plan, which was approved by stockholders in 1994.
Under this plan and upon election to the Board of Directors,
non-employee directors are granted a ten-year option to purchase
3,000 shares of the Company's common stock at its fair market
value on the date of grant. In addition, on the date of each
Annual Meeting of Stockholders in each year that this plan is in
effect, each non-employee director continuing in office will be
automatically granted, without payment, 2,000 shares of common
stock that is non-transferable for six months following the date
of grant. Grants of 8,000 shares of common stock were made under
this plan in August 1995. Expense recognized as a result of
these stock grants amounted to $40 for the year ended March 31,
1996.
In 1985, the Company adopted an Incentive Stock Option Plan
(qualified stock option plan) and authorized 200,000 shares of
common stock to be set aside for grants to officers and key
employees of the Company. In 1993, the stockholders approved an
amendment to the Incentive Stock Option Plan which increased the
number of shares reserved for issuance under this plan from
200,000 to 400,000. Options were granted with exercise prices
not lower than the fair market value of the Company's common
stock at the date of grant. Options generally became
excercisable in four equal annual installments, commencing one
year from the date of grant and expire, if not exercised, five
years from the date of grant, unless stipulated otherwise by the
Compensation and Stock Option Committee of the board of
directors. The Incentive Stock Option Plan terminated on March
18, 1995. Options granted prior to the plan termination date are
not affected.
The Company has also issued non-qualified stock options to
non-employees and directors in exchange for services provided to
the Company. Non-qualified stock options are granted with
exercise prices not lower than the fair market value of the
Company's common stock on the date of grant, are immediately
exercisable and expire two to ten years from the date of grant.
F-14
<PAGE>
CYANOTECH CORPORATION
Notes to Consolidated Financial Statements, Continued
A summary of transactions relating to options during the years
ended March 31, 1995 and 1996 is set forth below:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
--------------------------------------------------
QUALIFIED NON-QUALIFIED
------------------------ ------------------------
NUMBER OF NUMBER OF
SHARES SHARES SHARES
AVAILABLE UNDER PRICE PER UNDER PRICE PER
FOR GRANT OPTION SHARE OPTION SHARE
--------- ---------- ------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
Balances at March 31, 1994 175,700 221,000 $.56 to 1.50 2,000 $ .50
1.06 to
Options granted (98,900) 98,900 .94 115,000 2.00
Options exercised -- (4,300) .56 to .94 -- --
Options canceled 20,900 (20,900) .56 to 1.50 (3,000) 1.06
-------- ------- ----------- ------- ------------
Balances at March 31, 1995 97,700 294,700 .56 to 1.50 114,000 .50 to 2.00
Additional shares reserved 400,000 -- -- -- --
Options granted (101,000) 101,000 5.13 -- --
Options exercised -- (79,625) .56 to 1.50 (3,000) 1.06
Options canceled 7,375 (7,375) .56 to 1.50 -- --
Termination of 1985 Plan (104,375) -- -- -- --
-------- ------- ----------- ------- ------------
Balances at March 31, 1996 299,700 308,700 $.56 to 5.13 111,000 $.50 to 2.00
-------- ------- ------------ ------- ------------
-------- ------- ------------ ------- ------------
</TABLE>
At March 31, 1996, options to purchase 226,913 shares of
common stock were exercisable.
WARRANTS
At March 31, 1996, the Company has warrants outstanding to
acquire 801,000 shares of the Company's common stock. The
warrants were issued in consideration for loans to the Company,
in consideration for and in recognition of services performed and
to certain individuals who guaranteed notes payable by the
Company. Warrants granted for loans, services and guarantees
were granted with exercise prices not lower than the fair market
value of the Company's common stock on the date of grant. The
warrants are exercisable at prices ranging from $.40 to $1.00 per
share and expire on various dates from May 1996 to September
1999. Warrants to acquire 891,200 and 38,400 shares of common
stock were exercised at an average price of $.57 and $.63 in 1996
and 1995, respectively.
F-15
<PAGE>
CYANOTECH CORPORATION
Notes to Consolidated Financial Statements, Continued
(10) MAJOR CUSTOMERS AND EXPORT SALES
Sales to major customers for the years ended March 31, 1996 and
1995 are summarized as follows (percent of product sales):
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Customer A 29% *%
Customer B 11% 17%
Customer C *% 13%
---- ----
40% 30%
---- ----
---- ----
</TABLE>
*Less than 10% of product sales.
Product sales revenue by geographic area for the years ended
March 31, 1996 and 1995 are summarized as follows:
<TABLE>
<CAPTION>
1996 1995
------------ ------------
<S> <C> <C> <C> <C>
United States $3,614 45% $2,412 58%
Canada 896 11% 696 17%
Europe 747 9% 621 15%
China 2,375 29% 125 3%
Asia/Pacific, excluding China 449 6% 296 7%
------ ---- ------ ----
$8,081 100% $4,150 100%
------ ---- ------ ----
------ ---- ------ ----
</TABLE>
All foreign product sales transactions are consummated in U.S. dollars.
(11) INCOME TAXES
The provision for income taxes for the years ended March 31, 1996
and 1995 is nil due to the utilization of net operating losses.
F-16
<PAGE>
CYANOTECH CORPORATION
Notes to Consolidated Financial Statements, Continued
The tax effects of temporary differences related to various
assets and liabilities that give rise to deferred tax assets and
deferred tax liabilities as of March 31, 1996 and 1995 are as
follows:
<TABLE>
<CAPTION>
1996 1995
------- -------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 1,509 $ 2,585
Tax credit carryforwards 140 140
Other 169 73
------- -------
1,818 2,798
Less valuation allowance (1,750) (2,751)
------- -------
Net deferred tax assets $ 68 $ 47
------- -------
------- -------
Deferred tax liability - equipment and
leasehold improvements $ 68 $ 47
------- -------
------- -------
</TABLE>
The valuation allowance for deferred tax assets as of March
31, 1996 and 1995 was $1,750 and $2,751, respectively. The
valuation allowance decreased by $1,001 and $300 during the years
ended March 31, 1996 and 1995, respectively. In assessing the
realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of
the deferred tax assets will not be realized. The ultimate
realization of deferred tax assets is dependent upon the
generation of future taxable income during the periods in which
those temporary differences become deductible. Management
considers the scheduled reversal of deferred tax liabilities,
projected future taxable income, and tax planning strategies in
making this assessment.
Based upon the level of historical taxable income and
projections for future taxable income over the periods which the
deferred tax assets are deductible, management believes it is
more likely than not the Company will realize the benefits of
these deductible differences, net of the existing valuation
allowances at March 31, 1996.
At March 31, 1996, the Company has tax net operating tax
loss carryforwards available to offset future federal and state
taxable income and tax credit carryforwards available to offset
future federal income taxes as follows:
<TABLE>
<CAPTION>
NET RESEARCH AND
OPERATING INVESTMENT EXPERIMENTATION
EXPIRES MARCH 31, LOSSES TAX CREDITS TAX CREDITS
----------------- ---------- ----------- ---------------
<S> <C> <C> <C>
1998 $ -- $ -- $ 3
1999 -- -- 14
2000 -- 14 15
2001 -- -- 22
2002 -- -- 15
2003 1,223 -- 52
2004 1,825 -- 5
2005 155 -- --
2006 763 -- --
</TABLE>
F-17
<PAGE>
CYANOTECH CORPORATION
Notes to Consolidated Financial Statements, Continued
<TABLE>
<CAPTION>
NET RESEARCH AND
OPERATING INVESTMENT EXPERIMENTATION
EXPIRES MARCH 31, LOSSES TAX CREDITS TAX CREDITS
----------------- ---------- ----------- ---------------
<S> <C> <C> <C>
2007 $ 1 -- --
2008 -- -- --
2009 1 -- --
2010 1 -- --
----------- ----- -----
$ 3,969 $ 14 $ 126
----------- ----- -----
----------- ----- -----
</TABLE>
In addition, the Company has alternative minimum tax credit
carryforwards of approximately $52 which are available to reduce
future federal regular income taxes, if any, over an indefinite
period.
Investment tax credits will be recorded as a reduction of the provision
for federal income taxes in the year realized.
(12) FAIR VALUE OF FINANCIAL INSTRUMENTS
FASB Statement No. 107, "Disclosure about Fair Value of
Financial Instruments," defines the fair value of a financial
instrument as the amount at which the instrument could be
exchanged in a current transaction between willing parties.
The following methods and assumptions were used to estimate the
fair value of each class of financial instruments as of March 31,
1996:
CASH AND CASH EQUIVALENTS
The carrying amounts approximate fair value because of the short-term
nature of these instruments.
LONG-TERM DEBT
The carrying amounts approximate fair value because the
instruments reprice at market rates on a quarterly basis.
(13) COMMITMENTS AND CONTINGENCIES
At March 31, 1996, the Company has entered into commitments
for capital expenditures totaling $1,556.
The Company is involved in various claims arising in the
ordinary course of business. In the opinion of management, the
ultimate disposition of these matters will not have a material
adverse effect on the Company's consolidated financial position,
results of operations or liquidity.
F-18
<PAGE>
Exhibit 11.1
CYANOTECH CORPORATION
COMPUTATION OF EARNINGS PER SHARE
Fiscal years ended March 31
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
Net Income $ 2,509,000 $ 769,000
Less: requirement for preferred stock dividends - 60,600
------------- -----------
Net income available to common stockholders $ 2,509,000 $ 708,400
------------- -----------
------------- -----------
Earnings per Share: (1)
Weighted Average Common Shares Outstanding 9,833,000 8,894,000
Weighted Average Common Equivalent Shares
Outstanding 4,715,000 4,695,000
------------- -----------
Weighted Average Common and Common
Equivalent Shares Outstanding 14,548,000 13,589,000
------------- -----------
------------- -----------
Net Income per Common and Common Equivalent
Shares $ 0.17 $ 0.05
------------- -----------
------------- -----------
</TABLE>
____________________
(1) There was no difference between the computation of earnings per share on a
primary versus fully-diluted basis; accordingly, dual presentation is not
required.
<PAGE>
EXHIBIT 13.1
JUNE 20, 1996
TO OUR STOCKHOLDERS:
Propelled by increasing demand for Spirulina around the world, Cyanotech's
sales and profits climbed in fiscal 1996 for the third consecutive year. Our
fourth quarter marked the ninth consecutive quarter of year-to-year sales and
earnings improvements. The achievements of the past two years demonstrate
that the Cyanotech team is delivering on its commitment to build long-term
stockholder value through well-executed strategies.
Net income for the fiscal year ended March 31, 1996, increased 226% to
$2,509,000 from the prior year's $769,000. Earnings per share rose 240% to
$0.17 from $0.05 in fiscal 1995. Revenues in fiscal 1996 reached $8,081,000,
a 95% increase over fiscal 1995 revenues of $4,150,000.
GROWTH OPPORTUNITIES
Cyanotech's strategy, now in its third year of execution, targets growth
opportunities by focusing on four strategic goals. These are to:
- - - Build on the market leadership of our flagship product, SPIRULINA
PACIFICA-TM-, by promoting its brand uniqueness and by expanding production
and distribution channels;
- - - Increase the revenue per pond-acre by shifting the Spirulina product mix
from bulk products to packaged consumer products;
- - - Increase the breadth of our product offerings through the development of
new technologies to produce new microalgae-based products;
- - - Maintain our strong environmental commitment.
BUILDING FOR THE FUTURE
With the continued growth in demand for natural foods and food supplements,
more and more health-aware consumers are recognizing the benefits of
Spirulina in their daily diet. As a result, Cyanotech was
capacity-constrained since 1993. During fiscal 1996, we increased our
capacity for Spirulina production by 50% and, in anticipation of continued
growth in demand, we will increase capacity another 50% by September 1996.
The 21 additional acres of Spirulina production ponds currently under
construction will bring our total pond culture area to 65 acres. Upon
completion of these ponds, Cyanotech will become the world's largest producer
of Spirulina, producing an average of two tons per day (dry weight). We
believe this added capacity will be fully utilized once it comes onstream.
<PAGE>
One reason for this expectation is that we are continuing our strategy of
shifting the Spirulina product mix from a reliance on bulk products to more
profitable finished consumer products. To accomplish this transition, we
will be increasing our investment in sales and marketing personnel and
programs. In early June 1996, we recruited Walter M. Rick as national sales
manager of Nutrex, Inc., the company's wholly owned subsidiary that markets
Spirulina-based nutritional products to the retail market. Mr. Rick was
previously vice president and national sales manager for a competitor and
brings significant retail marketing experience in the health food channel to
Cyanotech, having built a national sales and broker network covering health
food stores, nutrition centers, supermarkets and drug stores.
We estimate that only one million consumers worldwide use Spirulina on a
regular basis today. Besides the growth potential of our expanded branded
retail product program, Cyanotech currently is selling Spirulina products on
a limited basis in only 12 countries with significant expansion opportunities
in those countries as well as others we have yet to enter. This potential
appears very large.
On the process front, we are continuing our investment in quality control to
maintain our worldwide leadership position as being the producer of the
highest quality microalgal products. In addition to being the only
microalgae producer to have received organic certification, we plan to be the
first microalgae producer to receive ISO 9000 certification. We are in the
registration process and hope to have it completed by late Summer.
New product development is a key part of our core strategy at Cyanotech. To
that end, we have continued the commercial development of natural astaxanthin
and licensed in the Fall of 1995 a promising new natural mosquitocide,
Synechococcus with the Bti toxin, developed at the University of Memphis.
Both products have the potential for large sales. Sales of synthetic
astaxanthin to the aquaculture market now total more than $150 million
annually. At this time, we are in preliminary discussions with potential
distributors and end-users of natural astaxanthin in the aquaculture industry.
We also are constructing a larger research facility and have hired a new
scientific director, R. Todd Lorenz, Ph.D., and additional technical staff to
help us bring these new products to market. Dr. Lorenz was senior scientist
and group leader, genetics and physiology, at IGENE Biotechnology, Inc. of
Columbia, Maryland. At IGENE, he worked on varied research projects related
to the production of natural astaxanthin.
Our work on the genetically-engineered mosquitocide has begun and we plan to
begin construction of a pilot-scale commercial production system later this
year.
INCREASING FINANCIAL STRENGTH
Building toward the future has been enabled by the successful secondary
public offering of common stock we concluded in April 1996. It raised net
proceeds of $10.6 million, which are earmarked for Spirulina capacity
expansion, sales and marketing expansion, infrastructure additions and new
product development. A portion of the proceeds from the public offering will
<PAGE>
be used for the construction of an astaxanthin production facility. We
expect to be in commercial production of natural astaxanthin later this year.
At March 31, 1996, total assets approached $20 million, working capital was
$9.7 million, and total stockholders' equity was $17.3 million. Cyanotech has
the financial resources to maintain the forward momentum experienced during
the past two years.
OUTLOOK FOR FISCAL 1997
Cyanotech Corporation is poised for major progress during fiscal 1997. With
Spirulina a proven market success, natural astaxanthin ready to launch into a
known market of considerable size, and the new mosquitocide in development
for what may be a major market opportunity worldwide, we have a sound and
profitable business with a promising pipeline into the future, as well as the
financial resources to continue our forward momentum.
In conclusion, I would like to thank our outstanding team of dedicated
associates for their hard work, and you, our stockholders, for your continued
support. As we succeed in carrying out our plans for 1997, the year will
form the base for major growth in 1998 and beyond.
Gerald R. Cysewski, Ph.D.
Chairman, President and Chief Executive Officer
<PAGE>
Exhibit 21.1
CYANOTECH CORPORATION
_____________________
Subsidiaries of the Company
(all wholly-owned by the Company)
1. NUTREX, Inc., incorporated in the State of Hawaii.
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