UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarterly Period Ended September 30, 1998
Commission File Number 0-14602
CYANOTECH CORPORATION
(Exact name of registrant as specified in its charter)
NEVADA 91-1206026
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification Number)
73-4460 Queen Kaahumanu Hwy. #102, Kailua-Kona, HI 96740
(Address of principal executive offices)
(808) 326-1353
(Registrant's telephone number)
Check whether the registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act 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 xx No___
Number of common shares outstanding as of October 31, 1998:
Title of Class Shares Outstanding
Common stock - $.005 par value stock 13,603,572
1
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CYANOTECH CORPORATION
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
<S> <C> <C>
Item 1. Financial Statements Page
Consolidated Balance Sheets (unaudited)
September 30, 1998 and March 31, 1998 . . . . . . . . . . . . . . . . . . . . . . . . . . . .3
Consolidated Statements of Operations (unaudited)
Three and six month periods ended
September 30, 1998 and 1997. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4
Consolidated Statements of Cash Flows (unaudited)
Six month periods ended
September 30, 1998 and 1997. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Notes to Consolidated Financial Statements (unaudited). . . . . . . . . . . . . . . . . . . . . . . . 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
PART II. OTHER INFORMATION
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Item 4. Submission of Matters to a Vote of Security Holders. . . . . . . . . . . . . . . . . . . . .18
Item 5. Other Information. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18
Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
SIGNATURES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
</TABLE>
2
<PAGE>
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CYANOTECH CORPORATION
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share amounts)
<S> <C> <C>
September 30, March 31,
1998 1998
Assets (Unaudited) (Audited)
Current assets: -------------- --------------
Cash and cash equivalents $ 345 $ 1,397
Accounts receivable, net 1,187 1,246
Inventories (note 2) 2,267 2,229
Prepaid expenses 94 88
-------------- --------------
Total current assets 3,893 4,960
Equipment and leasehold improvements, net (note 3) 20,146 20,544
Other assets 278 163
-------------- --------------
Total assets $ 24,317 $ 25,667
============== ==============
Liabilities and Stockholders' Equity
Current liabilities:
Current maturities of long-term debt $ 200 $ 50
Short-term revolving line of credit 209 0
Note payable 0 975
Current maturities of capital lease obligations 129 129
Accounts payable 788 938
Other accrued liabilities 277 272
-------------- --------------
Total current liabilities 1,603 2,364
Long-term debt, excluding current maturities 612 62
Obligations under capital leases, excluding current maturities 1 67
-------------- --------------
Total liabilities 2,216 2,493
Stockholders' equity:
Cumulative preferred stock, Series C, of $.001 par value
(aggregate involuntary liquidation preference $2,975 ($5 per
share), plus unpaid cumulative dividends). Authorized 5,000,000
shares; issued and outstanding 595,031 shares at September 30,
1998 and March 31, 1998 1 1
Common Stock of $0.05 par value, authorized 25,000,000 shares;
issued and outstanding 13,603,572 shares at September 30, 1998
and 13,599,572 shares at March 31, 1998 68 68
Additional paid-in capital 23,866 23,866
Accumulated deficit (1,834) (761)
-------------- --------------
Total stockholders' equity 22,101 23,174
-------------- --------------
Total liabilities and stockholders' equity $ 24,317 $ 25,667
============== ==============
See accompanying notes to consolidated financial statements.
</TABLE>
3
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CYANOTECH CORPORATION
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended Six Months Ended
September 30, September 30,
<S> <C> <C> <C> <C>
1998 1997 1998 1997
------------ ------------ ------------ ------------
NET SALES $ 1,525 $ 2,053 $ 3,288 $ 3,827
COST OF PRODUCT SALES 1,124 1,168 2,708 2,070
------------ ------------ ------------ ------------
Gross Profit 401 885 580 1,757
------------ ------------ ------------ ------------
OPERATING EXPENSES:
Research and development 245 173 467 314
General and administrative 358 375 689 706
Sales and marketing 242 410 499 791
------------ ------------ ------------ ------------
Total operating expenses 845 958 1,655 1,811
------------ ------------ ------------ ------------
Loss from operations (444) (73) (1,075) (54)
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Interest income 1 35 3 152
Interest expense (35) (16) (70) (27)
Other income (expense), net 2 - (5) -
------------ ------------ ------------ ------------
Total other income (expense) (32) 19 (72) 125
------------ ------------ ------------ ------------
Income (loss) before income taxes (476) (54) (1,147) 71
Income taxes 34 - 74 -
------------ ------------ ------------ ------------
NET INCOME (LOSS) (442) (54) (1,073) 71
Other comprehensive income - - - -
------------ ------------ ------------ ------------
COMPREHENSIVE INCOME (LOSS) $ (442) $ (54) $ (1,073) $ 71
============ ============ ============ ============
NET LOSS PER COMMON SHARE
Basic $ (0.04) $ (0.01) $ (0.09) $ (0.01)
Diluted $ (0.04) $ (0.01) $ (0.09) $ (0.01)
SHARES USED IN CALCULATION OF:
Basic 13,600 12,852 13,600 12,830
Diluted 13,600 12,852 13,600 12,830
See accompanying notes to consolidated financial statements.
</TABLE>
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CYANOTECH CORPORATION
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
Six Months Ended
September 30,
1998 1997
<S> <C> <C>
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (1,073) $ 71
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Deferred income taxes - (38)
Depreciation and amortization 687 434
Amortization of debt issue costs 6 -
Net (increase) decrease in:
Accounts receivable 59 853
Inventories (38) (873)
Prepaid expenses and other assets (24) (116)
Net increase (decrease) in:
Accounts payable (150) 410
Other accrued liabilities 5 (69)
------------- ------------
Net cash provided by (used in) operating activities (528) 672
------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in equipment and leasehold improvements (289) (5,460)
Proceeds from sales of investment securities - 2,454
------------- ------------
Net cash used in investing activities (289) (3,006)
------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from exercise of warrants and options - 63
Debt issue costs paid (103) -
Proceeds from issuance of long-term debt 750 -
Principal payments on long-term debt (25) (50)
Borrowings on short-term revolving line of credit, net 184 -
Principal payments on note payable (975) -
Principal payments on capital lease obligations (66) (108)
------------- ------------
Net cash used in financing activities (235) (95)
------------- ------------
Net decrease in cash and cash equivalents (1,052) (2,429)
Cash and cash equivalents at beginning of period 1,397 2,775
------------- ------------
Cash and cash equivalents at end of period $ 345 $ 346
============= ============
See accompanying notes to consolidated financial statements.
</TABLE>
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CYANOTECH CORPORATION
FORM 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles
for interim financial information and with the instructions to Form
10-Q and Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. These consolidated
financial statements and notes should be read in conjunction with the
Company's consolidated financial statements contained in the Company's
previously filed report on Form 10-K for the year ended March 31, 1998.
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
subsidiaries, Nutrex, Inc. and Cyanotech International FSC, Inc. All
significant intercompany balances and transactions have been eliminated
in consolidation. While the financial information furnished for the
three and six month periods ended September 30, 1998 is unaudited, the
statements in this report reflect all material items which, in the
opinion of management, are necessary for a fair presentation of the
results of operations for the interim periods covered and of the
financial condition of the Company at the dates of the consolidated
balance sheets. The operating results for the interim period presented
are not necessarily indicative of the results that may be expected for
the year ending March 31, 1999.
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.
2. INVENTORIES
Inventories are stated at the lower of cost (which approximates
first-in, first-out) or market and consist of the following (dollars in
thousands):
<TABLE>
<CAPTION>
<S> <C> <C> <C>
September 30, 1998 March 31, 1998
------------------ ----------------
Raw materials $ 54 $ 103
Work in process 324 362
Finished goods 1,658 1,524
Supplies 231 240
------------------ ----------------
$ 2,267 $ 2,229
================== ================
</TABLE>
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3. 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 the 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 estimated useful lives for
furniture and fixtures and the shorter of the lease terms or estimated
useful lives for leasehold improvements and equipment under capital
lease as follows:
<TABLE>
<CAPTION>
<S> <C> <C>
Equipment 3 to 10 years
Leasehold improvements Remaining lease term (10 to 28 years)
Furniture and fixtures 7 years
Equipment under capital lease Lease term (3 to 5 years)
</TABLE>
Equipment and leasehold improvements consist of the following (dollars
in thousands):
<TABLE>
<CAPTION>
<S> <C> <C>
September 30, 1998 March 31, 1998
------------------ -----------------
Equipment $ 7,952 $ 7,791
Leasehold improvements 13,311 13,285
Furniture and fixtures 94 94
Equipment under capital lease 569 569
------------------ -----------------
21,926 21,739
Less accumulated depreciation and amortization (5,394) (4,707)
Construction in-progress 3,614 3,512
------------------ -----------------
Equipment and leasehold improvements, net $ 20,146 $ 20,544
================== =================
</TABLE>
Construction in-progress includes costs incurred with respect to a
suspended production facility expansion project. As of March 31, 1998,
the Company had agreed with a construction contractor to resume work on
the suspended expansion project on or before January 1, 1999 in a
reasonable and customary manner in accordance with the terms of the
contract and at a minimum billable rate of $150 per month. Total costs
incurred as of September 30, 1998 with respect to this expansion
project approximate $2,643.
4. SERIES C PREFERRED STOCK
Series C 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. 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
September 30, 1998 amount to $2,180 ($3.663 per share). Upon conversion
of Series C preferred stock, cumulative dividends in arrears on
converted shares are no longer payable. The consent of Series C
preferred stockholders is required to modify their present rights or
sell all or substantially all of the Company's assets.
7
<PAGE>
5. EARNINGS PER SHARE
The company adopted Statement of Financial Accounting Standards No.
128, "Earnings Per Share" ("SFAS 128") during the quarter ended
December 31, 1997. All prior period earnings per share information has
been restated to reflect the provisions of SFAS No. 128.
For the three and six months ended September 30, 1998 and 1997,
warrants and options to purchase Common Stock shares of the Company and
convertible preferred stock were outstanding, but were not included in
the computation of Diluted net loss per common share because the
inclusion of these securities would have had an antidilutive effect on
the net loss per common share. As of September 30, 1998, warrants and
options to acquire 638,925 shares of the Company's common stock and
preferred stock convertible into 2,975,155 shares of the Company's
common stock were outstanding.
Following is a reconciliation of the numerators and denominators of the
Basic and Diluted EPS computations for the periods presented (in
thousands except share data):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
BASIC EARNINGS PER SHARE September 30, September 30,
<S> <C> <C> <C> <C>
1998 1997 1998 1997
--------------- --------------- --------------- ---------------
Net income (loss) $ (442) $ (54) $ (1,073) $ 71
Less: Requirement for Preferred Stock
dividends (59) (73) (119) (146)
--------------- --------------- --------------- ---------------
Loss to Common stockholders $ (501) $ (127) $ (1,192) $ (75)
=============== =============== =============== ===============
Weighted average Common Shares outstanding 13,600,143 12,851,730 13,599,858 12,829,787
=============== =============== =============== ===============
Net Loss per Common Share $ (0.04) $ (0.01) $ (0.09) $ (0.01)
=============== =============== =============== ===============
DILUTED EARNINGS PER SHARE
Loss to Common stockholders $ (501) $ (127) $ (1,192) $ (75)
Plus: Requirement for Preferred Stock
dividends - - - -
--------------- --------------- --------------- ---------------
Loss to Common stockholders, as adjusted $ (501) $ (127) $ (1,192) $ (75)
=============== =============== =============== ===============
Weighted average Common Shares outstanding 13,600,143 12,851,730 13,599,858 12,829,787
Effect of dilutive securities:
Stock options and warrants - - - -
Convertible preferred stock - - - -
--------------- --------------- --------------- ---------------
Weighted average Common Shares
outstanding, as adjusted 13,600,143 12,851,730 13,599,858 12,829,787
=============== =============== =============== ===============
Net loss per Common Share $ (0.04) $ (0.01) $ (0.09) $ (0.01)
=============== =============== =============== ===============
</TABLE>
8
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6. ACCOUNTING CHANGES
Comprehensive Income. In June 1997, the FASB issued SFAS No. 130,
"Reporting Comprehensive Income," which establishes standards for the
reporting and display of comprehensive income and its components
in a full set of general-purpose financial statements. SFAS No. 130 is
effective for fiscal years beginning after December 15, 1997. The
Company adopted the provisions of SFAS No. 130 effective April 1, 1998.
SFAS No. 130 requires reclassification of financial statements for
earlier periods provided for comparative purposes. Adoption of SFAS No.
130 did not affect the Company's reported financial information.
Segments of an Enterprise and Related Information. In June 1997, the
FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information," which establishes standards for the way that
public business enterprises report information about operating segments
in annual financial statements and requires that those enterprises
report selected information about operating segments in interim
financial reports issued to shareholders. SFAS No. 131 is effective for
periods beginning after December 15, 1997. The Company adopted the
provisions of SFAS No. 131 effective April 1, 1998. SFAS No. 131
requires restatement of comparative information presented for earlier
periods. Adoption of SFAS No. 131 had no impact on the Company's
segment disclosures.
Employers' Disclosures about Pensions and Other Postretirement
Benefits. In February 1998, the FASB issued SFAS No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits," which
amends the disclosure requirements of SFAS No. 87, "Employers'
Accounting for Pensions," SFAS No. 88, "Employers' Accounting for
Settlements and Curtailments of Defined Benefit Pension Plans and for
Termination Benefits," and SFAS No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions." SFAS No. 132 addresses
disclosure only and does not change any of the measurement or
recognition provisions provided for in SFAS Nos. 87, 88 or 106. SFAS
No. 132 is effective for fiscal years beginning after December 15,
1997 and requires restatement of comparative information presented
for earlier periods. The Company will adopt the provisions of SFAS No.
132 for its fiscal year 1999 financial statements.
Accounting for Derivative Instruments and Hedging Activities. In June
1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and
reporting standards for derivative instruments and for hedging
activities. SFAS No. 133 requires that an entity recognize all
derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. SFAS
No. 133 is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. Management does not expect adoption of SFAS No.
133 will have a material effect on the Company's financial condition,
results of operations or liquidity.
Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use. In March 1998, the American Institute of Certified Public
Accountants ("AICPA") Accounting Standards Executive Committee issued
Statement of Position ("SOP") 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use," which
requires that certain costs, including certain payroll and
payroll-related costs, be capitalized and amortized over the estimated
useful life of the software. The provisions of SOP 98-1 are effective
for fiscal years beginning after December 15, 1998. The Company has not
determined when it will adopt SOP 98-1. Management does not expect that
adoption of SOP 98-1 will have a material effect on the Company's
financial condition, results of operations or liquidity.
9
<PAGE>
Reporting on the Costs of Start-up Activities. In April 1998, the AICPA
Accounting Standards Executive Committee issued SOP 98-5, "Reporting on
the Costs of Start-up Activities." SOP 98-5 requires that costs of
start-up activities, including organization costs, be expensed as
incurred. The provisions of SOP 98-5 are effective for fiscal years
beginning after December 15, 1998 and earlier application is
encouraged. The Company has not determined when it will adopt SOP 98-5.
Management does not expect that adoption of SOP 98-5 will have a
material effect on the Company's financial condition, results of
operations or liquidity.
7. CONTINGENCY
On July 13, 1998, the Company filed a complaint in United States
District Court for the District of Hawaii (Case No. CV98-00600) against
Aquasearch, Inc. ("Aquasearch"), seeking declaratory judgement of
patent noninfringement, patent invalidity, and non-misappropriation of
trade secrets relating to closed culture production of astaxanthin. The
complaint was filed in response to assertions by Aquasearch regarding
their alleged intellectual property rights. Aquasearch has answered the
complaint and filed counter claims alleging patent infringement, trade
secret misappropriation, unfair competition and breach of contract. The
Company is pursuing this litigation vigorously. In the opinion of
management, the ultimate disposition of this matter will not have a
material adverse effect on the Company's financial condition, results
of operations or liquidity.
10
<PAGE>
CYANOTECH CORPORATION
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This report on Form 10-Q contains forward-looking statements regarding
the future performance of Cyanotech and future events that involve risks and
uncertainties that could cause actual results to differ materially from the
statements contained herein. This document, and the other documents that the
Company files from time to time with the Securities and Exchange Commission,
such as its reports on Form 10-K, Form 10-Q, Form 8-K, and its proxy materials,
contain additional important factors that could cause actual results to differ
from the Company's current expectations and the forward-looking statements
contained herein.
RESULTS OF OPERATIONS
The following table sets forth certain consolidated statement of
operations data as a percentage of net sales for the periods indicated:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30, September 30,
<S> <C> <C> <C> <C>
1998 1997 1998 1997
-------- -------- -------- --------
Net Sales 100.0 % 100.0 % 100.0 % 100.0 %
Cost of product sales 73.7 56.9 82.4 54.1
-------- -------- -------- --------
Gross profit 26.3 43.1 17.6 45.9
-------- -------- -------- --------
Operating expenses:
Research and development 16.1 8.4 14.2 8.2
General and administrative 23.4 18.2 20.9 18.4
Sales and marketing 15.9 20.0 15.2 20.7
Total operating expenses 55.4 46.6 50.3 47.3
-------- -------- -------- --------
Loss from operations (29.1) (3.5) (32.7) (1.4)
-------- -------- -------- --------
Other income (expense):
Interest income 0.1 1.7 0.1 4.0
Interest expense (2.3) (0.8) (2.1) (0.7)
Other income (expense), net 0.1 - (0.2) -
-------- -------- -------- --------
Total other income (expense) (2.1) 0.9 (2.2) 3.3
-------- -------- -------- --------
Income (loss)
before income taxes (31.2) 2.6 (34.9) 1.9
Income taxes 2.2 - 2.3 -
-------- -------- -------- --------
Net income (loss) (29.0) (2.6) (32.6) 1.9
Other comprehensive income - - - -
-------- -------- -------- --------
Comprehensive income (loss) (29.0)% (2.6)% (32.6)% 1.9%
======== ======== ======== ========
</TABLE>
11
<PAGE>
SECOND QUARTER OF FISCAL 1999 COMPARED TO SECOND QUARTER OF FISCAL 1998
Net Sales
Net sales for the three month period ended September 30, 1998 decreased
26% to $1,525,000 from $2,053,000 in the comparable period of fiscal 1998. This
decrease in net sales is primarily due to reduced sales of bulk Spirulina and
packaged consumer products.
International sales represented 37% and 34% of total net sales for the
three month periods ended September 30, 1998 and 1997, respectively.
Anticipated sales of NatuRose(TM) during the quarter were delayed
due to the cancellation of our sales agreement with a distributor in Japan. The
Company has established new sales arrangements in Japan and continues to see a
significant opportunity there. Total annual astaxanthin usage by the specialty
fish market in Japan is estimated to exceed $30 million.
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. Gross profit decreased 55% to
$401,000 for the three month period ended September 30, 1998, from $885,000 in
the comparable period of fiscal 1998. Our gross profit margin decreased to 26%
for the three month period ended September 30, 1998, compared to 43% for the
comparable period of fiscal 1998. This decrease in gross profit margin from the
prior year period is primarily attributable to a change in product mix to
greater sales of lower margin bulk Spirulina products, increased Spirulina
production costs and increased depreciation expense. Depreciation expense
included as a cost of product sales for the three months ended September 30,
1998 increased to $300,000 from $184,000 for the comparable period of fiscal
1998.
Operating Expenses
Operating expenses were $845,000 during the three month period ended
September 30, 1998, a decrease of 12% from $958,000 in the comparable period of
fiscal 1998. This decrease was primarily due to decreased sales and marketing
expenses, partially offset by increased research and development expenses.
Research and Development. Research and development expenses amounted to
$245,000 for the three month period ended September 30, 1998, an increase of 42%
from $173,000 for the comparable period of fiscal 1998. This increase from the
prior year was primarily due to higher personnel expenditures for the ongoing
development work done on our genetically engineered mosquitocide project, and
work on the Aldolase Catalytic Antibody project.
Sales and Marketing. Sales and marketing expenses amounted to $242,000
for the three month period ended September 30, 1998, a decrease of 41% from
$410,000 for the comparable period of fiscal 1998. This decrease from the prior
year is primarily due to reduced personnel, advertising and consulting service
costs dictated by lower revenues.
12
<PAGE>
Other Income (Expense)
Other income (expense) amounted to ($32,000) for the three month period
ended September 30, 1998, compared to $19,000 for the comparable period of
fiscal 1998. This fluctuation is primarily attributable to a $34,000 decrease in
interest income on investment securities coupled with an increase in interest
expense of $19,000 due to higher average outstanding balances of long-term debt.
Income Taxes
The Company presently expects that its fiscal year 1999 results will
provide for a tax refund of Hawaii State income taxes from net operating loss
carryback availability. Accordingly, an interperiod tax benefit of $34,000 has
been recorded for the three months ended September 30, 1998.
Net Income (Loss)
The Company recorded a net loss after taxes of $442,000 for the three
months ended September 30, 1998, compared to a net loss of $54,000 for the
comparable period of fiscal 1998. This increase in net loss is primarily
attributable to lower sales of Spirulina powder and tablets, as well as higher
cost of product sales, operating expenses, and interest expense in proportion to
net sales.
SIX MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO SIX MONTHS ENDED SEPTEMBER 30,
1997
Net Sales
Net sales for the six month period ended September 30, 1998 decreased
14% to $3,288,000 from $3,827,000 in the comparable period of fiscal 1998. This
decrease is primarily due to lower sales of packaged consumer products, lower
sales of bulk Spirulina powder and tablets, partially offset by increased sales
of NatuRose, our natural astaxanthin product.
International sales represented 40% and 33% of total net sales for the
six month periods ended September 30, 1998 and 1997, respectively.
Gross Profit
Gross profit decreased 67% to $580,000 for the six month period ended
September 30, 1998, from $1,757,000 in the comparable period of fiscal 1998. Our
gross profit margin decreased to 18% for the six month period ended September
30, 1998, compared to 46% for the comparable period of fiscal 1998. This
decrease in gross profit margin from the prior year period is primarily
attributable to a change in product mix to greater sales of lower margin bulk
Spirulina products, increased Spirulina production costs and increased
depreciation expense. Depreciation expense included as a cost of product sales
for the six months ended September 30, 1998 increased to $587,000 from $389,000
for the comparable period of fiscal 1998.
13
<PAGE>
Operating Expenses
Operating expenses were $1,655,000 during the six month period ended
September 30, 1998, a decrease of 9% from $1,811,000 in the comparable period of
fiscal 1998. This decrease was primarily due to decreased sales and marketing
expenses, partially offset by increased research and development expenses.
Research and Development. Research and development expenses amounted to
$467,000 for the six month period ended September 30, 1998, an increase of 49%
from $314,000 for the comparable period of fiscal 1998. This increase from the
prior year was primarily due to higher personnel expenditures for the ongoing
development work done on our genetically engineered mosquitocide project and
work on the Aldolase Catalytic Antibody project.
Sales and Marketing. Sales and marketing expenses amounted to $499,000
for the six month period ended September 30, 1998, a decrease of 37% from
$791,000 for the comparable period of fiscal 1998. This decrease from the prior
year is primarily due to reduced personnel, advertising and consulting service
costs dictated by lower revenues.
Other Income (Expense)
Other income (expense) amounted to ($72,000) for the six month period
ended September 30, 1998, compared to $125,000 for the comparable period of
fiscal 1998. This fluctuation is primarily attributable to a decrease in
interest income on investment securities coupled with an increase in interest
expense due to higher average outstanding balances of long-term debt.
Income Taxes
The Company presently expects that its fiscal year 1999 results will
provide for a tax refund of Hawaii State income taxes from net operating loss
carryback availability. Accordingly, an interperiod tax benefit of $74,000 has
been recorded for the six months ended September 30, 1998.
Net Income (Loss)
The Company recorded a net loss after taxes of $1,073,000 for the six
months ended September 30, 1998, compared to net income of $71,000 for the
comparable period of fiscal 1998. This increase in net loss is primarily
attributable to reduced sales of bulk Spirulina powder and tablets, decreased
interest income from investment securities, and increased depreciation, and
research and development expenses.
VARIABILITY OF RESULTS
The Company has experienced significant 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, government
action, weather patterns, the mix between sales 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 competitors, changes in the
Company's customer mix, overall trends in the market for Spirulina and
astaxanthin products, and other factors. 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 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 an inability to adjust spending quickly enough to
compensate for the sales shortfall. The Company may also choose to reduce prices
or increase spending on sales and marketing in response to market conditions,
which may have a material adverse effect on financial condition and results of
operations.
14
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
Our working capital decreased $306,000 during the first six months of
fiscal 1999 to $2,290,000. Our cash and cash equivalents balances decreased by
$1,052,000 to $345,000 and is primarily attributable to cash flows used in
operating and investing activities of $528,000 and $289,000, respectively,
offset in part by repayment of a note payable of $975,000 which was classified
as a current liability at March 31, 1998.
Cash used in operating activities during the first six months of fiscal
1999 amounted to $528,000 compared to cash provided by operating activities of
$672,000 in the comparable period of fiscal 1998. The primary uses of cash flows
from operating activities during the first six months of fiscal 1999 were the
net loss of $1,073,000 and a decrease in accounts payable of $150,000, offset by
depreciation and amortization of $687,000.
Cash used in investing activities for capital expenditures during the
first six months of fiscal 1999 amounted to $289,000 compared to $5,460,000 for
the comparable period of fiscal 1998.
Cash used in financing activities during the first six months of fiscal
1999 amounted to $235,000, compared to $95,000 in fiscal 1998. The primary uses
of cash flows in financing activities during the first six months of fiscal 1999
were for principal payments of $975,000 on a note payable, payments on capital
lease obligations of $66,000 and payments on long-term debt of $25,000; offset
in part by net proceeds from a short-term revolving line of credit of $184,000
and proceeds on issuance of long-term debt of $750,000.
As of March 31, 1998, the Company had agreed with a construction
contractor to resume work on a suspended expansion project on or before January
1, 1999 in a reasonable and customary manner in accordance with the terms of the
contract and at a minimum billable rate of $150,000 per month. The remaining
balance on the construction contract is approximately $1.9 million. If work does
not resume on or before January 1, 1999, the contract will be considered to have
been terminated by Cyanotech. Assertion by the contractor of its termination
rights could have a material adverse effect on the Company's financial
condition, results of operations and/or liquidity. The credit facilities
available to the Company on September 30, 1998, see below, unless supplemented
by funds from other sources, could be insufficient to finance this construction
work. Total costs incurred as of September 30, 1998 with respect to this
expansion project approximate $2,643,000.
On July 28, 1998, the Company entered into a Loan and Security
Agreement with a lender which provides for up to $3 million in credit
facilities, secured by all the assets of the Company. The major components of
the credit facility include working capital loans on a revolving basis, subject
to the availability of eligible accounts receivable and inventory, a sub-limit
term loan of up to $750,000 (amortized over sixty months) secured by eligible
machinery and equipment, and a sub-limit term loan of up to $2 million
(amortized over sixty months and subject to the Company achieving and
maintaining specific levels of financial performance) for the acquisition of new
machinery and equipment. The interest rate on the credit facility is prime plus
2.5% (at September 30, 1998, the prime rate was 8.25%) until the Company
achieves certain financial performance levels, at which time the interest rate
will decrease to prime plus 1.25%. Interest is calculated on a base amount of $1
million or the outstanding loan balance, whichever is greater. Proceeds from
borrowings under the credit facility were used to repay a short-term note
payable and fund working capital requirements.
15
<PAGE>
At September 30, 1998, the aggregate outstanding balance on the credit
facility amounted to $938,000, with remaining availability calculated at
$1,080,000. The remaining availability amount excludes the component of the
credit facility for the acquisition of new machinery and equipment as such
component is contingent on the Company's achievement of specific levels of
financial performance. This component, if available, may increase the
availability by an additional $1,920,000, up to the limit of $3 million for the
entire credit facility. The outstanding balance of the equipment term loan, less
current maturities, has been classified as a non-current liability in the
consolidated balance sheet at September 30, 1998. The outstanding working
capital loans on a revolving basis are payable through the daily collection of
accounts receivable and have been classified as a current liability in the
consolidated balance sheet at September 30, 1998.
YEAR 2000 COMPLIANCE
The Company has completed a comprehensive review of its computer
systems to identify the systems that could be affected by the "Year 2000" issue
and has developed an implementation plan, to be completed by the end of fiscal
1999, to resolve the issue. The Company believes that, with modifications to
existing software and converting to new software, the Year 2000 issue will not
pose significant operational problems for the Company's computer systems as so
modified and converted. The costs of such modifications and conversions are not
expected to exceed $10,000. However, if such modifications and conversions are
not completed in a timely manner, the Year 2000 problem may have a material
impact on the operations of the Company.
The Company is also reviewing and evaluating its reliance on other
third parties (e.g. utilities providers, distribution channels, major suppliers
and vendors) to determine and minimize the extent to which its operations may be
dependent on such third parties to remediate the Year 2000 issues in their
systems. In addition, contingency backup plans will be reviewed for each mission
critical system, with the emphasis on operational and production continuity. The
Company's business, operating results and financial condition could be
materially adversely affected by the failure of its systems or those of other
parties to operate properly beyond 1999.
16
<PAGE>
OUTLOOK
This outlook section contains a number of forward-looking statements,
all of which are based on current expectations. Actual results may differ
materially. See also the note at the beginning of this Item 2.
The Company believes that it has largely resolved the Spirulina
production problems which resulted from restarting the Spirulina culture ponds
that were idle from December 1997 to February 1998. At September 30, 1998,
Spirulina production remains consistently at 90% of full capacity compared to
the full production capacity achieved in the comparable period of fiscal 1998.
We plan to balance Spirulina production with NatuRose production resources to
meet our customers' requirements during the remainder of fiscal 1999. As a
result of increasing acceptance and promotion, we expect third quarter sales of
NatuRose to be approximately $250,000. Gross profit margin for NatuRose is
currently nil due to the high initial production costs, but is expected to
improve as current high-cost inventory is reduced. Gross profit margin on
NatuRose production is also expected to improve as we optimize processing
systems and production throughput; however, the higher costs related to
production of NatuRose may persist into the near future.
Research and development costs are expected to increase throughout this
fiscal year as we continue to optimize the PhytoMax PCS(sm) technology, continue
the research and development activities directed at the genetically engineered
mosquitocide project and on production of Aldolase Catalytic Antibody 38C2 under
our April 1998 agreement with The Scripps Research Institute.
Cyanotech's strategy has been, and continues to be, to produce higher
value natural products from microalgae. To continue the implementation of this
strategy, we have broadened our product offerings with the addition of NatuRose,
our natural astaxanthin product, and are continuing development work on the
geneticallyengineered mosquitocide project which we plan to have available for
initial testing by the end of the current fiscal year. Additionally, development
work on production of Aldolase Catalytic Antibody 38C2 is scheduled to continue
throughout this fiscal year. We are continuing our emphasis on selling higher
value packaged Spirulina consumer products over Spirulina bulk products as well
as exploring and developing new markets for our bulk products.
The Company's future results of operations and the other
forward-looking statements contained in this Outlook, in particular the
statements regarding revenues, gross margin, research and development, and
capital spending, involve a number of risks and uncertainties. In addition to
the factors discussed above, among the other factors that could cause actual
results to differ materially are the following: business conditions and growth
in the natural products industry and in the general economy; changes in customer
order patterns, and changes in demand for natural products in general; changes
in weather conditions; competitive factors, such as competing Spirulina
producers increasing their production capacity and their impact on world market
prices for Spirulina; government actions; shortage of manufacturing capacity;
and other factors beyond our control.
Cyanotech believes that it has the product offerings, facilities,
personnel, and competitive and financial resources for continued business
success, but future revenues, costs, margins and profits are all influenced by a
number of factors, as discussed above, all of which are inherently difficult to
forecast.
17
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
On July 13, 1998, the Company filed a complaint in United
States District Court for the District of Hawaii (Case No.
CV98-00600) against Aquasearch, Inc. ("Aquasearch"), seeking
declaratory judgement of patent noninfringement, patent
invalidity, and non-misappropriation of trade secrets relating
to closed culture production of astaxanthin. The complaint was
filed in response to assertions by Aquasearch regarding their
alleged intellectual property rights. Aquasearch has answered
the complaint and filed counter claims alleging patent
infringement, trade secret misappropriation, unfair
competition and breach of contract. The Company is pursuing
this litigation vigorously.
Item 4. Submission of Matters to a Vote of Security Holders
On September 17, 1998, the following matters were submitted to
a vote of stockholders entitled to vote at the Company's
Annual Meeting of Stockholders:
a) The following directors were elected to serve until the
next Annual Meeting or until their successors are elected:
Julian C. Baker, Gerald R. Cysewski, Eric H. Reichl, Ronald P.
Scott, John T. Waldron and Paul C. Yuen, all directors
receiving at least 14,077,331 votes and no more than 110,414
votes against or abstaining.
b) Ratification of the selection of KPMG Peat Marwick LLP as
the Company's independent auditors for the fiscal year ending
March 31, 1999.
For: 14,145,168 Against: 15,767 Abstaining: 26,810
Item 5. Other Information
Pursuant to SEC Rule 14a-4 (c) (1), management proxies for the
1999 Annual Meeting of Stockholders will exercise their
discretionary authority to vote on any stockholder proposal to
be presented at such meeting of which the Registrant has not
received notice by June 12, 1999.
Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are furnished with this report:
Exhibit 27.1 - Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter
ended September 30, 1998.
18
<PAGE>
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of
1934, the registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CYANOTECH CORPORATION (Registrant)
November 12, 1998 By: /s/Gerald R. Cysewski
- ------------------ ------------------------------
(Date) Gerald R. Cysewski
Chairman of the Board,
President and Chief Executive
Officer
By: /s/Ronald P. Scott
------------------------------
Ronald P. Scott
Executive Vice President -
Finance & Administration
(Principal Financial and
Accounting Officer)
19
<PAGE>
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