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 June 30, 1999
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 July 31, 1999:
Title of Class Shares Outstanding
-------------- ------------------
Common stock - $.005 par value stock 13,737,619
1
<PAGE>
CYANOTECH CORPORATION
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION
- -------------------------------
Item 1. Financial Statements Page
----
Consolidated Balance Sheets (unaudited)
June 30, 1999 and March 31, 1999. . . . . . . . . . . . . . .3
Consolidated Statements of Operations (unaudited)
Three month periods ended
June 30, 1999 and 1998. . . . . . . . . . . . . . . . . . . .4
Consolidated Statements of Cash Flows (unaudited)
Three month periods ended
June 30, 1999 and 1998. . . . . . . . . . . . . . . . . . . .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 . . . . . . . . . . . . . . . . . . . . . 16
Item 3. Defaults Upon Senior Securities. . . . . . . . . . . . . . .16
Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . 17
SIGNATURES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
2
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
<CAPTION>
CYANOTECH CORPORATION
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands except per share amounts)
<S> <C> <C>
June 30, March 31,
1999 1999
ASSETS (Unaudited) (Audited)
----------------- -----------------
Current assets:
Cash and cash equivalents $ 133 $ 323
Accounts receivable, net 1,116 1,012
Refundable income taxes 273 273
Inventories (note 2) 1,924 2,105
Prepaid expenses 110 105
----------------- -----------------
Total current assets 3,556 3,818
Equipment and leasehold improvements, net (note 3) 19,357 19,623
Other assets 159 180
----------------- -----------------
Total assets $ 23,072 $ 23,621
================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ 663 $ 700
Short-term revolving line of credit 931 994
Current maturities of capital lease obligation 44 67
Accounts payable 839 746
Other accrued liabilities 288 394
----------------- -----------------
Total current liabilities 2,765 2,901
Long-term debt, excluding current maturities - 13
----------------- -----------------
Total liabilities 2,765 2,914
----------------- -----------------
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 June 30, 1999
and March 31, 1999 1 1
Common Stock of $0.005 par value, authorized 25,000,000 shares
at June 30, 1999 and March 31, 1999; issued and outstanding
13,732,619 shares at June 30, 1999 and 13,603,572 shares at
March 31, 1999 69 68
Additional paid-in capital 24,082 23,956
Accumulated deficit (3,845) (3,318)
----------------- -----------------
Total stockholders' equity 20,307 20,707
----------------- -----------------
Total liabilities and stockholders' equity $ 23,072 $ 23,621
================= =================
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
<TABLE>
<CAPTION>
CYANOTECH CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended
June 30,
------------------------------------------
1999 1998
----------------- -----------------
<S> <C> <C>
NET SALES $ 1,599 $ 1,763
COST OF PRODUCT SALES 1,332 1,584
----------------- -----------------
Gross Profit 267 179
OPERATING EXPENSES
Research and development 166 222
General and administrative 387 331
Sales and marketing 193 257
----------------- -----------------
Total operating expenses 746 810
----------------- -----------------
Loss from operations (479) (631)
----------------- -----------------
OTHER INCOME (EXPENSE):
Interest income 4 2
Interest expense (55) (35)
Other income (expense), net 3 (7)
----------------- -----------------
Total other expense (48) (40)
----------------- -----------------
Loss before income taxes (527) (671)
Income tax benefit - 40
----------------- -----------------
NET LOSS (527) (631)
Other comprehensive income - -
----------------- -----------------
COMPREHENSIVE LOSS $ (527) $ (631)
================= =================
NET (LOSS) PER COMMON SHARE
Basic $ (0.04) $ (0.05)
Diluted $ (0.04) $ (0.05)
SHARES USED IN CALCULATION OF:
Basic 13,610 13,600
Diluted 13,610 13,600
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
<TABLE>
<CAPTION>
CYANOTECH CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
Three Months Ended
June 30,
------------------------------------------
1999 1998
CASH FLOWS FROM OPERATING ACTIVITIES: ----------------- -----------------
<S> <C> <C>
Net loss $ (527) $ (631)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 328 343
Net (increase) decrease in:
Accounts receivable (104) 27
Inventories 181 347
Prepaid expenses and other assets 16 (47)
Net increase (decrease) in:
Accounts payable 93 (330)
Other accrued liabilities (106) (22)
----------------- -----------------
Net cash used in operating activities (119) (313)
----------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in equipment and leasehold improvements (62) (59)
----------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock 99 -
Net proceeds from exercise of warrants and options 28 -
Repayment of borrowings on short-term revolving line of
credit (63) -
Principal payments on note payable - (210)
Principal payments on capital lease obligation (23) (33)
Principal payments on long-term debt (50) (12)
----------------- -----------------
Net cash used in financing activities (9) (255)
----------------- -----------------
Net decrease in cash and cash equivalents (190) (627)
Cash and cash equivalents at beginning of period 323 1,397
----------------- -----------------
Cash and cash equivalents at end of period $ 133 $ 770
================= =================
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
CYANOTECH CORPORATION
FORM 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
(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, 1999.
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 month period ended June 30, 1999 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, 2000.
As the Company's operations are solely related to microalgae-based
products, management considers its operations to be one industry
segment.
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>
June 30, 1999 March 31, 1999
----------------- -----------------
<S> <C> <C>
Raw materials $ 56 $ 63
Work in process 287 287
Finished goods 1,402 1,555
Supplies 179 200
----------------- -----------------
$ 1,942 $ 2,105
================= =================
</TABLE>
6
<PAGE>
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 the lease terms or
estimated useful lives for equipment under capital lease as follows:
Equipment 3 to 10 years
Leasehold improvements 10 to 27 years
Furniture and fixtures 7 years
Equipment under capital lease 10 years
Equipment and leasehold improvements consist of the following (dollars
in thousands):
<TABLE>
<CAPTION>
June 30, 1999 March 31, 1999
----------------- -----------------
<S> <C> <C>
Equipment $ 8,462 $ 8,421
Leasehold improvements 13,779 13,779
Furniture and fixtures 83 83
Equipment under capital lease 388 388
----------------- -----------------
22,712 22,671
Less accumulated depreciation and amortization (6,435) (6,107)
Construction in-progress 3,080 3,059
----------------- -----------------
Equipment and leasehold improvements, net $ 19,357 $ 19,623
================= =================
</TABLE>
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
June 30, 1999 amount to $2,386 ($4.01 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
For the three months ended June 30, 1999 and 1998, 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 June 30, 1999, warrants and options to
acquire 802,300 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>
BASIC EARNINGS PER SHARE June 30, 1999 June 30, 1998
----------------- -----------------
<S> <C> <C>
Net loss $ (527) $ (631)
Less: Requirement for Preferred Stock dividends (60) (60)
----------------- -----------------
Loss available to Common stockholders $ (587) $ (691)
================= =================
Weighted average Common Shares outstanding 13,610,241 13,599,572
================= =================
Net loss per Common Share $ (0.04) $ (0.05)
================= =================
DILUTED EARNINGS PER SHARE
Loss available to Common stockholders $ (587) $ (691)
Plus: Requirement for Preferred Stock dividends - -
----------------- -----------------
Net loss available to Common stockholders as adjusted $ (587) $ (691)
================= =================
Weighted average Common Shares outstanding 13,610,241 13,599,572
Effect of dilutive securities:
Stock options and warrants - -
Convertible preferred stock - -
----------------- -----------------
Weighted average Common Shares outstanding as adjusted 13,610,241 13,599,572
================= =================
Net loss per Common Share $ (0.04) $ (0.05)
================= =================
</TABLE>
8
<PAGE>
6. ACCOUNTING CHANGES
Accounting for Derivative Instruments and Hedging Activities. In June
1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("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. In July 1999, the FASB
issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date for FASB Statement No. 133,
an Amendment of FASB Statement No. 133," which defers the effective
date of SFAS No. 133 to be effective for all fiscal quarters of all
fiscal years beginning after June 15, 2000. The Company currently
holds no derivative instruments, nor is it currently participating in
hedging activities. Management does not expect adoption of SFAS No.
133 to 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 adopted
the provisions of SOP 98-1 effective April 1, 1999. Adoption of SOP
98-1 did not have a material effect on the Company's financial
condition, results of operations or liquidity.
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 adopted the provisions of SOP 98-5 effective
April 1, 1999. Adoption of SOP 98-5 did not have a material effect on
the Company's financial condition, results of operations or liquidity.
9
<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 our 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
June 30,
1999 1998
----------- -----------
<S> <C> <C>
Net Sales 100.0 % 100.0 %
Cost of product sales 83.3 89.8
----------- -----------
Gross profit 16.7 10.2
----------- -----------
Operating expenses:
Research and development 10.4 12.6
General and administrative 24.2 18.8
Sales and marketing 12.1 14.6
----------- -----------
Total operating expenses 46.7 46.0
----------- -----------
Loss from operations (30.0) (35.8)
----------- -----------
Other income (expense):
Interest income 0.2 0.1
Interest expense (3.4) (2.0)
Other income (expense), net 0.2 (0.4)
----------- -----------
Total other expense (3.0) (2.3)
----------- -----------
Loss before income taxes (33.0) (38.1)
Income tax benefit - 2.3
----------- -----------
Net Loss (33.0) (35.8)
Other comprehensive income - -
----------- -----------
Comprehensive Loss (33.0) % (35.8) %
=========== ===========
</TABLE>
10
<PAGE>
FIRST QUARTER OF FISCAL 2000 COMPARED TO FIRST QUARTER OF FISCAL 1999
Net Sales
Net sales for the three month period ended June 30, 1999 were
$1,599,000, a decrease of 9% from $1,763,000 recorded in the comparable period
in fiscal 1999. This decrease is primarily due to reduced sales of bulk
Spirulina powder and packaged Spirulina products, offset by an increase in bulk
Spirulina tablet sales.
International sales represented 53% and 50% of net sales for the three
month periods ended June 30, 1999 and 1998, respectively. This increase was
primarily due to increased sales of bulk Spirulina tablets to our largest
customer, a European distributor of natural products.
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 increased to $267,000
for the three months ended June 30, 1999, up 49% from $179,000 in the comparable
period of fiscal 1999. Our gross profit margin increased to 17% for the three
month period ended June 30, 1999, compared to 10% for the comparable period of
fiscal 1999. This increase in gross profit from the prior year period is
primarily attributable to greater sales of higher margin bulk Spirulina tablets
offset in part by reduced gross profit on lower sales of other bulk Spirulina
products.
Operating Expenses
Operating expenses were $746,000 during the three month period ended
June 30, 1999, a decrease of 8% from $810,000 in the comparable period of fiscal
1999. This decrease was primarily due to reduced research and development and
sales and marketing expenses, partially offset by increased general and
administrative costs.
Research and Development. Research and development expenses amounted to
$166,000 for the three month period ended June 30, 1999, a decrease of 25% from
$222,000 for the comparable period of fiscal 1999. This decrease from the prior
year was primarily due to reduced personnel expenditures, lower supply and
material costs and lower equipment maintenance expenses, totaling approximately
$69,000, offset by $17,000 of increased expenditures for outside services.
Sales and Marketing. Sales and marketing expenses amounted to $193,000
for the three month period ended June 30, 1999, a decrease of 25% from $257,000
for the comparable period of fiscal 1999. This decrease from the prior year is
primarily due to reduced advertising and promotion expenditures for packaged
Spirulina consumer products and lower personnel costs totaling approximately
$84,000, offset by increased expenditures for sales consulting services in Japan
amounting to approximately $21,000.
General and Administrative. General and administrative expenses
amounted to $387,000 for the three month period ended June 30, 1999, an increase
of 17% from $331,000 for the comparable period of fiscal 1999. This increase
from the prior year is primarily attributable to higher audit fees and an
increase in legal fees related to the ongoing patent litigation with Aquasearch
Inc. ("Aquasearch") totaling approximately $85,000, offset in part by a
reduction in personnel expenditures and other corporate administrative expenses
amounting to approximately $27,000.
11
<PAGE>
Other Income (Expense)
Other expense amounted to $48,000 for the first three months of fiscal
2000, an increase of 20% from $40,000 for the same period of fiscal 1999,
primarily from an increase in interest expense on higher outstanding debt.
Income Taxes
A provision for income taxes was not recorded for the three month
period ended June 30, 1999 due to the Company's taxable loss position compared
to an interperiod tax benefit of $40,000 booked in the same period of fiscal
1999.
Net Income (Loss)
The Company recorded a net loss after taxes of $527,000 for the first
quarter of fiscal 2000, compared to the net loss after taxes of $631,000 for the
comparable period of fiscal 1998. The improvement in results is primarily
attributable to the positive effect of the downsizing actions implemented in
January and April of calendar 1999 on cost of sales and operating expenses and
increased margin on increased sales of bulk Spirulina tablets.
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 our largest customers, new product introductions, production
difficulties, 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 our customer mix, overall trends in the market for our products, government
regulations and other factors beyond our control. While a significant portion of
our 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 our inability to adjust spending quickly enough
to compensate for the sales shortfall. We may also choose to reduce prices or
increase spending in response to market conditions, which may have a material
adverse effect on our financial condition and results of operations. The
Company's continuation as a going concern is dependent upon its ability to
generate sufficient cash flow to meet its obligations on a timely basis, to
comply with the terms of its financing agreement, to obtain additional
financing or refinancing as may be required, to attain profitability, or
a combination thereof. There can be no assurance that these efforts will be
successful or that the Company will return to generating profit on either a
quarterly or annual basis.
LIQUIDITY AND CAPITAL RESOURCES
Our working capital for the three month period ended June 30, 1999
decreased by $126,000 to $791,000 from $917,000 at March 31, 1999. Our cash and
cash equivalents balances decreased by $190,000 to $133,000 and is primarily
attributable to cash flows used in operating and investing activities of
$119,000 and $62,000, respectively.
12
<PAGE>
Cash used in operating activities during the first three months of
fiscal 2000 decreased by $194,000 to $119,000 compared to cash used in operating
activities of $313,000 in the comparable period of fiscal 1999. The primary uses
of cash flows in operating activities during the first three months of fiscal
2000 were the net loss of $527,000 and an increase in accounts receivable of
$104,000, offset in part by depreciation and amortization of $328,000 and a
decrease in inventory of $181,000.
Cash used in investing activities (for capital expenditures) during the
first three months of fiscal 2000 increased slightly to $62,000 compared to
$59,000 for the comparable period of fiscal 1999.
Cash used in financing activities during the first three months of
fiscal 2000 decreased by $246,000 to $9,000, compared to $255,000 in fiscal
1999. The primary uses of cash flows in financing activities during the first
quarter of fiscal 2000 were for repayment of borrowings on a short-term
revolving line of credit of $63,000, principal payments on long-term debt of
$50,000, and principal payments on a capital lease of $23,000, offset in part
by proceeds from issuance of common stock and proceeds from the exercise
of common stock options totaling $127,000.
In July 1998, we entered into a Loan and Security Agreement (Agreement)
with a lender which provides for up to $3 million in aggregate credit
facilities, secured by all the assets of the Company. The major components of
the Agreement include working capital loans on a revolving basis, subject to the
availability of eligible accounts receivable and inventory (as defined), a
sub-limit term loan of up to $750,000 (amortized in equal payments of $12,500
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 Agreement has a maturity
date of July 31, 2001 with an optional provision for automatic and continuous
renewal for successive, additional terms of one year each. The interest rate on
all borrowings under the agreement is prime plus 2.5%, adjusted monthly (at June
30, 1999, the prime rate was 7.75%) 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. The fee for renewing the Agreement beyond
the maturity date of July 31, 2001 is set at .5% of the aggregate outstanding
balance at the end of the initial term of the Agreement.
The Agreement contains certain restrictive covenants, which include,
among other things, the maintenance of minimum consolidated net worth, as
defined, and a subjective acceleration clause contingent upon the occurrence
of an event with a material adverse effect on the Company, as defined. On July
13, 1999, the lender declared the Company to be in technical default under the
Agreement because of the uncertainty of the Company's ability to continue as a
going concern. In view of this default, the lender exercised its right under the
Agreement effective July 13, 1999, to increase the interest rate on all
borrowings from prime plus 2.5% to prime plus 5.5%. Although it has not declared
its intent to do so, the lender reserved its right to assert other remedies,
among other things, to cease further lending transactions and demand immediate
repayment of outstanding borrowings under the Agreement. Consequently the
Company has classified the aggregate outstanding balance on this Agreement of
$1,544,000, representing outstanding working capital loans on a revolving basis
of $931,000 and an equipment term loan of $613,000, as a current liability in
the consolidated balance sheet at June 30, 1999. If the lender ceases further
lending and demands immediate repayment, such action would have a material
adverse effect on the Company's financial position, results of operations and
liquidity.
13
<PAGE>
At June 30, 1999, the remaining availability under the Agreement was
calculated by the lender to be $329,000. This amount excludes the facility for
the acquisition of new machinery and equipment which requires the Company to
maintain a Debt Service Coverage ratio of at least 1.25:1 for the two prior full
consecutive quarters. If this facility were available, it would increase the
availability by an additional $1,127,000 up to the limit of $3 million for the
entire Agreement.
As of March 31, 1999, we had a commitment for a pond construction
project which was suspended in February 1998. In June 1999 we reached an
agreement with the project contractor to resume work on the suspended
construction project on or before June 1, 2000. The remaining balance on the
construction contract is approximately $1.9 million. In consideration of the
extension of the contract, the Company will pay an additional $20,000 at the
startup of work and a surcharge of 1.5% on work not completed by September 30,
1999, and a surcharge of 4% on work not completed by September 30, 2000. If work
does not resume on or before June 1, 2000, then 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 or liquidity. As of June 30, 1999,
the credit facilities available to Cyanotech, as described above, unless
supplemented by funds from other sources, would not be sufficient to finance
this construction work. Total costs incurred as of June 30, 1999 with respect to
this expansion project approximated $2,643,000. Failure to comply with its
commitments on this project would have a material adverse effect on the
Company's financial condition, results of operations, or liquidity.
In June 1999, we reached an agreement with Norsk Hydro ASA ("Norsk
Hydro") to produce and market NatuRose (TM) natural astaxanthin product. Under
the agreement, Norsk Hydro will participate in the optimization of the
Cyanotech production technology for astaxanthin. Upon successful completion of
the optimization program, the two companies intend to enter into a joint venture
that will be owned 51% by Norsk Hydro and 49% by Cyanotech. The intention of the
joint venture is to build and operate a NatuRose production facility in
Kailua-Kona, Hawaii. Norsk Hydro will have worldwide exclusive rights to
distribute NatuRose product in the aquaculture and animal pigmentation and
animal nutrition markets; Cyanotech will retain worldwide exclusive rights to
distribute BioXanthin (TM) natural astaxanthin products in the human nutrition
markets. The Company's assessment of the impairment of certain long-lived assets
as of March 31, 1999 and June 30, 1999 is predicated on the consummation and
commercial success of this joint venture. Failure to consummate the joint
venture arrangement or failure by the joint venture to achieve expected
commercial outcomes may result in the impairment of such long-lived assets.
The unaudited consolidated financial statements at June 30, 1999 have
been prepared on a going concern basis, which assumes continuity of operations
and realization of assets and liquidation of liabilities in the ordinary
course of business. The Company's continuation as a going concern is dependent
upon its ability to generate sufficient cash flow to meet its obligations on
a timely basis, to comply with the terms of its financing agreement, to obtain
additional financing or refinancing as may be required, to attain
profitability, or a combination thereof. The Company is seeking other possible
sources of external financing, but unless it is successful, there may be
liquidity shortfalls in future periods. There can be no assurance that the
Company will be successful in obtaining additional financing or will have
sufficient cash resources to support its continued operations.
14
<PAGE>
YEAR 2000 COMPLIANCE
We have completed a comprehensive review of our computer systems to
identify the systems that could be affected by the "Year 2000" issue and has
developed an implementation plan, to be completed before the end of calendar
1999, to resolve the issue. We believe that, with modifications to existing
software and converting to new software, the Year 2000 issue will not pose
significant operational problems for our 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 adverse effect on
our operations.
The primary risks to the Company of Year 2000 problems are those of
business continuity related to reliance on third parties. We are continuing the
review and evaluation of our reliance on other third parties (e.g. utilities
providers, distribution channels, major suppliers and vendors) to determine and
minimize the extent to which our operations may be dependent on such third
parties to remedy 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, at least for a time, by the failure of its systems or those of other
parties to operate properly beyond 1999.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have not entered into any transactions using derivative financial
instruments or derivative commodity instruments and believe that our exposure to
market risk associated with other financial instruments is not material.
SUBSEQUENT EVENTS
On July 14, 1999, the Company announced that it had received Canadian
approval for its NatuRose product for use in salmon and other fish feeds as a
source of the pigment astaxanthin. The approval was from the Canadian Food
Inspection Agency which is similar to the Food & Drug Administration (FDA) in
the United States. This approval now allows Canadian fish-farming companies to
incorporate Cyanotech's natural astaxanthin, instead of synthetic astaxanthin,
into their aquaculture products.
On August 10, 1999, the Company was notified that the FDA review of its
application to sell BioXanthin, a natural astaxanthin product for human
nutrition, had been completed by the FDA without objection. With the completion
of this review, BioXanthin can now be offered for sale and use in the United
States as a human dietary supplement. Cyanotech produces BioXanthin from
microalgae and the Company believes it is the only source of astaxanthin for
human nutrition that has been reviewed by the FDA. Independent research
studies have shown that astaxanthin has up to 550 times the antioxidant
activity of vitamin E and 10 times the antioxidant activity of beta-carotene.
Human and animal studies have shown that astaxanthin can protect the skin from
the damaging effects of ultraviolet radiation, reduce age-related macular
degeneration, protect against chemically induced cancers, increase high-density
lipoprotein (HDL) production, enhance the immune system and enhance energy
metabolism.
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.
15
<PAGE>
The Company has begun to see positive results from the downsizing and
asset management program put in place during the fourth quarter of fiscal 1999.
During the three month period ended June 30, 1999, inventory levels were reduced
by approximately $181,000 and, entering the second quarter of fiscal 2000, the
Company continues to produce Spirulina at 50% of full capacity. We are balancing
Spirulina production with NatuRose production and plan to allocate more
resources towards NatuRose natural astaxanthin production in future quarters to
meet the anticipated demand of Norsk Hydro and our other customers. Gross profit
margin on sales of NatuRose was negative during the three months ended June 30,
1999, due to higher production costs related to operating at lower than optimal
production levels, but is expected to improve as we optimize the PhytoDome
CCS (TM) 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 slightly during
this fiscal year as we continue to optimize the PhytoDome CCS closed culture
technology for production of natural astaxanthin products and continue the
research and development activities directed at the genetically engineered
mosquitocide project and the Aldolase Catalytic Antibody 38C2.
Cyanotech's strategy has been, and continues to be, to produce higher
value natural products from microalgae. In support of this strategy, we have
broadened our product offerings with the addition of BioXanthin, our natural
astaxanthin product for use in the human nutrition market, and continue
development work on the genetically-engineered mosquitocide and Aldolase
Catalytic Antibody 38C2 projects.
In June 1999, Cyanotech Corporation became the first Hawaii business to
join the Marine Bioproducts Engineering Center (MarBEC) Industry Partner Program
(IPP). MarBEC was established jointly by the University of Hawaii (UH) at Manoa
and the University of California (UC) at Berkeley under a five-year $12.4
million grant from the National Science Foundation. MarBEC's purpose is to
identify and develop marine bioproducts for the chemical, pharmaceutical,
nutraceutical and life science industries and is supported by industry partners
such as Cyanotech. By becoming an active participant in the MarBEC program and
through the Company's representation on the MarBEC Industrial Advisory Board,
Cyanotech will assist the program leadership in defining the future research and
educational goals of the center. In return, the agreement provides Cyanotech
(and other IPP members) with benefits that include preferential rights to
intellectual property developed in MarBEC's research program at UH Manoa and
UC Berkeley. Cyanotech believes that it is the only member of MarBEC that has
developed commercial photobioreactor technology which is likely to be required
for the commercial exploitation of any new microalgal product developed through
MarBEC research.
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.
16
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
On July 13, 1998, the Company filed a complaint (Case No. CV98-00600)
in United States District Court for the District of Hawaii ("Court") 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 its 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 Court has granted Cyanotech's motion to amend its
complaint against Aquasearch to add claims of misappropriation of trade secrets
regarding open pond technology, unfair competition and breach of contract.
Motions for partial summary judgement filed by both parties are pending before
the court. In the opinion of management, the ultimate disposition of this matter
will not have a material adverse effect on the Company's consolidated financial
position, results of operations or liquidity.
Item 3. Defaults Upon Senior Securities.
In July 1998, the Company entered into a Loan and Security Agreement
(Agreement) with a lender which is described in detail in the discussion on
Liquidity and Capital resources in Item 2 of this report. The Agreement contains
certain restrictive covenants, which include, among other things, the
maintenance of minimum consolidated net worth, as defined, and a subjective
acceleration clause contingent upon the occurrence of an event with a material
adverse effect on the Company, as defined. On July 13, 1999, the lender declared
the Company to be in technical default under the Agreement because of the
uncertainty of the Company's ability to continue as a going concern. In view of
this default, the lender exercised its right under the Agreement effective July
13, 1999, to increase the interest rate on all borrowings from prime plus 2.5%
to prime plus 5.5%. Although it has not declared its intent to do so, the
lender reserved its right to assert other remedies, among other things, to cease
further lending transactions and demand immediate repayment of outstanding
borrowings under the Agreement. Consequently the Company has classified the
aggregate outstanding balance on this Agreement of $1,544,000, representing
outstanding working capital loans on a revolving basis of $931,000 and an
equipment term loan of $613,000 as a current liability in the consolidated
balance sheet at June 30, 1999. If the lender ceases further lending and demands
immediate repayment, such action would have a material adverse effect on the
Company's financial position, results of operations and liquidity.
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
June 30, 1999.
17
<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)
August 10, 1999 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
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