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 December 31, 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 February 05, 1999:
Title of Class Shares Outstanding
Common stock - $.005 par value stock 13,603,572
1
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<TABLE>
<CAPTION>
CYANOTECH CORPORATION
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION
<S> <C> <C>
Item 1. Financial Statements Page
Consolidated Balance Sheets (unaudited)
December 31, 1998 and March 31, 1998. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3
Consolidated Statements of Operations (unaudited)
Three and nine month periods ended
December 31, 1998 and 1997. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4
Consolidated Statements of Cash Flows (unaudited)
Nine month periods ended
December 31, 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 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18
SIGNATURES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . 19
</TABLE>
2
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
<CAPTION>
CYANOTECH CORPORATION
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share amounts)
(Unaudited)
<S> <C> <C>
December 31, March 31,
1998 1998
------------------- -----------------
Assets
Current assets:
Cash and cash equivalents $ 148 $ 1,397
Accounts receivable, net 908 1,246
Inventories (note 2) 2,376 2,229
Prepaid expenses 68 88
------------------- -----------------
Total current assets 3,500 4,960
Equipment and leasehold improvements, net (note 3) 20,034 20,544
Other assets 299 163
------------------- -----------------
Total assets $ 23,833 $ 25,667
------------------- -----------------
------------------- -----------------
Liabilities and Stockholders' Equity
Current liabilities:
Current maturities of long-term debt $ 200 $ 50
Short-term revolving line of credit 392 -
Note payable - 975
Current maturities of capital lease obligations 96 129
Accounts payable 904 938
Other accrued liabilities 296 272
------------------- -----------------
Total current liabilities 1,888 2,364
Long-term debt, excluding current maturities 563 62
Obligations under capital leases, excluding current maturities - 67
------------------- -----------------
Total liabilities 2,451 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 December 31, 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 December 31, 1998 and 13,599,572 shares at
March 31, 1998 68 68
Additional paid-in capital 23,866 23,866
Accumulated deficit (2,553) (761)
------------------- -----------------
Total stockholders' equity 21,382 23,174
------------------- -----------------
Total liabilities and stockholders' equity $ 23,833 $ 25,667
------------------- -----------------
------------------- -----------------
</TABLE>
See accompanying notes to consolidated financial statements.
3
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<TABLE>
<CAPTION>
CYANOTECH CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
December 31, December 31,
<S> <C> <C> <C> <C>
1998 1997 1998 1997
------------ ------------ ------------- -------------
NET SALES $ 1,675 $ 1,564 $ 4,963 $ 5,391
COST OF PRODUCT SALES 1,553 1,022 4,261 3,092
------------ ------------ ------------- -------------
Gross Profit 122 542 702 2,299
------------ ------------ ------------- -------------
OPERATING EXPENSES:
Research and development 185 183 652 497
General and administrative 397 336 1,086 1,042
Sales and marketing 248 342 747 1,133
------------ ------------ ------------- -------------
Total operating expenses 830 861 2,485 2,672
------------ ------------ ------------- -------------
Loss from operations (708) (319) (1,783) (373)
------------ ------------ ------------- -------------
OTHER INCOME (EXPENSE):
Interest income 4 39 7 191
Interest expense (51) (14) (121) (41)
Other income (expense), net (4) 8 (9) 8
------------ ------------ ------------- -------------
Total other income (expense) (51) 33 (123) 158
------------ ------------ ------------- -------------
Loss before income taxes (759) (286) (1,906) (215)
Income taxes 40 - 114 -
------------ ------------ ------------- -------------
NET LOSS (719) (286) (1,792) (215)
------------ ------------ ------------- -------------
------------ ------------ ------------- -------------
Other comprehensive income - - - -
------------ ------------ ------------- -------------
COMPREHENSIVE LOSS $ (719) $ (286) $ (1,792) $ (215)
------------ ------------ ------------- -------------
------------ ------------ ------------- -------------
NET LOSS PER COMMON SHARE
Basic $(0.06) $(0.03) $(0.14) $(0.03)
Diluted $(0.06) $(0.03) $(0.14) $(0.03)
SHARES USED IN CALCULATION OF:
Basic 13,604 12,864 13,601 12,840
Diluted 13,604 12,864 13,601 12,840
</TABLE>
See accompanying notes to consolidated financial statements.
4
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<TABLE>
<CAPTION>
CYANOTECH CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
<S> <C> <C>
Nine Months Ended
December 31,
1998 1997
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (1,792) $ (215)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Deferred income taxes - (38)
Depreciation and amortization 1,036 678
Amortization of debt issue costs 15 -
Common stock issued for services - 47
Net (increase) decrease in:
Accounts receivable 338 1,440
Inventories (147) (1,281)
Prepaid expenses and other assets (28) 47
Net increase (decrease) in:
Accounts payable (34) 51
Other accrued liabilities 24 (135)
------------- -------------
Net cash provided by (used in) operating activities (588) 594
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in equipment and leasehold improvements (526) (5,917)
Proceeds from sales of investment securities - 2,454
------------- -------------
Net cash used in investing activities (526) (2,963)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from exercise of warrants and options - 64
Debt issue costs (103) -
Proceeds from issuance of long-term debt 750 -
Principal payments on long-term debt (99) (88)
Borrowings on short-term revolving line of credit, net 392 -
Principal payments on note payable (975) -
Principal payments on capital lease obligations (100) (98)
------------- -------------
Net cash used in financing activities (135) (122)
------------- -------------
Net decrease in cash and cash equivalents (1,249) (2,491)
Cash and cash equivalents at beginning of period 1,397 2,775
------------- -------------
Cash and cash equivalents at end of period $ 148 $ 284
------------- -------------
------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
5
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CYANOTECH CORPORATION
FORM 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 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 nine month periods ended December 31, 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>
December 31, 1998 March 31, 1998
----------------- -----------------
Raw materials $ 63 $ 103
Work in process 324 362
Finished goods 1,751 1,524
Supplies 238 240
----------------- -----------------
$ 2,376 $ 2,229
----------------- -----------------
----------------- -----------------
</TABLE>
6
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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> <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>
December 31, 1998 March 31, 1998
----------------- -----------------
Equipment $ 8,313 $ 7,791
Leasehold improvements 13,695 13,285
Furniture and fixtures 96 94
Equipment under capital lease 569 569
----------------- -----------------
22,673 21,739
Less accumulated depreciation and amortization (5,743) (4,707)
Construction in-progress 3,104 3,512
----------------- -----------------
Equipment and leasehold improvements, net $ 20,034 $ 20,544
----------------- -----------------
----------------- -----------------
</TABLE>
Construction in-progress includes costs incurred with respect to a
suspended production facility expansion project. Prior to December 31,
1998, the Company reached an agreement with its construction contractor
to resume work on the suspended expansion project on or before June 1,
1999. The remaining balance on the construction contract is
approximately $1.9 million. Total costs incurred as of December 31,
1998 with respect to this expansion project approximate $2,643. If work
does not resume on or before June 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.
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
December 31, 1998 amount to $2,240 ($3.763 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
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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 nine months ended December 31, 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 December 31, 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 Net Loss per common share computations for the
periods presented (in thousands except share data):
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Three Months Ended Nine Months Ended
BASIC LOSS PER SHARE December 31, December 31,
1998 1997 1998 1997
------------ ------------ ------------ ------------
Net loss $ (719) $ (286) $ (1,792) $ (215)
Less: Requirement for Preferred Stock
dividends (59) (73) (179) (219)
------------ ------------ ------------ ------------
Loss to Common stockholders $ (778) $ (359) $ (1,971) $ (434)
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Weighted average Common Shares outstanding 13,603,572 12,863,912 13,601,110 12,840,182
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Net Loss per Common Share $ (0.06) $ (0.03) $ (0.14) $ (0.03)
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
DILUTED LOSS PER SHARE
Loss to Common stockholders $ (778) $ (359) $ (1,971) $ (434)
Plus: Requirement for Preferred Stock
dividends - - - -
------------ ------------ ------------ ------------
Loss to Common stockholders, as adjusted $ (778) $ (359) $ (1,971) $ (434)
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Weighted average Common Shares outstanding 13,603,572 12,863,912 13,601,110 12,840,182
Effect of dilutive securities:
Stock options and warrants - - - -
Convertible preferred stock - - - -
------------ ------------ ------------ ------------
Weighted average Common Shares
outstanding, as adjusted 13,603,572 12,863,912 13,601,110 12,840,182
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Net Loss per Common Share $ (0.06) $ (0.03) $ (0.14) $ (0.03)
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</TABLE>
8
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6. ACCOUNTING CHANGES
COMPREHENSIVE INCOME. In June 1997, the Financial Accounting Standards
Board (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 interim 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
fiscal years beginning after December 15, 1997. SFAS No. 131 need not
be applied to interim financial statements in the initial year of
application. The Company will adopt the provisions of SFAS No. 131 for
its fiscal year 1999 financial statements.
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.
9
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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.
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
and 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
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
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
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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>
<S> <C> <C> <C> <C>
Three Months Ended Nine Months Ended
December 31, December 31,
1998 1997 1998 1997
------------ ------------ ------------ ------------
Net Sales 100.0 % 100.0 % 100.0 % 100.0 %
Cost of product sales 92.7 65.3 85.9 57.3
------------ ------------ ------------ ------------
Gross profit 7.3 34.7 14.1 42.7
------------ ------------ ------------ ------------
Operating expenses:
Research and development 11.1 11.7 13.1 9.2
General and administrative 23.7 21.5 21.9 19.4
Sales and marketing 14.8 21.9 15.0 21.0
------------ ------------ ------------ ------------
Total operating expenses 49.6 55.1 50.0 49.6
------------ ------------ ------------ ------------
Loss from operations (42.3) (20.4) (35.9) (6.9)
------------ ------------ ------------ ------------
Other income (expense):
Interest income 0.2 2.5 0.1 3.5
Interest expense (3.0) (0.9) (2.4) (0.8)
Other income (expense), net (0.2) 0.5 (0.2) 0.2
------------ ------------ ------------ ------------
Total other income (expense) (3.0) 2.1 (2.5) 2.9
------------ ------------ ------------ ------------
Loss before income taxes (45.3) (18.3) (38.4) (4.0)
Income taxes 2.4 - 2.3 -
------------ ------------ ------------ ------------
Net loss (42.9) (18.3) (36.1) (4.0)
Other comprehensive income - - - -
------------ ------------ ------------ ------------
Comprehensive loss (42.9)% (18.3)% (36.1)% (4.0)%
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</TABLE>
11
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THIRD QUARTER OF FISCAL 1999 COMPARED TO THIRD QUARTER OF FISCAL 1998
NET SALES
Net sales for the three month period ended December 31, 1998 increased
7% to $1,675,000 from $1,564,000 in the comparable period of fiscal 1998. This
increase in net sales was primarily due to higher sales of bulk Spirulina and
packaged consumer products.
International sales represented 44% and 39% of total net sales for the
three month periods ended December 31, 1998 and 1997, respectively.
GROSS PROFIT
Gross profit represents net sales less the product sales, which
includes the cost of materials, manufacturing overhead costs, direct labor
expenses and depreciation and amortization. Gross profit decreased 77% to
$122,000 for the three month period ended December 31, 1998, from $542,000 in
the comparable period of fiscal 1998. The Company's gross profit margin
decreased to 7% for the three month period ended December 31, 1998, compared to
35% for the comparable period of fiscal 1998. This decrease in gross profit
margin from the prior year period was primarily attributable to a change in
product mix to greater sales of lower margin bulk Spirulina products, higher
costs associated with the optimization of NatuRose(TM) production and increased
depreciation expense. Depreciation expense included in cost of product sales for
the three months ended December 31, 1998 increased to $333,000 from $219,000 for
the comparable period of fiscal 1998 due to NatuRose assets placed into
production in the current year.
OPERATING EXPENSES
Operating expenses were $830,000 during the three month period ended
December 31, 1998, a decrease of 4% from $861,000 in the comparable period of
fiscal 1998. This decrease was primarily due to decreased sales and marketing
expenses, partially offset by increased general and administrative expenses.
General and administrative expenses amounted to $397,000 for the three
month period ended December 31, 1998, an increase of 18% from $336,000 for the
comparable period of fiscal 1998. This increase from the prior year was
primarily due to increased legal expenses related to the ongoing litigation with
Aquasearch, Inc. See Note 7. Contingency.
Sales and marketing expenses decreased to $248,000 for the three month
period ended December 31, 1998, down 27% from $342,000 for the comparable period
of fiscal 1998. This decrease was primarily due to reduced personnel,
advertising and consulting service costs dictated by lower revenues.
OTHER INCOME (EXPENSE)
Other expense was $51,000 for the three month period ended December 31,
1998, compared to other income of $33,000 for the comparable period of fiscal
1998. This resulted from the decrease in investment securities and the increase
in outstanding, interest-bearing debt.
12
<PAGE>
INCOME TAXES
The Company presently expects that its fiscal year 1999 results will
provide for a tax refund of Hawaii State income taxes from available net
operating loss carryback. Accordingly, an interperiod tax benefit of $40,000 has
been recorded for the three months ended December 31, 1998.
NET LOSS
The Company recorded a net loss of $719,000 for the three months ended
December 31, 1998, compared to a net loss of $286,000 for the comparable period
of fiscal 1998. This increase in net loss was primarily attributable to higher
cost of product sales, depreciation, and interest expense.
NINE MONTHS ENDED DECEMBER 31, 1998 COMPARED TO NINE MONTHS ENDED DECEMBER 31,
1997
NET SALES
Net sales for the nine month period ended December 31, 1998 decreased
8% to $4,963,000 from $5,391,000 in the comparable period of fiscal 1998. This
decrease was primarily due to lower sales of packaged consumer products and of
bulk Spirulina powder and tablets, partially offset by increased sales of
NatuRose, our natural astaxanthin product.
International sales represented 44% and 33% of total net sales for the
nine month periods ended December 31, 1998 and 1997, respectively.
GROSS PROFIT
Gross profit decreased 69% to $702,000 for the nine month period ended
December 31, 1998, from $2,299,000 in the comparable period of fiscal 1998. Our
gross profit margin decreased to 14% of net sales for the nine month period
ended December 31, 1998, compared to 43% for the comparable period of fiscal
1998. This decrease in gross profit margin from the prior year period was
primarily attributable to a change in product mix to greater sales of lower
margin bulk Spirulina products, increased production costs and increased
depreciation expense. Depreciation expense included in cost of product sales for
the nine months ended December 31, 1998 increased to $923,000 from $608,000 for
the comparable period of fiscal 1998.
OPERATING EXPENSES
Operating expenses were $2,485,000 during the nine month period ended
December 31, 1998, a decrease of 7% from $2,672,000 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 expenses amounted to $652,000 for the nine
month period ended December 31, 1998, an increase of 31% from $497,000 for the
comparable period of fiscal 1998. This increase was primarily due to higher
personnel expenditures for the ongoing development work done on our genetically
engineered mosquitocide project and on the Aldolase Catalytic Antibody project.
13
<PAGE>
General and administrative expenses amounted to $1,086,000 for the nine
month period ended December 31, 1998, an increase of 4% from $1,042,000 for the
comparable period of fiscal 1998. This increase was primarily due to increased
legal expenses related to the ongoing litigation with Aquasearch, Inc. See Note
7. Contingency.
Sales and marketing expenses decreased to $747,000 for the nine month
period ended December 31, 1998, down 34% from $1,133,000 for the comparable
period of fiscal 1998. This decrease was primarily due to reduced personnel,
advertising and consulting service costs dictated by lower revenues.
OTHER INCOME (EXPENSE)
Other expense was $123,000 for the nine month period ended December 31,
1998, compared to other income of $158,000 for the comparable period of fiscal
1998. This resulted from the decrease in investment securities and the increase
in outstanding, interest-bearing 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 available net
operating loss carryback. Accordingly, an interperiod tax benefit of $114,000
has been recorded for the nine months ended December 31, 1998.
NET LOSS
The Company recorded a net loss of $1,792,000 for the nine months ended
December 31, 1998, compared to a net loss of $215,000 for the comparable period
of fiscal 1998. This increase in net loss was primarily attributable to reduced
sales of bulk Spirulina powder and tablets, increased production costs,
decreased interest income from investment securities, increased interest expense
due to higher debt, offset in part by lower operating 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 by $984,000 during the first nine months
of fiscal 1999 to $1,612,000. Our cash and cash equivalents decreased
substantially by $1,249,000, primarily because of cash flows used in operations
and capital expenditures of $588,000 and $526,000, respectively.
The primary uses of cash flows in operating activities during the first
nine months of fiscal 1999 were the net loss of $1,792,000, offset by
depreciation and amortization of $1,036,000.
Cash used for capital expenditures during the first nine months of
fiscal 1999 decreased $5,391,000 to $526,000.
The primary uses of cash flows in financing activities during the first
nine months of fiscal 1999 were for repayment of a $975,000 short term note
payable, payments on capital lease obligations and long-term debt of $199,000,
offset in part by borrowings under a short-term revolving line of credit of
$392,000 and proceeds from the issuance of long-term debt of $750,000.
Prior to December 31, 1998, the Company reached an agreement with its
construction contractor to resume work on a suspended expansion project on or
before June 1, 1999. The remaining balance on the construction contract is
approximately $1.9 million. If work does not resume on or before June 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 December 31, 1998, as
described in the next paragraph, unless supplemented by funds from other
sources, may not be sufficient to finance this construction work. Total costs
incurred as of December 31, 1998 with respect to this expansion project
approximate $2,643,000. Failure by the Company to complete this expansion
project would have a material adverse effect on the Company's financial
condition and results of operations.
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 December 31, 1998, 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. Proceeds from
borrowings under the credit facility were used to repay a short-term note
payable and fund working capital requirements.
15
<PAGE>
At December 31, 1998, the aggregate outstanding balance on the credit
facility amounted to $1,080,000, with remaining availability calculated by the
lender at $610,000. 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 a Debt Service Coverage
ratio of at least 1.25:1 for the prior two full consecutive quarters on a
combined basis. 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 December 31, 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 December 31, 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 before the end of
calendar 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 adverse impact on the operations of the Company.
The Company is continuing the review and evaluation of 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 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 by the failure of its systems or those of
other parties to operate properly beyond 1999.
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 December 31, 1998, the
ponds are at 100% of the capacity allocated to Spirulina production. We plan to
balance Spirulina production with NatuRose production resources to meet our
customers' requirements during the remainder of fiscal 1999. Gross profit margin
for NatuRose is currently nil due to high initial production costs exceeding
unit selling price, but is expected to improve as current high-cost inventory is
reduced. Such gross profit margins are expected to improve as we optimize
processing systems and production throughput; however, at the currently reduced
production levels, such high production costs, presently related to production
of NatuRose, may persist into the near future.
16
<PAGE>
As of December 31, 1998, the Company's available borrowing capacity
amounted to $610,000. Absent a significant improvement in operating results, a
reduction in costs, additional debt or equity financing, or a combination
thereof, the Company may experience liquidity shortages in the near term.
In order to address this potential liquidity issue, the Company is
continuing to develop new and broader distribution channels for its products,
but until this effort results in increased sales, the Company is reducing costs
to be more in line with current sales levels. In January 1999, the Company
implemented a plan to improve liquidity and reduce or deter operating costs by
$1.1 million annually. The plan includes a deferral of land rent for the
suspended pond expansion project, significant reductions in capital spending,
elimination of all temporary labor agreements related to NatuRose production and
a reduction in workforce which is expected to result in an annual decrease in
labor cost of approximately 15%.
In conjunction with implementation of this plan, the Company has scaled
back production of NatuRose until such time as sales of NatuRose dictate an
increase in inventory. The objective of the cost reduction plan is to
significantly reduce cash required for operating activities. However, if
sales do not increase as projected or the cost reductions and deferrals do not
yield the desired results, further actions to reduce operating costs will be
taken by management.
Research and development costs are expected to remain constant
throughout this calendar year as we work to optimize the PhytoMax PCS(SM)
technology, as well as the research and development of both the genetically
engineered mosquitocide project and the Aldolase Catalytic Antibody 38C2 under
an 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
genetically-engineered mosquitocide which we plan to have available for initial
testing by the end of the current quarter. Additionally, development work on
production of Aldolase Catalytic Antibody 38C2 is scheduled to continue
throughout this calendar 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 forward-looking
statements contained in this Outlook, in particular the statements regarding
revenues, gross margin, research and development, cost reductions and deferrals,
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 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
December 31, 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)
February 11, 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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