CYANOTECH CORP - Quarter Report: 2012 December (Form 10-Q)

Table of Contents

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

x  Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For Quarterly Period Ended December 31, 2012

 

Or

 

o  Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the Transition Period From               to             

 

Commission File Number 0-14602

 

CYANOTECH CORPORATION

(Exact name of registrant as specified in its charter)

 

 

73-4460 Queen Kaahumanu Hwy. #102, Kailua-Kona, HI 96740

(Address of principal executive offices)

 

(808) 326-1353

(Registrant’s telephone number)

 

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

Number of common shares outstanding as of February 6, 2013:

 

 

 

Table of Contents

 

CYANOTECH CORPORATION

 

FORM 10-Q

 

INDEX

 

PART I.  FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited)	3
	Condensed Consolidated Balance Sheets as of December 31, 2012 and March 31, 2012	3
	Condensed Consolidated Statements of Operations for the three and nine month periods ended December 31, 2012 and 2011	4
	Condensed Consolidated Statements of Cash Flows for the nine month periods ended December 31, 2012 and 2011	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	19
Item 4.	Controls and Procedures	19
PART II.  OTHER INFORMATION
Item 1.	Legal Proceedings	19
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	19
Item 3.	Defaults upon Senior Securities	19
Item 5.	Other Information	19
Item 6.	Exhibits	20
SIGNATURES		21

 

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PART I.  FINANCIAL INFORMATION

 

Item 1.  Financial Statements (Unaudited)

 

CYANOTECH CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands except par value and number of shares)

(Unaudited)

 

		December 31, 2012			March 31, 2012
ASSETS
Current assets:
Cash and cash equivalents		$	3,609		$	5,061
Accounts receivable, net of allowance for doubtful accounts of $6 at December 31, 2012 and $16 at March 31, 2012		4,242			2,373
Inventories, net		3,488			3,548
Deferred tax assets		137			137
Prepaid expenses and other current assets		279			300
Total current assets		11,755			11,419
Equipment and leasehold improvements, net		8,471			5,834
Restricted cash		281			—
Deferred tax assets		1,307			1,307
Other assets		769			478
Total assets		$	22,583		$	19,038
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current maturities of long-term debt		$	64		$	234
Customer deposits		42			49
Accounts payable		1,956			1,726
Accrued expenses		793			1,352
Total current liabilities		2,855			3,361
Long-term debt, excluding current maturities		2,286			400
Deferred rent		16			12
Total liabilities		5,157			3,773
Commitments and contingencies
Stockholders’ equity:
Common stock of $0.02 par value, shares authorized 50,000,000; 5,463,938 shares issued and outstanding at December 31, 2012 and 5,440,968 shares at March 31, 2012		109			109
Additional paid-in capital		28,910			28,324
Accumulated deficit		(11,593		)	(13,168		)
Total stockholders’ equity		17,426			15,265
Total liabilities and stockholders’ equity		$	22,583		$	19,038

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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CYANOTECH CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share amounts)

(Unaudited)

 

		Three Months Ended December 31,						Nine Months Ended December 31,
		2012			2011			2012			2011
NET SALES		$	7,242		$	6,706		$	20,684		$	18,645
COST OF SALES		4,377			3,879			12,433			10,924
Gross profit		2,865			2,827			8,251			7,721
OPERATING EXPENSES:
General and administrative		1,175			955			3,608			3,019
Sales and marketing		1,004			631			2,722			1,808
Research and development		52			77			183			237
Loss on disposal of equipment and leasehold improvements		1			1			36			65
Total operating expenses		2,232			1,664			6,549			5,129
Income from operations		633			1,163			1,702			2,592
OTHER EXPENSE:
Loss on extinguishment of debt		—			—			(51		)	—
Interest expense, net		(14		)	(14		)	(43		)	(38		)
Total other expense, net		(14		)	(14		)	(94		)	(38		)
Income before provision for income taxes		619			1,149			1,608			2,554
PROVISION FOR INCOME TAXES		(12		)	(36		)	(32		)	(81		)
NET INCOME		$	607		$	1,113		$	1,576		$	2,473
NET INCOME PER SHARE:
Basic		$	0.11		$	0.21		$	0.29		$	0.46
Diluted		$	0.11		$	0.20		$	0.28		$	0.45
SHARES USED IN CALCULATION OF NET INCOME PER SHARE:
Basic		5,464			5,424			5,451			5,406
Diluted		5,617			5,571			5,692			5,490

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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CYANOTECH CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

 

		Nine Months Ended December 31,
		2012			2011
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	1,576		$	2,473
Adjustments to reconcile net income to net cash provided by operating activities:
Loss on extinguishment of debt		51			—
Loss on disposal of equipment and leasehold improvements		35			65
Depreciation and amortization		619			513
Amortization of debt issue costs and other assets		84			32
Share based compensation expense		563			326
Reduction of allowance for doubtful accounts		(10		)	(6		)
Net (increase) decrease in operating assets:
Accounts receivable		(1,859		)	(208		)
Inventories		60			71
Prepaid expenses and other assets		(95		)	(275		)
Net increase (decrease) in operating liabilities:
Customer deposits		(7		)	(76		)
Accounts payable		230			140
Accrued expenses		(559		)	520
Deferred rent		4			—
Net cash provided by operating activities		692			3,575
CASH FLOWS FROM INVESTING ACTIVITIES:
Restricted cash from issuance of long term debt		(281		)	—
Investment in equipment and leasehold improvements		(3,292		)	(1,438		)
Net cash used in investing activities		(3,573		)	(1,438		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long term debt, net of costs		2,281			95
Principal payments on long-term debt		(616		)	(160		)
Payments for debt issuance costs		(259		)	—
Proceeds from stock options exercised		23			56
Net cash provided by (used in) financing activities		1,429			(9		)
Net (decrease) increase in cash and cash equivalents		(1,452		)	2,128
Cash and cash equivalents at beginning of period		5,061			2,062
Cash and cash equivalents at end of period		$	3,609		$	4,190
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest		$	98		$	30
Income taxes		$	57		$	60

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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CYANOTECH CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012

(Unaudited)

 

1.                                      BASIS OF PRESENTATION

 

The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information pursuant to the instructions to Form 10-Q and Regulation S-X of the Securities and Exchange Commission (SEC).  These interim condensed consolidated financial statements are unaudited and, in the opinion of management, include all adjustments (consisting of normal recurring adjustments and accruals) necessary to present fairly the Condensed Consolidated Balance Sheets, Condensed Consolidated Statements of Operations, and Condensed Consolidated Statements of Cash Flows for the periods presented in accordance with GAAP. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. The Condensed Consolidated Balance Sheet as of March 31, 2012 was derived from the audited financial statements. These condensed consolidated financial statements and notes should be read in conjunction with the Company’s consolidated financial statements for the year ended March 31, 2012, contained in the Company’s annual report on Form 10-K as filed with the SEC on June 21, 2012.

 

The accompanying condensed consolidated financial statements include the accounts of Cyanotech Corporation and its wholly owned subsidiary, Nutrex Hawaii, Inc. (“Nutrex Hawaii” or “Nutrex”, collectively the “Company”). All significant intercompany balances and transactions have been eliminated in consolidation.

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the periods reported.  Management reviews these estimates and assumptions periodically and reflects the effect of revisions in the period that they are determined to be necessary.  Actual results could differ from those estimates and assumptions.

 

2.                                      INVENTORIES

 

Inventories are stated at the lower of cost or market.  Cost is determined by the first-in, first-out method.  Inventories consist of the following:

 

		December 31, 2012			March 31, 2012
		(in thousands)
Raw materials		$	840		$	344
Work in process		364			253
Finished goods(1)		2,051			2,722
Supplies		233			229
		$	3,488		$	3,548

(1)         Net of reserve for obsolescence of $11,000 and $41,000 at December 31, 2012 and March 31, 2012, respectively.

 

The Company recognizes abnormal production costs, including fixed cost variances from normal production capacity, as an expense in the period incurred. Approximately $161,000 and $875,000 of abnormal production costs were charged to cost of sales for the three and nine months ended December 31, 2012, respectively.  Approximately $236,000 and $652,000 of abnormal production costs were charged to cost of sales for the three and nine months ended December 31, 2011.

 

3.                                      EQUIPMENT AND LEASEHOLD IMPROVEMENTS

 

Equipment and leasehold improvements are stated at cost. Depreciation and amortization are provided using the straight-line method over the estimated useful lives for equipment and furniture and fixtures, or the shorter of the land lease term or estimated useful lives for leasehold improvements as follows:

 

Equipment		3 to 10 years
Furniture and fixtures		3 to 7 years
Leasehold improvements		10 to 25 years

 

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Equipment and leasehold improvements consist of the following:

 

		December 31, 2012			March 31, 2012
		(in thousands)
Equipment(1)		$	7,131		$	6,695
Leasehold improvements		8,313			7,524
Furniture and fixtures		176			154
		15,620			14,373
Less accumulated depreciation and amortization		(10,313		)	(9,867		)
Construction-in-progress		3,164			1,328
Equipment and leasehold improvements, net		$	8,471		$	5,834

(1)         Includes $97,000 of equipment under capital lease with accumulated amortization of $53,000 and $39,000 at December 31, 2012 and March 31, 2012, respectively.

 

The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Recoverability of these assets is measured by a comparison of the carrying amount to forecasted undiscounted future cash flows expected to be generated by the asset. If the carrying amount exceeds its estimated future cash flows, then an impairment charge is recognized to the extent that the carrying amount exceeds the asset’s fair value. Management has determined no asset impairment existed as of December 31, 2012. The Company recognized a loss on disposal of assets in the amount of $1,000 and $36,000 for the three and nine months ended December 31, 2012, respectively.  The Company recognized a loss on disposal of assets in the amount of $1,000 and $65,000 for the three and nine months ended December 31, 2011, respectively.

 

4.                                      ACCRUED EXPENSES

 

Accrued expenses consist of the following:

 

		December 31, 2012			March 31, 2012
		(in thousands)
Wages, commissions		$	487		$	491
Customer rebates		116			69
Bonuses		—			642
Rent		72			17
Other expenses		118			133
		$	793		$	1,352

 

5.                                      LONG-TERM DEBT

 

Long-term debt consists of the following:

 

		December 31, 2012			March 31, 2012
		(in thousands)
Term loans		$	2,350		$	634
Less current maturities		(64		)	(234		)
Long-term debt, excluding current maturities		$	2,286		$	400

 

Term Loan Agreements

 

On September 7, 2012, the Company completed a loan agreement with a lender providing for $5,500,000 in aggregate credit facilities (the “Loan”) secured by substantially all the Company’s assets, pursuant to a Term Loan Agreement dated August 14, 2012 (the “Loan Agreement”). The Loan Agreement is evidenced by promissory notes in the amounts of $2,250,000 and $3,250,000, the repayment of which is partially guaranteed under the provisions of a United States Department of Agriculture (“USDA”) Rural Development Guarantee program (the “Guarantees”). The proceeds of the Loan will be used to acquire new processing equipment and leasehold improvements at its Kona, Hawaii facility.

 

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The provisions of the Loan require the payment of interest only for the first 12 months of the term; thereafter, and until its maturity on August 14, 2032, the obligation fully amortizes over nineteen (19) years. Interest on the Loan accrues on the outstanding principal balance at an annual variable rate equal to the published Wall Street Journal prime rate (3.25% at December 31, 2012) plus 1.0% and is adjustable on the first day of each calendar quarter and fixed for that quarter. At no time shall the annual interest rate be less than 5.50%. The Loan has a prepayment penalty of 5% for any prepayment made prior to the first anniversary of the date of the Loan Agreement, which penalty is reduced by 1% each year thereafter until the fifth anniversary of such date, after which there is no prepayment penalty. The balance under this Loan was $2,250,000 at December 31, 2012. Proceeds from the Loan are classified as restricted cash until drawn upon to acquire new processing equipment and leasehold improvements.

 

The Loan includes a one-time origination and guaranty fees totaling $214,500 and an annual renewal fee payable in the amount of 0.25% of the USDA guaranteed portion of the outstanding principal balance as of December 31 of each year, beginning December 31, 2012.  The USDA has guaranteed 80% of all amounts owing under the Loan. The Company is subject to financial covenants and customary affirmative and negative covenants. The Company was in compliance with these financial covenants at December 31, 2012.

 

The Company has five equipment loans with John Deere credit providing for $163,000 in equipment financing; four of these loans are payable in 48 equal monthly principal payments and one is payable in 36 equal monthly principal payments.  At December 31, 2012 and March 31, 2012 the total outstanding combined balance was approximately $76,000. The equipment loans have maturity dates of  March 2013 as to $2,000, May 2015 as to $26,000, November 2015 as to $22,000 and June 2016 as to $26,000. The loans are at a 0% rate of interest and are net of unamortized discount of $3,000 at December 31, 2012.

 

In September 2011, the Company executed a Term Loan Agreement with Nissan Motor Acceptance Corporation providing for $23,000 in equipment financing, secured by the equipment. The Term Loan has a maturity date of September 13, 2016 and is payable in 60 equal monthly principal payments. The interest rate under this Term Loan is 0%. Imputed interest at a rate of 2% (cash discount offered by seller) has been recorded and is being amortized as interest over the term of the loan. The face value of the term loan is reported in the balance sheets at $16,000, less the unamortized discount of $600 at December 31, 2012.

 

Capital Lease

 

In March 2010, the Company executed a capital lease agreement with Thermo Fisher Financial providing for $97,000 in equipment, secured by the equipment financed. The capital lease has a maturity date of March 2013 and is payable in 36 equal monthly payments. The interest rate under this capital lease is 6.6%. The balance under this capital lease was $9,000 and $34,000 at December 31, 2012 at March 31, 2012, respectively.

 

Future principal payments under the term loans and capital lease agreement as of December 31, 2012 are as follows:

 

Payments Due		(in thousands)
Next 12 Months		$	64
Year 2		99
Year 3		97
Year 4		85
Year 5		83
Thereafter through 2032		1,922
Total principal payments		$	2,350

 

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6.                                      LEASES

 

The Company leases facilities, equipment and land under operating leases expiring between 2012 and 2035.  The land lease provides for contingent rental in excess of minimum rental commitments based on a percentage of the Company’s sales. Management has accrued for the estimated contingent rent as of December 31, 2012.

 

Future minimum lease payments under all non-cancelable operating leases at December 31, 2012 are as follows:

 

Payments Due		(in thousands)
Next 12 Months		$	466
Year 2		472
Year 3		425
Year 4		331
Year 5		299
Thereafter through 2026		5,385
Total minimum lease payments		$	7,378

 

7.                                      COMMITMENTS AND CONTINGENCIES

 

On September 12, 2012, the Company entered into an agreement with Uhde Corporation of America (“Uhde”) for the purchase of supercritical carbon dioxide extraction equipment to be used in the processing of its natural astaxanthin (“Equipment”). Pursuant to the terms of the agreement, Uhde will build, ship and provide assistance in installing the Equipment, which is required to be delivered in approximately 14 months from the date of the agreement. The Company will pay Uhde an aggregate of $3,222,000 for the equipment and services, of which $1,612,000  remains unpaid as of December 31, 2012.

 

8.                                      SHARE-BASED COMPENSATION

 

The Company accounts for share-based payment arrangements using fair value. If an award vests or becomes exercisable based on the achievement of a condition other than service, such as for meeting certain performance or market conditions, the award is classified as a liability. Liability-classified awards are remeasured to fair value at each balance sheet date until the award is settled. The Company currently has no liability-classified awards. Equity- classified awards, including grants of employee stock options, are measured at the grant-date fair value of the award and are not subsequently remeasured unless an award is modified. The cost of equity-classified awards is recognized in the statement of operations over the period during which an employee is required to provide the service in exchange for the award, or the vesting period. All of the Company’s stock options are service-based awards, and because the Company’s stock options are “plain vanilla,” as defined by the U.S. Securities and Exchange Commission in Staff Accounting Bulletin No. 107, they are reflected only in Equity and Compensation Expense accounts.

 

Stock Options

 

As of December 31, 2012, the Company had the following two shareholder approved plans under which shares were available for equity based awards: The 2005 Stock Option Plan (the “2005 Plan”) wherein 2,075,000 shares of common stock are reserved for issuance until the Plan terminates on August 21, 2015, and; The Independent Director Stock Option and Stock Grant Plan (the “2004 Directors Plan”) wherein 200,000 shares of common stock are reserved for issuance until the plan terminates in 2014.

 

Under the 2005 Plan, eligible employees and certain independent consultants may be granted options to purchase shares of the Company’s common stock. The shares issuable under the 2005 Plan will either be shares of the Company’s authorized but previously unissued common stock or shares reacquired by the Company, including shares purchased on the open market.  As of December 31, 2012, there were 411,478 options available for grant under the 2005 Plan.

 

Under the 2004 Directors Plan, upon election to the Board of Directors at an annual stockholders meeting, a newly elected non-employee director will be granted a ten-year option to purchase 6,000 shares of the Company’s common stock. Options vest and become exercisable six months from the date of grant. In addition, on the date of each annual stockholders meeting, each non-employee director continuing in office is automatically issued 4,000 shares of the Company’s common stock, and an additional 1,000 shares to the director serving as Chairman of the Board, non-transferable for six months following the date of grant. During the nine months ended December 31, 2012 and 2011, there were 13,000 and 8,000 shares issued under the 2004 directors Plan, respectively. As of December 31, 2012, there were 130,123 shares available for grant under the 2004 Directors Plan.

 

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The following table presents shares authorized, available for future grant and options outstanding under each of the Company’s plans:

 

		As of December 31, 2012
		Authorized		Available		Outstanding
2005 Plan		2,075,000		411,478		1,483,856
2004 Directors Plan		200,000		130,123		12,000
Total		2,275,000		541,601		1,495,856

 

All stock option grants made under the 2005 Plan and the 2004 Directors Plan were at exercise prices no less than the Company’s closing stock price on the date of grant. Options under the 2005 Plan and 2004 Directors Plan were determined by the Board of Directors or the Stock Option and Compensation Committee of the Board in accordance with the provisions of the respective plans.  The terms of each option grant include vesting, exercise and other conditions are set forth in a Stock Option Agreement evidencing each grant. No option can have a life in excess of ten (10) years.  The Company records compensation expense for employee stock options based on the estimated fair value of the options on the date of grant using the Black-Scholes option-pricing model. The model requires various assumptions, including a risk-free interest rate, the expected term of the options, the expected stock price volatility over the expected term of the options and the expected dividend yield. Compensation expense for employee stock options is recognized ratably over the vesting term which ranges from 4 to 7 years. Compensation expense recognized for options issued under the 2005 Plan was $191,000 and $486,000 for the three and nine months ended December 31, 2012, respectively. Compensation expense recognized for options issued under the 2005 Plan was $121,000 and $289,000 for the three and nine months ended December 31, 2011, respectively. Compensation expense recognized for options and shares issued under the 2004 Directors Plan was $0 and $77,000 for the three and nine months ended December 31, 2012, respectively. Compensation expense recognized for options and shares issued under the 2004 Directors Plan was $6,000 and $37,000 for the three and nine months ended December 31, 2011, respectively. All share-based compensation has been classified as General and Administrative expense.

 

A summary of option activity under the Company’s stock plans for the nine months ended December 31, 2012 is presented below:

 

Option Activity		Shares		Weighted Average Exercise Price			Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value
Outstanding at March 31, 2012		1,251,166		$	3.54		9.0 years		$	8,243,956
Granted		258,000		6.30			—		—
Exercised		(9,970	)	$	2.34		—		—
Forfeited or expired		(3,340	)	$	3.21		—		—
Outstanding at December 31, 2012		1,495,856		$	4.03		8.5 years		$	1,364,067
Exercisable at December 31, 2012		257,290		$	3.15		7.7 years		$	393,087

 

The aggregate intrinsic value as of December 31, 2012 in the table above is before applicable income taxes and represents the excess amount over the exercise price optionees would have received if all options had been exercised on the last business day of the period indicated, based on the Company’s closing stock price of $4.63 for such day.

 

A summary of the Company’s non-vested options for the nine months ended December 31, 2012 is presented below:

 

Nonvested Options		Shares		Weighted Average Grant-Date Fair Value
Nonvested at March 31, 2012		1,109,066		$	2.57
Granted		258,000		4.35
Vested		125,560		2.09
Forfeited or expired		(2,940	)	2.14
Nonvested at December 31, 2012		1,238,566		$	2.99

 

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The following table summarizes the weighted average characteristics of outstanding stock options as of December 31, 2012:

 

		Outstanding Options							Exercisable Options
Range of Exercise Prices		Number of Shares		Remaining Life (Years)		Weighted Average Price			Number of Shares		Weighted Average Price
$ 1.60 - $3.70		450,210		7.7		$	2.92		181,370		$	2.72
$ 3.71 - $4.42		732,646		8.7		3.82			56,920		3.82
$ 4.43 - $5.40		77,500		9.1		5.19			19,000		5.26
$ 5.41 - $7.08		235,500		9.5		6.40			—		—
Total stock options		1,495,856		8.5		$	4.03		257,290		$	3.15

 

There were 45,000 and 258,000 stock options granted during the three and nine months ended December 30, 2012, respectively. There were 55,000 and 922,516 stock options granted during the three and nine months ended December 31, 2011, respectively. The value assumptions related to options granted during the nine months ended December 31, 2012 and 2011 were as follows:

 

		2012		2011
Exercise Price:		$5.26 - 7.08		$3.58 - 5.40
Volatility:		78.26 - 80.39%		56.18 - 78.61%
Risk Free Rate:		0.85 - .93%		0.09 - 2.25%
Vesting Period:		5 - 7 years		0 - 5 years
Forfeiture Rate:		7.66 - 9.00%		0 - 16.88%
Expected Life		6.25 years		0.25 - 8.25 years
Dividend Rate		0%		0%

 

As of December 31, 2012, total unrecognized share-based compensation expense related to all unvested stock options was $2,654,000, which is expected to be recognized over a weighted average period of 4.3 years.

 

9.                                      INCOME TAXES

 

Income taxes are provided on the pretax income in the consolidated financial statements. The tax provision is based on the current quarter activity of the legal entities and jurisdictions in which the Company operates. Tax credits are recognized as a reduction to income taxes in the year the credits are earned, accordingly, the effective tax rate may vary from the customary relationship between income tax expense (benefit) and pretax income.  The effective tax rate for the three and nine months ended December 31, 2012 differs from the statutory rate due to utilization of net operating loss carryforwards that have been fully reserved due to the Company’s inconsistent taxable income in recent years and uncertainty about taxable income in future years.

 

The Company is subject to taxation in the United States and two state jurisdictions.  The preparation of tax returns requires management to interpret the applicable tax laws and regulations in effect in such jurisdictions, which could affect the amount of tax paid by the Company. Management, in consultation with its tax advisors, files its tax returns based on interpretations that are believed to be reasonable under the circumstances. The income tax returns, however, are subject to routine reviews by the various taxing authorities.  As part of these reviews, a taxing authority may disagree with respect to the tax positions taken by management (“uncertain tax positions”) and therefore may require the Company to pay additional taxes. Management evaluates the requirement for additional tax accruals, including interest and penalties, which the Company could incur as a result of the ultimate resolution of its uncertain tax positions. Management reviews and updates the accrual for uncertain tax positions as more definitive information becomes available from taxing authorities, completion of tax audits, expiration of statute of limitations, or upon occurrence of other events.

 

As of December 31, 2012, there was no liability for income tax associated with unrecognized tax benefits. The Company recognizes accrued interest related to unrecognized tax benefits as well as any related penalties in interest expense in its consolidated condensed statements of operations, which is consistent with the recognition of these items in prior reporting periods.

 

With few exceptions, the Company is no longer subject to U.S. federal, state, local, and non-U.S. income tax examination by tax authorities for tax years before 2008.

 

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10.                               COMMON AND PREFERRED STOCK

 

Following shareholder approval, the Company filed a Certificate of Amendment to its Articles of Incorporation to increase the total number of authorized shares from 12,500,000 to sixty million (60,000,000) shares of which fifty million (50,000,000) shares shall be common stock, par value $0.02, and ten million (10,000,000) shares shall be preferred stock, par value $0.01. There are no preferred shares issued or outstanding. The Amendment was effective as of November 2, 2012.

 

11.                               EARNINGS PER SHARE

 

Basic earnings per share is computed on the basis of the weighted average number of common shares outstanding.  Diluted earnings per share is computed on the basis of the weighted average number of common shares outstanding plus the potentially dilutive effect of outstanding stock options using the “treasury stock” method.

 

Reconciliations between the numerator and the denominator of the basic and diluted earnings per share computations for the three months ended December 31, 2012 and 2011 are as follows:

 

		Three Months Ended December 31, 2012
		Net Income			Shares		Per Share
		(Numerator)			(Denominator)		Amount
		(in thousands)
Basic income per share		$	607		5,464		$	0.11
Effect of dilutive securities — Common stock options		—			153		—
Diluted income per share		$	607		5,617		$	0.11

 

		Three Months Ended December 31, 2011
		Net Income			Shares		Per Share
		(Numerator)			(Denominator)		Amount
		(in thousands)
Basic income per share		$	1,113		5,424		$	0.21
Effect of dilutive securities — Common stock options		—			147		(0.01		)
Diluted income per share		$	1,113		5,571		$	0.20

 

Reconciliations between the numerator and the denominator of the basic and diluted earnings per share computations for the six months ended December 31, 2012 and 2011 are as follows:

 

		Nine Months Ended December 31, 2012
		Net Income			Shares		Per Share
		(Numerator)			(Denominator)		Amount
		(in thousands)
Basic income per share		$	1,576		5,451		$	0.29
Effect of dilutive securities—Common stock options		—			241		(0.01		)
Diluted income per share		$	1,576		5,692		$	0.28

 

		Nine Months Ended December 31, 2011
		Net Income			Shares		Per Share
		(Numerator)			(Denominator)		Amount
		(in thousands)
Basic income per share		$	2,473		5,406		$	0.46
Effect of dilutive securities — Common stock options		—			84		(0.01		)
Diluted income per share		$	2,473		5,490		$	0.45

 

Diluted earnings per share does not include the impact of common stock options totaling 732,032 and 786,756 for the three months ended December 31, 2012 and 2011, respectively, and 198,000 and 1,134,116 for the nine months ended December 31, 2012 and 2011, respectively, as the effect of their inclusion would be anti-dilutive.

 

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

FORWARD-LOOKING STATEMENTS

 

This Report and other presentations made by Cyanotech Corporation (“CYAN”) and its subsidiary contain “forward-looking statements,” which include statements that are predictive in nature, depend upon or refer to future events or conditions, and usually include words such as “expects,” “anticipates,” “intends,” “plan,” “believes,” “predicts”, “estimates” or similar expressions. In addition, any statement concerning future financial performance, ongoing business strategies or prospects and possible future actions are also forward-looking statements. Forward-looking statements are based upon current expectations and projections about future events and are subject to risks, uncertainties and the accuracy of assumptions concerning CYAN and its subsidiaries (collectively, the “Company”), the performance of the industry in which CYAN does business, and economic and market factors, among other things. These forward-looking statements are not guarantees of future performance.  You should not place undue reliance on forward-looking statements.

 

Forward-looking statements speak only as of the date of the Report, presentation or filing in which they are made. Except to the extent required by the Federal Securities Laws, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Our forward-looking statements in this Report include, but are not limited to:

 

·                  Statements relating to our business strategy;

 

·                  Statements relating to our business objectives; and

 

·                  Expectations concerning future operations, profitability, liquidity and financial resources.

 

These forward-looking statements are subject to risk, uncertainties and assumptions about us and our operations that are subject to change based on various important factors, some of which are beyond our control. The following factors, among others, could cause our financial performance to differ significantly from the goals, plans, objectives, intentions and expectations expressed in our forward-looking statements:

 

·                  Environmental restrictions, soil and water conditions, levels of sunlight and seasonal weather patterns, particularly heavy rain, wind and other hazards;

 

·                  Consumer perception of our products due to adverse scientific research or findings, publicity regarding nutritional supplements, litigation, regulatory investigations or other events, conditions and circumstances involving the Company which receive national media coverage;

 

·                  The effects of competition, including tactics and locations of competitors and operating and market competition;

 

·                  Demand for our products, the quantities and qualities thereof available for sale and levels of customer satisfaction, including significant unforeseen fluctuations in global demand for products similar to our products;

 

·                  Our dependence on the experience, continuity and competence of our executive officers and other key employees;

 

·                  The added risks associated with the current local, national and world economic crises, including but not limited to, the volatility of crude oil prices, inflation and currency fluctuations;

 

·                  Changes in domestic and/or foreign laws, regulations or standards, affecting nutraceutical products or our methods of operation;

 

·                  Access to available and reasonable financing on a timely basis;

 

·                  Changes in laws, corporate governance requirements and tax rates, regulations, accounting standards and the application to us or the nutritional products industry of new decisions by courts, regulators or other government authorities;

 

·                  The risk associated with the geographic concentration of our business;

 

·                  Acts of war, terrorist incidents or natural disasters; and

 

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Other risks or uncertainties described elsewhere in this Report and in other periodic reports previously and subsequently filed by us with the Securities and Exchange Commission.

 

Overview:

 

We are a world leader in the production of high value natural products derived from microalgae. Incorporated in 1983, we are guided by the principle of providing beneficial, quality microalgal products for health and human nutrition in a sustainable, reliable and environmentally sensitive operation. We are ISO 9001:2008 compliant and GMP (Good Manufacturing Practices) certified by the Natural Products Association™, reinforcing our commitment to quality in our products, quality in our relationships (with our customers, suppliers, co-workers and the communities we live in), and quality of the environment in which we work. Our products include:

 

·                  Hawaiian Spirulina Pacifica® - a nutrient-rich dietary supplement used for extra energy, a strengthened immune system, cardiovascular benefits and as a source of antioxidant carotenoids; and

 

·                  Hawaiian BioAstin® natural astaxanthin - a powerful dietary antioxidant shown to support and maintain the body’s natural inflammatory response, to enhance skin, and to support eye and joint health.  It has expanding applications as a human nutraceutical and functional food ingredient

 

Microalgae are a diverse group of microscopic plants that have a wide range of physiological and biochemical characteristics and contain, among other things, high levels of natural protein, amino acids, vitamins, pigments and enzymes. Microalgae have the following properties that make commercial production attractive: (1) microalgae grow much faster than land grown plants, often up to 100 times faster; (2) microalgae have uniform cell structures with no bark, stems, branches or leaves, permitting easier extraction of products and higher utilization of the microalgae cells; and (3) the cellular uniformity of microalgae makes it practical to control the growing environment in order to optimize a particular cell characteristic. Efficient and effective cultivation of microalgae requires consistent light, warm temperatures, low rainfall and proper chemical balance in a very nutrient-rich environment, free of environmental contaminants and unwanted organisms. This is a challenge that has motivated us to design, develop and implement proprietary production and harvesting technologies, systems and processes in order to provide human nutritional products derived from microalgae.

 

Our production of these products at the 90-acre facility on the Kona Coast of the island of Hawaii provides several benefits. We selected the Keahole Point location in order to take advantage of relatively consistent warm temperatures, sunshine and low levels of rainfall needed for optimal cultivation of microalgae. This location also offers us access to cold deep ocean water, drawn from an offshore depth of 2,000 feet, which we use in our Ocean-Chill Drying system to eliminate the oxidative damage caused by standard drying techniques and as a source of trace nutrients for microalgal cultures. The area is also designated a Biosecure Zone, free of pesticides and herbicides. We believe that our technology, systems, processes and favorable growing location generally permit year-round harvest of our microalgal products in a cost-effective manner.

 

Results of Operations

 

Because our core operations are agricultural and dependent on favorable environmental factors, from time to time we experience cycles of low production in our harvests. Our spirulina production has been experiencing one of those cycles over the past twelve months. Specifically, we have harvested microalgae with smaller cell sizes than had been typical over the past several years. While the quality of our spirulina remains very high, with nutrient levels at or above our high standards, the physical size of the cells has impacted our harvest levels. We continue to take steps to improve our harvest efficiency and maintain a large size cell. Our harvest level has improved and stabilized at a significantly higher level in the third quarter and through the first month of the fourth quarter but has not yet returned to targeted levels.

 

We have continued to make progress in developing our total consumer business. Our astaxanthin pond expansion project completed early this year and, the overall expertise we have developed in cultivating and harvesting our natural Hawaiian astaxanthin have helped us offset the downturn in our spirulina target harvest cycle.

 

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The following tables present selected consolidated financial data for each of the periods indicated ($ in thousands):

 

		Three Months Ended						Nine Months Ended
		December 31, 2012			December 31, 2011			December 31, 2012			December 31, 2011
Net sales		$	7,242		$	6,706		$	20,684		$	18,645
Net sales increase		8.0		%				10.9		%
Gross profit		$	2,865		$	2,827		$	8,251		$	7,721
Gross profit as % of net sales		39.6		%	42.2		%	39.9		%	41.4		%
Operating expenses		$	2,232		$	1,664		$	6,549		$	5,129
Operating expenses as % of net sales		30.8		%	24.8		%	31.7		%	27.5		%
Operating income		$	633		$	1,163		$	1,702		$	2,592
Operating income as % of net sales		8.7		%	17.3		%	8.2		%	13.9		%
Income tax expense		$	12		$	36		$	32		$	81
Net income		$	607		$	1,113		$	1,576		$	2,473
Net sales by product
Bulk sales
Spirulina bulk		$	755		$	1,236		$	2,646		$	3,963
Spirulina bulk sales decrease		(38.9		)%				(33.2		)%
Astaxanthin bulk		$	3,345		$	3,258		$	9,261		$	8,432
Astaxanthin bulk sales increase		2.7		%				9.8		%
Total Bulk sales		$	4,100		$	4,494		$	11,907		$	12,395
Total Bulk sales decrease		(8.8		)%				(3.9		)%
Packaged sales
Spirulina packaged		$	1,218		$	859		$	3,622		$	2,703
Spirulina packaged sales increase		41.8		%				34.0		%
Astaxanthin packaged		$	1,924		$	1,353		$	5,155		$	3,547
Astaxanthin packaged sales increase		42.2		%				45.3		%
Total Packaged sales		$	3,142		$	2,212		$	8,777		$	6,250
Total Packaged sales increase		42.0		%				40.4		%

 

Comparison of the Three Months Ended December 31, 2012 and 2011

 

Net Sales  The net sales growth of 8% for the quarter was driven by a 42% increase in our packaged products consistent with our focus and investment in the consumer packaged goods side of our business.  Within this growth, sales of spirulina increased 42% and sales of astaxanthin increased 42%.  Sales of our bulk products decreased only 9% as a result of the lower production of spirulina.  Within this decrease, sales of bulk spirulina decreased 39% as a result of low production during the quarter and sales of bulk astaxanthin increased 3%.  International sales represented 38% of net sales for the three months ended December 31, 2012 compared to 29% for the same period a year ago. There were no customers with sales equaling or exceeding 10% of our total sales for the three months ended December 31, 2012 and 2011.

 

Gross Profit  Our gross profit percent of net sales decreased by 2.6 points in the third quarter. Gross profit was impacted by lower spirulina production which resulted in the recognition of abnormal production costs of approximately $161,000 and $236,000, in the third quarter of fiscal years 2013 and 2012, respectively.  The abnormal costs were driven by a 17.5% decrease in spirulina production from the similar period in the prior year and a 6.2% increase in costs as compared with the similar period in the prior year.

 

Operating Expenses  Operating expenses increased by $568,000 for the third quarter compared to the same period in 2012.  Included in this is an increase in Sales and Marketing expenses of $373,000, or 59.1%, due to an increase in brand development costs, advertising programs for our packaged products and added management level staffing.  General and administrative expenses increased $220,000, or 23%, due to increases in costs associated with stock options granted to key employees and increased legal costs.

 

Income Taxes  We recorded income tax expense of $12,000 in the current quarter compared to $36,000 for the same period in 2012.  Our effective tax rate was 2.0% for the current quarter and 3.55% for the same period last year.  We do not expect any material federal or state income taxes to be recorded in the current fiscal year due to our available net operating loss carry forwards.

 

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Comparison of the Nine Months Ended December 31, 2012 and 2011

 

Net Sales  The net sales growth of 10.9% for the first nine months of fiscal 2013 was driven by a 40% increase in our packaged products consistent with our focus and investment in the consumer packaged goods side of our business.  Within this growth, sales of spirulina increased 34% and sales of astaxanthin increased 45%.  Sales of our bulk products decreased 4%, driven by lower production of spirulina in the third quarter.  Within this decrease, sales of bulk spirulina decreased 33% and sales of bulk astaxanthin increased 10%.  International sales represented 36% of net sales for the nine months ended December 31, 2012 compared to 32% for the same period a year ago. There were no customers with sales equaling or exceeding 10% of our total sales for the nine months ended December 31, 2012 and 2011.

 

Gross Profit  Our gross profit percent of net sales decreased by 1.5 points in the first nine months of fiscal 2013.  Gross profit was impacted by the reduction in spirulina production which resulted in the recognition of abnormal production costs of approximately $875,000 and $652,000, for the nine months ended December 31, 2012 and 2011, respectively.  The abnormal costs were driven by a 25.9% decrease in spirulina production from the similar period in the prior year and a 2.2% increase in costs as compared with the similar period in the prior year.

 

Operating Expenses  Operating expenses increased by $1,420,000 for the nine months ended December 31, 2012, compared to the same period in 2012.  Included in this is an increase in Sales and Marketing expenses of $914,000, or 50.6%, due to an increase in brand development costs, advertising programs for our packaged products and added management level staffing.  General and administrative expenses increased $589,000, or 19.5%, due to increases in costs associated with stock options granted to key employees and increased legal costs.

 

Income Taxes  We recorded income tax expense of $32,000 for the first nine months of fiscal 2013 compared to $81,000 for the same period last year.  Our effective tax rate was 2.1% for the first nine months of fiscal 2013 compared to 3.42% for the same period last year.  We do not expect any material federal or state income taxes to be recorded in the current fiscal year due to our available net operating loss carry forwards.

 

Variability of Results

 

We have experienced significant quarterly fluctuations in operating results and such fluctuations could occur in future periods. We have, during our history, experienced fluctuations in operating results due to the following:  changes in sales levels to our customers; competition including pricing, new products and shifts in market trends; production difficulties from environmental influences; increased production costs and variable production results due to inclement weather; and start up costs associated with new product introductions, new facilities and expansion into new markets. In addition, future operating results may fluctuate as a result of factors beyond our control such as foreign exchange fluctuations, changes in government regulations, and economic changes in the regions we have customers. A portion of our operating expenses are relatively fixed and the timing of increases in expense levels is based in large part on forecasts of future sales. Therefore, if net sales are below expectations in any given period, the adverse impact on results of operations may be magnified by our inability to effectively adjust spending in certain areas, or to adjust spending in a timely manner, as in personnel and administrative costs. We may also choose to reduce prices or increase spending in response to market conditions, and these decisions may have a material adverse effect on financial condition and results of operations.

 

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Liquidity and Capital Resources

 

Cash Flows The following table summarizes our cash flows for the period indicated ($ in thousands):

 

		Nine months ended December 31
		2012			2011
Total cash is (used in) provided by:
Operating activities		$	692		$	3,575
Investing activities		(3,573		)	(1,438		)
Financing activities		1,429			(9		)
(Decrease) increase in cash and cash equivalents		$	(1,452	)	$	2,128

 

Cash provided by operating activities decreased $2,883,000 compared to the same period last year due primarily to lower income and an increase in receivables of $1,859,000 compared to an increase of $208,000 last year. This increase is a function of higher sales and the timing of those sales.

 

Cash used in investing activities in the current period includes the addition of $281,000 in restricted cash from loan proceeds that can only be used to acquire certain new processing equipment and leasehold improvements.  In addition, we expended $3,292,000 on leasehold improvements and equipment acquisitions at our Kona facility compared to $1,438,000 during the same period last year.

 

Cash provided by (used in) financing activities in the period consists of proceeds from long-term debt offset by payoff of existing long-term debt and debt issuance cost for the new loan.  The prior year result is the net of receipt of proceeds from long-term debt and principal payments in the normal course of business.

 

Sources and Uses of Capital

 

At December 31, 2012, our working capital was $8.9 million, an increase of $842,000 compared to March 31, 2012. Cash and cash equivalents at December 31, 2012 totaled $3,609,000, a decrease of $1,452,000 compared to March 31, 2012.

 

On September 7, 2012, the Company completed a Term Loan Agreement with a lender providing for $5,500,000 in aggregate credit facilities pursuant to a Term Loan Agreement dated August 14, 2012.  The Term Loan Agreement is evidenced by promissory notes in the amounts of $2,250,000 and $3,250,000, and was secured under the provisions of a United States Department of Agriculture (“USDA”) Rural Development Guarantee program.  The proceeds of the Term Loan can only be used for specific new processing equipment and leasehold improvements at its Kona, Hawaii facility.  Until their disbursement for approved projects, the funds advanced are classified as restricted cash.

 

Our results of operations and financial condition can be affected by numerous factors, many of which are beyond our control and could cause future results of operations to fluctuate materially as it has in the past. Future operating results may fluctuate as a result of changes in sales volumes to our largest customers, weather patterns, increased competition, increased materials, nutrient and energy costs, government regulations and other factors beyond our control.

 

A significant portion of our expense levels are relatively fixed, so the timing of increases in expenses 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 financial condition and results of operations.

 

Based upon our current operating plan, analysis of our consolidated financial position and projected future results of operations, we believe that our operating cash flows, cash balances, and working capital will be sufficient to finance current operating requirements, debt service requirements, and routine planned capital expenditures, for the next twelve (12) months. We expect liquidity in the remainder of fiscal 2013 to be generated from operating cash flows.

 

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