CYANOTECH CORP - Quarter Report: 2013 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, 2013

 

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, 2014:

 

 

 

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, 2013 and March 31, 2013	3
	Condensed Consolidated Statements of Operations for the three and nine month periods ended December 31, 2013 and 2012	4
	Condensed Consolidated Statements of Cash Flows for the nine month periods ended December 31, 2013 and 2012	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	19
SIGNATURES		20

 

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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, 2013			March 31, 2013
ASSETS
Current assets:
Cash and cash equivalents		$	2,510		$	4,364
Accounts receivable, net of allowance for doubtful accounts of $6 at December 31, 2013 and $6 at March 31, 2013		4,502			3,766
Inventories, net		5,230			3,688
Deferred tax assets		110			110
Prepaid expenses and other current assets		426			263
Total current assets		12,778			12,191
Equipment and leasehold improvements, net		11,366			8,835
Restricted cash		1,851			3,360
Deferred tax assets		3,034			3,429
Other assets		843			772
Total assets		$	29,872		$	28,587
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current maturities of long-term debt		$	202		$	128
Customer deposits		60			33
Accounts payable		2,437			1,852
Accrued expenses		831			872
Total current liabilities		3,530			2,885
Long-term debt, excluding current maturities		5,303			5,454
Deferred rent		18			21
Total liabilities		8,851			8,360
Commitments and contingencies
Stockholders’ equity:
Common stock of $0.02 par value, shares authorized 50,000,000; 5,486,438 shares issued and outstanding at December 31, 2013 and 5,463,938 shares at March 31, 2013		110			109
Additional paid-in capital		29,698			29,077
Accumulated deficit		(8,787		)	(8,959		)
Total stockholders’ equity		21, 021			20,227
Total liabilities and stockholders’ equity		$	29,872		$	28,587

 

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,
		2013			2012			2013			2012
NET SALES		$	7,438		$	7,242		$	21,646		$	20,684
COST OF SALES		4,293			4,377			12,656			12,433
Gross profit		3,145			2,865			8,990			8,251
OPERATING EXPENSES:
General and administrative		1,685			1,175			4,502			3,608
Sales and marketing		1,011			1,004			3,195			2,722
Research and development		108			52			394			183
Loss on disposal of equipment and leasehold improvements		19			1			45			36
Total operating expenses		2,823			2,232			8,136			6,549
Income from operations		322			633			854			1,702
OTHER EXPENSE:
Loss on extinguishment of debt		—			—			—			(51		)
Interest expense, net		(29		)	(14		)	(90		)	(43		)
Total other expense, net		(29		)	(14		)	(90		)	(94		)
Income before provision for income taxes		293			619			764			1,608
PROVISION FOR INCOME TAXES		(257		)	(12		)	(592		)	(32		)
NET INCOME		$	36		$	607		$	172		$	1,576
NET INCOME PER SHARE:
Basic		$	0.01		$	0.11		$	0.03		$	0.29
Diluted		$	0.01		$	0.11		$	0.03		$	0.28
SHARES USED IN CALCULATION OF NET INCOME PER SHARE:
Basic		5,486			5,464			5,475			5,451
Diluted		5,659			5,617			5,656			5,692

 

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,
		2013			2012
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	172		$	1,576
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		46			35
Depreciation and amortization		784			619
Amortization of debt issue costs and other assets		32			84
Share based compensation expense		589			563
Reduction of allowance for doubtful accounts		—			(10		)
Reduction of inventory reserve		(3		)	—
Deferred income tax provision		395			—
Net (increase) decrease in assets:
Accounts receivable		(736		)	(1,859		)
Inventories		(1,539		)	60
Prepaid expenses and other assets		(266		)	(95		)
Net increase (decrease) in liabilities:
Customer deposits		27			(7		)
Accounts payable		585			230
Accrued expenses		(41		)	(559		)
Deferred rent		(3		)	4
Net cash provided by operating activities		42			692
CASH FLOWS FROM INVESTING ACTIVITIES:
Decrease (increase) in restricted cash		1,509			(281		)
Investment in equipment and leasehold improvements		(3,362		)	(3,292		)
Net cash used in investing activities		(1,853		)	(3,573		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long term debt, net of costs		—			2,281
Principal payments on long-term debt		(78		)	(616		)
Payments for debt issuance costs		—			(259		)
Proceeds from stock options exercised		35			23
Net cash (used in) provided by financing activities		(43		)	1,429
Net decrease in cash and cash equivalents		(1,854		)	(1,452		)
Cash and cash equivalents at beginning of period		4,364			5,061
Cash and cash equivalents at end of period		$	2,510		$	3,609
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest		$	229		$	98
Income taxes		$	118		$	57

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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CYANOTECH CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of December 31, 2013

(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, 2013 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, 2013, contained in the Company’s annual report on Form 10-K as filed with the SEC on June 24, 2013.

 

The accompanying consolidated condensed 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.

 

Recent Accounting Pronouncements

 

In July 2013, the Financial Accounting Standards Board (“FASB”) issued an Accounting Standards Update No. 2013-11 on the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss or tax credit carryforward, exists.  Under the guidance, an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward.  To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets.  The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date.  The updated guidance is effective for fiscal years and interim periods within those years, beginning after December 15, 2013.  The adoption of this guidance is not expected to have a material effect on the Company’s Consolidated Financial Statements.

 

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, 2013			March 31, 2013
		(in thousands)
Raw materials		$	915		$	932
Work in process		303			330
Finished goods(1)		3,812			2,164
Supplies		200			262
		$	5,230		$	3,688

(1)         Net of reserve for obsolescence of $6,000 and $9,000 at December 31, 2013 and March 31, 2013, respectively.

 

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The Company recognizes abnormal production costs, including fixed cost variances from normal production capacity, as an expense in the period incurred. Non inventoriable fixed costs of $44,000 were charged to cost of sales during the three months ended December 31, 2013. There were no abnormal production costs charged to cost of sales for the three and nine months ended December 31, 2013.  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.

 

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

 

Equipment and leasehold improvements consist of the following:

 

		December 31, 2013			March 31, 2013
		(in thousands)
Equipment		$	8,757		$	7,455
Leasehold improvements		9,525			8,313
Furniture and fixtures		288			208
		18,570			15,976
Less accumulated depreciation and amortization		(11,122		)	(10,496		)
Construction-in-progress		3,918			3,355
Equipment and leasehold improvements, net		$	11,366		$	8,835

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, 2013. The Company recognized a loss on disposal of assets in the amount of $19,000 and $45,000 for the three and nine months ended December 31, 2013, respectively.  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 has capitalized $50,000 and $148,000 of interest for the three and nine months ended December 31, 2013, respectively.  No interest was capitalized for the three and nine month period ended December 31, 2012.

 

4.                                      ACCRUED EXPENSES

 

Accrued expenses consist of the following:

 

		December 31, 2013			March 31, 2013
		(in thousands)
Wages, commissions		$	501		$	623
Customer rebates		93			109
Rent		72			21
Other expenses		165			119
		$	831		$	872

 

5.                                      LONG-TERM DEBT

 

Long-term debt consists of the following:

 

		December 31, 2013			March 31, 2013
		(in thousands)
Term loans		$	5,505		$	5,582
Less current maturities		(202		)	(128		)
Long-term debt, excluding current maturities		$	5,303		$	5,454

 

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Term Loan Agreements

 

The Company executed 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 are used to acquire new processing equipment and leasehold improvements at its Kona, Hawaii facility.

 

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, 2013) 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 $5,445,000 at December 31, 2013. 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, 2013.

 

The Company has three equipment loans with John Deere credit providing for $103,000 in equipment financing; these loans are payable in 48 equal monthly principal payments.  At December 31, 2013 and March 31, 2013 the total outstanding combined balance was approximately $48,000 and $66,000, respectively. The equipment loans have maturity dates of May 2015 as to $15,000, November 2015 as to $14,000 and June 2016 as to $19,000. The loans are at a 0% rate of interest and are net of unamortized discount of $1,000 and $2,000 at December 31, 2013 and March 31, 2013, respectively

 

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 balance outstanding under the Term Loan was $12,000 and $15,000 at December 31, 2013 and March 31, 2013, respectively, less the unamortized discount of $300 and $600 at December 31, 2013 and March 31, 2013, respectively.

 

Future principal payments under the term loan agreements as of December 31, 2013 are as follows:

 

Payments Due		(in thousands)
Next 12 Months		$	202
Year 2		205
Year 3		199
Year 4		203
Year 5		214
Thereafter		4,482
Total principal payments		$	5,505

 

6.                                      LEASES

 

The Company leases facilities, equipment and land under operating leases expiring through 2035.  The land lease provides for contingent rentals 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, 2013.

 

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Future minimum lease payments under all non-cancelable operating leases at December 31, 2013 are as follows:

 

Payments Due		(in thousands)
Next 12 Months		$	482
Year 2		442
Year 3		341
Year 4		305
Year 5		299
Thereafter		5,087
Total minimum lease payments		$	6,956

 

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.  The Equipment which was originally scheduled for delivery approximately 14 months from the date of the agreement, is now scheduled for a delivery in the first quarter of the next fiscal year. The Company will pay Uhde an aggregate of $3,222,000 for the equipment and services, of which $645,000 remains unpaid as of December 31, 2013.  Progress payments through December 31, 2013 of $2,577,000 have been classified as construction in progress on the consolidated balance sheet.

 

The Company is subject to legal proceedings and claims from time to time in the ordinary course of business.  Although management cannot predict with certainty the ultimate resolution of legal proceedings and claims asserted against the Company, management does not believe that any currently pending legal proceeding to which the Company is a party is likely to have a material adverse effect on its business, results of operations, cash flows or financial condition.

 

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, 2013, 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, 2013, there were 419,728 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. As of December 31, 2013, there were 121,123 shares available for grant under the 2004 Directors Plan.

 

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

 

		As of December 31, 2013
		Authorized		Available		Outstanding
2005 Plan		2,075,000		419,728		1,462,106
2004 Directors Plan		200,000		121,123		12,000
Total		2,275,000		540,851		1,474,106

 

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 $181,000 and $535,000 for the three and nine months ended December 31, 2013, respectively. 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 2004 Directors Plan was $2,000 and $54,000 for the three and nine months ended December 31, 2013, respectively. Compensation expense recognized for options issued under the 2004 Directors Plan was $0 and $77,000 for the three and nine months ended December 31, 2012, 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, 2013 is presented below:

 

Option Activity		Shares		Weighted Average Exercise Price			Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value
Outstanding at March 31, 2013		1,495,856		$	4.03		8.3 years		$	1,139,324
Granted		6,000		5.56			—		—
Exercised		(13,500	)	$	2.42		—		44,537
Forfeited or expired		(14,250	)	$	4.73		—		14,250
Outstanding at December 31, 2013		1,474,106		$	4.04		7.6 years		$	1,677,074
Exercisable at December 31, 2013		507,040		$	3.48		7.0 years		$	804,505

 

The aggregate intrinsic value as of December 31, 2013 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 $4.93 for such day.

 

A summary of the Company’s non-vested options for the nine months ended December 31, 2013 is presented below:

 

Nonvested Options		Shares		Weighted Average Grant-Date Fair Value
Nonvested at March 31, 2013		1,157,566		$	3.05
Granted		6,000		0.84
Vested		(188,250	)	2.65
Forfeited or expired		(8,250	)	3.08
Nonvested at December 31, 2013		967,066		$	3.11

 

The following table summarizes the weighted average characteristics of outstanding stock options as of December 31, 2013:

 

		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		433,190		6.7		$	2.93		323,270		$	2.82
$ 3.71 - $4.42		729,916		7.7		3.82			110,520		3.82
$ 4.43 - $5.40		72,500		8.2		5.17			27,500		5.18
$ 5.41 - $7.08		238,500		8.6		6.38			45,750		6.24
Total stock options		1,474,106		7.6		$	4.04		507,040		$	3.48

 

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There were 6,000 stock options granted during the three and nine months ended December 31, 2013. There were 45,000 and 258,000 stock options granted during the three and nine months ended December 31, 2012, respectively. The value assumptions related to options granted during the nine months ended December 31, 2013 were as follows:

 

		2013
Exercise Price:		$5.56
Volatility:		38.00%
Risk Free Rate:		0.14%
Vesting Period:		6 months
Forfeiture Rate:		0%
Expected Life		1.00 year
Dividend Rate		0%

 

As of December 31, 2013, total unrecognized share-based compensation expense related to all unvested stock options was $2,125,000, which is expected to be recognized over a weighted average period of 3.7 years.

 

9.                                      INCOME TAXES

 

We utilize our estimated annual effective tax rate to determine our provision for income taxes for interim periods.  The income tax provision is computed by taking the estimated annual effective tax rate and multiplying it by the year to date pre-tax book income.  We recorded income tax expense of $257,000 and $12,000 for the three months ended December 31, 2013 and 2012, respectively.  Our effective tax rate was 87.7% and 2.0% for the quarters ended December 31, 2013 and 2012, respectively. We recorded income tax expense of $592,000 and $32,000 for the nine months ended December 31, 2013 and 2012, respectively.  Our effective tax rate was 77.5% and 2.1% for the nine months ended December 31, 2013 and 2012, respectively.

 

The effective tax rate for the three months ended December 31, 2013 differs from the statutory rate of 34% as a result of the state taxes (net of federal benefit) and permanent differences.

 

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, 2013, 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 income or expense in its consolidated condensed statements of operations, which is consistent with the recognition of these items in prior reporting periods.

 

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.

 

10.                               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.

 

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Reconciliations between the numerator and the denominator of the basic and diluted earnings per share computations for the three months ended December 31, 2013 and 2012 are as follows:

 

		Three Months Ended December 31, 2013
		Net Income			Shares		Per Share
		(Numerator)			(Denominator)		Amount
		(in thousands)
Basic income per share		$	36		5,486		$	0.01
Effect of dilutive securities—Common stock options		—			173		—
Diluted income per share		$	36		5,659		$	0.01

 

		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

 

Reconciliations between the numerator and the denominator of the basic and diluted earnings per share computations for the nine months ended December 31, 2013 and 2012 are as follows:

 

		Nine Months Ended December 31, 2013
		Net Income			Shares		Per Share
		(Numerator)			(Denominator)		Amount
		(in thousands)
Basic income per share		$	172		5,475		$	0.03
Effect of dilutive securities—Common stock options		—			181		—
Diluted income per share		$	172		5,656		$	0.03

 

		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

 

Diluted earnings per share does not include the impact of common stock options totaling 680,142 and 732,032 for the three months ended December 31, 2013 and 2012, respectively, and 725,142 and 198,000 for the nine months ended December 31, 2013 and 2012, 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

 

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.

 

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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 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.

 

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Results of Operations

 

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

 

		Three Months Ended						Nine Months Ended
		December 31, 2013			December 31, 2012			December 31, 2013			December 31, 2012
Net sales		$	7,438		$	7,242		$	21,646		$	20,684
Net sales increase		2.7		%				4.7		%
Gross profit		$	3,145		$	2,865		$	8,990		$	8,251
Gross profit as % of net sales		42.3		%	39.6		%	41.5		%	39.9		%
Operating expenses		$	2,823		$	2,232		$	8,136		$	6,549
Operating expenses as % of net sales		38.0		%	30.8		%	37.6		%	31.7		%
Operating income		$	322		$	633		$	854		$	1,702
Operating income as % of net sales		4.3		%	8.7		%	3.9		%	8.2		%
Income tax expense		$	257		$	12		$	592		$	32
Net income		$	36		$	607		$	172		$	1,576
Net sales by product
Bulk sales
Spirulina bulk		$	778		$	755		$	2,642		$	2,646
Spirulina bulk sales increase (decrease)		3.0		%				(0.2		)%
Astaxanthin bulk		$	2,360		$	3,345		$	6,499		$	9,261
Astaxanthin bulk sales (decrease)		(29.4		)%				(29.8		)%
Total Bulk sales		$	3,138		$	4,100		$	9,141		$	11,907
Total Bulk sales (decrease)		(23.5		)%				(23.2		)%
Packaged sales
Spirulina packaged		$	1,201		$	1,218		$	4,120		$	3,622
Spirulina packaged sales (decrease) increase		(1.4		)%				13.8		%
Astaxanthin packaged		$	3,099		$	1,924		$	8,385		$	5,155
Astaxanthin packaged sales increase		61.1		%				62.7		%
Total Packaged sales		$	4,300		$	3,142		$	12,505		$	8,777
Total Packaged sales increase		36.9		%				42.5		%

 

Comparison of the Three Months Ended December 31, 2013 and 2012

 

Net Sales  The net sales growth of 3% for the quarter was driven by a 37% increase in our packaged products consistent with our increased sales and marketing efforts in the consumer packaged goods side of our business.  Within this growth, sales of packaged spirulina decreased 1% and sales of packaged astaxanthin increased 61%.  Sales of our bulk products decreased 24%, comprised of a 3% increase in sales of bulk spirulina offset by a 29% decrease in sales of bulk astaxanthin.  The decrease in bulk astaxanthin sales is a result of the lower production, discussed below under “Gross Profit”, as well as higher demand for our packaged products.  International sales represented 40% of net sales for the three months ended December 31, 2013 compared to 38% 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, 2013 and 2012.

 

Gross Profit  Our gross profit percent of net sales increased by 2.7 points in the current quarter. This improvement was the result of improved spirulina production.  During the same quarter last year, we experienced abnormal production costs of $161,000 whereas in the current quarter there were none.  Offsetting this improvement is an increase in the cost of our astaxanthin product driven by lower production that is the result of environmental factors that have affected the quantity, but not the quality, of our output during the third quarter. We continue to adjust the culture parameters to increase production rates; however, lower production rates could persist through the fourth quarter of this fiscal year.  As a result, of the lower astaxanthin production, we expensed non inventoriable fixed costs of $44,000 this quarter.

 

Operating Expenses  Operating expenses increased by $591,000 for the third quarter compared to the same period in last year.  Included in this is an increase in General and Administrative expenses of $510,000, or 43%, due to increases in legal costs, salary and benefit costs and other general expenses.  Legal costs incurred in the third quarter are substantially attributable to two legal proceedings(1) involving the Company’s position that a nineteen year old patent due to expire on October 27, 2014 (the “Patent”) owned by the Board of Trustees of the University of Illinois (“Patent Owner”) is invalid.  The Patent Owner has alleged that the Company has infringed on the Patent Owner’s Patent rights.  In the event that any Claim within the Patent is determined to be valid, it is our further position that any such valid Claim is of no application to our manufacturing, marketing or sales of our astaxanthin products, and, therefore, the Patent has not been infringed by us.  Increased legal costs are likely to continue until both proceedings are concluded or otherwise resolved.

 

(1)  (a) Complaint by U.S. Nutraceuticals LLC and Board of Trustees of the University of Illinois v. Cyanotech Corporation and Nutrex Hawaii, Inc., filed June 29, 2012 in the U.S. District Court for the Middle District of  Florida, Case No. 5:12-cv-366, the public files for which are available at www.pacer.gov by referencing the Middle District of Florida and the specific Case No. indicated herein, although access is subject to government charges for such access.  (b) Petitions by Cyanotech Corporation v. The Board of Trustees of the University of Illinois, filed June 28 and 29, 2013 before the Patent Trial and Appeal Board of the U.S. Patent and Trademark Office, the public files for which are available at https://ptabtrials.uspto.gov/ by entering “5527553” in the block for “Patent Number” and then clicking “Search.”

 

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Research and Development expenses increased $56,000, or 108%, due to increases in costs associated with clinical trials and scientific research.

 

Income Taxes  We recorded income tax expense of $257,000 in the current quarter compared to $12,000 for the same period last year.  Our effective tax rate was 87.7% for the current quarter and 2.0% for the same period last year.  The effective tax rate in the current year differs from the statutory rate of 34% as a result of state taxes (net of federal benefit) and permanent differences, primarily employee stock option expenses that are not deductible for tax purposes.

 

Comparison of the Nine Months Ended December 31, 2013 and 2012

 

Net Sales  The net sales growth of 5% for the first nine months of this year was driven by a 43% increase in our packaged products consistent with our increased sales and marketing efforts in the consumer packaged goods side of our business.  Within this growth, sales of packaged spirulina increased 14% and sales of packaged astaxanthin increased 63%.  Sales of our bulk products decreased 23%, comprised of a 0.2% decrease in sales of bulk spirulina and a 30% decrease in sales of bulk astaxanthin.  The decrease in bulk astaxanthin sales is a result of the lower production, discussed below under “Gross Profit”,along with higher demand for our packaged products.  International sales represented 40% of net sales for the nine months ended December 31, 2013 compared to 36% 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, 2013 and 2012.

 

Gross Profit  Our gross profit percent of net sales increased by 1.6 points in the first nine months of this year.  Gross profit improved compared to the prior year due to improved spirulina production.  During the same period last year, we experienced abnormal production costs of $875,000 whereas in same period this year there were none.  Offsetting this improvement is an increase in the cost of our astaxanthin product driven by lower production that is the result of environmental factors that have affected the quantity, but not the quality, of our output during the second quarter. We continue to adjust the culture parameters to increase production rates; however, lower production rates could persist through the fourth quarter of this fiscal year.  As a result, of the lower astaxanthin production, we expensed non inventoriable fixed costs of $44,000 this quarter.

 

Operating Expenses  Operating expenses increased by $1,587,000 for the nine months ended December 31, 2013, compared to the same period last year.  Included in this is an increase in General and administrative expenses of $894,000, or 25%, due to increases in legal costs (see explanation under “Comparison of the Three Months Ended December 31, 2013 and 2012” above), salary and benefit costs and other general expenses.  Sales and Marketing expenses increased $473,000, or 17%, due to an increase in brand development costs, advertising programs for our packaged products and added management level staffing.  Research and Development expenses increased $211,000, or 115%, due to increases in costs associated with clinical trials and scientific research.

 

Income Taxes  We recorded income tax expense of $592,000 for the first nine months of this year compared to $32,000 for the same period last year.  Our effective tax rate was 77.5% for the first nine months compared to 2.1% for the same period last year.  The effective tax rate in the current year differs from the statutory rate of 34% as a result of state taxes (net of federal benefit) and permanent differences, primarily employee stock option expenses that are not deductible for tax purposes.

 

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 periods indicated ($ in thousands):

 

		Nine months ended December 31
		2013			2012
Total cash (used in) provided by:
Operating activities		$	42		$	692
Investing activities		(1,853		)	(3,573		)
Financing activities		(43		)	1,429
Decrease in cash and cash equivalents		$	(1,854	)	$	(1,452	)

 

Cash provided by operating activities decreased $650,000 compared to the same period last year due primarily to lower net income and an increase in inventory of $1,539,000 compared to a decrease of $60,000 last year. This increase is a function of increased levels of inventory in packaged products to support the higher sales in this area.

 

Cash used in investing activities in the current period includes the use of $1,509,000 in restricted cash received last year from loan proceeds that can only be used to acquire certain new processing equipment and leasehold improvements.  In addition, we expended $3,362,000 on leasehold improvements and equipment acquisitions at our Kona facility compared to $3,292,000 during the same period last year.

 

Cash provided by 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 primarily due to proceeds of $2,281,000 received under our Term Loan Agreement dated August 14, 2012.

 

Sources and Uses of Capital

 

At December 31, 2013, our working capital was $9,248,000 and is slightly below March 31, 2013. Cash and cash equivalents at December 31, 2013 totaled $2,510,000, a decrease of $1,854,000 compared to March 31, 2013.

 

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.  As of December 31, 2013 we have $1,851,000 in restricted cash set aside for capital projects currently in progress.

 

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 2014 to be generated from operating cash flows.

 

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Outlook

 

This outlook section contains a number of forward-looking statements, all of which are based on current expectations. Actual results may differ materially.

 

Our strategic direction has been to position the Company as a world leader in the production and marketing of high-value natural products from microalgae. We are vertically aligned, producing raw materials in the form of microalgae processed at our 90-acre facility in Hawaii, and integrating those raw materials into finished products. In fiscal 2014, our primary focus has been to put a scalable foundation in place, improving our processes, systems, facilities and organization. We will continue putting increased emphasis on our Nutrex Hawaii consumer products to introduce them to a broader consumer market than in prior years. Our focus going forward will continue to be to leverage our experience and reputation for quality, building nutritional brands which promote health and well-being. The foundation of our nutritional products is naturally cultivated Hawaiian Spirulina Pacifica® in powder and tablet form; and BioAstin® Hawaiian Astaxanthin™ antioxidant in extract, softgel caplet and micro-encapsulated beadlet form.  Information about our Company and our products can be viewed at www.cyanotech.com and www.nutrex-hawaii.com. Consumer products can also be purchased online at www.nutrex-hawaii.com.

 

We are focused on sustainability of production levels in order to promote growth in our astaxanthin and spirulina product lines. We will continue to improve and expand this line to meet the demand of consumers. We will continue to promote the nutritional superiority of Hawaiian grown spirulinaand astaxanthin to maintain and expand market share. Significant sales variability between periods and even across several periods can be expected based on historical results.

 

Rising crude oil prices in prior years resulted in increased nutrient, utility and transportation costs which reflect and respond to oil prices. We feel that these conditions are likely to continue and/or reoccur from time to time in the future, and consequently, we are putting greater focus on prudent cost controls and expense avoidance.

 

Gross profit margin percentages going forward will be impacted by production volumes and continued pressure on input costs and greater competition in the market place. This could cause margins to decline in future periods. We will continue to focus on higher margin consumer products that promote health and well-being, We are dedicated to continuous improvements in process and production methods to stabilize and increase production levels for the future.

 

Producing the highest quality microalgae is a complex biological process which requires balancing numerous factors including microalgal strain variation, temperature, acidity, nutrient and other environmental considerations, some of which are not within our control. An imbalance or unexpected event can occur resulting in production levels below normal capacity. The allocation of fixed production overheads (such as depreciation, rent and general insurance) to inventories is determined based on normal production capacity. When our production volumes are below normal capacity limits, certain fixed production overhead costs cannot be inventoried and are recorded immediately in cost of sales. In addition, when production costs exceed historical averages, we evaluate whether such costs are one-time-period charges or an ongoing component of inventory cost.

 

To manage our cash resources effectively, we will continue to balance production in light of sales demand, minimizing the cost associated with build-ups in inventory when appropriate. We could experience unplanned cash outflows and may need to utilize other cash resources to meet working capital needs. A prolonged downturn in sales could impair our ability to generate sufficient cash for operations and minimize our ability to attract additional capital investment which could become necessary in order to expand facilities, enter into new markets or maintain optimal production levels.

 

Our future results of operations and the other forward-looking statements contained in this Outlook, in particular the statements regarding revenues, gross margin and capital spending, involve a number of risks and uncertainties. In addition to the factors discussed above, any of the following could cause actual results to differ materially: business conditions and growth in the natural products industry and in the general economy; changes in customer order patterns; changes in demand for natural products in general; changes in weather conditions; competitive factors, such as increased production capacity from competing spirulina and astaxanthin producers and the resulting impact, if any, on world market prices for these products; government actions and increased regulations both domestic and foreign; shortage of manufacturing capacity; and other factors beyond our control. Risk factors are discussed in detail in Item 1A in our Form 10-K report for the year ended March 31, 2013.

 

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. However, previously experienced imbalances in the highly complex biological production systems, together with volatile energy costs and rapidly changing world markets, suggest a need for continuing caution with respect to variables beyond our reasonable control. Therefore, we cannot, and do not attempt to, provide any definitive assurance with regard to our technology, systems, processes, location, or cost-effectiveness.

 

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Item 3.   Quantitative and Qualitative Disclosures about Market Risk

 

We do not enter into any transactions using derivative financial instruments or derivative commodity instruments and believe that our exposure to market risk associated with other financial instruments is not material.

 

Item 4.   Controls and Procedures

 

(a) Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15 (d)-15(e) under the Exchange Act that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Security and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure.  Our management, with the participation of the Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the fiscal period covered by this Quarterly Report on Form 10-Q.  Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of such date, our disclosure controls and procedures were effective to meet the objective for which they were designed and operate at the reasonable assurance level.

 

This Form 10-Q should be read in conjunction with Item 9A “Controls and Procedures” of the Company’s Form 10-K for the fiscal year ended March 31, 2013, filed June 24, 2013.

 

(b) Changes to Internal Control Over Financial Reporting

 

There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarterly period ended December 31, 2013 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

PART II.               OTHER INFORMATION

 

Item 1.   Legal Proceedings

 

We are subject to legal proceedings and claims from time to time in the ordinary course of business.  Although we cannot predict with certainty the ultimate resolution of legal proceedings and claims asserted against us, we do not believe that any currently pending legal proceeding to which we are a party is likely to have a material adverse effect on our business, results of operations, cash flows or financial condition. Fees and costs attributable to pending legal proceedings nonetheless impact operating expenses as a component of General and Administrative expense (see expanded explanation under “Comparison of the Three Months Ended December 31, 2013 and 2012” on page 15 above.)

 

Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds

 

None.

 

Item 3.   Defaults upon Senior Securities

 

None.

 

Item 5.   Other Information

 

None.

 

Item 6. Exhibits

 

a)    The following exhibits are furnished with this report:

 

31.1                        Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 signed as of February 6, 2014.

 

31.2                        Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 signed as of February 6, 2014.

 

32                                  Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed as of February 6, 2014.

 

101                           The following financial statements from Cyanotech Corporation’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2013, formatted in XBRL (eXtensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Operations, (iii) the Condensed Consolidated Statements of Cash Flows, and (iv) Notes to Condensed Consolidated Financial Statements

 

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