CYANOTECH CORP - Quarter Report: 2016 December (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

For Quarterly Period Ended December 31, 2016

Or

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 ☒  No ☐

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 ☒  No ☐

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 ☐  No ☒

Number of common shares outstanding as of February 7, 2017:

CYANOTECH CORPORATION

FORM 10-Q

INDEX

PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements (Unaudited)

CYANOTECH CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands except per share amounts)

(Unaudited)

See Accompanying Notes to Condensed Consolidated Financial Statements.

CYANOTECH CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

See Accompanying Notes to Condensed Consolidated Financial Statements.

CYANOTECH CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

See Accompanying Notes to Condensed Consolidated Financial Statements.

CYANOTECH CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2016

(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 results of operations for the interim periods are not necessarily indicative of the results to be expected for the full fiscal year. The Condensed Consolidated Balance Sheet as of March 31, 2016 was derived from the audited consolidated financial statements. These condensed consolidated financial statements and notes should be read in conjunction with the Company’s audited consolidated financial statements for the year ended March 31, 2016, contained in the Company’s annual report on Form 10-K as filed with the SEC on June 23, 2016.

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 any 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 December 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-20 “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers” (“ASU No. 2016-20”) and ASU 2016-19 “Technical Corrections and Improvements” ("2016-19") which contains amendments that affect a wide variety of topics in the Accounting Standards Codification (“ASC”). The amendments generally fall into one of the following four categories: (a) Amendments related to differences between original guidance and the ASC that either carry forward pre-codification guidance or subsequent amendments into the SAC or to guidance that was codified without some text, reference, or phrasing that, upon review, was deemed important to the guidance; (b) Guidance clarification and reference corrections; (c) Simplification; and (d) Minor improvements. The Company does not expect that the adoption of this guidance will have a significant impact on its consolidated financial position, results of operations or cash flows.

In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash” (“ASU No. 2016-18”).  This update addresses the fact that diversity exists in the classification and presentation of changes in restricted cash on the statement of cash flows under Topic 230, Statement of Cash Flows. ASU 2016-18 will take effect for public companies for the fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company does not anticipate that this guidance will have a material impact on its consolidated financial statements and related disclosures.

In August 2016, FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments” (“ASU No. 2016-15”). This ASU clarifies and provides specific guidance on eight cash flow classification issues that are not currently addressed by current GAAP and thereby reduces the current diversity in practice. ASU No. 2016-15 is effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2017, with early application permitted. This guidance is applicable to the Company's fiscal year beginning March 1, 2018. The Company does not anticipate that this guidance will have a material impact on its consolidated financial statements and related disclosures.

In March 2016, the FASB issued ASU 2016-09, “Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“ASU No. 2016-09”). This ASU makes several modifications to Topic 718 related to the accounting for forfeitures, employer tax withholding on share-based compensation, and the financial statement presentation of excess tax benefits or deficiencies. ASU No. 2016-09 also clarifies the statement of cash flows presentation for certain components of share-based awards. The standard is effective for interim periods beginning after December 15, 2016, with early adoption permitted. The Company expects to adopt this guidance on April 1, 2017. The Company does not anticipate that this guidance will have a material impact on its consolidated financial statements and related disclosures. 

In March 2016, the FASB issued ASU No. 2016-08, “Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)” (“ASU No. 2016-08”), which clarified the revenue recognition implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU No. 2016-10, “Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing”, which clarified the revenue recognition guidance regarding the identification of performance obligations and the licensing implementation. In May 2016, the FASB issued ASU No. 2016-12, “Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients”, which narrowly amended the revenue recognition guidance regarding collectability, noncash consideration, presentation of sales tax and transition. ASU No. 2016-08, ASU No. 2016-10 and ASU No. 2016-12 are effective during the same period as ASU No. 2014-09, Revenue from Contracts with Customers, which is effective for annual reporting period beginning after December 15, 2017, with the option to adopt one year earlier. The Company does not anticipate that the adoption of ASU No. 2016-08, ASU No. 2016-10 and ASU No. 2016-12 will have a material impact on its consolidated financial statements and related disclosures. 

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)” (“ASU No. 2016-02”). The principle objective of ASU No. 2016-02 is to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet. ASU No. 2016-02 continues to retain a distinction between finance and operating leases but requires lessees to recognize a right-of-use asset representing its right to use the underlying asset for the lease term and a corresponding lease liability on the balance sheet for all leases with terms greater than twelve months. ASU No. 2016-02 is effective for fiscal years and interim periods beginning after December 15, 2018. Early adoption of ASU No. 2016-02 is permitted. Entities are required to apply the amendments at the beginning of the earliest period presented using a modified retrospective approach. The Company expects this guidance will have a material impact on the Company’s consolidated balance sheets due to the recognition of lease rights and obligations as assets and liabilities. The Company does not expect this guidance to have a material effect on the Company’s consolidated results of operations and cash flows.

In November 2015, the FASB issued ASU No. 2015-17, “Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes”. This guidance simplifies the presentation of deferred income taxes and requires that deferred tax assets and liabilities be classified as noncurrent in the classified statement of financial position. This guidance is effective for the Company as of March 31, 2018 and is not expected to have a material impact on the consolidated financial statements as the guidance only changes the classification of deferred income taxes.

In August 2015, the FASB issued ASU 2015-14, “Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date”, which defers the effective date of ASU 2014-09 by one year to December 15, 2017 for interim and annual reporting periods beginning after that date, and permitted early adoption of the standard, but not before the original effective date. The Company expects to adopt this guidance when effective and is currently evaluating the effect that the updated standard will have on its consolidated financial statements and related disclosures.

In July 2015, the FASB issued ASU No. 2015-11, “Inventory: Simplifying the Measurement of Inventory”, that requires inventory not measured using either the last in, first out (LIFO) or the retail inventory method to be measured at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable cost of completion, disposal, and transportation. The new standard will be effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years, and will be applied prospectively. Early adoption is permitted. The Company does not anticipate that this guidance will have a material impact on its consolidated financial statements and related disclosures.

In April 2015, the FASB issued ASU No. 2015-03, “Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs”, which requires debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the debt liability rather than as an asset. ASU 2015-03 is effective for fiscal years beginning after December 15, 2015. The Company adopted this standard on a retroactive basis on June 30, 2016 and prior period amounts have been reclassified to conform to the current period presentation. As of December 31, 2016 and March 31, 2016, net debt issuance costs of $276,000 and $304,000, respectively, were reclassified in the Condensed Consolidated Balance Sheet from non-current other assets to non-current portion of long-term debt.

Other recently issued accounting pronouncements did not or are not believed by management to have a material impact on the Company’s present or future financial statements.

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:

(1)   Net of reserve for obsolescence of $8,000 at both December 31, 2016 and March 31, 2016.

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 $148,000 and $221,000 were charged to cost of sales for the three and nine months ended December 31, 2016, respectively. $21,000 of non-inventoriable fixed costs were charged to cost of sales for the three months ended December 31, 2015. $395,000 of extraction operations start-up costs and $149,000 of non-inventoriable fixed costs were charged to cost of sales for the nine months ended December 31, 2015.

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 and leasehold improvements consist of the following:

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, 2016

The Company has no capitalized interest for the nine months ended December 31, 2016. $35,000 and $172,000 of interest was capitalized for the three and nine month period ended December 31, 2015, respectively.

On August 30, 2016, the Revolving Credit Agreement (the “Credit Agreement”), which the Company and First Foundation Bank (“the Bank”) entered into on June 3, 2016, became effective after the Company and the Bank received the necessary approvals from the State of Hawaii to secure the lien on the Company’s leasehold property in Kona. The Credit Agreement allows the Company to borrow up to $2,000,000 on a revolving basis. Borrowings under the Credit Agreement bear interest at the Wall Street Journal prime rate + 2%, floating. The Credit Agreement’s initial term expires on August 30, 2017, and the term may be extended at the Bank’s sole discretion. The Credit Agreement includes various covenants as defined in the Credit Agreement. The Credit Agreement also contains standard acceleration provisions in the event of a default by the Company. Proceeds from the revolving line were used to repay a $600,000 short-term loan from First Foundation Bank. At December 31, 2016, the Company had borrowed $611,000 under the Credit Agreement and had $1,389,000 available on the line.

The Credit Agreement grants the Bank the following security interests in the Company’s property: (a) a lien on the Company’s leasehold interest in its Kona facility; (b) an assignment of the Company’s interest in leases and rents on its Kona facility; and (c) a security interest in all fixtures, furnishings and equipment related to or used by the Company at the Kona facility. Each security interest is further subject to the terms of the Credit Agreement.

Accrued expenses consist of the following:

Long-term debt consists of the following:

Term Loans

The Company executed a loan agreement with a lender providing for $2,500,000 in aggregate credit facilities (the “2015 Loan”) secured by substantially all the Company’s assets, pursuant to a Term Loan Agreement dated July 30, 2015 (the “2015 Loan Agreement”). The 2015 Loan Agreement is evidenced by a promissory note in the amount of $2,500,000, the repayment of which is partially guaranteed under the provisions of a United States Department of Agriculture (“USDA”) Rural Development Guarantee program. The proceeds of the 2015 Loan were used to pay off a $500,000 short term note payable that matured on September 18, 2015, and to acquire new processing equipment and leasehold improvements at the Company’s Kona, Hawaii facility.

The provisions of the 2015 Loan Agreement require the payment of principal and interest until its maturity on September 1, 2022, the obligation fully amortizes over seven (7) years. Interest on the 2015 Loan accrues on the outstanding principal balance at an annual variable rate equal to the published Wall Street Journal prime rate (3.75% at December 31, 2016) plus 2.0% 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 6.00%. The 2015 Loan has a prepayment penalty of 5% for any prepayment made prior to the first anniversary of the date of the 2015 Loan Agreement. The 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 the 2015 Loan was $2,127,000 and $2,354,000 at December 31, 2016 and March 31, 2016, respectively.

The 2015 Loan includes a one-time origination and guaranty fee totaling $113,900 and an annual renewal fee payable in the amount of 0.50% of the USDA guaranteed portion of the outstanding principal balance as of December 31 of each year, beginning December 31, 2015. The amount of unamortized debt issuance cost was $88,000 and $102,000 as December 31, 2016 and March 31, 2016, respectively. The USDA has guaranteed 80% of all amounts owing under the 2015 Loan. The Company is subject to financial covenants and customary affirmative and negative covenants.

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, including a mortgage on the Company's interest in its lease at the National Energy Laboratory of Hawaii Authority, 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 USDA Rural Development Guarantee. The proceeds of the Loan have been used to acquire new processing equipment and leasehold improvements at the Company’s Kona, Hawaii facility.

The provisions of the Loan Agreement required 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 (3.75% at December 31, 2016) 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. The 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 $4,904,000 and $5,049,000 at December 31, 2016 and March 31, 2016, respectively. Proceeds from the Loan were classified as restricted cash until drawn upon to acquire new processing equipment and leasehold improvements.

The Loan Agreement included 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 amount of unamortized debt issuance cost was $188,000 and $202,000 at December 31, 2016 and March 31, 2016, respectively. 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.

Capital Leases

The Company has four capital leases providing for $364,000 in equipment, secured by the equipment financed. The capital leases mature at various dates between March 2018 and March 2021 and are payable in 60 equal monthly payments, except for one which is payable in 36 equal monthly payments. The interest rates under these capital leases range from 4.18% to 12.90%. The balance under these leases was $259,000 and $261,000 at December 31, 2016 and March 31, 2016, respectively.

Future principal payments under the term loans and capital lease agreements as of December 31, 2016 are as follows:

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, 2016.

Future minimum lease payments under all non-cancelable operating leases at December 31, 2016 are as follows:

On May 24, 2016, one of our shareholders, Meridian OHC Partners, LP, initiated an action in the United States District Court, District of Nevada, entitled Meridian OHC Partners, LP vs. Cyanotech Corporation, Michael Davis and Rudolf Steiner Foundation (RSF), Inc.

On August 26, 2016, the Company moved to dismiss Meridian’s initial complaint on the ground that Meridian lacked standing to proceed derivatively on behalf of the Company. In response, on September 19, 2016, Meridian filed an amended complaint. On November 4, 2016, the Company filed a motion to dismiss the amended complaint, again arguing that Meridian lacks standing to proceed derivatively on behalf of the Company. On January 23, 2017, the court granted the Company’s motion to dismiss, but granted Meridian a 20-day period to file a second amended complaint. The first amended complaint (which has been dismissed) made certain derivative claims on behalf of the Company, direct claims on behalf of Meridian, and alleged, among other things, (i) that there were deficiencies in the beneficial ownership reports of Mr. Davis, the Chairman of our Board of Directors, and RSF, a shareholder of the Company, including that Mr. Davis and RSF are an undisclosed group with respect to their shares of Company Common Stock, and (ii) that Mr. Davis has breached fiduciary duties to the Company. Meridian sought, among other things, declaratory and injunctive relief to reform this conduct.

As previously disclosed, the Board of Directors of the Company formed a Special Committee comprised of independent directors to investigate, review and analyze the Meridian allegations and provide its recommendations to the Board. The Special Committee completed its investigation and presented its findings and recommendations to the Board on September 2, 2016. The special committee concluded, among other things, that (i) Mr. Davis should be filing his reports pursuant to Section 13 of the Exchange act (“Section 13”) on schedule 13D rather than on the short form schedule 13G; (ii) it has not found sufficient information to conclude that a “group” exists under Section 13; and (iii) it has not found any material corporate governance issues. The Special Committee recommended that the Board take no legal action in response to Meridian’s allegations. The Board unanimously approved the findings and adopted the recommendations of the Special Committee. Additional details regarding the Special Committee’s findings and recommendations are set forth in the Company’s Form 8-K filed with the SEC on September 9, 2016.

On March 31, 2016, the Company entered into a Separation Agreement and Release of Claims (the “Separation Agreement”), pursuant to which Brent Bailey, now-former CEO, resigned from the Company effective as of the date of the Separation Agreement. Under the Separation Agreement, Mr. Bailey was eligible to receive (i) an aggregate of $325,000 in separation payments, payable monthly through the end of April 2017, and (ii) up to 155,000 shares of the Company’s Common Stock, to be granted in two tranches. On April 29, 2016, the Company issued 48,467 shares of its Common Stock to Mr. Bailey in accordance with the Separation Agreement. On October 19, 2016 (the “Notification Date”), the Board notified Brent Bailey that, as a result of Mr. Baileys material breach of certain provisions of the Separation Agreement and his Employment Letter Agreement, dated November 5, 2010, the Board has exercised its right to terminate all future severance payments, healthcare benefits and share grants that would otherwise be payable to Mr. Bailey under the Separation Agreement, effective as of the Notification Date. In connection with the Separation and Release of Claims, the Company accrued separation expenses of $184,000 as of December 31, 2016. By letter dated October 27, 2016, Mr. Bailey informed the Company that he disputes the Company’s termination of his benefits. He has initiated the mediation procedures set forth in the Separation Agreement, and the mediation is tentatively scheduled for April 2017.

From time to time, the Company may be involved in other litigation and investigations relating to claims and matters arising out of its operations in the normal course of business. The Company believes that it currently is not a party to any legal proceedings which, individually or in aggregate, would have a material effect on its consolidated financial position, results of operations or cash flows.

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.

As of December 31, 2016, the Company had two equity-based compensation plans: the 2016 Cyanotech Equity Incentive Plan (the “2016 Plan”) and the 2014 Independent Director Stock Option and Restricted Stock Grant Plan (the “2014 Directors Plan”). The Company has also issued stock options, which remain outstanding as of December 31, 2016, under two equity-based compensation plans which have expired according to their terms: the 2005 Stock Option Plan (the “2005 Plan”) and the 2004 Independent Director Stock Option and Stock Grant Plan (the “2004 Directors Plan”). These plans allowed the Company to award stock options and shares of restricted common stock to eligible employees, certain outside consultants and independent directors.

On August 25, 2016, the Company’s shareholders approved the 2016 Plan as a successor to the 2005 Plan, authorizing the Board of Directors to provide incentive to the Company’s officers, employees and certain independent consultants through equity based compensation in the form of stock options, restricted stock, restricted stock units, stock appreciation rights and other stock based awards (together, “Stock Awards”) and performance shares and performance units (together, “Performance Awards”). Awards under the 2016 Plan are limited to the authorized amount of 1,300,000 shares, up to 600,000 of which are available for issuance in connection with Performance Awards and Stock Awards. As of December 31, 2016, there were 1,300,000 shares available for grant under the 2016 Plan.

On August 28, 2014, the Company’s shareholders approved the 2014 Directors Plan authorizing the Board of Directors to provide incentive to the Company’s independent directors through equity based compensation in the form of stock options and restricted stock. Awards under the 2014 Directors Plan are limited to the authorized amount of 350,000 shares. As of December 31, 2016, there were 289,124 shares available for grant under the 2014 Directors Plan.

The 2005 Plan and the 2004 Directors Plan have expired, and therefore no additional awards will be issued under those plans. 

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

All stock option grants made under equity-based compensation plans were issued at exercise prices no less than the Company’s closing stock price on the date of grant. Options under the 2005 Plan and 2014 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. Compensation expense recognized for options issued under all Plans was $1,500 and $138,000 for the three and nine months ended December 31, 2016, respectively. Compensation expense recognized for options issued under all Plans was $167,000 and $491,000 for the three and nine months ended December 31, 2015, respectively. Compensation expense recognized for restricted stock issued under the 2014 Directors Plan was $78,000 for the three and nine months ended December 31, 2016. Compensation expense recognized for restricted stock issued under the 2014 Directors Plan was $78,000 for the three and nine months ended December 31, 2015. All share-based compensation has been classified as general and administrative expense in the Condensed Consolidated Statement of Operations.

A summary of option activity under the Company’s stock plans for the nine months ended December 31, 2016 is presented below:

The aggregate intrinsic value 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 $4.30 for such day.  

A summary of the Company’s non-vested options for the nine months ended December 31, 2016 is presented below:

The following table summarizes the weighted average characteristics of outstanding stock options as of December 31, 2016:

The range of fair value assumptions related to options granted during the nine months ended December 31, 2016 were as follows:

As of December 31, 2016, total unrecognized stock-based compensation expense related to all unvested stock options was $40,000, which is expected to be expensed over a weighted average period of 0.7 years. 

We utilize our estimated annual effective tax rate to determine our provision (benefit) for income taxes for interim periods. The income tax provision (benefit) is computed by multiplying the estimated annual effective tax rate by the year to date pre-tax book income (loss). We recorded an income tax expense of $27,000 and $457,000 for the three months ended December 31, 2016 and 2015, respectively. We recorded an income tax expense of $3,000 and $139,000 for the nine months ended December 30, 2016 and 2015, respectively. Our effective tax rate was (8.4%) and (0.3%) for the three and nine months ended December 31, 2016, respectively, and 220.8% and (68.8%) for the three and nine months ended December 31, 2015, respectively. The effective tax rate for the three and nine months ended December 30, 2016 differ from the statutory rate of 34% as a result of state taxes (net of federal benefit) and the net change in valuation allowance against the net deferred tax asset the Company believes is not more likely than not to be realized.

 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, 2016, 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.

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 2011.

Basic earnings (loss) per share is computed on the basis of the weighted average number of common shares outstanding. Diluted earnings (loss) 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.

Basic and diluted earnings per share are the same in periods of a net loss, because share equivalents are anti-dilutive when a net loss is recorded. Diluted earnings per share does not include the impact of common stock options totaling 605,000 and 1,414,916 for the three and nine months ended December 31, 2016 and December 31, 2015, respectively, as the effect of their inclusion would be anti-dilutive.

Concentration of Accounts Receivable and Revenues

At December 31, 2016, 54.6% of the Company’s accounts receivable was comprised of two customer balances of 40.9% and 13.7%, respectively. At March 31, 2016, 44.4% of the Company’s accounts receivable was comprised of two customer balances of 30.7% and 13.4%, respectively. Two customers accounted for 36% and 35% of total net sales for the three months ended December 31, 2016 and 2015, respectively, and accounted for 34% and 28% of total net sales for the nine months ended December 31, 2016 and 2015, respectively. International sales represented 23% and 29% of net sales for the three and nine months ended December 31, 2016, respectively, compared to 23% and 26% for the same periods, respectively, a year ago.

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

FORWARD-LOOKING STATEMENTS

This Report and other presentations made by the Company 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 the Company the performance of the industry in which the Company 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:

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:

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 operate under GMP (Good Manufacturing Practices), reinforcing our commitment to quality in our products, quality in our relationships (with our customers, suppliers, employees and the communities we live in), and quality of the environment in which we work. Our products include:

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 commercially produce 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, with tight control of organisms allowed into the area and free of genetically modified organisms (GMO’s). 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

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

Comparison of the Three Months Ended December 31, 2016 and 2015

Net Sales Net sales for the quarter increased 0.9% compared to the same quarter last year, driven by a 4.3% increase in sales of our packaged products and a 15.5% decrease in sales of our bulk products. In our packaged products, astaxanthin sales were up 10% (+$411,000), driven by our Costco expansion and higher demand from international customers. Packaged spirulina sales were down 7% (-$140,000) due to lower volume resulting from a reduction in the level of discounts offered as transition to higher margin channels. In our bulk products, astaxanthin sales were down 41% (-$107,000) as a result of the increased demand in our packaged astaxanthin. Sales of bulk spirulina decreased 9% (-$93,000), due to a decrease in available supply driven by lower production this quarter. International demand for bulk spirulina remains strong. International sales represented 23% of net sales for the three months ended December 31, 2016 compared to 23% for the same period a year ago. Two customers accounted for 36% and 35% of total net sales for the three months ended December 31, 2016 and 2015, respectively.

Gross Profit Gross profit margin for the quarter decreased 3.3 percentage points compared to the same quarter last year, half of which was due to an increase of $127,000 in non-inventoriable costs, related primarily to our spirulina production. The remainder of the decline in gross profit margin relates to higher astaxanthin costs per kilo, driven by the lower production in the first two quarters of this year.

Operating Expenses Operating expenses increased by $242,000 for the quarter compared to the same period last year. Included in this is an increase in sales and marketing expenses of 32% (+$424,000), which includes $121,000 of severance costs related to a restructuring, an increase of $178,000 in the support for our Costco expansion and an increase of $79,000 in other promotional activities. General and administrative expenses decreased 15% (-$193,000), due primarily to compensation costs that included lower stock option and bonus costs ($166,000 and $160,000, respectively) offset by increased severance and holiday pay ($49,000 and $70,000, respectively).

Income Taxes We recorded an income tax expense of $27,000 in the current quarter compared to income tax expense of $457,000 for the same period last year. Our effective tax rate was (8.4%) for the current quarter and 220.8% for the same period last year. We established a 100% valuation allowance against our deferred tax assets in the fourth quarter of fiscal 2016. As a result, there was no adjustment to the deferred tax asset this quarter.

Comparison of the Nine Months Ended December 31, 2016 and 2015

Net Sales For the first nine months of the year, net sales increased 4.8% compared to the same period last year, driven by a 3.2% increase in sales of our packaged products and an 11.8% increase in sales of our bulk products. In our packaged products, astaxanthin sales were up 3.0% (+$418,000), driven by our Costco expansion and higher demand from international customers. Packaged spirulina sales were up 3.7% (+$203,000) due to reduced discounts combined with slightly lower volume. In our bulk products, astaxanthin sales were down 22.3% (-$225,000) as a result of increased demand for packaged astaxanthin. Sales of bulk spirulina increased 21.8% (+$749,000) due to higher pricing combined with increased international demand. International sales represented 29% of net sales for the nine months ended December 31, 2016 compared to 26% for the same period a year ago. Two customers accounted for 34% and 28% of total net sales for the nine months ended December 31, 2016 and 2015, respectively.

Gross Profit Gross profit margin for the first nine months of this year is slightly better than the same period last year. Gross profit was favorably impacted by a $323,000 reduction in non-inventoriable costs, which was offset by the sale of higher cost astaxanthin products produced in prior year. Astaxanthin production increased 8% from the same period in the prior year while spirulina production was down 9% from the same period in the prior year.

Operating Expenses Operating expenses increased by $953,000 for the first nine months of the year compared to the same period last year. Included in this is an increase in general and administrative expenses of 22% (+$866,000), primarily due to an increase in legal costs of $1,338,000 due to matters that arose in the first quarter of this year (see Part II, Item 1, Legal Proceedings). The recent litigation with Meridian has reduced our available cash and has negatively impacted our operations. This increase was offset by a net decrease in compensation costs that included lower stock option and bonus costs of $299,000 and $160,000, respectively, and a $177,000 decrease in accounting and auditing costs. Sales and marketing expenses increased 2% (+$101,000), which includes $169,000 of severance costs, offset by a $97,000 reduction in consulting costs.

 Income Taxes We recorded an income tax expense of $3,000 for the first nine months of this year compared to income tax expense of $139,000 for the same period last year. Our effective tax rate was (0.3%) for the first nine months compared to (68.8%) for the same period last year. We established a 100% valuation allowance against our deferred tax assets in the fourth quarter of fiscal 2016. As a result, there has been no adjustment to the deferred tax asset this year.

Liquidity and Capital Resources

Cash Flows 

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

Cash provided by operating activities decreased $213,000 compared to the same period last year due primarily to a higher net loss and a reduction in outstanding payables, offset by an increase in depreciation and decreases in inventories and receivables. The prior period included a $1.6 million increase in work-in-process inventory as a result of the increase in packaged astaxanthin demand.

Cash used in investing activities in the current period consisted primarily of small equipment purchases, whereas the prior period activity included the completion of our extraction facility and an expansion of our production capacity.

Cash provided by financing activities in the current period includes an advance against our line of credit, offset by payment of principal obligations, whereas the prior period includes the proceeds from a $2.5 million term loan used to fund the expansion of our production capacity.

Sources and Uses of Capital

At December 31, 2016, our working capital was $6.4 million, a decrease of $0.1 million compared to March 31, 2016. Cash and cash equivalents at December 31, 2016 totaled $1.7 million, an increase of $0.4 million compared to March 31, 2016.

On August 30, 2016, the Credit Agreement, which the Company and First Foundation Bank entered into on June 3, 2016, became effective. The Credit Agreement allows the Company to borrow up to $2.0 million on a revolving basis. At December 31, 2016, the Company had borrowed $0.6 million and had $1.4 million available on the line. The line of credit is secured by substantially all the Company’s assets. 

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.

We believe cash flows generated by operating activities and available financing will be sufficient to fund our operations for at least the next twelve months. If necessary, the Company has an available bank line of credit to help meet these requirements. The line is subject to renewal on August 30, 2017 and we intend to renew or replace it with another line of credit on or before the expiration date, subject to approval by our bank.

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 2017, our primary focus is on building our consumer brands, increasing our astaxanthin production volume and improving the consistency of our production for both astaxanthin and spirulina. We will continue to put emphasis on our Nutrex Hawaii consumer products to introduce them to a broader consumer market, and 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 and softgel caplet 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 these lines to meet the demand of consumers. We will continue to promote the nutritional superiority of Hawaiian grown microalgae to maintain and expand market share. Significant sales variability between periods and even across several periods can be expected based on historical results.

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 Part II, Item 1A of this quarterly report and in Part I, Item 1A of our Form 10-K report for the year ended March 31, 2016.

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.

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

Not applicable.

Item 4.  Controls and Procedures

Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our chief executive officer (“CEO”) and chief financial officer (“CFO”), we have evaluated the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15(d)-15(e) of the Exchange Act as of the end of the period covered by this Report. Based on that evaluation, our CEO and CFO have concluded that our disclosure controls and procedures are effective to provide reasonable assurance that information we are required to disclose in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (2) accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosures.

 Management’s Report on Internal Control over Financial Reporting.

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act). The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our management evaluated the effectiveness of our internal control over financial reporting as of December 31, 2016. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in “Internal Control - Integrated Framework” (2013 Framework). Based on that assessment, management concluded that our internal control over financial reporting was effective as of December 31, 2016.

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, 2016 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Limitations on the Effectiveness of Controls.

Our management, including our Chief Executive Officer and Chief Financial Officer, do not expect that our disclosure controls and procedures or our internal controls over financial reporting will prevent all errors and all fraud. A control system no matter how well designed and implemented, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues within a company are detected.

The inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistakes. Controls can also be circumvented by the individual acts of some persons, or by collusion of two or more people. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

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, 2016, filed June 23, 2016.

      PART II.     OTHER INFORMATION

Item 1.     Legal Proceedings

From time to time the Company may become party to lawsuits and claims that arise in the ordinary course of business relating to employment, intellectual property, and other matters. There were no significant legal matters outstanding at December 31, 2016.

On May 24, 2016, one of our shareholders, Meridian OHC Partners, LP, initiated an action in the United States District Court, District of Nevada, entitled Meridian OHC Partners, LP vs. Cyanotech Corporation, Michael Davis and Rudolf Steiner Foundation (RSF), Inc.

On August 26, 2016, the Company moved to dismiss Meridian’s initial complaint on the ground that Meridian lacked standing to proceed derivatively on behalf of the Company. In response, on September 19, 2016, Meridian filed an amended complaint. On November 4, 2016, the Company filed a motion to dismiss the amended complaint, again arguing that Meridian lacks standing to proceed derivatively on behalf of the Company. On January 23, 2017, the court granted the Company’s motion to dismiss, but granted Meridian a 20-day period to file a second amended complaint. The first amended complaint (which has been dismissed) made certain derivative claims on behalf of the Company, direct claims on behalf of Meridian, and alleged, among other things, (i) that there were deficiencies in the beneficial ownership reports of Mr. Davis, the Chairman of our Board of Directors, and RSF, a shareholder of the Company, including that Mr. Davis and RSF are an undisclosed group with respect to their shares of Company Common Stock, and (ii) that Mr. Davis has breached fiduciary duties to the Company. Meridian sought, among other things, declaratory and injunctive relief to reform this conduct. 

As previously disclosed, the Board of Directors of the Company formed a Special Committee comprised of independent directors to investigate, review and analyze the Meridian allegations and provide its recommendations to the Board. The Special Committee completed its investigation and presented its findings and recommendations to the Board on September 2, 2016. The special committee concluded, among other things, that (i) Mr. Davis should be filing his reports pursuant to Section 13 of the Exchange act (“Section 13”) on schedule 13D rather than on the short form schedule 13G; (ii) it has not found sufficient information to conclude that a “group” exists under Section 13; and (iii) it has not found any material corporate governance issues. The Special Committee recommended that the Board take no legal action in response to Meridian’s allegations. The Board unanimously approved the findings and adopted the recommendations of the Special Committee. Additional details regarding the Special Committee’s findings and recommendations are set forth in the Company’s Form 8-K filed with the SEC on September 9, 2016.

On March 31, 2016, the Company entered into a Separation Agreement and Release of Claims (the “Separation Agreement”), pursuant to which Brent Bailey, now-former CEO, resigned from the Company effective as of the date of the Separation Agreement. Under the Separation Agreement, Mr. Bailey was eligible to receive (i) an aggregate of $325,000 in separation payments, payable monthly through the end of April 2017, and (ii) up to 155,000 shares of the Company’s Common Stock, to be granted in two tranches. On April 29, 2016, the Company issued 48,467 shares of its Common Stock to Mr. Bailey in accordance with the Separation Agreement. On October 19, 2016 (the “Notification Date”), the Board notified Brent Bailey that, as a result of Mr. Bailey’s material breach of certain provisions of the Separation Agreement and his Employment Letter Agreement, dated November 5, 2010, the Board has exercised its right to terminate all future severance payments, healthcare benefits and share grants that would otherwise be payable to Mr. Bailey under the Separation Agreement, effective as of the Notification Date. By letter dated October 27, 2016, Mr. Bailey informed the Company that he disputes the Company’s termination of his benefits. He has initiated the mediation procedures set forth in the Separation Agreement, and the mediation is tentatively scheduled for April 2017 before Dispute Resolution & Prevention in Honolulu, Hawaii.

Item 1A.     Risk Factors

For a discussion of the risk factors relating to our business, please refer to Part I, Item 1A of our Form 10-K for the year ended March 31, 2016, and Part II, Item 1A of our Form 10-Q for the quarter ended September 30, 2016, both of which are incorporated by reference herein.

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

None.

Item 3.    Defaults upon Senior Securities

None.

Item 5.    Other Information

On January 18, 2017, Nancy Katz was appointed to the Audit Committee and to the Nominating and Corporate Governance Committee of the Board of Directors. Michael Davis has stepped down from the Audit Committee and Walter Menzel has stepped down from the Nominating and Corporate Governance Committee.

Item 6. Exhibits

a)     The following exhibits are furnished with this report:

SIGNATURES

In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

EXHIBIT INDEX

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