CYANOTECH CORP - Quarter Report: 2019 December (Form 10-Q)

 

 

Table of Contents

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

☒

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

For Quarterly Period Ended December 31, 2019

Or

☐

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)

NEVADA	91-1206026
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification Number)

 

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)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, $0.02 par value per share	CYAN	NASDAQ

 

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 every Interactive Data File required to be submitted 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 such files).  Yes ☒  No ☐ 

 

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

Large accelerated filer ☐		Accelerated filer ☐
Non-accelerated filer ☐		Smaller reporting company ☒
		Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

 

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

 

As of February 6, 2020, the number of shares outstanding of the registrant’s common stock was 5,929,479.

 

 

 

 

		December 31, 2019				March 31, 2019
ASSETS
Current assets:
Cash		$	1,609			$	840
Accounts receivable, net of allowance for doubtful accounts of $13 at December 31, 2019 and $27 at March 31, 2019			1,581				1,982
Inventories, net			11,206				11,274
Prepaid expenses and other current assets			424				496
Total current assets			14,820				14,592
Equipment and leasehold improvements, net			13,474				14,752
Operating lease right-of-use assets, net			3,909				—
Other assets			234				282
Total assets		$	32,437			$	29,626
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	2,700			$	4,922
Accrued expenses			901				992
Customer deposits			409				626
Operating lease obligations, current portion			311				—
Short-term contract obligation			38				285
Line of credit			2,000				2,000
Current maturities of long-term debt			700				663
Total current liabilities			7,059				9,488
Long-term debt, less current maturities			6,172				5,172
Long-term operating lease obligations			3,603				—
Other long-term liabilities			57				57
Total liabilities			16,891				14,717
Commitments and contingencies
Stockholders’ equity:
Preferred stock of $0.01 par value, authorized 10,000,000 shares; no shares issued and outstanding			—				—
Common stock of $0.02 par value, authorized 50,000,000 shares; issued and outstanding 5,925,717 shares at December 31, 2019 and 5,879,710 shares at March 31, 2019			118				117
Additional paid-in capital			32,817				32,447
Accumulated deficit			(17,389	)			(17,655	)
Total stockholders’ equity			15,546				14,909
Total liabilities and stockholders’ equity		$	32,437			$	29,626

 

		Three Months Ended December 31,								Nine Months Ended December 31,
		2019				2018				2019				2018
Net sales		$	7,504			$	10,044			$	23,265			$	24,143
Cost of sales			4,627				5,928				13,650				15,906
Gross profit			2,877				4,116				9,615				8,237
Operating expenses:
General and administrative			958				1,337				4,146				4,190
Sales and marketing			1,406				2,068				4,157				5,088
Research and development			146				216				487				635
Total operating expenses			2,510				3,621				8,790				9,913
Income (loss) from operations			367				495				825				(1,676	)
Interest expense, net			(164	)			(134	)			(530	)			(414	)
Income (loss) before income taxes			203				361				295				(2,090	)
Income tax expense			32				73				29				33
Net income (loss)		$	171			$	288			$	266			$	(2,123	)
Net income (loss) per share:
Basic		$	0.03			$	0.05			$	0.04			$	(0.37	)
Diluted		$	0.03			$	0.05			$	0.04			$	(0.37	)
Shares used in calculation of net income (loss) per share:
Basic			5,957				5,836				5,946				5,809
Diluted			5,962				5,862				5,949				5,809

 

		Common Stock Shares				Common Stock Amount				Additional Paid-in Capital				Accumulated Deficit				Total Stockholders’ Equity
		(in thousands, except per share data)
Balances at September 30, 2019			5,913,421			$	118			$	32,786			$	(17,560	)		$	15,344
Settlement agreement with former executive			12,296				—				—				—				—
Share-based compensation expense			—				—				31				—				31
Net income			—				—				—				171				171
Balances at December 31, 2019			5,925,717			$	118			$	32,817			$	(17,389	)		$	15,546
Balances at September 30, 2018			5,836,110			$	117			$	32,280			$	(16,470	)		$	15,927
Share-based compensation expense			—				—				38				—				38
Net income			—				—				—				288				288
Balances at December 31, 2018			5,836,110			$	117			$	32,318			$	(16,182	)		$	16,253

		Common Stock Shares				Common Stock Amount				Additional Paid-in Capital				Accumulated Deficit				Total Stockholders’ Equity
		(in thousands, except per share data)
Balances at March 31, 2019			5,879,710			$	117			$	32,447			$	(17,655	)		$	14,909
Issuance of common stock for exercise of stock options for cash			2,112				—				4				—				4
Issuance of vested shares of restricted stock			22,502				1				(26	)			—				(25	)
Shares withheld for tax payments			(7,685	)			—				—				—				—
Settlement agreement with former executive			29,078				—				320				—				320
Share-based compensation expense			—				—				72				—				72
Net income			—				—				—				266				266
Balances at December 31, 2019			5,925,717			$	118			$	32,817			$	(17,389	)		$	15,546
Balances at March 31, 2018			5,772,032			$	115			$	32,051			$	(14,059	)		$	18,107
Issuance of common stock for director stock grants			47,223				1				169				—				170
Issuance of common stock for exercise of stock options for cash			6,000				1				18				—				19
Issuance of vested shares of restricted stock			16,003				—				(32	)			—				(32	)
Shares withheld for tax payments			(5,148	)			—				—				—				—
Share-based compensation expense			—				—				112				—				112
Net loss			—				—				—				(2,123	)			(2,123	)
Balances at December 31, 2018			5,836,110			$	117			$	32,318			$	(16,182	)		$	16,253

 

		Nine Months Ended December 31,
		2019				2018
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)		$	266			$	(2,123	)
Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:
Depreciation and amortization			1,458				1,421
Amortization of debt issue costs and other assets			51				57
Amortization of operating leases right-of-use assets			219				—
Share-based compensation expense			392				282
Net (increase) decrease in assets:
Accounts receivable			401				781
Inventories			68				(1,078	)
Prepaid expenses and other assets			93				(84	)
Net increase (decrease) in liabilities:
Accounts payable			(2,222	)			528
Accrued expenses			(91	)			181
Customer deposits			(217	)			39
Operating lease obligations			(214	)			—
Deferred rent and other liabilities			—				(46	)
Net cash provided by (used in) operating activities			204				(42	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in equipment and leasehold improvements			(180	)			(375	)
Cash paid to acquire Cellana assets			—				(100	)
Net cash used in investing activities			(180	)			(475	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on short-term contract obligation			(247	)			(63	)
Net draws on line of credit			—				1,250
Proceeds from long-term debt - related party			1,500				—
Principal payments on long-term debt			(443	)			(429	)
Payments on finance leases			(44	)			(49	)
Shares withheld for tax payments			(25	)			(32	)
Proceeds from exercise of stock options			4				19
Net cash provided by financing activities			745				696
Net increase in cash			769				179
Cash and restricted cash at beginning of period			840				1,394
Cash and restricted cash at end of period		$	1,609			$	1,573
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest		$	499			$	358
Income taxes		$	—			$	17
Non-cash financing activities:
Purchase of Cellana assets		$	—			$	495
Less: Issuance of short-term contract obligation			—				(395	)
Cash paid to acquire Cellana assets		$	—			$	100
RECONCILIATION OF CASH AND RESTRICTED CASH AT BEGINNING OF PERIOD:
Cash		$	840			$	1,329
Restricted cash			—				65
Total cash and restricted cash at beginning of period		$	840			$	1,394

 

1.	ORGANIZATION AND BASIS OF PRESENTATION

 

Cyanotech Corporation (the “Company”), located in Kailua-Kona, Hawaii, was incorporated in the state of Nevada on March 3, 1983 and is listed on the NASDAQ Capital Market under the symbol “CYAN”. The Company is engaged in the production of natural products derived from microalgae for the nutritional supplements market.

 

The Company is an agricultural company that produces high value natural products derived from microalgae grown in complex and intricate open-pond agricultural systems on the Kona coast of Hawaii.  The Company's products include Hawaiian Spirulina Pacifica, a superfood with numerous benefits, including boosting the immune system and overall cellular health; and Hawaiian BioAstin, a powerful antioxidant shown to support and maintain the body's natural inflammatory response.

 

The accompanying unaudited 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, Condensed Consolidated Statements of Stockholders’ Equity 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, 2019 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, 2019, contained in the Company’s annual report on Form 10-K as filed with the SEC on July 1, 2019. 

 

Liquidity and Capital Resources

 

As of December 31, 2019, the Company had cash of $1,609,000 and working capital of $7,761,000 compared to $840,000 and $5,104,000, respectively, at March 31, 2019. In April 2019, the Company obtained an unsecured subordinated loan in the amount of $1,500,000 from a related party (see Notes 6 and 13). On August 30, 2016, the Revolving Credit Agreement (the Credit Agreement), which the Company entered into with First Foundation Bank (the Bank) on June 3, 2016, became effective. The Credit Agreement allows us to borrow up to $2,000,000 on a revolving basis. At December 31, 2019 and March 31, 2019, the Company had outstanding borrowings of $2,000,000 on the line of credit.  The line of credit is subject to renewal on August 30, 2020 and the Company intends to renew or replace it with another line of credit on or before the expiration date.

 

As of December 31, 2019, the Company had $5,410,000 in long-term debt (Term Loans) payable to the Bank that require the payment of principal and interest monthly through August 2032. Pursuant to the Term Loans and the Credit Agreement, the Company is subject to annual financial covenants, customary affirmative and negative covenants and certain subjective acceleration clauses. As of March 31, 2019, the Company’s debt service coverage ratio of -0.66:1 fell short of the Bank's annual requirement of 1.25:1. Additionally, on March 31, 2019, the Company’s current ratio of 1.49:1 fell short of the Bank’s annual requirement of 1.50:1.  On June 17, 2019, the Bank provided the Company with a letter waiving the covenant violations as of March 31, 2019, but noting that the Bank reserved its rights to declare a default in the future if any covenants remain out of compliance at applicable measurement dates.

 

Funds generated by operating activities and available cash are expected to continue to be the Company’s most significant sources of liquidity for working capital requirements, debt service and funding of maintenance levels of capital expenditures. In fiscal year 2020, the Company has undertaken strategic cost cutting, including the elimination of positions through attrition and the elimination of open positions to create a leaner organization. 

 

Based upon the Company’s operating plan and related cash flow and financial projections, cash flows expected to be generated by operating activities and available financing are expected to be sufficient to fund its operations through at least December 31, 2020, and its debt service coverage ratio and current ratio covenants are expected to be in compliance with the annual Term Loans and Credit Agreement covenant requirements as of March 31, 2020, the next measurement date. However, no assurances can be provided that the Company will achieve its operating plan and cash flow projections for the next fiscal years or its projected consolidated financial position as of March 31, 2020. Such estimates are subject to change based on future results and such change could cause future results to vary significantly from expected results.

 

2.	SIGNIFICANT ACCOUNTING POLICIES

 

Consolidation

 

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 intercompany balances and transactions have been eliminated in consolidation.

 

Use of Estimates

 

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.

  

Cash and Restricted Cash

 

Cash primarily consists of cash on hand and cash in bank deposits. Proceeds from equipment loans are classified as restricted cash until drawn upon.  There was no restricted cash as of December 31, 2019 or March 31, 2019.

 

Concentration Risk

 

A significant portion of revenue and accounts receivable are derived from a few major customers. For the three months ended December 31, 2019 and 2018, two customers accounted for 33% and 17%, and 35% and 31%, respectively, of the Company’s net sales. For the nine months ended December 31, 2019 and 2018, two customers accounted for 36% and 17%, and 35% and 27%, respectively, of the Company’s net sales. At December 31, 2019 and March 31, 2019, three customers accounted for 76% and 60%, respectively, of the Company’s accounts receivable balance.

 

Revenue Recognition

 

The Company records revenue based on the five-step model which includes: (1) identifying the contract with the customer; (2) identifying the performance obligations in the contract; (3) determining the transaction price; (4) allocating the transaction price to the performance obligations; and (5) recognizing revenue when the performance obligations are satisfied. Substantially all of the Company’s revenue is generated by fulfilling orders for the purchase of our microalgal nutritional supplements to retailers, wholesalers, or direct to consumers via online channels, with each order considered to be a distinct performance obligation. These orders may be formal purchase orders, verbal phone orders, e-mail orders or orders received online. Shipping and handling activities for which the Company is responsible under the terms and conditions of the order are not accounted for as performance obligations but as fulfillment costs. These activities are required to fulfill the Company’s promise to transfer the goods and are expensed when revenue is recognized. 

 

Revenue is measured as the net amount of consideration expected to be received in exchange for fulfilling a performance obligation. The Company has elected to exclude sales, use and similar taxes from the measurement of the transaction price.  The amount of consideration expected to be received and revenue recognized includes estimates of variable consideration, which includes costs for trade promotion programs, coupons, returns and early payment discounts.  Such estimates are calculated using historical averages adjusted for any expected changes due to current business conditions and experience. The Company reviews and updates these estimates at the end of each reporting period and the impact of any adjustments are recognized in the period the adjustments are identified. In assessing whether collection of consideration from a customer is probable, the Company considers the customer's ability and intent to pay that amount of consideration when it is due. Payment of invoices is due as specified in the underlying customer agreement, typically 30 days from the invoice date, which occurs on the date of transfer of control of the products to the customer. Revenue is recognized at the point in time that control of the ordered products is transferred to the customer. Generally, this occurs when the product is delivered, or in some cases, picked up from one of our distribution centers by the customer. Revenue from extraction services is recognized when control is transferred upon completion of the extraction process.

 

Customer contract liabilities consist of customer deposits received in advance of fulfilling an order and are shown separately on the consolidated balance sheets. During the three month periods ended December 31, 2019 and 2018, the Company recognized $33,000 and $0, respectively, of revenue from deposits that were included in contract liabilities as of March 31, 2019 and 2018, respectively. During the nine month periods ended December 31, 2019 and 2018, the Company recognized $550,000 and $114,000, respectively, of revenue from deposits that were included in contract liabilities as of March 31, 2019 and 2018, respectively. The Company’s contracts have a duration of one year or less and therefore, the Company has elected the practical expedient of not disclosing revenues allocated to partially unsatisfied performance obligations.

 

 

Disaggregation of Revenue

 

The following table represents revenue disaggregated by major product line and extraction services for the:

 

 

 

 

 

Recently Adopted Accounting Pronouncements

 

Effective April 1, 2019, the Company adopted Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842): Accounting for Leases and issued subsequent amendments to the initial guidance and implementation guidance including ASU No. 2018-01, 2018-10, 2018-11, 2018-20 and 2019-01 (collectively including ASU No. 2016-02, “ASC 842”). ASC 842 requires that lessees recognize right-of-use assets and lease liabilities that are measured at the present value of the future lease payments at lease commencement date. The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee will largely remain unchanged and shall continue to depend on its classification as a finance or operating lease. The Company elected the optional transition method that allows for a cumulative-effect adjustment in the period of adoption and did not restate prior periods. Under the new guidance, the majority of the Company’s leases continue to be classified as operating. Based on the Company’s lease portfolio, the impact of adopting ASC 842 increased both total assets and total liabilities, however, it did not have a significant impact on the Company’s consolidated statements of operations or cash flows. Finance leases continue to be classified with long-term debt on the Condensed Consolidated Balance Sheets and are described in Note 6. See Note 7 for operating leases.

 

In June 2018, the FASB issued ASU 2018-07, “Compensation - Stock Compensation (Topic 718)” (“ASU No. 2018-07”): Improvements to Nonemployee Share-Based Payment Accounting. ASU No. 2018-07 expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from non-employees, and as a result, the accounting for share-based payments to non-employees will be substantially aligned. ASU No. 2018-07 is effective for the Company in the first quarter of fiscal year 2020.  The Company adopted ASU No. 2018-07 as of April 1, 2019 with no impact on its consolidated financial statements and related disclosures.

 

 

In May 2017, the Financial Accounting Standards Board ("FASB") issued ASU 2017-09, Compensation-Stock Compensation (Topic 718) Scope of Modification Accounting ("ASU No. 2017-09"). ASU No. 2017-09 will clarify and reduce both (i) diversity in practice and (ii) cost and complexity when applying the guidance in Topic 718, to a change to the terms and conditions of a share-based payment award. This guidance became effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. The amendments in ASU No. 2017-09 are applied prospectively to awards modified on or after the adoption date. The Company adopted this standard as of April 1, 2018 with no impact on its consolidated financial statements. 

 

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 No. 2016-18 became effective for public companies for the fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company adopted this standard as of April 1, 2018 by using the retrospective method, which required reclassification of restricted cash in the accompanying consolidated statement of cash flows as of the beginning of the fiscal year ended March 31, 2017. 

 

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”). ASU No. 2016-15 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. The Company adopted this standard as of April 1, 2018 with no impact on its consolidated financial statements and related disclosures.

 

In May 2014, the FASB issued their converged standard on revenue recognition, ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU No. 2014-09”), updated in December 2016 with the release of ASU 2016-20. This standard outlines a single comprehensive model for companies to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that an entity recognizes revenue to depict the transfer of promised goods and services in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods and services. In addition, the new standard requires that reporting companies disclose the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.  In August 2015, the FASB issued ASU No 2015-14 Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which deferred the effective date of ASU No. 2014-09 to annual reporting periods beginning after December 15, 2017.

 

The new revenue standard is required to be applied either retrospectively to each prior reporting period presented or prospectively with the cumulative effect of initially applying the standard recognized at the date of the initial application, supplemented with certain disclosures related to the effect of adoption on previously reported amounts, if any (the modified retrospective method). The Company adopted the standard on April 1, 2018 for contracts that were not completed before the adoption date, using the modified retrospective method.  The Company has evaluated the effect of the standard and concluded it is not material to the timing or amount of revenues or expenses recognized in the Company’s historical consolidated financial statements. As a result, the Company has concluded that the application of the standard does not have a material effect that requires a retrospective adjustment to any previously reported amounts in the Company’s historical consolidated financial statements for reporting disclosure purposes.

 

Recently Issued Accounting Pronouncements

 

In November 2018, the FASB issued ASU 2018-18 – Collaborative Arrangements, which clarifies that certain transactions between collaborative arrangement participants should be accounted for as revenue when the collaborative arrangement participant is a customer in the context of a unit of account and precludes recognizing as revenue consideration received from a collaborative arrangement participant if the participant is not a customer. This ASU will be effective for the Company in the first quarter of fiscal 2021 with early adoption permitted. This ASU requires retrospective adoption to the date the Company adopted ASC 606, April 1, 2018, by recognizing a cumulative-effect adjustment to the opening balance of retained earnings of the earliest annual period presented. The Company is currently evaluating the impact of the adoption of this standard on its financial statements.

 

In August 2018, the FASB issued ASU 2018-15, “Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract” (“ASU No. 2018-15”), which aligns the capitalization requirements for implementation costs incurred in a hosting arrangement that is a service contract with the existing capitalization requirements for implementation costs incurred to develop or obtain internal-use software (Subtopic 350-40). ASU 2018-15 becomes effective for the Company in the first quarter of fiscal 2021 and may be adopted either retrospectively or prospectively. Early adoption is permitted. The Company is currently evaluating the impact of the adoption of this standard on its financial statements.

 

 

In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement - Disclosure Framework (Topic 820)” (“ASU No. 2018-13”). The updated guidance improves the disclosure requirements on fair value measurements. The updated guidance becomes effective for the Company in the first quarter of fiscal year 2021. Early adoption is permitted for any removed or modified disclosures. The Company is currently assessing the timing and impact of adopting the updated provisions.

 

3.	INVENTORIES

 

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

 

 

The Company recognizes abnormal production costs, including fixed cost variances from normal production capacity, as an expense in the period incurred. The Company expensed abnormal production costs of $0 and $250,000 to cost of sales for the three and nine months ended December 31, 2018, respectively. There were no abnormal production costs for the three and nine months ended December 31, 2019. Non-inventoriable fixed costs of $158,000 and $35,000 were expensed to cost of sales for the three months ended December 31, 2019 and 2018, respectively. Non-inventoriable fixed costs of $258,000 and $176,000 were expensed to cost of sales for the nine months ended December 31, 2019 and 2018, respectively.

 

4.	EQUIPMENT AND LEASEHOLD IMPROVEMENTS

 

Equipment and leasehold improvements consist of the following at:

 

 

Management has determined no asset impairment existed as of December 31, 2019 and March 31, 2019, respectively. Depreciation and amortization expense were approximately $487,000 and $471,000 for the three months ended December 31, 2019 and 2018, respectively. Depreciation and amortization expense were approximately $1,458,000 and $1,421,000 for the nine months ended December 31, 2019 and 2018, respectively.

 

5.	SHORT-TERM CONTRACT OBLIGATION

 

On November 30, 2018 the Company completed the purchase of a six acre production and research facility from Cellana LLC (“Cellana”) under a purchase agreement that was signed August 31, 2018. In accordance with the terms of the third amendment to the asset purchase agreement, the Company acquired the asset for $495,000 with a cash down payment of $100,000 leaving a short-term obligation of $395,000 on the asset purchase.

 

The short-term obligation was comprised of two separate loans in the principal amount of $180,000 and $215,000. The first loan of $180,000 bore an interest rate of 6.25% and was payable in four monthly installments of principal and interest. The loan commenced on December 1, 2018 and matured on July 15, 2019. The principal amounts outstanding at December 31, 2019 and March 31, 2019 were $0 and $137,000, respectively.

 

 

The second loan had a principal amount of $215,000 and was a non-interest bearing loan that was payable in twelve monthly installments. The loan commenced on December 1, 2018 and matured on October 15, 2019. This contract contains a hold back of $38,000 pending resolution of certain closing items by the seller, which is the balance outstanding at December 31, 2019. The principal amount outstanding March 31, 2019 was $148,000.

 

6.	LINE OF CREDIT AND LONG-TERM DEBT

 

Total debt consists of the following at December 31, 2019 and March 31, 2019:

 

  

Line of Credit and Term Loans

 

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, Hawaii. 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 (4.75% and 5.5% at December 31, 2019 and March 31, 2019, respectively) plus 2%, floating.

 

At both December 31, 2019 and March 31, 2019, the outstanding balance under the Credit Agreement was $2,000,000. The line of credit, which is subject to annual renewal, was renewed on August 30, 2019 and will be subject to renewal upon expiration on August 30, 2020. Pursuant to the August 30, 2019 renewal, the current ratio covenant was 1.50:1 and is applicable to both the line of credit and term loans with the Bank.

 

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.

 

In 2015, 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 is evidenced by a promissory note in the amount of $2,500,000, the repayment of which is partially guaranteed under the provisions of the 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 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 (5.0% and 5.5% at December 31, 2019 and March 31, 2019, respectively) 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 6.0%. The 2015 Loan has a prepayment penalty of 5.0% for any prepayment made prior to the first anniversary of the date of the 2015 Loan Agreement, which penalty is reduced by 1.0% each year thereafter until the fifth anniversary of such date, after which there is no prepayment penalty. The balance under the 2015 Loan was $1,131,000 and $1,389,000 at December 31, 2019 and March 31, 2019, respectively, and was included in long-term debt in the debt table above.

 

In 2012, the Company executed a loan agreement with a lender providing for $5,500,000 in aggregate credit facilities (the “2012 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 “2012 Loan Agreement”). The 2012 Loan 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 2012 Loan were used to acquire processing equipment and leasehold improvements at its Kona, Hawaii facility.

 

 

The provisions of the 2012 Loan 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 2012 Loan accrues on the outstanding principal balance at an annual variable rate equal to the published Wall Street Journal prime rate (5.0% and 5.5% at December 31, 2019 and March 31, 2019, respectively) 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 5.5%. The balance under the 2012 Loan was $4,279,000 and $4,439,000 at December 31, 2019 and March 31, 2019, respectively, and was included in long-term debt in the debt table above.

  

The 2015 Loan includes a one-time origination and guaranty fee totaling $113,900 and an annual renewal fee payable in the amount of 0.5% of the USDA guaranteed portion of the outstanding principal balance as of December 31 of each year, beginning December 31, 2015. The USDA has guaranteed 80% of all amounts owing under the 2015 Loan. The 2012 Loan 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 USDA has guaranteed 80% of all amounts owing under the 2012 Loan. The balance in unamortized debt issuance costs was $177,000 and $200,000 at December 31, 2019 and March 31, 2019, respectively.

 

Loan Covenant Violations and Waiver

 

The Company’s Credit Agreement, 2015 Loan and 2012 Loan are subject to annual debt service and other financial covenants, including covenants which require the Company to meet key financial ratios and customary affirmative and negative covenants.  As of March 31, 2019, the Company was not in compliance with the required debt service coverage ratio or the current ratio and due to these violations, the Bank would be contractually entitled to require immediate repayment of the outstanding term loan amounts of $5,828,000 and the outstanding line of credit balance of $2,000,000.  However, on June 17, 2019, the bank issued the Company a letter waiving the covenant violations as of March 31, 2019.  The outstanding balance of the terms loans is presented as a non-current liability at December 31, 2019 and March 31, 2019.

 

Long-term Debt – Related Party

 

In April 2019, the Company obtained an unsecured subordinated loan in the amount of $1,500,000.  Interest accrues at a rate of 6.5% and is payable quarterly.  The principal amount and any accrued and unpaid interest are due in April 2021 (see Note 13).  The balance under this loan was $1,500,000 at December 31, 2019.

 

 Equipment Finance Agreement

 

On October 6, 2017, the Company entered into an Equipment Finance Agreement (the “Equipment Agreement”) with a lender, which provides up to $175,000 of financing for equipment. The interest rate on this loan is 4.75%. The provisions of the Equipment Agreement require the payment of principal and interest until its maturity on October 31, 2022. The balance under this loan was $102,000 and $126,000 at December 31, 2019 and March 31, 2019, respectively, and was included in long-term debt in the debt table above.

 

 Finance Lease Obligations

 

In August 2016, the Company executed a finance lease agreement with Thermo Fisher Financial providing for $52,000 in equipment, secured by the equipment financed. The finance lease matured in May 2019 and was payable in 36 equal monthly payments. The interest rate under this capital lease was 12.90%. The balance under this lease was $0 and $7,800 at December 31, 2019 and March 31, 2019, respectively, and was included in long-term debt in the debt table above.

 

In February 2016, the Company executed a finance lease agreement with Bank of the West providing for $51,000 in equipment, secured by the equipment financed. The finance lease matures in March 2021 and is payable in 60 equal monthly payments. The interest rate under this finance lease is 4.18%. The balance under this lease was $14,000 and $22,000 at December 31, 2019 and March 31, 2019, respectively, and was included in long-term debt in the debt table above.

 

In July 2015, the Company executed a finance lease agreement with Huntington Technology Finance providing for $174,000 in equipment, secured by the equipment financed. The finance lease matures in July 2020 and is payable in 60 equal monthly payments. The interest rate under this lease is 6.57%. The balance under this lease was $23,000 and $52,000 at December 31, 2019 and March 31, 2019, respectively, and was included in long-term debt in the debt table above.

 

 

Future principal payments under the loans and finance lease obligations at December 31, 2019 are as follows:

 

 

 

7.	OPERATING LEASES

 

The Company leases it facilities, equipment and land under non-cancelable operating leases expiring through 2037. Right-of-use assets represent the right to use an underlying asset for the lease term and lease liabilities represent the obligation to make lease payments arising from the lease. Right-of-use assets and liabilities were recognized at April 1, 2019 based on the present value of lease payments over the lease term, using the Bank’s incremental borrowing rate based on the information available. At December 31, 2019, the weighted average remaining lease terms is 14.0 years, the weighted average discount rate is 7.5% and the operating lease costs are $445,000.

 

Supplemental balance sheet information related to leases at December 31, 2019 is as follows:

 

 

Maturities of lease liabilities at December 31, 2019 are as follows:

 

 

 

8.	ACCRUED EXPENSES

 

Accrued expenses consist of the following:

 

   

 

9.	COMMITMENTS AND CONTINGENCIES

 

From time to time, the Company may be involved in litigation and investigations relating to claims and matters arising out of its operations in the normal course of business.

 

On October 2, 2019, a shareholder of the Company, Meridian OHC Partners, LP (“Meridian”), filed a complaint in the United States District Court, District of Hawaii, against the Board of Directors seeking to proceed derivatively on behalf of the Company. The Company is named as a nominal defendant. The complaint alleges, among other things, that the directors have breached their fiduciary duties, in overseeing the Company. Meridian seeks declaratory and injunctive relief and an award of damages to the Company. The case is Meridian v. Davis et al. (Cyanotech), No. 19-cv-0536 (D. Hawaii). At December 31, 2019, the probability and magnitude of any potential loss cannot be estimated.

 

10.	SHARE-BASED COMPENSATION

 

The Company has share-based compensation plans, which are more fully described in Note 10, Share-Based Compensation, to the Consolidated Financial Statements included in the Company’s annual report on Form 10-K for the year ended March 31, 2019 as filed with the SEC on July 1, 2019.

 

As of December 31, 2019, the Company had two equity-based compensation plans: the 2016 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, 2019, 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. No additional awards will be issued under the 2005 Plan or the 2004 Directors Plan. 

 

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

 

 

Stock Options

 

All stock option grants made under the 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 2016 Plan, 2005 Plan and 2014 Directors Plan were determined by the Board of Directors or the Compensation Committee of the Board of Directors in accordance with the provisions of the respective plans.  The terms of each option grant include vesting, exercise, and other conditions 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 $5,000 and $18,000 for the three months ended December 31, 2019 and 2018, respectively. Compensation expense recognized for options issued under all Plans was $123,000 and $54,000 for the nine months ended December 31, 2019 and 2018, respectively. In the first nine months of fiscal year 2020, compensation expense included $109,000 related to a settlement agreement with a former executive.

 

 

A summary of option activity under the Company’s stock plans for the nine months ended December 31, 2019 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 $2.29 and $3.24 at December 31, 2019 and March 31, 2019, respectively.

 

A summary of the Company’s non-vested options for the nine months ended December 31, 2019 is presented below:

 

 

As of December 31, 2019, total unrecognized stock-based compensation expense related to all unvested stock options was $57,000, which is expected to be expensed over a weighted average period of 3.0 years.

 

Restricted Stock Units (“RSUs”) 

 

RSUs are service-based awards granted to eligible employees under the 2016 Plan. Compensation expense recognized for RSUs issued under the 2016 Plan was $26,000 and $20,000 for the three months ended December 31, 2019 and 2018, respectively. Compensation expense recognized for RSUs issued under the 2016 Plan was $64,000 and $58,000 for the nine months ended December 31, 2019 and 2018, respectively.  In the first nine months of fiscal 2020, compensation expense included $6,000 related to a settlement agreement with a former executive.

 

The following table summarizes information related to awarded RSUs for the nine months ended December 31, 2019:

 

 

As of December 31, 2019, total unrecognized stock-based compensation expense related to unvested restricted stock units was $35,000, which is expected to be expensed over a weighted average period of 1.0 years.

 

Common Stock 

 

In the first nine months of fiscal 2020, the Company recorded $205,000 in compensation expense related to a settlement agreement with a former executive.

 

11.	INCOME TAXES

 

On December 22, 2017 H.R. 1, originally known as the Tax Cuts and Jobs Act, (the “Tax Act”) was enacted. Among the significant changes to the U.S. Internal Revenue Code, the Tax Act lowers the U.S. federal corporate income tax rate (“Federal Tax Rate”) from 34% to 21% effective January 1, 2018. The 21% Federal Tax Rate applies to fiscal years ending March 31, 2019 and each year thereafter.

 

The Company utilizes its estimated annual effective tax rate to determine its provision or benefit for income taxes for interim periods. The income tax provision or benefit is computed by multiplying the estimated annual effective tax rate by the year to date pre-tax book income (loss). The Company recorded an income tax expense of $32,000 and $73,000 for the three months ended December 31, 2019 and 2018, respectively. The Company recorded an income tax expense of $29,000 and $33,000 for the nine months ended December 31, 2019 and 2018, respectively. The Company’s effective tax rate was 15.8% and 20.2% for the three months ended December 31, 2019 and 2018, respectively. The Company’s effective tax rate was 9.7% and (1.6%) for the nine months ended December 31, 2019 and 2018, respectively. The effective tax rates for the three and nine months ended December 31, 2019 and 2018 differ from the statutory rate of 21% 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 continues to carry a full valuation allowance on its net deferred tax assets.

 

The Company is subject to taxation in the United States and six 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, 2019 and 2018, 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 2014.

 

12.	EARNINGS PER SHARE

 

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

 

Reconciliations between the numerator and the denominator of the basic and diluted income (loss) per share computations for the three and nine months ended December 31, 2019 and 2018 are as follows:

 

 

 

 

 

 

Basic and diluted per share amounts are the same in periods of a net loss, because common 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 75,000 for the nine months ended December 31, 2018, as the effect of their inclusion would be anti-dilutive. Restricted stock units become dilutive within the period granted and remain dilutive until the units vest and are issued as common stock. Diluted earnings per share does not include the impact of restricted stock units totaling 21,000 for the nine months ended December 31, 2018, as the effect of their inclusion would be anti-dilutive.

 

13.	RELATED PARTY TRANSACTIONS

 

During the nine months ended December 31, 2018, the Company entered into a consulting agreement with an effective date of May 5, 2018 with a vendor that employs one of our independent directors.  The Company’s independent director is not named in or involved in the performance of the consulting agreement. The amount of the contract was for $120,000 and all the payments made against the contract were reflected in general and administrative expense.

 

During the nine months ended December 31, 2019, the Company obtained an unsecured subordinated loan from Skywords Family Foundation, Inc. (“Skywords”) in the principal amount of $1,500,000 pursuant to a Promissory Note (“the Skywords Note”) executed by the Company in favor of Skywords. Skywords is controlled by the Company’s Chairman of the Board of Directors and largest stockholder. The Skywords Note bears interest at a rate of 1% plus the prime rate (as published by the Wall Street Journal), which will be recalculated and payable on a quarterly basis. The principal amount and any accrued and unpaid interest will be due and payable on April 12, 2021, unless accelerated in an event of default. The Company may prepay the Skywords Note at any time without penalty. The proceeds of the Skywords Note were used to pay down accounts payable and for general operating capital purposes.