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 June Ended 30, 201December 31, 20167

 

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

(IRS Employer

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)

 

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” 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 ☒

(Do not check if a 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 ☒

 

Number of common shares outstanding as of AugustFebruary 7, 10, 2017:

 

Title of Class

  

Shares Outstanding

Common stock - $0.02 par value

  

5,668,8815,685,381

 

 
 

  

CYANOTECH CORPORATION

FORM 10-Q

 

INDEX

 

PART I. FINANCIAL INFORMATION

 

 

 

Item 1.

Financial Statements (Unaudited)

3

  

Condensed Consolidated Balance Sheets as of JuneDecember 31, 2016 30, 2017 and March 31, 20162017 (unaudited)

3

  

Condensed Consolidated Statements of Operations for the three months ended June 30, 2017 and nine month periods ended December 31, 2016 and 2015(unaudited)

4

  

Condensed Consolidated Statements of Cash Flows for the nine month periodsthree months ended December 31,June 30, 2017 and 2016 and 2015(unaudited)

5

  

Notes to Condensed Consolidated Financial Statements (unaudited)

6

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

16

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

21

Item 4.

Controls and Procedures

21

PART II.  OTHER INFORMATION

  

  

  

Item 1.

Legal Proceedings

2322

Item 1A

Risk Factors

2322

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

2422

Item 3.

Defaults upon Senior Securities

2422

Item 5.

Other Information

2422

Item 6.

Exhibits

2523

SIGNATURES

2624

 


 

PART I.1.  FINANCIAL INFORMATION

 

Item 1.  Financial Statements (Unaudited)

 

CYANOTECH CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)

(Unaudited)

 

 

December 31,
2016

  

March 31,
2016

  

June 30,
2017

  

March 31,
2017

 

ASSETS

                

Current assets:

                

Cash and cash equivalents

 $1,662  $1,240 

Accounts receivable, net of allowance for doubtful accounts of $49 at December 31, 2016 and $136 at March 31, 2016

  2,467   2,983 

Cash

 $1,299  $1,407 

Accounts receivable, net of allowance for doubtful accounts of $31 at June 30, 2017 and $49 at March 31, 2017

  2,619   2,135 

Inventories, net

  7,671   7,856   7,981   7,972 

Deferred tax assets

  74   74 

Prepaid expenses and other current assets

  758   502   427   565 

Total current assets

  12,632   12,655   12,326   12,079 
                

Equipment and leasehold improvements, net

  16,867   17,796   16,289   16,712 

Other assets

  222   392   207   213 

Total assets

 $29,721  $30,843  $28,822  $29,004 
                

LIABILITIES AND STOCKHOLDERS’ EQUITY

                

Current liabilities:

                

Line of credit

 $611  $—  $500  $611 

Current maturities of long-term debt

  614   574   624   623 

Customer deposits

  76   117   80   119 

Accounts payable

  3,548   4,000   3,132   3,666 

Accrued expenses

  1,396   1,430   1,143   1,013 

Total current liabilities

  6,245   6,121   5,479   6,032 
                

Long-term debt, net

  6,400   6,790 

Deferred tax liabilities

  74   74 

Deferred rent

  43   30 

Long-term debt, less current maturities

  6,105   6,249 

Other long-term liabilities

  99   116 

Total liabilities

  12,762   13,015   11,683   12,397 
                

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, shares authorized 50,000,000; 5,668,881 shares issued and outstanding at December 31, 2016 and 5,599,797 shares at March 31, 2016

  113   112 

Common stock of $0.02 par value, authorized 50,000,000 shares; 5,685,381 shares issued and outstanding at June 30, 2017 and March 31, 2017

  114   114 

Additional paid-in capital

  31,657   31,585   31,608   31,577 

Accumulated deficit

  (14,811

)

  (13,869

)

  (14,583

)

  (15,084

)

Total stockholders’ equity

  16,959   17,828   17,139   16,607 
        

Total liabilities and stockholders’ equity

 $29,721  $30,843  $28,822  $29,004 

 

See Accompanyingaccompanying Notes to Condensed Consolidated Financial Statements.

 


 

CYANOTECH CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

 

 

Three Months Ended
December 31,

  

Nine Months Ended
December 31,

  

Three Months Ended June 30,

 
 

2016

  

2015

  

2016

  

2015

  

2017

  

2016

 
                        

NET SALES

 $7,605  $7,534  $24,789  $23,644  $8,809  $7,322 

COST OF SALES

  4,748   4,450   15,226   14,536   5,206   4,501 

Gross profit

  2,857   3,084   9,563   9,108 

Gross Profit

  3,603   2,821 
                        

OPERATING EXPENSES:

                        

General and administrative

  1,138   1,331   4,864   3,998   1,352   1,710 

Sales and marketing

  1,749   1,325   4,774   4,673   1,489   1,555 

Research and development

  143   132   461   475   142   166 

Total operating expenses

  3,030   2,788   10,099   9,146   2,983   3,431 
                        

(Loss) income from operations

  (173

)

  296   (536

)

  (38

)

Income (loss) from operations

  620   (610

)

                        

Interest expense, net

  (149

)

  (89

)

  (403

)

  (164

)

  108   132 
                        

(Loss) income before income taxes

  (322

)

  207   (939

)

  (202

)

Income (loss) before income tax

  512   (742

)

                        

INCOME TAX EXPENSE

  27   457   3   139 

INCOME TAX EXPENSE (BENEFIT)

  11   (51

)

                        

NET LOSS

 $(349

)

 $(250

)

 $(942

)

 $(341

)

NET INCOME (LOSS)

 $501  $(691

)

                        

NET LOSS PER SHARE:

                

NET INCOME (LOSS) PER SHARE:

        

Basic

 $(0.06

)

 $(0.04

)

 $(0.17

)

 $(0.06

)

 $0.09  $(0.12

)

Diluted

 $(0.06

)

 $(0.04

)

 $(0.17

)

 $(0.06

)

 $0.09  $(0.12

)

                        

SHARES USED IN CALCULATION OF NET LOSS PER SHARE:

                

SHARES USED IN CALCULATION OF NET INCOME (LOSS) PER SHARE:

        

Basic

  5,669   5,594   5,653   5,576   5,685   5,633 

Diluted

  5,669   5,594   5,653   5,576   5,719   5,633 

 

See Accompanyingaccompanying Notes to Condensed Consolidated Financial Statements.

 


 

CYANOTECH CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

 

 

Nine Months Ended
December 31,

  

Three Months Ended June 30,

 
 

2016

  

2015

  

2017

  

2016

 
                

CASH FLOWS FROM OPERATING ACTIVITIES:

                

Net loss

 $(942

)

 $(341

)

Adjustments to reconcile net loss to net cash provided by operating activities:

        

Net income (loss)

 $501  $(691

)

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

        

Loss on disposal of assets

  —   3 

Depreciation and amortization

  1,489   1,057   479   493 

Amortization of debt issue costs and other assets

  49   41   15   13 

Share based compensation expense

  216   569 

Provision for doubtful accounts

  —   43 

Deferred income tax benefit

  —   168 

Share-based compensation expense

  31   78 

Net (increase) decrease in assets:

                

Accounts receivable

  516   61   (484

)

  737 

Inventories

  185   (1,645

)

  (9

)

  (532

)

Prepaid expenses

  (256

)

  (206

)

Other assets

  149   75 

Prepaid expenses and other assets

  138   (102

)

Net increase (decrease) in liabilities:

                

Customer deposits

  (41

)

  99   (40

)

  (52

)

Accounts payable

  (452

)

  984   (534

)

  (9

)

Accrued expenses

  (34

)

  198   130   230 

Deferred rent

  13   2 

Deferred rent and other liabilities

  (17

)

  4 

Net cash provided by operating activities

  892   1,105   210   172 
                

CASH FLOWS FROM INVESTING ACTIVITIES:

                

Proceeds from restricted cash

  —   486 

Investment in equipment and leasehold improvements

  (508

)

  (4,033

)

  (56

)

  (170

)

Net cash used in investing activities

  (508

)

  (3,547

)

  (56

)

  (170

)

                

CASH FLOWS FROM FINANCING ACTIVITIES:

                

Proceeds from short term notes payable

  600   500 

Net draw down on line of credit

  611   — 

Payment of short term notes payable

  (600

)

  (500

)

Proceeds from long-term debt, net of costs

  —   2,407 

Payments on capitalized leases

  (58

)

  (32

)

Proceeds from short term note payable

  —   600 

Net payments on line of credit

  (111

)

  — 

Payments in stock withheld for tax payment on issuance

  —   (147

)

Principal payments on long-term debt

  (372

)

  (230

)

  (130

)

  (124

)

Payments in stock withheld for tax payment on issuance

  (147

)

  — 

Proceeds from stock options exercised

  4   66 

Net cash provided by financing activities

  38   2,211 

Payments on capitalized leases

  (21

)

  (17

)

Net cash (used in) provided by financing activities

  (262

)

  312 
                

Net increase (decrease) in cash and cash equivalents

  422   (231

)

Net (decrease) increase in cash

  (108

)

  314 
                

Cash and cash equivalents at beginning of period

  1,240   2,226 

Cash at beginning of period

  1,407   1,240 
                

Cash and cash equivalents at end of period

 $1,662  $1,995 

Cash at end of period

 $1,299  $1,554 
                

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

                

Cash paid during the period for:

                

Interest

 $322  $290  $104  $105 

Income taxes

 $—  $21  $—  $— 

 

See Accompanyingaccompanying Notes to Condensed Consolidated Financial Statements.

 


 

CYANOTECH CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

DecJuneember 31, 2016 30, 2017
(Unaudited)

(Unaudited)

 

1.

1.     BASIS OF PRESENTATION

 

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, 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, 20162017 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, 2016,2017, contained in the Company’s annual report on Form 10-K as filed with the SEC on June 23, 2016.22, 2017.

 

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.

 

Liquidity and Debt Covenant Compliance

As of June 30, 2017, the Company had cash of $1.3 million and working capital of $6.8 million compared to $1.4 million and $6.0 million, respectively, at March 31, 2017. On August 30, 2016, the Credit Agreement, which the Company and First Foundation Bank (the 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 June 30, 2017, the Company had borrowed $0.5 million and had $1.5 million available on the line. The line of credit is subject to renewal on August 30, 2017 and the Company is working proactively with the Bank to renew the line of credit or replace it with another line of credit on or before the expiration date. The Bank has issued a letter to the Company dated June 12, 2017 indicating it intends to renew the line of credit subject to approval by its credit committee.

As of June 30, 2017, the Company had $6.8 million of term loans payable to the Bank that require the payment of principal and interest monthly through August 2032. Pursuant to the term loans, the Company is subject to annual financial covenants, customary affirmative and negative covenants and certain subjective acceleration clauses. As of March 31, 2017 and 2016, the Company's current ratio of 1.92:1 and 1.97:1, respectively, fell short of the Bank's annual requirement of 2.10:1. The Bank has provided the Company with letters stating they found the Company to be in compliance with this covenant requirement and all other financial covenants as of March 31, 2017 and 2016, and do not consider these shortfalls to be defaults under the Loan Agreements.

Funds generated by operating activities and available cash 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. Based upon the Company's fiscal year 2018 operating plan and related cash flow projections and the Company's projected consolidated financial position as of March 31, 2018, cash flows expected to be generated by operating activities and available financing are expected to be sufficient to fund the Company's operations for at least the next twelve months, and the Company's current ratio is expected to be in compliance with the annual term loan covenant requirement as of March 31, 2018. However, no assurances can be provided that the Company will achieve its operating plan and cash flow objectives for the next fiscal year or its projected consolidated financial position as of March 31, 2018. Such estimates are subject to change based on future results and such change could cause future results to vary significantly from expected results.

As indicated above, the Bank has not considered the shortfalls as of March 31, 2017 and 2016 in the Company's current ratio relative to the covenant requirement to be violations of the Loan Agreements. However, in the event the Company has a shortfall under the Loan Agreements as of March 31, 2018 or future fiscal year ends, there is no assurance that the Bank will not consider such to be a violation of the Loan Agreements and pursue its rights under the arrangements to call for the repayment of the outstanding borrowings payable to the Bank. If this occurs, the Company may need to raise additional funds to repay the loans; however, the Company may not be able to secure such funding on acceptable terms, or at all.


Recent Accounting Pronouncements

 

In December 2016,May 2017, the Financial Accounting Standards Board (“FASB”("FASB") issued Accounting Standards Update (“ASU”("ASU") 2017-09, Compensation-Stock Compensation (Topic 718) Scope of Modification Accounting. ASU 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 will become effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. Early adoption is permitted. The amendments in this ASU should be applied prospectively to an award modified on or after the adoption date. The Company is currently evaluating the impact of this updated standard. The Company does not believe this update will have a significant impact on its consolidated financial statements.

In December 2016, the FASB issued ASU 2016-20 “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers”Customers” (“ASU No. 2016-20”) and ASU 2016-19 “TechnicalCorrections and Improvements” ("("ASU No. 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 SACASC 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. ASU 2016-20 will take effect for public companies for the fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. This guidance is applicable to the Company’s fiscal year beginning April 1, 2018. 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.

 


InIn November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash”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. This guidance is applicable to the Company’s fiscal year beginning April 1, 2018. 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'sCompany’s fiscal year beginning MarchApril 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 interimannual periods beginning after December 15, 2016, and interim periods within those annual periods, with early adoption permitted. The Company expectsAmendments requiring recognition of excess tax benefits and tax deficiencies in the income statement must be applied prospectively. Amendments related to adopt this guidancethe presentation of excess tax benefits on the statement of cash flows may be applied either prospectively or retrospectively based on the Company’s election. Amendments related to the statement of cash flows presentation of employee taxes paid when an employer withholds shares must be applied retrospectively. As of April 1, 2017.2017, the Company adopted ASU 2016-09 and elected to present excess tax benefits as an operating activity prospectively and continues to estimate forfeitures rather than recognize them as they occur. The Company doesadoption of ASU 2016-09 did not anticipate that this guidance will have a materialan 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 periodperiods beginning after December 15, 2017, with the option to adopt one year earlier. This guidance is applicable to the Company’s fiscal year beginning April 1, 2018. 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. This guidance is applicable to the Company’s fiscal year beginning April 1, 2019. The Company expects this guidance will have a material impact on the Company’sits consolidated balance sheets due to the recognition of lease rights and obligations as assets and liabilities.liabilities, respectively. The Company does not expect this guidance to have a material effect on the Company’sits 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 effectiveASU 2015-17 will take effect for public companies for the fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. As required, the Company adopted this standard as of March 31, 2018April 1, 2017 and is not expected to have a material impact on the consolidated financial statementsaccordingly all deferred tax assets and liabilities are classified as the guidance only changes the classification of deferred income taxes.non-current. Prior periods were retrospectively adjusted.


 

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.  Prior to the issuance of the standard, inventory was measured at the lower of cost or market (where market was defined as replacement cost, with a ceiling of net realizable value and floor of net realizable value less a normal profit margin).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. As required, the Company adopted this standard as of April 1, 2017. The Company doesadoption of this standard did not anticipate that this guidance will have a material impact on the Company's financial position or results of operations.

In May 2014, The FASB issued ASU No 2014-09, “Revenue from Contracts with Customers (Topic 606)”. This guidance, as amended by subsequent ASUs on the topic, supersedes current guidance on revenue recognition in topic 605, Revenue Recognition. This guidance will be effective for annual periods beginning after December 15, 2017, including interim reporting periods. Early application of the guidance is permitted for annual periods beginning after December 31, 2016. This guidance is applicable to our fiscal year beginning April 1, 2018. The Company expects to adopt this guidance when effective in the first quarter of the fiscal year ended March 31, 2019 and is currently evaluating the effect that the updated standard will have on its consolidated financial statements and related disclosures. The Company expects to complete this evaluation in December 2017.

 

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.


 

2.

INVENTORIES

 

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

 

 

December 31,

2016

  

March 31,

2016

  

June 30, 2017

  

March 31, 2017

 
 

(in thousands)

  

(in thousands)

 

Raw materials

 $392  $375  $247  $347 

Work in process

  3,527   3,782   2,553   2,036 

Finished goods (1)

  3,501   3,543   5,064   5,460 

Supplies

  251   156   117   129 

Inventories, net

 $7,671  $7,856  $7,981  $7,972 

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

(1)

Net of reserve for obsolescence of $33,000 and $3,000 at June 30, 2017 and March 31, 2017, respectively.

 

The Company recognizes abnormal production costs, including fixed cost variances from normal production capacity, as an expense in the period incurred. Non-inventoriableNon-inventoriable fixed costs related to spirulina production of $148,000 and $221,000$9,000 were charged to cost of sales for the three and nine monthsquarter ended December 31, 2016, respectively. $21,000June 30, 2017. Non-inventoriable fixed costs related to astaxanthin production of non-inventoriable fixed costs$28,000 were charged to cost of sales for the three monthsquarter 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.June 30, 2016.


 

  

3.

EQUIPMENT AND LEASEHOLD IMPROVEMENTS, NET

 

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:

 

 

Years

 

Equipment

 

3

to

10

 

Furniture and fixtures

 

3

to

7

 

Leasehold improvements

 

10

to

25

 

  

Equipment and leasehold improvements consist of the following:

 

 

December 31,

2016

  

March 31,

2016

  

June 30, 2017

  

March 31, 2017

 
 

(in thousands)

  

(in thousands)

 

Equipment

 $17,453  $17,040  $17,427  $17,492 

Leasehold improvements

  13,887   13,797   13,892   13,892 

Furniture and fixtures

  379   354   380   380 
  31,719   31,191   31,699   31,764 

Less accumulated depreciation and amortization

  (15,472

)

  (14,067

)

  (16,315

)

  (15,835

)

Construction-in-progress

  620   672   905   783 

Equipment and leasehold improvements, net

 $16,867  $17,796  $16,289  $16,712 

 

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,June 30, 2017 and 2016, respectively.

 

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.


 

4.

NOTES PAYABLELINE OF CREDIT

 

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.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 (4.25% at June 30, 2017) + 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,June 30, 2017, the Company had borrowed $611,000$500,000 under the Credit Agreement and had $1,389,000$1,500,000 available on the line.The line of credit is subject to renewal on August 30, 2017 and the Company is working proactively with the Bank to renew the line of credit or replace it with another line of credit on or before the expiration date. The Bank has issued a letter to the Company dated June 12, 2017 indicating it intends to renew the line of credit subject to approval by its credit committee.

 

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.

  


5.

ACCRUED EXPENSES

 

Accrued expenses consist of the following:

 

  

December 31,

2016

  

March 31,

2016

 
  

(in thousands)

 

Wages, bonus and profit sharing

 $963  $972 

Legal

  136   95 

Use tax

  142   140 

Customer rebates

  —   74 

Rent and utilities

  68   49 

Other expenses

  87   100 

Total accrued expenses

 $1,396  $1,430 
  

June 30, 2017

  

March 31, 2017

 
  

(in thousands)

 

Wages, commissions, bonus and profit sharing

 $912  $793 

Rent and utilities

  78   69 

Other accrued expenses

  153   151 

Total accrued expenses

 $1,143  $1,013 

 

6.

LONG-TERM DEBT

 

Long-term debt consists of the following:

 

 

December 31,

2016

  

March 31,

2016

  

June 30, 2017

  

March 31, 2017

 
 

(in thousands)

  

(in thousands)

 

Long-term debt

 $7,290  $7,668  $6,988  $7,139 

Less current maturities

  (614

)

  (574

)

  (624

)

  (623

)

Long-term debt, excluding current maturities

  6,676   7,094   6,364   6,516 

Less unamortized debt issuance costs

  (276

)

  (304

)

  (259

)

  (267

)

Total long-term debt, net of current maturities and unamortized debt issuance costs

 $6,400  $6,790  $6,105  $6,249 

 

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%(4.25% at December 31, 2016)June 30, 2017) 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. TheAgreement, which penalty is reduced by 1% each year thereafter until the fifth anniversary of such date, after which there is no prepayment penalty. The balance under the 2015 Loan was $2,127,000$1,970,000 and $2,354,000$2,049,000 at December 31, 2016June 30, 2017 and March 31, 2016,2017, 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%(4.25% at December 31, 2016)June 30, 2017) 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. TheAgreement, which penalty is reduced by 1% each year thereafter until the fifth anniversary of such date, after which there is no prepayment penalty. The balance under this Loan was $4,904,000$4,804,000 and $5,049,000$4,854,000 at December 31, 2016June 30, 2017 and March 31, 2016,2017, respectively. Proceeds from the Loan were classified as restricted cash until drawn upon to acquire new processing equipment and leasehold improvements.

  

The Loan Agreement includedincludes 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.

The Company’s current ratio of 1.92 to 1 and 1.97 to 1 as of March 31, 2017 and 2016, respectively, fell short of the bank’s requirement of 2.10 to 1; however, the Company has received letters from its bank stating that they found the Company to be in compliance with this and all other financial covenants as of March 31, 2017 and 2016, and do not consider these shortfalls to be a defaults under the Loan Agreements.

  

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$214,000 and $261,000$236,000 at December 31, 2016June 30, 2017 and March 31, 2016,2017, respectively.

  

Future principal payments under the term loansloan and capital lease agreements as of JuneDecember 31, 2016 30, 2017 are as follows:

 

Payments Due

 

(in thousands)

  

(in thousands)

 

Next 12 Months

 $614  $624 

Year 2

  626   636 

Year 3

  644   653 

Year 4

  655   652 

Year 5

  662   678 

Thereafter

  4,089   3,745 

Total principal payments

 $7,290  $6,988 

 

7.

OPERATING LEASES

 

The Company leases facilities, equipment and land under operating leases expiring through 2035. The land lease provides for contingent rentals in excess of minimum rental commitments based on a percentage of the Company’s sales. Management has accrued for the estimated contingent rent as of December 31, 2016.June 30, 2017.


 

Future minimum lease payments under all non-cancelable operating leases at JuneDecember 31, 2016 30, 2017 are as follows:

 

Payments Due

 

(in thousands)

 

Next 12 Months

 $612 

Year 2

  611 

Year 3

  620 

Year 4

  556 

Year 5

  528 

Thereafter

  4,424 

Total minimum lease payments

 $7,351 


Payments Due

 

(in thousands)

 

Next 12 Months

 $614 

Year 2

  618 

Year 3

  608 

Year 4

  526 

Year 5

  532 

Thereafter

  4,157 

Total minimum lease payments

 $7,055 

 

8.

OTHER COMMITMENTS AND CONTINGENCIES

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 or claims which, individually or in aggregate, would have a material effect on its consolidated financial position, results of operations or cash flows.

 

9.

SHARE-BASED COMPENSATION

 

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

 


As of JuneDecember 31, 2016, 30, 2017, the Company had two equity-based compensation plans: the 2016 Cyanotech Equity Incentive Plan (the “2016 Plan”)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,June 30, 2017, 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.

 

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,June 30, 2017, there were 1,300,0001,247,656 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,June 30, 2017, 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:

 

 

As of December 31, 2016

  

As of June 30, 2017

 
 

Authorized

  

Available

  

Outstanding

  

Authorized

  

Available

  

Outstanding

 
                        

2016 Plan

  1,300,000   1,300,000   —   1,300,000   1,247,656   52,344 

2014 Directors Plan

  350,000   289,124   12,000   350,000   289,124   12,000 

2005 Plan

  —   —   581,000   —   —   477,500 

2004 Directors Plan

  —   —   12,000   —   —   12,000 

Total

  1,650,000   1,589,124   605,000   1,650,000   1,536,780   553,844 

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 2005 Plan and 2014 Directors Plan were determined by the Board of Directors or the Stock Option and 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 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$15,000 and $138,000$77,000 for the three and nine months ended December 31,June 30, 2017 and 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$16,000 and $0 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 threeJune 30, 2017 and nine months ended December 31, 2015.2016, respectively. All share-basedstock-based compensation has been classified as general and administrative expense in the Condensed Consolidated Statementcondensed consolidated statement of Operations.operations.


  

A summary of option activity under the Company’s stock plans for the ninethree months ended December 31, 2016June 30, 2017 is presented below:

 

Option Activity

 

Shares

  

Weighted
Average
Exercise

Price

  

Weighted

Average
Remaining
Contractual
Term (Years)

  

Aggregate
Intrinsic
Value

  

Shares

  

Weighted
Average
Exercise

Price

  

Weighted

Average
Remaining
Contractual
Term (in years)

  

Aggregate
Intrinsic
Value

 

Outstanding at March 31, 2016

  685,000  $4.65   5.7  $566,323 

Outstanding at March 31, 2017

  503,000  $4.10   4.7  $145,946 

Granted

  6,000  $4.08           —   —         

Exercised

  (1,500

)

 $3.11           —   —         

Forfeited

  (84,500

)

 $6.09           (1,500

)

 $3.11         

Outstanding at December 31, 2016

  605,000  $4.44   4.9  $315,881 

Exercisable at December 31, 2016

  579,500  $4.43   4.8  $314,561 

Outstanding at June 30, 2017

  501,500  $4.10   4.4  $103,461 

Exercisable at June 30, 2017

  482,000  $4.07   4.3  $103,461 

 

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$3.55 for such day.  

 

A summary of the Company’s non-vested options for the ninethree months ended December 31, 2016June 30, 2017 is presented below:

 

Nonvested Options

 

Shares

  

Weighted
Average
Grant-Date
Fair Value

 

Nonvested at March 31, 2016

  171,250  $3.75 

Granted

  6,000   .83 

Vested

  (97,250

)

  3.36 

Forfeited

  (54,500

)

  4.73 

Nonvested at December 31, 2016

  25,500  $2.43 

Nonvested Options

Shares

Weighted
Average
Grant-Date
Fair Value

Nonvested at March 31, 2017 

19,500

$

2.93

Granted

—

—

Vested

—

—

Forfeited

—

—

Nonvested at June 30, 2017 

19,500

$

2.93


 

The following table summarizes the weighted average characteristics of outstanding stock options as of JuneDecember 31, 2016: 30, 2017:

 

 

Outstanding Options

 

Exercisable Options

 

 

Outstanding Options

 

Exercisable Options

 

Range of
Exercise Prices

Range of
Exercise Prices

 

Number
of Shares

 

Remaining
Life (Years)

 

Weighted
Average

Price

 

Number of
Shares

 

Weighted
Average

Price

 

Range of
Exercise Prices

 

Number
of Shares

 

Remaining
Life (Years)

 

Weighted
Average

Price

 

Number of
Shares

 

Weighted
Average

Price

 

$1.60

-

$3.70

 

140,920

 

3.2

 

$

2.73

 

140,920

 

$

2.73

 

-

$3.70

 

124,620

 

2.7

 

$

2.73

 

124,620

 

$

2.73

 

$3.71

-

$4.42

 

199,080

 

4.8

 

$

3.83

 

193,080

 

$

3.82

 

-

$4.42

 

197,380

 

4.3

 

3.83

 

197,380

 

3.83

 

$4.43

-

$5.40

 

95,000

 

6.4

 

$

5.00

 

75,500

 

$

5.04

 

-

$5.40

 

95,000

 

5.9

 

5.00

 

75,500

 

5.04

 

$5.41

-

$7.08

 

 

170,000

 

 

5.7

 

$

6.27

 

 

170,000

 

$

6.27

 

-

$7.08

 

 

84,500

 

 

5.4

 

 

5.77

 

 

84,500

 

 

5.77

 

Total stock options

Total stock options

 

 

605,000

 

 

4.9

 

$

4.44

 

 

579,500

 

$

4.43

 

Total stock options

 

 

501,500

 

 

4.4

 

$

4.10

 

 

482,000

 

$

4.07

 

 

The range of fair value assumptions related to options granted during the nine monthsyear ended DecemberMarch 31, 20162017 were as follows:

 

  

2016

 

Exercise Price

 $4.08 

Volatility

  51.13

%

Risk Free Rate

  0.60

%

Vesting Period (years)

  0.5 

Forfeiture Rate

  0.00

%

Expected Life (years)

  1.00 

Dividend Rate

  0

%


  

2017

 

Exercise Price

 $4.08 

Volatility

  51.13

%

Risk Free Rate

  0.60

%

Vesting Period (years)

  0.5 

Forfeiture Rate

  0.00

%

Expected Life (in years)

  1.00 

Dividend Rate

  0

%

 

As of JuneDecember 31, 2016, 30, 2017, total unrecognized stock-based compensation expense related to all unvested stock options was $40,000,$11,000, which is expected to be expensed over a weighted average period of 0.70.3 years.

Subsequent to June 30, 2017, 75,000 stock options were granted from the 2016 Plan.

Restricted Stock Units (“RSUs”)

RSUs are service-based awards granted to eligible employees under the 2016 Plan.

On March 31, 2017, 25,000 restricted stock units (“RSUs”) were awarded to the CEO. This award is valued at $3.85 per share, the closing market price of Cyanotech common stock on the grant date, and vest over a period of three years.

On April 5, 2017, 28,074 RSUs were awarded to employees of the Company. This award is valued at $3.92 per share, the closing market price of Cyanotech common stock on the grant date, and vests over a period of three years.

The following table summarizes information related to awarded RSUs:

Nonvested Restricted Stock Units

 

Shares

  

Weighted
Average
Grant Price

 

Nonvested restricted stock units at March 31, 2017

  25,000  $3.85 

Granted

  28,074   3.92 

Vested

  —   — 

Exercised

  —   — 

Forfeited

  (730

)

  3.92 

Nonvested restricted stock units at June 30, 2017

  52,344  $3.89 

As of June 30, 2017, total unrecognized stock-based compensation expense related to unvested restricted stock units was $183,000, which is expected to be expensed over a weighted average period of 2.8 years. 

 

10.

INCOME TAXES

 

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$11,000 and $457,000income tax benefit of ($51,000) for the three months ended December 31,June 30, 2017 and 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%)2.1% and (0.3%)6.8% for the threequarters ended June 30, 2017 and nine months ended December 31,June 30, 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 DecemberJune 30, 2016 differ2017 differs 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 JuneDecember 31, 2016, 30, 2017, 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 2011.2012.

 

11.

EARNINGS (LOSS) PER SHARE

 

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.

Reconciliations between the numerator and the denominator of the basic and diluted earnings (loss) per share computations for the three months ended June 30, 2017 and 2016 are as follows:

  

Three Months Ended June 30, 2017

 
  

Net Income

(Numerator)

  

Shares

(Denominator)

  

Per Share

Amount

 
  

(in thousands)

     

Basic income per share

 $501   5,685  $0.09 

Effect of dilutive securities-Common stock options

  —   34   — 

Diluted income per share

 $501   5,719  $0.09 

  

Three Months Ended June 30, 2016

 
  

Net Loss

(Numerator)

  

Shares

(Denominator)

  

Per Share

Amount

 
  

(in thousands)

     

Basic and diluted loss per share

 $(691

)

  5,633  $(0.12

)

 

Basic and diluted earningsloss per share 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 605,0000 and 1,414,91645,000 for the three and nine months ended December 31,June 30, 2017 and 2016, and December 31, 2015, respectively, 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 27,344 for the three months ended June 30, 2017, as the effect of their inclusion would be anti-dilutive.

 

12.

CONCENTRATIONS OF RISK

  

Concentration of Accounts Receivable and Revenues

Concentration of Accounts Receivable and Revenues

 

At June 30, 201December 31, 2016, 54.6%7, 46% of the Company’s accounts receivable was comprised of twothree customer balances of 40.9%21%, 15% and 13.7%10%, respectively. At March 31, 2016, 44.4%2017, 59% of the Company’s accounts receivable was comprised of twothree customer balances of 30.7%38%, 12% and 13.4%9%, respectively. TwoThere were two customers accounted for 36%with sales equaling 32% and 35%13% of our total net sales for the three months ended December 31, 2016 and 2015, respectively, and accounted for 34% and 28%June 30, 2017. There was one customer with sales equaling 19% of our total net sales for the ninethree 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.June 30, 2016.

 


 

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

 

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

 

 

●

Statements relating to our business strategy;

 

●

Statements relating to our business objectives; and

 

●

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

 

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

 

 

●

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

 

●

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

 

●

Effects of competition, including tactics and locations of competitors and operating and market competition;

 

●

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

 

●

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

 

●

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

 

●

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

 

●

Access to available and reasonable financing on a timely basis;

 

●

The Company’s inability to generate enough revenues to meet its obligations or repay maturing indebtedness;

 

●

Failure of capital projects to operate as expected or meet expected results;

 

●

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


 

●

Legal costs associated with any legal proceedings, and the potential direct and indirect cost and other effects on our business or financial condition resulting from any legal proceedings.

 

●

Risk associated with the geographic concentration of our business;

 

●

Acts of war, terrorist incidents or natural disasters; and

 

●

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


 

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:

 

 

●

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

 

●

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

 

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):

 

 

Three Months Ended

  

Nine Months Ended

 
 

December 31,

  

December 31,

  

Three Months Ended

 
 

2016

  

2015

  

2016

  

2015

  

June 30, 2017

  

June 30, 2016

 

Net sales

 $7,605  $7,534  $24,789  $23,644  $8,809  $7,322 

Net sales increase

  0.9

%

      4.8

%

      20.3%    

Gross profit

 $2,857  $3,084  $9,563  $9,108  $3,603  $2,821 

Gross profit as % of net sales

  37.6

%

  40.9

%

  38.6

%

  38.5

%

  40.9

%

  38.5

%

Operating expenses

 $3,030  $2,788  $10,099  $9,146  $2,983  $3,431 

Operating expenses as % of net sales

  39.8

%

  37.0

%

  40.7

%

  38.7

%

  33.9

%

  46.9

%

Operating (loss) income

 $(173

)

 $296  $(536

)

 $(38

)

Operating (loss) income as % of net sales

  (2.3

)%

  3.9

%

  (2.2

)%

  (0.2

)%

Income tax expense

 $27  $457  $3  $139 

Net loss

 $(349

)

 $(250

)

 $(942

)

 $(341

)

Operating income (loss)

 $620  $(610

)

Operating income (loss) as % of net sales

  7.0

%

  (8.3

)%

Income tax expense (benefit)

 $11  $(51

)

Net income (loss)

 $501  $(691

)

                        

Net sales by product

                        

Packaged sales

                        

Astaxanthin packaged

 $4,533  $4,122  $14,168  $13,750  $5,505  $3,648 

Astaxanthin packaged sales increase

  10.0

%

      3.0

%

      50.9

%

    

Spirulina packaged

 $1,985  $2,125  $5,653  $5,450  $1,927  $1,581 

Spirulina packaged sales increase

  (6.6

)%

      3.7

%

      21.9

%

    

Total packaged sales

 $6,518  $6,247  $19,821  $19,200 

Total packaged sales increase

  4.3

%

      3.2

%

    

Total Packaged sales

 $7,432  $5,229 

Total Packaged sales increase

  42.1

%

    
                        

Bulk sales

                        

Astaxanthin bulk

 $152  $259  $785  $1,010  $221  $418 

Astaxanthin bulk sales decrease

  (41.3

)%

      (22.3

)%

      (47.1

)%

    

Spirulina bulk

 $935  $1,028  $4,183  $3,434  $1,156  $1,675 

Spirulina bulk sales increase

  (9.0

)%

      21.8

%

    

Total bulk sales

 $1,087  $1,287  $4,968  $4,444 

Total bulk sales increase

  (15.5

)%

      11.8

%

    

Spirulina bulk sales decrease

  (31.0

)%

    

Total Bulk sales

 $1,377  $2,093 

Total Bulk sales decrease

  (34.2

)%

    


 

Comparison of the Three Months Ended June 30, 201Dec7ember 3 and 2011, 2016 and 20156

 

Net SalesSales Net sales increased 20% for the quarter, increased 0.9% compared to the same quarter last year, driven by a 4.3%42% increase in our packaged products, offset by a 34% decrease in bulk sales. The increase in sales of our packaged products was the result of our continued focus on Costco and a 15.5%Amazon. The 51% increase in our packaged astaxanthin sales was primarily the result of an increase in sales to Costco. Sales growth at Amazon contributed to the 22% increase in our packaged spirulina sales. Compared to the fourth quarter of fiscal 2017, sales to Costco increased 100% and sales to Amazon increased 149%. Due to inventory shortages following low spirulina production in the fourth quarter of fiscal 2017, we were not able to fulfill all of the demand for packaged spirulina products this quarter. The 34% 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 inis primarily 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. Saleslack of bulkavailable 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.supply. International sales represented 23%27% of net sales for the three months ended December 31, 2016current quarter compared to 23%35% for the same period a year ago.last year. Two customers accounted for 36%made up 32% and 35%13% of total net sales for the three months ended December 31, 2016 and 2015,quarter, respectively.

 

Gross Profit GrossOur gross profit margin for the quarter decreased 3.3as a percent of net sales increased by 2.4 percentage points compared to the same period last year. The current period was favorably impacted by the higher mix of packaged sales this 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 indeliver a higher gross profit margin relates to higherpercent. Additionally, the current quarter reflect lower astaxanthin production costs per kilo, driven by the lowerresulting from improved production in the firstfourth quarter of fiscal 2017 compared to the fourth quarter of fiscal 2016. Astaxanthin production for the current quarter increased by over 20% compared to the same period last year as a result of new cultivation techniques and farm management practices that have been integrated over the last two quartersyears. These changes have resulted in stabilized open pond cultivation and improved consistency of this year.our production over recent quarters.

 

Operating Expenses Operating expenses increased by $242,000decreased $0.4 million (13%) for the first quarter of fiscal 2018 compared to the same period last year. Included in this is an increasefiscal 2017, primarily due to a reduction in legal fees.  Our sales and marketing expensesspending includes labor savings of 32% (+$424,000),$120,000, half of which includes $121,000was deployed back into marketing programs to drive sales growth in our areas 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).strategic focus.


 

Income Taxes We recorded an income tax expense of $27,000$11,000 in the current quarter with an effective tax rate of 2.1%, compared to income tax expensea benefit of $457,000$51,000 for the same period last year. Ourin fiscal 2017 with an effective tax rate was (8.4%) for the current quarter and 220.8% for the same period last year.of 6.8%. We establishedcontinue to carry a 100%full valuation allowance againston 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.asset.

 

Liquidity and Capital Resources

 

As of June 30, 2017, we had cash of $1.3 million and working capital of $6.8 million compared to $1.4 million and $6.0 million, respectively, at March 31, 2017. On August 30, 2016, the Credit Agreement, which we and First Foundation Bank (the Bank) entered into on June 3, 2016, became effective. The Credit Agreement allows us to borrow up to $2.0 million on a revolving basis. At June 30, 2017, we had borrowed $0.5 million and had $1.5 million available on the line. The line of credit is subject to renewal on August 30, 2017 and we are working proactively with the Bank to renew the line of credit or replace it with another line of credit on or before the expiration date. The Bank has issued a letter to us dated June 12, 2017 indicating it intends to renew the line of credit subject to approval by its credit committee.

As of June 30, 2017, we had $6.8 million of term loans payable to the Bank that require the payment of principal and interest monthly through August 2032. Pursuant to the term loans, we are subject to annual financial covenants, customary affirmative and negative covenants and certain subjective acceleration clauses. As of March 31, 2017 and 2016, our current ratio of 1.92:1 and 1.97:1, respectively, fell short of the Bank's annual requirement of 2.10:1. The Bank has provided us with letters stating they found us to be in compliance with this covenant requirement and all other financial covenants as of March 31, 2017 and 2016, and do not consider these shortfalls to be defaults under the Loan Agreement. 

Funds generated by operating activities and available cash continue to be our most significant sources of liquidity for working capital requirements, debt service and funding of maintenance levels of capital expenditures. Based upon our fiscal year 2018 operating plan and related cash flow projections and our projected consolidated financial position as of March 31, 2018, cash flows expected to be generated by operating activities and available financing are expected to be sufficient to fund our operations for at least the next twelve months, and our current ratio is expected to be in compliance with the annual term loan covenant requirement as of March 31, 2018. However, no assurances can be provided that we will achieve our operating plan and cash flow objectives for the next fiscal year ended March 31, 2018 or our projected consolidated financial position as of March 31, 2018. Such estimates are subject to change based on future results and such change could cause future results to vary significantly from expected results.


As indicated above, the Bank has not considered the shortfalls as of March 31, 2017 and 2016 in our current ratio relative to the covenant requirement to be violations of the Loan Agreements. However, in the event we have a shortfall under the Loan Agreements as of March 31, 2018 or future fiscal year ends, there is no assurance that the Bank will not consider such to be a violation of the Loan Agreements and pursue its rights under the arrangements to call for the repayment of the outstanding borrowings payable to the Bank. If this occurs, we may need to raise additional funds to repay the loans; however, we may not be able to secure such funding on acceptable terms, or at all.

Cash Flows

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

 

  

Nine months ended

December 31,

 
  

2016

  

2015

 

Total cash (used in) provided by:

        

Operating activities

 $892  $1,105 

Investing activities

  (508

)

  (3,547

)

Financing activities

  38   2,211 
         

Increase (decrease) in cash and cash equivalents

 $422  $(231

)


  

Three months ended June 30

 
  

2017

  

2016

 

Total cash provided by (used in):

        

Operating activities

 $210  $172 

Investing activities

  (56

)

  (170

)

Financing activities

  (262

)

  312 
         

(Decrease) increase in cash

 $(108) $314 

 

Cash provided by operating activities decreased $213,000for the three months ended June 30, 2017 was the result of net earnings, excluding non-cash charges, of $1.0 million and an increase in working capital of $0.8 million. The increase in working capital was primarily the result of a $0.5 million increase in accounts receivable due to higher sales in the current quarter compared to the same period last yearfourth quarter of fiscal 2017, and a $0.5 million decrease in accounts payable and accrued expenses resulting from timing of disbursements.

Cash provided by operating activities for the three months ended June 30, 2016 was the result of a net loss, excluding non-cash charges and credits, of $0.1 million offset by a decrease in working capital of $0.3 million. The decrease in working capital was primarily the result of a $0.7 million decrease in accounts receivable due primarily to a higher net lossdecrease in days sales outstanding and a reduction in outstanding payables, offset by an increase in depreciation and decreases in inventories and receivables. The prior period includedaccrued expenses related to the accrual of legal expenses, offset by a $1.6$0.5 million increase in work-in-process inventory as a result of the increase in packaged astaxanthin demand.inventory.

 

Cash used in investing activities infor the current period consisted primarily of smallthree months ended June 30, 2017 and June 30, 2016 includes costs for leasehold improvements and equipment purchases, whereas the prior period activity included the completion ofacquisitions at our extraction facility and an expansion of our production capacity.Kona facility.

 

Cash used in financing activities for the three months ended June 30, 2017 consists of $0.3 million in principal payments on debt in the normal course of business.

Cash provided by financing activities infor the current period includes an three months ended June 30, 2016 consists of a $0.6 million advance against our line of credit, offset by payment$0.14 million in principal payments on debt in the normal course of principal obligations, whereasbusiness and $0.15 million in taxes paid upon issuance of stock connected with the prior period includes the proceeds from a $2.5 million term loan used to fund the expansionseverance agreement of our production capacity.former CEO.

 

Sources and Uses of Capital

 

At JuneDecember 31, 2016, 30, 2017, our working capital was $6.4$6.8 million, a decreasean increase of $0.1$0.6 million compared to March 31, 2016. Cash and cash equivalents at December 31, 2016 totaled $1.7 million, an2017. The increase is due primarily to the reduction 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. trade payables.

 

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

Based upon our current operating plan, analysis of our consolidated financial position and projected future results of operations, we believe that our operating cash flows, generated by operating activitiescash balances, and available financingworking capital will be sufficient to fund our operationsfinance current operating requirements, debt service requirements, and routine planned capital expenditures, for at least the next twelve (12) 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 2017,2018, 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™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, 2016.2017.


 

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.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.June 30, 2017. 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.June 30, 2017.

 

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, 2016June 30, 2017 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

Limitations on the Effectiveness of Controls.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, 2016,2017, filed June 23, 2016.22, 2017.

 


 

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 JuneDecember 31, 2016. 30, 2017.

 

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 filedApril 6, 2017, after 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 2017session before Dispute Resolution & Prevention in Honolulu, Hawaii.Hawaii, the Company and Brent D. Bailey, our former Chief Executive Officer, entered into a Settlement Agreement (the “Settlement Agreement”) resolving all disputes between the Company and Mr. Bailey with respect to that certain Separation Agreement and Release of Claims, dated March 31, 2016. The Settlement Agreement is further described in our Form 8-K filed with the Securities and Exchange Commission on April 11, 2017.

 

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 of2017, which areis 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.None.

 


 

Item 6.    Exhibits

 

a)     The following exhibits are furnished with this report:

 

10.1

31.1Settlement Agreement, by and between Brent D. Bailey and the Company, dated April 6, 2017 (Incorporated by reference as Exhibit 10.1 to the Company’s Report on Form 8-K filed on April 11, 2017, File No. 0-14602)

31.1Certifications of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 signed as of February 7,August 10, 2017.

31.2

Certifications of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 signed as of February 7,August 10, 2017.

  

  

32

Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed as of February 7,August 10, 2017.

  

  

99.1

Press Release dated August February 7,10, 2017.

  

  

101

The following financial statements from Cyanotech Corporation’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2016,June 30, 2017, formatted in XBRL (eXtensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Operations, (iii) the Condensed Consolidated Statements of Cash Flows, and (iv) Notes to Condensed Consolidated Financial Statements.

 


 

SIGNATURES

 

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

 

  

  

CYANOTECH CORPORATION

  

  

(Registrant)

  

  

  

  

  

  

FebruaryAugust 7, 2017.10, 2017

  

By:

/s/ Gerald R. Cysewski

(Date)

  

  

Gerald R. Cysewski

  

  

  

President and Chief Executive Officer; Director

  

  

  

  

  

  

  

  

FebruaryAugust 7, 2017.10, 2017

  

By:

/s/ Jole E. Deal

(Date)

  

  

Jole E. Deal

  

  

  

Vice President — Finance & Administration and CFO

  

  

  

(Principal Financial and Accounting Officer)

 


 

EXHIBIT INDEX

 

Exhibit Number

  

Description

  

  

  

31.110.1

Settlement Agreement, by and between Brent D. Bailey and the Company, dated April 6, 2017 (Incorporated by reference as Exhibit 10.1 to the Company’s Report on Form 8-K filed on April 11, 2017, File No. 0-14602)

31.1Certifications of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 signed as of February 7,August 10, 2017.

31.2

  

Certifications of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 signed as of February 7,August 10, 2017.

  

  

  

32

  

Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed as of February 7,August 10, 2017.

  

  

  

99.1

  

Press Release dated August February 7,10, 2017.

  

  

  

101

  

The following financial statements from Cyanotech Corporation’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2016,June 30, 2017, formatted in XBRL (eXtensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Operations, (iii) the Condensed Consolidated Statements of Cash Flows, and (iv) Notes to Condensed Consolidated Financial StatementsStatements.

 

 

25

27