**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 

**Quarterly Report Under Section 13 or 15(d)of the Securities Exchange Act of 1934**

 

**For Quarterly PeriodEnded June 30, 2003**

 

**Commission FileNumber  0-14602**

 

**CYANOTECH CORPORATION**

(Exact name of registrant as specified in its charter)

 

| **NEVADA**                                                         |   | **91-1206026**                        |
|--------------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction  of incorporation or organization)    |   | (IRS Employer  Identification Number) |
|                                                               |   |                                  |
| **73-4460 Queen Kaahumanu Hwy. #102, Kailua-Kona, HI  96740** |
| (Address of principal executive offices)                           |
|                                                               |
| **(808) 326-1353**                                                 |
| (Registrant’s telephone number)                               |

 

Check whether the registrant (1) filed all reports required to be filedby Section 13 or 15(d) of the Exchange Act during the past 12 months (or forsuch 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  ý  No  o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act).   Yes  o  No  ý

 

Number ofcommon shares outstanding as of July 31, 2003

 

| **Title of  Class**                  |   | **Shares  Outstanding** |
|--------------------------------------|--------|-------------------------|
| Common stock - $.005 par value stock |   | 18,316,701              |

 

 

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CYANOTECH CORPORATION

FORM 10-Q

 

INDEX

 
| PART  I.   FINANCIAL INFORMATION                                                                        |
|-------------------------------------------------------------------------------------------------------------------|
|                                                                                                              |
| Item 1.  Financial Statements                                                                                |
|                                                                                                              |
| Consolidated Balance Sheets (unaudited)  June 30, 2003 and March 31, 2003                               |
|                                                                                                              |
| Consolidated Statements of Operations  (unaudited)  Three month periods ended  June 30, 2003 and 2002        |
|                                                                                                              |
| Consolidated Statements of Cash Flows  (unaudited)  Three month periods ended  June 30, 2003 and 2002        |
|                                                                                                              |
| Notes to Consolidated Financial Statements  (unaudited)                                                           |
|                                                                                                              |
| Item  2.  Management’s Discussion and Analysis  of Financial  Condition and Results of  Operations |
|                                                                                                              |
| Item 3.   Quantitative and Qualitative Disclosures About Market Risk                                         |
|                                                                                                              |
| Item 4.   Controls and Procedures                                                                            |
|                                                                                                              |
| PART II.  OTHER INFORMATION                                                                                  |
|                                                                                                              |
| Item 1.  Legal Proceedings                                                                                   |
|                                                                                                              |
| Item 6.   Exhibits and Reports on Form 8-K                                                                   |
|                                                                                                              |
| SIGNATURES                                                                                                        |

 

2

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PARTI. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

CYANOTECH CORPORATION

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands except share amounts)

(Unaudited)

 
|                                                                                                                                                 |   | **June 30,  2003** |   | **March 31,  2003** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|--------|--------------------------|--------|
| **Assets**                                                                                                                                           |   |                    |   |                     |   |
| Current assets:                                                                                                                                      |   |                    |   |                     |   |
| Cash and cash equivalents                                                                                                                            |   | $                       | 681    |                     | $      | 579 |   |
| Accounts receivable, net                                                                                                                             |   | 1,546                   |   | 1,839                    |   |
| Refundable income taxes                                                                                                                              |   | 27                      |   | 9                        |   |
| Inventories (note 2)                                                                                                                                 |   | 1,416                   |   | 1,400                    |   |
| Prepaid expenses                                                                                                                                     |   | 208                     |   | 40                       |   |
| Total current assets                                                                                                                                 |   | 3,878                   |   | 3,867                    |   |
|                                                                                                                                                 |   |                    |   |                     |   |
| Equipment and leasehold improvements,net (note 3)                                                                                                    |   | 12,489                  |   | 12,777                   |   |
| Other assets                                                                                                                                         |   | 816                     |   | 838                      |   |
| Total assets                                                                                                                                         |   | $                       | 17,183 |                     | $      | 17,482 |   |
|                                                                                                                                                 |   |                    |   |                     |   |
| **Liabilities and Stockholders’  Equity**                                                                                                       |   |                    |   |                     |   |
| Current liabilities:                                                                                                                                 |   |                    |   |                     |   |
| Current maturities of long-term debt                                                                                                                 |   | $                       | 323    |                     | $      | 323 |   |
| Accounts payable                                                                                                                                     |   | 737                     |   | 803                      |   |
| Accrued expenses                                                                                                                                     |   | 382                     |   | 389                      |   |
| Total current liabilities                                                                                                                            |   | 1,442                   |   | 1,515                    |   |
| Long-term debt, excluding currentmaturities                                                                                                          |   | 3,614                   |   | 3,694                    |   |
| Total liabilities                                                                                                                                    |   | 5,056                   |   | 5,209                    |   |
|                                                                                                                                                 |   |                    |   |                     |   |
| Stockholders’ equity:                                                                                                                           |   |                    |   |                     |   |
| Common Stock of $0.005 par value,authorized 25,000,000 shares; issuedand outstanding 18,316,701 shares atJune 30, 2003 and March 31,  2003 |   | 92                      |   | 92                       |   |
| Additional paid-in capital                                                                                                                           |   | 25,418                  |   | 25,418                   |   |
| Accumulated other comprehensive loss-foreign  currency translationadjustments                                                                        |   | (8                      | )      | (3                       | )      |
| Accumulated deficit                                                                                                                                  |   | (13,375                 | )      | (13,234                  | )      |
| Total stockholders’ equity                                                                                                                      |   | 12,127                  |   | 12,273                   |   |
| Total liabilities and stockholders’ equity                                                                                                      |   | $                       | 17,183 |                     | $      | 17,482 |   |

 

See accompanying notes toconsolidated financial statements.

 

3

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CYANOTECH CORPORATION

 

CONSOLIDATEDSTATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

 
|                                        |   | **Three  Months Ended  June 30,** |   |
|---------------------------------------------|--------|----------------------------------------|--------|
|                                        |   | **2003**                               |   | **2002** |   |
|                                        |   |                                   |   |   |   |
| NET SALES                                   |   | $                                      | 2,428  |   | $ | 2,032 |   |
| COST OF PRODUCT SALES                       |   | 1,724                                  |   | 1,247 |   |
| Gross Profit                                |   | 704                                    |   | 785 |   |
|                                        |   |                                   |   |   |   |
| OPERATING EXPENSES                          |   |                                   |   |   |   |
| Research and development                    |   | 38                                     |   | 101 |   |
| General and administrative                  |   | 407                                    |   | 585 |   |
| Sales and marketing                         |   | 309                                    |   | 538 |   |
| Total operating expenses                    |   | 754                                    |   | 1,224 |   |
|                                        |   |                                   |   |   |   |
| Loss from operations                        |   | (50                                    | )      | (439 | ) |
|                                        |   |                                   |   |   |   |
| OTHER INCOME (EXPENSE):                     |   |                                   |   |   |   |
| Interest income                             |   | 8                                      |   | 12 |   |
| Interest expense                            |   | (88                                    | )      | (124 | ) |
| Other expense, net                          |   | (29                                    | )      | (234 | ) |
| Total other expense                         |   | (109                                   | )      | (346 | ) |
|                                        |   |                                   |   |   |   |
| Loss before income taxes                    |   | (159                                   | )      | (785 | ) |
| INCOME TAX BENEFIT                          |   | 18                                     |   | C |   |
| NET LOSS                                    |   | $                                      | (141   | ) | $ | (785 | ) |
|                                        |   |                                   |   |   |   |
| NET LOSS PER COMMON SHARE                   |   |                                   |   |   |   |
| Basic and Diluted                           |   | $                                      | (0.01  | ) | $ | (0.05 | ) |
|                                        |   |                                   |   |   |   |
| SHARES USED IN CALCULATION OF:              |   |                                   |   |   |   |
| Basic and Diluted Net Loss Per Common Share |   | 18,317                                 |   | 17,259 |   |
| COMPREHENSIVE LOSS:                         |   |                                   |   |   |   |
| Net loss                                    |   | $                                      | (141   | ) | $ | (785 | ) |
| Other comprehensive loss                    |   | (5                                     | )      | — |   |
|                                        |   | $                                      | (146   | ) | $ | (785 | ) |

 

See accompanying notes to consolidated financial statements.

 

4

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CYANOTECH CORPORATION

CONSOLIDATED STATEMENTS OFCASH FLOWS

(Dollars in thousands)

(Unaudited)

 
|                                                                                         |   | **Three  Months Ended  June 30,** |   |
|----------------------------------------------------------------------------------------------|--------|----------------------------------------|--------|
|                                                                                         |   | **2003**                               |   | **2002** |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                        |   |                                   |   |   |   |
| Net loss                                                                                     |   | $                                      | (141   | ) | $ | (785 | ) |
| Adjustments to reconcile net loss to net cash  providedby (used in)  operating activities:   |   |                                   |   |   |   |
| Depreciation and amortization                                                                |   | 335                                    |   | 326 |   |
| Amortization of debt issue costs                                                             |   | 17                                     |   | 52 |   |
| Issuance and revision of warrants in connectionwith the extension of  convertible debentures |   | —                                 |   | 223 |   |
| Net (increase) decrease in:                                                                  |   |                                   |   |   |   |
| Accounts receivable                                                                          |   | 293                                    |   | (256 | ) |
| Inventories                                                                                  |   | (16                                    | )      | (231 | ) |
| Prepaid expenses and other assets                                                            |   | (168                                   | )      | 11 |   |
| Net increase (decrease) in:                                                                  |   |                                   |   |   |   |
| Accounts payable                                                                             |   | (66                                    | )      | 46 |   |
| Refundable income taxes                                                                      |   | (18                                    | )      | — |   |
| Accrued expenses                                                                             |   | (7                                     | )      | 122 |   |
| Net cash provided by (used in) operating  activities                                         |   | 229                                    |   | (492 | ) |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                        |   |                                   |   |   |   |
| Investment in equipment and leasehold improvements                                           |   | (47                                    | )      | (111 | ) |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                        |   |                                   |   |   |   |
| Debt issue costs                                                                             |   | —                                 |   | (59 | ) |
| Net proceeds from sale of common stock                                                       |   | —                                 |   | 350 |   |
| Principal payments on long-term debt                                                         |   | (80                                    | )      | (73 | ) |
| Net cash provided by (used in) financing  activities                                         |   | (80                                    | )      | 218 |   |
| Net increase (decrease) in cash and cash  equivalents                                        |   | 102                                    |   | (385 | ) |
| Cash and cash equivalents at beginning of period                                             |   | 579                                    |   | 1,051 |   |
| Cash and cash equivalents at end of period                                                   |   | $                                      | 681    |   | $ | 666 |   |

 

See accompanying notes to consolidated financial statements.

 

5

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**CYANOTECH CORPORATION**

FORM 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2003

(Unaudited)

 

1.                                       BASIS OF PRESENTATION

 

The accompanying unaudited consolidated financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States of America for interim financial information and with theinstructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all of the information and footnotesrequired by generally accepted accounting principles for complete financialstatements.  These consolidatedfinancial statements and notes should be read in conjunction with the Company’sconsolidated financial statements contained in the Company’s previously filedreport on Form 10-K for the year ended March 31, 2003.

 

The Company consolidates enterprises in which it has a controllingfinancial interest. The accompanying consolidated financial statements includethe accounts of Cyanotech Corporation and its wholly-owned subsidiaries,Nutrex-Hawaii, Inc. and Cyanotech Japan YK. All significant intercompany balances and transactions have beeneliminated in consolidation. While the financial information furnished as ofand for the three month period ended June 30, 2003 is unaudited, thestatements in this report reflect all material items which, in the opinion ofmanagement, are necessary for a fair presentation of the results of operationsfor the interim periods covered and of the financial condition of the Companyat the dates of the consolidated balance sheets. The operating results for theinterim period presented are not necessarily indicative of the results that maybe expected for the year ending March 31, 2004.

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements, and the reported amounts of revenuesand expenses during the reporting period. Actual results could differ significantly from those estimates.

 

2.                                       INVENTORIES

 

Inventories are stated at the lower of cost (which approximatesfirst-in, first-out) or market and consist of the following (dollars inthousands):

 
|            |   | **June 30,  2003** |   | **March 31,  2003** |   |
|-----------------|--------|-------------------------|--------|--------------------------|--------|
| Raw materials   |   | $                       | 170    |                     | $      | 161 |   |
| Work in process |   | 112                     |   | 117                      |   |
| Finished goods  |   | 1,016                   |   | 1,028                    |   |
| Supplies        |   | 118                     |   | 94                       |   |
|            |   | $                       | 1,416  |                     | $      | 1,400 |   |

 

6

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3.                                       EQUIPMENT AND LEASEHOLD IMPROVEMENTS

 

Owned equipment and leasehold improvements are stated at cost.Depreciation and amortization are provided using the straight-line method overthe estimated useful lives for furniture and fixtures and the shorter of thelease terms or estimated useful lives for leasehold improvements as follows:

 
| Equipment              |   | 3 to 10 years  |   |
|------------------------|--------|----------------|--------|
| Leasehold improvements |   | 10 to 23 years |   |
| Furniture and fixture  |   | 7 years        |   |

 

Equipment and leasehold improvements consist of the following (dollarsin thousands):

 
|                                           |   | **June 30,  2003** |   | **March 31,  2003** |   |
|------------------------------------------------|--------|-------------------------|--------|--------------------------|--------|
| Equipment                                      |   | $                       | 9,675  |                     | $      | 9,631 |   |
| Leasehold improvements                         |   | 14,305                  |   | 14,173                   |   |
| Furniture and fixtures                         |   | 83                      |   | 83                       |   |
|                                           |   | 24,063                  |   | 23,887                   |   |
| Less accumulated depreciation and amortization |   | (11,674                 | )      | (11,341                  | )      |
| Construction in-progress                       |   | 100                     |   | 231                      |   |
| Equipment and leasehold improvements, net      |   | $                       | 12,489 |                     | $      | 12,777 |   |

 

4.                                       EARNINGS PER SHARE

 

For the three months ended June 30, 2003 and 2002, warrants andoptions to purchase Common Stock of the Company and convertible debentures wereoutstanding, but were not included in the computation of Diluted net loss percommon share because the inclusion of these securities would have had anantidilutive effect on the net loss per common share.  As of June 30, 2003, warrants and options to acquire1,192,530 shares of the Company’s common stock and debentures convertible into1,923,077 shares of the Company’s common stock were outstanding.  As of June 30, 2002, warrants andoptions to acquire 1,267,530 shares of the Company=s common stock and debentures convertibleinto 1,238,000 shares of the Company=s common stock were outstanding.

 

5.                                       RECENT ACCOUNTING PRONOUNCEMENTS

 

**Accountingfor Asset Retirement Obligations**   In June 2001, the Financial Accounting StandardsBoard (“FASB”) issues Statement of Financial Accounting Standards (“SFAS”) No.143, “Accounting for Asset Retirement Obligations,” which requires that thefair value of a liability for an asset retirement obligation be recognized inthe period in which it is incurred if a reasonable estimate of fair value canbe made.  The associated assetretirement costs would be capitalized as part of the carrying amount of thelong-lived asset and depreciated over the life of the asset.  The liability is accreted at the end of eachperiod through charges to operating expense. If the obligation is settled for other than the carrying amount of theliability, the Company will recognize a gain or loss on settlement.  The provisions of SFAS No. 143 are effectivefor fiscal years beginning after June 15, 2002.  The adoption of SFAS No. 143 did not have a material effect onthe Company’s financial condition, results of operations or liquidity.

 

7

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**Accountingfor Certain Financial Instruments with Characteristics of Both Liabilities andEquity**   InMay 2003, the FASB issued SFAS No. 150. “Accounting for Certain FinancialInstruments with Characteristics of Both Liabilities and Equity.”  SFAS No. 150 requires issuers to classify asliabilities (or assets in some circumstance) three classes of freestandingfinancial instruments that embody obligations for the issuer.  Generally, SFAS No. 150 is effective forfinancial instruments entered into or modified after May 31, 2003 and isotherwise effective at the beginning of the first interim period beginningafter June 15, 2003.  Adoption ofSFAS No. 150 is not expected to have a material effect on the Company’sfinancial condition, results of operations or liquidity.

 

6.                                       GOING CONCERN

 

The accompanying unaudited consolidated financial statements have beenprepared on a going concern basis, which assumes continuity of operations andrealization of assets and liquidation of liabilities in the ordinary course ofbusiness.  During the years endedMarch 31, 2003, 2002 and 2001, the Company incurred losses of $1,775,000,$2,589,000 and $1,067,000, respectively. The Company=s working capital at June 30, 2003 was$2,436,000 with cash and cash equivalents amounting to $681,000.  Net cash and cash equivalents used inoperating activities for the years ended March 31, 2003 and 2002 amountedto $502,000 and $567,000, respectively.

 

The Company=s continuation as a going concern isdependent upon its ability to generate sufficient cash flow to meet itsobligations on a timely basis, to comply with the terms of its financingagreements, to obtain additional financing or refinancing as may be required,to attain profitability, or a combination thereof.  There can be no assurance that these efforts will be successfulor that the Company will have sufficient cash resources to support its futureoperations.  The accompanying unauditedconsolidated financial statements do not include any adjustments that mightresult from the outcome of this uncertainty.

 

7.                                       SUBSEQUENT EVENT

 

In May 2003, the Company applied with one of its long-term debtlenders for release of all, or a portion of $500,000 of restricted funds heldin reserve. In July 2003, the Company received approval of the release of$250,000. On July 29, 2003, the funds were received.  These restricted amounts are classified inthe consolidated balance sheets at June 30, 2003 and March 31, 2003as other assets. Use of these released funds is unrestricted.  The Company intends to use these funds forworking capital purposes.

 

8.                                       STOCK-BASED COMPENSATION

 

The Company applies the provisions of Accounting Principles BoardOpinion No. 25 in accounting for stock-based compensation and adopted thedisclosure-only provisions of Statement of Financial Accounting Standards No.123, “Accounting for Stock-Based Compensation.”  Had compensation cost for stock options granted been determinedbased on the fair value method for measuring stock-based compensation provisionsof Statement of Financial Accounting Standards No. 123, the Company’s net lossand basic and diluted net loss per common share would have been as follows:

 

8

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|                                                                                |   | **Three  months ended  June 30,** |   |
|-------------------------------------------------------------------------------------|--------|----------------------------------------|--------|
|                                                                                |   | **2003**                               |   | **2002** |   |
| Net loss, as reported                                                               |   | $                                      | (141   | ) | $ | (785 | ) |
| Less stock-based employee compensation  determined under the fair value method |   | (21                                    | )      | (20 | ) |
| Pro-forma net loss                                                                  |   | $                                      | (162   | ) | $ | (805 | ) |
|                                                                                |   |                                   |   |   |   |
| Basic and Diluted Net Loss Per Common Share:                                        |   |                                   |   |   |   |
| As reported                                                                         |   | $                                      | (0.01  | ) | $ | (0.05 | ) |
| Pro forma                                                                           |   | $                                      | (0.01  | ) | $ | (0.05 | ) |

 

9

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**CYANOTECH CORPORATION**

 

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

 

*This report on Form 10-Q contains forward-lookingstatements regarding the future performance of Cyanotech and future events thatinvolve risks and uncertainties that could cause actual results to differmaterially from the statements contained herein. This document, and the otherdocuments that the Company files from time to time with the Securities andExchange Commission, such as its reports on Form 10-K, Form 10-Q, Form 8-K, andits proxy materials, contain additional important factors that could causeactual results to differ from our current expectations and the forward-lookingstatements contained herein.*

 

**Going Concern**

 

The accompanying unaudited consolidated financial statements have beenprepared on a going concern basis, which assumes continuity of operations andrealization of assets and liquidation of liabilities in the ordinary course ofbusiness.  During the years endedMarch 31, 2003, 2002 and 2001, the Company incurred losses of $1,775,000,$2,589,000 and $1,067,000, respectively. The Company=s working capital at June 30, 2003 was$2,436,000 with cash and cash equivalents amounting to $681,000.  Net cash and cash equivalents used inoperating activities for the years ended March 31, 2003 and 2002 amountedto $502,000 and $567,000, respectively.

 

The Company=s continuation as a going concern isdependent upon its ability to generate sufficient cash flow to meet itsobligations on a timely basis, to comply with the terms of its financingagreements, to obtain additional financing or refinancing as may be required,to attain profitability, or a combination thereof.  There can be no assurance that these efforts will be successfulor that the Company will have sufficient cash resources to support its futureoperations.  The accompanying unauditedconsolidated financial statements do not include any adjustments that mightresult from the outcome of this uncertainty.

 

**Critical Accounting Policies**

 

In response to the Security and Exchange Commission (“SEC”) Release No.33-8040, “Cautionary Advice Regarding Disclosure about Critical AccountingPolicies,” the Company has identified certain of its policies as being ofparticular importance to the understanding of its financial position andresults of operations and which require the application of significant judgmentby Cyanotech management.  We determinedthe critical principles by considering accounting policies that involve themost complex or subjective decisions or assessments.  We identified our most critical accounting policies to be thoseprinciples related to inventory valuation, revenue recognition, equipment andleasehold improvements, income taxes and impairment of long-lived assets.  We state these accounting policies in thenotes to the consolidated financial statements in the Company=s previously filed report on Form 10-K forthe fiscal year ended March 31, 2003. This discussion and analysis should be read in conjunction with ourconsolidated financial statements and related notes included elsewhere in thisreport.

 

**Contractual Obligations**

 

See AContractual Obligations@ in AManagement=s Discussion and Analysis of FinancialCondition and Results of Operations@ incorporated by reference in the Company=s annual report on Form 10-K for the yearended March 31, 2003.  There havebeen no significant changes in contractual obligations from March 31, 2003to June 30, 2003 other than those reported elsewhere in this Form 10-Q.

 

10

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**Results of Operations**

 

The following table sets forth certain consolidated statement ofoperations data as a percentage of net sales for the periods indicated:

 
|                       |   | **Three  Months Ended  June 30,** |   |
|----------------------------|--------|----------------------------------------|--------|
|                       |   | **2003**                               |   | **2002** |   |
| Net sales                  |   | 100.0                                  | %      | 100.0 | % |
| Cost of product sales      |   | 71.0                                   |   | 61.4 |   |
| Gross profit               |   | 29.0                                   |   | 38.6 |   |
| Operating expenses:        |   |                                   |   |   |   |
| Research and development   |   | 1.6                                    |   | 4.9 |   |
| General and administrative |   | 16.8                                   |   | 28.8 |   |
| Sales and marketing        |   | 12.7                                   |   | 26.5 |   |
| Total operating expenses   |   | 31.1                                   |   | 60.2 |   |
| Loss from operations       |   | (2.1                                   | )      | (21.6 | ) |
| Other income (expense):    |   |                                   |   |   |   |
| Interest income            |   | 0.3                                    |   | 0.6 |   |
| Interest expense           |   | (3.6                                   | )      | (6.1 | ) |
| Other income, net          |   | (1.2                                   | )      | (11.5 | ) |
| Total other expense        |   | (4.5                                   | )      | (17.0 | ) |
| Loss before income taxes   |   | (6.6                                   | )      | (38.6 | ) |
| Income tax benefit         |   | 0.8                                    |   | — |   |
| Net loss                   |   | (5.8                                   | )%     | (38.6 | )% |

 

**First Quarter of Fiscal 2004 Compared to First Quarterof Fiscal 2003**

 

*Net Sales*

 

Net sales for the three month period ended June 30, 2003 were$2,428,000, an increase of 19% from the $2,032,000 recorded in the comparableperiod in fiscal 2003.  This increase isprimarily due to higher sales volume of all bulk products, offset in part by reducedsales volume of packaged consumer products.

 

Foreign sales accounted for 56% of total sales during the quartercompared to 52% reported for the comparable period of the prior fiscalyear.  Sales to Spirulina InternationalB.V.(“SI”), a European distributor of natural products and our largest customerwere comparable in amount to that reported for the same prior year period.  However, due to increased sales thiscustomer accounted for only 16% of net sales compared to 21% for the comparableprior fiscal year period.

 

*Gross Profit*

 

Gross profit represents net sales less the cost of goods sold, whichincludes the cost of materials, manufacturing overhead costs, direct laborexpenses and depreciation and amortization. Gross profit for the three monthsended June 30, 2003 decreased 10% from the $785,000 reported in the sameprior year period.  Our gross profitmargin also decreased from 39% for the three month period ended June 30,2002 to 29% for the three month period ended June 30, 2003.

 

11

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This reduced gross profit is primarily attributable to a finished goodsloss resulting from a contractual extraction facility problem which has sincebeen remedied, and other increased production costs incurred in preparation forhigher-growth summer months.

 

*Operating Expenses*

 

Operating expenses for the quarter ended June 30, 2003 amounted to$754,000, a decrease of 38% from the comparable prior year period.  This is due to decreased expenditures in allcategories due to the Company’s ongoing cost containment program.

 

*Research and Development*                                            Research and development expenses for thefirst quarter of fiscal 2004 amounted to $38,000, a decrease of 62% from$101,000 reported for the comparable period of fiscal 2003.  This decrease is due to reduced outsideservice expenses for scientific clinical trials.

 

*General and Administrative*                                         General and administrative expenses for thefirst quarter of fiscal 2004 amounted to $407,000, a decrease of 30% from$585,000 reported for the comparable period of fiscal 2003.  Reduced bad debt expenses and outsideservice costs accounted for nearly all of this decrease.

 

*Sales and Marketing*                              Sales and marketing expenses for the firstquarter of fiscal 2004 of $309,000 were a decrease of 43% from the $538,000reported for the comparable period of fiscal 2003.  This category’s expenses for the prior fiscal year included$110,000 for production of a television infomercial, abandoned late in fiscal2003.

 

*Other Expense*

 

Other expense for the first quarter of fiscal 2004 amounted to$109,000, a decrease of  69% from thesame prior year period.  This decreaseis primarily attributable to $235,000 of costs recognized in the prior fiscalyear quarter related to extension of the maturity date of subordinatedconvertible debentures issued in May 2000.  If these expenses are omitted from the prior fiscal year figuresfor comparison purposes, Other Expense for the first quarter of fiscal 2003would have amounted to $111,000.

 

*Income Taxes*

 

A provision for estimated state income tax refunds of $18,000 wasrecorded for the three months ended June 30, 2003. During the comparableprior year quarter, no refunds were due the Company.

 

*Net Loss*

 

The Company recorded a net loss of $141,000 for the first quarter of fiscal2004, an improvement in result of 82% over the loss of $785,000 reported forthe first quarter of fiscal 2003.  Thechange is primarily attributable to the elimination of the prior fiscal yearperiod’s expenses related to the subordinated convertible debenture maturityextension and the television infomercial costs and an overall reduction ofoperating expenses in the current period.

 

12

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**Variability of Results**

 

The Company has experienced significant quarterly fluctuations inoperating results and anticipates that these fluctuations may continue infuture periods. Future operating results may fluctuate as a result of changesin sales levels to our largest customers, new product introductions, productiondifficulties, weather patterns, the mix between sales of bulk products andpackaged consumer products, start-up costs associated with new facilities,expansion into new markets, sales promotions, competition, increased energycosts, the announcement or introduction of new products by competitors, changesin our customer mix, overall trends in the market for our products, governmentregulations and other factors beyond our control.  While a significant portion of our expense levels are relativelyfixed, and the timing of increases in expense levels is based in large part onforecasts of future sales, if net sales are below expectations in any givenperiod, the adverse impact on results of operations may be magnified by ourinability to adjust spending quickly enough to compensate for the salesshortfall. We may also choose to reduce prices or increase spending in responseto market conditions, which may have a material adverse effect on our financialcondition and results of operations.

 

**Liquidity and Capital Resources**

 

Working capital at June 30, 2003 amounted to $2,436,000, a slightincrease over the $2,352,000 reported at March 31, 2003.  Cash and cash equivalents increased by$102,000 to $681,000 from the $579,000 reported at March 31, 2003.  This increase in working capital resultedprimarily from increased cash and cash equivalents and decreased balances ofaccounts receivable, offset in part by higher balances of prepaid expenses anddecreased balances of accounts payable.

 

Cash provided by operating activities during the first three months offiscal 2004 amounted to $229,000 compared to cash used in operating activitiesof $492,000 for the comparable prior year period.  The primary source of cash flows during the quarter endedJune 30, 2003 was collections of accounts receivable (reduced balances) of$293,000, the net effect of the net loss as adjusted for non-cash depreciationand amortization expense (amounting to net positive cash flows of $196,000),offset in part by increases in prepaid expenses and other assets of $168,000.

 

Cash used in investing activities (representing capital expendituresfor production equipment) during the first three months of fiscal 2004 amountedto $47,000, a decrease of 58% from the $111,000 reported for the comparable prioryear period.

 

Cash used in financing activities during the first three months offiscal 2004 amounted to $80,000 and is attributable to repayments of long-termdebt.  This compares to $218,000provided by financing activities for the comparable prior year period. Theprimary source of cash flows from financing activities during the first quarterof the prior fiscal year was proceeds from the sale of restricted common stockof approximately $350,000, offset by principal payments of long-term debt of$73,000 and debt issue costs of $59,000.

 

*Term Loan Agreement*

 

On April 21, 2000, the Company executed a Term Loan Agreement (ATerm Loan@) with a lender which provided for up to $3.5million in credit facilities, secured by substantially all the assets of the Company.  The Term Loan has a maturity date ofMay 1, 2010 and is payable in 120 equal monthly principal and interestpayments of approximately $40,000, commencing June 1, 2000.  The interest rate under this Term Loan, inthe absence of a default under the agreement, is the prime rate, as defined, ineffect as of the close of business on the first day of each calendar quarter,plus 1% (at June 30, 2003, the prime rate was 4.25%).  Interest is calculated on the unpaid balanceof principal based on a straight-line amortization schedule which commencedMay 1, 2000.  Of the loan proceeds,$500,000 has been deposited in an interest-bearing restricted cash account perthe terms of the loan, with such amount included in Other 

 

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Assets in the consolidated balance sheets at June 30, 2003 andMarch 31, 2003.  In July 2003,$250,000 of this balance was released by the lender for use by the Company forworking capital purposes (See Note 7. Subsequent Event in the section entitled“Notes to Consolidated Financial Statements” in this report).  A warrant to purchase 20,000 shares of theCompany’s common stock was issued in conjunction with this Term Loan agreement.  The warrant expires in April 2011 andhas an exercise price of $2.55 per share. The warrant may only be exercised after the Company has repaid the TermLoan in full.

 

*Convertible Debentures due September 30, 2004*

 

In October 2002, the Company issued in a private placement (a)$1,250,000 principal amount of 10% convertible subordinated debentures, dueSeptember 30, 2004, convertible into shares of the Company’s common stockat a price of $0.65 per share and (b) 750,000 shares of Common Stock withproceeds to the Company of $300,000. Proceeds from the 10% convertible subordinated debentures issued inOctober were used to retire convertible debentures of $1,238,000 whichwere due to mature on October 31, 2002. The remaining net proceeds from the issuance of Common Stock was usedfor working capital purposes.  Subsequentto the transaction, the investor was elected to the Company’s Board ofDirectors.

 

**Recent Accounting Pronouncements**

 

In June 2001, the Financial Accounting Standards Board (“FASB”)issues Statement of Financial Accounting Standards (“SFAS”) No. 143, “Accountingfor Asset Retirement Obligations,” which requires that the fair value of aliability for an asset retirement obligation be recognized in the period inwhich it is incurred if a reasonable estimate of fair value can be made.  The associated asset retirement costs wouldbe capitalized as part of the carrying amount of the long-lived asset anddepreciated over the life of the asset. The liability is accreted at the end of each period through charges tooperating expense.  If the obligation issettled for other than the carrying amount of the liability, the Company willrecognize a gain or loss on settlement. The provisions of SFAS No. 143 are effective for fiscal years beginningafter June 15, 2002.  The adoptionof SFAS No. 143 did not have a material effect on the Company’s financialcondition, results of operations or liquidity.

 

In May 2003, the FASB issued SFAS No. 150. “Accounting for CertainFinancial Instruments with Characteristics of Both Liabilities andEquity.”  SFAS No. 150 requires issuersto classify as liabilities (or assets in some circumstance) three classes offreestanding financial instruments that embody obligations for the issuer.  Generally, SFAS No. 150 is effective forfinancial instruments entered into or modified after May 31, 2003 and isotherwise effective at the beginning of the first interim period beginningafter June 15, 2003.  Adoption ofSFAS No. 150 is not expected to have a material effect on the Company’s financialcondition, results of operations or liquidity.

 

**Other Material Events**

 

Subsequent Event - ISO 9001:2000 Certification

 

In July 2003, the Company applied for, and received certificationunder the newly promulgated ISO 9001:2000 guidelines.  Previously, the Company had been certified since 1995 under the ISO9001:1994 guidelines which are due to be superceded in December 2003 forall like manufacturers by the new ISO 9001:2000 standards.

 

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*CommonStock Listing*

 

During fiscal 2002, the Company’s Common Stock was traded on the NASDAQNational Market (“National Market”).  OnJune 17, 2002 the Company received a delisting warning letter from NASDAQfor failure to comply with the $1.00 per share minimum bid price.  Cyanotech had 90 calendar days, or untilSeptember 16, 2002, to regain compliance. The Company was unable to regain compliance prior to September 16,2002, and subsequently applied for, and received listing for its Common Stockon the NASDAQ SmallCap Market (“SmallCap”).

 

Listing on the NASDAQ SmallCap provided the Company a 180 calendar daygrace period, or until December 16, 2002 to regain compliance.  The Company failed to regain compliancebefore the end of this grace period but was eligible for an additional 180calendar day grace period, or until June 12, 2003, to demonstratecompliance, provided that it met NASDAQ listing criteria for the SmallCap.  The Company was unable to attain the $1.00per share value prior to June 12, 2003 but met the other listing criteriafor the SmallCap.  On June 13, 2003,the Company received notification from NASDAQ that under Marketplace Rule4210(c)(2)(A), the compliance period for listing on the SmallCap was extendedfrom 360 to 450 calendar days for companies which met certain heightenedcriteria.  The Company met the initiallisting requirements and in accordance with Marketplace Rule 4310(c)(8)(D), hasbeen provided with an additional 90 calendar days, or until September 10,2003 to regain compliance with the $1.00 per share minimum bid pricerequirement.

 

As of the date of this report, the Company’s Common Stock continues tobe listed on the NASDAQ SmallCap under symbol “CYAN”.  If at anytime before September 10, 2003, the bid price ofthe Company’s Common Stock closes at $1.00 per share or more for a minimum of10 consecutive trading days, NASDAQ Staff will provide written notificationthat the Company complies with listing requirements under Marketplace Rule4450(a)(5).  Under certaincircumstances, to ensure that the Company can sustain long-term compliance, NASDAQStaff may require that the closing bid price equals $1.00 per share or greaterfor more than 10 consecutive business days, but, generally, not more than 20consecutive business days before determining that the Company complies.  If compliance with this rule cannot bedemonstrated by September 10, 2003, NASDAQ Staff will provide writtennotification that the Company’s securities will be delisted from the SmallCapand begin trading on the NASDAQ Over-The-Counter Bulletin Boards (“OTC”).  In such case Common Stock of the Companywill be traded on a less active market to the possible detriment of thestockholders.  At that time, the Companymay appeal the NASDAQ Staff’s determination to a Listing Qualifications Panel.

 

**Outlook**

 

*This outlook section contains a number offorward-looking statements, all of which are based on current expectations.Actual results may differ materially. See also the discussion of going concern uncertainty at the beginning ofthis Item 2.*

 

Cyanotech=s strategy has been, and continuesto be, to successfully produce and market, high-value natural products frommicroalgae.  Our current line of productofferings include Certified Organic and Naturally Cultivated Spirulina Pacificain powder, flake and tablet form, NatuRose natural astaxanthin powder for theanimal nutrition market, BioAstin natural astaxanthin in lipid extract form andmicro-encapsulated beadlets for the human nutrition and cosmetic industries andPhycobiliproteins for use in medical diagnostics.  Information about our Company and our products can be viewed atwww.cyanotech.com, www.nutrex-hawaii.com or www.phycobiliprotein.com.  Consumer products can be purchased online atwww.nutrex-hawaii.com.

 

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Results from the first quarter of fiscal 2004 indicate that we arecontinuing our progress towards profitability, despite the net losses incurred.The quarter ended June 30, 2003 is the third consecutive quarter whichresulted in sales above $2.4 million and gross profit in excess of$700,000.  Our ongoing cost containmentefforts have reduced our Company’s operating expenses which contribute to ourimproved bottom line result. Concurrently, due to continued efforts atimproving our production yields we have maintained our ability to cultivate andmanufacture our high quality products at the levels needed to serve ourcustomers.

 

During the quarter ended June 30, 2003, Cyanotech Japan YK(“Cyanotech Japan”), again reported increased sales of NatuRose in the Japaneseaquaculture feed market over the levels achieved in the prior fiscalquarter.  Although we expect someseasonality effect on demand from quarter to quarter, we believe the trend ofincreasing sales through this subsidiary will continue into future quarters.

 

Our efforts in the human application market for BioAstin naturalastaxanthin are continuing to show promising results. We are working closelywith industry-leading cosmetic manufacturers, pharmaceutical companies offeringbranded nutraceuticals, direct marketing organizations and natural foodsupplement manufacturers to integrate our BioAstin natural astaxanthin intotheir offerings.

 

The Company’s future results of operations and the otherforward-looking statements contained in this Outlook, in particular the statementsregarding revenues, gross margin, research and development, and capitalspending, involve a number of risks and uncertainties. In addition to thefactors discussed above that could cause actual results to differ materiallyare the following: business conditions and growth in the natural productsindustry and in the general economy; changes in customer order patterns,outcome of the clinical trials for *BioAstin*,and changes in demand for natural products in general; changes in weatherconditions; competitive factors, such as competing Spirulina and astaxanthinproducers increasing their production capacity and their impact on world marketprices for Spirulina and astaxanthin; government actions; shortage ofmanufacturing capacity; and other factors beyond our control.  Risk factors are discussed in detail inexhibit 99.1, hereto included in this report.

 

Cyanotechbelieves that it has the product offerings, facilities, personnel, andcompetitive and financial resources for improved results, but future revenues,costs, margins and profits are all influenced by many factors, as discussedabove, all of which are inherently difficult to forecast.

 

**Item3.  Quantitative and QualitativeDisclosures About Market Risk**

 

We have not entered into any transactions using derivative financialinstruments or derivative commodity instruments and believe that our exposureto market risk associated with other financial instruments is not material.

 

**Item 4. Controls and Procedures**

 

In accordance with Item 307 of Regulation S-K promulgated by theSecurities and Exchange Commission, the Chairman of the Board, President andChief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”) of theCompany (the “Certifying Officers”) have conducted an evaluation of the Company’sdisclosure controls and procedures as of June 30, 2003.  As defined under Sections 13a-15(e) and15d-15(e) of the Securities Exchange Act of 1934, as amended (the “ExchangeAct”), the term “disclosure controls and procedures” means controls and otherprocedures of an issuer that are designed to ensure that information requiredto be disclosed by the issuer in the reports that it files or submits under theExchange Act is recorded, processed, summarized and reported, within the timeperiods specified in the Commission’s rules and forms.  Disclosure controls and procedures include,without 

 

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limitation, controls and procedures designed to ensure that informationrequired to be disclosed by an issuer in the reports that it files or submitsunder the Exchange Act is accumulated and communicated to the issuer’smanagement, including its principal executive officer or officers and principalfinancial officer or officers, or persons performing similar functions, asappropriate to allow timely decisions regarding required disclosure.

 

Based on that evaluation, the CEO and CFO have concluded that theCompany’s disclosure controls and procedures are effective to ensure that theinformation required to be disclosed by the Company in reports that it files orsubmits under the Exchange Act is recorded, processed, summarized and reportedwithin the time periods specified in Securities and Exchange Commission rulesand forms.  Subsequent to the date oftheir evaluation, there were no significant changes in the Company’s internalcontrols or in other factors that could significantly affect the disclosurecontrols, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

**PART II.****                                               ****OTHER INFORMATION**

 

Item 1.                                                             Legal Proceedings.

 

None

 

Item 6.                                                             Exhibits and Reports on Form 8-K

 

(a)                                  The following exhibits are furnished withthis report:

 

31.1             Certification by the Chief Executive Officerpursuant to Rule 13a-14(a) / 15d-14(a) of the Exchange Act.

 

31.2             Certification by the Chief Financial Officerpursuant to Rule 13a-14(a) / 15d-14(a) of the Exchange Act.

 

32.1             Certification by the Chief Executive Officerpursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

 

32.2             Certification by the Chief Financial Officerpursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

 

99.1             Risk Factors

 

(b)                                 Reports on Form 8-K

 

No reports on Form 8-K were filed during the quarter endedJune 30, 2003.

 

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**SIGNATURES**

 

In accordance with the requirements of the Securities Exchange Act of1934, the registrant caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 
|                 | CYANOTECH  CORPORATION (Registrant) |
|----------------------|-------------------------------------|
|                 |                                |
|                 |                                |
| August 12, 2003 |                                | By: | /s/  Gerald R. Cysewski |   |
| (Date)               |                                |   | Gerald  R. Cysewski |   |
|                 |                                | Chairman  of the Board, |   |
|                 |                                | President  and Chief Executive Officer |   |
|                 |                                |   |
|                 |                                |   |
|                 | By:                                 | /s/  Jeffrey H. Sakamoto |   |
|                 |                                | Jeffrey  H. Sakamoto |
|                 |                                | Vice  President - Finance & Administration  (Principal Financial and Accounting Officer) |
|                      |                                     |  |  |  |  |  |  |

 

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