**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

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

 

**For Quarterly Period Ended June 30, 2005**

 

** CommissionFile Number 0-14602**

 

**CYANOTECH CORPORATION**

(Exact name of registrant as specified in its charter)

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

 

**73-4460 Queen Kaahumanu Hwy. #102, Kailua-Kona,HI  96740**

(Address ofprincipal executive offices)

 

**(808) 326-1353**

(Registrant’s telephone number)

 

Check whether the registrant (1) filed all reportsrequired to be filed by Section 13 or 15(d) of the Exchange Act during the past12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

Yes ý No o

 

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

 

Number of common sharesoutstanding as of July 31, 2005:

 
| **Title of  Class**             | ** ** | **Shares  Outstanding** |
|---------------------------------|------------|-------------------------|
| Common stock -  $.005 par value |       | 20,896,265              |

 

 

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CYANOTECH CORPORATION

FORM 10-Q

 

INDEX

 
| PART I.  FINANCIAL INFORMATION |                                                                                                                                   |
|--------------------------------|----------------------------------------------------------------------------------------------------------------------------------------|
|                           |                                                                                                                                   |   |
| Item 1.                        | Financial Statements                                                                                                                   |   |
|                           |                                                                                                                                   |   |
|                           | Consolidated Balance Sheets  (unaudited)  As of June 30, 2005 and March 31, 2005                                                       |   |
|                           |                                                                                                                                   |   |
|                           | Consolidated Statements of  Operations  and Comprehensive Income (unaudited)  For the three month periods ended June 30, 2005 and 2004 |   |
|                           |                                                                                                                                   |   |
|                           | Consolidated Statements of  Cash Flows (unaudited)  For the three month periods ended  June 30, 2005 and 2004                          |   |
|                           |                                                                                                                                   |   |
|                           | 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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PART 1. FINANCIAL INFORMATION

Item 1. Financial Statements

 

CYANOTECHCORPORATION

CONSOLIDATEDBALANCE SHEETS

(Dollars inthousands except per share amounts)

(Unaudited)

 
| ** **                                                                                                                                     | ** ** | **June 30,  2005** | ** ** | **March 31,  2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|---------------------|------------|
| ASSETS                                                                                                                                         |       |               |       |                |       |
| Current  assets:                                                                                                                               |       |               |       |                |       |
| Cash  and cash equivalents                                                                                                                     |       | $                  | 1,743      |                | $          | 2,005 |   |
| Short-term  investments                                                                                                                        |       | 1,000              |       | 1,000               |       |
| Accounts  receivable, net                                                                                                                      |       | 2,371              |       | 2,069               |       |
| Refundable  income taxes                                                                                                                       |       | 51                 |       | 97                  |       |
| Inventories  (see Note 3)                                                                                                                      |       | 1,589              |       | 1,565               |       |
| Prepaid  expenses and other                                                                                                                    |       | 168                |       | 85                  |       |
| Total  current assets                                                                                                                          |       | 6,922              |       | 6,821               |       |
|                                                                                                                                           |       |               |       |                |       |
| Equipment  and leasehold improvements, net (see Note 4)                                                                                        |       | 10,877             |       | 11,174              |       |
| Other  assets                                                                                                                                  |       | 541                |       | 547                 |       |
| Total  assets                                                                                                                                  |       | $                  | 18,340     |                | $          | 18,542 |   |
|                                                                                                                                           |       |               |       |                |       |
| LIABILITIES  AND STOCKHOLDERS’ EQUITY                                                                                                     |       |               |       |                |       |
| Current  liabilities:                                                                                                                          |       |               |       |                |       |
| Current  maturities of long-term debt                                                                                                          |       | $                  | 354        |                | $          | 355 |   |
| Accounts  payable                                                                                                                              |       | 576                |       | 977                 |       |
| Accrued  expenses                                                                                                                              |       | 521                |       | 387                 |       |
| Total  current liabilities                                                                                                                     |       | 1,451              |       | 1,719               |       |
|                                                                                                                                           |       |               |       |                |       |
| Long-term  debt, excluding current maturities                                                                                                  |       | 1,658              |       | 1,743               |       |
| Total  liabilities                                                                                                                             |       | 3,109              |       | 3,462               |       |
|                                                                                                                                           |       |               |       |                |       |
| Stockholders’  equity:                                                                                                                    |       |               |       |                |       |
| Common  stock of $0.005 par value, shares authorized 30,000,000; 20,896,265 shares  issued and outstanding at June 30, 2005 and March 31, 2005 |       | 104                |       | 104                 |       |
| Additional  paid-in capital                                                                                                                    |       | 27,298             |       | 27,298              |       |
| Accumulated  other comprehensive income - foreign currency translation adjustments                                                             |       | 25                 |       | 27                  |       |
| Accumulated  deficit                                                                                                                           |       | (12,196            | )          | (12,349             | )          |
| Total  stockholders’ equity                                                                                                               |       | 15,231             |       | 15,080              |       |
|                                                                                                                                           |       |               |       |                |       |
| Total  liabilities and stockholders’ equity                                                                                               |       | $                  | 18,340     |                | $          | 18,542 |   |

 

See accompanyingNotes to Consolidated Financial Statements.

 

3

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CYANOTECH CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME

(In thousands, except per share amounts)

(Unaudited)

 
| ** **                                           | ** ** | **Three Months Ended June 30,** | ** ** |
|------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                           | ** ** | **2005**                        | ** ** | **2004** | ** ** |
|                                                 |       |                            |       |   |   |
| NET  SALES                                           |       | $                               | 3,029      |   | $ | 2,707 |   |
| COST  OF PRODUCT SALES                               |       | 2,004                           |       | 1,820 |   |
| Gross  Profit                                        |       | 1,025                           |       | 887 |   |
|                                                 |       |                            |       |   |   |
| OPERATING  EXPENSES:                                 |       |                            |       |   |   |
| Research  and development                            |       | 46                              |       | 65 |   |
| General  and administrative                          |       | 438                             |       | 367 |   |
| Sales  and marketing                                 |       | 333                             |       | 294 |   |
| Total  operating expenses                            |       | 817                             |       | 726 |   |
|                                                 |       |                            |       |   |   |
| Income  from operations                              |       | 208                             |       | 161 |   |
|                                                 |       |                            |       |   |   |
| OTHER  INCOME (EXPENSE):                             |       |                            |       |   |   |
| Interest  income                                     |       | 15                              |       | 8 |   |
| Interest  expense                                    |       | (55                             | )          | (39 | ) |
| Other  expense, net                                  |       | (10                             | )          | (2 | ) |
| Total  other expense, net                            |       | (50                             | )          | (33 | ) |
|                                                 |       |                            |       |   |   |
| Income  before income taxes                          |       | 158                             |       | 128 |   |
|                                                 |       |                            |       |   |   |
| INCOME  TAX EXPENSE                                  |       | 5                               |       | 15 |   |
|                                                 |       |                            |       |   |   |
| NET  INCOME                                          |       | $                               | 153        |   | $ | 113 |   |
|                                                 |       |                            |       |   |   |
| NET  INCOME PER SHARE:                               |       |                            |       |   |   |
| Basic                                                |       | $                               | 0.01       |   | $ | 0.01 |   |
| Diluted                                              |       | $                               | 0.01       |   | $ | 0.01 |   |
|                                                 |       |                            |       |   |   |
| SHARES  USED IN CALCULATION OF NET INCOME PER SHARE: |       |                            |       |   |   |
| Basic                                                |       | 20,896                          |       | 20,736 |   |
| Diluted                                              |       | 21,019                          |       | 20,992 |   |
|                                                 |       |                            |       |   |   |
| COMPREHENSIVE  INCOME:                               |       |                            |       |   |   |
| Net  income                                          |       | $                               | 153        |   | $ | 113 |   |
| Other  comprehensive income (loss)                   |       | (2                              | )          | 14 |   |
|                                                 |       | $                               | 151        |   | $ | 127 |   |

 

See accompanyingNotes to Consolidated Financial Statements.

 

4

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CYANOTECH CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

 
| ** **                                                                              | ** ** | **Three Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                              | ** ** | **2005**                        | ** ** | **2004** | ** ** |
|                                                                                    |       |                            |       |   |   |
| CASH  FLOWS FROM OPERATING ACTIVITIES:                                                  |       |                            |       |   |   |
| Net  income                                                                             |       | $                               | 153        |   | $ | 113 |   |
| Adjustment  to reconcile net income to cash provided by (used in) operating activities: |       |                            |       |   |   |
| Depreciation  and amortization                                                          |       | 337                             |       | 331 |   |
| Amortization  of debt issue costs                                                       |       | 8                               |       | 7 |   |
| Net  (increase) decrease in assets:                                                     |       |                            |       |   |   |
| Accounts  receivable                                                                    |       | (302                            | )          | 266 |   |
| Refundable  income taxes                                                                |       | 46                              |       | — |   |
| Inventories                                                                             |       | (24                             | )          | (208 | ) |
| Prepaid  expenses and other assets                                                      |       | (87                             | )          | (120 | ) |
| Net  increase (decrease) in liabilities:                                                |       |                            |       |   |   |
| Accounts  payable                                                                       |       | (401                            | )          | (158 | ) |
| Accrued  expenses                                                                       |       | 134                             |       | (36 | ) |
| Net  cash provided by (used in) operating activities                                    |       | (136                            | )          | 195 |   |
|                                                                                    |       |                            |       |   |   |
| CASH  FLOWS FROM INVESTING ACTIVITIES:                                                  |       |                            |       |   |   |
| Investment  in equipment and leasehold improvements                                     |       | (40                             | )          | (235 | ) |
|                                                                                    |       |                            |       |   |   |
| CASH  FLOWS FROM FINANCING ACTIVITES:                                                   |       |                            |       |   |   |
| Proceeds  from exercise of stock options and warrants                                   |       | —                          |       | 34 |   |
| Principal  payments on long-term debt                                                   |       | (86                             | )          | (84 | ) |
| Net  cash used in financing activities                                                  |       | (86                             | )          | (50 | ) |
|                                                                                    |       |                            |       |   |   |
| Net  decrease in cash and cash equivalents                                              |       | (262                            | )          | (90 | ) |
| Cash  and cash equivalents at beginning of period                                       |       | 2,005                           |       | 2,531 |   |
|                                                                                    |       |                            |       |   |   |
| Cash  and cash equivalents at end of period                                             |       | $                               | 1,743      |   | $ | 2,441 |   |
|                                                                                    |       |                            |       |   |   |
| Supplemental  disclosure of cash flow information:                                      |       |                            |       |   |   |
| Cash  paid during the period for:                                                       |       |                            |       |   |   |
| Interest                                                                                |       | $                               | 35         |   | $ | 30 |   |
| Income  taxes                                                                           |       | $                               | 4          |   | $ | 118 |   |

 

See accompanyingNotes to Consolidated Financial Statements.

 

5

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CYANOTECH CORPORATION

FORM 10-Q

NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS

As of June 30, 2005

(Unaudited)

 

1.             BASISOF PRESENTATION

 

The accompanying unaudited consolidated financialstatements have been prepared in accordance with accounting principlesgenerally accepted in the United States of America for interim financialinformation and with the instructions to Form 10-Q and Regulation S-X.  Accordingly, they do not include all of theinformation and footnotes required by generally accepted accounting principlesfor complete financial statements.  Theseconsolidated financial statements and notes should be read in conjunction withthe Company’s consolidated financial statements contained in the Company’spreviously filed report on Form 10-K for the year ended March 31, 2005.

 

The Companyconsolidates enterprises in which it has a controlling financial interest. Theaccompanying consolidated financial statements include the accounts ofCyanotech Corporation and its wholly-owned subsidiaries, Nutrex Hawaii, Inc.and Cyanotech Japan YK.  All significantintercompany balances and transactions have been eliminated in consolidation.  While the financial information furnished forthe three month period ended June 30, 2005 is unaudited, the statements in thisreport reflect all material items which, in the opinion of management, arenecessary for a fair presentation of the results of operations for the interimperiods covered and of the financial condition of the Company at the dates ofthe consolidated balance sheets. The operating results for the interim periodpresented are not necessarily indicative of the results that may be expectedfor the year ending March 31, 2006.

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities andthe disclosure of any contingent assets and liabilities as of the date of thefinancial statements and the reported amounts of revenues and expenses duringthe period reported.  Management reviewstheses estimates and assumptions periodically and reflects the effect ofrevisions in the period that they are determined to be necessary.  Actual results could differ significantlyfrom those estimates and assumptions.

 

2.             STOCK-BASEDCOMPENSATION

 

As allowed byStatement of Financial Accounting Standards (“SFAS”) No. 123, *Accounting for Stock-Based Compensation,*theCompany has elected to continue to apply the intrinsic value-based method ofaccounting for employee based stock options and adopted only the disclosurerequirements of SFAS No. 123.  Thefollowing table illustrates the effect on net income and net income per commonshare if the Company had applied the fair-value method under SFAS No. 123 toits employee stock options:

 
| ** **                                                                                           | ** ** | **Three Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                           | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| Net income, as  reported                                                                             |       | $                                | 153        |   | $ | 113 |   |
| Deduct  stock-based employee compensation expense determined under fair-value method  for all awards |       | (20                              | )          | (19 | ) |
| Pro forma net  income                                                                                |       | $                                | 133        |   | $ | 94 |   |
|                                                                                                 |       |                             |       |   |   |
| Basic net income  per common share:                                                                  |       |                             |       |   |   |
| As reported                                                                                          |       | $                                | 0.01       |   | $ | 0.01 |   |
| Pro forma                                                                                            |       | $                                | 0.01       |   | $ | 0.00 |   |
|                                                                                                 |       |                             |       |   |   |
| Diluted net  income per common share:                                                                |       |                             |       |   |   |
| As reported                                                                                          |       | $                                | 0.01       |   | $ | 0.01 |   |
| Pro forma                                                                                            |       | $                                | 0.01       |   | $ | 0.00 |   |

 

6

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3.             INVENTORIES

 

Inventories arestated at the lower of cost (which approximates first-in, first-out) or marketand consists of the following (dollars in thousands):
| ** **      | ** ** | **June 30,  2005** | ** ** | **March  31, 2005** | ** ** |
|-----------------|------------|--------------------|------------|---------------------|------------|
|            |       |               |       |                |       |
| Raw materials   |       | $                  | 324        |                | $          | 246 |   |
| Work in process |       | 303                |       | 243                 |       |
| Finished goods  |       | 831                |       | 957                 |       |
| Supplies        |       | 131                |       | 119                 |       |
|            |       | $                  | 1,589      |                | $          | 1,565 |   |

 

4.             EQUIPMENTAND LEASEHOLD IMPROVEMENTS

 

Equipment and leaseholdimprovements are stated at cost. Depreciation and amortization are providedusing the straight-line method over the estimated useful lives for equipmentand furniture and fixtures, or the shorter of the land lease term or estimateduseful lives for leasehold improvements as follows:

 
| Equipment              |   | 3 to 10 years  |
|------------------------|--------|----------------|
| Furniture and fixtures |   | 7 years        |
| Leasehold improvements |   | 10 to 20 years |

 

Equipment andleasehold improvements consist of the following (dollars in thousands):

 
| ** **                                      | ** ** | **June 30, 2005** | ** ** | **March 31, 2005** | ** ** |
|-------------------------------------------------|------------|-------------------|------------|--------------------|------------|
|                                            |       |              |       |               |       |
| Equipment                                       |       | $                 | 10,287     |               | $          | 10,241 |   |
| Leasehold  improvements                         |       | 14,613            |       | 14,603             |       |
| Furniture and  fixtures                         |       | 86                |       | 86                 |       |
|                                            |       | 24,986            |       | 24,930             |       |
| Less accumulated  depreciation and amortization |       | (14,343           | )          | (14,006            | )          |
| Construction  in-progress                       |       | 234               |       | 250                |       |
| Equipment and  leasehold improvements, net      |       | $                 | 10,877     |               | $          | 11,174 |   |

 

See accompanyingNotes to Consolidated Financial Statements.

 

7

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5.             EARNINGSPER SHARE

 

Basic earnings per share is computed on the basis of the weightedaverage number of common shares outstanding. Diluted earnings per share is computed on the basis of the weightedaverage number of common shares outstanding plus the potentially dilutiveeffect of outstanding stock options and warrants using the “treasury stock”method and convertible securities using the “if-converted” method.

 

Reconciliationsbetween the numerator and the denominator of the basic and diluted earnings pershare computations for the three months ended June 30, 2005 and June 30, 2004are as follows:

 
| ** **                                                              | ** ** | **Three Months Ended June 30, 2005** | ** ** |
|-------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                              | ** ** | **Net Income  (Numerator)**          | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
| ** **                                                              | ** ** | **(in thousands)**                   | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| Basic earnings  per share                                               |       | $                                    | 153        |   | 20,896 |   | $ | 0.01 |   |
| Effect of  dilutive securities – Common stock options and warrants |       | —                               |       | 123 |   |   |   |
| Diluted earnings  per share                                             |       | $                                    | 153        |   | 21,019 |   | $ | 0.01 |   |

 
| ** **                                                              | ** ** | **Three Months Ended June 30, 2004** | ** ** |
|-------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                              | ** ** | **Net Income  (Numerator)**          | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
| ** **                                                              | ** ** | **(in thousands)**                   | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| Basic earnings  per share                                               |       | $                                    | 113        |   | 20,736 |   | $ | 0.01 |   |
| Effect of  dilutive securities – Common stock options and warrants |       | —                               |       | 256 |   |   |   |
| Diluted earnings  per share                                             |       | $                                    | 113        |   | 20,992 |   | $ | 0.01 |   |

 

The following securitieswere excluded from the calculation of diluted earnings per share because theireffect was antidilutive (in thousands):

 
| ** **                  | ** ** | **Three Months Ended  June 30,** | ** ** |
|-----------------------------|------------|----------------------------------|------------|
| ** **                  | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| Stock options  and warrants |       | 360                              |       | 192 |   |

 

6.             NEW ACCOUNTING PRONOUNCEMENTS

 

In December 2004, the Financial Accounting Standards Board (“FASB”)issued SFAS No. 123 (Revised 2004) “Share-Based Payment” which is a revision ofFASB Statement No. 123 “Accounting for Stock-Based Compensation.”  SFAS No. 123 (Revised 2004) requires anentity to measure the cost of employee services received in exchange for anaward.  If an award vests or becomesexercisable based on the achievement of a condition other than service,performance or market condition, the award is liability-classified.  Liability-classified awards are remeasured tofair value at each balance sheet date until the award is settled.  Equity – classified awards, including grantsof employee stock options, are measured at the grant-date fair value of theaward and are not subsequently remeasured. The cost of equity-classified awards is recognized in the incomestatement over the period during which an employee is required to provide theservice in exchange for the award. Currently the company accounts for its employee and non-employeedirector stock options under the intrinsic value provision of APB Opinion No.25.   The Company is required to adoptthe provisions for SFAS No. 123 (Revised 2004) as of the beginning of the firstannual reporting period that begins after June 15, 2005, although earlieradoption is permitted.   SFAS No. 123(Revised 2004) offers several alternatives for implementation.  At this time, management has not made adecision as to the alternative it may select.

 

8

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In November 2004, the FASB issued SFAS No. 151 “Inventory Costs — anamendment of Accounting Research Bulletin No. 43, Chapter 4”.  SFAS No. 151 requires that abnormal amountsof freight, handling costs and wasted material (spoilage) be recognized as current-periodcharges and fixed production overhead costs be allocated to inventory based onthe normal capacity of production facilities. Normal capacity is defined as “the production expected to be achievedover a number of periods or seasons under normal circumstances, taking intoaccount the loss of capacity resulting from planned maintenance.”  Companies will no longer be permitted tocapitalize inventory costs on the balance sheet when the production defect ratevaries significantly from the expected defect rate.  SFAS No. 151 is effective for inventory costsincurred during fiscal years beginning after June 15, 2005.   Earlier application is permitted forinventory costs incurred during fiscal years beginning after November 24,2004.  The Company has yet to determinethe impact, if any, of SFAS No. 151 on its consolidated financial statements.

 

InDecember 2004, the FASB issued SFAS No. 153, “Exchange of Nonmonetary Assets,an amendment of APB Opinion No. 29, ‘Accounting for Nonmonetary Transactions.’” SFAS No. 153 is based on the principle that exchange of nonmonetary assetsshould be measured based on the fair market value of the assetsexchanged.  SFAS No. 153 eliminates the exception of nonmonetary exchangesof similar productive assets and replaces it with a general exception forexchanges of nonmonetary assets that do not have commercial substance. SFAS No. 153 is effective for nonmonetary asset exchanges in fiscal periodsbeginning after June 15, 2005.  Adoption of the provisions of SFASNo. 153 is not expected to have a material impact on the Company’s financialcondition, results of operations, or liquidity.

 

InMarch 2005, the FASB issued FASB Interpretation No. 47 (“FIN 47”), “Accountingfor Conditional Asset Retirement Obligations — an interpretation of FASBStatement No. 143.”  FIN 47 clarifies that the term “conditional assetretirement obligation” as used in FASB Statement No. 143, “Accounting for AssetRetirement Obligations,” refers to a legal obligation to perform an assetretirement activity in which the timing and (or) method of settlement areconditional on a future event that may or may not be within the control of theentity.  Accordingly, an entity is required to recognize a liability forthe fair value of a conditional asset retirement obligation if the fair valueof the liability can be reasonably estimated.  FIN 47 is effective forfiscal years ending after December 15, 2005.  The Company adopted theprovisions of FIN 47 effective April 2005.   Adoption of the provisions of FIN 47 had no material impact on theCompany’s financial condition, results of operations or liquidity.

 

OnMarch 29, 2005, the Securities and Exchange Commission (SEC) staffissued Staff Accounting Bulletin No. 107, “Share-Based Payment” (SABNo. 107), which expressed the SEC staff’s views on StatementNo. 123R, but did not modify any of Statement No. 123R’s provisions.The Company is evaluating the views expressed by the SEC in SAB No. 107 inconjunction with its assessment of Statement No. 123R’s impact to theCompany.

 

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes andError Corrections, a replacement of APB Opinion No. 20 and FASB Statement No.3.”  SFAS No. 154 requires retrospectiveapplication for voluntary changes in accounting principle unless it isimpracticable to do so.  In addition,indirect effects of a change in accounting principle should be recognized inthe period of the accounting change. SFAS No. 154 is effective for accountingchanges and corrections of errors made in fiscal years beginning after December15, 2005.

 

9

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**CYANOTECHCORPORATION**

 

**Item 2.****    Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

* *

*Thisreport on Form 10-Q contains forward-looking statements regarding the futureperformance of Cyanotech and future events that involve risks and uncertaintiesthat could cause actual results to differ materially from the statementscontained herein. This document, and the other documents that the Company filesfrom time to time with the Securities and Exchange Commission, such as itsreports on Form 10-K, Form 10-Q, Form 8-K, and its proxy materials, containadditional important factors that could cause actual results to differ from theCompany’s current expectations and the forward-looking statements containedherein.*

 

## **Overview**

 

A comparison of selected consolidated statements of operationsdata as reported herein and in the Company’s previously filed report on Form10-K for the year ended March 31, 2005 follows for the periods indicated(dollars in thousands):

 
| ** **                     | ** ** | ** **             | ** ** | **Prior Year**         | ** ** | **Prior**               | ** ** |
|--------------------------------|------------|------------------------|------------|------------------------|------------|-------------------------|------------|
| ** **                     | ** ** | ** **             | ** ** | **Comparable Quarter** | ** ** | **Consecutive Quarter** | ** ** |
| ** **                     | ** ** | **Three Months Ended** | ** ** | **Three Months Ended** | ** ** | **Three Months Ended**  | ** ** |
| ** **                     | ** ** | **June 30, 2005**      | ** ** | **June 30, 2004**      | ** ** | **March 31, 2005**      | ** ** |
| ** **                     | ** ** | **$**                  | ** ** | **$**                  | ** ** | **Change**              | ** ** | **$** | ** ** | **Change** | ** ** |
| ** **                     | ** ** | ** **             | ** ** | ** **             | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales:                     |       |                   |       |                   |       |                    |       |   |   |   |   |
| Spirulina  products            |       | $                      | 1,889      |                   | $          | 1,379                   |       | 37 | % | $ | 1,641 |   | 15 | % |
| Natural  astaxanthin products  |       | 1,054                  |       | 1,303                  |       | (19                     | )%         | 906 |   | 16 | % |
| Other products                 |       | 86                     |       | 25                     |       | 244                     | %          | 13 |   | 562 | % |
|                           |       | $                      | 3,029      |                   | $          | 2,707                   |       | 12 | % | $ | 2,560 |   | 18 | % |
| Gross profit                   |       | $                      | 1,025      |                   | $          | 887                     |       | 16 | % | $ | 714 |   | 44 | % |
| Income (loss)  from operations |       | $                      | 208        |                   | $          | 161                     |       | 29 | % | $ | (90 | ) | (331 | )% |
| Net income  (loss)             |       | $                      | 153        |                   | $          | 113                     |       | 35 | % | $ | (74 | ) | (307 | )% |

 

For the first quarter of fiscal 2006, the Company’s total sales increasedfrom the first quarter of the prior fiscal year and on a consecutive quarterbasis from the quarter ended March 31, 2005 by 12% and 18%, respectively.   For the three months ended June 30,2005, we continued to experience a stronger demand for our Spirulina productsand responded by reallocating four of our dual-cultivation ponds fromproduction of natural astaxanthin to Spirulina to meet such demand.  TheCompany’s sales of Spirulina products increased by 37% and 15% over the revenuelevels reported for the comparable quarter of fiscal 2005 and the prior consecutivequarter, respectively, reflecting increased demand for the Company’s Spirulinaproducts.

 

During the quarterended June 30, 2005 the Company was able to fill orders for all natural astaxanthinproducts through current production and from inventory on hand.  Forthe first quarter of fiscal 2006, sales of all natural astaxanthin productsdecreased by 19% from the level reported for the comparable quarter of theprior fiscal year, but increased by 16% compared to the prior consecutivequarter.  This fluctuation is dueprimarily to year-to-year changes in demand for NatuRose® from the Japanaquaculture market which is recovering from typhoon damage of a year ago andthe impact of lower demand during the prior consecutive quarter because of farmedfish being in hibernation during winter months.

 

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The currentquarter’s operating expenses and other expense, net were comparable to those ofthe fourth quarter of fiscal 2005.  Incomefrom operations and net income for the current quarter increased from both thecomparable quarter of the prior year and the prior consecutive quarter due tohigher sales and improved gross profit margins.

 

**Resultsof Operations**

 

*FirstQuarter of Fiscal 2006 Compared to First Quarter of Fiscal 2005*

 

Net sales for thethree months ended June 30, 2005 were $3,029,000, an increase of 12% from the$2,707,000 reported for the comparable period a year ago.  The increase resulted primarily fromincreased volume in sales of Spirulina products, offset in part by a decreasein sales volume of natural astaxanthin.  International sales were 58% of total sales for the first quarter offiscal 2006, compared to 46% a year ago. Historically, our major customers (sales exceeding 10% of total sales) havebeen two distributors, one based in Europe and one in the United States.   For the three months ended June 30, 2005, ourEuropean distributor, Spirulina International, accounted for 11% of total salesas compared to less than 10% of total sales for the comparable period of fiscal2005.   Sales to the United States distributorfor the three months ended June 30, 2005 were less than 10% of total sales ascompared to 11% of total sales for the comparable period of fiscal 2005.

 

Gross profitrepresents net sales less the cost of product sales, which includes the cost ofmaterials, manufacturing overhead costs, direct labor cost and depreciation andamortization.  Gross profit for the threemonths ended June 30, 2005 was $1,025,000, with gross profit margin of $34%, animprovement from the gross profit of $887,000 and gross profit margin of 33% ayear ago.  The increase in gross profitis primarily attributable to increased sales volume in the current year andnon-recurrence of inclement weather which affected production cost in the prioryear.

 

Operating expensesfor the quarter ended June 30, 2005 were $817,000, an increase of 13% fromoperating expenses of $726,000, reported for the comparable period of the prioryear.  Research and development expensedecreased by 29% due primarily to reduced personnel and outside servicesexpenses.  General and administrativeexpense increased by 19% due primarily to higher personnel and accounting expenses.  Sales and marketing expense increased by 13%due primarily to increased expenditures for advertising, promotion andtradeshow participation.  As a percentageof net sales, operating expenses remained consistent at 27% for the firstquarter of fiscal 2006 and of 2005.  TheCompany is committed to ongoing discretionary cost containment but may increaseexpenditures in future periods as dictated by the needs of the business.

 

Total other expense, net was $50,000, an increase from other expense,net of $33,000 for the same period a year ago. Such increase was due primarily to higher interest expense on debt.

 

For the threemonths ended June 30, 2005, an income tax provision of $5,000 was recorded forour operations in Japan as compared to a provision of $15,000 for the sameperiod a year ago.  For income taxes, theCompany records a valuation allowance to reduce its deferred tax assets to theamount that it believes is more likely than not to be realized.  Judgment is required in assessing the needfor the valuation allowance.  Theultimate realization of deferred tax assets is dependent upon the generation offuture taxable income during the periods in which those temporary differencesbecome deductible.  In recent periods theCompany has returned to profitability and begun to generate taxable incomewhich has resulted in the utilization of our previously generated net operatinglosses.  If we continue to generatetaxable income, management may conclude that a portion or all of the existingvaluation allowance is no longer required.

 

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*Variability of Results*

 

The Company hasexperienced significant quarterly fluctuations in operating results andanticipates that these fluctuations may continue in future periods. Futureoperating results may fluctuate as a result of changes in sales levels to ourlargest customers, new product introductions, production difficulties, weatherpatterns, the mix between sales of bulk products and packaged consumerproducts, start-up costs associated with new facilities, expansion into newmarkets, sales promotions, competition, increased energy costs, foreignexchange fluctuations, the announcement or introduction of new products bycompetitors, changes in our customer mix, overall trends in the market forour  products, government regulations andother factors beyond our control.  Asignificant portion of our expense levels are relatively fixed and the timingof increases in expense levels is based in large part on forecasts of futuresales.   Therefore, if net sales arebelow expectations in any given period, the adverse impact on results ofoperations may be magnified by our inability to adjust spending quickly enoughto compensate for the sales shortfall. We may also choose to reduce prices orincrease spending in response to market conditions, which may have a materialadverse effect on financial condition and results of operations.

 

**Liquidityand Capital Resources**

 

Working capitalfor the three months ended June 30, 2005 increased by $369,000 to $5,471,000from $5,102,000 at March 31, 2005.   Suchincrease was primarily attributable to higher accounts receivable and loweraccounts payable balances, offset in part by lower cash balances and higheraccrued expenses.   For the three monthsended June 30, 2005, cash and short term investments decreased by $262,000 to$2,743,000.

 

Cash used inoperating activities for the quarter ended June 30, 2005 was $136,000, incontrast to $195,000 of cash generated from operations during the comparable quarterof the prior year, due primarily to the timing of collection of accountsreceivable and payment of accounts payable.

 

Cash used ininvesting activities (for capital expenditures) was $40,000 for the threemonths ended June 30, 2005, compared to $235,000 in the comparable prior yearperiod.  This change is primarily due toexpenditures made in the prior fiscal year for the Company’s pond conversionand production upgrade project.  TheCompany has no such major projects planned for fiscal 2006 and expects lowerinvestment activities for capital expenditures for fiscal 2006 as compared tofiscal 2005.

 

Cash used infinancing activities represented principal payments on the Company long-termdebt of $86,000 and $84,000 for the three months ended June 30, 2005 and 2004,respectively.   In addition, the Companyreceived cash proceeds of $34,000 from the exercise of stock options andwarrants during the first quarter of fiscal 2005.

 

The Company’scontractual obligations and commitments (consisting of a term loan andoperating leases) are disclosed in the Company’s previously filed report onForm 10-K for the fiscal year ended March 31, 2005 in the following sections:Item. 7 Management’s Discussion and Analysis of Financial Condition and Resultsof Operations – Liquidity and Capital Resources, and Item 8. FinancialStatements and Supplementary Data – Notes 5 and 6 of Notes to ConsolidatedFinancial Statements.   There have beenno significant changes in contractual obligations and commitments from March31, 2005 to June 30, 2005, other than those reported elsewhere in this Form10-Q.

 

## **Critical AccountingPolicies**

 

Our unauditedfinancial statements and accompanying notes are prepared in accordance withaccounting principles generally accepted in the United States of America forinterim financial information and with the instructions to Form 10-Q andRegulation S-X.  Preparing financialstatements requires management to make estimates and assumptions that affectthe reported amounts of assets, liabilities, revenue and expenses.  These

 

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estimates andassumptions are affected by management’s application of accountingpolicies.  The Company has identifiedcertain policies that require the application of significant judgment bymanagement.  Our most critical accountingpolicies are those related to inventory valuations, valuation of equipment andleasehold improvements and long-lived assets and income taxes.  These critical accounting policies are statedin the notes to consolidated financial statements in the Company’s previouslyfiled report on Form 10-K for the fiscal year ended March 31, 2005.  This discussion and analysis should be readin conjunction with such notes and our consolidated financial statements and relatednotes included elsewhere in this report.

 

## **Outlook**

* *

*This outlook section contains anumber of forward-looking statements, all of which are based on currentexpectations.  Actual results may differmaterially.   See first paragraph of thisItem 2.*

 

The goal of CyanotechCorporation is based on its strategy to be a world-leader in the production andmarketing of high-value natural products from microalgae.  For fiscal 2006 we have refined this strategywith a heightened focus on the business-to-business wholesale market for theproducts and compounds that we extract from the microalgae processed at our 90acre facility in Hawaii.  Our currentproduct offerings include Certified Organic and Naturally Cultivated SpirulinaPacifica® in powder, flake and tablet form, NatuRose® natural astaxanthinpowder for the animal nutrition market, BioAstin® natural astaxanthinantioxidant in lipid extract, softgel caplet and micro-encapsulated beadletform for the human nutrition and cosmetic industries and Phycobiliproteins foruse in medical diagnostics.  Informationabout our Company and our products can be viewed at www.cyanotech.com,www.nutrex-hawaii.com or www.phycobiliprotein.com .  Consumer products can also be purchasedonline at www.nutrex-hawaii.com .

 

Our net sales for thefirst quarter of fiscal 2006 (the quarter ended June 30, 2005) were $3,029,000,compared to $2,707,000 and $2,560,000 reported for the first quarter and fourthquarter of fiscal 2005, respectively. Sales of our Spirulina Pacifica® products remained strong during thefirst quarter of fiscal 2006 accounting for 62% of sales as compared to thefirst quarter of the prior year when Spirulina revenues accounted for 51% ofsales.  Conversely, revenues from ournatural astaxanthin products accounted for 35% of sales for the quarter endedJune 30, 2005, as compared to 48% for the same period a year ago.  We believe that our product mix may changewith proportional increases in sales of NatuRose® and BioAstin® as the Japanaquaculture market recovers from last year’s weather-related disruption and fromincreased advertising and promotional efforts for BioAstin®, but there can beno guarantee of the timing of such recovery or if the Company’s advertising andpromotional strategy will be successful.

 

Our operating expensesduring the first quarter of fiscal 2006 were $817,000, compared to $726,000 and$804,000 reported for the first quarter and fourth quarter of fiscal 2005,respectively.  As a percentage of sales, thecurrent quarter operating expenses represents 27% of net sales compared to 27%and 31% for the first and fourth quarters of fiscal 2005.  We will continue to contain discretionaryoperating spending but have begun to increase expenditures for advertising andclinical trials in the human nutrition and cosmetic markets.

 

The Company’s futureresults of operations and the other forward-looking statements contained inthis Outlook, in particular the statements regarding revenues, gross margin andcapital spending involve a number of risks and uncertainties.  In addition to the factors discussed abovethat could cause actual results to differ materially are the following:  business conditions and growth in the naturalproducts industry and in the general economy; changes in customer orderpatterns; changes in demand for natural products in general; changes in weatherconditions; competitive factors, such as competing spirulina and astaxanthinproducers increasing their production capacity and the resulting impact, ifany, on world market prices for these products; 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.

 

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Cyanotech believes thatit has the product offerings, facilities, personnel, and competitive andfinancial resources for improved results, but future revenues, costs, marginsand profits are all influenced by a number of factors, as discussed above, allof which are inherently difficult to forecast.

 

**Item 3.****    Quantitative andQualitative Disclosures About Market Risk**

 

We have never enteredinto any transactions using derivative financial instruments or derivativecommodity instruments and believe that our exposure to market risk associatedwith other financial instruments is not material.

 

We have a termloan agreement which adjusts quarterly based on the prime rate.  As such we are exposed to the interest raterisk whereby a 1% increase in the prime rate would lead to an increase ofapproximately $15,000 in interest expense for the year ending March 31, 2006(based on March 31, 2005 amounts outstanding).

 

**Item 4. Controls and Procedures**

 

Underthe supervision and with the participation of management, including thePresident and Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”)of the Company (the “Certifying Officers”), we have evaluated the effectivenessof the Company’s disclosure controls and procedures as of the end of the periodcovered by this report in accordance with Item 307 of Regulation S-Kpromulgated by the Securities and Exchange Commission.  As defined under Rules 13a-15(e) or 15d-15(e)issued under the Securities Exchange Act of 1934, as amended (the “Exchange Act”),the term “disclosure controls and procedures” refers to 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 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.

 

Basedon that evaluation, the CEO and CFO have concluded that the Company’sdisclosure controls and procedures are effective.   There were no changes in our internal controlsover financial reporting during the quarter ended June 30, 2005 that havematerially affected, or are reasonably likely to materially affect, ourinternal controls over financial reporting.

 

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PART II.    OTHER INFORMATION

 

Item 1.                    Legal Proceedings

 

None

 

Item 6.                    Exhibits and Reports on Form 8-K

 

a)                    Thefollowing exhibits are furnished with this report:

 

31.1         Certificationby the Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of theExchange Act

 

31.2         Certificationby the Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of theExchange Act

 

32.1         Certificationby the Chief Executive Officer pursuant to 18 U. S. C. Section 1350, as adoptedpursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

32.2         Certificationby the Chief Financial Officer pursuant to 18 U. S. C. Section 1350, as adoptedpursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

99.1         RiskFactors

 

b)                    Reportson Form 8-K

 

1)     Areport on Form 8-K dated July 12, 2005 included Items 7.01-Regulation FDDisclosure, 8.01-Other Events and 9.01-Financial Statements and Exhibits, inconjunction with the Company’s press release announcing the appointment ofRussell Communications Group as its agency for coordinating investor relationsand marketing communications.

 

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**SIGNATURES**

 

In accordance withthe requirements of the Securities Exchange Act of 1934, the registrant causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 

 
|            |   |   |   |   | CYANOTECH CORPORATION  (Registrant) |   |
|-----------------|--------|--------|--------|--------|-------------------------------------|--------|
|            |   |   |   |   |                                |   |   |   |
|            |   |   |   |   |                                |   |   |   |
| August 12, 2005 |   |   |   |   |                                | 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, |
|            |   |   |   |   |                                |   | Chief Financial Officer |   |
|            |   |   |   |   |                                |   | (Principal Financial  and Accounting Officer) |

 

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