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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the fiscal year ended March 31, 1999 Commission file 0-146-02
CYANOTECH CORPORATION
(Exact name of Registrant as specified in its charter)
Nevada 91-1206026
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
73-4460 Queen Kaahumanu Hwy., Suite 102, Kailua-Kona, HI 96740
(Address of principal executive offices)
(808) 326-1353
(Registrant's telephone number)
Securities registered pursuant to Section 12(b) of the Exchange Act:
NONE
Securities registered pursuant to Section 12(g) of the Exchange Act:
Title of class
Common Stock, Par value $.005 per share
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein and will not be contained, to the best
of the registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
At June 28, 1999, the aggregate market value of the registrant's Common
Stock held by non-affiliates of the registrant was approximately $ 16,406,000.
At June 28, 1999, the number of shares outstanding of registrant's
Common Stock was 13,715,722.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Annual Report to Stockholders for the fiscal year
ended March 31, 1999 are incorporated by reference into Part II and Part IV of
this Report. Portions of the Registrant's Definitive Proxy Statement for its
1999 Annual Meeting of Stockholders, to be filed with the Securities and
Exchange Commission on or prior to July 29, 1999 and to be used in connection
with the Annual Meeting of Stockholders expected to be held August 26, 1999, are
incorporated by reference in Part III of this Form 10-K.
PART I
ITEM 1. BUSINESS
Except for historical information contained in this document, the matters
discussed in this report contain forward looking statements that involve risks
and uncertainties. These future risks and uncertainties could cause actual
results to differ materially.
GENERAL
Cyanotech Corporation is a leader in the development and commercialization
of high value products derived from microalgae. Microalgae are a diverse group
of over 30,000 species of microscopic plants which have a wide range of
physiological and biochemical characteristics and naturally contain high levels
of proteins, amino acids, vitamins, pigments and enzymes. Since 1983, we have
designed, developed and implemented proprietary production and harvesting
technologies, systems and processes which eliminate many of the stability and
contamination problems frequently encountered in the production of microalgae.
We believe that our technology, systems, processes and favorable growing
location permit year-round harvesting of our microalgal products in a cost
effective manner.
We currently produce natural products from microalgae for the nutritional
supplement, aquaculture feed, and immunological diagnostics markets. Since 1985,
Cyanotech has been producing microalgae-based "Spirulina" products for the
vitamin and supplement market. Spirulina Pacifica(TM), which is our principal
source of revenue, is a unique strain of Spirulina developed by us which
provides a vegetable-based, highly absorbable source of natural beta-carotene,
mixed carotenoids, B vitamins, gamma linolenic acid ("GLA"), protein, essential
amino acids and other phytonutrients. We currently market our Spirulina products
in the United States and thirty-seven other countries though a combination of
retail, wholesale, and private label channels. In early 1997, we introduced
NatuRose(TM) to the worldwide aquaculture industry. NatuRose is our brand name
for natural astaxanthin (pronounced "as-ta-zan-thin"). Astaxanthin is a red
pigment from the microalgae, Haematococcus, and is used in aquaculture to impart
a pink to red color to pen-raised fish and shrimp. NatuRose competes with
synthetic astaxanthin whose worldwide annual sales are estimated at more than
$150 million.
Cyanotech is also developing microalgae for the expression of native as
well as heterologous proteins through molecular biology. Because microalgae
naturally contain high levels of protein, because they have a uniform cell
structure, and because they can grow up to 100 times faster than land plants,
they offer unique advantages over plant, bacterial or mammalian systems for the
expression of proteins. Cyanotech intends to continue to exploit the largely
untapped commercial opportunities of microalgae by producing natural products
and also genetically engineered products through molecular biology. Like higher
plants, algal expression systems can be produced on a large-scale with culture
volumes of up to 600,000 liters without problems of contamination by bacterial
endotoxins or animal viruses. Unlike higher plants, however, the time required
to grow transgenic algae expressing the desired protein is on the order of one
to two months rather than the one to two years that would be required in corn or
soybeans, for example.
Since 1996, Cyanotech has been pursuing the development of a genetically
engineered biopesticide for the control of mosquitoes. A natural toxin from
Bacillus thuringiensis var. israelensis (Bti) is being transformed into a
blue-green algae, Synechococcus, a food for mosquito larvae. When applied to a
mosquito-infested body of water, the algae could act as an effective and
environmentally safe means of control.
2
In April 1998, the Company signed an agreement with The Scripps Research
Institute in La Jolla, California to develop a new compound for use in chiral
chemistry. The genetically engineered Aldolase Catalytic Antibody was generated
in the Scripps laboratory and subsequently expressed as a transgene in algae by
Scripps scientists. This antibody may have numerous potential applications in
industrial synthesis, including the synthesis of certain anti-cancer compounds.
Under the terms of the exclusive license agreement, Scripps will provide the
genetically engineered, live microalgae containing the catalytic aldolase
protein to Cyanotech. Cyanotech would be responsible for development of the
large scale production and purification process for the catalytic antibody.
Development tests are presently underway to assess the feasibility of the
proposed commercial product.
In March of 1999, we announced the development of a natural astaxanthin
product for use as a human dietary supplement. A growing body of scientific
literature is demonstrating that the antioxidant, astaxanthin, surpasses many of
the antioxidant benefits of vitamin C, vitamin E, beta-carotene and other
carotenoids.
Cyanotech Corporation is incorporated in Nevada. Our principal executive
offices are located at 73-4460 Queen Kaahumanu Highway, Suite 102, Kailua-Kona,
Hawaii 96740, and our telephone number is (808) 326-1353. Unless otherwise
indicated, all references in this report to the "Company," "we," and "Cyanotech"
refer to Cyanotech Corporation, a Nevada corporation, its wholly owned
subsidiaries, Nutrex, Inc., a Hawaii corporation, and Cyanotech International
FSC, Inc., a Barbados corporation.
INDUSTRY BACKGROUND
Microalgae are a diverse group of microscopic plants that have a wide range
of physiological and biochemical characteristics and naturally contain, among
other things, high levels of proteins, amino acids, vitamins, pigments and
enzymes. Microalgae have the following properties that make commercial
production attractive: (1) microalgae grow much faster than land grown plants,
often up to 100 times faster; (2) microalgae have a uniform cell structure with
no bark, stems, branches or leaves, which permits easier extraction of products
and higher utilization of the microalgae cells; (3) the cellular uniformity of
microalgae makes it practical to manipulate and control growing conditions in
order to optimize a particular cell characteristic; (4) microalgae contain a
wide array of vitamins and other important nutrients; (5) microalgae contain
natural pigments; and (6) are a potential source of medical products.
Current commercial applications for these microscopic plants include
nutritional products, diagnostic products, aquaculture feed and pigments,
natural food colorings and research grade chemicals. The Company believes that
microalgae could potentially be used for other commercial applications,
including genetically engineered products for the biopesticide and
pharmaceutical industries. The most significant microalgae products produced
today are algae utilized as food supplements.
While many unique compounds have been identified in microalgae, the
efficient and cost effective commercial production of microalgae is elusive.
Many microalgae culture systems over the last 20 years have failed. Because
microalgae produced for food supplements are typically cultivated and harvested
outdoors, production is significantly affected by climate, weather conditions
and the chemical composition of the culture media. Without consistent sunlight,
warm temperature, low rainfall and proper chemical balance, microalgae will not
grow quickly, resulting in longer harvesting cycles, decreased pond utilization
and increased cost. Furthermore, microalgal growth requires a very nutrient rich
environment. The high nutrient levels in the ponds promote the growth of
unwanted organisms, or "weeds," if the chemical composition of the ponds changes
from its required balance. Once contamination occurs, a pond must be emptied,
cleaned and refilled, a process that further decreases pond utilization and
increases production costs.
3
CYANOTECH'S TECHNOLOGY
Since 1983, we have designed, developed and implemented proprietary
production and harvesting technologies, systems and processes which reduce many
of the stability and contamination problems frequently encountered in the
production of microalgae. This proprietary production system is known as
Integrated Culture Biology Management (or "ICBM"). Through the application of
this technology, our Spirulina culture ponds can be productive year-round
without any significant loss in productivity due to contamination. We believe
that such an accomplishment remains unique to Cyanotech.
In addition to the advantages of our ICBM technology, we have developed a
patented system for the recovery of carbon dioxide from our drying system
exhaust gas, called Ocean-Chill Drying. Since microalgae are essentially
microscopic "plants," they require sunlight, water, carbon dioxide and nutrients
for optimal growth. By recovering carbon dioxide from the drying system that
would otherwise be released into the atmosphere, we can divert the recovered
carbon dioxide back to the algae cultures. This process provides us with another
significant cost advantage over other microalgae producers who must purchase
carbon dioxide. Moreover, Ocean-Chill Drying dries microalgal products in a low
oxygen environment, which protects oxygen sensitive nutrients. In addition, we
have developed an automated Spirulina processing system, which enables a single
operator to harvest and dry the Spirulina powder.
Another major advantage for us is the location of our production facility
at the Hawaii Ocean Science and Technology ("HOST") Park at Keahole Point,
Hawaii. We believe that the combination of consistent warm temperature, abundant
sunlight, and low rainfall at this facility makes this a highly favorable
location for the economical, large-scale cultivation of microalgae. In contrast
to our facility, microalgae producers in other areas lacking these favorable
characteristics stop producing for up to four months a year because of less
favorable climate or weather conditions. At the HOST Park, we have access to
cold, clean, deep sea water that is pumped from a depth of 2,000 feet. This sea
water is used both as a source of nutrients for microalgae culture and as a
cooling agent in the Ocean-Chill Drying process. Additionally, our facility has
access to a complete industrial infrastructure and is located 30 miles from a
deep water port and adjacent to an international airport.
Applying our experience in cultivating and harvesting Spirulina, we began
commercial production of our natural astaxanthin product, NatuRose, during the
fourth quarter of fiscal 1997. Our efforts in NatuRose production during the
year ended March 31, 1999, focused on working to improve and refine our
methodology for cultivation. This effort has resulted in an improved,
large-scale photo-bioreactor system, referred to as the BioDome Closed Culture
System, or BioDome CCS. We believe this improved technology will result in
reduced production costs, increased control of product purity and have a
positive effect on production yield. In early February 1999, we began conversion
of our astaxanthin production area to this system and expect to have our systems
fully converted by the fall of 1999.
Our primary business objective is to be the leading developer and producer
of microalgal products in our existing and future markets. We believe that the
combination of our ICBM technology, our BioDome CCS technology, our Ocean-Chill
Drying process, our automated processing system and a favorable growing location
with year-round production capabilities, can be successfully applied to the
commercial cultivation of many species of microalgae.
PRODUCTS
Spirulina
Our principal product, accounting for 91% and 95% of net sales for the
years ended March 31, 1999 and 1998, respectively, is a nutritional microalgae
marketed as Spirulina Pacifica. Developed by us and sold worldwide to the health
and natural foods market, Spirulina Pacifica is a unique strain of microalgae
that is a highly absorbable source of natural beta carotene, mixed carotenoids,
B vitamins, GLA, protein, essential amino acids and other phytonutrients. We
believe we were the first Spirulina producer to have its products and processes
certified organic and we are the only microalgae producer to have its quality
system registered under the ISO 9002-94 standards.
4
Cyanotech produces Spirulina Pacifica in three forms: powder, flake and
tablets. Powder is used as an ingredient in nutritional supplements and health
food drinks while flakes are used as a seasoning on various foods. Tablets are
consumed daily as a dietary supplement. We also produce and market a blended
product under the Hawaiian Energizer name. Hawaiian Energizer tablets contain
Spirulina Pacifica, Bee Pollen and Siberian Ginseng.
We anticipate that sales of our Spirulina Pacifica products will continue
to constitute a substantial portion of net sales during fiscal 2000. Any
material decrease in the overall level of sales of, or the prices for, our
Spirulina Pacifica products, whether as a result of competition, change in
consumer demand, increased worldwide supply of Spirulina or any other factors,
would have a material adverse effect on our business, financial condition and
results of operations.
Natural Astaxanthin
The fiscal year ended March 31, 1999 was the second year of commercial
production for our natural astaxanthin product, NatuRose. Astaxanthin is a red
pigment used primarily in the aquaculture industry to impart pink color to the
flesh of pen-raised fish and shrimp. The astaxanthin market currently is
dominated by a single producer, Hoffmann-LaRoche, who produces synthetic
astaxanthin from petrochemicals. Hoffmann-LaRoche currently sells synthetic
astaxanthin to the aquaculture industry at approximately $2,500 per pure
kilogram. As a result of continued growth in the world aquaculture industry, the
world market for astaxanthin is estimated to currently exceed $150 million per
year. Although sales of NatuRose for the fiscal year ended March 31, 1999 were
nominal, we anticipate that such sales may constitute a significant portion of
total sales in future periods.
Phycobiliproteins
Cyanotech also produces phycobiliproteins which are sold to the medical and
biotechnology research industry. Phycobiliproteins are highly fluorescent
pigments purified from microalgae. Their spectral properties make them useful as
tags or markers in many kinds of biological assays, such as flow cytometry,
fluorescence immunoassays and fluorescence microscopy. We anticipate that sales
of phycobiliproteins will not represent a significant component of total sales
in future periods.
PRODUCTS UNDER DEVELOPMENT
We continue to develop our unique, bio-engineered mosquitocide product and
our aldolase catalytic antibody.
Transformation of the microalgae, Synechococcus, to express the Bacillus
thuringiensis var. israelensis (Bti) mosquitocide toxin has proven more
difficult than originally anticipated and we now expect preliminary data on
toxin expression levels after mid-year 1999. The bacterial toxin of Bti is very
specific to mosquitoes and black flies, while the blue-green algae is a food for
mosquito larvae. We believe that when applied to a mosquito-infested body of
water, this bio-engineered product could act as an effective and environmentally
safe means of control.
On the aldolase catalytic antibody project, we continue to work with
research scientists from The Scripps Research Institute on expression of the
catalytic antibody gene. The genetically engineered aldolase catalytic antibody
may have numerous potential applications in industrial synthesis, including the
synthesis of certain anti-cancer compounds. Under the terms of the exclusive
license agreement, Scripps will provide the genetically engineered, live
microalgae containing the catalytic aldolase protein to Cyanotech. Development
tests are presently underway to assess the feasibility of the proposed
commercial product.
5
In March 1999, we announced development of a natural astaxanthin product
for use as a human dietary supplement as an adjunct to NatuRose, our natural
astaxanthin product for the commercial feed and aquaculture industries. There is
a growing body of scientific literature demonstrating that the antioxidant,
astaxanthin, surpasses many of the antioxidant benefits of vitamin C, vitamin E,
beta-carotene and other carotenoids. Scientific studies have also shown that
natural astaxanthin has up to 550 times the antioxidant activity of vitamin E
and 10 times the antioxidant activity of beta-carotene. We are currently
evaluating the feasibility of the proposed commercial product and pursuing the
appropriate approvals from various government authorities.
Development of all of these products is continuing but there is no
assurance that commercial products will be achieved. Cyanotech's products,
potential products and its manufacturing and research activities are subject to
varying degrees of regulation by a number of government authorities in the
United States and in other countries. Our inability to successfully develop or
commercialize additional products could have a material adverse effect on our
business, financial condition and results of operations.
RESEARCH & DEVELOPMENT EXPENSES
Cyanotech's expertise is in the development of efficient, stable and
cost-effective production systems for microalgal products. Our researchers
investigate specific microalgae identified in scientific literature for
potentially marketable products and then develop the technology to grow such
microalgae on a commercial scale.
During fiscal 1999, the Company incurred $895,000 in research and
development expenses, compared with $677,000 and $587,000 in the years 1998 and
1997, respectively. The Company intends to continue to develop new products and
prioritizes its research and development activities to focus on projects that it
believes will have the greatest market acceptance and achieve the highest return
on the Company's investment. Successful microalgal product development is highly
uncertain and is dependent on numerous factors, many of which are beyond the
Company's control. Products that appear promising in early phases of development
may be found to be ineffective, may be uneconomical because of manufacturing
costs or other factors, may be precluded from commercialization due to the
proprietary rights of other companies, or may fail to receive necessary
regulatory approvals.
DISTRIBUTION AND INTERNATIONAL SALES
The majority of our bulk Spirulina sales are to companies with their own
Spirulina product lines. Many of these companies identify and promote
Cyanotech's Hawaiian Spirulina in their products. In the United States, we sell
directly to health food manufacturers and health food formulators. Packaged
consumer products sell in the domestic market through an established health food
distribution network. Orders for packaged consumer products are taken at the
store level by one of 23 regional broker representatives and shipped through one
of 25 distributors. In selected foreign markets, we have appointed exclusive
sales distributors for both bulk Spirulina and packaged consumer products.
In the years ended March 31, 1999, 1998 and 1997, international sales
accounted for approximately 40%, 44% and 62%, respectively, of our net sales. We
expect that international sales will continue to represent a significant portion
of our net sales. Our business, financial condition and results of operations
may be materially adversely affected by any difficulties associated with
managing accounts receivable from international customers, tariff regulations,
imposition of governmental controls, political and economic instability or other
trade restrictions. Although our international sales are currently denominated
in United States dollars, fluctuations in currency exchange rates could cause
our products to become relatively more expensive to customers in the affected
country, leading to a reduction in sales in that country.
CUSTOMERS
Spirulina
We market and sell our Spirulina products to a variety of customers, which
range in size from $500 million in annual sales to small retail stores. Several
of our major customers are businesses that were established exclusively to
market and sell Spirulina products.
6
Approximately 11% of our net sales for the year ended March 31, 1999 was to
a single customer, Spirulina International B.V., a Spirulina marketing and
distribution company based in Europe. Sales to this customer were less than 10%
of net sales for the years ended March 31, 1998 and 1997.
We market and sell our Spirulina products to a variety of other customers,
including:
Health Food Manufacturers. Health food manufacturers often use Cyanotech's
Spirulina products as a key ingredient in their Spirulina-based products, or as
an ingredient in their health food formulations. These customers purchase bulk
powder or bulk tablets and package the products under their brand label for sale
to the health and natural food markets. Many of the products produced by these
customers are often marketed and sold domestically in direct competition with
our Nutrex line of retail consumer products.
Private Label Customers. We currently provide private label retail consumer
products to one international customer. Products for this customer are
manufactured only upon receipt of an order and no finished product inventories
are maintained.
Retail Distributors. Retail distributors act as product wholesalers to
independent and chain retailers. The majority of domestic Nutrex sales in the
year ended March 31, 1999 were to 25 distributors.
Natural Products Distributors. In the year ended March 31, 1999, we sold
bulk Spirulina products to sixteen domestic and ten foreign customers engaged in
the business of distributing natural raw materials to health and natural food
manufacturers. These distributors provide their customers with standardized
quality control, warehousing and distribution services, and charge a mark-up on
the products for providing these services. These distributors may differentiate
the products they sell, but they generally treat the products as commodities,
with price being the major determining factor in their purchasing decision.
Natural Astaxanthin
Our NatuRose product is presently being sold on a limited basis through a
network of agents and distributors directly to aquaculture farmers, vitamin
suppliers, aquaculture feed manufacturers and other end users in 15 countries
for use in aquaculture feed, poultry feed and pet feed industries.
COMPETITION
Spirulina
Our Spirulina Pacifica products compete with a variety of vitamins, dietary
supplements, other algal products and similar nutritional products available to
consumers. The nutritional products market is highly competitive. It includes
international, national, regional and local producers and distributors, many of
whom have greater resources than Cyanotech, and many of whom offer a greater
variety of products. Our direct competition in the Spirulina market currently is
from Dainippon Ink and Chemical Company's facility in California and several
farms in China. To a lesser extent, we compete with numerous smaller farms in
China, India, Thailand, Cuba, Brazil and South Africa. Packaged consumer
products marketed under our Nutrex brand also compete with products marketed by
health food manufacturing customers of Cyanotech who purchase bulk Spirulina
from us and package it for retail sales. A decision by another company to focus
on Cyanotech's existing or target markets or a substantial increase in the
overall supply of Spirulina could have a material adverse effect on our
business, financial condition and results of operations. There can be no
assurance that we will not experience competitive pressure, particularly with
respect to pricing, that could adversely affect our business, financial
condition and results of operations.
7
Natural Astaxanthin
Our natural astaxanthin product, NatuRose, competes directly with the
synthetic astaxanthin product produced and marketed for the commercial feed and
aquaculture industry worldwide by Hoffmann-LaRoche. In addition, several other
companies have announced plans to produce commercial quantities of natural
astaxanthin from microalgae and Phaffia yeast. We believe that these companies
are presently only producing small quantities for test purposes. Although we are
unaware of any studies indicating that natural astaxanthin has any benefits not
otherwise provided by synthetic astaxanthin, we believe there is commercial
demand for a natural astaxanthin product and that our NatuRose product can
compete on the basis of product performance and price.
Phycobiliproteins
Four major competitors manufacture phycobiliprotein products for sale,
including Molecular Probes, Inc., Quantify, Inc., Martek Biosciences Corporation
and Prozyme, Inc. Cyanotech competes with these companies on the basis of price
and quality. New synthetic fluorescent compounds have been developed by a third
party which are superior to phycobiliproteins in some applications. The
advantage of the synthetic compounds is their lower molecular weight and, in
some cases, their lower cost. While our phycobiliprotein products may not be
able to compete effectively against synthetic compounds in some applications,
Cyanotech's phycobiliproteins have gained a reputation for high quality at a
competitive price.
GOVERNMENT REGULATION
Cyanotech's products, potential products and its manufacturing and research
activities are subject to varying degrees of regulation by a number of
government authorities in the United States and in other countries, including
the Food and Drug Administration (the "FDA") pursuant to the Federal Food, Drug
and Cosmetic Act and by the Environmental Protection Agency ("EPA") under the
Federal Insecticide, Fungicide, and Rodenticide Act ("FIFRA"). The FDA
regulates, to varying degrees and in different ways, dietary supplements, other
food products, diagnostic medical devices and pharmaceutical products, including
their manufacture, testing, exportation, labeling, and, in some cases,
advertising. The EPA also rigorously regulates pesticides, among other types of
products.
Cyanotech is also subject to other federal, state and foreign laws,
regulations and policies with respect to labeling of its products, importation
of organisms, and occupational safety, among others. Federal, state and foreign
laws, regulations and policies are always subject to change and depend heavily
on administrative policies and interpretations. We work with foreign
distributors to ensure our compliance with foreign laws, regulations and
policies. There can be no assurance that any changes with respect to federal,
state and foreign laws, regulations and policies, and, particularly with respect
to the FDA and EPA or other such regulatory bodies, with possible retroactive
effect, will not have a material adverse effect on our business, financial
condition and results of operations. There can be no assurance that any of our
potential products will satisfy applicable regulatory requirements.
The Federal Dietary Supplement Health and Education Act ("DSHEA") regulates
the use and marketing of dietary supplements, including vitamin products. The
DSHEA covers only dietary supplements and contains a number of provisions that
differentiate dietary supplements from other foods. The DSHEA also sets forth
standards for adulteration of dietary supplements or ingredients thereof and
establishes current food Good Manufacturing Practices ("cGMP") requirements for
dietary supplements. It also provides detailed requirements for the labeling of
dietary supplements, including nutrition and ingredient labeling. We currently
believe that Spirulina Pacifica, marketed as a dietary supplement, is exempt
from FDA regulation as a food additive.
8
Our Spirulina manufacturing processes and our contract bottlers are
required to adhere to cGMP as prescribed by the FDA. We believe that we are
currently in compliance with all applicable cGMP and other food regulations.
Compliance with relevant cGMP requirements can be onerous and time consuming,
and there can be no assurance that Cyanotech can continue to meet relevant FDA
manufacturing requirements for existing products or meet such requirements for
any future products. Ongoing compliance with food cGMP and other applicable
regulatory requirements are monitored through periodic inspections by state and
federal agencies, including the FDA, the Hawaii Department of Health and
comparable agencies in other countries. Our processing facility is also
inspected annually for organic certification by Quality Assurance International
and for Kosher certification by the Kosher Overseers Association. The use of
Spirulina as a food additive for seasoning on salads or pasta or for such other
food uses has not been cleared by the FDA, however, the FDA has recognized
Spirulina as a safe food. We currently market the product for these food uses on
the basis of our belief that its use in these food applications is generally
recognized as safe and therefore is not subject to FDA pre-market clearances as
a food additive.
Our natural astaxanthin product, NatuRose, has received clearance for use
as a feed and food color additive in Japan and Canada and has received organic
registration for use in feed in New Zealand but will need clearance for use as a
feed color additive in the United States. We are actively pursuing clearance for
use in the U.S. markets and are presently in process with our petition to the
FDA and anticipate final approval by the fall of 1999. Our petition for approval
for the Canadian Food Industry Agency was submitted in June 1998 and received
approval in June 1999. The process of obtaining clearances for a new color
additive is expensive and time consuming. Extensive information is required on
the toxicity of the additive, including carcinogenicity studies and other animal
testing. No assurances can be given that any of our proposed products intended
for use as a feed additive will be approved for use in the United States on a
timely basis, if at all.
As in vitro diagnostic medical device components, phycobiliprotein products
do not currently require pre-market clearances by the FDA. However, as a
component of a medical device, they can be subject to other various medical
device requirements, including cGMP requirements.
Work is continuing on our genetically-engineered mosquitocide project. We
are aware that any resulting product will be subject to validation of efficacy
though field trials. If proven effective, any potential commercial product will
be subject to regulatory approval by the EPA for use in the United States.
However, Bti is currently approved for use as a biopesticide by the EPA and the
World Health Organization. We are uncertain of regulatory requirements in other
potential markets at this point.
PATENTS, LICENSES AND TRADEMARKS
Although we regard our proprietary technology, trade secrets, trademarks
and similar intellectual property as critical to our success, we rely on a
combination of trade secret, contract, patent, copyright and trademark law to
establish and protect our rights in our products and technology. There can be no
assurance that we will be able to protect our technology adequately or that
competitors will not be able to develop similar technology independently. In
addition, the laws of certain foreign countries may not protect the Company's
intellectual property rights to the same extent as the laws of the United
States. Cyanotech has two United States patents issued to it. Litigation in the
United States or abroad may be necessary to enforce our patent or other
intellectual property rights, to protect our trade secrets, to determine the
validity and scope of the proprietary rights of others or to defend against
claims of infringement. Such litigation, even if successful, could result in
substantial costs and diversion of resources and could have a material adverse
effect on our business, results of operations and financial condition.
Additionally, if any such claims are asserted against us, we may seek to obtain
a license under the third party's intellectual property rights. There can be no
assurance, however, that a license would be available on terms acceptable or
favorable to us, if at all.
For a description of pending patent litigation, see Item 3, Legal
Proceedings.
9
ASSOCIATES
Cyanotech employed 61 associates as of March 31, 1999, of which 58 are
full-time. Approximately 38 associates are involved in the harvesting and
production process, 9 are involved in research and product development, and the
remainder are involved in sales, administration and support. Management believes
that its relations with its associates are good. We have not experienced
difficulty in attracting personnel and none of our associates are represented by
a labor union.
INDUSTRY SEGMENTS AND EXPORT SALES
The Company has no assets outside of the United States. The Company's
business consists of one industry segment and is grouped into six geographic
areas: United States, Canada/South America, the Netherlands, Europe, excluding
the Netherlands, China and Asia/Pacific, excluding China. The following table,
(dollars in thousands), summarizes the product sales revenues from unaffiliated
customers in each of the six geographic regions:
1999 1998 1997
------------------------ ----------------------- ----------------------
United States $ 4,075 60% $ 4,297 56% $ 4,303 38%
Canada/South America 426 6% 404 5% 851 8%
The Netherlands 717 11% 496 7 499 4%
Europe, excluding the Netherlands 498 7% 788 10% 793 7%
China 50 1% 358 5% 3905 34%
Asia/Pacific, excluding China 972 15% 1284 17% 1048 9%
------------- ---------- ------------ ---------- ----------- ----------
Total Product Sales Revenues $ 6,738 100% $ 7,627 100% $11,399 100%
============= ========== ============ ========== =========== ==========
The Company believes that its profit margin on export sales is not
significantly different from that realized on sales in the United States. All
foreign product sales transactions are consummated in U.S. dollars.
For the years ended March 31, 1999 and 1998, the Company incurred losses of
$2,557,000 and $300,000, respectively. During these two fiscal years, the
Company has experienced declining sales which can be attributed to increased
competition for sales of Spirulina products in all of its major markets. The
most significant decline in sales revenue resulted from the loss of our largest
customer, a Hong Kong-based network marketing company, in fiscal 1998. This
matter is described in detail in Item 7. The major effect of the decrease in
sales has been a significant decrease in liquidity. Due to the significant
decrease in sales and the decline in working capital, the Company has taken
action to reduce expenditures and obtain additional sources of external
financing while concurrently continuing to diversify its product offerings and
explore opportunities for expanding the markets for its products. Management
believes that this plan may increase revenues and return the Company to
profitability. Furthermore, as described in detail in Item 7, the Company is in
technical default on certain debt. The Company's continuation as a going concern
is dependent upon its ability to generate sufficient cash flow to meet its
obligations on a timely basis, to comply with the terms of its financing
agreement, 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 successful or that the Company will return to generating
profit on either a quarterly or annual basis.
10
ITEM 2. PROPERTIES
Cyanotech Corporation is located in Kailua-Kona, Hawaii, at the HOST Park
and also owns a 2,500 square foot sales office in a light industrial area
located approximately four miles from the HOST Park. The HOST Park facility
consists of approximately 183 leased acres. Approximately 90 acres have been
fully developed and contain production ponds, a processing facility, a
laboratory, and administrative offices. All products are produced at this
facility. The property is leased from the State of Hawaii under a 30-year
commercial lease expiring in 2025. During 1997, we reached a preliminary
agreement with the State of Hawaii to lease an additional 93 acres at the HOST
Park, which increased the total acreage under lease to 183 acres. The State of
Hawaii has agreed to allow the Company to lease this additional 93 acres on a
year to year basis, until such time that the Company determines the need for a
longer lease term. Our current lease agreement is effective through December 31,
1999. Subject to available funds, we plan to use this new property to construct
a larger NatuRose production facility and additional culture ponds that would
use the BioDome CCS technology. We believe that there is sufficient available
land at the HOST Park to meet our currently planned future needs. Our Nutrex,
Inc. subsidiary maintains a sales office in Kailua-Kona, Hawaii.
ITEM 3. LEGAL PROCEEDINGS
On July 13, 1998, the Company filed a complaint (Case No. CV98-00600) in
United States District Court for the District of Hawaii ("Court") against
Aquasearch, Inc. ("Aquasearch"), seeking declaratory judgment of patent
noninfringement, patent invalidity, and non-misappropriation of trade secrets
relating to closed culture production of astaxanthin. The complaint was filed in
response to assertions by Aquasearch regarding its alleged intellectual property
rights. Aquasearch has answered the complaint and filed counter claims alleging
patent infringement, trade secret misappropriation, unfair competition and
breach of contract. The Court has granted Cyanotech's motion to amend its
complaint against Aquasearch to add claims of misappropriation of trade secrets
regarding open pond technology, unfair competition and breach of contract. We
believe that the Cyanotech technology involved in this dispute is outmoded and
have discontinued its use. We are pursing this litigation vigorously.
We maintain product liability insurance in limited amounts for products
involving human consumption. In the opinion of management, broader product
liability insurance coverage is prohibitively expensive at this time.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the stockholders during the fourth
quarter of fiscal 1999.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The information required by this Item is incorporated by reference to the
Section labeled "Market for Common Equity and Related Stockholder Matters"
appearing in the Company's 1999 Annual Report to Stockholders.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this Item is incorporated by reference to the
Section labeled "Selected Financial Data" appearing in the Company's 1999 Annual
Report to Stockholders.
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information required by this Item is incorporated by reference to
the Section labeled "Management's Discussion and Analysis of Financial Condition
and Results of Operations" appearing in the Company's 1999 Annual Report to
Stockholders.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have not entered into any transactions using derivative financial
instruments or derivative commodity instruments and believe that our exposure to
market risk associated with other financial instruments is not material.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated balance sheets of the Company and subsidiaries as of March
31, 1999 and 1998, and the related consolidated statements of operations,
stockholders' equity, and cash flows for each of the years in the three-year
period ended March 31, 1999, together with the accompanying notes and the
related Independent Auditors' Report, all contained in the Company's 1999 Annual
Report to Stockholders are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS; COMPLIANCE WITH SECTION 16(A) OF THE
EXCHANGE ACT
(a) IDENTIFICATION OF DIRECTORS
The information required by this Item is incorporated by reference from the
Sections captioned "Proposal One: Election of Directors," "Certain
Transactions," "Security Ownership of Certain Beneficial Owners and Management"
and "Compliance with Section 16(a) of the Exchange Act" contained in Cyanotech's
definitive 1999 Proxy Statement.
(b) IDENTIFICATION OF EXECUTIVE OFFICERS
The executive officers of Cyanotech and their ages and positions as of March 31,
1999 are as follows:
Name Age Position
---- --- --------
Gerald R. Cysewski, Ph.D. .....................50 Chairman of the Board, President and Chief
Executive Officer
Glenn D. Jensen ...............................40 Vice President - Operations
Larry L. Line .................................51 Vice President - Sales and Marketing
President - Nutrex, Inc.
Kelly J. Moorhead .............................43 Vice President - Product Development
Ronald P. Scott ...............................44 Executive Vice President - Finance and
Administration, Secretary, Treasurer
12
Dr. Cysewski co-founded Cyanotech in 1983 and has served as a director since
that time. Since March 1990, Dr. Cysewski has served as President and Chief
Executive Officer of Cyanotech and in October 1990 was also appointed to the
position of Chairman of the Board. From 1988 to November 1990, he served as Vice
Chairman and from 1983 to June, 1996 he served as Scientific Director of the
Company. From 1980 to 1982, Dr. Cysewski was group leader of microalgae research
and development at Battelle Northwest, a major contract research and development
firm. From 1976 to 1980, Dr. Cysewski was an assistant professor in the
Department of Chemical and Nuclear Engineering at the University of California,
Santa Barbara, where he received a two-year grant from the National Science
Foundation to develop a culture system for blue-green algae. Dr. Cysewski
received his doctorate in Chemical Engineering from the University of California
at Berkeley.
Mr. Jensen has served as Vice President - Operations since May 1993. He joined
Cyanotech in 1984 as Process Manager and was promoted to Production Manager in
1991, in which position he served until his promotion to Vice President -
Operations. Prior to joining Cyanotech, Mr. Jensen worked for three years as a
plant engineer at a Spirulina production facility, Cal-Alga, near Fresno,
California, which ceased to do business in 1983. Mr. Jensen holds a B.S. degree
in Health Science from California State University, Fresno.
Mr. Line has served as Vice President - Sales and Marketing and President of
Nutrex, Inc. since June, 1998. Prior to joining Cyanotech, Mr. Line was
President of Renaissance Executive Forums, an advisory board service for chief
executives in the San Jose, California area. In addition, he had a separate
management consulting and executive coaching practice that included domestic and
international clients. From 1978 through 1991, he acted in progressive
management roles for Syva Company, an international medical diagnostics company
which was a subsidiary of Syntex Corporation. Mr. Line holds a B.A. degree in
Chemistry from the California State University at Sacramento.
Mr. Moorhead has served as Vice President - Product Development since June,
1998. From October 1997 to June 1998, he served as Vice President - Sales and
Marketing of the Company and President of Nutrex, Inc. From August 1996 to
October 1997 he served as Vice President - International Sales. From December
1991 to August 1996 he served as Vice President - Sales and Marketing and
President of Nutrex, Inc. From August 1987 to December 1991, he served as Vice
President - Production of the Company. Mr. Moorhead joined Cyanotech as
Production Biologist in December 1984. Prior to joining Cyanotech, Mr. Moorhead
worked at the Oceanic Institute in Honolulu, Hawaii where he conducted research
on production of Spirulina from agricultural wastes. Mr. Moorhead holds a B.S.
degree in Aquatic Biology from the University of California, Santa Barbara.
Mr. Scott was appointed to the Board of Directors of the Company in November
1995, has served as Executive Vice President - Finance and Administration since
August 1995, and has served as Secretary and Treasurer since November 1990 and
June 1990, respectively. From December 1990 until August 1995 Mr. Scott served
as Vice President - Finance and Administration. From September 1990 to December
1990, Mr. Scott served as Controller. From 1989 to 1990, he was Assistant
Controller for PRIAM Corporation, a manufacturer of Winchester disk drives. From
1980 to 1989, he served in various accounting management positions with Measurex
Corporation, a manufacturer of industrial process control systems. Mr. Scott
holds a B.S. degree in Finance and Management from California State University,
San Jose, and an M.B.A. degree from the University of Santa Clara.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference from the
section captioned "Executive Compensation and Other Information," "Director
Remuneration" and "Stockholder Return Performance Graph" contained in
Cyanotech's definitive 1999 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference from the
section captioned "Security Ownership of Certain Beneficial Owners and
Management" contained in Cyanotech's definitive 1999 Proxy Statement.
13
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1). The following Consolidated Financial Statements of Cyanotech
Corporation and its subsidiaries are incorporated herein by reference pursuant
to Item 8:
Page in 1999
Annual Report
To Stockholders
Independent Auditors' Report....................................................................24
Consolidated Balance Sheets as of March 31, 1999 and 1998........................................9
Consolidated Statements of Operations for each of the years
in the three-year period ended March 31, 1999...................................................10
Consolidated Statements of Stockholders' Equity for
each of the years in the three-year period ended March 31, 1999.................................11
Consolidated Statements of Cash Flows for each of the years
in the three-year period ended March 31, 1999...................................................12
Notes to Consolidated Financial Statements....................................................13-23
(a) (2). The following financial statement schedule is included in this report
on the pages indicated below:
Schedule II Valuation and Qualifying Accounts...................................................17
Independent Auditors' Report on Schedule........................................................18
Schedules not listed above are omitted because of the absence of the conditions
under which they are required or because the required information is included in
the consolidated financial statements or notes thereto, which financial
statements are incorporated by reference.
(a) (3). Index to exhibits
EXHIBIT NUMBER DOCUMENT DESCRIPTION
3.1 Restated Articles of Incorporation. (Incorporated by reference to Exhibit 3.1 to the Company's Quarterly
Report on Form 10-QSB for the quarter ended December 31, 1996, file no. 0-14602.)
3.2 Bylaws of the Registrant, as amended. (Incorporated by reference to Exhibit 3.1 to the Company's Quarterly
Report on Form 10-QSB for the quarter ended December 31, 1995, file no. 0-14602.)
4.1 Specimen Common Stock Certificate. (Incorporated by reference to Exhibit 4.1 to the Company's Registration
Statement on Form SB-2 filed on February 28, 1996, file no. 333-00951.)
4.2 Terms of the Series C Preferred Stock as Revised 1991. (Incorporated by reference to Exhibit 4.1 to the
Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, file no. 0-14602.)
14
10.1 1985 Incentive Stock Option Plan dated March 18, 1985, as amended. (Incorporated by reference to Exhibit
4(d) to the Company's Registration Statement on Form S-8 filed on December 3, 1992, file no. 33-55310.)
10.2 Stockholders Agreement dated as of May 17, 1993.(Incorporated by reference to Exhibit 10.8 to the Company's
Annual Report on Form 10-KSB for the fiscal year ended March 31, 1994, file no. 0-14602.)
10.3 1994 Non-Employee Directors Stock Option and Stock Grant Plan. (Incorporated by reference to Exhibit 10.7
to the Company's Annual Report on Form 10-KSB for the fiscal year ended March 31, 1994, file no. 0-14602.)
10.4 Term Loan Agreement dated April 1, 1995 between Spirulina International B.V. and the Company. (Incorporated
by reference to Exhibit 10.13 to the Company's Annual Report on Form 10-KSB for the fiscal year ended March
31, 1995, file no. 0-14602.)
10.5 License Agreement by and between The University of Memphis and the Company dated June 19, 1995.
(Incorporated by reference to Exhibit 10.14 to the Company's Annual Report on Form 10-KSB for the fiscal
year ended March 31, 1995, file no. 0-14602.)
10.6 1995 Stock Option Plan for Cyanotech Corporation dated August 9, 1995, as amended. (Incorporated by
reference to Exhibit 4(C) to the Company's Registration Statement on Form S-8 filed on October 27, 1995,
file no. 33-63789.)
10.7 Sub-Lease Agreement between the Company and Natural Energy Laboratory of Hawaii Authority dated December
29, 1995. (Incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-QSB for
the quarter ended December 31, 1995, file no. 0-14602.)
10.8 Preferred Stock Conversion and Registration Rights Agreement by and between the Company and Firemen's
Insurance Company of Newark, New Jersey, dated as of February 20, 1996. (Incorporated by reference to
Exhibit 10.16 to the Company's Registration Statement on Form SB-2 as filed on February 28, 1996, file no.
333-00951.)
10.9 Registration Rights Agreement by and between the Company and American Cyanamid Company dated as of February
20, 1996. (Incorporated by reference to Exhibit 10.17 to the Company's Registration Statement on Form SB-2
as filed on February 28, 1996, file no 333-00951.)
10.10 License Agreement between The Scripps Research Institute and the Company dated April 14, 1998.(Incorporated
by reference to Exhibit 10.14 to the Company's Annual Report on Form 10-K for the fiscal year ended March
31, 1998, file no. 0-14602.)
10.11 Workout/suspension Agreement between the Company and Kiewit Pacific Co. dated March 30, 1998. (Incorporated
by reference to Exhibit 10.15 to the Company's Annual Report on Form 10-K for the fiscal year ended March
31, 1998, file no. 0-14602.)
10.12 Security Agreement between the Company and Kiewit Pacific Co. dated January 1, 1998. (Incorporated by
reference to Exhibit 10.16 to the Company's Annual Report on Form 10-K for the fiscal year ended March 31,
1998, file no. 0-14602.)
10.13 Loan and Security Agreement and Schedule to the Loan and Security Agreement dated July 28, 1998 between the
Company and Coast Business Credit. (Incorporated by reference to Exhibit 10.1 to the Company's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1998, file no. 0-14602.)
15
10.14 Workout/suspension Agreement between the Company and Kiewit Pacific Co. dated June 15, 1999.
11.1 Statement re: Computation of Earnings per Share
13 1999 Annual Report to Stockholders (portions only)
21.1 Subsidiaries of the Company.
23.1 Accountants' Consent
27 Financial Data Schedule.
(b) Reports on Form 8-K
The Registrant did not file any reports on Form 8-K during the fourth quarter of
the 1999 fiscal year.
No Annual Report to Stockholders or proxy material has been sent to Stockholders
as of this date. Such report and proxy material will be furnished to
Stockholders after the filing of this Form and copies of such materials will be
furnished to the Commission when they are sent to Stockholders.
16
Schedule II
Cyanotech Corporation and Subsidiaries
Valuation and Qualifying Accounts (in thousands)
Years Ended March 31, 1999, 1998 and 1997
Column A Column B Column C Column D Column E
Additions
Balance at Charged to Charged to Balance at
Beginning Costs and Other End of
Description of Year Expenses Accounts Deductions Year
Allowance for Doubtful Receivables
1999 $ 10 5 -- 3 $ 12
1998 $ -- 10 -- -- $ 10
1997 $ -- -- -- -- $ --
17
INDEPENDENT AUDITORS' REPORT ON SCHEDULE
The Board of Directors
Cyanotech Corporation:
Under date of May 14, 1999, except as to the second paragraph of note 3, the
second paragraph of note 4 and the second paragraph of note 13, which are as of
July 13, 1999, we reported on the consolidated balance sheets of Cyanotech
Corporation and subsidiaries as of March 31, 1999 and 1998, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the years in the three-year period ended March 31, 1999, as contained
in the 1999 annual report to stockholders. These consolidated financial
statements and our report thereon are incorporated by reference in the annual
report on Form 10-K for the year ended March 31, 1999. In connection with our
audits of the aforementioned consolidated financial statements, we also audited
the related financial statement schedule as listed in the accompanying index.
The financial statement schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion on the financial
statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in relation
to the basic consolidated financial statements taken as a whole, presents
fairly, in all material respects, the information set forth therein.
The independent auditors' report on the consolidated financial statements of
Cyanotech Corporation referred to above also contains an explanatory paragraph
that states that the consolidated financial statements have been prepared
assuming that Cyanotech Corporation will continue as a going concern. As
discussed in note 13 to the consolidated financial statements, the Company has
suffered recurring losses from operations and has limited sources of additional
liquidity that raise substantial doubt about its ability to continue as a going
concern. Management's plans in regard to these matters are also described in
note 13. The consolidated financial statements and financial statement schedule
do not include any adjustments that might result from the outcome of this
uncertainty.
/s/ KPMG LLP
Honolulu, Hawaii
May 14, 1999
18
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on the 23rd day of
June, 1999.
CYANOTECH CORPORATION
By: /s/ Gerald R. Cysewski, Ph.D.
-----------------------------
Gerald R. Cysewski, Ph.D.
Chairman of the Board,
President and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signatures Title Date
/s/ Gerald R. Cysewski Chairman of the Board, President and June 23, 1999
- ------------------------- Chief Executive Officer (Principal -------------
Gerald R. Cysewski, Ph.D. Executive Officer and Director)
/s/ Ronald P. Scott Executive Vice President - Finance and June 23, 1999
- ------------------------- Administration, Secretary and Treasurer -------------
Ronald P. Scott (Principal Financial and Accounting
Officer and Director)
/s/ Eric R. Reichl Director June 23, 1999
- ------------------------- -------------
Eric R. Reichl
/s/ John T. Waldron Director June 23, 1999
- ------------------------- -------------
John T. Waldron
/s/ Paul C. Yuen Director June 23, 1999
- ------------------------- -------------
Paul C. Yuen
19