FY 2019 Earnings Broadcast

July 2, 2019; 8:00PM EDT

Executives:

Gerry Cysewski – Chief Executive Officer

Brian Orlopp – Chief Financial Officer

Gerry Cysewski

Aloha from Kona, Hawaii.  Thank you all for joining us today.  We are honored to report Cyanotech’s fiscal year 2019 earnings results.  I am Gerry Cysewski, Chief Executive Officer for Cyanotech and Nutrex.  At this stage I would like to introduce our Chief Financial Officer, Brian Orlopp, who will make a Safe Harbor statement and review our financial results for the third quarter.  We will respond to questions after Brian shares the year-end results.

Brian Orlopp

Thank you Gerry.  Let me start by saying our discussion today may include forward-looking statements.  We do not undertake any obligation to update forward-looking statements either as a result of new information, future events or otherwise.  Our actual results may differ materially from what is described in these forward-looking statements.  Some of the factors that may cause results to differ are listed in our publicly filed documents.  For additional information, we encourage you to review our 10Q and 10K filings with the Securities and Exchange Commission.

Gerry Cysewski

Thank you Brian.  Before Brian discusses the financial details, I would like to point out fiscal year 2019 was a trying year for Cyanotech.  Unforeseen environmental factors that took place in the 4th quarter of fiscal year 2018 carried forward and effected our production of Spirulina in fiscal year 2019 resulting in a costly re-inoculation process to correct the nutrient level and stabilize our ponds.  These events resulted in a full year lower Spirulina availability, high production costs, lower sales revenue, and correspondingly higher operating losses which culminated in the comparative financial reporting to follow.

Brian Orlopp

Thanks Gerry.  Now let’s go through the results for the fiscal year.

Sales in the fourth quarter fell substantially from the prior quarter by $3.9 million to $6.1 million, resulting in an annual net sales of $30.2 million, 11.5% below fiscal year 2018.  Overall pre-tax loss for the fiscal year 2019 was $3.6 million, a $4.6 million swing from last year which recorded a $915K pretax income.   Fiscal 2019 was largely affected by the drop in Spirulina production.  We were unable to fulfill both Nutrex and bulk orders.  Of the $3.9 million drop in total sales, Spirulina was the largest attributable factor of $2.3 million due to product unavailability.  Astaxanthin drop of $1.7 million was largely due to a decrease in international sales of $1.3 million resulting from reduced orders from China.

Our gross profit percent of net sales decreased 4.5% percentage points of which 3.2 percentage points was the result of high cost astaxanthin inventory that was carried over from fiscal year 2018 and sold in 2019. The remaining 1.3 percentage point decrease was a result of unfavorable production variance stemming from Spirulina as compared to fiscal 2018.  The total impact on gross profit in fiscal year from the spirulina production issue and the re-inoculation process was $2.1 million or 7.0 percentage points.

Operating expenses increased $1.5 million from last fiscal year.  General and administrative expenses increased $0.8 million due to increases in legal and professional fees, pre-operating costs of the new pilot production and research facility and labor costs. Sales and Marketing expenses increased $0.3 million, made up primarily of promotion costs.  Research and Development expenses increased $0.3 million due labor and testing costs related to the pilot production.

Net loss for the fiscal year was $3.6 million or loss of $0.62 per diluted share as compared to the net income of $1.0 million or 18 cents per diluted share in fiscal year 2018.

Now back to Gerry.

Gerry Cysewski

Received some very good questions which I will respond to.

    1. Water conservation.  The company has long been dealing with water conservation issues and requirements.  The company reports that in FY2019, forced water conservation efforts substantially caused the production problems effecting spirulina.  Could you comment on how the requirements dealt with during FY2019 differed from prior years – this to give investors a sense of potential risk factors for future periods.A: This most recent water supply and conservation issue was unique in our experience in that 7 of the 13 wells operated by the Dept of Water Supply for the County of Hawaii failed. In the past, at most we had not seen any more than 2 or 3 fail at one time.
    2. Astaxanthin ponds.  The recent press release reports a plan to temporarily reduce the number of astaxanthin ponds in production in order to manage down inventory levels.  Is this a new plan, or has the company previously acted to intentionally reduce astaxanthin production and/or sought to reduce inventory levels?A: This is a new plan, but it is also the case that  we have on occasion reduced Ax production in the past  to respond to varying market conditions.
    3. Inventory levels.  Please provide a fuller explanation for the apparent rising inventory of astaxanthin.  The Costco and Amazon channels appear to be thriving and neither appears to require the co-presentation of spirulina and astaxanthin (Costco generally does not carry sprirulina offline).  Is the rising inventory the result of improved astaxanthin production techniques?A: Ax sales to Costco are stable and improving at Amazon. Ax inventory increased in FY19 due to slowdowns in other sales channels, and especially in the international market.
    4. Mistakes. Please expand on the disclosure of “errors in cultivation judgement and execution” – again to give investors a sense of potential risk factors for future periods.

      A: We were faced with a unique set of challenges with the most recent water shortage.  We at first looked for quick, cost effective solutions which, regrettably, did not pan out as we had hoped,  and may in fact have exacerbated the problems.  This was a complex and highly technical problem, which required more experimentation than anticipated.

    5. Please discuss why expenses were allowed to increase across the board, and particularly why sales and marketing expenses increased during a period when the company (apparently) knew that its inventory situation would inhibit near-term sales and result in lower revenue levels.  Why ramp up sales efforts and expense when you have no product to sell?

      A: Sales channels are always in flux. We try to be efficient with Sales and Marketing spending and ran some new experiments and promotions. Some were successful, some were not. We are paying closer attention to this expense, per your question, and expect a lower Sales and Marketing spend in FY2020.

    6. Capital allocation.  Please expand on the discussion concerning the rationale for acquiring the six-acre site adjacent to the company’s facility, particularly in light of the subsequent working capital problems that apparently required an emergency loan from a nonprofit family foundation controlled by the company’s chairman.

      A: The acquisition of the six-acre site adjacent to the Company’s facility was made at the end of the 3rd quarter of FY19. This acquisition was an opportunity that might not come again.  Our working capital problem did not come to light until well into the 4th quarter, with the sudden unexpected dropoff in sales. Sales in the first quarter of FY20 have returned to more normal levels.

    7. With regard to selling its retail products in Britain, I’m wondering if Cyanotech has applied to that country’s Medicines Control Agency for the license to do so, and if so, what is the status of that? And what is your view of the potential market for your products in the stores there?

      A: We have not applied to the UK Medicines Control agency for a license BioAstin products.  We do have current customers in the UK for both Cyanotech bulk products and Nutrex finished consumer products.

    8. I understand that Cyanotech is involved in a project to create a water desalinization plant that would supply it with the water it needs. Could you expound on the scope of that, the company’s role in it, the status of the project, and any relevant information about it you would like to share?

      A: We have looked into a water desalination plant, but have not moved ahead. We do keep water supply and water quality issues top of mind. We are in communication with the water desalination activities of a bottler here at NELHA.

I would like to take this opportunity for concluding comments.

While we were disappointed in the unfortuitous events in fiscal year 2019 affecting our financial performance and market commitment, we are encouraged by the resumption of normal production in Spirulina production by the end of the fiscal year, recent process improvements across our operations, and Company-wide cost cutting programs implementations.

The fundamental nature of agriculture will always present challenges but we remain resolute in our path forward direction.  Our strategic focus is committed to leveraging our quality reputation in improving markets penetration, sustainability of our production volume levels for both astaxanthin and spirulina and continuing to support initiatives that advance economic value for our Company.

We thank you for joining the call today.  Aloha