Cyanotech Corporation

Aloha from Kona, Hawaii. Thank you all for joining us today. We are honored to report Cyanotech's physical year 2019 earning results. I am Jerry Sesoski, Chief Executive Officer for Cyanotech and Nutrex. At this stage, I would like to introduce our Chief Financial Officer, Brian Orlop, who will make a safe harbor statement and review our financial results for the year. We will respond to questions after Brian shares the year-end financial results.

Thank you, Jerry. 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 Security and Exchange Commission.

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

Thanks, Jerry. 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 $915,000 pre-tax income. Fiscal year 2019, as Jerry mentioned, 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 a result of higher cost anthoxanthin 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 year 2018. The total impact on gross profit in fiscal year for the Spirulina production issue and the re-inoculation process was $2.1 million, or 7 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 cost of the new pilot production and research facility, and labor cost. Sales and marketing expenses increased $0.3 million, made up primarily of promotion costs. Research and development expenses increased $0.3 million as well, due to labor and testing costs related to the pilot production. Net loss for the fiscal year was $3.6 million, or a loss of $0.62 per diluted share, as compared to the net income of $1 million, or $0.18 per diluted share in fiscal year 2018. Now back to you, Jerry.

Thank you, Brian. We received some very good questions, which I will respond to. First question is about water conservation. The company has long been dealing with water conservation issues and requirements. The company reports that in FY 2019, forced water conservation efforts substantially caused the production problems affecting spirulina. Could you comment on how the requirements dealt with during FY 2019 differed from prior years? This is to give investors a sense of potential risk factors and future periods. The answer, this most recent water supply and conservation issue was unique in our experience in that 7 out of 13 wells operated by the Department of Water Supply for the County of Hawaii failed. In the past, at most, we have not seen any more than 2 or 3 wells fail at the same time. The next question is about 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 intentionally to reduce astaxanthin production and or sought to reduce inventory levels? This is a new plan, but it's also the case that on occasion in the past we have reduced astaxanthin production to respond to varying market conditions. Next question is concerning inventory levels. Please provide a full explanation for the apparent rise in inventory of astaxanthin. The Costco and Amazon channels appear to be thriving, and neither appears to require co-presentation of spirulina and astaxanthin. Costco generally does not carry spirulina offline. Is the rising inventory level the result of improved astaxanthin production techniques? The answer, Astaxanthin sales to Costco are stable and improving at Amazon. Axe inventory increases in FY19 were due to slowdowns in other market channels and especially in the international channel. The fourth question is concerning mistakes. Please expand on the disclosure of errors in the cultivation and judgment and execution and give investors a sense of potential risk factors for future periods. Answer. We were faced with a unique set of challenges with the most recent water shortage. We at first looked for a quick, cost-effective solution, 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. The fifth question was concerning expenses. Please discuss why expenses were allowed to increase across the board, and particularly why sales and marketing expenses increased significantly. during a period when the company apparently knew that its inventory situation would inhibit near-term sales and result in lower revenue levels. Why the ramp up in sales efforts and expenses when you have no product to sell? Answer, sales channels are always in flux. We try to be efficient with sales and marketing spending and we ran some new experiments and promotions. Some are successful, some are not. We are paying closer attention to these expenses and per your question, expect lower sales and marketing spend in FY 2020. The sixth question is 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 problem that apparently required an emergency loan from a non-profit family foundation controlled by the company's chairman. The acquisition of the six-acre site adjacent to the company's facility was made at the end of the third quarter of FY19. The next question is in regards to sales in Britain or the U.K., With regard to selling retail products in Britain, I'm wondering if cyanotex applied to the country's medicine control agency for the license to do so. And if so, what is the status of that? And what, in your view, is the potential for markets of your products in these stores? We have not applied to the UK Medicine Control Agency for a license for BioAsten products. We do have current customers in the UK for both Cyanotec bulk products and Nutrex finished consumer products. The final question is concerning water. I understand Cyanotec is involved in a project to create a water desalination plant that would supply it with the water it needs. Expond on the scope of that the company's role in it, and the status of the project, and any relevant information about it you would like to share. Answer, we have looked into the water desalination plant, but have not moved ahead. We do keep water supply and water quality issues at the top of mind. We are in communication with water desalination activities of a bottler here at the Natural Energy Lab. That is it. I would like to take this opportunity for concluding remarks. While we were disappointed with the unfortuitous events in fiscal year 2019 affecting our financial performance and market commitment, we are encouraged by the resumption of normal spirulina production by the middle of the fiscal year, recent process improvements across our operation, and a company-wide cost control program. The fundamental nature of agriculture will always present challenges, but we remain resolute in our path forward. Our strategic focus is committed to leveraging our quality reputation to improve market penetration, sustainability of our production volume levels for both Astaxanthin and Spirulina, and continuing to support initiatives that advance the economic value of our company. We thank you all for joining us today on the call. Aloha.