UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D. C. 20549

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FORM 10-K

|(Mark One)                                                       |                                                                                         
|---------------------------------------------------------------- | ----------------------------------------------------------------------------------------
|ý                                                                | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|For the Fiscal Year Ended March 31, 2005                        
|or                                                              
|o                                                                | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|For the transition period
from                                to

Commission File Number 0-146-02

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CYANOTECH CORPORATION(Exact name of registrant as specified in its charter)

|Nevada(State or other jurisdiction of
incorporation or organization)                                    |  | 91-1206026(I. R. S. Employer
Identification No.)
|------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------
|73-4460 Queen Kaahumanu Highway,
Suite 102,
Kailua-Kona, Hawaii(Address of principal executive offices) |  | 96740(Zip Code)                                 

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Registrant's
telephone number, including area code:(808) 326-1353

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $.005 par value(Title of Class)

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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 ý    No o

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 Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amndment to
this Form 10-K. ý

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

The aggregate market value of the Registrant's Common Stock held by non-affiliates of the Registrant on June 24, 2005 was approximately
$16,284,000 based on the closing sale price of the Common Stock on the NASDAQ SmallCap Market on that date.

Number
of shares outstanding of Registrant's Common Stock at June 24, 2005 was 20,269,000.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's Definitive Proxy Statement for its 2005 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission on or
prior to July 15, 2005 and to be used in connection with the Annual Meeting of Stockholders expected to be held on August 22, 2005, are incorporated by reference in Part III of
this Form 10-K.



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TABLE OF CONTENTS

|Item     |                                                                                       |  | Page
|-------- | ------------------------------------------------------------------------------------- |  | ----
|PART I  
|1.       | Business                                                                              |  | 3   
|2.       | Properties                                                                            |  | 10  
|3.       | Legal Proceedings                                                                     |  | 11  
|4.       | Submission of Matters to a Vote of Security Holders                                   |  | 11  
|PART II 
|5.       | Market for Registrant's Common Equity and Related Stockholder Matters                 |  | 12  
|6.       | Selected Financial Data                                                               |  | 12  
|7.       | Management's Discussion and Analysis of Financial Condition and Results of Operations |  | 13  
|7a.      | Quantitative and Qualitative Disclosures About Market Risk                            |  | 22  
|8.       | Financial Statements and Supplementary Data                                           |  | 23  
|9.       | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure  |  | 43  
|9a.      | Controls and Procedures                                                               |  | 43  
|PART III
|10.      | Directors and Executive Officers of the Registrant                                    |  | 43  
|11.      | Executive Compensation                                                                |  | 43  
|12.      | Security Ownership of Certain Beneficial Owners and Management                        |  | 43  
|13.      | Certain Relationships and Related Transactions                                        |  | 43  
|14.      | Principal Accounting Fees and Services                                                |  | 43  
|PART IV 
|15.      | Exhibits, Financial Statement Schedules, and Reports on Form 8-K                      |  | 44  
|         | Signatures                                                                            |  | 48  
|         |                                                                                       |  |     

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PART I

Item 1. Business

General

Cyanotech Corporation is a world leader in the production of high value natural products derived from microalgae. Incorporated in 1983, the Company is guided by
the principle of providing beneficial, quality microalgal products for human and animal nutrition in a sustainable, reliable and environmentally sensitive operation. We are ISO 9001:2000 compliant,
reinforcing our commitment to quality in our products, to quality in our relationships (with our customers, suppliers, co-workers and the communities we live in), and to quality of the
environment we work in. The Company's products include:



Microalgae
are a diverse group of microscopic plants that have a wide range of physiological and biochemical characteristics and contain, among other things, high levels of natural
protein, 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 uniform cell structure with no bark, stems, branches or leaves, permitting easier extraction of products and higher utilization of the
microalgae cells; and (3) the cellular uniformity of microalgae makes it practical to manipulate and control growing conditions in order to optimize a particular cell characteristic.Efficient
cultivation of microalgae requires consistent light, warm temperature, low rainfall and proper chemical balance in a very nutrient-rich environment. If the chemical composition of a pond
changes from its required balance, contamination can occur as a result of the growth of unwanted organisms.

Since
1983, we have designed, developed and implemented proprietary production and harvesting technologies, systems and processes resulting in the elimination of many of the stability
and contamination problems frequently encountered in the production of microalgae. Our capacity to produce these products at our 90-acre facility on the Kona Coast of Hawaii provides
significant advantages. We selected the Keahole Point location in order to take advantage of the consistent warm temperatures, abundant sunshine and low levels of rainfall needed for optimal
cultivation of microalgae. This location also offers us access to cold deep ocean water, drawn from an offshore depth of 2,000 feet, which we use in our patentedOcean-Chill
Dryingsystem to eliminate the oxidative damage caused by standard drying techniques and as a source of trace nutrients for microalgal cultures. We believe that our technology,
systems, processes and favorable growing location permit year-round harvest of our microalgal products in a cost-effective manner.

Unless
otherwise indicated, all references in this report to the "Company," "we," "us," "our," and "Cyanotech" refer to Cyanotech Corporation and its wholly owned subsidiaries, Nutrex
Hawaii, Inc.

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("Nutrex
Hawaii" or "Nutrex"), a Hawaii corporation, and Cyanotech Japan YK ("Cyanotech Japan" or "CJYK"), a Japan corporation.

Cyanotech's Business

The Company operates entirely in one operating segment, the cultivation and production of microalgae into high-value, high-quality natural
products. The Company currently cultivates, on a large-scale basis, two microalgal species from which our two major product lines, spirulina products and natural astaxanthin products, are derived.
Cyanotech records revenue and cost of sales information by product category but does not record operating expenses by such product category. The following table sets forth, for the three years ended
March 31, 2005, the net sales contributed by each of the Company's product lines (in thousands):

Net Sales2005

2004

2003Spirulina products:Spirulina Pacifica

$
6,626

$
6,511

$
6,181Natural astaxanthin products:NatuRose


1,817


2,545


1,301BioAstin


2,855


2,388


1,312Other including phycobiliproteins


147


138


157Total

$
11,445

$
11,582

$
8,951


SpirulinaProducts

Since 1985, Cyanotech has been producing a strain of spirulina microalgae marketed asSpirulina Pacifica.Accounting for 58%, 56% and 69% of net sales for the years ended March 31, 2005, 2004, and 2003, respectively,Spirulina Pacificaprovides a
vegetable-based, highly absorbable source of protein, natural beta-carotene, mixed carotenoids, B vitamins, gamma linolenic acid, essential amino acids and other phytonutrients. Spirulina Pacificais
produced 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 as a daily dietary supplement. All three forms are sold as raw material in bulk quantities and as packaged consumer
products under the Nutrex Hawaii label.

Since
1994, we have produced two grades ofSpirulina Pacifica: an all-natural grade cultivated by using conventional
agricultural fertilizers and an organic grade that is cultivated using only organic fertilizers. Our organicSpirulina Pacificais grown and processed
in accordance with the National Organic Program of the United States Department of Agriculture ("USDA") effective October 2002. Prior to the establishment of the USDA organic standard, our
organic standard was the California Organic Food Act of 1990. Our organic cultivation and processing methods are certified annually by Quality Assurance International of San Diego, California, a
leading third-party agency. In addition to such organic certification, both grades ofSpirulina Pacificaare certified Kosher by Organized Kashrus
Laboratories of Brooklyn, New York and are cultivated without the use of herbicides or pesticides. In its 2002 decision the USDA National Organics Standards Board ("NOSB") allowed the use of certain
fertilizers in organic Spirulina cultivation through October 2005, after which all cultivators must find alternate sources of key nutrients in order to retain organic certification. The Company
has determined that although alternative fertilizers exist, the costs are prohibitive. Other cultivators in the United States have reached similar conclusions. If the USDA-NOSB does not
extend the use of certain fertilizers for organic Spirulina cultivation at its October 2005 meeting, the Company plans to discontinue cultivating organic Spirulina and will convert all
Spirulina cultivation to all-natural. The

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Company
does not expect this decision to have a material effect on overall sales of our Spirulina Pacifica products.

In
March 2003, Cyanotech and Earthrise Nutritionals, Inc. of Petaluma, California submitted a joint notice to the United States Food and Drug Administration ("FDA")
reporting their determination, through scientific procedures, that the spirulina cultivated by both companies is GRAS (generally recognized as safe) for addition to a variety of foods. In
November 2003, the FDA concluded the notification procedure by written response that it had no questions about the companies' determination that spirulina is GRAS for addition to a variety of
foods.

OurSpirulina Pacificais cultivated in a combination of fresh water and a metered amount of nutrient-rich deep ocean water
(containing essential trace elements), drawn from a depth of 2,000 feet below sea level. This water mixture is supplemented with the other major required nutrients such as sodium bicarbonate (baking
soda) and infused with carbon dioxide. With the exception of deep ocean water, the raw materials and nutrients required in our spirulina production are available from multiple sources; however, there
can be no assurance that the pricing from a new source will be comparable to current pricing. In the case of deep ocean water, although abundantly available at this location, the facility to pump and
deliver the water to the Company is owned by the State of Hawaii. The facility is constructed of two separately located pump stations providing redundancy should one station fail. The State of Hawaii
sets the price for deep ocean water annually based on its cost to deliver the water. If the pricing for a critical raw material or nutrient significantly increases, this could have a material adverse
effect on our business, financial condition and results of operations. The ability of the Company's suppliers to meet performance and quality specifications and delivery schedules is important to
operations.

Continuing
the production process, the spirulina crop in each pond is circulated by paddlewheels to keep an even blend of nutrients in suspension and a uniform exposure of the algae to
sunlight. Our ponds are engineered to maintain the right media depth for sunlight to permeate each crop completely, facilitating rapid growth. The design of our cultivation ponds promotes efficient
growing conditions, allowing theSpirulina Pacificaalgae to reproduce rapidly. Each pond can be harvested, on average, in six days. As sunlight is a
major component of cultivation, production can be impacted from seasonality changes during the winter months, with shortened daylight hours and potential inclement weather.

Once
ready for harvest, some 70% of the spirulina algae is pumped from a pond through underground pipes to our processing building where the crop is separated from the culture media by
stainless steel screens. The remaining culture serves as an inoculum for the next growth cycle. Harvested spirulina is washed with fresh water and vacuum filtered before moving to the drying stage.
Culture media separated from spirulina algae during processing is conserved and recycled. Recycled media is refortified with nutrients before being returned to the culture ponds for another cycle of
cultivation. OurIntegrated Culture Biology Management("ICBM") technology for microalgae cultivation has proven to be a reliable and stable operating
environment, allowing us to grow and harvest spirulina without significant contamination by unwanted microorganisms and without associated loss of productivity.

Spirulina Pacificapowder is dried via our patented low-oxygenOcean-Chill
Dryingprocess, thereby preserving high levels of antioxidant carotenoids and other nutrients sensitive to heat and oxygen. This process also allows us to recover carbon
dioxide from our drying system gas to be reused as a raw material back in our growing ponds. The drying process takes about six seconds and results in a dark green powder. Spirulina powder is
difficult to form into tablets. Most tablet manufacturers either add high amounts (from 10% to 30%) of inert substances to "glue" the tablet together or use a heat granulation process that destroys
nutrients. In contrast, ourSpirulina Pacificatablets (except for ourHawaiian Energizerlabel) contain
a maximum of 2% of such substances and are produced in cold press

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compression
tablet-making machines. OurSpirulina Pacificaflakes are produced by combining freshly harvestedSpirulina
Pacificawith food-grade lecithin and drying this blend in a proprietary system.

Each
production lot ofSpirulina Pacificais sampled and subjected to thorough quality control analyses including testing for moisture,
carotenoids, minerals, color and taste, among others. Further, each lot of ourSpirulina Pacificaundergoes a prescribed set of microbiological food
product tests, including total aerobic bacteria, coliform bacteria and E. coli. TheSpirulina Pacificapowder, tablets and flakes are vacuum-sealed in
oxygen-barrier foil laminate bags along with a packet of oxygen absorbent. This packaging ensures product freshness and extends the shelf life of bulkSpirulina
Pacificaproducts. The Company's packaged consumer products are bottled and labeled by two contractors in California. These contractors are organic and Kosher certified,
subject to regular government inspections. Such packaging services are readily available from multiple sources.

The
majority of our bulk spirulina sales are to health food manufacturers and formulators with their own spirulina product lines, many of whom identify and promote Cyanotech's Hawaiian Spirulina Pacificain
their products. Such customers purchase bulk powder or bulk tablets and package these products under their brand label for sale to
the health and natural food markets. Many of the brands produced by these customers are marketed and sold domestically in direct competition with the packaged consumer products sold through our Nutrex
Hawaii subsidiary. Nutrex Hawaii packaged consumer products are sold through an established health food distribution network in the domestic market and shipped through one of our wholesale
distributors. In selected foreign markets, we have exclusive sales distributors for both our bulk and packaged consumer products.

OurSpirulina Pacificaproducts 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 and 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 is currently from Dainippon Ink and Chemical Company's Earthrise facility
in California and several farms in China. Other competitors include numerous smaller farms in China, India, Thailand, Taiwan, Cuba, South Africa and South America. The market for spirulina is mature
with slow growth expected in future periods. In this mature market, the Company has experienced increased price competition due to more spirulina suppliers as well as a larger portion of sales coming
from bulk product orders whose customers generally treat these products
as commodities with price being the major determining factor driving their purchasing decision. As one of the largest producers of spirulina, our challenge is to increase our market share among
customers who seek the high-quality products we produce while concurrently adjusting our product mix to meet our revenue targets. The backlog of all Spirulina products totaled $661,000,
$334,000 and $266,000 as of March 31, 2005, 2004 and 2003, respectively.

Natural AstaxanthinProducts

The Company commenced commercial production of natural astaxanthin in early 1997 with the introduction ofNatuRoseto the aquaculture market. Astaxanthin is a red pigment used in the aquaculture market primarily to impart a pink to red color to the flesh of commercially raised fish and shrimp but also has been
found to be essential for their proper growth and survival. Since its introduction, several feeding trials have been performed by our customers and potential customers that prove the efficacy of NatuRoseas an alternative to the petrochemical-based synthetic astaxanthin presently used by most aquaculture companies. The appeal of our product is
that it is derived from a natural source and produces results that are comparable, or in some cases superior, to synthetic astaxanthin. Sold in bulk quantities as a powder, NatuRosesales accounted for
16%, 22% and 14% of net sales for the years ended March 31, 2005, 2004 and 2003, respectively.

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In
1999, our natural astaxanthin product for the human nutrition market,BioAstin,was introduced. BioAstinsales accounted for 25%, 21% and 15% of net sales
for the years ended March 31, 2005, 2004 and 2003, respectively. BioAstinis produced in three forms: a liquid lipid extract, gelcaps and microencapsulated "beadlets" with all three forms sold in
bulk quantities. BioAstingelcaps are also sold in packaged consumer form under the Nutrex Hawaii label. A growing body of scientific literature is suggesting that the
beneficial antioxidant properties of natural astaxanthin may surpass many of the antioxidant properties of vitamin C, vitamin E, beta-carotene and other carotenoids. Independent scientific
studies indicate that in certain models, natural astaxanthin has up to 550 times the antioxidant activity of vitamin E and 10 times the antioxidant activity of beta-carotene.

The
Company produces natural astaxanthin fromHaematococcus pluvialismicroalgae grown in fresh water supplemented with nutrients. As
these algae are extremely susceptible to contamination by unwanted algae, protozoa and amoebae, the Company developed a proprietary system known as thePhytoDome Closed Culture
SystemorPhytoDome CCSto overcome this problem.Using these large-scale
photobioreactors, we are able to grow consistently large volumes of contaminant-freeHaematococcusculture. Raw materials and nutrients for
our natural astaxanthin production share the same sourcing constraints and pricing risks as those existing in our spirulina production. Fresh water is critical to the production of our natural
astaxanthin and is supplied by the County of Hawaii. While the Company has not experienced any constraint on fresh water availability to date, availability could be impacted by a significant
population growth in the region as
well as throughput constraints on the water delivery infrastructure. The Company has met with officials of the County of Hawaii to assess the fresh water situation and evaluate the probability of
future risks. The Company recycles fresh water in its production process where possible and continues to explore further recycling opportunities. However, there is no guarantee that these efforts will
result in significant changes to our fresh water utilization.

For
the final stage of cultivation, theHaematococcusalgae is transferred to open ponds where an environmental stress is applied causing
the algae to form spores which accumulate high levels of astaxanthin. Once ready for harvest, the media containing these spores is transported through underground pipes to our astaxanthin processing
building where the culture media and algal spores are separated. Fresh water recovered from this stage of processing may be recycled for further use in cultivation. The harvested algal spores are
dried to a fine powder. During processing, the spores are cracked in a proprietary system to assure high bioavailability of astaxanthin. Each production lot of astaxanthin is sampled and tested for
astaxanthin concentration. Finally the bulk powder is vacuum-sealed in oxygen-barrier foil laminate bags along with a packet of oxygen absorbent.

Unlike
spirulina, astaxanthin is produced in a batch-mode and each cultivation pond must be completely drained and thoroughly cleaned between cycles. While the entire
astaxanthin production cycle takes a total of four weeks, each stage of the four-step process is staggered and continuously feeds the next stage of cultivation. As a result, we are
currently able to produce a new crop of astaxanthin from each of our 500,000 liters culture ponds approximately once per week. Pond cultivation can be negatively impacted seasonally with shortened
daylight hours and potential inclement weather in winter months. The Company produced approximately the same quantity of product during fiscal 2005 as compared to fiscal 2004.

Natural
astaxanthin for human consumption is processed further utilizing a high-pressure extraction process. The resulting product is a lipid extract insoluble in water used
for the production of gelcaps. This product can also be micro-encapsulated into "beadlets" which our customers use in other formulations. All natural astaxanthin products destined for human
consumption undergo a prescribed set of microbiological food product tests to ensure safety and quality. The Company uses third party contractors for the extraction services, the production of gelcaps
and the production of beadlets. Although these services are available only from a limited number of sources, we have the ability to use other parties if any of the current contractors become
unavailable; however, there is no assurance that

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the
pricing from a new contractor will be comparable to current negotiated pricing. In addition, a new contractor would have to pass the Company's qualification process ensuring quality standards can
be met or exceeded. If the pricing, for any of these services, significantly increases, this could have a material adverse effect on our business, financial condition and results of operations.

NatuRoseis sold through a network of agents and distributors primarily to feed manufacturers and farmers in the aquaculture industry.
Japan is one of our primary markets for the application of NatuRosein aquaculture and was a major factor in our decision to establish CJYK as a channel of distribution. In addition, NatuRoseis sold to poultry feed formulators to naturally pigment the yolk of chicken eggs and to formulators of feeds for commercial breeding of
high-value tropical fish. As our product is a natural astaxanthin, many of these formulators identifyNatuRoseby name as a component of
their feed.

The
animal nutrition astaxanthin market is currently dominated by Royal DSM of the Netherlands ("Royal DSM"). Royal DSM purchased F. Hoffmann-LaRoche's division of vitamins and fine
chemicals, including their synthetic astaxanthin operation, in 2003.NatuRosecompetes with the synthetic astaxanthin products derived from
petrochemicals as well as other natural astaxanthin products derived from other natural sources such asPhaffiayeast and Paracoccus bacteria. Although
synthetic astaxanthin has widespread use as a pigmentation source in commercial aquaculture, independent scientific analysis and feeding trials have shown that the molecular structure of the
astaxanthin derived from theHaematococcusmicroalga more closely resembles the astaxanthin obtained naturally by fish in the wild. With the continued
growth in the world aquaculture industry and the growing propensity towards "natural" alternatives, we believeNatuRosecan compete against other
products on the basis of its natural state, performance and price.

While
the positive effects of astaxanthin in aquaculture have been recognized for years, the potential benefits of astaxanthin to human health are still emerging. As natural astaxanthin
is one of the most potent and bioactive biological antioxidants found in nature, the number of potential roles of natural astaxanthin for human health is growing. Much research has been published in
recent years on the beneficial roles of antioxidants in our health, in the aging process and on specific health conditions. The full efficacy of BioAstinas a human nutraceutical supplement requires
significant clinical studies and testing and, although the Company did not spend significant
amounts on clinical trials over the past two fiscal years in our efforts to contain costs, continued independent antioxidant research and prior clinical trials show promising human applications. The
Company holds three United States patents relating to the usage ofBioAstinin the treatment of Carpal Tunnel Syndrome, the treatment of canker/cold
sores and for its use as a topical and oral sunscreen.

BioAstinis sold in the liquid lipid form as a raw ingredient to dietary supplement manufacturers, health food formulators and cosmetic
manufacturers andBioAstingelcaps and beadlets are sold in bulk quantities to distributors.BioAstingelcaps are also sold as a packaged consumer product through Nutrex Hawaii directly to natural product distributors, retailers and consumers.BioAstincompetes directly with similar products marketed by other manufacturers including Fuji Chemical of Japan, Valensa (a joint venture between Algatechnologies of Israel and U.S. Nutraceuticals) and Mera
Pharmaceuticals in the United States. In the general category of nutritional supplements,BioAstinalso competes with a variety of vitamins, dietary
supplements and other antioxidant products available to consumers. The nutritional products market is highly competitive and 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.

The
natural astaxanthin market is an emerging market. In order to meet anticipated future demand growth and increase its ability to meet market demand the Company completed capital
investment projects aimed at improving adaptability of its cultivation and production in fiscal 2005. The Company constructed additionalPhytoDome CCSmodules, retrofitted existing Spirulina ponds for

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haematococcus
cultivation and invested in key production equipment providing for future redundancy in the case of equipment failure. The Company estimates that the expansion may provide an increase of
up to 70% over current production volumes for our natural astaxanthin. In addition, the Company believes that production, sales and our ability to meet our customer demands for spirulina may be
impacted from the conversion of ponds.

As
of March 31, 2005, the backlog of orders for all natural astaxanthin products totaled approximately $74,000 and such orders are expected to be fulfilled in the first quarter of
fiscal 2006. Such backlog at the end of fiscal 2004 and 2003 were $389,000 and $202,000, respectively.

PhycobiliproteinProducts

The Company also produces phycobiliproteins for sale to the medical and biotechnology research industries. 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 do not anticipate that phycobiliproteins will represent a significant component of total sales in future periods.

Major Customers

Approximately $1,130,000 or 10% of net sales for the year ended March 31, 2005 were to Spirulina International B. V., a spirulina marketing and
distribution company based in the Netherlands. Sales to this customer amounted to $1,560,000 or 13% of net sales for the fiscal year 2004 and $1,546,000 or 17% of net sales for the fiscal year 2003.
We believe that sales to this customer will continue to represent a significant portion of total net sales in future periods and any significant reduction in demand from this customer could have a
material adverse effect on our business, financial condition and results of operations.

Research and Development

Cyanotech's expertise is in the development of efficient, stable and cost-effective production systems for microalgal products. Our researchers
investigate each specific microalga identified in the scientific literature for potentially marketable products and then strive to develop the technology to grow such microalgae on a commercial scale.
Successful microalgal product development is highly uncertain and is dependent on numerous factors, many 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.

The
Company had research and development expenditures of $257,000, $149,000 and $217,000 in fiscal years 2005, 2004 and fiscal 2003, respectively. The Company reduced investment in
scientific clinical trials during the first three quarters of fiscal 2005 and throughout fiscal 2004 as part of our effort to contain cost, but plans to increase investment in such trials in future
periods. Fiscal 2005 and 2004 expenses were aimed at increasing production yields for Spirulina and Astaxanthin products and continually improving the quality and stability of such products. The
Company continues to explore customer sponsored research and development as a potential opportunity in the future. Amounts spent on customer-sponsored research were not material in each of the three
years ended March 31, 2005.

Patents, Trademarks and Licenses

Cyanotech has received five United States patents: two on aspects of our production methods and three for use of our BioAstinproducts.
The Company views its proprietary rights as important, but believes that a loss of such rights is not likely to have a material
adverse effect on the Company's present business as a whole. The Company's operations are not dependent upon any single trademark,

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although
some trademarks are identified with a number of the Company's products and are of importance in the sale and marketing of such products.

Regulations and Environmental Matters

On March 18, 2002, the Company was issued an Endangered Species Act ("ESA") incidental take permit by the United States Department of Interior Fish and
Wildlife Service ("FWS"). The ESA
defines "incidental take" as take that is "incidental to, and not the purpose of, the carrying out of an otherwise lawful activity." This permit authorizes incidental take of the endangered Hawaiian
stilt (Himantopus mexicanus knudseni)that is anticipated to occur as a result of ongoing operations and maintenance at the Company's Kona facility. As
a mandatory component for the issuance of a permit, the Company submitted and maintains a habitat conservation plan ("HCP") to ensure that the effects of the permitted action on listed species are
adequately minimized and mitigated.

The
HCP called for the creation of a nesting and breeding ground for the Hawaiian stilt to offset any take activity. The Company complied with these requirements in 2002. The breeding
program was so successful that the increase in the Hawaiian stilt population in the area became a potential hazard for the adjacent State airport facility. The Company disassembled the stilt habitat
and is mitigating "take" by using standard non-lethal hazing devices to discourage nesting and breeding.

A
requirement of the incidental take permit is to provide insurance of funding for project completion for the term of the incidental take permit. The Company's insurance broker was
unable to locate an underwriter who would provide such a bond. As permitted by law, the FWS waived this requirement recognizing that this HCP did not involve a significant capital expenditure.
However, under Hawaii state law, no waiver provision is available. In lieu of insurance, the Company provided a refundable deposit of approximately $89,000 to the State of Hawaii. The permit, which
expired on March 17, 2005 has been renewed by the Company for an additional year.

Employees

As of March 31, 2005, the Company employed 64 people on a full-time basis. Of the total, 48 are involved in the harvesting and production
process, 2 in research and development and the remainder in sales, administration and support. Management believes that its relations with employees are good. We currently are experiencing some
difficulty in attracting entry-level operations personnel due to increased wage competition for workers due to the growth in the State's construction industry. None of our employees are subject to
collective bargaining agreements.

Internet Information

Our Internet address iswww.cyanotech.com. There we make available, free of charge, copies of Cyanotech news
releases and financial statements issued in the last 12 months. The information found on our Web site, unless otherwise indicated, is not part of this or any other report we file with or
furnish to the Securities and Exchange Commission.Spirulina PacificaandBioAstinare sold directly
online through the Company's website,www.nutrex-hawaii.com, as well as through resellers in over 30 countries worldwide. Technical information for the
Company's phycobiliproteins products is available atwww.phycobiliprotein.com. Corporate data, product information and charters of our Board committees
are also available atwww.cyanotech.com.

Item 2. Properties

The Company's principal facility and corporate headquarters is located at the Natural Energy Laboratory of Hawaii Authority ("NELHA") at Keahole Point in
Kailua-Kona, Hawaii. It encompasses approximately 90 fully developed acres containing microalgal cultivation ponds, processing facilities, research and quality control laboratories, and
sales and administrative offices. The property is leased

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from
the State of Hawaii under a 30-year commercial lease expiring in 2025. We believe that there is sufficient available land at NELHA to meet our currently anticipated needs.

The
Company also rents warehouse space near NELHA and also in San Dimas, California and office space in Toyko, Japan.

Item 3. Legal Proceedings

From time to time the Company may become party to lawsuits and claims that arise in the ordinary course of business relating to employment, intellectual property,
and other matters. There were no significant legal matters which occurred during fiscal 2005. We believe that any future claims, individually or in the aggregate, will not result in a material adverse
effect on our business, financial position, or results of operations.

Item 4. Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of stockholders during the fourth quarter of fiscal 2005.

11

---





PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters

The Company's common stock is traded on the NASDAQ SmallCap Market under the symbol "CYAN". As of June 24, 2005, there were 1,304 registered holders of
record of our common stock. The high and low selling prices as reported by the NASDAQ Stock Market were as follows:

Quarter Ended:

June 30

September 30

December 31

March 31Fiscal 2005Common stock price per share:High

$
1.65

$
1.85

$
1.70

$
1.53Low

$
1.10

$
1.00

$
1.10

$
1.20Fiscal 2004Common stock price per share:High

$
0.72

$
0.75

$
1.97

$
2.30Low

$
0.40

$
0.41

$
0.36

$
1.05


During
fiscal 2002, the Company's common stock was traded on the NASDAQ National Market. On June 17, 2002, the Company received a delisting warning letter from NASDAQ for failure
to comply with the $1.00 per share minimum bid price. The Company was unable to regain compliance during the allowed grace period and subsequently applied for, and received listing for its common
stock on the NASDAQ SmallCap Market. The Company was provided additional time to comply with all of the listing criteria for the SmallCap Market. On September 15, 2003, the Company requested a
hearing with the NASDAQ Listing Qualifications Panel (the "Panel") which was subsequently heard on October 16, 2003. In a letter dated November 26, 2003, the Panel determined that the
Company had evidenced compliance with all requirements necessary for continued listing on the SmallCap Market.

The
Company is prohibited from declaring any common stock dividends without the prior written consent of a lender per the conditions of an existing term loan agreement with such lender.
The Company has never declared or paid cash dividends on its common stock. We currently intend to retain all of our earnings for use in the business and do not anticipate paying any cash dividends on
common stock in the foreseeable future.

Item 6. Selected Financial Data

|                                             |  | Years ended March 31, |       
|-------------------------------------------- |  | --------------------- | ------
|
|
|Results of Operations                        |  |                       |       
|Net sales                                    |  | $                     | 11,445
|Gross profit                                 |  |                       | 3,818 
|Income (loss) from operations                |  |                       | 562   
|Net income (loss)                            |  |                       | 486   
|Net income (loss) per common sharediluted   |  |                       | 0.02  
|Selected Balance Sheet Data                  |  |                       |       
|Cash and investment securities               |  |                       | 3,005 
|Working capital                              |  |                       | 5,102 
|Total assets                                 |  |                       | 18,542
|Long-term debt, excluding current maturities |  |                       | 1,743 
|Stockholders' equity                         |  |                       | 15,080

12

---



Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the Company's consolidated financial statements and accompanying notes
included in Part II. Item 8. Financial Statements and Supplementary Data. For a more comprehensive description of the Company's products and markets for such products, see Part I. Item
1. Business.

Overview

Cyanotech Corporation's core competency is cultivating and processing microalgae into high-value, high-quality natural products for the
human and animal nutrition markets. Our products are sold in bulk quantities to manufacturers, formulators and distributors in the health foods, nutritional supplements and animal nutrition markets
and as packaged consumer products to distributors, retailers and direct consumer sales. The Company manufactures its products in Hawaii but markets them worldwide, generating 49%, 58% and 54% of its
revenues outside of the United States for each of the years ended March 31, 2005, 2004 and 2003, respectively.
Competing in a global marketplace, the Company is influenced by the general economic conditions of the countries in which its customers operate, including adherence to its customers' local
governmental regulations and requirements. The Company has no material foreign exchange exposure.

The
Company reported net income of $486,000, or $0.02 per diluted share for fiscal 2005 an improvement of 22% over net income of $399,000, or $0.02 per diluted share for fiscal 2004.
Cash, cash equivalents and short-term investment balances at March 31, 2005 were $3,005,000, up $474,000 from a year ago. Working capital improved 25% to $5,102,000 at
March 31, 2005 from working capital of $4,083,000 a year ago, primarily due to increased short-term investment and inventory balances (see Consolidated Statements of Cash Flows in
Part II, Item 8.)

The
following table details selected financial data highlighting three key areas (dollars in thousands):

Year Ended March 31,2005

2004

2003Net sales:Spirulina products

$
6,626

$
6,511

$
6,181Natural astaxanthin products


4,672


4,933


2,613Other products


147


138


157$
11,445

$
11,582

$
8,951Gross profit as a percentage of sales


33
%

34
%

32
%Operating expenses as a percentage of sales


28
%

28
%

46
%


Net
sales for fiscal 2005 were $11,445,000, slightly lower than the $11,582,000 reported for the prior fiscal year. During fiscal 2005, the Company experienced a disruption of NatuRose
sales to the worldwide aquaculture market due to damage to customers' operations from typhoons in Japan and heightened competition in other markets, but this decrease was offset in large part by
increased sales of Spirulina and BioAstin. The Company believes that sales of NatuRose will return to historical levels in the Japan market during the coming fiscal year but there can be no guarantee
of the timing of such recovery. During fiscal 2005 the Company completed a capital project, funded from operations, aimed at improving its ability to meet market demand for all products and providing
increased production capacity of natural astaxanthin. Anticipating growth in demand for our natural astaxanthin products, the Company's internal focus was, and will be, on reallocating its cultivation
resources in an effort to increase production of natural astaxanthin while concurrently optimizing its spirulina production to improve yield and quality. The Company will continue to contain
discretionary operating spending but

13

---



may
invest in focused expenditures particularly in advertising and clinical trials in the human nutrition and cosmetics markets. Externally, the Company is also working with industry-leading
manufacturers in these markets to integrateBioAstininto their products. The Company believes that it needs to continue to focus on market acceptance
of its natural astaxanthin products in all markets as increased competition from other producers of natural and synthetic astaxanthin may result in the decline of margins generated for its natural
astaxanthin products. Management cannot predict whether the outcomes of any of these strategies will be successful.

Results of Operations

RevenuesNet sales for fiscal 2005 was $11,445,000, a slight decline from net sales of $11,582,000 in
fiscal 2004 and an increase of 28% from net sales of $8,951,000 reported in fiscal 2003. The following is a discussion of revenues by major product category.

SpirulinaThe Company has been producingSpirulina
Pacifica, a strain of spirulina microalga, since 1985. Revenues generated from the Company's spirulina products are a significant portion of total revenues, amounting to
$6,626,000, $6,511,000 and $6,181,000 for the years ended March 31, 2005, 2004 and 2003 respectively. Although the Company believes that Spirulina is a mature product in a highly competitive
market, the dollar amount of revenues has remained relatively consistent over the three year period. As a percentage of total revenues, spirulina product sales represented 58% in 2005, 56% in 2004 and
69% in 2003 reflecting the Company's changing product mix. Approximately $1,130,000 or 10% of net sales for the year ended March 31, 2005 were to Spirulina International B. V., a spirulina
marketing and distribution company based in the Netherlands. Sales to this customer amounted to $1,560,000 or 13% of net sales for the fiscal year 2004 and $1,546,000 or 17% of net sales for the
fiscal year 2003. We believe that sales to this customer will continue to represent a significant portion of total net sales in future periods and any significant reduction in demand from this
customer could have a material adverse effect on our business, financial condition and results of operations.

The
Company has experienced increased competition for its spirulina products resulting from an increasing number of suppliers of spirulina as well as from a larger portion of our sales
coming from bulk product orders whose customers generally treat these products as commodities with price being the major determining factor driving their purchasing decision. We expect this
competitive pricing pressure to continue in future periods and in response have focused on improving the quality of our Spirulina products in support of customers who demand higher quality raw
materials for their formulations. In fiscal 2005, this approach in Spirulina sales resulted in average unit prices improving approximately 5% in fiscal 2005 as compared to the prior year with a slight
decrease in the number of units sold during the current year. At March 31, 2005 our backlog of Spirulina orders increased from the previous year by $327,000, due primarily to the timing of
orders from our customers. In fiscal 2004, we had experienced a decline in average unit price of approximately 4% as compared to the prior year but this was offset by a 14% increase in the number of
units sold.

Natural AstaxanthinIn fiscal 2005, the Company's sales of its natural astaxanthin products were
$4,672,000, a decrease of 5% from $4,933,000 in fiscal 2004, with both years being a significant increase from revenues of $2,613,000 in fiscal 2003. The decrease in natural astaxanthin sales were
primarily due to weather-related disruptions affecting sales of NatuRose into the aquaculture market during fiscal 2005, but this decrease was offset in large part by increased unit sales of
higher-priced BioAstin into the human nutritional market. At March 31, 2005 our backlog of orders for all natural astaxanthin products was $74,000, a decrease of $315,000 from that of a year
ago. This decrease is due primarily to our improved ability to meet the demand for natural astaxanthin products due to increased production capacity resulting from our pond conversion project. The
sales growth in fiscal 2004 compared to fiscal 2003 resulted from increased units sold in all bulk natural astaxanthin products.

14

---



The
Company believes that the findings of clinical trials undertaken in prior years by the Company, its customers and other unaffiliated parties, taken individually and on a cumulative
basis, have generated a growing consumer awareness of the beneficial antioxidant and anti-inflammatory properties of astaxanthin. Validation of natural astaxanthin benefits identified in
such scientific studies has helped to spur demand for our natural astaxanthin products in both the human and animal nutrition markets and could provide the basis for proprietary intellectual property.
The Company reduced its expenditures on natural astaxanthin scientific clinical trials during the first three quarters of fiscal 2005 and all of fiscal 2004, as part of its cost containment effort,
but plans to increase expenditures on targeted scientific trials in the future in accordance with its strategy to increase sales of natural astaxanthin products.

In
order to meet anticipated future demand growth for all products, during fiscal 2005 and 2004 the Company invested in capital projects aimed at increasing its ability to respond to
market demand. Two major components of this capital investment were adaptation of existing ponds for cultivation of both Spirulina and Haematoccocus algae (for astaxanthin) and upgrading key elements
of our processing facility for natural astaxanthin products. All projects were complete as of March 31 2005 and were funded entirely from operating cash flows.

Cost of SalesOur cost of sales, as a percentage of net sales, was steady at 67%, 66% and 68% for
fiscal years 2005, 2004, and 2003, respectively. Cost of sales includes the cost of nutrients and materials, direct labor and manufacturing overhead costs, and depreciation and amortization of
production equipment, buildings and leasehold improvements specific to the production process. Although the Company experienced improved production efficiencies for both product lines during fiscal
2005 resulting from our completed natural astaxanthin pond conversion project and ongoing improvement in Spirulina cultivation. The Company continues to strive for increased production efficiencies in
volume yield, potency and quality consistent with our commitment to produce high-value, high-quality products. For fiscal 2004 and 2003 increased cultivation yields in biomass
were achieved. However, the cost improvement in fiscal 2004 was partially offset by the reduction of certain bulk spirulina finished goods inventory to market realizable value and a contract
extraction facility problem that was rectified during the first quarter of 2004.

Raw
materials and nutrients required in our production processes are available from multiple sources; however, there can be no assurance that the pricing from a new source will be
comparable to current negotiated pricing. If the pricing for a critical raw material or nutrient significantly increases, this could have a material adverse effect on our business, financial condition
and results of operations. For future periods, with the rising cost of fuel oil, the Company could incur higher electrical utility costs dependent upon the regulated public utility's ability to obtain
approval for rate increases. In addition, fresh water is critical for our natural astaxanthin production and while the Company has not experienced any constraint on fresh water availability, future
availability could be negatively impacted by significant growth in the local population as well as by throughput constraints on the water delivery infrastructure owned by the County of Hawaii. The
Company has met with County officials to assess the situation and evaluate the probability of future risks. In addition, given the criticality of fresh water to our operations and the community, the
Company recycles fresh water where possible and continues to explore further recycling opportunities in its efforts to efficiently utilize fresh water. For the production of BioAstin,the Company's
natural astaxanthin product for the human nutrition market, a sole third party contractor is utilized for each of the processes
of extraction, encapsulation (for gelcaps) and micro-encapsulation (for beadlets) and although these services are available only from a limited number of sources, we have the ability to use other
parties if any of the current contractors become unavailable. If pricing for any of these services significantly increases, this could have a material adverse effect on our business, financial
condition and results of operations.

Gross ProfitGross profit margin for fiscal 2005 was 33%, which is comparable to the 34% and 32%
gross profit margin for fiscal years 2004 and 2003, respectively.

15

---



Operating ExpensesOperating expenses as a percentage of net sales were 28% for fiscal 2005 and 2004,
significantly lower than the 46% reported in 2003. Operating expenses during fiscal 2005 increased slightly in amount due to higher spending in research and development. This increase, related to
clinical trials, was offset by decreased sales/marketing and general/administrative expenses. In comparison, spending decreased in all functional areas in fiscal 2004 as compared to fiscal 2003, a
direct result of the Company's efforts to contain costs and align its spending with actual sales. The Company is committed to ongoing cost containment aimed at controlling its level of operating
expenses but may increase such discretionary spending in future periods as dictated by the needs of the business. Fiscal 2003 operating expenses were impacted by certain write-offs that
did not recur in 2004. The following is a discussion of spending by functional area.

Ourresearch and developmentcosts increased to $257,000, up 72% from $149,000 in fiscal 2004 and up 18% from $217,000 in 2003. This
increase is due primarily to initiation of a new scientific clinical trial and costs related to product registration, both occurring during the fourth quarter of fiscal 2005. During most of fiscal
2005 and all of fiscal 2004, the Company reduced spending on scientific clinical trials as part of our efforts to contain costs. During these two years, such expenses related primarily to increasing
our production yields and improving the quality and stability of our products in contrast to fiscal 2003 when efforts were primarily directed at validating the anecdotal indications of BioAstinthrough
clinical evaluations and trials.

Oursales and marketingcosts were $1,202,000, $1,239,000 and $1,827,000 in fiscal 2005, 2004 and 2003, respectively. Fiscal 2005 and 2004
expenses were significantly lower than fiscal 2003 primarily due to reduced advertising expenditures for packaged consumer products and discretionary contract services. In addition, fiscal 2003 costs
included a $260,000 write-off for the discontinuation of a television infomercial project.

Ourgeneral and administrativecosts were $1,797,000, $1,823,000 and $2,061,000 in fiscal 2005, 2004 and 2003, respectively. Compared to
fiscal 2004, fiscal 2005 expenses decreased slightly primarily due to elimination of a royalty payment obligation which ended in fiscal 2004, reduced contract services expenses and a reduction in bad
debt expense, offset in part by increased personnel expenses. Fiscal 2004 expenses decreased from fiscal 2003 primarily due to costs associated with certain transactions in the prior year that did not
recur in 2004 and a lower bad debt provision. Fiscal 2003 expenses include a charge for the write-down of a warehouse project and a NASDAQ fee associated with the change in the trading of
the Company's common stock on the National Market to the Small Cap Market which did not recur in fiscal 2005 or 2004.

Other ExpenseThe following details the amounts included in other expense (dollars in thousands):

2005

2004

2003Interest expense on Term Loan Agreement(1)

$
158

$
160

$
196Interest expense on convertible debentures(2)





119


204Other interest expense


5


7


18Costs relating to extension of debentures(3)








236Other income, net(4)


(46
)

(31
)

(80
)Total other expense

$
117

$
255

$
574


---

16

---



Income TaxesFor fiscal 2005, an estimated federal and Hawaii State income tax benefit of $68,000 was
recorded partially offset by income taxes of $27,000 related to our Japan operations. For fiscal 2004, a provision for income taxes of $75,000 was recorded for taxes relating to our operations in
Japan partially offset by a state tax refund. For fiscal 2003 a $9,000 income tax benefit representing state tax refunds was recorded.

Liquidity and Capital Resources

Financial ConditionDuring fiscal 2005 and 2004, the Company funded its growth largely through cash
provided by operations. In prior years, the Company had primarily funded its growth in operations through a combination of long-term borrowings and the issuance of common stock in
connection with certain debt restructurings.

The
Company has a Term Loan Agreement ("Term Loan") with a lender providing up to $3.5 million in credit facilities, secured by substantially all the assets of the Company. The
outstanding balance under the Term Loan as of March 31, 2005 is approximately $2,098,000. The Term Loan has a maturity date of May 1, 2010 and is payable in 120 equal monthly principal
and interest payments of approximately $38,000. The interest rate under the Term Loan, in absence of a default under the agreement, is the prime rate, as defined, in effect as of the close of business
on the first day of each calendar quarter, plus 1% (the prime rate was 5.25% at March 31, 2005). The Company is in compliance with all restrictive covenants of the Term Loan. The Company is
prohibited by the Term Loan from declaring any cash dividends without the lender's prior written consent. In July 2003, the Company received approval from the Term Loan lender for the release
of $250,000 of cash previously held as a restricted deposit. A remaining $250,000 restricted cash deposit continues to be held in an interest-bearing
restricted cash account per the terms of the Term Loan and is included in Other Assets in the consolidated balance sheet at March 31, 2005.

In
October 2002, the Company issued in a private placement (a) $1,250,000 principal amount of 10% Convertible Subordinated Debentures (the "Debentures") originally due
September 30, 2004, convertible into shares of the Company's Common Stock at a price of $0.65 per share and (b) 750,000 shares of Common Stock with proceeds to the Company of $300,000.
Proceeds from the Debentures were used to retire convertible debentures of $1,238,000 due to mature on October 31, 2002. In December 2003, the holder of the Debentures voluntarily
converted the entire principal amount of the Debentures into 1,923,076 shares of Common Stock pursuant to the terms of the Debentures.

The
following table presents the Company's debt and lease obligations at March 31, 2005 (in thousands):

Less Than
1 Year

13
Years

45
Years

After
Years

TotalTerm Loan

$
355

$
780

$
884

$
79

$
2,098Operating leases


251


446


334


2,331


3,362Total

$
606

$
1,226

$
1,218

$
2,410

$
5,460


17

---



Our
working capital was $5,102,000 at March 31, 2005 compared to $4,083,000 and $2,352,000 at March 31, 2004 and 2003, respectively. The improvement in our working capital
balances as of March 31, 2005 and March 31, 2004 was primarily due to the Company's ability to generate cash from operations.

Cash FlowsOur cash, cash equivalents and short-term investments were $3,005,000,
$2,531,000 and $579,000 at March 31, 2005, 2004 and 2003, respectively. At March 31, 2005, $1,000,000 of this amount represents short-term investments in certificates of
deposit.

During
fiscal years 2005 and 2004, the Company generated cash fromoperating activitiesof $1,328,000 and $1,966,000, respectively. This
contrasts with cash used in operating activities of $502,000 during fiscal 2003. Cash from operations in fiscal years 2005 and 2004 reflect the Company's profitability and improved collection of trade
accounts receivable, with net income of $486,000 in 2005 and $399,000 in 2004 compared to a net loss of $1,775,000 in 2003.

Cash
used ininvesting activitiesduring fiscal 2005 of $1,649,000 included $1,000,000 invested in short-term financial
instruments and investments in equipment and leasehold improvements of $649,000. Investments in equipment and leasehold improvements were $413,000 and $250,000 in fiscal years 2004 and 2003. The
capital expenditures for all periods presented pertained primarily to improvements in cultivation and processing facilities. For fiscal 2005, such expenditures were primarily related to capital
projects aimed at increasing our ability to respond to market demand. Two major components of this capital investment were adaptation of existing ponds for cultivation of both Spirulina and
Haematoccocus algae (for astaxanthin) and upgrading key elements of our processing facility for natural astaxanthin products. Such pond conversion is substantially less costly than constructing new
ponds. At March 31, 2005, these projects were complete. Depreciation and amortization expense was $1,319,000, $1,346,000 and $1,324,000 for the years ended March 31 2005, 2004 and 2003,
respectively. For fiscal 2006 management expects investment in equipment and leasehold improvements to return to the level experienced in fiscal 2004.

During
fiscal 2005, cash used infinancing activitiesamounted to $205,000, representing principal payments on long-term debt
of $341,000, offset in part by proceeds from issuance of common stock and from the exercise of stock options and warrants totaling $136,000. For fiscal 2004 and 2003, financing activities provided
cash of $399,000 and $280,000, respectively. Fiscal 2004 financing activities consisted primarily of the following: (1) net proceeds received from the exercise of warrants and stock options
totaling $477,000 (see Note 7 of Notes to Consolidated Financial Statements in Part II. Item 8.), (2) the partial release of a restricted deposit held in connection with the Term
Loan of $250,000 and (3) principal payments on long-term debt of $328,000. For fiscal 2003, financing activities primarily consisted of (1) proceeds from the issuance of
$1,250,000 convertible subordinated debentures used to retire $1,238,000 of convertible debentures (see Note 5 of Notes to Consolidated Financial Statements in Part II. Item 8.),
(2) net proceeds received from the issuance of common stock and from the exercise of stock options and warrants of $630,000 and (3) principal payments on long-term debt of
$303,000 (excluding the debenture retirement previously noted).

18

---



Variability of Results

The following selected quarterly financial data (unaudited) as of and for the periods presented highlights the significant fluctuations in operating results and
financial condition that the Company has experienced in the past three fiscal years (dollars in thousands):

4th Quarter
Ended
March 31,

3rd Quarter
Ended
December 31,

2nd Quarter
Ended
September 30,

1st Quarter
Ended
June 30,Fiscal 2005:Net sales

$
2,560

$
3,180

$
2,998

$
2,707Cost of sales


1,846


2,017


1,944


1,820Operating expenses


804


845


881


726Net income (loss)


(74
)

326


121


113Working capital


5,102


4,991


4,474


4,274Fiscal 2004:Net sales

$
3,290

$
3,024

$
2,840

$
2,428Cost of sales


2,099


1,840


1,979


1,724Operating expenses


736


892


829


754Net income (loss)


441


109


(10
)

(141
)Working capital


4,083


3,141


2,921


2,436Fiscal 2003:Net sales

$
2,427

$
2,474

$
2,018

$
2,032Cost of sales


1,596


1,763


1,450


1,247Operating expenses


1,053


826


1,002


1,224Net income (loss)


(270
)

(180
)

(540
)

(785
)Working capital


2,352


2,367


1,965


1,051


As
a normal course of business, adjustments are recorded in the consolidated financial statements to fairly represent the Company's financial condition, results of operations or
liquidity. During the fourth quarter of fiscal 2005 adjustments were made to properly state certain accrued liabilities related to general and administrative operating expenses and receivables related
to income tax benefits of approximately $70,000. These adjustments related to previously reported periods but would not have had a material impact on any such previously reported period.

The
Company's results of operations and financial condition can be affected by numerous factors, many of which are beyond its control and could cause future results of operations to
fluctuate materially as it has in the past. Future operating results may fluctuate as a result of changes in sales volumes to our largest customers, weather patterns, increased competition, increased
materials, nutrient and energy costs, foreign currency exchange fluctuations, governmental regulations and other factors beyond our control. In addition, while the Company maintains product liability
insurance in limited amounts for all of its products involving human consumption, broader product liability coverages are cost prohibitive.

A
significant portion of our expense levels are relatively fixed, so the timing of increases in expense levels is based in large part on forecasts of future sales. If net sales are below
expectations in any given period, the adverse impact on results of operations may be magnified by our inability to adjust spending quickly enough to compensate for the sales shortfall. We may also
choose to reduce prices or increase spending in response to market conditions, which may have a material adverse effect on financial condition and results of operations.

19

---



Effect of Recently Issued Accounting Standards and Estimates

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

In
November 2004, the FASB issued SFAS No. 151 "Inventory Costsan amendment of Accounting Research Bulletin No. 43, Chapter 4". SFAS No. 151
requires that abnormal amounts of freight, handling costs and wasted material (spoilage) be recognized as current-period charges and fixed production overhead costs be allocated to inventory based on
the normal capacity of production facilities. Normal capacity is defined as "the production expected to be achieved over a number of periods or seasons under normal circumstances, taking into account
the loss of capacity resulting from planned maintenance." Companies will no longer be permitted to capitalize inventory costs on the balance sheet when the production defect rate varies significantly
from the expected defect rate. SFAS No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Earlier application is permitted for inventory
costs incurred during fiscal years beginning after November 24, 2004. The Company has yet to determine the impact, if any, of SFAS No. 151 on its consolidated financial statements.

In
December 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 assets should be measured based on the fair market value of the assets exchanged. SFAS No. 153 eliminates the exception of
nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. SFAS No. 153 is effective
for nonmonetary asset exchanges in fiscal periods beginning after June 15, 2005. Adoption of the provisions of SFAS No. 153 is not expected to have a material impact on the Company's
financial condition, results of operations, or liquidity.

In
March 2005, the FASB issued FASB Interpretation No. 47 ("FIN 47"), "Accounting for Conditional Asset Retirement Obligationsan interpretation of FASB
Statement No. 143." FIN 47 clarifies that the term "conditional asset retirement obligation" as used in FASB Statement No. 143,
"Accounting for Asset Retirement Obligations," refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event
that may or may not be within the control of the entity. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value
of the liability can be reasonably estimated. FIN 47 is effective for fiscal years ending after December 15, 2005. The Company has yet to determine the impact, if any, of FIN 47 on its
consolidated financial statements.

On
March 29, 2005, the Securities and Exchange Commission (SEC) staff issued Staff Accounting Bulletin No. 107, "Share-Based Payment" (SAB No. 107), which expressed
the SEC staff's views on

20

---



Statement
No. 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 in conjunction with its
assessment of Statement No. 123R's impact to the Company.

In
May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3." SFAS
No. 154 requires retrospective application for voluntary changes in accounting principle unless it is impracticable to do so. In addition, indirect effects of a change in accounting principle
should be recognized in the period of the accounting change. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15,
2005.

Application of Critical Accounting Policies and Estimates

The Company's discussion and analysis of its financial condition and results of operations are based upon the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements in conformity with those accounting principles requires
management to make judgments and estimates that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. The
Company regularly re-evaluates its judgments and estimates which are based upon historical experience and on various other assumptions that are believed to be reasonable under the
circumstances. The Company believes that of its significant accounting policies (see Note 1 of Notes to Consolidated Financial Statements in Part II. Item 8.), policies that may involve
a higher degree of judgment and complexity are inventory valuations, equipment and leasehold improvements and long-lived assets, and income taxes.

The
Company is required to state inventories at the lower of cost or market. Cost is defined as the sum of the applicable expenditures and charges directly or indirectly incurred in
bringing inventories to their existing condition and location. Cost for inventory purposes may be determined under any one of several assumptions as to the flow of cost factors, such as
first-in,
first-out; average cost; and last-in, first-out. Our inventories are stated at the lower of cost, which approximates first-in, first-out, or
market. For fiscal 2006, with the rising cost of fuel oil, the Company could incur higher electrical utility costs dependent upon the regulated public utility's ability to obtain approval for rate
increases. If electrical utility costs were to double from fiscal 2005 costs, the Company estimates that the cost to manufacture its products could increase by as much as 15% above prior year costs.

Equipment
and leasehold improvements are reported at cost. Self-constructed leasehold improvements include design, construction and supervision costs. These costs are
recorded in construction in progress and are transferred to equipment and leasehold improvements when construction is completed and the facilities are placed in service. If the Company experiences an
impairment to its equipment or leasehold improvement, we would account for the impairment in accordance with SFAS No. 144. Pursuant SFAS No. 144, long-lived assets, such as
property, plant and equipment and purchased intangibles subject to amortization shall be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be
generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized to the extent that the carrying amount exceeds the asset's fair
value.

Income
taxes are accounted for under the asset and liability method. The asset and liability method requires the recognition of deferred tax assets and liabilities for the expected
future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their tax bases and operating loss and tax credit
carryforwards. Deferred tax assets and liabilities are measured using enacted income tax rates applicable to the period in which the

21

---



deferred
tax assets or liabilities are expected to be recovered or settled. The Company records a valuation allowance to reduce its deferred tax assets to the amount that it believes is more likely
than not to be realized. Judgment is required in assessing the need for the valuation allowance. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable
income during the periods in which those temporary differences become deductible. In recent periods the Company has returned to profitability and begun to generate taxable income which has resulted in
the utilization of our previously generated net operating losses. If we continue to generate taxable income, management may conclude that a portion or all of the existing valuation allowance is no
longer required. (See Note 11 of Notes to Consolidated Financial Statements in Part II. Item 8.).

Item 7a. Quantitative and Qualitative Disclosures About Market Risk

We have never 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.

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

22

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Item 8. Financial Statements and Supplementary Data

Report of Independent Registered Public Accounting Firm

The
Board of Directors and Stockholders
Cyanotech Corporation:

We
have audited the accompanying consolidated balance sheets of Cyanotech Corporation and subsidiaries (the Company) as of March 31, 2005 and 2004, and the related consolidated statements of
operations, stockholders' equity and comprehensive income (loss), and cash flows for each of the years in the three-year period ended March 31, 2005. These consolidated financial
statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We
conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In
our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cyanotech Corporation and subsidiaries as of
March 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended March 31, 2005, in conformity with U.S.
generally accepted accounting principles.

/s/
KPMG LLP

Honolulu,
Hawaii
June 6, 2005

23

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CONSOLIDATED BALANCE SHEETSMarch 31, 2005 and 2004

|(in thousands, except share data)            |                                                                                                                                                             | 2005                                       |        | 2004    |       
|-------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | ------- | ------
|ASSETS                                       |                                                                                                                                                             |                                            |        |         |       
|Current assets:                              |                                                                                                                                                             |                                            |        |         |       
|                                             | Cash and cash equivalents                                                                                                                                   |                                            | $      | 2,005   |       
|                                             | Short-term investments                                                                                                                                      |                                            |        | 1,000   |       
|                                             | Accounts receivable, net of allowance for doubtful accounts of $46 in 2005 and $96 in 2004                                                                  |                                            |        | 2,069   |       
|                                             | Refundable income taxes                                                                                                                                     |                                            |        | 97      |       
|                                             | Inventories                                                                                                                                                 |                                            |        | 1,565   |       
|                                             | Prepaid expenses and other current assets                                                                                                                   |                                            |        | 85      |       
|                                             |                                                                                                                                                             |                                            |        |         |       
|                                             |                                                                                                                                                             | Total current assets                       |        |         | 6,821 
|Equipment and leasehold improvements, net    |                                                                                                                                                             |                                            | 11,174 |         |       
|Other assets                                 |                                                                                                                                                             |                                            | 547    |         |       
|                                             |                                                                                                                                                             |                                            |        |         |       
|                                             |                                                                                                                                                             | Total assets                               |        | $       | 18,542
|                                             |                                                                                                                                                             |                                            |        |         |       
|LIABILITIES AND STOCKHOLDERS' EQUITY         |                                                                                                                                                             |                                            |        |         |       
|Current liabilities:                         |                                                                                                                                                             |                                            |        |         |       
|                                             | Current maturities of long-term debt                                                                                                                        |                                            | $      | 355     |       
|                                             | Accounts payable                                                                                                                                            |                                            |        | 977     |       
|                                             | Accrued expenses                                                                                                                                            |                                            |        | 387     |       
|                                             |                                                                                                                                                             |                                            |        |         |       
|                                             |                                                                                                                                                             | Total current liabilities                  |        |         | 1,719 
|Long-term debt, excluding current maturities |                                                                                                                                                             |                                            | 1,743  |         |       
|                                             |                                                                                                                                                             |                                            |        |         |       
|                                             |                                                                                                                                                             | Total liabilities                          |        |         | 3,462 
|                                             |                                                                                                                                                             |                                            |        |         |       
|Stockholders' equity:                        |                                                                                                                                                             |                                            |        |         |       
|                                             | Common stock of $.005 par value, authorized
    30,000,000 shares; issued and outstanding
    20,896,265 shares for 2005 and
    20,714,246 shares for 2004 |                                            |        | 104     |       
|                                             | Additional paid-in capital                                                                                                                                  |                                            |        | 27,298  |       
|                                             | Accumulated other comprehensive incomeforeign currency translation adjustments                                                                             |                                            |        | 27      |       
|                                             | Accumulated deficit                                                                                                                                         |                                            |        | (12,349 | )     
|                                             |                                                                                                                                                             |                                            |        |         |       
|                                             |                                                                                                                                                             | Total stockholders' equity                 |        |         | 15,080
|                                             |                                                                                                                                                             |                                            |        |         |       
|                                             |                                                                                                                                                             | Total liabilities and stockholders' equity |        | $       | 18,542
|                                             |                                                                                                                                                             |                                            |        |         |       

See accompanying Notes to Consolidated Financial Statements

24

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CONSOLIDATED STATEMENTS OF OPERATIONSYears ended March 31, 2005, 2004 and 2003

|(in thousands, except per share data)                      |                             | 2005                              |        | 2004   |       | 2003   |       
|---------------------------------------------------------- | --------------------------- | --------------------------------- | ------ | ------ | ----- | ------ | ------
|Net sales                                                  |                             | $                                 | 11,445 |        | $     | 11,582 |       
|Cost of sales                                              |                             |                                   | 7,627  |        |       | 7,642  |       
|                                                           |                             |                                   |        |        |       |        |       
|                                                           |                             | Gross profit                      |        |        | 3,818 |        |       
|                                                           |                             |                                   |        |        |       |        |       
|Operating expenses:                                        |                             |                                   |        |        |       |        |       
|                                                           | Research and development    |                                   |        | 257    |       |        | 149   
|                                                           | Sales and marketing         |                                   |        | 1,202  |       |        | 1,239 
|                                                           | General and administrative  |                                   |        | 1,797  |       |        | 1,823 
|                                                           |                             |                                   |        |        |       |        |       
|                                                           |                             | Total operating expense           |        |        | 3,256 |        |       
|                                                           |                             |                                   |        |        |       |        |       
|                                                           |                             | Income (loss) from operations     |        |        | 562   |        |       
|                                                           |                             |                                   |        |        |       |        |       
|Other income (expense):                                    |                             |                                   |        |        |       |        |       
|                                                           | Interest income             |                                   |        | 31     |       |        | 6     
|                                                           | Interest expense            |                                   |        | (163   | )     |        | (286  
|                                                           | Other income (expense), net |                                   |        | 15     |       |        | 25    
|                                                           |                             |                                   |        |        |       |        |       
|                                                           |                             | Total other expense, net          |        |        | (117  | )      |       
|                                                           |                             |                                   |        |        |       |        |       
|                                                           |                             | Income (loss) before income taxes |        |        | 445   |        |       
|                                                           |                             | Income tax expense (benefit)      |        |        | (41   | )      |       
|                                                           |                             |                                   |        |        |       |        |       
|                                                           |                             | Net income (loss)                 |        | $      | 486   |        | $     
|                                                           |                             |                                   |        |        |       |        |       
|Net income (loss) per share:                               |                             |                                   |        |        |       |        |       
|                                                           | Basic                       |                                   | $      | 0.02   |       | $      | 0.02  
|                                                           |                             |                                   |        |        |       |        |       
|                                                           | Diluted                     |                                   | $      | 0.02   |       | $      | 0.02  
|                                                           |                             |                                   |        |        |       |        |       
|Shares used in calculation of net income (loss) per share: |                             |                                   |        |        |       |        |       
|                                                           | Basic                       |                                   |        | 20,784 |       |        | 18,971
|                                                           |                             |                                   |        |        |       |        |       
|                                                           | Diluted                     |                                   |        | 20,979 |       |        | 19,111
|                                                           |                             |                                   |        |        |       |        |       

See
accompanying Notes to Consolidated Financial Statements

25

---





CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND  COMPREHENSIVE INCOME (LOSS)  Years ended March 31, 2005, 2004 and 2003

|(in thousands,
except share data)                                                          |                                                                     | Common
Stock
Shares |           | Common
Stock |     | Additional
Paid-in
Capital |   | Accumulated
Deficit |     | Comprehensive
Income
(Loss) |         | Accumulated
Comprehensive
Other
Income (Loss) |   | Total
Stockholders'
Equity |       
|------------------------------------------------------------------------------------------ | ------------------------------------------------------------------- | ------------------- | --------- | ------------ | --- | -------------------------- | - | ------------------- | --- | --------------------------- | ------- | --------------------------------------------- | - | -------------------------- | ------
|Balances at March 31, 2002                                                                 |                                                                     | 17,043,701          |           | $            | 85  |                            | $ | 24,567              |     | $                           | (11,459 | )                                             | $ |                           |       
|Issuances of common stock for:                                                             |                                                                     |                     |           |              |     |                            |   |                     |     |                             |         |                                               |   |                            |       
|                                                                                           | Cash, net of costs of $21                                           |                     | 1,265,000 |              |     | 7                          |   |                     | 623 |                             |         |                                              |   |                            |      
|                                                                                           | Non-employee directors' services, at fair value                     |                     | 8,000     |              |     |                           |   |                     | 5   |                             |         |                                              |   |                            |      
|Issuance of warrants in connection with extension of convertible debentures, at fair value |                                                                     |                    |           |              |    |                            |   | 223                 |     |                             |        |                                               |   |                           |       
|Comprehensive loss:                                                                        |                                                                     |                     |           |              |     |                            |   |                     |     |                             |         |                                               |   |                            |       
|                                                                                           | Net loss                                                            |                     |          |              |     |                           |   |                     |    |                             |         | (1,775                                        | ) |                            | (1,775
|                                                                                           | Other comprehensive lossforeign currency translation adjustments   |                     |          |              |     |                           |   |                     |    |                             |         |                                              |   |                            | (1    
|                                                                                           |                                                                     |                     |           |              |     |                            |   |                     |     |                             |         |                                               |   |                            |       
|                                                                                           | Comprehensive loss                                                  |                     |          |              |     |                           |   |                     |    |                             |         |                                              |   |                            | (1,776
|                                                                                           |                                                                     |                     |           |              |     |                            |   |                     |     |                             |         |                                               |   |                            |       
|Balances at March 31, 2003                                                                 |                                                                     | 18,316,701          |           |              | 92  |                            |   | 25,418              |     |                             | (13,234 | )                                             |   |                           |       
|Conversion of debentures to common stock                                                   |                                                                     | 1,923,076           |           |              | 10  |                            |   | 1,240               |     |                             |        |                                               |   |                           |       
|Issuances of common stock for:                                                             |                                                                     |                     |           |              |     |                            |   |                     |     |                             |         |                                               |   |                            |       
|                                                                                           | Exercise of stock options for cash                                  |                     | 45,800    |              |     |                           |   |                     | 43  |                             |         |                                              |   |                            |      
|                                                                                           | Exercise of warrants for cash, net of costs $19                     |                     | 429,234   |              |     | 2                          |   |                     | 451 |                             |         |                                              |   |                            |      
|                                                                                           | Third party services, at fair value                                 |                     | 10,000    |              |     |                           |   |                     | 5   |                             |         |                                              |   |                            |      
|                                                                                           | Non-employee directors' services, at fair value                     |                     | 6,000     |              |     |                           |   |                     | 3   |                             |         |                                              |   |                            |      
|Common stock purchased at fair value and cancelled                                         |                                                                     | (16,565             | )         |              |    |                            |   | (19                 | )   |                             |        |                                               |   |                           |       
|Comprehensive income:                                                                      |                                                                     |                     |           |              |     |                            |   |                     |     |                             |         |                                               |   |                            |       
|                                                                                           | Net income                                                          |                     |          |              |     |                           |   |                     |    |                             |         | 399                                           |   |                            | 399   
|                                                                                           | Other comprehensive incomeforeign currency translation adjustments |                     |          |              |     |                           |   |                     |    |                             |         |                                              |   |                            | 33    
|                                                                                           |                                                                     |                     |           |              |     |                            |   |                     |     |                             |         |                                               |   |                            |       
|                                                                                           | Comprehensive income                                                |                     |          |              |     |                           |   |                     |    |                             |         |                                              |   |                            | 432   
|                                                                                           |                                                                     |                     |           |              |     |                            |   |                     |     |                             |         |                                               |   |                            |       
|Balances at March 31, 2004                                                                 |                                                                     | 20,714,246          |           |              | 104 |                            |   | 27,141              |     |                             | (12,835 | )                                             |   |                           |       
|Issuances of common stock for:                                                             |                                                                     |                     |           |              |     |                            |   |                     |     |                             |         |                                               |   |                            |       
|                                                                                           | Exercise of stock options for cash                                  |                     | 36,019    |              |     |                           |   |                     | 32  |                             |         |                                              |   |                            |      
|                                                                                           | Exercise of warrants for cash                                       |                     | 132,000   |              |     |                           |   |                     | 104 |                             |         |                                              |   |                            |      
|                                                                                           | Non-employee directors' services, at fair value                     |                     | 14,000    |              |     |                           |   |                     | 15  |                             |         |                                              |   |                            |      
|Issuance of stock options for third party services, at fair value                          |                                                                     |                    |           |              |    |                            |   | 6                   |     |                             |        |                                               |   |                           |       
|Comprehensive income (loss):                                                               |                                                                     |                     |           |              |     |                            |   |                     |     |                             |         |                                               |   |                            |       
|                                                                                           | Net income                                                          |                     |          |              |     |                           |   |                     |    |                             |         | 486                                           |   |                            | 486   
|                                                                                           | Other comprehensive lossforeign currency translation adjustments   |                     |          |              |     |                           |   |                     |    |                             |         |                                              |   |                            | (3    
|                                                                                           |                                                                     |                     |           |              |     |                            |   |                     |     |                             |         |                                               |   |                            |       
|                                                                                           | Comprehensive income                                                |                     |          |              |     |                           |   |                     |    |                             |         |                                              |   |                            | 483   
|                                                                                           |                                                                     |                     |           |              |     |                            |   |                     |     |                             |         |                                               |   |                            |       
|Balances at March 31, 2005                                                                 |                                                                     | 20,896,265          |           | $            | 104 |                            | $ | 27,298              |     | $                           | (12,349 | )                                             | $ |                           |       
|                                                                                           |                                                                     |                     |           |              |     |                            |   |                     |     |                             |         |                                               |   |                            |       

See accompanying Notes to Consolidated Financial Statements

26

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CONSOLIDATED STATEMENTS OF CASH FLOWS  Years ended March 31, 2005, 2004 and 2003

|(in thousands)                                                                                           |                                                                                          | 2005                              |        | 2004   |      | 2003  |      
|-------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------- | --------------------------------- | ------ | ------ | ---- | ----- | -----
|CASH FLOWS FROM OPERATING ACTIVITIES:                                                                    |                                                                                          |                                   |        |        |      |       |      
|Net income (loss)                                                                                        |                                                                                          | $                                 | 486    |        | $    | 399   |      
|Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities:           |                                                                                          |                                   |        |        |      |       |      
|                                                                                                         | Depreciation and amortization                                                            |                                   |        | 1,319  |      |       | 1,346
|                                                                                                         | Amortization of debt issue costs and other assets                                        |                                   |        | 27     |      |       | 65   
|                                                                                                         | Issuance of common stock and stock options in exchange for services                      |                                   |        | 21     |      |       | 8    
|                                                                                                         | Provision for doubtful accounts                                                          |                                   |        | 50     |      |       | 36   
|                                                                                                         | Issuance and revision of warrants in connection with extension of convertible debentures |                                   |        |       |      |       |     
|                                                                                                         | Write-down of capital expenditure project                                                |                                   |        |       |      |       |     
|                                                                                                         | Net (increase) decrease in assets:                                                       |                                   |        |        |      |       |      
|                                                                                                         |                                                                                          | Accounts receivable               |        |        | 92   |       |      
|                                                                                                         |                                                                                          | Refundable income taxes           |        |        | (86  | )     |      
|                                                                                                         |                                                                                          | Inventories                       |        |        | (466 | )     |      
|                                                                                                         |                                                                                          | Prepaid expenses and other assets |        |        | (1   | )     |      
|                                                                                                         | Net increase (decrease) in liabilities:                                                  |                                   |        |        |      |       |      
|                                                                                                         |                                                                                          | Accounts payable                  |        |        | 103  |       |      
|                                                                                                         |                                                                                          | Accrued expenses                  |        |        | (217 | )     |      
|                                                                                                         |                                                                                          |                                   |        |        |      |       |      
|                                                                                                         | Net cash provided by (used in) operating activities                                      |                                   |        | 1,328  |      |       | 1,966
|                                                                                                         |                                                                                          |                                   |        |        |      |       |      
|CASH FLOWS FROM INVESTING ACTIVITIES:                                                                    |                                                                                          |                                   |        |        |      |       |      
|Purchase of short-term investments                                                                       |                                                                                          |                                   | (1,000 | )      |      |      |      
|Investment in equipment and leasehold improvements                                                       |                                                                                          |                                   | (649   | )      |      | (413  | )    
|                                                                                                         |                                                                                          |                                   |        |        |      |       |      
|                                                                                                         | Net cash used in investing activities                                                    |                                   |        | (1,649 | )    |       | (413 
|                                                                                                         |                                                                                          |                                   |        |        |      |       |      
|CASH FLOWS FROM FINANCING ACTIVITIES:                                                                    |                                                                                          |                                   |        |        |      |       |      
|Proceeds from issuance of common stock and exercise of stock options and warrants, net of issuance costs |                                                                                          |                                   | 136    |        |      | 477   |      
|Release of restricted cash deposit                                                                       |                                                                                          |                                   |       |        |      | 250   |      
|Proceeds from issuance of long-term debt                                                                 |                                                                                          |                                   |       |        |      |      |      
|Principal payments on long-term debt                                                                     |                                                                                          |                                   | (341   | )      |      | (328  | )    
|Debt issue costs                                                                                         |                                                                                          |                                   |       |        |      |      |      
|                                                                                                         |                                                                                          |                                   |        |        |      |       |      
|                                                                                                         | Net cash provided by (used in) financing activities                                      |                                   |        | (205   | )    |       | 399  
|                                                                                                         |                                                                                          |                                   |        |        |      |       |      
|Net increase (decrease) in cash and cash equivalents                                                     |                                                                                          |                                   | (526   | )      |      | 1,952 |      
|Cash and cash equivalents at beginning of year                                                           |                                                                                          |                                   | 2,531  |        |      | 579   |      
|                                                                                                         |                                                                                          |                                   |        |        |      |       |      
|Cash and cash equivalents at end of year                                                                 |                                                                                          | $                                 | 2,005  |        | $    | 2,531 |      
|                                                                                                         |                                                                                          |                                   |        |        |      |       |      
|SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                                                        |                                                                                          |                                   |        |        |      |       |      
|Cash paid during the year for:                                                                           |                                                                                          |                                   |        |        |      |       |      
|                                                                                                         | Interest                                                                                 |                                   | $      | 132    |      | $     | 260  
|                                                                                                         |                                                                                          |                                   |        |        |      |       |      
|                                                                                                         | Income taxes                                                                             |                                   | $      | 178    |      | $     | 17   
|                                                                                                         |                                                                                          |                                   |        |        |      |       |      
|Supplemental disclosure of non-cash financing activities:                                                |                                                                                          |                                   |        |        |      |       |      
|                                                                                                         | Conversion of debentures to common stock                                                 |                                   | $      |       |      | $     | 1,250
|                                                                                                         |                                                                                          |                                   |        |        |      |       |      

See
accompanying Notes to Consolidated Financial Statements

27

---





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 Description of Business and Summary of Accounting Policies

Description of Business

Cyanotech Corporation (the Company) cultivates and produces high-value, high-quality natural products derived from microalgae. The Company
currently cultivates, on a large-scale basis, two microalgal species from which its two major product lines are derived. The Company is currently producing microalgal products for the nutritional
supplement, animal feed/pigments and immunological diagnostics markets. The Company manufactures all of its products in the United States and sells its products worldwide. As the Company's operations
are solely related to microalgae-based products, management of the Company considers its operations to be in one industry segment. Correspondingly, the Company records revenue and cost of sales
information by product category but does not record operating expenses by such product category.

Accounting Principles

The consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of
America.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of Cyanotech Corporation and its wholly owned subsidiaries, Nutrex Hawaii, Inc.
("Nutrex Hawaii" or "Nutrex") and Cyanotech Japan YK ("Cyanotech Japan" or "CJYK"). All significant intercompany balances and transactions have been eliminated in consolidation.

Estimates and Assumptions

The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of any contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the period reported.
Management reviews theses estimates and assumptions periodically and reflects the effect of revisions in the period that they are determined to be necessary. Actual results could differ significantly
from those estimates and assumptions.

Foreign Currency Translation and Risk

The Japanese Yen is the functional currency for Cyanotech Japan. As such, Cyanotech Japan's assets and liabilities are translated at the exchange rate on the
balance sheet date and revenues and expenses are translated at average rates of exchange prevailing during the year. Translation adjustments are charged or credited to accumulated other comprehensive
income (loss) in stockholders' equity. Certain transactions for Cyanotech Japan are exposed to foreign currency risk. The Company actively monitors and manages the balances subject to foreign currency
risk. Currently, we do not hedge any of our foreign currency risk.

Financial Instruments

Cash and cash equivalents consist of cash and highly liquid debt instruments such as commercial paper and certificates of deposit with maturities of three months
or less from the date of purchase. Short-term investments are certificates of deposits maturing between three and nine months from the purchase date and are stated at cost. Interest earned
on short-term investments is deposited monthly into an accessible cash account and is therefore classified as cash and cash equivalents. The Company's

28

---



practice
is to invest cash with financial institutions that have acceptable credit ratings and to limit the amount of credit exposure to any one financial institution.

Statement
of Financial Accounting Standards ("SFAS") No. 107, "Disclosures About Fair Value of Financial Instruments," defines the fair value of a financial instrument as the
amount at which the instrument could be exchanged in a current transaction between willing parties. Management applies the following methods and assumptions in estimating the fair value of each class
of financial instruments for all periods presented.

Cash and Cash Equivalents, Short-Term Investments, Accounts Receivable and Accounts Payable.Due to the
short-term nature of these instruments, management believes that the carrying amounts approximate fair value.

Long-Term Debt.The carrying amount of long-term debt approximates fair value as interest rates
applied to the underlying debt are adjusted quarterly to market interest rates which approximates current interest rates for similar debt instruments of comparable maturities.

Trade Accounts Receivable and Allowance for Doubtful Accounts

Trade accounts receivable are recorded at the invoiced amount and do not accrue interest. The allowance for doubtful accounts reflects management's best estimate
of probable credit losses inherent in the accounts receivable balance. The Company determines the allowance based on historical experience, specifically identified nonpaying accounts and other
currently available evidence. The Company reviews its allowance for doubtful accounts monthly with focus on significant individual past due balances over 90 days. All other balances are
reviewed on a pooled basis. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential
for recovery is considered remote. The Company does not have any off-balance sheet credit exposure related to its customers.

Inventories

Inventories are stated at the lower of cost (which approximates first-in, first-out) or market.

Equipment and Leasehold Improvements and Long-Lived Assets

Equipment and leasehold improvements are stated at cost. Depreciation and amortization are provided using the straight-line method over the estimated
useful lives for equipment and furniture and fixtures, or the shorter of the land lease term (see Note 3) or estimated useful lives for leasehold improvements as follows:

Equipment

3 to 10 yearsFurniture and fixtures

7 yearsLeasehold improvements

10 to 21 years


The
Company accounts for impairment of its equipment or leasehold improvement in accordance with SFAS No. 144. Pursuant SFAS No. 144, long-lived assets, such as
property, plant and equipment and purchased intangibles subject to amortization shall be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be
generated by the asset. If the

29

---



carrying
amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized to the extent that the carrying amount exceeds the asset's fair value.

Assets
to be disposed of and related liabilities would be separately presented in the consolidated balance sheet. Assets to be disposed of would be reported at the lower of the carrying
value or fair value less costs to sell and would not be depreciated.

SFAS
No. 143 "Accounting for Asset Retirement Obligations" requires the fair value of a liability for an asset retirement obligation to be recognized in the period in which it is
incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs would be capitalized as part of the carrying amount of the long-lived asset and
depreciated over the life of the asset. The liability is accreted at the end of each period through charges to operating expense. If the obligation is settled for other than the carrying amount of the
liability, the Company will recognize a gain or loss on settlement.

Revenue Recognition

The Company recognizes revenues when goods are shipped (FOB shipping point) and when significant risks and benefits of ownership are transferred.

Research and Development and Advertising

Research and development and advertising costs are expensed as incurred.

Income Taxes

Income taxes are accounted for under the asset and liability method. The asset and liability method requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their tax bases and operating
loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected
to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

Stock Option Plan

The Company applies the intrinsic value-based method of accounting prescribed by Accounting Principle Board ("APB") Opinion No. 25, Accounting for Stock
Issued to Employees, and related interpretations, in accounting for its fixed plan stock options issued to employees, including
non-employee directors. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. The
Company applies the fair value-based method of accounting prescribed by SFAS No. 123,Accounting for Stock-Based Compensation, and Emerging
Issues Task Force ("EITF") Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services" in
accounting for its fixed plan stock options issued to outside third parties other than non-employee directors. As such, expenses representing the fair value of stock-based awards on the
date of grant are recognized over the vesting period. See "New Accounting Pronouncements" in Note 1. for a description of SFAS No. 123 (Revised 2004).

As
allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic value-based method of accounting for employee based stock options and adopted only the
disclosure

30

---



requirements
of SFAS No. 123. The following table illustrates the effect on net income (loss) and net income (loss) per common share if the Company had applied the fair-value method
under SFAS No. 123 to its employee stock options:

(in thousands, except per share amounts)

2005

2004

2003Net income (loss), as reported

$
486

$
399

$
(1,775
)Deduct stock-based employee compensation expense determined under fair-value method for all awards


(90
)

(82
)

(89
)Pro forma net income (loss)

$
396

$
317

$
(1,864
)Net income (loss) per common shareBasic and Diluted:As reported

$
0.02

$
0.02

$
(0.10
)Pro forma

$
0.02

$
0.02

$
(0.10
)


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 of
FASB Statement No. 123 "Accounting for Stock-Based Compensation." SFAS No. 123 (Revised 2004) requires an entity to measure the cost of employee services received in exchange for an
award. If an award vests or becomes exercisable based on the achievement of a condition other than service, performance or market condition, the award is liability-classified. Liability-classified
awards are remeasured to fair value at each balance sheet date until the award is settled. Equity -classified awards, including grants of employee stock options, are measured at the
grant-date fair value of the award and are not subsequently remeasured. The cost of equity-classified awards is recognized in the income statement over the period during which an employee
is required to provide the service in exchange for the award. Currently the company accounts for its employee and non-employee director stock options under the intrinsic value
provision of APB Opinion No. 25. The Company is required to adopt the provisions for SFAS No. 123 (Revised 2004) as of the beginning of the first annual reporting period that begins
after June 15, 2005, although earlier adoption is permitted. SFAS No. 123 (Revised 2004) offers several alternatives for implementation. At this time, management has not made a decision
as to the alternative it may select.

In
November 2004, the FASB issued SFAS No. 151 "Inventory Costsan amendment of Accounting Research Bulletin No. 43, Chapter 4". SFAS No. 151
requires that abnormal amounts of freight, handling costs and wasted material (spoilage) be recognized as current-period charges and fixed production overhead costs be allocated to inventory based on
the normal capacity of production facilities. Normal capacity is defined as "the production expected to be achieved over a number of periods or seasons under normal circumstances, taking into account
the loss of capacity resulting from planned maintenance." Companies will no longer be permitted to capitalize inventory costs on the balance sheet when the production defect rate varies significantly
from the expected defect rate. SFAS No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Earlier application is permitted for inventory
costs incurred during fiscal years beginning after November 24, 2004. The Company has yet to determine the impact, if any, of SFAS No. 151 on its consolidated financial statements.

In
December 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 assets should be measured based on the fair market value of the assets exchanged. SFAS No. 153 eliminates the exception of
nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of

31

---



nonmonetary
assets that do not have commercial substance. SFAS No. 153 is effective for nonmonetary asset exchanges in fiscal periods beginning after June 15, 2005. Adoption of the
provisions of SFAS No. 153 is not expected to have a material impact on the Company's financial condition, results of operations, or liquidity.

In
March 2005, the FASB issued FASB Interpretation No. 47 ("FIN 47"), "Accounting for Conditional Asset Retirement Obligationsan interpretation of FASB
Statement No. 143." FIN 47 clarifies that the term "conditional asset retirement obligation" as used in FASB Statement No. 143, "Accounting for Asset Retirement Obligations," refers to a
legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity.
Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. FIN 47 is
effective for fiscal years ending after December 15, 2005. The Company has yet to determine the impact, if any, of FIN 47 on its consolidated financial statements.

On
March 29, 2005, the Securities and Exchange Commission (SEC) staff issued Staff Accounting Bulletin No. 107, "Share-Based Payment" (SAB No. 107), which expressed
the SEC staff's views on Statement No. 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 in conjunction with its assessment of Statement No. 123R's impact to the Company.

In
May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3." SFAS
No. 154 requires retrospective application for voluntary changes in accounting principle unless it is impracticable to do so. In addition, indirect effects of a change in accounting principle
should be recognized in the period of the accounting change. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15,
2005.

Note 2 Inventories

Inventories consists of the following as of March 31, 2005 and 2004:

(in thousands)

2005

2004Raw materials

$
246

$
191Work in process


243


154Finished goods


957


567Supplies


119


187$
1,565

$
1,099


32

---



Note 3 Equipment and Leasehold Improvements, Net

Equipment
and leasehold improvements consists of the following as of March 31, 2005 and 2004:

(in thousands)

2005

2004Equipment

$
10,241

$
9,753Leasehold improvements


14,603


14,326Furniture and fixtures


86


8324,930


24,162Less accumulated depreciation and amortization


(14,006
)

(12,687
)Construction in-progress


250


369$
11,174

$
11,844


Note 4 Accrued Expenses

Components
of accrued expenses as of March 31, 2005 and 2004 are as follows:

(in thousands)

2005

2004Accrued wages, commissions and royalties

$
158

$
214Accrued income taxes





119Accrued interest


11


11Other accrued expenses


218


260$
387

$
604


Note 5 Long-Term Debt

Long-term
debt consists of the following as of March 31, 2005 and 2004:

(in thousands)

2005

2004Term loan

$
2,098

$
2,439Less current maturities


(355
)

(346
)Long-term debt, excluding current maturities

$
1,743

$
2,093


At
March 31, 2005, the aggregate maturities of long-term debt are as follows:

Year ending March 31:

(in thousands)2006

$
3552007


3782008


4022009


4282010


456Thereafter


79$
2,098


Term Loan Agreement

In April 2000, the Company executed a Term Loan Agreement ("Term Loan") with a lender providing for $3.5 million in aggregate credit facilities,
secured by the Company's assets. The Term

33

---



Loan
has a maturity date of May 1, 2010 and is payable in 120 equal monthly principal and interest payments. The interest rate under this Term Loan, in the absence of a default under the
agreement, is the prime rate, in effect as of the close of business on the first day of each calendar quarter, plus 1%. As of March 31, 2005 and 2004, the prime rate was 5.25% and 4.0%,
respectively. The Company is in compliance with all restrictive covenants of the Term Loan as of March 31, 2005. The Company is prohibited from declaring any common stock dividends without the
lender's prior written consent. A warrant to purchase 20,000 shares of the Company's common stock was issued in conjunction with this Term Loan. The warrant expires in April 2011 and has an
exercise price of $2.55 per share. The warrant may only be exercised after the Company has repaid the Term Loan in full.

Of
the loan proceeds, $500,000 had been deposited in an interest-bearing restricted cash account per the terms of the Term Loan. In July 2003, the Company received $250,000 of
cash previously held as a restricted deposit. The remaining $250,000 restricted cash deposit continues to be held in the restricted cash account and is included in Other Assets in the accompanying
consolidated Balance Sheets at March 31, 2005 and 2004.

Convertible Debentures

In October 2002, the Company issued in a private placement $1,250,000 principal amount 10% convertible subordinated debentures (the "Debentures") and
750,000 shares of common stock. Subsequent to this transaction, the debenture holder was elected to the Company's Board of Directors. In December 2003, the holder of the Debentures voluntarily
converted the entire $1,250,000 principal amount into 1,923,076 shares of common stock at a conversion price of $0.65 per share pursuant to the terms of the Debentures.

Proceeds
from the Debentures were used in October 2002 to retire $1,238,000 of convertible debentures issued in May 2000 (the "May 2000 Debentures"). The
May 2000 Debentures which originally totaled $1,250,000, were convertible into shares of the Company's common stock and were originally due to mature on April 30, 2002. In addition,
warrants were issued in May 2000 to the placement agent to
purchase 83,334 shares of the Company's common stock. In May 2002, the maturity of the May 2000 Debentures was extended six months to October 31, 2002. In exchange for the six
months maturity extension, the terms of the May 2000 Debentures were revised:

Original Terms

Renegotiated TermsMaturity date


April 30, 2002


October 31, 2002Interest rate


6% per annum


10% per annumConversion price

$
1.50 per share

$
1.00 per shareWarrant terms:

Number of shares


83,334 shares


454,734 sharesExercise price

$
1.80 per share

$
1.10 per shareExpiration date


May 2005


May 2004


As
a result of the renegotiation of the May 2000 Debentures, the Company recorded a charge of approximately $236,000 during the year ended March 31, 2003, of which
approximately $223,000 was a non-cash charge. The charge was recorded as Other Expense, Net in the accompanying Consolidated Statement of Operations for the year ended March 31,
2003.

Note 6 Leases

The Company leases facilities, equipment and land under operating leases expiring between 2005 and 2025. The land lease provides for contingent rentals in excess
of minimum rental commitments based on a percentage of the Company's sales. Contingent rental for the years ended March 31, 2005

34

---



and
2004 was $88,000 and $39,000, respectively. Contingent rentals for fiscal year 2003 were not material.

Future
minimum lease payments under non-cancelable operating leases at March 31, 2005 are as follows:

Year ending March 31:

(in thousands)2006

$
2512007


2232008


2232009


1862010


148Thereafter through 2025


2,331Total minimum lease payments

$
3,362


Rent
expense under operating leases amounted to $338,000, $271,000 and $218,000 for the years ended March 31, 2005, 2004 and 2003, respectively.

Note 7 Stock Options and Warrants

Stock Options

The Company has a stock option plan, approved by stockholders in 1995 (the "1995 Plan"), that provides for the issuance of both incentive and
non-qualified stock options. Options are granted at, or above, the fair market value of the Company's common stock at the date of grant and generally become exercisable over a
five-year period. 800,000 shares of common stock were reserved for issuance under the 1995 Plan.

On
August 16, 2004, the stockholders approved the Independent Director Stock Option and Stock Grant Plan (the "2004 Plan"). 300,000 shares of common stock are reserved for
issuance under the 2004 Plan. Under the 2004 Plan, upon election to the Board of Directors, a newly elected non-employee director is granted a ten-year option to purchase 4,000
shares of the Company's common stock at a fair market value on the date of grant. In addition, on the date of each Annual Meeting of Stockholders, each non-employee director continuing in
office will be automatically granted, without payment, 3,500 shares of common stock, non-transferable for six months following the date of grant. Concurrently with the 2004 Plan approval,
the 1994 Non-Employee Director Stock Option and Stock Grant Plan was terminated except for the outstanding options issued thereunder.

Previously
under the terminated 1994 Plan, upon election to the Board of Directors, non-employee directors were granted a ten-year option to purchase 3,000 shares
of the Company's common stock at fair market value on the date of grant. In addition, on the date of each Annual Meeting of Stockholders, each non-employee director continuing in office
was granted, without payment, 2,000 shares of common stock, non-transferable for six months following the date of grant. Expense recognized from the 2004 Plan and the 1994 Plan grants of
shares of common stock for the years ended March 31, 2005, 2004 and 2003 was $15,000, $3,000 and $5,000, respectively.

At
March 31, 2005, there were 127,194 shares available for grant under the 1995 Plan and 282,000 shares available under the 2004 Plan. The per share weighted average fair value of
stock options

35

---



granted
during 2005, 2004 and 2003 was $0.80, $0.38 and $0.48, respectively, on the date of grant using a Black Scholes option pricing model with the following weighted average assumptions:

2005

2004

2003Expected dividend yield

0
%
0
%
0
%Risk-free interest rate

4.5
%
4.5
%
3.3
%Expected volatility

104
%
97
%
113
%Expected life in years

4.0

5.0

4.0


Activity
for stock options outstanding during the periods indicated were as follows:

Number of
Shares

Weighted
Average
Exercise PriceBalance at March 31, 2002

740,696

$
2.10Granted

142,500


0.59Exercised




Expired

(72,900
)

6.31Forfeited

(51,600
)

1.46Balance at March 31, 2003

758,696


1.46Granted

190,400


0.49Exercised

(45,800
)

0.95Expired

(75,900
)

3.13Forfeited

(171,700
)

1.31Balance at March 31, 2004

655,696


1.06Granted

139,095


1.10Exercised

(36,019
)

0.88Expired

(58,952
)

1.12Forfeited

(93,833
)

1.00Balance at March 31, 2005

605,987


1.09


The
following table summarizes the weighted average characteristics of outstanding stock options at March 31, 2005 for various exercise price ranges:

|            |  | Outstanding Options |  | Exercisable Options
|----------- |  | ------------------- |  | -------------------
|
|$0.46$0.77 |  | 266,098             |  | 3.0                
|$1.03$1.69 |  | 311,889             |  | 2.1                
|$3.69$6.13 |  | 28,000              |  | 2.9                

36

---



Warrants

The Company had issued warrants which allow the warrant holders rights to acquire an equivalent number of shares of common stock at a stated exercise price.
Warrants outstanding during the periods indicated were as follows:

Warrants
issued in connection with:

|Grant date:
Expiration date:
Exercise price: |                                                                                   | 3rd Party
Services
December 1999
December 2004
$0.63 |         | 50,000 Shares
Purchased by
Stockholder
January 2000
January 2005
$1.00 |         | Term Loan
(See Note 5)
April 2000
April 2011
$2.55 |   | Debentures
(See Note 5)
May 2000 &
May 2002
May 2004
$1.10 |          | Total   |         
|-------------------------------------------- | --------------------------------------------------------------------------------- | ---------------------------------------------------- | ------- | ---------------------------------------------------------------------- | ------- | -------------------------------------------------- | - | ---------------------------------------------------------- | -------- | ------- | --------
|Balance at March 31, 2002                    |                                                                                   | 75,000                                               |         | 50,000                                                                 |         | 20,000                                             |   | 83,334                                                     |          | 228,334 |         
|                                             | Granted in May 2002 in connection with Debentures maturity extension (see Note 5) |                                                      |        |                                                                        |        |                                                    |  |                                                            | 371,400  |         | 371,400 
|                                             |                                                                                   |                                                      |         |                                                                        |         |                                                    |   |                                                            |          |         |         
|Balance at March 31, 2003                    |                                                                                   | 75,000                                               |         | 50,000                                                                 |         | 20,000                                             |   | 454,734                                                    |          | 599,734 |         
|                                             | Exercises                                                                         |                                                      |        |                                                                        |        |                                                    |  |                                                            | (429,234 | )       | (429,234
|                                             |                                                                                   |                                                      |         |                                                                        |         |                                                    |   |                                                            |          |         |         
|Balance at March 31, 2004                    |                                                                                   | 75,000                                               |         | 50,000                                                                 |         | 20,000                                             |   | 25,500                                                     |          | 170,500 |         
|                                             | Exercises                                                                         |                                                      | (75,000 | )                                                                      | (50,000 | )                                                  |  |                                                            | (7,000   | )       | (132,000
|                                             | Expired                                                                           |                                                      |        |                                                                        |        |                                                    |  |                                                            | (18,500  | )       | (18,500 
|                                             |                                                                                   |                                                      |         |                                                                        |         |                                                    |   |                                                            |          |         |         
|Balance at March 31, 2005                    |                                                                                   |                                                     |         |                                                                       |         | 20,000                                             |   |                                                           |          | 20,000  |         
|                                             |                                                                                   |                                                      |         |                                                                        |         |                                                    |   |                                                            |          |         |         

Note 8 Earnings Per Share

Basic
earnings per share is computed on the basis of the weighted average number of common shares outstanding. Diluted earnings per share is computed on the basis of the weighted average
number of common shares outstanding plus the potentially dilutive effect of outstanding stock options and warrants using the "treasury stock" method and convertible securities using the
"if-converted" method.

37

---



Reconciliations
between the numerator and the denominator of the basic and diluted earnings per share computations for the years ended March 31, 2005 and 2004 are as follows
(there were no reconciling items for the year ended March 31, 2003):

|(in thousands, except per share amounts) |                                                                 | Net Income
(Numerator) |   | Shares
(Denominator) |  | Per Share
Amount
|---------------------------------------- | --------------------------------------------------------------- | ---------------------- | - | -------------------- |  | ----------------
|Year ended March 31, 2005:               |                                                                 |                        |   |                      |  |                 
|                                         | Basic earnings per share                                        |                        | $ | 486                  |  | 20,784          
|                                         |                                                                 |                        |   |                      |  |                 
|                                         | Effect of dilutive securitiesCommon stock options and warrants |                        |   |                     |  | 195             
|                                         |                                                                 |                        |   |                      |  |                 
|                                         | Diluted earnings per share                                      |                        | $ | 486                  |  | 20,979          
|                                         |                                                                 |                        |   |                      |  |                 
|Year ended March 31, 2004:               |                                                                 |                        |   |                      |  |                 
|                                         | Basic earnings per share                                        |                        | $ | 399                  |  | 18,971          
|                                         |                                                                 |                        |   |                      |  |                 
|                                         | Effect of dilutive securitiesCommon stock options and warrants |                        |   |                     |  | 140             
|                                         |                                                                 |                        |   |                      |  |                 
|                                         | Diluted earnings per share                                      |                        | $ | 399                  |  | 19,111          
|                                         |                                                                 |                        |   |                      |  |                 

The
following securities were excluded from the calculation of diluted earnings per share because their effect was antidilutive:

2005

2004

2003(in thousands)Debentures, prior to conversion (see Note 5)



1,329

1,923Stock options and warrants

158

441

1,358


Note 9 Profit Sharing Plan

The
Company sponsors a profit sharing plan for all employees not covered under a separate management incentive plan. Under the profit sharing plan, 5% of pre-tax profits on a
quarterly basis may be allocated to non-management employees based on gross wages. At management's discretion, the profit sharing bonus may be distributed all in cash on an
after-tax basis or distributed half in cash (on an after-tax basis) and the remainder deposited in an employee's 401(k) account on a pre-tax basis with a six year
vesting schedule, based on years of service with the Company. All employees may make voluntary pre-tax contributions to their 401(k) accounts; Company contributions are discretionary. For
the years ended March 31, 2005, 2004 and 2003 compensation expense relative to this plan was approximately $30,000, $36,000 and nil, respectively.

38

---



Note 10 Major Customers and Geographic Information

Net sales by product line for the years 2005, 2004 and 2003 are as follows:

(in thousands)

2005

2004

2003Net sales:Spirulina products

$
6,626

$
6,511

$
6,181Natural astaxanthin productsNatuRose


1,817


2,545


1,301BioAstin


2,855


2,388


1,312Other products


147


138


157$
11,445

$
11,582

$
8,951


Approximately
$1,130,000, or 10% of our total net sales for the year ended March 31, 2005 was to a single customer. Sales to this customer for fiscal 2004 and 2003 were $1,560,000
(13% of net sales) and $1,546,000 (17% of net sales), respectively.

The
following table presents sales for the years 2005, 2004 and 2003 by geographic region:

(dollars in thousands)

2005

2004

2003Net sales(1):United States

$
5,847

51
%
$
4,918

42
%
$
4,149

46
%Japan


1,759

16
%

2,020

17
%

1,043

12
%The Netherlands


1,180

10
%

1,562

14
%

1,550

17
%Other areas


2,659

23
%

3,082

27
%

2,209

25
%$
11,445

100
%
$
11,582

100
%
$
8,951

100
%


---

Substantially
all long-lived assets are located in the United States as of March 31, 2005 and 2004.

Note 11 Income Taxes

Income (loss) before income taxes consisted of:

(in thousands)

2005

2004

2003United States

$
375

$
224

$
(1,817
)Foreign


70


250


33Income (loss) before income taxes

$
445

$
474

$
(1,784
)


39

---



Income
tax expense (benefit) for the years ended March 31, 2005, 2004 and 2003 consisted of:

(in thousands)

2005

2004

2003Current:Foreign

$
11

$
121

$
Federal


(5
)

5


State


(62
)

(33
)

(9
)Total current


(56
)

93


(9
)Deferred:Foreign


15


(18
)

Federal








State








Total deferred


15


(18
)

Income tax expense (benefit)

$
(41
)
$
75

$
(9
)


The
following table reconciles the amount of income taxes computed at the federal statutory rate of 34%, for all periods presented, to the amount reflected in the Company's consolidated
statement of operations for the years ended March 31, 2005, 2004 and 2003:

(in thousands)

2005

2004

2003Tax provision at federal statutory income tax rate

$
151

$
161

$
(607
)State income taxes, net of federal income tax effect


(41
)

(22
)

(6
)Foreign income taxes in excess of federal statutory income tax rate


2


36


Increase (decrease) in valuation allowance for deferred tax assets


55


(188
)

727Utilization of net operating loss carryforwards


(123
)

(180
)

Other, net


(85
)

268


Income tax expense (benefit)

$
(41
)
$
75

$
(9
)


The
tax effects of temporary differences related to various assets, liabilities and carryforwards that give rise to deferred tax assets and deferred tax liabilities as of
March 31, 2005 and 2004 are as follows:

(in thousands)

2005

2004Deferred tax assets:Net operating loss carryforwards

$
5,340


5,295Impairment loss on leasehold improvements for financial reporting purposes


1,062


1,062Tax credit carryforwards


115


119Other


169


199Gross deferred tax assets


6,686


6,675Less valuation allowance


(5,133
)

(5,078
)Net deferred tax assets


1,553


1,597Deferred tax liability: Differences in depreciation and amortization on equipment and leasehold improvements


(1,550
)

(1,579
)Net deferred tax assets

$
3

$
18


40

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In
assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized.
The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management
considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based upon the level of historical taxable income
and projections for future taxable income
over the periods in which net deferred tax assets are deductible, management does not believe it is more likely than not the Company will realize a portion of its gross deferred tax assets, and has
thus established a valuation allowance to reflect its estimated realizability. The amount of the deferred tax assets considered realizable, however, could be reduced in the near term if estimates of
future taxable income during the carryforward period are reduced.

At
March 31, 2005, the Company has net operating loss carryforwards and tax carryfowards available to offset future federal income tax as follows (in thousands):

Expires March 31,

Net Operating
Losses

Research and
Experimentation
Tax Credits2011

$


$
232012





92013


1,514


2019


3,632


2020


2,051


2021


1,727


2022


3,161


2023


1,977


$
14,062

$
32


In
addition, at March 31, 2005, the Company has alternative minimum tax credit carryforwards of approximately $83,000 available to reduce future federal regular income taxes over
an indefinite period.

At
March 31, 2005, the Company has state tax net operating loss carryforwards of $9,322,000, which expire in March 31, 2019 through 2023, available to offset future Hawaii
state taxable income.

Note 12 Commitments and Contingencies

During the third quarter of fiscal 2004, a final royalty payment was made to Aquasearch under a confidential agreement relating to the settlement of a patent
suit.    The patent suit was settled in the fourth quarter of fiscal 2001 with agreement of the parties to dismiss, with prejudice, all claims asserted in the litigation. In compliance
with this settlement, the Company made a lump sum payment and paid royalties on sales ofBioAstinduring fiscal 2002 through 2004.

41

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Note 13 Selected Quarterly Financial Data (Unaudited)

|(in thousands, except per share data)         |  | First
Quarter |       | Second
Quarter |   | Third
Quarter |   | Fourth
Quarter |       | Year
|--------------------------------------------- |  | ------------- | ----- | -------------- | - | ------------- | - | -------------- | ----- | ----
|2005                                          |  |               |       |                |   |               |   |                |       |     
|Net sales                                     |  | $             | 2,707 |                | $ | 2,998         |   | $              | 3,180 |     
|Gross profit                                  |  |               | 887   |                |   | 1,054         |   |                | 1,163 |     
|Net income (loss)                             |  |               | 113   |                |   | 121           |   |                | 326   |     
|Net income (loss) per shareBasic and Diluted |  |               | 0.01  |                |   | 0.01          |   |                | 0.02  |     
|                                              |  |               |       |                |   |               |   |                |       |     
|2004                                          |  |               |       |                |   |               |   |                |       |     
|Net sales                                     |  | $             | 2,428 |                | $ | 2,840         |   | $              | 3,024 |     
|Gross profit                                  |  |               | 704   |                |   | 861           |   |                | 1,184 |     
|Net income (loss)                             |  |               | (141  | )              |   | (10           | ) |                | 109   |     
|Net income (loss) per shareBasic and Diluted |  |               | (0.01 | )              |   | (0.00         | ) |                | 0.01  |     
|                                              |  |               |       |                |   |               |   |                |       |     

As
a normal course of business, adjustments are recorded in the consolidated financial statements to fairly represent the Company's financial condition, results of operations or
liquidity. During the fourth quarter of fiscal 2005 adjustments were made to properly state certain accrued liabilities related to general and administrative operating expenses and receivables related
to income tax benefits of approximately $70,000. These adjustments related to previously reported periods but would not have had a material impact on any such previously reported period.

42

---





Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Not applicable.

Item 9A. Controls and Procedures

Under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the
effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief
Financial Officer have concluded that these disclosure controls and procedures are effective to ensure that the information required to be disclosed by the Company is recorded, processed, summarized
and reported in accordance with Securities and Exchange Commission rules and forms. Subsequent to the date of our evaluation, there were no changes in our internal control over financial reporting
that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

PART III

Item 10. Directors and Executive Officers of the Registrant

Information with respect to Directors may be found under captions "Proposal One: Election of Directors," "Board Meetings and Committees," "Security Ownership of
Certain Beneficial Owners and Management" and "Compliance with Section 16(a) of the Exchange Act" contained in Cyanotech's definitive 2005 Proxy Statement. Information on Executive Officers may
be found under the caption
"Executive Officers" contained in Cyanotech's definitive 2005 Proxy Statement. Such information is incorporated herein by reference.

We
have adopted the Cyanotech Code of Ethics for Chief Executive Officer and Senior Financial Officers (the "Code of Ethics") included in our Code of Conduct. Our Code of Ethics is
publicly available on our website at www.cyanotech.com. If we make any substantive amendments to or grant any waivers from the Code of Ethics relating to our Chief Executive Officer, Chief Financial
Officer or Controller, we will disclose the nature of such amendment in a report on Form 8-K.

Item 11. Executive Compensation

The information required by this Item is incorporated herein by reference from the sections captioned "Executive Compensation and Other Information," "Director
Remuneration" and "Stockholder Return Performance Graph" contained in Cyanotech's definitive 2005 Proxy Statement.

Item 12. Security Ownership of Certain Beneficial Owners and Management

The security ownership information required by this Item is incorporated herein by reference from the sections captioned "Equity Compensation Plan Information"
and "Security Ownership of Certain Beneficial Owners and Management" contained in Cyanotech's definitive 2005 Proxy Statement.

Item 13. Certain Relationships and Related Transactions

Not applicable.

Item 14. Principal Accountant Fees and Services

Information concerning principal accountant fees and services appears in Cyanotech's definitive 2005 Proxy Statement under the heading "Independent Registered
Public Accounting Firm's Fees" and is incorporated herein by reference.

43

---



PART IV

Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K



Consolidated Balance Sheets, March 31, 2005 and 2004Consolidated Statements of Operations for the years ended March 31, 2005, 2005 and 2003Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss) for the years ended March 31, 2005, 2004 and 2003Consolidated Statements of Cash Flows for the years ended March 31, 2005, 2004 and 2003Notes to Consolidated Financial Statements




Schedule IIValuation and Qualifying Accounts

46Report of Independent Registered Public Accounting Firm

47




44

---





Exhibit
Number

Document Description3.1

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, 1996, 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)10.1

1994 Non-Employee Directors Stock Option and Stock Grant Program (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)10.2

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)10.3

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)10.4

Term Loan Agreement dated April 21, 2000 between the Company and B&I Lending, LLC (Incorporated by reference to Exhibit 10.11 to the Company's Annual Report on Form 10-K for the year ended March 31, 2000, File No. 0-14602)14.1

Code of Ethics for Chief Executive Officer and Senior Financial Officers (Incorporated by reference to Exhibit E to the Company's definitive 2004 Proxy Statement)21.1

Subsidiaries of the Company (Incorporated by reference to Exhibit 21.1 to the Company's Annual Report on Form 10-K for the year ended March 31, 2003, File No. 0-14602)23.1

Consent of Independent Registered Public Accounting Firm31.1

Certifications of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.2

Certifications of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 200232.1

Certifications of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2

Certifications of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 200299.1

Risk Factors


45

---





Schedule II

Cyanotech Corporation and Subsidiaries  Valuation and Qualifying Accounts

Years Ended March 31, 2005, 2004 and 2003
(In Thousands)

|                                    |      |  |   | Additions |  |   |    | 
|----------------------------------- | ---- |  | - | --------- |  | - | -- | 
|
|Allowance for Doubtful Receivables: |      |  |   |           |  |   |    | 
|                                    | 2005 |  | $ | 96        |  | $ | 31 | 
|                                    |      |  |   |           |  |   |    | 
|                                    | 2004 |  | $ | 60        |  | $ | 37 | 
|                                    |      |  |   |           |  |   |    | 
|                                    | 2003 |  | $ | 40        |  | $ | 70 | 
|                                    |      |  |   |           |  |   |    | 

46

---





REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The
Board of Directors
Cyanotech Corporation:

Under
date of June 6, 2005, we reported on the consolidated balance sheets of Cyanotech Corporation and subsidiaries (the Company) as of March 31, 2005 and 2004, and the related
consolidated statements of operations, stockholders' equity and comprehensive income (loss), and cash flows for each of the years in the three-year period ended March 31, 2005,
which are included in the Company's March 31, 2005 annual report on Form 10-K. In connection with our audits of the aforementioned consolidated financial statements, we also
audited the related financial statement schedule as listed in Item 15(a)(2). 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.

/s/
KPMG LLP

Honolulu,
Hawaii
June 6, 2005

47

---





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 27th day of June, 2005.

| |  | CYANOTECH CORPORATION
| |  | ---------------------
| |  |                      
| |  | By:                  

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, PH. D.Gerald R. Cysewski, Ph. D. |  | Chairman of the Board, President and
Chief Executive Officer (Principal
Executive Officer and Director) |  | July 8, 2005
|/s/JEFFREY H. SAKAMOTOJeffrey H. Sakamoto               |  | Chief Financial Officer, Vice President
Finance and Administration, Secretary
and Treasurer            |  | July 8, 2005
|/s/MICHAEL A. DAVISMichael A. Davis                     |  | Director                                                                                                |  | July 8, 2005
|/s/GREGG W. ROBERTSONGregg W. Robertson                 |  | Director                                                                                                |  | July 8, 2005
|/s/DAVID I. ROSENTHALDavid I. Rosenthal                 |  | Director                                                                                                |  | July 8, 2005
|/s/JOHN T. WALDRONJohn T. Waldron                       |  | Director                                                                                                |  | July 8, 2005
|/s/PAUL C. YUENPaul C. Yuen                             |  | Director                                                                                                |  | July 8, 2005

48

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