UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K

                Annual Report Pursuant to Section 13 or 15(d) of
                       the Securities Exchange Act of 1934

For the fiscal year ended March 31, 1997               Commission file 0-146-02

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


            Nevada                                                 91-1206026
(State or other jurisdiction                                   (I.R.S. Employer
              of                                            Identification No.)
      incorporation or
        organization)

         73-4460 Queen Kaahumanu Hwy., Suite 102, Kailua-Kona, HI 96740
                    (Address of principal executive offices)

                                 (808) 326-1353
                         (Registrant's telephone number)

               Securities registered pursuant to Section 12(b) of
                               the Exchange Act:
                                      NONE
               Securities registered pursuant to Section 12(g) of
                               the Exchange Act:

                                 Title of class
                     Common Stock, Par value $.005 per share

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period that the  Registrant  was
required  to file  such  reports),  and  (2) has  been  subject  to such  filing
requirements for the past 90 days. Yes X No

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation S-K is not contained herein and will not be contained, to the best
of the registrant's  knowledge,  in definitive  proxy or information  statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ____


         At June 20, 1997, the aggregate market value of the registrant's Common
Stock held by non-affiliates of the registrant was approximately $ 67,469,000.

         At  June 20, 1997,  the number of  shares  outstanding of  registrant's
Common Stock was 12,842,912.


                       DOCUMENTS INCORPORATED BY REFERENCE

         Portions of the Proxy  Statement  to be filed with the  Securities  and
Exchange  Commission  on or prior to July 25, 1997 and to be used in  connection
with the Annual Meeting of  Stockholders  expected to be held September 17, 1997
are incorporated by reference in Part III of this Form 10-K.


<PAGE>
                                     PART I


Item 1. Description of Business

         Except for  historical  information  contained  in this  document,  the
matters discussed in this report contain forward looking statements that involve
risks and uncertainties. These future risks and uncertainties could cause actual
results to differ materially.

General

         Cyanotech    Corporation,    incorporated   in   1983,   develops   and
commercializes natural products from microalgae.  Microalgae are a diverse group
of over  30,000  species  of  microscopic  plants  which  have a wide  range  of
physiological and biochemical  characteristics and naturally contain high levels
of certain nutrients.  Microalgae represent a largely unexplored and unexploited
renewable natural resource, which grow much faster than land-based plants. Under
favorable growing conditions,  certain microalgae produce a new crop every week.
We  currently  produce  microalgae  products  for  the  nutritional  supplement,
aquaculture  feed,  and  immunological  diagnostics  markets and are  developing
microalgae-based  products for the biopesticide,  nutraceutical,  cosmetic,  and
food coloring markets.  Since 1983, we have designed,  developed and implemented
proprietary production and harvesting technologies,  systems and processes which
eliminate  many  of  the  stability  and   contamination   problems   frequently
encountered  in the production of  microalgae.  We believe that our  technology,
systems,   processes  and  favorable  growing  location  permitting   year-round
harvesting of microalgal products in a cost effective manner.

         Substantially  all  of  our  revenue  currently  comes  from  sales  of
microalgae-based  "Spirulina"  products for the vitamin and  supplement  market.
Spirulina  Pacifica  is a  unique  strain  of  Spirulina  developed  by us which
provides a  vegetable-based,  highly absorbable source of natural beta carotene,
mixed carotenoids,  B vitamins, gamma linolenic acid ("GLA"), protein, essential
amino acids and other  phytonutrients.  We currently  market our products in the
United States and seventeen  other  countries  through a combination  of retail,
wholesale, and private label channels.

         In early 1997, we introduced  NatuRose(TM) to the worldwide aquaculture
industry.  NatuRose  is our  brand  name  for  natural  astaxanthin  (pronounced
"as-ta-zan-thin").   Astaxanthin   is  a  red  pigment   from  the   microalgae,
Haematococcus,  and is used in  aquaculture  to  impart  a pink to red  color to
pen-raised  fish and shrimp.  NatuRose will compete with  synthetic  astaxanthin
(manufactured from petrochemicals) whose worldwide annual sales are estimated at
more than $150 million.

         Products in development include genetically-engineered  microalgae that
contain a natural soil toxin,  Bacillus  thuringiensis  var.  israelensis,  also
known as Bti. The Bti toxin is  specifically  toxic to mosquitoes  and black fly
larvae.  Synechococcus  microalgae  (a natural  food for  mosquito  larvae) were
genetically-engineered  to contain the Bti toxin.  We believe that, when applied
to a  mosquito-infested  body of water, this algae could act as an effective and
environmentally safe means of mosquito control.

         Cyanotech   Corporation  is  incorporated  in  Nevada.   Our  principal
executive  offices are located at 73-4460 Queen  Kaahumanu  Highway,  Suite 102,
Kailua-Kona,  Hawaii 96740, and our telephone  number is (808) 326-1353.  Unless
otherwise indicated,  all references in this report to the "Company",  "we", and
"Cyanotech" refer to Cyanotech Corporation, a Nevada corporation, and its wholly
owned subsidiary, Nutrex, Inc.



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<PAGE>
Industry Background

         Microalgae are a diverse group of  microscopic  plants that have a wide
range of physiological and biochemical  characteristics  and naturally  contain,
among other things, high levels of proteins, amino acids, vitamins, pigments and
enzymes.  Microalgae  grow extremely  fast,  making it possible to harvest a new
crop every week utilizing optimal culture and processing  technologies.  The raw
materials  required  for  microalgae  growth are readily  available  and include
sunlight, carbon dioxide and agricultural fertilizers.

         Microalgae   have  the  following   properties   that  make  commercial
production  attractive:  (1) microalgae grow much faster than land grown plants,
often up to 100 times faster;  (2) microalgae have a uniform cell structure with
no bark, stems,  branches or leaves, which permits easier extraction of products
and higher  utilization of the microalgae cells; (3) the cellular  uniformity of
microalgae  makes it practical to manipulate and control  growing  conditions in
order to optimize a particular  cell  characteristic;  (4) microalgae  contain a
wide array of vitamins and other important nutrients; and (5) microalgae contain
natural pigments and are a potential source of medical products.

         Commercial   applications   for  these   microscopic   plants   include
nutritional  products,  diagnostic  products,  aquaculture  feed  and  pigments,
natural food colorings and research grade  chemicals.  The Company believes that
microalgae  could  potentially  be  used  for  other  commercial   applications,
including   genetically   engineered   products   for   the   biopesticide   and
pharmaceutical  industries.  The most significant  microalgae  products produced
today are algae  utilized as food  supplements.  Animal  studies,  published  in
scientific  journals,  suggest  that  increased  dietary  levels  of some of the
natural  compounds  in algae may reduce the risk of cancer  and  strengthen  the
immune system.

         While many unique  compounds have been  identified in  microalgae,  the
efficient  and cost  effective  commercial  production of microalgae is elusive.
Many  microalgae  culture  systems over the last 20 years have  failed.  Because
microalgae produced for food supplements are typically  cultivated and harvested
outdoors,  production is affected  significantly by climate,  weather conditions
and the chemical  composition of the culture media. Without consistent sunlight,
warm temperature,  low rainfall and proper chemical balance, microalgae will not
grow  as  quickly,   resulting  in  longer  harvesting  cycles,  decreased  pond
utilization and increased cost.  Furthermore,  microalgal growth requires a very
nutrient rich  environment.  The high  nutrient  levels in the ponds promote the
growth of unwanted  organisms,  or "weeds," if the chemical  composition  of the
ponds changes from its required balance.  Once contamination occurs, a pond must
be  emptied,  cleaned  and  refilled,  a process  that  further  decreases  pond
utilization and increases production costs.

         Microalgae  producers face  relatively  high  harvesting and processing
costs,  particularly  with  respect  to the  energy  costs  required  to dry the
microalgae  prior to packaging and the labor required  throughout the harvesting
and processing cycles. Once harvested,  microalgal cells contain from 85% to 95%
water which cannot be removed by mechanical  means. We estimate that the cost of
conventional heat-based microalgae drying processes represents approximately 30%
of total  production  cost.  Most drying  systems also damage or destroy  oxygen
sensitive nutrients in the finished microalgae products.


Cyanotech's Technology

         Since  1983, we have designed,  developed and  implemented  proprietary
production and harvesting technologies,  systems and processes which reduce many
of the  stability  and  contamination  problems  frequently  encountered  in the
production of microalgae. This



                                        3

<PAGE>
proprietary  production system is known as Integrated Culture Biology Management
(or "ICBM").  Through the application of this technology,  our Spirulina culture
ponds are in production  year-round without any significant loss in productivity
due to contamination and many of our production ponds, all based in Hawaii, have
been in continuous production since 1988. We believe that such an accomplishment
remains unique to Cyanotech.

         In addition to the advantages of our ICBM technology, we have developed
a patented  system for the  recovery of carbon  dioxide  from our drying  system
exhaust  gas,  called  Ocean-Chill  Drying.  Since  microalgae  are  essentially
microscopic "plants", they require sunlight, water, carbon dioxide and nutrients
for optimal  growth.  By  recovering  carbon  dioxide  that would  otherwise  be
released into the atmosphere, we can divert the recovered carbon dioxide back to
the algae  cultures.  This  process  provides us with another  significant  cost
advantage  over other  microalgae  producers who must purchase  carbon  dioxide.
Moreover,   Ocean-Chill  Drying  dries  microalgal  products  in  a  low  oxygen
environment,  which protects oxygen sensitive  nutrients.  In addition,  we have
developed an  automated  Spirulina  processing  system,  which  enables a single
operator to harvest and dry the Spirulina powder.

         During  the  fourth  quarter  of  fiscal  1997,  we  began   commercial
production  of our  natural  astaxanthin  product,  NatuRose.  The  product  was
produced using our newly developed large-scale photo-bioreactor system, which we
call the PhytoMax Pure Culture  System(TM),  or PhytoMax PCS, which incorporates
closed-culture  technology and allows for the large-scale commercial cultivation
of microalgae  strains that are other- wise highly  susceptible to environmental
contamination.  In addition,  with the PhytoMax PCS we now have the potential to
produce a broader range of new products  from  microalgae.  Such products  could
include   genetically-engineered   biopesticides,   nutraceuticals,   additional
nutritional products, poly-unsaturated fatty acids, anti-microbial agents, plant
growth regulators, and anti-viral compounds.

         Another  major  advantage  for us is  the  location  of our  production
facility at the Hawaii Ocean  Science and  Technology  ("HOST")  Park at Keahole
Point,  Hawaii.  We believe that the combination of consistent warm temperature,
abundant  sunlight,  and low  rainfall  at this  facility  makes  this a  highly
favorable location for the economical, large-scale cultivation of microalgae. In
contrast to our  facility,  microalgae  producers in other areas  lacking  these
favorable characteristics stop producing for up to four months a year because of
less favorable climate or weather conditions.

         At the HOST Park, we have access to cold, clean, deep sea water that is
pumped  from a depth of 2,000  feet.  This sea water is used both as a source of
nutrients  for  microalgae  culture  and as a cooling  agent in the  Ocean-Chill
Drying process.  Additionally,  our facility has access to a complete industrial
infrastructure and is located 30 miles from a deep water port and adjacent to an
international  airport.  We believe that the combination of our ICBM technology,
the new PhytoMax PCS technology,  a favorable  growing  location with year-round
production  capabilities,  the  Ocean-Chill  Drying  process,  and our automated
processing system can be successfully  applied to the commercial  cultivation of
other species of microalgae then those that we are now marketing.


Marketing Strategy

         Our primary  objective is to be the leading  developer  and producer of
microalgal  products in our existing and future markets. We seek to achieve this
objective through the following marketing strategies:





                                        4

<PAGE>
         o Increase the Company's  Spirulina Market Share. We intend to increase
our world market share for  Spirulina  by  expanding  channels of  distribution,
expanding  geographically  and locating  new  potential  markets for  Spirulina.
During fiscal 1997, we expanded our production capacity by 50% and also expanded
our domestic  sales and  marketing  efforts for our Nutrex  products and private
label packaged  products,  with the goal of increasing  world market share.  Our
products are sold in seventeen foreign  countries and we are investigating  ways
to expand the global presence of our products, including through the addition of
foreign  distributors.   We  are  also  investigating  potential  new  uses  for
Spirulina.

         o Promote Brand Uniqueness and Packaged Products. Cyanotech is the only
Hawaiian  producer of Spirulina  and has  developed a unique strain of Spirulina
marketed as "Spirulina  Pacifica." Our private label  customers also promote the
brand uniqueness of Hawaiian  Spirulina,  which we believe provides  competitive
differentiation  in the  marketplace.  Our  plans  include  increased  marketing
emphasis on packaged  products,  which  generally have higher  associated  gross
profit per pound than bulk products.

         o Increase the Company's Natural  Astaxanthin  Market Share.  Being the
first producer of commercial  quantities of natural  astaxanthin from microalgae
gives us a competitive advantage that we intend to build upon. Our customer base
for NatuRose is growing and we currently  supply  customers in six countries and
two industries.  We intend to maintain this leadership position by expanding our
natural  astaxanthin  production  capacity  as  quickly as  indicated  by market
demand.

         o Increase Breadth of Product Offerings.  We are developing and plan to
develop  other new  products  from  microalgae  utilizing  either our  open-pond
technology   or  the   PhytoMax   PCS   technology.   These   products   include
genetically-engineered   biopesticides,    nutraceuticals,   other   nutritional
products,  poly-unsaturated  fatty acids,  anti-microbial  agents,  plant growth
regulators,    and   anti-viral   compounds.   We   are   currently   conducting
laboratory-scale work on a genetically engineered mosquitocide.

         o Continue Improvement Upon Production  Methodologies.  During the past
thirteen years we have continued to improve upon our ICBM proprietary production
system and Ocean-Chill  Drying system.  Recently,  we applied certain aspects of
these  technologies to the  development of the new PhytoMax PCS  technology.  We
intend to apply these to the development of additional microalgae-based products
for the biopesticide,  food coloring,  fine chemical and nutrition  markets,  as
well as other potential commercial uses.

         o Promote Environmental Responsibility.  We have a strong commitment to
the environment. Our Ocean-Chill Drying system recovers approximately 96% of the
carbon dioxide from our drying system exhaust gas, the ICBM technology allows us
to recycle 100% of the growing media,  and the entire facility  operates without
the use of  pesticides  or  herbicides.  Our  production  system does not create
erosion, fertilizer runoff or water pollution.


Products

Spirulina

         Our principal product,  accounting for 98% of net sales in the 1996 and
1997 fiscal years, is a nutritional  microalgae  marketed as Spirulina Pacifica.
Developed  by us and sold  worldwide  to the health and  natural  foods  market,
Spirulina  Pacifica is unique strain of microalgae  that is a highly  absorbable
source of natural beta carotene,  mixed carotenoids,  B vitamins,  GLA, protein,
essential  amino  acids and other  phytonutrients.  We  believe  that  Spirulina
Pacifica has greater  concentrations of natural beta carotene,  better taste and
more consistent color than



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<PAGE>
competing Spirulina products. We were the first Spirulina producer to have their
products and processes certified organic and we are the only microalgae producer
to have their quality system registered under the ISO 9002-94 standards.

         Spirulina  is a naturally  occurring  microscopic  plant which has been
used for  thousands of years as a food.  Today,  Spirulina is used by the health
conscious  consumer for a variety of immediate and long term effects.  Spirulina
is  a  good  source  of  natural   phytonutrients,   including  carotenoids  and
phycocyanin,  among others.  Published  scientific  animal studies  suggest that
increased  levels of some of these natural  compounds in the diet may reduce the
risk of cancer and strengthen the immune system.

         We  produce  Spirulina  Pacifica  in  three  forms:  powder,  flake and
tablets.  Powder is used as an ingredient in health food drinks while flakes are
used  as a seasoning  on various foods.   Tablets  are  consumed daily as a food
supplement.

         We also  produce and market two products  under the Hawaiian  Energizer
name.  Hawaiian  Energizer  sports  drink  contains  complex  carbohydrates  and
vegetarian  protein  in  combination  with  Spirulina  Pacifica,  Bee Pollen and
Siberian Ginseng.  Hawaiian  Energizer tablets contain Spirulina  Pacifica,  Bee
Pollen and Siberian Ginseng.

         We  anticipate  that  sales of our  Spirulina  Pacifica  products  will
continue to constitute a substantial portion of net sales during fiscal 1998. We
increased our production  capacity of Spirulina  products by  approximately  50%
during 1996 by  constructing  more  Spirulina  ponds and expanding our Spirulina
processing  facilities.  While we intend to make every effort to sell the output
from the recently  expanded  facility,  we cannot provide any assurance that the
market for Spirulina products in general,  or our Spirulina Pacifica products in
particular,  will  support the  increased  output from the 1996  expansion.  Any
decrease in the  overall  level of sales of, or the prices  for,  our  Spirulina
Pacifica  products,  whether  as a result of  competition,  change  in  consumer
demand, increased worldwide supply of Spirulina or any other factors, would have
a material  adverse effect on our business,  financial  condition and results of
operations.

Natural Astaxanthin

         Astaxanthin is a red pigment used primarily in the aquaculture industry
to impart pink color to the flesh of  pen-raised  fish and shrimp.  For example,
without  astaxanthin  in its diet,  the flesh of a  pen-raised  salmon is white,
reducing its commercial  value by as much as half.  Wild or free swimming salmon
and shrimp  acquire  their pink flesh or shells in nature  from  eating  natural
astaxanthin  contained in  microalgae  or from eating other fish that have eaten
the microalgae.  Farm-raised salmon and shrimp,  however,  can only acquire pink
flesh or shells from the addition of astaxanthin to their feed.

         The  astaxanthin  market  currently is dominated by a single  producer,
Hoffmann-LaRoche,   who  produces  synthetic  astaxanthin  from  petrochemicals.
Hoffmann-LaRoche  currently  sells  synthetic  astaxanthin  to  the  aquaculture
industry at  approximately  $2,500 per pure  kilogram.  As a result of continued
growth in the world  aquaculture  industry,  the world market for astaxanthin is
estimated to currently exceed $150 million per year.

         During  the  fourth  quarter  of  fiscal  1997,  we  began   commercial
production  of our  natural  astaxanthin  product,  NatuRose.  The  product  was
introduced to the aquaculture  industry at the World  Aquaculture '97 Conference
in Seattle, Washington at the end of February, 1997. We currently have customers
in six countries who use the product and we anticipate that these customers will
purchase our entire NatuRose production output during fiscal 1998.





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<PAGE>
Phycobiliproteins

         We also  produce  phycobiliproteins  which are sold to the  medical and
biotechnology  research  industry.   Phycobiliproteins  are  highly  fluorescent
pigments purified from microalgae. Their spectral properties make them useful as
tags or markers  in many kinds of  biological  assays,  such as flow  cytometry,
fluorescence    immunoassays    and    fluorescence    microscopy.    Sales   of
phycobiliproteins  accounted  for less than 2% of our net  sales for the  fiscal
year ended March 31, 1997. We anticipate  that sales of  phycobiliproteins  will
not be material in future periods.


Product Under Development

         A new product  which is currently  under  development  is a genetically
engineered   mosquitocide   from   microalgae.   This   genetically   engineered
mosquitocide  is being  developed  under license from the University of Memphis.
The toxin gene from Bacillus thuringiensis var. israelensis (Bti) is cloned into
the blue-green algae Synechococcus.  The bacterial toxin of Bti is very specific
to mosquitoes and black flies, while the blue-green algae is a food for mosquito
larvae. We believe that when applied to a mosquito-infested  body of water, this
algae  could act as an  effective  and  environmentally  safe means of  control.
Development  of this  product is  continuing  and there is no  assurance  that a
commercial  product will be achieved.  Our inability to successfully  develop or
commercialize  additional  products could have a material  adverse effect on our
business, financial condition and results of operations.


Research & Development

         Cyanotech's  expertise is in the  development of efficient,  stable and
cost-effective  production  systems for  microalgal  products.  Our  researchers
investigate  specific  microalgae   identified  in  scientific   literature  for
potentially  marketable  products and then develop the  technology  to grow such
microalgae on a commercial scale.


Distribution

         The majority of our bulk  Spirulina  sales are to companies  with their
own  Spirulina  product  lines.  Many of these  companies  identify  and promote
Cyanotech's Hawaiian Spirulina in their products.  In the United States, we sell
directly to health food  manufacturers  and health  food  formulators.  Packaged
consumer products sell in the domestic market through an established health food
distribution  network.  Orders for packaged  consumer  products are taken at the
store level by one of 52 regional broker representatives and shipped through one
of 25 distributors.  In selected foreign  markets,  we have appointed  exclusive
sales distributors for both bulk Spirulina and packaged consumer products.

         In the years ended March 31, 1997, 1996 and 1995,  international  sales
accounted for approximately 62%, 55% and 42%, respectively, of our net sales. We
expect that international sales will continue to represent a significant portion
of our net sales.  Our business,  financial  condition and results of operations
may be  materially  adversely  affected  by  any  difficulties  associated  with
managing accounts receivable from international  customers,  tariff regulations,
imposition of governmental controls, political and economic instability or other
trade restrictions.  Although our international sales are currently  denominated
in United States dollars,  fluctuations  in currency  exchange rates could cause
our products to become  relatively  more  expensive to customers in the affected
country, leading to a reduction in sales in that country.



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<PAGE>
Additionally, our largest customer, a distributor located in Hong Kong (which on
July 1, 1997  becomes a part of  China)  resells  our  products  principally  in
mainland  China,  and thus we become exposed to political,  legal,  economic and
other risks and uncertainties associated with doing business in China.


Customers

Spirulina

         We market and sell our  Spirulina  products to a variety of  customers,
which range in size from $500 million in annual  sales to small  retail  stores.
Several of our major customers are businesses that were established  exclusively
to market and sell Spirulina products.

         Approximately  47%, 49% and 32% of  Cyanotech's  net sales in the years
ended March 31, 1997,  1996 and 1995,  respectively,  were derived from sales to
our top three  customers  during those  periods.  Although we sell to almost 300
customers,  our largest customer, Life Foundate, Ltd., a Hong Kong-based natural
products  marketing and distribution  company,  accounted for approximately 34%,
29% and 3% of our net sales in the years  ended March 31,  1997,  1996 and 1995,
respectively.  This  unaffiliated  company  purchases  both  bulk  products  and
packaged  consumer  products  from us and  sells  them  under a  private  label,
principally in mainland China. Hong Kong, where our largest customer is located,
reverts to China on July 1, 1997,  with  possible  unpredictable  effects on our
business with such customer.  The loss of, or significant adverse change in, the
relationship  between  Cyanotech  and its  largest  customer  or any other major
customer  would  have a  material  adverse  effect  on the  Company's  business,
financial condition and results of operations.

          Health  Food  Manufacturers.   Health  food  manufacturers  often  use
Cyanotech's  Spirulina  products as a key  ingredient  in their  Spirulina-based
products, or as an ingredient in their health food formulations. These customers
purchase bulk powder or bulk tablets and package the products  under their brand
label for sale to the health and  natural  food  markets.  Many of the  products
produced by these  customers are often  marketed and sold in direct  competition
with our Nutrex line of retail consumer products.  However, we differentiate our
Nutrex  products  from those of our bulk  customers by reserving  the  certified
organic line of products for sale  exclusively  under our Nutrex label and a few
private labels.

         Private  Label  Customers.  We currently  provide  private label retail
consumer  products to two private label  international  customers.  Products for
these customers are  manufactured  only upon receipt of an order and no finished
product inventories are maintained.

         Retail Distributors.  Retail distributors act as product wholesalers to
independent  and chain  retailers.  The majority of domestic Nutrex sales in the
year ended March 31, 1997 were to 25 distributors.

         Natural  Products  Distributors.  In the year ended March 31, 1997,  we
sold bulk Spirulina  products to seven domestic and one foreign customer engaged
in the business of distributing natural raw materials to health and natural food
manufacturers.  These  distributors  provide their  customers with  standardized
quality control,  warehousing and distribution services, and charge a mark-up on
the products for providing these services.  These distributors may differentiate
the products they sell,  but they generally  treat the products as  commodities,
with price being the major determining factor in their purchasing decision.






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<PAGE>
Natural Astaxanthin

         Our  NatuRose   product  is  being  sold   directly  to  end-users  and
distributors  in six  countries for use in two  industries.  We believe that our
customer base and geographic  distribution should increase as additional natural
astaxanthin production capacity is added.


Competition

Spirulina

         Our  Spirulina  Pacifica  products  compete with a variety of vitamins,
dietary  supplements,  other algal  products  and similar  nutritional  products
available to consumers.  The nutritional  products market is highly competitive.
It  includes   international,   national,   regional  and  local  producers  and
distributors,  many of whom have greater  resources than Cyanotech,  and many of
whom  offer a  greater  variety  of  products.  Our  direct  competition  in the
Spirulina market currently is from Dainippon Ink and Chemical Company's facility
in California and several farms in China.  To a lesser  extent,  we compete with
numerous  smaller farms in India,  Thailand,  Brazil and South Africa.  Packaged
consumer  products  marketed  under our Nutrex brand also compete with  products
marketed by health food  manufacturing  customers of Cyanotech who purchase bulk
Spirulina  from us and  package it for retail  sales.  Spirulina  Pacifica  also
competes in certain markets with other "green  superfoods," such as Chlorella (a
green  microalgae  with sales primarily in Japan),  Aphamizomenon  flos-aquae (a
blue-green  algae harvested from a eutrophic lake in Oregon with sales primarily
through  multilevel  marketing)  and cereal  grasses  such as barley,  wheat and
kamut. A decision by another company to focus on Cyanotech's  existing or target
markets or a substantial  increase in the overall supply of Spirulina could have
a material  adverse effect on our business,  financial  condition and results of
operations. While we believe that our products compete favorably on factors such
as quality,  brand name recognition and loyalty, our Spirulina Pacifica products
have typically been sold at prices higher than other Spirulina  products.  There
can  be  no  assurance  that  we  will  not  experience   competitive  pressure,
particularly with respect to pricing,  that could adversely affect our business,
financial condition and results of operations.

Natural Astaxanthin

         Our natural astaxanthin product,  NatuRose,  will compete directly with
the  synthetic   astaxanthin   product   produced  and  marketed   worldwide  by
Hoffmann-LaRoche.  In addition,  several other companies have announced plans to
produce natural  astaxanthin  from microalgae or are producing small  quantities
for test  purposes.  Although  we are  unaware of any  studies  indicating  that
natural  astaxanthin  has any  benefits  not  otherwise  provided  by  synthetic
astaxanthin,  we believe  there is commercial  demand for a natural  astaxanthin
product  and that our  NatuRose  product  can  compete  on the basis of  product
performance and price.

Phycobiliproteins

         There are four major  competitors  which  manufacture  phycobiliprotein
products for sale,  including  Molecular  Probes,  Inc.,  Quantify Inc.,  Martek
Biosciences Corporation and Prozyme Inc. Cyanotech competes with these companies
on the basis of price and quality. New synthetic fluorescent compounds have been
developed  by a third party  which are  superior  to  phycobiliproteins  in some
applications.  The advantage of the synthetic compounds is their lower molecular
weight and, in some cases, their lower cost. While our phycobiliprotein products
may



                                        9

<PAGE>
not  be  able  to  compete  effectively  against  synthetic  compounds  in  some
applications,  Cyanotech's  phycobiliproteins  have gained a reputation for high
quality at a competitive price.


Government Regulation

         Cyanotech's  products,  potential  products and its  manufacturing  and
research  activities are subject to varying degrees of regulation by a number of
government  authorities in the United States and in other  countries,  including
the Food and Drug  Administration (the "FDA") pursuant to the Federal Food, Drug
and Cosmetic Act and by the  Environmental  Protection  Agency ("EPA") under the
Federal  Insecticide,   Fungicide,   and  Rodenticide  Act  ("FIFRA").  The  FDA
regulates, to varying degrees and in different ways, dietary supplements,  other
food products, diagnostic medical devices and pharmaceutical products, including
their  manufacture,   testing,  exportation,   labeling,  and,  in  some  cases,
advertising.  Generally,  prescription  pharmaceuticals  and  certain  types  of
diagnostic products, such as medical devices, are regulated more rigorously than
dietary supplements.  The EPA rigorously regulates pesticides, among other types
of products.

         Cyanotech is also  subject to other  federal,  state and foreign  laws,
regulations  and policies with respect to labeling of its products,  importation
of organisms,  and occupational safety, among others. Federal, state and foreign
laws,  regulations  and policies are always subject to change and depend heavily
on   administrative   policies  and   interpretations.   We  work  with  foreign
distributors  to ensure  our  compliance  with  foreign  laws,  regulations  and
policies.  There can be no  assurance  that any changes with respect to federal,
state and foreign laws, regulations and policies, and, particularly with respect
to the FDA and EPA or other such regulatory  bodies,  with possible  retroactive
effect,  will not have a  material  adverse  effect on our  business,  financial
condition and results of  operations.  There can be no assurance that any of our
potential products will satisfy applicable regulatory requirements.

         The Federal  Dietary  Supplement  Health and  Education  Act  ("DSHEA")
regulates  the use and  marketing  of  dietary  supplements,  including  vitamin
products.  The DSHEA  covers only dietary  supplements  and contains a number of
provisions that  differentiate  dietary  supplements from other foods. The DSHEA
also sets forth standards for adulteration of dietary supplements or ingredients
thereof and  establishes  current  food Good  Manufacturing  Practices  ("cGMP")
requirements for dietary supplements. It also provides detailed requirements for
the  labeling  of  dietary  supplements,   including  nutrition  and  ingredient
labeling.  We  currently  believe  that our  Spirulina  Pacifica,  marketed as a
dietary supplement, is exempt from FDA regulation as a food additive.

         Our Spirulina  manufacturing  processes  and our contract  bottlers are
required  to adhere to cGMP as  prescribed  by the FDA.  We believe  that we are
currently in compliance  with all  applicable  cGMP and other food  regulations.
Compliance  with relevant cGMP  requirements  can be onerous and time consuming,
and there can be no assurance  that  Cyanotech can continue to meet relevant FDA
manufacturing  requirements for existing  products or meet such requirements for
any future  products.  Ongoing  compliance  with food cGMP and other  applicable
regulatory  requirements are monitored through periodic inspections by state and
federal  agencies,  including  the FDA,  the  Hawaii  Department  of Health  and
comparable  agencies  in  other  countries.  Our  processing  facility  is  also
inspected annually for organic certification by Quality Assurance  International
and for Kosher  certification  by the Kosher Overseers  Association.  The use of
Spirulina as a food  additive for seasoning on salads or pasta or for such other
food uses has not been cleared by the FDA. We  currently  market the product for
these  food  uses  on the  basis  of our  belief  that  its  use in  these  food
applications is generally recognized as safe and therefore is not subject to FDA
pre-market clearances as a food additive.




                                       10

<PAGE>
         Our natural astaxanthin product,  NatuRose, will need FDA clearance for
use as a feed color additive in the United States. We believe that no regulatory
approval  is  required  for use of  NatuRose  as a colorant in feeds or foods in
major markets outside the United States. The process of obtaining clearances for
a new color additive is expensive and time consuming.  Extensive  information is
required on the toxicity of the additive,  including carcinogenicity studies and
other  animal  testing.  No  assurances  can be given  that any of our  proposed
products  intended for use as a feed  additive  will be approved by the FDA on a
timely basis, if at all.

         As in vitro  diagnostic  medical  device  components,  phycobiliprotein
products do not currently require pre-market  clearances by the FDA. However, as
a component of a medical device,  they can nonetheless still be subject to other
various medical device requirements, including cGMP requirements.


Patents, Licenses and Trademarks

         Although  we  regard  our   proprietary   technology,   trade  secrets,
trademarks and similar intellectual property as critical to our success, we rely
on a combination of trade secret, contract,  patent, copyright and trademark law
to establish and protect our rights in our products and technology. There can be
no assurance that we will be able to protect our  technology  adequately or that
competitors  will not be able to develop similar  technology  independently.  In
addition,  the laws of certain  foreign  countries may not protect the Company's
intellectual  property  rights  to the same  extent  as the  laws of the  United
States.  Cyanotech has had one United States patent issued to it.  Litigation in
the United  States or abroad  may be  necessary  to enforce  our patent or other
intellectual  property  rights,  to protect our trade secrets,  to determine the
validity  and scope of the  proprietary  rights  of others or to defend  against
claims of  infringement.  Such litigation,  even if successful,  could result in
substantial  costs and diversion of resources and could have a material  adverse
effect  on  our  business,   results  of  operations  and  financial  condition.
Additionally,  although  currently  there are no pending claims or lawsuits that
have been brought against us, if any such claims are asserted against us, we may
seek to obtain a license under the third party's  intellectual  property rights.
There can be no assurance,  however,  that a license would be available on terms
acceptable or favorable to us, if at all.


Associates

         Cyanotech  employed 78 associates as of March 31, 1997, of which 74 are
full-time.  Approximately  31  associates  are  involved in the  harvesting  and
production process, 10 are involved in research and product development, and the
remainder are involved in sales, administration and support. Management believes
that its  relations  with  its  associates  are  good.  We have not  experienced
difficulty in attracting personnel and none of our associates are represented by
a labor union.

         Effective  April 1, 1995,  Cyanotech  implemented a profit sharing plan
for all associates not covered under a separate management incentive plan. Under
the profit  sharing  plan, 5% of pre-tax  profits are  allocated  based on gross
wages to non-management  associates on a quarterly basis.  Fifty percent of each
associate's  profit sharing bonus is distributed in cash on an after-tax  basis,
the remainder is deposited in each associate's 401(k) account on a pre-tax basis
with a six year vesting schedule, based on years of service with the Company.

         Cyanotech's  success depends to a significant extent upon the continued
service of Dr. Gerald R. Cysewski,  its President and Chief  Executive  Officer,
and other members of the Company's executive management. The loss of any of such
key executives could have a material  adverse effect on our business,  financial
condition or results of operations. Furthermore, our



                                       11

<PAGE>
future  performance  depends on our ability to identify,  recruit and retain key
management  personnel.  The competition for such personnel is intense, and there
can be no assurance  that we will be  successful  in such  efforts.  We are also
dependent on our ability to continue to attract, retain and motivate production,
distribution, sales and other personnel, of which there can be no assurance. The
failure  to attract  and retain  such  personnel  could have a material  adverse
effect on our business, financial condition and results of operations.


Item 2. Description of Properties

         Cyanotech  Corporation is located in Kailua-Kona,  Hawaii,  at the HOST
Park and also owns a 2,500 square foot sales office in a light  industrial  area
located  approximately  four miles from the HOST  Park.  The HOST Park  facility
consists  of  approximately  90 leased  acres  containing  production  ponds,  a
processing facility, a laboratory,  administrative  offices and additional space
for production  ponds. All products are produced at this facility.  The property
is leased from the State of Hawaii under a 30-year  commercial lease expiring in
2025.  During 1997, we reached an agreement with the State of Hawaii to lease an
additional  88 acres at the HOST Park,  which will  increase  the total  acreage
under lease to 178 acres. We plan to use this new property to construct a larger
NatuRose  production  facility and  additional  culture ponds that would use the
PhytoMax PCS technology.  We believe that there is sufficient  available land at
the HOST Park to meet our  currently  planned  future  needs.  Our Nutrex,  Inc.
subsidiary  maintains  sales  offices in  Kailua-Kona,  Hawaii  and  Burlingame,
California.



Item 3. Legal Proceedings

         Cyanotech  is not  currently  subject  to any  material  pending  legal
proceedings.

         We maintain product liability insurance in limited amounts for products
involving  human  consumption.  In the opinion of  management,  broader  product
liability insurance coverage is prohibitively expensive at this time.


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

         No matters  were  submitted  to a vote of the  stockholders  during the
fourth quarter of fiscal 1997.





                                       12

<PAGE>
                                     Part II


Item 5. Market for Common Equity and Related Stockholder Matters

         Until  February  17, 1996,  Cyanotech's  Common Stock was quoted on The
Nasdaq  SmallCap  Market.  On that date,  our Common Stock began  trading on the
Nasdaq  National  Market under the symbol "CYAN." The following table sets forth
the high and low bid  quotation  per  share of our  Common  Stock on The  Nasdaq
SmallCap  Market and the  Nasdaq  National  Market,  as the case may be, for the
periods  indicated.  Quotations  from The  Nasdaq  SmallCap  Market are from the
Nasdaq Monthly  Statistical  Summary Report,  and reflect  inter-dealer  prices,
without retail mark-up or commission, and may not represent actual transactions.
<TABLE>
<CAPTION>

Three Months Ended                    High       Low          High       Low
------------------                  -------    --------     -------    ------
<S>                                 <C>        <C>          <C>        <C>
June 30, 1996 and 1995...........   $ 9-1/8    $ 6-1/4      $ 3-3/8    $ 1-1/8

September 30, 1996 and 1995...      $ 8-1/8    $ 5-5/16     $ 6-5/8    $ 2-11/16

December 31, 1996 and 1995...       $ 7-3/8    $ 5-1/8      $ 14-7/8   $ 5-1/8

March 31, 1997 and 1996........     $ 8-1/8    $ 5-1/2      $ 11-3/8   $ 6-1/4
</TABLE>

         Cyanotech  has never  declared  or paid cash  dividends  on its  Common
Stock.  Holders of Series C Preferred  Stock are entitled to  cumulative  annual
dividends  at the rate of $.40 per  share if and when  declared  by the Board of
Directors. Cyanotech may not pay dividends on the Common Stock until it has paid
accumulated  dividends on the Series C Preferred Stock.  Cumulative dividends in
arrears  on the  Series C  Preferred  Stock as of March  31,  1997  amounted  to
$2,251,000 ($3.063 per share). We currently intend to retain all of our earnings
for use in the  business  and do not  anticipate  paying any cash  dividends  on
Series C Preferred Stock or Common Stock in the foreseeable future.

         The approximate number of record holders of outstanding Common Stock as
of June 17, 1997 was 1,450.




                                       13

<PAGE>
Item 6. Selected Financial Data
(in thousands, except earnings per share)
<TABLE>
<CAPTION>
                                               Years ended March 31,
                                  ----------------------------------------------
                                    1997     1996     1995     1994     1993 (a)
                                  -------  -------  -------  -------  -------
<S>                               <C>      <C>      <C>      <C>      <C> 
Net Sales                         $11,399  $ 8,081  $ 4,150  $ 2,697  $ 2,485
Income from Operations              3,751    2,571      718      220      131
Net Income                          4,159    2,509      769      204      255
Net Income per Common Share         $0.25    $0.17    $0.05    $0.02    $0.03

Cash and Investment Securities     $6,729   $9,409  $   496  $   866  $   107

Total Assets                       26,015   19,716    6,212    5,132    2,677
Long-term Debt and
   Capital Lease Obligations          559      838      184      109      425
Stockholders' Equity              $23,335  $17,316   $5,104   $4,160  $ 1,521

Average Shares Outstanding         16,598   14,548   13,589   13,330    9,159
</TABLE>
(a) The  Company  changed  its fiscal  year end from  December  31, to March 31,
effective  April 1, 1993.  Accordingly,  the 1993  information is for the period
January 1, 1992 through December 31, 1992.

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

Overview

         This report on Form 10-K contains forward-looking  statements regarding
the future  performance  of  Cyanotech  and future  events that involve risk and
uncertainties  that could cause  actual  results to differ  materially  from the
statements contained herein. This document, and the other documents that we file
from time to time  with the  Securities  and  Exchange  Commission,  such as our
reports on Form 10-K,  Form 10-Q,  Form 8-K,  and our proxy  materials,  contain
additional  important factors that could cause actual results to differ from our
current expectations and the forward-looking statements contained herein.

         All references to years in this Item 7 are to fiscal years.

         During 1997,  substantially  all of our resources were dedicated to the
production of Spirulina Pacifica,  a nutritional  microalgae.  We sell Spirulina
Pacifica  to health food  manufacturers,  health  food  distributors  and retail
consumers  on a worldwide  basis.  Through  the  application  of our  Integrated
Culture Biology Management  ("ICBM")  technology,  we maintain  continuous algae
cultures  and  produce  a new  crop  from  each of our 67  algal  culture  ponds
(aggregating approximately 60 acres) approximately every week, on average.

         Historically,  the  majority  of our net sales have been  derived  from
sales of bulk Spirulina  Pacifica  products,  which have lower  associated gross
profit  (measured in dollars) but higher  associated gross margin (measured as a
percentage of net sales) than our packaged consumer  products.  Accordingly,  an
increase in the  percentage of net sales  attributable  to bulk  products  would
increase  gross margin.  Conversely,  an increase in the percentage of net sales
attributable  to packaged  consumer  products  would  decrease  gross margin but
likely  increase  gross  profit.  We expect  that the product mix will vary from
period to period,  and a decrease in orders from a customer  such as our largest
current  customer which purchases  primarily  packaged  consumer  products could
require us to reallocate  greater  portions of our production  capacity to lower
gross profit bulk products.



                                       14

<PAGE>
         During the second half of 1997, we began limited commercial  production
of our natural  astaxanthin  product,  NatuRose,  and commenced full  commercial
production in March, 1997. Also in March 1997, we announced that we had received
approval  from the  State of  Hawaii  to lease an  additional  88 acres  for the
purpose of expanding NatuRose production  capacity.  Expansion onto the 88 acres
is currently planned to be accomplished in three increments; the first increment
is planned to include 13 acres of culture systems,  together with harvesting and
processing  equipment  sufficient to accommodate the entire site.  Completion of
the first phase is planned for June 1998.

         Since 1992, we have experienced  substantial growth in our revenues and
operations,  and have  undergone  substantial  changes in our business that have
placed significant demands on the management,  working capital and financial and
management control systems of Cyanotech.  Our current and future expansion plans
may also place a  significant  strain on the  management,  working  capital  and
financial control systems of Cyanotech. Although we believe that our systems and
controls  are adequate to address our current  needs,  there can be no assurance
that such  systems  will be adequate to address  our future  business  expansion
plans.  Our results of operations will be adversely  affected if revenues do not
increase  sufficiently  to  compensate  for the increase in  operating  expenses
resulting  from any expansion  and there can be no assurance  that any expansion
will be  profitable  or that  it  will  not  adversely  affect  our  results  of
operations.  In addition,  the success of any current or future  expansion plans
will  depend in part upon our  ability to  continue  to  improve  and expand our
management and financial  control systems,  to attract,  retain and motivate key
personnel,  and to raise additional required capital.  There can be no assurance
that we will be successful in such respects.

Results of Operations

         The following table sets forth certain consolidated statement of income
data as a percentage of net sales for the periods indicated:
<TABLE>
<CAPTION>
                                                   Year Ended March 31,
                                                    1997         1996
                                                   ------       ------
<S>                                                <C>          <C>    
Net sales.....................................     100.0%       100.0%
   Cost of sales..............................      40.3         43.5
                                                   ------       ------
Gross profit..................................      59.7         56.5
                                                   ------       ------
Operating expenses:
   Research and development...................       5.1          4.4
   General and administrative.................      12.6         14.8
   Sales and marketing........................       9.1          5.5
                                                   ------       ------
      Total operating expenses................      26.8         24.7
                                                   ------       ------
      Income from operations..................      32.9         31.8
                                                   ------       ------
Other income (expense):
   Interest income............................       3.9          0.3
   Interest expense...........................      (0.4)        (1.1)
   Other income, net..........................       0.1           -
                                                   ------       ------
      Total other income (expense)............       3.6         (0.8)
                                                   ------       ------
      Net income..............................      36.5%        31.0%
                                                   ------       ------
                                                   ------       ------
</TABLE>
                                       15

<PAGE>
Fiscal 1997 Compared to Fiscal 1996

Net Sales

         Net sales for the year ended March 31, 1997 were  $11,399,000,  a 41.1%
increase  over net sales of  $8,081,000  for the year ended March 31, 1996.  The
increase in net sales  during the year ended March 31, 1997 is  attributable  to
significantly  higher  production and sales of bulk Spirulina powder and tablets
and increased  sales of packaged  consumer  products  which carry a higher sales
price than bulk Spirulina  Pacifica  products.  The increased  production is the
result of Spirulina  production  expansions  that were completed in February and
November 1996.

         International  sales represented 62% and 55% of total net sales for the
years ended March 31, 1997 and 1996,  respectively.  This increase  reflects the
Company's  continuing  emphasis on developing  international  markets and higher
sales of packaged  consumer  products into Asian retail  markets.  The Company's
largest customer,  a Hong Kong-based natural products marketing and distribution
company, accounted for approximately 34% and 29% of Cyanotech's net sales in the
years ended March 31, 1997 and 1996,  respectively.  Hong Kong becomes a part of
China  on July 1,  1997  with  possible  unpredictable  effects  on  Cyanotech's
business  with  such  customer.  Loss  of,  or a  significant  decrease  in such
business,  would  have a  material  adverse  effect on our  business,  financial
condition and results of operations.

Gross Profit

         Gross profit  represents  net sales less the cost of goods sold,  which
includes  the cost of  materials,  manufacturing  overhead  costs,  direct labor
expenses and depreciation and  amortization.  Gross profit increased to 59.7% of
net sales for the year ended March 31, 1997 from 56.5% of net sales for the year
ended  March 31,  1996.  The  increase  in gross  profit  from the prior year is
primarily  attributable  to economies of scale related to the production of both
bulk and packaged consumer Spirulina Pacifica products, but was partially offset
by lower average selling prices for bulk products.

Operating Expenses

         Operating  expenses increased by $1,066,000 and were 26.8% of net sales
for the year ended March 31, 1997, against 24.7% of net sales for the year ended
March 31, 1996, with significant increases in all three components.

         Research  and  Development.  Expenditures  for research and development
increased 67.2% to $587,000,  or 5.1% of net sales, for the year ended March 31,
1997,  from $351,000,  or 4.4% of net sales,  for the year ended March 31, 1996.
The increase from the prior year is primarily the result of the development work
done on the  natural  astaxanthin  product  and the  research  work  done on the
mosquitocide  product.  Research and development  costs are expected to increase
further  during  fiscal  1998  as we  continue  to  optimize  the  PhytoMax  PCS
technology   and  also  increase  the  research   activities   directed  at  the
mosquitocide product.

         General  and  Administrative.   General  and  administrative   expenses
increased 20.2% to $1,437,000,  or 12.6% of net sales,  for the year ended March
31, 1997, from  $1,196,000,  or 14.8% of net sales, for the year ended March 31,
1996. The increase is due to higher staff-related  expenditures,  the accrual of
associate  incentive bonuses indexed to the Company's  profitability  during the
year ended March 31, 1997, and higher insurance costs.

         Sales and Marketing.  Sales and marketing  expenses increased 132.4% to
$1,034,000,  or 9.1% of net  sales,  for the year  ended  March 31,  1997,  from
$445,000,  or 5.5% of net sales, for the year ended March 31, 1996. The increase
from the prior year is primarily due to higher staff-related  expenditures,  and
increased domestic and international marketing efforts associated



                                       16

<PAGE>
with higher sales of packaged consumer products and with the introduction of the
NatuRose product.

Other Income (Expense)

         Other income increased to $408,000,  or 3.6% of net sales, for the year
ended March 31, 1997, from other expense of $62,000, or (0.8%) of net sales, for
the year ended March 31,  1996.  The  increase  from the prior year is primarily
related to increased earnings on larger cash and investment securities balances.

Net Income

         Net income increased to $4,159,000, or 36.5% of net sales, for the year
ended March 31, 1997, from $2,509,000, or 31.0% of net sales, for the year ended
March 31,  1996.  The  increase in net income is primarily a result of increased
production and sales of bulk and packaged consumer Spirulina Pacifica products.


Fiscal 1996 Compared to Fiscal 1995

Net Sales

         Net sales for the year  ended  March 31,  1996 were  $8,081,000,  a 95%
increase  over net sales of  $4,150,000  for the year ended March 31, 1995.  The
increase in net sales during the year ended March 31, 1996 was  attributable  to
price  increases,  significantly  higher  production and sales of bulk Spirulina
powder and tablets and increased sales of packaged consumer products which carry
a higher  sales  price than bulk  Spirulina  Pacifica  products.  The  increased
production is the result of Spirulina production  expansions that were completed
in May, September and December of 1995 and February of 1996.

         International  sales represented 55% and 42% of total net sales for the
years ended March 31, 1996 and 1995,  respectively.  This increase reflected our
increased  emphasis on  developing  international  markets  and higher  sales of
packaged  consumer products into Asian retail markets.  Our largest customer,  a
Hong Kong-based natural products marketing and distribution  company,  accounted
for  approximately  29% and 3% of Cyanotech's net sales in the years ended March
31, 1996 and 1995, respectively.

Gross Profit

         Gross profit  represents  net sales less the cost of goods sold,  which
includes  the cost of  materials,  manufacturing  overhead  costs,  direct labor
expenses and depreciation and  amortization.  Gross profit increased to 56.5% of
net sales for the year ended March 31, 1996 from 45.2% of net sales for the year
ended March 31, 1995.  The increase in gross profit was  attributable  to higher
prices  and  higher  production  levels  resulting  in the  absorption  of fixed
manufacturing overhead costs over a significantly  increased sales volume during
the fiscal year.

Operating Expenses

         Operating  expenses  decreased to 24.7% of net sales for the year ended
March 31, 1996,  from 27.9% of net sales for the year ended March 31, 1995.  Its
components were:




                                       17

<PAGE>
         Research and  Development.  Expenditures  for research and  development
increased to 4.4% of net sales for the year ended March 31,  1996,  from 4.1% of
net sales for the year ended March 31, 1995.  The  increase  from the prior year
was  primarily  the result of the  research  work done on beta  carotene for the
joint venture partnership with Hauser Chemical Research, Inc.
and on the natural astaxanthin product.

         General  and  Administrative.   General  and  administrative   expenses
decreased to 14.8% of net sales for the year ended March 31, 1996, from 16.5% of
net sales for the year ended March 31, 1995.  The  increase in absolute  dollars
was due to the accrual of associate  incentive  bonuses indexed to the Company's
profitability  during the year ended March 31, 1996, higher insurance costs, and
compensation  expense  associated  with grants of Common  Stock to  non-employee
directors.

         Sales and  Marketing.  Sales and  marketing  expenses  increased 48% to
$445,000,  or 5.5% of net  sales,  for the  year  ended  March  31,  1996,  from
$301,000,  or 7.3% of net sales, for the year ended March 31, 1995. The increase
in absolute dollars from the prior year was primarily due to expenses related to
increasing domestic and international marketing efforts and higher staff-related
expenditures.


Proportionate Share of Loss of Joint Venture

          Proportionate  share of loss of joint venture represents the Company's
50%  ownership  interest  in a  joint  venture  with  Aquasearch,  Inc.  for the
development of astaxanthin. The loss in the year ended March 31, 1995 represents
services,  and  facilities  and equipment use that was  contributed to the joint
venture by  Cyanotech.  The joint  venture was  terminated  in November  1994 by
mutual consent and the Company has no further obligation under the joint venture
arrangement.

Net Income

         Net income increased to $2,509,000, or 31.0% of net sales, for the year
ended March 31, 1996, from $769,000,  or 18.5% of net sales,  for the year ended
March 31, 1995.  The increase in net income was  primarily a result of increased
production and sales of bulk and packaged consumer Spirulina Pacifica products.

         Inflation  during the years ended March 31, 1997, 1996 and 1995 did not
have a material impact on the Company's operations.

Variability of Results

         Cyanotech  Corporation was formed in 1983 and did not become profitable
on an annual basis until fiscal 1992 (the twelve month period ended December 31,
1992). As of March 31, 1997, our accumulated deficit was $461,000.  There can be
no assurance that we will be consistently profitable on either a quarterly or an
annual basis. We have experienced  quarterly  fluctuations in operating  results
and anticipate that these  fluctuations  may continue in future periods.  Future
operating  results may  fluctuate  as a result of changes in sales levels to our
largest customers, new product introductions,  weather patterns, the mix between
sales of bulk products and packaged consumer products, start-up costs associated
with new facilities, expansion into new markets, sales promotions,  competition,
increased  energy costs, the announcement or introduction of new products by our
competitors,  changes in our customer mix, and overall  trends in the market for
Spirulina  products.  While a  significant  portion  of our  expense  levels are
relatively  fixed,  and the timing of  increases  in expense  levels is based in
large



                                       18

<PAGE>
part on our 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 our results of
operations.

New Accounting Standards

         In March 1995, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial  Accounting Standards (SFAS) No. 121, "Accounting for the
Impairment of Long-Lived  Assets and for  Long-Lived  Assets to Be Disposed Of."
SFAS  No.  121  requires  that  long-lived   assets  and  certain   identifiable
intangibles  held and used by an  entity be  reviewed  for  impairment  whenever
events or changes in circumstances indicate that the carrying amount of an asset
may  not  be  recoverable.  If  the  sum  of  the  expected  future  cash  flows
(undiscounted  and without interest charges) is less than the carrying amount of
the asset, an impairment  loss is recognized.  Measurement of that loss would be
based on the fair value of the asset.  Generally,  SFAS No.  121  requires  that
long-lived  assets and  certain  identifiable  intangibles  to be disposed of be
reported  at the lower of carrying  amount or fair value less cost to sell.  The
Company  adopted the  provisions  of SFAS No. 121 effective  April 1, 1996.  The
adoption  of SFAS  No.  121 did not  have a  material  effect  on the  Company's
financial condition, results of operations or liquidity.

         In  October  1995,  the FASB  issued  SFAS  No.  123,  "Accounting  for
Stock-Based Compensation." SFAS No. 123 establishes a fair value based method of
accounting for stock-based compensation, but does not require an entity to adopt
the new method for preparing its basic  financial  statements.  For entities not
adopting the new method,  SFAS No. 123 requires footnote disclosure of pro forma
net  income  and net income  per share  information  as if the fair value  based
method  had been  adopted.  The  disclosure  requirements  of SFAS  No.  123 are
effective for financial statements for fiscal years beginning after December 31,
1995.  Effective  April 1, 1996, the Company adopted SFAS No, 123 and elected to
continue  to apply  the  provisions  of APB No.  25 and  provide  the pro  forma
disclosures required by SFAS No. 123.

         In June 1996, the FASB issued SFAS No. 125,  "Accounting  for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities".  SFAS No.
125 generally is effective  for transfers and servicing of financial  assets and
extinguishments  of liabilities  occurring after December 31, 1996, and is to be
applied   prospectively.   This  Statement  provides  accounting  and  reporting
standards for transfers and servicing of financial assets and extinguishments of
liabilities based on consistent application of a  financial-components  approach
that focuses on control. It distinguishes transfers of financial assets that are
sales from transfers that are secured borrowings. Management of the Company does
not expect  that  adoption  of SFAS No.  125 will have a material  impact on the
Company's financial position, results of operations or liquidity.

         In February 1997,  the FASB issued SFAS No. 128,  "Earnings per Share".
SFAS No. 128 is  effective  for both  interim and annual  periods  ending  after
December 15, 1997.  The Company will adopt SFAS No. 128 in the third  quarter of
fiscal  1998.  SFAS No. 128 requires the  presentation  of "Basic"  earnings per
share,  representing  income  available  to common  shareholders  divided by the
weighted  average  number of common shares  outstanding  during the period,  and
"Diluted"  earnings per share,  which is similar to the current  presentation of
fully diluted earnings per share. SFAS No. 128 requires restatement of all prior
period earnings per share presented. Management does not expect adoption of SFAS
No. 128 to have a material impact on the Company's  previously reported earnings
per share, financial position, results of operations or liquidity.




                                       19

<PAGE>
Liquidity and Capital Resources

          Cyanotech's  cash and investment  securities  decreased  $2,680,000 to
$6,729,000  during the  fiscal  year  ended  March 31,  1997.  The  decrease  is
primarily  attributable  to increased  capital  expenditures  for  equipment and
leasehold improvements.

         Cash flows  provided by operating  activities  were  $2,860,000 in 1997
compared  to  $2,598,000  in 1996.  The  primary  source of 1997 cash flows from
operating  activities was net income and an increase in accounts  payable offset
by increases in accounts  receivable , inventories,  prepaid  expenses and other
assets and a decrease in accrued expenses and other.

         Cash  flows  used in  investing  activities  were  $10,962,000  in 1997
compared to  $3,910,000  in 1996.  The primary  uses of cash flows in  investing
activities  during  1997 were for  capital  expenditures  and net  purchases  of
investment securities.

         Cash flows  provided by financing  activities  were  $1,468,000 in 1997
compared to $10,225,000  in 1996. The primary  sources of cash flows provided by
financing  activities  were  $1,393,000 in net proceeds from the sale of 225,000
shares  of common  stock to the  underwriters  of a public  stock  offering  and
$350,000  from the  exercise of common  stock  options and  warrants,  offset by
principal payments on long-term debt and capital lease obligations.

         As  of  March  31,  1997,  we  had  construction  commitments  totaling
$903,000,  which we intend to fund from cash reserves and anticipated cash flows
from  future  operations.  We  presently  estimate  that  our  existing  capital
resources and anticipated  cash flows from future  operations will be sufficient
to fund  current  operations.  However,  we plan to spend,  subject to available
financing,  approximately $12.3 million on capital  expenditures during the next
two fiscal years, primarily to expand NatuRose production on the newly leased 88
acres and existing  capital  resources  and  anticipated  cash flows from future
operations  will not be sufficient to fund these  capital  expenditures.  We are
currently  seeking an increase in our credit  facilities to meet any anticipated
shortfall.  We  currently  have a  $1,000,000  bank  line  of  credit  which  is
collateralized  by a certificate  of deposit and an additional  $1,000,000  bank
line of credit which is collateralized  by all the assets of the Company.  As of
March 31, 1997, there were no borrowings under either of these credit lines.


Item 8. Financial Statements and Supplementary Data

The financial statements required to be filed herewith begin on page F-1.




                                       20

<PAGE>
                  Selected Quarterly Financial Data (unaudited)
                    (in thousands, except earnings per share)
<TABLE>
<CAPTION>
                                First    Second      Third     Fourth      Total
                              Quarter    Quarter   Quarter    Quarter       Year
                              -------    -------   -------    -------    -------
1997
<S>                           <C>        <C>       <C>        <C>       <C>    
Net Sales                     $ 2,455    $ 2,812   $ 2,782    $ 3,350    $11,399
Gross Profit                    1,470      1,740     1,731      1,868      6,809
Net Income                        845      1,104       956      1,254      4,159
Net Income per Common Share   $  0.05    $  0.07   $  0.06    $  0.08    $  0.25

1996

Net Sales                     $ 1,568    $ 2,056   $ 2,348    $ 2,109    $ 8,081
Gross Profit                      778      1,112     1,298      1,375      4,563
Net Income                        413        605       711        780      2,509
Net Income per Common Share   $  0.03    $  0.04   $  0.05    $  0.05    $  0.17
</TABLE>

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

Not applicable.



                                       21

<PAGE>
                                    Part III


Item 10.  Directors and Executive Officers; Compliance with Section 16(a) of the
Exchange Act

Identification of Directors

The  information  required by this Item is  incorporated  by reference  from the
Sections  captioned  "Proposal One: Election of Directors," " Security Ownership
of Certain  Beneficial Owners and Management" and "Compliance with Section 16(a)
of the Exchange Act" contained in Cyanotech's definitive 1997 Proxy Statement.

Identification of Executive Officers

The executive officers of Cyanotech and their ages and positions as of March 31,
1997 are as follows:
<TABLE>
<CAPTION>
      Name                       Age                Position
      ----                       ---                --------
<S>                               <C>   <C>
Gerald R. Cysewski, Ph.D. .....   48    Chairman of the Board, President and
                                           Chief Executive Officer
Glenn D. Jensen. ..............   38    Vice President - Operations
Brent F. Kunimoto..............   38    Vice President - Sales and Marketing
                                           and
                                        President, Nutrex, Inc.
Kelly J. Moorhead..............   41    Vice President - International Sales
Ronald P. Scott................   42    Executive Vice President - Finance
                                           and Administration, Secretary,
                                           Treasurer
</TABLE>
Dr.  Cysewski  co-founded  Cyanotech  in 1983 and has served as a director since
that time.  Since March 1990,  Dr.  Cysewski has served as  President  and Chief
Executive  Officer of Cyanotech  and in October  1990 was also  appointed to the
position of Chairman of the Board. From 1988 to November 1990, he served as Vice
Chairman  and from 1983 to June,  1996 he served as  Scientific  Director of the
Company. From 1980 to 1982, Dr. Cysewski was group leader of microalgae research
and development at Battelle Northwest, a major contract research and development
firm.  From  1976 to  1980,  Dr.  Cysewski  was an  assistant  professor  in the
Department of Chemical and Nuclear  Engineering at the University of California,
Santa  Barbara,  where he received a two-year  grant from the  National  Science
Foundation  to  develop a culture  system for  blue-green  algae.  Dr.  Cysewski
received his doctorate in Chemical Engineering from the University of California
at Berkeley.

Mr. Jensen has served as Vice President - Operations  since May 1993.  He joined
Cyanotech in 1984 as Process  Manager and was promoted to Production  Manager in
1991,  in which  position  he served  until his  promotion  to Vice  President -
Operations.  Prior to joining Cyanotech,  Mr. Jensen worked for three years as a
plant  engineer at a  Spirulina  production  facility,  Cal-Alga,  near  Fresno,
California,  which ceased to do business in 1983. Mr. Jensen holds a B.S. degree
in Health Science from California State University, Fresno.

Mr.  Kunimoto  joined  Cyanotech  in  August   1996  and  has  served  as   Vice
President - Sales and Marketing  since that time.  From 1989 to August 1996, Mr.
Kunimoto  worked as a Marketing  Manager and Marketing  Director for Nestle Food
Company.  From 1987 to 1989,  he was an  Assistant  Product  Manager for General
Mills,  Inc.. From 1982 to 1985 he was a Senior Consultant for Arthur Andersen &
Company.  Mr.  Kunimoto  received a B.S. degree in Economics and an M.B.A degree
from the University of California at Los Angeles.



                                       22

<PAGE>
Mr. Moorhead has served as  Vice President - International  Sales of the Company
since August 1996. From December 1991 to August 1996 he served as Vice President
- Sales and Marketing and President of Nutrex, Inc. From August 1987 to December
1991,  he served as Vice  President - Production  of the Company.  Mr.  Moorhead
joined  Cyanotech as  Production  Biologist in December  1984.  Prior to joining
Cyanotech,  Mr.  Moorhead  worked at the Oceanic  Institute in Honolulu,  Hawaii
where he conducted research on production of Spirulina from agricultural wastes.
Mr.  Moorhead  holds a B.S.  degree in Aquatic  Biology from the  University  of
California, Santa Barbara.

Mr.  Scott was  appointed  to the Board of Directors of the Company in  November
1995, has served as Executive Vice President - Finance and Administration  since
August 1995,  and has served as Secretary and Treasurer  since November 1990 and
June 1990,  respectively.  From December 1990 until August 1995 Mr. Scott served
as Vice President - Finance and Administration.  From September 1990 to December
1990,  Mr.  Scott  served as  Controller.  From 1989 to 1990,  he was  Assistant
Controller for PRIAM Corporation, a manufacturer of Winchester disk drives. From
1980 to 1989, he served in various accounting management positions with Measurex
Corporation,  a manufacturer of industrial  process control  systems.  Mr. Scott
holds a B.S. degree in Finance and Management from California State  University,
San Jose, and an M.B.A. degree from the University of Santa Clara.


Item 11. Executive Compensation

The  information  required by this Item is  incorporated  by reference  from the
section captioned  "Executive  Compensation and Other Information" and "Director
Renumeration" contained in Cyanotech's definitive 1997 Proxy Statement.


Item 12. Security Ownership of Certain Beneficial Owners and Management

The  information  required by this Item is  incorporated  by reference  from the
section  captioned   "Security   Ownership  of  Certain  Beneficial  Owners  and
Management" contained in Cyanotech's definitive 1997 Proxy Statement.


Item 13. Certain Relationships and Related Transactions

The  information  required by this Item is  incorporated  by reference  from the
section captioned  "Certain  Transactions"  contained in Cyanotech's  definitive
1997 Proxy Statement.






                                       23

<PAGE>
Part IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K


<TABLE>
<CAPTION>
Exhibit Number           Document Description
--------------           ---------------------
  <S>                    <C>

  3.1                    Restated  Articles  of  Incorporation. (Incorporated by 
                         reference to  Exhibit  3.1  to  the Company's Quarterly
                         Report  on  Form  10-QSB for the quarter ended December
                         31, 1996, file no. 0-14602.)
  3.2                    Bylaws of the Registrant,  as amended. (Incorporated by
                         reference  to  Exhibit  3.1 to the Company's  Quarterly
                         Report  on  Form  10-QSB for the quarter ended December
                         31, 1995, file no. 0-14602.)
  4.1                    Specimen Common  Stock  Certificate.  (Incorporated  by
                         reference to Exhibit 4.1 to the Company's  Registration
                         Statement on Form SB-2 filed on February 28, 1996, file
                         no. 333-00951.)
  4.2                    Terms of  the Series C Preferred Stock as Revised 1991. 
                         (Incorporated  by  reference  to  Exhibit  4.1  to  the
                         Company's  Annual  Report  on  Form 10-K for the fiscal
                         year ended December 31, 1990, file no. 0-14602.)
10.1                     1985  Incentive Stock Option Plan dated March 18, 1985, 
                         as amended.  (Incorporated by reference to Exhibit 4(d)
                         to the  Company's  Registration  Statement  on Form S-8
                         filed on December 3, 1992, file no. 33-55310.)
10.2                     Stockholders  Agreement  dated  as  of  May  17,  1993.
                         (Incorporated  by  reference  to  Exhibit  10.8  to the
                         Company's  Annual Report on  Form 10-KSB for the fiscal
                         year ended March 31, 1994, file no. 0-14602.)
10.3                     1994  Non-Employee  Directors  Stock  Option  and Stock
                         Grant Plan.  (Incorporated by reference to Exhibit 10.7
                         to the Company's  Annual  Report on Form 10-KSB for the
                         fiscal year ended March 31, 1994, file no. 0-14602.)
10.4                     Supply  and  Exclusive  Marketing Agreement between the
                         Company  and  Nutrition  Gandalf  dated  July  8, 1994.
                         Confidential portions of this exhibit have been omitted
                         and filed separately with the Commission. (Incorporated
                         by reference to Exhibit 10.2 to the Company's Quarterly
                         Report  on  Form  10-QSB for the quarter ended December
                         31, 1995, file no. 0-14602.)
10.5                     Facilities  Rental  Agreement  dated  November 1,  1994
                         between the  Company and  Natural  Energy Laboratory of
                         Hawaii  Authority.  (Superseded  by  Exhibit  10.13.) 
                         (Incorporated  by  reference  to  Exhibit 10.11  to the
                         Company's Annual Report on Form 10-KSB  for  the fiscal
                         year ended March 31, 1995, file no. 0-14602.)
10.6                     Facilities  Rental  Agreement  dated  December  2, 1994
                         between the  Company  and  Natural Energy Laboratory of
                         Hawaii  Authority.  (Superseded  by  Exhibit  10.11.)  
                         (Incorporated  by  reference  to  Exhibit  10.12 to the
                         Company's Annual Report on Form  10-KSB for  the fiscal
                         year ended March 31, 1995, file no. 0-14602.)
10.7                     Term  Loan  Agreement  dated  April  1,  1995   between
                         Spirulina  International  B.V.  and  the  Company.     
                         (Incorporated  by reference  to  Exhibit 10.13  to  the
                         Company's Annual Report on Form 10-KSB  for  the fiscal
                         year ended March 31, 1995, file no. 0-14602.)




                                       24

<PAGE>
10.8                     License  Agreement  by  and  between The  University of
                         Memphis  and  the  Company  dated  June  19,  1995. 
                         (Incorporated  by  reference to  Exhibit  10.14  to the
                         Company's  Annual Report on Form 10-KSB for  the fiscal
                         year ended March 31, 1995, file no. 0-14602.)
10.9                     Term  Loan  Agreement dated  July 11, 1995  between the
                         Company and Satoshi Sakurada.(Incorporated by reference 
                         to Exhibit  10.3 to the  Company's Quarterly  Report on
                         Form  10-QSB  for  the quarter ended December 31, 1995,
                         file no. 0-14602.)
10.10                    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.)
10.11                    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.)
10.12                    Preferred  Stock  Conversion  and  Registration  Rights
                         Agreement by and  between  the  Company  and  Firemen's
                         Insurance  Company of Newark,  New Jersey,  dated as of
                         February  20,  1996.   (Incorporated  by  reference  to
                         Exhibit  10.16 to the Company's Registration  Statement
                         on  Form  SB-2  as filed on February 28, 1996, file no.
                         333-00951.)
10.13                    Registration  Rights  Agreement   by  and  between  the 
                         Company  and  American  Cynamid  Company  dated  as  of
                         February 20, 1996.(Incorporated by reference to Exhibit
                         10.17 to the Company's  Registration  Statement on Form
                         SB-2 as filed on February 28, 1996, file no 333-00951.)
10.14                    Credit Agreement between the Company and First Hawaiian
                         Bank, dated February 27, 1997.
10.15                    Promissory  Note between the Company and First Hawaiian
                         Bank, dated February 27, 1997.
10.16                    Security   Agreement  between  the  Company  and  First 
                         Hawaiian Bank, dated February 27, 1997.
11.1                     Statement re: Computation of Earnings Per Share.
21.1                     Subsidiaries of the Company.
23.1                     Consent of Independent Auditors
27                       Financial Data Schedule.
</TABLE>
---------------------

(b)      Reports on Form 8-K

         The  Registrant  did not file any reports on Form 8-K during the fourth
quarter of the 1997 fiscal year.






                                       25

<PAGE>
                                   SIGNATURES

         Pursuant to the  requirements  of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the  undersigned,  thereunto duly  authorized,  on the 23rd day of
June, 1997.

                              CYANOTECH CORPORATION

                            By:/s/Gerald R. Cysewski
                               ---------------------
                            Gerald R. Cysewski, Ph.D
                             Chairman of the Board,
                               President and Chief
                                Executive Officer

         Pursuant to the  requirements  of the Securities  Exchange Act of 1934,
this  report has been  signed  below by the  following  persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
               Signature                  Title                     Date
<S>                             <C>                                <C>
/s/Gerald R. Cysewski           Chairman of the Board, President   June 23, 1997
---------------------           and Chief Executive Officer        -------------
   Gerald R. Cysewski, Ph.D     (Principal Executive Officer)


/s/Ronald P. Scott              Executive Vice President -         June 23, 1997
---------------------           Finance and Administration,        -------------
   Ronald P. Scott              Secretary and Treasurer
                                (Principal Financial and
                                Accounting Officer)


/s/Julian C. Baker              Director                           June 26, 1997
---------------------                                              -------------
   Julian C. Baker


/s/Eva R. Reichl                Director                           June 21, 1997
---------------------                                              -------------
   Eva R. Reichl


/s/John T. Ushijima             Director                           June 25, 1997
---------------------                                              -------------
   John T. Ushijima


/s/Paul C. Yuen                 Director                           June 23, 1997
---------------------                                              -------------
   Paul C. Yuen
</TABLE>

                                       26

<PAGE>

<PAGE>



CYANOTECH CORPORATION

Index to Financial Statements




                                                                    Page

Independent Auditors' Report                                         F-2

Consolidated Balance Sheets                                          F-3

Consolidated Statements of Income                                    F-4

Consolidated Statements of Stockholders' Equity                      F-5

Consolidated Statements of Cash Flows                                F-6

Notes to Financial Statements                                    F-7 to F-20




























                                      F-1
<PAGE>










                          INDEPENDENT AUDITORS' REPORT



The Board of Directors
Cyanotech Corporation:


We have  audited  the  accompanying  consolidated  balance  sheets of  Cyanotech
Corporation  and  subsidiary  as of March  31,  1997 and 1996,  and the  related
consolidated statements of income,  stockholders' equity and cash flows for each
of the years in the three-year  period ended March 31, 1997. 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  generally   accepted  auditing
standards.  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  subsidiary  as of March 31, 1997 and 1996,  and the results of
their  operations  and their cash flows for each of the years in the  three-year
period ended March 31, 1997 in conformity  with  generally  accepted  accounting
principles.


KPMG Peat Marwick LLP


Honolulu, Hawaii
April 28, 1997


                                      F-2
<PAGE>
                              CYANOTECH CORPORATION
                           Consolidated Balance Sheets
                             March 31, 1997 and 1996
                        (in thousands, except share data)
<TABLE>
<CAPTION>
                 Assets                                    1997         1996
                                                        ----------   ----------
<S>                                                     <C>          <C>
Current assets:
    Cash and cash equivalents                           $   2,775    $   9,409
    Investment securities                                   3,954           --
    Accounts receivable                                     2,791        1,288
    Inventories                                             1,138          494
    Prepaid expenses                                          155          120
    Deferred tax assets                                       373           --
                                                        ----------   ----------

           Total current assets                            11,186       11,311

Equipment and leasehold improvements, net                  14,666        8,349

Other assets                                                  163           56
                                                        ----------   ----------

           Total assets                                 $  26,015    $  19,716
                                                        ==========   ==========

                 Liabilities and Stockholders' Equity

Current liabilities:
    Current maturities of long-term debt                $     150    $     150
    Current maturities of capital lease obligations           130          126
    Accounts payable                                        1,508          852
    Accrued expenses and other                                333          434
                                                        ----------   ----------

           Total current liabilities                        2,121        1,562

Long-term debt, excluding current maturities                  363          513
Obligations under capital lease, excluding current
    maturities                                                196          325
                                                        ----------   ----------

           Total liabilities                                2,680        2,400
                                                        ----------   ----------

Stockholders' equity:
    Preferred stock                                             1            1
    Common stock of $.005 par value, authorized
        25,000,000  shares at March 31, 1997 and 
        18,000,000  shares at March 31, 1996; issued
        and outstanding 12,712,682 shares at 
        March 31, 1997 and 11,755,650 shares at
        March 31, 1996                                         63           59
    Additional paid-in capital                             23,732       21,876
    Accumulated deficit                                      (461)      (4,620)
                                                        ----------   ----------

           Total stockholders' equity                      23,335       17,316
                                                        ----------   ----------

Commitments and contingencies

           Total liabilities and stockholders' equity   $  26,015    $  19,716
                                                        ==========   ==========
</TABLE>
See accompanying notes to consolidated financial statements.

                                      F-3
<PAGE>
                              CYANOTECH CORPORATION
                        Consolidated Statements of Income
                    Years ended March 31, 1997, 1996 and 1995
                      (in thousands, except per-share data)

<TABLE>
<CAPTION>
                                             1997         1996          1995
                                          ----------   ----------    ----------
<S>                                       <C>          <C>           <C>
Net sales                                 $  11,399    $   8,081     $   4,150
Cost of sales                                 4,590        3,518         2,275
                                          ----------   ----------    ----------

           Gross profit                       6,809        4,563         1,875
                                          ----------   ----------    ----------

Operating expenses:
    Research and development                    587          351           171
    General and administrative                1,437        1,196           685
    Sales and marketing                       1,034          445           301
                                          ----------   ----------    ----------

           Total operating expenses           3,058        1,992         1,157
                                          ----------   ----------    ----------

           Income from operations             3,751        2,571           718
                                          ----------   ----------    ----------
Other income (expense):
    Interest income                             443           32            17
    Interest expense, net of interest
       costs capitalized of $23 in 1997
       and nil in 1996 and 1995                 (47)         (90)          (27)
    Other income (expense), net                  12           (4)           98
    Proportionate share of loss of
       joint venture                             --           --           (37)
                                          ----------   ----------    ----------

           Total other income (expense)         408          (62)           51
                                          ----------   ----------    ----------

           Net income                     $   4,159    $   2,509     $     769
                                          ==========   ==========    ==========

Net income per common share               $    0.25    $    0.17     $    0.05
                                          ==========   ==========    ==========

Weighted average number of common
   shares and common share equivalents       16,598       14,548        13,589
                                          ==========   ==========    ==========
</TABLE>
See accompanying notes to consolidated financial statements.

                                      F-4
<PAGE>
                              CYANOTECH CORPORATION
                 Consolidated Statements of Stockholders' Equity
                    Years ended March 31, 1997, 1996 and 1995
                        (in thousands, except share data)
<TABLE>
<CAPTION>
                                           
                                        Preferred stock      Common Stock
                                    ---------------------------------------   Additional                            Total stock-
                                                   Par                 Par       paid-in   Accumulated   Treasury       holders'
                                         Shares   value      Shares   value      capital       deficit      stock         equity
                                    -----------------------------------------------------------------------------------------------
<S>                                   <C>         <C>      <C>         <C>     <C>          <C>           <C>        <C>
Balances at March 31, 1994            2,118,507   $   2    8,736,506   $  44   $   12,042   $   (7,898)   $   (30)   $     4,160

Common stock issued for cash, net
    of costs of $6                           --      --      146,969       1          144           --         --            145
Exercise of common stock warrants 
    for cash                                 --      --       38,400      --           24           --         --             24
Exercise of stock options for cash           --      --        4,300      --            3           --         --              3
Conversion of 21,030 shares of
    Series C preferred stock to
    105,150 shares of common stock      (21,030)     --      105,150      --           --           --         --             --
Conversion of 100,000 shares of
    Series E preferred stock to
    20,000 shares of common stock      (100,000)     --       20,000      --           --           --         --             --
Issuance of common stock warrants
    for services                             --      --           --      --            3           --         --              3
Net Income                                   --      --           --      --           --          769         --            769
---------------------------------------------------------------------------------------------------------------------------------

Balances at March 31, 1995            1,997,477   $   2    9,051,325   $  45   $   12,216   $   (7,129)   $   (30)   $     5,104

Exercise of common stock warrants 
    for cash                                 --      --      891,200       5          507           --         --            512
Exercise of stock options for cash           --      --       82,625      --           76           --         --             76
Issuance of common stock to
    nonemployee directors for
    services                                 --      --        8,000      --           40           --         --             40
Exchange of Series A preferred
    stock for common stock           (1,250,000)     (1)     250,000       1           --           --         --             --
Exchange of Series B preferred
    stock for common stock              (12,500)     --        2,500      --           --           --         --             --
Retirement of treasury stock                 --      --      (30,000)     --          (30)          --         30             --
Common stock issued for cash, net of
    costs of $556                            --      --    1,500,000       8        9,067           --         --          9,075
Net income                                   --      --           --      --           --        2,509         --          2,509
---------------------------------------------------------------------------------------------------------------------------------

Balances at March 31, 1996              734,977   $   1   11,755,650   $  59   $   21,876   $   (4,620)        --   $     17,316


Exercise of common stock warrants
    for cash                                 --      --      668,120       3          298           --         --            301
Exercise of stock options for cash           --      --       57,912      --           49           --         --             49
Issuance of common stock options for
    other assets                             --      --           --      --           80           --         --             80
Issuance of common stock to nonemployee 
    directors for services                   --      --        6,000      --           37           --         --             37
Common stock issued for cash, net
    of costs of $51                          --      --      225,000       1        1,392           --         --          1,393
Net income                                   --      --           --      --           --        4,159         --          4,159
---------------------------------------------------------------------------------------------------------------------------------

Balances at March 31, 1997              734,977   $   1   12,712,682   $  63   $   23,732   $     (461)        --   $     23,335
                                    =============================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.

                                      F-5
<PAGE>
                              CYANOTECH CORPORATION
                      Consolidated Statements of Cash Flows
                    Years ended March 31, 1997, 1996 and 1995
                                 (in thousands)
<TABLE>
<CAPTION>
                                                   1997       1996       1995
                                                 ---------  ---------   --------
<S>                                              <C>        <C>        <C>
Cash flows from operating activities:
  Net income                                     $  4,159   $  2,509   $    769
  Adjustments to reconcile net income to
    net cash provided by operating activities:
    Deferred income taxes                            (373)        --         --
    Proportionate share of loss of joint venture       --         --         37
    Depreciation and amortization                     691        499        338
    Increase in accounts receivable                (1,503)      (640)      (186)
    (Increase) decrease in inventories               (644)      (119)        23
    Increase in prepaid expenses and other
      assets                                          (62)      (118)       (17)
    Increase in accounts payable                      656        223         63
    Increase (decrease) in accrued expenses
      and other                                      (101)       204        (28)
    Other                                              37         40         --
                                                 ---------  ---------  ---------

Net cash provided by operating activities           2,860      2,598        999
                                                 ---------  ---------  ---------

Cash flows from investing activities:
  Investment in equipment and leasehold
    improvements                                   (7,008)    (3,910)    (1,442)
  Investment in joint venture                          --         --        (37)
  Purchases of investment securities              (10,827)        --         --
  Proceeds from sales and maturities of 
    investment securities                          (6,873)        --         --
                                                 ---------  ---------  ---------

Net cash used in investing activities             (10,962)    (3,910)    (1,479)
                                                 ---------  ---------  ---------

Cash flows from financing activities:
  Net proceeds from issuance of common stock
    and exercise of stock options and warrants      1,743      9,663        175
  Proceeds from issuance of long-term debt             --        750         --
  Principal payments on long-term debt               (150)       (94)       (13)
  Principal payments on capital lease
    obligations                                      (125)       (94)       (52)
                                                  --------   --------   --------

Net cash provided by financing activities           1,468     10,225        110
                                                  --------   --------   --------

Net increase (decrease) in cash and cash
  equivalents                                      (6,634)     8,913       (370)

Cash and cash equivalents at beginning of year      9,409        496        866
                                                  --------   --------  ---------

Cash and cash equivalents at end of year          $ 2,775    $ 9,409    $   496
                                                  ========   ========   ========

Supplemental disclosure of cash flow information:

  Cash paid during the year for interest,
    net of amounts capitalized                    $    36    $    73    $    26
                                                  ========   ========   ========

    Cash paid during the year for income taxes    $   355    $    --    $    --
                                                  ========   ========   ========

    Non-cash investing and financing activities:
      Equipment leased under capital lease
        obligations                               $    --    $   303    $   166
                                                  ========   ========   ========

    Issuance of common stock and options
      for services and other assets               $   117    $    40    $    --
                                                  ========   ========   ========
</TABLE>
See accompanying notes to consolidated financial statements.

                                      F-6
<PAGE>
                              CYANOTECH CORPORATION
                   Notes to Consolidated Financial Statements
                         March 31, 1997, 1996, and 1995
                  (all amounts in thousands, except share data)



(1)  Description of Business and Summary of Accounting Policies

     (a)    Description of Business

            Cyanotech Corporation (Company) develops and commercializes  natural
            products  from  microalgae.   The  Company  is  currently  producing
            microalgae products for the nutritional supplement and immunological
            diagnostics markets and is also developing microalgae-based products
            for the aquaculture  feed/pigments,  biopesticide  and food coloring
            markets.

            Substantially  all of the Company's net sales have been attributable
            to its  Spirulina  Pacifica  products.  Sales of Spirulina  Pacifica
            products  accounted for approximately 98% of the Company's net sales
            for the years  ended  March  31,  1997 and 1996 and 97% for the year
            ended March 31, 1995.

     (b)    Principles of Consolidation

            The Company  consolidates  enterprises in which it has a controlling
            financial   interest.   The  accompanying   consolidated   financial
            statements  include the  accounts of Cyanotech  Corporation  and its
            wholly owned subsidiary,  Nutrex, Inc. All significant  intercompany
            balances and transactions have been eliminated in consolidation.

     (c)    Cash and Cash Equivalents

            For  purposes of the  consolidated  statements  of cash  flows,  the
            Company  considers all highly liquid debt securities  purchased with
            original  remaining  maturities  of  three months or less to be cash
            equivalents.

     (d)    Investment Securities

            Investment  securities  at March 31, 1997 consist of U.S.  Treasury,
            mortgage-backed,  and other interest bearing securities. The Company
            classifies   its  debt  and  equity   securities  in  one  of  three
            categories;   trading,   available-for-sale,   or  held-to-maturity.
            Trading  securities are bought and held  principally for the purpose
            of selling  them in the near  term.  Held-to-maturity  security  are
            those  securities in which the Company has the ability and intent to
            hold the security until maturity.  All other securities not included
            in trading or held-to-maturity are classified as available-for-sale.

            Trading  and  available-for-sale  securities  are  recorded  at fair
            value.  Held-to-maturity  securities are recorded at amortized cost,
            adjusted for the amortization or accretion of premiums or discounts.
            Unrealized  holding  gains and  losses  on  trading  securities  are
            included in earnings.  Unrealized  holding gains and losses,  net of
            the  related  tax  effects,  on  available-for-sale  securities  are
            excluded from  earnings and are reported as a separate  component of
            stockholders  equity until realized.  Realized gains and losses from
            the sale of held-to-maturity and  available-for-sale  securities are
            determined on a specific identification basis.

            A  decline  in  the  market  value  of  any   available-for-sale  or
            held-to-maturity security below cost that is deemed to be other than
            temporary  results in a reduction in carrying  amount to fair value.
            The  impairment  is charged to earnings and a new cost basis for the
            security is  established.  Premiums and  discounts  are amortized or
            accreted over the life of the related  held-to-maturity  security as
            an adjustment to yield using the effective interest method. Dividend
            and interest income are recognized when earned.

                                      F-7
<PAGE>

     (e)    Inventories

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

     (f)    Equipment and Leasehold Improvements

            Owned  equipment  and  leasehold  improvements  are  stated at cost.
            Equipment  under capital lease is stated at the lower of the present
            value of minimum  lease  payments or fair value of the  equipment at
            the  inception  of the  lease.  Depreciation  and  amortization  are
            provided using the  straight-line  method over the estimated  useful
            lives for  equipment  and  furniture and fixtures and the shorter of
            the lease terms or estimated useful lives for leasehold improvements
            and equipment under capital lease as follows:
<TABLE>
            <S>                             <C>   

            Equipment                                              3 to 10 years
            Leasehold improvement           remaining lease term (3 to 29 years)  
            Furniture  and  fixtures                                     7 years  
            Equipment  under capital lease             lease term (3 to 5 years)
</TABLE>

            Amortization  of  equipment  under  capital  lease  is  included  in
            depreciation   and   amortization   expense   in  the   accompanying
            consolidated financial statements.

     (g)    Investments in Joint Ventures

            Investments  in joint ventures and other  investments  for which the
            Company has the ability to exercise  significant  influence over the
            operating and financing policies of the enterprise are accounted for
            under the equity method.

     (h)    Net Income Per Common Share

            Net income per common  share is computed  based on net income  after
            preferred  stock  dividend  requirements  and the  weighted  average
            number of common  shares  outstanding  during the year,  adjusted to
            reflect  the  assumed  exercise  of  outstanding  stock  options and
            warrants and the  conversion  of preferred  stock to the extent such
            items have a dilutive effect on the  computation.  Fully diluted net
            income per common share is not materially different from primary net
            income per common share.

     (i)    Research and Development

            Research and  development  costs are expensed as incurred.  Research
            and development  costs amounted to $587, $351 and $171 in 1997, 1996
            and 1995, respectively.

     (j)    Income Taxes

            Deferred tax assets and  liabilities  are  recognized for the future
            tax consequences  attributable to differences  between the financial
            statement  carrying  amounts of existing  assets and liabilities and
            their tax bases  and  operating  loss  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 realized or settled.  As changes in
            tax laws or rates are enacted,  deferred tax assets and  liabilities
            are adjusted through the provision for income taxes.

                                      F-8
<PAGE>

     (k)    Stock Option Plan

            Prior to April 1, 1996,  the Company  accounted for its stock option
            plan in accordance  with the  provisions  of  Accounting  Principles
            Board  ("APB")  Opinion  No.  25,  Accounting  for  Stock  Issued to
            Employees,  and  related  interpretations.   As  such,  compensation
            expense  would be  recorded on the date of grant only if the current
            market price for the underlying  stock exceeded the exercise  price.
            Effective April 1, 1996, the Company adopted  Statement of Financial
            Accounting  Standards  ("SFAS") No. 123,  Accounting for Stock-Based
            Compensation,  which  permits  entities to recognize as expense over
            the vesting period the fair value of all  stock-based  awards on the
            date of grant.  Alternatively,  SFAS No. 123 also allows entities to
            continue to apply the  provisions  of APB Opinion No. 25 and provide
            pro forma net  income  and pro forma net  income  per  common  share
            disclosures  for employee  stock  option  grants made in fiscal year
            1996 and future years as if the  fair-value-based  method defined in
            SFAS No. 123 had been  applied.  The Company has elected to continue
            to apply  the  provisions  of APB No. 25 and  provide  the pro forma
            disclosures required by SFAS No. 123.

     (l)    Impairment  of  Long-Lived  Assets  and  Long-Lived  Assets to Be
            Disposed Of

            The Company  adopted the provisions of SFAS No. 121,  Accounting for
            the Impairment of Long-Lived  Assets and for Long-Lived Assets to Be
            Disposed Of,  effective  April 1, 1996.  SFAS No. 121 requires  that
            long-lived assets and certain  identifiable  intangibles 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 future  net cash
            flows  expected  to be  generated  by the asset.  If such assets are
            considered  to be  impaired,  the  impairment  to be  recognized  is
            measured  by the amount by which the  carrying  amount of the assets
            exceed the fair value of the  assets.  Assets to be  disposed of are
            reported  at the lower of the  carrying  amount or fair  value  less
            costs to sell.  Adoption  of SFAS  No.  121 did not have a  material
            impact on the Company's financial position, results of operations or
            liquidity.

     (m)    Transfers  and Servicing of Financial  Assets and  Extinguishments
            of Liabilities

            In June 1996,  the Financial  Accounting  Standards  Board  ("FASB")
            issued SFAS No. 125,  Accounting  for  Transfers  and  Servicing  of
            Financial Assets and  Extinguishments  of Liabilities.  SFAS No. 125
            generally  is effective  for  transfers  and  servicing of financial
            assets and  extinguishments of liabilities  occurring after December
            31, 1996 and is to be applied prospectively. This Statement provides
            accounting  and  reporting  standards for transfers and servicing of
            financial  assets  and   extinguishments  of  liabilities  based  on
            consistent  application  of  a  financial-components  approach  that
            focuses on control.  It distinguishes  transfers of financial assets
            that  are  sales  from  transfers   that  are  secured   borrowings.
            Management  of the Company does not expect that adoption of SFAS No.
            125 will have a material impact on the Company's financial position,
            results of operations or liquidity.

     (n)    Earnings per share

            In February 1997, the FASB issued SFAS No. 128,  Earnings per Share.
            SFAS No. 128 is effective for both interim and annual periods ending
            after  December 15, 1997. The Company will adopt SFAS No. 128 in the
            third quarter of fiscal 1998. SFAS No. 128 requires the presentation
            of "Basic"  earnings  per share,  representing  income  available to
            common shareholders divided by the weighted average number of common
            shares 

                                      F-9
<PAGE> 
            outstanding for the period, and "Diluted" earnings per share,  which
            is similar to the current presentation of fully diluted earnings per
            share.  SFAS No.  128  requires  restatement  of  all  prior  period
            earnings  per  share  data presented.  Management  does  not  expect
            adoption of SFAS No. 128 to have a material impact on the  Company's
            previously reported earnings per share,  financial position, results
            of operations or liquidity.

     (o)    Use of Estimates

            The preparation of financial statements in conformity with generally
            accepted accounting principles requires management to make estimates
            and  assumptions  that  affect  the  reported  amounts of assets and
            liabilities  and disclosure of contingent  assets and liabilities at
            the date of the financial  statements,  and the reported  amounts of
            revenues and expenses  during the reporting  period.  Actual results
            could differ significantly from those estimates.

     (p)    Reclassifications

            Certain 1995 and 1996 amounts were reclassified to conform with 1997
            presentations.   Such   reclassifications   had  no  effect  on  the
            previously reported results of operations.

(2)  Investment Securities

     Investment  securities held as  available-for-sale as of March 31, 1997 are
     as follows (fair value approximates amortized cost):
<TABLE>
     <S>                                               <C>
     U.S. Treasury securities                          $  2,454
     Mortgage-backed securities                             500
     Other interest bearing securities                    1,000
                                                       --------
                                                       $  3,954
                                                       ========
</TABLE>
     Proceeds from the sales and maturities of investment  securities  classifed
     as available for sale amounted to $6,873 in 1997.  Gross realized gains and
     losses on the disposal of investment  securities available-for-sale  during
     1997 totaled $25  and  nil,  respectively.  At March  31,  1997,  scheduled
     maturities for investment securities classified as available- for-sale were
     less than twelve months for $1,000 and between twelve and twenty months for
     $2,954.

(3)  Inventories

     Inventories consists of the following as of March 31, 1997 and 1996:
<TABLE>
<CAPTION>
                                                       1997        1996
                                                     --------    --------
     <S>                                             <C>         <C>
     Raw materials                                   $   166     $    73
     Work in process                                     362         200
     Finished goods                                      346         105
     Supplies                                            264         116
                                                     --------    --------
                                                     $ 1,138     $   494
                                                     ========    ========
</TABLE>
                                      F-10
<PAGE>
(4)  Equipment and Leasehold Improvements, Net

     Equipment and leasehold  improvements consists of the following as of March
     31, 1997 and 1996:
<TABLE>
<CAPTION>
                                                       1997        1996
                                                     --------    --------
     <S>                                             <C>         <C>
     Equipment                                       $ 5,715     $ 3,538
     Leasehold improvements                           10,935       6,815
     Furniture and fixtures                               67          36
     Equipment under capital lease                       602         602
                                                     --------    --------
                                                      17,319      10,991
     Less accumulated depreciation and
          amortization                                (3,729)     (3,038)
     Construction in-progress                          1,076         396
                                                     --------    --------

     Equipment and leasehold improvements, net       $14,666     $ 8,349
                                                     ========    ========
</TABLE>

(5)  Long-Term Debt and Bank Lines of Credit

     Long-term Debt

     Long-term debt consists of the following as of March 31, 1997 and 1996:
<TABLE>
<CAPTION>
                                                           1997        1996
                                                         --------   ---------
     <S>                                                <C>        <C>
     Notes payable  at  the  London  Interbank  
          Offered  Rate  (LIBOR)  plus  2%,
          adjusted quarterly; principal payments of 
          $37.5 due quarterly, plus interest            $   513    $    663

     Less current maturities of long-term debt             (150)       (150)
                                                        --------   ---------

     Long-term debt, excluding current maturities       $   363    $    513
                                                        ========   =========
</TABLE>
     On April 1, 1995,  the Company  executed a $250 note,  payable in principal
     installments  of $12.5 each quarter  through April 1, 2000,  plus interest,
     with principal and interest payments  satisfied by delivering to the lender
     an  equivalent  market  value  amount of  salable  product  or cash (at the
     lender's  option).  The note  payable  bears  interest  at  LIBOR  plus 2%,
     adjusted quarterly, and is secured by certain production equipment.

     On July 11, 1995,  the Company  executed a $500 note,  payable in principal
     installments of $25 each quarter through July 1, 2000, plus interest,  with
     principal  and interest  payments  satisfied by delivering to the lender an
     equivalent  market value amount of salable product or cash (at the lender's
     option).  The  note  payable  bears  interest  at LIBOR  plus 2%,  adjusted
     quarterly, and is secured by certain leasehold improvements.

                                      F-11
<PAGE>

     Bank lines of credit

     As of March 31, 1997,  the Company has  available  two bank lines of credit
     aggregating  $2,000,  both expiring on January 31, 1998,  collateralized by
     investment  securities  and other  assets of the  Company.  As of March 31,
     1997, there were no borrowings under either of these credit lines.


(6)  Leases

     The Company leases certain  equipment and a portable building under capital
     leases expiring between 1998 and 2000, and leases facilities, equipment and
     land under operating  leases  expiring  between 1997 and 2025. At March 31,
     1997, the net book value of equipment  under the capital leases amounted to
     $472.

     Future minimum lease payments under non-cancelable operating leases and the
     present value of future minimum capital lease payments as of March 31, 1997
     are as follows:
<TABLE>
<CAPTION>
                                           Capital leases    Operating leases
                                           ---------------   ----------------
<S>                                        <C>               <C>
     Year ending March 31:
         1998                             $          152    $            117
         1999                                        142                 114
         2000                                         68                 112
         2001                                         --                 112
         2002                                         --                 112
         Thereafter, through 2025                     --               2,659
                                          ---------------   ----------------

     Total minimum lease payments                    362    $          3,226
                                                            ================
     Less amount representing interest
        (at rates ranging from 7% to 19%)             36
                                          ---------------
     Present value of net minimum
        capital lease payments                       326

     Less current maturities of
        capital lease obligations                    130
                                          --------------
     Obligations under capital lease,
        excluding current maturities      $          196
                                          ==============
</TABLE>
     Total rent expense under  operating  leases  amounted to $138, $89, and $48
     for the years ended March 31, 1997, 1996, and 1995, respectively.

(7)  Investment in Joint Venture

     On August 31, 1994,  the Company  formed a joint venture  partnership  with
     Hauser Chemical Research,  Inc. ("Hauser") to develop,  produce, and market
     natural beta carotene. On July 1, 1996, the joint venture was terminated by
     mutual consent.  Under the terms of the termination  agreement,  Hauser had
     until  March  31,  1997 to  acquire  a license  to use the  Company's  beta

                                      F-12
<PAGE>

     carotene  technology.  The  consideration  for  the  license  was to be the
     payment  of  aggregate  out-of-pocket  research  and  development  expenses
     incurred  by the  Company on behalf of the joint  venture  since  August 1,
     1994, which totaled $380. Prior to March 31, 1997, the Company was informed
     by Hauser that it would not acquire the Cyanotech  technology license.  All
     research  and  development  costs  incurred by the Company on behalf of the
     joint venture were expensed as incurred.

(8)  Series C Preferred Stock

     Series C preferred  stock is  convertible  into common stock at the rate of
     one share of  preferred  stock for five  shares  of  common  stock  through
     February 23,  2000,  after which date the  conversion  feature is no longer
     applicable.  Series C preferred stock has voting rights equal to the number
     of shares of common stock into which it is convertible and has a preference
     in  liquidation  over all other series of  preferred  stock of $5 per share
     plus any  accumulated but unpaid  dividends.  Holders of Series C preferred
     stock are entitled to 8%  cumulative  annual  dividends at the rate of $.40
     per share;  cumulative  dividends in arrears as of March 31, 1997 amount to
     $2,251  ($3.063 per share).  Upon  conversion of Series C preferred  stock,
     cumulative  dividends in arrears on converted shares are no longer payable.
     The amount of cumulative  dividends  foregone due to conversion  during the
     year  ended  March 31,  1995 was $36.  The  consent  of Series C  preferred
     stockholders  is required  to modify  their  present  rights or sell all or
     substantially all of the Company's assets.

     The Series C  convertible  preferred  stock was  originally  issued  with a
     redemption feature.  Terms of the Series C preferred stock were modified in
     February 1991 to eliminate such redemption feature.

     Preferred stock as of March 31, 1997 and 1996 consists of the following:
<TABLE>
<CAPTION>
                                                         1997          1996
                                                      ----------    ----------
     <S>                                             <C>           <C>
     Preferred stock, authorized 5,000,000
         shares; $.001 par value, issued and
         outstanding:
            Series C, 8% cumulative,  convertible;  
              734,977 shares;  liquidation
              value $5.00 per share plus unpaid
              accumulated dividends                  $       1     $       1
                                                     ==========    ==========
</TABLE>

(9)  Stock Options and Warrants

     Stock options

     At the Company's annual meeting held on August 9, 1995, the stockholders of
     the  Company  approved  the  Company's  1995 Stock  Option  Plan (the "1995
     Plan"),  reserving a total of 400,000  shares of common  stock for issuance
     under the Plan.  The 1995 Plan provides for the issuance of both  incentive
     and non-qualified stock options.  Options are to be 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.

     The Company also has a  Non-employee  Director Stock Option and Stock Grant
     Plan,  which was approved by stockholders in 1994 (the "1994 Plan").  Under
     the  1994  Plan  and  upon election to the Board of Directors, non-employee
     directors are granted a ten-year option to purchase 3,000

                                      F-13
<PAGE>

     shares of the  Company's  common stock at its fair market value on the date
     of grant.  In addition,  on the date of each Annual Meeting of Stockholders
     in each year that the 1994 Plan is in effect,  each  non-employee  director
     continuing in office will be automatically granted, without payment,  2,000
     shares of common stock  that is  non-transferable for six months  following
     the date of grant.  Grants of 6,000 and 8,000  shares of common  stock were
     made under the 1994 Plan in  September 1996 and  August 1995, respectively.
     Expense  recognized  as  a result of these stock grants amounted to $37 and
     $40 for the years ended March 31, 1997 and 1996, respectively.

     In 1985,  the Company  adopted an Incentive  Stock  Option Plan  (qualified
     stock option plan) and authorized  200,000 shares of common stock to be set
     aside for grants to officers and key employees of the Company. In 1993, the
     stockholders approved an amendment to the Incentive Stock Option Plan which
     increased the number of shares  reserved for issuance  under this plan from
     200,000 to 400,000.  Options were granted  with  exercise  prices not lower
     than the fair market  value of the  Company's  common  stock at the date of
     grant.   Options   generally  became   exercisable  in  four  equal  annual
     installments, commencing one year from the date of grant and expire, if not
     exercised,  five years from the date of grant, unless stipulated  otherwise
     by the  Compensation  and Stock Option Committee of the Board of Directors.
     The  Incentive  Stock Option Plan  terminated  on March 18,  1995.  Options
     granted prior to the plan termination date are not affected.

     At March 31, 1997, there were 142,100 additional shares available for grant
     under the 1995 Plan and 71,000  additional  shares available under the 1994
     Plan. The per share  weighted-average  fair value of stock options  granted
     during  1997 and 1996 was $6.02  and  $3.90 on the date of grant  using the
     Black  Scholes  option-pricing  model with the  following  weighted-average
     assumptions:  1997 - expected  dividend  yield of 0%, a risk-free  interest
     rate of 6.6%,  expected  volatility  of 130%,  and an expected  life of 4.1
     years;  1996 - expected  dividend yield of 0%,  risk-free  interest rate of
     6.2%, expected volatility of 110%, and an expected life of 4.3 years.

     The  Company  applies  APB  Opinion  No.  25  in  accounting  for  employee
     stock-based  compensation and,  accordingly,  no compensation cost has been
     recognized  for its employee  stock options in the  accompanying  financial
     statements.  Had the Company determined compensation cost based on the fair
     value at the grant date for its employee  stock options under SFAS No. 123,
     the  Company's  net income and net income per common  share would have been
     reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
                                                       1997          1996
                                                     --------      --------
     <S>                                             <C>           <C>
     Net income                As reported           $ 4,159       $ 2,509
                               Pro forma             $ 3,738       $ 2,408
     Net income
       per common share        As reported             $0.25         $0.17
                               Pro forma               $0.23         $0.17
</TABLE>
     Pro forma net income and net income per common share  reflects only options
     granted  during 1997 and 1996.  Therefore,  the full impact of  calculating
     compensation  cost for stock options under SFAS No. 123 is not reflected in
     the pro forma net income and net income per common share amounts  presented
     above  because  compensation  cost is reflected  over the options'  vesting
     period of 5 years, and compensation cost for options granted prior to April
     1, 1995 is not considered.

                                      F-14
<PAGE>

     Stock option activity during the periods indicated is as follows:
<TABLE>
<CAPTION>
                                                                    Weighted-
                                                                      average
                                                Number               exercise
                                             of shares                  price
                                             ---------              ---------
     <S>                                      <C>                      <C>
     Balance at March 31, 1994                223,000                  $1.00
        Granted                               213,900                   1.45
        Exercised                              (4,300)                   .74
        Forfeited                             (23,900)                  1.08

     Balance at March 31, 1995                408,700                   1.23
        Granted                               101,000                   5.13
        Exercised                             (82,625)                   .92
        Forfeited                              (7,375)                  1.03

     Balance at March 31, 1996                419,700                   2.24
        Granted                               166,000                   7.30
        Exercised                             (57,912)                   .85
        Forfeited                            (107,400)                  1.31
                                             ---------             ---------
     Balance at March 31, 1997                420,388                  $4.42
                                             =========             =========
</TABLE>
     The following table summarizes  information about stock options outstanding
     at March 31, 1997:
<TABLE>
<CAPTION>
                              OPTIONS OUTSTANDING           OPTIONS EXERCISABLE
                ------------------------------------     ----------------------
                              Weighted-avg.  Weighted-                Weighted-
    Range of          Number      remaining       avg.        Number       avg.
    exercise     outstanding    contractual   exercise   exercisable   exercise
     prices       at 3/31/97           life      price    at 3/31/97      price
--------------  ------------  -------------  ---------   -----------  ---------
<S>                   <C>       <C>             <C>           <C>       <C>
    $0.56             27,550    0.2 years       $0.56         27,550    $0.56
$.94 to $1.38         76,975    2.5 years       $0.95         39,987    $0.97
    $1.50             55,363       1 year       $1.50         55,363    $1.50
$5.13 to $7.63       260,500    3.8 years       $6.47         47,800    $5.82
                     -------                                 -------
$.56 to $7.63        420,388      3 years       $4.42        170,700    $2.43
                     =======                                 =======
</TABLE>

     Warrants

     At March 31, 1997, the Company has warrants  outstanding to acquire 132,880
     shares  of  the  Company's  common  stock.  The  warrants  were  issued  in
     consideration  for  loans  to the  Company,  in  consideration  for  and in
     recognition of services performed and to certain individuals who guaranteed
     notes  payable by the  Company.  Warrants  granted for loans,  services and
     guarantees were granted with exercise prices not lower than the fair market
     value of the Company's  common stock on the date of grant. The warrants are
     exercisable  at prices  ranging  from $.40 to $1.00 per share and expire on
     various dates from May 1997 to September 1999. Warrants to acquire 

                                      F-15
<PAGE>

     668,120,  891,200 and  38,400  shares  of  common  stock  were exercised at
     average prices of $.45, $.57 and $.63 in 1997, 1996 and 1995, respectively.

(10) Major Customers and Export Sales

     Sales to major  customers for the years ended March 31, 1997, 1996 and 1995
     are summarized as follows (percent of product sales):
<TABLE>
<CAPTION>
                                          1997          1996          1995
                                       ----------    ----------    ----------
     <S>                                <C>           <C>           <C>
     Customer A                             34%           29%            *
     Customer B                              *            11%          17%
     Customer C                              *             *           13%
                                       ----------    ----------    ----------
                                             34%           40%          30%
                                       ==========    ==========    ==========
</TABLE>
     *Less than 10% of product sales.

     Net product  sales by  geographic  area for the years ended March 31, 1997,
     1996 and 1995 are summarized as follows:
<TABLE>
<CAPTION>
                               1997               1996              1995
                         -------------      -------------      -------------
     <S>                 <C>       <C>      <C>       <C>      <C>       <C>
     United States       $ 4,303   38%      $ 3,614   45%      $ 2,412   58%
     Canada                  851    8%          896   11%          696   17%
     Europe                1,292   11%          747    9%          621   15%
     China                 3,905   34%        2,375   29%          125    3%
     Asia/Pacific,
        excluding China    1,048    9%          449    6%          296    7%
                         -------  ----      -------  ----      -------  ----
                         $11,399  100%      $ 8,081  100%      $ 4,150  100%
                         =======  ====      =======  ====      =======  ====
</TABLE>
     All foreign product sales transactions are consummated in U.S. dollars.

                                      F-16
<PAGE>

(11) Income Taxes

     The components of income  taxes are as follows for the year ended March 31,
     1997:
<TABLE>
<CAPTION>
                               Federal       State         Total
                             ----------   ----------    ----------
     <S>                     <C>           <C>            <C>
        Current              $     138    $     235     $     373
        Deferred                  (352)         (21)         (373)
                             ----------   ----------    ----------
                             $    (214)   $    (214)    $      --
                             ==========   ==========    ==========
</TABLE>
     The  provision for income taxes for the years ended March 31, 1997 and 1996
     was nil due to the utilization of net operating loss carryforwards.

     A  reconciliation  of the amount of income  taxes  computed  at the federal
     statutory rate of 34% to the amount provided in the Company's  consolidated
     statements  of income for the years  ended  March 31,  1997,  1996 and 1995
     areas follows:
<TABLE>
<CAPTION>
                                                 1997        1996        1995
                                              ---------  ---------   ---------
     <S>                                      <C>         <C>         <C>
     Amount at the federal
          statutory income tax rate           $  1,414    $   853     $    261
     State income taxes, net of
          federal income tax effect                141         --           --
     Benefit of operating loss
          carryforwards                         (1,328)      (853)        (261)
     Change in the beginning-of-the-year
          balance of the valuation
          allowance for deferred tax assets       (213)        --           --
     Other                                         (14)        --           --
                                              ---------   ---------   ---------
                                              $     --    $    --     $     --
                                              =========   =========   =========
</TABLE>
     The  significant  components  of  deferred  income tax benefit for the year
     ended March 31, 1997 are as follows:
<TABLE>
        <S>                                                         <C>
        Deferred tax benefit, exclusive of the change in             
             beginning-of-the-year valuation allowance balance
        Decrease in beginning-of-the-year balance of the            $   (160)
             valuation allowance for deferred tax assets                (213)
                                                                    ----------
                                                                    $   (373)
                                                                    ==========
</TABLE>
                                      F-17
<PAGE>

     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, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
                                                       1997           1996
                                                     ---------      ---------
     <S>                                             <C>            <C>
     Deferred tax assets:
         Net operating loss carryforwards            $     99       $   1,427
         Tax credit carryforwards                         301             147
         Other                                            145             169
                                                     ---------      ----------
                Gross deferred tax assets                 545           1,743
         Less valuation allowance                        (134)         (1,675)
                                                     ---------    ------------
                Net deferred tax assets                   411              68

     Deferred tax liability - equipment and
         leasehold improvements                           (38)            (68)
                                                     =========    ============
                Net deferred tax asset               $    373     $        --
                                                     =========    ============
</TABLE>
     The valuation  allowance for deferred tax assets as of April 1, 1996,  1995
     and 1994  was  $1,675,  $2,751  and  $3,051,  respectively.  The  valuation
     allowance decreased by $1,541, $1,076 and $300 during the years ended March
     31, 1997, 1996 and 1995,  respectively.  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  which the net deferred tax assets
     are deductible,  management believes it is more likely than not the Company
     will  realize the  benefits  of these  deductible  differences,  net of the
     existing valuation  allowance at March 31, 1997. The amount of the deferred
     tax asset considered realizable, however, could be reduced in the near term
     if estimates of future  taxable income during the  carryforward  period are
     reduced.

                                      F-18
<PAGE>

     At March 31, 1997, the Company has tax net operating tax loss carryforwards
     available to offset future  federal and state taxable income and tax credit
     carryforwards available to offset future federal income taxes as follows:
<TABLE>
<CAPTION>
                           Net                     Research and
          Expires    operating    Investment    experimentation
         March 31,      losses    tax credits       tax credits
         ---------    ---------    -----------   ---------------
           <S>        <C>          <C>           <C>
           1998       $      --    $        --   $             3
           1999              --             --                14
           2000              --             14                15
           2001              --             --                22
           2002              --             --                15
           2003              --             --                52
           2004              --             --                 5
           2005             292             --                --
           2011              --             --                23
                      ---------    -----------    --------------
                      $     292    $        14    $          149
                      =========    ===========    ==============
</TABLE>

     In addition,  at March 31, 1997,  the Company has  alternative  minimum tax
     credit  carryforwards of  approximately  $138 which are available to reduce
     future federal regular income taxes, over an indefinite period.

     Investment tax credits will be recorded as a reduction of the provision for
     federal income taxes in the year realized.

(12) Fair Value of Financial Instruments

     SFAS  Statement  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.  Note 2 presents  the  estimated  fair values of
     investment securities.

     The following  methods and assumptions were used to estimate the fair value
     of each class of financial instruments as of March 31, 1997:

     Cash and Cash Equivalents

     The  carrying  amounts  approximate  fair value  because of the  short-term
     nature of these instruments.

     Long-Term Debt

     The carrying amounts approximate fair value because the instruments reprice
     at market rates on a quarterly basis.

                                      F-19
<PAGE>

(13) Profit Sharing Plan

     The Company  sponsors a 401(k) profit  sharing plan for all  associates not
     covered under a separate management incentive plan. Under the 401(k) profit
     sharing plan, 5% of pre-tax  profits are allocated  based on gross wages to
     non-management  associates  on a  quarterly  basis.  Fifty  percent of each
     associate's  profit  sharing bonus is  distributed  in cash on an after-tax
     basis, the remainder is deposited in each  associate's  401(k) account on a
     pre-tax basis with a six year vesting  schedule,  based on years of service
     with  the  Company.   All  associates  can  also  make  voluntary   pre-tax
     contributions  to their 401(k) account.  Compensation  expense  relative to
     this plan  amounted to $219,  $132 and nil for years ended March 31,  1997,
     1996 and 1995, respectively.

(14) Commitments and Contingencies

     At March 31,  1997,  the Company has entered into  commitments  for capital
     expenditures totaling $903.

     The Company is involved in various claims arising in the ordinary course of
     business.  In the opinion of management,  the ultimate disposition of these
     matters  will  not  have  a  material   adverse  effect  on  the  Company's
     consolidated financial position, results of operations or liquidity.

                                      F-20