**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D. C. 20549**

**FORM 10-K**

**ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

**For the Fiscal Year Ended March 31,2007**

**CommissionFile Number 0-146-02**

**CYANOTECH CORPORATION**

(Exact name of registrantas specified in its charter) 

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

 

Registrant’s telephonenumber, including area code:  **(808) 326-1353**

| Securities registered pursuant to  Section 12(b) of the Act: |   | Name of each exchange  on which registered: |
|------------------------------------------------------------------------|--------|---------------------------------------------|
| **None**                                                               |   | **NASDAQ  Capital Market**                  |

 

Securities registeredpursuant to Section 12(g) of the Act:

**Common Stock, $.02 par value**

(Title of Class)

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act.     o Yes    x No

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act.     o Yes    x No

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days.  x Yes  o No

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 ofRegulation S-K (§229.405 of this chapter) is not contained herein, andwill not be contained, to the best of registrant’s knowledge, in definitiveproxy or information statements incorporated by reference in Part III ofthis Form 10-K or any amendment to this Form 10-K.     x

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the ExchangeAct. (Check one):

| Large accelerated filer o |   | Accelerated  filer o |   | Non-accelerated filer x |
|--------------------------------|--------|---------------------------|--------|------------------------------|

 

Indicated by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Act).  o Yes  x No

The aggregate market value of the Registrant’s CommonStock held by non-affiliates of the Registrant on July 30, 2007 wasapproximately $5,113,000 based on the closing sale price of the Common Stock onthe NASDAQ Capital Market on that date.

Number of shares outstanding of Registrant’s CommonStock at July 30, 2007 was 5,233,520.

**DOCUMENTS INCORPORATED BY REFERENCE**

None

 

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**TABLEOF CONTENTS**
| Item       | ** ** | ** **                                                                                      | ** ** | ** ** | ** ** | ** ** |
|------------|------------|-------------------------------------------------------------------------------------------------|------------|------------|------------|------------|
| ** ** | ** ** | **PART I**                                                                                 | ** ** | ** ** |
|       |       | Discussion of  Forward-Looking Statements                                                       |       |       |
| 1.         |       | Business                                                                                        |       | 3          |
| 1A.        |       | Risk Factors                                                                                    |       | 11         |
| 2.         |       | Properties                                                                                      |       | 16         |
| 3.         |       | Legal Proceedings                                                                               |       | 16         |
| 4.         |       | Submission of Matters to a  Vote of Security Holders                                            |       | 16         |
| ** ** | ** ** | **PART II**                                                                                | ** ** | ** ** |
| 5.         |       | Market for Registrant’s  Common Equity and Related Stockholder Matters.                    |       | 17         |
| 6.         |       | Selected Financial Data                                                                         |       | 19         |
| 7.         |       | Management’s Discussion and  Analysis of Financial Condition and Results of Operations     |       | 19         |
| 7A.        |       | Quantitative and Qualitative  Disclosures About Market Risk                                     |       | 31         |
| 8.         |       | Financial Statements and  Supplementary Data                                                    |       | 32         |
| 9.         |       | Changes in and Disagreements  with Accountants on Accounting and Financial Disclosure           |       | 53         |
| 9A.        |       | Controls and Procedures.                                                                        |       | 53         |
| 9B.        |       | Other Information                                                                               |       | 54         |
| ** ** | ** ** | **PART III**                                                                               | ** ** | ** ** |
| 10.        |       | Directors and Executive  Officers of the Registrant                                             |       | 54         |
| 11.        |       | Executive Compensation                                                                          |       | 57         |
| 12.        |       | Security Ownership of  Certain Beneficial Owners and Management and Related Stockholder Matters |       | 62         |
| 13.        |       | Certain Relationships and  Related Transactions                                                 |       | 63         |
| 14.        |       | Principal Accountant Fees  and Services.                                                        |       | 63         |
| ** ** | ** ** | **PART IV**                                                                                | ** ** | ** ** |
| 15.        |       | Financial Statement  Schedules and Exhibits                                                     |       | 64         |
| 16.        |       | Signatures                                                                                      |       | 69         |

 

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**PART I**

*This Form 10-Kshould be read in conjunction with the Company’s Form 10-K/A for thefiscal year ended March 31, 2006 filed February 14, 2007. Priorperiod comparative information contained in this Form 10-K has beenrestated consistent with the Company’s Form 10-K/A,  and to reflect the Company’s one-for-fourreverse stock split (see Note 2  toConsolidated Financial Statements included in Form 10-Q  for thefiscal  quarter ended December 31,2006).*

*The Company did not file Form 10-K/A, forthe fiscal years 2005 or 2004, or Form 10-Q/A, for the interimperiods affected by the restatement prior to and including December 31,2005. The consolidated financial statements and related financial informationfor such periods as previously filed, contain errors and should therefore nolonger be relied upon. The related audit reports for the years ended March 31,2005 and 2004 of KPMG LLP, the Company’s independent registered publicaccounting firm, with respect to those financial statements should also nolonger be relied upon.*

**Item 1. Business**

**General**

CyanotechCorporation is a world leader in the production of high value natural productsderived from microalgae. Incorporated in 1983, the Company is guided by theprinciple of providing beneficial, quality microalgal products for human andanimal nutrition in a sustainable, reliable and environmentally sensitiveoperation. We are ISO 9001:2000 compliant, reinforcing our commitment toquality in our products, to quality in our relationships (with our customers, suppliers,co-workers and the communities we live in), and to quality of the environmentwe work in. The Company’s products include:

·       *BioAstin®*natural astaxanthin is apowerful dietary antioxidant with expanding applications as a humannutraceutical and functional food ingredient, shown to support and maintain thebody’s natural inflammatory response, to enhance skin, muscle and joint health.

·       *NatuRose®* natural astaxanthin, is used asa feed ingredient for the aquaculture feed industry, specifically providingnatural pigmentation to aquaculture-raised shrimp, salmon, yellowtail tuna and “tai”(red sea bream), and for the animal feed industry such as in poultry feedformulations to naturally pigment the yolk of chicken eggs;

·       *Spirulina**Pacifica®*is a nutrient-rich dietary supplement used for extra energy, a strengthenedimmune system and as a source of antioxidant carotenoids;

·       Naturalphycobiliproteins are highly fluorescent pigments used as tags or markers inmany kinds of biological assays in the immunological diagnostics market.

Microalgae are a diverse group of microscopic plantsthat have a wide range of physiological and biochemical characteristics andcontain, among other things, high levels of natural protein, amino acids,vitamins, pigments and enzymes. Microalgae have the following properties thatmake commercial production attractive: (1) microalgae  grow much faster than land grown plants,often up to 100 times faster; (2) microalgae have uniform cell structurewith no bark, stems, branches or leaves, permitting easier extraction ofproducts and higher utilization of the microalgae cells; and (3) thecellular uniformity of microalgae makes it practical to manipulate and controlgrowing conditions in order to optimize a particular cell characteristic.Efficient cultivation of microalgae requires consistent light, warmtemperature, low rainfall and proper chemical balance in a very nutrient-richenvironment. If the chemical composition of a pond changes from its requiredbalance, contamination can occur from the growth of unwanted organisms.

Since 1983, we have designed, developed andimplemented proprietary production and harvesting technologies, systems andprocesses, thereby eliminating many of the stability and contamination problems

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frequently encountered inthe production of microalgae. Our production of these products at the 90-acrefacility on the Kona Coast of Hawaii provides significant advantages. Weselected the Keahole Point location in order to take advantage of theconsistent warm temperatures, abundant sunshine and low levels of rainfallneeded for optimal cultivation of microalgae. This location also offers usaccess to cold deep ocean water, drawn from an offshore depth of 2,000 feet,which we use in our patented *Ocean-ChillDrying*system to eliminate the oxidative damage caused by standarddrying techniques and as a source of trace nutrients for microalgal cultures.We believe that our technology, systems, processes and favorable growinglocation permit year-round harvest of our microalgal products in acost-effective manner.

Unless otherwiseindicated, all references in this report to the “Company,” “we,” “us,” “our,”and “Cyanotech” refer to Cyanotech Corporation and its wholly ownedsubsidiaries, Nutrex Hawaii, Inc. (“Nutrex Hawaii” or “Nutrex”), a Hawaiicorporation, and Cyanotech Japan YK (“Cyanotech Japan” or “CJYK”), a Japancorporation.

**Cyanotech’sBusiness**

TheCompany operates entirely in one operating segment, the cultivation andproduction of microalgae into high-value, high-quality natural products. TheCompany cultivates, on a large-scale basis, two microalgal species from whichour two major product lines, spirulina products and natural astaxanthinproducts, are derived. Cyanotech records revenue and cost of sales informationby product category but does not record operating expenses by such productcategory. The following table sets forth, for the three years ended March 31,2007, the net sales contributed by each of the Company’s product lines(in thousands):

| ** **                         | ** ** | **Net Sales** | ** ** |
|------------------------------------|------------|--------------------|------------|
| ** **                         | ** ** | **2007**           | ** ** | **2006** | ** ** | **2005** | ** ** |
| Spirulina products:                |       |               |       |   |   |   |   |
| *Spirulina  Pacifica*              |       | $                  | 6,090      |   | $ | 6,517 |   | $ | 6,626 |   |
| Natural astaxanthin  products:     |       |               |       |   |   |   |   |
| *NatuRose*                         |       | 1,142              |       | 1,403 |   | 1,817 |   |
| *BioAstin*                         |       | 2,354              |       | 2,967 |   | 2,855 |   |
| Other including  phycobiliproteins |       | 97                 |       | 244 |   | 147 |   |
| Total                              |       | $                  | 9,683      |   | $ | 11,131 |   | $ | 11,445 |   |

*** ***

***Spirulina Products***

Since 1985, Cyanotech has been producing a strain ofspirulina microalgae marketed as *SpirulinaPacifica.*Accounting for 63%, 59% and 58% of net sales for the yearsended March 31, 2007, 2006, and 2005, respectively, *Spirulina Pacifica*provides avegetable-based, highly absorbable source of protein, natural beta-carotene,mixed carotenoids, B vitamins, gamma linolenic acid, essential amino acids andother phytonutrients. *Spirulina Pacifica*isproduced in three forms:  powder, flakeand tablets. Powder is used as an ingredient in nutritional supplements andhealth food drinks while flakes are used as a seasoning on various foods. Tabletsare consumed as a daily dietary supplement. All three forms are sold as rawmaterial in bulk quantities and as packaged consumer products under the NutrexHawaii label.

Beginning in 1994, we have produced two grades of *Spirulina Pacifica*:  an all-natural grade cultivated by usingconventional agricultural fertilizers and an organic grade that is cultivatedusing only organic fertilizers. Our organic *SpirulinaPacifica* was grown and processed in accordance with the NationalOrganic Program of the United States Department of Agriculture (“USDA”)effective October 2002. Prior to the establishment of the USDA organicstandard, our organic standard was the California Organic Food Act of 1990. Ourorganic cultivation and processing methods were certified annually by QualityAssurance International of San Diego, California, a leading third-party agency.In its 2002 decision, the USDA 

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National OrganicsStandards Board (“NOSB”) allowed the use of certain fertilizers in organicSpirulina cultivation through October 2005, after which all cultivatorsmust find alternate sources of key nutrients in order to retain organiccertification. The Company determined that although alternative fertilizersexist, their costs are prohibitive and their use would lead to lower qualitySpirulina products. Other cultivators in the United States have reached similarconclusions. The USDA-NOSB did not extend the use of certain fertilizers fororganic Spirulina cultivation at its October 2005 meeting and the Companydiscontinued cultivating organic Spirulina and has converted all Spirulinacultivation to “all natural”. The Company does not expect this decision to havea material effect on overall sales of our Spirulina Pacifica products. TheCompany’s all natural *Spirulina Pacifica*iscertified Kosher by Organized Kashrus Laboratories of Brooklyn, New York and iscultivated without the use of herbicides or pesticides.

In March 2003, Cyanotech and EarthriseNutritionals, Inc. of Petaluma, California submitted a joint notice to theUnited States Food and Drug Administration (“FDA”) reporting theirdetermination, through scientific procedures, that the spirulina cultivated byboth companies is GRAS (generally recognized as safe) for addition to a varietyof foods. In November 2003, the FDA concluded the notification procedureby written response that it had no questions about the companies’ determinationthat spirulina is GRAS for addition to a variety of foods.

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

Continuing theproduction process, the Spirulina crop in each pond is circulated bypaddlewheels to keep an even blend of nutrients in suspension and a uniformexposure of the algae to sunlight. Our ponds are engineered to maintain theright media depth for sunlight to permeate each crop completely, facilitatingrapid growth. The design of our cultivation ponds promotes efficient growingconditions, allowing the *Spirulina Pacifica*algae to reproduce rapidly. Each pond can be harvested, on average, in sixdays. As sunlight is a major component of cultivation, production can beimpacted by seasonality changes during the winter months, with shorteneddaylight hours and potential inclement weather.

Once readyfor harvest, some 70% of the Spirulina algae are pumped from a pond throughunderground pipes to our processing building where the crop is separated fromthe culture media by stainless steel screens. The remaining culture serves asan inoculum for the next growth cycle. Harvested Spirulina is washed with freshwater and vacuum filtered before moving to the drying stage. Culture mediaseparated from Spirulina algae during processing are conserved and recycled.Recycled media are refortified with nutrients before being returned to theculture ponds for another cycle of cultivation. Our *Integrated Culture Biology Management*(“ICBM”) technologyfor microalgae cultivation has proven to be a reliable and stable operatingenvironment, allowing us to grow and harvest Spirulina without significantcontamination by unwanted microorganisms and without associated loss ofproductivity.

*SpirulinaPacifica* powder is dried via our patented low-oxygen *Ocean-Chill Drying* process, therebypreserving high levels of antioxidant carotenoids and other nutrients sensitiveto heat and oxygen. This 

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process also allows us torecover carbon dioxide from our drying system gas to be reused as a rawmaterial back in our growing ponds. The drying process takes about six secondsand results in a dark green powder. Spirulina powder is difficult to form intotablets. Most tablet manufacturers either add high amounts (from 10% to 30%) ofinert substances to “glue” the tablet together or use a heat granulationprocess that destroys nutrients. In contrast, our *Spirulina Pacifica*tablets contain a maximum of 2% of suchsubstances and are produced in cold press compression tablet-making machines.Our *Spirulina Pacifica* flakes areproduced by combining freshly harvested *SpirulinaPacifica*with food-grade lecithin and drying this blend in aproprietary system.

Each production lot of *Spirulina Pacifica* is sampled and subjected to thoroughquality control analyses including testing for moisture, carotenoids, minerals,color and taste, among others. Further, each lot of our *Spirulina Pacifica* undergoes a prescribedset of microbiological food product tests, including total aerobic bacteria,coliform bacteria and E. coli. The *SpirulinaPacifica* powder, tablets and flakes are vacuum-sealed inoxygen-barrier foil laminate bags along with a packet of oxygen absorbent. Thispackaging ensures product freshness and extends the shelf life of bulk *Spirulina Pacifica*products. The Company’spackaged consumer products are bottled and labeled by two contractors inCalifornia. These contractors are Kosher certified and subject to regulargovernment inspections. Such packaging services are readily available frommultiple sources.

The majority of our bulk Spirulina sales are to healthfood manufacturers and formulators with their own Spirulina product lines, manyof whom identify and promote Cyanotech’s Hawaiian *Spirulina Pacifica*in their products. Such customerspurchase bulk powder or bulk tablets and package these products under theirbrand label for sale to the health and natural food markets. Many of the brandsproduced by these customers are marketed and sold domestically in directcompetition with the packaged consumer products sold through our Nutrex Hawaiisubsidiary. Nutrex Hawaii packaged consumer products are sold through anestablished health food distribution network in the domestic market and shippedthrough one of our wholesale distributors. In selected foreign markets, we haveexclusive sales distributors for both our bulk and packaged consumer products.

Our *SpirulinaPacifica* products compete with a variety of vitamins, dietarysupplements, other algal products and similar nutritional products available toconsumers. The nutritional products market is highly competitive and includesinternational, national, regional and local producers and distributors, many ofwhom have greater resources than Cyanotech and many of whom offer a greater varietyof products. Our direct competition in the Spirulina market is currently fromDainippon Ink and Chemical Company’s Earthrise facility in California andseveral farms in China. Other competitors include numerous smaller farms inChina, India, Thailand, Taiwan, Cuba, South Africa and South America. Themarket for Spirulina is mature with slow growth expected in future periods. Inthis mature market, the Company has experienced increased price competition dueto more Spirulina suppliers as well as a larger portion of sales coming frombulk product orders whose customers generally treat these products ascommodities with price being the major determining factor driving theirpurchasing decision. As one of the largest producers of Spirulina, ourchallenge is to increase our market share among customers who seek thehigh-quality products we produce while concurrently adjusting our product mixto meet our revenue targets.

As of March 31, 2007,the backlog of orders for all Spirulina products totaled approximately $432,000and the majority of these orders were filled in the first quarter of fiscal2008. Such backlogs at the end of fiscal 2006 and 2005 were $448,000 and$661,000 respectively.

***Natural*******Astaxanthin Products**

The Company commenced commercial production of naturalastaxanthin in early 1997 with the introduction of *NatuRose* to the aquaculture market. Astaxanthin is a redpigment used in the aquaculture market primarily to impart a pink to red colorto the flesh of commercially raised fish and shrimp but also 

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has been found to beessential for their proper growth and survival. Since its introduction, severalfeeding trials have been performed by our customers and potential customersthat prove the efficacy of *NatuRose*asan alternative to the petrochemical-based synthetic astaxanthin presently usedby most aquaculture companies. The appeal of our product is that it is derivedfrom a natural source and produces results that are comparable, or in somecases superior, to synthetic astaxanthin. Sold in bulk quantities as a powder, *NatuRose*sales accounted for 12%, 13% and16% of net sales for the years ended March 31, 2007, 2006 and 2005,respectively.

In 1999, our natural astaxanthin product for the humannutrition market, *BioAstin,*wasintroduced. *BioAstin*salesaccounted for 24%, 27% and 25% of net sales for the years ended March 31,2007, 2006 and 2005, respectively. *BioAstin*isproduced in three forms: a liquid lipid extract, gelcaps and microencapsulated “beadlets”with all three forms sold in bulk quantities. *BioAstin*gelcaps are also sold in packaged consumer form under the NutrexHawaii label. A growing body of scientific literature is suggesting that thebeneficial antioxidant properties of natural astaxanthin may surpass many ofthe antioxidant properties of vitamin C, vitamin E, beta-carotene and othercarotenoids. Independent scientific studies indicate that in certain models,natural astaxanthin has up to 550 times the antioxidant activity of vitamin Eand 10 times the antioxidant activity of beta-carotene.

The Company produces natural astaxanthin from *Haematococcus pluvialis* microalgae grownin fresh water supplemented with nutrients. As these algae are extremelysusceptible to contamination by unwanted algae, protozoa and amoebae, theCompany developed a proprietary system known as the *PhytoDome Closed Culture System*or *PhytoDome CCS*to overcome this problem*.*Using these large-scalephotobioreactors, we are able to grow consistently large volumes ofcontaminant-free *Haematococcus*culture. Raw materials and nutrients for our natural astaxanthin productionshare the same sourcing constraints and pricing risks as those existing in ourSpirulina production. Fresh water is critical to the production of our naturalastaxanthin and is supplied by the County of Hawaii. While the Company has notexperienced any constraint on fresh water availability to date, availabilitycould be impacted by a significant population growth in the region as well asthroughput constraints on the water delivery infrastructure. The Company hasmet with officials of the County of Hawaii to assess the fresh water situationand evaluate the probability of future risks. The Company recycles fresh waterin its production process where possible and continues to explore furtherrecycling opportunities. However, there is no guarantee that these efforts willresult in significant changes to our fresh water utilization.

For the final stage of cultivation, the *Haematococcus*algae is transferred to openponds where an environmental stress is applied causing the algae to form sporeswhich accumulate high levels of astaxanthin. Once ready for harvest, the mediacontaining these spores is transported through underground pipes to ourastaxanthin processing building where the culture media and algal spores areseparated. Fresh water recovered from this stage of processing may be recycledfor further use in cultivation. The harvested algal spores are dried to a finepowder. During processing, the spores are cracked in a proprietary system toassure high bioavailability of astaxanthin. Each production lot of astaxanthinis sampled and tested for astaxanthin concentration. Finally the bulk powder isvacuum-sealed in oxygen-barrier foil laminate bags along with a packet ofoxygen absorbent.

Unlike Spirulina, astaxanthin is produced in abatch-mode and each cultivation pond must be completely drained and thoroughlycleaned between cycles. While the entire astaxanthin production cycle takes atotal of four weeks, each stage of the four-step process is staggered andcontinuously feeds the next stage of cultivation. As a result, we are currentlyable to produce a new crop of astaxanthin from each of our 500,000 literculture ponds approximately once per week. Pond cultivation can be negativelyimpacted seasonally with shortened daylight hours and potential inclementweather in winter months.

Natural astaxanthin for human consumption is processedfurther utilizing a high-pressure extraction process. The resulting product isa lipid extract insoluble in water used for the production of gelcaps. This 

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product can also bemicro-encapsulated into “beadlets” which our customers use in otherformulations. All natural astaxanthin products destined for human consumptionundergo a prescribed set of microbiological food product tests to ensure safetyand quality. The Company uses third party contractors for the extractionservices, the production of gelcaps and the production of beadlets. Althoughthese services are available only from a limited number of sources, we have theability to use other parties if any of the current contractors becomeunavailable; however, there is no assurance that the pricing from a newcontractor will be comparable to current negotiated pricing. In addition, a newcontractor would have to pass the Company’s qualification process ensuringquality standards can be met or exceeded. If the pricing, for any of theseservices, significantly increases, this could have a material adverse effect onour business, financial condition and results of operations.

*NatuRose*is sold through a network of agents and distributorsprimarily as feed to manufacturers and farmers in the aquaculture industry.Japan is one of our primary markets for the application of *NatuRose*in aquaculture and was a majorfactor in our decision to establish Cyanotech Japan as a channel ofdistribution. Although, as discussed and reported previously, sales in Japanhave decreased in recent years, but Japan remains a primary *NatuRose*market from which sales are expected to remain animportant part of our business*.*In addition, *NatuRose*is sold to poultry feedformulators as a natural pigment for the yolk of chicken eggs and also toformulators of feeds for commercial breeding of high-value tropical fish. Asour product is a natural astaxanthin, many of these formulators identify *NatuRose* by name as a component of theirfeed. While the Company has taken action to diversify its market for *NatuRose* in selected markets in Europe and new aquaculturemarkets in Japan, it is focusing less effort on sales of *NatuRose*and more effort on sales of *Bioastin.*

The animal nutrition astaxanthin market is currentlydominated by Royal DSM of the Netherlands (“Royal DSM”). Royal DSM purchased F.Hoffmann-LaRoche’s division of vitamins and fine chemicals, including theirsynthetic astaxanthin operation, in 2003. *NatuRose*competes with the synthetic astaxanthin products derived frompetrochemicals as well as other natural astaxanthin products derived from othernatural sources such as *Phaffia*yeastand Paracoccus bacteria. Although synthetic astaxanthin has widespread use as apigmentation source in commercial aquaculture, independent scientific analysisand feeding trials have shown that the molecular structure of the astaxanthinderived from the *Haematococcus*microalga more closely resembles the astaxanthin obtained naturally by fish inthe wild. With the continued growth in the world aquaculture industry and thegrowing propensity towards “natural” alternatives, we believe *NatuRose*can compete against otherproducts on the basis of its natural state, performance and price.

While the positive effects of astaxanthin inaquaculture have been recognized for years, the potential benefits ofastaxanthin to human health are still emerging. As natural astaxanthin is oneof the most potent and bioactive biological antioxidants found in nature, thenumber of potential roles of natural astaxanthin for human health is growing.Much research has been published in recent years on the beneficial roles ofantioxidants in our health, in the aging process and on specific healthconditions. The full efficacy of *BioAstin*asa human nutraceutical supplement requires further significant clinical study.The Company, to contain costs, did not spend significant amounts on clinicaltrials over the past two fiscal years. Independent antioxidant research andprior clinical trials show promising human applications. The Company holdsthree United States patents relating to the usage of *BioAstin*in the treatment of Carpal Tunnel Syndrome, thetreatment of canker/cold sores and for its use as a topical and oral sunscreen.

*BioAstin*is sold in liquid lipid form as a raw ingredient todietary supplement manufacturers, health food formulators and cosmeticmanufacturers and *BioAstin*gelcapsand beadlets are sold in bulk quantities to distributors. *BioAstin*gelcaps are also sold as apackaged consumer product through Nutrex Hawaii directly to natural productdistributors, retailers and consumers. *BioAstin*competes directly with similar products marketed by other manufacturersincluding Fuji Chemical of Japan, Algatechnologies of Israel, and Valensa(formally U.S. Nutraceuticals), and Mera Pharmaceuticals in the United States.In the general 

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category of nutritionalsupplements, *BioAstin*alsocompetes with a variety of vitamins, dietary supplements and other antioxidantproducts available to consumers. The nutritional products market is highlycompetitive and includes international, national, regional and local producersand distributors, many of whom have greater resources than Cyanotech and manyof whom offer a greater variety of products. The Company’s emphasis is on firstgrowing the market for its *BioAstin*products followed by market growth for *NatuRose*.

During the second, third and fourth quarters of fiscalyear 2007, the Company experienced and reported decreased Astaxanthinproduction volumes due to an imbalance in the many critical factors, somebeyond Company control, which are involved in the production of microalgae. Theproduction shortfalls resulting from this imbalance dramatically increased theCompany’s per unit production costs. Efforts to correct this complex biologicalimbalance started to become effective late in the fourth quarter, and, as ofthe date of this report, several key factors causing the imbalance have beenidentified and corrective efforts, which are time consuming due to thebiological nature of the process, are resulting in increased production levels.A key factor causing an imbalance in our culture system was the concentrationof certain micronutrients. This can be affected by the level of micronutrientsin water received from the Department of Water supply.

As of March 31, 2007,the backlog of orders for all Natural Astaxanthin products increased toapproximately $802,000, due to production problems. The majority of theseorders were filled in the first quarter of fiscal 2008. Backlogs at the end offiscal 2006 and 2005 were $257,000 and $74,000, respectively.

***PhycobiliproteinProducts***

The Company also producesphycobiliproteins for sale to the medical and biotechnology researchindustries. Phycobiliproteins are highly fluorescent pigments derived frommicroalgae. Their spectral properties make them useful as tags or markers inmany kinds of biological assays, such as flow cytometry, fluorescenceimmunoassays and fluorescence microscopy. We do not anticipate thatphycobiliproteins will represent a significant component of total sales infuture periods.

**Major Customers**

Approximately $937,000 or10% of net sales for the year ended March 31, 2007 were to SpirulinaInternational B. V., a Spirulina marketing and distribution company based inthe Netherlands. Sales to this customer amounted to $1,285,000 or 12% of netsales for the fiscal year 2006 and $1,130,000 or 10% of net sales for the fiscalyear 2005. We believe that sales to this customer will continue to represent asignificant portion of total net sales in future periods and any significantreduction in demand from this customer could have a material adverse effect onour business, financial condition and results of operations. No other customeraccounted for more than 5% of net sales for the year ended March 31, 2007.

**Research andDevelopment**

Cyanotech’s expertise is in the development ofefficient, stable and cost-effective production systems for microalgalproducts. Our researchers investigate each specific microalgae identified inthe scientific literature for potentially marketable products and then striveto develop the technology to grow such microalgae on a commercial scale. Successfulmicroalgal product development is highly uncertain and is dependent on numerousfactors, many beyond the Company’s control. Products that appear promising inearly phases of development may be found to be ineffective, may be uneconomicalbecause of manufacturing costs or other factors, may be precluded fromcommercialization due to the proprietary rights of other companies, or may failto receive necessary regulatory approvals.

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The Company had researchand development expenditures of $203,000, $187,000 and $251,000 in fiscal years2007, 2006 and fiscal 2005, respectively. We made no investment in scientificclinical trials during fiscal 2007, but plan to invest some funds in fiscal2008 as part of our effort to contain production costs and improve productionyields. Fiscal 2006 and 2005 expenses included those for the initiation ofclinical trials aimed at increasing production yields and improving the qualityand stability of some products. The Company also continues to explore customersponsored research and development, although amounts spent for this purposewere not material in each of the three years ended March 31, 2007.

**Patents, Trademarksand Licenses**

Cyanotech has receivedfive United States patents: two on aspects of our production methods and threerelating to usage of our BioAstin**products.The Company views its proprietary rights as important, but believes that a lossof such rights is not likely to have a material adverse effect on the Company’spresent business as a whole. The Company’s operations are not dependent uponany single trademark, although some trademarks are identified with a number ofthe Company’s products and are of importance in the sale and marketing of suchproducts.

**Regulations andEnvironmental Matters**

In 2002, the Company was issued under the EndangeredSpecies Act (“ESA”) an Incidental Take Permit (“ITP”) by the United StatesDepartment of Interior Fish and Wildlife Service (“FWS”). The ESA defines “incidentaltake” as “incidental to, and not the purpose of, the carrying out of anotherwise lawful activity.” This permit authorizes incidental take of theendangered Hawaiian stilt (*Himantopusmexicanus knudseni)* that is anticipated to occur as a result ofongoing operations and maintenance at the Company’s Kona facility. As amandatory component for the issuance of such permit, the Company submitted andmaintains a Habitat Conservation Plan (“HCP”) to ensure that the effects of thepermitted action on listed species are adequately minimized and mitigated.

The HCP called for the creation of a nesting andbreeding ground for the Hawaiian stilt to offset any take activity. The Companyhas complied with these requirements since 2002. The breeding program was sosuccessful that the increase in the Hawaiian stilt population in the areabecame a potential hazard for the adjacent State airport facility. The Companydisassembled the stilt habitat and is mitigating “take” by using standardnon-lethal hazing devices to discourage nesting and breeding.

A requirement of the ITPis to provide insurance coverage for funding the project for the term of theITP. The Company’s insurance broker was unable to locate an underwriter whowould provide such a bond. As permitted by law, the FWS waived this requirementrecognizing that this HCP did not involve a significant capital expenditure.However, under Hawaii state law, no waiver provision is available. A new ITPwas issued by the FWS on September 29, 2006, and by the State of HawaiiDivision of Forestry and Wildlife (DOFAW) on October 13, 2006, both whichexpire on March 17, 2016. In October, 2005, the Company submitted a newten-year HCP to the FWS and the DOFAW.

**Employees**

As of March 31, 2007,the Company employed 64 people on a full-time basis. Of the total, 48 areinvolved in harvesting and production and the remainder in sales,administration and support. Management believes that its relations withemployees are good. We continue to experience some difficulty in attractingentry-level operations personnel due to increased wage competition for workersstemming from the growth in the State’s construction industry. None of ouremployees are subject to collective bargaining agreements.

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**InternetInformation**

Our Internet address iswww.cyanotech.com. There we make available, free of charge, copies of Cyanotechdocuments, news releases and financial statements issued in the last 12 months.Included there are copies of the Company’s Code of Conduct and Ethics, theNominating and Corporate Governance Committee Charter, and the Charter andPowers of the Audit Committee. The information found on our Web site, unlessotherwise indicated, is not part of this or any other report we file with orfurnish to the Securities and Exchange Commission. *Spirulina Pacifica*and *BioAstin*are sold directly online through the Company’s website, www.nutrex-hawaii.com,as well as through resellers in over 40 countries worldwide. Technicalinformation for the Company’s phycobiliproteins products is available atwww.phycobiliprotein.com. Corporate data, product information and charters ofour Board committees are also available at www.cyanotech.com.

**Item 1A. RiskFactors**

You should carefullyconsider the risks described below which we believe are significant but not theonly ones we face. Any of the following risks could have a material adverseeffect on our business, financial condition and operating results. You shouldalso refer to the other information contained in this report, including ourfinancial statements and the related notes.

**We May Need toRaise Additional Capital in the Future Which May Not Be Available**

At March 31, 2007, our working capital was$3,361,000. Cash and cash equivalents at the same date totaled $1,444,000. Ourcash requirements will depend on numerous factors, including demand forproducts; normal requirements to maintain and upgrade facilities and equipment;whether opportunities emerge in either new markets or in research anddevelopment activities; or, in the event we need to expand or contract ourproduction or distribution infrastructure. 

We believe our cash andcash equivalents to be provided from operations will be sufficient to meet ourcapital and operating requirements for at least the next 12 months, but we mayneed to raise additional funds and we may not be able to secure funding onacceptable terms, if at all. If we raise additional funds through the issuanceof equity or convertible debt securities, the percentage ownership of our thencurrent stockholders may be reduced. If we raise additional funds through theissuance of convertible debt securities, or through additional debt or similarinstruments, such securities, debt, or similar instruments could have rightssenior to those of our common stockholders and such instruments could containprovisions restricting our operations. If adequate funds are not available tosatisfy either short-term or long-term capital requirements, we may be requiredto limit operations with adverse results.

**We have incurredsignificant losses in the past, and we may continue to incur significant lossesin the future. If we continue to incur losses, we will experience negative cashflow which may hamper current operations and prevent us from sustaining orexpanding our business.**

We have incurred netlosses in three of the last five fiscal years. As of March 31, 2007, wehad an accumulated deficit of approximately $19.9 million. During fiscal years2007, 2006 and 2003, we incurred net losses in the amounts of approximately$7.4 million, $391,000 and $1.8 million, respectively, accounting forapproximately one half of our accumulated deficit since our inception.Historically, we have relied upon cash from operations and financing activitiesto fund all of the cash requirements of our business. If an extended period ofnet losses continues, our negative cash flow will likewise, and may hampercurrent operations and prevent us from sustaining or expanding our business. Wecannot assure you that we will attain, sustain or increase profitability on aquarterly or annual basis in the future. If we do not achieve, sustain orincrease profitability, our business will be adversely affected and our stockprice may decline. 

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**Our stock price is volatile, which could result insubstantial losses for investors purchasing shares of our common stock.**

The market price ofour common stock has fluctuated significantly in the past and may continue tofluctuate significantly in the future. During the first three months of fiscal2008, the high and low closing bid prices of a share of our common stock were$1.90 and $1.43, respectively. During fiscal 2007, the high and low closing bidprices of a share of our common stock were $3.40 and $1.61, respectively. Duringfiscal 2006, the high and low closing bid prices of a share of our common stockwere $4.92 and $2.20, respectively. The market price of our common stock maycontinue to fluctuate in response to one or more of the following factors, manyof which are beyond our control:

·       changesin market valuations of similar companies; 

·       stockmarket price and volume fluctuations generally; 

·       economicconditions specific to the nutritional products industry; 

·       announcementsby us or our competitors of new or enhanced products or of significantcontracts, acquisitions, strategic relationships, joint ventures or capitalcommitments; 

·       theloss of one or more of our top retailers or the cancellation or postponement oforders from any of those retailers; 

·       problemsin the functioning of new products or innovations; 

·       changesin our pricing policies or the pricing policies of our competitors; 

·       changesin foreign currency exchange rates affecting our product costs and pricing; 

·       regulatorydevelopments or increased enforcement; 

·       fluctuationsin our quarterly or annual operating results; and

·       additionsor departures of key personnel.

The price at which youpurchase shares of our common stock may not be indicative of the price thatwill prevail later in the trading market. You may be unable to sell your sharesof common stock at or above your purchase price, which may result insubstantial losses to you. As of March 31, 2007, there were approximately5.2 million shares of our common stock outstanding. Our common stock has alarge public float, and as a group, our executive officers, directors and 5%stockholders, beneficially own less than 20% of our common stock. We cannotpredict the effect, if any, that future sales of shares of our common stockinto the public market will have on the market price of our common stock. Eventhough we have a large public float, sales of substantial amounts of commonstock, including shares issued upon the exercise of stock options, or inanticipation of such sales, may materially and adversely affect prevailingmarket prices for our common stock.

**The nutritionalproducts industry is extremely competitive. Many of our significant competitorshave greater financial and other resources than we do, and one or more of thesecompetitors could use their greater resources to gain market share at ourexpense.**

The nutritional productsmarket includes international, national, regional and local producers anddistributors, many of whom have substantially greater production, financial,research and development, personnel and marketing resources than we do, andmany of whom offer a greater variety of products. As a result, each of thesecompanies could compete more aggressively and sustain that competition over alonger period of time than we could. Our lack of resources relative to oursignificant competitors may cause us to fail to anticipate or respondadequately to development of new products and changing consumer demands andpreferences, or may cause us to experience significant delays in obtaining or 

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introducingnew or enhanced products. These failures or delays could reduce ourcompetitiveness and cause a decline in our market share and sales. Increasedcompetition in our industry could result in price reductions, reduced grossprofit margin or loss of market share, any of which could have a materialeffect on our business, results of operations and financial condition.

**Our Revenues CouldBe Adversely Affected By the Loss of a Significant Customer or the Failure toCollect a Large Accounts Receivable**

We have in the pastderived, and may continue in the future to derive, a significant portion of ourrevenues from a relatively limited number of major customers. From quarter toquarter, revenues from one or more individual customers may exceed 10% of ourrevenues for the quarter. During each of the three years ended March 31,2007, sales to one customer, a European distributor of natural products, wereapproximately 10%, 12% and 10% of net sales, respectively. If sales to thiscustomer or other such major customer decrease significantly, this may materiallyaffect our results of operations. In addition, if we fail to collect one ormore accounts receivable from major customers, we could be subject tosignificant financial exposure.

**We depend heavilyon the unique abilities and knowledge of our officers and key personnel whichinclude the President and Chief Executive Officer who is also the Company’sprimary scientific resource, Chief Financial Officer and Vice President ofFinance and Administration, Vice President of Operations and Vice President ofSales and Marketing. Cyanotech is a small company and the loss of any suchpersonnel or the delay in the replacement of one could significantly delay theachievement of our business objectives, and could adversely affect our abilityto do business or could hinder our ability to provide needed management.**

Our success depends, to asignificant extent, upon the continued services of such personnel. For example,the Chief Executive Officer, as the Company’s primary scientific resource, hasdeveloped and continues to improve production and cultivation technology and toinvestigate new microalgal products. Our Chief Financial Officer has a uniqueunderstanding of the company’s financial systems and needs. Our Vice PresidentOperations has years of experience with the mechanical operation of theproduction facility and continues to improve our production process. Our VicePresident Sales and Marketing has developed valuable personal relationshipswith domestic and foreign customers.

**Our production ofalgae involves an agricultural process, subject to such risks as weather,disease, and contamination.**

The production of ouralgae products involves complex agricultural systems with inherent risksincluding weather, disease, and contamination. These risks are unpredictable,and also include such elements as the control and balance of necessarynutrients and other factors.

**Our operations arevulnerable because we have limited personnel and redundancy and backup systemsin our data management function.**

Our internal order, inventoryand product data management system is an electronic system through which ordersare placed for our products and through which we manage product pricing,shipment, returns and other matters. This system’s continued and uninterruptedperformance is critical to our day-to-day business operations. Despite ourprecautions, unanticipated interruptions in our computer and telecommunicationssystems have, in the past, caused problems or stoppages in this electronicsystem. These interruptions, and resulting problems, could occur in the future.We also have limited personnel available to process purchase orders and tomanage product pricing and other matters in any manner other than through thiselectronic system. Any significant interruption or delay in the operation ofthis electronic system could cause a decline in our sales and profitability.

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**A Significant orProlonged Economic Downturn Could Have a Material Adverse Effect on Our Resultsof Operations**

Our results of operationsare affected by the business activity of our customers who in turn are affectedby the level of economic activity in the industries and markets that theyserve. A decline in the level of business activity of our clients could have amaterial adverse effect on our revenues and profit margin.

**Our QuarterlyOperating Results May Vary From Quarter to Quarter, Which May Resultin Increased Volatility of Our Share Price**

We haveexperienced, and may in the future continue to experience, fluctuations in ourquarterly operating results. These fluctuations could reduce the market priceof our Common Stock. Factors that may cause our quarterly operating results tovary include, but are not limited to:

·       thebusiness decisions of our customers regarding orders for our products;

·       increasedenergy costs;

·       increasedraw material costs;

·       productiondifficulties;

·       weather-relatedcultivation difficulties;

·       contaminationof our cultivation and production facilities;

·       theeffect of weather on customer demand patterns;

·       theintroduction of new products by us or our competitors;

·       changesin our pricing policies or those of our competitors;

·       changesin seasonal and other trends in our customers’ buying patterns;

·       changesin government regulation, both domestic and foreign;

·       fluctuationin foreign currency exchange rates, although our exposure is currently notmaterial;

·       globaleconomic and political conditions and related risks, including acts ofterrorism; and

·       otherfactors beyond our control.

A significant portion ofour expense levels are relatively fixed and the timing of increases in expenselevels is based in large part on our forecasts of future sales. If net salesare below expectations in any given period, the adverse impact on results ofoperations may be magnified by our inability to adjust expenses quickly enoughto compensate for the sales shortfall.

**Our GlobalOperations Expose Us to Complex Management, Foreign Currency, Legal, Tax andEconomic Risks, Which We May Not Be Able to Address Quickly and Adequately**

We conduct businessin a number of countries around the world. For the year ended March 31,2007, approximately 46% of our net sales were from sales to foreign customers.As a result, we are subject to a number of risks which include, but are notlimited to:

·       theburden of complying with a wide variety of national and local laws;

·       potentiallylonger payment cycles for foreign sales;

·       multipleand possibly overlapping and conflicting tax laws;

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·       coordinatinggeographically separated locations;

·       restrictions(government and otherwise) on the movement of cash;

·       theabsence in some jurisdictions of effective laws protecting our intellectualproperty rights;

·       changesin government regulations, both domestic and foreign;

·       globaleconomic and political conditions and related risks, including acts ofterrorism; and

·       fluctuations in foreigncurrency exchange rates although our exposure is currently not material.

**If We Are Unable toProtect Our Intellectual Property Rights or if We Infringe Upon theIntellectual Property Rights of Others Our Business May Be Harmed**

Cyanotech has receivedfive United States patents: two on aspects of our production methods and threefor use of our *BioAstin*âproducts. Although we regard our proprietary technology, trade secrets,trademarks and similar intellectual property as important, we rely on acombination of trade secret, contract, patent, copyright and trademark law toestablish and protect our rights in our products and technology. There can beno assurance that we will be able to protect our technology adequately or thatcompetitors will not be able to develop similar technology independently. Inaddition, the laws of certain foreign countries may not protect the Company’sintellectual property rights to the same extent as the laws of the UnitedStates. Litigation in the United States or abroad may be necessary to enforceour patent or other intellectual property rights, to protect our trade secrets,to determine the validity and scope of the proprietary rights of others or todefend against claims of infringement. Such litigation, even if successful,could result in substantial costs and diversion of resources and could have amaterial adverse effect on our business, results of operations and financialcondition. Additionally, if any such claims are asserted against us, we mayseek 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 termsacceptable or favorable to us, if at all.

**Our InsuranceLiability Coverage is Limited**

In the ordinary course ofbusiness, the Company purchases insurance coverages (e.g., property andliability coverages) to protect itself against loss of or damage to itsproperties and claims made by third parties and employees for property damageor personal injuries. However, the protection provided by such insurance islimited in significant respects and, in some instances, the Company has nocoverage and certain of the Company’s insurance has substantial “deductibles”or has limits on the maximum amounts that may be recovered. For example, if ahurricane or other uninsured catastrophic natural disaster should occur, theCompany may not be able to recover all facility restoration costs and revenueslost from business interruption. In addition, the Company maintains productliability insurance in limited amounts for all of its products involving humanconsumption; however, broader product liability coverage is prohibitivelyexpensive. Insurers have also introduced new exclusions or limitations ofcoverage for claims related to certain perils including, but not limited to,mold and terrorism. If a series of losses occurred, such as from a series oflawsuits in the ordinary course of business each of which were subject to thedeductible amount, or if the maximum limit of the available insurance weresubstantially exceeded, the Company could incur losses in amounts that wouldhave a material adverse effect on its result of operations and financialcondition.

**Our Ability toDevelop and Market New Products or Modify Existing Products and ProductionMethods May be Adversely Affected If we Lose the Services of or CannotReplace Certain Employees Knowledgeable in Advanced Scientific and Other Fields**

The Company’s products arederived from and depend on proprietary and non-proprietary processes andmethods founded on advanced scientific knowledge, skills, and expertise. If theservices of employees 

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knowledgeablein these fields are lost and cannot be replaced in a reasonable time frame atreasonable costs, the Company’s ability to develop and market new products ormodify existing products and production methods would be adversely impacted. Atthe same time, regulatory compliance surrounding the Company’s products andfinancial matters generally requires minimum levels of knowledge and expertiserelated to production, quality assurance, and financial control. If the Companyloses the services or cannot reasonably replace employees who have thenecessary knowledge and expertise the Company’s ability to remain in regulatorycompliance could be adversely affected.

**By March 31,2008 the Company is required to be in full compliance with the Sarbanes-OxleyAct and Rules issued thereunder by the Securities and Exchange Commission,including Section 404 Compliance Standards established by the PublicCompanies Accounting Oversight Board. The cost of attaining and maintainingsuch compliance could materially decrease reported net income or increasereported net losses in future periods.**

Although the Company haspreviously taken steps toward what is generally referred to as Sarbanes-OxleyAct compliance, the process of preparing and filing the Company’s Form 10-K/Afiled February 14, 2007 and subsequent delayed filings of the Company’sForms 10-Q for fiscal year 2007, coupled with the lack of resources discussedin Item 9A of this report, have delayed the Company’s efforts towardimplementing full Sarbanes-Oxley compliance. Such compliance must be achievedby March 31, 2008. To do so could require significant expenditures andeffort between this date and March 31, 2008. Such expenditures and effortare not subject to reasonable estimation at this time.

**Item 2. Properties**

The Company’s principal facility and its corporateheadquarters are located at the Natural Energy Laboratory of Hawaii Authority(“NELHA”) at Keahole Point in Kailua-Kona, Hawaii. It encompasses approximately90 fully developed acres containing microalgal cultivation ponds, processingfacilities, research and quality control laboratories, and sales and administrativeoffices. The property is leased from the State of Hawaii under a 30-yearcommercial lease expiring in 2025. We believe that there is sufficientavailable land at NELHA to meet anticipated needs if a revised NELHA lease canbe negotiated with acceptable terms. Under the terms of the existing NELHAlease, the Company could be required to remove improvements at the end of thelease term. Based upon analysis pursuant to Statement of Financial AccountingStandards No. 143 and FASB Interpretation No. 47, we do not believethe projected cost for such removal to be material to the consolidatedfinancial statements, or likely, given historical experience. However,conditions could change in the future. It is not possible to predict suchchanges or estimate any impact thereof.

The Company also rentswarehouse space near NELHA and also in San Dimas, California and office spacein Tokyo, Japan.

**Item 3. LegalProceedings**

From time to time theCompany may become party to lawsuits and claims that arise in the ordinarycourse of business relating to employment, intellectual property, and othermatters. There were no significant legal matters outstanding at March 31,2007.

**Item 4. Submissionof Matters to a Vote of Security Holders**

No matters were submitted to a vote of stockholdersduring the fourth quarter of fiscal 2007.

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**PART II**

**Item 5. Market forRegistrant’s Common Equity and Related Stockholder Matters**

TheCompany’s common stock is listed and traded on the NASDAQ Capital Market underthe symbol “CYAN”. As of July 30, 2007, the closing price and approximatenumber of holders of record of our common stock was **$**1.21and 1,200, respectively. The high and low selling prices as reported by NASDAQ,adjusted for the one for four reverse stock split, effective November 3,2006, were as follows:

| **Quarter Ended:**        | ** ** | ** ** | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31** | ** ** | **March 31** | ** ** |
|--------------------------------|------------|------------|------------|------------------|------------|-----------------------|------------|----------------------|------------|-------------------|------------|
| Fiscal 2007                    |       |       |       |             |       |                  |       |                 |       |              |       |   |   |   |   |   |   |
| Common stock price per  share: |       |       |       |             |       |                  |       |                 |       |              |       |   |   |   |   |   |   |
| High                           |       |       | $          | 3.76             |       |                  |       | $                    | 4.60       |              |       |   | $ | 2.32 |   |   |   | $ | 2.48 |   |   |
| Low                            |       |       | $          | 2.20             |       |                  |       | $                    | 1.60       |              |       |   | $ | 1.48 |   |   |   | $ | 1.61 |   |   |
| Fiscal 2006                    |       |       |       |             |       |                  |       |                 |       |              |       |   |   |   |   |   |   |
| Common stock price per share:  |       |       |       |             |       |                  |       |                 |       |              |       |   |   |   |   |   |   |
| High                           |       |       | $          | 4.96             |       |                  |       | $                    | 4.84       |              |       |   | $ | 4.24 |   |   |   | $ | 3.52 |   |   |
| Low                            |       |       | $          | 3.20             |       |                  |       | $                    | 2.92       |              |       |   | $ | 2.04 |   |   |   | $ | 2.20 |   |   |

 

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

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**STOCKHOLDER RETURNPERFORMANCE GRAPH**

The following graph setsforth the Corporation’s total cumulative stockholder return as compared to theNASDAQ Composite U.S. Index (COMP) and the NASDAQ Biotech Index (NBI) for theperiod beginning March 31, 2002 and ending March 31, 2007. Totalstockholder return assumes $100.00 invested at the beginning of the period inthe Common Stock of the Corporation, the stocks represented in the NASDAQComposite—U.S. Index and the NASDAQ Biotech, respectively. Total return assumesreinvestment of dividends; the Corporation has paid no dividends on its CommonStock. Historical price performance should not be relied upon as indicative offuture performance.

**Comparisonof 5-Year Cumulative Total ReturnAmong Cyanotech Corporation, NASDAQ Composite Index and Peer Group Index**

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**Item6. Selected Financial Data**

| ** **                                               | ** ** | **Years ended March 31,**                           | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                               | ** ** | **2007**                                                           | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                               | ** ** | **(In thousands, except per share data)** | ** ** |
| **Statement of Operations Data**                         | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                                |       | $                                                                  | 9,683      |   | $ | 11,131 |   | $ | 11,445 |   | $ | 11,582 |   | $ | 8,951 |   |
| Gross profit                                             |       | 1,131                                                              |       | 3,060 |   | 3,892 |   | 3,744 |   | 2,776 |   |
| Impairment loss  on equipment and leasehold improvements |       | 4,487                                                              |       | — |   | — |   | — |   | — |   |
| Income (loss)  from operations                           |       | (7,304                                                             | )          | (253 | ) | 724 |   | 634 |   | (1,229 | ) |
| Net income (loss)                                        |       | (7,425                                                             | )          | (391 | ) | 601 |   | 318 |   | (1,783 | ) |
| Net income (loss)  per common share—diluted         |       | (1.42                                                              | )          | (0.07 | ) | 0.11 |   | 0.07 |   | (0.40 | ) |
| **Balance Sheet Data**                                   |       |                                                               |       |   |   |   |   |   |   |   |   |
| Cash and  investment securities                          |       | 1,444                                                              |       | 2,535 |   | 3,005 |   | 2,531 |   | 579 |   |
| Working capital                                          |       | 3,361                                                              |       | 5,647 |   | 5,347 |   | 4,213 |   | 2,563 |   |
| Total assets                                             |       | 9,906                                                              |       | 17,595 |   | 18,787 |   | 18,487 |   | 17,693 |   |
| Long-term debt,  excluding current maturities            |       | 992                                                                |       | 1,387 |   | 1,743 |   | 2,093 |   | 3,694 |   |
| Stockholders’ equity                                |       | 7,510                                                              |       | 14,939 |   | 15,325 |   | 14,570 |   | 12,484 |   |
|                                                          |            |                                                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Item 7. Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

*The following discussionshould be read in conjunction with the consolidated financial statements andnotes thereto appearing elsewhere in this Form 10-K. For a morecomprehensive description of the Company’s products and markets for suchproducts, see Part I. Item 1. Business.*

*This report on Form 10-K containsforward-looking statements regarding the future performance of Cyanotech andfuture events that involve risks and uncertainties that could cause actualresults to differ materially from the statements contained herein. Thisdocument, and the other documents that the Company files from time to time withthe Securities and Exchange Commission, such as its reports—except those ofwhich have been designated as no longer to be relied upon—on Form 10-K,Form 10-K/A, Form 10-Q, Form 8-K, and itsproxy materials, contain additional important factors that could cause actualresults to differ from the Company’s current expectations and theforward-looking statements contained herein.*

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**Results of Operations for the 2007, 2006 and 2005Fiscal Years**

| ** **                                               | ** ** | ** **              | ** ** | ** **                              | *** *** | *** *** | *** *** | **Fiscal Year 2007** | *** *** | **Fiscal year 2006** | *** *** |
|----------------------------------------------------------|------------|-------------------------|------------|-----------------------------------------|--------------|--------------|--------------|--------------------------------|--------------|--------------------------------|--------------|
| ** **                                               | ** ** | ** **              | ** ** | ** **                              | ** **   | ** **   | ** **   | **vs. 2006**              | ** **   | **vs. 2005**              | ** **   |
| ** **                                               | ** ** | **Fiscal Year**    | ** ** | **Favorable / (Unfavorable)** | ** **   |
| ** **                                               | ** ** | **2007**                | ** ** | **2006**                                | ** **   | **2005**     | ** **   | **$**                          | ** **   | **%**                          | ** **   | **$** | ** ** | **%** | ** ** |
| ** **                                               | ** ** | **(In thousands)** | ** ** |
| Net sales                                                |       | $                       | 9,683      |                                    | $            | 11,131       |         | $                              | 11,445       |                           | $            | (1,448 | ) | (13.0 | )% | $ | (314 | ) | (2.7 | )% |
| Cost of sales                                            |       | 8,552                   |       | 8,071                                   |         | 7,553        |         | (481                           | )            | (6.0                           | )            | (518 | ) | (6.9 | ) |
| Gross profit                                             |       | 1,131                   |       | 3,060                                   |         | 3,892        |         | (1,929                         | )            | (63.0                          | )            | (832 | ) | (21.4 | ) |
| Operating  expenses                                      |       |                    |       |                                    |         |         |         |                           |         |                           |         |   |   |   |   |
| Research & development                          |       | 203                     |       | 187                                     |         | 251          |         | (16                            | )            | (8.6                           | )            | 64 |   | 25.5 |   |
| Sales and marketing                                      |       | 1,297                   |       | 1,312                                   |         | 1,189        |         | 15                             |         | 1.1                            |         | (123 | ) | (10.3 | ) |
| General & administrative                        |       | 2,448                   |       | 1,814                                   |         | 1,728        |         | (634                           | )            | (35.0                          | )            | (86 | ) | (5.0 | ) |
| Impairment loss on equipment and leasehold  improvements |       | 4,487                   |       | —                                  |         | —       |         | (4,487                         | )            | (100.0                         | )            | — |   | — |   |
| Total operating expense                                  |       | 8,435                   |       | 3,313                                   |         | 3,168        |         | (5,122                         | )            | (154.6                         | )            | (145 | ) | (4.6 | ) |
| Income (loss) from operations                            |       | (7,304                  | )          | (253                                    | )            | 724          |         | (7,051                         | )            | (2,787.0                       | )            | (977 | ) | (134.9 | ) |
| Other income  (expense)                                  |       |                    |       |                                    |         |         |         |                           |         |                           |         |   |   |   |   |
| Interest income                                          |       | 59                      |       | 46                                      |         | 31           |         | 13                             |         | 28.3                           |         | 15 |   | 48.4 |   |
| Interest expense                                         |       | (186                    | )          | (180                                    | )            | (163         | )            | (6                             | )            | (3.3                           | )            | (17 | ) | (10.4 | ) |
| Other income (expense), net                              |       | (3                      | )          | (10                                     | )            | 15           |         | 7                              |         | 70.0                           |         | (25 | ) | (166.7 | ) |
| Total other expense                                      |       | (130                    | )          | (144                                    | )            | (117         | )            | 14                             |         | 9.7                            |         | (27 | ) | (23.1 | ) |
| Income (loss) before income taxes                        |       | (7,434                  | )          | (397                                    | )            | 607          |         | (7,037                         | )            | (1,772.5                       | )            | (1,004 | ) | (165.4 | ) |
| Income tax expense (benefit)                             |       | (9                      | )          | (6                                      | )            | 6            |         | 3                              |         | 50.0                           |         | 12 |   | 200.0 |   |
| Net income (loss)                                        |       | $                       | (7,425     | )                                       | $            | (391         | )            | $                              | 601          |                           | $            | (7,034 | ) | (1,799.0 | )% | $ | (992 | ) | (165.1 | )% |

 

**Overview**

Cyanotech Corporation’s core competency is cultivatingand processing microalgae into high-value, high-quality natural products forthe human and animal nutrition markets. Our products are sold in bulkquantities to manufacturers, formulators and distributors in the health foods,nutritional supplements and animal nutrition markets and as packaged consumerproducts to distributors, retailers, and direct consumer sales. The Companymanufactures its products in Hawaii but markets them worldwide, generating 46%,52% and 49% of its revenues outside of the United States for each of the yearsended March 31, 2007, 2006 and 2005, respectively. Competing in a globalmarketplace, the Company is influenced by the general economic conditions ofthe countries in which its customers operate, including adherence to itscustomers’ local governmental regulations and requirements. The Companycurrently has no material foreign exchange exposure.

The Company reported a net loss of $7,425,000, or($1.42) per diluted share for fiscal 2007 compared to a net loss of $391,000,or ($0.07) per diluted share for fiscal 2006. Cash and cash equivalents at March 31,2007 were $1,444,000, down $1,091,000 from a year ago. Working capital declined40% to $3,361,000 at March 31, 2007 from working capital of $5,647,000 ayear ago, primarily due to decreased cash and equivalents, short terminvestments, accounts receivable and inventory balances.

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Thefollowing table details selected financial data highlighting three key areas:

| ** **                                   | ** ** | **Year Ended March 31,** | ** ** |
|----------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                   | ** ** | **2007**                                | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                   | ** ** | **(In thousands)**                 | ** ** |
| Net sales:                                   |       |                                    |       |   |   |   |   |
| Spirulina products                           |       | $                                       | 6,090      |   | $ | 6,517 |   | $ | 6,626 |   |
| Natural astaxanthin products                 |       | 3,496                                   |       | 4,370 |   | 4,672 |   |
| Other products                               |       | 97                                      |       | 244 |   | 147 |   |
|                                         |       | $                                       | 9,683      |   | $ | 11,131 |   | $ | 11,445 |   |
| Gross profit as a percentage of sales        |       | 12                                      | %          | 27 | % | 34 | % |
| Operating expenses as a  percentage of sales |       | 87                                      | %          | 30 | % | 28 | % |

 

Net sales for fiscal 2007 were $9,683,000, or 13%lower than the $11,131,000 reported for the prior fiscal year. During fiscal2007, the Company experienced a reduction of *NatuRose*sales to the worldwide aquaculture market compared to fiscal 2006 due todecreased production of astaxanthin during part of the second quarter, thethird quarter, and continuing into the fourth quarter of fiscal 2007. Thelimited production of astaxanthin during this time was used for the productionof higher value and higher margin BioAstin products rather than NatuRose. Whilethe Company has taken action to diversify its market for *NatuRose*in selected markets in Europe and new aquaculture markets in Japan, it isfocusing less effort on NatuRose. The Company’s emphasis is on first growingthe market for its BioAstin products followed by market growth for NatuRose.The Company will continue to contain discretionary operating spending but mayinvest in focused expenditures particularly in advertising and clinical trialsin the human nutrition and cosmetics markets. Externally, the Company is alsoworking with industry-leading manufacturers in these markets to integrate *BioAstin*into their products. The Companyintends to emphasize market acceptance of its natural astaxanthin products asincreased competition from other producers of natural and synthetic astaxanthinmay result in the decline of margins generated by its natural astaxanthinproducts. Management cannot predict whether the outcomes of any of thesestrategies will be successful.

As depicted in the preceding table, the Company’sgross profit margin as a percentage of net sales decreased to 12% for thefiscal year ended March 31, 2007, down from 27% for fiscal 2006 and 34%for fiscal 2005. Management expects the Company’s gross profit marginpercentage for the first quarter of fiscal 2008 to be improved over thosereported for the last part of fiscal 2007. There are many factors which havematerially diminished gross profit. These particularly include sales volume andmix and below normal capacity due to both customary and complex productionvariables related to astaxanthin production. Factors also include an increasein sales volume discounts, competitive pricing results, and increases in thecost of raw materials, raw material freight costs, and significant changes in demandfor the Company’s products. Astaxanthin production during fiscal 2007 wasparticularly impacted by an imbalance in the complex biological processes andmechanisms involved in its growth and production. After months of effort, webelieve we have resolved the imbalance in previously discussed astaxanthinproduction problems. Astaxanthin production appears to be returning tohistorical levels. This should result in concurrent improvement in per unitproduction costs. However, because complex biological processes are involved,we cannot assure the results of such corrective efforts. Because the Company’sprocesses are agricultural, it is important to maintain increased astaxanthinproduction volumes in order to support the minimal resource levels required tosustain a large scale agricultural facility

The Company expects its financial results of the firstquarter of fiscal 2008 compared to the last quarter of fiscal 2007 to reflectan improved gross margin percentage and a reduction in general and administrativeexpenses as a percentage of net sales, however, the specific level ofimprovement is not yet determinable. The decrease in gross profit marginpercentage between fiscal 2006 and 2005 was primarily due to a change in salesmix. The Company will continue to contain discretionary spending, and will take

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advantage of opportunitiesto minimize the use of raw materials, including chemicals and utilities. TheCompany recorded a non-cash impairment write-down of production equipment andleasehold improvements of $4.5 million in fiscal year 2007 as a result of ananalysis required under SFAS No. 144. If we achieve our future plannedresults, we do not currently expect to record additional non-cash impairmentcharges in 2008.

To offset increasedproduction costs, the Company continues to strive to increase productionefficiencies in volume yield, potency, and quality consistent with the Company’scommitment to produce high-value, high-quality products. However, these effortscannot be guaranteed to achieve the desired results.

**Results ofOperations**

***Revenues***   Netsales for fiscal 2007 totaled $9,683,000, a 13% decrease from net sales of$11,131,000 in fiscal 2006 and a decrease of 15% from net sales of $11,445,000reported in fiscal 2005. The following is a discussion of revenues by majorproduct category.

***Spirulina***   TheCompany has been producing Spirulina Pacifica, a strain of Spirulina microalga,since 1985. Revenues generated from the Company’s Spirulina products are asignificant portion of total revenues, amounting to $6,090,000, $6,517,000 and$6,626,000 for the years ended March 31, 2007, 2006 and 2005 respectively.Although the Company believes that Spirulina is a mature product in a highlycompetitive market, the dollar amount of revenues has remained relativelyconstant as a percentage of total revenues for the three years ended March 31,2007, at 63%, 59% and 58%, respectively. Approximately $937,000 or 10% of netsales for the year ended March 31, 2007 were to Spirulina International B.V., a Spirulina marketing and distribution company based in the Netherlands. Salesto this customer during fiscal years 2006 and 2005 amounted to $1,285,000 or12%, and $1,130,000 or 10% of net sales. We believe that sales to this customerwill continue to represent a significant portion of total net sales in futureperiods.

The Company has experienced increased competition forits Spirulina products resulting from an increasing number of suppliers ofSpirulina as well as from a larger portion of our sales coming from bulkproduct orders whose customers generally treat these products as commoditieswith price being the major determining factor driving their purchasingdecision. We expect this competitive pricing pressure to continue in futureperiods and in response have focused on improving the quality of our Spirulinaproducts in support of customers who demand higher quality raw materials fortheir formulations. However, fiscal 2007 Spirulina sales declined $427,000 or7% resulting from average units sold and average unit sales prices, decreasingapproximately 3% and 4%, respectively, as compared to the prior fiscal year. Infiscal 2006, we had experienced an increase in average unit price ofapproximately 5% as compared to the prior year with a slight increase in thenumber of units sold. At March 31, 2007 our backlog of Spirulina orderstotaled approximately $432,000 and such backlog at the end of fiscal 2006 was$448,000. The majority of these orders were filled in the first quarter of thesubsequent fiscal year.

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***Natural Astaxanthin***   Infiscal 2007, the Company’s sales of its natural astaxanthin products were$3,496,000 a decrease of 20% from $4,370,000 in fiscal 2006, and a decrease of25% from $4,672,000 in fiscal 2005. The decrease in natural astaxanthin salesfor the year was primarily due to decreased bulk product unit sales, includingNatuRose, and decreased average bulk selling prices. In addition, decliningnatural astaxanthin sales results from decreased production of these products,and reduced average sales prices due to competitive pricing requirements. TheCompany believes it would have generated additional astaxanthin sales hadproduction levels been consistent with prior years. BioAstin, which is ahigher-priced product in the human nutritional market, had declining sales of$613,000 or 21% from fiscal 2006, resulting from a decrease in average unitsales price of 18%, and average sales units of 5%. NatuRose sales decreased$261,000 or 19% from fiscal 2006, resulting from a decrease in average salesprice of 11%, and average sales units of 9%. At March 31, 2007 our backlogof orders for all natural astaxanthin products totaled approximately $802,000,an increase of $545,000 from $257,000 at the end of fiscal 2006 due primarilyto the decreased production levels and the timing of customer orders at the endof March, 2007. The majority of these orders were filled in the first quarterof the subsequent fiscal year. The Company believes that the findings ofclinical trials undertaken in prior years and in this fiscal year by theCompany, its customers and other unaffiliated parties, taken individually andon a cumulative basis, have generated growing consumer awareness of thebeneficial antioxidant and anti-inflammatory properties of astaxanthin.Validation of natural astaxanthin benefits identified in such scientificstudies has helped to spur demand for our natural astaxanthin products in thehuman nutrition market and could provide the basis for proprietary intellectualproperty. The Company completed and issued reports on two positive scientificclinical trials on natural astaxanthin during fiscal 2006. One studydemonstrated that natural astaxanthin could lower levels of C-Reactive Protein,an indicator of systemic inflammation and the second study showed that gripstrength could be increased in those suffering from tennis elbow by consumptionof natural astaxanthin. The Company plans to continue expenditures on targetedscientific trials in the future in accordance with its strategy to increasesales of natural astaxanthin products.

***Cost of Sales******  ***Our cost ofsales, as a percentage of net sales, was at 88%, 73% and 66% for fiscal years2007, 2006, and 2005, respectively. Cost of sales includes the cost ofnutrients and materials, direct labor and manufacturing overhead costs,depreciation and amortization of production equipment, buildings and leaseholdimprovements associated with the production of inventory units sold and otherproduction related period costs. The cost of sales percentage increase of 15points between 2007 and 2006 is due primarily to both customary and complexproduction variables related to astaxanthin and spirulina production. Factorsalso include increases in the cost of raw materials and raw material freightcosts, as well as diminished demand for these products with unabsorbed relatedfixed production costs. Astaxanthin production during fiscal 2007 wasparticularly impacted by an imbalance in the complex biological processes andmechanisms involved in its growth and production. The Company feels that it hasidentified and is correcting the factors leading to the imbalance. However,because complex biological processes are involved, the Company cannot predictthe magnitude or results of such corrective efforts. Because the Company’sprocesses are agricultural, it is important to increase astaxanthin productionvolumes in order to support the minimal resource levels required to sustain alarge scale agricultural facility. Labor and chemical costs, coupled with otherefforts, were not effective in correcting the imbalance in the factorsaffecting the Company’s biological cultivation process. Some of the labor andchemical costs were deemed to be period costs resulting from an abnormal usageof nutrients and labor efforts. Labor costs, compared to last fiscal year,increased due to hourly wage rate increases in the first quarter of the year,and also due to the additional effort required in light of the just mentionedimbalance. The imbalance also required the Company to incur additional utilitycosts relative to the level of product produced. In general, the forgoingelements combined to significantly increase the cost of sales, andcorrespondingly reduce gross profit for the year ended March 31, 2007relative to the prior fiscal year. The cost of sales increase for fiscal year2007 relative to fiscal 2006 was mainly due to the aforementioned factors, withimbalance in the cultivation process, and attendant additional efforts andcosts. The impact of the imbalance is discussed, in part, below 

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Spirulina productionvariables are normal and occur from time to time as a normal part of anyagricultural business.

During the year ended March 31, 2007, as part ofcost of sales, the Company recorded non-inventoriable costs of approximately$1,668,000. Comparable non-inventoriable costs recorded in fiscal 2006 were$864,000, increasing $804,000 during fiscal 2007. Fiscal 2007 included anincrease of period costs due to abnormal chemical, labor, and utility usage. Inaddition, there was an increase in production costs associated with the Company’sanimal nutrition market products which were not inventoriable because suchcosts would have exceeded the market value for the related inventory.

The cost of sales percentage increased between fiscal2006 and 2005 in part due to the result of production variances associated withdecreased astaxanthin production in response to lower orders for NatuRose. Inaddition, the company experienced increased chemical (primarily nutrient) andelectrical costs, with the latter also serving to increase the cost of water.The increase in chemical (primarily nutrient) costs is due to several factorsincluding increased usage due to weather and production variables as well asincreased raw material prices.

For fiscal 2008, with the rising cost of fuel oil, theCompany could incur higher electrical utility costs dependent upon theregulated public utility’s ability to obtain approval for rate increases. Ifelectrical utility costs were to increase significantly from fiscal 2007, thecost to manufacture its products could increase materially above prior yearcosts.

Fresh water is critical for our natural astaxanthinproduction and while the Company has not experienced any constraint on freshwater availability, future availability could be negatively impacted bysignificant growth in the local population as well as by throughput constraintson the water delivery infrastructure owned by the County of Hawaii. Given thecriticality of fresh water to our operations and the community, the Companyrecycles fresh water where possible and developed additional water recyclingsystems during fiscal 2007 in its efforts to utilize fresh water efficiently.

For the production of *BioAstin,*the Company’s natural astaxanthin product for the human nutritionmarket, three third party contractors are utilized for the processes ofextraction, and a sole third party contractor is utilized for each of theencapsulation (for gelcaps) and micro-encapsulation (for beadlets), Althoughthese services are available only from a limited number of sources, we have theability to use other parties if any of the current contractors becomeunavailable. If pricing for any of these services significantly increases,there could be a material adverse effect on our business, financial conditionand results of operations. There have not been any significant changes in thecost of extraction or encapsulation services and none are now anticipated.

To offset increased production costs, the Companyseeks ways to increase production efficiencies in volume yield, potency, and qualityconsistent with the Company’s commitment to produce high-value, high-qualityproducts. However, these efforts cannot be guaranteed to achieve the desiredresults.

The Company adopted SFAS No. 151 effective April 1,2006. The provisions of SFAS No. 151 “Inventory Costs—an amendment ofAccounting Research Bulletin No. 43, Chapter 4” require that abnormalamounts of freight, handling costs and wasted material (spoilage) be recognizedas current-period charges and fixed production overhead costs be allocated toinventory based on the normal capacity of production facilities. Normalcapacity is defined as “the production expected to be achieved over a number ofperiods or seasons under normal circumstances, taking into account the loss ofcapacity resulting from planned maintenance.” Companies are no longer permittedto capitalize inventory costs on the balance sheet when the production defectrate varies significantly from the expected defect rate. SFAS No. 151is effective for inventory costs incurred during fiscal years beginning after June 15,2005.

Adoption of the provisions of SFAS No. 151 didnot have a significant impact on the Company’s financial condition and resultsof operations for the year ended March 31, 2007.

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Unforeseen changes in any of the factors surroundingthe estimates imbedded in the determination of inventory values and cost ofsales could have a material impact on cost of sales. Such changes in factorsand estimates include but are not limited to: production levels and capacity,changes in the prices paid for raw materials, supplies, and labor, changes inyield, potency, and quality of biomass, and changes in processing or productionmethods.

***Gross Profit Margin******  ***The Company’sgross profit margin as a percentage of net sales decreased to 12% for thefiscal year ended March 31, 2007, down from 27% for fiscal 2006 and 34%for fiscal 2005 as previously described.

Management expects the Company’s fiscal 2008 gross profitmargin percentage to increase from the results reported for fiscal 2007 sincethe astaxanthin production variables are not expected to negatively impactgross margins in fiscal 2008 to the extent experienced in fiscal 2007. TheCompany recognized period costs resulting from an abnormal usage of nutrientscoupled with the cost of other efforts which were not effective in correctingan imbalance in the cultivation process. Producing the highest qualitymicroalgae is a complex biological process which requires the tenuous balancingof numerous factors including microalgal strain variations, temperature,acidity, nutrient and other environmental considerations, some of which are notin the Company’s control. As a result, especially for natural astaxanthin cultivation,it is difficult and time consuming to adjust, improve or correct the productionprocess when quality levels fall below specifications. While the Companypossesses the scientific knowledge and resources to correct its productionprocesses, there are many variables involved for the Company to make reliableprojections concerning such efforts, however, we have identified someproduction variables, and as a result, we are correcting the imbalances whichwe believe will result in increased production yields in both quantity andquality. There are factors which could materially diminish gross profit. Theseinclude, but are not limited to, sales volume and mix, increases in the cost ofraw materials and raw material freight costs, and production volumes belownormal capacity in response to customary production variables (such as weather)and significant changes in demand for the Company’s products, and theallocation of production resources, principally the factors impactingAstaxanthin and Spirulina biomass production levels and rates based on thevariables just mentioned.

***Operating Expenses***   Operatingexpenses as a percentage of net sales were 87% for fiscal 2007, 30% for fiscal2006 and 28% for fiscal 2005. The 57 point increase from 2007 to 2006 as apercentage of net sales was due primarily to two factors. The Company recordeda non-cash impairment write-down of production equipment and leaseholdimprovements of $4.5 million as a result of an analysis required under SFAS No. 144.In addition, the Company incurred general and administrative expenses inconjunction with the restatement of our amended prior period annual report on Form 10-K/A,for the fiscal year ended March 31, 2006, filed with the Securities andExchange Commission on February 14, 2007. In addition to these factors,there were costs incurred during the third quarter of fiscal 2007 meetinglisting requirements with NASDAQ Capital Market, including our one for fourreverse stock split, as discussed in our December 31, 2006, Form 10-Qfiling with the Securities and Exchange Commission on March 14, 2007.

During fiscal 2007, sales and marketing and researchand development expenses were comparable to fiscal 2006, and general andadministrative expenses increased significantly over 2006 The Company iscommitted to ongoing cost containment aimed at controlling its level ofoperating expenses, but may increase some discretionary spending in futureperiods as dictated by the needs of the business.

Our research and development costs increased to$203,000, up 9% from $187,000 in fiscal 2006, and down 19% from $251,000 infiscal 2005. The major expenditures in research and development were forinitiation of new scientific clinical trials, costs related to productregistration and work aimed at increasing production yields and improving thequality and stability of such products.

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Our sales and marketing costs were $1,297,000,$1,312,000 and $1,189,000 in fiscal 2007, 2006 and 2005, respectively; suchexpenses decreased 1% from fiscal 2006, but were 9% higher than in fiscal 2005,primarily due to increased advertising expenditures for bulk BioAstin andNatuRose products.

Our general and administrative costs were $2,448,000,$1,814,000 and $1,728,000 in fiscal 2007, 2006 and 2005, respectively. Comparedto fiscal 2006, fiscal 2007 expenses increased by $634,000 or 35% due primarilyto costs incurred for restatement of prior year’s annual reports on Form 10-K/Aas of March 31, 2006, and the work associated with the threatened NASDAQCapital Market delisting issues resulting in increases in audit, attorneys,accountants and other financial fees totaling a combined $709,000. We do notexpect these fees during fiscal 2008. Compared to fiscal 2005, fiscal 2006expenses increased by 5% due to increased personnel costs and increasedregulatory compliance reporting costs.

The Company periodically reviews the recoverability ofthe carrying value of long-lived assets using the methodology prescribed inStatement of Financial Accounting Standards (SFAS) 144, “Accounting for theImpairment and Disposal of Long-Lived Assets.” The Company also reviewslong-lived assets and intangible assets for potential impairment wheneverevents or changes in circumstances indicate that the carrying value of suchassets may not be recoverable. Such analysis under SFAS No. 144 at March 31,2007 determined that the Company should record a non-cash impairment loss reducing,by $4.5 million, the values of certain production related equipment andleasehold improvement assets at March 31, 2007. Accordingly, the values ofthe Company’s equipment and leasehold improvement assets as reported on theConsolidated Balance Sheets as of March 31, 2007 have been reduced by theimpairment loss, and the Company’s Consolidated Statements of Operations forthe year ended March 31, 2007 includes the corresponding charge of $4.5million for the impairment of equipment and leasehold improvements. The Companynotes that the foregoing reduction of asset carrying values will significantlyand correspondingly reduce depreciation expense in future periods. See Note 3to the consolidated financial statements for further discussion of thisimpairment charge.

The Company expects operating expense spending willremain consistent with or moderately increase from fiscal 2007 levels after theexclusion of the previously mentioned non-cash impairment write-down and therestatement related costs. Increases may be necessary in research anddevelopment as new opportunities arise. However, the Company will continue toseek additional leverage from customer supported research where and aspracticable. Increases in sales and marketing expenses may become necessary asthe Company seeks new and increased markets and market share. Whether sales andmarketing expenses increase over fiscal year 2007 levels will be based oncustomer demand and response and customer and market opportunities that mayarise. Finally, the cost of regulatory compliance—including internationalstandards (ISO), US food and drug manufacturing practice (GMP), Sarbanes Oxley,and other regulatory compliance areas—continue to increase. However, the Companymust remain competitive in the labor market, and this may lead to someincreases in general and administrative costs.

***Other Expense******  ***The followingdetails the amounts included in other expense:

|                                             | ** ** | **2007**                | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                                  | ** ** | **(In thousands)** | ** ** |
| Interest expense on Term  Loan Agreement(1) |       | $                       | 181        |     | $          | 175      |       | $ | 158 |   |
| Other interest  expense                     |       | 5                       |       | 5        |       | 5        |       |
| Other income, net(2)                        |       | (56                     | )          | (36      | )          | (46      | )          |
| Total other  expense                        |       | $                       | 130        |     | $          | 144      |       | $ | 117 |   |
|                                        |       |                    |       |     |       |     |       |

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(1)          The principal balance onthe Term Loan was $1,390,000, $1,751,000 and $2,098,000 as of March 31,2007, 2006 and 2005 respectively. The interest rate under the Term Loan is 1%above the prime rate. The prime rate as of March 31, 2007, 2006 and 2005was 8.25%, 7.25% and 5.25%, respectively. Interest expense includesamortization of debt issue costs.

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(2)          Otherincome, net includes interest earned on certain cash and cash equivalentsbalances and gains arising from exchange rate fluctuations on transactions ofthe Company’s Japan subsidiary.

***Income Taxes***   Forfiscal 2007 and 2006, the Company recorded income tax benefit of $9,000 and$6,000, respectively, primarily related to Hawaii State tax credits. For fiscal2005, a Federal and Hawaii State income tax expense of $6,000 was recorded. At March 31,2007 the Company had Federal and Hawaii state net operating loss carry forwardsof approximately $15,774,000 and $11,307,000, respectively. These net operatingloss benefits have been fully reserved as their utilization is not assured.

**Liquidity and Capital Resources**

***Financial Condition******  ***At March 31,2007, the Company’s working capital was $3,361,000, a decrease of $2,286,000compared to $5,647,000 at March 31, 2006. Cash and cash equivalents andshort-term investments at March 31, 2007 totaled $1,444,000, a decrease of$1,091,000 from $2,535,000 at March 31, 2006. The decreases in workingcapital, cash and cash equivalents, and short term investments are due to cashused in operating activities primarily resulting from significant increases ingeneral and administrative costs previously discussed, and decreased balancesin accounts receivable and inventory.

The Company has a TermLoan Agreement (“Term Loan”) with a lender providing up to $3.5 million incredit facilities, secured by substantially all the assets of the Company. Theoutstanding balance under the Term Loan as of March 31, 2007 isapproximately $1,390,000. The Term Loan has a maturity date of May 1, 2010and is payable in 120 equal monthly principal and interest payments ofapproximately $42,000. The interest rate under the Term Loan, in absence of adefault under the agreement, is the prime rate, as defined, in effect as of theclose of business on the first day of each calendar quarter, plus 1% (the primerate was 8.25% at March 31, 2007). The Company received a waiver of relevantrestrictive covenants of the Term Loan related to the filings of Forms 10-Qfor fiscal year 2007. In addition, the Company has received a waiver ofcovenants related to delayed filing of this Form 10-K. The Companyis prohibited by the Term Loan from declaring any cash dividends without thelender’s prior written consent. A $250,000 restricted cash deposit is held inan interest-bearing restricted cash account per the terms of the Term Loan andis included in Other Assets in the consolidated balance sheets at March 31,2007 and 2006.

Thefollowing table presents the Company’s debt and lease obligations at March 31,2007 (in thousands):

| ** **                     | ** ** | **Less Than  1 Year** | ** ** | **1-3 Years** | ** ** | **4-5 Years** | ** ** | **After 5  Years** | ** ** | **Total** | ** ** |
|--------------------------------|------------|---------------------------------|------------|--------------------|------------|--------------------|------------|-------------------------|------------|-----------|------------|
| Term Loan                      |       |                            | $          | 398                |       |               |       | $                       | 908        |      |       |   | $ | 84 |   |   | $ | — |   | $ | 1,390 |   |
| Interest Expense on Term  Loan |       |                            | 114        |               |       |               | 108        |                    |       |      | 1          |   |   | — |   | 223 |   |
| Operating Leases               |       |                            | 241        |               |       |               | 361        |                    |       |      | 297        |   |   | 2,035 |   | 2,934 |   |
| Total                          |       |                            | $          | 753                |       |               |       | $                       | 1,377      |      |       |   | $ | 382 |   |   | $ | 2,035 |   | $ | 4,547 |   |

*** ***

***Cash Flows******  ***Our cash andcash equivalents and short-term investments were $1,444,000, $2,535,000 and$3,005,000 at March 31, 2007, 2006 and 2005, respectively. At March 31,2007, $200,000 of this amount represents certificates of deposit included incash and cash equivalents.

During fiscal year 2007,the Company used cash in operating activities of $459,000, whereas duringfiscal years 2006 and 2005, the Company generated cash from operatingactivities of $179,000 and $1,328,000, respectively. The reduction in cash fromoperations in fiscal year 2007 compared to fiscal year 2006 is primarily due tothe fiscal 2007 net loss of $7,425,000 compared to a net loss of $391,000 infiscal year 2006 and net income of $601,000 in fiscal year 2005. Partiallyoffsetting the fiscal 2007 net loss of $7,425,000 (reduced by non-cash expensesof $5,760,000) was cash provided from decreases in accounts receivables andinventories totaling $610,000 and $463,000, and increases in accounts payableof $131,000. Cash used in operating activities of $459,000 in fiscal 2007represents a decline of $638,000 from cash provided during fiscal 2006 of$179,000.

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Net cash of $426,000provided by investing activities during fiscal 2007 was due to $700,000generated from the maturity of short-term investments, net of $274,000 ofinvestment in equipment and leasehold improvements. The capital expenditurespertain primarily to production equipment, including a cell cracking mill, andresearch and development equipment. Such expenditures continue to be aimedtoward capital projects enhancing or maintaining our ability to respond tomarket demand. Depreciation and amortization expense was $1,250,000, $1,321,000and $1,319,000 for the years ended March 31, 2007, 2006 and 2005,respectively. For fiscal 2008, management expects to continue to invest inequipment upgrades and leasehold improvements tied to market requirements andproduction efficiency. Capital expenditures are expected to approximate amountsexpended in fiscal 2007.

During fiscal 2007, cash used in financing activitiesamounted to $358,000 representing principal payments on long-term debt of$361,000, slightly reduced by proceeds from the exercise of stock options.

***Sufficiency ofLiquidity******  ***Basedupon our current operating plan, analysis of our consolidated financialposition and projected future results of operations, we believe that ouroperating cash flows and expected cash balances will be sufficient to financecurrent operating requirements, debt service, and planned capital expenditures,for the next 12 months. With****total workingcapital of $3.4 million, and a current ratio of 3.4 to 1 as of March 31,2007, management expects liquidity in fiscal 2008 to be generated primarilyfrom operating cash flows.

The Company has usedestimates of future financial results including projected revenue, expenses,borrowings, and capital expenditures in reaching its conclusions. Suchestimates are subject to change based on future results and such change couldcause future conclusions to vary significantly from those presented in this Form 10-K.

**Variabilityof Results**

Thefollowing selected quarterly financial data (unaudited) as of and for theperiods presented highlights the significant fluctuations in operating resultsand financial condition that the Company has experienced in the past threefiscal years: 

| **Ended**          | ** ** | ** **              | ** ** | **4**th Quarter  March 31, | ** ** | **3**rd Quarter  December 31, | ** ** | **2**nd Quarter  September 30, | ** ** | **1**st Quarter  June 30, | ** ** |
|--------------------|------------|-------------------------|------------|--------------------------------------|------------|-----------------------------------------|------------|------------------------------------------|------------|-------------------------------------|------------|
| ** **         | ** ** | **(In thousands)** | ** ** |
| Fiscal 2007:       |       |                    |       |                                 |       |                                    |       |                                     |       |                                |       |   |   |   |   |   |   |
| Net sales          |       |                    | $          | 2,330                                |       |                                    |       | $                                        | 2,434      |                                |       |   | $ | 2,475 |   |   |   | $ | 2,444 |   |   |
| Cost of sales      |       |                    | 2,152      |                                 |       |                                    | 2,356      |                                     |       |                                | 2,071      |   |   |   | 1,973 |   |   |
| Operating expenses |       |                    | 5,466      |                                 |       |                                    | 1,241      |                                     |       |                                | 946        |   |   |   | 782 |   |   |
| Net income (loss)  |       |                    | (5,319     | )                                    |       |                                    | (1,187     | )                                        |       |                                | (572       | ) |   |   | (347 | ) |   |
| Working capital    |       |                    | 3,361      |                                 |       |                                    | 4,055      |                                     |       |                                | 5,080      |   |   |   | 5,594 |   |   |
| Fiscal 2006:       |       |                    |       |                                 |       |                                    |       |                                     |       |                                |       |   |   |   |   |   |   |
| Net sales          |       |                    | $          | 3,252                                |       |                                    |       | $                                        | 2,333      |                                |       |   | $ | 2,517 |   |   |   | $ | 3,029 |   |   |
| Cost of sales      |       |                    | 2,438      |                                 |       |                                    | 1,674      |                                     |       |                                | 1,935      |   |   |   | 2,024 |   |   |
| Operating expenses |       |                    | 831        |                                 |       |                                    | 835        |                                     |       |                                | 856        |   |   |   | 791 |   |   |
| Net income (loss)  |       |                    | (43        | )                                    |       |                                    | (210       | )                                        |       |                                | (297       | ) |   |   | 159 |   |   |
| Working capital    |       |                    | 5,647      |                                 |       |                                    | 5,555      |                                     |       |                                | 5,587      |   |   |   | 5,772 |   |   |
| Fiscal 2005:       |       |                    |       |                                 |       |                                    |       |                                     |       |                                |       |   |   |   |   |   |   |
| Net sales          |       |                    | $          | 2,560                                |       |                                    |       | $                                        | 3,180      |                                |       |   | $ | 2,998 |   |   |   | $ | 2,707 |   |   |
| Cost of sales      |       |                    | 1,833      |                                 |       |                                    | 2,013      |                                     |       |                                | 1,882      |   |   |   | 1,825 |   |   |
| Operating expenses |       |                    | 790        |                                 |       |                                    | 821        |                                     |       |                                | 858        |   |   |   | 699 |   |   |
| Net income (loss)  |       |                    | (94        | )                                    |       |                                    | 354        |                                     |       |                                | 206        |   |   |   | (135 | ) |   |
| Working capital    |       |                    | 5,347      |                                 |       |                                    | 5,256      |                                     |       |                                | 4,711      |   |   |   | 4,426 |   |   |

 

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The Company’s results of operations and financialcondition can be affected by numerous factors, many of which are beyond itscontrol and could cause future results of operations to fluctuate materially asit has in the past. Future operating results may fluctuate as a result ofchanges in sales volumes to our largest customers, weather patterns, increasedcompetition, increased materials, nutrient and energy costs, foreign currencyexchange fluctuations, governmental regulations and other factors beyond ourcontrol. In addition, the Company maintains product liability insurance only inlimited amounts for products involving human consumption because broaderproduct liability coverage is cost prohibitive.

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

**Effectof Recently Issued Accounting Standards and Estimates**

In December 2005, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 123 (Revised 2004) (SFAS No. 123R),“Share-Based Payment”, which is a revision of FASB Statement No. 123 “Accountingfor Stock-Based Compensation.” SFAS No. 123R requires an entity to measurethe cost of employee services received in exchange for an award. If an awardvests or becomes exercisable based on the achievement of a condition other thanservice, performance or market condition, the award is liability-classified.Liability-classified awards are remeasured to fair value at each balance sheetdate until the award is settled. Equity-classified awards, including grants ofemployee stock options, are measured at the grant-date fair value of the awardand are not subsequently remeasured. The cost of equity-classified awards isrecognized in the income statement over the period during which an employee isrequired to provide the service in exchange for the award. Currently thecompany accounts for its employee and non-employee director stock options underthe intrinsic value provision of APB Opinion No. 25. The Company wasrequired to adopt the provisions for SFAS No. 123R as of the beginning ofthe first annual reporting period that begins after June 15, 2005,although earlier adoption was permitted. Management adopted the provisions ofSFAS No. 123R, “Share-Based Payment,” for its share-based compensationplans effective April 1, 2006 using the Modified Prospective method ofaccounting. Adoption of the provisions of SFAS No. 123R had nomaterial impact on the Company’s financial condition or results of operationsfor the year ended March 31, 2007.

In November 2004, the FASB issued SFAS No. 151“Inventory Costs—an amendment of Accounting Research Bulletin No. 43,Chapter 4”. SFAS No. 151 requires that abnormal amounts of freight,handling costs and wasted material (spoilage) be recognized as current-periodcharges and fixed production overhead costs be allocated to inventory based onthe normal capacity of production facilities. Normal capacity is defined as “theproduction expected to be achieved over a number of periods or seasons undernormal circumstances, taking into account the loss of capacity resulting fromplanned maintenance.” Companies will no longer be permitted to capitalizeinventory costs on the balance sheet when the production defect rate variessignificantly from the expected defect rate. SFAS No. 151 is effective forinventory costs incurred during fiscal years beginning after June 15, 2005.The Company adopted SFAS No. 151 effective April 1, 2006. Adoption ofthe provisions of SFAS No. 151 did not have a significant impact on theCompany’s financial condition and results of operations for the year ended March 31,2007.

In December 2004, the FASB issued SFAS No. 153,“Exchange of Nonmonetary Assets, an amendment of APB Opinion No. 29, ‘Accountingfor Nonmonetary Transactions.’” SFAS No. 153 is based on the principlethat exchange of nonmonetary assets should be measured based on the fair marketvalue of the assets exchanged. SFAS No. 153 eliminates the exception ofnonmonetary exchanges of similar productive assets and replaces it with ageneral exception for exchanges of nonmonetary assets that do not 

29

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have commercial substance.SFAS No. 153 is effective for nonmonetary asset exchanges in fiscalperiods beginning after June 15, 2005. The Company adopted SFAS No. 153effective April 1, 2006. Adoption of the provisions of SFAS No. 153had no material impact on the Company’s financial condition, results ofoperations, or liquidity.

In June 2006, the FASB issued FASB InterpretationNo. 48 (“FIN No. 48”), “Accounting for Uncertainty in Income Taxes,an interpretation of FASB Statement No. 109”. This interpretationprescribes a “more-likely-than-not” recognition threshold and measurementattribute (the largest amount of benefit that is greater than 50% likely ofbeing realized upon ultimate settlement with tax authorities) for the financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return. This interpretation also provides guidance onderecognition, classification, interest and penalties, accounting in interimperiods, disclosure and transition. FIN No. 48 is effective for fiscalyears beginning after December 15, 2006. The Company adopted FIN No. 48on April 1, 2007 with no material impact to the financial statements, andbelieves the impact of FIN No. 48 will not materially impact the Company’sresults of operations for fiscal 2008 or beyond.

In June 2006, theFASB ratified the consensus on Emerging Issues Task Force Issue No. 06-3(“EITF No. 06-3”), “How Taxes Collected from Customers and Remittedto Governmental Authorities Should Be Presented in the Income Statement”. Thescope of EITF No. 06-3 includes any tax assessed by agovernmental authority that is directly imposed on a revenue-producing transactionbetween a seller and a customer and may include, but is not limited to, sales,use, value added, Universal Service Fund (USF) contributions and someexcise taxes. The Task Force affirmed its conclusion that entities shouldpresent these taxes in the income statement on either a gross or a net basisbased on their accounting policy, which should be disclosed pursuant to APBOpinion No. 22, “Disclosure of Accounting Policies.” If such taxes aresignificant and are presented on a gross basis, the amounts of those taxesshould be disclosed. The consensus on EITF No. 06-3 indicatesit should be effective for annual and interim reporting periods beginning afterDecember 15, 2006. The Company adopted EITF No. 06-3 on January 1,2007 and the impact of EITF No. 06-3 had no material impact on theCompany’s results of operations for the year ended March 31, 2007.

**Applicationof Critical Accounting Policies and Estimates**

The Company’s discussion and analysis of its financialcondition and results of operations are based upon the Company’s consolidatedfinancial statements, which have been prepared in accordance with accountingprinciples generally accepted in the United States. The preparation offinancial statements in conformity with those accounting principles requiresmanagement to make judgments and estimates that affect the amounts reported inthe consolidated financial statements and accompanying notes. Actual resultscould differ from those estimates. The Company regularly re-evaluates itsjudgments and estimates which are based upon historical experience and onvarious other assumptions that are believed to be reasonable under thecircumstances. The Company believes that of its significant accountingpolicies, policies that may involve a higher degree of judgment and complexityare inventory valuations, valuation of equipment and leasehold improvements andlong-lived assets, revenue recognition, and income taxes.

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

The Company is required to state inventories at thelower of cost or market. Cost is defined as the sum of the applicableexpenditures and charges directly or indirectly incurred in bringinginventories to their existing condition and location. Cost for inventorypurposes may be determined under any one of several assumptions as to the flowof cost factors, such as first-in, first-out; average cost; and last-in,first-out. Our inventories are stated at the lower of cost, which approximatesfirst-in, first-out, or market. Inventory values are subject to many criticalestimates, and unforeseen changes in any of the factors 

30

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surrounding the estimatesimbedded in the determination of inventory values and cost of sales could havea material impact on the Company’s results. Such changes in factors andestimates include but are not limited to: production levels and capacity,changes in the prices paid for raw materials, supplies, and labor, changes inyield, potency, and quality of biomass, changes in processing or productionmethods, and changes in the carrying value of our inventories resulting fromthe prices our customers are willing to pay for our products.

Equipment and leasehold improvements are reported atcost less accumulated depreciation and amortization. Self-constructed leaseholdimprovements include design, construction and supervision costs. These costsare recorded in construction in progress and are transferred to equipment andleasehold improvements when construction is completed and the facilities areplaced in service. If the Company experiences impairment to its equipment orleasehold improvement, we would account for the impairment in accordance withSFAS No. 144. Pursuant to SFAS No. 144, long-lived assets, such asproperty, plant and equipment and purchased intangibles subject to amortizationshall be reviewed for impairment whenever events or changes in circumstancesindicate 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 thecarrying amount of an asset to the estimated undiscounted future cash flowsexpected to be generated by the asset. If the carrying amount of an assetexceeds its estimated future cash flows, an impairment charge is recognized tothe extent that the carrying amount exceeds the asset’s fair value.

During the year ended March 31, 2007, the Companyrecorded an impairment charge of $4,487,000. The Company has determined fairvalue based upon present values of expected future cash flows. This techniquerequires the use of a variety of estimates including projected financialinformation, discount rates, as well as estimates of asset values many years inthe future. As such, the results from the use of this method can result insignificant volatility in the results should any of these estimates orassumptions change.

Income taxes are accountedfor under the asset and liability method. The asset and liability methodrequires the recognition of deferred tax assets and liabilities for theexpected future tax consequences attributable to differences between thefinancial statement carrying amounts of existing assets and liabilities andtheir tax bases and operating loss and tax credit carry forwards. Deferred taxassets and liabilities are measured using enacted income tax rates applicableto the period in which the deferred tax assets or liabilities are expected tobe recovered or settled. The Company records a valuation allowance to reduceits deferred tax assets to the amount that it believes is more likely than notto be realized. Judgment is required in assessing the need for the valuationallowance. The ultimate realization of deferred tax assets is dependent uponthe generation of future taxable income during the periods in which thosetemporary differences become deductible. Should the Company generate sustainedtaxable income in the future, management may conclude that a portion or all ofthe existing valuation allowance is no longer required.

**Item7A. Quantitative and Qualitative Disclosures About Market Risk**

We have never entered into any transactions usingderivative financial instruments or derivative commodity instruments andbelieve that our exposure to market risk associated with other financialinstruments is not material.

We have a term loan agreement which adjusts quarterlybased on the prime rate. As such, we are exposed to the interest rate riskwhereby a 1% increase in the prime rate would lead to an increase ofapproximately $14,000 in interest expense for the year ending March 31,2008 (based on March 31, 2007 amounts outstanding).

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**Item8. Financial Statements and Supplementary Data**

**Report of IndependentRegistered Public Accounting Firm**

The Board of Directors and StockholdersCyanotech Corporation:

We have audited the accompanying consolidated balancesheets of Cyanotech Corporation and subsidiaries (the Company) as of March 31,2007 and 2006, and the related consolidated statements of operations,stockholders’ equity and comprehensive income (loss), and cash flows for eachof the years in the three-year period ended March 31, 2007. Theseconsolidated financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these consolidatedfinancial statements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, 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 statementsreferred to above present fairly, in all material respects, the financialposition of Cyanotech Corporation and subsidiaries as of March 31, 2007and 2006, and the results of their operations and their cash flows for each ofthe years in the three-year period ended March 31, 2007, in conformitywith U.S. generally accepted accounting principles.

As discussed in Note 1 tothe consolidated financial statements, effective April 1, 2006, theCompany adopted Statement of Financial Accounting Standards No. 123(R), *Share Based Payment*.

/s/ KPMG LLP

Honolulu, HawaiiAugust 15, 2007

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**CYANOTECH CORPORATION AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETSMarch 31, 2007 and 2006**

| ** **                                                                                                                                    | ** ** | **2007**                                                    | ** ** | **2006** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|----------|------------|
| ** **                                                                                                                                    | ** ** | **(in thousands,   except share data)** | ** ** |
| ASSETS                                                                                                                                        |       |                                                        |       |     |       |
| Current assets:                                                                                                                               |       |                                                        |       |     |       |
| Cash and cash equivalents                                                                                                                     |       | $                                                           | 1,444      |     | $          | 1,835 |   |
| Short-term investments                                                                                                                        |       | —                                                      |       | 700      |       |
| Accounts receivable, net of allowance for doubtful  accounts of $23 and $25 in 2007 and 2006, respectively                                    |       | 1,587                                                       |       | 2,209    |       |
| Inventories                                                                                                                                   |       | 1,593                                                       |       | 2,056    |       |
| Prepaid expenses and other current assets                                                                                                     |       | 141                                                         |       | 116      |       |
| Total current assets                                                                                                                          |       | 4,765                                                       |       | 6,916    |       |
| Equipment and leasehold improvements, net                                                                                                     |       | 4,701                                                       |       | 10,164   |       |
| Other assets                                                                                                                                  |       | 440                                                         |       | 515      |       |
| Total assets                                                                                                                                  |       | $                                                           | 9,906      |     | $          | 17,595 |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                    |       |                                                        |       |     |       |
| Current  liabilities:                                                                                                                         |       |                                                        |       |     |       |
| Current maturities of long-term debt                                                                                                          |       | $                                                           | 398        |     | $          | 364 |   |
| Accounts payable                                                                                                                              |       | 616                                                         |       | 485      |       |
| Accrued expenses                                                                                                                              |       | 390                                                         |       | 420      |       |
| Total current liabilities                                                                                                                     |       | 1,404                                                       |       | 1,269    |       |
| Long-term debt, excluding current maturities                                                                                                  |       | 992                                                         |       | 1,387    |       |
| Total liabilities                                                                                                                             |       | 2,396                                                       |       | 2,656    |       |
| Stockholders’  equity:                                                                                                                   |       |                                                        |       |     |       |
| Common stock of $.02 par value, authorized 7,500,000  shares; issued and outstanding 5,233,520 shares for 2007 and 5,224,066 shares  for 2006 |       | 105                                                         |       | 105      |       |
| Additional paid-in capital                                                                                                                    |       | 27,333                                                      |       | 27,330   |       |
| Accumulated other comprehensive loss                                                                                                          |       | (8                                                          | )          | (1       | )          |
| Accumulated deficit                                                                                                                           |       | (19,920                                                     | )          | (12,495  | )          |
| Total stockholders’ equity                                                                                                               |       | 7,510                                                       |       | 14,939   |       |
| Total liabilities  and stockholders’ equity                                                                                              |       | $                                                           | 9,906      |     | $          | 17,595 |   |

 

 

See accompanying notes to consolidated financial statements

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**CYANOTECH CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONSYears ended March 31, 2007, 2006 and 2005**

| ** **                                                  | ** ** | **2007**                                                             | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                                  | ** ** | **(in thousands, except   per share data)** | ** ** |
| Net sales                                                   |       | $                                                                    | 9,683      |     | $          | 11,131   |       | $ | 11,445 |   |
| Cost of sales                                               |       | 8,552                                                                |       | 8,071    |       | 7,553    |       |
| Gross profit                                                |       | 1,131                                                                |       | 3,060    |       | 3,892    |       |
| Operating expenses:                                         |       |                                                                 |       |     |       |     |       |
| Research and development                                    |       | 203                                                                  |       | 187      |       | 251      |       |
| Sales and marketing                                         |       | 1,297                                                                |       | 1,312    |       | 1,189    |       |
| General and administrative                                  |       | 2,448                                                                |       | 1,814    |       | 1,728    |       |
| Impairment loss on equipment and leasehold improvements     |       | 4,487                                                                |       | —   |       | —   |       |
| Total operating expense                                     |       | 8,435                                                                |       | 3,313    |       | 3,168    |       |
| Income (loss) from operations                               |       | (7,304                                                               | )          | (253     | )          | 724      |       |
| Other income (expense):                                     |       |                                                                 |       |     |       |     |       |
| Interest income                                             |       | 59                                                                   |       | 46       |       | 31       |       |
| Interest expense                                            |       | (186                                                                 | )          | (180     | )          | (163     | )          |
| Other income (expense), net                                 |       | (3                                                                   | )          | (10      | )          | 15       |       |
| Total other expense, net                                    |       | (130                                                                 | )          | (144     | )          | (117     | )          |
| Income (loss) before income taxes                           |       | (7,434                                                               | )          | (397     | )          | 607      |       |
| Income tax expense (benefit)                                |       | (9                                                                   | )          | (6       | )          | 6        |       |
| Net income (loss)                                           |       | $                                                                    | (7,425     | )        | $          | (391     | )          | $ | 601 |   |
| Net income (loss)  per share:                               |       |                                                                 |       |     |       |     |       |
| Basic                                                       |       | $                                                                    | (1.42      | )        | $          | (0.07    | )          | $ | 0.12 |   |
| Diluted                                                     |       | $                                                                    | (1.42      | )        | $          | (0.07    | )          | $ | 0.11 |   |
| Shares used in  calculation of net income (loss) per share: |       |                                                                 |       |     |       |     |       |
| Basic                                                       |       | 5,234                                                                |       | 5,226    |       | 5,196    |       |
| Diluted                                                     |       | 5,234                                                                |       | 5,226    |       | 5,245    |       |

 

See accompanying notes to consolidated financial statements

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**CYANOTECH CORPORATION AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY ANDCOMPREHENSIVE INCOME (LOSS)**

**Years ended March 31, 2007, 2006 and 2005**

| ** **                                                                   | ** ** | **Common  Stock  Shares**                                 | ** ** | **Common  Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Comprehensive  Income  (Loss)** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|--------------------------|------------|-----------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                   | ** ** | **(in thousands, except share data)** | ** ** |
| Balances at March 31, 2004                                              |       | 5,178,561                                                 |       |              | $          | 104                              |       |                     |       | $                                 | 27,141     |                                                      |       |                                  | $          | (12,705 | ) |   |   | $ | — |   |   |   | $ | 30 |   |   |   | $ | 14,570 |   |   |
| Issuances of common stock  for:                                              |       |                                                      |       |              |       |                             |       |                     |       |                              |       |                                                      |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Exercise of stock options for cash                                           |       | 9,005                                                     |       |              | —     |                             |       |                     | 32         |                              |       |                                                      | —     |                                  |       |   | — |   |   |   | — |   |   |   | 32 |   |   |
| Exercise of warrants for  cash                                               |       | 33,000                                                    |       |              | —     |                             |       |                     | 104        |                              |       |                                                      | —     |                                  |       |   | — |   |   |   | — |   |   |   | 104 |   |   |
| Non-employee directors’ services, at fair value                         |       | 3,500                                                     |       |              | —     |                             |       |                     | 15         |                              |       |                                                      | —     |                                  |       |   | — |   |   |   | — |   |   |   | 15 |   |   |
| Issuance of stock options for third party services,  at fair value           |       | —                                                    |       |              | —     |                             |       |                     | 6          |                              |       |                                                      | —     |                                  |       |   | — |   |   |   | — |   |   |   | 6 |   |   |
| Comprehensive income:                                                        |       |                                                      |       |              |       |                             |       |                     |       |                              |       |                                                      |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                   |       | —                                                    |       |              | —     |                             |       |                     | —     |                              |       |                                                      | 601        |                                  |       |   | 601 |   |   |   | — |   |   |   | 601 |   |   |
| Other comprehensive loss—foreign currency  translation adjustments |       | —                                                    |       |              | —     |                             |       |                     | —     |                              |       |                                                      | —     |                                  |       |   | (3 | ) |   |   | (3 | ) |   |   | (3 | ) |   |
| Comprehensive income                                                         |       | —                                                    |       |              | —     |                             |       |                     | —     |                              |       |                                                      | —     |                                  |       |   | 598 |   |   |   | — |   |   |   | — |   |   |
| Balances at March 31, 2005                                              |       | 5,224,066                                                 |       |              | 104        |                             |       |                     | 27,298     |                              |       |                                                      | (12,104    | )                                     |       |   | — |   |   |   | 27 |   |   |   | 15,325 |   |   |
| Issuances of common stock  for:                                              |       |                                                      |       |              |       |                             |       |                     |       |                              |       |                                                      |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Exercise of stock options for cash                                           |       | 3,625                                                     |       |              | 1          |                             |       |                     | 8          |                              |       |                                                      | —     |                                  |       |   | — |   |   |   | — |   |   |   | 9 |   |   |
| Non-employee directors’ services, at fair value                         |       | 4,375                                                     |       |              | —     |                             |       |                     | 14         |                              |       |                                                      | —     |                                  |       |   | — |   |   |   | — |   |   |   | 14 |   |   |
| Compensation expense for accelerated vesting of  stock options          |       | —                                                    |       |              | —     |                             |       |                     | 10         |                              |       |                                                      | —     |                                  |       |   | — |   |   |   | — |   |   |   | 10 |   |   |
| Comprehensive loss:                                                          |       |                                                      |       |              |       |                             |       |                     |       |                              |       |                                                      |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                                     |       | —                                                    |       |              | —     |                             |       |                     | —     |                              |       |                                                      | (391       | )                                     |       |   | (391 | ) |   |   | — |   |   |   | (391 | ) |   |
| Other comprehensive loss—foreign currency  translation adjustments |       | —                                                    |       |              | —     |                             |       |                     | —     |                              |       |                                                      | —     |                                  |       |   | (28 | ) |   |   | (28 | ) |   |   | (28 | ) |   |
| Comprehensive loss                                                           |       | —                                                    |       |              | —     |                             |       |                     | —     |                              |       |                                                      | —     |                                  |       |   | (419 | ) |   |   | — |   |   |   | — |   |   |
| Balances at March 31, 2006                                              |       | 5,232,066                                                 |       |              | 105        |                             |       |                     | 27,330     |                              |       |                                                      | (12,495    | )                                     |       |   | — |   |   |   | (1 | ) |   |   | 14,939 |   |   |
| Issuances of common stock  for:                                              |       |                                                      |       |              |       |                             |       |                     |       |                              |       |                                                      |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Exercise of stock options for cash                                           |       | 1,575                                                     |       |              | —     |                             |       |                     | 3          |                              |       |                                                      | —     |                                  |       |   | — |   |   |   | — |   |   |   | 3 |   |   |
| Reverse stock split fractional shares                                        | ** ** | (121                                                      | )          |              | —     |                             |       |                     | —     |                              |       |                                                      | —     |                                  |       |   | — |   |   |   | — |   |   |   | — |   |   |
| Comprehensive loss:                                                          |       |                                                      |       |              |       |                             |       |                     |       |                              |       |                                                      |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                                     |       | —                                                    |       |              | —     |                             |       |                     | —     |                              |       |                                                      | (7,425     | )                                     |       |   | (7,425 | ) |   |   | — |   |   |   | (7,425 | ) |   |
| Other comprehensive loss—foreign currency  translation adjustments |       | —                                                    |       |              | —     |                             |       |                     | —     |                              |       |                                                      | —     |                                  |       |   | (7 | ) |   |   | (7 | ) |   |   | (7 | ) |   |
| Comprehensive loss                                                           |       | —                                                    |       |              | —     |                             |       |                     | —     |                              |       |                                                      | —     |                                  |       |   | $ | (7,432 | ) |   |   | — |   |   |   | — |   |   |
| Balances at  March 31, 2007                                             |       | 5,233,520                                                 |       |              | $          | 105                              |       |                     |       | $                                 | 27,333     |                                                      |       |                                  | $          | (19,920 | ) |   |   |   |   |   |   | $ | (8 | ) |   |   | $ | 7,510 |   |   |

 

See accompanying notes to consolidated financial statements

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**CYANOTECH CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWSYears ended March 31, 2007, 2006 and 2005**

| ** **                                                                                                                          | ** ** | **2007**                | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                                                                                                                          | ** ** | **(in thousands)** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                                                              |       |                    |       |     |       |     |       |
| Net income (loss)                                                                                                                   |       | $                       | (7,425     | )        | $          | (391     | )          | $ | 601 |   |
| Adjustments to reconcile  net income (loss) to cash provided by (used in) operating activities:                                     |       |                    |       |     |       |     |       |
| Impairment loss on equipment and leasehold  improvements                                                                            |       | 4,487                   |       | —   |       | —   |       |
| Depreciation and amortization                                                                                                       |       | 1,250                   |       | 1,321    |       | 1,319    |       |
| Amortization of debt issue costs and other assets                                                                                   |       | 35                      |       | 37       |       | 27       |       |
| Issuance of common stock and stock options in  exchange for services                                                                |       | —                  |       | 14       |       | 21       |       |
| Compensation expense for accelerated vesting of  stock options                                                                      |       | —                  |       | 10       |       | —   |       |
| Provision for (reduction of) allowance for doubtful  accounts                                                                       |       | 12                      |       | (8       | )          | 31       |       |
| Net (increase)  decrease in assets:                                                                                                 |       |                    |       |     |       |     |       |
| Accounts receivable                                                                                                                 |       | 610                     |       | (132     | )          | 111      |       |
| Inventories                                                                                                                         |       | 463                     |       | (224     | )          | (628     | )          |
| Prepaid expenses and other assets                                                                                                   |       | 8                       |       | 11       |       | (40      | )          |
| Net increase  (decrease) in liabilities:                                                                                            |       |                    |       |     |       |     |       |
| Accounts payable                                                                                                                    |       | 131                     |       | (492     | )          | 103      |       |
| Accrued expenses                                                                                                                    |       | (30                     | )          | 33       |       | (217     | )          |
| Net cash provided by (used in) operating activities                                                                                 |       | (459                    | )          | 179      |       | 1,328    |       |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                                                              |       |                    |       |     |       |     |       |
| Maturity  (purchase) of short-term investments                                                                                      |       | 700                     |       | 300      |       | (900     | )          |
| Investment in  equipment and leasehold improvements                                                                                 |       | (274                    | )          | (311     | )          | (649     | )          |
| Net cash provided by (used in) investing activities                                                                                 |       | 426                     |       | (11      | )          | (1,549   | )          |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                                                              |       |                    |       |     |       |     |       |
| Proceeds from  issuance of common stock in conjunction with the exercise of stock options  and warrants, net of issuance costs |       | 3                       |       | 9        |       | 136      |       |
| Principal  payments on long-term debt                                                                                               |       | (361                    | )          | (347     | )          | (341     | )          |
| Net cash used in financing activities                                                                                               |       | (358                    | )          | (338     | )          | (205     | )          |
| Net increase  (decrease) in cash and cash equivalents                                                                               |       | (391                    | )          | (170     | )          | (426     | )          |
| Cash and cash  equivalents at beginning of year                                                                                     |       | 1,835                   |       | 2,005    |       | 2,431    |       |
| Cash and cash  equivalents at end of year                                                                                           |       | $                       | 1,444      |     | $          | 1,835    |       | $ | 2,005 |   |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION:                                                                                  |       |                    |       |     |       |     |       |
| Cash paid during the  year for:                                                                                                     |       |                    |       |     |       |     |       |
| Interest                                                                                                                            |       | $                       | 157        |     | $          | 148      |       | $ | 132 |   |
| Income taxes                                                                                                                        |       | $                       | 1          |     | $          | —   |       | $ | 178 |   |

 

See accompanying notes to consolidated financial statements

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**CYANOTECH CORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**Note 1 Descriptionof Business and Summary of Accounting Policies**

**Description ofBusiness**

Cyanotech Corporation (theCompany) cultivates and produces high-value, high-quality natural productsderived from microalgae. The Company currently cultivates, on a large-scalebasis, two microalgal species from which its two major product lines arederived. The Company is currently producing microalgal products for thenutritional supplement, animal feed/pigments and immunological diagnosticsmarkets. The Company manufactures all of its products in the United States andsells its products worldwide. As the Company’s operations are solely related tomicroalgae-based products, management of the Company considers its operationsto be in one industry segment. Correspondingly, the Company records revenue andcost of sales information by product category.

**Basis ofPresentation**

The accompanyingconsolidated financial statements have been prepared in accordance withaccounting principles generally accepted in the United States of America. Theaccompanying consolidated financial statements include the accounts ofCyanotech Corporation and its wholly owned subsidiaries, NutrexHawaii, Inc. (“Nutrex Hawaii” or “Nutrex”) and Cyanotech Japan YK(“Cyanotech Japan” or “CJYK”). All significant intercompany balances andtransactions have been eliminated in consolidation.

**Reclassifications**

Reclassifications havebeen made in the comparative 2006 and 2005 financial statement amounts includedin this report. This provides for conformation to the 2007 presentation. Thereclassifications had no effect on net income.

**Estimates andAssumptions**

The preparation of theconsolidated financial statements requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities and thedisclosure of any contingent assets and liabilities as of the date of thefinancial statements and the reported amounts of revenues and expenses duringthe period reported. Management reviews theses estimates and assumptionsperiodically and reflects the effect of revisions in the period that they aredetermined to be necessary. Actual results could differ significantly fromthose estimates and assumptions.

**Foreign CurrencyTranslation and Risk**

The Japanese Yen is thefunctional currency for Cyanotech Japan. As such, Cyanotech Japan’s assets andliabilities are translated at the exchange rate on the balance sheet date andrevenues and expenses are translated at average rates of exchange prevailingduring the year. Translation adjustments are charged or credited to accumulatedother comprehensive income (loss) in stockholders’ equity. Certain transactionsfor Cyanotech Japan are exposed to foreign currency risk. The Company activelymonitors and manages the balances subject to foreign currency risk. Currently,we do not hedge any of our foreign currency risk through the use of derivativefinancial instruments. For the years ended March 31, 2007, 2006 and 2005,the difference between net income (loss) and comprehensive income (loss) is$(7,000), $(28,000) and $(3,000), respectively, which is attributable toforeign currency translation adjustment losses.

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**FinancialInstruments**

Cash and cash equivalents consist of cash and highlyliquid debt instruments such as commercial paper and certificates of depositwith maturities of three months or less from the date of purchase. Short-terminvestments are certificates of deposits maturing between three and nine monthsfrom the purchase date and are stated at cost. Interest earned on short-terminvestments is deposited monthly into an accessible cash account and istherefore classified as cash and cash equivalents. The Company’s practice is toinvest cash with financial institutions that have acceptable credit ratings andto limit the amount of credit exposure to any one financial institution.

Statement of Financial Accounting Standards (“SFAS”)No. 107, “Disclosures About Fair Value of Financial Instruments,” definesthe fair value of a financial instrument as the amount at which the instrumentcould be exchanged in a current transaction between willing parties. Managementapplies the following methods and assumptions in estimating the fair value ofeach class of financial instruments for all periods presented.

*Cashand Cash Equivalents, Short-Term Investments, Accounts Receivable and AccountsPayable*   Due to the short-termnature of these instruments, management believes that the carrying amountsapproximate fair value.

*Long-Term Debt*   Thecarrying amount of long-term debt approximates fair value as interest ratesapplied to the underlying debt are adjusted quarterly to market interest rateswhich approximate current interest rates for similar debt instruments ofcomparable maturities.

**Trade AccountsReceivable and Allowance for Doubtful Accounts**

Trade accounts receivableare recorded at the invoiced amount and do not accrue interest. The allowancefor doubtful accounts reflects management’s best estimate of probable creditlosses inherent in the accounts receivable balance. The Company determines theallowance based on historical experience, specifically identified nonpayingaccounts and other currently available evidence. The Company reviews itsallowance for doubtful accounts monthly with focus on significant individualpast due balances over 90 days. All other balances are reviewed on a pooledbasis. Account balances are charged off against the allowance after all meansof collection have been exhausted and the potential for recovery is consideredremote. The Company does not have any off-balance sheet credit exposure relatedto its customers.

**Inventories**

Inventories are stated atthe lower of cost or market. Cost is determined using the first-in, first-out(FIFO) method. Market is defined as sales price less cost to dispose and anormal profit margin.

**Equipment andLeasehold Improvements**

Equipmentand leasehold improvements are stated at cost. Depreciation and amortizationare provided using the straight-line method over the estimated useful lives forequipment and furniture and fixtures, or the shorter of the land lease term(see Notes 3 and 6) or estimated useful lives for leasehold improvements asfollows:

| Equipment               |   | 3 to 10 years  |   |
|-------------------------|--------|----------------|--------|
| Furniture and  fixtures |   | 7 years        |   |
| Leasehold improvements  |   | 10 to 20 years |   |

 

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**Impairment ofLong-Lived Assets**

The Company accounts for impairment of its equipmentor leasehold improvements in accordance with SFAS No. 144. Pursuant toSFAS No. 144, long-lived assets, such as property, plant and equipment andpurchased intangibles subject to amortization shall be reviewed for impairmentwhenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable. Recoverability of assets to be held andused is measured by a comparison of the carrying amount of an asset to theestimated undiscounted future cash flows expected to be generated by the asset.If the carrying amount of an asset exceeds its estimated future cash flows, animpairment charge is recognized to the extent that the carrying amount exceedsthe asset’s fair value. The Company has determined fair value based uponpresent values of expected future cash flows. Assets to be disposed of andrelated liabilities would be separately presented in the consolidated balancesheet. Assets to be disposed of would be reported at the lower of the carryingvalue or fair value less costs to sell and would not be depreciated.

In the fourth quarter ofthe fiscal year ended March 31, 2007, the Company concluded that certainproduction assets were partially impaired as a result of its periodicassessment under SFAS 144. This impairment resulted in a non-cash charge ofapproximately **$**4.5 million**.**Theimpairment charge was classified within operating expenses in the consolidatedstatement of operations for the fiscal year ended March 31, 2007. Therewas no impairment as of March 31, 2006 and 2005. See Note 3 to theconsolidated financial statements for further discussion of this impairmentcharge.

**Revenue Recognition**

The Company recognizesrevenues as goods are shipped to customers (FOB shipping point). The criteriafor recognition of revenue are when persuasive evidence that an arrangementexists and both title and risk of loss have passed to the customer, the priceis fixed or determinable and collectibility is reasonably assured.

**Research andDevelopment and Advertising**

Research and developmentand advertising costs are expensed as incurred

**Income Taxes**

Income taxes are accountedfor under the asset and liability method. The asset and liability methodrequires the recognition of deferred tax assets and liabilities for theexpected future tax consequences attributable to differences between thefinancial statement carrying amounts of existing assets and liabilities andtheir tax bases and operating loss and tax credit carry forwards. Deferred taxassets and liabilities are measured using enacted income tax rates applicableto the period that includes the enactment date.

**Share-BasedCompensation**

Effective April 1, 2006, The Company adopted theprovisions of SFAS No. 123(R), “Share-Based Payment,” for its share-basedcompensation plans, using the intrinsic value-based method of accounting foremployee based stock options. The Company previously accounted for these plansunder the recognition and measurement principles of Accounting Principles BoardOpinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” andrelated interpretations and disclosure requirements established by SFASNo. 123, “Accounting for Stock-Based Compensation,” as amended by SFASNo. 148, “Accounting for Stock-Based Compensation—Transition andDisclosure.”

Under APB No. 25, no compensation expense wasrecorded for the Company’s stock options issued under the qualified plan. Thepro forma effects on net earnings and earnings per share for qualified stock 

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options were insteaddisclosed in a footnote to the financial statements. Under APB No. 25,compensation expense for non-qualified stock options with stock appreciationrights features were recorded utilizing the market price of the Company’s stockat each period-end to determine the vested intrinsic value of the stock appreciationrights.

Under SFASNo. 123(R), share-based compensation cost is measured at fair value. Allof the Company’s stock options are performance based and liability-classifiedawards. The Company utilizes a closed-form valuation model to determine thefair value of each option award. Expected volatilities are based on thehistorical volatility of the Company’s stock over a period consistent with thatof the expected terms of the options. The expected terms of the options areestimated based on factors such as vesting periods, contractual expirationdates, historical trends in Cyanotech’s stock price, and historical exercisebehavior. The risk-free rates for periods within the contractual life of theoptions are based on the yields of U.S. Treasury instruments with termscomparable to the estimated option terms.

**Per Share Amounts**

Basic earnings per commonshare is calculated by dividing net income for the period by theweighted-average number of common shares outstanding during the period. Dilutedearnings per common share is calculated by dividing net income for the periodby the sum of the weighted-average number of common shares outstanding duringthe period, plus the number of potentially dilutive common shares (“dilutivesecurities”) that were outstanding during the period. Dilutive securitiesinclude options granted pursuant to the Company’s stock option plans, potentialshares related to the Employee Stock Purchase Plan and Restricted Stock grantsto employees and non-employees. Dilutive securities related to the Company’sstock option plans are included in the calculation of diluted earnings percommon share using the treasury stock method. Potentially dilutive securitiesare excluded from the computation of earnings per share in periods in which anet loss is reported, as their effect would be antidilutive. A reconciliationof the numerators and denominators of the basic and diluted earnings per commonshare calculations for the years ended March 31, 2007, 2006 and 2005 ispresented in Note 8.

**New Accounting Pronouncements**

On September 15, 2006, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 157, Fair Value Measurement**(“SFAS157”). SFAS 157 defines fair value, establishes a framework for measuring fairvalue and expands disclosures about fair value measurements. SFAS 157 iseffective for financial statements issued for fiscal years beginning afterNovember 15, 2007 and interim periods within those fiscal years. TheCompany is evaluating the impact of adopting SFAS 157 on the Company’s consolidatedfinancial position, results of operations and cash flows.

In May 2005, the FASB issued SFAS No. 154,“Accounting Changes and Error Corrections, a replacement of APB OpinionNo. 20 and FASB Statement No. 3”. SFAS No. 154 requiresretrospective application for voluntary changes in accounting principle unlessit is impracticable to do so. In addition, indirect effects of a change inaccounting principle should be recognized in the period of the accountingchange. The Company adopted SFAS No. 154 effective April 1, 2006.Because the impact of adopting the provisions of SFAS No. 154 will bedependent on future events or circumstances, management cannot predict suchimpact.

In December 2004, the FASB issued SFASNo. 153, “Exchange of Nonmonetary Assets, an amendment of APB OpinionNo. 29, “Accounting for Nonmonetary Transactions”. SFAS No. 153 isbased on the principle that exchange of nonmonetary assets should be measuredbased on the fair market value of the assets exchanged. SFAS No. 153 eliminatesthe exception of nonmonetary exchanges of similar productive assets andreplaces it with a general exception for exchanges of nonmonetary assets thatdo not have commercial substance. SFAS No. 153 is effective fornonmonetary asset exchanges in fiscal periods 

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beginning afterJune 15, 2005. The Company adopted SFAS No. 153 effectiveApril 1, 2006. Adoption of the provisions of SFAS No. 153 had nomaterial impact on the Company’s financial condition or results of operations.

In November 2004, the FASB issued Statement ofFinancial Accounting Standards No. 151 (“SFAS No. 151”)“Inventory Costs—an Amendment of Accounting Research Bulletin No. 43,Chapter 4”. SFAS No. 151 requires that abnormal amounts of freight,handling costs and wasted material (spoilage) be recognized as current-periodcharges and fixed production overhead costs be allocated to inventory based onthe normal capacity of production facilities. Normal capacity is defined as“the production expected to be achieved over a number of periods or seasons undernormal circumstances, taking into account the loss of capacity resulting fromplanned maintenance”. The Company adopted SFAS No. 151 effectiveApril 1, 2006. Adoption of the provisions of SFAS No. 151 did nothave a significant impact on the Company’s financial condition and results ofoperations for the year ended March 31, 2007.

On September 13, 2006, the SEC issued StaffAccounting Bulletin No. 108 (“SAB No. 108”), “Considering the Effectsof Prior Year Misstatements when Quantifying Misstatements of Current YearFinancial Statements” which expresses the SEC’s views regarding the process ofquantifying financial statement misstatements. SAB No. 108 providesguidance on the consideration of the effects of prior year misstatements(misstatements that were not corrected at the end of the prior year) inquantifying current year misstatements for the purpose of a materialityassessment. Common practice in quantifying a misstatement allows for multipleapproaches. A misstatement can be based on the amount of the error originatingin the current year income statement or be based on the effects of correctingthe misstatement existing in the balance sheet at the end of the current year,irrespective of the misstatement’s year(s) of origination. Therefore, inquantifying the impact of correcting all misstatements, including both thecarryover and reversing effects of prior year misstatements, on the currentyear financial statements, errors should be measured under each approach andevaluated for materiality. An adjustment would be required when either approachresults in quantifying a misstatement that is material, as defined in FASBConcepts Statement No. 2, after considering all relevant quantitative andqualitative factors. SAB No. 108 is effective for fiscal years ended afterNovember 15, 2006. There was no impact from adoption on the Company’sfinancial condition and results of operations for the year ended March 31,2007.

In June 2006, the FASB issued FASB InterpretationNo. 48 (“FIN No. 48”), “Accounting for Uncertainty in Income Taxes,an interpretation of FASB Statement No. 109”. This interpretationprescribes a “more-likely-than-not” recognition threshold and measurementattribute (the largest amount of benefit that is greater than 50% likely of beingrealized upon ultimate settlement with tax authorities) for the financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return. This interpretation also provides guidance onderecognition, classification, interest and penalties, accounting in interimperiods, disclosure and transition. FIN No. 48 is effective for fiscalyears beginning after December 15, 2006. The Company adopted FINNo. 48 on April 1, 2007, and believes the impact of FIN No. 48will not materially impact the Company’s results of operations for fiscal 2008or beyond.

In June 2006, theFASB ratified the consensus on Emerging Issues Task Force Issue No. 06-3(“EITF No. 06-3”), “How Taxes Collected from Customers and Remittedto Governmental Authorities Should Be Presented in the Income Statement”. Thescope of EITF No. 06-3 includes any tax assessed by agovernmental authority that is directly imposed on a revenue-producingtransaction between a seller and a customer and may include, but is not limitedto, sales, use, value added, Universal Service Fund (USF) contributionsand some excise taxes. The Task Force affirmed its conclusion that entitiesshould present these taxes in the income statement on either a gross or a netbasis based on their accounting policy, which should be disclosed pursuant toAPB Opinion No. 22, “Disclosure of Accounting Policies.” If such taxes aresignificant and are presented on a gross basis, the amounts of those taxesshould be disclosed. The consensus on EITF No. 06-3 indicatesit should be effective for annual and interim 

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reportingperiods beginning after December 15, 2006. The Company adopted EITFNo. 06-3 on January 1, 2007, and currently does not invoicegovernmental taxes to customers, thus there was no impact from the adoption ofEITF No. 06-3 on the Company’s results of operations for the yearended March 31, 2007.

**Note 2 Inventories**

Inventoriesconsist of the following as of March 31, 2007 and 2006: 

| ** **      | ** ** | **2007**                | ** ** | **2006** | ** ** |
|-----------------|------------|-------------------------|------------|----------|------------|
| ** **      | ** ** | **(in thousands)** | ** ** |
| Raw materials   |       | $                       | 246        |     | $          | 240 |   |
| Work in process |       | 281                     |       | 260      |       |
| Finished goods  |       | 929                     |       | 1,432    |       |
| Supplies        |       | 137                     |       | 124      |       |
|            |       | $                       | 1,593      |     | $          | 2,056 |   |

 

The Company adopted SFASNo. 151 effective April 1, 2006.

**Note 3 Equipmentand Leasehold Improvements, Net**

Equipmentand leasehold improvements consists of the following as of March 31, 2007and 2006:

| ** **                                      | ** ** | **2007**                | ** ** | **2006** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                      | ** ** | **(in thousands)** | ** ** |
| Equipment                                       |       | $                       | 6,257      |     | $          | 10,461 |   |
| Leasehold  improvements                         |       | 7,335                   |       | 14,642   |       |
| Furniture and  fixtures                         |       | 87                      |       | 86       |       |
|                                            |       | 13,679                  |       | 25,189   |       |
| Less accumulated  depreciation and amortization |       | (9,110                  | )          | (15,327  | )          |
| Construction  in-progress                       |       | 132                     |       | 302      |       |
|                                            |       | $                       | 4,701      |     | $          | 10,164 |   |

 

The above equipment andleasehold improvement amounts as of March 31, 2007, have been reduced by a$4.5 million charge resulting from management’s analysis under SFASNo. 144 as discussed below.

The Company reviewslong-lived assets for impairment whenever events or changes in circumstancesindicate that the carrying value of such assets may not be recoverable. Uponsuch an occurrence, recoverability of these assets is determined by comparingthe forecasted undiscounted net cash flows to which the assets relate, to thecarrying amount. If the asset is determined to be unable to recover itscarrying value, then the carrying value of the long-lived assets are comparedto the assets fair value. The Company has determined fair value based uponpresent values of expected future cash flows.

For purposes of SFASNo. 144, the Company’s equipment and leasehold improvements are evaluatedfor recoverability as a single group since they cannot be separated intospecific cash flow generating groups. Other Company assets are readilyrecoverable and not long lived. For the fiscal year ended March 31, 2007,the Company experienced a pre-impairment net loss of approximately $2.9 millionagainst revenues of $9.6 million, and reduced its cash balance from $2.5 to$1.4 million. In addition, in the second quarter and through the fourthquarter, the Company began to experience erratic astaxanthin biomass productionshortfalls (volumes, quality, density: collectively a “production imbalance”)not apparent in previous quarters. The service potential of the productionassets is expected to be concurrent with the underlying lease from the NaturalEnergy Laboratory of Hawaii (NELHA) which expires in 2025. Only future cashflows directly associated with and expected to arise from the use of the assetswere used in the analysis.

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TheCompany considers it necessary to record an impairment of production assetsunder SFAS No. 144 wherein we recognize a loss for the amount bywhich the carrying amount or net book value of the assets exceeds the estimatedfair value upon comparison. The net book value will be depreciated down to itsestimated salvage value. The impairment charge was allocated to long-livedproduction assets based upon the relative net book values and is presented asfollows: 

| ** **                                               | ** ** | **Impairment** | ** ** |
|----------------------------------------------------------|------------|----------------|------------|
| ** **                                               | ** ** | **Charge**     | ** ** |
| Equipment                                                |       |           | $          | (4,490 | ) |   |
| Leasehold improvements                                   |       |           | (7,331     | ) |   |
| Furniture and fixtures                                   |       |           | —     |   |   |
|                                                     |       |           | (11,821    | ) |   |
| Accumulated depreciation  and amortization               |       |           | 7,467      |   |   |
| Construction in-progress                                 |       |           | (133       | ) |   |
| Impairment loss on equipment and leasehold  improvements |       |           | $          | (4,487 | ) |   |

 

The Company determinedthat the carrying value of long-lived assets was not impaired as ofMarch 31, 2006 and 2005.

**Note 4 Accrued Expenses**

Componentsof accrued expenses as of March 31, 2007 and 2006 are as follows:

| ** **                        | ** ** | **2007**                | ** ** | **2006** | ** ** |
|-----------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                        | ** ** | **(in thousands)** | ** ** |
| Wages, commissions and  royalties |       | $                       | 165        |     | $          | 181 |   |
| Professional fees                 |       | 53                      |       | 104      |       |
| Other accrued expenses            |       | 172                     |       | 135      |       |
|                              |       | $                       | 390        |     | $          | 420 |   |

 

**Note 5 Long-Term Debt**

Long-termdebt consists of the following as of March 31, 2007 and 2006:

| ** **                                   | ** ** | **2007**                | ** ** | **2006** | ** ** |
|----------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                   | ** ** | **(in thousands)** | ** ** |
| Term loan                                    |       | $                       | 1,390      |     | $          | 1,751 |   |
| Less current maturities                      |       | (398                    | )          | (364     | )          |
| Long-term debt, excluding current maturities |       | $                       | 992        |     | $          | 1,387 |   |

 

*Term Loan Agreement*

In April 2000, the Company executed a Term LoanAgreement (“Term Loan”) with a lender providing for $3.5 million in aggregatecredit facilities, secured by the Company’s assets. The Term Loan has amaturity date of May 1, 2010 and is payable in 120 equal monthly principaland interest payments. The interest rate under this Term Loan, in the absenceof a default under the agreement, is the prime rate, in effect as of the closeof business on the first day of each calendar quarter, plus 1%. As ofMarch 31, 2007 and 2006, the prime rate was 8.25% and 7.25%, respectively.The Company received a waiver of relevant covenants of the Term Loan related tothe previous filing of Forms 10-Q for fiscal year 2007. In addition, theCompany has received a waiver of the covenant related to delayed filing of thisForm 10-K. The Company is prohibited from declaring any common stockdividends without the lender’s prior written consent. A warrant to purchase5,000 shares of the Company’s common stock was issued in conjunction with thisTerm Loan. The warrant expires in April 2011 and has an exercise price of$10.20 per share. The warrant may only be exercised after the Company hasrepaid the Term Loan in full.

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A $250,000 restricted cashdeposit continues to be held in the restricted cash account and is included inOther Assets in the accompanying consolidated Balance Sheets at March 31,2007 and 2006.

**Note 6 Leases**

The Company leases facilities, equipment and landunder operating leases expiring between 2007 and 2025. The land lease providesfor contingent rentals in excess of minimum rental commitments based on apercentage of the Company’s sales. Contingent rental for the years ended March 31,2007, 2006 and 2005 was $52,000, $55,000 and $88,000, respectively.

Futureminimum lease payments under non-cancelable operating leases at March 31,2007 are as follows:

| **Year ending March 31** | ** ** | ** ** | ** ** | **(in thousands)** | ** ** |
|-----------------------------------------|------------|------------|------------|-------------------------|------------|
| 2008                                    |       |       | $          | 241                     |       |   |
| 2009                                    |       |       | 201        |                    |       |
| 2010                                    |       |       | 160        |                    |       |
| 2011                                    |       |       | 149        |                    |       |
| 2012                                    |       |       | 148        |                    |       |
| Thereafter  through 2025                |       |       | 2,035      |                    |       |
| Total minimum  lease payments           |       |       | $          | 2,934                   |       |   |

 

Rent expense underoperating leases amounted to $283,000, $316,000 and $338,000 for the yearsended March 31, 2007, 2006 and 2005, respectively.

**Note 7 Share-BasedCompensation**

Effective April 1,2006, the Company adopted the provisions of Statement of Financial AccountingStandard No. 123(R) (“SFAS No. 123R”), “Share-Based Payment,”for its share-based compensation plans, which is a revision of Statement ofFinancial Accounting Standard No. 123 “Accounting for Stock-BasedCompensation”. On March 29, 2005, the SEC staff issued StaffAccounting Bulletin No. 107, “Share-Based Payment” (SAB No. 107),which expressed the SEC staff’s views on SFAS No. 123R, but did not modifyany of SFAS No. 123R’s provisions.  SFAS No. 123R requires an entity tomeasure the cost of employee services received in exchange for an award. If anaward vests or becomes exercisable based on the achievement of a conditionother than service, performance or market condition, the award isliability-classified. Liability-classified awards are remeasured to fair valueat each balance sheet date until the award is settled. Equity-classifiedawards, including grants of employee stock options, are measured at thegrant-date fair value of the award and are not subsequently remeasured. Thecost of equity-classified awards is recognized in the income statement over theperiod during which an employee is required to provide the service in exchangefor the award.  In the Company’s case,all of the Company’s stock options are performance based awards. As allowed bySFAS No. 123, for fiscal 2006 the Company elected to continue to apply theintrinsic value-based method of accounting for employee based stock options andadopted only the disclosure requirements of SFAS No. 123.

***Stock Options***

Under the 2005 Stock Option Plan (the “2005 Plan”),200,000 shares of common stock are reserved for issuance and the planterminates on August 21, 2015. Under the 2005 Plan, eligible employees andcertain independent consultants may be granted options to purchase shares ofthe Company’s Stock. The shares issuable under the 2005 Plan will either beshares of the Company’s authorized but previously unissued common stock orshares reacquired by the Company, including shares purchased on the open market.As of March 31, 2007, 195,000 options remained available for grant underthe 2005 Plan. 

44

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Concurrent with the 2005Plan approval on August 22, 2005, the 1995 Stock Option Plan was terminatedexcept for the outstanding options issued thereunder.

Options under the 2005 Plan are granted, and arevested and exercisable as determined by the Board of Directors or the StockOption and Compensation Committee of the Board in accordance with the provisionsof the 2005 Stock Option Plan. Discussion relative to option granting, vesting,exercising, and other conditions are set forth in a Stock Option Agreementevidencing each grant. No option can have a life in excess of ten (10) years.All shares granted in the form of options under the 2005 Plan will reduce, on ashare for share basis, the number of shares available for subsequent grants.Option grants which forfeit under the terms of the 2005 Plan will return to thepool of reserved shares and be available for subsequent grants under the termsof the 2005 Plan.

SFAS No. 123R offered alternatives forimplementation, among them the Modified Prospective Method of accounting forcompensation costs related to “Share Based Payments” which the Company has determinedto apply. In the Company’s case, its employee incentive stock options are “plainvanilla” as defined by the SEC in Staff Accounting Bulletin (“SAB”) No. 107,normally vesting over a five year period and exercisable under the terms of theCompany’s Stock Plan up to ten years from the grant date. Because the Company’sfuture employee incentive stock options are expected to be “plain vanilla,”they will be reflected only in Equity and Compensation Expense accounts. TheCompany has determined that a Black-Scholes-Merton model will be mostreflective of the fair value of option grants, consistent with the provisionsof SFAS No. 123R and SAB No. 107. Key inputs and assumptions used toestimate the fair value of stock options include the grant price of the award,the expected option term, volatility of the Company’s stock, risk-free rate andthe Company’s dividend yield.  Estimatesof fair value are not intended to predict actual future events or the valueultimately realized by employees who receive equity awards, and subsequentevents are not indicative of the reasonableness of the original estimates offair value made by the Company.

Currently outstanding nonvested options are optionsthat were granted to non-employees and the compensation cost for these optionswas recognized in prior years’ operating results. There are no nonvestedemployee options because, on March 23, 2006, in response to SFAS No. 123R,the Compensation and Stock Option Committee of the Company’s Board of Directorsapproved accelerating the vesting of all outstanding unvested employeeincentive stock options under the provisions of APB Opinion No. 25, andrelated interpretations. Options held by non-employees and directors were notincluded in the vesting acceleration. The decision to accelerate vesting of alloutstanding unvested employee incentive stock options was made to avoidrecognizing, pursuant to the Company’s April 1, 2006 adoption of SFAS No. 123R,the non-cash compensation cost related to unvested employee incentive stock optionsfor the Company’s less than 100 employees. This resulted in the Companyrecognizing non-cash compensation expense of approximately $10,000 for the yearended March 31, 2006, representing the estimated benefit of acceleratedvesting for those unvested incentive options with exercise prices less than thefair market value of the Company’s stock on March 23, 2006. It isestimated that the total future compensation expense that will be avoided infuture years is approximately $78,000, before tax, based on the March 23,2006 acceleration date. The foregoing amount would have primarily impactedfiscal years ending March 31, 2007 through March 31, 2009. Due to theCompany’s tax net operating loss carry forward position, no tax benefits arereceived or are expected to be received over the remaining life of the 2005Stock Plan. Accordingly, Stock Plan amounts are the same both before and aftertax.

At the effective vesting acceleration date of March 23,2006, there were 5,000 unvested employee incentive stock options outstandingunder the company’s 1995 and 2005 Stock Plans, and 40,714 unvested employeeincentive stock options outstanding under the company’s 1994 and 2004 StockPlans. Of the outstanding incentive stock options, 19,123 had exercise priceswhich were greater than the $2.72 per share fair market value of the Company’scommon stock on March 23, 2006. The remaining 26,591 options had 

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exercise prices less thanor equal to the $2.72 fair market value of the Company’s stock, and rangingfrom $2.00 to $2.60 per incentive option for the 26,591 options with exerciseprices less than or equal to $2.72.

The Independent Director Stock Option and Stock GrantPlan (the “2004 Plan”) has 75,000 shares of common stock reserved for issuance.Under the 2004 Plan, upon election to the Board of Directors, a newly electednon-employee director is granted a ten-year option to purchase 1,000 shares ofthe Company’s common stock at a fair market value on the date of grant. Allsuch options are granted at fair market value on the date of grant. Optionsgranted vest and become exercisable six months from the date of grant. Inaddition, on the date of each Annual Meeting of Stockholders, each non-employeedirector continuing in office is automatically granted, without payment, 875shares of common stock, non-transferable for six months following the date ofgrant. As of March 31, 2007, 70,250 options remained available for grantunder the 2004 Plan. Concurrent with the 2004 Plan approval on August 16,2004, the 1994 Non-Employee Director Stock Option and Stock Grant Plan wasterminated except for the outstanding options issued thereunder.

Previously under the terminated 1994 Plan, uponelection to the Board of Directors, non-employee directors were granted aten-year option to purchase 750 shares of the Company’s common stock at fairmarket value on the date of grant. In addition, on the date of each AnnualMeeting of Stockholders, each non-employee director continuing in office wasgranted, without payment, 500 shares of common stock, non-transferable for sixmonths following the date of grant. There was no expense recognized from the2004 Plan and the 1994 Plan grants of shares of common stock for the year endedMarch 31, 2007, and expense recognized for the years  ended March 31, 2006 and 2005 was$14,000 and $15,000, respectively.

Therewere no stock options granted during 2007. The per share weighted average fairvalue of stock options granted during 2006 and 2005 was $2.60 and $3.20,respectively, on the date of the grant using a Black Scholes option pricingmodel with the following weighted average assumptions:

| ** **               | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|
| Expected dividend  yield |       |     | 0          | %        |       |   | 0 | % |   |
| Risk-free  interest rate |       |     | 4.3        | %        |       |   | 4.5 | % |   |
| Expected  volatility     |       |     | 107        | %        |       |   | 104 | % |   |
| Expected life in years   |       |     | 4.5        |     |       |   | 4.0 |   |   |

 

The expected life of the Company’s options is based onevaluations of historical and expected future exercise behavior. The risk freeinterest rate is based on the U.S. Treasury yield curve at the date of grantwith maturity dates approximately equal to the expected term of the options atthe date of the grant. The expected volatility is based on the historicalvolatility, among other factors, of the Company’s stock. The valuation modelapplied in this calculation utilizes highly subjective assumptions that couldpotentially change over time. Changes in the subjective input assumptionscan  materially affect the fair valueestimates of an option. Furthermore, the estimated fair value of an option doesnot necessarily represent the value that will ultimately be realized by theemployee holding the option.

As of March 31, 2007, total unrecognizedstock-based compensation expense related to unvested stock options was $4,400which is expected to be expensed over a weighted-average period of 2.38 years.

46

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Activityfor stock options during the periods indicated was as follows:

| ** **                      | ** ** | ** **         | ** ** | ** **              | ** ** | **Weighted Average** | ** ** | ** **    | ** ** |
|---------------------------------|------------|--------------------|------------|-------------------------|------------|---------------------------|------------|---------------|------------|
| ** **                      | ** ** | ** **         | ** ** | **Weighted**            | ** ** | **Remaining**             | ** ** | **Average**   | ** ** |
| ** **                      | ** ** | **Number of** | ** ** | **Average**             | ** ** | **Contractual Term** | ** ** | **Intrinsic** | ** ** |
| ** **                      | ** ** | **Shares**         | ** ** | **Exercise Price** | ** ** | **In Years**         | ** ** | **Value**     | ** ** |
| Balance at  March 31, 2004 |       |               | 163,924    |                    |       |                      | $          | 4.24          |       |   |   |   |   |   |   |   |
| Granted                         |       |               | 34,774     |                    |       |                      | 4.40       |          |       |   |   |   |   |   |   |
| Exercised                       |       |               | (9,005     | )                       |       |                      | 3.52       |          |       |   |   |   |   |   |   |
| Expired                         |       |               | (14,738    | )                       |       |                      | 4.48       |          |       |   |   |   |   |   |   |
| Forfeited                       |       |               | (23,458    | )                       |       |                      | 4.00       |          |       |   |   |   |   |   |   |
| Balance at  March 31, 2005 |       |               | 151,497    |                    |       |                      | 4.36       |          |       |   | 2.53 |   |   | $ | 660,527 |   |
| Granted                         |       |               | 5,000      |                    |       |                      | 2.60       |          |       |   |   |   |   |   |   |
| Exercised                       |       |               | (3,625     | )                       |       |                      | 2.12       |          |       |   |   |   |   |   |   |
| Expired                         |       |               | (25,900    | )                       |       |                      | 6.76       |          |       |   |   |   |   |   |   |
| Forfeited                       |       |               | (9,741     | )                       |       |                      | 3.28       |          |       |   |   |   |   |   |   |
| Balance at  March 31, 2006 |       |               | 117,231    |                    |       |                      | 3.92       |          |       |   | 2.08 |   |   | 459,546 |   |
| Granted                         |       |               | —     |                    |       |                      | —     |          |       |   |   |   |   |   |   |
| Exercised                       |       |               | (1,575     | )                       |       |                      | 2.15       |          |       |   |   |   |   |   |   |
| Expired                         |       |               | (19,625    | )                       |       |                      | 3.85       |          |       |   |   |   |   |   |   |
| Forfeited                       |       |               | (11,859    | )                       |       |                      | 4.53       |          |       |   |   |   |   |   |   |
| Balance at  March 31, 2007 |       |               | 84,172     |                    |       |                      | $          | 3.86          |       |   |   | 1.77 |   |   | $ | 324,904 |   |

 

Thefollowing table summarizes the weighted average characteristics of outstandingstock options at March 31, 2007 for various exercise price ranges:

| ** **                                  | ** ** | **Outstanding Options** | ** ** | **Exercisable Options** | ** ** |
|---------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                  | ** ** | **Number of**           | ** ** | **Remaining**                | ** ** | **Weighted** | ** ** | **Number of** | ** ** | **Weighted** | ** ** |
| **Range of Exercise Prices** | ** ** | ** **                   | ** ** | **Shares**                   | ** ** | **Life (Years)** | ** ** | **Average Price** | ** ** | **Shares** | ** ** | **Average Price** | ** ** |
| $1.84-$3.08                                 |       |                         | 50,944     |                         |       |   | 1.4 |   |   |   | $ | 2.18 |   |   |   | 50,944 |   |   |   | $ | 2.18 |   |   |
| $3.88-$6.75                                 |       |                         | 26,978     |                         |       |   | 2.6 |   |   |   | 4.51 |   |   |   | 26,278 |   |   |   | 4.52 |   |   |
| $14.75-$14.75                               |       |                         | 6,250      |                         |       |   | 1.0 |   |   |   | 14.75 |   |   |   | 6,250 |   |   |   | 14.75 |   |   |
|                                             |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Prior Period Proforma Presentation***

Prior to April 1, 2006, the Company hadpreviously adopted the provisions of SFAS No. 123 through disclosure only. The table presented below illustratesthe effects on net income and earnings per share for the years ended March 31,2006 and 2005 as if the company had applied the fair value recognitionprovisions of SFAS No. 123 to share-based awards.

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Thefollowing table illustrates the effect on net income (loss) and net income(loss) per common share if the Company had applied the fair-value method underSFAS No. 123 to its employee stock options:  

| ** **                                                                                              | ** ** | **2006**                                                                | ** ** | **2005** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|----------|------------|
| ** **                                                                                              | ** ** | **(in thousands,   except per share amounts)** | ** ** |
| Net income  (loss), as reported                                                                         |       | $                                                                       | (391       | )        | $          | 601 |   |
| Reverse  accelerated vesting expense recognized under intrinsic value method                            |       | 10                                                                      |       | —   |       |
| Deduct  stock-based employee compensation expense determined under fair-value method  for all awards(1) |       | (135                                                                    | )          | (90      | )          |
| Pro forma net  income (loss)                                                                            |       | $                                                                       | (516       | )        | $          | 511 |   |
| Net income (loss) per  common share                                                                     |       |                                                                    |       |     |       |
| —Basic:                                                                                            |       |                                                                    |       |     |       |
| As reported                                                                                             |       | $                                                                       | (0.07      | )        | $          | 0.12 |   |
| Pro forma                                                                                               |       | $                                                                       | (0.10      | )        | $          | 0.10 |   |
| —Diluted:                                                                                          |       |                                                                    |       |     |       |
| As reported                                                                                             |       | $                                                                       | (0.07      | )        | $          | 0.11 |   |
| Pro forma                                                                                               |       | $                                                                       | (0.10      | )        | $          | 0.10 |   |

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(1)          Forthe year ended March 31, 2006, the amount includes the impact ofaccelerated vesting of unvested employee stock options on March 23, 2006amounting to $78,000.

***Warrants***

The Company had issued warrants which allow thewarrant holders rights to acquire an equivalent number of shares of commonstock at a stated exercise price. Warrants outstanding during the periodsindicated were as follows:

Warrants issued in connection with:

| ** **                      | ** ** | ** **             | ** ** | **50,000 Shares** | ** ** | ** **                 | ** ** | ** **                   | ** ** | ** ** | ** ** |
|---------------------------------|------------|------------------------|------------|------------------------|------------|----------------------------|------------|------------------------------|------------|------------|------------|
| ** **                      | ** ** | **3**rd Party     | ** ** | **Purchased by**  | ** ** | **Term Loan**         | ** ** | ** **                   | ** ** | ** ** | ** ** |
| ** **                      | ** ** | **Services**           | ** ** | **Stockholder**        | ** ** | **(See Note 5)** | ** ** | **Debentures**               | ** ** | ** ** | ** ** |
| **Grant date:**            | ** ** | **December 1999** | ** ** | **January 2000**  | ** ** | **April 2000**        | ** ** | **May 2000 &** | ** ** | ** ** | ** ** |
| ** **                      | ** ** | ** **             | ** ** | ** **             | ** ** | ** **                 | ** ** | **May 2002**            | ** ** | ** ** | ** ** |
| **Expiration date:**       | ** ** | **December 2004** | ** ** | **January 2005**  | ** ** | **April 2011**        | ** ** | **May 2004**            | ** ** | ** ** | ** ** |
| **Exercise price:**        | ** ** | **$2.52**              | ** ** | **$4.00**              | ** ** | **$10.20**                 | ** ** | **$4.40**                    | ** ** | **Total**  | ** ** |
| Balance at  March 31, 2004 |       |                   | 18,750     |                   |       |                       | 12,500     |                         |       |       | 5,000      |   |   |   | 6,375 |   |   |   | 42,625 |   |   |
| Exercises                       |       |                   | (18,750    | )                      |       |                       | (12,500    | )                            |       |       | —     |   |   |   | (1,750 | ) |   |   | (33,000 | ) |   |
| Expired                         |       |                   | —     |                   |       |                       | —     |                         |       |       | —     |   |   |   | (4,625 | ) |   |   | (4,625 | ) |   |
| Balance at March 31, 2005  |       |                   | —     |                   |       |                       | —     |                         |       |       | 5,000      |   |   |   | — |   |   |   | 5,000 |   |   |
| Exercises                       |       |                   | —     |                   |       |                       | —     |                         |       |       | —     |   |   |   | — |   |   |   | — |   |   |
| Expired                         |       |                   | —     |                   |       |                       | —     |                         |       |       | —     |   |   |   | — |   |   |   | — |   |   |
| Balance at March 31, 2006  |       |                   | —     |                   |       |                       | —     |                         |       |       | 5,000      |   |   |   | — |   |   |   | 5,000 |   |   |
| Exercises                       |       |                   | —     |                   |       |                       | —     |                         |       |       | —     |   |   |   | — |   |   |   | — |   |   |
| Expired                         |       |                   | —     |                   |       |                       | —     |                         |       |       | —     |   |   |   | — |   |   |   | — |   |   |
| Balance at  March 31, 2007 |       |                   | —     |                   |       |                       | —     |                         |       |       | 5,000      |   |   |   | — |   |   |   | 5,000 |   |   |

 

**Note 8 Earnings PerShare**

Basic earnings per share is computed on the basis ofthe weighted average number of common shares outstanding. Diluted earnings pershare is computed on the basis of the weighted average number of 

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common shares outstandingplus the potentially dilutive effect of outstanding stock options and warrantsusing the “treasury stock” method and convertible securities using the “if-converted”method.

Reconciliationsbetween the numerator and the denominator of the basic and diluted earnings pershare computations for the years ended March 31, 2007, 2006 and 2005 areas follows:  

|                                                                             | ** ** | **Net Income**                                                   | ** ** | **Shares**        | ** ** | **Per Share** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|-------------------|------------|--------------------|------------|
| ** **                                                                  | ** ** | **(Numerator)**                                                       | ** ** | **(Denominator)** | ** ** | **Amount**         | ** ** |
| ** **                                                                  | ** ** | **(in thousands, except per share amounts)** | ** ** |
| Year ended March 31,  2007:                                            |       |                                                                  |       |              |       |               |       |   |   |   |   |   |   |
| Basic and diluted earnings  per share                                       |       |                                                                  | $          | (7,425            | )          |               |       | 5,234 |   |   |   | $ | (1.42 | ) |   |
| Year ended  March 31, 2006:                                            |       |                                                                  |       |              |       |               |       |   |   |   |   |   |   |
| Basic and diluted earnings per share                                        |       |                                                                  | $          | (391              | )          |               |       | 5,226 |   |   |   | $ | (0.07 | ) |   |
| Year ended March 31,  2005:                                            |       |                                                                  |       |              |       |               |       |   |   |   |   |   |   |
| Basic earnings per share                                                    |       |                                                                  | $          | 601               |       |               |       | 5,196 |   |   |   | $ | 0.12 |   |   |
| Effect of dilutive securities—  Common stock options and warrants |       |                                                                  | —     |              |       |               | 49         |   |   |   | (.01 | ) |   |
| Diluted earnings per share                                                  |       |                                                                  | $          | 601               |       |               |       | 5,245 |   |   |   | $ | 0.11 |   |   |

 

The following securities were excluded from thecalculation of diluted earnings per share because their effect was antidilutivedue to the exercise price being greater than the Company’s weighted-averagestock price for the period:

| ** **                  | ** ** | **2007**                | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                  | ** ** | **(in thousands)** | ** ** |
| Stock options and  warrants |       |                    | 89         |     |       |     | 122        |   |   |   | 40 |   |   |
|                             |            |                         |            |          |            |          |            |  |  |  |  |  |  |

 

**Note 9 ProfitSharing Plan**

The Company sponsors aprofit sharing plan for all employees not covered under a separate managementincentive plan. Under the profit sharing plan, 5% of pre-tax profits on aquarterly basis may be allocated to non-management employees based on grosswages. At management’s discretion, the profit sharing bonus may be distributedall in cash on an after-tax basis or distributed half in cash (on an after-taxbasis) and the remainder deposited in an employee’s 401(k) account on apre-tax basis with a five year vesting schedule, based on years of service withthe Company. All employees may make voluntary pre-tax contributions to their401(k) accounts; Company contributions are discretionary. There was nocompensation expense for fiscal 2007, and for fiscal years 2006 and 2005,compensation expense relative to this plan was approximately $18,000 and$30,000, respectively.

**Note 10 MajorCustomers and Geographic Information**

Netsales by product line for the years 2007, 2006 and 2005 are as follows:

| ** **                   | ** ** | **2007**                | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                   | ** ** | **(in thousands)** | ** ** |
| Net sales:                   |       |                    |       |     |       |     |       |
| Spirulina products           |       | $                       | 6,090      |     | $          | 6,517    |       | $ | 6,626 |   |
| Natural astaxanthin products |       |                    |       |     |       |     |       |
| NatuRose                     |       | 1,142                   |       | 1,403    |       | 1,817    |       |
| BioAstin                     |       | 2,354                   |       | 2,967    |       | 2,855    |       |
| Other products               |       | 97                      |       | 244      |       | 147      |       |
|                         |       | $                       | 9,683      |     | $          | 11,131   |       | $ | 11,445 |   |

 

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Approximately $937,000, or 10% of our total net salesfor the year ended March 31, 2007, was to a single customer. Sales to thiscustomer for fiscal 2006 and 2005 were $1,285,000 (12% of net sales) and$1,130,000 (10% of net sales), respectively.

Thefollowing table presents sales for the years 2007, 2006 and 2005 by geographicregion:

| ** **      | ** ** | **2007**                             | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------|------------|--------------------------------------|------------|----------|------------|----------|------------|
| ** **      | ** ** | **(dollars in thousands)** | ** ** |
| Net sales(1):   |       |                                 |       |     |       |     |       |   |   |   |   |   |   |
| United States   |       | $                                    | 5,275      |     | 54         | %        | $          | 5,343 |   | 48 | % | $ | 5,847 |   | 51 | % |
| Japan           |       | 772                                  |       | 8        |       | 1,328    |       | 12 |   | 1,759 |   | 16 |   |
| The Netherlands |       | 937                                  |       | 10       |       | 1,300    |       | 12 |   | 1,180 |   | 10 |   |
| Other areas     |       | 2,699                                |       | 28       |       | 3,160    |       | 28 |   | 2,659 |   | 23 |   |
|            |       | $                                    | 9,683      |     | 100        | %        | $          | 11,131 |   | 100 | % | $ | 11,445 |   | 100 | % |

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(1)          Netsales are attributed to countries based on location of customer. Substantiallyall long-lived assets      are located inthe United States as of March 31, 2007 and 2006.

**Note 11 IncomeTaxes**

Income(loss) before income taxes consisted of:

| ** **                         | ** ** | **2007**                | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                         | ** ** | **(in thousands)** | ** ** |
| United States                      |       | $                       | (7,358     | )        | $          | (311     | )          | $ | 537 |   |
| Foreign                            |       | (76                     | )          | (86      | )          | 70       |       |
| Income (loss)  before income taxes |       | $                       | (7,434     | )        | $          | (397     | )          | $ | 607 |   |

 

Thefollowing table reconciles the amount of income taxes computed at the federalstatutory rate of 34%, for all periods presented, to the amount reflected inthe Company’s consolidated statements of operations for the years ended March 31,2007, 2006 and 2005:

| ** **                                                           | ** ** | **2007**                | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                                                           | ** ** | **(in thousands)** | ** ** |
| Tax provision  (benefit) at federal statutory income tax rate        |       | $                       | (2,528     | )        | $          | (135     | )          | $ | 206 |   |
| State income  taxes, net of federal income tax effect                |       | (314                    | )          | (17      | )          | 26       |       |
| Foreign income  taxes in excess of federal statutory income tax rate |       | —                  |       | —   |       | 2        |       |
| Increase  (decrease) in valuation allowance for deferred tax assets  |       | 2,526                   |       | 146      |       | (162     | )          |
| Other, net                                                           |       | 307                     |       | —   |       | (66      | )          |
| Income tax  expense (benefit)                                        |       | $                       | (9         | )        | $          | (6       | )          | $ | 6 |   |

 

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Thetax effects of temporary differences related to various assets, liabilities andcarry forwards that give rise to deferred tax assets and deferred taxliabilities as of March 31, 2007 and 2006 are as follows:

| ** **                                                                                                     | ** ** | **2007**                | ** ** | **2006** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                                                                                     | ** ** | **(in thousands)** | ** ** |
| Deferred tax assets:                                                                                           |       |                    |       |     |       |
| Net operating loss carry forwards                                                                              |       | $                       | 5,815      |     | $          | 5,359 |   |
| Impairment loss on equipment & leasehold  improvements for financial  reporting purposes              |       | 2,768                   |       | 1,062    |       |
| Tax credit carry forwards                                                                                      |       | 124                     |       | 122      |       |
| Other                                                                                                          |       | 209                     |       | 235      |       |
| Gross deferred tax assets                                                                                      |       | 8,916                   |       | 6,778    |       |
| Less valuation  allowance                                                                                      |       | (7,855                  | )          | (5,329   | )          |
| Net deferred tax assets                                                                                        |       | 1,061                   |       | 1,449    |       |
| Deferred tax  liability: Differences in depreciation and amortization on  equipment and leasehold improvements |       | (1,061                  | )          | (1,449   | )          |
| Net deferred tax  assets                                                                                       |       | $                       | —     |     | $          | — |   |

 

In assessing the realizability of deferred tax assets,management considers whether it is more likely than not that some portion orall of the deferred tax assets will not be realized. The ultimate realizationof deferred tax assets is dependent upon the generation of future taxableincome during the periods in which those temporary differences becomedeductible. Management considers the scheduled reversal of deferred taxliabilities, projected future taxable income and tax planning strategies inmaking this assessment. Based upon the level of historical taxable income andprojections for future taxable income over the periods in which net deferredtax assets are deductible, management does not believe it is more likely thannot the Company will realize a portion of its gross deferred tax assets, andhas thus established a valuation allowance to reflect its estimatedrealizability. The amount of the deferred tax assets considered realizable,however, could change in the near term if estimates of future taxable incomeduring the carry forward period change.

Incometax expense (benefit) for the years ended March 31, 2007, 2006 and 2005consisted of:

| ** **                    | ** ** | **2007**                | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                    | ** ** | **(in thousands)** | ** ** |
| Current:                      |       |                    |       |     |       |     |       |   |   |   |   |
| Foreign                       |       |                    | $          | —   |       |     |       | $ | — |   |   | $ | 11 |   |
| Federal                       |       |                    | —     |     |       |     | —     |   |   | — |   |
| State                         |       |                    | (9         | )        |       |     | (9         | ) |   | (20 | ) |
| Total current                 |       |                    | (9         | )        |       |     | (9         | ) |   | (9 | ) |
| Deferred:                     |       |                    |       |     |       |     |       |   |   |   |   |
| Foreign                       |       |                    | —     |     |       |     | 3          |   |   | 15 |   |
| Federal                       |       |                    | —     |     |       |     | —     |   |   | — |   |
| State                         |       |                    | —     |     |       |     | —     |   |   | — |   |
| Total deferred                |       |                    | —     |     |       |     | 3          |   |   | 15 |   |
| Income tax  expense (benefit) |       |                    | $          | (9       | )          |     |       | $ | (6 | ) |   | $ | 6 |   |

 

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At March 31,2007, the Company has net operating loss carry forwards and tax credit carryforwards available to offset future federal income tax as follows (inthousands):

| ** **                      | ** ** | ** **             | ** ** | **Research and** | ** ** |
|---------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **Net Operating** | ** ** | **Experimentation**   | ** ** |
| **Expires March 31,** | ** ** | ** **             | ** ** | **Losses**            | ** ** | **Tax Credits** | ** ** |
| 2011                            |       |                   | $          | —                |       |   |   | $ | 23 |   |   |
| 2012                            |       |                   | —     |                  |       |   | 9 |   |   |
| 2018                            |       |                   | 1,061      |                  |       |   | — |   |   |
| 2019                            |       |                   | 3,632      |                  |       |   | — |   |   |
| 2020                            |       |                   | 2,051      |                  |       |   | 7 |   |   |
| 2021                            |       |                   | 1,732      |                  |       |   | 2 |   |   |
| 2022                            |       |                   | 3,161      |                  |       |   | — |   |   |
| 2023                            |       |                   | 1,863      |                  |       |   | — |   |   |
| 2026                            |       |                   | 159        |                  |       |   | — |   |   |
| 2027                            |       |                   | 2,115      |                  |       |   | — |   |   |
|                            |       |                   | $          | 15,774                |       |   |   | $ | 41 |   |   |
|                                 |            |                        |            |                       |            |  |  |  |  |  |  |  |  |

 

In addition, at March 31, 2007, the Company hasalternative minimum tax credit carry forwards of approximately $83,000available to reduce future federal regular income taxes over an indefiniteperiod.

At March 31, 2007,the Company has state tax net operating loss carry forwards of $11,307,000which expire in March 31, 2019 through 2026, available to offset futureHawaii and California state taxable income.

**Note 12 Selected Quarterly Financial Data (Unaudited)**

| ** **                                            | ** ** | **First**                                                          | ** ** | **Second**  | ** ** | **Third**   | ** ** | **Fourth**  | ** ** | ** ** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|------------|------------|
| ** **                                            | ** ** | **Quarter**                                                        | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Year**   | ** ** |
| ** **                                            | ** ** | **(in thousands, except per share data)** | ** ** |
| 2007                                                  |       |                                                               |       |        |       |        |       |        |       |       |       |   |   |   |   |
| Net sales                                             |       |                                                               | $          | 2,444       |       |        |       | $           | 2,475      |       |       | $ | 2,434 |   | $ | 2,330 |   | $ | 9,683 |   |
| Gross profit                                          |       |                                                               | 471        |        |       |        | 404        |        |       | 78         |       | 178 |   | 1,131 |   |
| Net loss                                              |       |                                                               | (347       | )           |       |        | (572       | )           |       | (1,187     | )          | (5,319 | )(1) | (7,425 | ) |
| Net loss per  share—  Basic and Diluted          |       |                                                               | (0.07      | )           |       |        | (0.11      | )           |       | (0.23      | )          | (1.02 | ) | (1.42 | ) |
| 2006                                                  |       |                                                               |       |        |       |        |       |        |       |       |       |   |   |   |   |
| Net sales                                             |       |                                                               | $          | 3,029       |       |        |       | $           | 2,517      |       |       | $ | 2,333 |   | $ | 3,252 |   | $ | 11,131 |   |
| Gross profit                                          |       |                                                               | 1,005      |        |       |        | 582        |        |       | 659        |       | 814 |   | 3,060 |   |
| Net income (loss)                                     |       |                                                               | 159        |        |       |        | (297       | )           |       | (210       | )          | (43 | ) | (391 | ) |
| Net income (loss) per  share—  Basic and Diluted |       |                                                               | 0.03       |        |       |        | (0.06      | )           |       | (0.04      | )          | (0.01 | ) | (0.07 | ) |

----

(1)          The Company recorded anon-cash impairment charge of $4,487,000 on certain production relatedequipment and leasehold improvements as required by SFAS No. 144. See Note3 for additional information.

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

Not applicable.

**Item 9A. Controlsand Procedures**

As required by Regulation S-K Rules 307 and 308,Cyanotech Corporation management has assessed the effectiveness of internalcontrol over financial reporting.

Disclosure controls and procedures are controls andother procedures that are designed to ensure that information required to bedisclosed by the company is recorded, processed, summarized and reported,within the time periods as defined in Rules 13a-15(e) or 15d-15(e) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”). As of theyear ended March 31, 2007, management conducted an evaluation (under thesupervision and with the participation of the chief executive officer and thechief financial officer), pursuant to Rules 13a-15(e) or 15d-15(e) promulgatedunder the Exchange Act, of the effectiveness of the company’s disclosurecontrols and procedures. As part of such evaluation, management considered thematters discussed below relating to internal control over financial reporting.Based on this evaluation, the Company’s Chief Executive Officer and ChiefFinancial Officer have concluded that the Company’s disclosure controls andprocedures were not effective as of March 31, 2007, due to the materialweaknesses in internal control over financial reporting described below.

A material weakness in internal control over financialreporting (as defined in paragraph 140 of Auditing Standard No. 2 of thePublic Company Accounting Oversight Board) is a significant deficiency, orcombination of significant deficiencies that results in more than a remotelikelihood that a material misstatement of the annual or interim consolidatedfinancial statements will not be prevented or detected.

While the Company believes its systems and proceduresare sufficient to reasonably ensure accurate financial data, it has concludedthat due to a lack of adequately trained internal accounting resources,there exists more than a remote likelihood that a material misstatement to theinterim or annual financial statements could occur and not be detected byprocedures and controls over financial reporting on a timely basis as of March 31,2007. This material weakness in internal control over financial reporting haslead to an inability to produce timely filings over the past year includingthis Form 10-K.

As discussed in theCompany’s Form 10-K/A for the year ended March 31, 2006, errorswere identified in the application of certain accounting practices andprocedures related to accounting for certain fixed costs such as portions ofdepreciation, general insurance and minor compensation costs which should beincluded in the carrying value of inventory. The Company’s Board of Directorsapproved and adopted a remediation plan for improving our internal controls andprocedures. In accordance with this plan, the Company will ensure fullcompliance with GAAP, address key financial reporting risk elements, subjectits disclosures to a rigorous review process prior to releasing financialstatements, update its inventory accounting systems and procedures to properlyaccommodate specific inventoriable fixed costs in accordance with GAAP and,apply resources with the critical skills necessary to ensure full compliancewith GAAP. With respect to the last element, the Company’s new Controller—Inventoryand Cost Accounting began employment on July 9, 2007. However, the dutiesand tasks associated with that position have not yet been integrated into theCompany’s accounting and internal control systems. Until this integration andrelated tasks are fully accomplished the Company believes that a materialweakness exists.

*Changes in InternalControl over Financial Reporting.*

In order to address the materialweakness identified in the previous year, we made changes in our internalcontrols over financial reporting, during the quarters ended December 31,2006 and March 31, 2007. These changes, designed to improve our internalcontrols and procedures, relate primarily to proper accounting for inventorycosts in accordance with generally accepted accounting principles (GAAP). We 

53

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believethat we now have in place policies and procedures to ensure that allinventoriable fixed cost components such as depreciation, portions of generalinsurance costs, and portions of direct labor burden costs are capitalized intoinventory unit costs. In addition, as of July 9, 2007 the Company’s newController—Inventory and Cost Accounting began employment.

*Limitations on the Effectivenessof Disclosure Controls and Procedures.*

Our management, includingour Chief Executive Officer and Chief Financial Officer, do not expect that ourdisclosure controls and procedures or internal control over financial reportingwill prevent all errors and all fraud. A control system no matter how welldesigned and implemented, can provide only reasonable, not absolute, assurancethat the control system’s objectives will be met. Further, the design of acontrol system must reflect the fact that there are resource constraints, andthe benefits of controls must be considered relative to their costs. Because ofthe inherent limitations in all control systems, no evaluation of controls canprovide absolute assurance that all control issues within a company aredetected. The inherent limitations include the realities that judgments indecision-making can be faulty, and that breakdowns can occur because of simpleerror or mistakes. Controls can also be circumvented by the individual acts ofsome persons, or by collusion of two or more people. Because of the inherentlimitations in a cost-effective control system, misstatements due to error orfraud may occur and not be detected.

**Item 9B. OtherInformation**

Not applicable

**PART III**

**Item 10. Directorsand Executive Officers of the Registrant**

**(a) Information pertaining to Directors of theCompany**

Thefollowing table sets forth certain information regarding the members of theBoard of Directors, all of whom were elected at the last annual meeting ofstockholders. 

| Name                      | ** ** | ** **                                                                                               | ** ** | **Principal Occupation** | ** ** | **Director  Since** | ** ** | **Age** |
|---------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|---------------------|------------|---------|
| Gerald R. Cysewski, Ph.D. |       | Chairman of the Board,  President and Chief Executive Officer, Cyanotech Corporation                     |       | 1983                     |       | 58                  |
| Michael A. Davis          |       | Private Investor                                                                                         |       | 2003                     |       | 54                  |
| Gregg W. Robertson        |       | President and  Chief Executive Officer of Robertson & Company (Financial services  consultancy) |       | 2004                     |       | 73                  |
| David I. Rosenthal        |       | Chief Financial  Officer, Sanz Corporation (Value added reseller of data storage solutions)              |       | 2000                     |       | 52                  |
| John T. Waldron           |       | Adjunct Professor  of Marketing—Lake Forest Graduate School of Management                           |       | 1998                     |       | 55                  |
| Paul C. Yuen, Ph.D.       |       | Retired, formerly  Dean of the College of Engineering—University of Hawaii at Manoa                 |       | 1993                     |       | 79                  |

 

*GeraldR. Cysewski, Ph. D.—Kailua Kona, Hawaii:*   Dr. Cysewskico-founded the Company in 1983 and has served as a director of the Companysince that time. Until June 1996, he also served as Scientific Director.Since March 1990, Dr. Cysewski has served as President and ChiefExecutive Officer of the Company and in October 1990 was also appointed tothe position of Chairman of the Board. From 1988 to 

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November 1990, heserved as Vice Chairman of the Company. From 1980 to 1982, Dr. Cysewskiwas Group Leader of Microalgae Research and Development at Battelle Northwest,a major contract research and development firm. From 1976 to 1980, Dr. Cysewskiwas an assistant professor in the Department of Chemical and NuclearEngineering at the University of California, Santa Barbara, where he received atwo-year grant from the National Science Foundation to develop a culture systemfor blue-green algae. Dr. Cysewski received his doctorate in ChemicalEngineering from the University of California at Berkeley.

*MichaelA. Davis—Tiburon, California:*   Mr. Davis wasappointed to the Board of Directors of the Company in March 2003subsequent to his acquisition of $1,250,000 of subordinated convertibledebentures of the Company in September 2002. Mr. Davis is a Principalat Ebb and Flow Ventures, a private equity firm; President of Skywords FamilyFoundation and a Director of Canobie Films, Inc. Mr. Davis attendedHarvard University and resides in San Francisco, California.

*GreggW. Robertson—Honolulu, Hawaii:*   Mr. Robertsonwas appointed to the Board of Directors of the Company in August 2004.Mr. Robertson is the President and Chief Executive Officer of Robertson &Company, a privately-owned investment banking firm which was established in1986 and is currently based in Honolulu. Prior to establishing this firm, Mr. Robertsonwas the President and Chief Executive Officer of Dillingham Industries, Inc.,a subsidiary of Dillingham Corporation. Previously Mr. Robertson held thepositions of Executive Vice President and Chief Financial Officer of DillinghamCorporation. Mr. Robertson holds a B.S. degree in Economics from FairleighDickenson University, Teaneck, N.J.

*David I. Rosenthal—Denver, Colorado:*   Mr. Rosenthalwas appointed to the Board of Directors of the Company in November 2000. Mr. Rosenthalis currently the Chief Financial Officer at Sanz, Inc, a public-traded companylocated in Englewood, Colorado that is a value added reseller for data storagesolutions. From 2003 to May of 2006 he was the Executive Vice Presidentand Chief Financial Officer for SpectraLink Corporation, a publicly-tradedcompany located in Boulder Colorado that designs, manufactures and marketswireless phones for the workplace. Mr. Rosenthal was Executive VicePresident and Chief Financial Officer of StarTek, Inc., a provider ofcustomized outsourcing services from 2000 to 2003. Mr. Rosenthal wasacting Chief Financial Officer at Celestial Seasoning, Inc. until itsmerger with the Hain Food Group in 2000 and the Chief Financial Officer ofHauser, Inc., a manufacturer of natural extracts products, from 1994 to1999. Mr. Rosenthal holds a B.S. degree in Accounting from the Universityof California at Berkeley and a M.B.A degree from California State University,Hayward. Mr. Rosenthal is also a Certified Public Accountant.

*JohnT. Waldron—Deerfield, Illinois:*   Mr. Waldronwas appointed to the Board of Directors of the Company in July 1998.Mr. Waldron is an Adjunct Professor of Marketing at the Lake ForestGraduate School of Management in Lake Forest, Illinois. From 1986 to 1999, Mr. Waldronwas Vice President-Sales and Marketing, Senior Vice President-Sales andMarketing, and Executive Vice President for Takeda U.S.A. Inc., a bulk vitaminand fine chemical products manufacturer. Mr. Waldron was also a Directorof Takeda U.S.A. from 1993 to 1999, and served as a member of its ExecutiveCommittee and Compensation Committee. Mr. Waldron holds a Master ofManagement degree from Northwestern University’s J. L. KelloggGraduate School of Management.

*PaulC. Yuen, Ph.D.—Honolulu, Hawaii:*   Dr. Yuenwas appointed to the Board of Directors of the Company in August 1993.Prior to his retirement in September 1999, Dr. Yuen served as Dean,College of Engineering for the University of Hawaii at Manoa. From July 1992to March 1993, Dr. Yuen was Acting President of the University ofHawaii. From 1989 to 1992, Dr. Yuen was Senior Vice President for AcademicAffairs, University of Hawaii at Manoa. Dr. Yuen holds M.S. and Ph.D.degrees in Electrical Engineering from the Illinois Institute of Technology.

The Board has determinedthat all nominees, except Dr. Cysewski, are independent directors asdefined in Nasdaq Stockmarket Rule 4200A.

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*DirectorCompensation*

At the 2004 AnnualMeeting of Stockholders, the stockholders of the Company approved the IndependentDirector Stock Option and Stock Grant Plan (the “2004 Plan”). Under the 2004Plan each Independent Director receives on first election, pursuant to the 2004Plan, a 10-year option to purchase 1,000 shares of the Company’s CommonStock, and thereafter a grant of 875 shares of Common Stock each year that theIndependent director is elected to the board. Such grants and options arenon-transferable and non-exercisable for six months following the date ofgrant. On the date of the 2006 Annual Meeting of Stockholders, each IndependentDirector was entitled to receive under the 2004 Plan, an automatic grant of 875shares of fully paid and non-assessable shares of Common Stock. Because of anadministrative oversight, such shares were not issued until fiscal year 2008. Inaddition, each Independent Director receives an annual fee of $1,000 forparticipation on the Board and $1,000 per Board meeting attended in person, andis also reimbursed for out-of-pocket costs incurred in connection withattendance at such meetings. Each Independent Director receives $150 forparticipation in telephonic meetings. An Independent Director who serves as amember of any Board committee receives an annual fee of $500 and an IndependentDirector who serves as chairperson of a Board committee is entitled toadditional compensation as follows: 1) Audit Committee Chairperson—$1,500; 2)Compensation and Stock Option Committee Chairperson—$800; and 3) Nominating andCorporate Governance Committee—$800.

**(b) Information pertaining to the Executive Officers of the Company**

The executive officers are elected by and serve at thepleasure of the Board.

Theexecutive officers and other key employees of Cyanotech as of March 31,2007 are as follows:

| **Name**                   | ** ** | ** ** | ** ** | **Age**                                                                                           | ** ** | **Position** |
|----------------------------|------------|------------|------------|---------------------------------------------------------------------------------------------------|------------|--------------|
| Gerald R. Cysewski, Ph.  D |       | 58         |       | Chairman of the Board,  President and Chief Executive Officer                                     |
| William R. Maris           |       | 58         |       | Chief Financial Officer,  Vice President—Finance and Administration, Secretary and Treasurer |
| Glenn D. Jensen            |       | 48         |       | Vice  President—Operations                                                                   |
| Robert J. Capelli          |       | 47         |       | Vice President—Sales                                                                         |

* *

*Dr. Cysewski***co-founded Cyanotechin 1983. Since March 1990, Dr. Cysewski has served as President andChief Executive Officer and prior to this time, served as Scientific Director. Dr. Cysewskihas also served as a Director since 1983. In 1998, he was Vice Chairman of theBoard and in October 1990 he was appointed Chairman of the Board. Prior tohis tenure at Cyanotech, from 1980 to 1982, Dr. Cysewski was group leaderof microalgae research and development at Battelle Northwest, a major contractresearch and development firm. From 1976 to 1980, Dr. Cysewski was anassistant professor in the Department of Chemical and Nuclear Engineering atthe University of California, Santa Barbara. Dr. Cysewski received hisdoctorate in Chemical Engineering from the University of California atBerkeley.

*Mr. Maris*has served asChief Financial Officer, Vice President—Finance & Administration,Secretary and Treasurer since January 2006. From February 2003 to December 2005he was self employed as a Certified Public Accountant. From September 1994to January 2003 Mr. Maris was CFO, Treasurer and Secretary of MarketTransport, Ltd., a logistics and transportation provider based in Portland,Oregon. Prior to this he served as CFO and Vice President, Operations ofWholesome and Hearty Foods (“Garden Burger”), a food products manufacturer inPortland, and CFO and Treasurer of Crown Pacific, Ltd., a forest resources andmanufacturing concern in Portland. Earlier in his career, Maris was a divisiontreasurer and financial manager for AMFAC, Inc. of Honolulu, Hawaii. Hebegan his career at Touche Ross and Company becoming senior auditor and auditsupervisor. He holds a B.A. Degree from the University of Oregon.

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*Mr. Jensen*has served asVice President—Operations since May 1993. He had been Production Managersince 1991. Mr. Jensen joined Cyanotech in 1984 as Process Manager. Priorto joining the Company, Mr. Jensen worked as a plant engineer at Cal-Alga,a spirulina production facility, near Fresno, California. Mr. Jensen holdsa B.S. degree in Health Science from California State University, Fresno.

*Mr. Capelli,*has servedas Vice President—Sales since March 2002. He joined the Company in January 2002as Director of Sales. Prior to joining Cyanotech, Mr. Capelli was SeniorSales Manager for Forecite-The Source, a division of Tree of Life, Inc. Mr. Capelliholds a B.A. degree from Rutgers University.

**(c) Compliance with section 16(a) of the Exchange Act**

Section 16(a) of the Securities Exchange Actof 1934, as amended (the “Exchange Act”), requires the Company’s directors,executive officers, and beneficial owners of more than 10% of a registeredclass of the Company’s equity securities, (collectively “Insiders”) to filereports with the SEC and the National Association of Securities Dealers, Inc.disclosing direct and indirect ownership of Common Stock and other equitysecurities of the Company and reports of changes in such ownership. Insidersare required by SEC regulation to provide the Company with copies of all Section 16(a) formsfiled with the SEC. Based solely on review of copies of Section 16(a) reportsreceived by the Company, and written representations that no other reports wererequired by the SEC, the Company believes Insiders have complied with all Section 16(a) filingrequirements for the fiscal year ended March 31, 2007.

**(d)** We have adopted the Cyanotech Code of Ethics for Chief Executive Officer andSenior Financial Officers (the “Code of Ethics”) included in our Code ofConduct. Our Code of Conduct and Ethics is publicly available on our website atwww.cyanotech.com. If we make any substantive amendments to or grant anywaivers from such Code relating to our Chief Executive Officer, Chief FinancialOfficer or Controller, we will disclose the nature of such amendment in areport on Form 8-K and amend the website disclosure.

**Item 11. ExecutiveCompensation**

The following table setsforth the compensation paid or accrued by the Company to the Chief ExecutiveOfficer and all executive officers of the Company who earned more than $100,000for services rendered in all capacities to the Company (hereinafter referred toas the “named executive officers”) for the fiscal years ended March 31,2007, 2006, and 2005.

**SUMMARYCOMPENSATION TABLE**

|                                                | ** ** | **ANNUAL COMPENSATION** | ** ** |
|------------------------------------------------|------------|------------------------------|------------|
| **Name And Principal Position** | ** ** | ** **                   | ** ** | **Fiscal  Year** | ** ** | **Salary** | ** ** | **Bonus** | ** ** | **Option  Awards(1)** | ** ** | **Total** | ** ** |
| **Gerald R. Cysewski,**                        |       |                         | 2007       |   |   | $ | 130,000 |   | — |   |   | — |   |   | $ | 130,000 |   |
| Chairman of the Board,  President and          |       |                         | 2006       |   |   | $ | 130,048 |   | — |   |   | — |   |   | $ | 130,048 |   |
| Chief Executive Officer                        |       |                         | 2005       |   |   | $ | 121,731 |   | $ | 20,000 |   |   | — |   |   | $ | 141,731 |   |
| **William  R. Maris**                          |       |                         | 2007       |   |   | $ | 104,616 |   | — |   |   | — |   |   | $ | 104,616 |   |
| Chief Financial Officer  and Vice              |       |                         | 2006       |   |   | $ | 23,077 |   | — |   |   | — |   |   | $ | 23,077 |   |
| President of Finance and  Administration       |       |                         | 2005       |   |   | — |   | — |   |   | — |   |   | — |   |
| **Robert J. Capelli**                          |       |                         | 2007       |   |   | $ | 101,738 |   | — |   |   | — |   |   | $ | 101,738 |   |
| Vice President of Sales                        |       |                         | 2006       |   |   | $ | 107,462 |   | — |   |   | — |   |   | $ | 107,462 |   |
|                                                |       |                         | 2005       |   |   | $ | 98,965 |   | $ | 5,000 |   |   | — |   |   | $ | 103,965 |   |
|                                                |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Expenserecognized in the Company’s financial statements. There were no stock optionawards during fiscal 2007, which is the fiscal year the Company adopted SFAS No. 123R,which requires compensation expense to be recorded in the Company’s financialstatements.

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**OPTION GRANTS INLAST FISCAL YEAR**

The Company granted nostock options under the 2005 Stock Option Plan for the fiscal year ended March 31,2007.

**FISCAL YEAR-ENDOPTION VALUES**

**a.**The following table provides information with respect to the named executiveofficers concerning the number and value of unexercised options held at yearend. No SARs have been granted under the Company’s 2005 Stock Plan.

| ** **             | ** ** | **Shares  Acquired  on Exercise** | ** ** | **Value  Realized** | ** ** | **Number of Shares of Common  Stock Underlying Unexercised  Options at FY-End (#)** | ** ** | **Value of Unexercised  In-The-Money Options  at FY-End ($)(1)** | ** ** |
|------------------------|------------|----------------------------------------|------------|---------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------|------------|
| **Name**               | ** ** | ** **                             | ** ** | **(#)**             | ** ** | **($)**                                                                                                                          | ** ** | **Exercisable(4)**                                                                        | ** ** | **Unexercisable** | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| Gerald R.  Cysewski(2) |       |                                   | 0          |                |       |                                                                                                                             | $          | 0                                                                                         |       |   |   | 7,875(2 | ) |   |   | — |   |   |   | $ | — |   |   |   | $ | — |   |   |
| Robert J.  Capelli(2)  |       |                                   | 0          |                |       |                                                                                                                             | $          | 0                                                                                         |       |   |   | 5,500(2 | ) |   |   | — |   |   |   | $ | — |   |   |   | $ | — |   |   |
| William R. Maris(3)    |       |                                   | 0          |                |       |                                                                                                                             | $          | 0                                                                                         |       |   |   | 5,000(3 | ) |   |   | — |   |   |   | $ | — |   |   |   | $ | — |   |   |
|                        |            |                                        |            |                     |            |                                                                                                                                  |            |                                                                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Refers to the Marketvalue of shares covered by in-the-money options on March 31, 2007 whichwas $1.64, less the option exercise price. Options are not in-the-money if themarket value of the shares covered thereby is less than the option exerciseprice, which was so at the fiscal year ended March 31, 2007.

(2)          Options which remainexercisable granted under 1995 Stock Plan.

(3)          Options which areexercisable granted under 2005 Stock Plan. The options were granted under theCompany’s 2005 Stock Plan on January 2, 2006, and were exercisable in fourequal and cumulative annual installments over the optionee’s period of servicewith the Company, beginning one year after the grant date. The option has aterm of five years.

(4)          As reported in theCompany’s 10-K filed June 28, 2006, on March 23, 2006, inresponse to SFAS No. 123(R), the Compensation and Stock OptionCommittee of the Company’s Board of Directors approved accelerating the vestingof all outstanding unvested employee incentive stock options under theprovisions of APB Opinion No. 25, and related interpretations. Optionsheld by non-employees and directors were not included in the vestingacceleration since all such options were already fully vested. The decision toaccelerate vesting of all outstanding unvested employee incentive stock optionswas made to avoid recognizing, pursuant to the Company’s April 1, 2006adoption of SFAS No. 123(R), the non-cash compensation cost related tounvested Employee Incentive Stock Options. These options would otherwise havebeen unvested as of March 31, 2007 and would have been reflected as anon-cash expense in future statements of operations.

Due to the Company’shaving fewer than 100 employees, it was deemed prudent to accelerate thevesting of all outstanding employee incentive stock options including thoseshown above. This resulted in the company recognizing non-cash compensationexpense of approximately $10,000 for the year ended March 31, 2006,representing the estimated benefit of accelerated vesting for those unvestedincentive options with exercise prices less than the fair market value of theCompany’s stock on March 23, 2006. It is estimated that the total futurecompensation expense that will be avoided in future years is approximately$78,000, before tax, based on the March 23, 2006 acceleration date. The foregoingamount would have primarily impacted fiscal years ending March 31, 2007through March 31, 2009.

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**COMPENSATIONDISCUSSION AND ANALYSIS**

**b.    **The Compensation andStock Option Committee reviewed and discussed with senior management theCompensation Discussion and Analysis that follows. Based on that review anddiscussion, the Committee recommended and the Board of Directors concurred,that the Compensation Discussion and Analysis be included in this Form 10-K.
|          | **Cyanotech Corporation**                   |
|----------|---------------------------------------------|
|     | **Compensation and Stock Option Committee** |
|     |                                        | John  C. Waldron, *Chairman* |
| * * |                                        | Paul  C. Yuen, *Member* |

 

*CompensationDiscussion and Analysis*

**Who is responsiblefor determining appropriate executive compensation?**

The Compensation Committeehas the responsibility for recommending the total compensation program for theCompany and its subsidiaries, subject to the approval of the Board. Thisincludes determining the compensation for the Cyanotech Corporation NamedExecutive Officers (“NEO’s”) (the individuals named in the Summary CompensationTable herein: (1) Gerald R. Cysewski, PhD, Chairman, President andChief Executive Officer of the Company; (2) William R. Maris, ChiefFinancial Officer, Vice President-Finance and Administration, Secretary andTreasurer of the Company; and (3) Robert J. Capelli, Vice President-Salesof the Company;

**What are theobjectives of the Company’s compensation programs?**

The goals of thecompensation program are to align compensation with business objectives andperformance, and to enable the Company to attract, motivate and retainexecutives of outstanding ability, potential and drive commensurate with thesize and development requirements of the Company. Key components include:

·       TheCompany pays competitively with comparable small companies with which theCompany competes for talent. To ensure that pay is competitive, the Companycompares its pay practices with these companies and sets its pay parametersbased in part on this review.

·       TheCompany maintains annual incentive opportunities sufficient to providemotivation to achieve specific operating goals and to generate rewards thatbeing total compensation to competitive levels.

·       TheCompany provides stock options for executive officers to ensure that they aremotivated over the long term to respond to the Company’s business challenges.

The Compensation Committeeendeavors to balance Company needs and values with the employees’ needs andbelieves that it is important that the Committee maintain this relationship.

**What are thecompensation programs designed to reward?**

The Company’s compensation programs are designed torecognize and reward Company annual and long-term performance and individualperformance that enhance shareholder value. To that end:

·       *Company Performance*.   The Compensation Committeeconsiders each executive’s overall contribution to the Company’s long-term andshort-term results and projections in relation to the Company goal of achievingsustainable profitability from sales of its products.

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·       *IndividualPerformance.  *The Compensation Committee has not establishedspecific individual goals. The Company has a small executive team of talentedindividuals with clear divisions of responsibility for achieving the Company’sgoals. The Compensation Committee evaluates the Chief Executive Officer as acommittee, or in conjunction with the other independent members of the Board ofDirectors (as determined by the full Board). That evaluation entails a reviewof the Chief Executive Officer’s performance and progress towards achievingsustainable profitability through improved long-term and short-term results attributableto the Chief Executive Officer. The Compensation Committee or the full Board(excluding the Chief Executive Officer) acting with the Committee or upon itsrecommendations also considers relative shareholder return over the same periodand chief executive compensation for similar-sized companies with similarresults within the relevant geographic and industry area. For other NEO’s, theCompensation Committee considers a performance assessment and base salaryrecommendation from the Chief Executive Officer. The performance evaluations ofthese executives are based on an overall assessment of each executive’scontribution to the Company’s long-term and short-term results and projectionsin relation to the Company goal of achieving sustainable profitability fromsales of its products. The compensation for the Vice President-Sales includes adirect commission-based component.

**What are theelements of executive compensation?**

The elements of theCompany’s executive compensation include:

·       Basesalary and bonus, if awarded.

·       Incentive stock optiongrants.

**How is base salarydetermined?**

The base salaries of theexecutive officers are determined initially on the basis of one or more salarysurveys conducted by third parties as well as surveys of biopharmaceuticalcompanies both nationally and more specifically in the Western United Statesobtained from public information such as filings with the Securities andExchange Commission. Based on such surveys, the executive officers’ salariesare set within the ranges of the surveys targeted at the median; the exactlevel is determined after the Committee considers the experience and capabilityof the executive officer, the level of responsibility and the needs of theCompany.

**What were the basesalary increases for 2007?**

None, because the Companyincurred a loss in operations.

**Are bonuses paid toexecutive officers?**

The Committee believes that, as a general rule, annualcompensation in excess of base salaries should be dependent on the employee’sperformance and the Company’s performance, and should be awarded based onrecommendations of the Committee, and in the discretion of the Board. Accordingly,at the beginning of a fiscal year, the Committee may adopt an incentive planfor executive officers and other key management personnel under which executiveofficers and other key management personnel may earn bonuses, provided theCompany achieves or exceeds the pre-tax net income goal established for theyear.

The net income goal is established in part on thebasis of an annual operating plan developed by management and approved by theBoard of Directors. The annual operating plan is designed to maximizeprofitability, within the constraints of economic and competitive conditions,some of which are outside the control of the Company, and is developed on thebasis of: (i) the Company’s performance in the prior year; (ii) estimatesof sales revenue for the plan year based upon recent market conditions andtrends and other 

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factors which, based onhistorical experience, are expected to affect the level of sales that can beachieved; (iii) historical operating cost and cost savings that managementbelieves can be achieved; and (iv) competitive conditions faced by theCompany. Taking all of these factors into account, as part of the operatingplan, bonus awards are determined and fixed at what is believed to be arealistic level so as to make the incentives meaningful to executives and toavoid penalizing executives and other key management personnel for conditionsoutside of their control.

In certain instances, bonuses may be awarded not onlyon the basis of the Company’s overall profitability, but also on theachievement by an executive of specific objectives within his or her area ofresponsibility. For example, a bonus may be awarded for an executive’s effortsin achieving greater than anticipated cost savings, or establishing new orexpanded markets for the Company’s products. Typically, the maximum bonus thatmay be awarded for achievement of specific objectives is determined at thebeginning of the year to provide the requisite incentive for such performance.

As a result of suchperformance-based criteria, executive compensation, and the proportion of eachexecutive’s total cash compensation that is represented by incentive or bonusincome, may increase in those years in which the Company achieves theanticipated level of growth and profitability. On the other hand, in years inwhich the Company experiences less than anticipated growth, bonuses and totalexecutive compensation should be lower or not awarded. No bonuses were paidduring or for fiscal years 2006 or 2007.

**What is the Company’sincentive stock option program?**

The 2005 Stock Option Plan(“Plan”) rewards select executives and key employees as an incentive for themto join or remain in the service of the Company. The Stock Option andCompensation Committee administers the Plan

**How does theCompany award stock option grants?**

The Committee generallyintends to make stock option grants on an annual basis. Each grant is designedto align the interests of the executive officers with those of the stockholdersand provide each individual with a significant incentive to manage the Companyfrom the perspective of an owner with an equity stake in the business. Eachgrant generally allows the executive officer to acquire shares of the Company’sCommon Stock at a fixed price per share (usually the market price on the dateof grant) over a specified period of time (up to 10 years), thus providing areturn to the executive officer only if he or she remains in the employ of theCompany and the market price of the shares appreciate over the option term. Thesize of the option grant to each executive officer generally is set at a levelthat is intended to create a meaningful opportunity for stock ownership basedupon the individual’s current position with the Company, but also taken intoaccount are the size of comparable awards made to individuals in similarpositions in the industry as reflected in external surveys, the individual’spotential for future responsibility and promotion over the option term, theindividual’s personal performance in recent periods and the number of optionsheld by the individual at the time of grant. Generally, as an executive officer’slevel of responsibility increases, a greater portion of his or her totalcompensation will be dependent upon Company performance and stock priceappreciation rather than base salary. The relative weight given to thesefactors varies with each individual, in the sole discretion of the Committee.

**What perquisitesand other personal benefits do executive officers have?**

None.

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**Do executiveofficers have change-in-control agreements?**

No, however provisionscontained in the 2005 Stock Option Plan concerning acceleration of stockoptions when a Corporate transaction, as defined in such Plan occurs, unlessthe option is assumed or replaced by the successor corporation with acomparable option or cash incentive program.

**How was the ChiefExecutive Officer’s compensation determined last fiscal year?**

The compensation payableto Dr. Cysewski, the Company’s Chief Executive Officer in fiscal 2007, wasdetermined by the Committee. Dr. Cysewski’s base salary was set at a levelwhich the Board felt would be competitive with the base salary levels in effectfor chief executive officers at similarly-sized companies within the industry.Based on Dr. Cysewski’s performance and on the compensation policysummarized in this report, the Compensation Committee decided that Dr. Cysewski’ssalary would remain at its 2006 level of $130,000.

**Item 12. Security Ownership of Certain BeneficialOwners and Management and Related Stockholder Matters**

Thefollowing table sets forth information regarding the beneficial ownership ofthe Company’s Common Stock as of July 30, 2007 by (i) each person whois known by the Company to own beneficially more than 5% of the outstandingshares of the Common Stock of the Company and Common Stock equivalents, (ii) eachof the Company’s executive officers named in the Summary Compensation Tableappearing herein, (iii) each director and (iv) all directors andexecutive officers named in the Summary Compensation Table appearing herein asa group. The following table sets forth what such persons’ beneficial securityownership position would be assuming the exercise of all outstanding stockoptions and warrants, exercisable on July 30, 2007 or within 60 days ofsuch date. All shares shown are subject to the named person’s sole voting andinvestment power except as noted below.

| **Name**                                                     | ** ** | ** ** | ** ** | **Shares Beneficially  Owned** | ** ** | **Approximate Percent  Owned** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|-------------------------------------|------------|-------------------------------------|------------|
| Gerald R.  Cysewski(1)                                       |       |       | 121,527    | (2)                                 |       |                                | 2.3        | % |   |
| Robert J.  Capelli(1)                                        |       |       | 5,500      | (3)                                 |       |                                | *          |   |   |
| Michael A.  Davis(1)                                         |       |       | 868,269    | (4)(5)                              |       |                                | 16.6       | % |   |
| Gregg W.  Robertson(1)                                       |       |       | 2,375      | (6)                                 |       |                                | *          |   |   |
| William R.  Maris(1)                                         |       |       | 5,000      | (7)                                 |       |                                | *          |   |   |
| David I.  Rosenthal(1)                                       |       |       | 3,250      | (8)                                 |       |                                | *          |   |   |
| John T.  Waldron(1)                                          |       |       | 13,488     | (9)                                 |       |                                | *          |   |   |
| Paul C. Yuen(1)                                              |       |       | 10,200     |                                |       |                                | *          |   |   |
| All directors and  executive officers as a group (8 persons) |       |       | 1,029,609  | (10)                                |       |                                | 19.7       | % |   |

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                 * Less than 1.0%

       (1) Address is c/o Cyanotech Corporation, 73-4460 Queen KaahumanuHwy., Suite 102, Kailua Kona, HI 96740.

       (2) Includes options for 7,875 shares of Common Stock.

       (3) Includes options for 5,500 shares of Common Stock

       (4) Includes 80,500 shares over which Mr. Davis holds sole votingand investment power. Also includes 787,019 shares over which Mr. Davisholds shared voting and investment power, including 31,250 shares held by Mr. Davis’spouse, Janet J. Johnstone (“Johnstone”); 175,000 shares held by the SkywordsFamily Foundation, a charitable foundation of which Mr. Davis andJohnstone are the sole directors; 100,000 shares held by trusts for the benefitof Mr. Davis’ and Johnstone’s minor children 

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for which Mr. Davisis a co-trustee; and 480,769 shares held by the Michael Arlen Davis CharitableLead Annuity Trust of which Mr. Davis is a co-trustee.

       (5) Includes options for 750 shares of Common Stock held by a trust forthe benefit of Mr. Davis, Johnstone & Mr. Davis’descendents, of which Mr. Davis is a trustee.

       (6) Includes options for 1,000 shares of Common Stock.

       (7) Includes options for 5,000 shares of Common Stock.

       (8) Includes options for 750 shares of Common Stock.

       (9) Includes options for 750 shares of Common Stock.

(10) Includes options for 21,625 shares of CommonStock.

**Item 13. CertainRelationships and Related Transactions**

Not applicable.

**Item 14. PrincipalAccountant Fees and Services**

**Audit Fees**

The aggregate fees billedby KPMG LLP, our independent registered public accounting firm, forprofessional services rendered for the audit of the Company’s annual financialstatements and timely quarterly reviews for the fiscal year ended March 31,2007 and 2006 were $361,600 and $162,700, respectively.

**Audit Related Fees**

There were no auditrelated fees billed by KPMG LLP for the fiscal years ended March 31, 2007and 2006.

**Tax Fees**

The aggregate fees billedby KPMG LLP for tax services rendered to the Company, for the fiscal yearsended March 31, 2007 and 2006, were $4,800 and $7,600, respectively.

**All Other Fees**

There were no other fees billed by KPMG LLP for thefiscal years ended March 31, 2007 and 2006.

The Audit Committee has considered and does notbelieve the provision of all other services by the Company’s registered publicaccounting firm is incompatible with maintaining KPMG LLP’s independence. See “Reportof the Audit Committee.”

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**PART IV**

**Item 15. FinancialStatement Schedules and Exhibits**

(a)   Financial Statements and Schedules

·        The following FinancialStatements of Cyanotech Corporation and subsidiaries and the Report ofIndependent Registered Public Accounting Firm are included in Item 8 of thisreport:

| Consolidated Balance Sheets,  March 31, 2007 and 2006                                                                                    |   | 33 |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|----|
| Consolidated Statements of  Operations for the years ended March 31, 2007, 2006 and 2005                                            |   | 34 |
| Consolidated Statements of  Stockholders’ Equity and Comprehensive Income (Loss) for the years ended March 31,  2007, 2006 and 2005 |   | 35 |
| Consolidated Statements of  Cash Flows for the years ended March 31, 2007, 2006 and 2005                                            |   | 36 |
| Notes  to Consolidated Financial Statements                                                                                                   |   | 37 |

 

·        Thefollowing financial statement schedule is included in this report on the pages indicatedbelow:

| Schedule II—Valuation and Qualifying Accounts       |   | 67 |
|----------------------------------------------------------|--------|----|
| Report  of Independent Registered Public Accounting Firm |   | 68 |

 

Financial statement schedules not listed above havebeen omitted since they are either not required, not applicable or theinformation is included in the consolidated financial statements or notesthereto.

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(b)   Exhibit Listing

| Exhibit Number | ** ** | **Document Description**                                                                                                                                                                                                                                                                                                                                             |
|---------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                 |       | Restated Articles of  Incorporation (Incorporated by reference to Exhibit 3.1 to the Company’s  Quarterly Report on Form 10-QSB for the quarter ended  December 31, 1996, File No. 0-14602)                                                                                                                                                 |
| 3.2                 |       | Certificate of  Amendment to Restated Articles of Incorporation effective September 1,  2004 (Incorporated by reference to Exhibit 3.1 to the Company’s Report  on Form 8-K filed April 2, 2007, File No. 0-14602)                                                                                                                     |
| 3.3                 |       | Certificate of  Change to Restated Articles of Incorporation effective November 3, 2006  (Incorporated by reference to Exhibit 3.1 to the Company’s Report on  Form 8-K filed March 20, 2007, File No. 0-14602)                                                                                                                        |
| 3.4                 |       | Amended Bylaws  (Incorporated by reference to Exhibit 3.3 to the Company’s Report on  Form 8-K filed April 2, 2007, File No. 0-14602)                                                                                                                                                                                                       |
| 4.1*                |       | Specimen Common  Stock                                                                                                                                                                                                                                                                                                                                               |
| 10.1                |       | 1994 Non-Employee  Directors Stock Option and Stock Grant Program (Incorporated by reference to  Exhibit 10.7 to the Company’s Annual Report on Form 10-KSB  for the fiscal year ended March 31, 1994, File No. 0-14602)                                                                                                                    |
| 10.2                |       | 1995 Stock Option  Plan for Cyanotech Corporation dated August 9, 1995, as amended  (Incorporated by reference to Exhibit 4(c) to the Company’s  Registration Statement on Form S-8 filed on October 27, 1995,  File No. 33-63789)                                                                                                |
| 10.3                |       | Sub-Lease  Agreement between the Company and Natural Energy Laboratory of Hawaii  Authority dated December 29, 1995 (Incorporated by reference to  Exhibit 10.1 to the Company’s Quarterly Report on Form 10-QSB  for the quarter ended December 31, 1995, File No. 0-14602)                                                           |
| 10.4                |       | Term Loan  Agreement dated April 21, 2000 between the Company and B&I Lending,  LLC (Incorporated by reference to Exhibit 10.11 to the Company’s Annual  Report on Form 10-K for the year ended March 31, 2000, File  No. 0-14602)                                                                                                 |
| 10.5                |       | 2005 Stock Option  Plan for Cyanotech Corporation dated August 22, 2005, incorporated by  reference to Exhibit A of the Company’s definitive Proxy Statement filed  July 14, 2005, File No. 0-14602                                                                                                                                         |
| 10.6                |       | 2004 Independent  Director Stock Option and Restricted Stock Grant Plan for Cyanotech  Corporation dated August 16, 2004 (Incorporated by reference as Exhibit D  to the Company’s definitive Proxy Statement filed July 2, 2004, File  No. 0-14602)                                                                                        |
| 14.1                |       | Amended Code of  Ethics for Chief Executive Officer and Senior Financial Officers, which is  included in the Code of Conduct and Ethics.(Incorporated by reference  to Exhibit 99.2 to the Company’s Report on Form 8-K filed on  December 19, 2005, and by reference and attachment to the Company’s  Internet address www.cyanotech.com.) |
| 21.1                |       | Subsidiaries of  the Company (Incorporated by reference to Exhibit 21.1 to the Company’s  Annual Report on Form 10-K for the year ended March 31, 2003,  File No. 0-14602)                                                                                                                                                                  |
| 23.1*               |       | Consent of  Independent Registered Public Accounting Firm signed August 15, 2007.                                                                                                                                                                                                                                                                               |
| 24.1*               |       | Power of attorney  David I. Rosenthal                                                                                                                                                                                                                                                                                                                                |
| 24.2*               |       | Power of attorney  Paul C. Yuen                                                                                                                                                                                                                                                                                                                                      |
| 24.3*               |       | Power of attorney  Michael A. Davis                                                                                                                                                                                                                                                                                                                                  |

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| 24.4* |   | Power of attorney Gregg  W. Robertson                                                                                                         |
|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------|
| 24.5* |   | Power of attorney  John T. Waldron                                                                                                            |
| 31.1* |   | Certifications of  Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002 signed as of August 15, 2007. |
| 31.2* |   | Certifications of  Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002 signed as of August 15, 2007. |
| 32.1* |   | Certifications of  Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002 signed as of August 15, 2007. |
| 32.2* |   | Certifications of  Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002 signed as of August 15, 2007. |

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*                    Includedherewith. Other exhibits were filed as shown above.

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**Schedule II**

**CyanotechCorporation and SubsidiariesValuation and Qualifying Accounts**

**YearsEnded March 31, 2007, 2006 and 2005(In Thousands)**

| ** **                           | ** ** | ** **          | ** ** | **Additions**       | ** ** | ** **          | ** ** | ** **   | ** ** |
|--------------------------------------|------------|---------------------|------------|---------------------|------------|---------------------|------------|--------------|------------|
| ** **                           | ** ** | **Balance at** | ** ** | **Charged to** | ** ** | **Charged to** | ** ** | ** **   | ** ** | **Balance at** | ** ** |
| ** **                           | ** ** | **Beginning**       | ** ** | **Costs and**  | ** ** | **Other**           | ** ** | ** **   | ** ** | **End of** | ** ** |
| **Description**                      | ** ** | ** **          | ** ** | **of Year**    | ** ** | **Expense**         | ** ** | **Accounts** | ** ** | **Deductions** | ** ** | **Year** | ** ** |
| Allowance for Doubtful  Receivables: |       |                |       |                |       |                |       |         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| 2007                                 |       |                | $          | 25                  |       |                |       | $            | 12         |   |   |   | $ | — |   |   |   | $ | 14 |   |   |   | $ | 23 |   |   |
| 2006                                 |       |                | $          | 46                  |       |                |       | $            | (8         | ) |   |   | $ | — |   |   |   | $ | 13 |   |   |   | $ | 25 |   |   |
| 2005                                 |       |                | $          | 96                  |       |                |       | $            | 31         |   |   |   | $ | — |   |   |   | $ | 81 |   |   |   | $ | 46 |   |   |
|                                      |            |                     |            |                     |            |                     |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**Report of IndependentRegistered Public Accounting Firm**

The Board of Directors and StockholdersCyanotech Corporation:

Under date of August 15, 2007, we reported on theconsolidated balance sheets of Cyanotech Corporation and subsidiaries (theCompany) as of March 31, 2007 and 2006, and the related consolidatedstatements of operations, stockholders’ equity and comprehensive income (loss),and cash flows for each of the years in the three-year period ended March 31,2007, which are included in the Company’s March 31, 2007 annual report on Form 10-K.In connection with our audits of the aforementioned consolidated financialstatements, we also audited the related financial statement schedule as listedin Item 15(a)(2). The financial statement schedule is the responsibility of theCompany’s management. Our responsibility is to express an opinion on thefinancial statement schedule based on our audits.

In our opinion, such financial statement schedule,when considered in relation to the basic consolidated financial statementstaken as a whole, presents fairly, in all material respects, the informationset forth therein.

Asdiscussed in Note 1 to the consolidated financial statements, effective April 1,2006, the Company adopted Statement of Financial Accounting Standards No. 123(R),*Share Based Payment*.

/s/ KPMG LLP

Honolulu,Hawaii

August 15, 2007

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**SIGNATURES**

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized, on the 15th day of August, 2007.
|        | **Cyanotech Corporation** |
|--------|---------------------------|
|   | By:                       | /s/  Gerald R. Cysewski, Ph. D. |
|   |                      | Gerald R.  Cysewski, Ph. D. |
|   | * *                  | *Chairman  of the Board, President* |
|   | * *                  | *and  Chief Executive Officer* |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.
|                                | **Signatures** | ** **                                     | ** ** | ** **            | **Title** | ** ** | ** ** | **Date** | ** ** | ** ** |
|--------------------------------|----------------|------------------------------------------------|------------|-----------------------|-----------|------------|------------|----------|------------|------------|
| /s/ Gerald R. Cysewski, Ph. D. |           | Chairman of the  Board, President              |       | August 15,  2007 |
| Gerald  R. Cysewski, Ph. D.    |           | and Chief Executive  Officer (Principal        |       |                  |
|                           |           | Executive Officer and  Director)               |       |                  |
| /s/ William R. Maris           |           | Chief Financial  Officer, Vice President— |       | August 15,  2007 |
| William  R. Maris              |           | Finance and  Administration, Secretary         |       |                  |
|                           |           | and Treasurer                                  |       |                  |
| /s/ William R. Maris*          |           | Director                                       |       | August 15,  2007 |
| David  I. Rosenthal            |           |                                           |       |                  |
| /s/ William R. Maris*          |           | Director                                       |       | August 15,  2007 |
| Paul  C. Yuen                  |           |                                           |       |                  |
| /s/ William R. Maris*          |           | Director                                       |       | August 15,  2007 |
| Michael  A. Davis              |           |                                           |       |                  |
| /s/ William R. Maris*          |           | Director                                       |       | August 15,  2007 |
| Gregg  W. Robertson            |           |                                           |       |                  |
| /s/ William R. Maris*          |           | Director                                       |       | August 15,  2007 |
| John  T. Waldron               |           |                                           |       |                  |

 

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*                    By Power ofAttorney.

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