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

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended March 31, 2004

Commission File Number 0-146-02

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

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

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

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

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

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

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

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

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

The aggregate market value of the Registrant's Common Stock held by non-affiliates of the Registrant on June 18, 2004 was approximately
$21,367,000 based on the closing sale price of the Common Stock on the NASDAQ SmallCap Market on that date.

Number
of shares outstanding of Registrant's Common Stock at June 18, 2004 was 20,743,990.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's Definitive Proxy Statement for its 2004 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission on or
prior to July 2, 2004 and to be used in connection with the Annual Meeting of Stockholders expected to be held on August 16, 2004, are incorporated by reference in Part III of
this Form 10-K.



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TABLE OF CONTENTS

|Item     |  |                                                                                       |  | Page
|-------- |  | ------------------------------------------------------------------------------------- |  | ----
|PART I  
|1.       |  | Business                                                                              |  | 3   
|2.       |  | Properties                                                                            |  | 10  
|3.       |  | Legal Proceedings                                                                     |  | 11  
|4.       |  | Submission of Matters to a Vote of Security Holders                                   |  | 11  
|         |  | Executive Officers of the Registrant                                                  |  | 11  
|PART II 
|5.       |  | Market for Registrant's Common Equity and Related Stockholder Matters                 |  | 12  
|6.       |  | Selected Financial Data                                                               |  | 13  
|7.       |  | Management's Discussion and Analysis of Financial Condition and Results of Operations |  | 13  
|7a.      |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 20  
|8.       |  | Financial Statements and Supplementary Data                                           |  | 21  
|9.       |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure  |  | 39  
|9a.      |  | Controls and Procedures                                                               |  | 39  
|PART III
|10.      |  | Directors and Executive Officers of the Registrant                                    |  | 39  
|11.      |  | Executive Compensation                                                                |  | 39  
|12.      |  | Security Ownership of Certain Beneficial Owners and Management                        |  | 39  
|13.      |  | Certain Relationships and Related Transactions                                        |  | 39  
|14.      |  | Principal Accounting Fees and Services                                                |  | 39  
|PART IV 
|15.      |  | Exhibits, Financial Statement Schedules, and Reports on Form 8-K                      |  | 40  
|         |  | Signatures                                                                            |  | 44  

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PART I

Item 1. Business

General

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



Microalgae
are a diverse group of microscopic plants that have a wide range of physiological and biochemical characteristics and contain, among other things, high levels of natural
protein, amino acids, vitamins, pigments and enzymes. Microalgae have the following properties that make commercial production attractive: (1) microalgae grow much faster than land grown
plants, often up to 100 times faster; (2) microalage have uniform cell structure with no bark, stems, branches or leaves, permitting easier extraction of products and higher utilization of the
microalgae cells; and (3) the cellular uniformity of microalgae makes it practical to manipulate and control growing conditions in order to optimize a particular cell characteristic. Efficient
cultivation of microalgae requires consistent light, warm temperature, low rainfall and proper chemical balance in a very nutrient-rich environment. If the chemical composition of a pond
changes from its required balance, contamination can occur as a result of the growth of unwanted organisms.

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

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

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

Cyanotech's Business

The Company operates entirely in one operating segment, the cultivation and production of microalgae into high-value, high-quality natural
products. The Company currently cultivates, on a large-scale basis, two microalgal species from which our two major product lines, our spirulina products and our natural astaxanthin products, are
derived. The following table sets forth, for the three years ended March 31, 2004, the net sales contributed by each of the Company's product lines (in thousands):

Net Sales2004

2003

2002Spirulina products:Spirulina Pacifica

$
6,511

$
6,181

$
6,086Natural astaxanthin products:NatuRose


2,545


1,301


1,009BioAstin


2,388


1,312


685Other including phycobiliproteins


138


157


455Total

$
11,582

$
8,951

$
8,235


SpirulinaProducts

Since 1985, Cyanotech has been producing a strain of spirulina microalgae marketed asSpirulina Pacifica.Accounting for 56%, 69% and 74% of net sales for the years ended March 31, 2004, 2003 and 2002, respectively,Spirulina Pacificaprovides a
vegetable-based, highly absorbable source of protein, natural beta-carotene, mixed carotenoids, B vitamins, gamma linolenic acid, essential amino acids and other phytonutrients. Spirulina Pacificais
produced in three forms: powder, flake and tablets. Powder is used as an ingredient in nutritional supplements and health food
drinks while flakes are used as a seasoning on various foods. Tablets are consumed as a daily dietary supplement. All three forms are sold as raw material in bulk quantities and as packaged consumer
products under the Nutrex Hawaii label.

Since
1994, we have produced two grades ofSpirulina Pacifica: an all-natural grade cultivated by using conventional
agricultural fertilizers and an organic grade that is cultivated using only organic fertilizers. Our organicSpirulina Pacificais grown and processed
in accordance with the National Organic Program of the United States Department of Agriculture ("USDA") effective October 2002. Prior to the establishment of the USDA organic standard, our
organic standard was the California Organic Food Act of 1990. Our organic cultivation and processing methods are certified annually by Quality Assurance International of San Diego, California, a
leading third-party agency. In addition to such organic certification, both grades ofSpirulina Pacificaare certified Kosher by Organized Kashrus
Laboratories of Brooklyn, New York and are cultivated without the use of herbicides or pesticides.    In March 2003, Cyanotech and Earthrise Nutritionals, Inc. of Petaluma,
California submitted a joint notice to the United States Food and Drug Administration ("FDA") reporting their determination, through scientific procedures, that the spirulina cultivated by both
companies is GRAS (generally recognized as safe) for addition to a variety of foods. In November 2003, the FDA concluded the notification procedure by written response that it had no questions
about the companies' determination that spirulina is GRAS for addition to a variety of foods.

OurSpirulina Pacificais cultivated in a combination of fresh water and a metered amount of nutrient-rich deep ocean water
(containing essential trace elements), drawn from a depth of 2,000 feet below sea level. This water mixture is supplemented with the other major required nutrients such as

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

Continuing
the production process, the spirulina crop in each pond is circulated by paddlewheels to keep an even blend of nutrients in suspension and a uniform exposure of the algae to
sunlight. Our ponds are engineered to maintain the right media depth for sunlight to permeate each crop completely, facilitating rapid growth. The design of our cultivation ponds promotes efficient
growing conditions, allowing theSpirulina Pacificaalgae to reproduce rapidly. Each pond can be harvested, on average, in six days. As sunlight is a
major component of cultivation, production can be impacted from seasonality changes during the winter months, with shortened daylight hours and potential inclement weather. Based on fiscal 2004
activity, the difference in finished goods produced between the quarter with the highest volume and the lowest was approximately 6% (using the lowest quarter's production volume as the basis).

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

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

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

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These
contractors are organic and Kosher certified, subject to regular government inspections. Such packaging services are readily available from multiple sources.

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

Our Spirulina Pacificaproducts compete with a variety of vitamins, dietary supplements, other algal products and similar nutritional
products available to consumers. The nutritional products market is highly competitive and includes international, national, regional and local producers and distributors, many of whom have greater
resources than Cyanotech and many of whom offer a greater variety of products. Our direct competition in the spirulina market is currently from Dainippon Ink and Chemical Company's Earthrise facility
in California and several farms in China. Other competitors include numerous smaller farms in China, India, Thailand, Taiwan, Cuba, South Africa and South America. The market for spirulina is mature
with slow growth expected in future periods. In this mature market, the Company has experienced increased price competition due to more spirulina suppliers as well as a larger portion of sales coming
from bulk product orders whose customers generally treat these products as commodities with price being the major determining factor driving their purchasing decision. As one of the largest producers
of spirulina, our challenge is to increase our market share among customers who seek the high-quality products we produce while concurrently adjusting our product mix to meet our revenue
targets. As of March 31, 2004, the backlog of orders for all spirulina products totaled approximately $334,000, and such orders are expected to be fulfilled in the first quarter of fiscal year
2005. As of March 31, 2003, backlogged orders totaled approximately $266,000.

Natural AstaxanthinProducts

The Company commenced commercial production of natural astaxanthin in early 1997 with the introduction ofNatuRoseto the aquaculture market. Astaxanthin is a red pigment used in the aquaculture market primarily to impart a pink to red color to the flesh of commercially raised fish and shrimp but also has been
found to be essential for their proper growth and survival. Since its introduction, several feeding trials have been performed by our customers and potential customers that prove the efficacy of NatuRoseas an alternative to the petrochemical-based synthetic astaxanthin presently used by most aquaculture companies. The appeal of our product is
that it is derived from a natural source and produces results that are comparable, or in some cases superior, to synthetic astaxanthin. Sold in bulk quantities as a powder, NatuRosesales accounted for
22%, 14% and 12% of net sales for the years ended March 31, 2004, 2003 and 2002, respectively.

In
1999, our natural astaxanthin product for the human nutrition market,BioAstin,was introduced. BioAstinsales accounted for 21%, 15% and 9% of net sales
for the years ended March 31, 2004, 2003 and 2002, respectively. BioAstinis produced in three forms: a liquid lipid extract, gelcaps and microencapsulated "beadlets" with all three forms sold in
bulk quantities. BioAstingelcaps are also sold in packaged consumer form under the Nutrex Hawaii label. A growing body of scientific literature is suggesting that the
beneficial antioxidant properties of natural astaxanthin may surpass many of the antioxidant properties of vitamin C, vitamin E, beta-carotene and other carotenoids. Independent scientific
studies indicate that in certain models, natural astaxanthin has up to 550 times the antioxidant activity of vitamin E and 10 times the antioxidant activity of beta-carotene.

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

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

Unlike
spirulina, astaxanthin is produced in a batch-mode and each cultivation pond must be completely drained and thoroughly cleaned between cycles. While the entire
astaxanthin production cycle takes a total of four weeks, each stage of the four-step process is staggered and continuously feeds the next stage of cultivation. As a result, we are
currently able to produce a new crop of astaxanthin from each of our 500,000 liters culture ponds approximately once per week. Pond cultivation can be negatively impacted seasonally with shortened
daylight hours and potential inclement weather in winter months. Based on fiscal 2004 activity, the difference in finished goods produced between the quarter with the highest volume and the lowest was
approximately 13% (using the lowest quarter's production volume as the basis).

Natural
astaxanthin for human consumption is processed further utilizing a high-pressure extraction process. The resulting product is a lipid extract insoluble in water used
for the production of gelcaps. This product can also be micro-encapsulated into "beadlets" which our customers use in other formulations. All natural astaxanthin products destined for human
consumption undergo a prescribed set of microbiological food product tests to ensure safety and quality. The Company uses third party contractors for the extraction services, the production of gelcaps
and the production of beadlets. Although these services are available only from a limited number of sources, we have the ability to use other parties if any of the current contractors become
unavailable; however, there is no assurance that the pricing from a new contractor will be comparable to current negotiated pricing. In addition, a new contractor would have to pass the Company's
qualification process ensuring quality standards can be met or exceeded. If the pricing, for any of these services, significantly increases, this could have a material adverse effect on our business,
financial condition and results of operations.

NatuRoseis sold through a network of agents and distributors primarily to feed manufacturers and farmers in the aquaculture industry.
Japan is one of our primary markets for the application ofNatuRosein aquaculture and was a major factor in our decision to establish CJYK as a channel
of distribution. In addition,NatuRoseis sold to poultry feed formulators to naturally pigment the yolk of

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chicken
eggs and to formulators of feeds for commercial breeding of high-value tropical fish. As our product is a natural astaxanthin, many of these formulators identify NatuRoseby name as a component of their
feed.

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

While
the positive effects of astaxanthin in aquaculture have been recognized for years, the potential benefits of astaxanthin to human health are still emerging. As natural astaxanthin
is one of the most potent and bioactive biological antioxidants found in nature, the number of potential roles of natural astaxanthin for human health is growing. Much research has been published in
recent years on the beneficial roles of antioxidants in our health, in the aging process and on specific health conditions. The full efficacy of BioAstinas a human nutraceutical supplement requires
significant clinical studies and testing and, although the Company did not spend significant
amounts on clinical trials in fiscal 2004 due to our efforts to contain costs, continued independent antioxidant research and prior clinical trials show promising human applications. The Company holds
three United States patents relating to the usage ofBioAstinin the treatment of Carpal Tunnel Syndrome, the treatment of canker/cold sores and for its
use as a topical and oral sunscreen.

BioAstinis sold in the liquid lipid form as a raw ingredient to dietary supplement manufacturers, health food formulators and cosmetic
manufacturers andBioAstingelcaps and beadlets are sold in bulk quantities to distributors.BioAstingelcaps are also sold as a packaged consumer product through Nutrex Hawaii directly to natural product distributors, retailers and consumers.BioAstincompetes directly with similar products marketed by other manufacturers including Fuji Chemical of Japan, Algatechnologies of Israel and U.S. Nutraceuticals and Mera Pharmaceuticals in the United
States. In the general category of nutritional supplements,BioAstinalso competes with a variety of vitamins, dietary supplements and other antioxidant
products available to consumers. The nutritional products market is highly competitive and includes international, national, regional and local producers and distributors, many of whom have greater
resources than Cyanotech and many of whom offer a greater variety of products.

The
natural astaxanthin market is an emerging market. In order to meet anticipated future demand growth, the Company is in the process of increasing astaxanthin production by converting
existing spirulina ponds toHaematococcuscultivation and constructing additionalPhytoDome CCSmodules.
Concurrent with this conversion, the Company is investing in key production equipment currently operating at or near full utilization thus providing for future redundancy in the case of equipment
failure. It is anticipated that the expansion will be phased in with full completion by the end of the third quarter of fiscal 2005 at an estimated cost of approximately $750,000. The Company
estimates that the expansion may provide an increase of up to 70% over current production volumes for our natural astaxanthin. In addition, the Company believes that production, sales and our ability
to meet our customer demands for spirulina may be impacted from the conversion of ponds.

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

PhycobiliproteinProducts

The Company also produces phycobiliproteins for sale to the medical and biotechnology research industries. Phycobiliproteins are highly fluorescent pigments
purified from microalgae. Their spectral properties make them useful as tags or markers in many kinds of biological assays, such as flow cytometry, fluorescence immunoassays and fluorescence
microscopy. We do not anticipate that phycobiliproteins will represent a significant component of total sales in future periods.

Major Customers

Approximately $1,560,000 or 13% of net sales for the year ended March 31, 2004 were to Spirulina International B. V., a spirulina marketing and
distribution company based in the Netherlands. Sales to this customer amounted to $1,546,000 or 17% of net sales for the fiscal year 2003 and $1,031,000 or 13% of net sales for the fiscal year 2002.
We believe that sales to this customer will continue to represent a significant portion of total net sales in future periods and any significant reduction in demand from this customer could have a
material adverse effect on our business, financial condition and results of operations.

Research and Development

Cyanotech's expertise is in the development of efficient stable and cost-effective production systems for microalgal products. Our researchers
investigate each specific microalga identified in the scientific literature for potentially marketable products and then strive to develop the technology to grow such microalgae on a commercial scale.
Successful microalgal product development is highly uncertain and is dependent on numerous factors, many beyond the Company's control. Products that appear promising in early phases of development may
be found to be ineffective, may be uneconomical because of manufacturing costs or other factors, may be precluded from commercialization due to the proprietary rights of other companies, or may fail
to receive necessary regulatory approvals.

The
Company had research and development expenditures of $149,000 in fiscal 2004, $217,000 in fiscal 2003 and $343,000 in fiscal 2002. The Company curtailed its scientific clinical
trials during fiscal 2004 as part of our efforts to contain cost. Fiscal 2004 expenses were aimed at increasing our production yields and continually improving the quality and stability of our
products. In fiscal 2003, efforts were primarily directed at validating the anecdotal indications ofBioAstinthrough clinical evaluations and trials.
In fiscal 2002, efforts were primarily directed at validating the efficacy ofNatuRoseas an alternative to synthetic pigments in both aquaculture and
avian feed markets. The Company will explore customer sponsored research and development as a potential opportunity in the future. Amounts spent on customer-sponsored research were not material in the
three years ended March 31, 2004.

Patents, Trademarks and Licenses

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

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Regulations and Environmental Matters

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

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

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

Employees

As of March 31, 2004, the Company employed 64 people on a full-time basis. Of the total, 44 are involved in the harvesting and production
process, 4 in research and development and the remainder in sales, administration and support. Management believes that its relations with employees are good. We currently are experiencing some
difficulty in attracting entry-level operations personnel due to increased wage competition for workers due to the growth in the State's construction industry. None of our employees are subject to
collective bargaining agreements.

Internet Information

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

Item 2. Properties

The Company's principal facility and corporate headquarters is located at the Natural Energy Laboratory of Hawaii Authority ("NELHA") at Keahole Point in
Kailua-Kona, Hawaii. It encompasses approximately 90 fully developed acres containing microalgal cultivation ponds, processing facilities, research and quality control laboratories, and
sales and administrative offices. The property is leased from the State of Hawaii under a 30-year commercial lease expiring in 2025. We believe that there is sufficient available land at
NELHA to meet our currently anticipated needs.

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

Item 3. Legal Proceedings

There were no legal matters addressed during fiscal 2004.

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

No matters were submitted to a vote of stockholders during the fourth quarter of fiscal 2004.

Executive Officers of the Registrant

The executive officers and other key employees of Cyanotech as of March 31, 2004 were as follows:

Name

Age

PositionGerald R. Cysewski, Ph. D

55

Chairman of the Board, President and Chief Executive OfficerJeffrey H. Sakamoto

46

Chief Financial Officer, Vice PresidentFinance and Administration, Secretary and TreasurerGlenn D. Jensen

45

Vice PresidentOperationsRobert J. Capelli

44

Vice PresidentSalesJohn E. Dore, Ph. D

38

Scientific DirectorE. Dennis Ehrenberg

44

Director of Production


Dr. Cysewskico-founded Cyanotech in 1983. Since March 1990, Dr. Cysewski has served as President and
Chief Executive Officer and prior to this time, served as Scientific Director. Dr. Cysewski has also served as a Director since the Company's founding. In 1998, he was Vice Chairman of the
Board and in October 1990 was he appointed Chairman of the Board. Prior to his tenure at Cyanotech, from 1980 to 1982, Dr. Cysewski was group leader of microalgae research and
development at Battelle Northwest, a major contract research and development firm. From 1976 to 1980, Dr. Cysewski was an assistant professor in the Department of Chemical and Nuclear
Engineering at the University of California, Santa Barbara. Dr. Cysewski received his doctorate in Chemical Engineering from the University of California at Berkeley.

Mr. Sakamotohas served as Chief Financial Officer, Vice PresidentFinance & Administration, Secretary and
Treasurer since March 2003. Previously, he served as Controller from 1997 to 2003. He joined the Company in 1995 as Accounting Manager. Prior to joining Cyanotech, Mr. Sakamoto served as
Assistant Controller for Hale Makua, Inc., a healthcare organization and as Accounting Manager for the Hawaii Division of Fleming Foods. Mr. Sakamoto holds a B.B.A. degree in Accounting
from the University of Hawaii at Manoa.

Mr. Jensenhas served as Vice PresidentOperations since May 1993. He had been Production Manager since 1991.
Mr. Jensen joined Cyanotech in 1984 as Process Manager. Prior to joining the Company, Mr. Jensen worked as a plant engineer at Cal-Alga, a spirulina production facility, near
Fresno, California. Mr. Jensen holds a B.S. degree in Health Science from California State University, Fresno.

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

11

---





Dr. Dorehas served as Scientific Director since joining the Company in March 2002. He is also a member of the faculty of
the University of Hawaii at Manoa as an Associate Researcher, a position held since March 2000. Prior to joining Cyanotech, from 1996 to 2000, Dr. Dore was Product Development Manager at
Aquasearch, Inc., a manufacturer of natural products from microalgae. Dr. Dore holds a B.S. degree in Engineering ScienceBioengineering from the University of California at
Berkeley and a doctorate in Biological Oceanography from the University of Hawaii at Manoa.

Mr. Ehrenbergwas appointed Director of Production in March 2004. Before holding this position, Mr. Ehrenberg was
Inventory and Materials Control Manager. He joined the Company in November 2001. Prior to joining Cyanotech, from 1996 to 2001, Mr. Ehrenberg was involved in various aspects of
production at Aquasearch, Inc. as the Quality Assurance Coordinator and Director of Purchasing. Mr. Ehrenberg holds a B.A. degree from Sonoma State University.

PART II

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

The Company's common stock is traded on the NASDAQ SmallCap Market under the symbol "CYAN". As of June 18, 2004, there were 1,337 registered holders of
record of our common stock. The high and low selling prices as reported by the NASDAQ Stock Market were as follows:

Quarter Ended:

June 30

September 30

December 31

March 31Fiscal 2004Common stock price per share:High

$
0.72

$
0.75

$
1.97

$
2.30Low

$
0.40

$
0.41

$
0.36

$
1.05Fiscal 2003Common stock price per share:High

$
1.20

$
0.85

$
0.63

$
0.60Low

$
0.40

$
0.40

$
0.26

$
0.35


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

The
Company has never declared or paid cash dividends on its common stock. We currently intend to retain all of our earnings for use in the business and do not anticipate paying any cash
dividends on common stock in the foreseeable future.

12

---



Item 6. Selected Financial Data

|                                             |  | Years ended March 31, |       
|-------------------------------------------- |  | --------------------- | ------
|
|
|Results of Operations                        |  |                       |       
|Net sales                                    |  | $                     | 11,582
|Gross profit                                 |  |                       | 3,940 
|Income (loss) from operations                |  |                       | 729   
|Net income (loss)                            |  |                       | 399   
|Net income (loss) per common sharediluted   |  |                       | 0.02  
|Selected Balance Sheet Data                  |  |                       |       
|Cash and investment securities               |  |                       | 2,531 
|Working capital                              |  |                       | 4,083 
|Total assets                                 |  |                       | 18,357
|Long-term debt, excluding current maturities |  |                       | 2,093 
|Stockholders' equity                         |  |                       | 14,440

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

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

Overview

Cyanotech Corporation's core competency is cultivating and processing microalgae into high-value, high-quality natural products for the
human and animal nutrition markets. Our products are sold in bulk quantities to manufacturers, formulators and distributors in the health foods, nutritional supplements and animal nutrition markets
and as packaged consumer products to distributors, retailers and direct consumer sales. The Company manufactures its products in Hawaii but markets them worldwide, generating 53%, 54% and 47% of its
revenues outside of the United States for each of the years ended March 31, 2004, 2003 and 2002, respectively. Competing in a global marketplace, the Company is influenced by the general
economic conditions of the countries in which its customers operate, including adherence to its customers' local governmental regulations and requirements. The Company has no material foreign exchange
exposure.

Fiscal
2004 marked the Company's return to profitability, reporting net income of $399,000 or $0.02 per diluted share. In addition, the Company's cash and cash equivalents balances
improved over 300% to $2,531,000 from $579,000 a year ago with the increased cash balances generated from operating activities (see Consolidated Statements of Cash Flows in Part II.
Item 8.) Working capital was $4,083,000 as of March 31, 2004 compared to $2,352,000 a year ago principally due to the increased cash balances derived from operations. In addition, in
December 2003, the entire $1,250,000 principal amount of convertible subordinated debentures was voluntarily converted into 1,923,076 shares of Common Stock (see Note 5 of Notes to
Consolidated Financial Statements in Part II. Item 8.)

The
current year's turnaround to profitability was the result of focused attention in three key areas: (1) market penetration of natural astaxanthin products, (2) continued
stabilization of and improved efficiencies in cultivation and production cycles, and (3) containment of discretionary

13

---



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

Year Ended March 31,2004

2003

2002Net sales:Spirulina products

$
6,511

$
6,181

$
6,086Natural astaxanthin products


4,933


2,613


1,694Other products


138


157


455$
11,582

$
8,951

$
8,235Gross profit as a percentage of sales*


34
%

32
%

19
%Operating expenses as a percentage of sales


28
%

46
%

46
%


---

With
the growth in demand for our natural astaxanthin products, the Company's internal focus will be on reallocating its cultivation resources in an effort to increase production of
natural astaxanthin while concurrently optimizing its spirulina production to improve yield and quality. The Company will continue to contain discretionary operating spending but may invest in focused
expenditures particularly in advertising and clinical trials in the human nutrition and cosmetics markets. Externally, the Company is also working with industry-leading manufacturers in these markets
to integrateBioAstininto their products. The Company believes that it needs to continue to focus on market acceptance of its natural astaxanthin
products in all markets as increased competition from other producers of natural and synthetic astaxanthin may result in the decline of margins generated for its natural astaxanthin products.
Management cannot predict whether the outcomes of any of these strategies will be successful.

Results of Operations

RevenuesFiscal 2004 net sales increased 29% compared to 2003 and increased 9% for 2003 compared to
2002. The following is a discussion of revenues by major product category.

The
Company has been producingSpirulina Pacifica, a strain of spirulina microalga, since 1985. Revenues generated from the Company's
spirulina products are a significant portion of total revenues, amounting to $6,511,000, $6,181,000 and $6,086,000 for the years ended March 31, 2004, 2003 and 2002, respectively. Although the
dollar amount of revenues has remained relatively consistent over the three year period, as a percentage of total revenues, spirulina product sales have declined each year from 74% in fiscal 2002 to
69% in 2003 to 56% in 2004 reflecting the mature market for spirulina. Approximately $1,560,000, or 13% of our total net sales for the year ended March 31, 2004 were to a single customer,
Spirulina International B.V., a spirulina marketing and distribution company based in the Netherlands. Sales to this customer for fiscal 2003 and 2002 were $1,546,000 (17% of net sales) and $1,031,000
(13% of net sales), respectively. We believe that sales to this customer will continue to represent a significant portion of total net sales in future periods. Any significant reduction in demand from
this customer could have a material adverse effect on our business, financial condition and results of operations.

The
Company has experienced increased price competition for its spirulina products resulting from an increasing number of suppliers of spirulina as well as from a larger portion of our
sales coming from bulk product orders whose customers generally treat these products as commodities with price being the major determining factor driving their purchasing decision. We expect this
competitive pricing pressure to continue in future periods. For bulk spirulina sales, average unit prices declined approximately 4% in fiscal 2004 as compared to the prior year but the number of units
sold increased

14

---



by
14%. In fiscal 2003, we experienced an 11% increase in bulk prices but this was offset by an 8% decrease in units sold.

In
fiscal 2004, the Company's sales of its natural astaxanthin products were $4,933,000 compared to $2,613,000 in fiscal 2003 and $1,694,000 in 2002. The sales growth in fiscal 2004
resulted from increased units sold in all bulk natural astaxanthin products. For fiscal 2003, the sales increase was primarily due to increased bulk BioAstinsales resulting from higher units sold and
increasedNatuRosesales due to higher average
pricing. Fiscal 2002 revenues included income of $204,000 from a settlement related to product distribution license fees. Although the Company curtailed its scientific clinical trials during fiscal
2004, the Company believes that the findings of clinical trials undertaken in prior years by the Company, its customers and other unaffiliated parties, taken individually and on a cumulative basis,
have generated a growing consumer awareness of the beneficial antioxidant and anti-inflammatory properties of astaxanthin. Such awareness has helped to spur demand for our natural
astaxanthin products in both the human and animal nutrition markets. In order to meet anticipated future demand growth, the Company is in process of increasing astaxanthin production by converting
spirulina ponds toHaematococcuscultivation and by upgrading key elements of our production system.

Cost of SalesOur cost of sales, as a percentage of net sales, was 66% for fiscal 2004, 68% for 2003
and 81% for 2002. Cost of sales includes the cost of nutrients and materials, direct labor and manufacturing overhead costs, and depreciation and amortization of production equipment, buildings and
leasehold improvements specific to the production process. Consistent with our commitment to produce high-value, high-quality products, the Company continually strives to
improve its production efficiency in volume yield, potency and quality. Increased cultivation yields in biomass were achieved in both fiscal 2004 and 2003. However, the cost improvement in fiscal 2004
was partially offset by the reduction of certain bulk spirulina finished goods inventory to market realizable value and a contract extraction facility problem that was rectified during the first
quarter of 2004. The improvement in fiscal 2003 also reflects the inclusion in 2002 of a finished goods inventory write-off of $454,000.

With
respect to the cost of materials, the raw materials and nutrients required in our production processes are available from multiple sources; however, there can be no assurance that
the pricing from a new source will be comparable to current negotiated pricing. If the pricing for a critical raw material or nutrient significantly increases, this could have a material adverse
effect on our business, financial condition and results of operations. For fiscal 2005, with the rising cost of fuel oil, the Company could incur higher electrical utility costs dependent upon the
regulated public utility's ability to obtain
approval for rate increases. If electrical utility costs were to double from fiscal 2004 costs, the Company estimates that the cost to manufacture its products could increase by as much as 15% above
prior year costs. In addition, fresh water is critical for our natural astaxanthin production and while the Company has not experienced any constraint on fresh water availability, future availability
could be negatively impacted by significant growth in the local population as well as by throughput constraints on the water delivery infrastructure owned by the County of Hawaii. The Company has met
with County officials to assess the situation and evaluate the probability of future risks. In addition, given the criticality of fresh water to our operations and the community, the Company recycles
fresh water where possible and continues to explore further recycling opportunities in its efforts to efficiently utilize fresh water. For the production of BioAstin,the Company's natural astaxanthin
product for the human nutrition market, a sole third party contractor is utilized for each of the processes
of extraction, encapsulation (for gelcaps) and micro-encapsulation (for beadlets) and although these services are available only from a limited number of sources, we have the ability to use other
parties if any of the current contractors become unavailable. If pricing for any of these services significantly increases, this could have a material adverse effect on our business, financial
condition and results of operations.

Gross ProfitAs a result of our product sales growth coupled with the continued improvements in cost
of sales as a percentage of sales, our gross profit margin improved from 19% in fiscal 2002 to 32% in 2003 to 34% in 2004.

15

---



Operating ExpensesOperating expenses as a percentage of net sales were 28% for fiscal 2004 and 46%
in both 2003 and 2002. Spending decreased in all functional areas in fiscal 2004, a direct result of the Company's efforts to contain costs and align its spending with sales achievement. The Company
is committed to ongoing cost containment aimed at controlling its level of operating expenses but may increase such discretionary spending in future periods as dictated by the needs of the business.
Fiscal 2003 spending was impacted by certain write-offs that did not recur in 2004. The following is a discussion of spending by functional area.

Our
research and development costs were $149,000 in fiscal 2004, $217,000 in 2003 and $343,000 in 2002. The Company curtailed its scientific clinical trials during fiscal 2004 as part of
our efforts to contain costs. Fiscal 2004 expenses related to increasing our production yields and continually improving the quality and stability of our products. In fiscal 2003, efforts were
primarily directed at validating the anecdotal indications ofBioAstinthrough clinical evaluations and trials. In fiscal 2002, efforts were primarily
directed at validating the efficacy ofNatuRoseas an alternative to synthetic pigments in both aquaculture and avian feed markets.

Our
sales and marketing costs were $1,239,000 in fiscal 2004, $1,827,000 in 2003 and $1,751,000 in 2002. Fiscal 2004 expenses were significantly lower than the prior year primarily due
to reduced advertising expenditures for packaged consumer products and discretionary contractual services. In addition, fiscal 2003 costs included a $260,000 write-off for the
discontinuation of a television infomercial project.

Our
general and administrative costs were $1,823,000 in fiscal 2004, $2,061,000 in 2003 and $1,653,000 in 2002. Fiscal 2004 expenses decreased from the prior year primarily due to costs
associated with certain transactions in the prior year that did not recur in 2004 and a lower bad debt provision from a year ago. The non-recurring fiscal 2003 expenses include a charge
for the write-down of a warehouse project and a NASDAQ fee associated with the change in the trading of the Company's common stock on the National Market to the Small Cap Market.

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

2004

2003

2002Interest expense on Term Loan Agreement(1)

$
160

$
196

$
274Interest expense on convertible debentures(2)


119


204


224Other interest expense


7


18


1Costs relating to extension of debentures(3)





236


Other income, net(4)


(31
)

(80
)

(86
)Total other expense

$
255

$
574

$
413


---

Income TaxesFor fiscal 2004, a provision for income taxes of $75,000 was recorded for taxes relating
to our operations in Japan partially offset by a state tax refund. For fiscal 2003 and 2002, a $9,000 income tax benefit was recorded in each of the years representing state tax refunds.

16

---



Liquidity and Capital Resources

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

The
Company has a Term Loan Agreement ("Term Loan") with a lender providing up to $3.5 million in credit facilities, secured by substantially all the assets of the Company. The
outstanding balance under the Term Loan as of March 31, 2004 is approximately $2,439,000. The Term Loan has a maturity date of May 1, 2010 and is payable in 120 equal monthly principal
and interest payments of approximately $38,000. The interest rate under the Term Loan, in absence of a default under the agreement, is the prime rate, as defined, in effect as of the close of business
on the first day of each calendar quarter, plus 1% (the prime rate was 4.0% at March 31, 2004). The Company is in compliance with all restrictive covenants of the Term Loan. In connection with
the Term Loan, the Company is prohibited from declaring any cash dividends without the lender's prior written consent. In July 2003, the Company received approval from the Term Loan lender for
the release of $250,000 of cash previously held as a restricted deposit. A remaining $250,000 restricted cash deposit continues to be held in an interest-bearing restricted cash account per the terms
of the Term Loan and is included in Other Assets on the consolidated balance sheet at March 31, 2004.

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

The
following table presents the Company's contractual obligations at March 31, 2004 (in thousands):

Less Than
1 Year

1-3 Years

4-5 Years

After
Years

TotalTerm Loan

$
346

$
746

$
825

$
522

$
2,439Operating leases


243


461


409


2,479


3,592Total

$
589

$
1,207

$
1,234

$
3,001

$
6,031


Our
working capital was $4,083,000 at March 31, 2004 compared to $2,352,000 at March 31, 2003 and $1,008,000 at March 31, 2002. The improvement in our working
capital balance as of March 31, 2004 compared to the prior year was primarily due to the Company's ability to generate cash from operations. The improvement in working capital as of
March 31, 2003 compared to March 31, 2002 was primarily due to the retirement of $1,238,000 of convertible debentures in October 2002.

Cash FlowsOur cash and cash equivalents were $2,531,000 at March 31, 2004, $579,000 at
March 31, 2003 and $1,051,000 at March 31, 2002.

The
Company generated cash of $1,966,000 from operating activities in fiscal 2004 in contrast with the previous two years in which cash was used in operating activities, $502,000 in 2003
and $567,000 in 2002. The generation of cash from operations in fiscal 2004 reflects the Company's return to profitability, with net income of $399,000 in 2004 compared to a net loss of $1,775,000 in
2003 and a net loss of $2,589,000 in 2002.

Cash
used for investments in equipment and leasehold improvements was $413,000 in fiscal 2004, $250,000 in 2003 and $382,000 in fiscal 2002. The capital expenditures for all periods
presented pertained primarily to improvements in cultivation and processing facilities. For fiscal 2005, the

17

---



Company
is increasing its capacity for natural astaxanthin production by shifting an additional ten ponds from spirulina toHaematococcuscultivation
and by upgrading key elements of our production system. Such pond conversion, budgeted at approximately $750,000, is substantially less costly than constructing new ponds. Depreciation and
amortization expense for fiscal 2004 totaled $1,346,000 compared to $1,324,000 in 2003 and $1,312,000 in 2002.

For
fiscal 2004 and 2003, financing activities provided cash of $399,000 and $280,000, respectively. For fiscal 2002, cash was used in financing activities totaling $269,000 primarily
representing principal payments on long-term debt. Fiscal 2004 financing activities consisted primarily of the following: (1) net proceeds received from the exercise of warrants and
stock options totaling $477,000
(see Note 7 of Notes to Consolidated Financial Statements in Part II. Item 8.), (2) the partial release of a restricted deposit held in connection with the Term Loan of
$250,000 and (3) principal payments on long-term debt of $328,000. For fiscal 2003, financing activities primarily consisted of (1) proceeds from the issuance of $1,250,000
convertible subordinated debentures used to retire $1,238,000 of convertible debentures (see Note 5 of Notes to Consolidated Financial Statements in Part II. Item 8.), (2) net
proceeds received from the issuance of common stock and from the exercise of stock options and warrants of $630,000 and (3) principal payments on long-term debt of $303,000
(excluding the debenture retirement previously noted).

Variability of Results

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

Ended

4th Quarter
March 31,

3rd Quarter
December 31,

2nd Quarter
September 30,

1st Quarter
June 30,Fiscal 2004:Net sales

$
3,290

$
3,024

$
2,840

$
2,428Cost of sales


2,099


1,840


1,979


1,724Operating expenses


736


892


829


754Net income (loss)


441


109


(10
)

(141
)Working capital


4,083


3,141


2,921


2,436Fiscal 2003:Net sales

$
2,427

$
2,474

$
2,018

$
2,032Cost of sales


1,596


1,763


1,450


1,247Operating expenses


1,053


826


1,002


1,224Net income (loss)


(270
)

(180
)

(540
)

(785
)Working capital


2,352


2,367


1,965


1,051Fiscal 2002:Net sales

$
2,055

$
1,916

$
1,951

$
2,313Cost of sales


1,715


1,863


1,460


1,635Operating expenses


988


893


890


976Net income (loss)


(730
)

(937
)

(509
)

(413
)Working capital


1,008


1,626


2,541


2,808


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

18

---



amounts
for all of its products involving human consumption, broader product liability coverages are cost prohibitive.

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

Effect of Recently Issued Accounting Standards and Estimates

In June 2001, the Financial Accounting Standards Board (the "FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 143 "Accounting
for Asset Retirement Obligations." SFAS No. 143 requires the fair value of a liability for an asset retirement obligation to be recognized in the period in which it is incurred if a reasonable
estimate of fair value can be made. The associated asset retirement costs would be capitalized as part of the carrying amount of the long-lived asset and depreciated over the life of the
asset. The liability is accreted at the end of each period through charges to operating expense. If the obligation is settled for other than the carrying amount of the liability, the Company will
recognize a gain or loss on settlement. The provisions of SFAS No. 143 are effective for fiscal years beginning after June 15, 2002. The adoption of SFAS No. 143 did not have a
material effect on the Company's financial condition, results of operations or liquidity.

In
May 2003, the FASB issued SFAS No. 150 "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity." SFAS No. 150 requires
issuers to classify as liabilities (or assets in some circumstances) three classes of freestanding financial instruments that embody obligations for the issuer. Generally, SFAS No. 150 is
effective for financial instruments entered into or modified after May 31, 2003 and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. In
November 2003, the effective date for certain mandatorily redeemable non-controlling interests has been deferred indefinitely. The adoption of SFAS No. 150 did not have a
material effect on the Company's financial condition, results of operations or liquidity.

Application of Critical Accounting Policies and Estimates

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

The
Company is required to state inventories at the lower of cost or market. Cost is defined as the sum of the applicable expenditures and charges directly or indirectly incurred in
bringing inventories to their existing condition and location. Cost for inventory purposes may be determined under any one of several assumptions as to the flow of cost factors, such as
first-in, first-out; average cost; and last-in, first-out. Our inventories are stated at the lower of cost, which approximates first-in,
first-out, or market, which is determined by net realizable value. For fiscal 2005, with the rising cost of fuel oil, the Company could incur higher electrical utility costs dependent upon
the regulated public utility's ability to obtain approval for rate increases. If electrical utility costs were to double from fiscal 2004 costs, the

19

---



Company
estimates that the cost to manufacture its products could increase by as much as 15% above prior year costs.

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

Income
taxes are accounted for under the asset and liability method. The asset and liability method requires the recognition of deferred tax assets and liabilities for the expected
future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their tax bases and operating loss and tax credit
carryforwards. Deferred tax assets and liabilities are measured using enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be recovered or
settled. The Company records a valuation allowance to reduce its deferred tax assets to the amount that it believes is likely to be realized. Judgment is required in assessing the need for the
valuation allowance. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become
deductible. (See Note 11 of Notes to Consolidated Financial Statements in Part II. Item 8.).

Item 7a. Quantitative and Qualitative Disclosures About Market Risk

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

20

---





Item 8. Financial Statements and Supplementary Data

Report of Independent Registered Public Accounting Firm

The Board of Directors
Cyanotech Corporation:

We
have audited the accompanying consolidated balance sheets of Cyanotech Corporation and subsidiaries (the Company) as of March 31, 2004 and 2003, and the related consolidated
statements of operations, stockholders' equity and comprehensive income (loss), and cash flows for each of the years in the three-year period ended March 31, 2004. These
consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

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

In
our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cyanotech Corporation and subsidiaries as of
March 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended March 31, 2004 in conformity with U. S.
generally accepted accounting principles.

/s/KPMG LLPHonolulu, Hawaii
April 30, 2004

21

---





CONSOLIDATED BALANCE SHEETS        March 31, 2004 and 2003

|                                             |                                                                                                                                                 | 2004                                       |        | 2003    |       
|-------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | ------- | ------
|
|ASSETS                                       |                                                                                                                                                 |                                            |        |         |       
|Current assets:                              |                                                                                                                                                 |                                            |        |         |       
|                                             | Cash and cash equivalents                                                                                                                       |                                            | $      | 2,531   |       
|                                             | Accounts receivable, net of allowance for doubtful accounts of $96 in 2004 and $60 in 2003                                                      |                                            |        | 2,211   |       
|                                             | Refundable income taxes                                                                                                                         |                                            |        | 11      |       
|                                             | Inventories                                                                                                                                     |                                            |        | 1,099   |       
|                                             | Prepaid expenses and other current assets                                                                                                       |                                            |        | 55      |       
|                                             |                                                                                                                                                 |                                            |        |         |       
|                                             |                                                                                                                                                 | Total current assets                       |        |         | 5,907 
|Equipment and leasehold improvements, net    |                                                                                                                                                 |                                            | 11,844 |         |       
|Other assets                                 |                                                                                                                                                 |                                            | 606    |         |       
|                                             |                                                                                                                                                 |                                            |        |         |       
|                                             |                                                                                                                                                 | Total assets                               |        | $       | 18,357
|                                             |                                                                                                                                                 |                                            |        |         |       
|LIABILITIES AND STOCKHOLDERS' EQUITY         |                                                                                                                                                 |                                            |        |         |       
|Current liabilities:                         |                                                                                                                                                 |                                            |        |         |       
|                                             | Current maturities of long-term debt                                                                                                            |                                            | $      | 346     |       
|                                             | Accounts payable                                                                                                                                |                                            |        | 874     |       
|                                             | Accrued expenses                                                                                                                                |                                            |        | 604     |       
|                                             |                                                                                                                                                 |                                            |        |         |       
|                                             |                                                                                                                                                 | Total current liabilities                  |        |         | 1,824 
|Long-term debt, excluding current maturities |                                                                                                                                                 |                                            | 2,093  |         |       
|                                             |                                                                                                                                                 |                                            |        |         |       
|                                             |                                                                                                                                                 | Total liabilities                          |        |         | 3,917 
|                                             |                                                                                                                                                 |                                            |        |         |       
|Stockholders' equity:                        |                                                                                                                                                 |                                            |        |         |       
|                                             | Common stock of $.005 par value, authorized 25,000,000 shares; issued and outstanding 20,714,246 shares for 2004 and 18,316,701 shares for 2003 |                                            |        | 104     |       
|                                             | Additional paid-in capital                                                                                                                      |                                            |        | 27,141  |       
|                                             | Accumulated other comprehensive income (loss)foreign currency translation adjustments                                                          |                                            |        | 30      |       
|                                             | Accumulated deficit                                                                                                                             |                                            |        | (12,835 | )     
|                                             |                                                                                                                                                 |                                            |        |         |       
|                                             |                                                                                                                                                 | Total stockholders' equity                 |        |         | 14,440
|                                             |                                                                                                                                                 |                                            |        |         |       
|                                             |                                                                                                                                                 | Total liabilities and stockholders' equity |        | $       | 18,357
|                                             |                                                                                                                                                 |                                            |        |         |       

See
accompanying Notes to Consolidated Financial Statements.

22

---





CONSOLIDATED STATEMENTS OF OPERATIONS        Years ended March 31, 2004, 2003 and 2002

|                                                           |                             | 2004                              |        | 2003   |       | 2002  |       
|---------------------------------------------------------- | --------------------------- | --------------------------------- | ------ | ------ | ----- | ----- | ------
|
|Net sales                                                  |                             | $                                 | 11,582 |        | $     | 8,951 |       
|Cost of sales                                              |                             |                                   | 7,642  |        |       | 6,056 |       
|                                                           |                             |                                   |        |        |       |       |       
|                                                           |                             | Gross profit                      |        |        | 3,940 |       |       
|                                                           |                             |                                   |        |        |       |       |       
|Operating expenses:                                        |                             |                                   |        |        |       |       |       
|                                                           | Research and development    |                                   |        | 149    |       |       | 217   
|                                                           | Sales and marketing         |                                   |        | 1,239  |       |       | 1,827 
|                                                           | General and administrative  |                                   |        | 1,823  |       |       | 2,061 
|                                                           |                             |                                   |        |        |       |       |       
|                                                           |                             | Total operating expense           |        |        | 3,211 |       |       
|                                                           |                             |                                   |        |        |       |       |       
|                                                           |                             | Income (loss) from operations     |        |        | 729   |       |       
|                                                           |                             |                                   |        |        |       |       |       
|Other income (expense):                                    |                             |                                   |        |        |       |       |       
|                                                           | Interest income             |                                   |        | 6      |       |       | 33    
|                                                           | Interest expense            |                                   |        | (286   | )     |       | (418  
|                                                           | Other income (expense), net |                                   |        | 25     |       |       | (189  
|                                                           |                             |                                   |        |        |       |       |       
|                                                           |                             | Total other expense               |        |        | (255  | )     |       
|                                                           |                             |                                   |        |        |       |       |       
|                                                           |                             | Income (loss) before income taxes |        |        | 474   |       |       
|                                                           |                             | Income tax expense (benefit)      |        |        | 75    |       |       
|                                                           |                             |                                   |        |        |       |       |       
|                                                           |                             | Net income (loss)                 |        | $      | 399   |       | $     
|                                                           |                             |                                   |        |        |       |       |       
|Net income (loss) per share:                               |                             |                                   |        |        |       |       |       
|                                                           | Basic                       |                                   | $      | 0.02   |       | $     | (0.10 
|                                                           |                             |                                   |        |        |       |       |       
|                                                           | Diluted                     |                                   | $      | 0.02   |       | $     | (0.10 
|                                                           |                             |                                   |        |        |       |       |       
|Shares used in calculation of net income (loss) per share: |                             |                                   |        |        |       |       |       
|                                                           | Basic                       |                                   |        | 18,971 |       |       | 17,840
|                                                           |                             |                                   |        |        |       |       |       
|                                                           | Diluted                     |                                   |        | 19,111 |       |       | 17,840
|                                                           |                             |                                   |        |        |       |       |       

See
accompanying Notes to Consolidated Financial Statements.

23

---





CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY  AND COMPREHENSIVE INCOME (LOSS)        Years ended March 31, 2004, 2003 and 2002

|                                                                                           |                                                                     | Common Stock |           |   |     |   |   |        |     |   |         |        |  
|------------------------------------------------------------------------------------------ | ------------------------------------------------------------------- | ------------ | --------- | - | --- | - | - | ------ | --- | - | ------- | ------ | -
|
|
|
|Balances at March 31, 2001                                                                 |                                                                     | 16,949,702   |           | $ | 85  |   | $ | 24,480 |     | $ | (8,870  | )      | $
|Issuances of common stock for:                                                             |                                                                     |              |           |   |     |   |   |        |     |   |         |        |  
|                                                                                           | Third party services, at fair value                                 |              | 80,000    |   |     |  |   |        | 80  |   |         |       |  
|                                                                                           | Non-employee directors' services, at fair value                     |              | 6,000     |   |     |  |   |        | 6   |   |         |       |  
|Conversion of debentures to common stock                                                   |                                                                     | 7,999        |           |   |    |   |   | 12     |     |   |        |        |  
|Series C preferred stock conversion costs                                                  |                                                                     |             |           |   |    |   |   | (11    | )   |   |        |        |  
|Comprehensive loss:                                                                        |                                                                     |              |           |   |     |   |   |        |     |   |         |        |  
|                                                                                           | Net loss                                                            |              |          |   |     |  |   |        |    |   |         | (2,589 | )
|                                                                                           | Other comprehensive lossforeign currency translation adjustments   |              |          |   |     |  |   |        |    |   |         |       |  
|                                                                                           |                                                                     |              |           |   |     |   |   |        |     |   |         |        |  
|                                                                                           | Comprehensive loss                                                  |              |          |   |     |  |   |        |    |   |         |       |  
|                                                                                           |                                                                     |              |           |   |     |   |   |        |     |   |         |        |  
|Balances at March 31, 2002                                                                 |                                                                     | 17,043,701   |           |   | 85  |   |   | 24,567 |     |   | (11,459 | )      |  
|Issuances of common stock for:                                                             |                                                                     |              |           |   |     |   |   |        |     |   |         |        |  
|                                                                                           | Cash, net of costs of $21                                           |              | 1,265,000 |   |     | 7 |   |        | 623 |   |         |       |  
|                                                                                           | Non-employee directors' services, at fair value                     |              | 8,000     |   |     |  |   |        | 5   |   |         |       |  
|Issuance of warrants in connection with extension of convertible debentures, at fair value |                                                                     |             |           |   |    |   |   | 223    |     |   |        |        |  
|Comprehensive loss:                                                                        |                                                                     |              |           |   |     |   |   |        |     |   |         |        |  
|                                                                                           | Net loss                                                            |              |          |   |     |  |   |        |    |   |         | (1,775 | )
|                                                                                           | Other comprehensive lossforeign currency translation adjustments   |              |          |   |     |  |   |        |    |   |         |       |  
|                                                                                           |                                                                     |              |           |   |     |   |   |        |     |   |         |        |  
|                                                                                           | Comprehensive loss                                                  |              |          |   |     |  |   |        |    |   |         |       |  
|                                                                                           |                                                                     |              |           |   |     |   |   |        |     |   |         |        |  
|Balances at March 31, 2003                                                                 |                                                                     | 18,316,701   |           |   | 92  |   |   | 25,418 |     |   | (13,234 | )      |  
|Conversion of debentures to common stock                                                   |                                                                     | 1,923,076    |           |   | 10  |   |   | 1,240  |     |   |        |        |  
|Issuances of common stock for:                                                             |                                                                     |              |           |   |     |   |   |        |     |   |         |        |  
|                                                                                           | Exercise of stock options for cash                                  |              | 45,800    |   |     |  |   |        | 43  |   |         |       |  
|                                                                                           | Exercise of warrants for cash, net of costs $19                     |              | 429,234   |   |     | 2 |   |        | 451 |   |         |       |  
|                                                                                           | Third party services, at fair value                                 |              | 10,000    |   |     |  |   |        | 5   |   |         |       |  
|                                                                                           | Non-employee directors' services, at fair value                     |              | 6,000     |   |     |  |   |        | 3   |   |         |       |  
|Common stock purchased at fair value and cancelled                                         |                                                                     | (16,565      | )         |   |    |   |   | (19    | )   |   |        |        |  
|Comprehensive income:                                                                      |                                                                     |              |           |   |     |   |   |        |     |   |         |        |  
|                                                                                           | Net income                                                          |              |          |   |     |  |   |        |    |   |         | 399    |  
|                                                                                           | Other comprehensive incomeforeign currency translation adjustments |              |          |   |     |  |   |        |    |   |         |       |  
|                                                                                           |                                                                     |              |           |   |     |   |   |        |     |   |         |        |  
|                                                                                           | Comprehensive income                                                |              |          |   |     |  |   |        |    |   |         |       |  
|                                                                                           |                                                                     |              |           |   |     |   |   |        |     |   |         |        |  
|Balances at March 31, 2004                                                                 |                                                                     | 20,714,246   |           | $ | 104 |   | $ | 27,141 |     | $ | (12,835 | )      | $
|                                                                                           |                                                                     |              |           |   |     |   |   |        |     |   |         |        |  

See accompanying Notes to Consolidated Financial Statements.

24

---





CONSOLIDATED STATEMENTS OF CASH FLOWS        Years ended March 31, 2004, 2003 and 2002

|                                                                                                         |                                                                                          | 2004                                     |       | 2003  |       | 2002   |      
|-------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------- | ---------------------------------------- | ----- | ----- | ----- | ------ | -----
|
|CASH FLOWS FROM OPERATING ACTIVITIES:                                                                    |                                                                                          |                                          |       |       |       |        |      
|Net income (loss)                                                                                        |                                                                                          | $                                        | 399   |       | $     | (1,775 | )    
|Adjustments to reconcile net income (loss) to cash provided by, (used in) operating activities:          |                                                                                          |                                          |       |       |       |        |      
|                                                                                                         | Depreciation and amortization                                                            |                                          |       | 1,346 |       |        | 1,324
|                                                                                                         | Amortization of debt issue costs and other assets                                        |                                          |       | 65    |       |        | 123  
|                                                                                                         | Issuance of common stock in exchange for services                                        |                                          |       | 8     |       |        | 5    
|                                                                                                         | Issuance and revision of warrants in connection with extension of convertible debentures |                                          |       |      |       |        | 223  
|                                                                                                         | Write-down of capital expenditure project                                                |                                          |       |      |       |        | 80   
|                                                                                                         | Net (increase) decrease in assets:                                                       |                                          |       |       |       |        |      
|                                                                                                         |                                                                                          | Accounts receivable                      |       |       | (372  | )      |      
|                                                                                                         |                                                                                          | Refundable income taxes                  |       |       | (2    | )      |      
|                                                                                                         |                                                                                          | Inventories                              |       |       | 301   |        |      
|                                                                                                         |                                                                                          | Prepaid expenses and other assets        |       |       | (65   | )      |      
|                                                                                                         | Net increase (decrease) in liabilities:                                                  |                                          |       |       |       |        |      
|                                                                                                         |                                                                                          | Accounts payable                         |       |       | 71    |        |      
|                                                                                                         |                                                                                          | Accrued expenses                         |       |       | 215   |        |      
|                                                                                                         |                                                                                          | Deferred revenue                         |       |       |      |        |      
|                                                                                                         |                                                                                          |                                          |       |       |       |        |      
|                                                                                                         | Net cash provided by (used in) operating activities                                      |                                          |       | 1,966 |       |        | (502 
|                                                                                                         |                                                                                          |                                          |       |       |       |        |      
|CASH FLOWS FROM INVESTING ACTIVITIES:                                                                    |                                                                                          |                                          |       |       |       |        |      
|Investment in equipment and leasehold improvements                                                       |                                                                                          |                                          | (413  | )     |       | (250   | )    
|                                                                                                         |                                                                                          |                                          |       |       |       |        |      
|                                                                                                         | Net cash used in investing activities                                                    |                                          |       | (413  | )     |        | (250 
|                                                                                                         |                                                                                          |                                          |       |       |       |        |      
|CASH FLOWS FROM FINANCING ACTIVITIES:                                                                    |                                                                                          |                                          |       |       |       |        |      
|Proceeds from issuance of common stock and exercise of stock options and warrants, net of issuance costs |                                                                                          |                                          | 477   |       |       | 630    |      
|Release of restricted cash deposit                                                                       |                                                                                          |                                          | 250   |       |       |       |      
|Proceeds from issuance of long-term debt                                                                 |                                                                                          |                                          |      |       |       | 1,250  |      
|Principal payments on long-term debt                                                                     |                                                                                          |                                          | (328  | )     |       | (1,541 | )    
|Debt issue costs                                                                                         |                                                                                          |                                          |      |       |       | (59    | )    
|Cost of conversion of Series C preferred stock to common stock                                           |                                                                                          |                                          |      |       |       |       |      
|                                                                                                         |                                                                                          |                                          |       |       |       |        |      
|                                                                                                         | Net cash provided by (used in) financing activities                                      |                                          |       | 399   |       |        | 280  
|                                                                                                         |                                                                                          |                                          |       |       |       |        |      
|Net increase (decrease) in cash and cash equivalents                                                     |                                                                                          |                                          | 1,952 |       |       | (472   | )    
|Cash and cash equivalents at beginning of year                                                           |                                                                                          |                                          | 579   |       |       | 1,051  |      
|                                                                                                         |                                                                                          |                                          |       |       |       |        |      
|Cash and cash equivalents at end of year                                                                 |                                                                                          | $                                        | 2,531 |       | $     | 579    |      
|                                                                                                         |                                                                                          |                                          |       |       |       |        |      
|SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                                                        |                                                                                          |                                          |       |       |       |        |      
|Cash paid during the year for:                                                                           |                                                                                          |                                          |       |       |       |        |      
|                                                                                                         | Interest                                                                                 |                                          | $     | 260   |       | $      | 295  
|                                                                                                         |                                                                                          |                                          |       |       |       |        |      
|                                                                                                         | Income taxes                                                                             |                                          | $     | 17    |       | $      |     
|                                                                                                         |                                                                                          |                                          |       |       |       |        |      
|Supplemental disclosure of non-cash financing activities:                                                |                                                                                          |                                          |       |       |       |        |      
|                                                                                                         |                                                                                          | Conversion of debentures to common stock |       | $     | 1,250 |        | $    
|                                                                                                         |                                                                                          |                                          |       |       |       |        |      

See
accompanying Notes to Consolidated Financial Statements.

25

---





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 Description of Business and Summary of Accounting Policies

Description of Business

Cyanotech Corporation (the Company) cultivates and produces high-value, high-quality natural products derived from microalgae. The Company
currently cultivates, on a large-scale basis, two microalgal species from which its two major product lines are derived. The Company is currently producing microalgal products for the nutritional
supplement, animal feed/pigments and immunological diagnostics markets. The Company manufactures all of its products in the United States and sells worldwide. As the Company's operations are solely
related to microalgae-based products, management of the Company considers its operations to be in one industry segment.

Accounting Principles

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

Principles of Consolidation

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

Estimates and Assumptions

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

Foreign Currency Translation

The local currency is the functional currency for one of the Company's subsidiaries, Cyanotech Japan YK. Assets and liabilities recorded in foreign currencies are
translated at the exchange rate on the balance sheet date. Revenue and expenses are translated at average rates of exchange prevailing during the year. Translation adjustments are charged or credited
to accumulated other comprehensive income (loss) in stockholders' equity.

Cash and Cash Equivalents

Cash and cash equivalents represents cash and short-term highly liquid debt securities purchased with original maturities of three months or less.

Trade Accounts Receivable and Allowance for Doubtful Accounts

Trade accounts receivable are recorded at the invoiced amount and do not accrue interest. The allowance for doubtful accounts reflects management's best estimate
of probable credit losses inherent in the accounts receivable balance. The Company determines the allowance based on historical experience, known trouble accounts and other currently available
evidence. The Company reviews its allowance for doubtful accounts monthly with focus on significant individual past due balances over

26

---



90 days.
All other balances are reviewed on a pooled basis. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for
recovery is considered remote. The Company does not have any off-balance credit exposure related to its customers.

Inventories

Inventories are stated at the lower of cost (which approximates first-in, first-out) or market. Market is determined by net realizable
value.

Equipment and Leasehold Improvements and Long-Lived Assets

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

Equipment

3 to 10 yearsFurniture and fixtures

7 yearsLeasehold improvements

10 to 22 years


The
Company accounts for impairment of its equipment or leasehold improvement in accordance with Statement of Financial Accounting Standards ("SFAS") No. 144. SFAS No. 144
requires long-lived assets, such as property, plant and equipment and purchased intangibles subject to amortization, to be reviewed for impairment annually or whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the
estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized to the
extent that the carrying amount exceeds the asset's fair value.

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

Fair Value of Financial Instruments

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

Cash and Cash EquivalentsDue to the short-term nature of these instruments, management believes that the
carrying amounts approximate fair value.

Long-Term DebtManagement believe the carrying amounts approximate fair value due to long-term debt
interest rates adjust quarterly to market interest rates or approximates current interest rates for similar debt instruments of comparable maturities.

Revenue Recognition

The Company recognizes revenues when goods are shipped and when significant risks and benefits of ownership are transferred. Amounts received in advance under
sales and distribution agreements for the right to sell and distribute the Company's products are recognized as revenue on a straight-line basis over the term of such agreements.

27

---



Research and Development and Advertising

Research and development and advertising costs are expensed as incurred.

Income Taxes

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

Stock Option Plan

The Company applies the intrinsic value-based method of accounting prescribed by Accounting Principle Board ("APB") Opinion No. 25, Accounting for Stock
Issued to Employees, and related interpretations, in accounting for its fixed plan stock options issued to employees, including
non-employee directors. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. The
Company applies the fair value-based method of accounting prescribed by SFAS No. 123,Accounting for
Stock-Based Compensation, in accounting for its fixed plan stock options issued to outside third parties other than non-employee directors. As such, expenses
representing the fair value of stock-based awards on the date of grant are recognized over the vesting period.

As
allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic value-based method of accounting for employee based stock options and adopted only the
disclosure requirements of SFAS No. 123. The following table illustrates the effect on net income (loss) and net income (loss) per common share if the Company had applied the
fair-value method under SFAS No. 123 to its employee stock options:

2004

2003

2002(in thousands, except per share amounts)Net income (loss), as reported

$
399

$
(1,775
)
$
(2,589
)Deduct stock-based employee compensation expense determined under fair-value method for all awards


(82
)

(89
)

(121
)Pro forma net income (loss)

$
317

$
(1,864
)
$
(2,710
)Net income (loss) per common shareBasic and Diluted:As reported

$
0.02

$
(0.10
)
$
(0.15
)Pro forma

$
0.02

$
(0.10
)
$
(0.16
)


New Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board (the "FASB") issued SFAS No. 143 "Accounting for Asset Retirement Obligations." SFAS
No. 143 requires the fair value of a liability for an asset retirement obligation to be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The
associated asset retirement costs would be capitalized as part of the carrying amount of the long-lived asset and depreciated over the life of the asset. The liability is accreted at the
end of each period through charges to operating expense. If the obligation is settled for

28

---



other
than the carrying amount of the liability, the Company will recognize a gain or loss on settlement. The provisions of SFAS No. 143 are effective for fiscal years beginning after
June 15, 2002. The adoption of SFAS No. 143 did not have a material effect on the Company's financial condition, results of operations or liquidity.

In
May 2003, the FASB issued SFAS No. 150 "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity." SFAS No. 150 requires
issuers to classify as liabilities (or assets in some circumstances) three classes of freestanding financial instruments that embody obligations for the issuer. Generally, SFAS No. 150 is
effective for financial instruments entered into or modified after May 31, 2003 and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. In
November 2003, the effective date for certain mandatorily redeemable non-controlling interests has been deferred indefinitely. The adoption of SFAS No. 150 did not have a
material effect on the Company's financial condition, results of operations or liquidity.

Note 2 Inventories

Inventories consists of the following as of March 31, 2004 and 2003:

2004

2003(in thousands)Raw materials

$
191

$
161Work in process


154


117Finished goods


567


1,028Supplies


187


94$
1,099

$
1,400


Note 3 Equipment and Leasehold Improvements, Net

Equipment and leasehold improvements consists of the following as of March 31, 2004 and 2003:

2004

2003(in thousands)Equipment

$
9,753

$
9,631Leasehold improvements


14,326


14,173Furniture and fixtures


83


8324,162


23,887Less accumulated depreciation and amortization


(12,687
)

(11,341
)Construction in-progress


369


231$
11,844

$
12,777


Note 4 Accrued Expenses

Components of accrued expenses as of March 31, 2004 and 2003 are as follows:

2004

2003(in thousands)Accrued wages, commissions and royalties

$
214

$
210Accrued income taxes


119


Accrued interest


11


34Other accrued expenses


260


145$
604

$
389


29

---



Note 5 Long-Term Debt

Long-term debt consists of the following as of March 31, 2004 and 2003:

2004

2003(in thousands)Term loan

$
2,439

$
2,767Convertible subordinated debentures





1,250Total long-term debt


2,439


4,017Less current maturities


(346
)

(323
)Long-term debt, excluding current maturities

$
2,093

$
3,694


At
March 31, 2004, the aggregate maturities of long-term debt are as follows:

Year ending March 31:

(in thousands)2005

$
3462006


3642007


3822008


4022009


423Thereafter


522$
2,439


Term Loan Agreement

In April 2000, the Company executed a Term Loan Agreement ("Term Loan") with a lender providing for $3.5 million in aggregate credit facilities,
secured by the Company's assets. The Term Loan has a maturity date of May 1, 2010 and is payable in 120 equal monthly principal and interest payments. The interest rate under this Term Loan, in
the absence of a default under the agreement, is the prime rate, in effect as of the close of business on the first day of each calendar quarter, plus 1%. As of March 31, 2004 and 2003, the
prime rate was 4.0% and 4.25%, respectively. The Company is in compliance with all restrictive covenants of the Term Loan as of March 31, 2004. The Company is prohibited from declaring any
common stock dividends without the lender's prior written consent. A warrant to purchase 20,000 shares of the Company's common stock was issued in conjunction with this Term Loan. The warrant expires
in April 2011 and has an exercise price of $2.55 per share. The warrant may only be exercised after the Company has repaid the Term Loan in full.

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

Convertible Debentures

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

30

---



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

Original Terms

Renegotiated TermsMaturity date

April 30, 2002

October 31, 2002Interest rate

6% per annum

10% per annumConversion price

$1.50 per share

$1.00 per shareWarrant terms:

Number of shares

83,334 shares

454,734 sharesExercise price

$1.80 per share

$1.10 per shareExpiration date

May 2005

May 2004


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

Note 6 Leases

The Company leases facilities, equipment and land under operating leases expiring between 2005 and 2025. The land lease provides for contingent rentals in excess
of minimum rental commitments based on a percentage of the Company's sales. Contingent rental for the year ended March 31, 2004 was $39,000. Contingent rentals for the fiscal years 2003 and
2002 were not material.

Future
minimum lease payments under non-cancelable operating leases at March 31, 2004 are as follows:

Year ending March 31:

(in thousands)2005

$
2432006


2382007


2232008


2232009


186Thereafter through 2025


2,479Total minimum lease payments

$
3,592


The
Company also had a year-to-year lease on an additional 93 acres parcel of land adjacent to the Company's existing 90-acre facility until the
Company decided to terminate the lease in the first quarter of fiscal 2003. Rent expense under operating leases amounted to $271,000, $218,000 and $286,000 for the years ended March 31, 2004,
2003 and 2002, respectively.

Note 7 Stock Options and Warrants

Stock Options

The Company has a stock option plan, approved by stockholders in 1995 (the "1995 Plan"), that provides for the issuance of both incentive and
non-qualified stock options. Options are granted at, or above, the fair market value of the Company's common stock at the date of grant and generally

31

---



become
exercisable over a five-year period. 800,000 shares of common stock were reserved for issuance under the 1995 Plan.

The
Company also has a Non-Employee Director Stock Option and Stock Grant Plan, approved by stockholders in 1994 (the "1994 Plan"). Under the 1994 Plan, upon election to the
Board of Directors, non-employee directors are granted a ten-year option to purchase 3,000 shares of the Company's common stock at fair market value on the date of grant. In
addition, on the date of each Annual Meeting of Stockholders, each non-employee director continuing in office will be automatically granted, without payment, 2,000 shares of common stock,
non-transferable for six months following the date of grant. Expense recognized from the 1994 Plan grants for the years ended March 31, 2004, 2003 and 2002 was $3,000, $5,000 and
$6,000, respectively. 100,000 shares of common stock were reserved for issuance under the 1994 Plan.

At
March 31, 2004, there were 115,504 shares available for grant under the 1995 Plan and 9,000 shares available under the 1994 Plan. The per share weighted average fair value of
stock options granted during 2004, 2003 and 2002 was $0.38, $0.48 and $0.84, respectively, on the date of grant using a Black Scholes option pricing model with the following weighted average
assumptions:

2004

2003

2002Expected dividend yield

0
%
0
%
0
%Risk-free interest rate

4.5
%
3.3
%
4.5
%Expected volatility

97
%
113
%
120
%Expected life in years

5.0

4.0

4.3


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

Number of
Shares

Weighted
Average
Exercise PriceBalance at March 31, 2001

765,696

$
3.05Granted

164,000


1.00Exercised




Expired

(96,300
)

7.63Forfeited

(92,700
)

2.26Balance at March 31, 2002

740,696


2.10Granted

142,500


0.59Exercised




Expired

(72,900
)

6.31Forfeited

(51,600
)

1.46Balance at March 31, 2003

758,696


1.46Granted

190,400


0.49Exercised

(45,800
)

0.95Expired

(75,900
)

3.13Forfeited

(171,700
)

1.31Balance at March 31, 2004

655,696


1.06


32

---



The
following table summarizes the weighted average characteristics of outstanding stock options at March 31, 2004 for various exercise price ranges:

|              |  | Outstanding Options |  | Exercisable Options
|------------- |  | ------------------- |  | -------------------
|
|$0.46 - $0.77 |  | 310,200             |  | 4.0                
|$0.97 - $1.69 |  | 317,496             |  | 1.5                
|$3.69 - $6.13 |  | 28,000              |  | 3.9                

Warrants

The Company had warrants outstanding during the periods indicated as follows:

Rights to Acquire
Number of Shares
Of Common StockGranted in December 1999, exercisable at $0.63 per share, as consideration for services provided by a third party, expiring in December 2004

75,000Granted in January 2000, exercisable at $1.00 per share, issued in connection with the purchase of 50,000 shares of common stock by an existing stockholder, expiring in January 2005

50,000Granted in April 2000, exercisable at $2.55 per share, issued in conjunction with the Term Loan (see Note 5), expiring in April 2011

20,000Granted in May 2000 in conjunction with the May 2000 Debentures, revised terms include exercise price of $1.10 per share and expiring in May 2004 (see Note 5 for original and renegotiated warrant terms)

83,334Balance outstanding at March 31, 2002

228,334Granted in May 2002, exercisable at $1.10 per share, issued in connection with the May 2000 Debentures maturity extension, expiring in May 2004 (see Note 5)

371,400Balance outstanding at March 31, 2003

599,734Exercised during the fourth quarter of fiscal 2004 at $1.10 per share, warrants issued in connection with the May 2000 Debenture

(429,234
)Balance outstanding at March 31, 2004

170,500


Note 8 Earnings Per Share

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

33

---



Reconciliations
between the numerator and the denominator of the basic and diluted earnings per share computations for the year ended March 31, 2004 are as follows (there were no
reconciling items for the years ended March 31, 2003 and 2002):

|                                                                |  | Net Income
(Numerator) |     | Shares
(Denominator) |        | Per Share
Amount
|--------------------------------------------------------------- |  | ---------------------- | --- | -------------------- | ------ | ----------------
|
|Basic earnings per share                                        |  | $                      | 399 |                      | 18,971 |                 
|                                                                |  |                        |     |                      |        |                 
|Effect of dilutive securitiescommon stock options and warrants |  |                        |    |                      | 140    |                 
|                                                                |  |                        |     |                      |        |                 
|Diluted earnings per share                                      |  | $                      | 399 |                      | 19,111 |                 
|                                                                |  |                        |     |                      |        |                 

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

2004

2003

2002(in thousands)Debentures, prior to conversion (see Note 5)

1,329

1,923

825Stock options and warrants

441

1,358

969


Note 9 Profit Sharing Plan

The Company sponsors a profit sharing plan for all employees not covered under a separate management incentive plan. Under the profit sharing plan, 5% of
pre-tax profits on a quarterly basis may be allocated to non-management employees based on gross wages. At management's discretion, the profit sharing bonus may be distributed
all in cash on an after-tax basis or distributed half in cash (on an after-tax basis) and the remainder deposited in an employee's 401(k) account on a pre-tax basis
with a six year vesting schedule, based on years of service with the Company. All employees may make voluntary pre-tax contributions to their 401(k) accounts; Company contributions are
discretionary. For the year ended March 31, 2004, compensation expense relative to this plan was approximately $36,000. For the years ended March 31, 2003 and 2002, compensation expense
relative to this plan was nil.

Note 10 Major Customers and Geographic Information

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

2004

2003

2002(in thousands)Net sales:Spirulina products

$
6,511

$
6,181

$
6,086Natural astaxanthin products


4,933


2,613


1,694Other products


138


157


455$
11,582

$
8,951

$
8,235


Approximately
$1,560,000, or 13% of our total net sales for the year ended March 31, 2004 was to a single customer. Sales to this customer for fiscal 2003 and 2002 were $1,546,000
(17% of net sales) and $1,031,000 (13% of net sales), respectively.

34

---



The
following table presents sales for the years 2004, 2003 and 2002 by geographic region:

2004

2003

2002(dollars in thousands)Net sales(1):United States

$
4,918

42
%
$
4,149

46
%
$
4,393

53
%Japan


2,020

17
%

1,043

12
%

767

9
%The Netherlands


1,562

14
%

1,550

17
%

1,032

13
%Other areas


3,082

27
%

2,209

25
%

2,043

25
%$
11,582

100
%
$
8,951

100
%
$
8,235

100
%


---

Substantially
all long-lived assets are located in the United States as of March 31, 2004 and 2003.

Note 11 Income Taxes

Income (loss) before income taxes consisted of:

2004

2003

2002(in thousands)United States

$
224

$
(1,817
)
$
(2,598
)Foreign


250


33


Income (loss) before income taxes

$
474

$
(1,784
)
$
(2,598
)


Income
tax expense (benefit) for the years ended March 31, 2004, 2003 and 2002 consisted of:

2004

2003

2002(in thousands)Current:Foreign

$
121

$


$
Federal


5





State


(33
)

(9
)

(9
)Total current


93


(9
)

(9
)Deferred:Foreign


(18
)




Federal








State








Total deferred


(18
)




Income tax expense (benefit)

$
75

$
(9
)
$
(9
)


35

---



The
following table reconciles the amount of income taxes computed at the federal statutory rate of 34%, for all periods presented, to the amount reflected in the Company's consolidated
statement of operations for the years ended March 31, 2004, 2003 and 2002:

|                                                                    |                              | 2004 |      | 2003 |   | 2002 |   
|------------------------------------------------------------------- | ---------------------------- | ---- | ---- | ---- | - | ---- | --
|
|Tax provision at federal statutory income tax rate                  |                              | $    | 161  |      | $ | (607 | ) 
|State income taxes, net of federal income tax effect                |                              |      | (22  | )    |   | (6   | ) 
|Foreign income taxes in excess of federal statutory income tax rate |                              |      | 36   |      |   |     |   
|Increase (decrease) in valuation allowance for deferred tax assets  |                              |      | (188 | )    |   | 727  |   
|Other, net                                                          |                              |      | 88   |      |   | (123 | ) 
|                                                                    |                              |      |      |      |   |      |   
|                                                                    | Income tax expense (benefit) |      | $    | 75   |   | $    | (9
|                                                                    |                              |      |      |      |   |      |   

Deferred
income taxes are provided for temporary differences between income tax and financial statement recognition of revenues and expenses. The significant components of deferred
income tax benefit for the years ended March 31, 2004, 2003 and 2002 are as follows:

|                                                                                                             |  | 2004 |      | 2003 |   | 2002 |  
|------------------------------------------------------------------------------------------------------------ |  | ---- | ---- | ---- | - | ---- | -
|
|Deferred tax expense (benefit), exclusive of the change in beginning-of-the-year valuation allowance balance |  | $    | 170  |      | $ | (727 | )
|Increase (decrease) in beginning-of-the-year balance of the valuation allowance for deferred tax assets      |  |      | (188 | )    |   | 727  |  
|                                                                                                             |  |      |      |      |   |      |  
|                                                                                                             |  | $    | (18  | )    | $ |     |  
|                                                                                                             |  |      |      |      |   |      |  

The
tax effects of temporary differences related to various assets, liabilities and carryforwards that give rise to deferred tax assets and deferred tax liabilities as of
March 31, 2004 and 2003 are as follows:

|                                                                                                                                |                                                                           | 2004                      |        | 2003  |      
|------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------- | ------------------------- | ------ | ----- | -----
|
|Deferred tax assets:                                                                                                            |                                                                           |                           |        |       |      
|                                                                                                                                | Net operating loss carryforwards                                          |                           | $      | 5,295 |      
|                                                                                                                                | Impairment loss on leasehold improvement for financial reporting purposes |                           |        | 1,062 |      
|                                                                                                                                | Tax credit carryforwards                                                  |                           |        | 119   |      
|                                                                                                                                | Other                                                                     |                           |        | 199   |      
|                                                                                                                                |                                                                           |                           |        |       |      
|                                                                                                                                |                                                                           | Gross deferred tax assets |        |       | 6,675
|Less valuation allowance                                                                                                        |                                                                           |                           | (5,078 | )     |      
|                                                                                                                                |                                                                           |                           |        |       |      
|                                                                                                                                |                                                                           | Net deferred tax assets   |        |       | 1,597
|Deferred tax liability: Principally due to differences in depreciation and amortization on equipment and leasehold improvements |                                                                           |                           | (1,579 | )     |      
|                                                                                                                                |                                                                           |                           |        |       |      
|                                                                                                                                |                                                                           | Net deferred tax assets   |        | $     | 18   
|                                                                                                                                |                                                                           |                           |        |       |      

In
assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized.
The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management
considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based upon the level of historical taxable income
and projections for future taxable income over the periods in which net deferred tax assets are deductible, management believes it is more likely than not the Company will realize the benefits of
these deductible differences, net of the

36

---



existing
valuation allowance. The amount of the deferred tax assets considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward
period are reduced.

At
March 31, 2004, the Company has net operating loss carryforwards and tax carryfowards available to offset future federal income tax as follows (in thousands):

Expires March 31,

Net Operating
Losses

Research and Experimentation Tax Credits2005

$


$
42006





2011





232012





92013


1,514


2019


3,632


2020


2,051


2021


1,727


2022


3,161


2023


1,863


$
13,948

$
36


In
addition, at March 31, 2004, the Company has alternative minimum tax credit carryforwards of approximately $83,000 available to reduce future federal regular income taxes over
an indefinite period.

At
March 31, 2004, the Company has state tax net operating loss carryforwards of $9,205,000, which expire in March 31, 2019 through 2023, available to offset future Hawaii
state taxable income.

Note 12 Commitments and Contingencies

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

37

---



Note 13 Selected Quarterly Financial Data (Unaudited)

|                             |                   | First Quarter |       | Second Quarter |   | Third Quarter |       | Fourth Quarter |       | Year  |  
|---------------------------- | ----------------- | ------------- | ----- | -------------- | - | ------------- | ----- | -------------- | ----- | ----- | -
|
|2004                         |                   |               |       |                |   |               |       |                |       |       |  
|Net sales                    |                   | $             | 2,428 |                | $ | 2,840         |       | $              | 3,024 |       | $
|Gross profit                 |                   |               | 704   |                |   | 861           |       |                | 1,184 |       |  
|Net income (loss)            |                   |               | (141  | )              |   | (10           | )     |                | 109   |       |  
|Net income (loss) per share |                   |               |       |                |   |               |       |                |       |       |  
|                             | Basic and Diluted |               |       | (0.01          | ) |               | (0.00 | )              |       | 0.01  |  
|                             |                   |               |       |                |   |               |       |                |       |       |  
|2003                         |                   |               |       |                |   |               |       |                |       |       |  
|Net sales                    |                   | $             | 2,032 |                | $ | 2,018         |       | $              | 2,474 |       | $
|Gross profit                 |                   |               | 785   |                |   | 568           |       |                | 711   |       |  
|Net loss                     |                   |               | (785  | )              |   | (540          | )     |                | (180  | )     |  
|Net loss per share          |                   |               |       |                |   |               |       |                |       |       |  
|                             | Basic and Diluted |               |       | (0.05          | ) |               | (0.03 | )              |       | (0.01 | )
|                             |                   |               |       |                |   |               |       |                |       |       |  

38

---





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

Not applicable.

Item 9A. Controls and Procedures

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

PART III

Item 10. Directors and Executive Officers of the Registrant

Information with respect to Directors may be found under captions "Proposal One: Election of Directors," "Board Meetings and Committees," "Security Ownership of
Certain Beneficial Owners and Management" and "Compliance with Section 16(a) of the Exchange Act" contained in Cyanotech's
definitive 2004 Proxy Statement. Such information is incorporated herein by reference. Information on executive officers is included in Part I.

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

Item 11. Executive Compensation

The information required by this Item is incorporated herein by reference from the sections captioned "Executive Compensation and Other Information," "Director
Remuneration" and "Stockholder Return Performance Graph" contained in Cyanotech's definitive 2004 Proxy Statement.

Item 12. Security Ownership of Certain Beneficial Owners and Management

The security ownership information required by this Item is incorporated herein by reference from the sections captioned "Equity Compensation Plan Information"
and "Security Ownership of Certain Beneficial Owners and Management" contained in Cyanotech's definitive 2004 Proxy Statement.

Item 13. Certain Relationships and Related Transactions

Not applicable.

Item 14. Principal Accountant Fees and Services

Information concerning principal accountant fees and services appears in Cyanotech's definitive 2004 Proxy Statement under the heading "Independent Auditor's
Fees" and is incorporated herein by reference.

39

---





PART IV

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



Schedule IIValuation and Qualifying Accounts

42Report of Independent Registered Public Accounting Firm

43




Exhibit Number

Document Description3.1

Restated Articles of Incorporation (Incorporated by reference to Exhibit 3.1 to the Company's Quarterly Report on Form 10-QSB for the quarter ended December 31, 1996, File No. 0-14602)3.2

Bylaws of the Registrant, as amended (Incorporated by reference to Exhibit 3.1 to the Company's Quarterly Report on Form 10-QSB for the quarter ended December 31, 1996, File No. 0-14602)4.1

Specimen Common Stock Certificate (Incorporated by reference to Exhibit 4.1 to The Company's Registration Statement on Form SB-2 filed on February 28, 1996, File No. 333-00951)10.1

1994 Non-Employee Directors Stock Option and Stock Grant Program (Incorporated by reference to Exhibit 10.7 to the Company's Annual Report on Form 10-KSB for the fiscal year ended March 31, 1994, File No. 0-14602)10.2

1995 Stock Option Plan for Cyanotech Corporation dated August 9, 1995, as amended (Incorporated by reference to Exhibit 4(c) to the Company's Registration Statement on Form S-8 filed on October 27, 1995, File No. 33-63789)


40

---



10.3

Sub-Lease Agreement between the Company and Natural Energy Laboratory of Hawaii Authority dated December 29, 1995 (Incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-QSB for the quarter ended December 31, 1995,
File No. 0-14602)10.4

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

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

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

Consent of Independent Registered Public Accounting Firm31.1

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

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

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

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

Risk Factors


41

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Schedule II

Cyanotech Corporation and Subsidiaries    Valuation and Qualifying AccountsYears Ended March 31, 2004, 2003 and 2002  (In Thousands)

|                                    |      |  |   | Additions |  |   |    | 
|----------------------------------- | ---- |  | - | --------- |  | - | -- | 
|
|Allowance for Doubtful Receivables: |      |  |   |           |  |   |    | 
|                                    | 2004 |  | $ | 60        |  | $ | 37 | 
|                                    |      |  |   |           |  |   |    | 
|                                    | 2003 |  | $ | 40        |  | $ | 70 | 
|                                    |      |  |   |           |  |   |    | 
|                                    | 2002 |  | $ | 20        |  | $ | 20 | 
|                                    |      |  |   |           |  |   |    | 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The
Board of Directors
Cyanotech Corporation:

Under
date of April 30, 2004, we reported on the consolidated balance sheets of Cyanotech Corporation and subsidiaries (the Company) as of March 31, 2004 and 2003, and the
related consolidated statements of operations, stockholders' equity and comprehensive income (loss), and cash flows from each of the years in the three-year period ended March 31,
2004, as contained in the 2004 annual report on Form 10-K. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related
financial statement schedule as listed in Item 15 (a)(2). The financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on the
financial statement schedule based on our audits.

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

/s/
KPMG LLP

Honolulu,
Hawaii
April 30, 2004

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, on the 25th day of June, 2004.

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

Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on
the dates indicated.

|Signatures                                              |  | Title                                                                                                   |  | Date         
|------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------- |  | -------------
|                                                        |  |                                                                                                         |  |              
|/s/GERALD R. CYSEWSKI, PH. D.Gerald R. Cysewski, Ph. D. |  | Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer and Director) |  | June 25, 2004
|/s/JEFFREY H. SAKAMOTOJeffrey H. Sakamoto               |  | Chief Financial Officer, Vice President Finance and Administration, Secretary and Treasurer            |  | June 25, 2004
|/s/MICHAEL A. DAVISMichael A. Davis                     |  | Director                                                                                                |  | June 25, 2004
|/s/DAVID I. ROSENTHALDavid I. Rosenthal                 |  | Director                                                                                                |  | June 25, 2004
|/s/JOHN T. WALDRONJohn T. Waldron                       |  | Director                                                                                                |  | June 25, 2004
|/s/PAUL C. YUENPaul C. Yuen                             |  | Director                                                                                                |  | June 25, 2004

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