Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 

**Quarterly Report Under Section 13or 15(d)of the Securities Exchange Act of 1934**

 

**ForQuarterly Period Ended June 30, 2008**

 

**CommissionFile Number 0-14602**

 

**CYANOTECH CORPORATION**

(Exact name of registrant as specified in itscharter)

 

| **NEVADA**                         | **91-1206026**         |
|------------------------------------|------------------------|
| (State or other  jurisdiction      | (IRS Employer          |
| of incorporation or  organization) | Identification Number) |

 

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

 

**(808)326-1353**(Registrant’s telephone number)

 

Check whether the registrant (1) filed all reports required to befiled by Section 13 or 15(d) of the Exchange Act during the past 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.

Yes  x   No  o

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, a non-accelerated filer, or a smaller reportingcompany. See definitions of “large accelerated filer,” “accelerated filer,” and“smaller reporting company” in Rule 12b-2 of the Exchange Act. (Checkone):

 

| Large accelerated filer o | Accelerated filer o | Non-accelerated filer o(Do not check if a  smaller  reporting company) | Smaller reporting company x |
|--------------------------------|--------------------------|-----------------------------------------------------------------------------|----------------------------------|

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).  Yes  o   No  x

 

Number of common shares outstanding as of August 14, 2008:

 
| **Title of Class**              | ** ** | **Shares  Outstanding** | ** ** |
|---------------------------------|------------|-------------------------|------------|
| Common stock  - $0.02 par value |       | 5,242,270               |       |

 

 

 

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CYANOTECHCORPORATIONFORM 10-Q

 

INDEX

 
| ** ** | **PART I.  FINANCIAL  INFORMATION**                                                                                              | ** ** |
|------------|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** ** | ** **                                                                                                                                      | ** ** |
| Item 1.    | Financial Statements  (unaudited)                                                                                                               | 3          |
|       | Consolidated Condensed  Balance Sheets as of June 30, 2008 and March 31, 2008                                                         | 3          |
|       | Consolidated Condensed  Statements of Operations and Comprehensive Income (Loss) for the three month  periods ended June 30, 2008 and 2007 | 4          |
|       | Consolidated Condensed  Statements of Cash Flows for the three month periods ended June 30, 2008  and 2007                                 | 5          |
|       | Notes to  Consolidated Condensed Financial Statements                                                                                           | 6          |
| Item 2.    | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                     | 13         |
| Item 3.    | Quantitative  and Qualitative Disclosures About Market Risk                                                                                     | 19         |
| Item 4.    | Controls and  Procedures                                                                                                                        | 19         |
| ** ** | **PART II.  OTHER  INFORMATION**                                                                                                 | ** ** |
| ** ** | ** **                                                                                                                                      | ** ** |
| Item 1.    | Legal Proceedings                                                                                                                               | 20         |
| Item 2.    | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                    | 20         |
| Item 3.    | Defaults upon  Senior Securities                                                                                                                | 20         |
| Item 4.    | Submission  of Matters to a Vote of Security Holders                                                                                            | 20         |
| Item 5.    | Other Information                                                                                                                               | 20         |
| Item 6.    | Exhibits                                                                                                                                        | 20         |
| SIGNATURES | 21                                                                                                                                              |

 

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PART 1.  FINANCIAL INFORMATION

Item 1.  Financial Statements (Unaudited)

 

CYANOTECH CORPORATION

CONSOLIDATED CONDENSEDBALANCE SHEETS

(Dollars in thousands except par value andnumber of shares)

(Unaudited)

 
| ** **                                                                                                                                            | ** ** | **June 30,  2008** | ** ** | **March 31,  2008** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|--------------------------|------------|
| ASSETS                                                                                                                                                |       |                    |       |                     |       |
| Current assets:                                                                                                                                       |       |                    |       |                     |       |
| Cash and cash equivalents                                                                                                                             |       | $                       | 1,099      |                     | $          | 1,090 |   |
| Accounts receivable, net of allowance for  doubtful accounts of $23 at June 30, 2008 and March 31, 2008                                     |       | 2,394                   |       | 1,934                    |       |
| Inventories                                                                                                                                           |       | 1,724                   |       | 1,601                    |       |
| Prepaid expenses and other                                                                                                                            |       | 191                     |       | 263                      |       |
| Total current assets                                                                                                                                  |       | 5,408                   |       | 4,888                    |       |
|                                                                                                                                                  |       |                    |       |                     |       |
| Equipment and leasehold improvements, net                                                                                                             |       | 4,205                   |       | 4,269                    |       |
| Other assets                                                                                                                                          |       | 508                     |       | 623                      |       |
| Total assets                                                                                                                                          |       | $                       | 10,121     |                     | $          | 9,780 |   |
|                                                                                                                                                  |       |                    |       |                     |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                             |       |                    |       |                     |       |
| Current liabilities:                                                                                                                                  |       |                    |       |                     |       |
| Current maturities of long-term debt                                                                                                                  |       | $                       | 582        |                     | $          | 567 |   |
| Customer deposits                                                                                                                                     |       | 64                      |       | 104                      |       |
| Accounts payable                                                                                                                                      |       | 954                     |       | 805                      |       |
| Accrued expenses                                                                                                                                      |       | 519                     |       | 320                      |       |
| Total current liabilities                                                                                                                             |       | 2,119                   |       | 1,796                    |       |
|                                                                                                                                                  |       |                    |       |                     |       |
| Long-term debt, less current maturities                                                                                                               |       | 1,352                   |       | 1,505                    |       |
| Other long-term debt                                                                                                                                  |       | —                  |       | 100                      |       |
| Total liabilities                                                                                                                                     |       | 3,471                   |       | 3,401                    |       |
|                                                                                                                                                  |       |                    |       |                     |       |
| Commitments (Note 5)                                                                                                                                  |       |                    |       |                     |       |
|                                                                                                                                                  |       |                    |       |                     |       |
| Stockholders’ equity:                                                                                                                            |       |                    |       |                     |       |
| Common stock of $0.02 par value, shares  authorized 7,500,000; 5,242,270 shares issued and outstanding at  June 30, 2008 and March 31, 2008 |       | 105                     |       | 105                      |       |
| Additional paid-in capital                                                                                                                            |       | 27,337                  |       | 27,337                   |       |
| Accumulated deficit                                                                                                                                   |       | (20,792                 | )          | (21,063                  | )          |
| Total stockholders’ equity                                                                                                                       |       | 6,650                   |       | 6,379                    |       |
|                                                                                                                                                  |       |                    |       |                     |       |
| Total liabilities and stockholders’ equity                                                                                                       |       | $                       | 10,121     |                     | $          | 9,780 |   |

 

See accompanying Notes to ConsolidatedCondensed Financial Statements.

 

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CYANOTECH CORPORATION

CONSOLIDATED CONDENSEDSTATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME (LOSS)

(Dollars in thousands, except per shareamounts)

(Unaudited)

 
| ** **                                                  | ** ** | **Three Months Ended June 30,** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                  | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
|                                                        |       |                                                |       |   |   |
| NET SALES                                                   |       | $                                                   | 3,701      |   | $ | 2,583 |   |
| COST OF PRODUCT SALES                                       |       | 2,397                                               |       | 1,837 |   |
| Gross Profit                                                |       | 1,304                                               |       | 746 |   |
|                                                        |       |                                                |       |   |   |
| OPERATING EXPENSES:                                         |       |                                                |       |   |   |
| Research and development                                    |       | 36                                                  |       | 47 |   |
| Sales and marketing                                         |       | 267                                                 |       | 368 |   |
| General and administrative                                  |       | 709                                                 |       | 672 |   |
| Total operating expenses                                    |       | 1,012                                               |       | 1,087 |   |
|                                                        |       |                                                |       |   |   |
| Income (loss) from operations                               |       | 292                                                 |       | (341 | ) |
|                                                        |       |                                                |       |   |   |
| OTHER INCOME (EXPENSE):                                     |       |                                                |       |   |   |
| Interest income                                             |       | 3                                                   |       | 11 |   |
| Interest expense                                            |       | (45                                                 | )          | (41 | ) |
| Other income (expense), net                                 |       | 10                                                  |       | (1 | ) |
| Total other expense, net                                    |       | (32                                                 | )          | (31 | ) |
|                                                        |       |                                                |       |   |   |
| Income (loss) before income taxes                           |       | 260                                                 |       | (372 | ) |
|                                                        |       |                                                |       |   |   |
| (BENEFIT) PROVISION FOR INCOME TAXES                        |       | (11                                                 | )          | 10 |   |
|                                                        |       |                                                |       |   |   |
| NET INCOME (LOSS)                                           |       | $                                                   | 271        |   | $ | (382 | ) |
|                                                        |       |                                                |       |   |   |
| NET INCOME (LOSS) PER SHARE:                                |       |                                                |       |   |   |
| Basic                                                       |       | $                                                   | 0.05       |   | $ | (0.07 | ) |
| Diluted                                                     |       | $                                                   | 0.05       |   | $ | (0.07 | ) |
|                                                        |       |                                                |       |   |   |
| SHARES USED IN CALCULATION OF NET INCOME  (LOSS) PER SHARE: |       |                                                |       |   |   |
| Basic                                                       |       | 5,242                                               |       | 5,234 |   |
| Diluted                                                     |       | 5,242                                               |       | 5,234 |   |
|                                                        |       |                                                |       |   |   |
| COMPREHENSIVE INCOME (LOSS):                                |       |                                                |       |   |   |
| Net income (loss)                                           |       | $                                                   | 271        |   | $ | (382 | ) |
| Other comprehensive income (loss)                           |       | —                                              |       | (5 | ) |
|                                                        |       | $                                                   | 271        |   | $ | (387 | ) |

 

See accompanying Notes to Consolidated CondensedFinancial Statements.

 

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CYANOTECH CORPORATIONCONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)(Unaudited)

 
| ** **                                                                                          | ** ** | **Three Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2008**                                        | ** ** | **2007** | ** ** |
| ** **                                                                                          | ** ** | ** **                                      | ** ** | ** ** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                               |       |                                            |       |   |   |
| Net income (loss)                                                                                   |       | $                                               | 271        |   | $ | (382 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by (used in) operating activities: |       |                                            |       |   |   |
| Depreciation and amortization                                                                       |       | 109                                             |       | 147 |   |
| Amortization of debt issue costs and other  assets                                                  |       | 13                                              |       | 9 |   |
| Net (increase) decrease in:                                                                         |       |                                            |       |   |   |
| Accounts receivable                                                                                 |       | (460                                            | )          | (94 | ) |
| Inventories                                                                                         |       | (123                                            | )          | (99 | ) |
| Prepaid expenses and other assets                                                                   |       | 34                                              |       | 71 |   |
| Net increase (decrease) in:                                                                         |       |                                            |       |   |   |
| Accounts payable                                                                                    |       | 149                                             |       | (262 | ) |
| Accrued expenses                                                                                    |       | 199                                             |       | 30 |   |
| Net cash provided by (used in) operating  activities                                                |       | 192                                             |       | (580 | ) |
|                                                                                                |       |                                            |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                               |       |                                            |       |   |   |
| Additions to equipment and leasehold  improvements                                                  |       | (45                                             | )          | (36 | ) |
| Cash used in investing activities                                                                   |       | (45                                             | )          | (36 | ) |
|                                                                                                |       |                                            |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                               |       |                                            |       |   |   |
| Principal payments on long-term debt                                                                |       | (138                                            | )          | (95 | ) |
| Cash used in financing activities                                                                   |       | (138                                            | )          | (95 | ) |
|                                                                                                |       |                                            |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                                               |       | 9                                               |       | (711 | ) |
|                                                                                                |       |                                            |       |   |   |
| Cash and cash equivalents at beginning of  period                                                   |       | 1,090                                           |       | 1,444 |   |
|                                                                                                |       |                                            |       |   |   |
| Cash and cash equivalents at end of period                                                          |       | $                                               | 1,099      |   | $ | 733 |   |
|                                                                                                |       |                                            |       |   |   |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW  INFORMATION:                                                  |       |                                            |       |   |   |
| Cash paid during the period for:                                                                    |       |                                            |       |   |   |
| Interest                                                                                            |       | $                                               | 49         |   | $ | 33 |   |
| Income taxes                                                                                        |       | $                                               | —     |   | $ | 2 |   |

 

See accompanying Notes to ConsolidatedCondensed Financial Statements.

 

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CYANOTECH CORPORATIONFORM 10-QNOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

As of June 30, 2008(Unaudited)

 

**1.****                                     ****BASIS OF PRESENTATION**

 

The accompanying consolidated condensed financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States of America for interim financial information and with theinstructions to Form 10-Q and Regulation S-X.  Accordingly, they donot include all of the information and footnotes required by generally acceptedaccounting principles (“GAAP”) for complete financial statements.  These consolidated condensed financialstatements and notes should be read in conjunction with the Company’sconsolidated financial statements contained in the Company’s report on Form 10-Kfor the year ended March 31, 2008 filed on June 26, 2008.

 

The accompanying consolidated condensed financial statements includethe accounts of Cyanotech Corporation and its wholly owned subsidiaries, NutrexHawaii, Inc. (“Nutrex Hawaii” or “Nutrex”) and Cyanotech Japan YK (“CyanotechJapan” or “CJYK”). All significant intercompany balances and transactions havebeen eliminated in consolidation.  On August 31, 2007, the Companydiscontinued the activity of its wholly owned Japanese subsidiary CJYK. Allaquaculture feed business in Japan was absorbed through the Company’s domesticoperations. CJYK remained a registered Japanese corporation until November 30,2007, at which time it was dissolved.  All CJYK assets and liabilitieswere absorbed into the Company as of September 1, 2007.  The Companymade this decision due to declining sales of approximately 40% in each of thetwo fiscal years 2007 and 2006. CJYK sales for the quarter ended June 30,2007 were approximately $20,000. Dissolution of this subsidiary has not had asignificant impact on the consolidated financial statements.

 

The preparation of financial statements in conformity with GAAPrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and the disclosures of contingent assets andliabilities at the balance sheet date and the reported amounts of revenues andexpenses during the period reported.  Management reviews these estimatesand assumptions periodically and reflects the effect of revisions in the periodthat they are determined to be necessary.  Actual results could differfrom those estimates and assumptions.

 

2.                                       **INVENTORIES**

 

Inventories are stated at the lower of cost (which approximatesfirst-in, first-out) or market. Market is defined as sales price less cost todispose and a normal profit margin.  Inventories consist of the following

 
| ** **      | ** ** | **June 30, 2008**  | ** ** | **March 31, 2008** | ** ** |
|-----------------|------------|-------------------------|------------|------------------------------|------------|
| ** **      | ** ** | **(in thousands)** | ** ** |
| Raw materials   |       | $                       | 286        |                         | $          | 321 |   |
| Work in process |       | 194                     |       | 214                          |       |
| Finished goods  |       | 1,089                   |       | 888                          |       |
| Supplies        |       | 155                     |       | 178                          |       |
|            |       | $                       | 1,724      |                         | $          | 1,601 |   |

 

In accordance with SFAS No. 151, fixed production related costs ofapproximately $20,000, and $23,000 were not inventoried for the quarter ended June 30,2008 and 2007, respectively, due to below normal production capacity.

 

**3.****                                     ****EQUIPMENT AND LEASEHOLDIMPROVEMENTS**

 

Equipment and leasehold improvements are stated at cost. Depreciationand amortization are provided using the straight-line method over the estimateduseful lives for equipment and furniture and fixtures, or the shorter of theland lease term or estimated useful lives for leasehold improvements asfollows:

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

 

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Equipment and leasehold improvements consist of the following:

 
| ** **                                      | ** ** | **June 30, 2008**  | ** ** | **March 31, 2008** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|------------------------------|------------|
| ** **                                      | ** ** | **(in thousands)** | ** ** |
| Equipment                                       |       | $                       | 6,361      |                         | $          | 6,335 |   |
| Leasehold improvements                          |       | 7,358                   |       | 7,348                        |       |
| Furniture and fixtures                          |       | 98                      |       | 94                           |       |
|                                            |       | 13,817                  |       | 13,777                       |       |
| Less accumulated depreciation and  amortization |       | (9,709                  | )          | (9,600                       | )          |
| Construction-in-progress                        |       | 97                      |       | 92                           |       |
| Equipment and leasehold improvements, net       |       | $                       | 4,205      |                         | $          | 4,269 |   |

 

Management reviews long-lived assets for impairment whenever events orchanges in circumstances indicate that the carrying value of such assets maynot be recoverable. Upon such an occurrence, recoverability of these assets isdetermined by comparing the forecasted undiscounted net cash flows to which theassets relate, to its carrying amount. If the carrying value exceeds therelated cash flows, then the carrying value of the long-lived assets arecompared to the asset’s fair value using discounted cash flow. Management hasdetermined no asset impairment occurred during the three months ended June 30,2008.

 

**4.**                                      **LONG-TERM DEBT**

 

Long-term debt consists ofthe following:

 
| ** **                                    | ** ** | **June 30, 2008**  | ** ** | **March 31, 2008** | ** ** |
|-----------------------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                                    | ** ** | **(in thousands)** | ** ** |
| Term loans                                    |       | $                  | 1,934      |               | $          | 2,072 |   |
| Less current maturities                       |       | (582               | )          | (567               | )          |
| Long-term debt, excluding current  maturities |       | $                  | 1,352      |               | $          | 1,505 |   |

 

*Term Loan Agreement*

 

In February 2008, the Company executed a Term Loan Agreement (“TermLoan”) with a lender providing for $1.1 million in aggregate creditfacilities, secured by the Company’s assets. The Term Loan has a maturity dateof March 1, 2015 and is payable in 84 equal monthly principal and interestpayments. The interest rate under this Term Loan, in the absence of a defaultunder the agreement, is the prime rate in effect as of the close of business onthe first day of each calendar quarter, plus 1%. As of June 30, 2008 and March 31,2008, the prime rate was 5.00% and 5.25%, respectively. The Company isprohibited from declaring any common stock dividends without the lender’s priorwritten consent.

 

In April 2000, the Company executed a Term Loan Agreement (“TermLoan”) with a lender providing for $3.5 million in aggregate creditfacilities, secured by the Company’s assets. The Term Loan has a maturity dateof May 1, 2010 and is payable in 120 equal monthly principal and interestpayments. The interest rate under this Term Loan, in the absence of a defaultunder the agreement, is the prime rate, in effect as of the close of businesson the first day of each calendar quarter, plus 1%. As of June 30, 2008and March 31, 2008, the prime rate was 5.00% and 5.25%, respectively. TheCompany is prohibited from declaring any common stock dividends without thelender’s prior written consent. A warrant to purchase 5,000 shares of theCompany’s common stock was issued in conjunction with this Term Loan. Thewarrant expires in April 2011 and has an exercise price of $10.20 pershare. The warrant may only be exercised after the Company has repaid the TermLoan in full.

 

These notes are additionally secured by a $250,000 restricted cashdeposit which is included in Other Assets in the accompanying consolidatedcondensed balance sheets at June 30, 2008 and March 31, 2008.

 

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Future principal payments under the Term Loan Agreements as of June 30,2008 are as follows:

 
| ** **               | ** ** | **(in  thousands)** | ** ** |
|--------------------------|------------|---------------------|------------|
| Less than 1 year         |       | $                   | 582        |   |
| Year 2                   |       | 572                 |       |
| Year 3                   |       | 146                 |       |
| Year 4                   |       | 155                 |       |
| Year 5                   |       | 165                 |       |
| Thereafter through 2015  |       | 314                 |       |
| Total principal payments |       | $                   | 1,934      |   |

 

**5.****                                     ****LEASES**

 

TheCompany leases facilities, equipment and land under operating leases expiringbetween 2008 and 2025.  The land leaseprovides for contingent rental in excess of minimum rental commitments based ona percentage of the Company’s annual sales. Contingent rental for the yearended March 31, 2008 was $46,000.

 

Futureminimum lease payments under all non-cancelable operation leases at June 30,2008 are as follows:

 
| ** **                   | ** ** | **(in  thousands)** | ** ** |
|------------------------------|------------|---------------------|------------|
| Less than 1 year             |       | $                   | 188        |   |
| Year 2                       |       | 166                 |       |
| Year 3                       |       | 156                 |       |
| Year 4                       |       | 152                 |       |
| Year 5                       |       | 148                 |       |
| Thereafter through 2025      |       | 1,812               |       |
| Total minimum lease payments |       | $                   | 2,622      |   |

 

**6.**                                      **SHARE-BASED COMPENSATION**

 

The Company has adopted the provisions of Statement of FinancialAccounting Standard (“SFAS”) No. 123(R) (“SFAS No. 123R”) “Share-BasedPayment” for its share-based compensation plans.  SFAS No. 123Rrequires an entity to measure the cost of employee services received inexchange for an award.  If an award vests or becomes exercisable based onthe achievement of a condition other than service such as for meeting certainperformance or market condition, the award is classified as aliability.   Liability-classified awards are remeasured to fair valueat each balance sheet date until the award is settled. The Company currentlyhas no liability-classified awards.  Equity-classified awards, includinggrants of employee stock options, are measured at the grant-date fair value ofthe award and are not subsequently remeasured.  The cost ofequity-classified awards is recognized in the income statement over the periodduring which an employee is required to provide the service in exchange for theaward. All of the Company’s stock options are service-based awards, andbecause the Company’s future employee incentive stock options are “plainvanilla,” as defined by the U. S. Securities and Exchange Commission in StaffAccounting Bulletin No. 107, they are reflected only in Equity andCompensation Expense accounts.

 

***Stock Options***

 

As of June 30, 2008, the Company had the following two shareholderapproved stock plans under which shares were available for equity-based awards:the 2005 Stock Option Plan (the “2005 Plan”) wherein 200,000 shares of commonstock are reserved for issuance until the plan terminates on August 21,2015, and the Independent Director Stock Option and Stock Grant Plan (the “2004Directors Plan”) wherein 75,000 shares of common stock are reserved forissuance until the plan terminates in 2014.  Under the 2005 Plan, eligibleemployees and certain independent consultants may be granted options topurchase shares of the Company’s common stock. The shares issuable under the2005 Plan will either be shares of the Company’s authorized but previouslyunissued common stock or shares reacquired by the Company, including sharespurchased on the open market.  As of June 30, 2008, 17,694 optionsremain available for grant under the 2005 Plan.  Concurrent with the 2005Plan approval on August 22, 2005, the 1995 Stock Option Plan wasterminated except for the outstanding options issued thereunder.  Underthe 2004 Directors Plan, upon election to the Board of Directors, a newly electednon-employee director is granted a 

 

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ten-yearoption to purchase 1,000 shares of the Company’s common stock at fair marketvalue on the date of grant. Options granted vest and become exercisable sixmonths from the date of grant.  In addition, on the date of each AnnualMeeting of Stockholders, each non-employee director continuing in office isautomatically granted 875 shares of common stock, non-transferable for ninemonths following the date of grant.  As of June 30, 2008, 70,250options remain available for grant under the 2004 Plan.  Concurrent withthe 2004 Plan approval on August 16, 2004, the 1994 Non-Employee DirectorStock Option and Stock Grant Plan was terminated except for the outstandingoptions issued thereunder.

 

The following table presents shares authorized,available for future grant and outstanding under each of the Company’s plans:

 
| ** ** | ** ** | **As of June 30, 2008** | ** ** |
|------------|------------|----------------------------------------|------------|
| ** ** | ** ** | **Authorized**                         | ** ** | **Available** | ** ** | **Outstanding** | ** ** |
|       |       |                                   |       |   |   |   |   |
| 2005 Plan  |       | 200,000                                |       | 17,694 |   | 182,306 |   |
| 2004 Plan  |       | 75,000                                 |       | 70,250 |   | 1,000 |   |
| 1995 Plan  |       | —                                 |       | — |   | 45,972 |   |
| 1994 Plan  |       | —                                 |       | — |   | 3,750 |   |
| Total      |       | 275,000                                |       | 87,944 |   | 233,028 |   |

 

All stock option grants made under the 2005 Plan and the 2004 DirectorsPlan are at exercise prices no less than the Company’s closing stock price onthe date of grant. Options under the 2005 Plan and 2004 Plan are determined bythe Board of Directors or the Stock Option and Compensation Committee of theBoard in accordance with the provisions of the respective plans. Discussion relative to option granting, vesting, exercising, and otherconditions are set forth in a Stock Option Agreement evidencing each grant. Nooption can have a life in excess of ten (10) years.  The Companyrecords compensation expense for employee stock options based on the estimatedfair value of the options on the date of grant using the Black-Scholesoption-pricing model. The model will use various assumptions, including arisk-free interest rate, the expected term of the options, the expected stockprice volatility over the expected term of the options, and the expecteddividend yield. Compensation expense for employee stock options will berecognized ratably over the vesting term.

 

A summary of option activity under Cyanotech Corporation’s Stock Plansfor the three months ended June 30, 2008 is presented below:

 
| ** **                     | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term in  Years** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|--------------------------------|------------|----------------------------|------------|----------------------------------------|------------|--------------------------------------------------------------------|------------|---------------------------------|------------|
| Balance at March 31, 2008 |       | 111,447                    |       | $                                      | 3.15       |                                                               | 4.9        |                            | $          | 4,735 |   |
| Granted                        |       | 131,056                    |       | 1.41                                   |       | 9.9                                                                |       | 38,006                          |       |
| Exercised                      |       | —                     |       | —                                 |       | —                                                             |       | —                          |       |
| Expired                        |       | (8,075                     | )          | 12.00                                  |       | —                                                             |       | (60                             | )          |
| Forfeited                      |       | (1,400                     | )          | 2.76                                   |       | —                                                             |       | (50                             | )          |
| Balance at June 30, 2008  |       | 233,028                    |       | $                                      | 2.77       |                                                               | 7.7        |                            | $          | 42,631 |   |

 

The aggregate intrinsic value in the tableabove is before applicable income taxes and represents the amount optioneeswould have received if all options had been exercised on the last business dayof the period indicated, based on the Company’s closing stock price for thatday.

 

The following table summarizes the weighted average characteristics ofoutstanding stock options as of June 30, 2008:

 
| ** **                              | ** **   | **Outstanding Options** | ** ** | **Exercisable Options**     | ** ** |
|-----------------------------------------|--------------|------------------------------|------------|----------------------------------|------------|
| **Range of  Exercise Prices** | ** **   | **Number  of Shares**   | ** ** | **Remaining  Life (Years)** | ** ** | **Weighted  Average Price** | ** ** | **Number of  Shares** | ** ** | **Weighted  Average Price** | ** ** |
| $                                       | 1.41 - $2.60 |                         | 208,225    |                             | 8.5        |   | $ | 1.55 |   | 30,919 |   | $ | 2.10 |   |
| $                                       | 4.20 - $6.50 |                         | 24,803     |                             | 1.3        |   | 4.52 |   | 24,739 |   | 4.52 |   |
| Total stock options                     |         | 233,028                      |       | 7.7                              |       | $ | 1.87 |   | 55,658 |   | $ | 3.18 |   |
|                                         |              |                              |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |

 

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There were 131,056 stock options granted during the three months ended June 30,2008. The average fair value assumptions related to options granted during thecurrent quarter are:

 
| Exercise Price:   |   | $      | 1.41   |   |
|-------------------|--------|--------|--------|--------|
| Volatility:       |   | 103.6  | %      |
| Risk Free Rate:   |   | 4.0    | %      |
| Vesting Period:   |   | 1 year |   |
| Termination Rate: |   | 0.0    | %      |

 

Total unrecognized stock-based compensation expense related to the131,056 stock options granted during the three months ended June 30, 2008 was$144,162 based on a fair value of $1.10 per option.  The unrecognized compensation expense forthese options is expected to be expensed when the options fully vest in thefirst quarter of fiscal year 2010.  As ofJune 30, 2008, total unrecognized stock-based compensation expense relatedto all unvested stock options was $164,247 which is expected to be amortizedover a weighted-average period of 4.1 years through February 22, 2013.

 

**7.****                                     ****INCOME TAXES**

 

The Company is subject to taxation in the United States and two statejurisdictions. No remaining or future tax liabilities are expected with respectto the dissolution of CJYK.  The preparation of tax returns requires managementto interpret the applicable tax laws and regulations in effect in suchjurisdictions, which could affect the amount of tax paid by the Company.Management, in consultation with its tax advisors, files its tax returns oninterpretations that are believed to be reasonable under the circumstances. Thetax returns, however, are subject to routine reviews by the various taxingauthorities in the jurisdictions in which the Company files its returns. As part of these reviews, a taxing authority may disagree with respect to thetax positions taken by management (“uncertain tax positions”) and thereforerequire the Company to pay additional taxes. As required under applicableaccounting rules, management evaluates the requirement for additional taxaccruals, but for the three months ended June 30, 2008 and 2007, noaccrual was recorded based on this evaluation of potential additional taxliability, including interest and penalties, which the Company could incur as aresult of the ultimate resolution of its uncertain tax positions. Managementreviews and updates the accrual for uncertain tax positions as more definitiveinformation becomes available from taxing authorities, completion of taxaudits, expiration of statute of limitations, or upon occurrence of otherevents.

 

As a result of the implementation of Financial Accounting StandardsBoard (“FASB”) Interpretation No.48 (“FIN 48”) “Accounting for Uncertainty inIncome Taxes, an interpretation of FASB Statement No. 109,” the Companydid not recognize a liability for unrecognized tax benefits and, accordingly,was not required to record any cumulative effect adjustment to beginning ofyear retained earnings.  As of both the date of adoption, April 1,2007 and June 30, 2008, there was no significant liability for income taxassociated with unrecognized tax benefits.

 

Income taxes are provided on the earnings in the consolidated financialstatements. The provision is based on the current quarter activity of the legalentities and jurisdictions in which the Company operates. Tax credits such asHawaii capital goods excise tax credits, are recognized as a reduction toincome taxes in the year the credits are earned.  Accordingly, the effective tax rate may varyfrom the customary relationship between income tax expense (benefit) andpre-tax income (loss).  The Company’seffective tax rate is reconciled quarterly to consider the tax effect of netoperating losses incurred in prior periods.

 

The Company recognizes accrued interest related to unrecognized taxbenefits as well as any related penalties in interest income or expense in itsconsolidated condensed statements of operations, which is consistent with therecognition of these items in prior reporting periods.  With fewexceptions, the Company is no longer subject to U.S. federal, state and local,and non-U.S. income tax examination by tax authorities for tax years before2001.

 

8.                                       **EARNINGS PER SHARE**

 

Basic earnings per share is computed on the basis of the weightedaverage number of common shares outstanding.  Diluted earnings per shareis computed on the basis of the weighted average number of common sharesoutstanding plus the potentially dilutive effect of outstanding stock optionsand warrants using the “treasury stock” method and convertible securities usingthe “if-converted” method.

 

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Reconciliations between the numerator and the denominator of the basicand diluted earnings per share computations for the three months ended June 30,2008 and June 30, 2007 are as follows:

 
| ** **                                                              | ** ** | **Three Months Ended June 30, 2008** | ** ** |
|-------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                              | ** ** | **Net Income**                                           | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| ** **                                                              | ** ** | **(Numerator)**                                               | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
| ** **                                                              | ** ** | **(in thousands)**                                       | ** ** | ** ** | ** ** |
| Basic income per share                                                  |       | $                                                             | 271        |   | 5,242 |   | $ | 0.05 |   |
| Effect of dilutive securities – Common  stock options and warrants |       | —                                                        |       | — |   | — |   |
| Diluted income per share                                                |       | $                                                             | 271        |   | 5,242 |   | $ | 0.05 |   |

 
| ** **                                                              | ** ** | **Three Months Ended June 30, 2007** | ** ** |
|-------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                              | ** ** | **Net Loss**                                             | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| ** **                                                              | ** ** | **(Numerator)**                                               | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
| ** **                                                              | ** ** | **(in thousands)**                                       | ** ** | ** ** | ** ** |
| Basic loss per share                                                    |       | $                                                             | (382       | ) | 5,234 |   | $ | (0.07 | ) |
| Effect of dilutive securities – Common  stock options and warrants |       | —                                                        |       | — |   | — |   |
| Diluted loss per share                                                  |       | $                                                             | (382       | ) | 5,234 |   | $ | (0.07 | ) |

 

Basic and diluted earnings per share are thesame in periods of a net loss, thus there is no effect of dilutive securitieswhen a net loss is recorded.  There wereapproximately 238,028 and 84,000 securities excluded from the calculation ofdiluted loss per share because their effect was anti-dilutive for the threemonths ended June 30, 2008 and 2007, respectively.  They were anti-dilutive due to the exerciseprice being greater than the Company’s weighted-average stock price for theperiod.

 

9.                                       **CUSTOMER DEPOSIT**

 

The Company received a restricted security deposit of $200,000 cash inconjunction with a sales contract dated November 1, 2007. On June 30,2008 the contract was modified to release the restricted funds to settleoutstanding accounts receivable balances and to prepay portions of new productorders from the customers. At June 30, 2008, $64,000 which includesinterest earned on the deposit, remained restricted for the benefit of thecustomer.  Those funds have since beenapplied to prepay pending orders as specified in the contract.

 

**10.****                             ****NEW ACCOUNTING PRONOUNCEMENTS**

 

In May 2007, the FASB issued FASB Staff Position (“FSP”) FIN 48-1Definition of Settlement in FASB Interpretation No. 48 (FSP FIN48-1). FSP FIN 48-1 provides guidance on how to determine whether a taxposition is effectively settled for the purpose of recognizing previouslyunrecognized tax benefits. FSP FIN 48-1 is effective retroactively to January 1,2007. The implementation of this FSP did not have a material impact on ourconsolidated financial position or results of operations.

 

InDecember 2007, the FASB issued SFAS No. 141R, “Business Combinations”. SFAS 141Rrequires the acquiring entity in a business combination to recognize all theassets acquired and liabilities assumed in the transaction at fair value as ofthe acquisition date. SFAS 141R is effective for business combinations forwhich the acquisition date is on or after the beginning of the first annualreporting period beginning on or after December 15, 2008. We are requiredto adopt SFAS 141R in the first quarter of fiscal year 2010.

 

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in ConsolidatedFinancial Statements.” SFAS No. 160 amends Accounting ResearchBulletin No. 51, “ConsolidatedFinancial Statements,” to establish accounting and reporting standardsfor the non-controlling interest in a subsidiary and for the deconsolidation ofa subsidiary. SFAS No.160 is effective for fiscal years beginning after December 15,2008. We do not expect the adoption of this statement to have a material impacton our consolidated financial statements.

 

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In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instrumentsand Hedging Activities – an amendment of FASB Statement No. 133.”This statement enhances the disclosure requirements for derivative instrumentsand hedging activities, and thereby is designed to improve the transparency offinancial reporting. SFAS No.161 is effective for fiscal years beginning after November 15,2008. We do not expect the adoption of this statement to have a material impacton our consolidated financial statements.

 

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally AcceptedAccounting Principles.” SFAS No. 162 identifies the sources ofaccounting principles and the framework for selecting the principles used inthe preparation of financial statements of nongovernmental entities that arepresented in conformity with generally accepted accounting principles. SFAS No. 162will become effective 60 days following the SEC’s approval of the PublicCompany Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in ConformityWith Generally Accepted Accounting Principles.” We do not expect theadoption of this statement to have a material effect on our consolidatedfinancial statements.

 

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**CYANOTECHCORPORATION**

 

**Item 2.       Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

**FORWARD LOOKING STATEMENTS**

 

This Report on Form 10-Q and other presentations made by CyanotechCorporation (“CYAN”) and its subsidiaries contain “forward-looking statements,”which include statements that are predictive in nature, depend upon or refer tofuture events or conditions, and usually include words such as “expects,” “anticipates,”“intends,” “plan,” “believes,” “predicts,” “estimates” or similar expressions.In addition, any statement concerning future financial performance, ongoingbusiness strategies or prospects and possible future actions are alsoforward-looking statements. Forward-looking statements are based upon currentexpectations and projections about future events and are subject to risks,uncertainties and the accuracy of assumptions concerning CYAN and itssubsidiaries (collectively, the “Company”), the performance of the industry inwhich they do business and economic and market factors, among other things. **These forward-looking statements are not guarantees offuture performance.**

 

Forward-looking statements speak only as of the date of the Report,presentation or filing in which they are made. Except to the extent required bythe Federal Securities Laws, the Company undertakes no obligation to publiclyupdate or revise any forward-looking statements, whether as a result of newinformation, future events or otherwise. Our forward-looking statements in thisReport include, but are not limited to:

 

·                  Statements relating to our business strategy;

 

·                  statements relating to our businessobjectives; and,

 

·                  expectations concerning future operations,profitability, liquidity and financial resources.

 

These forward-looking statements are subject to risk, uncertainties andassumptions about us and our operations that are subject to change based onvarious important factors, some of which are beyond our control. The followingfactors, among others, could cause our financial performance to differsignificantly from the goals, plans, objectives, intentions and expectationsexpressed in our forward-looking statements:

 

·                  The effects of competition, includinglocations of competitors and operating and market competition;

 

·                  environmental restrictions, soil and waterconditions, weather and other hazards;

 

·                  access to available and reasonable financingon a timely basis;

 

·                  changes in laws, including increased taxrates, regulations or accounting standards, and decisions of courts, regulatorsand governmental bodies;

 

·                  demand for the company’s products, thequantities and qualities thereof available for sale and levels of customersatisfaction;

 

·                  our dependence on the experience andcompetence of our executive officers and other key employees;

 

·                  the risk associated with the geographicconcentration of the company’s business;

 

·                  acts of war, terrorists incidents or naturaldisasters; and,

 

·                  other risks or uncertainties describedelsewhere in this Report and in other periodic reports previously andsubsequently filed by the Company with the Securities and Exchange Commission.

 

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**Overview**

 

Comparisonsof selected consolidated statements of operations data as reported hereinfollow for the periods indicated (dollars in thousands):

 
| ** **                   | ** ** | **Three Months Ended  June 30, 2008** | ** ** | **Three Months Ended  June 30, 2007** | ** ** | **Change** | ** ** |
|------------------------------|------------|-----------------------------------------------------------|------------|-----------------------------------------------------------|------------|------------|------------|
| ** **                   | ** ** | ** **                                                | ** ** | ** **                                                | ** ** | ** ** | ** ** |
| Net sales:                   |       |                                                      |       |                                                      |       |       |       |
| Spirulina products           |       | $                                                         | 2,040      |                                                      | $          | 1,531      |       | 33 | % |
| Natural astaxanthin products |       | 1,621                                                     |       | 997                                                       |       | 63         | %          |
| Other products               |       | 40                                                        |       | 55                                                        |       | -27        | %          |
| Total sales, all products    |       | $                                                         | 3,701      |                                                      | $          | 2,583      |       | 43 | % |

 
| ** **                    | ** ** | **Three Months Ended  June 30, 2008** | ** ** | **Three Months Ended  June 30, 2007** | ** ** | **Change** | ** ** |
|-------------------------------|------------|-----------------------------------------------------------|------------|------------------------------------------------------|------------|------------|------------|
|                          |       |                                                      |       |                                                 |       |       |       |
| Gross profit             |       | $                                                         | 1,304      |                                                 | $          | 746        |       | 75 | % |
| Income (loss) from operations |       | $                                                         | 292        |                                                 | $          | (341       | )          | N/A |   |
| Net income (loss)             |       | $                                                         | 271        |                                                 | $          | (382       | )          | N/A |   |

 

Sales for the first quarter of fiscal year 2009 increased from thecomparable prior year period by $1,118,000 or 43% due to increases in bothspirulina and natural astaxanthin product sales.

 

Spirulina sales increased 33% over the same period of fiscal year 2008,primarily due to increased units sold of both bulk and packages products whileprices increased only slightly.

 

Natural astaxanthin product sales increased as well over the comparableprior year period due to an increase in sales of both bulk and packagedastaxanthin products. Bulk products sales increased by 49% while packagednutrition products increased by 126%. The Company is now focused on building market share based on nutritionalbrands which promote health and well-being.

 

Gross profit margin as a percentage of sales increased to 35% for thethree months ended June, 30, 2008 from 29% for the same period a yearago.  Sales for the first quarter of fiscal year 2009 increased 43% fromthe comparable prior year period while cost of products sold increased 31% for thesame respective period. Variable production costs increased 5% in the currentperiod compared to one year ago primarily as a result of the impact of risingfuel costs on electrical rates, which have increased approximately 31%, and onthe shipping costs of chemicals used in production. Fixed costs have declinedby 9% primarily due to production equipment becoming fully depreciated. Weexpect continued pressure on input costs going forward and this could causegross margins to decline in future periods. Management is consistentlyresearching methodology to promote and sustain production at desired capacityand quality levels.

 

The net income of $271,000 for the first quarter of fiscal 2009represents a positive improvement of $653,000 over the comparable quarter offiscal 2008 which had a net loss of $382,000. The improvement is the result ofincreased sales, increased gross profit and 7% reduction in operating expenses.

 

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**Results of Operations**

 

# ***First Quarter of Fiscal 2009 Compared to First Quarter ofFiscal 2008***

# ** **

Net sales for the first quarter of fiscal 2009 increased to $3,701,000a 43% increase from the $2,583,000 reported for the comparable period a yearago.  Company sales of Spirulina products for the first quarter of fiscal2009 were $2,040,000, which is a 33% increase over sales generated in the firstquarter of fiscal 2008.  As a percentage of sales, Spirulina accounted for55% of total sales in the first quarter of fiscal 2008, compared to 59% for thecomparable period a year ago. Spirulina sales have declined as a percentage oftotal sales due to greater sales of Natural Astaxanthin products, producing afavorable margin impact.

 

Natural astaxanthin product sales were $1,621,000 during the firstquarter of 2009, a 63% increase from $997,000 in the first quarter of the prioryear.  The natural astaxanthin product lines increased to 44% of totalsales from 39% of total sales in the first quarter of fiscal 2008. Thisincrease is the result of the Company focusing its products to buildnutritional brands which promote health and well-being. During fiscal year2008, the Company closed it’s wholly owned Japan subsidiary CJYK, which sold tothe aquaculture market, and discontinued its NatuRose animal nutrition product.The aquaculture and animal nutrition market had been experiencing declines inboth demand and profit margins. Other products sales were $40,000 during thefirst quarter of fiscal 2009 and $55,000 during the first quarter of fiscal2008, and represented 1% and 2% of sales in the respective periods.

 

International sales were 41% of total sales for the first quarter offiscal year 2009 and 2008. Major customers are those equaling or exceeding 10%of the Company’s sales for the period. For the first quarter of fiscal 2009,two European distributors each had sales equal to 10% of the Company’s totalsales for the quarter. Only one distributor, with 11% of sales for the period,met or exceeded major customer sales volume in the first quarter of fiscal year2008.

 

Gross profit, derived from net sales less the cost of product sales,includes the cost of materials, direct labor, manufacturing overhead and depreciation.Gross profit for the three months ended June 30, 2008 was $1,304,000, witha gross profit margin percentage of 35%. This was an increase from gross profitmargin of $558,000 and gross profit margin of 29% reported for the comparableprior year quarter. Sales for the first quarter of fiscal year 2009 increased43% from the comparable prior year period while costs of products soldincreased 31% for the same respective period, resulting in the 6% improvementin gross profit margin percentage. Variable production costs increased 5% inthe current period compared to one year ago. Rising fuel costs have resulted inan increase in electrical rates of 31%. There have been related increases infreight costs and the cost of chemicals used in production. Labor costsdecreased 12% for the current quarter compared to the quarter ended June 30,2007 due to maintaining reduced work force levels implemented in the thirdquarter of fiscal year 2008. Fixed costs have declined by 9% primarily due toproduction equipment becoming fully depreciated. Direct cost increases areexpected to continue in all areas consistent with the local and nationaleconomy.

 

Pursuant to SFAS No. 151 “Inventory Costs – an amendment of ARB No. 43,Chapter 4,” approximately $20,000 and $23,000 of fixed production overhead costwas not inventoriable during the three months ended June 30, 2008 and June 30,2007 respectively. Approximately $30,000 of production costs were notinventoriable in the first quarter of fiscal year 2008 because such costs wouldhave exceeded the market value of the inventory. There were no such lower ofcost or market issues for the first quarter of fiscal year 2009.

 

Operating expenses for the three months ended June 30,2008 were 27% of sales or $1,012,000, compared to 42% of sales or $1,087,000for the three months ended June 30, 2007. This decrease in operatingexpenses in the three months ended June 30, 2008 as compared with thethree months ended June 30, 2007, was primarily the result of sales andmarketing expense reductions of $101,000 or 27% from the prior year period,offset by a $37,000 or 6% increase in general and administrative expense.Research and development expense for the first quarter of 2009 decreased by$11,000 from the first quarter of 2008. Management expects that research anddevelopment expenses in future periods will focus on improved productionmethods.

 

For the three months ended June 30, 2008, the Company recorded anincome tax receivable of $11,000 related to Federal and state tax credits. Forthe three months ended June 30, 2007, an income tax expense of $10,000 wasrecorded resulting from the write-off of a previously recorded income taxreceivable.  The Company does not expectany U.S. Federal or state income taxes to be recorded for the current fiscalyear because of available net operating loss carry-forwards.

 

The Company had net income of $271,000 or $0.05 per diluted share, forthe three months ended June 30, 2008 compared****to a net loss of $382,000, or ($0.07) per diluted share forthe three months ended June 30, 2007.

 

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**Variability of Results**

 

The Company has experienced significant quarterly fluctuations inoperating results and anticipates that these fluctuations may continue infuture periods.  As described in previousparagraphs, operating results have fluctuated as a result of changes in saleslevels to our customers, competition (both pricing, new products and othermarket trends) and production difficulties, including non-inventoriableproduction costs, variable production results, and the impact of operating inan area where utility costs are sensitive to oil prices. The Company has also,during its history, experienced production difficulties as a result ofinclement weather, changes in the mix between sales of bulk and packagedconsumer products and start up costs associated with new product introductions,new facilities and expansion into new markets. In addition, future operating results may fluctuate as a result offactors beyond the Company’s control such as foreign exchange fluctuations,changes in government regulations, and economic changes in the regions itoperates in and sells to. A portion of our operating expenses are relativelyfixed, and the timing of increases in expense levels is based in large part onforecasts of future sales.  Therefore, ifnet sales are below expectations in any given period, the adverse impact on resultsof operations may be magnified by our inability to meaningfully adjust spendingin certain areas, or the inability to adjust spending quickly enough, as inpersonnel and administrative costs, to compensate for a sales shortfall. We mayalso choose to reduce prices or increase spending in response to marketconditions, and these decisions may have a material adverse effect on financialcondition and results of operations.

 

**Financial Condition**

 

Cash and cash equivalents remained consistent with levels at March 31,2008 increasing $9,000 or less than 1%. Cash provided by operating activitiesof $192,000 was offset by cash used in investing activities and cash used infinancing activities. Cash of $192,000 was provided by operations; increases inaccounts receivable and inventory used $583,000 of cash and increases inaccounts payable and accrued expenses contributed $348,000 to cash.

 

Cash flows used in investing activities reflect capital expendituresduring the three months of fiscal 2009. Cash flows used in financing activitiesare attributable to debt payments during that period.

 

As of June 30, 2008, the Company’s net accounts receivableincreased $460,000 to $2,394,000 from $1,934,000 as of March 31, 2008. Theincrease in accounts receivable is primarily the result of the timing of salesfor the quarter. Management believes that its accounts receivable arecollectible net of the allowance for doubtful accounts of $23,000 at June 30,2008.

 

The Company’s net inventory increased $123,000 or 7% to $1,724,000 asof June 30, 2008 compared to $1,601,000 as of March 31, 2008. Theincrease in inventory during the first three months of fiscal 2009 is primarilydue to an increase in packaged product finished goods. This is consistent withthe Company’s emphasis on nutrition products.

 

**Liquidity and Capital Resources**

 

At June 30, 2008, the Company’s working capital was $3,289,000, anincrease of $197,000 compared to $3,092,000 at March 31, 2008. Cash andcash equivalents at June 30, 2008 totaled $1,099,000, an increase of$9,000 from $1,090,000 at March 31, 2008.

 

The Company has two Term Loan Agreements (“Term Loans”) with a lender.These provided up to $4.6 million in combined credit facilities which aresecured by substantially all the assets of the Company. The outstandingcombined balance under the Term Loans as of June 30, 2008 is approximately$1,934,000. The Term Loans have maturity dates of May 1, 2010 as to$1,100,000 and March 1, 2015 as to $834,000 and are payable in equalmonthly principal and interest payments of totaling approximately $58,000.

 

The interest rate under the Term Loans, in absence of a default underthe agreement, is the prime rate, as defined, in effect as of the close ofbusiness on the first day of each calendar quarter, plus 1% (the prime rate was5.00% at June 30, 2008). The Company received a waiver of relevantrestrictive covenants of the Term Loans related to the delayed filing of Form 10-Qfor the quarter ended June 30, 2007. The Company is prohibited by the TermLoan from declaring any cash dividends without the lender’s prior writtenconsent. A $250,000 restricted cash deposit is held in an interest-bearingrestricted cash account per the terms of the Term Loan and is included in otherassets in the consolidated balance sheet at June 30, 2008.

 

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The Company has, as previously reported,experienced a number of factors that have negatively impacted its balance sheetand liquidity, including the following:

 

·                  The Company has experienced significantrecurring net losses. At June 30, 2008, the Company had an accumulateddeficit of $20,792,000 compared to an accumulated deficit of $21,063,000 at March 31,2008. The accumulated deficit decreased by $271,000 for the quarter ended June 30,2008. As discussed earlier, and as required under SFAS No. 144, “Accountingfor the Impairment and Disposal of Long-Lived Assets,” as of March 31,2007 the Company recorded a non-cash impairment charge reducing, by $4.5million, the values of certain production equipment and leasehold improvementassets. *This non-cash charge did not impactliquidity.*

 

·                  The Company’s business has not generatedpositive cash from operating activities in seven of the eight quarters duringfiscal years ended March 31, 2008 and 2007. The first quarter of thefiscal year ended March 31, 2009 generated positive cash from operatingactivities for the second quarter in a row.

 

·                  Material weaknesses in its internal controls,as previously reported, have caused the Company to experience delays incompleting its consolidated financial statements and filing periodic reportswith the SEC on a timely basis. Accordingly, the Company continues to devotesubstantial additional internal resources, and to experience higher thanexpected fees for audit services. At present the Company has concluded thatmore rigorous emphasis on improving the capabilities of existing systems,procedures, and existing personnel, will correct the material weakness.

 

·                  In addition to the foregoing item, toconserve liquidity and reduce costs as previously announced, the Company cutits workforce by approximately 20% in early December 2007. The lay-offshave not had a negative impact on productivity and are not expected to do so.However, to achieve and sustain improved sales and enhanced productionefficiency and effectiveness, it may be necessary for the Company to increaseits operations workforce in future quarters.

 

·                  Finally, as part of its request to the seniordebt holder for additional funding, the Company has undertaken an aggressiveplan to de-emphasize new product introductions and related sales and marketingexpenses, and to aggressively reduce administrative and sales and marketingexpenses in general.

 

***Sufficiency of Liquidity***

 

Based upon analysis of the Company’s consolidated financial positionand projected future results of operations, we believe that our estimatedoperating cash flows, cash balances, and working capital will be sufficient tofinance current operating requirements, debt service, and planned capitalexpenditures, for the next 12 months. With total working capital ofapproximately $3.2 million, and a current ratio of 2.52 as of June 30,2008, management expects that liquidity in the remainder of fiscal 2009 to begenerated through operating cash flows.

 

**Capital Resources**

 

The Company does not currently have any material commitments forcapital expenditures. The Company expects fiscal 2009 capital expenditures ofapproximately $200,000 to be funded from operating cash flows. This includescapital expenditures in support of the Company’s normal operations, andexpenditures that we may incur in conjunction with initiatives to improve grossmargins and reduce expenses.

 

**Critical Accounting Policies and Estimates**

 

There have been no material changes to our critical accounting policiesand estimates from the information provided in Item 7, “Management’sDiscussion and Analysis of Financial Condition and Results of Operations,”included in our Form 10-K for the fiscal year ended March 31, 2008.

 

The Company adopted FIN 48 on April 1, 2007. The adoption of thisinterpretation did not have a material impact on its consolidated financialstatements.

 

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## **Outlook**

## ** **

*This outlook section contains a number offorward-looking statements, all of which are based on current expectations.Actual results may differ materially.*

 

Cyanotech Corporation’s strategic direction has always been to positionitself as a world leader in the production and marketing of high-value naturalproducts from microalgae. We are vertically aligned, producing raw materials inthe form of microalgae processed at our 90-acre facility in Hawaii, andintegrating those raw materials into finished products. In fiscal 2009, we willput greater emphasis on our Nutrex Hawaii consumer products. Our focus goingforward will be to leverage our experience and reputation for quality, buildingnutritional brands which promote health and well-being. The foundation of ournutritional products is naturally cultivated Spirulina Pacifica® in powder,flake and tablet form; and *BioAstin*®natural astaxanthin antioxidant in extract, softgel caplet andmicro-encapsulated beadlet form. Information about our Company and our productscan be viewed at www.cyanotech.com, www.nutrex-hawaii.com. Consumer productscan also be purchased online at www.nutrex-hawaii.com.

 

We are currently experiencing an upward trend in sales with unit salesincreasing during the first quarter of fiscal 2009 as compared to the firstquarter of fiscal 2008. The most significant impact was due to an increase inthe astaxanthin bulk product line. The Company expects spirulina sales toremain essentially level since the product has reached a mature life cyclestage. A portion of the upward trend in sales is attributable to filling orderswe could not fill during the third and fourth quarters of fiscal year 2008 dueto insufficient inventory. Accordingly, sales may trend down or remain level infuture periods depending on the rate orders are backlogged and fulfilled.Significant sales variability between periods and even across several periodscan be expected based on historical results.

 

As discussed in Note 1 to Consolidated Condensed Financial Statements,the Company has discontinued all business activity of its wholly owned Japanesesubsidiary CJYK. Management made this decision due to declining sales of approximately40% in each of the prior two fiscal years. Discontinuance of this subsidiaryhas not had a significant impact on our consolidated financial statements.

 

Overall costs have been increasing in part because of increasingutility, chemical, and transportation costs which reflect and respond to oilprices. We feel that these conditions will likely continue, and consequently, weare putting greater focus on cost controls and expense avoidance.

 

Gross profit margin percentages in fiscal year 2009 will be impacted bycontinued pressure on input costs and this could cause margins to decline infuture periods. Management will continue its focus on health and well-being,promoting higher gross margin items. Management is also focused on improvementsin process and production methods to stabilize and increase production levelsfor the future.

 

With the adoption of SFAS 151, the Company recognizes costs associatedwith abnormal amounts of idle facility expense, freight, handling costs andwasted materials (such as spoilage) as current-period charges in cost of sales.When production costs exceed historical averages, management evaluates whethersuch costs are current-period charges or are inventoriable costs. In addition,the allocation of fixed production overheads (such as depreciation and generalinsurance) to inventories is determined based on normal production capacity.When the Company’s production volumes are below normal capacity limits, certainfixed production overhead costs cannot be inventoried and are recordedimmediately in cost of sales. Producing the highest quality microalgae is acomplex biological process which requires balancing numerous factors includingmicroalgal strain variation, temperature, acidity, nutrient and otherenvironmental considerations, some of which are not within the Company’scontrol.

 

To manage its cash resources effectively, the Company will continue tobalance production in light of sales demand, minimizing the cost associatedwith build-ups in inventory. The Company has experienced other significant cashoutflows and may need to utilize other cash resources to meet working capitalneeds if prolonged net losses are incurred in future periods. A prolongeddownturn in sales could impair the Company’s ability to generate sufficientcash for operations and minimize the Company’s ability to attract additionalcapital investment which could become necessary in order to expand into newmarkets or increase product offerings.

 

The Company expects operating expense spending to remain consistentfiscal year 2008 levels. However, by March 31, 2010, the Company isrequired to be in full compliance with the Sarbanes-Oxley Act and Rules issuedthereunder by the SEC, including Section 404 Compliance Standardsestablished by the Public Companies Accounting Oversight Board. 

 

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Thecost of attaining and maintaining such compliance could materially decrease reportednet income or increase reported net losses in future periods.

 

The Company’s future results of operations and the otherforward-looking statements contained in this Outlook, in particular thestatements regarding revenues, gross margin and capital spending involve anumber of risks and uncertainties. In addition to the factors discussed above,any of the following could cause actual results to differ materially: businessconditions and growth in the natural products industry and in the general economy;changes in customer order patterns; changes in demand for natural products ingeneral; changes in weather conditions; competitive factors, such as increasedproduction capacity from competing spirulina and astaxanthin producers and theresulting impact, if any, on world market prices for these products; governmentactions; shortage of manufacturing capacity; and other factors beyond ourcontrol. Risk factors are discussed in detail in Item 1A in our Form 10-Kreport for the year ended March 31, 2008.

 

Managementbelieves that our technology, systems, processes and favorable growing locationgenerally permit year-round harvest of our microalgal products in acost-effective manner. However, imbalances in astaxanthin production in fiscalyear 2007 and spirulina production in 2008, together with increasing energycosts, suggest a need for continuing caution. We cannot, and do not attempt to,provide any form of assurance with regard to our technology, systems,processes, location, or cost-effectiveness.

 

**Item 3.****          ****Quantitative and QualitativeDisclosures about Market Risk**

 

The Company has not entered into any transactions using derivativefinancial instruments or derivative commodity instruments and believes thatexposure to market risk associated with other financial instruments is notmaterial.

 

The Company has term loan agreements that adjust quarterly based on theprime rate. As such, we are exposed to the interest rate risk whereby a 1%increase in the prime rate would lead to an increase of approximately $19,000in interest expense for the year ending March 31, 2009 (based on June 30,2008 amounts outstanding).

 

**Item 4.****          ****Controls and Procedures**

 

(a) **Disclosure Controls and Procedures**

 

We maintain disclosure controls andprocedures (as defined in Rules 13a-15(e) and 15 (d)-15(e) underthe Exchange Act that are designed to ensure that information required to bedisclosed in our reports filed or submitted under the Exchange Act is recorded,processed, summarized and reported, within the time periods specified in theSecurity and Exchange Commissions’s rules and forms, and that suchinformation is accumulated and communicated to management, including our ChiefExecutive Officer and Chief Financial Officer, as appropriate, to allow fortimely decisions regarding required disclosure.

 

This Form 10-Q should be read inconjunction with Item 9A(T) “Controls and Procedures” of the Company’s Form 10-Kfor the fiscal year ended March 31, 2008 filed June 26, 2008. Therewere no material changes in controls and Procedures during the current quarter.As of June 30, 2008, management believe systems and procedures were inplace to reasonably ensure accurate financial data.  However, these controls and procedures havenot been in place for a sufficient amount of time to demonstrate a high levelof assurance of the effectiveness and to conclude that the material weaknesspreviously identified has been remediated. 

 

As discussed in the Company’sForm 10-K for the year ended March 31, 2008, errors were identifiedin the application of certain accounting practices and procedures related toaccounting for certain fixed costs such as portions of depreciation, generalinsurance and minor compensation costs which should be included in the carryingvalue of inventory. The Company has taken extensive measures over the past yearto correct the identified weakness: (1) The Company engaged the servicesof qualified independent consultants to advise the Company on improvements tointernal controls and procedures. (2) In January 2008, the Company hired aController, replacing the former controller and controller of cost accounting.and (3) Consultants independent from those who assisted with improvementsand procedures have tested the Company’s internal controls over financialreporting.  In addition to thosemeasures, management is re-evaluating its overall information technology (“IT”)systems as it relates to the weakness and its remediation, and will makesufficient upgrades in the future to improve the efficiency and effectivenessof system information.

(b)**Changes to Internal Control Over FinancialReporting**

Therewas no change in our internal control over financial reporting during thecurrent quarter that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

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**PART II.****                  ****OTHER INFORMATION**

 

**Item 1.**                    **Legal Proceedings**

 

None.

 

**Item 2.**                   **Unregistered Sales of EquitySecurities and Use of Proceeds**

 

None.

 

**Item 3.**                    **Defaults upon SeniorSecurities**

 

None.

 

**Item 4.**                   **Submission of Matters to aVote of Security Holders**

 

None.

 

**Item 5.**               **Other Information**

 

None.

 

**Item 6.****                                                          ****Exhibits**

 
| a)     | The  following exhibits are furnished with this report: |
|--------|---------------------------------------------------------|
|   |                                                    |
|   | 31.1                                                    |   | Certification  by the Chief Executive Officer pursuant to  Rule 13a-14(a)/15d-14(a) of the Exchange Act |
|   |                                                    |   |   |
|   | 31.2                                                    |   | Certification  by the Chief Financial Officer pursuant to  Rule 13a-14(a)/15d-14(a) of the Exchange Act |
|   |                                                    |   |   |
|   | 31.3                                                    |   | Certification  by the Executive Vice President and Chief Scientific Officer pursuant to  Rule 13a-14(a)/15d-14(a) of the Exchange Act |
|   |                                                    |   |   |
|   | 32.1                                                    |   | Certification  by the Chief Executive Officer pursuant to 18 U. S. C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
|   |                                                    |   |   |
|   | 32.2                                                    |   | Certification  by the Chief Financial Officer pursuant to 18 U. S. C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
|   |                                                    |   |   |
|   | 32.3                                                    |   | Certification  by the Executive Vice President and Chief Scientific Officer pursuant to 18  U. S. C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |

 

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SIGNATURES

 

Inaccordance with the requirements of the Securities Exchange Act of 1934, theregistrant caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 
|                 |   |            | CYANOTECH  CORPORATION                                    |
|----------------------|--------|-----------------|-----------------------------------------------------------|
|                 |   |            | (Registrant)                                              |
|                 |   |            |                                                      |
|                 |   |            |                                                      |
| August 14, 2008 |   | By:   | /s/ Andrew  H. Jacobson                              |
| (Date)               |   |            | Andrew  H. Jacobson                                       |
|                 |   |            | President  and Chief Executive  Officer                   |
|                 |   |            |                                                      |
|                 |   |            |                                                      |
| August 14, 2008 |   | By:   | /s/  William R. Maris                                     |
| (Date)               |   |            | William  R. Maris                                         |
|                 |   |            | Vice  President — Finance & Administration, |
|                 |   |            | Chief  Financial Officer                                  |
|                 |   |            | (Principal  Financial and Accounting Officer)             |

 

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