Table of Contents

** **

 

** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-Q**

 
| **x** | ** ** | **Quarterly Report Pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934** |
|-------|------------|--------------------------------------------------------------------------------------------------------|

 

**ForQuarterly Period Ended June 30, 2009**

 

**Or**

 
| **o** | ** ** | **Transition  Report Pursuant to Section 13 or 15(d) of the Securities Exchange  Act of 1934** |
|-------|------------|----------------------------------------------------------------------------------------------------------|

 

**For theTransition Period From                  to**

 

**Commission File Number 0-14602**

 

**CYANOTECH CORPORATION**

(Exact name of registrant as specified in its charter)

 

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

 

**73-4460 Queen Kaahumanu Hwy. #102,Kailua-Kona, HI  96740**

(Address of principal executive offices)

 

**(808) 326-1353**

(Registrant’s telephone number)

 

**Not Applicable**

(Former name, former address and former fiscal year, if changed sincelast report)

 

Indicateby check mark whether the registrant (1) filed all reports required to befiled by Section 13 or 15(d) of the Exchange Act of 1934 during thepast 12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days.    Yes  x    No  o

 

Indicate by check mark whether the registrant hassubmitted electronically and posted on its corporate Web site, if any, every InteractiveData File required to be submitted and posted pursuant to Rule 405 ofRegulation S-T (§232.405 of this chapter) during the preceding 12 months (orfor such shorter period that the registrant was required to submit and postsuch files).    Yes  o    No  o

 

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,a non-accelerated filer, or a smaller reporting company. See definitions of “largeaccelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2of the Exchange Act. (Check one):

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

 

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

 

Numberof common shares outstanding as of August 13, 2009:

 

| **Title of  Class**             | ** ** | **Shares  Outstanding** |
|---------------------------------|------------|-------------------------|
| Common stock -  $0.02 par value |       | 5,245,770               |

 

 

 

----

Table ofContents

 

CYANOTECH CORPORATION

 

FORM 10-Q

 

INDEX

 
| ** ** | **PART I.  FINANCIAL  INFORMATION**                                                              | ** ** |
|------------|-----------------------------------------------------------------------------------------------------------------|------------|
| ** ** | ** **                                                                                                      | ** ** |
| Item 1.    | Financial  Statements (unaudited)                                                                               | 3          |
|       | Consolidated  Condensed Balance Sheets as of June 30, 2009 and March 31, 2009                         | 3          |
|       | Consolidated  Condensed Statements of Operations for the three month periods ended  June 30, 2009 and 2008 | 4          |
|       | Consolidated  Condensed Statements of Cash Flows for the three month periods ended  June 30, 2009 and 2008 | 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                                                     | 18         |
| 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                                                                                                              |

 

2

----

Tableof Contents

 

PART 1.  FINANCIAL INFORMATION

 

Item1.  Financial Statements (Unaudited)

 

CYANOTECH CORPORATION

CONSOLIDATED CONDENSED BALANCE SHEETS

(Dollars in thousands except par value and number of shares)

(Unaudited)

 
| ** **                                                                                                                                            | ** ** | **June 30,  2009** | ** ** | **March 31,  2009** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|--------------------------|------------|
| ASSETS                                                                                                                                                |       |                    |       |                     |       |
| Current assets:                                                                                                                                       |       |                    |       |                     |       |
| Cash and cash equivalents                                                                                                                             |       | $                       | 953        |                     | $          | 977 |   |
| Accounts receivable, net of allowance for doubtful  accounts of $14 at June 30, 2009 and March 31, 2009                                     |       | 2,292                   |       | 1,785                    |       |
| Inventories                                                                                                                                           |       | 3,098                   |       | 3,124                    |       |
| Prepaid expenses and other                                                                                                                            |       | 105                     |       | 110                      |       |
| Total current assets                                                                                                                                  |       | 6,448                   |       | 5,996                    |       |
|                                                                                                                                                  |       |                    |       |                     |       |
| Equipment and leasehold improvements, net                                                                                                             |       | 4,560                   |       | 4,316                    |       |
| Other assets                                                                                                                                          |       | 459                     |       | 475                      |       |
| Total assets                                                                                                                                          |       | $                       | 11,467     |                     | $          | 10,787 |   |
|                                                                                                                                                  |       |                    |       |                     |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                             |       |                    |       |                     |       |
| Current liabilities:                                                                                                                                  |       |                    |       |                     |       |
| Current maturities of long-term debt                                                                                                                  |       | $                       | 586        |                     | $          | 620 |   |
| Customer deposits                                                                                                                                     |       | 23                      |       | —                   |       |
| Accounts payable                                                                                                                                      |       | 1,108                   |       | 1,040                    |       |
| Accrued expenses                                                                                                                                      |       | 694                     |       | 444                      |       |
| Total current liabilities                                                                                                                             |       | 2,411                   |       | 2,104                    |       |
|                                                                                                                                                  |       |                    |       |                     |       |
| Long-term debt, less current maturities                                                                                                               |       | 790                     |       | 909                      |       |
| Total liabilities                                                                                                                                     |       | 3,201                   |       | 3,013                    |       |
|                                                                                                                                                  |       |                    |       |                     |       |
| Commitments and contingencies                                                                                                                         |       |                    |       |                     |       |
|                                                                                                                                                  |       |                    |       |                     |       |
| Stockholders’ equity:                                                                                                                            |       |                    |       |                     |       |
| Common stock of $0.02 par value, shares authorized  7,500,000; 5,245,770 shares issued and outstanding at June 30, 2009 and  March 31, 2009 |       | 105                     |       | 105                      |       |
| Additional paid-in capital                                                                                                                            |       | 27,667                  |       | 27,590                   |       |
| Accumulated deficit                                                                                                                                   |       | (19,506                 | )          | (19,921                  | )          |
| Total stockholders’ equity                                                                                                                       |       | 8,266                   |       | 7,774                    |       |
|                                                                                                                                                  |       |                    |       |                     |       |
| Total liabilities and stockholders’ equity                                                                                                       |       | $                       | 11,467     |                     | $          | 10,787 |   |

 

See accompanying Notes to Consolidated Condensed Financial Statements.

 

3

----

Table ofContents

 

CYANOTECH CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

 (Dollars in thousands, exceptper share amounts)

(Unaudited)

 
| ** **                                           | ** ** | **Three Months Ended June 30,** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                           | ** ** | **2009**                                            | ** ** | **2008** | ** ** |
|                                                 |       |                                                |       |   |   |
| NET SALES                                            |       | $                                                   | 4,021      |   | $ | 3,701 |   |
| COST OF PRODUCT SALES                                |       | 2,288                                               |       | 2,397 |   |
| Gross Profit                                         |       | 1,733                                               |       | 1,304 |   |
|                                                 |       |                                                |       |   |   |
| OPERATING EXPENSES:                                  |       |                                                |       |   |   |
| General and administrative                           |       | 896                                                 |       | 709 |   |
| Sales and marketing                                  |       | 322                                                 |       | 267 |   |
| Research and development                             |       | 80                                                  |       | 36 |   |
| Total operating expenses                             |       | 1,298                                               |       | 1,012 |   |
|                                                 |       |                                                |       |   |   |
| Income from operations                               |       | 435                                                 |       | 292 |   |
|                                                 |       |                                                |       |   |   |
| OTHER INCOME (EXPENSE):                              |       |                                                |       |   |   |
| Interest expense, net                                |       | (29                                                 | )          | (42 | ) |
| Other income, net                                    |       | 17                                                  |       | 10 |   |
| Total other expense, net                             |       | (12                                                 | )          | (32 | ) |
|                                                 |       |                                                |       |   |   |
| Income before income taxes                           |       | 423                                                 |       | 260 |   |
|                                                 |       |                                                |       |   |   |
| PROVISION (BENEFIT) FOR INCOME TAXES                 |       | 10                                                  |       | (11 | ) |
|                                                 |       |                                                |       |   |   |
| NET INCOME                                           |       | $                                                   | 413        |   | $ | 271 |   |
|                                                 |       |                                                |       |   |   |
| NET INCOME PER SHARE:                                |       |                                                |       |   |   |
| Basic                                                |       | $                                                   | 0.08       |   | $ | 0.05 |   |
| Diluted                                              |       | $                                                   | 0.08       |   | $ | 0.05 |   |
|                                                 |       |                                                |       |   |   |
| SHARES USED IN CALCULATION OF NET INCOME PER  SHARE: |       |                                                |       |   |   |
| Basic                                                |       | 5,246                                               |       | 5,242 |   |
| Diluted                                              |       | 5,294                                               |       | 5,242 |   |

 

See accompanying Notes to Consolidated Condensed Financial Statements.

 

4

----

Table of Contents

 

CYANOTECH CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)(Unaudited)

 
| ** **                                                                         | ** ** | **Three Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2009**                                        | ** ** | **2008** | ** ** |
| ** **                                                                         | ** ** | ** **                                      | ** ** | ** ** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                              |       |                                            |       |   |   |
| Net income                                                                         |       | $                                               | 413        |   | $ | 271 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                                            |       |   |   |
| Depreciation and amortization                                                      |       | 114                                             |       | 109 |   |
| Amortization of debt issue costs and other assets                                  |       | 14                                              |       | 13 |   |
| Stock based compensation expense                                                   |       | 77                                              |       | — |   |
| Net (increase) decrease in:                                                        |       |                                            |       |   |   |
| Accounts receivable                                                                |       | (507                                            | )          | (460 | ) |
| Inventories                                                                        |       | 26                                              |       | (123 | ) |
| Prepaid expenses and other assets                                                  |       | 9                                               |       | 34 |   |
| Net increase in:                                                                   |       |                                            |       |   |   |
| Customer deposits                                                                  |       | 23                                              |       | — |   |
| Accounts payable                                                                   |       | 68                                              |       | 149 |   |
| Accrued expenses                                                                   |       | 250                                             |       | 199 |   |
| Net cash provided by operating activities                                          |       | 487                                             |       | 192 |   |
|                                                                               |       |                                            |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                              |       |                                            |       |   |   |
| Investment in equipment and leasehold improvements                                 |       | (358                                            | )          | (45 | ) |
| Cash used in investing activities                                                  |       | (358                                            | )          | (45 | ) |
|                                                                               |       |                                            |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                              |       |                                            |       |   |   |
| Principal payments on long-term debt                                               |       | (153                                            | )          | (138 | ) |
| Cash used in financing activities                                                  |       | (153                                            | )          | (138 | ) |
|                                                                               |       |                                            |       |   |   |
| Net (decrease) increase in cash and cash  equivalents                              |       | (24                                             | )          | 9 |   |
|                                                                               |       |                                            |       |   |   |
| Cash and cash equivalents at beginning of period                                   |       | 977                                             |       | 1,090 |   |
|                                                                               |       |                                            |       |   |   |
| Cash and cash equivalents at end of period                                         |       | $                                               | 953        |   | $ | 1,099 |   |
|                                                                               |       |                                            |       |   |   |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                                  |       |                                            |       |   |   |
| Cash paid during the period for:                                                   |       |                                            |       |   |   |
| Interest                                                                           |       | $                                               | 18         |   | $ | 49 |   |
| Income taxes                                                                       |       | $                                               | 20         |   | $ | — |   |

 

See accompanying Notes to Consolidated Condensed Financial Statements.

 

5

----

Table of Contents

 

CYANOTECH CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

As of June 30, 2009(Unaudited)

 

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

 

The accompanyingconsolidated condensed financial statements have been prepared in accordancewith accounting principles generally accepted in the United States of Americafor interim financial information and with the instructions to Form 10-Qand Regulation S-X.  Accordingly, they do not include all of theinformation and footnotes required by generally accepted accounting principles(“GAAP”) for complete financial statements.  These consolidated condensed financial statements and notes should beread in conjunction with the Company’s consolidated financial statementscontained in the Company’s report on Form 10-K for the year ended March 31,2009 filed on June 25, 2009.

 

The accompanyingconsolidated condensed financial statements include the accounts of CyanotechCorporation and its wholly owned subsidiary, Nutrex Hawaii, Inc. (“NutrexHawaii” or “Nutrex”). All significant intercompany balances and transactionshave been eliminated in consolidation.

 

The preparation offinancial statements in conformity with GAAP requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and the disclosures of contingent assets and liabilities at thebalance sheet date and the reported amounts of revenues and expenses during theperiod reported.  Management reviews these estimates and assumptionsperiodically and reflects the effect of revisions in the period that they aredetermined to be necessary.  Actual results could differ from thoseestimates and assumptions.

 

**2.**                                      **INVENTORIES**

 

Inventories arestated at the lower of cost (which approximates first-in, first-out) or market.Market is defined as sales price less cost to dispose and a normal profitmargin.  Inventories consist of the following:

 
| ** **      | ** ** | **June 30, 2009**  | ** ** | **March 31, 2009** | ** ** |
|-----------------|------------|-------------------------|------------|------------------------------|------------|
| ** **      | ** ** | **(in thousands)** | ** ** |
| Raw materials   |       | $                       | 272        |                         | $          | 323 |   |
| Work in process |       | 325                     |       | 329                          |       |
| Finished goods  |       | 2,360                   |       | 2,315                        |       |
| Supplies        |       | 141                     |       | 157                          |       |
|            |       | $                       | 3,098      |                         | $          | 3,124 |   |

 

In accordance withStatement of Financial Accounting Standards (“SFAS”) No. 151, fixed production relatedcosts of approximately $0, and $23,000 were charged to cost of sales for thequarters ended June 30, 2009 and 2008, respectively, due to below normalproduction capacity.

 

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

 

Equipment andleasehold improvements are stated at cost. Depreciation and amortization areprovided using the straight-line method over the estimated useful lives forequipment and furniture and fixtures, or the shorter of the land lease term orestimated useful lives for leasehold improvements as follows:

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

 

6

----

Table ofContents

 

Equipment and leaseholdimprovements consist of the following:

 
| ** **                                     | ** ** | **June 30, 2009**  | ** ** | **March 31, 2009** | ** ** |
|------------------------------------------------|------------|-------------------------|------------|------------------------------|------------|
| ** **                                     | ** ** | **(in thousands)** | ** ** |
| Equipment                                      |       | $                       | 6,569      |                         | $          | 6,526 |   |
| Leasehold improvements                         |       | 7,671                   |       | 7,580                        |       |
| Furniture and fixtures                         |       | 120                     |       | 117                          |       |
|                                           |       | 14,360                  |       | 14,223                       |       |
| Less accumulated depreciation and amortization |       | (10,145                 | )          | (10,031                      | )          |
| Construction-in-progress                       |       | 345                     |       | 124                          |       |
| Equipment and leasehold improvements, net      |       | $                       | 4,560      |                         | $          | 4,316 |   |

 

Management reviewslong-lived assets for impairment whenever events or changes in circumstancesindicate that the carrying value of such assets may not be recoverable.Recoverability of these assets is measured by a comparison of the carryingamount to forecasted undiscounted future cash flows expected to be generated bythe asset. If the carrying amount exceeds its estimated future cash flows, thenan impairment charge is recognized to the extent that the carrying amountexceeds the asset’s fair value. Management has determined no asset impairmentoccurred during the three months ended June 30, 2009.

 

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

 

Long-term debt consists of the following:

 
| ** **                                   | ** ** | **June 30, 2009** | ** ** | **March 31, 2009** | ** ** |
|----------------------------------------------|------------|------------------------|------------|-------------------------|------------|
| ** **                                   | ** ** | **(in thousands)**     | ** ** |
| Term loans                                   |       | $                      | 1,376      |                    | $          | 1,529 |   |
| Less current maturities                      |       | (586                   | )          | (620                    | )          |
| Long-term debt, excluding current maturities |       | $                      | 790        |                    | $          | 909 |   |

 

*TermLoan Agreement*

 

In April 2000,the Company executed a Term Loan Agreement (“Term Loan A”) with a lenderproviding for $3.5 million in aggregate credit facilities, secured by theCompany’s assets. Term Loan A has a maturity date of May 1, 2010 and ispayable in 120 equal monthly principal payments plus interest. The interestrate under Term Loan A, in the absence of a default under the agreement, is theprime rate, in effect as of the close of business on the first day of eachcalendar quarter, plus 1%. As of June 30, 2009, the prime rate was 3.25%.The balance under this loan was $435,000 and $551,000 at June 30, 2009 andMarch 31, 2009, respectively. The Company is prohibited from declaring anycommon stock dividends without the lender’s prior written consent. A warrant topurchase 5,000 shares of the Company’s common stock was issued in conjunctionwith this Term Loan. The warrant expires in April 2011 and has an exerciseprice of $10.20 per share. The warrant may only be exercised after the Companyhas repaid the Term Loan in full. The credit agreementrequires the Company to meet certain financial covenants. The Company was incompliance with these financial covenants at June 30, 2009.

 

In February 2008,the Company executed a Term Loan Agreement (“Term Loan B”) with the same lenderproviding for $1.1 million in aggregate credit facilities, secured by theCompany’s assets. Term Loan B has a maturity date of March 1, 2015 and ispayable in 84 equal monthly principal payments plus interest. The interest rateunder Term Loan B, in the absence of a default under the agreement, is theprime rate in effect as of the close of business on the first day of eachcalendar quarter, plus 1%. As of June 30, 2009 and March 31, 2009,the prime rate was 3.25%. The balance under this loan was $915,000 and $950,000at June 30, 2009 and March 31, 2009, respectively. The Company isprohibited from declaring any common stock dividends without the lender’s priorwritten consent.

 

A $250,000restricted cash deposit continues to be held to secure these loans and it isincluded in Other Assets in the accompanying consolidated condensed balancesheets at June 30, 2009 and March 31, 2009.

 

In March 2009, the Company executed a Term Loan Agreement withJohn Deere credit providing for $29,340 in equipment, secured by the equipmentfinanced. The Term Loan has a maturity date of March 25, 2013 and ispayable in 48 equal monthly principal payments. The interest rate under thisTerm Loan is 0%.  Imputed interest at arate of 2% (cash discount offered by seller) has been recorded and will beamortized as interest over the term of the loan. The balance under this loan was $26,000 and $29,000 atJune 30, 2009 and March 31, 2009, respectively, less theunamortized discount of $1,917 and $2,053, respectively.  Amortization of discount is recognized in theincome statement as interest expense and was $136 for the quarter ended June 30,2009.

 

7

----

Table of Contents

 

On April 24, 2009, the Company entered into an agreement withFirst Hawaiian Bank for a Line of Credit in the amount of $150,000 for a termof one year. The obligation is secured by the Company’s U.S. accountsreceivable and bears a variable interest rate based on prime plus 2%. There isno outstanding balance as of June 30, 2009.

 

Future principalpayments under the Term Loan Agreements as of June 30, 2009 are asfollows:

 
| **Year ending March 31** | ** ** | **(in  thousands)** | ** ** |
|-------------------------------|------------|---------------------|------------|
| 2010 (9 Months)               |       | $                   | 586        |   |
| 2011                          |       | 157                 |       |
| 2012                          |       | 163                 |       |
| 2013                          |       | 168                 |       |
| 2014                          |       | 170                 |       |
| Thereafter through 2015       |       | 132                 |       |
| Total principal payments      |       | $                   | 1,376      |   |

 

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

 

The Company leasesfacilities, equipment and land under operating leases expiring between 2009 and2026.  The land lease provides for contingentrental in excess of minimum rental commitments based on a percentage of theCompany’s sales. Management has accrued for the estimated contingent rent as ofJune 30, 2009.

 

Future minimum leasepayments under all non-cancelable operation leases at June 30, 2009 are asfollows:

 
| **Year ending March 31** | ** ** | **(in  thousands)** | ** ** |
|-------------------------------|------------|---------------------|------------|
| 2010 (9 Months)               |       | $                   | 168        |   |
| 2011                          |       | 159                 |       |
| 2012                          |       | 149                 |       |
| 2013                          |       | 148                 |       |
| 2014                          |       | 148                 |       |
| Thereafter through 2026       |       | 1,701               |       |
| Total minimum lease payments  |       | $                   | 2,473      |   |

 

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

 

The Company appliesthe provisions of  SFAS No. 123(R), “Share-BasedPayment,” for its share-based compensation plans.  SFAS No. 123(R) requiresan entity to measure the cost of employee services received in exchange for anaward.  If an award vests or becomes exercisable based on the achievementof a condition other than service, such as for meeting certain performance ormarket condition, the award is classified as a liability. Liability-classified awards are remeasured to fair value at each balance sheetdate until the award is settled. The Company currently has noliability-classified awards.  Equity-classified awards, including grantsof employee stock options, are measured at the grant-date fair value of theaward and are not subsequently remeasured unless an award is modified. The cost of equity-classified awards is recognized in the income statement overthe period during which an employee is required to provide the service inexchange for the award. All of the Company’s stock options areservice-based awards, and because the Company’s future employee incentive stockoptions are “plain vanilla,” as defined by the U. S. Securities and ExchangeCommission in Staff Accounting Bulletin No. 107, they are reflected onlyin Equity and Compensation Expense accounts.

 

***Stock Options***

 

As of June 30,2009, the Company had the following two shareholder-approved stock plans underwhich shares were available for equity-based awards: the 2005 Stock Option Plan(the “2005 Plan”) wherein 700,000 shares of common stock are reserved forissuance until the plan terminates on August 21, 2015, and; TheIndependent Director Stock Option and Stock Grant Plan (the “2004 Plan”)wherein 75,000 shares of common stock are reserved for issuance until the planterminates in 2014.

 

8

----

Table ofContents

 

Underthe 2005 Plan, eligible employees and certain independent consultants may begranted options to purchase shares of the Company’s common stock. The sharesissuable under the 2005 Plan will either be shares of the Company’s authorizedbut previously unissued common stock or shares reacquired by the Company,including shares purchased on the open market.  As of June 30, 2009, 101,282options remain available for grant under the 2005 Plan.  Concurrent withthe 2005 Plan approval, the 1995 Stock Option Plan was terminated except forthe outstanding options issued thereunder.

 

Under the 2004Plan, upon election to the Board of Directors, a newly elected non-employeedirector is granted a ten-year option to purchase 1,000 shares of the Company’scommon stock at fair market value on the date of grant. Options granted vestand become exercisable six months from the date of grant.  In addition, onthe date of each Annual Meeting of Stockholders, each non-employee directorcontinuing in office is automatically issued 875 shares of common stock,non-transferable for nine months following the date of grant.   As ofJune 30, 2009, 53,875 options remain available for grant under the 2004Plan. Concurrent with the 2004 Plan approval on August 16, 2004, the 1994Non-Employee Director Stock Option and Stock Grant Plan was terminated exceptfor the outstanding options issued thereunder.

 

The followingtable presents shares authorized, available for future grant and outstandingunder each of the Company’s plans:

 
| ** ** | ** ** | **As of June 30, 2009** | ** ** |
|------------|------------|-------------------------|------------|
| ** ** | ** ** | **Authorized**          | ** ** | **Available** | ** ** | **Outstanding** | ** ** |
|       |       |                    |       |   |   |   |   |
| 2005 Plan  |       | 700,000                 |       | 101,282 |   | 598,718 |   |
| 2004 Plan  |       | 75,000                  |       | 53,875 |   | 1,000 |   |
| 1995 Plan  |       | —                  |       | — |   | 20,753 |   |
| 1994 Plan  |       | —                  |       | — |   | 2,250 |   |
| Total      |       | 775,000                 |       | 155,157 |   | 622,721 |   |

 

All stock optiongrants made under the 2005 Plan and the 2004 Plan were at exercise prices noless than the Company’s closing stock price on the date of grant. Options underthe 2005 Plan and 2004 Plan are determined by the Board of Directors or theStock Option and Compensation Committee of the Board in accordance with theprovisions of the respective plans.  The terms of each option grantinclude vesting, exercise, and other conditions are set forth in a Stock OptionAgreement evidencing each grant. No option can have a life in excess of ten (10) years. The Company records compensation expense for employee stock options based onthe estimated fair value of the options on the date of grant using theBlack-Scholes option-pricing model. The model requires various assumptions,including a risk-free interest rate, the expected term of the options, theexpected stock price volatility over the expected term of the options, and theexpected dividend yield. Compensation expense for employee stock options willbe recognized ratably over the vesting term. Compensation expense recognizedfor options issued under the 2005 Plan was $77,000 for the three months ended June 30,2009 and is classified as General and Administrative expense in theconsolidated condensed statement of operations. There was no compensationexpense recognized under the 2004 and 2005 Plan for the three months ended June 30,2008.

 

A summary ofoption activity under Cyanotech Corporation’s Stock Plans for the three monthsended June 30, 2009 is presented below:

 
| **Option Activity**           | ** ** | **Shares** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Weighted Average  Remaining  Contractual Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|------------------------------------|------------|------------|------------|------------------------------------------------|------------|-------------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at March 31, 2009 |       | 509,721    |       | $                                              | 2.11       |                                                        | 8.9 years  |                            | $          | 38,130 |   |
| Granted                            |       | 113,000    |       | 2.08                                           |       | 9.8 years                                                   |       | (12,430                         | )          |
| Exercised                          |       | —     |       | $                                              | —     |                                                        | —     |                            | —     |   |
| Forfeited or expired               |       | —     |       | $                                              | —     |                                                        | —     |                            | —     |   |
| Outstanding at June 30, 2009  |       | 622,721    |       | $                                              | 1.96       |                                                        | 8.9 years  |                            | $          | 5,311 |   |
| Exercisable at June 30, 2009  |       | 159,314    |       | $                                              | 1.84       |                                                        | 9.7 years  |                            | $          | 20,388 |   |

 

The aggregate intrinsic value in the table above is before applicableincome taxes and represents the amount optionees would have received if alloptions had been exercised on the last business day of the period indicated,based on the Company’s closing stock price of $1.97 for such day.

 

9

----

Table ofContents

 

A summary of theCompany’s non-vested options for the three months ended June 30, 2009 ispresented below:

 
| **Nonvested Options**       | ** ** | **Shares** | ** ** | **Weighted Average  Grant-Date  Fair Value** | ** ** |
|----------------------------------|------------|------------|------------|--------------------------------------------------------|------------|
| Nonvested at March 31, 2009 |       | 481,463    |       | $                                                      | 1.30       |   |
| Granted                          |       | 113,000    |       | .65                                                    |       |
| Vested                           |       | (131,056   | )          | 1.10                                                   |       |
| Forfeited or expired             |       | —     |       | —                                                 |       |
| Nonvested at June 30, 2009  |       | 463,407    |       | $                                                      | 1.20       |   |

 

The followingtable summarizes the weighted average characteristics of outstanding stockoptions as of June 30, 2009:

 
| ** **                              | ** ** | **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                     |       | 600,218                      |       | 7.36                             |       | $ | 1.87 |   | 136,811 |   | $ | 1.42 |   |
| $ 4.20 - $6.50                     |       | 22,503                       |       | .42                              |       | 4.39 |   | 22,503 |   | 4.39 |   |
| Total stock options                     |       | 622,721                      |       | 7.11                             |       | $ | 1.96 |   | 159,314 |   | $ | 1.84 |   |

 

There were 113,000stock options granted during the three months ended June 30, 2009. Theaverage fair value assumptions related to options granted during the currentquarter are:

 
| Exercise Price:  |   | $          | 2.08   |   |
|------------------|--------|------------|--------|--------|
| Volatility:      |   | 88.9       | %      |
| Risk Free Rate:  |   | 3.13       | %      |
| Vesting Period:  |   | 4 years    |   |
| Forfeiture Rate: |   | 20         | %      |
| Expected Life    |   | 6.25 years |   |

 

As of June 302009, total unrecognized stock-based compensation expense related to allunvested stock options was $376,546. Of the 463,407 unvested options at June 30,2009, 262,112 options cliff vest as follows: 131,056 of the options have an exercise price of $2.12 and cliff vest100% on May 16, 2010; and 131,056 of the options have an exercise price of$2.12 and cliff vest 100% on May 16, 2011. These cliff vesting optionshave a combined unrecognized compensation expense of $265,948 as of June 30,2009 that will be amortized over a remaining 10 months and 22 months,respectively. The unrecognized compensation expense of  $110,598 for the remaining 201,295 unvestedoptions is expected to be amortized over a remaining weighted-average period of3.49 years through April 29, 2013.

 

***Warrant***

 

The Company hasoutstanding a warrant to acquire 5,000 shares of common stock at $10.20 pershare. The warrant was granted to lenders in connection with the Term Loan Bdescribed in Note 4.  The warrant wasgranted in April 2000 and expires in April 2011, and may only beexercised after the Company has repaid the Term Loan B in full.

 

10

----

Table ofContents

 

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

 

The Company issubject to taxation in the United States and two state jurisdictions.  The preparation of tax returns requiresmanagement to interpret the applicable tax laws and regulations in effect insuch jurisdictions, 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 therefore mayrequire 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, 2009 and 2008, 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.

 

The Companyapplies the provisions of Financial Accounting Standards Board (“FASB”)Interpretation No.48 (“FIN 48”) “Accounting for Uncertainty in Income Taxes, aninterpretation of FASB Statement No. 109.” As of June 30, 2009, there was no significant liability for incometax associated with unrecognized tax benefits. The Company recognizes accruedinterest related to unrecognized tax benefits as well as any related penaltiesin interest income or expense in its consolidated condensed statements of operations,which is consistent with the recognition of these items in prior reportingperiods.

 

Income taxes areprovided on the earnings in the consolidated financial statements. Theprovision is based on the current quarter activity of the legal entities andjurisdictions in which the Company operates. Tax credits, such as Hawaiicapital goods excise tax credits, are recognized as a reduction to income taxesin the year the credits are earned. Accordingly, the effective tax rate may vary from the customary relationshipbetween income tax expense (benefit) and pre-tax income.

 

Withfew exceptions, the Company is no longer subject to U.S. federal, state andlocal, and non-U.S. income tax examination by tax authorities for tax yearsbefore 2002.

 

**8.**                                      **EARNINGS PER SHARE**

 

Basic earnings pershare is computed on the basis of the weighted average number of common sharesoutstanding.  Diluted earnings per share is computed on the basis of theweighted average number of common shares outstanding plus the potentially dilutiveeffect of outstanding stock options and warrants using the “treasury stock”method and convertible securities using the “if-converted” method.

 

Reconciliationsbetween the numerator and the denominator of the basic and diluted earnings pershare computations for the three months ended June 30, 2009 and June 30,2008 are as follows:

 
| ** **                                              | ** ** | **Three Months Ended June 30, 2009** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                              | ** ** | **Net Income**                                           | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| ** **                                              | ** ** | **(Numerator)**                                               | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
| ** **                                              | ** ** | **(in thousands)**                                       | ** ** | ** ** | ** ** |
| Basic income per share                                  |       | $                                                             | 413        |   | 5,246 |   | $ | 0.08 |   |
| Effect of dilutive securities–Common stock options |       | —                                                        |       | 49 |   | — |   |
| Diluted income per share                                |       | $                                                             | 413        |   | 5,294 |   | $ | 0.08 |   |

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

 

Basic and diluted earnings per share are the same in periods of a netloss, thus there is no effect of dilutive securities when a net loss isrecorded.  There were approximately454,115 and 238,028 securities excluded from the calculation of diluted lossper share because their effect was anti-dilutive for the three months ended June 30,2009 and 2008, respectively.

 

11

----

Table ofContents

 

**9.**                                      **CUSTOMER DEPOSIT**

 

The Companyreceived a restricted security deposit of $200,000 cash in conjunction with asales contract dated November 1, 2007. On June 30, 2008 the contractwas modified to release the restricted funds to settle outstanding accountsreceivable balances and to prepay portions of new product orders from thecustomers. At June 30, 2008, $64,000 which includes interest earned on thedeposit, remained restricted for the benefit of the customer.  At June 30, 2009, $23,000 ofnon-restricted prepayment funds are included in Customer deposits.

 

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

 

In March 2008,the FASB issued SFAS No. 161, “Disclosures about Derivative Instrumentsand Hedging Activities — an amendment of FASB Statements No. 133.” Thisstatement enhances the disclosure requirements for derivative instruments andhedging activities, and thereby is designed to improve the transparency offinancial reporting.  SFAS No. 161is effective for fiscal years beginning after November 15, 2008 or April 1,2009, for the Company. The adoption of this statement did not have a materialimpact on the Company’s consolidated financial statements.

 

In May 2009,the FASB issued SFAS No. 165, “Subsequent events”, which established general accounting standards anddisclosures for subsequent events. The Company adopted SFAS No. 165 duringthe second quarter of 2009. In accordance with SFAS No. 165, the Companyhas evaluated subsequent events through the date and time the financialstatements were issued on August 13, 2009.

 

On June 29, 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codificationand the Hierarchy of Generally Accepted Accounting Principles,” a replacementof SFAS No. 162.   SFAS No. 168,which establishes the FASB Accounting Standards Codification (“Codification”)as the source of authoritative accounting principles to be applied in thepreparation of financial statements in conformity with GAAP. SFAS No. 168becomes effective for interim and annual periods ending after September 15,2009. At that date, all then-existing non-SEC accounting and reportingstandards will be superseded by the Codification. The Company will adopt SFAS No. 168for the interim period ending September 30, 2009. Adoption is not expectedto have any materialeffect on the Company’s consolidated financial statements.

 

12

----

Table of Contents

 

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

 

**FORWARD LOOKING STATEMENTS**

 

This Report and other presentations made by Cyanotech Corporation (“CYAN”)and its subsidiary contain “forward-looking statements,” which includestatements that are predictive in nature, depend upon or refer to future eventsor conditions, and usually include words such as “expects,” “anticipates,” “intends,”“plan,” “believes,” “predicts”, “estimates” or similar expressions. Inaddition, 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 itssubsidiary (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 ourbusiness strategy;

 

·                  Statements relating to ourbusiness objectives; and

 

·                  Expectations concerningfuture 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 added risks associatedwith the current local, national and world economic crisis;

 

·                  The effects of competition,including locations of competitors and operating and market competition;

 

·                  Environmental restrictions,soil and water conditions, weather and other hazards;

 

·                  Access to available andreasonable financing on a timely basis;

 

·                  Changes in laws, includingincreased tax rates, regulations or accounting standards, and decisions ofcourts, regulators and governmental bodies;

 

·                  Demand for the company’sproducts, the quantities and qualities thereof available for sale and levels ofcustomer satisfaction;

 

·                  Our dependence on theexperience and competence of our executive officers and other key employees;

 

·                  The risk associated with thegeographic concentration of the company’s business;

 

·                  Acts of war, terroristsincidents or natural disasters; and

 

·                  Other risks oruncertainties described elsewhere in this Report and in other periodic reportspreviously and subsequently filed by the Company with the Securities andExchange Commission.

 

13

----

Table of Contents

 

**Overview**

 

Comparisons of selectedconsolidated statements of operations data as reported herein follow for theperiods indicated (dollars in thousands):

 
| ** **                   | ** ** | **Three Months Ended  June 30, 2009** | ** ** | **Three Months Ended  June 30, 2008** | ** ** | **Change** | ** ** |
|------------------------------|------------|-----------------------------------------------------------|------------|-----------------------------------------------------------|------------|------------|------------|
| ** **                   | ** ** | ** **                                                | ** ** | ** **                                                | ** ** | ** ** | ** ** |
| Net sales:                   |       |                                                      |       |                                                      |       |       |       |
| Spirulina products           |       | $                                                         | 1,918      |                                                      | $          | 2,040      |       | (6 | )% |
| Natural astaxanthin products |       | 2,101                                                     |       | 1,621                                                     |       | 30         | %          |
| Other products               |       | 2                                                         |       | 40                                                        |       | (95        | )%         |
| Total sales, all products    |       | $                                                         | 4,021      |                                                      | $          | 3,701      |       | 9 | % |

 
| ** **             | ** ** | **Three Months Ended  June 30, 2009** | ** ** | **Three Months Ended  June 30, 2008** | ** ** | **Change** | ** ** |
|------------------------|------------|-----------------------------------------------------------|------------|------------------------------------------------------|------------|------------|------------|
|                   |       |                                                      |       |                                                 |       |       |       |
| Gross profit      |       | $                                                         | 1,733      |                                                 | $          | 1,304      |       | 33 | % |
| Income from operations |       | $                                                         | 435        |                                                 | $          | 292        |       | 49 | % |
| Net income             |       | $                                                         | 413        |                                                 | $          | 271        |       | 52 | % |

 

Sales for thefirst quarter of fiscal year 2010 increased from the first quarter prior yearperiod by $320,000 or 9% due to an increase in natural astaxanthin productsales.

 

Spirulina salesdecreased 6% over the first quarter of fiscal year 2009, primarily due to thefulfillment of $710,000 of backlog sales orders which carried over from the March 31,2008 into the first quarter of fiscal 2009. Spirulina sales increased 44% overthe first quarter of fiscal year 2009 when adjusted for this backlog. No suchbacklog existed at March 31, 2009.

 

Naturalastaxanthin product sales increased over the first quarter prior year perioddue to an increase in sales of both bulk and packaged astaxanthin products.Bulk product sales increased by 37% while packaged nutrition products increasedby 18%.  A backlog of astaxanthinproducts in the amount of $209,000 at March 31, 2008 carried over into thefirst quarter of fiscal 2009. Astaxanthin sales increased  49% over the first quarter of fiscal year2009 when adjusted for this backlog. The Company is focused on building marketshare as a nutritional brand which promotes health and well-being. Astaxanthinproducts are a growing segment of this market.

 

Gross profit marginas a percentage of sales increased to 43% for the three months ended June, 30,2009 from 35% for the first quarter a year ago. This is the result of a salesincrease for the first quarter of fiscal year 2010 of 9% coupled with  cost of products sold decrease of 5% from thefirst quarter of the last fiscal year. The improvement reflects the company’sincreased inventory levels allowing better customer service and essentiallyeliminating backlog orders. Additionally, improved production levels reduced per unit cost.Management continues researching methodology to promote and sustain productionat desired capacity and quality levels.

 

Net income of$413,000 for the first quarter of fiscal 2010 represents an improvement of$142,000 over the first quarter of fiscal 2009 which had a net income of$271,000. The increase is the result of improved gross margins offset by someincreases in operating costs.

 

**Results of Operations**

 

# ***First Quarter of Fiscal 2010 Compared to First Quarter ofFiscal 2009***

# ** **

Net sales for thefirst quarter of fiscal 2010 increased to $4,021,000, a 9% increase from the$3,701,000 reported for the comparable period a year ago.  Company salesof Spirulina products for the first quarter of fiscal 2010 were $1,918,000,which is a 6% decrease from sales generated in the first quarter of fiscal2009.  As a percentage of sales, Spirulina accounted for 48% of totalsales in the first quarter of fiscal 2010, compared to 55% for the comparableperiod a year ago. Spirulina sales have declined as a percentage of total salesprimarily due to increased sales of Natural Astaxanthin products in the firstquarter of the current fiscal year and a decline in Spirulina sales as a resultof backlog shipments made in the prior year fiscal quarter.

 

14

----

Table ofContents

 

Naturalastaxanthin product sales were $2,101,000 during the first quarter of 2010, a30% increase from $1,621,000 in the first quarter of the prior year. Natural astaxanthin product sales increased to 52% of total sales from 44% oftotal sales in the first quarter of fiscal 2009. This increase is the result ofthe Company focusing its products to build nutritional brands which promotehealth and well-being. Sales of packaged products increased 18% over the sameperiod last fiscal year. Bulk sales increased as well at 37%.

 

Internationalsales were 47% of total sales for the first quarter of fiscal year 2010 and 41%in the first quarter of 2009. Major customers are those equaling or exceeding10% of the Company’s sales for the period. For the first quarter of fiscal 2010there were no customers who had sales equal to or greater than 10% of theCompany’s total sales for the quarter. Two European distributors each had salesequal to or greater than 10% of the Company’s total sales for the first quarterof fiscal year 2009.

 

Gross profit,derived from net sales less the cost of product sales, includes the cost ofmaterials, direct labor, manufacturing overhead and depreciation. Gross profitfor the three months ended June 30, 2009 was $1,733,000, with a grossprofit margin percentage of 43%. This was an increase from gross profit marginof $1,304,000 and gross profit margin of 35% reported for the comparable prioryear quarter. Sales for the first quarter of fiscal year 2010 increased 9% fromthe comparable prior year period while costs of products sold decreased 5% forthe same respective period, resulting in the 8% improvement in gross profitmargin percentage. The improvement reflects the growth and stabilization ofproduction levels over several quarters, which results in lower costs per unitand improved margins.

 

Variableproduction costs increased 7% in the current period compared to one year agoprimarily due to labor costs which increased 41% from combined pay rateincreases and added personnel to achieve increased production. Fixed costs haveincreased by 4% primarily due to production equipment additions beingdepreciated. Spirulina production increased 22% and astaxanthin productionincreased 2% over the same quarter one year ago. Total variable and fixed costsspread over increased production units is continuing to lower individual unitcosts.

 

Pursuant to SFAS No. 151“Inventory Costs — an amendment of ARB No. 43, Chapter 4,” approximately$0 and $23,000 of fixed production overhead cost was charged to cost of salesduring the three months ended June 30, 2009 and June 30, 2008,respectively. There were no lower of cost or market issues for the firstquarters of fiscal years 2010 or 2009.

 

Operating expenses for the three months ended June 30,2009 were 32% of sales or $1,298,000, compared to 27% of sales or $1,012,000for the three months ended June 30, 2008. The increase in operatingexpenses in the three months ended June 30, 2009 as compared with thethree months ended June 30, 2008, was primarily the result of General andadministrative expenses incurred in completing the reporting requirements forthe prior fiscal year, and initiation of programs in Research and developmentand in Sales and marketing. General and administrative expense for the firstquarter 2010 increased by $187,000 from the first quarter of 2009. Research anddevelopment expense for the first quarter of 2010 increased by $44,000 from thefirst quarter of 2009. Management expects that Research and developmentexpenses in future periods will focus on improved production methods.

 

For the threemonths ended June 30, 2009, the Company recorded an income tax expense of$10,000 related to Federal and state alternative minimum tax. For the threemonths ended June 30, 2008, an income tax receivable of $11,000 wasrecorded related to Federal and state tax credits.  The Company does not expect any material U.S.Federal or state income taxes to be recorded for the current fiscal yearbecause of available net operating loss carry-forwards.

 

In Summary, theCompany had net income of $413,000 or $0.08 per diluted share, for the threemonths ended June 30, 2009 compared****toa net income of $271,000, or $0.05 per diluted share for the three months endedJune 30, 2008.

 

**Variabilityof Results**

 

The Company hasexperienced significant quarterly fluctuations in operating results and suchfluctuations could occur in future periods. The Company has, during itshistory, experienced fluctuations in operating results due to thefollowing:  changes in sales levels toour customers, competition (both pricing, new products and other markettrends), production difficulties from increased production costs and variable production results due toinclement weather, and start up costs associated with new productintroductions, new facilities and expansion into new markets. In addition,future operating results may fluctuate as a result of factors beyond theCompany’s control such as foreign exchange fluctuations, changes in governmentregulations, and economic changes in the regions it operates in and sells to. Aportion of our operating expenses are relatively fixed and the timing ofincreases in expense levels is based in large part on forecasts of futuresales. Therefore, if net sales are below expectations in any given period, theadverse impact on results of operations may be magnified by our inability toadjust spending in certain areas meaningfully, or to adjust spending quicklyenough, as in personnel and administrative costs. We may also choose to reduceprices or increase spending in response to market conditions, and thesedecisions may have a material adverse effect on financial condition and resultsof operations.

 

15

----

Table ofContents

 

**FinancialCondition**

 

Cash and cashequivalents remained consistent with levels at March 31, 2009 decreasingonly $24,000 or 2%. Cash provided by operating activities of $487,000 increased$295,000 over the same quarter last fiscal year. The increase is due to theincrease in net income of $142,000, plus the increase of non-cash expenses of$83,000 and the net improvement of changes in current assets and liabilities of$70,000 over the same quarter of last fiscal year.

 

As of June 30,2009, the Company’s net accounts receivable increased $507,000 to $2,292,000from $1,785,000 as of March 31, 2009. The increase in accounts receivableis primarily the result of the timing of sales for the quarter. Managementbelieves that its accounts receivable are collectible, net of the allowance fordoubtful accounts of $14,000 at June 30, 2009.

 

The Company’s netinventory decreased $26,000 or 1% to $3,098,000 as of June 30, 2009 comparedto $3,124,000 as of March 31, 2009. The decrease in inventory during thefirst three months of fiscal 2010 is primarily due to an increase in sales ofpackaged product finished goods. This is consistent with the Company’s emphasison nutrition products.

 

Cash flows used ininvesting activities reflect capital expenditures which totaled $358,000 duringthe first three months of fiscal 2010 compared to just $45,000 one year ago.Cash flows used in financing activities are attributable to debt paymentsduring that period which were $152,000 and $138,000 for the first quarters offiscal 2010 and 2009, respectively.

 

**Liquidityand Capital Resources**

 

At June 30,2009, the Company’s working capital was $4,037,000, an increase of $145,000compared to $3,892,000 at March 31, 2009. Cash and cash equivalents at June 30,2009 totaled $953,000, a decrease of $24,000 from $977,000 at March 31,2009.

 

The Company hastwo Term Loan Agreements (“Term Loans”) with a lender. These provided up to$4.6 million in combined credit facilities which are secured bysubstantially all the assets of the Company. The outstanding combined balanceunder the Term Loans as of June 30, 2009 is approximately $1,351,000. TheTerm Loans have maturity dates of May 1, 2010 as to $435,000 and March 1,2015 as to $916,000 and are payable in equal monthly principal payments plusinterest totaling approximately $55,000.

 

The interest rateunder the Term Loans, in absence of a default under the agreement, is the primerate, as defined, in effect as of the close of business on the first day ofeach calendar quarter, plus 1% (the prime rate was 3.25% at June 30,2009). The Company is prohibited by the Term Loan from declaring any cashdividends without the lender’s prior written consent. A $250,000 restrictedcash deposit must be held in an interest-bearing restricted cash account perthe terms of the Term Loan and is included in other assets in the consolidatedbalance sheet at June 30, 2009.

 

On April 24, 2009, the Company entered into an agreement withFirst Hawaiian Bank for a Line of Credit in the amount of $150,000 for a termof one year. The obligation is secured by the Company’s U.S. accountsreceivable and bears a variable interest rate based on prime plus 2%. There wasno outstanding balance as of June 30, 2009.  The lenderunder the Company’s existing Term Loans has subordinated its position up to$150,000 of U.S. accounts receivable.

 

The Company has,as previously reported, experienced a number of factors that have negativelyimpacted its balance sheet and liquidity, including the following:

 

·                  The Company had experienced significant recurring net losses. At June 30,2009, the Company had an accumulated deficit of $19,506,000 compared to anaccumulated deficit of $19,921,000 at March 31, 2009. The accumulateddeficit decreased by $415,000 for the quarter ended June 30, 2009.

 

·                  Material weaknesses in its internal controls, as previously reported,have caused the Company to experience delays in completing its consolidatedfinancial statements and filing periodic reports with the SEC on a timelybasis. Accordingly, the Company continues to devote substantial additionalinternal resources, and to experience higher than expected fees for auditservices. At present the Company has concluded that more rigorous emphasis onimproving the capabilities of existing systems, procedures, and existingpersonnel, will correct the material weakness.

 

16

----

Tableof Contents

 

·                  In early December 2007, the Company cut its workforce byapproximately 20% to conserve liquidity and reduce costs to allow time for theCompany to recover from weather related production losses. The Company hassince increased its operations workforce to achieve enhanced productionefficiency and effectiveness and sustain improved sales.

 

***Sufficiency of Liquidity***

 

Based upon ourcurrent operating plan, analysis of our consolidated financial position andprojected future results of operations, we believe that our operating cashflows, cash balances, and working capital, together with a moderate amount ofadditional borrowing, will be sufficient to finance current operatingrequirements, meet debt service requirements, and make planned capitalexpenditures, for the next twelve (12) months. Management expects liquidity inthe remainder of fiscal 2010 to be generated from operating cash flows.

 

**CapitalResources**

 

The Companyexpects fiscal 2010 capital expenditures to be approximately $1,000,000 and tobe funded from operating cash flows. This includes capital expenditures insupport of the Company’s normal operations, and expenditures that we may incurin conjunction with initiatives to improve gross margins and reduce expenses.

 

## **Outlook**

## ** **

*Thisoutlook section contains a number of forward-looking statements, all ofwhich are based on current expectations. Actual results may differ materially.*

 

CyanotechCorporation’s strategic direction has always been to position itself as a worldleader in the production and marketing of high-value natural products frommicroalgae. We are vertically aligned, producing raw materials in the form ofmicroalgae processed at our 90-acre facility in Hawaii, and integrating thoseraw materials into finished products. In fiscal 2010, we will put greateremphasis on our Nutrex Hawaii consumer products. Our focus going forward willbe to leverage our experience and reputation for quality, building nutritionalbrands which promote health and well-being. The foundation of our nutritionalproducts is naturally cultivated Spirulina Pacifica® in powder, flake andtablet 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 and www.nutrex-hawaii.com. Consumer productscan also be purchased online at www.nutrex-hawaii.com.

 

We are currentlyexperiencing an upward trend in sales primarily in our Natural astaxanthinproducts.  The Company is focused onsustainability of its production levels in order to promote continued growth inits astaxanthin product line. The Company expects spirulina sales to remainessentially level since the product has reached a mature life cycle stage.Significant sales variability between periods and even across several periodscan be expected based on historical results.

 

Overall costs havebeen increasing in part because of increasing utility, chemical, andtransportation costs which reflect and respond to oil prices. We feel thatthese conditions will likely continue, and consequently, we are putting greaterfocus on cost controls and expense avoidance.

 

Gross profitmargin percentages in fiscal year 2010 will be impacted by continued pressure oninput costs and this could cause margins to decline in future periods.Management will continue its focus on health and well-being, promoting highergross margin items. Management is dedicated to continuous improvements inprocess and production methods to stabilize and increase production levels forthe future.

 

With the adoptionof SFAS 151, the Company recognizes costs associated with abnormal amounts ofidle facility expense, freight, handling costs and wasted materials (such asspoilage) as current-period charges in cost of sales. When production costsexceed historical averages, management evaluates whether such costs arecurrent-period charges or are inventoriable costs. In addition, the allocationof fixed production overheads (such as depreciation and general insurance) toinventories is determined based on normal production capacity. When the Company’sproduction volumes are below normal capacity limits, certain fixed productionoverhead costs cannot be inventoried and are recorded immediately in cost ofsales. Producing the highest quality microalgae is a complex biological processwhich requires balancing numerous factors including microalgal strainvariation, temperature, acidity, nutrient and other environmentalconsiderations, some of which are not within the Company’s control.

 

17

----

Table ofContents

 

To manage its cashresources effectively, the Company will continue to balance production in lightof sales demand, minimizing the cost associated with build-ups in inventorywhen appropriate. The Company has experienced other significant cash outflowsand may need to utilize other cash resources to meet working capital needs ifprolonged net losses are incurred in future periods. A prolonged downturn insales could impair the Company’s ability to generate sufficient cash foroperations and minimize the Company’s ability to attract additional capitalinvestment which could become necessary in order to expand into new markets orincrease product offerings.

 

Management expectsGeneral and administrative expense to increase somewhat over fiscal year 2009levels. By March 31, 2010, the Company is required to be in fullcompliance with the Sarbanes-Oxley Act and Rules issued there under by theSEC, including Section 404 Compliance Standards established by the PublicCompanies Accounting Oversight Board. The cost of attaining and maintainingsuch compliance could materially decrease reported net income or increasereported net losses in future periods.

 

The Company’sfuture results of operations and the other forward-looking statements containedin this Outlook, in particular the statements regarding revenues, gross marginand capital spending involve a number of risks and uncertainties. In additionto the factors discussed above, any of the following could cause actual resultsto differ materially: business conditions and growth in the natural productsindustry and in the general economy; changes in customer order patterns;changes in demand for natural products in general; changes in weatherconditions; competitive factors, such as increased production capacity fromcompeting spirulina and astaxanthin producers and the resulting impact, if any,on world market prices for these products; government actions; shortage ofmanufacturing capacity; and other factors beyond our control. Risk factors arediscussed in detail in Item 1A in our Form 10-K report for the year ended March 31,2009.

 

Management believes thatour technology, systems, processes and favorable growing location generallypermit year-round harvest of our microalgal products in a cost-effectivemanner. However, imbalances in astaxanthin production in fiscal year 2007 andspirulina production in 2008, together with increasing energy costs, suggest aneed for continuing caution. We cannot, and do not attempt to, provide any formof assurance with regard to our technology, systems, processes, location, orcost-effectiveness.

 

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

 

We do not enter into any transactions using derivative financialinstruments or derivative commodity instruments and believe that our exposureto market risk associated with other financial instruments is not material.

 

We have two term loans which adjust quarterly based on the prime rate.As such, we are exposed to the interest rate risk whereby a 1% increase in theprime rate would lead to an increase of approximately $14,000 in interestexpense for the year ending March 31, 2010 (based on June 30, 2009amounts outstanding).

 

18

----

Table of Contents

 

**Item 4.   Controls and Procedures**

 

(a) **Disclosure Controls and Procedures**

 

We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and15 (d)-15(e) under the Exchange Act that are designed to ensure thatinformation required to be disclosed in our reports filed or submitted underthe Exchange Act is recorded, processed, summarized and reported, within thetime periods specified in the Security and Exchange Commission’s rules andforms, and that such information is accumulated and communicated to management,including our Chief Executive Officer and Chief Financial Officer, asappropriate, to allow for timely decisions regarding required disclosure.

 

This Form 10-Q should be read in conjunction with Item 9A(T) “Controlsand Procedures” of the Company’s Form 10-K for the fiscal year ended March 31,2009 filed June 25, 2009. There were no material changes in controls andprocedures during the current quarter. As of June 30, 2009, managementbelieves systems and procedures were in place to reasonably ensure accurate financialdata.

 

As noted in prior years’ Form 10-K, errors were identified in thecalculations and applications of certain accounting practices relating to thecarrying value of inventory. Accordingly, the Company has taken measures overthe past two years to correct the identified weakness: (1) The Companyengaged the services of qualified independent consultants to advise the Companyon improvements to internal controls and procedures; (2) the Company addedto its staff of educated and experienced accounting personnel; and (3) consultantsindependent from those who assisted with improvements and procedures havetested the Company’s internal controls over financial reporting concurrent withthis Form 10-Q. Based on these measures, management believes systems andprocedures are in place to reasonably ensure accurate financial data. However,these controls and procedures continue to rely heavily on manual transfers ofdata, manual calculations and supervisory review of the work product. It is notpractical to believe that such manual activities will eliminate the possibilityof a material misstatement of the annual or interim financial statements.

 

(b) **Changes to Internal Control Over Financial Reporting**

 

There was no change in our internal control over financial reportingduring the current quarter that has materially affected or is reasonably likelyto materially affect, our internal control over financial reporting. TheCompany has undertaken to upgrade its resource management software to provide asingle source for all financial data; establish access controls to data andtransactions; and to automate allocations, calculations and periodicreports.  The upgrade is in process andis expected to be completed prior to March 31, 2010.

 

19

----

Table of Contents

 

**PART II.      OTHER INFORMATION**

 

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

 

None.

 

**Item 2.**           **Unregistered Sales ofEquity Securities and Use of Proceeds**

 

None.

 

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

 

None.

 

**Item 4.**           **Submission of Matters toa Vote of Security Holders**

 

None.

 

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

 

TheCompany’s Bylaws were amended by its Board of Directors on April 30,2009.  The Amended and Restated Bylaws (“Bylaws”),among other changes, provide an advance notice procedure for stockholders tonominate a person or persons as a director. Procedurally, eligible stockholders must submit for actual receipt bythe Company, Attention Corporate Secretary, at its principal executive office,any nomination within 120-150 days prior to the anniversary date of the prioryear’s annual meeting of stockholders. As an example, in the case of the Company’s 2010 Annual Meeting,nominations by eligible stockholders, as defined in the Bylaws, must bereceived no later than May 10, 2010 and no earlier than April 10,2010, unless our Annual Meeting date occurs more than 30 days before or after September 9,2010.  In that case, the Company mustreceive nominations not earlier than the close of business 120 days prior tothe date of the annual meeting and not later than 90 days prior to the date ofthe annual meeting, or, if the first public announcement of the date of suchannual meeting is less than 100 days prior to the date of such annual meeting,the tenth day following the day on which public announcement of the date ofsuch meeting is first made by the Company.

 

To bein proper form, a stockholder’s notice must include specified informationconcerning the proposed nominee, as well as the stockholder and possiblypersons affiliated with the stockholder, as described in the Bylaws.  The Company will not consider any proposednomination that does not meet all requirements of the Bylaws and of theSecurities and Exchange Commission.

 

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

 
| a)     | The following exhibits  are furnished with this report: |
|--------|---------------------------------------------------------|
|   |                                                    |
|   | 31.1                                                    |   | Certifications  of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002 signed as of August 13, 2009 |
|   |                                                    |   |   |
|   | 31.2                                                    |   | Certifications  of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002 signed as of August 13, 2009. |
|   |                                                    |   |   |
|   | 32.1                                                    |   | Certifications  of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002 signed as of August 13, 2009. |
|   |                                                    |   |   |
|   | 32.2                                                    |   | Certifications  of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002 signed as of August 13, 2009. |

 

20

----

Table ofContents

 

SIGNATURES

 

In accordance with therequirements of the Securities Exchange Act of 1934, the registrant caused thisreport to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 
|                 |   |            | CYANOTECH CORPORATION                                      |
|----------------------|--------|-----------------|------------------------------------------------------------|
|                 |   |            | (Registrant)                                               |
|                 |   |            |                                                       |
|                 |   |            |                                                       |
| August 13, 2009 |   | By:   | /s/ Andrew H. Jacobson                                |
| (Date)               |   |            | Andrew H. Jacobson                                         |
|                 |   |            | *President and Chief Executive Officer*                    |
|                 |   |            |                                                       |
|                 |   |            |                                                       |
| August 13, 2009 |   | By:   | /s/ Deanna L. Spooner                                      |
| (Date)               |   |            | Deanna L. Spooner                                          |
|                 |   |            | *Vice President — Finance & Administration,* |
|                 |   |            | *Chief Financial Officer*                                  |

 

21

----

 

EXHIBIT INDEX

 
| **Exhibit Number** | ** ** | **Description**                                                                                                                               |
|-------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------|
|                    |       |                                                                                                                                          |
| 31.1                    |       | Certifications of Chief  Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 signed as of August 13, 2009. |
|                    |       |                                                                                                                                          |
| 31.2                    |       | Certifications of Chief  Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 signed as of August 13, 2009. |
|                    |       |                                                                                                                                          |
| 32.1                    |       | Certifications of Chief  Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002 signed as of August 13, 2009.      |
|                    |       |                                                                                                                                          |
| 32.2                    |       | Certifications of Chief  Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002 signed as of August 13, 2009. |

 

22

----