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**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**   |
|---------------------------------------------------|----------------------------------------------------------------------------------------------------------|
|                                              |                                                                                                     |
| **For Quarterly Period Ended June 30, 2010** |
|                                              |
| **Or**                                            |
|                                              |                                                                                                     |
| **o**                                             | **Transition  Report Pursuant to Section 13 or 15(d) of the Securities Exchange  Act of 1934** |

 

**For the Transition 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 markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)during the preceding 12 months (or for such shorter period that the registrantwas required to submit and post such files).   Yes  x   No  o

 

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

 

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

 

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

 

Numberof common shares outstanding as of August 12, 2010:

 

| **Title of Class**   | ** ** | **Shares Outstanding** |
|--------------------------------|------------|-----------------------------|
| Common stock - $0.02 par value |       | 5,383,628                   |

 

 

 

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CYANOTECHCORPORATION

 

FORM 10-Q

 

INDEX

 
| **PART I.  FINANCIAL  INFORMATION** |
|----------------------------------------------------|
| ** **                                         | ** ** | ** ** |
| Item 1.                                            | Financial Statements  (unaudited) | 3 |
|                                               | Consolidated Condensed  Balance Sheets as of June 30, 2010 and March 31, 2010 | 3 |
|                                               | Consolidated Condensed  Statements of Operations for the three months ended June 30, 2010 and  2009 | 4 |
|                                               | Consolidated Condensed  Statements of Cash Flows for the three months ended June 30, 2010 and  2009 | 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 | 18 |
| **PART II.  OTHER  INFORMATION**    |
| ** **                                         | ** ** | ** ** |
| Item 1.                                            | Legal Proceedings | 19 |
| Item 2.                                            | Unregistered  Sales of Equity Securities and Use of Proceeds | 19 |
| Item 3.                                            | Defaults  upon Senior Securities | 19 |
| Item 5.                                            | Other Information | 19 |
| Item 6.                                            | Exhibits | 19 |
| SIGNATURES                                         | 20 |

 

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PART 1.  FINANCIALINFORMATION

 

Item1.  Financial Statements (Unaudited)

 

CYANOTECH CORPORATION

CONSOLIDATED CONDENSEDBALANCE SHEETS

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

(Unaudited)

 
| ** **                                                                                                                                                              | ** ** | **June 30,  2010** | ** ** | **March 31,  2010** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|--------------------------|------------|
| ASSETS                                                                                                                                                                  |       |                    |       |                     |       |
| Current assets:                                                                                                                                                         |       |                    |       |                     |       |
| Cash and cash equivalents                                                                                                                                               |       | $                       | 868        |                     | $          | 817 |   |
| Accounts receivable, net of allowance for doubtful  accounts of $10 at June 30, 2010 and March 31, 2010                                                  |       | 2,188                   |       | 2,064                    |       |
| Inventories, net                                                                                                                                                        |       | 4,177                   |       | 3,933                    |       |
| Prepaid expenses and other assets                                                                                                                                       |       | 143                     |       | 400                      |       |
| Total current assets                                                                                                                                                    |       | 7,376                   |       | 7,214                    |       |
|                                                                                                                                                                    |       |                    |       |                     |       |
| Equipment and leasehold improvements, net                                                                                                                               |       | 4,732                   |       | 4,681                    |       |
| Other assets                                                                                                                                                            |       | 257                     |       | 253                      |       |
| Total assets                                                                                                                                                            |       | $                       | 12,365     |                     | $          | 12,148 |   |
|                                                                                                                                                                    |       |                    |       |                     |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                               |       |                    |       |                     |       |
| Current liabilities:                                                                                                                                                    |       |                    |       |                     |       |
| Current maturities of long-term debt                                                                                                                                    |       | $                       | 198        |                     | $          | 276 |   |
| Line of credit                                                                                                                                                          |       | 150                     |       | 150                      |       |
| Customer deposits                                                                                                                                                       |       | 37                      |       | —                   |       |
| Accounts payable                                                                                                                                                        |       | 882                     |       | 1,125                    |       |
| Accrued expenses                                                                                                                                                        |       | 866                     |       | 721                      |       |
| Total current liabilities                                                                                                                                               |       | 2,133                   |       | 2,272                    |       |
|                                                                                                                                                                    |       |                    |       |                     |       |
| Long-term debt, excluding current maturities                                                                                                                            |       | 706                     |       | 756                      |       |
| Total liabilities                                                                                                                                                       |       | 2,839                   |       | 3,028                    |       |
|                                                                                                                                                                    |       |                    |       |                     |       |
| Commitments and contingencies                                                                                                                                           |       |                    |       |                     |       |
|                                                                                                                                                                    |       |                    |       |                     |       |
| Stockholders’ equity:                                                                                                                                              |       |                    |       |                     |       |
| Common stock of $0.02 par value, shares authorized  7,500,000; 5,252,572 shares issued and outstanding at June 30, 2010  and 5,252,572 at March 31, 2010 |       | 105                     |       | 105                      |       |
| Additional paid-in capital                                                                                                                                              |       | 27,552                  |       | 27,545                   |       |
| Accumulated deficit                                                                                                                                                     |       | (18,131                 | )          | (18,530                  | )          |
| Total stockholders’ equity                                                                                                                                         |       | 9,526                   |       | 9,120                    |       |
|                                                                                                                                                                    |       |                    |       |                     |       |
| Total liabilities and stockholders’ equity                                                                                                                         |       | $                       | 12,365     |                     | $          | 12,148 |   |

 

See accompanying Notes to Consolidated Condensed Financial Statements.

 

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CYANOTECH CORPORATION

CONSOLIDATED CONDENSED STATEMENTSOF OPERATIONS

 (Dollars in thousands, exceptper share amounts)

(Unaudited)

 
| ** **                                           | ** ** | **Three Months Ended June 30,** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                           | ** ** | **2010**                                            | ** ** | **2009** | ** ** |
|                                                 |       |                                                |       |   |   |
| NET SALES                                            |       | $                                                   | 3,856      |   | $ | 4,021 |   |
| COST OF PRODUCT SALES                                |       | 2,197                                               |       | 2,288 |   |
| Gross Profit                                         |       | 1,659                                               |       | 1,733 |   |
|                                                 |       |                                                |       |   |   |
| OPERATING EXPENSES:                                  |       |                                                |       |   |   |
| General and administrative                           |       | 763                                                 |       | 896 |   |
| Sales and marketing                                  |       | 383                                                 |       | 322 |   |
| Research and development                             |       | 84                                                  |       | 80 |   |
| Total operating expenses                             |       | 1,230                                               |       | 1,298 |   |
|                                                 |       |                                                |       |   |   |
| Income from operations                               |       | 429                                                 |       | 435 |   |
|                                                 |       |                                                |       |   |   |
| OTHER INCOME (EXPENSE):                              |       |                                                |       |   |   |
| Interest expense, net                                |       | (20                                                 | )          | (29 | ) |
| Other income, net                                    |       | —                                              |       | 17 |   |
| Total other expense, net                             |       | (20                                                 | )          | (12 | ) |
|                                                 |       |                                                |       |   |   |
| Income before income taxes                           |       | 409                                                 |       | 423 |   |
|                                                 |       |                                                |       |   |   |
| PROVISION FOR INCOME TAXES                           |       | 10                                                  |       | 10 |   |
|                                                 |       |                                                |       |   |   |
| NET INCOME                                           |       | $                                                   | 399        |   | $ | 413 |   |
|                                                 |       |                                                |       |   |   |
| NET INCOME PER SHARE:                                |       |                                                |       |   |   |
| Basic                                                |       | $                                                   | 0.08       |   | $ | 0.08 |   |
| Diluted                                              |       | $                                                   | 0.07       |   | $ | 0.08 |   |
|                                                 |       |                                                |       |   |   |
| SHARES USED IN CALCULATION OF NET INCOME PER  SHARE: |       |                                                |       |   |   |
| Basic                                                |       | 5,253                                               |       | 5,246 |   |
| Diluted                                              |       | 5,321                                               |       | 5,294 |   |

 

See accompanying Notes to Consolidated Condensed Financial Statements.

 

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CYANOTECH CORPORATION

CONSOLIDATED STATEMENTS OFCASH FLOWS

(Dollars in thousands)(Unaudited)

 
| ** **                                                                         | ** ** | **Three Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2010**                                        | ** ** | **2009** | ** ** |
| ** **                                                                         | ** ** | ** **                                      | ** ** | ** ** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                              |       |                                            |       |   |   |
| Net income                                                                         |       | $                                               | 399        |   | $ | 413 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                                            |       |   |   |
| Depreciation and amortization                                                      |       | 145                                             |       | 114 |   |
| Amortization of debt issue costs and other assets                                  |       | 6                                               |       | 14 |   |
| Stock based compensation expense                                                   |       | 8                                               |       | 77 |   |
| Net (increase) decrease in assets:                                                 |       |                                            |       |   |   |
| Accounts receivable                                                                |       | (124                                            | )          | (507 | ) |
| Inventories                                                                        |       | (244                                            | )          | 26 |   |
| Prepaid expenses and other assets                                                  |       | (7                                              | )          | 9 |   |
| Net increase (decrease) in liabilities:                                            |       |                                            |       |   |   |
| Customer deposits                                                                  |       | 37                                              |       | 23 |   |
| Accounts payable                                                                   |       | (242                                            | )          | 68 |   |
| Accrued expenses                                                                   |       | 145                                             |       | 250 |   |
| Net cash provided by operating activities                                          |       | 123                                             |       | 487 |   |
|                                                                               |       |                                            |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                              |       |                                            |       |   |   |
| Investment in equipment and leasehold improvements                                 |       | (194                                            | )          | (358 | ) |
| Proceeds from return of restricted cash                                            |       | 250                                             |       | — |   |
| Net cash provided by (used in) investing  activities                               |       | 56                                              |       | (358 | ) |
|                                                                               |       |                                            |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                              |       |                                            |       |   |   |
| Principal payments on long-term debt                                               |       | (128                                            | )          | (153 | ) |
| Cash used in financing activities                                                  |       | (128                                            | )          | (153 | ) |
|                                                                               |       |                                            |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                              |       | 51                                              |       | (24 | ) |
|                                                                               |       |                                            |       |   |   |
| Cash and cash equivalents at beginning of period                                   |       | 817                                             |       | 977 |   |
|                                                                               |       |                                            |       |   |   |
| Cash and cash equivalents at end of period                                         |       | $                                               | 868        |   | $ | 953 |   |
|                                                                               |       |                                            |       |   |   |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                                  |       |                                            |       |   |   |
| Cash paid during the period for:                                                   |       |                                            |       |   |   |
| Interest                                                                           |       | $                                               | 17         |   | $ | 18 |   |
| Income taxes                                                                       |       | $                                               | 7          |   | $ | 20 |   |

 

See accompanying Notes to Consolidated Condensed Financial Statements.

 

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CYANOTECH CORPORATION

NOTES TO CONSOLIDATEDCONDENSED FINANCIAL STATEMENTS

As of June 30, 2010(Unaudited)

 

**1.****                                     ****BASISOF PRESENTATION**

 

Theaccompanying consolidated condensed financial statements have been prepared inaccordance with accounting principles generally accepted in the United Statesof America (“GAAP”) for interim financial information and with the instructionsto Form 10-Q and Regulation S-X.  Accordingly, they do not includeall of the information and footnotes required by GAAP for complete financialstatements. The consolidated condensed balance sheet as of March 31, 2010was derived from the audited financial statements. These consolidated condensed financial statements and notes should beread in conjunction with the Company’s consolidated financial statements forthe year ended March 31, 2010, contained in the Company’s report onForm 10-K as filed on June 24, 2010.

 

Theaccompanying consolidated condensed financial statements include the accountsof Cyanotech Corporation and its wholly owned subsidiary, NutrexHawaii, Inc. (“Nutrex Hawaii” or “Nutrex”). All significant intercompanybalances and transactions have been eliminated in consolidation.

 

Thepreparation of financial statements in conformity with GAAP requires managementto make estimates and assumptions that affect the reported amounts of assetsand liabilities 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,NET**

 

Inventoriesare stated at the lower of cost (which approximates first-in, first-out) ormarket. Market is defined as sales price less cost to dispose and a normalprofit margin.  Inventories consist of the following:

 
| ** **        | ** ** | **June 30, 2010**  | ** ** | **March 31, 2010** | ** ** |
|-------------------|------------|-------------------------|------------|------------------------------|------------|
| ** **        | ** ** | **(in thousands)** | ** ** |
| Raw  materials    |       | $                       | 485        |                         | $          | 392 |   |
| Work in process   |       | 302                     |       | 303                          |       |
| Finished goods(1) |       | 3,218                   |       | 3,062                        |       |
| Supplies          |       | 172                     |       | 176                          |       |
|              |       | $                       | 4,177      |                         | $          | 3,933 |   |

 

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(1)          Net of reserve forobsolescence of $54,000 at both June 30 and March 31, 2010.

 

TheCompany recognizes abnormal production costs including fixed cost variancesfrom normal production capacity as an expense in the period incurred. No fixedproduction related costs were charged to cost of sales for the quarters endedJune 30, 2010 and 2009, respectively.

 

**3.****                                     ****EQUIPMENTAND LEASEHOLD IMPROVEMENTS, NET**

 

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

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

 

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Equipmentand leasehold improvements consist of the following:

 
| ** **                                     | ** ** | **June 30, 2010**  | ** ** | **March 31, 2010** | ** ** |
|------------------------------------------------|------------|-------------------------|------------|------------------------------|------------|
| ** **                                     | ** ** | **(in thousands)** | ** ** |
| Equipment(1)                                   |       | $                       | 6,468      |                         | $          | 6,350 |   |
| Leasehold improvements                         |       | 7,298                   |       | 7,298                        |       |
| Furniture and fixtures                         |       | 93                      |       | 88                           |       |
|                                           |       | 13,859                  |       | 13,736                       |       |
| Less accumulated depreciation and amortization |       | (9,387                  | )          | (9,243                       | )          |
| Construction-in-progress                       |       | 260                     |       | 188                          |       |
| Equipment and leasehold improvements, net      |       | $                       | 4,732      |                         | $          | 4,681 |   |

 

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(1)          Includes $97,000 of equipment under capital leasewith accumulated depreciation of $5,000 and $0 at June 30, 2010 and March 31,2010, respectively.

 

Managementreviews long-lived assets for impairment whenever events or changes incircumstances indicate that the carrying value of such assets may not berecoverable. Recoverability of these assets is measured by a comparison of thecarrying amount to forecasted undiscounted future cash flows expected to begenerated by the asset. If the carrying amount exceeds its estimated futurecash flows, then an impairment charge is recognized to the extent that thecarrying amount exceeds the asset’s fair value. Management has determined noasset impairment existed as of June 30, 2010.

 

**Note 4 Accrued Expenses**

 

Accrued expenses consist of the following:

 
| ** **                       | ** ** | **June 30, 2010** | ** ** | **March 31, 2010** | ** ** |
|----------------------------------|------------|------------------------|------------|-------------------------|------------|
| ** **                       | ** ** | **(in thousands)**     | ** ** |
| Wages, commissions and royalties |       | $                      | 428        |                    | $          | 334 |   |
| Professional fees                |       | 25                     |       | 34                      |       |
| Bonuses                          |       | 175                    |       | 140                     |       |
| Other accrued expenses           |       | 238                    |       | 213                     |       |
|                             |       | $                      | 866        |                    | $          | 721 |   |

 

**Note 5 Line of Credit**

 

The Company has a line of credit agreement with First Hawaiian Bank inthe amount of $350,000 for a term of one year. The amount of the line was increased from $150,000 on March 25, 2010,the date that the line of credit agreement was renewed.  The obligation is secured by the Company’sU.S. accounts receivable and bears a variable interest rate based on prime(3.25% at June 30, 2010) plus 2%. The outstanding balance as of June 30,2010 and March 31, 2010 was $150,000. The credit agreement requires theCompany to meet certain financial covenants. The Company was in compliance withthese financial covenants at June 30, 2010.

 

**4.**                                      **LONG-TERMDEBT**

 

Long-term debt consists ofthe following:

 
| ** **                                   | ** ** | **June 30, 2010** | ** ** | **March 31, 2010** | ** ** |
|----------------------------------------------|------------|------------------------|------------|-------------------------|------------|
| ** **                                   | ** ** | **(in thousands)**     | ** ** |
| Term loans                                   |       | $                      | 904        |                    | $          | 1,032 |   |
| Less current maturities                      |       | (198                   | )          | (276                    | )          |
| Long-term debt, excluding current maturities |       | $                      | 706        |                    | $          | 756 |   |

 

*Term Loan Agreement*

 

In April 2000, the Company executed a Term Loan Agreement (“TermLoan A”) with a lender providing for $3.5 million in aggregate creditfacilities, secured by the Company’s assets. Term Loan A had a maturity date ofMay 1, 2010. The balance under this loan was $0 and $80,000 atJune 30, 2010 and March 31, 2010, respectively. A warrant to purchase5,000 shares of the Company’s common stock was issued in conjunction with thisTerm Loan. The warrant expires 

 

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inApril 2011 and has an exercise price of $10.20 per share. The warrant mayonly be exercised after the Company has repaid the Term Loan in full. Thecredit agreement requires the Company to meet certain financial covenants. TheCompany was in compliance with these financial covenants at June 30, 2010.

 

In February 2008, the Company executed a Term Loan Agreement (“TermLoan B”) with the same lender providing for $1.1 million in aggregatecredit facilities, secured by the Company’s assets. Term Loan B has a maturitydate of March 1, 2015 and is payable in 84 equal monthly principalpayments plus interest. The interest rate under Term Loan B, in the absence ofa default under the agreement, is the prime rate in effect as of the close ofbusiness on the first day of each calendar quarter, plus 1%. As ofJune 30, 2010, the prime rate was 3.25%. The balance under this loan was$772,000 and $808,000 at June 30, 2010 and March 31, 2010,respectively. The Company is prohibited from declaring any common stockdividends without the lender’s prior written consent.

 

A $250,000 restricted cash deposit was held to secure these loans andwas released to the Company in May 2010 upon maturity of Term Loan A. The$250,000 restricted cash deposit is included in other current assets in theaccompanying consolidated condensed balance sheet at March 31, 2010.

 

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 face value of the termloan is reported in the balance sheets at $20,000, less the unamortizeddiscount of $1,509 at June 30, 2010 and $22,000, less the unamortizeddiscount of $2,053 at March 31, 2010.

 

In January 2010, the Company executed a Term Loan Agreement withJohn Deere credit providing for $27,217 in equipment, secured by the equipmentfinanced. The Term Loan has a maturity date of December 28, 2012 and ispayable in 36 equal monthly principal payments. The interest rate under thisTerm Loan is 0%. Imputed interest at a rate of 2% (cash discount offered byseller) has been recorded and will be amortized as interest over the term ofthe loan. The face value of the term loan is reported in the balance sheets at$24,000, less the unamortized discount of $1,418 at June 30, 2010 and$27,000, less the unamortized discount of $1,552 at March 31, 2010.

 

In March 2010, the Company executed a capital lease agreement withThermo Fisher Financial providing for $97,000 in equipment, secured by theequipment financed. The capital lease has a maturity date of March 2013and is payable in 36 equal monthly payments. The interest rate under thiscapital lease is 6.6%. The balance under this lease was $90,000 at June 30,2010 and $97,000 at March 31, 2010.

 

Future principal payments under the term loan agreements as ofJune 30, 2010 are as follows:

 
| **Payments  Due**        | ** ** | **(in  thousands)** | ** ** |
|--------------------------|------------|---------------------|------------|
| Next 12 Months           |       | $                   | 198        |   |
| Year 2                   |       | 204                 |       |
| Year 3                   |       | 199                 |       |
| Year 4                   |       | 170                 |       |
| Year 5                   |       | 133                 |       |
| Thereafter through 2015  |       | —              |       |
| Total principal payments |       | $                   | 904        |   |

 

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

 

TheCompany leases facilities, equipment and land under operating leases expiringbetween 2010 and 2026.  The land leaseprovides for contingent rental in excess of minimum rental commitments based ona percentage of the Company’s sales. Management has accrued for the estimatedcontingent rent as of June 30, 2010.

 

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Futureminimum lease payments under all non-cancelable operation leases atJune 30, 2010 are as follows:

 
| **Payments  Due**            | ** ** | **(in  thousands)** | ** ** |
|------------------------------|------------|---------------------|------------|
| Next 12 Months               |       | $                   | 165        |   |
| Year 2                       |       | 157                 |       |
| Year 3                       |       | 157                 |       |
| Year 4                       |       | 157                 |       |
| Year 5                       |       | 154                 |       |
| Thereafter through 2026      |       | 1,554               |       |
| Total minimum lease payments |       | $                   | 2,344      |   |

 

**6.**                                      **SHARE-BASEDCOMPENSATION**

 

TheCompany accounts for transactions under share based payment arrangements withemployees based on fair value. If an award vests or becomes exercisable basedon the achievement of a condition other than service, such as for meetingcertain performance or market condition, the award is classified as aliability.  Liability-classified awards are remeasured to fair value ateach balance sheet date until the award is settled. The Company currently hasno liability-classified awards.  Equity-classified awards, includinggrants of employee stock options, are measured at the grant-date fair value ofthe award and are not subsequently remeasured 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 stock options are “plainvanilla,” as defined by the U. S. Securities and Exchange Commission in StaffAccounting Bulletin No. 107, they are reflected only in Stockholders’Equity and Compensation Expense accounts.

 

***Stock Options***

 

Asof June 30, 2010, the Company had the following two shareholder approvedstock plans under which shares were available for equity based awards: The 2005Stock Option Plan (the “2005 Plan”) wherein 700,000 shares of common stock arereserved for issuance until the Plan terminates on August 21, 2015, and;The Independent Director Stock Option and Stock Grant Plan (the “2004 DirectorsPlan”) wherein 75,000 shares of common stock are reserved for issuance untilthe plan terminates in 2014.

 

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, 2010,369,794 options remain available for grant under the 2005 Plan.

 

Underthe 2004 Directors Plan, upon election to the Board of Directors, a newlyelected non-employee director is granted a ten-year option to purchase 1,000shares of the Company’s common stock. Options granted vest and becomeexercisable six months from the date of grant.  In addition, on the dateof each Annual Meeting of Stockholders, each non-employee director continuingin office is automatically issued 875 shares of common stock, non-transferablefor nine months following the date of grant. The 2004 Directors Plan wasamended effective March 24, 2010, to increase the number of shares of commonstock issued to each non-employee director to 2,000 shares and an additional2,000 shares to the director serving as Chairman of the Board. As ofJune 30, 2010, 47,123 options remain available for grant under the 2004Directors Plan.

 

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Thefollowing table presents shares authorized, available for future grant andoutstanding under each of the Company’s plans:

 
| ** **          | ** ** | **As of June 30, 2010** | ** ** |
|---------------------|------------|------------------------------|------------|
| ** **          | ** ** | **Authorized**               | ** ** | **Available** | ** ** | **Outstanding** | ** ** |
|                |       |                         |       |   |   |   |   |
| 2005 Plan           |       | 700,000                      |       | 369,794 |   | 330,206 |   |
| 2004 Directors Plan |       | 75,000                       |       | 47,123 |   | 1,000 |   |
| 1994 Plan           |       | —                       |       | — |   | 2,250 |   |
| Total               |       | 775,000                      |       | 416,917 |   | 333,456 |   |

 

Allstock option grants made under the 2005 Plan and the 2004 Directors Plan wereat exercise prices no less than the Company’s closing stock price on the dateof grant. Options under the 2005 Plan and 2004 Directors Plan were determinedby the Board of Directors or the Stock Option and Compensation Committee of theBoard in accordance with the provisions of the respective plans.  Theterms of each option grant include vesting, exercise, and other conditions areset forth in a Stock Option Agreement evidencing each grant. No option can havea life in excess of ten (10) years.  The Company records compensationexpense for employee stock options based on the estimated fair value of theoptions on the date of grant using the Black-Scholes option-pricing model. Themodel requires various assumptions, including a risk-free interest rate, theexpected term of the options, the expected stock price volatility over theexpected term of the options, and the expected dividend yield. Compensationexpense for employee stock options is recognized ratably over the vesting term.Compensation expense recognized for options issued under the 2005 Plan was$8,000 and $77,000 for the three months ended June 30, 2010 and 2009,respectively and is classified as General and Administrative expense in theconsolidated condensed statement of operations. There was no compensationexpense recognized under the 2004 Directors Plan for the three months endedJune 30, 2010 and 2009.

 

Asummary of option activity under the Company’s stock plans for the three monthsended June 30, 2010 is presented below:

 
| **Option Activity**           | ** ** | **Shares** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Weighted Average  Remaining  Contractual Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|------------------------------------|------------|------------|------------|------------------------------------------------|------------|-------------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at March 31, 2010 |       | 333,606    |       | $                                              | 1.69       |                                                        | 8.4 years  |                            | $          | 555,281 |   |
| Granted                            |       | —     |       | —                                         |       | —                                                      |       | —                          |       |
| Exercised                          |       | —     |       | $                                              | —     |                                                        | —     |                            | —     |   |
| Forfeited or expired               |       | (150       | )          | $                                              | 1.60       |                                                        | —     |                            | —     |   |
| Outstanding at June 30, 2010  |       | 333,456    |       | $                                              | 1.69       |                                                        | 8.2 years  |                            | $          | 71,507 |   |
| Exercisable at June 30, 2010  |       | 162,351    |       | $                                              | 1.51       |                                                        | 7.3 years  |                            | $          | 63,448 |   |

 

Theaggregate intrinsic value in the table above is before applicable income taxesand represents the amount optionees would have received if all options had beenexercised on the last business day of the period indicated, based on theCompany’s closing stock price of $1.90 for such day.

 

Asummary of the Company’s non-vested options for the three months endedJune 30, 2010 is presented below:

 
| **Nonvested Options**       | ** ** | **Shares** | ** ** | **Weighted  Average  Grant-Date  Fair Value** | ** ** |
|----------------------------------|------------|------------|------------|----------------------------------------------------|------------|
| Nonvested at March 31, 2010 |       | 181,955    |       | $                                                  | .62        |   |
| Granted                          |       | —     |       | —                                             |       |
| Vested                           |       | (10,850    | )          | .65                                                |       |
| Forfeited or expired             |       | —     |       | —                                             |       |
| Nonvested at June 30, 2009  |       | 171,105    |       | $                                                  | .62        |   |

 

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Thefollowing table summarizes the weighted average characteristics of outstandingstock options as of June 30, 2010:

 
| ** **                              | ** ** | **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                     |       | 331,706                      |       | 8.2                              |       | $ | 1.67 |   | 160,601 |   | $ | 1.48 |   |
| $ 4.20 - $4.40                     |       | 1,750                        |       | 2.9                              |       | 4.31 |   | 1,750 |   | 4.31 |   |
| Total stock options                     |       | 333,456                      |       | 8.2                              |       | $ | 1.69 |   | 162,351 |   | $ | 1.51 |   |

 

Therewere no stock options granted during the three months ended June 30, 2010and 113,000 stock options granted during the three months ended June 30,2009. The range of fair value assumptions related to options granted during thethree months ended June 30 were as follows:

 
| ** **       | ** ** | ** ** | ** ** | **2009**   | ** ** |
|------------------|------------|------------|------------|------------|------------|
| Exercise Price:  |       |       |       |       | $          | 2.08 |   |
| Volatility:      |       |       |       | 88.9       | %          |
| Risk Free Rate:  |       |       |       | 3.13       | %          |
| Vesting Period:  |       |       |       | 4 years    |       |
| Forfeiture Rate: |       |       |       | 20         | %          |
| Expected Life    |       |       |       | 6.25 years |       |
| Dividend Rate    |       |       |       | 0          | %          |
|                  |            |            |            |            |            |  |  |

 

Asof June 30 2010, total unrecognized stock-based compensation expenserelated to all unvested stock options was $80,030, which is expected to beexpensed over a weighted average period of 2.5 years.

 

***Warrant***

 

AtJune 30, 2010 and 2009, the Company had a single warrant outstanding whichallows the warrant holder rights to acquire 5,000 shares of the Company’scommon stock.  The warrant was valued atthe date of grant and was amortized as premium, but was subsequently deemed tohave no value as a result of a reverse split which occurred in a prioryear.  Accordingly, no expense wasrecognized in the quarters ended June 30, 2010 or 2009.  The warrant expires in April 2011 andhas an exercise price of $10.20 per share.

 

**7.            ****INCOMETAXES**

 

TheCompany is subject to taxation in the United States and two statejurisdictions.  The preparation of taxreturns requires management to interpret the applicable tax laws andregulations in effect in such jurisdictions, which could affect the amount oftax paid by the Company. Management, in consultation with its tax advisors,files its tax returns on interpretations that are believed to be reasonableunder the circumstances. The income tax returns, however, are subject toroutine reviews by the various taxing authorities in the jurisdictions in whichthe Company files its returns.  As part of these reviews, a taxingauthority may disagree with respect to the tax positions taken by management (“uncertaintax positions”) and therefore may require the Company to pay additional taxes.Management evaluates the requirement for additional tax accruals, includinginterest and penalties, which the Company could incur as a result of theultimate resolution of its uncertain tax positions. Management reviews andupdates the accrual for uncertain tax positions as more definitive informationbecomes available from taxing authorities, completion of tax audits, expirationof statute of limitations, or upon occurrence of other events.

 

Asof December 31, 2009, there was no significant liability for income taxassociated 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 ofoperations, which is consistent with the recognition of these items in priorreporting periods.

 

Incometaxes are provided on the earnings in the consolidated financial statements.The provision is based on the current quarter activity of the legal entitiesand jurisdictions 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 customaryrelationship between income tax expense (benefit) and pre-tax income.  The effective tax rate for the three monthsended June 30, 2010 differs from the statutory rate due to utilization ofnet operating loss carryforwards that have been fully reserved due to theCompany’s inconsistent taxable income in recent years and uncertainty abouttaxable income in future years.

 

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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.**             **EARNINGSPER SHARE**

 

Basicearnings per share is computed on the basis of the weighted average number ofcommon shares outstanding.  Diluted earnings per share is computed on thebasis of the weighted average number of common shares outstanding plus thepotentially dilutive effect 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, 2010 andJune 30, 2009 are as follows:

 
| ** **                                              | ** ** | **Three Months Ended June 30, 2010** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                              | ** ** | **Net Income**                                           | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| ** **                                              | ** ** | **(Numerator)**                                               | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
| ** **                                              | ** ** | **(in thousands)**                                       | ** ** | ** ** | ** ** |
| Basic income per share                                  |       | $                                                             | 399        |   | 5,253 |   | $ | 0.08 |   |
| Effect of dilutive securities—Common stock options |       | —                                                        |       | 68 |   | — |   |
| Diluted income per share                                |       | $                                                             | 399        |   | 5,321 |   | $ | 0.07 |   |

 
| ** **                                                 | ** ** | **Three Months Ended June 30, 2009** | ** ** |
|------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **Net Loss**                                             | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| ** **                                                 | ** ** | **(Numerator)**                                               | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
| ** **                                                 | ** ** | **(in thousands)**                                       | ** ** | ** ** | ** ** |
| Basic income per share                                     |       | $                                                             | 413        |   | 5,246 |   | $ | 0.08 |   |
| Effect of dilutive securities — Common stock  options |       | —                                                        |       | 48 |   | — |   |
| Diluted income per share                                   |       | $                                                             | 413        |   | 5,294 |   | $ | 0.08 |   |

 

**9.            NEW ACCOUNTINGPRONOUNCEMENTS**

 

In January 2010, the Financial Accounting Standards Board (“FASB”)issued Accounting Standards Update (“ASU”) No. 2010-06, “ImprovingDisclosures about Fair Value Measurements,” an amendment to AccountingStandards Codification (“ASC”) 820, “Fair Value Measurements and Disclosures.”The standard requires disclosure for transfers in and out of Level 1 andLevel 2, as well as the disclosure of Level 3 activity on a gross,rather than net, basis. The guidance also requires enhancements to certainexisting disclosures. The amendments are effective as of the beginning of ourfiscal year 2011, or April 1, 2010, except for the new requirementsregarding Level 3 activity, which is deferred until the beginning offiscal year 2012. The guidance is not expected to have an impact on the Company’sconsolidated financial statements.

 

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**Item 2.    Management’s Discussion and Analysis of Financial Condition andResults of Operations**

 

**FORWARD LOOKING STATEMENTS**

 

This Report and other presentations made by Cyanotech Corporation (“CYAN”)and its subsidiaries 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, ongoing businessstrategies or prospects and possible future actions are also forward-lookingstatements. Forward-looking statements are based upon current expectations andprojections about future events and are subject to risks, uncertainties and theaccuracy of assumptions concerning CYAN and its subsidiaries (collectively, the“Company”), the performance of the industry in which CYAN does business, andeconomic and market factors, among other things. **These forward-looking statements are not guarantees of future 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 our businessobjectives; 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, including but notlimited to, the volatility of crude oil prices and currency fluctuations;

 

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

 

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

 

·                  Changes in domestic and/orforeign laws, regulations or standards, affecting nutraceutical products or theCompany’s methods of operation;

 

·                  Environmental restrictions,soil and water conditions, variations in daylight hours and seasonal weatherpatterns, particularly heavy rain, wind and other hazards;

 

·                  Access to available andreasonable financing on a timely basis;

 

·                  Changes in laws, includingnew corporate governance requirements and increased tax rates, regulations oraccounting standards, and decisions of courts, regulators and governmentalbodies;

 

·                  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, terroristincidents 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.

 

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**Overview**

 

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

 
| ** **                   | ** ** | **Three Months Ended**      | ** ** | ** **                  | ** ** |
|------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                   | ** ** | **June 30, 2010** | ** ** | **June 30, 2009** | ** ** | **Change** | ** ** |
| ** **                   | ** ** | ** **                  | ** ** | ** **                  | ** ** | ** ** | ** ** |
| Net sales:                   |       |                        |       |                        |       |   |   |
| Spirulina products           |       | $                           | 1,954      |                        | $          | 1,918 |   | 2 | % |
| Natural astaxanthin products |       | 1,900                       |       | 2,101                       |       | (10 | )% |
| Other products               |       | 2                           |       | 2                           |       | 0 | % |
| Total sales, all products    |       | $                           | 3,856      |                        | $          | 4,021 |   | (4 | )% |

 
| ** **             | ** ** | **Three Months Ended**      | ** ** | ** **                  | ** ** |
|------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **             | ** ** | **June 30, 2010** | ** ** | **June 30, 2009** | ** ** | **Change** | ** ** |
|                   |       |                        |       |                        |       |   |   |
| Gross profit      |       | $                           | 1,659      |                        | $          | 1,733 |   | (4 | )% |
| Income from operations |       | $                           | 429        |                        | $          | 435 |   | (1 | )% |
| Net income             |       | $                           | 399        |                        | $          | 413 |   | (3 | )% |

 

Spirulinasales increased 2% over the first quarter of fiscal year 2009, primarily due toan increase of $113,000 (or 9%) in bulk product sales offset by a decrease of$77,000 (or 11%) in packaged spirulina. Packaged spirulina sales decreasedprimarily due to reduced sales to foreign private label customers as comparedto prior year.

 

Naturalastaxanthin product sales decreased over the first quarter prior year perioddue to a decrease in sales of both bulk and packaged astaxanthin products. Bulkproduct sales decreased by 5% or $67,000 while packaged astaxanthin productsdecreased by 22% or $134,000 over the first quarter of fiscal year 2009.Packaged astaxanthin sales decreased primarily due to reduced sales to foreignprivate label customers as compared to prior year.

 

Grossprofit margin, as a percentage of sales, remained the same at 43% for the threemonths ended June, 30, 2010 and for the comparable period in the prior year.

 

Netincome of $399,000 for the first quarter of fiscal 2011 represents a decline of$14,000 from the first quarter of fiscal 2010, which had a net income of$413,000. The decrease is the result of decreased sales over the same period inthe prior year.

 

**Results of Operations**

 

*First Quarter of Fiscal 2011 Compared to FirstQuarter of Fiscal 2010*

 

Netsales for the first quarter of fiscal 2011 were $3,856,000, a 4% decrease fromthe $4,021,000 reported for the comparable period a year ago.  As apercentage of sales, Spirulina accounted for 51% of total sales in the firstquarter of fiscal 2011, compared to 48% for the comparable period a year ago.Spirulina sales have increased as a percentage of total sales primarily due todecreased sales of Natural Astaxanthin products in the first quarter of thecurrent fiscal year.

 

Naturalastaxanthin product sales decreased to 49% of total sales from 52% of totalsales in the first quarter of fiscal 2009. This decrease is the result ofdecrease in both bulk and packaged sales from the same period last fiscal year.

 

Internationalsales were 46% of total sales for the first quarter of fiscal year 2011 and 47%in the first quarter of 2010. Major customers are those equaling or exceeding10% of our sales for the period. For the first quarter of fiscal 2011 therewere two customers who had sales equal to or greater than 10% of our totalsales for the quarter.  For the firstquarter of fiscal 2010 there were no customers who had sales equal to orgreater than 10% of our total sales for the quarter.

 

Grossprofit, derived from net sales less the cost of product sales, includes thecost of materials, direct labor, manufacturing overhead and depreciation. Grossprofit for the three months ended June 30, 2010 and 2009 was $1,659,000and $1,733,000, respectively.  Thedecrease is the direct result of reduced sales, as gross profit marginpercentages remained unchanged at 43% for both the current three months and thesame period one year ago

 

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Variableproduction costs remained consistent in the current period compared to one yearago. Increases in labor and supplies were offset by decreases in repair andmaintenance and miscellaneous expenses. Fixed costs have increased approximately 20% primarily due todepreciation expense associated with additions to production equipment.Spirulina production increased 12% and astaxanthin production increased 13%over the same quarter one year ago reflecting higher yields. Total variable andfixed costs spread over increased production units continue to lower individualunit production costs.

 

Operatingexpenses were $1,230,000 in the three months ended June 30, 2010 comparedto $1,298,000 in the quarter ended June 30, 2009, a decrease of $68,000.As a percentage of sales, operating expenses were 32% in the quarters ended June 30,2010 and 2009.

 

Thedecrease in operating expenses in the three months ended June 30, 2010 ascompared with the three months ended June 30, 2009, was primarily theresult of reduced general and administrative expense offset by increases inboth sales and marketing expense and research and development expense.  General and administrative expense for thefirst quarter 2011 decreased by $133,000, down 15% from the first quarter of2010. The decrease is primarily the result of reduced expenses associated withpublic company reporting requirements and reductions in stock compensationexpense. Sales and marketing expense for the first quarter of 2011 increased by$61,000 or 19% over the first quarter of 2010. The increase is due primarily tothe initiation of new marketing programs for packaged products. Research anddevelopment expense for the first quarter of 2011 increased by $4,000, up 5%from the first quarter of 2010.

 

Werecorded an income tax expense of $10,000 related to federal and statealternative minimum tax for each of the three months ended June 30, 2010and June 30, 2009.  We do not expectany material U.S. federal or state income taxes to be recorded for the currentfiscal year because of available net operating loss carry-forwards.

 

Insummary, we reported net income of $399,000 or $0.07 per diluted share, for thethree months ended June 30, 2010 compared****to net income of $413,000, or $0.08 per diluted share for the threemonths ended June 30, 2009.

 

**Variability of Results**

 

TheCompany has experienced significant quarterly fluctuations in operating resultsand such fluctuations could occur in future periods. The Company has, duringits history, experienced fluctuations in operating results due to the following:  changes in sales levels to our customers;competition including pricing, new products and shifts in market trends;production difficulties from increased production costs and variable productionresults due to inclement weather; and start up costs associated with newproduct introductions, new facilities and expansion into new markets. Inaddition, future operating results may fluctuate as a result of factors beyondthe Company’s control such as foreign exchange fluctuations, changes ingovernment regulations, and economic changes in the regions it operates in andsells to. A portion of our operating expenses are relatively fixed and thetiming of increases in expense levels is based in large part on forecasts offuture sales. Therefore, if net sales are below expectations in any givenperiod, the adverse impact on results of operations may be magnified by ourinability to effectively adjust spending in certain areas, or to adjustspending in a timely manner, as in personnel and administrative costs. We mayalso choose to reduce prices or increase spending in response to marketconditions, and these decisions may have a material adverse effect on financialcondition and results of operations.

 

**Financial Condition**

 

Cashand cash equivalents remained consistent with levels at March 31, 2010increasing $51,000, or 6% to $868,000 at June 30, 2010. Cash provided byoperating activities of $123,000 decreased $364,000 from the same quarter lastfiscal year. The decrease is due to the decrease in net income of $14,000, plusthe decrease of non-cash expenses of $46,000 and the net changes in currentassets and liabilities using cash of $304,000 over the same quarter of lastfiscal year. Net cash provided by investing activities improved by $414,000over the same quarter of last fiscal year mainly due to the return ofrestricted cash in the amount of $250,000.

 

Asof June 30, 2010, our accounts receivable, net increased $124,000 to$2,188,000 from $2,064,000 as of March 31, 2010. The increase in accountsreceivable is primarily the result of the timing of sales for the quarter.Management believes that its accounts receivable are collectible, net of theallowance for doubtful accounts of $10,000 at June 30, 2010.

 

Ournet inventory increased $244,000 or 6% to $4,177,000 as of June 30, 2010compared to $3,933,000 as of March 31, 2010. The increase in inventoryduring the first three months of fiscal 2011 is primarily due to increasedproduction as the hours of daylight increase in the summer months and slightlyreduced sales.

 

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Cashflows used in investing activities reflect capital expenditures which totaled$194,000 during the first three months of fiscal 2011 compared to $358,000 oneyear ago. Cash flows used in financing activities are attributable to debtpayments during that period which were $128,000 and $153,000 for the firstquarters of fiscal 2011 and 2010, respectively.

 

**Liquidity and Capital Resources**

 

At June 30, 2010, our working capital was $5,243,000, an increaseof $301,000 compared to $4,942,000 at March 31, 2010. Cash and cashequivalents at June 30, 2010 totaled $868,000, an increase of $51,000 from$817,000 at March 31, 2010.

 

We had two Term Loan Agreements (“Term Loans”) with a lender. Theseprovided up to $4.6 million in combined credit facilities which aresecured by substantially all the assets of the Company. One of the Term Loanswas paid in full on its maturity date of May 1, 2010. The outstandingbalance under the remaining Term Loan as of June 30, 2010 is approximately$772,000 with a maturity date of March 1, 2015 and is payable in equalmonthly principal payments plus interest totaling approximately $15,000. Theinterest rate under the Term Loan, in absence of a default under the agreement,is the prime rate, as defined, in effect as of the close of business on thefirst day of each calendar quarter, plus 1% (the prime rate was 3.25% atJune 30, 2010). We are prohibited by the Term Loan from declaring any cashdividends without the lender’s prior written consent.

 

We have a line of credit agreement with First Hawaiian Bank in theamount of $350,000 for a term of one year. The amount of the line was increased from $150,000 on March 25,2010, the date that the line of credit agreement was renewed.  The obligation is secured by the Company’sU.S. accounts receivable and bears a variable interest rate based on prime,(3.25% at June 30, 2010), plus 2%. The outstanding balance as of June 30,2010 and March 31, 2010 was $150,000. The credit agreement requires theCompany to meet certain financial covenants. The Company was in compliance withthese financial covenants at June 30, 2010.

 

We have, as previously reported, experienced a number of factors thathave negatively impacted our balance sheet and liquidity. At June 30,2010, we had an accumulated deficit of $18,131,000 compared to an accumulateddeficit of $18,530,000 at March 31, 2010. The accumulated deficitdecreased by $399,000 for the quarter ended June 30, 2010.

 

***Sufficiency of Liquidity***

 

Basedupon our current operating plan, analysis of our consolidated financialposition and projected future results of operations, we believe that ouroperating cash flows, cash balances, and working capital, together with amoderate amount of additional borrowing, will be sufficient to finance currentoperating requirements, debt service requirements, and planned capitalexpenditures, for the next twelve (12) months. We expect liquidity in theremainder of fiscal 2011 to be generated from operating cash flows.

 

**CapitalResources**

 

Weexpect fiscal 2011 capital expenditures to be approximately $900,000 and to befunded from operating cash flows. This includes capital expenditures in supportof our normal operations, and expenditures that we may incur in conjunctionwith initiatives to improve gross margins and reduce expenses.

 

**Outlook**

 

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

 

Ourstrategic direction has been to position the Company as a world leader in theproduction and marketing of high-value natural products from microalgae. We arevertically aligned, producing raw materials in the form of microalgae processedat our 90-acre facility in Hawaii, and integrating those raw materials intofinished products. In fiscal 2011, we are putting increased emphasis on ourNutrex Hawaii consumer products to introduce them to a broader consumer marketthan in prior years. Our focus going forward will continue to be to leverageour experience and reputation for quality, building nutritional brands whichpromote health and well-being. The foundation of our nutritional products isnaturally cultivated Spirulina Pacifica® in powder, flake and tablet form; and *BioAstin*® natural astaxanthin antioxidantin extract, softgel caplet and micro-encapsulated beadlet form. Informationabout our Company and our products can be viewed at www.cyanotech.com andwww.nutrex-hawaii.com. Consumer products can also be purchased online atwww.nutrex-hawaii.com.

 

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Weare focused on sustainability of its production levels in order to promotegrowth in its astaxanthin product line. In fiscal year 2010 we expanded ourBioAstin based MD Formulas Hawaii line in order to provide all vegetariancondition specific alternatives to consumers. Our introduction of Spirulina Pacifica Multivitamins in fiscal year2010, is expected to allow spirulina sales to increase even though spirulinahas reached a mature life cycle stage. We will continue to promote thenutritional superiority of Hawaiian grown spirulina to maintain and expandmarket share. Significant sales variability between periods and even acrossseveral periods can be expected based on historical results.

 

Risingcrude oil prices in prior years resulted in increased nutrient, utility andtransportation costs which reflect and respond to oil prices. We feel thatthese conditions are likely to occur again in the near or distant future, andconsequently, we are putting greater focus on prudent cost controls and expenseavoidance.

 

Grossprofit margin percentages going forward will be impacted by continued pressureon input costs and greater competition in the market place. This could causemargins to decline in future periods. We will continue to focus on health and well-being,promoting higher gross margin items. We are dedicated to continuousimprovements in process and production methods to stabilize and increaseproduction levels for the future.

 

Producingthe highest quality microalgae is a complex biological process which requiresbalancing numerous factors including microalgal strain variation, temperature,acidity, nutrient and other environmental considerations, some of which are notwithin our control. An imbalance or unexpected event can occur resulting in productionlevels below normal capacity. The allocation of fixed production overheads(such as depreciation and general insurance) to inventories is determined basedon normal production capacity. When our production volumes are below normalcapacity limits, certain fixed production overhead costs cannot be inventoriedand are recorded immediately in cost of sales. In addition, when productioncosts exceed historical averages, we evaluate whether such costs areone-time-period charges or an ongoing component of inventory cost.

 

Tomanage our cash resources effectively, we will continue to balance productionin light of sales demand, minimizing the cost associated with build-ups ininventory when appropriate. We could experience unplanned cash outflows and mayneed to utilize other cash resources to meet working capital needs. A prolongeddownturn in sales could impair our ability to generate sufficient cash foroperations and minimize our ability to attract additional capital investmentwhich could become necessary in order to expand into new markets or maintainoptimal production levels.

 

Ourfuture 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 and increasedregulations both domestic and foreign; shortage of manufacturing capacity; andother factors beyond our control. Risk factors are discussed in detail in Item1A in our Form 10-K report for the year ended March 31, 2010.

 

Webelieve that our technology, systems, processes and favorable growing locationgenerally permit year-round harvest of our microalgal products in acost-effective manner. However, previously experienced imbalances in the highlycomplex biological production systems, together with volatile energy costs andrapidly changing world markets, suggest a need for continuing caution withrespect to variables beyond our reasonable control. Therefore, we cannot, anddo not attempt to, provide any definitive assurance with regard to ourtechnology, systems, processes, location, or cost-effectiveness.

 

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**Item 3.   Quantitative and Qualitative Disclosures 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 one term loan which adjusts 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 $7,000 in interestexpense for the year ending March 31, 2011 (based on June 30, 2010amount outstanding).

 

**Item 4.   Controls and Procedures**

 

(a) **Disclosure Controls and Procedures**

 

Wemaintain 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 the timeperiods 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.

 

ThisForm 10-Q should be read in conjunction with Item 9A “Controls andProcedures” of the Company’s Form 10-K for the fiscal year endedMarch 31, 2010, filed June 24, 2010. There were no material changesin controls and procedures during the current quarter. As of June 30,2010, management believes systems and procedures were in place to reasonablyensure accurate financial data.

 

As noted in prior years’ Forms 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 few 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) consultants independent from those who assisted with improvements andprocedures have tested the Company’s internal controls over financial reportingconcurrent with this Form 10-Q. Based on these measures, managementbelieves systems and procedures are in place to reasonably ensure accuratefinancial data. However, these controls and procedures continue to rely heavilyon manual transfers of data, manual calculations and supervisory review of thework product. It is not practical to believe that such manual activities willeliminate the possibility of a material misstatement of the annual or interimfinancial 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. We haveundertaken to upgrade our resource management software to provide a singlesource for all financial data; establish access controls to data andtransactions; and to automate allocations, calculations and periodicreports.  All critical manual processesare expected to be automated prior to March 31, 2011.  Additional functionality will continue to beadded to our resource management system throughout fiscal 2012 in order toprovide additional assurances of the accuracy of our financial reporting.

 

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**PART II.      OTHER INFORMATION**

 

**Item 1.**    **LegalProceedings**

 

None.

 

**Item 2.**    **UnregisteredSales of Equity Securities and Use of Proceeds**

 

None.

 

**Item 3.**    **Defaultsupon Senior Securities**

 

None.

 

**Item 5.**    **OtherInformation**

 

None.

 

**Item 6.    Exhibits**

 

a)           The followingexhibits 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 12, 2010                               |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                       |
| 31.2   | Certifications  of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002 signed as of August 12, 2010.                              |
|   |                                                                                                                                                                       |
| 32     | Certifications  of Chief Executive Officer and Chief Financial Officer Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 signed as of  August 12, 2010. |

 

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SIGNATURES

 

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

 
|                 |     | CYANOTECH  CORPORATION                                             |
|----------------------|----------|--------------------------------------------------------------------|
|                 |     | (Registrant)                                                       |
|                 |     |                                                               |
|                 |     |                                                               |
| August 12, 2010 |     | By:                                                                | /s/ David I. Rosenthal |
| (Date)               |     | David I. Rosenthal                                                 |
|                 | * * | *Interim President and Chief Executive Officer and  Director*      |
|                 | * * | *(Performing the Functions of Principal Executive  Officer)*       |
|                 |     |                                                               |
| August 12, 2010 |     | By:                                                                | /s/ Deanna L. Spooner |
| (Date)               |     | Deanna L. Spooner                                                  |
| * *             | * * | *Vice President — Finance &  Administration and CFO* |
| * *             | * * | *(Principal Financial and Accounting Officer)*                     |

 

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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 12, 2010                               |
|                    |       |                                                                                                                                                                       |
| 31.2                    |       | Certifications  of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002 signed as of August 12, 2010.                              |
|                    |       |                                                                                                                                                                       |
| 32                      |       | Certifications  of Chief Executive Officer and Chief Financial Officer Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 signed as of  August 12, 2010. |

 

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