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** **

 

** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-Q**

 

**x  QuarterlyReport Pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934**

 

**ForQuarterly Period Ended September 30, 2009**

 

**Or**

 

**o  Transition Report Pursuant to Section 13or 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 QueenKaahumanu 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, everyInteractive Data File required to be submitted and posted pursuant to Rule 405of Regulation 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 November 12, 2009:

 

| **Title of  Class**             | ** ** | **Shares  Outstanding** |
|---------------------------------|------------|-------------------------|
| Common stock -  $0.02 par value |       | 5,249,270               |

 

 

 

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CYANOTECH CORPORATION

 

FORM 10-Q

 

INDEX

 
| ** ** | ** ** | **PART I.  FINANCIAL  INFORMATION**                                                                           | ** ** |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------|------------|
| ** ** | ** ** | ** **                                                                                                                   | ** ** |
| Item 1.    |       | Financial Statements  (unaudited)                                                                                            | 3          |
|       |       | Consolidated  Condensed Balance Sheets as of September 30, 2009 and March 31,  2009                                | 3          |
|       |       | Consolidated  Condensed Statements of Operations for the three and six month periods ended  September 30, 2009 and 2008 | 4          |
|       |       | Consolidated  Condensed Statements of Cash Flows for the six month periods ended  September 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                                                                  | 19         |
| Item 4.    |       | Controls and  Procedures                                                                                                     | 19         |
| ** ** | ** ** | **PART II.  OTHER  INFORMATION**                                                                              | ** ** |
| ** ** | ** ** | ** **                                                                                                                   | ** ** |
| Item 1.    |       | Legal Proceedings                                                                                                            | 20         |
| Item 2.    |       | Unregistered Sales of Equity  Securities and Use of Proceeds                                                                 | 20         |
| Item 3.    |       | Defaults upon Senior Securities                                                                                              | 20         |
| Item 4.    |       | Submission of Matters to a Vote  of Security Holders                                                                         | 20         |
| Item 5.    |       | Other Information                                                                                                            | 20         |
| Item 6.    |       | Exhibits                                                                                                                     | 21         |
| SIGNATURES | 22         |

 

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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)

 
| ** **                                                                                                                                                                   | ** ** | **September 30,  2009** | ** ** | **March 31,  2009** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|--------------------------|------------|
| ASSETS                                                                                                                                                                       |       |                         |       |                     |       |
| Current assets:                                                                                                                                                              |       |                         |       |                     |       |
| Cash and cash equivalents                                                                                                                                                    |       | $                            | 1,100      |                     | $          | 977 |   |
| Accounts receivable, net of allowance for doubtful  accounts of $11 at September 30, 2009 and $14 at March 31,  2009                                          |       | 1,830                        |       | 1,785                    |       |
| Inventories                                                                                                                                                                  |       | 3,521                        |       | 3,124                    |       |
| Prepaid expenses and other                                                                                                                                                   |       | 194                          |       | 110                      |       |
| Total current assets                                                                                                                                                         |       | 6,645                        |       | 5,996                    |       |
|                                                                                                                                                                         |       |                         |       |                     |       |
| Equipment and leasehold improvements, net                                                                                                                                    |       | 4,583                        |       | 4,316                    |       |
| Other assets                                                                                                                                                                 |       | 456                          |       | 475                      |       |
| Total assets                                                                                                                                                                 |       | $                            | 11,684     |                     | $          | 10,787 |   |
|                                                                                                                                                                         |       |                         |       |                     |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                    |       |                         |       |                     |       |
| Current liabilities:                                                                                                                                                         |       |                         |       |                     |       |
| Current maturities of long-term debt                                                                                                                                         |       | $                            | 471        |                     | $          | 620 |   |
| Accounts payable                                                                                                                                                             |       | 773                          |       | 1,040                    |       |
| Accrued expenses                                                                                                                                                             |       | 753                          |       | 444                      |       |
| Total current liabilities                                                                                                                                                    |       | 1,997                        |       | 2,104                    |       |
|                                                                                                                                                                         |       |                         |       |                     |       |
| Long-term debt, less current maturities                                                                                                                                      |       | 752                          |       | 909                      |       |
| Total liabilities                                                                                                                                                            |       | 2,749                        |       | 3,013                    |       |
|                                                                                                                                                                         |       |                         |       |                     |       |
| Commitments and contingencies                                                                                                                                                |       |                         |       |                     |       |
|                                                                                                                                                                         |       |                         |       |                     |       |
| Stockholders’ equity:                                                                                                                                                   |       |                         |       |                     |       |
| Common stock of $0.02 par value, shares authorized  7,500,000; 5,249,270 shares issued and outstanding at September 30,  2009 and 5,245,770 at March 31, 2009 |       | 105                          |       | 105                      |       |
| Additional paid-in capital                                                                                                                                                   |       | 27,737                       |       | 27,590                   |       |
| Accumulated deficit                                                                                                                                                          |       | (18,907                      | )          | (19,921                  | )          |
| Total stockholders’ equity                                                                                                                                              |       | 8,935                        |       | 7,774                    |       |
|                                                                                                                                                                         |       |                         |       |                     |       |
| Total liabilities and stockholders’ equity                                                                                                                              |       | $                            | 11,684     |                     | $          | 10,787 |   |

 

See accompanying Notes to Consolidated Condensed Financial Statements.

 

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CYANOTECH CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share amounts)

(Unaudited)

 
| ** **                                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Six Months Ended  September 30,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                           | ** ** | **2009**                                             | ** ** | **2008**                                           | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                 |       |                                                 |       |                                               |       |   |   |   |   |
| NET SALES                                            |       | $                                                    | 3,925      |                                               | $          | 3,274 |   | $ | 7,946 |   | $ | 6,975 |   |
| COST OF PRODUCT SALES                                |       | 2,163                                                |       | 1,896                                              |       | 4,451 |   | 4,293 |   |
| Gross profit                                         |       | 1,762                                                |       | 1,378                                              |       | 3,495 |   | 2,682 |   |
|                                                 |       |                                                 |       |                                               |       |   |   |   |   |
| OPERATING EXPENSES:                                  |       |                                                 |       |                                               |       |   |   |   |   |
| General and administrative                           |       | 778                                                  |       | 864                                                |       | 1,674 |   | 1,573 |   |
| Sales and marketing                                  |       | 303                                                  |       | 255                                                |       | 624 |   | 522 |   |
| Research and development                             |       | 42                                                   |       | 54                                                 |       | 123 |   | 90 |   |
| Total operating expenses                             |       | 1,123                                                |       | 1,173                                              |       | 2,421 |   | 2,185 |   |
|                                                 |       |                                                 |       |                                               |       |   |   |   |   |
| Income from operations                               |       | 639                                                  |       | 205                                                |       | 1,074 |   | 497 |   |
|                                                 |       |                                                 |       |                                               |       |   |   |   |   |
| OTHER INCOME (EXPENSE):                              |       |                                                 |       |                                               |       |   |   |   |   |
| Interest expense, net                                |       | (28                                                  | )          | (42                                                | )          | (57 | ) | (84 | ) |
| Other income, net                                    |       | —                                               |       | —                                             |       | 17 |   | 10 |   |
|                                                 |       |                                                 |       |                                               |       |   |   |   |   |
| Total other expense, net                             |       | (28                                                  | )          | (42                                                | )          | (40 | ) | (74 | ) |
|                                                 |       |                                                 |       |                                               |       |   |   |   |   |
| Income before provision (benefit) for income taxes   |       | 611                                                  |       | 163                                                |       | 1,034 |   | 423 |   |
|                                                 |       |                                                 |       |                                               |       |   |   |   |   |
| PROVISION (BENEFIT) FOR INCOME TAXES                 |       | 12                                                   |       | —                                             |       | 22 |   | (11 | ) |
|                                                 |       |                                                 |       |                                               |       |   |   |   |   |
| NET INCOME                                           |       | $                                                    | 599        |                                               | $          | 163 |   | $ | 1,012 |   | $ | 434 |   |
|                                                 |       |                                                 |       |                                               |       |   |   |   |   |
| NET INCOME PER SHARE:                                |       |                                                 |       |                                               |       |   |   |   |   |
| Basic                                                |       | $                                                    | .11        |                                               | $          | .03 |   | $ | .19 |   | $ | .08 |   |
| Diluted                                              |       | $                                                    | .11        |                                               | $          | .03 |   | $ | .19 |   | $ | .08 |   |
|                                                 |       |                                                 |       |                                               |       |   |   |   |   |
| SHARES USED IN CALCULATION OF NET INCOME PER  SHARE: |       |                                                 |       |                                               |       |   |   |   |   |
| Basic                                                |       | 5,247                                                |       | 5,242                                              |       | 5,246 |   | 5,242 |   |
| Diluted                                              |       | 5,308                                                |       | 5,242                                              |       | 5,300 |   | 5,242 |   |

 

See accompanying Notes to Consolidated Condensed Financial Statements.

 

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CYANOTECH CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)(Unaudited)

 
| ** **                                                                         | ** ** | **Six Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2009**                                           | ** ** | **2008** | ** ** |
| ** **                                                                         | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                              |       |                                               |       |   |   |
| Net income                                                                         |       | $                                                  | 1,012      |   | $ | 434 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                                               |       |   |   |
| Depreciation and amortization                                                      |       | 242                                                |       | 216 |   |
| Amortization of debt issue costs and other assets                                  |       | 29                                                 |       | 27 |   |
| Issuance of common stock for services                                              |       | 10                                                 |       | — |   |
| Stock based compensation expense                                                   |       | 138                                                |       | 66 |   |
| Net (increase) decrease in:                                                        |       |                                               |       |   |   |
| Accounts receivable                                                                |       | (45                                                | )          | (118 | ) |
| Inventories                                                                        |       | (397                                               | )          | (1,012 | ) |
| Prepaid expenses and other assets                                                  |       | (93                                                | )          | 262 |   |
| Net increase (decrease) in:                                                        |       |                                               |       |   |   |
| Customer deposits                                                                  |       | 2                                                  |       | (80 | ) |
| Accounts payable                                                                   |       | (269                                               | )          | 406 |   |
| Accrued expenses                                                                   |       | 309                                                |       | 128 |   |
| Net cash provided by operating activities                                          |       | 938                                                |       | 329 |   |
|                                                                               |       |                                               |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                              |       |                                               |       |   |   |
| Investment in equipment and leasehold improvements                                 |       | (509                                               | )          | (151 | ) |
| Cash used in investing activities                                                  |       | (509                                               | )          | (151 | ) |
|                                                                               |       |                                               |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                              |       |                                               |       |   |   |
| Principal payments on long-term debt                                               |       | (306                                               | )          | (279 | ) |
| Cash used in financing activities                                                  |       | (306                                               | )          | (279 | ) |
|                                                                               |       |                                               |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                              |       | 123                                                |       | (101 | ) |
|                                                                               |       |                                               |       |   |   |
| Cash and cash equivalents at beginning of period                                   |       | 977                                                |       | 1,090 |   |
|                                                                               |       |                                               |       |   |   |
| Cash and cash equivalents at end of period                                         |       | $                                                  | 1,100      |   | $ | 989 |   |
|                                                                               |       |                                               |       |   |   |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                                  |       |                                               |       |   |   |
| Cash paid during the period for:                                                   |       |                                               |       |   |   |
| Interest                                                                           |       | $                                                  | 35         |   | $ | 81 |   |
| Income taxes                                                                       |       | $                                                  | 30         |   | $ | — |   |

 

See accompanying Notes to Consolidated Condensed Financial Statements.

 

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CYANOTECH CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

September 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 principlesin the United States of America (“GAAP”) for complete financial statements. Theconsolidated balance sheet as of March 31, 2009 was derived from the auditedfinancial statements. Theseconsolidated condensed financial statements and notes should be read inconjunction with the Company’s consolidated financial statements contained inthe Company’s report on Form 10-K for the year ended March 31, 2009, asfiled 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:

 
| ** **      | ** ** | **September 30,  2009** | ** ** | **March 31, 2009** | ** ** |
|-----------------|------------|------------------------------|------------|------------------------------|------------|
| ** **      | ** ** | **(in thousands)**      | ** ** |
| Raw materials   |       | $                            | 389        |                         | $          | 323 |   |
| Work in process |       | 311                          |       | 329                          |       |
| Finished goods  |       | 2,669                        |       | 2,315                        |       |
| Supplies        |       | 152                          |       | 157                          |       |
|            |       | $                            | 3,521      |                         | $          | 3,124 |   |

 

In accordance withStatement of Financial Accounting Standards (“SFAS”) No. 151(*now known asAccounting Standards Codification (“ASC”) 330-10* ), the companyrecognizes abnormal production costs as an expense in the period incurred. Theobjective of ASC 330-10 is to provide guidance on the variable and fixed costsof inventory in conjunction with variances in normal production capacity.  No fixed production related costs werecharged to cost of sales for the quarters ended September 30, 2009 and2008, respectively, and costs of $0 and $20,000 were charged to cost of salesfor the six months ended September 30, 2009 and 2008, respectively, due tobelow normal production 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 |   |

 

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Equipment andleasehold improvements consist of the following:

 
| ** **                                     | ** ** | **September 30, 2009** | ** ** | **March 31, 2009** | ** ** |
|------------------------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| ** **                                     | ** ** | **(in thousands)**     | ** ** |
| Equipment                                      |       | $                           | 6,806      |                         | $          | 6,526 |   |
| Leasehold improvements                         |       | 7,713                       |       | 7,580                        |       |
| Furniture and fixtures                         |       | 123                         |       | 117                          |       |
|                                           |       | 14,642                      |       | 14,223                       |       |
| Less accumulated depreciation and amortization |       | (10,273                     | )          | (10,031                      | )          |
| Construction-in-progress                       |       | 214                         |       | 124                          |       |
| Equipment and leasehold improvements, net      |       | $                           | 4,583      |                         | $          | 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 impairmentexisted as of September 30, 2009.

 

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

 

Long-term debt consists of the following:

 
| ** **                                   | ** ** | **September 30, 2009** | ** ** | **March 31, 2009** | ** ** |
|----------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| ** **                                   | ** ** | **(in thousands)**          | ** ** |
| Term loans                                   |       | $                           | 1,223      |                    | $          | 1,529 |   |
| Less current maturities                      |       | (471                        | )          | (620                    | )          |
| Long-term debt, excluding current maturities |       | $                           | 752        |                    | $          | 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 September 30, 2009 and March 31,2009, the prime rate was 3.25%. The balance under this loan was $319,000 and$551,000 at September 30, 2009 and March 31, 2009, respectively. TheCompany is prohibited from declaring any common stock dividends without thelender’s prior written consent. A warrant to purchase 5,000 shares of theCompany’s common stock was issued in conjunction with this Term Loan. Thewarrant expires in April 2011 and has an exercise price of $10.20 pershare. The warrant may only be exercised after the Company has repaid the TermLoan in full. The credit agreement requires the Company to meetcertain financial covenants. The Company was in compliance with these financialcovenants at September 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%. The balance under this loan was $880,000 and$950,000 at September 30, 2009 and March 31, 2009, respectively. TheCompany is prohibited from declaring any common stock dividends without thelender’s prior written 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 September 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 $24,000 and $28,000 atSeptember 30, 2009 and March 31, 2009, respectively, less theunamortized discount of $1,781 and $2,053, respectively.  Amortization of discount is recognized in theincome statement as interest expense and was $136 for the quarter ended September 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 the prime rate plus 2%.There is no outstanding balance as of September 30, 2009.

 

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

 
| **Payments Due**         | ** ** | **(in  thousands)** | ** ** |
|--------------------------|------------|---------------------|------------|
| Next 12 months           |       | $                   | 471        |   |
| Year 2                   |       | 158                 |       |
| Year 3                   |       | 165                 |       |
| Year 4                   |       | 168                 |       |
| Year 5                   |       | 172                 |       |
| Thereafter through 2015  |       | 89                  |       |
| Total principal payments |       | $                   | 1,223      |   |

 

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

 

The Company leasesfacilities, equipment and land under operating leases expiring between 2009 and2026.  The land lease provides forcontingent rental in excess of minimum rental commitments based on a percentageof the Company’s sales. Management has accrued for the estimated contingentrent as of September 30, 2009.

 

Future minimum leasepayments under all non-cancelable operation leases at September 30, 2009are as follows:

 
| **Payments Due**             | ** ** | **(in  thousands)** | ** ** |
|------------------------------|------------|---------------------|------------|
| Next 12 months               |       | $                   | 167        |   |
| Year 2                       |       | 155                 |       |
| Year 3                       |       | 148                 |       |
| Year 4                       |       | 148                 |       |
| Year 5                       |       | 148                 |       |
| Thereafter through 2026      |       | 1,665               |       |
| Total minimum lease payments |       | $                   | 2,431      |   |

 

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

 

The Companyapplies the provisions of SFAS No. 123(R), “Share-Based Payment”(*nowknown as ASC 718-10*). The objective of ASC 718-10, accounting fortransactions under share based payment arrangements with employees, is to recognizein the financial statements the employee services received in exchange forequity instruments issued or liabilities incurred and the related cost to theentity as those services are consumed. If an award vests or becomes exercisablebased on 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 Equity andCompensation Expense accounts.

 

***Stock Options***

 

As of September 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.

 

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 September 30,2009, 102,782 options remain available for grant under the 2005 Plan.

 

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 ofSeptember 30, 2009, 50,375 options remain available for grant under the2004 Plan. Concurrent with the 2004 Plan approval on August 16, 2004, the1994 Non-Employee Director Stock Option and Stock Grant Plan was terminatedexcept for the outstanding options issued thereunder.

 

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

 
| ** ** | ** ** | **As of September 30, 2009** | ** ** |
|------------|------------|-----------------------------------|------------|
| ** ** | ** ** | **Authorized**                    | ** ** | **Available** | ** ** | **Outstanding** | ** ** |
|       |       |                              |       |   |   |   |   |
| 2005 Plan  |       | 700,000                           |       | 102,782 |   | 597,218 |   |
| 2004 Plan  |       | 75,000                            |       | 50,375 |   | 1,000 |   |
| 1994 Plan  |       | —                            |       | — |   | 2,250 |   |
| Total      |       | 775,000                           |       | 153,157 |   | 600,468 |   |

 

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 isrecognized ratably over the vesting term. Compensation expense recognized foroptions issued under the 2005 Plan was $61,000 and $138,000 for the three andsix months ended September 30, 2009, respectively, and is classified asGeneral and Administrative expense in the consolidated condensed statement ofoperations. Compensation expense recognized under the 2005 Plan was $66,000 forthe three and six months ended September 30, 2008. There was nocompensation expense recognized under the 2004 Plan for the three and sixmonths ended September 30, 2009 and 2008.

 

A summary ofoption activity under Cyanotech Corporation’s stock option plans for the sixmonths ended September 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       |                                                        | 9.0 years  |                            | $          | 38,130 |   |
| Granted                                |       | 113,000    |       | 2.08                                           |       | 10.0 years                                                  |       | 62,720                          |       |
| Exercised                              |       | —     |       | —                                         |       |                                                        |       |                            |       |
| Forfeited or expired                   |       | (22,253    | )          | 4.23                                           |       |                                                        |       |                            |       |
| Outstanding at September 30, 2009 |       | 600,468    |       | 1.88                                           |       | 9.0 years                                                   |       | $                               | 457,979    |   |
| Exercisable at September 30, 2009 |       | 138,511    |       | 1.46                                           |       | 8.5 years                                                   |       | $                               | 163,602    |   |
|                                        |            |            |            |                                                |            |                                                             |            |                                 |            |  |  |

 

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 $2.64 for such day.

 

A summary of theCompany’s non-vested options for the six months ended September 30, 2009is presented 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                 |       | (1,450     | )          | .57                                                    |       |
| Nonvested at September 30, 2009 |       | 461,957    |       | 1.20                                                   |       |
|                                      |            |            |            |                                                        |            |  |

 

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The followingtable summarizes the weighted average characteristics of outstanding stockoptions as of September 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                     |       | 598,718                      |       | 9.0                              |       | $ | 1.87 |   | 136,761 |   | $ | 1.42 |   |
| $ 4.20 - $6.50                     |       | 1,750                        |       | 3.6                              |       | 4.31 |   | 1,750 |   | 4.31 |   |
| Total stock options                     |       | 600,468                      |       | 9.0                              |       | 1.88 |   | 138,511 |   | 1.46 |   |
|                                         |            |                              |            |                                  |            |  |  |  |  |  |  |  |  |

 

The range of fairvalue assumptions related to options granted during the three and six monthperiods ended September 30:

 
| ** **        | ** ** | **2009** | ** **  | **2008** | ** **                        |
|-------------------|------------|----------|-------------|----------|-----------------------------------|
|              |       |     |        |     |                              |
| Exercise  Price:  |       | $2.08    |        |     | $1.41 -  $2.12                    |   |
| Volatility:       |       | 88.9     |  %     |     | 103.6 %                           |   |
| Risk  Free Rate:  |       | 3.13     |  %     |     | 4.0 - 4.7  %            |   |
| Vesting  Period:  |       | 4        |  years |     | 1 – 2.7 years |   |
| Forfeiture  Rate: |       | 20       |  %     |     | 0 %                               |   |
| Expected  Life    |       | 6.25     |  years |     | 5 years                      |   |

 

As of September 302009, total unrecognized stock-based compensation expense related to allunvested stock options was $315,996. Of the 461,957 unvested options at September 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 $213,164 as of September 30,2009 that will be amortized over a remaining 7 months and 19 months,respectively. The unrecognized compensation expense of $102,832 for theremaining 199,845 unvested options is expected to be amortized over a remainingweighted-average period of 3.26 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.

 

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

 

The Company issubject to taxation in the United States and two state jurisdictions.  The preparation of income tax returnsrequires management to interpret the applicable tax laws and regulations ineffect in such jurisdictions, which could affect the amount of tax paid by theCompany. Management, in consultation with its tax advisors, files its taxreturns on interpretations that are believed to be reasonable under thecircumstances. The income tax returns, however, are subject to routine reviewsby the various taxing authorities in the jurisdictions in which the Companyfiles its returns.  As part of these reviews, a taxing authority maydisagree with respect to the tax positions taken by management (“uncertain taxpositions”) and therefore may require the Company to pay additional taxes.Management evaluates the requirement for additional tax accruals, but for thethree and six months ended September 30, 2009 and 2008, no accrual wasrecorded based on this evaluation of potential additional tax liability,including interest and penalties, which the Company could incur as a result ofthe ultimate 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.

 

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” (*now known as ASC 740*). As of September 30, 2009, therewas no significant liability for income tax associated with unrecognized taxbenefits. The Company recognizes accrued interest related to unrecognized taxbenefits as well as any related penalties in interest income or expense in itsconsolidated condensed statements of operations, which is consistent with therecognition of these items in prior reporting periods.

 

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 customaryrelationship between income tax expense (benefit) and pre-tax income.

 

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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.**             **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 potentiallydilutive effect of outstanding stock options and warrants using the “treasurystock” 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 September 30, 2009 and September 30,2008 are as follows:

 
|                                                    |   | **Three Months Ended September 30, 2009** |   |
|---------------------------------------------------------|--------|--------------------------------------------------------------------|--------|
|                                                    |   | **Net Income**                                                |   | **Shares** |   | **Per Share** |   |
|                                                    |   | **(Numerator)**                                                    |   | **(Denominator)** |   | **Amount** |   |
|                                                    |   | **(in thousands)**                                            |   |   |   |
| Basic income per share                                  |   | $                                                                  | 599    |   | 5,247 |   | $ | 0.11 |   |
| Effect of dilutive securities–Common stock options |   | —                                                             |   | 61 |   | — |   |
| Diluted income per share                                |   | $                                                                  | 599    |   | 5,308 |   | $ | 0.11 |   |

 
|                                                       |   | **Three Months Ended September 30, 2008** |   |
|------------------------------------------------------------|--------|--------------------------------------------------------------------|--------|
|                                                       |   | **Net Loss**                                                  |   | **Shares** |   | **Per Share** |   |
|                                                       |   | **(Numerator)**                                                    |   | **(Denominator)** |   | **Amount** |   |
|                                                       |   | **(in thousands)**                                            |   |   |   |
| Basic income per share                                     |   | $                                                                  | 163    |   | 5,242 |   | $ | 0.03 |   |
| Effect of dilutive securities – Common stock  options |   | —                                                             |   | — |   | — |   |
| Diluted income per share                                   |   | $                                                                  | 163    |   | 5,242 |   | $ | 0.03 |   |

 

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

 
|                                                    |   | **Six Months Ended September 30, 2009** |   |
|---------------------------------------------------------|--------|------------------------------------------------------------------|--------|
|                                                    |   | **Net Income**                                              |   | **Shares** |   | **Per Share** |   |
|                                                    |   | **(Numerator)**                                                  |   | **(Denominator)** |   | **Amount** |   |
|                                                    |   | **(in thousands)**                                          |   |   |   |
| Basic income per share                                  |   | $                                                                | 1,012  |   | 5,246 |   | $ | 0.19 |   |
| Effect of dilutive securities–Common stock options |   | —                                                           |   | 54 |   | — |   |
| Diluted income per share                                |   | $                                                                | 1,012  |   | 5,300 |   | $ | 0.19 |   |

 
|                                                       |   | **Six Months Ended September 30, 2008** |   |
|------------------------------------------------------------|--------|------------------------------------------------------------------|--------|
|                                                       |   | **Net Loss**                                                |   | **Shares** |   | **Per Share** |   |
|                                                       |   | **(Numerator)**                                                  |   | **(Denominator)** |   | **Amount** |   |
|                                                       |   | **(in thousands)**                                          |   |   |   |
| Basic income per share                                     |   | $                                                                | 434    |   | 5,242 |   | $ | 0.08 |   |
| Effect of dilutive securities – Common stock  options |   | —                                                           |   | — |   | — |   |
| Diluted income per share                                   |   | $                                                                | 434    |   | 5,242 |   | $ | 0.08 |   |

 

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 approximately382,362 and 474,221 securities excluded from the calculation of diluted lossper share because their effect was anti-dilutive for the three and six monthsended September 30, 2009 and 2008, respectively.

 

**9.****           ****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” (*now known as ASC 815* ). ASC 815 isintended to improve financial reporting about derivative instruments andhedging activities by requiring enhanced disclosures to enable investors to betterunderstand their effects on an entity’s financial position, financialperformance, and cash flows. The new standard is effective for financialstatements issued for fiscal years and interim periods beginning after November 15,2008. The adoption of ASC 815 effective January 1, 2009 did not have amaterial impact on the Company’s financial statements.

 

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InMay 2009, the FASB issued SFAS No. 165, “Subsequent events”, (*now known as ASC 855* ).The objectiveof this Statement is to establish general standards of accounting for anddisclosure of events that occur after the balance sheet date but beforefinancial statements are issued or are available to be issued. In particular,this Statement sets forth: 1. the period after the balance sheet date duringwhich management of a reporting entity should evaluate events or transactionsthat may occur for potential recognition or disclosure in the financialstatements, 2. the circumstances under which an entity should recognize eventsor transactions occurring after the balance sheet date in its financialstatements and 3. the disclosures that an entity should make about events ortransactions that occurred after the balance sheet date. In accordance withthis Statement, an entity should apply the requirements to interim or annualfinancial periods ending after June 15, 2009. The Company adopted ASC 855 during the second quarter of 2009. Theadoption of ASC 855 did not have a material impact on the Company’s financialstatements or condition. In accordancewith ASC 855, management has evaluated subsequent events through the dateand time the financial statements were issued on November 12, 2009, and is not aware of any subsequentevents which would require recognition or disclosure in the financialstatements.

 

OnJune 29, 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of GenerallyAccepted Accounting Principles,” a replacement of SFAS No. 162 (now known as *ASC 105-10*).ASC 105-10 provides for the FASB Accounting Standards Codification (the “Codification”)to become the single official source of authoritative, nongovernmental U.S.generally accepted accounting principles (GAAP). The Codification did notchange GAAP but reorganizes the literature. ASC 105-10 is effective forinterim and annual periods ending after September 15, 2009. Our adoptionof the codification did not impact our financial position or results ofoperations.

 

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** **

**Item 2.****   ****Management’s Discussion and Analysisof Financial Condition 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, including but notlimited to the volatility of crude oil prices;

 

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

 

·                  Environmental restrictions,soil and water conditions, variations in daylight hours and seasonal weatherpatterns, particularly heavy rains wind 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.

 

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**Overview**

 

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

 
| ** **                   | ** ** | **Three Months Ended**           | ** ** | ** **                       | ** ** |
|------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                   | ** ** | **September 30, 2009** | ** ** | **September 30, 2008** | ** ** | **Change** | ** ** |
| Net sales:                   |       |                             |       |                             |       |   |   |
| Spirulina products           |       | $                                | 1,958      |                             | $          | 1,644 |   | 19 | % |
| Natural astaxanthin products |       | 1,956                            |       | 1,621                            |       | 21 | % |
| Other products               |       | 11                               |       | 9                                |       | 22 | % |
| Total sales, all products    |       | $                                | 3,925      |                             | $          | 3,274 |   | 20 | % |
|                         |       |                             |       |                             |       |   |   |
| Gross profit            |       | $                                | 1,762      |                             | $          | 1,378 |   | 28 | % |
| Income  from operations      |       | $                                | 639        |                             | $          | 205 |   | 212 | % |
| Net income                   |       | $                                | 599        |                             | $          | 163 |   | 267 | % |

 
| ** **                   | ** ** | **Six Months Ended**             | ** ** | ** **                       | ** ** |
|------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                   | ** ** | **September 30, 2009** | ** ** | **September 30, 2008** | ** ** | **Change** | ** ** |
| Net sales:                   |       |                             |       |                             |       |   |   |
| Spirulina products           |       | $                                | 3,876      |                             | $          | 3,684 |   | 5 | % |
| Natural astaxanthin products |       | 4,057                            |       | 3,242                            |       | 25 | % |
| Other products               |       | 13                               |       | 49                               |       | (73 | )% |
| Total sales, all products    |       | $                                | 7,946      |                             | $          | 6,975 |   | 14 | % |
|                         |       |                             |       |                             |       |   |   |
| Gross profit            |       | $                                | 3,495      |                             | $          | 2,682 |   | 30 | % |
| Income from operations       |       | $                                | 1,074      |                             | $          | 497 |   | 116 | % |
| Net income                   |       | $                                | 1,012      |                             | $          | 434 |   | 133 | % |

 

Sales continued toimprove in the second quarter and six month period ending September 30,2009 over the second quarter and six month period ending September 30,2008 with increases in both spirulina and natural astaxanthin product sales.

 

Spirulina salesincreased overall for both the three and six month periods over one year agodue to bulk product sales increases offset by packaged products decreases fromreductions in private label customer sales.

 

Naturalastaxanthin products showed increases in both bulk product sales and packagednutrition product sales over the same three and six month periods of the lastfiscal year.  The Company is focused onbuilding market share as a nutritional brand which promotes health andwell-being. Astaxanthin products are a growing segment of this market.

 

Gross profitmargin as a percentage of sales increased by 3% and 6% for the three months andsix months ended September, 30, 2009 over the same periods a year ago. Theincreases are a combined result of price increases instituted in the middle ofthe last fiscal year, improved production levels allowing for increasedinventory levels to meet customer demand and reduced per unit product costs.Management continues researching methodology to promote and sustain productionat desired capacity and quality levels.

 

Net incomeimprovements of the current year three and six month periods over thecorresponding periods of last fiscal year are the result of increased sales andimproved gross profit margin out pacing increases experienced in operatingexpenses.

 

**Results of Operations**

 

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

# ** **

Net sales for thesecond quarter of fiscal 2010 increased to $3,925,000, a 20% increase from the$3,274,000 reported for the comparable period a year ago.  Spirulinaproduct sales for the second quarter of fiscal 2010 were $1,958,000, which is a19% increase from sales generated in the second quarter of fiscal 2009. Bulk spirulina sales increased 38% while packaged spirulina products decreasedby ll% primarily due to reductions of foreign private label product sales. TheCompany’s own Nutrex brand products increased 14% over sales in the comparableperiod a year ago. As a percentage of sales, Spirulina accounted for 50% of totalsales in the second quarter of fiscal 2010, compared to 50% for the comparableperiod a year ago.

 

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Natural astaxanthinproduct sales were $1,956,000 during the second quarter of 2010, a 21% increasefrom $1,621,000 in the second quarter of the prior year.  Bulk productsales increased 19% and packaged nutrition product sales increased 24%.  Improved production has allowed the companyto increase astaxanthin packaged products inventory and sales.  Natural astaxanthin product sales remain at50% of total sales, the same as in the second quarter of fiscal 2009.

 

Internationalsales were 37% of total sales for the second quarter of fiscal year 2010 and52% in the second quarter of 2009. International sales decreased as a result ofreduction in orders from two European customers.  Major customers are those equaling orexceeding 10% of the Company’s sales for the period. For the second quarter offiscal 2010 one domestic customer 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 secondquarter of fiscal year 2009.

 

Gross profit forthe three months ended September 30, 2009 was $1,762,000, with a grossprofit margin percentage of 45%. This was an increase from gross profit of$1,378,000 and gross profit margin of 42% reported for the comparable prioryear quarter. Sales for the second quarter of fiscal year 2010 increased 20%from the comparable prior year period while costs of products sold increasedonly 14% for the same respective period, resulting in the 3% improvement ingross profit margin percentage. The improvement reflects the growth andstabilization of production levels over several quarters, which results inlower costs per unit and improved margins.

 

Variableproduction costs decreased 6% in the current period compared to one yearago.  The decrease is primarily due tothe combined result of  threefactors:  chemical costs which decreased20% from favorable weather conditions: utility rates were lower than thecomparable prior year period; and labor costs increased from combined pay rateincreases and added personnel to achieve increased production. Fixed costs haveincreased by 13% primarily due to depreciation of production equipmentadditions. Spirulina production increased 6% and astaxanthin productionincreased 5% over the same quarter one year ago. Total variable and fixed costsspread over increased production units is continuing to lower individual unitcosts.

 

Operating expenses for the three months ended September 30,2009 were 29% of sales or $1,123,000, compared to 36% of sales or $1,173,000for the three months ended September 30, 2008. The 4% decrease inoperating expenses in the three months ended September 30, 2009 ascompared with the three months ended September 30, 2008, was primarily theresult of reduced General and administrative expenses incurred.  General and administrative expense for thesecond quarter fiscal 2010 decreased by $86,000 from the second quarter offiscal 2009 primarily due to reductions in service costs associated with theCompany’s proxy filing and annual meeting. Research and development expense forthe second quarter of fiscal 2010 decreased by $11,000 or 20% as a result ofthe temporary allocation of R&D resources to facilitate increasedproduction from the second quarter of 2009. Sales and marketing expense increased $48,000 or 19% as a result ofreinstituting marketing programs to expand consumer awareness from the secondquarter of 2009.

 

For the threemonths ended September 30, 2009, the Company recorded an income taxexpense of $12,000 related to Federal and state alternative minimum tax. Noexpense or benefit from income taxes was recorded in the three months ended September 30,2008. The Company does not expect any material U.S. Federal or state incometaxes to be recorded for the current fiscal year because of available netoperating loss carry-forwards.

 

The Company hadnet income of $599,000 or $0.11 per diluted share, for the three months ended September 30,2009 compared****to a net income of$163,000, or $0.03 per diluted share for the three months ended September 30,2008.

 

*SixMonths Ended September 30, 2009 Compared to Six Months Ended September 30,2008*

 

Net sales for thesix months ended September 30, 2009 were $7,946,000, an increase of 14%from sales of $6,975,000 reported for the comparable period a year ago. The increase in sales over the prior year’s six-month period was the result ofincreased sales of both spirulina, (5% increase) and natural astaxanthinproducts (25% increase).  Spirulina bulk sales increased 11% whilepackaged nutrition products decreased 4% directly related to decreases inprivate label product sales.  Astaxanthinbulk sales increased 28% while packaged nutrition product sales increased 19%,both primarily the result of improved production and available inventory.

 

Internationalsales represented 43% of net sales for the six months ended September 30,2009 compared to 46% for the same period a year ago.  For the six months ended September 30,2009 and September 30, 2008, two European distributors accounted for 6%and 13% of total sales, respectively.

 

For the six monthsended September 30, 2009, cost of sales decreased as a percentage of salesby 6% from the comparable prior year period.  For the six months ended September 30,2009, variable production costs increased 2% primarily due to increase in laborcosts from combined pay rate increases and added personnel to achieve increasedproduction. For the six months ended September 30, 2009, fixed costoverhead increased 19% primarily due to depreciation of production equipmentadditions.

 

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Operating expensesfor the six months ended September 30, 2009 were $2,421,000, an increaseof $236,000 or 11% from the comparable prior year period.  Sales andmarketing expense increased by $102,000 or 20% as a result of reinstitutingmarketing programs to expand consumer awareness.  General and administrative expense increased$101,000 or 6% due to increased compensation expenses offset by reductions incontractual services related to public company reporting. Research anddevelopment expense increased $33,000 or 37% from the comparable prior period,due to initiation of a product use research study being conducted at aCalifornia university.  While it is ourgoal to contain discretionary operating spending, it may become necessary forthe Company to selectively increase spending in some or all of these areas toremain competitive and to comply with regulatory requirements.

 

Net other expense,which includes interest on the Company’s debt, for the six months ended September 30,2009 decreased by 46% to $40,000 from $74,000 for the same prior year period.The current year decrease represents reduced interest as the Company pays downthe outstanding balances of its long-term debt.

 

For the six monthsended September 30, 2009, the Company recorded an income tax expense of$22,000 related to Federal and state alternative minimum tax. An income taxbenefit of $11,000 was recorded for the same period of the prior year. The Company does not expect any material United States income taxes for thecurrent fiscal year as a result of available net operating loss carry-forwards.

 

The Companyrecorded net income of $1,012,000 or $0.19 per diluted share for the six monthperiod ended September 30, 2009. For the same period a year ago theCompany reported net income of $434,000 or $0.8 per diluted share.

 

**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 the following:  changes in sales levels to our customers,competition (both pricing, new products and other market trends), productiondifficulties from increased production costs and variable production resultsdue to inclement 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.

 

**FinancialCondition**

 

Cash and cashequivalents increased $123,000 or 13% to $1,100,000 at September 30, 2009,from $977,000 at March 31, 2009. Cash provided by operating activities of $938,000 increased $609,000over the same six month period of last fiscal year. The increase is due to theincrease in net income of $578,000 and an increase of non-cash expenses of$115,000 over the same six month period of last fiscal year, offset by a netcash usage due to changes in current assets and liabilities.

 

As of September 30,2009, the Company’s net accounts receivable increased $45,000 to $1,830,000from $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 $11,000 at September 30, 2009.

 

The Company’s netinventory increased $397,000 or 13% to $3,521,000 as of September 30, 2009compared to $3,124,000 as of March 31, 2009. The increase in inventoryduring the first six months of fiscal 2010 is primarily due to an increase inspirulina production during the quarter and timing of large astaxanthin bulkorders.

 

Cash flows used ininvesting activities reflect capital expenditures which totaled $509,000 duringthe first six months of fiscal 2010 compared to just $151,000 one year ago.Cash flows used in financing activities are attributable exclusively to debtrepayments of $306,000 and $279,000 for the first six months of fiscal 2010 and2009, respectively.

 

**Liquidityand Capital Resources**

 

At September 30,2009, the Company’s working capital was $4,648,000, an increase of $756,000compared to $3,892,000 at March 31, 2009. Cash and cash equivalents at September 30,2009 totaled $1,100,000 an increase of $123,000 from $977,000 at March 31,2009.

 

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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 September 30, 2009 is approximately $1,198,000.The Term Loans have maturity dates of May 1, 2010 as to $318,000 and March 1,2015 as to $880,000 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 September 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 September 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 September 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 overextended periods preceding the most recent seven quarters. At September 30,2009, the Company had an accumulated deficit of $18,907,000 compared to anaccumulated deficit of $19,921,000 at March 31, 2009. The accumulateddeficit decreased by $599,000 for the quarter ended September 30, 2009.

 

·                  Material weaknesses in its internal controls, as previously reported,caused the Company to experience delays in completing its consolidated financialstatements and filing periodic reports with the SEC on a timely basis forperiods prior to fiscal year end March 31, 2008. At present the Companymaintains that more rigorous emphasis on improving the capabilities of existingdata systems and procedures will ultimately correct the material weakness.Accordingly, the Company continues to expend substantial human resources and toexperience higher than expected fees for audit services.

 

·                  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 been to position itself as a world leaderin the production and marketing of high-value natural products from microalgae.We are vertically aligned, producing raw materials in the form of microalgaeprocessed at our 90-acre facility in Hawaii, and integrating those rawmaterials into finished products. In fiscal 2010, we will put greater emphasison our Nutrex Hawaii consumer products. Our focus going forward will be toleverage our experience and reputation for quality, building nutritional brandswhich promote health and well-being. The foundation of our nutritional productsis naturally cultivated Spirulina Pacifica® in powder, flake and tablet form;and *BioAstin*® natural astaxanthinantioxidant in extract, softgel caplet and micro-encapsulated beadlet form.Information about our Company and our products can be viewed at www.cyanotech.comand www.nutrex-hawaii.com. Consumer products can also be purchased online atwww.nutrex-hawaii.com.

 

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We are currentlyexperiencing an upward trend in sales primarily in our Natural astaxanthinproducts. The Company is focused on sustainability of its production levels inorder to promote continued growth in its astaxanthin product line. The Companyexpects spirulina sales to remain essentially level since the product hasreached a mature life cycle stage. The Company 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.

 

Rising crude oilprices in the last fiscal year 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 cost controls and expenseavoidance.

 

Gross profitmargin percentages in fiscal year 2010 will be impacted by continued pressureon input 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.

 

Producing thehighest 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 the Company’s control. An imbalance or unexpected event can occurresulting in production levels below normal capacity. The allocation of fixedproduction 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. In addition, when production costs exceed historical averages,management evaluates whether such costs are one-time-period charges or anongoing component of inventory cost.

 

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, 2011, the Company is required to be in full compliancewith the Sarbanes-Oxley Act and Rules issued there under by the SEC,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.

 

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**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 $12,000 in interestexpense for the year ending March 31, 2010 (based on September 30,2009 amounts outstanding).

 

**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 September 30, 2009,management believes systems and procedures were in place to reasonably ensureaccurate 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 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 progressing.  It is expected to becompleted prior to March 31, 2010.

 

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** **

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

 

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

 

None.

 

**Item 2.**           **Unregistered Sales of Equity Securities and Use ofProceeds**

 

None.

 

**Item 3.**           **Defaults upon Senior Securities**

 

None.

 

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

 

On September 9, 2009, the following matters weresubmitted and voted by stockholders entitled to vote at the Company’s AnnualMeeting of Stockholders:

 

a)                    The following directors were elected to serve untilthe next Annual Meeting or until their successors are elected.

 
| ** **          | ** ** | **For Votes** | ** ** | **Withheld Votes** | ** ** |
|---------------------|------------|--------------------|------------|-------------------------|------------|
| Gerald  R. Cysewski |       | 4,289,958          |       | 27,557                  |       |
| Michael  A. Davis   |       | 3,783,840          |       | 533,675                 |       |
| Andrew  H. Jacobson |       | 4,283,346          |       | 34,169                  |       |
| Gregg  W. Robertson |       | 3,692,182          |       | 625,333                 |       |
| David  I. Rosenthal |       | 3,691,068          |       | 626,447                 |       |
| John  T. Waldron    |       | 3,690,886          |       | 626,629                 |       |

 

b)                   Ratification of the selection of Grant Thornton LLP asthe Company’s Independent Registered Public Accounting Firm for the fiscal yearending March 31, 2010.  The vote on the ratification was 4,290,474for, 25,431 against, and 1,610 abstaining.

 

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

 

None

 

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**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 November 12, 2009 |
|   |                                                    |   |   |
|   | 31.2                                                    |   | Certifications  of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002 signed as of November 12, 2009. |
|   |                                                    |   |   |
|   | 32.1                                                    |   | Certifications  of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002 signed as of November 12, 2009. |
|   |                                                    |   |   |
|   | 32.2                                                    |   | Certifications  of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002 signed as of November 12, 2009. |

 

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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 duly authorized.

 
|                   |     | CYANOTECH CORPORATION                                       |
|------------------------|----------|-------------------------------------------------------------|
|                   |     | (Registrant)                                                |
|                   |     |                                                        |
|                   |     |                                                        |
| November 12, 2009 |     | By:                                                         | /s/ Andrew  H. Jacobson |
| (Date)                 |     | Andrew H.  Jacobson                                         |
| * *               | * * | *President  and Chief Executive Officer*                    |
|                   |     |                                                        |
|                   |     |                                                        |
| November 12, 2009 |     | By:                                                         | /s/ Deanna L.  Spooner |
| (Date)                 |     | Deanna L.  Spooner                                          |
| * *               | * * | *Vice  President — Finance & Administration,* |
| * *               | * * | *Chief  Financial 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 November 12, 2009. |
|                    |       |                                                                                                                                            |
| 31.2                    |       | Certifications of Chief  Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002  signed as of November 12, 2009. |
|                    |       |                                                                                                                                            |
| 32.1                    |       | Certifications of Chief  Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002 signed as of November 12, 2009. |
|                    |       |                                                                                                                                            |
| 32.2                    |       | Certifications of Chief  Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002 signed as of November 12, 2009. |

 

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