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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 December 31, 2008**

 

**Or**

 

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

 

**Forthe Transition Period From                  to                  **

 

**CommissionFile Number 0-14602**

 

**CYANOTECH CORPORATION**

(Exact name of registrant as specified in itscharter)

 

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

 

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

(Address of principal executive offices)

 

**(808)326-1353**

(Registrant’s telephone number)

 

**NotApplicable**

(Former name, former address and formerfiscal year, if changed since last 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 90days.        Yes  x   No  o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-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  (Do not check if a smaller  reporting company) |   | Smaller  reporting company x |
|---------------------------------|--------|---------------------------|--------|-------------------------------------------------------------------------------|--------|-----------------------------------|

 

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 February 12, 2009:

 

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

 

 

 

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CYANOTECHCORPORATION

 

FORM 10-Q

 

INDEX

 
| PART I.  FINANCIAL  INFORMATION | 2                                                                                                                                                     |
|------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                           |                                                                                                                                                  |   |
| Item  1.                                       | Financial  Statements (unaudited)                                                                                                                     | 2 |
|                                           | Consolidated  Condensed Balance Sheets as of December 31, 2008 and March 31, 2008                                                           | 2 |
|                                           | Consolidated  Condensed Statements of Operations and Comprehensive Income (Loss) for the  three and nine months ended December 31, 2008 and 2007 | 3 |
|                                           | Consolidated  Condensed Statements of Cash Flows for the nine months ended  December 31, 2008 and 2007                                           | 4 |
|                                           | Notes to Consolidated Condensed Financial Statements                                                                                                  | 5 |
| 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    | 20                                                                                                                                                    |
| Item 1.                                        | Legal  Proceedings                                                                                                                                    | 20 |
| Item 2.                                        | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                          | 20 |
| Item 3.                                        | Defaults upon  Senior Securities                                                                                                                      | 20 |
| Item 4.                                        | Submission of  Matters to a Vote of Security Holders                                                                                                  | 20 |
| Item 5.                                        | Other Information                                                                                                                                     | 20 |
| Item 6.                                        | Exhibits                                                                                                                                              | 20 |
| SIGNATURES                                     |                                                                                                                                                  | 21 |

 

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Part 1. FINANCIAL INFORMATION

 

Item 1. Financial Statements (unaudited)

 

CYANOTECH CORPORATION

CONSOLIDATED CONDENSEDBALANCE SHEETS

(Dollars in thousands except par value andshare amounts)

(unaudited)

 
| ** **                                                                                                                                                                            | ** ** | **December 31,  2008** | ** ** | **March 31,  2008** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| ASSETS                                                                                                                                                                                |       |                        |       |                     |       |
| Current assets:                                                                                                                                                                       |       |                        |       |                     |       |
| Cash and cash equivalents                                                                                                                                                             |       | $                           | 276        |                     | $          | 1,090 |   |
| Accounts receivable, net of allowance for doubtful accounts of $15 at  December 31, 2008 and $23 at March 31, 2008                                                          |       | 2,346                       |       | 1,934                    |       |
| Inventories                                                                                                                                                                           |       | 3,100                       |       | 1,601                    |       |
| Prepaid expenses and other assets                                                                                                                                                     |       | 229                         |       | 263                      |       |
| Total current assets                                                                                                                                                                  |       | 5,951                       |       | 4,888                    |       |
|                                                                                                                                                                                  |       |                        |       |                     |       |
| Equipment and leasehold improvements, net                                                                                                                                             |       | 4,276                       |       | 4,269                    |       |
| Other assets                                                                                                                                                                          |       | 487                         |       | 623                      |       |
| Total assets                                                                                                                                                                          |       | $                           | 10,714     |                     | $          | 9,780 |   |
|                                                                                                                                                                                  |       |                        |       |                     |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                             |       |                        |       |                     |       |
| Current liabilities:                                                                                                                                                                  |       |                        |       |                     |       |
| Accounts payable                                                                                                                                                                      |       | $                           | 1,213      |                     | $          | 805 |   |
| Accrued expenses                                                                                                                                                                      |       | 361                         |       | 320                      |       |
| Customer deposits                                                                                                                                                                     |       | —                      |       | 104                      |       |
| Current maturities of long-term debt                                                                                                                                                  |       | 605                         |       | 567                      |       |
| Total current liabilities                                                                                                                                                             |       | 2,179                       |       | 1,796                    |       |
|                                                                                                                                                                                  |       |                        |       |                     |       |
| Long-term debt, less current maturities                                                                                                                                               |       | 1,045                       |       | 1,505                    |       |
| Other liabilities                                                                                                                                                                     |       | —                      |       | 100                      |       |
| Total liabilities                                                                                                                                                                     |       | 3,224                       |       | 3,401                    |       |
|                                                                                                                                                                                  |       |                        |       |                     |       |
| Commitments and contingencies (Note 5)                                                                                                                                                |       |                        |       |                     |       |
|                                                                                                                                                                                  |       |                        |       |                     |       |
| Stockholders’ equity:                                                                                                                                                            |       |                        |       |                     |       |
| Common stock of $0.02 par value, shares authorized 7,500,000;  5,245,770 and 5,242,270 shares issued and outstanding at December 31,  2008 and March 31, 2008, respectively |       | 105                         |       | 105                      |       |
| Additional paid-in capital                                                                                                                                                            |       | 27,500                      |       | 27,337                   |       |
| Accumulated deficit                                                                                                                                                                   |       | (20,115                     | )          | (21,063                  | )          |
| Total stockholders’ equity                                                                                                                                                       |       | 7,490                       |       | 6,379                    |       |
|                                                                                                                                                                                  |       |                        |       |                     |       |
| Total liabilities and stockholders’ equity                                                                                                                                       |       | $                           | 10,714     |                     | $          | 9,780 |   |

 

See accompanying Notes to ConsolidatedCondensed Financial Statements.

 

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CYANOTECH CORPORATION

CONSOLIDATED CONDENSEDSTATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME (LOSS)

(In thousands, except per share amounts)

(Unaudited)

 
| ** **                                                 | ** ** | **Three Months Ended  December 31,** | ** ** | **Nine Months Ended  December 31,** | ** ** |
|------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                 | ** ** | **2008**                                            | ** ** | **2007**                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                       |       |                                                |       |                                               |       |   |   |   |   |
| NET SALES                                                  |       | $                                                   | 3,553      |                                               | $          | 2,763 |   | $ | 10,528 |   | $ | 7,950 |   |
| COST OF PRODUCT SALES                                      |       | 1,987                                               |       | 2,410                                              |       | 6,280 |   | 6,083 |   |
| Gross profit                                               |       | 1,566                                               |       | 353                                                |       | 4,248 |   | 1,867 |   |
|                                                       |       |                                                |       |                                               |       |   |   |   |   |
| OPERATING EXPENSES:                                        |       |                                                |       |                                               |       |   |   |   |   |
| Research and development                                   |       | 65                                                  |       | 22                                                 |       | 155 |   | 105 |   |
| Sales and marketing                                        |       | 298                                                 |       | 391                                                |       | 820 |   | 1,096 |   |
| General and administrative                                 |       | 647                                                 |       | 501                                                |       | 2,220 |   | 1,882 |   |
| Total operating expenses                                   |       | 1,010                                               |       | 914                                                |       | 3,195 |   | 3,083 |   |
|                                                       |       |                                                |       |                                               |       |   |   |   |   |
| Income (loss) from operations                              |       | 556                                                 |       | (561                                               | )          | 1,053 |   | (1,216 | ) |
|                                                       |       |                                                |       |                                               |       |   |   |   |   |
| OTHER INCOME (EXPENSE):                                    |       |                                                |       |                                               |       |   |   |   |   |
| Interest income                                            |       | 2                                                   |       | 3                                                  |       | 7 |   | 20 |   |
| Interest expense                                           |       | (41                                                 | )          | (36                                                | )          | (130 | ) | (115 | ) |
| Other income, net                                          |       | —                                              |       | —                                             |       | 10 |   | 1 |   |
|                                                       |       |                                                |       |                                               |       |   |   |   |   |
| Total other expense, net                                   |       | (39                                                 | )          | (33                                                | )          | (113 | ) | (94 | ) |
|                                                       |       |                                                |       |                                               |       |   |   |   |   |
| Income (loss) before income tax (benefit) expense          |       | 517                                                 |       | (594                                               | )          | 940 |   | (1,310 | ) |
|                                                       |       |                                                |       |                                               |       |   |   |   |   |
| INCOME TAX (BENEFIT) EXPENSE                               |       | 3                                                   |       | —                                             |       | (8 | ) | 10 |   |
|                                                       |       |                                                |       |                                               |       |   |   |   |   |
| NET INCOME (LOSS)                                          |       | $                                                   | 514        |                                               | $          | (594 | ) | $ | 948 |   | $ | (1,320 | ) |
|                                                       |       |                                                |       |                                               |       |   |   |   |   |
| NET INCOME (LOSS) PER SHARE:                               |       |                                                |       |                                               |       |   |   |   |   |
| Basic                                                      |       | $                                                   | 0.10       |                                               | $          | (0.11 | ) | $ | 0.18 |   | $ | (0.25 | ) |
| Diluted                                                    |       | $                                                   | 0.10       |                                               | $          | (0.11 | ) | $ | 0.18 |   | $ | (0.25 | ) |
|                                                       |       |                                                |       |                                               |       |   |   |   |   |
| SHARES USED IN CALCULATION OF NET INCOME (LOSS) PER SHARE: |       |                                                |       |                                               |       |   |   |   |   |
| Basic                                                      |       | 5,246                                               |       | 5,242                                              |       | 5,243 |   | 5,242 |   |
| Diluted                                                    |       | 5,246                                               |       | 5,242                                              |       | 5,246 |   | 5,242 |   |
|                                                       |       |                                                |       |                                               |       |   |   |   |   |
| COMPREHENSIVE INCOME (LOSS):                               |       |                                                |       |                                               |       |   |   |   |   |
| Net income (loss)                                          |       | $                                                   | 514        |                                               | $          | (594 | ) | $ | 948 |   | $ | (1,320 | ) |
| Other comprehensive loss                                   |       | —                                              |       | —                                             |       | — |   | (4 | ) |
|                                                       |       | $                                                   | 514        |                                               | $          | (594 | ) | $ | 948 |   | $ | (1,324 | ) |

 

See accompanying Notes to ConsolidatedCondensed Financial Statements.

 

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CYANOTECH CORPORATION

CONSOLIDATED CONDENSEDSTATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

 
| ** **                                                                            | ** ** | **Nine Months Ended  December 31,** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                            | ** ** | **2008**                                           | ** ** | **2007** | ** ** |
|                                                                                  |       |                                               |       |   |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                 |       |                                               |       |   |   |
| Net income (loss)                                                                     |       | $                                                  | 948        |   | $ | (1,320 | ) |
| Adjustments to reconcile net income (loss) to net cash used in  operating activities: |       |                                               |       |   |   |
| Depreciation                                                                          |       | 324                                                |       | 380 |   |
| Amortization of debt issue costs and other assets                                     |       | 41                                                 |       | 27 |   |
| Share-based compensation expense                                                      |       | 156                                                |       | — |   |
| Net (increase) decrease in:                                                           |       |                                               |       |   |   |
| Accounts receivable                                                                   |       | (404                                               | )          | 295 |   |
| Refundable income taxes                                                               |       | —                                             |       | 8 |   |
| Inventories                                                                           |       | (1,499                                             | )          | (257 | ) |
| Prepaid expenses and other assets                                                     |       | 129                                                |       | (304 | ) |
| Net increase (decrease) in:                                                           |       |                                               |       |   |   |
| Accounts payable                                                                      |       | 408                                                |       | 551 |   |
| Accrued expenses                                                                      |       | 41                                                 |       | 50 |   |
| Customer deposits                                                                     |       | (205                                               | )          | 289 |   |
| Net cash used in operating activities                                                 |       | (61                                                | )          | (281 | ) |
|                                                                                  |       |                                               |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                 |       |                                               |       |   |   |
| Investment in equipment and leasehold improvements                                    |       | (331                                               | )          | (80 | ) |
| Cash used in investing activities                                                     |       | (331                                               | )          | (80 | ) |
|                                                                                  |       |                                               |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                 |       |                                               |       |   |   |
| Principal payments on long-term debt                                                  |       | (422                                               | )          | (293 | ) |
| Cash used in financing activities                                                     |       | (422                                               | )          | (293 | ) |
|                                                                                  |       |                                               |       |   |   |
| Net decrease in cash and cash equivalents                                             |       | (814                                               | )          | (654 | ) |
|                                                                                  |       |                                               |       |   |   |
| Cash and cash equivalents at beginning of period                                      |       | 1,090                                              |       | 1,444 |   |
|                                                                                  |       |                                               |       |   |   |
| Cash and cash equivalents at end of period                                            |       | $                                                  | 276        |   | $ | 790 |   |
|                                                                                  |       |                                               |       |   |   |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                                     |       |                                               |       |   |   |
| Cash paid during the period for:                                                      |       |                                               |       |   |   |
| Interest                                                                              |       | $                                                  | 110        |   | $ | 94 |   |
| Income taxes                                                                          |       | $                                                  | —     |   | $ | 10 |   |

 

See accompanying Notes to ConsolidatedCondensed Financial Statements.

 

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CYANOTECH CORPORATIONNOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

As of December 31, 2008(Unaudited)

 

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

 

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

 

The accompanying consolidated condensed financial statements includethe accounts of Cyanotech Corporation and its wholly-owned subsidiaries, NutrexHawaii, Inc. (“Nutrex Hawaii” or “Nutrex”) and Cyanotech Japan YK (“CyanotechJapan” or “CJYK”). All significant intercompany balances and transactions havebeen eliminated in consolidation.  On August 31, 2007, the Companydiscontinued the activity of its wholly owned Japanese subsidiary CJYK. Allaquaculture feed business in Japan was absorbed by the Company’s U.S.operations. CJYK remained a registered Japanese corporation until November 30,2007, at which time it was dissolved.  All CJYK assets and liabilitieswere absorbed into the Company as of September 1, 2007.  The Companymade this decision due to declining sales of approximately 40% in each of thetwo fiscal years 2007 and 2006. CJYK sales for the quarter ended December 31,2007, were approximately $45,000. Dissolution of this subsidiary has not had asignificant impact on the consolidated financial statements.

 

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

 

**2.**                                      **INVENTORIES**

 

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

 
| ** **      | ** ** | **December 31, 2008** | ** ** | **March 31, 2008** | ** ** |
|-----------------|------------|---------------------------------|------------|------------------------------|------------|
| ** **      | ** ** | **(in thousands)**         | ** ** |
| Raw materials   |       | $                               | 448        |                         | $          | 321 |   |
| Work in process |       | 357                             |       | 214                          |       |
| Finished goods  |       | 2,104                           |       | 888                          |       |
| Supplies        |       | 191                             |       | 178                          |       |
|            |       | $                               | 3,100      |                         | $          | 1,601 |   |

 

In accordance with Statement of Financial Accounting Standards (“SFAS”)No. 151, fixed production related costs of approximately $18,000 and$121,000 were not inventoried for the quarter ended December 31, 2008 and2007, respectively, and $40,000 and $178,000 for the nine months ended December 31,2008 and 2007, respectively, due to below normal production capacity.

 

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

 

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

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

 

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Equipmentand leasehold improvements consist of the following:

 
| ** **                                      | ** ** | **December 31, 2008** | ** ** | **March 31, 2008** | ** ** |
|-------------------------------------------------|------------|---------------------------------|------------|------------------------------|------------|
| ** **                                      | ** ** | **(in thousands)**         | ** ** |
| Equipment                                       |       | $                               | 6,431      |                         | $          | 6,335 |   |
| Leasehold improvements                          |       | 7,432                           |       | 7,348                        |       |
| Furniture and fixtures                          |       | 115                             |       | 94                           |       |
|                                            |       | 13,978                          |       | 13,777                       |       |
| Less accumulated depreciation and  amortization |       | (9,924                          | )          | (9,600                       | )          |
| Construction-in-progress                        |       | 222                             |       | 92                           |       |
| Equipment and leasehold improvements, net       |       | $                               | 4,276      |                         | $          | 4,269 |   |

 

Management reviews long-lived assets for impairment whenever events orchanges in circumstances indicate that the carrying value of such assets maynot be recoverable. Upon such an occurrence, recoverability of these assets isdetermined by comparing the forecasted undiscounted net cash flows from therelated assets, to its carrying amount. If the carrying value exceeds therelated cash flows, then the carrying value of the long-lived assets arecompared to the asset’s fair value using discounted cash flow. Management hasdetermined no asset impairment occurred during the three or nine months ended December 31,2008.

 

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

 

Long-term debt consists of the following:

 
| ** **                                    | ** ** | **December 31, 2008** | ** ** | **March 31, 2008** | ** ** |
|-----------------------------------------------|------------|---------------------------------|------------|------------------------------|------------|
| ** **                                    | ** ** | **(in thousands)**         | ** ** |
| Term loans                                    |       | $                               | 1,650      |                         | $          | 2,072 |   |
| Less current maturities                       |       | (605                            | )          | (567                         | )          |
| Long-term debt, excluding current  maturities |       | $                               | 1,045      |                         | $          | 1,505 |   |

 

*Term Loan Agreements*

 

InFebruary 2008, the Company executed a Term Loan Agreement (“Term Loan A”)with a lender providing for $1.1 million in aggregate credit facilities,secured by the Company’s assets. Term Loan A has a maturity date of March 1,2015, and is payable in 84 monthly principal and interest payments. Theinterest rate under Term Loan A, in the absence of a default under theagreement, is the prime rate in effect as of the close of business on the firstday of each calendar quarter, plus 1%. As of December 31, 2008, the primerate was 3.25%. The Company is prohibited from declaring any common stockdividends without the lender’s prior written consent. Borrowings outstandingunder Term Loan A were $984,351 and $1,078,400 at December 31, 2008, and March 31,2008, respectively.

 

InApril 2000, the Company executed a Term Loan Agreement (“Term Loan B”)with the same lender providing for $3.5 million in aggregate creditfacilities, secured by the Company’s assets. Term Loan B has a maturity date ofMay 1, 2010, and is payable in 120 monthly principal and interestpayments. The interest rate under Term Loan B, in the absence of a defaultunder the agreement, is the prime rate in effect as of the close of business onthe first day of each calendar quarter, plus 1%. As of December 31, 2008,the prime rate was 3.25%. The Company is prohibited from declaring any commonstock dividends without the lender’s prior written consent. A warrant topurchase 5,000 shares of the Company’s common stock was issued in conjunctionwith Term Loan B. The warrant expires in April 2011 and has an exerciseprice of $10.20 per share. The warrant may only be exercised after the Companyhas repaid Term Loan B in full. Borrowings outstanding under Term Loan B were$665,177 and $993,376 at December 31, 2008, and March 31, 2008,respectively.

 

The Company is required to comply with certain financial and operatingcovenants in connection with its loan agreements. At December 31, 2008,the Company was in compliance with these covenants.

 

Theseterm loans are additionally secured by a $250,000 restricted cash deposit whichis included in Other Assets in the accompanying consolidated condensed balancesheets at December 31, 2008 and March 31, 2008.

 

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Futureprincipal payments under the Term Loan Agreements are as follows:

 
| **Year Ending March 31** | ** ** | **(in  thousands)** | ** ** |
|-----------------------------------------|------------|---------------------|------------|
| 2009 (3 Months)                         |       | $                   | 148        |   |
| 2010                                    |       | 612                 |       |
| 2011                                    |       | 229                 |       |
| 2012                                    |       | 155                 |       |
| 2013                                    |       | 161                 |       |
| Thereafter through 2015                 |       | 345                 |       |
| Total principal payments                |       | $                   | 1,650      |   |

 

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

 

TheCompany leases facilities, equipment and land under operating leases expiringbetween 2008 and 2025.  The land leaseprovides for contingent rental in excess of minimum rental commitments based ona percentage of the Company’s annual sales. Contingent rental paid for ninemonths ended December 31, 2008 and 2007, was $54,000 and $35,000,respectively.

 

Futureminimum lease payments under all non-cancelable operation leases are asfollows:

 
| **Year ending March 31** | ** ** | **(in  thousands)** | ** ** |
|-----------------------------------------|------------|---------------------|------------|
| 2009 (3 Months)                         |       | $                   | 46         |   |
| 2010                                    |       | 168                 |       |
| 2011                                    |       | 161                 |       |
| 2012                                    |       | 151                 |       |
| 2013                                    |       | 148                 |       |
| Thereafter through 2025                 |       | 1,887               |       |
| Total minimum lease payments            |       | $                   | 2,561      |   |

 

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

 

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

 

***Stock Options***

 

As of December 31, 2008, the Company had the following twoshareholder approved stock plans under which shares were available forequity-based awards: The 2005 Stock Option Plan (the “2005 Plan”) wherein700,000 shares of common stock are reserved for issuance until the Planterminates on August 21, 2015, which includes 500,000 additional shares ofcommon stock pursuant to a vote of the Company’s stockholders on September 9,2008, and; The Independent Director Stock Option and Stock Grant Plan (the “2004Directors Plan”) wherein 75,000 shares of common stock are reserved forissuance until the Plan terminates in 2014.

 

  Under the 2005 Plan, eligible employees and certain independentconsultants may be granted options to purchase shares of the Company’s commonstock. The shares issuable under the 2005 Plan will either be shares of theCompany’s authorized but previously unissued common stock or shares reacquiredby the Company, including shares purchased on the open market.  As of December 31,2008, 205,782 options remain available for grant under the 2005 Plan.Concurrent with the 2005 Plan approval, the 1995 Stock Option Plan wasterminated, except for the outstanding options issued thereunder.

 

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Under the 2004 Directors Plan, upon election to the Board of Directors,a newly elected non-employee director is granted a ten-year option to purchase1,000 shares of the Company’s common stock at fair market value on the date ofgrant. Options granted vest and become exercisable six months from the date ofgrant.  In addition, on the date of each Annual Meeting of Stockholders,each non-employee director continuing in office is automatically issued 875shares of common stock, non-transferable for nine months following the date ofgrant. Compensation expense recognized for shares issued under the 2004Plan was $7,000 and $4,000 for the nine months ended December 31, 2008 and2007, respectively. As of December 31, 2008, 70,250 options remainavailable for grant under the 2004 Plan.  Concurrent with the 2004 Planapproval on August 16, 2004, the 1994 Non-Employee Director Stock Optionand Stock Grant Plan was terminated except for the outstanding options issuedthereunder.

 

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

 
| ** ** | ** ** | **As of December 31, 2008** | ** ** |
|------------|------------|-------------------------------------------------|------------|
| ** ** | ** ** | **Authorized**                                  | ** ** | **Available** | ** ** | **Outstanding** | ** ** |
| 2005 Plan  |       | 700,000                                         |       | 205,782 |   | 494,218 |   |
| 2004 Plan  |       | 75,000                                          |       | 70,250 |   | 1,000 |   |
| 1995 Plan  |       | —                                          |       | — |   | 21,553 |   |
| 1994 Plan  |       | —                                          |       | — |   | 2,250 |   |
| Total      |       | 775,000                                         |       | 276,032 |   | 519,021 |   |

 

All stock option grants made under the 2005 Plan and the 2004 DirectorsPlan were at exercise prices no less than the Company’s closing stock price onthe date of grant. Options under the 2005 Plan and 2004 Plan were determined bythe Board of Directors or the Stock Option and Compensation Committee of theBoard in accordance with the provisions of the respective plans.  Theterms of each option grant including vesting, exercising, and other conditionsare set forth in a Stock Option Agreement evidencing each grant. No option canhave a life in excess of ten (10) years.  The Company recordscompensation expense for employee stock options based on the estimated fairvalue of the options on the date of grant using the Black-Scholesoption-pricing model. The model requires various assumptions, including arisk-free interest rate, the expected term of the options, the expected stockprice volatility over the expected term of the options, and the expecteddividend yield. Compensation expense for employee stock options will berecognized ratably over the vesting term. Compensation expense recognized for options issued under the 2005 Planwas $91,000 and $156,000, respectively, for the three and nine months ended December 31,2008 and is classified as General and Administrative expense in theconsolidated condensed statement of operations. There was no compensationexpense recognized under the 2005 Plan for the three and nine months endedDecember 31, 2007.

 

A summary of option activity under the Company’s Stock Plans for thenine months ended December 31, 2008 is presented below:

 
| **Option Activity**              | ** ** | **Shares** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Weighted Average  Remaining  Contractual Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|---------------------------------------|------------|------------|------------|------------------------------------------------|------------|-------------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at March 31, 2008    |       | 111,447    |       | $                                              | 3.15       |                                                        | 4.9 years  |                            | $          | (176,086 | ) |
| Granted                               |       | 443,168    |       | 1.84                                           |       | 9.7 years                                                   |       | (169,441                        | )          |
| Exercised                             |       | —     |       | $                                              | —     |                                                        | —     |                            | —     |   |
| Forfeited or expired                  |       | (35,594    | )          | $                                              | 4.49       |                                                        | —     |                            | (107,731   | ) |
| Outstanding at December 31, 2008 |       | 519,021    |       | $                                              | 1.94       |                                                        | 9.1years   |                            | $          | (250,759 | ) |
| Exercisable at December 31, 2008 |       | 29,803     |       | $                                              | 3.97       |                                                        | 1.1years   |                            | $          | (74,871 | ) |

 

The aggregate intrinsic value in the tables above is before applicableincome taxes and represents the amount optionees would have received if alloptions had been exercised on the last business day of the period indicated,based on the Company’s closing stock price of $1.46 per share for such day.

 

A summary of the Company’s non-vested options for the nine months endedDecember 31, 2008 is presented below:

 
| **Nonvested Options**          | ** ** | **Shares** | ** ** | **Weighted Average  Grant-Date  Fair Value** | ** ** |
|-------------------------------------|------------|------------|------------|--------------------------------------------------------|------------|
| Nonvested at March 31, 2008    |       | 47,529     |       | $                                                      | 1.61       |   |
| Granted                             |       | 443,168    |       | 1.84                                                   |       |
| Vested                              |       | (179       | )          | 4.40                                                   |       |
| Forfeited or expired                |       | (1,300     | )          | 1.60                                                   |       |
| Nonvested at December 31, 2008 |       | 489,218    |       | $                                                      | 1.80       |   |

 

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The following table summarizes the weighted average characteristics ofoutstanding stock options as of December 31, 2008:

 
| ** **                              | ** ** | **Outstanding Options** | ** ** | **Exercisable Options**     | ** ** |
|-----------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | **Number  of Shares**   | ** ** | **Remaining  Life (Years)** | ** ** | **Weighted  Average Price** | ** ** | **Number of  Shares** | ** ** | **Weighted  Average Price** | ** ** |
| $ 1.41 - $2.60                     |       | 495,718                      |       | 9.49                             |       | $ | 1.67 |   | 6,500 |   | $ | 2.46 |   |
| $ 4.20 - $6.50                     |       | 23,303                       |       | .91                              |       | 4.39 |   | 23,303 |   | 4.39 |   |
| Total stock options                     |       | 519,021                      |       | 8.15                             |       | $ | 1.94 |   | 29,803 |   | $ | 3.97 |   |

 

There were 50,000 and 443,168 stock options granted during the threeand nine months ended December 31, 2008. The range of fair value assumptions related to options granted duringthe periods ended December 31, 2008 are:

 
| Exercise Price:  |   | $1.41- $2.12       |   |
|------------------|--------|--------------------|--------|
| Volatility:      |   | 101.9 — 103.6 | %      |
| Risk Free Rate:  |   | 4.0 - 4.7          | %      |
| Vesting Period:  |   | 1 — 4 years   |   |
| Forfeiture Rate: |   | 0 - 15             | %      |
| Expected Life    |   | 5.0 - 6.5 years    |   |

 

As of December 31 2008, total unrecognized stock-basedcompensation expense related to all unvested stock options was $474,497. Of the489,218 unvested options, 393,168 options cliff vest as follows:  131,056 of the options have an exercise priceof $1.41 and cliff vest 100% on May 16, 2009; 131,056 of the options havean exercise price of $2.12 and cliff vest 100% on May 16, 2010; and131,056 of the options have an exercise price of $2.12 and cliff vest 100% on May 16,2011. These cliff vesting options have a combined unrecognized compensationexpense of $425,373 as of December 31, 2008 that will be amortized over aremaining 4.5 months, 16 months and 28 months, respectively. The unrecognizedcompensation expense of  $49,124 for theremaining 96,050 unvested options is expected to be amortized over a remainingweighted-average period of 3.56 years through December 3, 2013.

 

***Warrant***

 

The Company has outstanding a warrant to acquire 5,000 shares of commonstock at $10.20 per share. The warrant was granted to lenders in connectionwith the Term Loan B described in Note 4. The warrant was granted in April 2000 and expires in April 2011,and may only be exercised after the Company has repaid the Term Loan B in full.

 

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

 

The Company is subject to taxation in the United States and two statejurisdictions. No remaining or future tax liabilities are expected with respectto the dissolution of CJYK.  The preparation of tax returns requiresmanagement to interpret the applicable tax laws and regulations in effect insuch jurisdictions, which could affect the amount of tax paid by the Company.Management, in consultation with its tax advisors, files its tax returns oninterpretations that are believed to be reasonable under the circumstances. Thetax returns, however, are subject to routine reviews by the various taxingauthorities in the jurisdictions in which the Company files its returns. As part of these reviews, a taxing authority may disagree with respect to the taxpositions taken by management (“uncertain tax positions”) and therefore requirethe Company to pay additional taxes. As required under applicable accountingrules, management evaluates the requirement for additional tax accruals foruncertain tax positions, and for the three and nine months ended December 31,2008 and 2007, no accrual was recorded based on this evaluation of potentialadditional tax liability, including interest and penalties, which the Companycould incur as a result of the ultimate resolution of its uncertain taxpositions. Management reviews and updates the accrual for uncertain taxpositions as more definitive information becomes available from taxingauthorities, completion of tax audits, expiration of statute of limitations, orupon occurrence of other events.

 

As a result of the implementation of Financial Accounting StandardsBoard (“FASB”) Interpretation No.48 (“FIN 48”) “Accounting for Uncertainty inIncome Taxes, an interpretation of FASB Statement No. 109,” the Companydid not recognize a liability for unrecognized tax benefits or uncertain taxpositions and, accordingly, did not record any cumulative effect adjustment tobeginning retained earnings, at the date of adoption, April 1, 2007.  As of December 31, 2008, there was nosignificant liability for income tax associated with unrecognized tax benefits.

 

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

 

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

 

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

 

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

 

Reconciliations between the numerator and the denominator of the basicand diluted earnings per share computations for the three months ended December 31,2008 and 2007 are as follows (in thousands, except per share amounts):

 
| ** **                                                              | ** ** | **Three Months Ended December 31, 2008** | ** ** | **Three Months Ended December 31, 2007** | ** ** |
|-------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                              | ** ** | **Net Income**                                               | ** ** | **Shares**                                                        | ** ** | **Per Share** | ** ** | **Net Loss** | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| ** **                                                              | ** ** | **(Numerator)**                                                   | ** ** | **(Denominator)**                                                 | ** ** | **Amount** | ** ** | **(Numerator)** | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
| Basic net income (loss) per share                                       |       | $                                                                 | 514        |                                                              | 5,246      |   | $ | 0.10 |   | $ | (594 | ) | 5,242 |   | $ | (0.11 | ) |
| Effect of dilutive securities — Common  stock options and warrants |       | —                                                            |       | —                                                            |       | — |   | — |   | — |   | — |   |
| Diluted net income (loss) per share                                     |       | $                                                                 | 514        |                                                              | 5,246      |   | $ | 0.10 |   | $ | (594 | ) | 5,242 |   | $ | (0.11 | ) |

 

Reconciliations between the numerator and the denominator of the basicand diluted earnings per share computations for the nine months ended December 31,2008 and 2007 are as follows (in thousands, except per share amounts):

 
| ** **                                                              | ** ** | **Nine Months Ended December 31, 2008** | ** ** | **Nine Months Ended December 31, 2007** | ** ** |
|-------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                                              | ** ** | **Net Income**                                              | ** ** | **Shares**                                                       | ** ** | **Per Share** | ** ** | **Net Loss** | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| ** **                                                              | ** ** | **(Numerator)**                                                  | ** ** | **(Denominator)**                                                | ** ** | **Amount** | ** ** | **(Numerator)** | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
| Basic net income (loss) per share                                       |       | $                                                                | 948        |                                                             | 5,243      |   | $ | 0.18 |   | $ | (1,320 | ) | 5,242 |   | $ | (0.25 | ) |
| Effect of dilutive securities — Common  stock options and warrants |       | —                                                           |       | 3                                                                |       | — |   | — |   | — |   | — |   |
| Diluted net income (loss) per share                                     |       | $                                                                | 948        |                                                             | 5,246      |   | $ | 0.18 |   | $ | (1,320 | ) | 5,242 |   | $ | (0.25 | ) |

 

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 approximately 521,244 potentially dilutivesecurities for the three and nine months ended December 31, 2008and 71,000 potentially dilutive securities for the three and nine months end December 31,2007, that were excluded from the calculation of diluted income (loss) pershare because their effect was anti-dilutive.

 

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

 

The Company received a restricted security deposit of $200,000 cash inconjunction with a sales contract dated November 1, 2007. On June 30,2008 the contract was modified to release the restricted funds to settleoutstanding accounts receivable balances and to prepay portions of new productorders from the customer. At December 31, 2008, no restricted funds areheld.

 

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

 

In September 2006, theFASB issued SFAS No. 157, “Fair Value Measurements”. This statementclarifies the definition of fair value, establishes a framework for measuringfair value, and expands the disclosures on fair measurements. SFAS No. 157defines fair value as the exchange price that would be received for an asset orpaid to transfer a liability (an exit price) in the principal or mostadvantageous market for the asset or liability in an orderly transactionbetween market participants on the measurement date. SFAS No. 157 alsoestablishes a fair value hierarchy which requires an entity to maximize the useof observable inputs and minimize the use of unobservable inputs when measuringfair value. The standard describes three levels of inputs that may be used tomeasure fair value:

 

Level 1 - Quoted prices inactive markets for identical assets or liabilities.

Level 2 - Inputs other thanquoted prices included within Level 1 that are either directly or indirectlyobservable;

Level 3 - Unobservableinputs that are supported by little or no market activity, therefore requiringan entity to develop its own assumptions about the assumptions that marketparticipants would use in pricing.

 

SFASNo. 157 is effective for the Company’s fiscal year beginning April 1,2008, except for non-financial assets and liabilities recognized or disclosedat fair value on a non-recurring basis, for which the effective date is fiscalyears beginning after November 15, 2008. The adoption of SFAS No. 157 did not have an impact on the Company’sconsolidated results of operations, cash flows or financial condition.  In February 2008, the FASB issued FASB StaffPosition for SFAS No. 157 (“FSP FAS 157-1”) to amend SFAS No. 157to exclude SFAS No 13, “Accountingfor Leases,” and other accounting pronouncements that address fair valuemeasurements for purposes of lease classification or measurement underSFAS No. 13. However, this scope exception does not apply to assetsacquired and liabilities assumed in a business combination that are required tobe measured at fair value under SFAS No. 141, “Business Combinations”, or SFAS No. 141R, “Business Combinations”**(as discussed in more detailbelow), regardless of whether those assets and liabilities are related toleases. Additionally, in February 2008, the FASB issued FASB StaffPosition for SFAS No. 157 (“FSP FAS 157-2”), which delays theeffective date of SFAS No. 157 for non-financial assets andnon-financial liabilities, except for items that are recognized or disclosed atfair value in an entity’s financial statements on a recurring basis (at leastannually) until fiscal years beginning after November 15, 2008. Also, in October 2008,the FASB issued FASB Staff Position for SFAS No. 157 (“FSPFAS 157-3”), which clarifies the application of SFAS No. 157 in amarket that is not active.

 

The Company will adopt SFAS No. 157 for non-financial assets thatare recognized or disclosed on a non-recurring basis on April 1, 2009 andthe management is currently evaluating the effect, if any, on the Company’sconsolidated results of operations, cash flows or financial condition.

 

In February 2007, the FASB issued SFAS No. 159, “The FairValue Option for Financial Assets and Financial Liabilities — Including anamendment of FASB Statement No. 115”. SFAS No. 159 permits entitiesto choose to measure eligible items at fair value at specified election datesand report unrealized gains and losses on items for which the fair market valueoption has been elected in earnings at each subsequent reporting date. SFAS No. 159is effective for the Company’s fiscal year beginning April 1, 2008. Theadoption of this statement did not have a material impact on the Company’sfinancial position and results of operations.

 

In December 2007, the FASB issued SFAS No. 141R, “Business Combinations”. SFAS No. 141Rrequires the acquiring entity in a business combination to recognize all theassets acquired and liabilities assumed in the transaction at fair value as ofthe acquisition date. SFAS No. 141R is effective for business combinationsfor which the acquisition date is on or after the beginning of the firstquarterly reporting period beginning on or after December 15, 2008. TheCompany is required to adopt SFAS No. 141R in the first quarter ofcalendar year 2009.

 

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

 

In March 2008, the FASB issued SFAS No. 161,“Disclosures about Derivative Instruments and Hedging Activities — an amendmentof FASB Statements No. 133.” This statement enhances the disclosurerequirements for derivative instruments and hedging activities, and thereby isdesigned to improve the transparency of financial reporting.  SFAS No. 161 is effective for fiscalyears beginning after November 15, 2008. Management does not expect the adoption of this statementto have a material impact on the Company’s consolidated financial statements.

 

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In April 2008, the FASB issued Staff Position No. FAS 142-3,“Determination of the Useful Life ofIntangible Assets”**(“FAS 142-3”)that amends the factors that should be considered in developing renewal orextension assumptions used to determine the useful life of a recognizedintangible asset under SFAS No. 142, “Goodwill and Other IntangibleAssets.”  The intent of FAS 142-3 isto improve the consistency between the useful life of a recognized intangibleasset under SFAS No. 142 and the period of expected cash flows used tomeasure the fair value of the asset under SFAS No. 141 and otherU.S. generally accepted accounting principles. FAS 142-3 is effectivefor fiscal years and interim periods beginning after December 15, 2008.The management is currently evaluating the impact of this pronouncement on itsconsolidated financial statements, if any.

 

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally AcceptedAccounting Principles.” SFAS No. 162 identifies the sources ofaccounting principles and the framework for selecting the principles used inthe preparation of financial statements of nongovernmental entities that arepresented in conformity with generally accepted accounting principles. SFAS No. 162was effective on November 15, 2008. Management does not expect the adoption of this statement to have amaterial effect on the Company’s consolidated financial statements.

 

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**Item 2.  Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

**FORWARD LOOKING STATEMENTS**

 

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

 

Forward-lookingstatements speak only as of the date of the Report, presentation or filing inwhich they are made or were made. Investors are cautioned not to place undue reliance on forward lookingstatements. Except to the extent required by the federal securities laws, theCompany undertakes no obligation to publicly update or revise anyforward-looking statements, whether as a result of new information, futureevents or otherwise. Our forward-looking statements in this Report include, butare not limited to:

 

·                  statements relating to our business strategy;

 

·                  statements relating to our businessobjectives; and,

 

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

 

Theseforward-looking statements are subject to risk, uncertainties and assumptionsabout us and our operations that are subject to change based on variousimportant factors, some of which are beyond our control. The following factors,among others, could cause our financial performance to differ significantlyfrom the goals, plans, objectives, intentions and expectations expressed in ourforward-looking statements:

 

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

 

·                  worldwideeconomic conditions and their effects on costs, pricing and descretionaryspending on health products;

 

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

 

·                  access to available and reasonable financingon a timely basis;

 

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

 

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

 

·                  changes to capital markets and access tosufficient capital on satisfactory terms;

 

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

 

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

 

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

 

·                  other risks or uncertainties describedelsewhere in this Report in our most recent annual report on Form 10-K andin other periodic reports previously and subsequently filed by the Company withthe Securities and Exchange Commission.

 

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**Overview**

 

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

 
| ** **                    | ** ** | **Three Months Ended  December 31, 2008** | ** ** | **Three Months Ended  December 31, 2007** | ** ** | **% Change** | ** ** |
|-------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|-------------------|------------|
| Net sales:                    |       |                                                          |       |                                                          |       |              |       |
| Spirulina products            |       | $                                                             | 1,650      |                                                          | $          | 1,095             |       | 51 | % |
| Natural astaxanthin products  |       | 1,903                                                         |       | 1,632                                                         |       | 17                | %          |
| Other products                |       | —                                                        |       | 36                                                            |       | (100              | )%         |
| Total sales, all products     |       | $                                                             | 3,553      |                                                          | $          | 2,763             |       | 29 | % |
|                          |       |                                                          |       |                                                          |       |              |       |
| Gross profit             |       | $                                                             | 1,566      |                                                          | $          | 353               |       | 344 | % |
| Income (loss) from operations |       | $                                                             | 556        |                                                          | $          | (561              | )          | 199 | %  |
| Net income (loss)             |       | $                                                             | 514        |                                                          | $          | (594              | )          | 187 | %  |

 
| ** **                    | ** ** | **Nine Months Ended  December 31, 2008** | ** ** | **Nine Months Ended  December 31, 2007** | ** ** | **Change** | ** ** |
|-------------------------------|------------|--------------------------------------------------------------|------------|--------------------------------------------------------------|------------|------------|------------|
| Net sales:                    |       |                                                         |       |                                                         |       |       |       |
| Spirulina products            |       | $                                                            | 5,344      |                                                         | $          | 4,033      |       | 33 | % |
| Natural astaxanthin products  |       | 5,146                                                        |       | 3,805                                                        |       | 35         | %          |
| Other products                |       | 38                                                           |       | 112                                                          |       | (66        | )%         |
| Total sales, all products     |       | $                                                            | 10,528     |                                                         | $          | 7,950      |       | 32 | % |
|                          |       |                                                         |       |                                                         |       |       |       |
| Gross profit             |       | $                                                            | 4,248      |                                                         | $          | 1,867      |       | 128 | % |
| Income (loss) from operations |       | $                                                            | 1,053      |                                                         | $          | (1,216     | )          | 187 | %  |
| Net income (loss)             |       | $                                                            | 948        |                                                         | $          | (1,320     | )          | 172 | %  |

 

Sales for the third quarter of fiscal year 2009 increased from thecomparable prior year period by $790,000 or 29% due to increases in bothspirulina and natural astaxanthin product sales.

 

Spirulina sales increased 51% over the same period of fiscal year 2008,primarily due to increased units sold of bulk products and price increases inpackaged products.

 

Natural astaxanthin product sales increased as well over the comparableprior year period due to an increase in sales of both bulk and packagedastaxanthin products. Packaged nutrition products increased by 58%. The Companyis now focused on building market share based on nutritional brands whichpromote health and well-being.

 

Gross profit margin as a percentage of sales increased to 44% for thethree months ended December, 31, 2008 from 13% for the same period a yearago.  Sales for the third quarter of fiscal year 2009 increased 29% fromthe comparable prior year period while cost of products sold decreased by 18%for the same respective period, mainly due to the affect of non inventoriablecosts recognized in the prior year. Variable production costs increased 15% inthe current period compared to one year ago primarily as a result of the impactof rising fuel costs on electrical rates and on the shipping costs of chemicalsused in production. Recent reductions in fuel prices have not been reflected inlocal utility rates which resulted in utilities expense 53% above levels oneyear ago.  Management remains diligent inresearching methodology to promote and sustain production at desired capacityand quality levels.

 

The net income of $514,000 for the third quarter of fiscal 2009represents a positive improvement of $1,108,000 over the comparable quarter offiscal 2008 which had a net loss of $594,000. The improvement is the result ofincreased sales volume and improved gross profit margins in the current periodcoupled with the absence of production issues experienced in the prior fiscalyear.

 

# ***Third Quarter of Fiscal 2009 Compared toThird Quarter of Fiscal 2008***

# ** **

Net sales for the third quarter of fiscal 2009 increased to $3,553,000,a 29% increase from the $2,763,000 reported for the comparable period a yearago.  Company sales of Spirulina productsfor the third quarter of fiscal 2009 were $1,650,000, which is a 51% increaseover sales generated in the third quarter of fiscal 2008.  As a percentage of sales, Spirulina accountedfor 46% of total sales in the third quarter of fiscal 2009, compared to 40% forthe comparable quarter of fiscal year 2008. Production problems in fiscal year 2008 resulted in less inventoryavailable to meet bulk sales demands. Current year Spirulina production has been good therefore sales of bulkSpirulina products are up and inventory levels are sufficient to meet currentdemands.

 

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Natural astaxanthin product sales were $1,903,000 during the thirdquarter of 2009, a 17% increase from $1,632,000 in the third quarter of theprior year.  Although the naturalastaxanthin product lines increased in sales dollars, they decreased to 54% oftotal sales from 60% of total sales in the third quarter of fiscal 2008.  This decrease is the result of the increasedbulk sales of Spirulina as mentioned above. There were no other products sales during the third quarter of fiscal2009 and $36,000 during the third quarter of fiscal 2008.

 

International sales were 53% of total sales for the third quarter offiscal year 2009 and 41% of sales for the third quarter of fiscal year2008.  Major customers are those equalingor exceeding 10% of the Company’s sales for the period.  For the third quarter of fiscal 2009, oneEuropean distributor accounted for 18% of the Company’s total sales.  There were no customers exceeding 10% ofsales volume in the third quarter of fiscal year 2008.

 

Gross profit, derived from net sales less the cost of product sales,includes the cost of materials, direct labor, manufacturing overhead anddepreciation.  Gross profit for the thirdquarter of fiscal 2009 was $1,566,000, with a gross profit margin percentage of44%.  This was an increase from grossprofit margin of $353,000 and gross profit margin of 13% reported for thecomparable prior year quarter.  Sales forthe third quarter of fiscal year 2009 increased 29% from the comparable prioryear period while costs of products sold decreased 18% for the same respectiveperiod, resulting in the substantial improvement in gross profit marginpercentage.  Variable production costsincreased 15% in the current period compared to one year ago.  Rising fuel costs have resulted in anincrease in electrical rates and freight costs of chemicals and supplies usedin production.  These increases werepartially offset by decreased chemical usage for the current quarter comparedto the quarter ended December 31, 2008 due to favorable weather conditionscompared to last year.  The currentperiod increases were fully inventoriable compared to $604,000 ofnon-inventoriable period costs associated with production problems in the sameperiod of fiscal year 2008.  Direct costincreases are expected to continue in all areas consistent with the local andnational economy.

 

Pursuant to SFAS No. 151, “Inventory Costs — an amendment of ARB No. 43,Chapter 4,” all fixed production overhead costs were inventoriable for thecurrent quarter.  Approximately $18,000and $121,000 of fixed production overhead cost was not inventoriable during thethree months ended December 31, 2008 and 2007, respectively, because suchcosts would have exceeded the market value of the inventory. There were no suchlower of cost or market issues for the third quarter of fiscal year 2009.

 

Operating expenses for the third quarter of fiscal2009 were 28% of sales or $1,010,000, compared to 33% of sales or $914,000 forthe third quarter of fiscal 2008. This decrease in operating expenses as apercentage of sales in the three months ended December 31, 2008 ascompared with the three months ended December 31, 2007 was primarily theresult of the increase in sales. Sales and marketing expenses decreased by$93,000 or 24%, offset by a $146,000 or 29% increase in general andadministrative expense and a $43,000 or 195% increase in research anddevelopment expense for the third quarter of 2009 from the third quarter of2008. These changes are primarily due to headcount variations in the respectivedepartments as the Company executes its focused operating plan.

 

Net other expense, which includes interest on the Company’s debt, forthe three months ended December 31, 2008 increased by 18% to $39,000 from$33,000 for the same prior year period. The current period increase representsinterest on the additional long-term debt secured in the fourth quarter offiscal year 2008.

 

Income taxes are provided on the earnings in theconsolidated financial statements. The provision is based on the currentquarter activity of the legal entities and jurisdictions in which the Companyoperates. Tax credits, such as Hawaii capital goods excise tax credits, arerecognized as a reduction to income taxes in the period the credits are earned.Accordingly, the effective tax rate may vary from the customary relationshipbetween income tax expense (benefit) and pre-tax income (loss). The Company’seffective tax rate is reconciled to consider the tax effect of net operatinglosses incurred in prior periods.

 

A $3,000 income tax expense was recorded in thequarter ended December 31, 2008, related to a reduction in expected taxcredits for the period.  No expense orbenefit from income taxes was recorded the quarter ended December 31,2007. The Company does not expect any U.S. Federal or state income taxes to berecorded for the current fiscal year because of available net operating losscarry-forwards.

 

The Company had net income of $514,000 or $0.10 per basic and dilutedshare, for the three months ended December 31, 2008 compared****to a net loss of $594,000, or ($0.11) perbasic and diluted share for the three months ended December 31, 2007.

 

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*Nine Months Ended December 31, 2008 Compared to NineMonths Ended December 31, 2007*

 

Net sales for the nine months ended December 31, 2008 were$10,528,000, an increase of 32% from sales of $7,950,000 reported for thecomparable period a year ago.  The increase in sales over the prior year’snine-month period was largely the result of increased sales of both spirulinaand natural astaxanthin products.  International sales represented 49% ofnet sales for the nine months ended December 31, 2008 compared to 42% forthe same period a year ago.  For the ninemonths ended December 31, 2008 and December 31, 2007, our Europeandistributors accounted for 24% and 14% of total sales respectively.

 

For the nine months ended December 31, 2008, cost of salesdecreased as a percentage of sales by 17% from the comparable prior yearperiod. Variable production costs increased 13% for the nine months ended December 31,2008 and were fully inventoriable due to increased production compared withnon-inventoriable period costs of approximately $647,000 for the nine monthsended December 31, 2007.  For thenine months ended December 31, 2008 fixed cost overhead increased 8% dueto increases in certain fixed costs such as insurances.  Pursuant to SFAS No. 151, $40,000 and$178,000 of fixed overhead costs were not inventoriable during the nine monthsended December 31, 2008 and 2007, respectively, because production levelswere below normal capacity.  In addition,production costs associated with the Company’s inventory totaling approximately$141,000 incurred during the nine months ended December 31, 2007 were notinventoriable because such costs would have exceeded the market value for suchinventory, no such adjustment was required for the current period end.  As a result of the increase in sales andimproved production volumes, gross profit margins as a percentage of salesincreased to 40% for the nine months ended December 31, 2008 as comparedto 23% for the comparable prior year period.

 

Operating expenses for the nine months ended December 31, 2008were $3,195,000, an increase of $112,000 or 4% from the comparable prior yearperiod.  Sales and marketing expensedecreased by $276,000 or 25% as a result of cost reduction measures, includingheadcount and promotional programs, initiated in the third quarter of fiscalyear 2008.  General and administrativeexpense increased $338,000 due to $156,000 of stock related compensation,$100,000 increase in accounting and legal costs to comply with regulatoryrequirements and inflationary increases, rather than added spending in the ninemonth period.  While it is our goal tocontain discretionary operating spending it may become necessary for the Companyto selectively increase spending in some or all of these areas to remaincompetitive and to comply with regulatory requirements.

 

Net other expense, which includes interest on the Company’s debt, forthe nine months ended December 31, 2008 increased by 20% to $113,000 from$94,000 for the same prior year period. The current year increase representsinterest on the additional long-term debt secured in the fourth quarter offiscal year 2008.

 

For the nine months ended December 31, 2008, the Company recordedan income tax benefit of $8,000 related to Federal and state tax credits. Anincome tax expense of $10,000 was recorded for the same period of the prioryear.  The Company does not expect any additional United States incometaxes for the current fiscal year as a result of available net operating losscarry-forwards.

 

The Company recorded net income of $948,000 or $0.18 per basic anddiluted share for the nine month period ended December 31, 2008. For thesame period a year ago the Company reported a net loss of $1,320,000 or ($0.25)per basic and diluted share.

 

### ***Variability of Results***

### ** **

The Company has experienced significant quarterly fluctuations inoperating results and anticipates that these fluctuations may continue infuture periods. As described in previous paragraphs, operating results havefluctuated as a result of changes in sales levels to our customers, competition(both pricing, new products and other market trends) and productiondifficulties, including increased production costs and variable productionresults. The Company has also, during its history, experienced productiondifficulties as a result of inclement weather, changes in the mix between salesof bulk and packaged consumer products and start up costs associated with newproduct introductions, new facilities and expansion into new markets. Inaddition, future operating results may fluctuate as a result of factors beyondthe Company’s control such as foreign exchange fluctuations, changes ingovernment regulations, and economic changes in the regions it operates in andsells to. A portion of our operating expenses are relatively fixed and thetiming of increases in expense levels is based in large part on forecasts offuture sales. Therefore, if net sales are below expectations in any givenperiod, the adverse impact on results of operations may be magnified by ourinability to adjust spending in certain areas meaningfully, or to adjustspending quickly enough, as in personnel and administrative costs. We may alsochoose to reduce prices or increase spending in response to market conditions,and these decisions may have a material adverse effect on financial conditionand results of operations.

 

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**Financial Condition**

 

Cash and cash equivalents decreased $814,000 or 75% to $276,000 atDecember 31, 2008, from $1,090,000 million at March 31, 2008.  This decrease in cash resulted from cash usedin investing activities of $331,000, and cash used in financing activities of$422,000, and cash used in operating activities of $61,000.  Cash used in operating activities for thenine months ended December 31, 2008 represents the results of operationsadjusted for non-cash depreciation, amortization and share based compensationexpenses of $521,000, increases in inventory and accounts receivable of$1,903,000, offset by increases in accounts payable and accrued expenses of$449,000 and other less significant changes. Cash flows used in investing activities reflect capital expendituresduring the nine months of fiscal 2009. Cash flows used in financing activitiesare attributable to debt payments during that period.

 

As of December 31, 2008, the Company’s net accounts receivableincreased $412,000 to $2,346,000 from $1,934,000 as of March 31,2008.  The increase in accountsreceivable is primarily the result of the increased sales to foreign customerswith extended terms.  Management believesthat its accounts receivable are collectible net of the allowance for doubtfulaccounts of $15,000 at December 31, 2008.

 

The Company’s net inventory increased $1,499,000 or 94% to $3,100,000as of December 31, 2008 compared to $1,601,000 as of March 31,2008.  The increase in inventory duringthe first nine months of fiscal 2009 is primarily due to increased productionlevels of both spirulina and astaxanthin during the summer months with longerdaylight hours and lower rainfall. Management considers this buildup of inventory necessary to respond toour bulk customers fluctuating demands and to cover longer lead times forproduction of our *BioAstin*® based health andnutrition products.

 

**Liquidity and Capital Resources**

 

AtDecember 31, 2008, the Company’s working capital was $3,772,000, anincrease of $680,000 compared to $3,092,000 at March 31, 2008.  Cash and cash equivalents at December 31,2008 totaled $276,000, a decrease of $814,000 from $1,090,000 at March 31,2008.

 

TheCompany has two Term Loan Agreements (“Term Loans”) with a lender. Theseprovided up to $4.6 million in combined credit facilities and are securedby substantially all the assets of the Company. The outstanding combined balance under the Term Loans as of December 31,2008 is approximately $1,650,000.  TheTerm Loans have maturity dates of May 1, 2010 as to $665,000 and March 1,2015 as to $985,000 and are payable in equal monthly principal and interestpayments totaling approximately $55,000.

 

Theinterest rate under the Term Loans, in absence of a default under theagreement, is the prime rate, as defined, in effect as of the close of businesson the first day of each calendar quarter, plus 1% (the prime rate was 3.25% atDecember 31, 2008).  The Company isprohibited by the Term Loan from declaring any cash dividends without thelender’s prior written consent.  A$250,000 restricted cash deposit is held in an interest-bearing restricted cashaccount per the terms of the Term Loan and is included in other assets in theconsolidated balance sheet at December 31, 2008.

 

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

 

·      The Company has experienced significantrecurring net losses. At December 31, 2008, the Company had an accumulateddeficit of $20,115,000 compared to an accumulated deficit of $21,063,000 at March 31,2008. The accumulated deficit decreased by $514,000 for the quarter ended December 31,2008. As discussed earlier, and as required under SFAS No. 144, “Accountingfor the Impairment and Disposal of Long-Lived Assets,” as of March 31, 2007 the Company recorded anon-cash impairment charge, reducing by $4.5 million the values of certainproduction equipment and leasehold improvement assets. This non-cash charge did not impact liquidity.

 

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

 

·      To conserve liquidity and reduce costs theCompany as previously announced, cut its workforce by approximately 20% inearly December 2007. The lay-offs have not had a negative impact onproductivity and are not expected to do so. To achieve and sustain improvedsales and enhanced production efficiency and effectiveness, it has beennecessary for the Company to increase its operations workforce in subsequentquarters.

 

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·      Finally, as part of its request to thesenior debt holder for additional funding, the Company has undertaken anaggressive plan to de-emphasize new product introductions and related sales andmarketing expenses, and to aggressively reduce administrative and sales andmarketing expenses in general. However, to achieve and sustain improved salesand enhanced production efficiency and effectiveness, it may be necessary toincrease such expenses in future quarters.

 

***Sufficiency of Liquidity***

 

Based upon our current operating plan, analysis of our consolidatedfinancial position and projected future results of operations, we believe thatour operating cash flows, cash balances, and working capital, together with amoderate amount of additional borrowing, will be sufficient to finance currentoperating requirements, meet debt service requirements, and make plannedcapital expenditures, for the next 12 months. Management expects liquidity inthe remainder of fiscal 2009 to be generated from operating cash flows.

 

**Capital Resources**

 

The Company does not currently have any material commitments forcapital expenditures.  The Company expects fiscal 2009 capitalexpenditures to be under $500,000 and to be funded by operating cashflows.  This includes capital expenditures in support of the Company’snormal operations, and expenditures that we may incur in conjunction withinitiatives to improve gross margins and reduce expenses.

 

## **Outlook**

## ** **

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

 

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

 

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

 

As discussed in Note 1 to Consolidated Condensed Financial Statements,the Company has discontinued all business activity of its wholly owned Japanesesubsidiary CJYK. Management made this decision due to declining sales ofapproximately 40% in each of the prior two fiscal years. Discontinuance of thissubsidiary has not had a significant impact on our consolidated financialstatements.

 

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

 

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

 

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With the adoption of SFAS No.151, the Company recognizes costsassociated with abnormal amounts of idle facility expense, freight, handlingcosts and wasted materials (such as spoilage) as current-period charges in costof sales. When production costs exceed historical averages, managementevaluates whether such costs are current-period charges or are inventoriablecosts. In addition, the allocation of fixed production overheads (such asdepreciation and general insurance) to inventories is determined based onnormal production capacity. When the Company’s production volumes are belownormal capacity limits, certain fixed production overhead costs cannot beinventoried and are recorded immediately in cost of sales. 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.

 

To manage its cash resources effectively, the Company will continue tobalance production in light of sales demand, minimizing the cost associatedwith build-ups in inventory when appropriate. The Company has experienced other significant cash outflows and may needto utilize other cash resources to meet working capital needs if prolonged netlosses are incurred in future periods. A prolonged downturn in sales couldimpair the Company’s ability to generate sufficient cash for operations andminimize the Company’s ability to attract additional capital investment whichcould become necessary in order to expand into new markets or increase productofferings.

 

Management expects operating expense spending to remain consistent withcurrent year levels. However, by March 31, 2010, the Company is requiredto be in full compliance with the Sarbanes-Oxley Act and Rules issuedthereunder by the SEC, including Section 404 Compliance Standardsestablished by the Public Companies Accounting Oversight Board.  The cost of attaining and maintaining suchcompliance could materially decrease reported net income or increase reportednet losses in future periods.

 

The Company’s future results of operations and the otherforward-looking statements contained in this Outlook, in particular thestatements regarding revenues, gross margin and capital spending involve anumber of risks and uncertainties. In addition to the factors discussed above,any of the following could cause actual results to differ materially: businessconditions and growth in the natural products industry and in the generaleconomy; changes in customer order patterns; changes in demand for naturalproducts in general; changes in weather conditions; competitive factors, suchas increased production capacity from competing spirulina and astaxanthinproducers and the resulting impact, if any, on world market prices for theseproducts; government actions; shortage of manufacturing capacity; and otherfactors beyond our control. Risk factors are discussed in detail in Item 1A inour Form 10-K report for the year ended March 31, 2008.

 

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

 

**Item 3.  Quantitative and Qualitative Disclosures aboutMarket Risk**

 

We have never entered 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 term loan agreements that adjust quarterly based on the primerate.  As such, we are exposed to the interest rate risk whereby a 1%increase in the prime rate would lead to an increase of approximately $17,000in interest expense for the year ending March 31, 2009 (based on December 31,2008 amounts outstanding).

 

**Item 4.  Controls andProcedures**

 

(a) **Disclosure Controls and Procedures**

 

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

 

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

 

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As discussed in the Company’s Form 10-Kfor the year ended March 31, 2008, errors were identified in theapplication of certain accounting practices and procedures related toaccounting for certain fixed costs such as portions of depreciation, generalinsurance and minor compensation costs which should be included in the carryingvalue of inventory. The Company has taken extensive measures over the past yearto correct the identified weakness: (1) the Company engaged the servicesof qualified independent consultants to advise the Company on improvements tointernal controls and procedures; (2) during the current fiscal year theCompany hired a dedicated Inventory Accounting Specialist; and (3) consultantsindependent from those who assisted with improvements and procedures havetested the Company’s internal controls over financial reporting.  In addition to those measures, management isre-evaluating its overall information technology (“IT”) systems as it relatesto the weakness and its remediation, and will make sufficient upgrades in thefuture to improve the efficiency and effectiveness of system information.

 

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

 

Management does not believe that current quarter changes in financedepartment personnel, as previously reported on Form 8-K, have had amaterial negative impact on the Company’s internal control over accounting andfinancial reporting during the current quarter.

 

**PART II.  OTHERINFORMATION**

 
| **Item 1.**       | ** ** | **Legal Proceedings**                                            |
|------------------------|------------|------------------------------------------------------------------|
|                   |       |                                                             |
| None.                  |
|                   |
| **Item 2.**       |       | **Unregistered Sales of Equity  Securities and Use of Proceeds** |
| ** **             |       | ** **                                                       |
| None.                  |
|                   |
| **Item 3.**       |       | **Defaults upon Senior Securities**                              |
| ** **             |       | ** **                                                       |
| None.                  |
|                   |
| **Item 4.**       |       | **Submission of Matters to a Vote  of Security Holders**         |
| ** **             |       | ** **                                                       |
| None.                  |
|                   |
|  **Item 5.** |       | **Other Information**                                            |
|                   |       | ** **                                                       |
| None.                  |
|                   |
| **Item 6.**       |       | **Exhibits**                                                     |

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

 

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SIGNATURES

 

**In accordance with the requirements of the Securities Exchange Act of1934, the registrant caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.**

 
|                   |   |   | CYANOTECH  CORPORATION                                    |
|------------------------|--------|--------|-----------------------------------------------------------|
|                   |   |   | (Registrant)                                              |
|                   |   |   |                                                      |
|                   |   |   |                                                      |
| February 12, 2009 |   | By:    | /s/ Andrew  H. Jacobson                              |
|                   |   |   |                                                      |
| (Date)                 |   |   | Andrew  H. Jacobson                                       |
|                   |   |   | President  and Chief Executive Officer                    |
|                   |   |   |                                                      |
|                   |   |   |                                                      |
| February 12, 2009 |   | By:    | /s/  Deanna L. Spooner                                    |
| (Date)                 |   |   | Deanna  L. Spooner                                        |
|                   |   |   | Vice  President — Finance & Administration, |
|                   |   |   | Chief  Financial Officer                                  |
|                   |   |   | (Principal  Financial and Accounting Officer)             |

 

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