Table of Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

** **

**FORM 10-Q**

** **
| **x**                                                  | **Quarterly Report Pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934**  |
|--------------------------------------------------------|---------------------------------------------------------------------------------------------------------|
| ** **                                             |
| **For  Quarterly Period Ended December 31, 2009** |
| ** **                                             |
| **Or**                                                 |
| ** **                                             |
| **o**                                                  | **Transition Report Pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934** |

** **

**For the Transition Period From             to             **

** **

**CommissionFile Number 0-14602**

** **

**CYANOTECHCORPORATION**

(Exact name of registrant as specified in its charter)

 

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

 

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

(Address of principal executive offices)

 

**(808) 326-1353**

(Registrant’s telephone number)

 

**Not Applicable**

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

 

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

 

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

 

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

 

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

 

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

 

Numberof common shares outstanding as of February 11, 2010:

 

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

 

 

 

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CYANOTECH CORPORATION

 

FORM 10-Q

 

INDEX

 
| ** ** | **PART I.  FINANCIAL  INFORMATION**                                                                           | ** ** | ** ** |
|------------|------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| ** ** | ** **                                                                                                                   | ** ** | ** ** |
| Item 1.    | Financial Statements  (unaudited)                                                                                            |       | 3          |
|       | Consolidated  Condensed Balance Sheets as of December 31, 2009 and March 31, 2009                                  |       | 3          |
|       | Consolidated  Condensed Statements of Operations for the three and nine month periods ended  December 31, 2009 and 2008 |       | 4          |
|       | Consolidated  Condensed Statements of Cash Flows for the nine month periods ended  December 31, 2009 and 2008           |       | 5          |
|       | Notes  to Consolidated Condensed Financial Statements                                                                        |       | 6          |
| Item 2.    | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                  |       | 13         |
| Item 3.    | Quantitative  and Qualitative Disclosures About Market Risk                                                                  |       | 18         |
| Item 4.    | Controls and  Procedures                                                                                                     |       | 19         |
| ** ** | **PART II.  OTHER  INFORMATION**                                                                              | ** ** | ** ** |
| ** ** | ** **                                                                                                                   | ** ** | ** ** |
| Item 1.    | Legal Proceedings                                                                                                            |       | 20         |
| Item 2.    | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                 |       | 20         |
| Item 3.    | Defaults upon  Senior Securities                                                                                             |       | 20         |
| Item 4.    | Submission of  Matters to a Vote of Security Holders                                                                         |       | 20         |
| Item 5.    | Other Information                                                                                                            |       | 20         |
| Item 6.    | Exhibits                                                                                                                     |       | 21         |
| SIGNATURES |                                                                                                                         | 22         |

 

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PART 1.  FINANCIAL INFORMATION

 

Item1.  Financial Statements (Unaudited)

 

CYANOTECH CORPORATION

CONSOLIDATED CONDENSED BALANCE SHEETS

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

(Unaudited)

 
| ** **                                                                                                                                                                    | ** ** | **December 31,  2009** | ** ** | **March 31,  2009** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| ASSETS                                                                                                                                                                        |       |                        |       |                     |       |
| Current assets:                                                                                                                                                               |       |                        |       |                     |       |
| Cash and cash equivalents                                                                                                                                                     |       | $                           | 791        |                     | $          | 977 |   |
| Accounts receivable, net of allowance for doubtful  accounts of $10 at December 31, 2009 and $14 at March 31, 2009                                             |       | 2,386                       |       | 1,785                    |       |
| Inventories                                                                                                                                                                   |       | 3,844                       |       | 3,124                    |       |
| Prepaid expenses and other                                                                                                                                                    |       | 201                         |       | 110                      |       |
| Total current assets                                                                                                                                                          |       | 7,222                       |       | 5,996                    |       |
|                                                                                                                                                                          |       |                        |       |                     |       |
| Equipment and leasehold improvements, net                                                                                                                                     |       | 4,701                       |       | 4,316                    |       |
| Other assets                                                                                                                                                                  |       | 441                         |       | 475                      |       |
| Total assets                                                                                                                                                                  |       | $                           | 12,364     |                     | $          | 10,787 |   |
|                                                                                                                                                                          |       |                        |       |                     |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                     |       |                        |       |                     |       |
| Current liabilities:                                                                                                                                                          |       |                        |       |                     |       |
| Current maturities of long-term debt                                                                                                                                          |       | $                           | 354        |                     | $          | 620 |   |
| Accounts payable                                                                                                                                                              |       | 1,011                       |       | 1,040                    |       |
| Accrued expenses                                                                                                                                                              |       | 686                         |       | 444                      |       |
| Total current liabilities                                                                                                                                                     |       | 2,051                       |       | 2,104                    |       |
|                                                                                                                                                                          |       |                        |       |                     |       |
| Long-term debt, less current maturities                                                                                                                                       |       | 713                         |       | 909                      |       |
| Total liabilities                                                                                                                                                             |       | 2,764                       |       | 3,013                    |       |
|                                                                                                                                                                          |       |                        |       |                     |       |
| Commitments and contingencies                                                                                                                                                 |       |                        |       |                     |       |
|                                                                                                                                                                          |       |                        |       |                     |       |
| Stockholders’ equity:                                                                                                                                                    |       |                        |       |                     |       |
| Common stock of $0.02 par value, shares authorized  7,500,000; 5,249,270 shares issued and outstanding at December 31, 2009  and 5,245,770 shares at March 31, 2009 |       | 105                         |       | 105                      |       |
| Additional paid-in capital                                                                                                                                                    |       | 27,797                      |       | 27,590                   |       |
| Accumulated deficit                                                                                                                                                           |       | (18,302                     | )          | (19,921                  | )          |
| Total stockholders’ equity                                                                                                                                               |       | 9,600                       |       | 7,774                    |       |
|                                                                                                                                                                          |       |                        |       |                     |       |
| Total liabilities and stockholders’ equity                                                                                                                               |       | $                           | 12,364     |                     | $          | 10,787 |   |

 

See accompanying Notes to Consolidated Condensed Financial Statements.

 

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CYANOTECH CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share amounts)

(Unaudited)

 
| ** **                                           | ** ** | **Three Months Ended  December 31,** | ** ** | **Nine Months Ended  December 31,** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                           | ** ** | **2009**                                            | ** ** | **2008**                                           | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                 |       |                                                |       |                                               |       |   |   |   |   |
| NET SALES                                            |       | $                                                   | 3,982      |                                               | $          | 3,553 |   | $ | 11,928 |   | $ | 10,528 |   |
| COST OF PRODUCT SALES                                |       | 2,232                                               |       | 1,987                                              |       | 6,683 |   | 6,280 |   |
| Gross profit                                         |       | 1,750                                               |       | 1,566                                              |       | 5,245 |   | 4,248 |   |
|                                                 |       |                                                |       |                                               |       |   |   |   |   |
| OPERATING EXPENSES:                                  |       |                                                |       |                                               |       |   |   |   |   |
| General and administrative                           |       | 716                                                 |       | 647                                                |       | 2,390 |   | 2,220 |   |
| Sales and marketing                                  |       | 336                                                 |       | 298                                                |       | 961 |   | 820 |   |
| Research and development                             |       | 66                                                  |       | 65                                                 |       | 188 |   | 155 |   |
| Total operating expenses                             |       | 1,118                                               |       | 1,010                                              |       | 3,539 |   | 3,195 |   |
|                                                 |       |                                                |       |                                               |       |   |   |   |   |
| Income from operations                               |       | 632                                                 |       | 556                                                |       | 1,706 |   | 1,053 |   |
|                                                 |       |                                                |       |                                               |       |   |   |   |   |
| OTHER INCOME (EXPENSE):                              |       |                                                |       |                                               |       |   |   |   |   |
| Interest expense, net                                |       | (26                                                 | )          | (39                                                | )          | (83 | ) | (123 | ) |
| Other income, net                                    |       | 6                                                   |       | —                                             |       | 23 |   | 10 |   |
|                                                 |       |                                                |       |                                               |       |   |   |   |   |
| Total other expense, net                             |       | (20                                                 | )          | (39                                                | )          | (60 | ) | (113 | ) |
|                                                 |       |                                                |       |                                               |       |   |   |   |   |
| Income before provision (benefit) for income taxes   |       | 612                                                 |       | 517                                                |       | 1,646 |   | 940 |   |
|                                                 |       |                                                |       |                                               |       |   |   |   |   |
| PROVISION (BENEFIT) FOR INCOME TAXES                 |       | 7                                                   |       | 3                                                  |       | 29 |   | (8 | ) |
|                                                 |       |                                                |       |                                               |       |   |   |   |   |
| NET INCOME                                           |       | $                                                   | 605        |                                               | $          | 514 |   | $ | 1,617 |   | $ | 948 |   |
|                                                 |       |                                                |       |                                               |       |   |   |   |   |
| NET INCOME PER SHARE:                                |       |                                                |       |                                               |       |   |   |   |   |
| Basic                                                |       | $                                                   | .12        |                                               | $          | .10 |   | $ | .31 |   | $ | .18 |   |
| Diluted                                              |       | $                                                   | .11        |                                               | $          | .10 |   | $ | .30 |   | $ | .18 |   |
|                                                 |       |                                                |       |                                               |       |   |   |   |   |
| SHARES USED IN CALCULATION OF NET INCOME PER  SHARE: |       |                                                |       |                                               |       |   |   |   |   |
| Basic                                                |       | 5,249                                               |       | 5,246                                              |       | 5,247 |   | 5,243 |   |
| Diluted                                              |       | 5,403                                               |       | 5,246                                              |       | 5,317 |   | 5,246 |   |

 

See accompanying Notes to Consolidated Condensed Financial Statements.

 

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CYANOTECH CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(Dollars in thousands)(Unaudited)

 
| ** **                                                                                   | ** ** | **Nine Months Ended  December 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2009**                                           | ** ** | **2008** | ** ** |
| ** **                                                                                   | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                        |       |                                               |       |   |   |
| Net income                                                                                   |       | $                                                  | 1,617      |   | $ | 948 |   |
| Adjustments to reconcile net income to net cash  provided by (used in) operating activities: |       |                                               |       |   |   |
| Depreciation and amortization                                                                |       | 374                                                |       | 324 |   |
| Amortization of debt issue costs and other assets                                            |       | 43                                                 |       | 41 |   |
| Issuance of common stock for services                                                        |       | 10                                                 |       | — |   |
| Stock based compensation expense                                                             |       | 198                                                |       | 156 |   |
| Net (increase) decrease in:                                                                  |       |                                               |       |   |   |
| Accounts receivable                                                                          |       | (601                                               | )          | (404 | ) |
| Inventories                                                                                  |       | (720                                               | )          | (1,499 | ) |
| Prepaid expenses and other assets                                                            |       | (99                                                | )          | 129 |   |
| Net increase (decrease) in:                                                                  |       |                                               |       |   |   |
| Customer deposits                                                                            |       | 1                                                  |       | (205 | ) |
| Accounts payable                                                                             |       | (29                                                | )          | 408 |   |
| Accrued expenses                                                                             |       | 241                                                |       | 41 |   |
| Net cash provided by (used in) operating  activities                                         |       | 1,035                                              |       | (61 | ) |
|                                                                                         |       |                                               |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                        |       |                                               |       |   |   |
| Investment in equipment and leasehold improvements                                           |       | (759                                               | )          | (331 | ) |
| Cash used in investing activities                                                            |       | (759                                               | )          | (331 | ) |
|                                                                                         |       |                                               |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                        |       |                                               |       |   |   |
| Principal payments on long-term debt                                                         |       | (462                                               | )          | (422 | ) |
| Cash used in financing activities                                                            |       | (462                                               | )          | (422 | ) |
|                                                                                         |       |                                               |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                                        |       | 186                                                |       | (814 | ) |
|                                                                                         |       |                                               |       |   |   |
| Cash and cash equivalents at beginning of period                                             |       | 977                                                |       | 1,090 |   |
|                                                                                         |       |                                               |       |   |   |
| Cash and cash equivalents at end of period                                                   |       | $                                                  | 791        |   | $ | 276 |   |
|                                                                                         |       |                                               |       |   |   |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                                            |       |                                               |       |   |   |
| Cash paid during the period for:                                                             |       |                                               |       |   |   |
| Interest                                                                                     |       | $                                                  | 49         |   | $ | 110 |   |
| Income taxes                                                                                 |       | $                                                  | 30         |   | $ | — |   |

 

See accompanying Notes to Consolidated Condensed Financial Statements.

 

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CYANOTECH CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

December 31, 2009(Unaudited)

 

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

 

The accompanyingconsolidated condensed financial statements have been prepared in accordancewith accounting principles generally accepted in the United States of Americafor interim financial information and with the instructions to Form 10-Qand Regulation S-X.  Accordingly, they do not include all of theinformation and footnotes required by generally accepted accounting principlesin the United States of America (“GAAP”) for complete financial statements. Theconsolidated condensed balance sheet as of March 31, 2009 was derived fromthe audited financial statements. Theseconsolidated condensed financial statements and notes should be read inconjunction with the Company’s consolidated financial statements for the yearended March 31, 2009, contained in the Company’s report on Form 10-Kas filed on June 25, 2009.

 

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

 

The preparation offinancial statements in conformity with GAAP requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities andthe disclosures of contingent assets and liabilities at the balance sheet dateand the reported amounts of revenues and expenses during the periodreported.  Management reviews these estimates and assumptions periodicallyand reflects the effect of revisions in the period that they are determined tobe necessary.  Actual results could differ from those estimates andassumptions.

 

**2.**                                      **INVENTORIES**

 

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

 
| ** **      | ** ** | **December 31, 2009** | ** ** | **March 31, 2009** | ** ** |
|-----------------|------------|----------------------------|------------|------------------------------|------------|
| ** **      | ** ** | **(in thousands)**    | ** ** |
| Raw materials   |       | $                          | 512        |                         | $          | 323 |   |
| Work in process |       | 316                        |       | 329                          |       |
| Finished goods  |       | 2,884                      |       | 2,315                        |       |
| Supplies        |       | 132                        |       | 157                          |       |
|            |       | $                          | 3,844      |                         | $          | 3,124 |   |

 

The Companyrecognizes abnormal production costs including fixed cost variances from normalproduction capacity as an expense in the period incurred. Approximately $0 and$18,000 of fixed production related costs were charged to cost of sales for thequarters ended December 31, 2009 and 2008, respectively, and costs of $0and $40,000 were charged to cost of sales for the nine months ended December 31,2009 and 2008, respectively, due to below normal production capacity.

 

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

 

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

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

 

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Equipmentand leasehold improvements consist of the following:

 
| ** **                                     | ** ** | **December 31, 2009** | ** **  | **March 31, 2009** | ** ** |
|------------------------------------------------|------------|----------------------------|-------------|------------------------------|------------|
| ** **                                     | ** ** | **(in thousands)**    | ** **  |
| Equipment                                      |       | $                          |  6,896 |                         | $          |  6,526 |   |
| Leasehold improvements                         |       | 7,790                      |        | 7,580                        |       |
| Furniture and fixtures                         |       | 124                        |        | 117                          |       |
|                                           |       | 14,810                     |        | 14,223                       |       |
| Less accumulated depreciation and amortization |       | (10,405                    | )           | (10,031                      | )          |
| Construction-in-progress                       |       | 296                        |        | 124                          |       |
| Equipment and leasehold improvements, net      |       | $                          |  4,701 |                         | $          |  4,316 |   |

 

Management reviewslong-lived assets for impairment whenever events or changes in circumstancesindicate that the carrying value of such assets may not be recoverable.Recoverability of these assets is measured by a comparison of the carryingamount to forecasted undiscounted future cash flows expected to be generated bythe asset. If the carrying amount exceeds its estimated future cash flows, thenan impairment charge is recognized to the extent that the carrying amountexceeds the asset’s fair value. Management has determined that no assetimpairment existed as of December 31, 2009.

 

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

 

Long-term debt consists of the following:

 
| ** **                                   | ** ** | **December 31, 2009** | ** **  | **March 31, 2009** | ** ** |
|----------------------------------------------|------------|----------------------------|-------------|-------------------------|------------|
| ** **                                   | ** ** | **(in thousands)**         | ** **  |
| Term loans                                   |       | $                          |  1,067 |                    | $          |  1,529 |   |
| Less current maturities                      |       | (354                       | )           | (620                    | )          |
| Long-term debt, excluding current maturities |       | $                          |  713   |                    | $          |  909 |   |

 

*TermLoan Agreement*

 

In April 2000,the Company executed a Term Loan Agreement (“Term Loan A”) with a lenderproviding for $3.5 million in aggregate credit facilities, secured by theCompany’s assets. Term Loan A has a maturity date of May 1, 2010 and ispayable in 120 equal monthly principal payments plus interest. The interestrate under Term Loan A, in the absence of a default under the agreement, is theprime rate, in effect as of the close of business on the first day of eachcalendar quarter, plus 1%. As of December 31, 2009 the prime rate was3.25%. The balance under this loan was $200,000 and $551,000 at December 31,2009 and March 31, 2009, respectively. The Company is prohibited fromdeclaring any common stock dividends without the lender’s prior writtenconsent. A warrant to purchase 5,000 shares of the Company’s common stock wasissued in conjunction with this Term Loan. The warrant expires in April 2011and has an exercise price of $10.20 per share. The warrant may only beexercised after the Company has repaid the Term Loan in full. The creditagreement requires the Company to meet certain financial covenants. The Companywas in compliance with these financial covenants at December 31, 2009.

 

In February 2008,the Company executed a Term Loan Agreement (“Term Loan B”) with the same lenderproviding for $1.1 million in aggregate credit facilities, secured by theCompany’s assets. Term Loan B has a maturity date of March 1, 2015 and ispayable in 84 equal monthly principal payments plus interest. The interest rateunder Term Loan B, in the absence of a default under the agreement, is theprime rate in effect as of the close of business on the first day of eachcalendar quarter, plus 1%. The balance under this loan was $845,000 and$950,000 at December 31, 2009 and March 31, 2009, respectively. TheCompany is prohibited from declaring any common stock dividends without thelender’s prior written consent.

 

A $250,000 restrictedcash deposit continues to be held to secure these loans and it is included inOther Assets in the accompanying consolidated condensed balance sheets at December 31,2009 and March 31, 2009.

 

In March 2009, the Company executed a Term Loan Agreement withJohn Deere Credit providing for $29,340 in equipment, secured by the equipmentfinanced. The Term Loan has a maturity date of March 25, 2013 and ispayable in 48 equal monthly principal payments. The interest rate under thisTerm Loan is 0%.  Imputed interest at arate of 2% (cash discount offered by seller) has been recorded and will beamortized as interest over the term of the loan. The balance under this loan was $24,000 and $28,000 atDecember 31, 2009 and March 31, 2009, respectively, less the unamortizeddiscount of $1,645 and $2,053, respectively. Amortization of discount is recognized in the income statement asinterest expense and was $136 for the quarter ended December 31, 2009.

 

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On April 24, 2009, the Company entered into an agreement withFirst Hawaiian Bank for a Line of Credit in the amount of $150,000 for a termof one year. The obligation is secured by the Company’s U.S. accountsreceivable and bears a variable interest rate based on the prime rate plus 2%.There is no outstanding balance as of December 31, 2009.

 

Future principalpayments under the Term Loan Agreements as of December 31, 2009 are asfollows:

 
| **Payments  Due**        | ** ** | **(in  thousands)** | ** **  |
|--------------------------|------------|---------------------|-------------|
| Next 12 months           |       | $                   |  354   |   |
| Year 2                   |       | 160                 |        |
| Year 3                   |       | 166                 |        |
| Year 4                   |       | 168                 |        |
| Year 5                   |       | 174                 |        |
| Thereafter through 2015  |       | 45                  |        |
| Total principal payments |       | $                   |  1,067 |   |

 

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

 

The Company leasesfacilities, equipment and land under operating leases expiring between 2009 and2026.  The land lease provides forcontingent rental in excess of minimum rental commitments based on a percentageof the Company’s sales. Management has accrued for the estimated contingentrent as of December 31, 2009.

 

Future minimum leasepayments under all non-cancelable operation leases at December 31, 2009are as follows:

 
| **Payments  Due**            | ** ** | **(in  thousands)** | ** **  |
|------------------------------|------------|---------------------|-------------|
| Next 12 months               |       | $                   |  164   |   |
| Year 2                       |       | 152                 |        |
| Year 3                       |       | 148                 |        |
| Year 4                       |       | 148                 |        |
| Year 5                       |       | 148                 |        |
| Thereafter through 2026      |       | 1,221               |        |
| Total minimum lease payments |       | $                   |  1,981 |   |

 

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

 

The Companyapplies the provisions of Financial Accounting Standards Board *AccountingStandards Codification*, (ASC 718-10), “Compensation — StockCompensation.” The objective of ASC 718-10,accounting for transactions under share based payment arrangements withemployees, is to recognize in the financial statements the employee servicesreceived in exchange for equity instruments issued or liabilities incurred andthe related cost to the entity as those services are consumed based on fairvalue. If an award vests or becomes exercisable based on the achievement of acondition other than service, such as for meeting certain performance or marketcondition, the award is classified as a liability.  Liability-classifiedawards are remeasured to fair value at each balance sheet date until the awardis settled. The Company currently has no liability-classified awards. Equity-classified awards, including grants of employee stock options, aremeasured at the grant-date fair value of the award and are not subsequentlyremeasured unless an award is modified.  The cost of equity-classifiedawards is recognized in the income statement over the period during which anemployee is required to provide the service in exchange for the award. Allof the Company’s stock options are service-based awards, and because theCompany’s stock options are “plain vanilla,” as defined by the U. S. Securitiesand Exchange Commission in Staff Accounting Bulletin No. 107, they arereflected only in Equity and Compensation Expense accounts.

 

***Stock Options***

 

As of December 31,2009, the Company had the following two shareholder-approved stock plans underwhich shares were available for equity-based awards: the 2005 Stock Option Plan(the “2005 Plan”) wherein 700,000 shares of common stock are reserved forissuance until the plan terminates on August 21, 2015, and; TheIndependent Director Stock Option and Stock Grant Plan (the “2004 Plan”)wherein 75,000 shares of common stock are reserved for issuance until the planterminates in 2014.

 

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Under the 2005Plan, eligible employees and certain independent consultants may be grantedoptions to purchase shares of the Company’s common stock. The shares issuableunder the 2005 Plan will either be shares of the Company’s authorized butpreviously unissued common stock or shares reacquired by the Company, includingshares purchased on the open market.  As of December 31, 2009,106,632 options remain available for grant under the 2005 Plan.

 

Under the 2004Plan, upon election to the Board of Directors, a newly elected non-employeedirector is granted a ten-year option to purchase 1,000 shares of the Company’scommon stock at fair market value on the date of grant. Options granted vestand become exercisable six months from the date of grant.  In addition, onthe date of each Annual Meeting of Stockholders, each non-employee directorcontinuing in office is automatically issued 875 shares of common stock,non-transferable for nine months following the date of grant.  As of December 31, 2009, 50,375 optionsremain available 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 followingtable presents shares authorized, available for future grant and outstandingunder each of the Company’s plans:

 
| ** ** | ** ** | **As of December 31, 2009** | ** ** |
|------------|------------|----------------------------------|------------|
| ** ** | ** ** | **Authorized**                   | ** ** | **Available** | ** ** | **Outstanding** | ** ** |
|       |       |                             |       |   |   |   |   |
| 2005 Plan  |       | 700,000                          |       | 106,632 |   | 593,368 |   |
| 2004 Plan  |       | 75,000                           |       | 50,375 |   | 1,000 |   |
| 1994 Plan  |       | —                           |       | — |   | 2,250 |   |
| Total      |       | 775,000                          |       | 157,007 |   | 596,618 |   |

 

All stock optiongrants made under the 2005 Plan and the 2004 Plan were at exercise prices noless than the Company’s closing stock price on the date of grant. Options underthe 2005 Plan and 2004 Plan are determined by the Board of Directors or theStock Option and Compensation Committee of the Board in accordance with theprovisions of the respective plans.  The terms of each option grantinclude vesting, exercise, and other conditions are set forth in a Stock OptionAgreement evidencing each grant. No option can have a life in excess of ten (10) years. The Company records compensation expense for employee stock options based onthe estimated fair value of the options on the date of grant using theBlack-Scholes option-pricing model. The model requires various assumptions,including a risk-free interest rate, the expected term of the options, theexpected stock price volatility over the expected term of the options, and theexpected dividend yield. Compensation expense for employee stock options isrecognized ratably over the vesting term. Compensation expense recognized foroptions issued under the 2005 Plan was $60,000 and $91,000 for the three monthsended December 31, 2009 and 2008, respectively, and $198,000 and $156,000for the nine months ended December 31, 2009 and 2008, respectively, and isclassified as General and Administrative expense in the consolidated condensedstatement of operations. Compensation expense of $9,000 and $7,000 wasrecognized under the 2004 Plan for the nine months ended December 31, 2009and 2008, respectively.

 

A summary ofoption activity under Cyanotech Corporation’s stock option plans for the ninemonths ended December 31, 2009 is presented below:

 
| **Option Activity**              | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** **      |
|---------------------------------------|------------|------------|------------|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------|-----------------|
| Outstanding at March 31, 2009    |       | 509,721    |       | $                                      |  2.11 |                                                | 9.0 years  |                            | $               |  — |   |
| Granted                               |       | 113,000    |       | 2.08                                   |       | 10.0 years                                          |       | 361,600                         |            |
| Exercised                             |       | —     |       | —                                 |       | —                                              |       | —                          |            |
| Forfeited or expired                  |       | (26,103    | )          | 3.90                                   |       | —                                              |       | —                          |            |
| Outstanding at December 31, 2009 |       | 596,618    |       | 1.88                                   |       | 8.7 years                                           |       | $                               |  2,030,487 |   |
| Exercisable at December 31, 2009 |       | 143,426    |       | 1.46                                   |       | 8.3 years                                           |       | $                               |  547,758   |   |
|                                       |            |            |            |                                        |            |                                                     |            |                                 |                 |  |  |

 

The aggregate intrinsic value in the table above is before applicableincome taxes and represents the amount optionees would have received if alloptions had been exercised on the last business day of the period indicated,based on the Company’s closing stock price of $5.28 for such day.

 

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A summary of theCompany’s non-vested options for the nine months ended December 31, 2009is presented below:

 
| **Nonvested Options**          | ** ** | **Shares** | ** ** | **Weighted  Average  Grant-Date  Fair Value** | ** ** |
|-------------------------------------|------------|------------|------------|----------------------------------------------------|------------|
| Nonvested at March 31, 2009    |       | 481,463    |       | $                                                  | 1.30       |   |
| Granted                             |       | 113,000    |       | .65                                                |       |
| Vested                              |       | (136,056   | )          | 1.08                                               |       |
| Forfeited or expired                |       | (5,215     | )          | .59                                                |       |
| Nonvested at December 31, 2009 |       | 453,192    |       | 1.21                                               |       |
|                                     |            |            |            |                                                    |            |  |

 

The followingtable summarizes the weighted average characteristics of outstanding stockoptions as of December 31, 2009:

 
| ** **                              | ** ** | **Outstanding Options** | ** ** | **Exercisable Options**     | ** ** |
|-----------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | **Number  of Shares**   | ** ** | **Remaining  Life (Years)** | ** ** | **Weighted  Average  Price** | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Price** | ** ** |
| $ 1.41 - $2.60                     |       | 594,868                      |       | 8.7                              |       | $ |  1.87 |   | 141,676 |   | $ |  1.43 |   |
| $ 4.20 - $6.50                     |       | 1,750                        |       | 3.4                              |       | 4.31 |   | 1,750 |   | 4.31 |   |
| Total stock options                     |       | 596,618                      |       | 8.7                              |       | 1.88 |   | 143,426 |   | 1.46 |   |
|                                         |            |                              |            |                                  |            |  |  |  |  |  |  |  |  |

 

The range of fairvalue assumptions related to options granted during the three and nine monthperiods ended December 31:

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

 

As of December 31,2009, total unrecognized stock-based compensation expense related to allunvested stock options was $255,591. Of the 453,192 unvested options at December 31,2009, 262,112 options cliff vest as follows: 131,056 of the options have an exercise price of $2.12 and cliff vest100% on May 16, 2010; and 131,056 of the options have an exercise price of$2.12 and cliff vest 100% on May 16, 2011. These cliff vesting optionshave a combined unrecognized compensation expense of $160,381 as of December 31,2009 that will be amortized over a remaining 4 months and 15 months,respectively. The unrecognized compensation expense of $95,210 for theremaining 191,080 unvested options is expected to be amortized over a remainingweighted-average period of 3.06 years through April 29, 2013.

 

***Warrant***

 

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

 

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

 

The Company issubject to taxation in the United States and two state jurisdictions.  The preparation of income tax returnsrequires management to interpret the applicable tax laws and regulations ineffect in such jurisdictions, which could affect the amount of tax paid by theCompany. Management, in consultation with its tax advisors, files its taxreturns on interpretations that are believed to be reasonable under thecircumstances. The income tax returns, however, are subject to routine reviewsby the various taxing authorities in the jurisdictions in which the Companyfiles its returns.  As part of these reviews, a taxing authority maydisagree with respect to the tax positions taken by management (“uncertain taxpositions”) and therefore may require the Company to pay additional taxes.Management evaluates the requirement for additional tax accruals, includinginterest and penalties, which the Company could incur as a result of theultimate resolution of its uncertain tax positions. Management reviews andupdates the accrual for uncertain tax positions as more definitive informationbecomes available from taxing authorities, completion of tax audits, expirationof statute of limitations, or upon occurrence of other events.

 

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The Companyapplies the provisions of *ASC Topic 740, “*Accountingfor Uncertainty in Income Taxes”. As of December 31, 2009, there was nosignificant liability for income tax associated with unrecognized tax benefits.The Company recognizes accrued interest related to unrecognized tax benefits aswell as any related penalties in interest income or expense in its consolidatedcondensed statements of operations, which is consistent with the recognition ofthese items in prior reporting periods.

 

Income taxes areprovided on the earnings in the consolidated financial statements. Theprovision is based on the current quarter activity of the legal entities andjurisdictions in which the Company operates. Tax credits, such as Hawaiicapital goods excise tax credits, are recognized as a reduction to income taxesin the year the credits are earned. Accordingly, the effective tax rate may vary from the customaryrelationship between income tax expense (benefit) and pre-tax income.  The effective tax rate for the three and ninemonths ended December 31, 2009 differs from the statutory rate due toutilization of net operating loss carryforwards that have been fully reserveddue to the Company’s inconsistent taxable income in recent years anduncertainty about taxable income in future years.

 

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 before2002.

 

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

 

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

 

Reconciliationsbetween the numerator and the denominator of the basic and diluted earnings pershare computations for the three months ended December 31, 2009 and December 31,2008 are as follows:

 
| ** **                                              | ** ** | **Three Months Ended December 31, 2009** | ** ** |
|---------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                              | ** ** | **Net Income**                                               | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| ** **                                              | ** ** | **(Numerator)**                                                   | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
| ** **                                              | ** ** | **(in thousands)**                                           | ** ** | ** ** | ** ** |
| Basic income per share                                  |       | $                                                                 |  605  |   | 5,249 |   | $ |  0.12 |   |
| Effect of dilutive securities—Common stock options |       | —                                                            |       | 154 |   | .01 |   |
| Diluted income per share                                |       | $                                                                 |  605  |   | 5,403 |   | $ |  0.11 |   |

 
| ** **                                                 | ** ** | **Three Months Ended December 31, 2008** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **Net Income**                                               | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| ** **                                                 | ** ** | **(Numerator)**                                                   | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
| ** **                                                 | ** ** | **(in thousands)**                                           | ** ** | ** ** | ** ** |
| Basic income per share                                     |       | $                                                                 |  514  |   | 5,246 |   | $ |  0.10 |   |
| Effect of dilutive securities — Common stock  options |       | —                                                            |       | — |   | — |   |
| Diluted income per share                                   |       | $                                                                 |  514  |   | 5,246 |   | $ |  0.10 |   |

 

Reconciliationsbetween the numerator and the denominator of the basic and diluted earnings pershare computations for the nine months ended December 31, 2009 and December 31,2008 are as follows:

 
| ** **                                              | ** ** | **Nine Months Ended December 31, 2009** | ** **  |
|---------------------------------------------------------|------------|------------------------------------------------------------------|-------------|
| ** **                                              | ** ** | **Net Income**                                              | ** **  | **Shares** | ** ** | **Per Share** | ** ** |
| ** **                                              | ** ** | **(Numerator)**                                                  | ** **  | **(Denominator)** | ** ** | **Amount** | ** ** |
| ** **                                              | ** ** | **(in thousands)**                                          | ** **  | ** ** | ** ** |
| Basic income per share                                  |       | $                                                                |  1,617 |   | 5,247 |   | $ |  0.31 |   |
| Effect of dilutive securities—Common stock options |       | —                                                           |        | 70 |   | .01 |   |
| Diluted income per share                                |       | $                                                                |  1,617 |   | 5,317 |   | $ |  0.30 |   |

 

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| ** **                                                | ** ** | **Nine Months Ended December 31, 2008** | ** ** |
|-----------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                                | ** ** | **Net Income**                                              | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| ** **                                                | ** ** | **(Numerator)**                                                  | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
| ** **                                                | ** ** | **(in thousands)**                                          | ** ** | ** ** | ** ** |
| Basic income per share                                    |       | $                                                                |  948  |   | 5,243 |   | $ |  0.18 |   |
| Effect of dilutive securities — Common stock options |       | —                                                           |       | 3 |   | — |   |
| Diluted income per share                                  |       | $                                                                |  948  |   | 5,246 |   | $ |  0.18 |   |

 

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 8,250and 58,250 securities excluded from the calculation of diluted income per sharebecause their effect was anti-dilutive for the three and nine months ended December 31,2009 and 521,244 for the three and nine months ended December 31, 2008.

 

**9.****           ****NEW ACCOUNTING PRONOUNCEMENTS**

 

InMay 2009, the FASB issued *ASC 855*,“Subsequent events”.The objectiveof this Statement is to establish general standards of accounting for anddisclosure of events that occur after the balance sheet date but beforefinancial statements are issued or are available to be issued. In particular,this Statement sets forth: 1. the period after the balance sheet date duringwhich management of a reporting entity should evaluate events or transactionsthat may occur for potential recognition or disclosure in the financialstatements, 2. the circumstances under which an entity should recognize eventsor transactions occurring after the balance sheet date in its financialstatements and 3. the disclosures that an entity should make about events or transactionsthat occurred after the balance sheet date. In accordance with this Statement,an entity should apply the requirements to interim or annual financial periodsending after June 15, 2009. TheCompany adopted ASC 855 during the second quarter of 2009. Theadoption of ASC 855 did not have a material impact on the Company’s financialstatements or condition. In accordancewith ASC 855, management has evaluated subsequent events through the datethe financial statements are filed with the SEC and is not aware of any subsequent eventswhich would require recognition or disclosure in the financial statements.

 

OnOctober 1, 2009, we adopted ASU No. 2010-02, “Consolidation (Topic810) Accounting and Reporting for Decreases in Ownership of a Subsidiary—a ScopeClarification,” as codified in ASC 810, “Consolidation.” ASU No. 2010-02applies retrospectively to April 1, 2009, our adoption date for ASC810-10-65-1. This ASU clarifies the applicable scope of ASC 810 for a decreasein ownership in a subsidiary or an exchange of a group of assets that is abusiness or nonprofit activity. The ASU also requires expanded disclosures. Theadoption of this ASU did not have a material impact on our consolidatedfinancial statements; however, it may affect future divestitures ofsubsidiaries or groups of assets within its scope.

 

OnOctober 1, 2009, we adopted ASU No. 2010-01, “Equity (Topic 505):Accounting for Distributions to Shareholders with Components of Stock andCash—a consensus of the FASB Emerging Issues Task Force,” as codified in ASC505, “Equity.” ASU No. 2010-01 clarifies the treatment of certaindistributions to shareholders that have both stock and cash components. Thestock portion of such distributions is considered a share issuance that isreflected in earnings per share prospectively and is not a stock dividend. Theadoption of this ASU did not have a material impact on our consolidatedfinancial statements; however, it may affect any future stock distributions.

 

OnOctober 1, 2009, we adopted ASU No. 2009-12, “Fair Value Measurementsand Disclosures (Topic 820): Investments in Certain Entities That Calculate NetAsset Value per Share (or Its Equivalent),” as codified in ASC 820-10, “FairValue Measurements and Disclosures—Overall.” ASU No. 2009-12 permits areporting entity to measure the fair value of certain alternative investmentsthat do not have a readily determinable fair value on the basis of theinvestments’ net asset value per share or its equivalent. This ASU alsorequires expanded disclosures. The adoption of this ASU did not have a materialimpact on our consolidated financial statements; however, it may impact thevaluation of our future investments.

 

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**Item 2.**** ****Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

**FORWARD LOOKING STATEMENTS**

 

This Report and other presentations made by Cyanotech Corporation (“CYAN”)and its subsidiary contain “forward-looking statements,” which includestatements that are predictive in nature, depend upon or refer to future eventsor conditions, and usually include words such as “expects,” “anticipates,” “intends,”“plan,” “believes,” “seeks”, “estimates” or similar references to futureperiods. In addition, any statement concerning future financial performance,ongoing business strategies or prospects and possible future actions are alsoforward-looking statements. Forward-looking statements are based upon currentexpectations about future events and conditions and are subject to risks,uncertainties, changes in circumstances and the accuracy of assumptionsconcerning CYAN and its subsidiary (collectively, the “Company”), theperformance of our industry, market and competitive factors, and global,national and regional economic factors and conditions. **These forward-looking statements are not guarantees offuture performance. **Our actual results may differ materially fromthose contemplated by the forward-looking statements.  They are neither statements of historicalfact nor guarantees of future performance.

 

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

 

·                  Statements relating to ourbusiness strategy;

 

·                  Statements relating to ourbusiness objectives; and

 

·                  Expectations concerningfuture operations, profitability, liquidity and financial resources.

 

Examples in this Report include, but are not limited to, statements wemake regarding sufficiency of liquidity, capital resources and outlook over thenext twelve (12) months or through the end of fiscal 2010.

 

The following factors, among others, could cause our financialperformance to differ significantly from the goals, plans, objectives,intentions and expectations expressed in our forward-looking statements:

 

·                  The added risks associatedwith the current local, national and world economic crisis, including but notlimited to the volatility of crude oil prices;

 

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

 

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

 

·                  Changes in domestic and/orforeign laws, regulations or standards, affecting nutraceutical products;

 

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

 

·                  Access to available andreasonable financing on a timely basis;

 

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

 

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

 

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

 

·                  Acts of war, terroristsincidents or natural disasters; and

 

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

 

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**Overview**

 

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

 
| ** **                   | ** ** | **Three Months Ended**          | ** **  | ** **                      | ** ** |
|------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| ** **                   | ** ** | **December 31, 2009** | ** **  | **December 31, 2008** | ** ** | **Change** | ** ** |
| Net sales:                   |       |                            |        |                            |       |   |   |
| Spirulina products           |       | $                               |  1,763 |                            | $          |  1,650 |   | 7 | % |
| Natural astaxanthin products |       | 2,213                           |        | 1,903                           |       | 16 | % |
| Other products               |       | 6                               |        | —                          |       | 100 | % |
| Total sales, all products    |       | $                               |  3,982 |                            | $          |  3,553 |   | 12 | % |
|                         |       |                            |        |                            |       |   |   |
| Gross profit            |       | $                               |  1,750 |                            | $          |  1,566 |   | 12 | % |
| Income  from operations      |       | $                               |  632   |                            | $          |  556 |   | 14 | % |
| Net income                   |       | $                               |  605   |                            | $          |  514 |   | 18 | % |

 
| ** **                   | ** ** | **Nine Months Ended**           | ** **   | ** **                      | ** ** |
|------------------------------|------------|---------------------------------|--------------|---------------------------------|------------|
| ** **                   | ** ** | **December 31, 2009** | ** **   | **December 31, 2008** | ** ** | **Change** | ** ** |
| Net sales:                   |       |                            |         |                            |       |   |   |
| Spirulina products           |       | $                               |  5,638  |                            | $          |  5,344 |   | 6 | % |
| Natural astaxanthin products |       | 6,271                           |         | 5,146                           |       | 22 | % |
| Other products               |       | 19                              |         | 38                              |       | (50 | )% |
| Total sales, all products    |       | $                               |  11,928 |                            | $          |  10,528 |   | 13 | % |
|                         |       |                            |         |                            |       |   |   |
| Gross profit            |       | $                               |  5,245  |                            | $          |  4,248 |   | 23 | % |
| Income from operations       |       | $                               |  1,706  |                            | $          |  1,053 |   | 62 | % |
| Net income                   |       | $                               |  1,617  |                            | $          |  948 |   | 71 | % |

 

Sales continued toimprove in the third quarter and nine month period ending December 31,2009 over the third quarter and nine month period ending December 31, 2008with increases in both spirulina and natural astaxanthin product sales.

 

Spirulina sales ofboth bulk and packaged nutrition products increased for the three and ninemonth periods over one year ago. However, sales of bulk spirulina tablets decreased for the third quartercompared to the third quarter of last fiscal year due to timing of customerorders.

 

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

 

Gross profitmargin as a percentage of sales remained unchanged for the three months ended December 31,2009 and 2008, at 44%. Gross profit margin as a percentage of sales increased4% for the nine months ended December 31, 2009 over the same period a yearago. The increase is a combined result of increases in average selling prices,increases in units sold and improved production levels resulting in reduced perunit product costs. Management continues researching methodologies to promoteand sustain production at desired capacity and quality levels.

 

Net incomeimprovements of the current year three and nine month periods over thecorresponding periods of last fiscal year are the result of stable productionallowing increased sales and improved gross profit margin while closely controllingincreasing operating expenses.

 

**Results of Operations**

 

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

# ** **

Net sales for thethird quarter of fiscal 2010 increased to $3,982,000, a 12% increase from the$3,553,000 reported for the comparable period a year ago.  Spirulinaproduct sales for the third quarter of fiscal 2010 were $1,763,000, which is a7% increase from sales generated in the third quarter of fiscal 2009. Bulk spirulina sales decreased 8% due to reduced bulk tablet sales whilepackaged spirulina products increased by 40% primarily due to increased foreignprivate label product sales. The Company’s own Nutrex brand products increased22% over sales in the comparable period a year ago. As a percentage of sales,Spirulina accounted for 44% of total sales in the third quarter of fiscal 2010,compared to 46% for the comparable period a year ago.

 

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Naturalastaxanthin product sales were $2,213,000 during the third quarter of 2010, a16% increase from $1,903,000 in the third quarter of the prior year.  Bulkproduct sales increased 21% and packaged nutrition product sales increased 4%.  Improved production has allowed the companyto increase astaxanthin products inventory and sales.  Natural astaxanthin product sales accountedfor 56% of total sales in the third quarter of fiscal 2010, compared to 54% forthe third quarter of fiscal 2009.

 

Internationalsales were 43% of total sales for the third quarter of fiscal year 2010 and 53%in the third quarter of 2009. International sales decreased as a result ofreduction in orders from two European customers.  Major customers are those equaling or exceeding10% of the Company’s sales for the period. For the third quarter of fiscal 2010one domestic customer had sales equal to or greater than 10% of the Company’stotal sales for the quarter. One European distributor accounted for 18% of theCompany’s total sales for the third quarter of fiscal year 2009.

 

Gross profit forthe three months ended December 31, 2009 was $1,750,000, an increase of$184,000 from $1,566,000 for the three months ended December 31,2008.  The gross profit margin of 44%remained the same for the two quarters.

 

Variableproduction costs decreased 3% in the current period compared to one yearago.  The decrease is primarily due tothe combined result of utility and water rates being lower than the comparableprior year period, reduced water usage and reduced packaging costs compared tothe prior year period.  Theseimprovements were partially offset by labor costs increases from combined payrate increases and added personnel. Fixed costs have increased by 10% primarilydue to depreciation of added production equipment. Spirulina productiondecreased 6% and astaxanthin production increased 23% over the same quarter oneyear ago

 

Operating expenses for the three months ended December 31,2009 were $1,118,000 compared to $1,010,000 for the three months ended December 31,2008, an increase of 11%.  Operatingexpenses were 28% of sales for both three month periods.  General and administrative expense and salesand marketing expense for the third quarter fiscal 2010 increased by $69,000 and$38,000 respectively, from the third quarter of fiscal 2009 primarily due toincreases in employee compensation and benefits.

 

For the threemonths ended December 31, 2009, the Company recorded an income tax expenseof $12,000 related to Federal alternative minimum tax. This expense was offsetby a $5,000 credit related to State income taxes making the net tax expense forthis period $7,000 compared to $3,000 of income tax expense for the threemonths ended December 31, 2008. Management does not expect any materialU.S. Federal or state income taxes to be recorded for the current fiscal yearbecause of available net operating loss carry-forwards.

 

The Companyreported net income of $605,000 or $0.11 per diluted share, for the threemonths ended December 31, 2009 compared****toa net income of $514,000, or $0.10 per diluted share for the three months endedDecember 31, 2008.

 

*NineMonths Ended December 31, 2009 Compared to Nine Months Ended December 31,2008*

 

Net sales for thenine months ended December 31, 2009 were $11,928,000, an increase of$1,400,000 or 13% over sales of $10,528,000 reported for the comparable perioda year ago.  The increase in sales over the prior year’s nine-month periodwas the result of a 6% increase in spirulina sales and a 22% increase innatural astaxanthin product sales.  Spirulina bulk sales increased 4%while packaged nutrition products increased 8% with increases in both Nutrexbrand and private label product sales. Astaxanthin bulk sales increased 25% and packaged nutrition productsales increased 14%, both primarily the result of improved production andavailable inventory.

 

Internationalsales represented 43% of net sales for the nine months ended December 31,2009 compared to 49% for the same period a year ago.  For the nine months ended December 31,2009, one domestic customer accounted for 10% of total sales.  For the nine months ended December 31,2008, two European distributors accounted for 24% of total sales.

 

For the ninemonths ended December 31, 2009, cost of sales decreased as a percentage ofsales by 4% from the comparable prior year period.  Total variableproduction costs for the nine months ended December 31, 2009, remainedconsistent with the prior year nine month period. Increases in labor wereoffset by decreases in Nutrients and utilities. Fixed costs increased 11% forthe nine months ended December 31, 2009, primarily due to depreciation ofproduction equipment additions.

 

Operating expensesfor the nine months ended December 31, 2009 were $3,539,000, an increaseof $344,000 or 11% from the comparable prior year period.  Sales andmarketing expense increased by $141,000 or 17% as a result of reinstitutingmarketing programs to expand consumer awareness.  General and administrative expense increased$170,000 or 8% due to increased compensation expenses offset by reductions incontractual services related to public company reporting. Research anddevelopment expense increased $33,000 or 21% from the comparable prior period,due to initiation of a product use research study being conducted at aCalifornia university.  While it is ourgoal to contain discretionary operating spending, it may become necessary forthe Company to selectively increase spending in some or all of these areas toremain competitive and to comply with regulatory requirements.

 

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Net other expense,which includes interest on the Company’s debt, for the nine months ended December 31,2009 decreased by 47% to $60,000 from $113,000 for the same prior year period.The current year decrease represents reduced interest as the Company pays downthe outstanding balances of its long-term debt.

 

For the ninemonths ended December 31, 2009, the Company recorded an income tax expenseof $29,000 related to Federal and state alternative minimum tax compared to anincome tax benefit of $8,000 for the same period of the prior year. Managementdoes not expect any material United States income taxes for the current fiscalyear as a result of available net operating loss carry-forwards.

 

The Companyrecorded net income of $1,617,000 or $0.30 per diluted share for the nine monthperiod ended December 31, 2009. For the same period a year ago the Companyreported net income of $948,000 or $0.18 per diluted share.

 

**Variabilityof Results**

 

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

 

**FinancialCondition**

 

Cash and cashequivalents decreased $186,000 or 19% to $791,000 at December 31, 2009,from $977,000 at March 31, 2009. Cash provided by operating activities of $1,035,000 increased $1,096,000over the same nine month period of last fiscal year. The increase is due to theincrease in net income of $669,000 and an increase of non-cash expenses of$100,000 offset by a $327,000 reduction in net cash usage due to changes incurrent assets and liabilities over the same nine month period of last fiscalyear.

 

As of December 31,2009, the Company’s net accounts receivable increased $601,000 to $2,386,000from $1,785,000 as of March 31, 2009. The increase in accounts receivableis primarily the result of the timing of sales for the quarter. Managementbelieves that its accounts receivable are collectible, net of the allowance fordoubtful accounts of $10,000 at December 31, 2009.

 

The Company’s netinventory increased $720,000 or 23% to $3,844,000 as of December 31, 2009compared to $3,124,000 as of March 31, 2009. The increase in inventoryduring the first nine months of fiscal 2010 is the result of continued effortsto maintain consistent production levels in spirulina and astaxanthinproduction to allow for better customer service and sales expansion.

 

As of December 31,2009, the Company’s accounts payable and accrued expenses increased $213,000 to$1,697,000 from $1,484,000 as of March 31, 2009. The increase in accountspayable and accrued expenses is primarily the result of the timing of purchasesfor the quarter.

 

Cash flows used ininvesting activities reflect capital expenditures which totaled $759,000 duringthe first nine months of fiscal 2010 compared to just $331,000 one year ago.Cash flows used in financing activities are attributable exclusively to debtrepayments of $462,000 and $422,000 for the first nine months of fiscal 2010and 2009, respectively.

 

**Liquidityand Capital Resources**

 

At December 31,2009, the Company’s working capital was $5,171,000, an increase of $1,279,000compared to $3,892,000 at March 31, 2009. Cash and cash equivalents at December 31,2009 totaled $791,000 a decrease of $186,000 from $977,000 at March 31,2009.

 

The Company hastwo Term Loan Agreements (“Term Loans”) with a lender. These provided up to$4.6 million in combined credit facilities which are secured bysubstantially all the assets of the Company. The outstanding combined balanceunder the Term Loans as of December 31, 2009 is approximately $1,045,000.The Term Loans have maturity dates of May 1, 2010 as to $200,000 and March 1,2015 as to $845,000 and are payable in equal monthly principal payments plusinterest totaling approximately $55,000.

 

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The interest rateunder the Term Loans, in absence of a default under the agreement, is the primerate, as defined, in effect as of the close of business on the first day ofeach calendar quarter, plus 1% (the prime rate was 3.25% at December 31,2009). The Company is prohibited by the Term Loan from declaring any cashdividends without the lender’s prior written consent. A $250,000 restrictedcash deposit must be held in an interest-bearing restricted cash account perthe terms of the Term Loan and is included in other assets in the consolidatedbalance sheet at December 31, 2009.

 

On April 24, 2009, the Company entered into an agreement withFirst Hawaiian Bank for a Line of Credit in the amount of $150,000 for a termof one year. The obligation is secured by the Company’s U.S. accountsreceivable and bears a variable interest rate based on prime plus 2%. There wasno outstanding balance as of December 31, 2009. The lender under the Company’sexisting Term Loans has subordinated its position up to $150,000 ofU.S. accounts receivable.

 

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

 

·                  The Company had experienced significant recurring net losses overextended periods preceding the most recent seven quarters. At December 31,2009, the Company had an accumulated deficit of $18,302,000 compared to anaccumulated deficit of $19,921,000 at March 31, 2009. The accumulateddeficit decreased by $605,000 for the quarter ended December 31, 2009.

 

·                  Material weaknesses in its internal controls, as previously reported,caused the Company to experience delays in completing its consolidatedfinancial statements and filing periodic reports with the SEC on a timely basisfor periods prior to fiscal year end March 31, 2008. At present managementbelieves that improving the capabilities of existing data systems andprocedures will ultimately correct the material weakness.

 

·                  In early December 2007, the Company cut its workforce byapproximately 20% to conserve liquidity and reduce costs to allow time for theCompany to recover from weather related production losses. The Company hassince increased its operations workforce to achieve enhanced productionefficiency and effectiveness and sustain improved sales.  As of December 31, 2009, the Companyemployed 68 full time employees and 1 part time employee. Of the total, 36 areinvolved in harvesting and production and the remainder in sales,administration and support.

 

***Sufficiency of Liquidity***

 

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

 

**CapitalResources**

 

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

 

## **Outlook**

## ** **

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

 

CyanotechCorporation’s strategic direction has been to position itself as a world leaderin the production and marketing of high-value natural products from microalgae.We are vertically aligned, producing raw materials in the form of microalgaeprocessed at our 90-acre facility in Hawaii, and integrating those rawmaterials into finished products. In fiscal 2010, we have put greater emphasison our Nutrex Hawaii consumer products to reintroduce them to the consumermarket. Our focus going forward will be to leverage our experience andreputation for quality, building nutritional brands which promote health andwell-being. The foundation of our nutritional products is naturally cultivatedSpirulina Pacifica® in powder, flake and tablet form; and *BioAstin*® natural astaxanthin antioxidantin extract, softgel caplet and micro-encapsulated beadlet form. Informationabout our Company and our products can be viewed at www.cyanotech.com andwww.nutrex-hawaii.com. Consumer products can also be purchased online atwww.nutrex-hawaii.com.

 

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We are currentlyexperiencing an upward trend in sales primarily in our Natural astaxanthinproducts. The Company is focused on sustainability of its production levels inorder to promote continued growth in its astaxanthin product line. The Companyexpects spirulina sales to remain essentially level since the product hasreached a mature life cycle stage. The Company will continue to promote thenutritional superiority of Hawaiian grown spirulina to maintain and expandmarket share. Significant sales variability between periods and even acrossseveral periods can be expected based on historical results.

 

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

 

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

 

Producing thehighest quality microalgae is a complex biological process which requiresbalancing numerous factors including microalgal strain variation, temperature,acidity, nutrient and other environmental considerations, some of which are notwithin the Company’s control. An imbalance or unexpected event can occurresulting in production levels below normal capacity. The allocation of fixedproduction overheads (such as depreciation and general insurance) toinventories is determined based on normal production capacity. When the Company’sproduction volumes are below normal capacity limits, certain fixed productionoverhead costs cannot be inventoried and are recorded immediately in cost ofsales. In addition, when production costs exceed historical averages,management evaluates whether such costs are one-time-period charges or anongoing component of inventory cost.

 

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

 

Management expectsGeneral and administrative expense to continue to increase in future periodsdue to normal inflationary increases and increased regulatory and reportingdemands on the Company. For the fiscal year ending March 31, 2011, theCompany will be required to be in full compliance with the Sarbanes-Oxley Actand Rules issued thereunder by the SEC, including Section 404Compliance Standards established by the Public Companies Accounting OversightBoard, including the requirement for our auditors to report on management’sassessment of internal controls over financial reporting. The cost of attainingand maintaining such compliance could materially decrease reported net incomeor increase reported net losses in future periods.

 

The Company’sfuture results of operations and the other forward-looking statements containedin this Outlook, in particular the statements regarding revenues, gross marginand capital spending involve a number of risks and uncertainties. In additionto the factors discussed above, any of the following could cause actual resultsto differ materially: business conditions and growth in the natural productsindustry and in the general economy; changes in customer order patterns;changes in demand for natural products in general; changes in weatherconditions; competitive factors, such as increased production capacity fromcompeting spirulina and astaxanthin producers and the resulting impact, if any,on world market prices for these products; government actions and increasedregulations both domestic and foreign; shortage of manufacturing capacity; andother factors beyond our control. Risk factors are discussed in detail in Item1A in our Form 10-K report for the year ended March 31, 2009.

 

Management believes thatour technology, systems, processes and favorable growing location generallypermit year-round harvest of our microalgal products in a cost-effectivemanner. However, imbalances in astaxanthin production in fiscal year 2007 andspirulina production in 2008, together with volatile energy costs and rapidlychanging world markets, suggest a need for continuing caution with respect tovariables beyond our reasonable control. Therefore, we cannot, and do notattempt to, provide any definitive assurance with regard to our technology,systems, processes, location, or cost-effectiveness.

 

**Item 3.  Quantitativeand Qualitative Disclosures about Market Risk**

 

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

 

We have two term loans which adjust quarterly based on the prime rate. Assuch, we are exposed to the interest rate risk whereby a 1% increase in theprime rate would lead to an increase of approximately $10,000 in interestexpense for the year ending March 31, 2010 (based on December 31,2009 amounts outstanding).

 

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**Item 4.  Controls and Procedures**

 

(a) **Disclosure Controls and Procedures**

 

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

 

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

 

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

 

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

 

There was no change in our internal control over financial reportingduring the current quarter that has materially affected or is reasonably likelyto materially affect, our internal control over financial reporting. TheCompany has undertaken to upgrade its resource management software to provide asingle source for all financial data; establish access controls to data andtransactions; and to automate allocations, calculations and periodicreports.  The upgrade is in process andis expected to be completed prior to March 31, 2011.

 

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**PART II.  OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

None.

 

**Item 2.  Unregistered Sales of Equity Securities andUse of Proceeds**

 

None.

 

**Item 3.  Defaults upon Senior Securities**

 

None.

 

**Item 4.  Submission of Matters to a Vote of SecurityHolders**

 

None.

 

**Item 5.  Other Information**

 

None

 

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**Item 6.  Exhibits**

 
| a)     | The following exhibits  are furnished with this report: |
|--------|---------------------------------------------------------|
|   |                                                    |   |
|   | 31.1                                                    | Certifications  of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002 signed as of February 11, 2010. |
|   |                                                    |   |
|   | 31.2                                                    | Certifications  of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002 signed as of February 11, 2010. |
|   |                                                    |   |
|   | 32                                                      | Certifications  of Chief Executive Officer and Chief Financial Officer Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 signed as of  February 11, 2010. |

 

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SIGNATURES

 

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

 
|                   |     |     | CYANOTECH CORPORATION                                       |
|------------------------|----------|----------|-------------------------------------------------------------|
|                   |     |     | (Registrant)                                                |
|                   |     |     |                                                        |
|                   |     |     |                                                        |
| February 11, 2010 |     | By:      | /s/ Andrew  H. Jacobson                                |
| (Date)                 |     |     | Andrew H.  Jacobson                                         |
| * *               | * * | * * | *President  and Chief Executive Officer*                    |
|                   |     |     |                                                        |
|                   |     |     |                                                        |
| February 11, 2010 |     | By:      | /s/ Deanna L.  Spooner                                      |
| (Date)                 |     |     | Deanna L.  Spooner                                          |
| * *               | * * | * * | *Vice  President — Finance & Administration,* |
| * *               | * * | * * | *Chief  Financial Officer*                                  |

 

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EXHIBIT INDEX

 
| **Exhibit Number** | ** ** | **Description**                                                                                                                                                             |
|-------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                    |       |                                                                                                                                                                        |
| 31.1                    |       | Certifications of Chief  Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 signed as of February 11, 2010.                             |
|                    |       |                                                                                                                                                                        |
| 31.2                    |       | Certifications of Chief  Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 signed as of February 11, 2010.                             |
|                    |       |                                                                                                                                                                        |
| 32                      |       | Certifications of Chief  Executive Officer and Chief Financial Officer Pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002 signed as of February 11, 2010. |

 

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