**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

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**FORM 10-Q**

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| **x** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|----------------------------------------------------------------------------------------------|

 

**For the quarterly period ended June 30, 2007**

**OR**

| **o** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|-----------------------------------------------------------------------------------------------|

 

**For the transition period                        to**

**Commission File Number 0-14602**

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**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 Queen Kaahumanu Hwy. #102,Kailua-Kona, HI  96740**(Address of principal executive offices)

**(808) 326-1353**(Registrant’s telephone number)

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d)of the Securities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past 90days.    Yes o    No **x**

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer (asdefined in Rule 12b-2 of the Exchange Act).

Large accelerated filer  o                    Acceleratedfiler  o                    Non-acceleratedfiler  **x**

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the ExchangeAct).    Yes o    No **x**

The number of shares outstanding of the Registrant’s Common Stock, $.02par value, as of September 21, 2007 was 5,233,520.

 

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CYANOTECH CORPORATION

FORM 10-Q

INDEX
|            | PART  I.  FINANCIAL INFORMATION                                                                                                              |
|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------|
|            | Discussion of  Forward-Looking Statements                                                                                                              |
| Item 1.    | Financial Statements                                                                                                                                   |
|       | Consolidated  Condensed Balance Sheets As of June 30, 2007 (unaudited) and March 31, 2007                                                              |
|       | Consolidated  Condensed Statements of Operations and Comprehensive Income (Loss)  (unaudited) For the three month periods ended June 30, 2007 and 2006 |
|       | Consolidated  Condensed Statements of Cash Flows (unaudited) For the three month periods  ended June 30, 2007 and 2006                                 |
|       | Notes to  Consolidated Condensed Financial Statements (unaudited)                                                                                      |
| Item 2.    | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                            |
| Item 3.    | Quantitative  and Qualitative Disclosures About Market Risk                                                                                            |
| Item 4.    | Controls and  Procedures                                                                                                                               |
|       | PART  II.  OTHER INFORMATION                                                                                                                 |
| Item 1.    | Legal  Proceedings                                                                                                                                     |
| Item 1A.   | Risk  Factors                                                                                                                                          |
| Item 2.    | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                           |
| Item 3.    | Defaults upon  Senior Securities                                                                                                                       |
| Item 4.    | Submission of  Matters to a Vote of Security Holders                                                                                                   |
| Item 5.    | Other  Information                                                                                                                                     |
| Item 6.    | Exhibits                                                                                                                                               |
| SIGNATURES |

 

2

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**Discussion of Forward-LookingStatements:**

***Important Notice toInvestors:***Statements made in this report that relate tofuture plans, events, liquidity, financial results or performance includingstatements relating to cash flows and liquidity, as well as estimatedunrecognized compensation expense, projected capital expenditures, and futurecontractual obligations, are forward-looking statements as defined under thePrivate Securities Litigation Reform Act of 1995.  These statements are based upon current informationand expectations.  Actual results maydiffer materially from those anticipated as a result of certain risks anduncertainties, including delays, difficulties, changed strategies, orunanticipated factors affecting the implementation of the Company’s grossmargin, as well as the general risks and uncertainties applicable to theCompany and its business.  For detailsconcerning these and other risks and uncertainties, see Part I, Item IA, “RiskFactors” of our most recent Form 10-K as well as the Company’s other reportssubsequently filed with the Securities and Exchange Commission from time totime.  Investors are cautioned not toplace undue reliance on these forward-looking statements, which speak only asof the date hereof.  The Company undertakesno obligation to update forward-looking statements to reflect events orcircumstances after the date hereof or to reflect the occurrence ofunanticipated events. Investors should also be aware that while the Companyfrom time to time does communicate with securities analysts, it is against theCompany’s policy to disclose to them any material non-public information orother confidential commercial information. Furthermore, the Company has a policy against distributing or confirmingfinancial forecasts or projections issued by analysts and any reports issued bysuch analysts are not the responsibility of the Company.  Investors should not assume that the Companyagrees with any report issued by any analyst or with any statements,projections, forecasts or opinions contained in any such report.

3

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CYANOTECH CORPORATIONCONSOLIDATED CONDENSED BALANCE SHEETS(Dollars in thousands except per share amounts)
| ** **                                                                                                                                  | ** ** | **June 30,  2007** | ** ** | **March 31,  2007** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|--------------------------|------------|
| ** **                                                                                                                                  | ** ** | **(Unaudited)**         | ** ** | ** **               | ** ** |
| ASSETS                                                                                                                                      |       |                    |       |                     |       |
| Current assets:                                                                                                                             |       |                    |       |                     |       |
| Cash and cash equivalents                                                                                                                   |       | $                       | 733        |                     | $          | 1,444 |   |
| Accounts receivable, net of allowance for doubtful  accounts of $23                                                                         |       | 1,681                   |       | 1,587                    |       |
| Inventories                                                                                                                                 |       | 1,692                   |       | 1,593                    |       |
| Prepaid expenses and other                                                                                                                  |       | 63                      |       | 141                      |       |
| Total current assets                                                                                                                        |       | 4,169                   |       | 4,765                    |       |
|                                                                                                                                        |       |                    |       |                     |       |
| Equipment and  leasehold improvements, net                                                                                                  |       | 4,590                   |       | 4,701                    |       |
| Other assets                                                                                                                                |       | 433                     |       | 440                      |       |
| Total assets                                                                                                                                |       | $                       | 9,192      |                     | $          | 9,906 |   |
|                                                                                                                                        |       |                    |       |                     |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                  |       |                    |       |                     |       |
| Current  liabilities:                                                                                                                       |       |                    |       |                     |       |
| Current maturities of long-term debt                                                                                                        |       | $                       | 405        |                     | $          | 398 |   |
| Accounts payable                                                                                                                            |       | 354                     |       | 616                      |       |
| Accrued expenses                                                                                                                            |       | 420                     |       | 390                      |       |
| Total current liabilities                                                                                                                   |       | 1,179                   |       | 1,404                    |       |
|                                                                                                                                        |       |                    |       |                     |       |
| Long-term debt,  excluding current maturities                                                                                               |       | 890                     |       | 992                      |       |
| Total liabilities                                                                                                                           |       | 2,069                   |       | 2,396                    |       |
|                                                                                                                                        |       |                    |       |                     |       |
| Stockholders’  equity: (see Note 3)                                                                                                    |       |                    |       |                     |       |
| Common stock of $0.02 par value, shares authorized  7,500,000; 5,233,520 shares issued and outstanding at June 30, 2007 and March  31, 2007 |       | 105                     |       | 105                      |       |
| Additional paid-in capital                                                                                                                  |       | 27,333                  |       | 27,333                   |       |
| Accumulated other comprehensive income (loss) -  foreign currency translation adjustments                                                   |       | (13                     | )          | (8                       | )          |
| Accumulated deficit                                                                                                                         |       | (20,302                 | )          | (19,920                  | )          |
| Total stockholders’ equity                                                                                                             |       | 7,123                   |       | 7,510                    |       |
|                                                                                                                                        |       |                    |       |                     |       |
| Total  liabilities and stockholders’ equity                                                                                            |       | $                       | 9,192      |                     | $          | 9,906 |   |

 

See accompanying Notes to Consolidated CondensedFinancial Statements.

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CYANOTECH CORPORATIONCONSOLIDATED CONDENSED STATEMENTS OF OPERATIONSAND COMPREHENSIVE INCOME (LOSS)(In thousands, except per share amounts)(Unaudited)
| ** **                                         | ** ** | **Three Months Ended June 30,** | ** ** |
|----------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                         | ** ** | **2007**                                            | ** ** | **2006** | ** ** |
|                                               |       |                                                |       |   |   |
| NET SALES                                          |       | $                                                   | 2,583      |   | $ | 2,444 |   |
| COST OF PRODUCT  SALES                             |       | 1,837                                               |       | 1,973 |   |
| Gross Profit                                       |       | 746                                                 |       | 471 |   |
|                                               |       |                                                |       |   |   |
| OPERATING  EXPENSES:                               |       |                                                |       |   |   |
| Research and development                           |       | 47                                                  |       | 30 |   |
| Sales and marketing                                |       | 368                                                 |       | 290 |   |
| General and administrative                         |       | 672                                                 |       | 462 |   |
| Total operating expenses                           |       | 1,087                                               |       | 782 |   |
|                                               |       |                                                |       |   |   |
| Loss from operations                               |       | (341                                                | )          | (311 | ) |
|                                               |       |                                                |       |   |   |
| OTHER INCOME  (EXPENSE):                           |       |                                                |       |   |   |
| Interest income                                    |       | 11                                                  |       | 9 |   |
| Interest expense                                   |       | (41                                                 | )          | (47 | ) |
| Other expense, net                                 |       | (1                                                  | )          | — |   |
| Total other expense, net                           |       | (31                                                 | )          | (38 | ) |
|                                               |       |                                                |       |   |   |
| Loss before income taxes                           |       | (372                                                | )          | (349 | ) |
|                                               |       |                                                |       |   |   |
| INCOME TAX  EXPENSE (BENEFIT)                      |       | 10                                                  |       | (2 | ) |
|                                               |       |                                                |       |   |   |
| NET LOSS                                           |       | $                                                   | (382       | ) | $ | (347 | ) |
|                                               |       |                                                |       |   |   |
| NET LOSS PER  SHARE:                               |       |                                                |       |   |   |
| Basic                                              |       | $                                                   | (0.07      | ) | $ | (0.07 | ) |
| Diluted                                            |       | $                                                   | (0.07      | ) | $ | (0.07 | ) |
|                                               |       |                                                |       |   |   |
| SHARES USED IN  CALCULATION OF NET LOSS PER SHARE: |       |                                                |       |   |   |
| Basic                                              |       | 5,234                                               |       | 5,232 |   |
| Diluted                                            |       | 5,234                                               |       | 5,232 |   |
|                                               |       |                                                |       |   |   |
| COMPREHENSIVE  INCOME (LOSS):                      |       |                                                |       |   |   |
| Net Loss                                           |       | $                                                   | (382       | ) | $ | (347 | ) |
| Other comprehensive income (loss)                  |       | (5                                                  | )          | 2 |   |
|                                               |       | $                                                   | (387       | ) | $ | (345 | ) |

 

See accompanying Notes to Consolidated CondensedFinancial Statements.

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CYANOTECH CORPORATIONCONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS(Dollars in thousands)(Unaudited)
| ** **                                                                            | ** ** | **Three Months Ended June 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                            | ** ** | **2007**                                            | ** ** | **2006** | ** ** |
| ** **                                                                            | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                |       |                                                |       |   |   |
| Net loss                                                                              |       | $                                                   | (382       | ) | $ | (347 | ) |
| Adjustment to reconcile net loss to cash provided by  (used in) operating activities: |       |                                                |       |   |   |
| Depreciation                                                                          |       | 147                                                 |       | 335 |   |
| Amortization of debt issue costs and other assets                                     |       | 9                                                   |       | 9 |   |
| Provision for allowance for doubtful accounts                                         |       | —                                              |       | 4 |   |
| Net (increase) decrease in assets:                                                    |       |                                                |       |   |   |
| Accounts receivable                                                                   |       | (94                                                 | )          | 408 |   |
| Inventories                                                                           |       | (99                                                 | )          | (159 | ) |
| Prepaid expenses and other assets                                                     |       | 71                                                  |       | 55 |   |
| Net increase (decrease) in liabilities:                                               |       |                                                |       |   |   |
| Accounts payable                                                                      |       | (262                                                | )          | 123 |   |
| Accrued expenses                                                                      |       | 30                                                  |       | (69 | ) |
| Net cash provided by (used in) operating activities                                   |       | (580                                                | )          | 359 |   |
|                                                                                  |       |                                                |       |   |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                |       |                                                |       |   |   |
| Investment in equipment and leasehold improvements                                    |       | (36                                                 | )          | (55 | ) |
|                                                                                  |       |                                                |       |   |   |
| CASH FLOWS FROM  FINANCING ACTIVITES:                                                 |       |                                                |       |   |   |
| Proceeds from exercise of stock options                                               |       | —                                              |       | 3 |   |
| Principal payments on long-term debt                                                  |       | (95                                                 | )          | (87 | ) |
|                                                                                  |       |                                                |       |   |   |
| Net cash used in financing activities                                                 |       | (95                                                 | )          | (84 | ) |
|                                                                                  |       |                                                |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                                 |       | (711                                                | )          | 220 |   |
| Cash and cash  equivalents at beginning of period                                     |       | 1,444                                               |       | 1,835 |   |
| Cash and cash  equivalents at end of period                                           |       | $                                                   | 733        |   | $ | 2,055 |   |
|                                                                                  |       |                                                |       |   |   |
| Supplemental  disclosure of cash flow information:                                    |       |                                                |       |   |   |
| Cash paid during the period for:                                                      |       |                                                |       |   |   |
| Interest                                                                              |       | $                                                   | 33         |   | $ | 40 |   |
| Income taxes                                                                          |       | $                                                   | 2          |   | $ | 1 |   |

 

See accompanying Notes to Consolidated CondensedFinancial Statements.

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CYANOTECH CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

As of June 30,2007

(Unaudited)

**1.  BASISOF PRESENTATION**

The accompanying consolidated condensed financialstatements have been prepared in accordance with accounting principles generallyaccepted in the United States of America for interim financial information andwith the instructions to Form 10-Q and Regulation S-X.  Accordingly, theydo not include all of the information and footnotes required by GAAP forcomplete financial statements.  *Theseconsolidated financial statements and notes should be read in conjunction withthe Company’s consolidated financial statements contained in the Company’sreport on Form 10-K for the year ended March 31, 2007 filed on August 16, 2007.*

The accompanying consolidated financial statementsinclude the accounts of Cyanotech Corporation and its wholly ownedsubsidiaries, Nutrex Hawaii, Inc. (“Nutrex Hawaii” or “Nutrex”) andCyanotech Japan YK (“Cyanotech Japan” or “CJYK”). All significant intercompanybalances and transactions have been eliminated in consolidation.  See further information in Note 9, SubsequentEvent.

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Actual results could differmaterially from those estimates and assumptions.

**2.  INCOME TAXES**

The Company is subject to taxation in the UnitedStates, Japan, and two state jurisdictions. The preparation of these tax returns requires the Company to interpretthe applicable tax laws and regulations in effect in such jurisdictions, whichcould affect the amount of tax paid by the Company. The Company, inconsultation with its tax advisors, bases its tax returns on interpretationsthat are believed to be reasonable under the circumstances. The tax returns,however, are subject to routine reviews by the various taxing authorities inthe jurisdictions in which the Company files its returns.  As part of these reviews, a taxing authoritymay disagree with respect to the tax positions taken by the Company (“uncertaintax positions”) and therefore require the Company to pay additional taxes. Asrequired under applicable accounting rules, the Company evaluates therequirement for additional tax accruals, but for the quarter ended June 30,2007, no accrual was booked from this evaluation of potential additional taxliability, including interest and penalties, which the Company could incur as aresult of the ultimate resolution of its uncertain tax positions.  The Company reviews and updates the accrualfor uncertain tax positions as more definitive information becomes availablefrom taxing authorities, completion of tax audits, expiration of statute oflimitations, or upon occurrence of other events.

In June 2006, the FASB issued FASB InterpretationNo. 48 (“FIN No. 48”), “Accounting for Uncertainty in Income Taxes,an interpretation of FASB Statement No. 109”. This interpretationprescribes a “more-likely-than-not” recognition threshold and measurement attribute(the largest amount of benefit that is greater than 50% likely of beingrealized upon ultimate settlement with tax authorities) for the financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return. This interpretation also provides guidance onderecognition, classification, interest and penalties, accounting in interimperiods, disclosure and transition. FIN No. 48 is effective for fiscalyears beginning after December 15, 2006. The Company adopted FINNo. 48 on April 1, 2007.

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As a result of the implementation of FIN 48, theCompany did not recognize a liability for unrecognized tax benefits, andaccordingly, was not required to record any cumulative effect adjustment tobeginning of year retained earnings.  Asof both the date of adoption and June 30, 2007, there was no significantliability for income tax associated with unrecognized tax benefits.

The Company recognizes interest accrued related tounrecognized tax benefits as well as any related penalties in interest incomeor expense in its condensed consolidated statements of operations, which isconsistent with the recognition of these items in prior reporting periods.  As of the date of adoption, the Company wasnot required to have an accrual for the payment of interest and penalties.  No accrual for interest and penalties relatedto uncertain tax positions was required during the quarter ended June 30, 2007.

The Company is subject to taxation in the UnitedStates, Japan, and two state jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal,state and local, or non-U.S. income tax examination by tax authorities for taxyears before 2001.

**3.**  **SHARE-BASED COMPENSATION**

Effective April 1, 2006, the Company adopted theprovisions of Statement of Financial Accounting Standard No. 123(R) (“SFASNo. 123R”), “Share-Based Payment,” for its share-based compensation plans, whichis a revision of Statement of Financial Accounting Standard No. 123 “Accountingfor Stock-Based Compensation”.  On March 29, 2005, theSEC staff issued Staff Accounting Bulletin No. 107, “Share-BasedPayment” (SAB No. 107), which expressed the SEC staff’s views on SFASNo. 123R, but did not modify any of SFAS No. 123R’sprovisions.   SFAS No. 123R requires an entity to measure the cost ofemployee services received in exchange for an award.  If an award vests orbecomes exercisable based on the achievement of a condition other than service,performance or market condition, the award is liability-classified.  Liability-classified awards are remeasured to fair value at each balance sheetdate until the award is settled.  Equity-classified awards, includinggrants of employee stock options, are measured at the grant-date fair value ofthe award and are not subsequently remeasured.  The cost ofequity-classified awards is recognized in the income statement over the periodduring which an employee is required to provide the service in exchange for theaward.   In the Company’s case, all of the Company’s stock optionsare performance based awards and because the Company’s future employeeincentive stock options are expected to be “plain vanilla” as defined by theSEC in Staff Accounting Bulletin No. 107, they will be reflected only in Equityand Compensation Expense accounts.

***StockOptions***

Asof June 30, 2007, the Company had the following two shareholder approved stockplans under which shares were available for equity-based awards: the 2005 StockOption Plan (the “2005 Plan”) wherein 200,000 shares of common stock arereserved for issuance, and 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.  Under the 2005 Plan, eligible employees andcertain independent consultants may be granted options to purchase shares ofthe Company’s Stock. The shares issuable under the 2005 Plan will either beshares of the Company’s authorized but previously unissued common stock orshares reacquired by the Company, including shares purchased on the openmarket.  As of June 30, 2007, 195,000 options remained available for grantunder the 2005 Plan.  Concurrent with the2005 Plan approval on August 22, 2005, the 1995 Stock Option Plan wasterminated except for the outstanding options issued thereunder.  Under the 2004 Plan, upon election to theBoard of Directors, a newly elected non-employee director is granted a ten-yearoption to purchase 1,000 shares of the Company’s common stock at a fair marketvalue on the date of grant.  All such options are granted at fair marketvalue on the date of grant.  Options granted vest and become exercisablesix months from the date of grant.  In addition, on the date of eachAnnual Meeting of Stockholders, each non-employee director continuing in officeis automatically granted, without payment, 875 shares of common stock,non-transferable for six months following the date of grant.  As of June30, 2007, 70,250 options remained available for grant under the 2004Plan.  Concurrent with the 2004 Plan approval on August 16, 2004, the 1994Non-Employee Director Stock Option and Stock Grant Plan was terminated exceptfor the outstanding options issued thereunder.

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The following table presents shares authorized,available for future grant and outstanding under each of the Company’s plans: 
|            | ** ** | **As of June 30, 2007** | ** ** |
|------------|------------|---------------------------------------------|------------|
| ** ** | ** ** | **Authorized**                              | ** ** | **Available** | ** ** | **Outstanding** | ** ** |
| ** ** | ** ** | **(In thousands)**                     | ** ** |
| 2005 Plan  |       | 200,000                                     |       | 195,000 |   | 5,000 |   |
| 2004 Plan  |       | 75,000                                      |       | 70,250 |   | 1,000 |   |
| 1995 Plan  |       | —                                      |       | — |   | 74,422 |   |
| 1994 Plan  |       | —                                      |       | — |   | 3,750 |   |
| Total      |       | 275,000                                     |       | 265,250 |   | 84,172 |   |

All stock option grants made under the 2005 Plan andthe 2004 Directors Plan are made at exercise prices no less than the Company’sclosing stock price on the date of grant. Options under the 2005 Plan aregranted, and are vested and exercisable as determined by the Board of Directorsor the Stock Option and Compensation Committee of the Board in accordance withthe provisions of the 2005 Stock Option Plan. Discussion relative to option granting, vesting, exercising, and otherconditions are set forth in a Stock Option Agreement evidencing each grant. Nooption can have a life in excess of ten (10) years.  The Companyrecords compensation expense for employee stock options based on the estimatedfair value of the options on the date of grant using the Black-Scholesoption-pricing model. The model will use various assumptions, including arisk-free interest rate, the expected term of the options, the expected stockprice volatility over the expected term of the options, and the expecteddividend yield. Compensation expense for employee stock options will berecognized ratably over the vesting term.  There were no stock options granted during the quarter ended June30, 2007 or fiscal 2007, thus the average fair value assumptions used in thevaluation of stock option grants are not disclosed until the time of suchgrants.

Asof June 30, 2007, total unrecognized stock-based compensation expense relatedto unvested stock options was $2,489 which is expected to be expensed over aweighted-average period of 2.13 years.

Activity for stockoptions during the periods indicated was as follows:
| ** **                 | ** ** | **Number of  Shares** | ** ** | **Weighted   Average  Exercise   Price** | ** ** | **Weighted   Average   Remaining  Contractual   Term in   Years** | ** ** | **Average   Intrinsic  Value** | ** ** |
|----------------------------|------------|----------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| Balance at March  31, 2007 |       | 84,172                     |       | $                                                  | 3.86       |                                                                                       | 1.77       |                                | $          | 324,904 |   |
| Granted                    |       | —                     |       | —                                             |       |                                                                                       |       |                                |       |
| Exercised                  |       | —                     |       | —                                             |       |                                                                                       |       |                                |       |
| Expired                    |       | —                     |       | —                                             |       |                                                                                       |       |                                |       |
| Forfeited                  |       | —                     |       | —                                             |       |                                                                                       |       |                                |       |
| Balance at June 30,  2007  |       | 84,172                     |       | $                                                  | 3.86       |                                                                                       | 1.52       |                                | $          | 324,904 |   |

The following table summarizes the weighted averagecharacteristics of outstanding stock options as of June 30, 2007:
| ** **                | ** ** | **Outstanding Options** | ** ** | **Exercisable Options** | ** ** |
|---------------------------|------------|------------------------------|------------|------------------------------|------------|
| **Range of**         | ** ** | **Number**                   | ** ** | **Remaining**                | ** ** | **Weighted** | ** ** | **Number of** | ** ** | **Weighted** | ** ** |
| **Exercise Prices**  | ** ** | **of Shares**           | ** ** | **Life (Years)**        | ** ** | **Average Price** | ** ** | **Shares** | ** ** | **Average Price** | ** ** |
| $ 1.84 - $ 2.60 |       | 50,944                       |       | 1.19                         |       | $ | 2.18 |   | 50,944 |   | $ | 2.18 |   |
| $ 4.20 - $ 6.50 |       | 26,978                       |       | 2.32                         |       | 4.51 |   | 26,412 |   | 4.51 |   |
| $14.75 - $14.75           |       | 6,250                        |       | 0.79                         |       | 14.75 |   | 6,250 |   | 14.75 |   |
| Total stock options       |       | 84,172                       |       |                         |       | 3.86 |   | 83,606 |   | 3.86 |   |
|                           |            |                              |            |                              |            |  |  |  |  |  |  |  |  |

 

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***Warrants***

TheCompany had issued warrants which allow the warrant holders rights to acquirean equivalent number of shares of common stock at a stated exercise price.Warrants outstanding during the periods indicated were as follows:
| **Warrants issued in connection with:** | ** ** | **Term Loan**  | ** ** |
|-------------------------------------------------------------|------------|---------------------|------------|
| **Grant date:**                                        | ** ** | **April 2000** | ** ** |
| **Expiration date:**                                   | ** ** | **April 2011** | ** ** |
| **Exercise price:**                                    | ** ** | **$10.20**          | ** ** |

 
| Balance at  March 31, 2007 |   | 5,000  |   |
|---------------------------------|--------|--------|--------|
| Exercises                       |   | — |   |
| Expired                         |   | — |   |
| Balance at June 30,  2007       |   | 5,000  |   |

See Form 10-K, Note 5 tothe Consolidated Financial Statements for the year ended March 31, 2007 forfurther discussion relative to warrants issued in connection with the Term Loanagreement.

** 4.**  **INVENTORIES**

Inventoriesare stated at the lower of cost or market. Cost is determined using the first-in, first-out (FIFO) method.  Market is defined as sales price less cost todispose and a normal profit margin.   Inventories consist of the following:
|                 | ** ** | **June 30, 2007** | ** ** | **March 31, 2007** | ** ** |
|-----------------|------------|-----------------------------|------------|------------------------------|------------|
| ** **      | ** ** | **(in thousands)**     | ** ** |
| Raw materials   |       | $                           | 165        |                         | $          | 246 |   |
| Work in process |       | 195                         |       | 281                          |       |
| Finished goods  |       | 1,219                       |       | 929                          |       |
| Supplies        |       | 113                         |       | 137                          |       |
|            |       | $                           | 1,692      |                         | $          | 1,593 |   |

 The Company adoptedSFAS No. 151 effective April 1, 2006. In accordance with SFAS No. 151, fixedproduction related costs of approximately $23,000 and $36,000 were notinventoried for the quarter ended June 30, 2007 and June 30, 2006 respectively,due to production below normal capacity.

**5.  EQUIPMENT, LEASEHOLD IMPROVEMENTSAND LONG-LIVED ASSETS**

Equipment and leasehold improvements are stated atcost. Depreciation and amortization are provided using the straight-line methodover the estimated useful lives for equipment and furniture and fixtures, orthe shorter of the land lease term or estimated useful lives for leaseholdimprovements as follows:
| Equipment               |   | 3 to 10 years  |
|-------------------------|--------|----------------|
| Furniture and  fixtures |   | 7 years        |
| Leasehold  improvements |   | 10 to 20 years |

 Equipment andleasehold improvements consist of the following:
|                                                   | ** ** | **June 30, 2007** | ** ** | **March 31, 2007** | ** ** |
|---------------------------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| ** **                                        | ** ** | **(in thousands)**          | ** ** |
| Equipment                                         |       | $                           | 6,298      |                         | $          | 6,257 |   |
| Leasehold improvements                            |       | 7,350                       |       | 7,335                        |       |
| Furniture and fixtures                            |       | 87                          |       | 87                           |       |
|                                              |       | 13,735                      |       | 13,679                       |       |
| Less accumulated depreciation  & amortization |       | (9,257                      | )          | (9,110                       | )          |
| Construction  in-progress                         |       | 112                         |       | 132                          |       |
| Equipment and leasehold  improvements, net        |       | $                           | 4,590      |                         | $          | 4,701 |   |

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At March 31, 2007, the above equipment, leaseholdimprovements, accumulated depreciation and construction in-progress amountswere reduced by a net $4.5 million charge resulting from management’s analysisunder SFAS No. 144, as discussed in Note 3 to the Consolidated FinancialStatements of Form 10-K for the year ended March 31, 2007.

The Company reviews long-lived assets for impairmentwhenever events or changes in circumstances indicate that the carrying value ofsuch assets may not be recoverable. Upon such an occurrence, recoverability ofthese assets is determined by comparing the forecasted undiscounted net cashflows to which the assets relate, to the carrying amount. If the asset isdetermined to be unable to recover its carrying value, then the carrying valueof the long-lived assets are compared to the asset’s fair value. The Companyhas determined fair value based upon present values of expected future cashflows.  The Company’s SFAS No. 144analysis for the quarter ended June 30, 2007, resulted in no production assetimpairment charge.

**6.**   **TERM LOAN AGREEMENT COVENANTS WAIVER**

The Company’s long-term debt consists of a Term LoanAgreement (“Term Loan”) with a lender providing for $3.5 million in aggregatecredit facilities, secured by the Company’s assets.  The Term Loancontains restrictive covenants.  The Company obtained a waiver of the debtcovenants as related to the untimely submission of its quarterly financialstatements for the quarter ended June, 30, 2007.

**7.**  **EARNINGS PER SHARE**

Basic earnings per share is computed on the basis ofthe weighted average number of common shares outstanding.  Diluted earningsper share is computed on the basis of the weighted average number of commonshares outstanding plus the potentially dilutive effect of outstanding stockoptions and warrants using the “treasury stock” method and convertiblesecurities using the “if-converted” method.

Reconciliations between the numerator and thedenominator of the basic and diluted earnings per share computations for thethree months ended June 30, 2007 and June 30, 2006 are as follows:
| ** **                            | ** ** | **Three Months Ended June 30, 2007** | ** ** |
|---------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                            | ** ** | **Net Loss**                                             | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| ** **                            | ** ** | **(Numerator)**                                               | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
| ** **                            | ** ** | **(in thousands)**                                       | ** ** |
| Basic loss per  share                 |       | $                                                             | (382       | ) | 5,234 |   | $ | (0.07 | ) |
| Effect of  dilutive securities – |       |                                                          |       |   |   |   |   |
| Common stock options and warrants     |       | —                                                        |       | — |   |   |   |
| Diluted loss per share                |       | $                                                             | (382       | ) | 5,234 |   | $ | (0.07 | ) |

 
| ** **                            | ** ** | **Three Months Ended June 30, 2006** | ** ** |
|---------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                            | ** ** | **Net Loss**                                             | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| ** **                            | ** ** | **(Numerator)**                                               | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
| ** **                            | ** ** | **(in thousands)**                                       | ** ** |
| Basic loss per  share                 |       | $                                                             | (347       | ) | 5,232 |   | $ | (0.07 | ) |
| Effect of  dilutive securities – |       |                                                          |       |   |   |   |   |
| Common stock options and warrants     |       | —                                                        |       | — |   |   |   |
| Diluted loss per share                |       | $                                                             | (347       | ) | 5,232 |   | $ | (0.07 | ) |

 Basic and dilutedearnings per share are the same in periods of a net loss, thus there is noeffect of dilutive securities when a net loss is recorded.  There were approximately 84,000 and 115,000securities excluded from the calculation of diluted loss per share becausetheir effect was anti-dilutive for the three months ended June 30, 2007 and2006, respectively.  They wereanti-dilutive due to the exercise price being greater than the Company’sweighted-average stock price for the period.

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**8.  NEW ACCOUNTINGPRONOUNCEMENTS**

In September 2006, the FASB issued SFAS No. 157, “FairValue Measurements” (“SFAS No. 157”). This new standard provides guidance forusing fair value to measure assets and liabilities and information about theextent to which companies measure assets and liabilities at fair value, theinformation used to measure fair value, and the effect of fair valuemeasurements on earnings.  This frameworkis intended to provide increased consistency in how fair value determinationsare made under various existing accounting standards which permit, or in somecases require, estimates of fair market value. SFAS No. 157 also expandsfinancial statement disclosure requirements about a company’s use of fair valuemeasurements, including the effect of such measures on earnings.  The provisions of SFAS No. 157 are effectivefor financial statements issued for fiscal years beginning afterNovember 15, 2007.  While theCompany is currently evaluating the provisions of SFAS No. 157, the adoption isnot expected to have a material impact on our consolidated financial positionor results of operations.

In May 2007, the FASB issued FASB Staff Position (“FSP”)FIN 48-1 Definition of Settlement in FASB Interpretation No. 48 (FSPFIN 48-1). FSP FIN 48-1 provides guidance on how to determine whether a taxposition is effectively settled for the purpose of recognizing previouslyunrecognized tax benefits. FSP FIN 48-1 is effective retroactively to January1, 2007. The implementation of this standard did not have a material impact onour consolidated financial position or results of operations.

**9.  SUBSEQUENT EVENT**

On August 31, 2007, the Company discontinued allbusiness activity of its wholly owned Japanese subsidiary, “CJYK.”  All aquaculture feed business in Japan wasabsorbed through the Company’s domestic operations.  “CJYK” will remain a registered Japanesecorporation until November 30, 2007, at which time it will be dissolved.  All assets and liabilities were absorbed bythe Company as of September 1, 2007, and no significant assets or liabilitiesexisted except for cash of approximately $50,000.  CJYK was under no contractual obligations atAugust 31, 2007.  The Company made thisdecision due to declining sales of approximately 40% in each of the prior twofiscal years in addition to declining gross profit margins of 13% and 5% forfiscal 2007, and the quarter ended June 30, 2007, respectively.  “CJYK” sales for fiscal year 2007 and thequarter ended June 30, 2007, were $482,000 and $20,000, respectively.  We do not expect the dissolution of thissubsidiary to have a significant impact on our consolidated financialstatements.

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**Item2.  Management’s Discussion and Analysis of Financial Condition andResults of Operations**

*This report on Form 10-Q containsforward-looking statements regarding the future performance of Cyanotech andfuture events that involve risks and uncertainties that could cause actualresults to differ materially from the statements contained herein. Thisdocument, and the other documents that the Company files from time to time withthe Securities and Exchange Commission, such as its reports on Form 10-K, Form10-K/A, Form 10-Q, Form 8-K, and its proxy materials, contain additional importantfactors that could cause actual results to differ from the Company’s currentexpectations and the forward-looking statements contained herein.*

## **Overview**

A comparison of selected consolidated statements ofoperations data as reported herein follows for the periods indicated. 
| ** **                   | ** ** | **Three Months Ended** | ** ** | **Three Months Ended** | ** ** |
|------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                   | ** ** | **June 30, 2007**      | ** ** | **June 30, 2006**      | ** ** |
| **Net sales:**          | ** ** | **(in thousands)**          | ** ** | **Change**                       | ** ** |
| Spirulina products           |       | $                                | 1,531      |                             | $          | 1,540 |   | (0.6 | )% |
| Natural astaxanthin products |       | 997                              |       | 876                              |       | 13.8 | % |
| Other products               |       | 55                               |       | 28                               |       | 96.4 | % |
|                         |       | $                                | 2,583      |                             | $          | 2,444 |   | 5.7 | % |
| Gross profit                 |       | $                                | 746        |                             | $          | 471 |   | 63.1 | % |
| Loss from  operations        |       | $                                | (341       | )                                | $          | (311 | ) | (8.8 | )% |
| Net loss                     |       | $                                | (382       | )                                | $          | (347 | ) | (9.1 | )% |

 Sales for the first quarter of fiscal 2008 endedJune 30, 2007 increased from the comparable prior year period by $139,000 or5.7% due primarily to increases in the number of units sold of BioAstinproducts.

Spirulina sales remained consistent decreasing 0.6%from the prior year period due to selling 9% more units coupled with a 9%decrease in average selling prices.

Natural astaxanthin product sales increased 13.8% fromthe comparable prior year period due to a 79% increase in sales of BioAstin,our human nutrition market product, coupled with a 90% decrease in sales ofNaturose in the aquaculture market.  Ourprevious statements predicting that a shortfall in the Japan aquaculture marketwould persist have proven correct, thus we expect NatuRose fish feedastaxanthin product sales will not recover to previous levels during thecurrent fiscal year.  As discussed inNote 9, the Company has discontinued all business activity of its wholly ownedJapanese subsidiary, “CJYK”.  Inaddition, the Company is increasing focus on building market share in the humannutrition market with a major focus on differentiating BioAstin from lowerquality offerings from competitors. The natural astaxanthin product lineoverall experienced a 31% average price decline with NatuRose prices down 9%coupled with a 90% decrease in units sold. BioAstin prices decreased 29% with a 151% increase in units soldaccounting for a $120,000 or 14% increase in all natural astaxanthin productsales.

Our gross profit margin as a percentage of salesincreased to 29% for the three months ended June, 30, 2007 from 19% for thesame period a year ago.  Sales for the first quarter of fiscal year 2008increased 6% from the comparable prior year period, and costs of sales declined7% for the same respective period.   For the three months ended June30, 2007, variable production costs increased 2% primarily in chemicalcosts.  Approximately $23,000 and $36,000 of fixed production overheadcost was not inventoriable during the three months ended June 30, 2007 and June30, 2006 respectively. In addition, approximately $30,000 and $118,000 ofproduction costs were not inventoriable because such costs would have exceededthe market value for such inventory during the three months ended June 30, 2007and 2006, respectively.  We expect thatthe Company’s gross profit margins during fiscal year 2008 will continue to bemore than the margins reported for comparable prior year periods, and theCompany is consistently researching methodology to ensure we obtain productionat desired capacity and quality levels.

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The net loss for the first quarter of fiscal 2008 increased$35,000 compared to the comparable quarter of fiscal 2007. The increase in netloss is primarily due to increased operating expenses of $305,000 offsetpartially by the increased gross profit of $275,000.

**Results of Operations**

# ***First Quarter of Fiscal 2008Compared to First Quarter of Fiscal 2007***

Net sales for the first quarter of fiscal 2008increased to $2,583,000, a 6% increase from the $2,444,000 reported for thecomparable period a year ago.  Company sales of Spirulina products for thefirst quarter of fiscal 2008 were $1,531,000, which approximates the $1,540,000generated in the first quarter of fiscal 2007.  As a percentage of sales,Spirulina declined to 59% of total sales in the first quarter of fiscal 2008,compared to 63% for the comparable period a year ago.  Natural astaxanthin product sales were$997,000 during the first quarter of 2008, a 14% increase from $876,000 in thefirst quarter of the prior year.  The natural astaxanthin product lines increasedto 39% of total sales from 36% of total sales in the first quarter of fiscal2007.  NatuRose sales decreased as a result of lower demand in theJapanese aquaculture market, and a lower emphasis on sales of this productline. The astaxanthin product line overall experienced an average 31% pricedecline with NatuRose prices down 9%. We feel that the Japan aquaculture marketadapted to using less astaxanthin (including NatuRose) in favor of using lesscostly substitutes.  With the sales price constraints in the animalnutrition market coupled with rising production costs in labor, nutrient,utility and transportation, profit margins are being limited to the point thatmaintaining a profitable business in the animal nutrition market is becomingdifficult.  Other products sales were $55,000 during the first quarter offiscal 2008 and $28,000 during the first quarter of fiscal 2007, andrepresented 2% and 1% of sales in the respective periods.

International sales were 41% of total sales for thefirst quarter of fiscal 2008, compared to 54% a year ago.  Historically,our major customers (sales exceeding 10% of total sales) have been twodistributors, one based in Europe and one in the United States.   Forthe three months ended June 30, 2007, our European distributor accounted for11% of total sales as compared to 13% of total sales for the comparable periodof fiscal 2007.   Sales to the United States distributor were lessthan 10% of total sales in each of the first quarters of fiscal years 2008 and2007.

Gross profit, derived from net sales less the cost ofproduct sales, includes the cost of materials, manufacturing overhead costs,direct labor costs and depreciation.  Gross profit for the three monthsended June 30, 2007 was $746,000, with a gross profit margin percentage of 29%.This was a significant increase from gross profit of $471,000 and gross profitmargin of 19% reported for the comparable prior year quarter.  Sales forthe first quarter of fiscal year 2008 increased 6% from the comparable prioryear period, costs of sales decreased 7% for the same respectiveperiod.   For the three months ended June 30, 2007, variableproduction costs increased 2% from the comparable prior year quarter primarilydue to a 22% increase in chemical costs and an 8% increase in labor and taxes,offset partially by a 22% decrease in packaging, a 7% decrease in utilities,and a 7% decrease in overhead.   Chemical costs increased as a resultof increased consumption of nutrients used to balance cultivation toestablished parameters. We expect gradual direct cost price increases tocontinue in all areas consistent with the local and nationaleconomy.  Pursuant to SFAS No. 151, approximately $23,000 and $36,000of fixed production overhead cost was not inventoriable during the three monthsended June 30, 2007 and June 30, 2006, due to production output below normalcapacity.  In addition, approximately $30,000 and $118,000 of productioncosts was not inventoriable because such costs would have exceeded the marketvalue for such inventory during the three months ended June 30, 2007 and 2006,respectively.

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Operating expenses forthe three months ended June 30, 2007 were 42% of sales or $1,087,000, comparedto 32% of sales or $782,000 for the three months ended June 30, 2006.  The$305,000 increase in operating expenses in the three months ended June 30, 2007as compared with the three months ended June 30, 2006, and the 10% increase asa percentage of sales were primarily the result of general and administrativeexpense increasing by $210,000 or 45%, coupled with an increase in sales andmarketing expenses of $78,000 or 27%.  The increase in general andadministrative expenses as a percentage of sales resulted primarily fromincreased accounting and auditing expense, contractual services and legalexpenses incurred in conjunction with the filing of Form 10-K for the yearended March 31, 2007.

The Company periodicallyreviews the recoverability of the carrying value of long-lived assets using themethodology prescribed in Statement of Financial Accounting Standards (SFAS)No. 144.  This analysis resulted in animpairment charge of $4.5 million being recognized at March 31, 2007.  The determination of this impairment chargewere the primary cause of the delayed filing of the fiscal 2007 Form 10-K.  Most of the accounting and auditing feesassociated with the SFAS No. 144 impairment analysis will be included ingeneral and administrative expense of the second quarter of the fiscal 2008consolidated financial statements.  TheCompany expects that total operating expenses will increase in the secondfiscal quarter due to the work on the Company’s Form 10-K filed on August 16,2007, as well as for the late filing of its Form 10-Q for the first quarterended June 30, 2007.  The related feesfor accounting, auditing and contractual services comprise most of thesecosts.  Other increases were incurred inpayroll expenses including sales commissions, and in advertising andpromotional sales expenses.  Sales and marketingexpenses increased 27% in the first quarter of fiscal 2008 over the prior yearlevels.  Whether sales and marketingexpenses continue to increase over fiscal year 2007 levels in subsequentquarters will be based on customer demand and response and customer and marketopportunities that may arise.  Increasesin sales and marketing expenses may also become necessary as the Company seeksnew markets and improved market share. Research and development expense remained constant over both firstquarter periods.  Research anddevelopment expenses may also increase as new opportunities arise.  However, the Company will continue to seekadditional leverage from customer supported research where and as practicable.The Company expects overall operating expense spending will remain consistentwith or moderately increase from fiscal 2007 levels after the exclusion of thepreviously mentioned non-cash impairment write-down and the SFAS No. 144related costs.

By March 31, 2008 theCompany is required to be in full compliance with the Sarbanes-Oxley Act andRules issued thereunder by the Securities and Exchange Commission, includingSection 404 Compliance Standards established by the Public Companies AccountingOversight Board. The cost of attaining and maintaining such compliance couldmaterially decrease reported net income or increase reported net losses infuture periods.  Although the Company haspreviously taken steps toward what is generally referred to as Sarbanes-OxleyAct compliance, the process of preparing and filing the Company’s Form 10-K/Afiled February 14, 2007 and subsequent delayed filings of the Company’s Form10-K and Forms 10-Q for fiscal year 2007, coupled with the lack of resourcesdiscussed in Item 9A of Form 10-K for the year ended March 31, 2007, haveeffected the Company’s efforts toward implementing full Sarbanes-Oxleycompliance. Such compliance must be achieved by March 31, 2008. To do so couldrequire significant expenditures and effort over the remaining time to achievecompliance.  The costs of compliance withinternational standards (ISO), US food and drug manufacturing practice (GMP),Sarbanes Oxley, and other regulatory compliance areas will continue toincrease.

For the three months ended June 30, 2007, an incometax expense of $10,000 was recorded resulting from the write-off of apreviously recorded income tax receivable. The Company does not expect any United States or State income taxes tobe recorded for the current fiscal year because of available net operating losscarry-forwards.

The end result of the foregoing was a net loss of$382,000, or ($0.07) per diluted share, for the three months endedJune 30, 2007, as  compared****to a net loss of $347,000, or ($0.07) perdiluted share, for the comparable prior year quarter.

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### *Variability of Results*

The Company has experienced significant quarterlyfluctuations in operating results and anticipates that these fluctuations maycontinue in future periods.   As described in previous paragraphs,operating results have fluctuated as a result of changes in sales levels to ourcustomers, competition (both pricing, new products and other market trends) andproduction difficulties including increased production costs.  TheCompany has also during its history experienced production difficulties as aresult of inclement weather, changes in the mix between sales of bulk and packagedconsumer products and start up costs associated with new product introductions,new facilities and expansion into new markets.    In addition,future operating results may fluctuate as a result of factors beyond theCompany’s control such as foreign exchange fluctuations, changes in governmentregulations and economic changes in the regions it operates in and sellsto.  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 anygiven period, the adverse impact on results of operations may be magnified byour inability to meaningfully adjust spending in certain areas, or theinability to adjust spending quickly enough, as in personnel and administrativecosts, to compensate for a sales shortfall. We may also choose to reduce pricesor increase spending in response to market conditions, and these decisions mayhave a material adverse effect on financial condition and results ofoperations.

**Financial Condition**

Cash and cash equivalents decreased $711,000 or49% to $733,000 at June 30, 2007, from $1.4 million at March 31,2007.  This decrease in cash resultedfrom cash used in operating activities of $580,000, as well as cash used ininvesting activities of $36,000 and cash used in financing activities of$95,000.  Cash used in operatingactivities for the quarter ended June 30, 2007 reflects increases in netaccounts receivable and inventory of $193,000, and a decrease in accountspayable of $262,000, offset partially by a decrease in prepaid expenses andother assets of $71,000, and an increase in accrued expenses of $30,000. Thesenegative impacts on cash were combined with a net loss of $382,000, adjustedfor depreciation and amortization of $155,000. Cash flows used in investing activities reflects capital expendituresduring the first quarter of fiscal 2008. Cash flows used in financingactivities are attributable to debt payments during that period.

As of June 30, 2007, the Company’s net accountsreceivable increased $94,000 to $1,681,000 from $1,587,000 as of March 31,2007.  The increase in accountsreceivable is primarily the result of the timing of collection on the customer’saccounts.  The Company believes that itsaccounts receivable are collectible net of the allowance for doubtful accountsof $23,000 at June 30, 2007.

The Company’s net inventory increased $99,000 to$1,692,000 as of June 30, 2007 compared to $1,593,000 as of March 31,2007.  The increase in inventory duringthe first quarter of fiscal 2008 is primarily due to the Company’s producingmore product in the first quarter of fiscal 2008 than in the fourth quarter offiscal 2007, due to the reversal of an astaxanthin production imbalance.

**Liquidity and Capital Resources**

The Company has recently experienced a number offactors that have negatively impacted its balance sheet and liquidity,including the following:

·      TheCompany has experienced significant recurring net losses. At March 31,2007, the Company had an accumulated deficit of $19,920,000 compared to anaccumulated deficit of $12,495,000 at March 31, 2006.  This accumulated deficit increased by$382,000 for the quarter ended June 30, 2007. As required under Statement of Financial Accounting standards (SFAS) No.144, “Accounting for the Impairment and Disposal of Long-Lived Assets,” theCompany recorded a non-cash impairment charge reducing, by $4.5 million, thevalues of certain production equipment and leasehold improvement assets atMarch 31, 2007.  *This chargedid not impact liquidity.*

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·      TheCompany’s business has not generated positive cash from operating activities infive of the eight quarters during fiscal years ended March 31, 2007 and 2006,nor during the quarter covered by this report.

·      Materialweaknesses in its internal controls caused the Company to experience delays incompleting its consolidated financial statements and filing periodic reportswith the U.S. Securities and Exchange Commission (the “SEC”) on a timelybasis. Accordingly, the Company continues to devote substantial additionalinternal and external resources, and experience higher than expected fees foraudit services.  As a result of thehiring of key financial personnel early in the second quarter of fiscal 2008,the Company does not anticipate delayed filings in future periods.

***Sourcesof Liquidity***

For the three months ended June 30, 2007, cash andshort-term investments decreased $711,000 to $733,000 from $1,444,000 at March31, 2007.  Working capital for the same three month period decreasedby $371,000 to $2,990,000 from $3,361,000 at March 31, 2007, primarily as aresult of decreases in cash and accounts payable and increases in accountsreceivable and inventory in the current three month period.

The decrease in cash resulted primarily from cash usedfrom operating activities, capital expenditures and payments on the Company’slong-term debt.   Cash used in operating activities for the quarterended June 30, 2007 was $580,000 compared to cash provided from operations of$359,000 for the comparable prior year quarter. Capital expenditures totaled$36,000 for the three months ended June 30, 2007 compared to $55,000 for thecomparable prior year period.   Cash used in financing activities includedrepayments of the Company’s long-term debt of $95,000 and $87,000 for the threemonths ended June 30, 2007 and 2006, respectively.

The Company’s contractual obligations and commitments(consisting of a term loan and operating leases) are disclosed below and in theCompany’s 2007 Annual Report on Form 10-K in the following sections: Item 7Management’s Discussion and Analysis of Financial Condition and Results ofOperations – Liquidity and Capital Resources, and Item 8 Financial Statementsand Supplementary Data – Notes 5 and 6 of Notes to Consolidated FinancialStatements.  There were no significant changes in contractual obligationsand commitments from March 31, 2007 to June 30, 2007, but the Company considersit prudent to disclose these obligations in consideration of the reduction ofcash during the past four quarters.  TheCompany is not aware of any other significant cash or contractual obligationsas of the filing date of this Form 10-Q.

***Other Significant Cash andContractual Obligations***

The following tablepresents the Company’s debt and lease obligations at June 30, 2007:
| **(in thousands)**        | ** ** | **Less Than  1 Year** | ** ** | **1-3   Years** | ** ** | **4-5  Years** | ** ** | **After 5  Years** | ** ** | **Total** | ** ** |
|--------------------------------|------------|---------------------------------|------------|----------------------|------------|----------------|------------|-------------------------|------------|-----------|------------|
| Term Loan                      |       | $                               | 405        |                 | $          | 890            |       | $                       | —     |      | $          | — |   | $ | 1,295 |   |
| Interest Expense  on Term Loan |       | 105                             |       | 86                   |       | —         |       | —                  |       | 191       |       |
| Operating Leases               |       | 241                             |       | 339                  |       | 296            |       | 1,997                   |       | 2,873     |       |
| Total                          |       | $                               | 751        |                 | $          | 1,315          |       | $                       | 296        |      | $          | 1,997 |   | $ | 4,359 |   |

***Sufficiency of Liquidity***

Based upon our currentoperating plan, analysis of our consolidated financial position and projectedfuture results of operations, we believe that our operating cash flows and cashbalances will be sufficient to finance current operating requirements, debtservice, and planned capital expenditures, for the next 12 months.  With****total workingcapital of $3.0 million, and a current ratio of 3.5 as of June 30, 2007,management expects liquidity in fiscal 2008 to be generated primarily fromoperating cash flows.

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***Capital Resources***

The Company does not currently have any materialcommitments for capital expenditures. The Company expects fiscal 2008 capital expenditures to be under$250,000 which approximates those of fiscal 2007.  This includes capital expenditures in supportof the Company’s normal operations, and expenditures that we may incur inconjunction with initiatives to improve gross margins and reduce expenses.

**Critical Accounting Policies and Estimates**

There have been no material changes to our criticalaccounting policies and estimates from the information provided in Item 7,“Management’s Discussion and Analysis of Financial Condition and Results ofOperations”, included in our Form 10-K for the fiscal year ended March 31,2007.

In June 2006, the FASB issued FASB Interpretation No.48 (“FIN No. 48”), “Accounting for Uncertainty in Income Taxes, aninterpretation of FASB Statement No. 109”.  The Company adopted FIN No. 48 on April 1,2007.  The adoption of thisinterpretation did not have a material impact on its consolidated financialstatements.

## **Outlook**

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

Cyanotech Corporation’s strategic direction is toposition itself as a world-leader in the production and marketing of high-valuenatural products from microalgae.  We are vertically aligned; producingraw materials in the form of microalgae processed at our 90-acre facility inHawaii, and integrating those raw materials into finished products.  Forfiscal 2008, we will continue to focus on the business-to-business wholesalemarket for the products and compounds that we produce, but will put greateremphasis on our Nutrex Hawaii consumer products with introduction of newproduct lines.  Our current product offerings include Naturally CultivatedSpirulina Pacifica® in powder, flake and tablet form, NatuRose® naturalastaxanthin powder for the animal nutrition market, BioAstin® naturalastaxanthin antioxidant in lipid extract, softgel caplet and micro-encapsulatedbeadlet form for the human nutrition and cosmetic industries and Phycobiliproteinsfor use in medical diagnostics.  Information about our Company and ourproducts can be viewed at www.cyanotech.com, www.nutrex-hawaii.com orwww.phycobiliprotein.com.  Consumer products can also be purchased onlineat www.nutrex-hawaii.com.

We are currently experiencing an upward trend insales, with unit sales increasing during the first quarter of fiscal 2008 ascompared to the first quarter of fiscal 2007. The most significant impact was due to an increase in the humanastaxanthin bulk product line. The Company expects Spirulina sales to remainessentially level since the product has reached a mature life cycle stage.  However, significant variability betweenperiods and even across several periods can be expected based on historicalresults.

The Company also continues to experience a reductionof NatuRose sales to the worldwide aquaculture market due to reduced demand inthe Japanese aquaculture market as a result of pricing competition fromsynthetic astaxanthin offerings and competition from new natural formulationsentering the markets.   As discussedin Note 9, the Company has discontinued all business activity of its whollyowned Japanese subsidiary, “CJYK”.  TheCompany made this decision due to declining sales of approximately 40% in eachof the prior two fiscal years in addition to declining gross profit margins of13% and 5% for fiscal 2007, and the quarter ended June 30, 2007,respectively.  “CJYK” sales for fiscalyear 2007 and the quarter ended June 30, 2007, were $482,000 and $20,000, respectively.  We do not expect the dissolution of thissubsidiary to have a significant impact on our consolidated financialstatements.

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The Company’s costs are increasing because of complexnon-US registration costs and rising labor, nutrient, utility and transportationcosts.  We feel that these conditions will likely remain which placessignificant pressure on being able to deliver a profitable natural astaxanthinproduct in the animal nutrition market.  In response to this, we areshifting our natural astaxanthin production into higher value products such asBioAstin for human consumption until such time that animal nutrition marketscan be identified that can generate reasonable profitability for the Company.

The Company is exploring options to expand consumerbrand awareness and knowledge of its product lines, with particular focus ofBioAstin, the Company’s human natural astaxanthin product line, for which itbelieves full market penetration has not yet been realized.  To accomplish these objectives the Company,among other initiatives, has hired a knowledgeable sales employee based on theUS mainland to increase the Company’s outreach to both the US and Europeanmarkets.  We will be introducing newproduct lines to be sold through our Nutrex Hawaii subsidiary during the secondquarter of fiscal year 2008.

Gross profit margin percentages in fiscal year 2008are expected to increase in comparison to the previous period.  We identified and corrected imbalances inastaxanthin production in the fourth quarter of fiscal 2007.  These imbalances negatively impacted fiscalyear 2007 gross margins, and we expect this

imbalance correction to result in increased grossmargins as a percentage of sales during fiscal 2008.  With competition increasing and higherproduction costs, pressure is placed on achieving a reasonable profit margin.

With the adoption of SFAS No. 151, the Companyrecognizes costs associated with abnormal amounts of idle facility expense,freight, handling costs and wasted materials (such as spoilage) ascurrent-period charges in cost of sales.   When production costsexceed historical averages, the Company evaluates whether such costs arecurrent-period charges or can be inventoried.   In addition, theallocation of fixed production overheads (such as depreciation and generalinsurance) to inventories is determined based on normal productioncapacity.   When the Company’s production volumes are below normalcapacity limits, certain fixed production overhead costs cannot be inventoriedand are recorded immediately in cost of sales.   Currently, theCompany’s natural astaxanthin production is back to levels which prevailedprior to fiscal year 2007.  Producing the highest quality microalgae is acomplex biological process which requires balancing numerous factors includingmicroalgal strain variations, temperature, acidity, nutrient and otherenvironmental considerations, some of which are not within the Company’scontrol

To manage its cash resources effectively, the Companywill continue to balance production in light of sales demand, minimizing thecost associated with build-ups in inventory.  The Company has experiencedother significant cash outflows, and may need to utilize other cash resourcesto meet working capital needs if prolonged net losses are incurred in futureperiods.  A prolonged downturn in sales could impair the Company’s abilityto generate sufficient cash for operations and minimize the Company’s abilityto attract additional capital investments which may be necessary in order toexpand into new markets or increase product offerings.

The Company expects operating expense spending willremain consistent with or moderately increase from fiscal 2007 levels after theexclusion of the previously mentioned non-cash impairment write-down and the SFASNo. 144 related costs.  By March 31, 2008the Company is required to be in full compliance with the Sarbanes-Oxley Actand Rules issued thereunder by the Securities and Exchange Commission,including Section 404 Compliance Standards established by the Public CompaniesAccounting Oversight Board. The cost of attaining and maintaining suchcompliance could materially decrease reported net income or increase reportednet losses in future periods.

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The Company’s future results of operations and theother forward-looking statements contained in this Outlook, in particular thestatements regarding revenues, gross margin and capital spending involve anumber of risks and uncertainties.  In addition to the factors discussedabove, any of the following could cause actual results to differmaterially:  business conditions and growth in the natural productsindustry and in the general economy; changes in customer order patterns;changes in demand for natural products in general; changes in weatherconditions; competitive factors, such as increased production capacity fromcompeting Spirulina and Astaxanthin producers and the resulting impact, if any,on world market prices for these products; government actions; shortage ofmanufacturing capacity; and other factors beyond our control.  Riskfactors are discussed in detail in Item 1A in our Form 10-K report for the yearended March 31, 2007.

Cyanotech believes that it has the products,facilities, personnel, competitive, and financial resources for improvedresults, but future revenues, costs, gross margins and profits are allinfluenced by a number of factors, as discussed above, all of which areinherently difficult to forecast.

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**Item3.    Quantitative and Qualitative Disclosures about Market Risk**

We have never entered into any transactions usingderivative financial instruments or derivative commodity instruments andbelieve that our exposure to market risk associated with other financialinstruments is not material.

We have a term loan agreement that adjusts quarterlybased on the prime rate.  As such we are exposed to the interest rate riskwhereby a 1% increase in the prime rate would lead to an increase ofapproximately $13,000 in interest expense for the year ending March 31, 2008(based on June 30, 2007 amounts outstanding).

**Item 4.  Controls and Procedures**

(a) **Disclosure Controls and Procedures**

ThisForm 10-Q should be read in conjunction with Item 9A “Controls and Procedures”of the Company’s Form 10-K for the fiscal year ended March 31, 2007 filedAugust 16, 2007.  There were nomaterial changes in Controls and Procedures during the current quarter.  As of June 30, 2007, as discussed in thefiscal 2007 Form 10-K, the Company believes its systems and procedures aresufficient to reasonably ensure accurate financial data, but it has concludedthat due to a lack of adequately trained internal accounting resources,there exists more than a remote likelihood that a material misstatement to theinterim financial statements could occur and not be detected by proceduresand controls over financial reporting on a timely basis.  This material weakness in internal controlover financial reporting has lead to an inability to produce timely filingsover the past year including this Form 10-Q.

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**PARTII.   OTHER INFORMATION**
| **Item 1.** | **Legal Proceedings** |
|------------------|-----------------------|

None.
| **Item 1A.** | **Risk Factors** |
|-------------------|------------------|

**Certain Factors Affecting Cyanotech Corporation**

The Company has includedin Part I, Item 1A of its Annual Report on Form 10-K for the year endedMarch 31, 2007, a description of certain risks and uncertainties thatcould affect the Company’s business, future performance or financial condition(the “Risk Factors”). There are no material changes from the disclosureprovided in the Form 10-K for the year ended March 31, 2007 with respectto the Risk Factors. Investors should consider the Risk Factors prior to makingan investment decision with respect to the Company.
| **Item 2.** | **Unregistered Sales of Equity Securities and Use  of Proceeds** |
|------------------|------------------------------------------------------------------|

None.
| **Item 3.** | **Defaults upon Senior Securities** |
|------------------|-------------------------------------|

None.
|  **Item 4.** | **Submission of Matters to a Vote of Security  Holders** |
|------------------------|----------------------------------------------------------|

None. 
|  **Item 5.** | **Other Information** |
|------------------------|-----------------------|

None. 
| **Item 6.** | **Exhibits** |
|------------------|--------------|

  The following exhibits are furnished withthis report:

24.1   Power of Attorney.

31.1   Certificationby the Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of theExchange Act

31.2   Certificationby the Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of theExchange Act

32.1   Certificationby the Chief Executive Officer pursuant to 18 U. S. C. Section 1350, as adoptedpursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2   Certificationby the Chief Financial Officer pursuant to 18 U. S. C. Section 1350, as adoptedpursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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SIGNATURES

Inaccordance with the requirements of the Securities Exchange Act of 1934, theregistrant caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.
|                    | CYANOTECH CORPORATION  (Registrant) |
|--------------------|-------------------------------------|
|               |                                |
| September 21, 2007 |                                |   | By: |  /s/Gerald R. Cysewski |   |
| (Date)             |                                |   | Gerald R. Cysewski |
|               |                                |   | Chairman of the Board, |
|               |                                |   | President and Chief  Executive Officer |
|               |                                |   |   |
|               |                                |   |   |
| September 21, 2007 |                                |   |   | William R. Maris |
| (Date)             |                                |   | Vice President –  Finance & Administration, |
|               |                                |   | Chief Financial Officer |
|               |                                |   | (Principal Financial  and Accounting |
|               |                                |   | Officer) |
|               |                                |   |   |
|               |                                | By: | /s/ Gerald R.  Cysewski |   |
|               |                                |   | Gerald R. Cysewski |
|               |                                |   | As Attorney-in-fact |
|               |                                |   | (See Exhibit 24.1) |
|                    |                                     |  |  |  |  |  |  |  |  |

 

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