This Report and other presentations made by Cyanotech Corporation ("CYAN") and its subsidiary contain "forward-looking statements," which include statements that are predictive in nature, depend upon or refer to future events or conditions, and usually include words such as "expects," "anticipates," "intends," "plan," "believes," "predicts", "estimates" or similar expressions. In addition, any statement concerning future financial performance, ongoing business strategies or prospects and possible future actions are also forward-looking statements. Forward-looking statements are based upon current expectations and projections about future events and are subject to risks, uncertainties and the accuracy of assumptions concerning CYAN and its subsidiary (collectively, the "Company"), the performance of the industry in which they do business and economic and market factors, among other things. These forward-looking statements are not guarantees of future performance.

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

† Statements relating to our business strategy;

† Statements relating to our business objectives; and

† Expectations concerning future operations, profitability, liquidity and financial resources.

These forward-looking statements are subject to risk, uncertainties and assumptions about us and our operations that are subject to change based on various important factors, some of which are beyond our control. The following factors, among others, could cause our financial performance to differ significantly from the goals, plans, objectives, intentions and expectations expressed in our forward-looking statements:

† The added risks associated with the current local, national and world economic crisis;

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

† Environmental restrictions, soil and water conditions, weather and other hazards;

†          Access to available and reasonable financing on a timely basis;



†          Changes in laws, including increased tax rates, regulations or
accounting standards, and decisions of courts, regulators and governmental
bodies;

† Demand for the company's products, the quantities and qualities thereof available for sale and levels of customer satisfaction;

† Our dependence on the experience and competence of our executive officers and other key employees;

† The risk associated with the geographic concentration of the company's business;

† Acts of war, terrorists incidents or natural disasters; and

† Other risks or uncertainties described elsewhere in this Report and in other periodic reports previously and subsequently filed by the Company with the Securities and Exchange Commission.

Overview



Comparisons of selected consolidated statements of operations data as reported
herein follow for the periods indicated (dollars in thousands):



                               Three Months Ended    Three Months Ended
                                  June 30, 2009         June 30, 2008      Change

Net sales:
Spirulina products             $             1,918   $             2,040       (6 )%
Natural astaxanthin products                 2,101                 1,621       30 %
Other products                                   2                    40      (95 )%
Total sales, all products      $             4,021   $             3,701        9 %




                         Three Months Ended    Three Months Ended
                            June 30, 2009         June 30, 2008      Change

Gross profit             $             1,733   $             1,304       33 %
Income from operations   $               435   $               292       49 %
Net income               $               413   $               271       52 %

Sales for the first quarter of fiscal year 2010 increased from the first quarter prior year period by $320,000 or 9% due to an increase in natural astaxanthin product sales.

Spirulina sales decreased 6% over the first quarter of fiscal year 2009, primarily due to the fulfillment of $710,000 of backlog sales orders which carried over from the March 31, 2008 into the first quarter of fiscal 2009. Spirulina sales increased 44% over the first quarter of fiscal year 2009 when adjusted for this backlog. No such backlog existed at March 31, 2009.

Natural astaxanthin product sales increased over the first quarter prior year period due to an increase in sales of both bulk and packaged astaxanthin products. Bulk product sales increased by 37% while packaged nutrition products increased by 18%. A backlog of astaxanthin products in the amount of $209,000 at March 31, 2008 carried over into the first quarter of fiscal 2009. Astaxanthin sales increased 49% over the first quarter of fiscal year 2009 when adjusted for this backlog. The Company is focused on building market share as a nutritional brand which promotes health and well-being. Astaxanthin products are a growing segment of this market.

Gross profit margin as a percentage of sales increased to 43% for the three months ended June, 30, 2009 from 35% for the first quarter a year ago. This is the result of a sales increase for the first quarter of fiscal year 2010 of 9% coupled with cost of products sold decrease of 5% from the first quarter of the last fiscal year. The improvement reflects the company's increased inventory levels allowing better customer service and essentially eliminating backlog orders. Additionally, improved production levels reduced per unit cost. Management continues researching methodology to promote and sustain production at desired capacity and quality levels.

Net income of $413,000 for the first quarter of fiscal 2010 represents an improvement of $142,000 over the first quarter of fiscal 2009 which had a net income of $271,000. The increase is the result of improved gross margins offset by some increases in operating costs.

Results of Operations

First Quarter of Fiscal 2010 Compared to First Quarter of Fiscal 2009

Net sales for the first quarter of fiscal 2010 increased to $4,021,000, a 9% increase from the $3,701,000 reported for the comparable period a year ago. Company sales of Spirulina products for the first quarter of fiscal 2010 were $1,918,000, which is a 6% decrease from sales generated in the first quarter of fiscal 2009. As a percentage of sales, Spirulina accounted for 48% of total sales in the first quarter of fiscal 2010, compared to 55% for the comparable period a year ago. Spirulina sales have declined as a percentage of total sales primarily due to increased sales of Natural Astaxanthin products in the first quarter of the current fiscal year and a decline in Spirulina sales as a result of backlog shipments made in the prior year fiscal quarter.

Natural astaxanthin product sales were $2,101,000 during the first quarter of 2010, a 30% increase from $1,621,000 in the first quarter of the prior year. Natural astaxanthin product sales increased to 52% of total sales from 44% of total sales in the first quarter of fiscal 2009. This increase is the result of the Company focusing its products to build nutritional brands which promote health and well-being. Sales of packaged products increased 18% over the same period last fiscal year. Bulk sales increased as well at 37%.

International sales were 47% of total sales for the first quarter of fiscal year 2010 and 41% in the first quarter of 2009. Major customers are those equaling or exceeding 10% of the Company's sales for the period. For the first quarter of fiscal 2010 there were no customers who had sales equal to or greater than 10% of the Company's total sales for the quarter. Two European distributors each had sales equal to or greater than 10% of the Company's total sales for the first quarter of fiscal year 2009.

Gross profit, derived from net sales less the cost of product sales, includes the cost of materials, direct labor, manufacturing overhead and depreciation. Gross profit for the three months ended June 30, 2009 was $1,733,000, with a gross profit margin percentage of 43%. This was an increase from gross profit margin of $1,304,000 and gross profit margin of 35% reported for the comparable prior year quarter. Sales for the first quarter of fiscal year 2010 increased 9% from the comparable prior year period while costs of products sold decreased 5% for the same respective period, resulting in the 8% improvement in gross profit margin percentage. The improvement reflects the growth and stabilization of production levels over several quarters, which results in lower costs per unit and improved margins.

Variable production costs increased 7% in the current period compared to one year ago primarily due to labor costs which increased 41% from combined pay rate increases and added personnel to achieve increased production. Fixed costs have increased by 4% primarily due to production equipment additions being depreciated. Spirulina production increased 22% and astaxanthin production increased 2% over the same quarter one year ago. Total variable and fixed costs spread over increased production units is continuing to lower individual unit costs.

Pursuant to SFAS No. 151 "Inventory Costs - an amendment of ARB No. 43, Chapter 4," approximately $0 and $23,000 of fixed production overhead cost was charged to cost of sales during the three months ended June 30, 2009 and June 30, 2008, respectively. There were no lower of cost or market issues for the first quarters of fiscal years 2010 or 2009.

Operating expenses for the three months ended June 30, 2009 were 32% of sales or $1,298,000, compared to 27% of sales or $1,012,000 for the three months ended June 30, 2008. The increase in operating expenses in the three months ended June 30, 2009 as compared with the three months ended June 30, 2008, was primarily the result of General and administrative expenses incurred in completing the reporting requirements for the prior fiscal year, and initiation of programs in Research and development and in Sales and marketing. General and administrative expense for the first quarter 2010 increased by $187,000 from the first quarter of 2009. Research and development expense for the first quarter of 2010 increased by $44,000 from the first quarter of 2009. Management expects that Research and development expenses in future periods will focus on improved production methods.

For the three months ended June 30, 2009, the Company recorded an income tax expense of $10,000 related to Federal and state alternative minimum tax. For the three months ended June 30, 2008, an income tax receivable of $11,000 was recorded related to Federal and state tax credits. The Company does not expect any material U.S. Federal or state income taxes to be recorded for the current fiscal year because of available net operating loss carry-forwards.

In Summary, the Company had net income of $413,000 or $0.08 per diluted share, for the three months ended June 30, 2009 compared to a net income of $271,000, or $0.05 per diluted share for the three months ended June 30, 2008.

Variability of Results

The Company has experienced significant quarterly fluctuations in operating results and such fluctuations could occur in future periods. The Company has, during its history, experienced fluctuations in operating results due to the following: changes in sales levels to our customers, competition (both pricing, new products and other market trends), production difficulties from increased production costs and variable production results due to inclement weather, 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 the Company's control such as foreign exchange fluctuations, changes in government regulations, and economic changes in the regions it operates in and sells to. A portion of our operating expenses are relatively fixed and the timing of increases in expense levels is based in large part on forecasts of future sales. Therefore, if net sales are below expectations in any given period, the adverse impact on results of operations may be magnified by our inability to adjust spending in certain areas meaningfully, or to adjust spending quickly enough, as in personnel and administrative costs. We may also choose to reduce prices or increase spending in response to market conditions, and these decisions may have a material adverse effect on financial condition and results of operations.

Financial Condition

Cash and cash equivalents remained consistent with levels at March 31, 2009 decreasing only $24,000 or 2%. Cash provided by operating activities of $487,000 increased $295,000 over the same quarter last fiscal year. The increase is due to the increase in net income of $142,000, plus the increase of non-cash expenses of $83,000 and the net improvement of changes in current assets and liabilities of $70,000 over the same quarter of last fiscal year.

As of June 30, 2009, the Company's net accounts receivable increased $507,000 to $2,292,000 from $1,785,000 as of March 31, 2009. The increase in accounts receivable is primarily the result of the timing of sales for the quarter. Management believes that its accounts receivable are collectible, net of the allowance for doubtful accounts of $14,000 at June 30, 2009.

The Company's net inventory decreased $26,000 or 1% to $3,098,000 as of June 30, 2009 compared to $3,124,000 as of March 31, 2009. The decrease in inventory during the first three months of fiscal 2010 is primarily due to an increase in sales of packaged product finished goods. This is consistent with the Company's emphasis on nutrition products.

Cash flows used in investing activities reflect capital expenditures which totaled $358,000 during the first three months of fiscal 2010 compared to just $45,000 one year ago. Cash flows used in financing activities are attributable to debt payments during that period which were $152,000 and $138,000 for the first quarters of fiscal 2010 and 2009, respectively.

Liquidity and Capital Resources

At June 30, 2009, the Company's working capital was $4,037,000, an increase of $145,000 compared to $3,892,000 at March 31, 2009. Cash and cash equivalents at June 30, 2009 totaled $953,000, a decrease of $24,000 from $977,000 at March 31, 2009.

The Company has two Term Loan Agreements ("Term Loans") with a lender. These provided up to $4.6 million in combined credit facilities which are secured by substantially all the assets of the Company. The outstanding combined balance under the Term Loans as of June 30, 2009 is approximately $1,351,000. The Term Loans have maturity dates of May 1, 2010 as to $435,000 and March 1, 2015 as to $916,000 and are payable in equal monthly principal payments plus interest totaling approximately $55,000.

The interest rate under the Term Loans, in absence of a default under the agreement, is the prime rate, as defined, in effect as of the close of business on the first day of each calendar quarter, plus 1% (the prime rate was 3.25% at June 30, 2009). The Company is prohibited by the Term Loan from declaring any cash dividends without the lender's prior written consent. A $250,000 restricted cash deposit must be held in an interest-bearing restricted cash account per the terms of the Term Loan and is included in other assets in the consolidated balance sheet at June 30, 2009.

On April 24, 2009, the Company entered into an agreement with First Hawaiian Bank for a Line of Credit in the amount of $150,000 for a term of one year. The obligation is secured by the Company's U.S. accounts receivable and bears a variable interest rate based on prime plus 2%. There was no outstanding balance as of June 30, 2009. The lender under the Company's existing Term Loans has subordinated its position up to $150,000 of U.S. accounts receivable.

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

† The Company had experienced significant recurring net losses. At June 30, 2009, the Company had an accumulated deficit of $19,506,000 compared to an accumulated deficit of $19,921,000 at March 31, 2009. The accumulated deficit decreased by $415,000 for the quarter ended June 30, 2009.

† Material weaknesses in its internal controls, as previously reported, have caused the Company to experience delays in completing its consolidated financial statements and filing periodic reports with the SEC on a timely basis. Accordingly, the Company continues to devote substantial additional internal resources, and to experience higher than expected fees for audit services. At present the Company has concluded that more rigorous emphasis on improving the capabilities of existing systems, procedures, and existing personnel, will correct the material weakness.

† In early December 2007, the Company cut its workforce by approximately 20% to conserve liquidity and reduce costs to allow time for the Company to recover from weather related production losses. The Company has since increased its operations workforce to achieve enhanced production efficiency and effectiveness and sustain improved sales.

Sufficiency of Liquidity

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

Capital Resources

The Company expects fiscal 2010 capital expenditures to be approximately $1,000,000 and to be funded from operating cash flows. This includes capital expenditures in support of the Company's normal operations, and expenditures that we may incur in conjunction with initiatives to improve gross margins and reduce expenses.

Outlook

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

Cyanotech Corporation's strategic direction has always been to position itself as a world leader in the production and marketing of high-value natural products from microalgae. We are vertically aligned, producing raw materials in the form of microalgae processed at our 90-acre facility in Hawaii, and integrating those raw materials into finished products. In fiscal 2010, we will put greater emphasis on our Nutrex Hawaii consumer products. Our focus going forward will be to leverage our experience and reputation for quality, building nutritional brands which promote health and well-being. The foundation of our nutritional products is naturally cultivated Spirulina Pacifica® in powder, flake and tablet form; and BioAstin® natural astaxanthin antioxidant in extract, softgel caplet and micro-encapsulated beadlet form. Information about our Company and our products can be viewed at www.cyanotech.com and www.nutrex-hawaii.com. Consumer products can also be purchased online at www.nutrex-hawaii.com.

We are currently experiencing an upward trend in sales primarily in our Natural astaxanthin products. The Company is focused on sustainability of its production levels in order to promote continued growth in its astaxanthin product line. The Company expects spirulina sales to remain essentially level since the product has reached a mature life cycle stage. Significant sales variability between periods and even across several periods can be expected based on historical results.

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

Gross profit margin percentages in fiscal year 2010 will be impacted by continued pressure on input costs and this could cause margins to decline in future periods. Management will continue its focus on health and well-being, promoting higher gross margin items. Management is dedicated to continuous improvements in process and production methods to stabilize and increase production levels for the future.

With the adoption of SFAS 151, the Company recognizes costs associated with abnormal amounts of idle facility expense, freight, handling costs and wasted materials (such as spoilage) as current-period charges in cost of sales. When production costs exceed historical averages, management evaluates whether such costs are current-period charges or are inventoriable costs. In addition, the allocation of fixed production overheads (such as depreciation and general insurance) to inventories is determined based on normal production capacity. When the Company's production volumes are below normal capacity limits, certain fixed production overhead costs cannot be inventoried and are recorded immediately in cost of sales. Producing the highest quality microalgae is a complex biological process which requires balancing numerous factors including microalgal strain variation, temperature, acidity, nutrient and other environmental considerations, some of which are not within the Company's control.

To manage its cash resources effectively, the Company will continue to balance production in light of sales demand, minimizing the cost associated with build-ups in inventory when appropriate. The Company has experienced other significant cash outflows and may need to utilize other cash resources to meet working capital needs if prolonged net losses are incurred in future periods. A prolonged downturn in sales could impair the Company's ability to generate sufficient cash for operations and minimize the Company's ability to attract additional capital investment which could become necessary in order to expand into new markets or increase product offerings.

Management expects General and administrative expense to increase somewhat over fiscal year 2009 levels. By March 31, 2010, the Company is required to be in full compliance with the Sarbanes-Oxley Act and Rules issued there under by the SEC, including Section 404 Compliance Standards established by the Public Companies Accounting Oversight Board. The cost of attaining and maintaining such compliance could materially decrease reported net income or increase reported net losses in future periods.

The Company's future results of operations and the other forward-looking statements contained in this Outlook, in particular the statements regarding revenues, gross margin and capital spending involve a number of risks and uncertainties. In addition to the factors discussed above, any of the following could cause actual results to differ materially: business conditions and growth in the natural products industry and in the general economy; changes in customer order patterns; changes in demand for natural products in general; changes in weather conditions; competitive factors, such as increased production capacity from competing spirulina and astaxanthin producers and the resulting impact, if any, on world market prices for these products; government actions; shortage of manufacturing capacity; and other factors beyond our control. Risk factors are discussed in detail in Item 1A in our Form 10-K report for the year ended March 31, 2009.

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