The following discussion should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this Form 10-K. For a more comprehensive description of the Company's products and markets for such products, see Part I. Item 1. Business.

Results of Operations for the 2009, 2008 and 2007 Fiscal Years

                                                                 Fiscal Year 2009       Fiscal year 2008
                                                                     vs. 2008               vs. 2007
                                       Fiscal Year                      Favorable / (Unfavorable)
                                2009       2008       2007         $           %         $          %
                                                             (In thousands)
Net sales                     $ 13,950   $ 11,364   $  9,683    $   2,586      22.8 % $ 1,681         17.4 %
Cost of sales                    8,438      8,293      8,552         (145 )    (1.7 )     259          3.0

  Gross profit                   5,512      3,071      1,131        2,441      79.5     1,940        171.5

Operating expenses
  Research & development           206        143        203          (63 )   (44.1 )      60         29.6
  Sales and marketing            1,125      1,355      1,297          230      17.0       (58 )       (4.5 )
  General & administrative       2,873      2,478      2,448         (395 )   (15.9 )     (30 )       (1.2 )
  Impairment loss on
  equipment and leasehold
  improvements                       -          -      4,487            0      00.0     4,487        100.0

     Total operating
     expense                     4,204      3,976      8,435         (228 )    (5.7 )   4,459         52.9

     Income (loss) from
     operations                  1,308       (905 )   (7,304 )      2,213     244.5     6,399         87.6

Other income (expense)
  Interest income                    8         24         59          (16 )   (66.7 )     (35 )      (59.3 )
  Interest expense                (162 )     (164 )     (186 )          2       1.2        22         11.8
  Other income (expense),
  net                               10        (65 )       (3 )         75     115.4       (62 )   (2,066.7 )

  Total other expense             (144 )     (205 )     (130 )         61      29.8       (75 )      (57.7 )

Income (loss) before income
tax expense (benefit)            1,164     (1,110 )   (7,434 )      2,274     204.9     6,325         85.1
Income tax expense
(benefit)                           22         29         (9 )          7      24.1       (38 )     (422.2 )

  Net income (loss)           $  1,142   $ (1,139 ) $ (7,425 )  $   2,281     200.3 % $ 6,287         84.7 %

Overview

Cyanotech Corporation's core competency is cultivating and processing microalgae into high-value, high-quality natural products for the human nutrition market. Our products are sold in bulk quantities to manufacturers, formulators and distributors in the health foods and nutritional supplements markets and as packaged consumer products to distributors, retailers and direct consumer sales. The Company manufactures its products in Hawaii, but markets them worldwide, generating 47%, 43% and 46% of its revenues outside of the United States for each of the years ended March 31, 2009, 2008 and 2007, respectively. Competing in a global marketplace, the Company is influenced by the general economic conditions of the countries in which its customers operate, including adherence to its customers' local governmental regulations and requirements. The Company currently has no material foreign exchange exposure as all sales are in U.S. currency.

The Company reported a net income of $1,142,000 or $.22 per diluted share for fiscal 2009 compared to a net loss of $1,139,000, or ($.22) per diluted share for fiscal year 2008. Cash and cash equivalents at March 31, 2009 were $977,000, down $113,000 from a year ago. Working capital increased 26% to $3,892,000 at March 31, 2009 from working capital of $3,092,000 a year ago, primarily due to increased inventory balances.

The following table details selected financial data highlighting three key areas:

                                                          Year Ended March 31,
                                                        2009       2008      2007
                                                             (In thousands)
      Net sales:
          Spirulina products                          $  6,835   $  5,980   $ 6,090
          Natural astaxanthin products                   7,093      5,251     3,496
          Other products                                    22        133        97

                                                      $ 13,950   $ 11,364   $ 9,683

      Gross profit as a percentage of sales                 40 %       27 %      12 %
      Operating expenses as a percentage of sales           30 %       35 %      87 %

Net sales for fiscal 2009 were $13,950,000, or 22.8% higher than the $11,364,000 reported for the prior fiscal year. This increase was due primarily to increased production of both astaxanthin and spirulina compared to 2008. Astaxanthin production during fiscal 2009 was used entirely to produce higher value and higher margin BioAstin nutrition products, compared to fiscal year 2008 which saw the shift away from the NatuRose animal product which was ultimately discontinued in March 2008.

The Company's emphasis is on growing the market for its health and nutritional products, BioAstin and Spirulina Pacifica, as well as an expanded line of supplements and vitamins based on these products. The Company intends to grow its spirulina business by focusing on the higher nutritional content of its Hawaiian spirulina and its superior service to its customers. The Company will emphasize the benefits of its natural astaxanthin products as increased competition from other producers of natural, and synthetic astaxanthin may result in the decline of margins generated by its natural astaxanthin products. Management cannot predict whether the outcomes of any of its strategies will be successful.

As depicted in the preceding table, the Company's gross profit margin as a percentage of net sales increased to 40% for the fiscal year ended March 31, 2009, up from 27% for fiscal 2008 and 12% for fiscal 2007. Fiscal year 2009 margins increased as a result of stabilized production levels and strategic price increases instituted thoughout the year. Several factors impacted gross profit in prior fiscal years, such as below normal capacity production due to both customary and complex variables related to astaxanthin production in 2007 and spirulina production in the third quarter of 2008. Other factors combining to

impact prior years' gross margins were customer and product mix, increased price competition, increases in raw materials costs and increased energy costs.

Spirulina production recovered from the environmental problems experienced in fiscal year 2008 and described in prior years' Form 10-K, as did astaxanthin production, which was impaired in fiscal year 2007. Spirulina and astaxanthin production is anticipated to remain at 2009 levels which result in lower per unit production costs. However, because complex biological processes are involved and these processes are influenced by factors beyond Company control-the weather, for example-we cannot assure the results of any of the Company's corrective or improvement efforts. Because the Company's processes are agricultural, it is important to maintain reasonably strong production volumes in order to support the basic resource levels required to sustain a large scale, open culture, natural agricultural facility.

The Company expects its financial results for the first quarter of fiscal 2010 to remain comparable to fiscal 2009 in both gross margin and operating expenses as a percentage of net sales. However, operating expenses may increase as a result of the Company's efforts to stabilize production, improve processes, introduce new products and expand its business. Specific level of income and expense can not be determined with certainty. The Company will continue to contain discretionary spending, and is actively pursuing methods of improving productivity, controlling energy, water and freight costs.

In fiscal year 2007, the Company recorded a non-cash impairment write-down of production equipment and leasehold improvements of $4.5 million as a result of the analysis required under SFAS No. 144. Due to a history of losses, the Company assessed the recoverability of its long-lived assets in accordance with SFAS No. 144 as of March 31, 2009 and 2008. However, no additional non-cash impairment write-down of production equipment and leasehold improvements was necessary for 2008 and 2009.

To offset increased production costs, the Company continues to strive to increase production efficiencies in volume yield, potency and quality consistent with the Company's commitment to produce high-value, high-quality products. However, these efforts cannot be guaranteed to achieve the desired results.

Results of Operations

Revenues Net sales for fiscal 2009 totaled $13,950,000, a 22.8% increase from net sales of $11,364,000 in fiscal 2008 and a 44% increase from net sales of $9,683,000 reported in fiscal 2007. The following is a discussion of revenues by major product category.

Spirulina The Company has been producing Spirulina Pacifica, a strain of Spirulina microalgae, since 1985. Revenues generated from the Company's Spirulina products are a significant portion of total revenues, amounting to $6,835,000, $5,980,000 and $6,090,000 for the years ended March 31, 2009, 2008 and 2007 respectively. Spirulina revenues as a percentage of total revenues for the three years ended March 31, 2009, is 49%, 53% and 63%, respectively. Approximately $1,521,000 or 11% of net sales for the year ended March 31, 2009 were to a Spirulina marketing and distribution company based in the Netherlands. Sales to this customer during fiscal years 2008 and 2007 amounted to $1,149,000 or 10% of net sales, and $937,000 or 10% of net sales.

In recent years, the Company has experienced increased competition for its Spirulina products resulting from an increasing number of suppliers of Spirulina as well as from a larger portion of our sales coming from bulk product orders whose customers generally treat these products as commodities with price being the major determining factor driving their purchasing decision. We expect this competitive pricing pressure to continue in future periods and in response have focused on improving the quality of our Spirulina products in support of customers who demand higher quality raw materials for their formulations. Fiscal 2009 Spirulina sales increased $855,000 or 14%, a result of 4% more units sold and 10% increase in average selling price as compared to 2008. In fiscal 2008, sales decreased 2% from 2007

resulting from fewer units sold as a result of third quarter production issues. As of March 31, 2009, there was no backlog of orders for Spirulina products. Backlogs at the end of fiscal 2008 and 2007 were $710,000 and $432,000 respectively.

Natural Astaxanthin In fiscal 2009, the Company's sales of its natural astaxanthin products were $7,093,000, an increase of 35% from $5,251,000 in fiscal 2008, and an increase of 103% from $3,496,000 in fiscal 2007. The increase in natural astaxanthin sales for 2009 was the result of a 38% increase in units sold. Increased production in 2008 accounted for the 50% sales improvement from 2007. A single customer accounted for $1,806,000 or 13% of net sales for the year ended March 31, 2009. We believe that sales to this customer will continue to represent a significant portion of total net sales in future periods. During 2008, the Company discontinued production of its animal product, NatuRose, in order to focus on the human astaxanthin products which are experiencing greater demand and have higher gross margins. As of March 31, 2009, there was no backlog of orders for Natural Astaxanthin products. Backlog at the end of fiscal 2008 and 2007 was $209,000 and $802,000, respectively. The decline in order backlog from year to year is the result of increased production allowing for timely order fulfillment.

The Company believes that the findings of clinical trials undertaken in prior years by the Company, its customers and other unaffiliated parties, taken individually and on a cumulative basis, have generated growing consumer awareness of the beneficial antioxidant and anti-inflammatory properties of astaxanthin. Validation of natural astaxanthin benefits identified in such scientific studies has helped to spur demand for our natural astaxanthin products in the human nutrition market and could provide the basis for proprietary intellectual property. The Company completed and issued reports on two positive scientific clinical trials on natural astaxanthin during fiscal 2006. One study demonstrated that natural astaxanthin could lower levels of C-Reactive Protein, an indicator of systemic inflammation and the second study showed that grip strength could be increased in those suffering from tennis elbow by consumption of natural astaxanthin. The Company plans to continue expenditures on targeted scientific trials in the future in accordance with its strategy to increase sales of natural astaxanthin products.

Cost of Sales Cost of sales, as a percentage of net sales, was at 60%, 73% and 88% for fiscal years 2009, 2008, and 2007, respectively. Cost of sales includes the cost of nutrients and materials, direct labor and manufacturing overhead costs; depreciation and amortization of production equipment, buildings and leasehold improvements associated with the production of inventory units sold; and other production-related period costs. The cost of sales as a percent of sales decrease of 13 points between 2009 and 2008; and 12 points between 2008 and 2007, is the result of improved control of customary and complex production variables related to astaxanthin and spirulina production. Customary variables include availability and costs of personnel, raw materials, energy and freight. These variables fluctuate based on changes in the local, national and world economies. Complex variables include cultivation methods, feeding formulations and harvesting processes, all of which include efforts to anticipate the extent of weather and environmental events and make timely and sufficient adjustments. Although the variability of such costs can not be fully anticipated, the Company has focused increased effort in this area in order to produce both spirulina and astaxanthin at levels sufficient to fully absorb production costs into inventory. (See discussion of SFAS No. 151 below) Because the Company's processes are agricultural, it is important to maintain production volumes in order to support the minimal resource levels required to sustain a large-scale open culture agricultural facility. The Company expensed $59,000 of non-inventoriable costs in fiscal year 2009.

In fiscal 2008, $1,298,000 of non-inventoriable costs were deemed to be period costs resulting from an abnormal usage of chemical, labor and utilities expended to manage the spirulina production problems, re-inoculation and subsequent flooding which occurred in December 2007. These expenditures combined to significantly increase cost of sales relative to units produced and correspondingly reduced gross profit for the year ended March 31, 2008. Fiscal year 2007 included $1,668,000 of non-inventoriable costs as a result of abnormal chemical, labor and utility usage related to astaxanthin production coupled with costs associated with the company's animal nutrition market products which were not inventoriable because

such costs would have exceeded the market value for the related inventory. On March 23, 2008, the Company announced its decision to abandon the animal nutrition market in favor of human products with higher demand and margins.

Fresh water is critical for our natural astaxanthin production and, while the Company has not experienced any constraint on fresh water availability, future availability could be negatively impacted by significant growth in the local population as well as by throughput constraints on the water delivery infrastructure owned by the County of Hawaii. Given the criticality of fresh water to our operations and the community, the Company recycles fresh water where possible and developed additional water recycling systems during fiscal 2007 in its efforts to utilize fresh water efficiently. Both fresh and sea water require electricity for pumping; and electricity, the Company's single largest expenditure, depends on the cost of fuel oil which is, in turn, tied to the global price of crude oil. The general price of fuel in Hawaii has increased in excess of 46% since the end of fiscal 2007 and the Company's cost of electricity has increased 33% per kilowatt hour.

For fiscal 2010, the Company expects to incur higher electric, water and shipping costs due to the impact of fuel cost increases experienced in fiscal 2009 and considering the likelihood of continued volatility in fuel cost in the future.

For the production of BioAstin, the Company's natural astaxanthin product for the human nutrition market, two third-party contractors are utilized for the processes of extraction, and several third-party contractors are utilized for both encapsulation (for gelcaps) and micro-encapsulation (for beadlets). Although these services are available from a limited number of sources, we believe we have the ability to use other parties if any of the current contractors become unavailable. If pricing for any of these services significantly increases, there could be a material adverse effect on our business, financial condition and results of operations. There have not been any significant changes in the cost of extraction or encapsulation services and none are currently anticipated.

To offset increased production costs, the Company seeks ways to increase production efficiencies in volume yield, potency, and quality consistent with the Company's commitment to produce high-value, high-quality products. However, these efforts cannot be guaranteed to achieve the desired results.

The Company adopted SFAS No. 151 effective April 1, 2006. The provisions of SFAS No. 151 "Inventory Costs-an amendment of Accounting Research Bulletin No. 43, Chapter 4" require that abnormal amounts of freight, handling costs and wasted material (spoilage) be recognized as current-period charges and fixed production overhead costs be allocated to inventory based on the normal capacity of production facilities. Normal capacity is defined as "the production expected to be achieved over a number of periods or seasons under normal circumstances, taking into account the loss of capacity resulting from planned maintenance." These amounts were $136,000, $1,298,000 and $1,668,000 for the fiscal years ended March 31, 2009, 2008 and 2007, respectively.

Unforeseen changes in any of the factors surrounding the estimates imbedded in the determination of inventory values and cost of sales could have a material impact on cost of sales. Such changes in factors and estimates include but are not limited to production levels and capacity; changes in the prices paid for raw materials, supplies, and labor; changes in yield, potency, and quality of biomass; and changes in processing or production methods.

Gross Profit Margin The Company's gross profit margin as a percentage of net sales increased 13 points to 40% for the fiscal year ended March 31, 2009, up from 27% for fiscal 2008 The improvement is the result of increased sales volume driven by product availability and quality, price increases instituted throughout 2009 and increases in units produced resulting in lower unit costs. The increase of 15 percentage points in fiscal 2008 over 2007 was primarily the result of lower period costs resulting from production levels below normal capacity as previously explained.

Management expects the Company's fiscal 2010 gross profit margin percentage to remain generally consistent with the results reported for fiscal 2009. However, as discussed elsewhere in this Annual Report, the Company cannot predict future production levels. Producing the highest quality microalgae is a complex biological process which requires the tenuous balancing of numerous factors including microalgal strain variations, temperature, acidity, nutrient and other environmental considerations, some of which are not in the Company's control. As a result, it can be difficult and time consuming to adjust, improve or correct production process when quality levels fall below specifications. While the Company generally possesses scientific knowledge and resources to correct its production processes, there are too many variables involved for the Company to make reliable projections concerning such efforts. However, we constantly strive to anticipate events requiring adjustments to nutrients, processes, customer demands, etc. and strive to achieve increased production yields and improve quality. In addition to the items discussed above, there are many factors which could materially diminish gross profit.

Operating Expenses Operating expenses as a percentage of net sales were 30% for fiscal 2009, 35% for fiscal 2008 and 87% for fiscal 2007. Total operating expense increased by $228,000 or 6% over 2008 levels. The decrease in 2008 from 2007 as a percentage of sales was primarily due to factors occurring in 2007: a non-cash impairment write-down of production equipment and leasehold improvements of $4.5 million (as a result of an analysis required under SFAS No. 144); expenses in conjunction with the restatement and amendment of a prior period annual report on Form 10-K; and costs incurred to meet listing requirements with NASDAQ Capital Market including a one-for-four reverse stock split, all discussed in detail in prior Forms 10-K.

Research and development costs increased to $206,000 in 2009, up 44% from $143,000 in fiscal 2008, and approximately equal to the $203,000 in fiscal 2007. During fiscal year 2008 personnel were redirected to assist with urgent production issues accounting for the decrease in research and development expense from 2007 to 2008. In fiscal 2009 these resources returned their focus on identifying potential areas to improve cultivation and production processes therefore 2009 expense increased from 2008. The Company benefited from these efforts in fiscal 2009 and they will continue in 2010. No new clinical trials were conducted in 2009 and 2008. However, the Company expects to sponsor clinical studies in fiscal year 2010 in order to expand the applications of its health products.

Sales and marketing costs were $1,125,000, $1,355,000 and $1,297,000 in fiscal 2009, 2008 and 2007, respectively, decreasing 17% in 2009 from fiscal 2008 and increasing 5% in 2008 from fiscal 2007. The decrease in 2009 from 2008 is due to the cessation of advertising programs and selling promotions eliminated with efforts to control expenses in the latter part of fiscal 2008. The 5% increase in fiscal 2008 compared to 2007 was due to inflationary increases. The Company anticipates resuming selected advertising and promotional programs in fiscal 2010 in order to maintain and expand sales levels.

General and administrative expenses were $2,873,000, $2,478,000 and $2,448,000 in fiscal 2009, 2008 and 2007, respectively. General and administrative expenses increased 16% from 2008 due to increased salaries and benefits from the addition of a new Chief Executive Officer, an accountant to improve internal controls, and salary and benefits increases. General and administrative expense in 2008 increased less than 1% over 2007 as a result of a workforce reduction which occurred in December 2007, to balance costs with sales and production environment occurring at the time. Current staffing has returned to the pre-workforce reduction levels in order maintain adequate administration and financial accounting. The Company is committed to ongoing cost containment aimed at controlling its level of operating expenses, but may increase some discretionary spending in future periods as dictated by the needs of the business.

The Company reviews the recoverability of the carrying value of long-lived assets using the methodology prescribed in Statement of Financial Accounting Standards (SFAS) 144, "Accounting for the Impairment and Disposal of Long-Lived Assets." The Company reviews long-lived assets and intangible assets for potential impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. This analysis under SFAS No. 144 at March 31, 2009

determined that the Company's equipment and leasehold improvements are not impaired in Cyanotech's Consolidated Balance Sheet at March 31, 2009. However, such analysis under SFAS No. 144 at March 31, 2007 had determined that the Company should record a non-cash impairment loss reducing, by $4.5 million, the values of certain production related equipment and leasehold improvement assets. Accordingly, the values of the Company's equipment and leasehold improvement assets as reported on the Consolidated Balance Sheets as of March 31, 2007 were reduced by the impairment loss, and the Company's Consolidated Statements of Operations for the year ended March 31, 2007 includes the corresponding charge of $4.5 million for the impairment of equipment and leasehold improvements. The Company notes that the foregoing reduction of asset carrying values significantly and correspondingly reduced depreciation expense in future periods.

The Company expects fiscal 2010 operating expense spending will remain consistent with or increase from fiscal 2009 due to increased personnel costs, inflationary increases of expenses and the resumption of selected advertising and research activities as previously discussed. The Company will continue to leverage customer supported research where and as practicable. Increases in sales and marketing expenses may become necessary as the Company seeks new and increased markets and market share. Also, the cost of regulatory compliance-including international standards (ISO), US food and drug manufacturing practice (GMP), Securities and Exchange Commission requirements including Sarbanes Oxley, NASDAQ Capital Market listing requirements and other regulatory compliance areas-continue to increase. The Company will be required under Sarbanes-Oxley to have an independent audit of the Company's internal control over financial reporting for fiscal year ending March 31, 2010. This will be an expense not currently incurred by the Company. Finally, the Company must remain competitive in the labor market, and this may lead to some increases in general and administrative costs.

Other Expense The following details the amounts included in other expense:

                                                         2009    2008    2007
                                                            (In thousands)
          Interest expense on Term Loan Agreement(1)     $ 152   $ 148   $ 181
          Other interest expense                            10      16       5
          Other (income) expense, net(2)                   (18 )    41     (56 )

              Total other expense                        $ 144   $ 205   $ 130