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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended March 31, 20112012

Commission File Number 0-146-020-14602

CYANOTECH CORPORATION

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (808) 326-1353

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $.02$0.02 par value
(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. 
o  Yes]Yes  x  No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. 
o  Yes  x  No

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 such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  x  Yes  o  No

Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files).  x  Yes  o  No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

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

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

The aggregate market value of the Registrant’s Common Stock held by non-affiliates of the Registrant on June 17,September 30, 2011 was approximately $10,992,377$15,991,566 based on the closing sale price of the Common Stock on the NASDAQ Capital Market on that date.

Number of shares outstanding of Registrant’s Common Stock at June 17, 201115, 2012 was 5,395,168.5,440,968.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s Definitive Proxy Statement for its 20112012 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission on or prior to July 22, 201130, 2012 and to be used in connection with the Annual Meeting of Stockholders expected to be held on August 29, 2011,27, 2012, are incorporated by reference in Part III of this Form 10-K.

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FORWARD-LOOKING STATEMENTS

This Report and other presentations made by Cyanotech Corporation (“CYAN”) and its subsidiariessubsidiary 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 subsidiariessubsidiary (collectively, the “Company”), the performance of the industry in which CYAN does business, and economic and market factors, among other things. These forward-looking statements are not guarantees of future performance.  InvestorsYou should not place undue reliance on forward-looking statements.

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 undertakeswe undertake 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:

·                  Environmental restrictions, soil and water conditions, levels of sunlight and seasonal weather patterns, particularly heavy rain, wind and other hazards;

·Consumer perception of our products due to adverse scientific research or findings, publicity regarding nutritional supplements, litigation, regulatory investigations or other national media attention;

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

·Demand for our products, the quantities and qualities thereof available for sale and levels of customer satisfaction, including significant unforeseen fluctuations in global demand for products similar to our products;

·Our dependence on the experience, continuity and competence of our executive officers and other key employees;

·The added risks associated with the current local, national and world economic crises, including but not limited to, the volatility of crude oil prices, inflation and currency fluctuations;

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

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

·Changes in domestic and/or foreign laws, regulations or standards, affecting nutraceutical products or the Company’sour methods of operation;

·Environmental restrictions, soil and water conditions, variations in daylight hours and seasonal weather patterns, particularly heavy rain, wind and other hazards;

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

·                  Changes in laws, including new corporate governance requirements and increased tax rates, regulations, or accounting standards and the application to us or the nutritional products  industry of new decisions ofby courts, regulators and governmental bodies;

·Our dependence on the experience, continuity and competence of our executive officers andor other key employees;government authorities;

·                  The risk associated with the geographic concentration of the company’sour business;

·                  Acts of war, terrorist 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 Companyus with the Securities and Exchange Commission.

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PART I

Item 1.  Business

Unless otherwise indicated, all references in this report to the “Company”, “we”, “us”, “our”, and “Cyanotech” refer to Cyanotech Corporation and its wholly owned subsidiary, Nutrex Hawaii, Inc. (“Nutrex Hawaii” or “Nutrex”), a Hawaii corporation.

General

Cyanotech Corporation isWe are a world leader in the production of high value natural products derived from microalgae. Incorporated in 1983, the Company iswe are guided by the principle of providing beneficial, quality microalgal products for health and human nutrition in a sustainable, reliable and environmentally sensitive operation. We are ISO 9001:2008 compliant and GMP (Good Manufacturing Practices) certified by the Natural Products Association™, reinforcing our commitment to quality in our products, quality in our relationships (with our customers, suppliers, co-workers and the communities we live in), and quality of the environment in which we work in.work. Our products include:

·Hawaiian BioAstin® natural astaxanthin is a powerful dietary antioxidant with expanding applications as a human nutraceutical and functional food ingredient, shown to support and maintain the body’s natural inflammatory response, to enhance skin, eye and joint health; and

·                  Hawaiian Spirulina Pacifica® is- a nutrient-rich dietary supplement used for extra energy, a strengthened immune system, cardiovascular benefits and as a source of antioxidant carotenoids.carotenoids; and

·Hawaiian BioAstin® natural astaxanthin - a powerful dietary antioxidant shown to support and maintain the body’s natural inflammatory response, to enhance skin, and to support eye and joint health.  It has expanding applications as a human nutraceutical and functional food ingredient

Microalgae are a diverse group of microscopic plants that have a wide range of physiological and biochemical characteristics and contain, among other things, high levels of natural protein, amino acids, vitamins, pigments and enzymes. Microalgae have the following properties that make commercial production attractive: (1) microalgae grow much faster than land grown plants, often up to 100 times faster; (2) microalgae have uniform cell structures with no bark, stems, branches or leaves, permitting easier extraction of products and higher utilization of the microalgae cells; and (3) the cellular uniformity of microalgae makes it practical to manipulate and control the growing conditionsenvironment in order to optimize a particular cell characteristic. Efficient and effective cultivation of microalgae requires consistent light, warm temperatures, low rainfall and proper chemical balance in a very nutrient-rich environment, free of environmental contaminants and unwanted organisms. This is a challenge that has motivated us to design, develop and implement proprietary production and harvesting technologies, systems and processes in order to provide human nutritional products derived from microalgae.

Our production of these products at the 90-acre facility on the Kona Coast onof the island of Hawaii provides several benefits. We selected the Keahole Point location in order to take advantage of relatively consistent warm temperatures, sunshine and low levels of rainfall needed for optimal cultivation of microalgae. This location also offers us access to cold deep ocean water, drawn from an offshore depth of 2,000 feet, which we use in our patented Ocean-Chill Drying system to eliminate the oxidative damage caused by standard drying techniques and as a source of trace nutrients for microalgal cultures. The area is also designated a Biosecure Zone, free of pesticides and herbicides. We believe that our technology, systems, processes and favorable growing location generally permit year-round harvest of our microalgal products in a cost-effective manner.

Unless otherwise indicated, all references in this report to the “Company,” “we,” “us,” “our,” and “Cyanotech” refer to Cyanotech Corporation and its wholly owned subsidiary, Nutrex Hawaii, Inc. (“Nutrex Hawaii” or “Nutrex”), a Hawaii corporation.

Cyanotech’sOur Business

The Company operatesWe operate entirely in one operating segment, the cultivation and production of microalgae into high-value, high-quality natural health and nutrition products. We cultivate, on a large-scale basis, two microalgal species from which our two major product lines, spirulina products and natural astaxanthin products, are derived. We record revenue and cost of sales information by product category, but do not record operating expenses by such product category.

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Spirulina Products

We have been producing a strain of spirulina microalgae marketed as Hawaiian Spirulina PacificaPacifica® since 1984. Spirulina Pacifica® represents 50%35%, 49%50% and 49% of net sales for the years ended March 31, 2012, 2011 2010 and 2009,2010, respectively. Spirulina Pacifica® provides a vegetable-based, highly absorbable source of protein, natural beta-carotene, mixed carotenoids, B vitamins, gamma linolenic acid, essential amino acids and other phytonutrients.

Spirulina Pacifica® is produced in two forms: powder and tablets. Powder is used as an ingredient in nutritional supplements and health beverages; tablets are consumed as a daily dietary supplement. Both forms are sold as raw material ingredients in bulk quantities, as a private label consumer packaged product and as packaged consumer products under the Nutrex Hawaii label.label and as private label consumer packaged products.

Spirulina Pacifica® is GRAS (generally recognized as safe) for addition to a variety of foods as determined by the United States Food and Drug Administration. Our all natural Spirulina Pacifica® is alsocultivated without the use of herbicides or pesticides, is not genetically modified (non GMO) and is certified Kosher by Organized Kashrus Laboratories of Brooklyn, New York and certified Halal by the Islamic Food and Nutrition Council of America and is cultivated without the use of herbicides or pesticides.America.

Our Spirulina Pacifica® is cultivated in a combination of fresh water and a metered amount of nutrient-rich deep ocean water (containing essential trace elements), drawn from a depth of 2,000 feet below sea level. This water mixture is supplemented with other major required nutrients. With the exception of deep ocean water, the raw materials and nutrients required in our spirulina production are available from multiple sources; however, there can be no assurance that the pricing from a new source will be comparable to current pricing. In the case of deep ocean water, although abundantly available at this location, the facility to pump and deliver the water to the Companyour location is owned by the State of Hawaii. The facility is constructed of two separately located pump stations providing redundancy should one station fail. The State of Hawaii sets the price for deep ocean water annually based on its cost to deliver the water. If the pricing for a critical raw material or nutrient significantly increases, this could have a material adverse effect on our business, financial condition and results of operations. The ability of our suppliers to meet performance and quality specifications and delivery schedules is also important to operations.

Continuing the production process, the spirulina crop in each pond is circulated by paddlewheels to keep an even blend of nutrients in suspension and a uniform exposure of the algae to sunlight. Our ponds are engineered to maintain the right media depth for sunlight to permeate each crop completely, facilitating rapid growth. The design of our cultivation ponds promotes efficient growing conditions, allowing the Spirulina Pacifica® algae to reproduce rapidly. Each pond can be harvested, on average, in six days. As sunlight is a major component of cultivation, production can be impacted by seasonalityseasonal changes during the winter months, with shortened daylight hours, increased cloud cover and potential inclement weather.

Once ready for harvest, a majority of the spirulina algae are pumped from a pond to our processing building where the crop is separated from the culture media. The culture remaining in the ponds serves as an inoculum for the next growth cycle. Harvested spirulina is washed with fresh water and filtered before moving to the drying stage. Culture media separated from spirulina algae during processing are conserved and recycled. Our Integrated Culture Biology Management (“ICBM”) technology for microalgae cultivation has proven to be a reliable and stable operating environment, allowing us to grow and harvest spirulina without significant contamination by unwanted microorganisms and without associated loss of productivity.

Spirulina Pacifica® powder is dried via our patented low-oxygen Ocean-Chill Drying process, thereby preserving high levels of antioxidant carotenoids and other nutrients sensitive to heat and oxygen. The rapid drying process takes about six seconds and results in a dark green powder. Spirulina powder is difficult to form into tablets. Most tablet manufacturers either add high amounts (from 10% to 30%) of inert substances to “glue” the tablet together or use a heat granulation process that destroys nutrients. In contrast, our Spirulina Pacifica® tablets contain a maximum of 2% of such substances and are produced in cold press compression tablet-making machines. Our Spirulina Pacifica flakes are produced by combining freshly harvested Spirulina Pacifica with food-grade lecithin and drying this blend in a proprietary system.

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The majority of our bulk spirulina sales are to health food manufacturers and formulators with their own spirulina product lines, many of whom identify and promote Cyanotech’s Hawaiian Spirulina Pacifica® in their products. Such customers purchase bulk powder or bulk tablets and package these products under their brand label for sale to the health and natural food markets. Some of the brands produced by these customers are marketed and sold domestically in direct competition with the packaged consumer products sold through our Nutrex Hawaii subsidiary. Nutrex Hawaii packaged consumer products are sold direct to consumers and through an established health food distribution network in the domestic market and shipped through our wholesale distributors.market. In selected foreign markets, we have exclusive sales distributors for both our bulk and packaged consumer products.

Our Spirulina Pacifica® products compete with a variety of vitamins, dietary supplements, other algal products and similar nutritional products available to consumers. The nutritional products marketcategory is highly competitive and includes international, national, regional and local producers and distributors, many of whom have greater resources than Cyanotech and many of whom offer a greater variety of products. Our direct competition in the spirulina market is currently from Dainippon Ink and Chemical Company’s Earthrise facility in California, Parry Nutraceuticals, a division of Murugappa Group of India and several farms in China. Other competitors include numerous smaller farms in China, India, Thailand, Taiwan, Cuba, South Africa and South America. We have experienced increased price competition due to morethe large number of spirulina suppliers as well as customers who generally treat these products as commodities with price being the major determining factor driving their purchasing decision. As one of the largest producers of spirulina, our challenge is to increase our market share among customers who seek the high-quality products we produce while concurrently adjusting our product mix to meet our revenue and profitability targets.

Natural Astaxanthin Products

We commenced commercial production of natural astaxanthin in 1997. Astaxanthin is a red pigment which we initially sold to the aquaculture market, primarily to impart a pink to red color to the flesh of commercially raised fish1997 and shrimp. Inin 1999 introduced BioAstinBioAstin®, our natural astaxanthin product for the human health and nutrition market was introduced. Over time, we have shifted our focus and resources on producing and marketing natural astaxanthin for the higher value human nutrition market. BioAstinBioAstin® sales accounted forrepresents 65%, 50%, 51% and 51% of net sales for the years ended March 31, 2012, 2011 and 2010, and 2009, respectively.

BioAstin is produced in three forms: a liquid lipid extract, gelcaps and microencapsulated “beadlets” with all three forms sold in bulk quantities. BioAstin gelcaps are also sold as a private label consumer packaged product and in packaged consumer form under the Nutrex Hawaii label. A growing body of scientific literature suggests that the beneficial properties of natural astaxanthin as an antioxidant, anti-inflammatory, for joint, skin and eye health. Its Astaxanthin’s antioxidant properties mayare believed to surpass many of the antioxidant properties of vitamin C, vitamin E, beta-carotene and other carotenoids. Independent scientific studies indicate that in certain models, natural astaxanthin has up to 550 times the antioxidant activity of vitamin E and 10 times the antioxidant activity of beta-carotene.  In addition, a growing body of scientific literature suggests that natural astaxanthin has beneficial properties as an anti-inflammatory, with additional benefits for joint, skin and eye health.

BioAstin® is produced in three forms: a liquid lipid extract, gelcaps and microencapsulated “beadlets” with all three forms sold in bulk quantities. BioAstin® gelcaps are also sold in packaged consumer form under the Nutrex Hawaii label as well as private label consumer packaged product. Over time, we have shifted our focus and resources on producing and marketing natural astaxanthin for the higher value human nutrition market.

BioAstin® is GRAS (generally recognized as safe) as determined by the United States Food and Drug Administration. Our all natural BioAstin® is cultivated without the use of herbicides or pesticides and is not genetically modified (non GMO). In fiscal 2012 we applied for a new dietary ingredient (NDI), with the United States Food and Drug Administration, providing for a daily dosage of 12mg of astaxanthin which was reviewed without comment.

We produce natural astaxanthin from Haematococcus pluvialis microalgae grown in fresh water supplemented with nutrients. As these algae are extremely susceptible to contamination by unwanted algae, protozoa and amoebae, we developed a proprietary system known as the PhytoDome Closed Culture System or PhytoDome CCS to overcome this problem. Using these large-scale photobioreactors, we have generally been able to grow consistently large volumes of contaminant-free Haematococcus culture.culture, although quarterly production levels are subject to seasonality. Raw materials and nutrients for our natural astaxanthin production share the same sourcing constraints and pricing risks as those existing in our spirulina production. Fresh water is critical to the production of our natural astaxanthin and is supplied by the County of Hawaii. While we have not experienced any constraint on fresh water availability to date, availability could be impacted by a significant population growth in the region as well as throughput constraints on the water delivery infrastructure. We have met with officials of the County of Hawaii to assess the fresh water situation and evaluate the probability of future risks. We recycle fresh water in itsour production process where possible and continue to explore further recycling opportunities. However, there is no guarantee that these efforts will result in significant changes to our fresh water utilization.

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The harvested algal spores are dried to flakes or a fine powder. During processing, the spores are cracked in a proprietary system to assure high bioavailability of astaxanthin. Each production lot of astaxanthin is sampled and tested for astaxanthin concentration. Finally, the bulk powder is vacuum-packed.

Unlike spirulina, astaxanthin is produced in a batch-mode and each cultivation pond must be completely drained and thoroughly cleaned between cycles. Pond cultivation can be negatively impacted seasonally with shortened daylight hours and potential inclement weather in winter months.

Natural astaxanthin for human consumption is processed further utilizing a high-pressure extraction process. The resulting product is a lipid extract insoluble in water used forin the production of gelcaps. This product can also be micro-encapsulated into “beadlets” which our customers use in other formulations.

All natural astaxanthin products destined for human consumption undergo a prescribed set of microbiological food product tests to ensure safety and quality. We use third party contract manufacturers for the extraction services, the production of gelcaps and the production of beadlets. . All third party contract manufacturers are audit inspected by Cyanotech’sour Quality Control Department and are required to comply with FDA Good Manufacturing Practices (GMP) regulations. The majority of these contract manufacturers hold independent third party GMP certifications. Although these services are available only from a limited number of sources, we believe we have the ability to use other parties if any of the current contract manufacturers become unavailable; however, there is no assurance that the pricing from a new contract manufacturer will be comparable to current negotiated pricing. In addition, a new contract manufacturer would have to pass our qualification process ensuring quality standards can be met or exceeded. Significant pricingprice increases for any of these services could have a material adverse effect on our business, financial condition and results of operations.

BioAstin® is sold in liquid lipid form as a raw ingredient to dietary supplement manufacturers, health food formulators and cosmetic manufacturers, and BioAstin® gelcaps and beadlets are sold in bulk quantities to distributors. BioAstin® gelcaps are also sold as a packaged consumer product through Nutrex Hawaii directly to natural product distributors, retailers and consumers. In 2007, we also introduced a line of BioAstin® based nutritional supplements, MDFormulas. MDFormulas combined the health benefits of BioAstin® with other proven nutrients with benefits for targeted applications such as skin, heart and joint health.

BioAstin® and MDFormulas compete directly with similar products marketed by other manufacturers including Fuji Chemical of Japan, Algatechnologies of Israel, and Valensa (formally U.S. Nutraceuticals, LLC) in the United States. In the general category of nutritional supplements, BioAstin® also competes with a variety of vitamins, dietary supplements and other antioxidant products available to consumers. The nutritional products market is highly competitive and includes international, national, regional and local producers and distributors, many of whom have greater resources than we have, and many of whom offer a greater variety of products.

The potential benefits of astaxanthin to human health are continuing to emerge. Natural astaxanthin isAs one of the most potent and bioactive biological antioxidants found in nature, therefore, the number of potential roles of natural astaxanthin for human health is growing. Much research has been published in recent years on the beneficial roles of antioxidants in our health, in the aging process and on specific health conditions. The full efficacy of BioAstinBioAstin® as a human nutraceutical supplement requires further significant clinical study. We have spent limited amounts on clinical trials over the past few fiscal years. Independent antioxidant research and prior clinical trials show promising human applications. The Company holdsWe hold three United States patents relating to the usage of BioAstinBioAstin® in the treatment of Carpal Tunnel Syndrome, the treatment of canker/cold sores and for its use as a topical and oral sunscreen.

BioAstin is sold in liquid lipid form as a raw ingredient to dietary supplement manufacturers, health food formulators and cosmetic manufacturers, and BioAstin gelcaps and beadlets are sold in bulk quantities to distributors. BioAstin gelcaps are also sold as a packaged consumer product through Nutrex Hawaii directly to natural product distributors, retailers and consumers. In 2007, we also introduced a line of BioAstin based nutritional supplements, MDFormulas. MDFormulas combined the health benefits of BioAstin with other proven nutrients with benefits for targeted applications such as skin, heart and joint health.

BioAstin and MDFormulas compete directly with similar products marketed by other manufacturers including Fuji Chemical of Japan, Algatechnologies of Israel, and Valensa (formally U.S. Nutraceuticals) in the United States. In the general category of nutritional supplements, BioAstin also competes with a variety of vitamins, dietary supplements and other antioxidant products available to consumers. The nutritional products market is highly competitive and includes international, national, regional and local producers and distributors, many of whom have greater resources than Cyanotech and many of whom offer a greater variety of products.

Major Customers

The Company has two major European customers. Sales to a single spirulina customer were approximately $1,037,000, or 6% of our total net sales for the year ended March 31, 2011. Sales to this customer for fiscal 2010 and 2009 were $1,027,000 (7% of net sales) and $1,521,000 (11% of net sales), respectively. Sales to a single astaxanthin customer were approximately $1,064,000 or 7% of sales for the year ended March 31, 2011. Sales to this customer were $784,000 (5% of net sales) and $1,806,000 (13% of net sales), for the fiscal years 2010 and 2009, respectively. The Company hasWe have one major USU.S. customer. Astaxanthin salesSales to this customer for the year ended March 31, 20112012 were approximately $780,000$1,577,000 or 5%6% of our total net sales. Salessales, compared to this customer were approximately $1,653,000 (10%$780,000 (5% of net sales) and $821,000 (6%$1,653,000 (10% of net sales), for the fiscal years 2011 and 2010, and 2009, respectively.

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Employees

As of March 31, 2011,2012, we employed 7176 people on a full-time basis and 1 person4 people on a part-time basis. Of the total, 3533 are involved in harvesting, production and quality, with the remainder in maintenance, shipping, sales, administration and support. Management believes that its relations with employees are good. Attracting permanent entry level and skilled employees can be difficult due to the limited local population to draw from.population. None of our employees are subject to collective bargaining agreements.

Internet Information

Our Internet address is www.cyanotech.com. There we make available, free of charge, copies of Cyanotech documents, news releases and financial statements issued in the last 12 months. Included are copies of the Company’s Code of Conduct and Ethics, the Nominating and Corporate Governance Committee Charter, the Compensation Committee Charter and the Charter and Powers of the Audit Committee. The information found on our Web site, unless otherwise indicated, is not part of this or any other report we file or furnish to the Securities and Exchange Commission. Spirulina Pacifica® and BioAstin® are sold directly online through the Company’sour wholly owned subsidiary website, www.nutrex-hawaii.com, as well as through resellers in over 40 countries worldwide. Corporate data and product information are also available at www.cyanotech.com.

Item 1A.  Risk Factors

You should carefully consider the risks described below which we believe are significant but not the only ones we face. Any of the following risks could have a material adverse effect on our business, financial condition and operating results. You should also refer to the other information contained in this report, including our financial statements and the related notes.

Our production of algae involves an agricultural process, subject to such risks as weather, disease and contamination.

The production of our algae products involves complex agricultural systems with inherent risks including weather, disease, and contamination. These risks are unpredictable and also include such elements as the control and balance of necessary nutrients and other factors. The efficient and effective cultivation of microalgae requires consistent light, warm temperatures, low rainfall and proper chemical balance in a very nutrient-rich environment. If the chemical composition of a pond changes from its required balance, unusually high levels of contamination due to the growth of unwanted organisms or other biological problems may occur and would result in a loss of harvestable output. These often arise without warning and sometimes there are few or no clear indicators as to appropriate remediation or corrective measures. We believe that our technology, systems, processes and favorable growing location generally permit year-round harvest of our microalgal products in a cost-effective manner. However, environmental factors cannot be controlled in an open air environment, therefore, we cannot, and do not attempt to, provide any form of assurance with regard to our systems, processes, location, or cost-effectiveness.

There is risk in operating entirely in one business segment such as the cultivation and production of microalgae at a single production facility.

Single location agricultural and production facilities do not provide the protections and assurances afforded by operations in two or more widely separated locations. Our single location in Hawaii is susceptible to catastrophic natural disasters such as earthquakes, tsunamis, hurricanes and volcanic eruptions. In the event of a natural disaster or localized extended outages of critical utilities or transportation systems, we could experience a significant business interruption. In addition, Hawaii from time to time has experienced shortages of water, electric power and fuels. Future shortages could disrupt our operations and could result in additional expense. Also, a single agricultural facility provides limited biologic diversity protection against invasive, mutant, or harmful organisms.

Our facilities in Hawaii are located adjacent to a major airport, and an aircraft disaster could disrupt our operations.

Our production facility and corporate headquarters in Hawaii are located adjacent to the Keahole International airport. In the event of an aircraft disaster, we could experience a significant business interruption, including loss of water, electrical and communication services as well as inability to access our facilities.

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Our quarterly operating results may vary from quarter to quarter, which may result in increased volatility of our share price.

We have experienced, and may in the future continue to experience, fluctuations in our quarterly operating results. These fluctuations could reduce the market price of our Common Stock. Factors that may cause our quarterly operating results to vary include, but are not limited to:

·                  weather-related cultivation difficulties;

·fluctuations in customer demand;

·business decisions of our customers regarding orders for our products;

·                  increasedchanges in energy costs;

·                  increasedchanges in raw material costs;

·                  production problems which we cannot solve technically or economically;

·                  weather-related cultivation difficulties;

·contamination of our cultivation and production facilities;

·                  effects of weather on our ability to meet customer demand patterns;demand;

·timing of promotional activities;

·                  the introduction of new products by us or our competitors;

·                  changes in our pricing policies or those of our competitors;

·                  changes in seasonal and other trends in our customers’ buying patterns;

·                  changes in government regulation, both domestic and foreign;

·                  fluctuation in foreign currency exchange rates, although our exposure is currently not material;rates;

·                  global economic and political conditions and related risks, including acts of terrorism; and

·                  other factors beyond our control.

A significant portion of our expense levels are relatively fixed, and the timing of increases in expense levels is based in large part on our forecasts of future sales.fixed. If net sales are below expectations in any given period, the adverse impact on results of operations may be magnified by our inability to adjustreduce expenses quickly enough to compensate for the sales shortfall.

Our global operations expose us to complex management, foreign currency, legal, tax and economic risks, which we may not be able to address quickly and adequately.

Our products are marketed in a number of countries around the world. For the year ended March 31, 2011,2012, approximately 42%33% of our net sales were from sales to foreign customers. As a result, we are subject to a number of risks which include, but are not limited to:

·                  the burden of complying with a wide variety of national and local laws;

·                  potentially longer payment cycles for foreign sales;

·                  restrictions (government and otherwise) on the movement of cash;

·                  the absence in some jurisdictions of effective laws protecting our intellectual and proprietary property rights;rights, or of enforcement of such laws where they do exist;

·                  changes in government regulations, both domestic and foreign;

·                  global economic and political conditions and related risks, including acts of terrorism; and

·                  fluctuations in foreign currency exchange rates, although our exposure is currently not material.rates.

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If we are unable to protect our intellectual property rights or if we infringe upon the intellectual property rights of others our business may be harmed.

Cyanotech has received fiveWe currently have  four United States patents: twopatents in force: one on aspects of our production methods and three for use of our BioAstin® products. Although weWe regard our proprietary technology, trade secrets, trademarks and similar intellectual property as important and  we rely on a combination of trade secret, contract, patent, copyright and trademark law to establish and protect our rights in our products and technology. ThereHowever, there can be no assurance that we will be able to protect our technology adequately or that competitors will not be able to develop similar technology independently. In addition, the laws of certain foreign countries may not protect the Company’sour intellectual property rights to the same extent as the laws of the United States. Litigation in the United States or abroad may be necessary to enforce our patent or other intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement. Such litigation, even if successful, could result in substantial costs and diversion of resources and could have a material adverse effect on our business, results of operations and financial condition. Additionally, if any such claims are asserted against us, we may seek to obtain a license under the third party’s intellectual property rights. There can be no assurance, however, that a license would be available on terms acceptable or favorable to us, if at all.

InsuranceOur insurance liability coverage is limited.limited and may not be adequate to cover potential losses.

In the ordinary course of business, we purchase insurance coverage (e.g., property and liability coverage) to protect the Companyus against loss of or damage to itsour properties and claims made by third parties and employees for property damage or personal injuries. However, the protection provided by such insurance is limited in significant respects and, in some instances, the Company haswe have no coverage and certain of the Company’sour insurance has substantial “deductibles” or has limits on the maximum amounts that may be recovered. For example, if a hurricanetsunami, earthquake or other uninsured catastrophic natural disaster should occur, we may not be able to recover all facility restoration costs and revenues lost from business interruption. In addition, we maintain product liability insurance in limited amounts for all of itsour products involving human consumption; however, broader product liability coverage is prohibitively expensive. Insurers have also introduced new exclusions or limitations of coverage for claims related to certain perils including, but not limited to, mold and terrorism. If a series of losses occurred, such as from a series of lawsuits in the ordinary course of business each of which were subject to the deductible amount, or if the maximum limit of the available insurance were substantially exceeded, we could incur losses in amounts that would have a material adverse effect on its resultour results of operations and financial condition.

Our ability to develop and market new products or modify existing products and production methods may be adversely affected if we lose the services of or cannot replace certain employees knowledgeable in advanced scientific and other fields.

Our products are derived from and depend on proprietary and non-proprietary processes and methods founded on advanced scientific knowledge, skills, and expertise. If the services of employees knowledgeable in these fields are lost and cannot be replaced in a reasonable time frame at reasonable costs, our ability to develop and market new products or modify existing products and production methods would be adversely impacted. At the same time, regulatory compliance surrounding our products and financial matters generally requires a basic knowledge and level of expertise related to production, quality assurance, and financial control. If we lose the services or cannot reasonably replace employees who have the necessary knowledge and expertise our ability to remain in regulatory compliance could be adversely affected.

We may need to raise additional capital in the future which may not be available.

At March 31, 2011, our working capital was $6,285,000. Cash and cash equivalents at the same date totaled $2,062,000. Our cash requirements will depend on numerous factors, including demand for products; normal requirements to maintain and upgrade facilities and equipment, whether opportunities emerge in either new markets or in research and development activities, or in the event we need to expand or contract our production or distribution infrastructure.

On February 19, 2008, Cyanotech Corporation entered into a Senior Debt direct financial obligation term loan with Bridgeview Capital Solutions, LLC (“Bridgeview”) under the provisions of a United States Department of Agriculture (USDA) Rural Development Guarantee program. Term Loan proceeds, remaining after deducting closing costs, statutory fees, and other customary borrowing costs, were used for working capital purposes. The full amount of the obligation assumed February 19, 2008 was $1,078,000, payable in monthly installments to Bridgeview. The obligation fully amortizes over seven (7) years at an interest rate of Prime plus one percent (1%) per annum, adjustable on the first day of each calendar quarter for the term of the obligation. Repayment may be accelerated under specified conditions of default if the Company is not able to remedy such default within the terms and conditions of the Loan. The Term Loan is fully secured by all of the

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and leasehold improvements.improvements of $4,487,000. These account for approximately 51%65% of our accumulated deficit since our inception. Historically, we have relied upon cash from operations and financing activities to fund all of the cash requirements of our business. However, extended periods of net income do not assure positive cash flows. Future periods of net losses from operations could result in negative cash flow, and may hamper ongoing operations and prevent us from sustaining or expanding our business. We cannot assure you that we will sustain or increase profitability on a quarterly or annual basis in the future. If we do not achieve, sustain or increase profitability, our business will be adversely affected and our stock price may decline. The global cost of oil derived energy impacts Cyanotech in several ways, and it may hinder our efforts to achieve profitability. Oil prices primarily impact Cyanotech through the costs of electricity, transportation, materials and supplies which are tied to the cost of oil either directly or indirectly.

Our stock price is volatile, which could result in substantial losses for investors purchasing shares of our common stock.

TheStock markets have experienced extreme volatility that has often been unrelated to the operating performance of particular companies.  These broad market fluctuations may adversely affect the trading price of our common stock.  In addition, the average daily trading volume of the securities of small companies can be very low.  Limited trading volume of our stock has fluctuated significantlymay contribute to its future volatility.  Price declines in the past and may continue to fluctuate significantly in the future. During the first two months of fiscal 2012, the high and low closing bid prices of a share of our common stock were $3.69could result from general market and $3.04, respectively. During fiscal 2011, the higheconomic conditions and low closing bid pricesa variety of a share of our common stock were $3.90 and $1.55, respectively. During fiscal 2010, the high and low closing bid prices of a share of our common stock were $5.68 and $1.78, respectively. During fiscal 2009, the high and low closing bid prices of a share of our common stock were $2.12 and $1.12, respectively. The market price of our common stock may continue to fluctuate in response to one or moreother factors, including any of the following factors, many of which are beyond our control:following:

·                  volatility resulting from minimal trading activity;

·                  changes in market valuations of similar companies;

·                  stock market price and volume fluctuations generally;

·                  economic conditions specific to the nutritional products industry;

·                  economic conditions tied to global resource markets, such as fuel costs;

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Unforeseen changesFiscal 2012 summary:

·Net sales for the year were $24.6 million, an increase of $7.8 million or 46.4% over the prior year, driven primarily by an increase in anydemand for astaxanthin products

·Net income was $3.6 million, an increase of $1.9 million or 110%, driven by the volume increase and the reversal of a portion of the factors surroundingvaluation allowance on our deferred tax asset.  Earnings per diluted share were $0.66 for fiscal 2012 compared to $0.32 per diluted share for fiscal year 2011.

·Cash from operating activities was $5.1 million, an increase of $3.3 million over the estimates imbeddedprior year, resulting from the increased volume and non-cash items such as stock option compensation and increases in accounts payable and accrued expenses.  Cash and cash equivalents at March 31, 2012 were $5.1 million, up $3.0 million from a year ago. As a result, working capital increased 29% to $8.1 million at March 31, 2012 from $6.3 million a year ago.

Results of Operations for the determination2012, 2011 and 2010 Fiscal Years

The following tables present selected consolidated financial data for each of inventory values and cost of sales could have a material impact on cost of sales. Such changesthe past three fiscal years ($ 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.thousands):

Fiscal 2012 results compared with Fiscal 2011

Gross Profit MarginNet SalesThe Company’s gross profit margin as a percentage of net sales decreased 4 pointsgrowth of 46.4% in fiscal 2012 was driven largely by increased demand for BioAstin®, fueled by continued mainstream media attention on the health benefits of astaxanthin.  Our astaxanthin sales increased 88.7% over the prior year.  Our spirulina products also received the benefit of positive media on its health benefits and experienced 3.7% growth. Both products are sold in bulk form for use worldwide and in consumer packaged goods distributed primarily in the U.S. We cannot predict the impact of this publicity on future period sales. We will continue to 38%focus on growing the market for our high quality, higher margin consumer products by emphasizing the fiscalhigher nutritional content of our Hawaiian spirulina and the benefits of our natural astaxanthin over synthetics; however, increased competition may result in the decline of margins in the future.  Two customers accounted for 10% of astaxanthin net sales for the year ended March 31, 2011, down from 42% for fiscal 2010. The decline is the result of lower production volume and increased inventory reserves resulting in higher costs. The Company’s gross profit margin as a percentage of net sales increased 2 points to 42% for the fiscal year ended March 31, 2010, up from 40% for fiscal 2009. 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.2012.

Management expects the Company’s fiscal 2012 gross profit margin to improve from the results reportedCompetition for fiscal 2011.  There is currently no planned production slowdown to reduce inventory and the production interruptions experienced in fiscal year 2011 have been resolved. However, as discussed elsewhere in this Annual Report, management cannot predict future production levels. Producing the highest quality microalgae is a complex biological process which requires the tenuous balancingsales 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, management constantly strives 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 2011, 33% for fiscal 2010 and 30% for fiscal 2009. Total operating expense decreased by $20,000 or less than 1% from 2010 levels. The decrease includes a decrease in General and administrative expenses of $489,000, an increase Sales and marketing expense of $584,000, an increase in Research and development expense of $18,000 and a decrease in loss on disposal of equipment and leasehold improvements of $133,000. The increase in 2010 from 2009 as a percentage of sales was primarily due to an increase in General and administrative expenses of $438,000, an increase Sales and marketing expense of $277,000, an increase in Research and development expense of $58,000 and an increase in loss on disposal of equipment and leasehold improvements of $155,000.

General and administrative expenses were $2,822,000, $3,311,000 and $2,873,000 in fiscal 2011, 2010 and 2009, respectively. General and administrative expenses decreased 15% from 2010spirulina remains intense due to the costs associated with separationlarge number of the Chief Executive Officer in March 2010. General and administrative expenses increased 15% from 2009suppliers. We expect competitive pricing pressure to 2010 due to costs associated with separation of the Chief Executive Officer in March 2010 and salary and benefits increases. The Company is committed to ongoing cost containment aimed at controlling its level of operating expenses, but may increase some discretionary spendingcontinue in future periods as necessaryand will continue to maintain product quality and the Company’s competitive position.

Sales and marketing costs were $1,986,000, $1,402,000 and $1,125,000 in fiscal 2011, 2010 and 2009, respectively, increasing 42% in 2011 from fiscal 2010 and increasing 25% in 2010 from fiscal 2009. The increase in 2011 over 2010 is due to the Company expanding advertising and promotional programs in fiscal 2011 in order to increase consumer product sales levels in the mainland USA market. The increase in 2010 over 2009 is due to the Company resuming selected advertising and promotional programs in fiscal 2010 in order to maintain and expand sales levels. Management anticipates continuing advertising and promotional programs to increase consumer awareness in fiscal 2012 in order to maintain and expand sales levels as the Company focusesfocus on the higher margin consumer products.  .

Researchquality of Hawaiian spirulina in support of customers who demand higher quality raw materials for their formulations.  Conversely, because of the limited number of suppliers and development costs increasedincreasing demand for astaxanthin, the competitive forces are currently not quite as high.  Because of this, we expect current producers to $282,000 in 2011, up 7% from $264,000 in fiscal 2010, and up by 37% from $206,000 in fiscal 2009. The 2011 expense includes the balance of costs associated with a clinical trial initiated in fiscal year 2010,increase capacity to expand the applications of sprirulina products. In fiscal 2009, no product trials were underway; research resources focusedmeet this increasing demand, placing further competitive pressures on identifying potential areas to improve cultivation and production processes. The Company has benefited from these effortsus in the subsequent fiscal years.  The Company will continue to identify research activities that will expand the applications of its products, advance the efficiency of its production processes and/or increase product quality.

Loss on disposal of equipment and leasehold improvements was $22,000 in fiscal 2011 and $155,000 in fiscal year 2010. There was no loss on disposal of assets in 2009.future.

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Management reviews long-lived assetsGross Profit  Our gross profit percent of net sales increased by 2% in fiscal 2012.  An increase in sales of our higher margin consumer and intangible assetsbulk astaxanthin sales, and increased astaxanthin production accounted for potential impairment whenever events or changesthe growth.  This favorable mix impact was partially offset by abnormal production costs of $1.2 million in circumstances indicate that2012 compared to $0.5 million in the carrying value of such assets may not be recoverable. Management’s analysis at March 31, 2011 determined that the Company’s equipment and leasehold improvements are not impaired in Cyanotech’s Consolidated Balance Sheet at March 31, 2011.prior year, mostly related to spirulina production.

Management expectsIn fiscal 2012, operating expense spending will remainastaxanthin production levels increased by 69% over the prior year and spirulina production levels decreased by 12%.  The increase in astaxanthin production levels was the result of improvements to our production processes as well as generally favorable growing conditions through the third quarter of fiscal 2012.  These factors combined to increase output and reduce unit costs of astaxanthin.  The decrease in spirulina production levels was driven by a morphological change in the size of the algae that inhibited successful harvests.  We recently implemented process changes and ordered additional process equipment for culture media which should gradually increase production levels and help ensure more sustainable production over the long term.

Continued volatility in fuel costs in the future is likely. Therefore, we expect that electricity, water and shipping costs could be higher due to the impact of fuel cost increases for fiscal 2013.  We continue to strive to increase production efficiencies in volume yield, potency and quality consistent with our commitment to produce high-value, high-quality products. However, these efforts cannot be guaranteed to achieve the desired results.

Operating Expenses  Operating expenses increased by $1.8 million in 2012 but decreased as a percentage of net sales by 2.5%.   Included in this is an increase in General and Administrative expenses of $1.2 million, or increase from fiscal 201142%, due to increases in costs associated with stock option grants to key employees of $376,000, increased personnelbonus costs inflationary increases of expenses$338,000 as result of the financial performance for the year, an increase in compensation costs related to salary adjustments and the expansionnew hires of selected marketing 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 be necessary as the Company seeks new$194,000 and increased marketsrecruitment costs of $102,000.  Sales and market share. Also,Marketing expenses increased 25% and made up $0.5 million of the costincrease in operating expenses as a result 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. Finally, the Company must remain competitive in the labor market, and this may lead to some increases in generalcommissions of $189,000 driven by sales growth, increased bonus costs of $125,000 as result of the financial performance for the year and administrative costs.increased advertising and promotion spending $76,000 to build our consumer business.

Other Expense  Other Expense, net was $66,000, $86,000 and $144,000 for the fiscal years ended March 31, 2011, 2010 and 2009, respectively.  Itexpense is comprised primarily of interest expense on term loans, amortization of debt issue costs and interest on other financing agreements, offset by deminimus interest earned and miscellaneous sales.  The declining balancereduction of $16,000 in 2012 is primarily due to the reduction of the principal balance on our Term Loans.

Income Taxes  For fiscal 2012 we recorded an income tax benefit of $779,000 compared with an income tax benefit of $567,000 for 2011.  The 2012 and 2011 tax benefits are the Company’s Term Loansresult of $660,000, $889,000a reduction in the deferred tax valuation allowance and $1,501,000 asrecording of a net deferred tax asset.  As a result, our effective tax rate was -27.3% and -48.8% for the fiscal years ended March 31, 2012 and 2011, respectively. As of March 31, 2012, the remaining valuation allowance on our deferred tax asset is $3 million, compared to $5 million at the end of last year.  At March 31, 2012 we had a Federal net operating loss carry forward of $12.3 million and state net operating losses of $7.6 million and $0.5 million for Hawaii and California, respectively.

Fiscal 2011 results compared with Fiscal 2010

Net SalesThe net sales growth of 6.9% in fiscal 2011 over 2010 was driven by fourth quarter mainstream media attention to the health benefits of spirulina and 2009, respectively.astaxanthin.  Our spirulina products experienced 8.3% growth and our astaxanthin sales increased 5.7% over the prior year. Two customers accounted for 11% of astaxanthin net sales for the year ended March 31, 2011.

Gross Profit  Our gross profit percent decreased by 4.4% in fiscal 2011from 2010 due to lower average selling prices, lower production levels and an increase in inventory reserves during fiscal 2011.  Also contributing to the decline, abnormal production costs of $.5 million in 2011 not experienced in the prior year, mostly related to spirulina production.

Operating Expenses  Operating expenses in fiscal 2011 were relatively flat and decreased as a percent of sales by 2.2% over 2010 as a result of a focus on cost containment.  General and administrative expenses decreased $489,000 or 14.7%, due to costs associated with the separation of the former Chief Executive Officer in 2010.  Sales and marketing expenses in fiscal 2011 increased $584,000 or 41.6% over 2010, due to expanded advertising and promotional programs to increase consumer product sales in the mainland U.S. market.

Other Expense  Other expense is comprised primarily of interest expense on term loans, amortization of debt issue costs and interest on other financing agreements, offset by deminimus interest earned and miscellaneous sales.  The reduction of $39,000 in 2011 is primarily due to the reduction of the principal balance on our Term Loans.

Income Taxes  For fiscal 2011 the Companywe recorded an income tax benefit of $567,000 compared with an income tax expense of $24,000 for 2010 and $22,000 for 2009.2010.  The fiscal 2011 tax benefit is the result of a reduction in the deferred tax valuation allowance and recording of a net deferred tax asset at March 31, 2011. Previous year incomeAs a result, our effective tax expense represents primarily alternative minimum taxes due torate was -48.8% and 1.34% for the utilization of tax loss carry forwards. Atfiscal years ended March 31, 2011 and 2010, respectively.  In fiscal year 2010, fully reserved deferred tax assets were utilized to reduce taxable income, resulting in the Company had Federal and Hawaii state net operating loss carry forwards of approximately $15,996,000 and $10,768,000, respectively.low tax rate.

Liquidity and Capital Resources

Financial Condition  At March 31, 2011, the Company’s working capital was $6,285,000, an increase of $1,343,000 compared to $4,942,000 at March 31, 2010. Cash and cash equivalents at March 31, 2011 totaled $2,062,000, an increase of $1,245,000 from $817,000 at March 31, 2010.

The Company had 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. One term loan with a balance of $80,000 at March 31, 2010 was paid in full on May 1, 2010. The remaining Term Loan has a balance of approximately $660,000 as of March 31, 2011, payable in equal monthly principal and interest payment of approximately $15,000 and a maturity date of March 1, 2015. The interest rate under the Term Loans, in absence of a default under the agreement, is the prime rate 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 March 31, 2011. 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 was held in an interest-bearing restricted cash account per the terms of the Term Loan and was included in Other Assets in the consolidated balance sheets at March 31, 2010. The restricted cash was returned to the Company in May of 2010.

The Company has two equipment loans with John Deere at March 31, 2011 with a total outstanding combined balance of approximately $32,000. The equipment loans have maturity dates of December 28, 2012 as to $17,000 and March 25, 2013 as to $15,000 and are payable in equal monthly principal payments of approximately $1,400. The loans are at a 0% rate of interest and are net of imputed interest of $2,000.

The Company has an equipment capital lease with Thermo Fisher Financial Services. The outstanding balance under the capital lease as of March 31, 2011 is approximately $67,000 and has a maturity date of March 2013.

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Contractual ObligationsLiquidity and Capital Resources

The following table presents the Company’s debt and lease obligations at March 31, 2011 (in thousands):

(1)Includes term loan, equipment loans and capital lease mentioned above.

On March 25, 2010, the Company renewed the agreement with First Hawaiian Bank for a Line of credit in the amount of $350,000 with a maturity date of April 1, 2012. 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 March 31, 2011.

Cash FlowsSources of Liquidity  OurFunds generated by operating activities and available cash and cash equivalents were $2,062,000 and $817,000 at March 31, 2011and 2010, respectively.

The Company generated cash from operating activities was $1,747,000, $1,219,000 and $908,000 for fiscal years 2011, 2010 and 2009 respectively. The increase in cash provided by operations for 2011 was primarily due to the decrease in inventory of $306,000 compared to an increase in inventory in 2010 over 2009 of $809,000. The increase in cash provided by operations from 2010 was primarily due to an increase inventory of $809,000 compared with an increase of $1.5 million in 2009. Depreciation and amortization expense was $617,000, $512,000 and $431,000 for the years ended March 31, 2011, 2010 and 2009, respectively. Depreciation expense for 2011 and 2010 was more than 2009 as a result of additions to depreciable assets in fiscal 2010 and 2011. It is uncertain whether operating activities will generate cash in future periods due to the volatility of the world economy and its impact on our foreign customers, and our ability to maintain production levels within a reasonable range.

Cash of $514,000 was used in investing activities offset by $250,000 cash provided for the return of restricted cash, for net cash used in investing activities of $264,000 during fiscal 2011, compared to net cash used in investing activities of $1,032,000 during fiscal 2010. Net cash used in investing activities in 2009 was $449,000. Investments are primarily plant and equipment purchases aimed toward maintaining and enhancing our ability to respond to market demand. Management expects to continue to investbe our most significant sources of liquidity for normal working capital requirements and for funding of a normal level of investment in equipment, upgrades and leasehold improvements tied to market requirements and production efficiency. Investment was also made in expansion and enhancement of our resource management systems. Capital expenditures are expected to increase in fiscal 2012 compared to fiscal 2011 with projects to extend plant life, equipment additions and systems expansions.

During fiscal 2011, cash used in financing activities was $238,000, consisting of $187,000 cash provided from the exercise of stock options, offset by principal payments on term debt and revolving line of credit of $425,000. During fiscal 2010, cash used in financing activities was $347,000, consisting of $150,000 cash provided from drawing on the credit line with First Hawaiian Bank, offset by principal payments on term debt of $497,000. During fiscal 2009, cash used in financing activities was $572,000 representing principal payments on long-term debt.

Sufficiency of Liquiditysystem upgrades.  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 and existing cash balances will be sufficient to finance current operating requirements, debt service and planned capital expenditures, for the next 12 months. With working capital of $6.3 million and a current ratio of 4 to 1 as of March 31, 2011, management expects liquidity in fiscal 2012 to be generated primarily from operating cash flows. Unanticipated capital expenditures or business expansion could require the Company to incur additional debt or equity funding sources.

The Company has usedWe use estimates of future financial results including projected revenue, expenses, borrowings, and capital expenditures in reaching itsour conclusions. Such estimates are subject to change based on future results and such change could cause future results to vary significantly from expected results presented in this Form 10-K.  Any significant investments in capital equipment related to capacity expansion may not be able to be funded from operating activities and available cash, and may require additional debt or equity funding.

The Company’sOur results of operations and financial condition can be affected by numerous factors, many of which are beyond itsour control and could cause future results of operations to fluctuate materially as it has in the past. Future operating results may fluctuate as a result of changes in sales volumes to our largest customers, weather patterns, increased competition, increased materials, nutrient and energy costs, foreign currency exchange fluctuations, governmentalgovernment regulations and other factors beyond our control.

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Cash Flows  The following table summarizes our cash flows from operating, investing and financing activities for each of the past three fiscal years ($ in thousands):

The increase in cash provided by operating activities in fiscal 2012 compared to fiscal 2011 was driven largely by the increase in sales and related profit.  Increases in accounts payable and accrued expenses contributed $1.2 million of this increase, and was mainly the result of increased activity with our third party processors and service providers. The increase in accrued expenses was the result of the accrual of the annual bonus, which is paid out after the end of the year.   The increase in cash provided by operating activities in fiscal 2011 compared to fiscal 2010 was driven by a reduction in inventory levels compared to the prior year.

Cash used in investing activities increased in fiscal 2012 compared to fiscal 2011 due to the investment in capital projects to increase astaxanthin production capacity and improve overall production efficiencies.  Additionally, fiscal 2011 includes the benefit of proceeds from the return of restricted cash in the amount of $250,000, contributing to the reduction in investment activities compared to 2010.

Cash used in financing activities consists primarily of principal payments on debt in the normal course of business, offset by stock option exercises.  The decrease in fiscal 2012 compared to fiscal 2011 was also the result of a payment on a line of credit in fiscal 2011 that was not utilized in fiscal 2012.

Effect of Recently Issued Accounting Standards and Estimates

In January 2010, the Financial Accounting Standards Board (“FASB”)We do not believe that any recently issued, Accounting Standards Update (“ASU”) No. 2010-06, “Improving Disclosures about Fair Value Measurements,” an amendment to Accounting Standards Codification (“ASC”) No. 820, “Fair Value Measurements and Disclosures.” The standard requires disclosure for transfers in and out of Level 1 and Level 2, as well as the disclosure of Level 3 activitybut not yet effective, accounting standards, if currently adopted, will have a material effect on a gross, rather than net, basis. The guidance also requires enhancements to certain existing disclosures. The amendments will be effective as of the beginning of fiscal 2011, except for the new requirements around Level 3 activity, which is deferred until the beginning of fiscal 2012. The adoption of this guidance did not have an impact on the Company’sour consolidated financial statements.position, results of operations, or cash flows.

Application of Critical Accounting Policies and Estimates

The Company’sOur discussion and analysis of itsour financial condition and results of operations are based upon the Company’sour consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements in conformity with those accounting principles requires management to make judgments and estimates that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Management regularly re-evaluates its judgments and estimates which are based upon historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Management believes that of its significant accounting policies, policies that may involve a higher degree of judgment and complexity are inventory valuations, valuation of equipment and leasehold improvements and long-lived assets, and income taxes.

Revenue —  We recognize revenues as goods are shipped to customers and title is transferred. The criteria for recognition of revenue are when productpersuasive evidence that an arrangement exists and both title and risk of loss have passed to the customer, the price is shipped.fixed or determinable, and collectability is reasonably assured. Sales returns and allowances are estimated and recorded as a reduction to sales when we agree with a customer that a return or allowance is warranted. Promotions and other volume based incentives are charged to net sales in the period in which they can be reasonably known or estimated.sales are recorded. We record net shipping charges and sales tax in cost of goods sold.

Inventory - The Company recordsWe record inventories at the lower of cost or market. Cost is defined as the sum of the applicable expenditures and charges directly or indirectly incurred in bringing inventories to their existing condition and location. Cost for inventory purposes may be determined under any one of several assumptions as to the flow of cost factors, such as first-in, first-out; average cost; and last-in, first-out. Our inventories are stated using the first-in, first-out method. Inventory values are subject to many critical estimates, including production levels and capacity, changes in the prices paid for raw materials, supplies, and labor, changes in yield, potency, and quality of biomass, changes in processing or production methods, and changes in the carrying value of our inventories resulting from the prices our customers are willing to pay for our products. Such estimates are revised quarterly. Changes in management’s estimates could result in increases or decreases in the recorded amounts of inventory and cost of sales.

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To the extent that our production levels are not sufficient to absorb all production costs on a period basis, we recognize abnormal production costs, including fixed cost variances from normal production capacity, as an expense in the period incurred. Abnormal amounts of freight, handling costs and wasted material (spoilage) are recognized as current-period charges and fixed production overhead costs are 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.” Changes in management’s estimates could result in increases or decreases in the recorded amounts of inventory and cost of sales.

Management reviews inventory levels, inventory turnover, product age and product marketability quarterly to evaluate recoverability and determine if a reserve for inventory is deemed necessary. At March 31, 20112012 an inventory reserve in the amount of $148,000$41,000 has been recognized. In the prior fiscal year,recognized, compared to $148,000 as of March 31, 2010, an inventory reserve in the amount of $54,000 had been recognized.2011.

Equipment and leasehold improvements - Equipment and leasehold improvements are reported at cost less accumulated depreciation and amortization. Self-constructed leasehold improvements include design, construction and supervision costs. These costs are recorded in construction in progress and are transferred to equipment and leasehold improvements when construction is completed and the facilities are placed in service. Long-lived assets, such as property, plant and equipment and purchased intangibles subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized to the extent that the carrying amount exceeds the asset’s fair value.

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