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                          SECURITIES AND EXCHANGE COMMISSION
                               WASHINGTON, D.C.  20549

                                     FORM 10-KSB

(x)           ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
                                EXCHANGE ACT OF 1934

           FOR THE FISCAL YEAR                      COMMISSION FILE
         ENDED OCTOBER 31, 1998                   NUMBER 33-23460-LA


                                   AQUASEARCH, INC.
                    (NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)


                COLORADO                               33-0034535
        (STATE OR INCORPORATION)          (I.R.S. EMPLOYER IDENTIFICATION NO.)


                           73-4460 QUEEN KA'AHUMANU HIGHWAY
                                      SUITE 110
                              KAILUA-KONA, HAWAII 96740
                                    (808) 326-9301
                (ADDRESS AND TELEPHONE OF PRINCIPAL EXECUTIVE OFFICES)

          Securities registered pursuant to Section 12(b) of the Act:  None

          Securities registered pursuant to Section 12(g) of the Act:  None

     Check whether the issuer (1) filed all reports required to be filed by 
Section 13 or 15(d) of the Exchange Act during the past 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.  Yes  [ X ] 
No  [    ]    

     Check if there is no disclosure of delinquent filers pursuant to Item 405
of Regulation S-B is not contained in this form, and no disclosure will 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-KSB
or any amendment to this Form 10-KSB. [ X ]

     Registrant's revenues for its most recent fiscal year:  $ -- 0 --

     The  aggregate market value of the voting stock held by non-affiliates
computed by reference to the price at which the stock was sold, or the average
bid and asked prices of such stock, as of December 31, 1998, was $13,027,162.

     The number of shares outstanding of each of issuer's classes of common 
equity, as of October 31, 1998, was 68,564,013 shares of Common Stock, $0.0001
par value.

     Documents Incorporated by Reference:  None

     Transitional Small Business Disclosure Format (check one):
     [  ] Yes     [X] No

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                                        PART I

     THIS ANNUAL REPORT ON FORM 10-KSB (THE "ANNUAL REPORT") CONTAINS CERTAIN 
FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 21E OF THE SECURITIES
EXCHANGE ACT OF 1934, AS AMENDED, (THE "EXCHANGE ACT"), INCLUDING STATEMENTS
THAT INDICATE WHAT THE COMPANY "BELIEVES", "EXPECTS" AND "ANTICIPATES" OR
SIMILAR EXPRESSIONS.  THESE STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS,
UNCERTAINTIES AND OTHER FACTORS WHICH MAY CAUSE ACTUAL RESULTS, PERFORMANCE OR
ACHIEVEMENTS OF THE COMPANY TO DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED
BY SUCH FORWARD-LOOKING STATEMENTS.  SUCH FACTORS INCLUDE, AMONG OTHERS, THE
INFORMATION CONTAINED UNDER THE CAPTION "PART II, ITEM 6, MANAGEMENT'S PLAN OF
OPERATION - FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS" AND ELSEWHERE IN
THIS ANNUAL REPORT.  THE READER IS CAUTIONED NOT TO PLACE UNDUE RELIANCE ON
THESE FORWARD-LOOKING STATEMENTS, WHICH REFLECT MANAGEMENT'S ANALYSIS ONLY AS OF
THE DATE OF THIS ANNUAL REPORT.  THE COMPANY UNDERTAKES NO OBLIGATION TO
PUBLICLY RELEASE THE RESULTS OF ANY REVISION OF THESE FORWARD-LOOKING
STATEMENTS.  THE READER IS STRONGLY URGED TO READ THE INFORMATION SET FORTH
UNDER THE CAPTION "PART II, ITEM 6, MANAGEMENT'S PLAN OF OPERATION-FACTORS THAT
MAY AFFECT FUTURE OPERATING RESULTS" FOR A MORE DETAILED DESCRIPTION OF THESE
SIGNIFICANT RISKS AND UNCERTAINTIES.


ITEM 1.  DESCRIPTION OF BUSINESS.

OVERVIEW

     Aquasearch, Inc. is a development stage company that develops and
commercializes natural products from microalgae using its proprietary,
large-scale photobioreactor known as the Aquasearch Growth Module (the "AGM").

     Microalgae are a diverse group of over 30,000 species of microscopic plants
that have a wide range of physiological and biochemical characteristics. 
Microalgae produce many different and unusual fats, sugars, proteins, amino
acids, vitamins, enzymes, pigments and other bioactive compounds that have
existing and potential commercial applications in such fields as animal and
human nutrition, food colorings, cosmetics, diagnostic products,
pharmaceuticals, research grade chemicals, pigments and dyes. Microalgae grow
ten times faster than the fastest growing land-based crops and represent a
largely unexploited and renewable natural resource with a biodiversity
comparable to that of land-based plants.

     The Company believes that the principal impediment to commercializing
microalgae is the lack of large-scale cultivation technology.  Other microbes,
such as bacteria and fungi, are cultivated in large, closed-system
"bioreactors."  The products manufactured in this way are the basis of both the
pharmaceutical and brewing industries, for example.

     Bioreactors are closed to avoid contamination by unwanted species. 
Bioreactors are controlled because every microbe prefers certain environmental
conditions, such as temperature, to grow optimally.


                                         -2-
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     Bacteria and fungi grow in the dark.  Bioreactors, therefore, are dark. 
Microalgae, however, are green plants: they require light.  Microalgae cannot
grow in bioreactors.  They must be grown in "photobioreactors" -- closed,
controlled cultivation chambers into which light can penetrate.  

     Commercial bioreactors for cultivating bacteria and fungi are large.  The
size of industrial bioreactors is typically in the range of 1,000 to 20,000
gallons.  The Company believes that photobioreactors will have to be more than
1,000 gallons in capacity to be of commercial value but, according to recent
technology surveys by experts, most photobioreactors now in use around the world
are less than 100 gallons in size.

     THE AQUASEARCH GROWTH MODULE

     Aquasearch believes it has developed the largest commercial-scale
photobioreactor known.  The Company has for the past year routinely -- and
simultaneously -- operated more than ten AGMs ranging in size from 1,000 to
4,000 gallons.  Subsequent tothe close of the 1998 fiscal year, the Company
began operating AGMs with 7,000 gallon capacity.  

     Aquasearch has spent more than $2.0 million over the last two years on
research and development of its AGM technology.  The Company believes that it
has made several significant and proprietary advances in several key areas of
its production technology, including: (i) biology-based improvements; (ii)
advanced production procedures; (iii) significant increases in AGM size; and
(iv) production automation advancements.  During the 1998 fiscal year, the
Company increased the size of its largest AGM from 1,000 gallons to 4,000
gallons.  Following the close of the 1998 fiscal year, the Company further
increased the capacity of its AGMs to 7,000 gallons.  The larger AGM is not only
less costly, but requires less labor, operates for a longer period of time and
has significantly greater productivity than the smaller version.  Management
anticipates replacing all production capacity with the new 7,000 gallon AGMs in
early 1999, contingent on available capital.  The Company believes that the use
of these very large AGMs will increase current total production capacity by a
factor of more than six with no increase in labor costs.

     Aquasearch began replacing its computer control system with
state-of-the-art industrial process control in late 1997.  Improvements that are
still underway have already reduced labor and hardware costs, and have provided
significantly better quality control.  The Company believes that its process
control system is already greatly advanced compared to the standard in
biology-based manufacturing.  Aquasearch continues to develop certain
proprietary process control software that it believes will provide a significant
competitive advantage over other known systems.

     The Company introduced in late 1997 certain changes in nutrient media
formulation, sterility procedures and other practices resulting from its
research that have significantly enhanced productivity.

     Aquasearch believes that the AGM offers significant technical and economic
advantages compared with the open pond systems currently used by certain
competitors.  These advantages include increased yields and the ability to
economically cultivate hundreds of microalgal species at commercial scale that
cannot be produced in competitive microalgae cultivation systems due to
substantially higher risks of contamination and lack of control.  Aquasearch
also believes that the AGM compares favorably with other known closed systems
with respect to both capital and operating costs, primarily due to the large
size of the AGM.

     Aquasearch believes that its current AGM technology can be used to
cultivate hundreds of species of microalgae for commercial purposes. 
Notwithstanding these perceived advantages of the Company's 


                                         -3-
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technology, the production of various species of microalgae on a commercial
scale involves various risks and uncertainties.

     ASTAXANTHIN

     Aquasearch's first commercial product is astaxanthin, a naturally occurring
red pigment derived from HAEMATOCOCCUS PLUVIALIS, a freshwater microalga.  The
primary market for astaxanthin currently is aquaculture.  According to industry
sources, the global aquaculture market steadily doubled in value from $13
billion in 1985 to $26 billion in 1990, and is projected to grow to more than
$50 billion by the year 2000.  Industry sources indicate that farmed salmon and
shrimp (the fastest and fourth fastest growing aquaculture products) will
account for more than half the total value of world aquaculture production by
the year 2000.  Free swimming salmon and shrimp acquire pink flesh from natural
astaxanthin contained in microalgae and other species ingested in the wild. 
Farmed salmon and shrimp, however, currently acquire pink flesh only from the
addition of synthetic astaxanthin (or a less effective substitute product) to
their feed.  (Recent feeding trials also have demonstrated that astaxanthin is
an important nutritional component to the proper development and growth of
farmed salmon and trout.)  The world market for astaxanthin in aquaculture was
estimated to be approximately $175 million in 1998, and continued growth is
expected.

     Aquasearch believes it is one of the first companies to produce commercial
quantities of natural astaxanthin from microalgae.  The world market for
astaxanthin is currently dominated by a single producer, Hoffman-LaRoche, Inc.
("Hoffman-LaRoche"), which has maintained the market price of its synthetic
astaxanthin product (which is derived from petrochemicals) at approximately
$2,500 per kilogram for more than a decade.  Products incorporating Aquasearch's
natural astaxanthin product (such as Cultor's Aquaxan-Registered Trademark-
product) will compete directly with Hoffman-LaRoche's synthetic astaxanthin
product.  There can be no assurance that the market price of synthetic
astaxanthin will be maintained at historical levels or what effect this may have
on the market price of products incorporating Aquasearch's natural astaxanthin
product.

     In May 1996, Aquasearch entered into a three-year exclusive Distribution
and Development Agreement with Cultor (recently extended to four years) pursuant
to which Aquasearch will act as the exclusive worldwide supplier of natural
astaxanthin derived from microalgae to Cultor in the field of animal feed and
animal nutrition and Cultor will act as the exclusive worldwide distributor of
Aquasearch's natural astaxanthin product in the field of animal feed and animal
nutrition. Cultor is a $2 billion Finnish food conglomerate that is a leading
worldwide producer of animal feed and animal nutrition products.  Aquasearch
estimates that Cultor and its affiliated companies currently utilize
approximately $30 million of synthetic astaxanthin per year in feed products for
the aquaculture and livestock industries.  Astaxanthin is currently used in
poultry feed to impart a more reddish hue to egg yolks.  Research indicates that
astaxanthin may have additional benefits with respect to fertility, weight gain
and feed efficiency in broiler chickens and layer hens.

     PHARMACEUTICALS

     Most pharmaceutical products developed to date have been derived from the
20,000 species of land-based plants.  Aquasearch believes that the 30,000
estimated species of microalgae represent a comparable -- but as yet untapped --
source of pharmaceutical products.  The Company is aware of several compounds,
isolated from microalgae, that have demonstrated activity against certain
diseases in pre-clinical trials.  However, despite the likelihood of new drug
discoveries among the microalgae, the Company believes that the pharmaceutical
industry has largely ignored the microalgae because commercial scale production
technology, such as the AGM, has been unavailable to produce the amounts
required.


                                         -4-
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     Aquasearch believes that the discovery and manufacture of pharmaceuticals
from microalgae is potentially a large market.  According to industry experts,
pharmaceutical companies are now under intense pressure to fill their
development pipelines with new drug candidates.  Aquasearch believes that this
pressure, in combination with new screening techniques based on genomics, is
already causing the pharmaceutical industry to broaden its search for new drugs.
The wider and more intensive search for new drug candidates, Aquasearch
believes, will put microalgae high on the list of unexplored but potentially
valuable sources.

     Aquasearch believes it is capable of producing the relatively large
quantities of microalgae raw material necessary for the drug discovery process. 
The Company was awarded a Master Agreement from the U.S. National Cancer
Institute for just this purpose, although no contracts have yet been issued. 
The Company does not have the expertise to develop and fully commercialize
pharmaceutical products on its own.  Aquasearch's strategy is to establish the
AGM as a core technology for the cultivation of microalgae and to seek
collaborative research and development, sales, marketing and distributing
relationships with established pharmaceutical companies in order to develop and
commercialize potential pharmaceutical products from microalgae.

     In December 1998, shortly after the close of the 1998 fiscal year,
Aquasearch entered into a drug discovery agreement with Enzymed, Inc., a
U.S.-based, privately-held biotechnology company.  Enzymed uses its proprietary
technology, "Combinatorial Biocatalysis," for lead optimization of promising new
drug candidates, under contract to a variety of major pharmaceutical companies,
including Merck, Hoffman LaRoche, and Novartis.  Under the terms of the
agreement with Aquasearch, Enzymed will generate a large number of novel
compounds based upon the starting materials found originally in microalgae and
provided by Aquasearch.  Both companies will share in the potential revenues
from the commercialization of the resulting compound libraries, including access
fees, licensing fees, milestone payments, royalties and commercial sales.

     The Company is currently in preliminary discussions with a major U.S.
chemical company and a major Japanese food/pharmaceutical company with respect
to the development of certain human nutritional supplements or nutraceuticals. 
The Company is also in late-stage discussions with a French pharmaceutical
company with respect to the possible formation of a joint venture to
commercialize microalgae in the nutraceutical and pharmaceutical markets.  There
can be no assurances as to when or if these discussions will lead to the
execution of a letter of intent or final agreement, or whether the terms of such
arrangements will be attractive to the Company.  The Company's development of
pharmaceutical products from microalgae involves many significant risks and
uncertainties.

INDUSTRY BACKGROUND

     Microalgae have the following properties that make their commercial
production attractive: 

     (i)    microalgae naturally produce a vast array of natural compounds: 
            many different and unusual fats, sugars, proteins, amino acids,
            vitamins, enzymes, pigments and other bioactive compounds;

     (ii)   microalgae grow ten times faster than sugar cane, the fastest
            growing land-based crop, which makes it possible to harvest new
            crops every two to three days utilizing optimal culture and
            processing technologies;


                                         -5-
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     (iii)  ease of processing:  microalgae have a uniform cell structure with
            no bark, stems, branches or leaves which permits easier extraction
            of products and higher utilization of cells and makes it practical
            to manipulate and control growing conditions in order to optimize
            particular cell characteristics; and

     (iv)   the raw materials required for microalgae growth are abundant and
            include sunlight, carbon dioxide and nitrogen.

     Existing and potential commercial applications for microalgae include
animal and human nutrition, natural food colorings, cosmetics ingredients and
colorings, diagnostic products, pharmaceuticals, research grade chemicals and
pigments and dyes.  The largest volume of microalgae products produced today are
algae used as human food and nutritional supplements.  These include forms of
SPIRULINA SPP., CHLORELLA SPP., lake grown blue green algae (APHANIZOMENON
FLOS-AQUAE) and natural beta carotene from DUNALIELLA SALINA.  These microalgae
food supplements contain varying degrees of highly absorbable sources of
phytonutrients including mixed carotenoids, B vitamins, GLA, protein and
essential amino acids.  Emerging commercial applications for microalgae include
products for drug design, pharmaceuticals and diagnostics.  One company has
developed an infant formula ingredient from microbial oils enriched with
microbial fatty acid components derived from microalgae and fungi that may be
linked to the development and function of the brain and retina.

     Although many potentially valuable compounds have been identified in
microalgae, until recently there was no technology to provide for cost effective
production of multiple species of photosynthetic microalgae in commercial
quantities.  To the Company's knowledge, and with the exception of the infant
formula product, substantially all other commercial quantities of microalgae
products are currently produced in open pond environments with microalgae
species that thrive in harsh environments which eliminate or neutralize
competing species, predators and contaminants.  These few species, such as
SPIRULINA SPP., CHLORELLA SPP., and DUNALIELLA SALINA require a medium for
growth characterized by either an extremely high salinity or pH or another
chemistry that is hostile to most competing species, predators and contaminants.
Accordingly, the problem of contamination is drastically reduced in such
abnormal environments, as is the number of microalgae species that can be
produced.

     Commercial cultivation of the other three principal groups of microbes --
bacteria, yeast and fungi -- is currently accomplished in closed, controlled
bioreactors (fermentors), and provides the basis for multi-billion dollar
industries (such as pharmaceuticals) based on natural products produced by these
microbes.  The Company believes that microalgae are the only major group of
microbes that are not currently widely cultivated in closed, controlled
cultivation systems and that such closed systems are essential for commercial
exploitation of the estimated 30,000 species of microalgae.

THE AQUASEARCH SOLUTION

     Aquasearch has designed, developed and implemented proprietary production
technologies, systems and processes that provide a controlled environment for
the principal conditions required to optimize and maintain microalgae growth.
This technology includes the AGM, which is a closed-system photosynthetic
bioreactor that utilizes computer-controlled equipment to monitor and adjust the
turbulence rate, pH, gas exchange, temperature and nutrient levels within the
AGM to optimize microalgae growth rates.  To date, the AGM has produced at least
a doubling of growth rate in tested species compared with conventional open pond
technology.  Equally important, the AGM is a closed, sterile, controlled,
photosynthetic system that protects the cultured microalgae species from the
bacteria and other microbial contaminants that frequently destroy them in
conventional open pond systems.


                                         -6-
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     As a result, the AGM enables the continuous growth and harvesting of
microalgae for periods of up to six months without re-inoculation, thus enabling
a semi-batch continuous production cycle.  The specific processes and controlled
conditions are designed to meet the unique requirements of each microalgae
species.  To date, Aquasearch has conducted experiments on five different
microalgae species, each with significantly different optimal growth
environments.  In each case, the AGM has provided a stable environment that
fostered sustained continuous growth.  Based on these preliminary studies, the
Company believes that the AGM can be used to cultivate hundreds of species of
microalgae.

     The Company has also designed, developed and implemented proprietary
harvesting technologies, systems and processes for the production of microalgae
that it believes provide significant competitive advantages over traditional
microalgae production techniques.

     Aquasearch believes that the capital cost of operating the AGM compares
favorably with other known closed cultivation systems, thus reducing the
Company's costs of production and potentially expanding the number of microalgae
species that can be commercially exploited.

     Notwithstanding these perceived advantages of the Company's technology, the
production of certain species of microalgae on a commercial scale involves many
significant technical challenges, some of which may never have been faced
before.

     The Company believes that the location of its business in Hawaii and, in
particular, the location of its research and development and production facility
in the Hawaii Ocean Science and Technology ("HOST") Business Park at Keahole
Point, Kailua-Kona, Hawaii is an important competitive advantage.  The
combination of various factors at this facility -- consistent warm temperatures;
abundant sunlight; low rainfall; access to HOST Business Park scientific
equipment, personnel and facilities; tax incentives; and the provision of cold,
clean seawater -- makes this a favorable location to demonstrate the production
economics of various species of microalgae.  The Company believes that, in
contrast to its facility (and others in the HOST Business Park), other
microalgae production facilities located in areas lacking these characteristics
are likely to be subject to significantly higher costs of production and fewer
production days per year.

     At the HOST Business Park, Aquasearch has access to cold, clean deep
seawater that is pumped up from a depth of 2,000 feet.  This seawater is used as
a means of controlling the temperature of the AGM and may be used by Aquasearch
as a source of nutrients for culture of marine microalgae.  Additionally,
Aquasearch's facility has access to a complete industrial infrastructure and is
located 30 miles from a deep water port and immediately adjacent to an
international airport.

     However, because of the significant construction costs associated with the
rough lava of the HOST Business Park, the Company believes that large commercial
scale production of fresh water microalgal species, including HAEMATOCOCCUS
PLUVIALIS (the species from which the Company currently derives astaxanthin),
may be undertaken more economically at other similar high sunlight, low rainfall
locations in the Hawaiian Islands.  In this regard, the Company believes that
the availability of large tracts of land in Hawaii with moderate temperatures,
high sunlight, low rainfall, easy access to fresh water, cooling sea water and
power, a favorable business environment, and proximity to the renowned marine
biotechnology expertise of the University of Hawaii make the Hawaiian Islands
one of the most advantageous and economical locations in the world to cultivate
microalgae on a commercial scale.


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     The concentration of the Company's existing and planned research and
development facilities and production facilities in the HOST Business Park (as
well as any other potential production sites in the Hawaiian Islands) involves
various risks and uncertainties relating to potential natural disasters such as
volcanic eruptions, earthquakes, tidal waves, hurricanes and related matters
indigenous to Hawaii.

AQUASEARCH'S STRATEGY

     The Company's objective is to become the leader in cost-effective
cultivation technology to produce natural commercial products from microalgae.
The Company's strategies to achieve this goal may be summarized as follows:

     -     BUILD SIGNIFICANT MARKET SHARE IN THE ASTAXANTHIN MARKET. 
           Aquasearch intends to build upon its position as one of the first
           producers of commercial quantities of natural astaxanthin from
           microalgae.  Through its collaboration with Cultor, Aquasearch's
           products will gain faster access to the world market than would have
           been possible if Aquasearch had attempted to build its own marketing
           and distribution channel.  The Company believes that the combination
           of its microalgae cultivation technology and expertise with Cultor's
           animal feed and animal nutrition research and development
           capabilities and worldwide sales, marketing and distribution network
           is an important competitive advantage. Aquasearch plans to
           independently develop and/or collaborate with Cultor and other
           corporate partners with respect to the development of additional
           applications for its natural astaxanthin product.

     -     CONTINUALLY IMPROVE AND ENHANCE ITS CORE PLATFORM TECHNOLOGY. 
           Aquasearch has developed proprietary, cost effective microalgae
           cultivation and harvesting technologies and processes that it
           believes provide it with a significant competitive advantage over
           other known cultivation technologies.  Aquasearch plans to continue
           to improve upon its AGM technology and other technologies in order
           to improve yields of natural astaxanthin from HAEMATOCOCCUS
           PLUVIALIS and to develop additional products from other microalgae
           species.

     -     DEVELOP OTHER COMMERCIAL PIGMENTS.  Aquasearch plans to undertake
           additional research and development of potential commercial pigments
           from other species of microalgae.  In particular, Aquasearch plans
           to determine whether canthaxanthin, another carotenoid pigment, can
           be derived cost-effectively from microalgae in commercial
           quantities.  Synthetic canthaxanthin is currently used in cakes,
           candy, soda and processed meats. The Company believes that the world
           market for synthetic canthaxanthin is in excess of $200 million per
           year.

     -     EXPAND STRATEGIC ALLIANCES.  Aquasearch intends to strengthen
           existing and develop new relationships with companies interested in
           commercializing microalgae products.  In particular, Aquasearch is
           targeting potential partners that have greater research and
           development, scientific, technical, financial, marketing, sales
           and/or distribution resources than Aquasearch.  The Company's
           primary  objective in expanding relationships with these companies
           is to gain visibility into their product requirements in order
           further develop Aquasearch's technology and expand the markets for
           its existing and potential products.

     -     DEVELOP PHARMACEUTICALS, COSMETICS AND OTHER APPLICATIONS. 
           Aquasearch currently plans to conduct research and development of
           potential pharmaceutical, cosmetics and other applications from
           microalgae. Aquasearch intends to identify such potentially
           marketable 


                                         -8-
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           compounds through the efforts of its existing technical staff, its
           Scientific Advisory Board and the Marine Bioproducts Engineering
           Center (MarBEC) at University of Hawaii.  MarBEC, funded at the rate
           of approximately $4 million per year for the next five years (and
           possibly for the next ten years) by the U.S. National Science
           Foundation and the State of Hawaii, is focused primarily on the
           development of new commercial products from microalgae, and is
           strongly supported by global industry partners.  Aquasearch is a
           founding member of MarBEC, and expects to benefit significantly from
           highly leveraged research and development.  Aquasearch also relies
           on expertise derived through its relationship with other the
           scientific institutes and universities (such as Scripps Institute of
           Oceanography, University of California, San Diego and the University
           of Southern Mississippi) at which members of the Company's
           Scientific Advisory Board are conducting teaching and research
           activities.

PRODUCTS AND POTENTIAL PRODUCTS

     The following discussion describes the Company's existing natural
astaxanthin product and potential future products:

     EXISTING PRODUCT: ASTAXANTHIN

     Substantially all of Aquasearch's efforts to date have been focused on the
development of its AGM technology and the initial production of natural
astaxanthin derived from HAEMATOCOCCUS PLUVIALIS.  The two primary markets for
natural astaxanthin are currently aquaculture and poultry feed.

     AQUACULTURE.  Astaxanthin is the red pigment that occurs in the natural
diets of a number of marine species (including, for example, salmon, shrimp,
carp, trout, red sea bream, ornamental fish, lobsters and crabs) which provides
the red coloring in their flesh or shells.  In nature, astaxanthin, like other
marine pigments, is produced only by microalgae and is then passed up the food
chain.  Farmed salmon, trout and shrimp do not obtain astaxanthin in
non-pigmented commercial fish feed.  The resulting salmon, trout and shrimp
taste the same as pink salmon, trout and shrimp, but, due to consumer
preference, fetch about half the price.  (Industry studies have demonstrated
that color is the most significant factor influencing consumer salmon
purchases.)  For this reason, fish farmers have an important incentive to add
astaxanthin (in synthetic or natural form) or an alternative product into their
fish feed in order to increase the value of their produce.  In addition, recent
feeding trials have demonstrated that astaxanthin is an important nutritional
component to the proper development and growth of farmed salmon and trout.

     The aquaculture market for synthetic astaxanthin is currently estimated to
be approximately $175 million per annum, and continued growth is expected. This
market is currently dominated by a single producer, Hoffman-LaRoche, which has
maintained the market price of synthetic astaxanthin at about $2,500 per
kilogram for more than a decade.  Aquasearch has entered into an exclusive
distribution and development agreement with Cultor with respect to the
production and distribution of Aquasearch's natural astaxanthin product derived
from HAEMATOCOCCUS PLUVIALIS.  Cultor owns Ewos, a Finnish company with
production facilities worldwide, which Aquasearch believes currently sells
approximately one-third of the world's salmon feed.  Aquasearch's natural
astaxanthin product has compared favorably with synthetic astaxanthin in tests
conducted by Cultor. Cultor's natural feed additive, Aquaxan-Registered
Trademark-, which will contain Aquasearch's natural astaxanthin, will compete
directly with Hoffman-LaRoche's synthetic astaxanthin product in the aquaculture
feed market. There can be no assurance that the market price of synthetic
astaxanthin will be maintained at historical levels or what effect this may have
on the market price of Aquasearch's natural astaxanthin product.


                                         -9-
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     POULTRY FEED.  The amount of natural pigments ingested in the diet
determines the hue of the egg yolks produced by poultry.  For many years,
poultry producers have added synthetic canthaxanthin -- a closely related
pigment to astaxanthin -- and other natural pigments (such as marigolds) to
livestock feeds in order to satisfy consumer preferences for various colored egg
yolks.  Recent legislation in Sweden, however, requires that all colorants added
to animal feeds be derived from natural sources.  This legislation prompted
Svenska Foder, the largest poultry feed producer in Sweden (and a subsidiary of
Cultor prior to December 1996), to seek out Aquasearch to provide natural
astaxanthin as an alternative colorant for poultry feed.  Aquasearch's natural
astaxanthin product has compared favorably with synthetic astaxanthin in tests
performed by Svenska Foder.  In addition, recently published studies by Svenska
Foder suggest that astaxanthin may have additional benefits with respect to
fertility, weight gain and feed efficiency in broiler chickens and layer hens.
In December 1996, Cultor sold its majority interest in Svenska Foder to KKR, a
Danish animal feeds company. In connection with this sale, Cultor acquired all
of Svenska Foder's rights under the Svenska Foder Supply Agreement.

     OTHER POTENTIAL APPLICATIONS.  Aquasearch intends to explore, independently
and jointly with its corporate partners, additional applications of natural
astaxanthin in the field of animal feed and animal nutrition and in other
fields, such as human nutrition and food coloring.  The Company believes that
the potential market for astaxanthin in human health and nutrition is large.  No
assurance can be given that Aquasearch or any of its corporate partners will be
successful in developing additional commercial applications for the Company's
natural astaxanthin product.  Aquasearch is also seeking an arrangement with
Cultor whereby it might be released from exclusivity so that the Company might
market directly to other consumers of astaxanthin in the fish feed business.

     POTENTIAL PRODUCTS

     PHARMACEUTICALS.  Most pharmaceutical products developed to date have been
derived from land-based plants, and the biodiversity of microalgae is comparable
to that of land-based plants.  Aquasearch is aware of at least one company,
Martek Biosciences Corporation, that has collaborated with Merck & Co. and
others to develop pharmaceuticals from microalgae.  Aquasearch is also aware
that certain compounds derived from microalgae enhanced the production of an
anti-cancer drug that is now in Phase II clinical trials.  The Company believes
that many pharmaceutical and biotechnology companies will be interested to
collaborate with Aquasearch to develop new drugs from microalgae.  The Company
believes this interest exists especially because of the AGM technology, which
Aquasearch views as unique in its ability to provide the large quantities of
pure material required for research, development and manufacture of drugs from
microalgae.  Aquasearch does not currently have the expertise to develop and
commercialize pharmaceutical products on its own.  Aquasearch's strategy will be
to establish the AGM as a core technology for the cultivation of commercial
quantities of microalgae and to seek collaborative research and development and
sales, marketing and distribution relationships with established pharmaceutical
companies in order to develop and commercialize potential microalgal
pharmaceutical products.  The Company's development of pharmaceutical products
from microalgae involves many significant risks and uncertainties.

     OTHER PIGMENTS FROM MICROALGAE.  Using its AGM technology, Aquasearch has
the capability of cultivating additional microalgae species rich in pigments.
Microalgae contain the entire spectrum of colors found in aquatic environments,
including more than 1,000 specific pigments.  These pigments may be useful in
other feeds for the aquaculture and animal feed markets.  In addition, the
Company believes that natural pigments found in microalgae can be substituted
for synthetic pigments currently used in the food processing industry.  For
example, canthaxanthin is used widely in the food industry today for colorings
in cakes, candy, soda and processed meats.  The Company believes that the
worldwide market for synthetic canthaxanthin 


                                         -10-
<PAGE>

is currently in excess of $200 million. Aquasearch is aware of a number of
microalgae species that contain a high percentage of canthaxanthin.  Similarly,
there is a growing demand for natural pigments in cosmetics, skin and hair care
products that could be derived from microalgae species.  Aquasearch believes it
has the technical expertise to identify microalgae species that produce pigments
that could be useful in the food processing, cosmetics and consumer products
industries, among others.  The Company believes that the combined worldwide
market for canthaxanthin and three other pigments currently being evaluated by
the Company is in excess of $1 billion.  The Company's development of additional
microalgae pigmentation products involves many significant risks and
uncertainties.

     AQUACULTURE FEEDS.  Microalgae are the primary source of food for most
aquatic species in their larval stages.  According to independent sources, the
aquaculture market currently produces approximately 18% of the world's fisheries
consumption based on 1994 figures (which are the most recent data available) and
was estimated to be a $35 billion  market in 1996.  Aquaculture feeds typically
represent the highest cost of production for the aquaculture farmer and many are
required to grow or purchase microalgae or microalgae sources for their
hatcheries.  Problems of contamination are a significant business risk and some
farmers are currently purchasing prepared larval feeds.  One of the significant
obstacles to the development of aquaculture has been the difficulty of feeding
the larvae.  Aquasearch believes that the AGM can provide a cost-effective
technology for growing feed for the aquaculture industry, both for existing
species and future aquaculture species.  The Company's development of microalgae
aquaculture feed products involves many significant risks and uncertainties.

     COSMETICS.  Aquasearch believes that microalgae contain several significant
features of importance to the cosmetics industry.  First, the natural colors
that occur in microalgae can be used directly as coloring agents in cosmetics.
Second, many species of microalgae possess light blocking compounds that
regulate the amount of ultraviolet and other wavelengths they absorb and have
potential applications in sunscreens and other products containing sun blocking
agents.  Last, bioactive agents derived from microalgae may be useful as
cosmetics themselves.  For example, Aquasearch is aware that an extract from a
marine organism is an active ingredient in a wrinkle-reducing skin cream
marketed by Estee Lauder.  This product currently generates more than $1 million
a year in royalties to its developer.  Aquasearch believes that the market for
cosmetics derived from microalgae is a potentially large market. Aquasearch does
not currently have the expertise to develop and commercialize cosmetics products
on its own.  Aquasearch's strategy will be to establish the AGM as a core
technology for the cultivation of commercial quantities of microalgae and to
seek collaborative research and development and marketing, sales and
distribution relationships with established cosmetics and consumer goods
companies in order to develop and commercialize potential microalgae cosmetics
products.  The Company's development of microalgae cosmetics products involves
many significant risks and uncertainties.

MANUFACTURING

     ASTAXANTHIN

     Aquasearch began culturing HAEMATOCOCCUS PLUVIALIS at its current facility
in the HOST park in 1995.  HAEMATOCOCCUS PLUVIALIS is cultured using a series of
photobioreactors of varying sizes to achieve culturing consistency before
entering the AGM.  The AGM is a large photobioreactor that utilizes
computer-controlled equipment to monitor and adjust  the turbulence rate, pH,
gas exchange, temperature and nutrient levels within the AGM to optimize
microalgae growth rates.

     The AGMs are harvested regularly and the extracted amount is pumped from
the AGM into open ponds where, using proprietary processes, the microalgae is
caused to turn red (biosynthesis of astaxanthin). 


                                         -11-
<PAGE>

Once the optimal reddening has occurred, the microalgae are drained from the
ponds and dewatered.  The microalgae slurry is then further processed, dried and
packaged using proprietary equipment and processes.

     The Cultor Distribution and Development Agreement originally called for
production targets of 40 kilograms per month by September 1997 and 120 kilograms
per month by September 1998.  By mutual agreement, the initial Aquasearch
production targets were each extended one year and, in addition, the focus of
both parties' development efforts were shifted from achieving monthly production
targets to achieving long-term production economics.  Since the Cultor
Distribution and Development Agreement was signed, Cultor has devoted
substantial resources to developing its Aquaxan-Registered Trademark- animal
feed and animal nutrition product (which incorporates Aquasearch's natural
astaxanthin), including conducting extensive product formulation research and
feeding trials.  During the past several quarters, the Company has achieved and
sustained significant improvements in virtually every phase of its production
process.  As a result of these developments, the Company is expanding its
existing one-acre facility to a three-acre facility and increasing its
production capacity.  Based on the current production rate of existing AGMs, the
Company estimates that the expanded facility could produce more than 80
kilograms of astaxanthin per month if sufficient space were available for
finishing ponds.  However, since space for finishing ponds at the Keahole Point
site is constrained, the Company (with Cultor's approval) expects to limit
astaxanthin production to approximately 20 kilograms per month at the expanded
site.  The extra module capacity at the expanded site will be used for further
optimization of the astaxanthin production process and the development-up of new
microalgal products.

     Under the Cultor Distribution and Development Agreement, Cultor and
Aquasearch may, at Cultor's option, mutually develop a new joint venture company
for the sole purpose of producing and selling natural astaxanthin derived from
microalgae in the field of animal feed and animal nutrition.  Pursuant to this
arrangement, Aquasearch would license certain technology to the new company to
make, use and sell natural astaxanthin derived from microalgae within the field
of animal feed and animal nutrition only and will retain the right to make, use
and sell natural astaxanthin derived from microalgae in all fields other than
animal feed and nutrition as well as the right to make, use and sell any
microalgae products other than natural astaxanthin in all fields, including the
field of animal feed and animal nutrition.  In the event that Cultor exercises
its option to create a joint venture, Aquasearch would contribute a ten-acre
natural astaxanthin production facility to be constructed at a later date in
return for a 50% stake in the new company and Cultor would contribute cash equal
to the appraised value of Aquasearch's production facility in return for a 50%
stake.  In addition, Cultor has the option to increase its stake in the new
company by purchasing from Aquasearch a further 25% of the new company (thus
increasing Cultor's stake to 75%) for cash based on a formula specified in the
Cultor Disribution and Development Agreement.

     In view of the recent advancements achieved in astaxanthin production, and
pending further discussions with Cultor (or other potential partners, provided
Aquasearch can be released from its exclusivity with Cultor), Aquasearch
currently plans to develop a second site for large-scale astaxanthin production
that would be larger than the ten-acre site initially contemplated in the Cultor
Distribution and Development Agreement and would have a production capacity
significantly greater than 120 kilograms per month.  There is currently no
agreement between Aquasearch and Cultor as to if, or when, a second site would
be constructed, what the size, location or production capacity of such a site
would be, or how the construction or scale-up of this facility would be
financed.  There can be no assurances that Aquasearch and Cultor will reach an
agreement regarding the development, timing, location or financing of a second
site, whether the Cultor Distribution and Development Agreement would need to be
amended or terminated to accommodate these plans, or whether Cultor would have
any role in connection with this project.  The expansion of the 


                                         -12-
<PAGE>

Keahole Point site and the construction and scale-up of any additional
production site will involve various risks and uncertainties.  

     OTHER MICROALGAE SPECIES

     In addition to HAEMATOCOCCUS PLUVIALIS, the Company has used its AGM
technology to successfully culture the following species of microalgae:
CHLORELLA SOROKINIENSIS, LYNGBYA LAGERHEIMIL, SPIRULINA PLATENSIS and
HAEMATOCOCCUS LACUSTRIS.  Commercial production of additional species of
microalgae will require the development of custom processes to create optimal
conditions for the cultivation and harvesting of each species.  Based on
preliminary studies, Aquasearch believes that the fundamental aspects of the
technology used to produce HAEMATOCOCCUS PLUVIALIS will be directly applicable
to the production of hundreds of other species of microalgae and that principal
variations are likely to occur in the modification of harvesting processes
rather than adaptation of the AGM.

MARKETING AND SALES

     Aquasearch's primary business strategy is to continue development of its
platform technology and to establish its expertise and reputation as a cost
effective developer and manufacturer of high value microalgae products.  The
Company presently plans to develop strategic research and development, sales and
marketing and distribution arrangements with established companies that have
significant market shares in the fields in which Aquasearch intends to develop
and sell products.  The Company believes that this approach reduces the time to
market for its products and increases the likelihood of market acceptance for
its products.  Alternatively, Aquasearch does not believe that acquiring or
developing the legal, regulatory, sales and marketing expertise necessary to
compete with established vertically integrated companies with significant market
shares is likely to yield the best return on investment for the Company or its
shareholders.  In general, Aquasearch intends to follow substantially the same
strategy with respect to the development, marketing and sale of future products
that it followed in connection with the development, marketing and sale of its
natural astaxanthin product; namely, to identify potential corporate partners
already familiar with the potential product as part of their own research and
development efforts and to enter into strategic development agreements to
manufacture value-added products to the specifications of these corporate
partners.  Once new products are in production, the Company may create one or
more separate operating companies with licenses to use the technology solely for
the specific microalgae species and end use.

CORPORATE PARTNER RELATIONSHIPS

     SVENSKA FODER

     In July 1995, Aquasearch signed the Svenska Foder Supply Agreement with
Svenska Foder, pursuant to which Svenska Foder agreed to act as the exclusive
distributor of Aquasearch's natural astaxanthin for animal feed and animal
nutrition applications in Sweden, Denmark, Norway and Finland for poultry, pigs,
cattle and horses.  The Svenska Foder Supply Agreement had a term of three years
and required Aquasearch to deliver five kilograms of natural astaxanthin per
month.  Svenska Foder used the natural astaxanthin in place of synthetic
astaxanthin in chicken feed to increase the reddish hue in egg yolks.  Recently
published studies suggest that natural astaxanthin may have additional benefits
with respect to fertility, weight gain and feed efficiency in broiler chickens
and layer hens.  In December 1996, Cultor sold Svenska Foder to KKR, a Danish
animal feeds company, and assumed all of Svenska Foder's rights and obligations
under the Svenska Foder Supply Agreement.


                                         -13-
<PAGE>

     CULTOR

     In May 1996, Aquasearch entered into a three-year exclusive Distribution
and Development Agreement with Cultor (recently extended to four years) pursuant
to which Aquasearch will act as the exclusive worldwide supplier of natural
astaxanthin from microalgae to Cultor in the field of animal feed and animal
nutrition and Cultor will act as the exclusive worldwide distributor of
Aquasearch's natural astaxanthin in the field of animal feed and animal
nutrition.  The following description of certain terms and conditions of the
Cultor Distribution and Development Agreement does not purport to be complete
and is qualified in its entirety by reference to the definitive Agreement.

     The Cultor Distribution and Development Agreement initially provided that
from and after September 24, 1997 the target production requirement for the
Company and the target purchase requirement for Cultor would be 40 kilograms of
natural astaxanthin per month, and that the target production requirement for
the Company and the target purchase requirement for Cultor from and after
September 24, 1998 would be 120 kilograms of natural astaxanthin per month;
however, the Company and Cultor recently agreed to extend the term of the Cultor
Distribution and Development Agreement by one year and to amend the production
targets to be 40 kilograms per month at the end of the second year (September
1998) and 120 kilograms per month at the end of the third year (September 1999).
By mutual agreement, the initial Aquasearch production targets were each
extended one year and, in addition, the focus of both parties' development
efforts were shifted from achieving monthly production targets to achieving
long-term production economics.  Since the Cultor Distribution and Development
Agreement was signed, Cultor has devoted substantial resources to developing its
Aquaxan-Registered Trademark-  animal feed and animal nutrition product (which
incorporates Aquasearch's natural astaxanthin), including conducting extensive
product formulation research and feeding trials.  During the past several
quarters, the Company has achieved and sustained significant improvements in
virtually every phase of its production process.  As a result of these
developments, the Company is expanding its existing one-acre facility to a
three-acre facility and increasing its production capacity.  Based on the
current production rate of existing AGMs, the Company estimates that the
expanded facility could produce more than 80 kilograms of astaxanthin per month
if sufficient space were available for finishing ponds.  However, because space
for finishing ponds at the Keahole Point site is constrained, the Company (with
Cultor's approval) expects to limit astaxanthin production to approximately 20
kilograms per month at the expanded site.  The extra module capacity at the
expanded site will be used for further optimization of the astaxanthin
production process and the development and scale-up of new microalgal products.

     Under the Agreement, Cultor has the obligation to obtain all governmental
approvals for, promote and distribute the product, at its own expense, in each
country in which it proposes to sell the product.  During the term of the
Agreement, the Company and Cultor will share equally in the margin (the
"Transfer Price") between the production costs of Aquasearch (the "Aquasearch
Production Costs") and the net sales price (which is equal to the gross sales
price to the end user less volume bonuses, freight and agent's commissions).

     The Cultor Distribution and Development Agreement provides that Cultor and
Aquasearch may, at Cultor's option, mutually develop a new joint venture company
for the sole purpose of producing and selling natural astaxanthin in the field
of animal feed and animal nutrition.  The original arrangement called for
Aquasearch to contribute a production site to the joint venture for its 50%
share of the joint venture company and Cultor to contribute cash equivalent to
the value of that production site for its 50% share of the joint venture. 
Pursuant to this arrangement, Aquasearch would contribute a natural astaxanthin
production facility to be constructed in return for its 50% stake in the new
company and Cultor would contribute cash equal to the appraised value of the
Aquasearch production facility in return for its 50% stake.  Under the
Agreement, 


                                         -14-
<PAGE>

Cultor also has the option to increase its stake in the new company by
purchasing from Aquasearch a further 25% of the new company (thus increasing
Cultor's stake to 75%) for cash based on a formula.  The formula provides that
the purchase price for the additional shares to be acquired by Cultor from
Aquasearch will equal the greater of (i) $1 million, (ii) half of the current
replacement value of the astaxanthin production facilities initially contributed
by Aquasearch or (iii) an amount equal to X multiplied by Y; where "X" equals
the difference between the Transfer Price and the Aquasearch Production Costs
for the six-month period commencing on November 1, 1999 and ending on April 30,
2000 and "Y" equals six (or, in other words, an amount equal to twelve times
annual profit in the third year of the contract).

     Because of recent advancements in astaxanthin production capability, the
Company, subject to Cultor's approval, plans to develop a second site for
large-scale astaxanthin production.  It is currently contemplated that this
second site would be larger than the production site initially contemplated in
the Cultor Distribution and Development Agreement and would have a production
capacity significantly greater than the 120 kilograms per month.  There is
currently no written agreement between Aquasearch and Cultor as to if, or when,
a second site will be constructed, or what the size or production capacity of
such a site will be.  There can be no assurances that Aquasearch and Cultor will
reach an agreement regarding the development or timing of a second site, or
whether the Cultor Distribution and Development Agreement will need to be
amended to accommodate the construction of a larger site with greater production
capacity.  The expansion of the Keahole Point site and the construction and
scale-up of any additional production site will involve various risks and
uncertainties.  

     Under the Cultor Distribution and Development Agreement, Aquasearch will
license certain technology to the new company to make, use and sell natural
astaxanthin within the field of animal feed and animal nutrition only and will
retain the right (i) to make, use and sell natural astaxanthin in all fields
other than animal feed and nutrition and (ii) to make, use and sell any
microalgae products other than natural astaxanthin in all fields, including the
field of animal feed and animal nutrition.  The Agreement contains detailed
provisions regarding the financing and management of the new company, procedures
for resolving deadlocks between the parties, mechanisms governing the buy-out of
one party by the other, covenants mandating the distribution of 40% of the
annual profits of the new company to its shareholders and establishing royalty
rates under a marketing agreement that may be entered into between the new
company and Cultor, provisions restricting the transfer of ownership interests
by Aquasearch and Cultor and providing for rights of first refusal and
registration rights, termination provisions and detailed provisions governing
the allocation of intellectual property rights upon termination.

     In connection with the execution of the Cultor Distribution and Development
Agreement, Cultor and Aquasearch also entered into a Stock Subscription
Agreement pursuant to which Cultor purchased 400,000 shares of Aquasearch Common
Stock at a purchase price of $0.50 per share.

     The Company believes that the Cultor Distribution and Development Agreement
is beneficial to the Company in the following ways.  First, the arrangement will
substantially reduces the time to market for the Company's natural astaxanthin
product because Cultor, at its own expense, will be responsible for obtaining
all regulatory approvals and promoting and selling the product.  Second, by
establishing an exclusive arrangement with Cultor (along with its affiliated
entities, the second largest consumer of synthetic astaxanthin in the world),
the Company believes it has established an additional barrier to entry to
potential competitors.  Third, the Company retains all of its intellectual
property rights to develop applications for astaxanthin outside the field of
animal feed and animal nutrition and will obtain an exclusive license to use all
microalgae technology developed by the new company, if any.  Fourth, the Company
believes that the collaboration with Cultor to develop the market for
astaxanthin in animal feed and nutrition will enhance the Company's reputation
in the industry and stimulate additional research and development with respect
to 


                                         -15-
<PAGE>

microalgae products other than astaxanthin.  The Company's obligations and
performance under the Cultor Distribution and Development Agreement and the
potential formation of a new joint venture company with Cultor involve various
risks and uncertainties. In addition, in order to meet the production targets
under the Cultor Distribution and Development Agreement, Aquasearch must
significantly expand and improve its production facilities and processes which
will involve various risks and uncertainties.

     Notwithstanding the foregoing, if the Company is unable to develop any
commercial uses for natural astaxanthin outside of the field of animal feed and
animal nutrition and if the Company is unable to develop, cultivate and sell
microalgae products other than astaxanthin, then the Company and its
shareholders will have sold the Company's sole product and source of revenues to
Cultor for the purchase price set forth in the Cultor Distribution and
Development Agreement.  The Company believes that its ability to develop
additional uses for astaxanthin outside of the field of animal feed and
nutrition and its ability to develop microalgae products other than astaxanthin
will be significantly enhanced by its collaboration with Cultor in developing
the astaxanthin market for animal feed and animal nutrition.

COMPETITION

     The Company's natural astaxanthin product will compete directly with the
synthetic astaxanthin product developed and marketed worldwide by
Hoffman-LaRoche.  Hoffman-LaRoche has significantly greater research and
development, technical, financial, management, marketing and sales resources
than Aquasearch as well as a worldwide reputation and a dominant market share. 
In addition, at least two companies, Astacarotene AB ("Astacarotene") and
Cyanotech Corporation ("Cyanotech"), have either announced plans to produce
natural astaxanthin from microalgae or are producing significant quantities for
test and commercial purposes.  In particular, Cyanotech has announced its
intention to enter into large scale commercial production of natural astaxanthin
and entered into a $1.5 million supply agreement in the fiscal quarter ended
June 30, 1998.  Aquasearch believes that competition in the astaxanthin market
will intensify significantly in the near future.  

     Alternative sources of pigmentation that have been tested include
astaxanthin from shrimp shells, paprika and a yeast strain PFAFFIA RHODOZYMA.
Aquasearch believes that only PFAFFIA RHODOZYMA continues to be evaluated as a
potential alternative to synthetic or natural astaxanthin.  Aquasearch's natural
astaxanthin product is expected to compete with synthetic astaxanthin (and any
other alternative products) primarily on the basis of product performance, price
and proprietary position.  In this regard, although Hoffman-LaRoche maintained
the market price of synthetic astaxanthin at approximately $2,500 per kilogram
for more than a decade when there was no viable competitive product available,
there can be no assurance that Hoffman-LaRoche will not cut the price of its
synthetic astaxanthin product significantly in response to the introduction of
any competing natural astaxanthin product.  Any such pricing or other
competitive pressure could have a material adverse effect on Aquasearch's
business, financial condition, results of operations and relationships with
corporate partners. The existence of products of which Aquasearch is not aware,
or products that may be developed in the future, may also adversely affect the
marketability of Aquasearch's natural astaxanthin product.

     Aquasearch plans to aggressively pursue pharmaceutical drug discovery
alliances with potential corporate partners.  Aquasearch is not presently aware
of any other microalgae company engaged or interested in the possibility of
pharmaceutical drug development that also has the capability of large-volume,
commercial scale cultivation represented by Aquasearch's AGM technology.

     Aquasearch believes that its AGM and related microalgae cultivation and
harvesting technologies currently offer significant technical and economic
advantages compared with the open pond systems 


                                         -16-
<PAGE>

currently used by certain competitors, including increased yields and the
ability to cultivate hundreds of microalgal species that cannot be produced in
open pond systems due to substantially higher risks of contamination and lack of
control.  Aquasearch also believes that its AGM and related microalgae
cultivation and harvesting technologies compare favorably with other known
closed systems with respect to capital and operating costs.  However, the
existence of technology of which Aquasearch is not aware, or technology that may
be developed in the future, may adversely affect the technical and competitive
advantages that Aquasearch currently believes it holds compared with competing
open pond and known closed system microalgae cultivation technologies.

     Aquasearch intends to develop other natural products from microalgae that
will compete with existing natural and synthetic products. The Company
anticipates that competition to develop additional microalgae products will be
intense.  Aquasearch's future competitors are expected to include major
pharmaceutical, food processing, chemical and specialized biotechnology
companies, many of which will have financial, technical and marketing resources
significantly greater than those of Aquasearch.  In addition, specialized
biotechnology companies may form collaborations with large established companies
to support research, development and commercialization of products that may be
competitive with future products of Aquasearch.  Also, academic institutions,
governmental agencies and other public and private research organizations are
conducting research activities and seeking patent protection and may
commercialize products competitive with those of Aquasearch on their own or
through joint ventures.  The existence of products of which Aquasearch is not
aware, or products that may be developed in the future, may adversely affect the
marketability of additional products developed by Aquasearch.

     Aquasearch's competitive position will also depend on its ability to
attract and retain qualified scientific and other personnel, develop effective
proprietary products, successfully perform under the Cultor Distribution and
Development Agreement, implement research and development and production plans,
obtain patent protection and secure adequate capital sources.

PATENTS, LICENSES AND PROPRIETARY TECHNOLOGY

     Aquasearch relies upon a combination of patents, copyright protection,
trade secrets, know-how, continuing technological innovation and licensing
opportunities to develop and maintain its competitive position.  The Company's
future prospects depend in part on its ability to obtain patent protection for
its products and processes, to preserve its copyright and trade secrets and to
operate without infringing the proprietary rights of third parties.  Aquasearch
has been awarded one patent in the United States, one patent by the European
Patent Office (which is applicable to all member nations of the European Union),
one patent in Australia and one patent in Hong Kong for its closed system
microalgae cultivation process. The Company has additional patents pending
internationally and in the United States.

     The patent positions of pharmaceutical, biopharmaceutical and biotechnology
companies, which are analogous to the Company, are generally uncertain and
involve complex legal and factual questions.  There can be no assurance that any
of the Company's pending patent applications will result in issued patents, that
the Company will develop additional proprietary technologies that are
patentable, that any patents issued to the Company or its strategic partners
will provide a basis for commercially viable products or will provide the
Company with any competitive advantages or will not be challenged by third
parties, or that the patents of others will not have a material adverse effect
on the ability of the Company to do business.  In addition, patent law relating
to the scope of claims in the technology fields in which the Company operates is
still evolving.  The degree of future protection for the Company's proprietary
rights, therefore, is uncertain.  Furthermore, there can be no assurance that
others will not independently develop similar or alternative technologies,
duplicate any of the Company's technologies, or, if patents are issued to the
Company, design 


                                         -17-
<PAGE>

around the patented technologies developed by the Company.  In addition, the
Company could incur substantial costs in litigation if it is required to defend
itself in patent suits brought by third parties or if it initiates such suits.

     Others may have filed and in the future are likely to file patent
applications that are similar or identical to those of the Company.  To
determine the priority of inventions, the Company may have to participate in
interference proceedings declared by the United States Patent and Trademark
Office that could result in substantial cost to the Company.  No assurance can
be given that any such patent application will not have priority over patent
applications filed by the Company.  In addition, the laws of certain foreign
countries may not protect the Company's patent and other intellectual property
rights to the same extent as the laws of the United States.

     The Company's future prospects also depend in part on the Company 
neither infringing patents or proprietary rights of third parties nor 
breaching any licenses that may relate to the Company's technologies and 
products.  There can be no assurance that the Company will not infringe the 
patents, licenses or other proprietary rights of third parties.  In addition, 
the Company may in the future receive notices claiming infringement from 
third parties as well as invitations to take licenses under third party 
patents.  Any legal action against the Company or its strategic partners 
claiming damages and seeking to enjoin commercial activities relating the 
affected products and processes could, in addition to subjecting the Company 
to potential liability for damages, require the Company or its strategic 
partners to obtain a license in order to continue to manufacture or market 
the affected products and processes.  There can be no assurance that the 
Company or its strategic partners would prevail in any such action or that 
any license (including licenses proposed by third parties) required under any 
such patent would be made available on commercially acceptable terms, if at 
all.  The Company has not conducted an exhaustive patent search and no 
assurance can be given that patents do not exist or could not be filed that 
would have a material adverse effect on the Company's ability to develop and 
market its products.  There are a significant number of United States and 
foreign patents and patent applications in the Company's area of interest, 
and the Company believes that there may be significant litigation in the 
industry regarding patent and other intellectual property rights. 

     On July 13, 1998, Cyanotech filed a complaint in the United States 
District Court for the District of Hawaii against the Company seeking 
declaratory judgment of noninfringement of the Company's U.S. Letters Patent 
No. 5,541,056 (the "5,541,056 Patent"); invalidity of the 5,541,056 Patent; 
and non-misappropriation of the Company's trade secrets relating to closed 
culture production of astaxanthin. Cyanotech filed the complaint after the 
Company expressed to Cyanotech its concern that Cyanotech infringed the 
5,541,056 patent and misappropriated Aquasearch trade secrets.  On September 
11, 1998, the Company filed (i) an answer denying all of Cyanotech's 
allegations and (ii) a counter claim, alleging infringement of the 5,541,056 
Patent; misappropriation of trade secrets; unfair competition; and breach of 
contract relative to its 1994 Dissolution Agreement with Cyanotech. On 
December 14, 1998, Cyanotech filed a motion for partial summary judgment of 
noninfringement and invalidity of the 5,541,056 Patent. The summary judgment 
motion is set for a hearing on March 29, 1999. The trial in the lawsuit is 
currently set to begin on September 27, 1999. The Company does not believe 
that Cyanotech's claims are meritorious.  However, the Company may be 
required to dedicate significant management time and incur significant legal 
fees and expenses to pursue this action, which could have a material adverse 
effect on the Company's business, financial condition, results of operations 
and relationships with corporate partners.  In addition, in the event that 
Cyanotech were to prevail in this action, a finding of noninfringement or 
declaration of invalidity of the 5,541,056 Patent could have a material 
adverse effect on the Company's business, financial condition, results of 
operations and relationships with corporate partners.  "See Item 3.  Legal 
Proceedings."

     The enactment of legislation implementing the General Agreement on Trade
and Tariffs has resulted in certain changes in United States patent laws that
became effective on June 8, 1995.  Most notably, the term of patent protection
for patent applications filed on or after June 8, 1995 is no longer a period of
seventeen 


                                         -18-
<PAGE>

years from the date of grant.  The new term of United States patents will
commence on the date of issuance and terminate twenty years after the effective
date of filing may result in a substantially shortened term of the Company's
patent protection which may adversely affect the Company's patent position.

     While the disclosure and use of the Company's proprietary technology,
know-how and trade secrets are generally controlled under agreements with the
parties involved, there can be no assurance that all confidentiality agreements
will be honored, that others will not independently develop similar or superior
technology, that disputes will not arise concerning the ownership of
intellectual property, or that dissemination of the Company's proprietary
technology, know-how and trade secrets will not occur.

GOVERNMENT REGULATION AND PRODUCT TESTING

     Aquasearch's natural astaxanthin product, potential products and its
manufacturing and research activities are or may become subject to varying
degrees of regulation by a number of government authorities in the United States
and other countries, including the FDA pursuant to the Federal Food, Drug and
Cosmetic Act.  Each existing or potential microalgae product that is developed
or marketed by Aquasearch, its licensees or its strategic partners for use by
humans may present unique regulatory problems and risks, depending on the
product type, uses and method of manufacture.  The FDA regulates, in varying
degrees and in different ways, dietary supplements, other food products, medical
devices and pharmaceutical products, including their manufacture, testing,
exportation, labeling, and, in some cases, advertising.

     Generally, prescription pharmaceuticals and certain types of medical
devices are regulated more vigorously than foods, such as dietary supplements. 
Any future products developed by Aquasearch for use in human nutrition,
pharmaceuticals or cosmetics may require Aquasearch to develop and adhere to GMP
as required by the FDA, ISO standards as required in Europe, and any other
applicable standards mandated by federal, state, local or foreign laws,
regulations and policies.  Currently, the Company's production facilities do not
comply with GMP or ISO standards and significant capital expenditures and
compliance procedures would have to be made and implemented before the Company's
production facilities could meet GMP and ISO qualifications.

     The Company is or may become subject to other federal, state and foreign
laws, regulations and policies with respect to labeling of its products,
importation of organisms, and occupational safety, among others.  Federal, state
and foreign laws, regulations and policies are always subject to change and
depend heavily on administrative policies and interpretations.  The Company is
working with Cultor with respect to compliance with foreign laws, regulations
and policies pertaining to use of its natural astaxanthin product in the field
of animal feed and animal nutrition.  There can be no assurance that any changes
with respect to federal, state and foreign laws, regulations and policies, and,
particularly with respect to the FDA or other such regulatory bodies, with
possible retroactive effect, will not have a material adverse effect on the
Company's business, financial condition, results of operations and relationships
with corporate partners.  There can be no assurance that any of the Company's
potential products will satisfy applicable regulatory requirements.

     The Company's natural astaxanthin product is viewed as a food ingredient by
regulatory authorities in Sweden.  Regulatory authorities in other jurisdictions
may view the Company's natural astaxanthin product as a food additive.  All new
color additives for ultimate human consumption in the United States require
premarket clearances from the FDA.  Therefore, Aquasearch's natural astaxanthin
product and any additional food color products for use in the United States will
require FDA clearance, unless they meet the requirements of current color
additive regulations.  The process of obtaining clearances for a new color
additive is expensive and time consuming (although significantly less expensive
than the process related to 


                                         -19-
<PAGE>

obtaining clearances for a new pharmaceutical).  Extensive information is
required on the toxicity of the additive, including carcinogenicity studies and
other animal testing. Although the FDA approved the Hoffman-LaRoche synthetic
astaxanthin product as a food additive in 1995, there can be no assurance that
the FDA will grant similar approval for Aquasearch's natural astaxanthin
product.  As of October 31, 1998, neither the Company nor any of its corporate
partners has applied for FDA clearance for the Company's natural astaxanthin
product as a food additive. No assurances can be given that any potential
Aquasearch food color product will be cleared by the FDA on a timely basis, if
at all.

     Although the FDA approved the Hoffman-LaRoche synthetic astaxanthin product
as a food ingredient in 1995, there can be no assurances that the FDA will grant
similar approval for Aquasearch's natural astaxanthin product.

     Regulatory approvals in other markets in which Aquasearch's natural
astaxanthin product is likely to be distributed -- including the European Union,
Japan, Canada and Australia -- vary by market.  Currently, the Aquasearch
natural astaxanthin product has been approved in Sweden for use in poultry feed
and is considered by the Swedish authorities as a feed ingredient rather than a
food additive.  The Company believes that the approval process in Australia,
Japan and certain other Asian countries will come under their "natural" status
and be approved relatively quickly; however, there can be no assurances in this
regard.  The Aquasearch natural astaxanthin product has not been submitted for
approval by the European Union, and there can be no assurance that the
determination by Swedish authorities will have any influence on the
determination to be made by the European Union.

     Under the terms of the Cultor Distribution and Development Agreement,
Cultor has the responsibility to obtain any FDA and other approvals necessary in
each country in which Cultor determines to distribute the product.

     The Company is also subject to numerous environmental and safety laws and
regulations, including those governing the use and disposal of hazardous
materials.  Any violation of, and the cost of compliance with, these regulations
could have a material adverse effect on the Company's business, financial
condition, results of operations and relationships with corporate partners.

EMPLOYEES

     As of October 31, 1998, Aquasearch has 18 full-time employees, of whom
three have Ph.D.s, nine are involved in the production and harvesting process,
five are involved in research and development and four are involved in
administration and support.  The Company considers relations with its employees
to be good.  None of the Company's employees is covered by a collective
bargaining agreement.

SCIENTIFIC ADVISORY BOARD

     The Aquasearch Scientific Advisory Board is composed of leading experts in
aquaculture, marine biology and fluid dynamics and the chemistry, photobiology,
genetics and mass culture of microalgae.  The Scientific Advisory Board provides
guidance to the Company regarding the optimization of its production and
processing methods and research and development pertaining to both existing and
potential microalgae products.  The Scientific Advisory Board held its inaugural
meeting in May 1996 and was originally scheduled to meet approximately four
times per year.  The Company intends to replace such meetings by mid-1999 with
various forms of electronic communication.  Between meetings, individual
Scientific Advisory Board members consult with the Company on an as-needed
basis.  Aquasearch believes that the individual and collective knowledge and
experience of its Scientific Advisory Board provide the Company 


                                         -20-
<PAGE>

with an important competitive advantage.  The current members of the Aquasearch
Scientific Advisory Board are as follows:

     DR. FAROOQ AZAM received a B.Sc. in Chemistry and Physics in 1962, and
M.SC. in Chemistry and Biochemistry in 1964 from the University of Panjab,
Lahore, Pakistan; he received a Ph.D. in Microbiology, Czechoslovak Academy of
Sciences, Prague in 1968.  Dr. Azam is a Professor of Biology at Scripps
Institution of Oceanography in La Jolla, California and one of the world's
leading marine microbiologists.  Dr. Azam is noted for his discovery of the
"microbial loop," a pathway that diverts much of the ocean's productivity into
bacteria and other microbes.  Before this pathway was discovered in the 1980's
it was generally believed that most of the ocean's productivity was passed up
the food chain to fishes and other predators.  Dr. Azam's contributions changed
the field of marine biology.

     DR. JOHN BARDACH received a B.Sc. in Zoology from Queen's University,
Canada in 1946 and a Ph.D. in Zoology from University of Wisconsin in 1949. Dr.
Bardach has served as Director of the Bermuda Biological Station, the Hawaii
Institute of Marine Biology and the East-West Center, as well as Professor at
the University of Hawaii. Dr. Bardach's numerous international appointments have
included Chairmanship of the U.S. National Academy of Sciences Panel on Aquatic
Food Sources, the World Bank-FAO Panel on Aquaculture Research Needs of
Developing Countries, and the State of Hawaii Aquaculture Advisory Council. 
Three of his books, HARVEST OF THE SEA, AQUACULTURE (now in its 25th printing)
and SUSTAINABLE AQUACULTURE (published in 1997), establish him as one of the
fathers of modern aquaculture.

     DR. ROBERT R. BIDIGARE received a B.S. (SUMMA CUM LAUDE) in Aquatic Biology
from Eastern Michigan University in 1977 and a Ph.D. in Biological Oceanography
from Texas A&M University in 1981.  Dr. Bidigare currently is Associate
Professor of Oceanography at University of Hawaii.  Dr. Bidigare serves on the
Advisory Board for the National Center for the Culture of Marine Phytoplankton,
is a member of the NASA SeaWIFS Science Working Team and an observer on the
International Oceanographic Commission Group of Experts on Standards and
Reference Materials.  Dr. Bidigare has authored more than 75 scientific papers,
and is a recognized expert on plant pigment chemistry, bio-optics and
biochemistry of microalgae.

     DR. JOHN CULLEN received a B.Sc. (Honors in Biology) from University of
California, Santa Cruz in 1974 and a Ph.D. in Biological Oceanography from
Scripps Institution of Oceanography, University of California, San Diego, in
1980.  Dr. Cullen has held faculty positions at the University of Texas, the
Bigelow Laboratory for Ocean Sciences and Dalhousie University in Halifax,
Canada, where he now holds the Chair of Environmental Observation Technology.
Dr. Cullen's research has focused in the area of microalgae growth rates,
productivity, nutrient requirements and bio-optics.

     DR. JOHN DORE received his Ph.D. in Biological Oceanography from the
University of Hawaii in 1995.  Dr. Dore conducted his Ph.D. research on the
microbially-mediated chemical processes of nitrogen cycling.  As a graduate
student, Dr. Dore received fellowships from the Research Corporation of the
University of Hawaii (1991-1992) and Achievement Rewards for College Scientists
(1989-1990).  As a Post-Doctoral Researcher at the University of Hawaii for the
past year he has been studying growth and carbon isotope chemistry of microalgae
in continuous cultures.  Dr. Dore has published 17 scientific articles.  Dr.
Dore is a full-time employee of Aquasearch, responsible for production as well
as research and development in the area of algal nutrition.

     DR. WILLIAM FENICAL received a B.S. in Biochemistry from California State
Polytechnic University in 1963, an M.S. in Organic Chemistry from San Jose State
University in 1965 and a  Ph.D. in Organic Chemistry from University of
California, Riverside in 1968.  Dr. Fenical joined the faculty of Scripps
Institution of Oceanography, University of California, San Diego, in 1973, where
he has served as Director 


                                         -21-
<PAGE>

of the University of California-wide Institute of Marine Resources (1988-1993)
and Director of the Marine Research Division since 1989.  Dr. Fenical is
recognized as one of the world's authorities on the chemistry of marine natural
products, an area in which he has published more than 250 scientific articles. 
Dr. Fenical has served as an advisor on marine natural product chemistry to the
National Institutes of Health, the National Research Council, and numerous
pharmaceutical companies, including Sterling Winthrop, Ligand, Pharmagenesis and
Bristol-Myers.  He serves on the editorial boards of the JOURNAL OF NATURAL
PRODUCTS, MOLECULAR MARINE BIOLOGY AND BIOTECHNOLOGY, and the JOURNAL OF MARINE
BIOTECHNOLOGY.  He holds seven patents for novel chemical compounds of a
biomedical nature, including a wrinkle reducing agent that is the active
ingredient in a skin cream marketed by Estee Lauder, which produces more than $1
million per year in royalties for the University of California.

     DR. MALCOLM GREGORY received a B.Sc. (HONOURS) in Applied Microbiology from
the Bath University of Technology, UK in 1981, and a Ph.D. in Algaculture from
King's College, University of London, in 1985, where he focused his research on
cultivation of microalgae in tubular reactors.  Dr. Gregory has more than
fifteen years experience in bioprocess engineering, specializing in process
control.  With Cyanamid of Great Britain, he implemented control systems for
bulk antibiotics production.  At the Interdisciplinary Research Centre for
Process Systems Engineering at University College, London, a world-renowned
center for excellence in biochemical engineering, he developed novel process
control methods now adopted in industry.  He is an expert in microbiological
process control.

     DR. MARK E. HUNTLEY received a B.Sc. degree (SUMMA CUM LAUDE) in Biology
from the University of Victoria, Canada in 1976 and earned a Ph.D. in Biological
Oceanography from Dalhousie University in Halifax, Canada in 1980.  Dr. Huntley
is a research biologist at Scripps Institution of Oceanography, University of
California, San Diego, and President, Chief Executive Officer and Chairman of
the Board of Directors of Aquasearch.  Dr. Huntley has won numerous awards and
grants in his field, published more than 75 articles and a book, and lectured
throughout the world.  He serves on the Executive Committee of the Global Ocean
Ecosystem Dynamics program, a component of the U.S. Global Change Research
Program, and the only element of the International Geosphere-Biosphere Program
that is examining the impact of global climate change on marine ecosystems.  He
has served as an advisor to numerous international, national and state agencies,
including the United States State Department, the United States Department of
Interior and the White House Office of Science and Technology Policy.  Dr.
Huntley is a co-founder of Aquasearch and a co-inventor of the Aquasearch Growth
Module.

     DR. EDWARD A. LAWS received a B.A. (MAGNA CUM LAUDE) in Chemistry from
Harvard College in 1967 and a Ph.D. in Chemical Physics from Harvard College in
1971.  He was an instructor in Oceanography at Florida State University from
1971 through 1974, and then joined the faculty at the University of Hawaii,
where he is now a Professor of Oceanography.  Dr. Laws has served as Chairman of
the Oceanography Department, School of Ocean and Earth Science and Technology at
the University of Hawaii, which was ranked by the National Academy of Sciences
in 1995 as the fifth best program of its kind in the nation.  Dr. Laws recently
was appointed Assistant Vice President, Graduate Research and Education, of the
University of Hawaii.  Dr. Laws is an expert on the large-scale cultivation of
microalgae, an area in which he has focused his research and has graduated a
number of Ph.D.s.

     DR. PEARN P. NIILER received his B.S. degree from Lehigh University in
1960, earned honors as a Fulbright Scholar at Cambridge University, England in
1961, and was awarded a Ph.D. as a Woodrow Wilson Fellow from Brown University
in 1964.  Dr. Niiler has taught and conducted research at Harvard College, Nova
University and Oregon State University.  He is currently a Professor of
Oceanography at Scripps Institution of Oceanography, University of California,
San Diego, where he heads one of the largest oceanographic research programs in
the nation.  Dr. Niiler has published more than 125 scientific papers and 


                                         -22-
<PAGE>

has invented various oceanographic instrumentation technologies that are now in
commercial production with sales of $6 million annually.  Dr. Niiler is an
expert in applied mathematics and fluid mechanics and was a co-inventor of
processes used in the Aquasearch Growth Module.

     DR. MIGUEL OLAIZOLA received his Ph.D. in Biological Oceanography from the
State University of New York at Stony Brook in 1993.  Dr. Olaizola devoted his
graduate and post-graduate research to the study of carotenoid biosynthesis in
microalgae, primarily diatoms and cyanobacteria.  During 1995 and 1996, Dr.
Oliazola was a Post-Doctoral Researcher at Scripps Institution of Oceanography,
University of California, San Diego, where he studied microalgal growth and
physiology.  Dr. Oliazola is a full-time employee of Aquasearch, responsible for
pigment biosynthesis.

     DR. DONALD REDALJE received his B.S. in Environmental Biology from the
University of California, Santa Barbara in 1971 and his Ph.D. from University of
Hawaii in 1980.  He has conducted research and taught at Scripps Institution of
Oceanography, University of California, San Diego, the Naval Postgraduate
School, Moss Landing Marine Laboratory, and the University of Southern
Mississippi, where he recently served as Director of the Center for Marine
Science.  Dr. Redalje is internationally recognized for his development of a
method to measure the productivity of microalgae, and is an expert on the
biochemistry and physiology of marine plants.  Dr. Redalje is a co-founder of
Aquasearch and co-inventor of the Aquasearch Growth Module.

     DR. ALADAR SZALAY received a M.Sc. in Biochemistry from the Martin Luther
University, Germany in 1966, and a Ph.D. in Biochemistry from the Martin Luther
University, Germany in 1972.  He carried out post-doctoral research on plant
genetics at the California Institute of Technology.  Dr. Szalay is founding
Director of the Center for Molecular Biology and Gene Therapy at the School of
Medicine of Loma Linda University in California.  His career has been built on
the genetic engineering of plants, including microalgae, with nutritionally and
medically important traits.  He is an expert on the genetics of microalgae.  Dr.
Szalay holds numerous patents in the area of genetic engineering, including
transgenic patents and methods for preparing and using artificial chromosomes. 
He has acted as an advisor to a variety of institutions and companies, including
Rockefeller Foundation, Allied Chemical, Siemens AG, and Boehringer Mannheim.

     Most members of the Scientific Advisory Board are not employed by the
Company and each of these members may have commitments to other entities that
could limit their availability to the Company.  There can be no assurance that
the Company will be able to retain its key Scientific Advisory Board members.

ITEM 2.  DESCRIPTION OF PROPERTIES

     The Company is located in the HOST Business Park in Kailua-Kona, Hawaii. 
This facility currently consists of approximately five leased acres containing a
number of AGMs, reddening ponds, a processing facility, a laboratory,
administrative offices and additional space for production and research and
development.  All products are currently produced at this facility. Aquasearch
has no production facilities or offices outside the State of Hawaii.

     The Company has initiated the application process for a thirty-year lease
of its current five acre parcel from the Natural Energy Laboratory of Hawaii
Authority ("NELHA"), the state entity which administers the HOST Business Park.
Leases of thirty years have historically been awarded to companies once they
have completed their research and development stage, which the Company plans to
complete this year.  The government-administered process to award a thirty-year
lease has usually taken less than two years.  More than half of the 800-acre
HOST Business Park facility is currently undeveloped and the 


                                         -23-
<PAGE>

Company believes that, as one of the fastest growing and largest employers in
HOST Business Park, its lease application is likely to be considered favorably,
although there can be no assurances in this regard.

     Construction to expand the Company's existing one-acre research and
development/production facility to a three-acre facility began in early 1998. 
The design and engineering process for this expansion was initiated in April
1996 when Aquasearch solicited bids from various engineering firms.  As a result
of the bidding process, Aquasearch retained Harris Group, Inc. of Seattle, an
engineering firm with extensive experience in the design of biotech,
microbe-based production plants, to design the build-out of the facility.  The
engineering process for this expansion was completed in September 1996.  More
recently, the engineering plans for expanded production capability have been
updated in collaboration with the significant involvement of Cultor engineering
personnel.

     In late 1997 the Company retained a local team including architects,
engineers and contractors to complete the design process and to obtain the
necessary construction permits.  In late 1997, Aquasearch was granted the
necessary permits to begin construction.  Construction of the expanded facility
began in early 1998 and is scheduled to be completed in January 1999 at an
estimated cost of $2.3 million.

     On November 14, 1996, the Company executed a Letter of Intent with C.
Brewer and Company, Limited ("C. Brewer") with respect to the acquisition by the
Company of between 80 and 90 acres of property in the Ka'u region of the Big
Island of Hawaii valued at between $900,000 and $1,000,000 in exchange for the
issuance to C. Brewer of between 2,570,000 and 2,850,000 shares of Common Stock
of the Company (the "C. Brewer Common Stock") at a purchase price of $0.35 per
share. In addition, C. Brewer acquired a three-year warrant to purchase up to
500,000 shares of Common Stock at a purchase price of $1.25 per share.  In the
light of the Company's recent advances in production technology and yields, the
consummation of this transaction will be delayed until the Company and Cultor
determine the best strategy and location for future development of a natural
astaxanthin production facility dedicated solely to satisfying the requirements
of an expanded Aquasearch/Cultor relationship.

ITEM 3. LEGAL PROCEEDINGS

     On July 13, 1998, Cyanotech filed a complaint (the "Complaint") in the 
United States District Court for the District of Hawaii (Case No. 
CV98-00600ACK) against the Company.  In the Complaint, Cyanotech seeks 
declaratory judgment of noninfringement of the Company's U.S. Letters Patent 
No. 5,541,056 (the "5,541,056 Patent"); invalidity of the 5,541,056 Patent; 
and non-misappropriation of the Company's trade secrets relating to closed 
culture production of astaxanthin. Cyanotech filed the Complaint after the 
Company expressed to Cyanotech its concern that Cyanotech infringed the 
5,541,056 patent and misappropriated Aquasearch trade secrets. The Company 
does not believe that Cyanotech's Complaint is meritorious.  However, the 
Company may be required to dedicate significant management time and incur 
significant legal fees and expenses to pursue this action, which could have a 
material adverse effect on the Company's business, financial condition, 
results of operations and relationships with corporate partners.  In 
addition, in the event that Cyanotech were to prevail in this action, a 
finding of noninfringement or declaration of invalidity of the 5,541,056 
Patent could have a material adverse effect on the Company's business, 
financial condition, results of operations and relationships with corporate 
partners.

     On September 11, 1998, the Company filed an answer denying all of 
Cyanotech's allegations and a counter claim, alleging  infringement of the 
5,541,056 Patent; misappropriation of trade secrets; unfair competition; and 
breach of contract relative to its 1994 Dissolution Agreement with Cyanotech.

     On December 14, 1998, Cyanotech filed a motion for partial summary 
judgment of noninfringement and invalidity of the 5,541,056 Patent. The 
Company does not believe that this motion is meritorious. The Cyanotech 
summary judgment motion is scheduled to be heard on March 29, 1999.

     The trial in the lawsuit with Cyanotech is currently set to begin on 
September 27, 1999.

                                         -24-
<PAGE>

                                       PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

MARKET INFORMATION

     The Company's Common Stock is currently traded in the "pink sheets" (OTC
Bulletin Board Symbol: AQSE).  The following table sets forth for the periods
indicated the high and low bid quotations for the Company's Common Stock as
reported by M.H. Myerson & Company, one of the Company's market makers.  These
quotations are believed to represent inter-dealer quotations, without adjustment
for retail mark-up, mark-down or commissions and may not represent actual
transactions.

<TABLE>
<CAPTION>
                                                         HIGH BID      LOW BID
                                                         --------      -------
<S>                                                      <C>           <C>
FISCAL 1997
     First Quarter  . . . . . . . . . . . . . . . .         $0.63        $0.33
     Second Quarter . . . . . . . . . . . . . . . .         $0.39        $0.20
     Third Quarter  . . . . . . . . . . . . . . . .         $0.28        $0.17
     Fourth Quarter . . . . . . . . . . . . . . . .         $0.36        $0.19

FISCAL 1998
     First Quarter  . . . . . . . . . . . . . . . .         $0.29        $0.20
     Second Quarter . . . . . . . . . . . . . . . .         $0.28        $0.19
     Third Quarter  . . . . . . . . . . . . . . . .         $0.24        $0.18
     Fourth Quarter . . . . . . . . . . . . . . . .         $0.21        $0.18

</TABLE>

     As of October 31, 1998, the Company had approximately 2,000 record holders
of its 68,564,013 shares of Common Stock.

DIVIDEND POLICY

     The Company has never paid cash dividends on its capital stock.  The
Company currently intends to retain all available funds for use in the operation
and expansion of its business.  The Company does not anticipate paying any cash
dividends in the foreseeable future.  As of October 31, 1998, the Company had an
accumulated deficit of approximately $7.1 million, and until this deficit is
eliminated will be prohibited from paying dividends except out of net profits.

RECENT SALES OF UNREGISTERED SECURITIES

     In September and October 1998, the Company issued one-year Convertible 
Notes amounting to $565,000.  The holders of these notes have an option to 
convert to the Company's Common Stock.  The Convertible Notes carry an 
interest rate of 10 percent per annum and warrants to purchase 1,000 shares 
of Common Stock at $0.50 per share for each $1,000 aggregate principal amount 
of Convertible Notes.  The holders are shareholders and an officer/director 
of the Company.

     During the period from June 1997 to September 1998, the Company sold
$3,305,000 aggregate principal amount of Convertible Notes to a total of twelve
"accredited investors".  In connection with the issuance of the convertible
notes, the Company also issued a total of 3,305,000 Warrants to purchase a total
of 3,305,000 shares of Common Stock.  The warrants have an exercise price of
$0.50 per share and have a term of three years.  As part of this transaction, an
officer/director, purchased a $760,000 Convertible Note and 760,000 Warrants. 
Between July and September 1998, these convertible notes and accrued interest,
were converted into 20,075,648 shares of common stock.


                                      -25-

<PAGE>

     In March 1998, a former officer of  the Company, Tana Alcalay exercised 
an option to purchase 466,862 shares of Common Stock at $0.0625 per share 
under a 3 year 5 per cent note payable, secured by the underlying shares of 
Common Stock.

     In January and March 1998, the Company issued a total of 234,000 shares, 
valued at $0.25 per share, of Common Stock to a total of eight members of its 
Scientific Advisory Board (Farooq Azam, Robert Bidigare, John Bardach, 
William Fenical, Malcolm Gregory, Pearn Niiler, Edward Laws and Aladar 
Szalay) for services rendered or to be rendered in 1997 and 1998.  No 
underwriters were used.  This offering was made in reliance on the exemption 
provided under Section 4(2) of the Securities Act.

     In October 1997, the Company issued 50,000 shares of Common Stock at $0.25
per share to Edward E. David, Sc.D., for consulting services rendered as a
member of the Company's Board of Directors. No underwriter was used. This
offering was made pursuant to the exemption provided under Section 4(2) of the
Securities Act.

     In October 1997, the Company sold 50,000 shares of Common Stock at $0.25
per share to Edward E. David, Sc.D., a member of the Company's Board of
Directors. The total proceeds to the Company from this transaction were $12,500.
No underwriter was used. This offering was made pursuant to the exemption
provided under Section 4(2) of the Securities Act.

     In October 1997, the Company issued 10,000 shares of Common Stock at $0.25
per share to Oskar R. Zaborsky, Ph.D., for consulting services rendered as a
member of the Company's Board of Directors. No underwriter was used. This
offering was made pursuant to the exemption provided under Section 4(2) of the
Securities Act.

     In October 1997, the Company sold 10,000 shares of Common Stock at $0.25
per share to Oskar R. Zaborsky, Ph.D., a member of the Company's Board of
Directors. The total proceeds to the Company from this transaction were $2,500.
No underwriter was used. This offering was made pursuant to the exemption
provided under Section 4(2) of the Securities Act.

     In September 1997, a former officer of  the Company, Tana Alcalay 
exercised an option to purchase 463,250 shares of Common Stock at $0.0625 per 
share under a 3  year  5 per cent note payable, secured by the underlying 
shares of Common Stock. 

     During the two quarters ended October 31, 1997, the Company issued one-year
Convertible Notes Payable amounting to $560,000. The holders of these notes have
an option to convert to equity under a planned private placement in early fiscal
1998. The Convertible Notes carry an interest rate of 10 percent per annum and
warrants to purchase 1,000 shares of Common Stock at $0.50 per share for each
$1,000 aggregate principal amount of Convertible Notes.  The holders are
shareholders and an officer/director of the Company.

     In April 1997, the Company sold 1,000,000 shares of its Common Stock to an
officer of the Company at a purchase price of $0.21 per share.  In addition, the
Company granted this person a non-statutory stock option to purchase 1,000,000
shares of Common Stock at an exercise price of $1.00 per share.  The option has
a term of ten years.  These transactions were exempt from registration under the
Securities Act of 1933 pursuant to Section 4(2).  No underwriters were involved
in these transactions.

     During the period from October 1996 to April 1997, the Company sold an
aggregate of 5,044,570 Units, consisting of one share of Common Stock and one
Common Stock Purchase Warrant (the "Warrants"), 


                                      -26-

<PAGE>

to 42 accredited investors (the "Unit Investors") in a private placement (the
"Unit Offering") under Section 4(2) of the Securities Act of 1933, as amended. 
The purchase price of the Units ranged from $0.21 per Unit to $0.44 per Unit. 
The Warrants have a term of three years and are exercisable at $1.00 per share,
subject to adjustment.  The Warrants are redeemable by the Company at $.01 per
Warrant during their three-year exercise period upon 30 days' notice anytime
that the closing bid price per share of the Common Stock exceeds $1.50 per share
(subject to adjustment) for 20 trading days out of 30 consecutive trading days
ending on the third day prior to the date of the notice of redemption.  The
gross proceeds from the Unit Offering were $1,275,980. The Placement Agent for
the Unit Offering, First Honolulu Securities, Inc., received total commissions
of $76,558.80 (equal to 6% of the gross proceeds from the sale of the Units) and
302,674 Common Stock Purchase Warrants (equal to 6% of the number of Units
sold). The terms of the Warrants issued to First Honolulu Securities, Inc. are
identical to the terms of the Warrants issued to the Unit Investors in the Unit
Offering.

     In October 1997, the Company issued 1,303,000 shares of Common Stock to the
Unit Investors as compensation for the failure by the Company to cause the
registration statement of the shares purchased in the Unit Offering to be
declared effective by the Securities and Exchange Commission (the "Commission")
on or before May 29, 1997.  The registration statement was declared effective on
November 12, 1997.  These have been reflected in the shares issued and
outstanding as of October 31, 1997.

     In November 1996, the Company issued a total of 18,760 shares of Common 
Stock to a total of four members of its Scientific Advisory Board (Robert 
Bidigare, John Bardach, William Fenical and Edward Laws) for services 
rendered through May 1996 (4,488 shares at $0.892 per share), through August 
1996 (5,407 shares at $0.50 per share) and through November 1996 (8,865 
shares at $0.638 per share).  No underwriters were used.  This offering was 
made in reliance on the exemption provided under Section 4(2) of the 
Securities Act.

     In October 1996, the Company sold 400,000 shares of Common Stock at $0.50
per share to Cultor pursuant to the Cultor Stock Subscription Agreement.  The
total proceeds to the Company from this transaction were $200,000.  No
underwriters were used.  This offering was made in reliance on the exemption
provided under Section 4(2) of the Securities Act.

     On September 24, 1996, the Company's shareholders approved (i) the Cultor
Distribution and Development Agreement, (ii) the Cultor Stock Subscription
Agreement and (iii) an amendment to the Company's Articles of Incorporation to
increase the number of shares of Common Stock that the Company is authorized to
issue from 50,000,000 shares to 100,000,000 shares and authorized the creation
and issuance from time to time of up to 5,000,000 shares of Preferred Stock in
one or more series with such designations, rights, preferences, privileges and
restrictions as the Board of Directors may determine.

     In February 1996, the Company issued 40,000 shares of Common Stock at $0.62
per share, to Seth Huntley, one of the Company's production technicians, for
services rendered during the period from August 1995 through January 1996.  No
underwriter was used.  This offering was made to Mr. Huntley without
registration pursuant to the exemption provided under Section 4(2) of the
Securities Act.

     In January 1996, the Company sold 4,000,000 shares of Common Stock at $0.15
per share to 18 accredited investors in a private placement under Section 4(2)
of the Securities Act.  The total proceeds to the Company from this transaction
were $600,000.  No underwriters were used.


                                      -27-

<PAGE>

     In January 1996, the Company sold 2,492,000 shares of Common Stock at
$0.125 per share to three purchasers under Regulation S under the
Securities Act. The total proceeds to the Company from this transaction were
$311,600.  No underwriters were used.

     In December 1995, the Company issued 40,000 shares of Common Stock at
$0.125 per share to John J. Emerick, the Company's Vice President of Operations,
for services rendered during the period from July 1995 through December 1995. 
No underwriter was used.  This offering was made to Mr. Emerick without
registration pursuant to the exemption provided under Section 4(2) of the
Securities Act.

     In November 1995, the Company issued an aggregate of 264,000 shares of
Common Stock at $0.125 per share to nine accredited investors as partial payment
for their services in constructing the Company's research and development
facility at Keahole Point.  No underwriters were used.  This offering was made
in reliance on the exemption provided under Section 4(2) of the Securities Act.

     In October 1995, the Company issued 127,875 shares at $0.0625 to 4 
accredited investors and employees for prior services rendered to the 
Company. No underwriters were used.  This offering was made under Section 
4(2) of the Securities Act.

     In September 1995, the Company sold 2,712,500 shares of Common Stock at
$0.08 per share to 16 accredited investors in a private placement under Section
4(2) of the Securities Act. No underwriters were used.
    
     In August 1995, the Company returned to Mark E. Huntley, Ph.D., the
Company's President and Chief Executive Officer, 1,320,000 shares of Common
Stock out of the 4,635,575 shares of Common Stock gifted to the Company by Dr.
Huntley in 1989.  The closing bid price of the Company's Common Stock on the
date the 1,320,000 shares were returned to Dr. Huntley was $0.15 per share. No
underwriters were used.   This offering was made to Dr. Huntley under
Section 4(2) of the Securities Act.

     In July 1995, the Company sold 3,200,000 shares of Common Stock at $0.0625
per share to one non-U.S. purchaser under Regulation S under the Securities Act.
The total proceeds to the Company from this transaction were $200,000.  No
underwriters were used.

     In June 1995, the Company issued 50,000 shares of Common Stock at $0.10 per
share to Robert Bidigare, Ph.D., for services rendered in connection with the
analysis of scientific data from feed trials with Cultor.  No underwriters were
used.  These shares were issued to Dr. Bidigare without registration pursuant to
the exemption provided under Section 4(2) of the Securities Act.

     In March 1995, the Company sold 1,710,000 shares of Common Stock at $0.10
per share to 33 accredited investors in a private placement under Section 4(2)
of the Securities Act.  No underwriters were used.  The total proceeds to the
Company were $171,000.


ITEM 6.  MANAGEMENT'S PLAN OF OPERATION

     THIS ANNUAL REPORT CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING
OF SECTION 21E OF THE EXCHANGE ACT, INCLUDING STATEMENTS, TREND ANALYSIS AND
OTHER INFORMATION RELATIVE TO MARKETS FOR THE COMPANY'S PRODUCTS AND TRENDS IN
REVENUES AND ANTICIPATED EXPENSE LEVELS, AS WELL AS STATEMENTS INCLUDING WORDS
SUCH AS "ANTICIPATE," "EXPECT," "BELIEVE," "PLAN," 


                                      -28-

<PAGE>

"ESTIMATE" AND "INTEND" AND OTHER SIMILAR EXPRESSIONS. SUCH FORWARD-LOOKING
STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS THAT
MAY CAUSE ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS OF THE COMPANY TO DIFFER
MATERIALLY FROM THOSE EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS.
SUCH FACTORS INCLUDE, AMONG OTHERS, THE INFORMATION DESCRIBED UNDER THE CAPTION
"FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS" AND OTHER RISKS DETAILED FROM
TIME TO TIME IN THE COMPANY'S PERIODIC REPORTS AND OTHER INFORMATION FILED WITH
THE COMMISSION.

OVERVIEW

     Aquasearch is a development stage company that is developing a proprietary,
closed-system technology for the large-scale, commercial cultivation of
photosynthetic microalgae.  The Company's microalgae cultivation technology is
known as the Aquasearch Growth Module (the "AGM").

     The Company was founded in February 1988 as a Colorado corporation and
acquired all the assets of Aquasearch, Inc., a California corporation, in May
1988 in a stock-for-stock exchange.  The Company commenced operations in Borrego
Springs, California and developed its first prototype of the AGM in 1988. Until
March 1993, the Company conducted research and development focused on refining
its production technology and cultivating microalgal species of several markedly
different varieties.

     In March 1993, the Company formed a joint venture company with Cyanotech,
an unaffiliated producer of microalgae, to develop commercial systems for the
production of astaxanthin-rich microalgae. Aquasearch contributed approximately
$147,000 in capital to the joint venture company and licensed its AGM technology
to the joint venture company.  Cyanotech contributed approximately $15,000 in
capital to the joint venture company and made available its facilities and
personnel at the HOST Business Park at Keahole Point, Kailua-Kona, Hawaii.  AGMs
were constructed in July 1993 that demonstrated the economics of the production
process and provided samples of astaxanthin-rich microalgae for analysis and
trial applications.

     In the summer of 1994, Aquasearch initiated discussions with Cultor, a
Finnish food conglomerate, regarding the purchase of astaxanthin-rich
microalgae.  While awaiting a response from Cultor, Aquasearch elected to
discontinue its participation in the joint venture company and the joint venture
agreement was terminated by mutual consent in November 1994.  The dissolution
agreement provided that all intellectual property rights to the AGM technology
reverted to Aquasearch.

     In December 1994, Cultor initiated a series of feeding trials with farmed
salmon using astaxanthin-rich microalgae produced by the Company.

     In April 1995, the Company leased a half-acre site within the HOST Business
Park and began construction of a research and development facility capable of
producing small amounts of microalgae containing astaxanthin for marketing
purposes.  This half-acre facility, comprised of AGMs and an operating
laboratory, was completed in June 1995.

     In July 1995, the Company entered into a three-year Supply Agreement with
Svenska Foder, then a subsidiary of Cultor, pursuant to which Svenska Foder
agreed to act as the exclusive distributor of the Company's natural astaxanthin
product for animal feed and animal nutrition applications in Sweden, Norway and
Finland for poultry, pigs, cattle and horses.  In December 1996, Cultor sold
Svenska Foder to KKR, a 


                                      -29-

<PAGE>

Danish animal feeds company, and assumed all of Svenska Foder's rights and
obligations under the Svenska Foder Supply Agreement.

     In July 1995, the Company leased additional space in the HOST Business Park
to expand its half-acre research and development facility to a one-acre research
and development/production facility.  Construction of the one-acre research and
development/production facility was completed in October 1995.

     In May 1996, the Company entered into a three-year Distribution and
Development Agreement with Cultor (recently extended to four years) pursuant to
which the Company will act as the exclusive worldwide supplier of natural
astaxanthin derived from microalgae to Cultor in the field of animal feed and
animal nutrition and Cultor will act as the exclusive worldwide distributor of
Aquasearch's natural astaxanthin product in the field of animal feed and animal
nutrition. Under the Cultor Distribution and Development Agreement, Cultor and
Aquasearch may, at Cultor's option, mutually develop a new joint venture company
for the sole purpose of producing and selling natural astaxanthin derived from
microalgae in the field of animal feed and animal nutrition.  See "Description
of Business--Cultor Distribution and Development Agreement."

     In July 1996, the Company was awarded U.S. Patent Number 5,541,056 for a
"Method of Control of Microorganism Growth Process," which claims certain
processes that operate in the Company's proprietary, closed-system
photobioreactor, the Aquasearch Growth Module.  The Company's U.S. filing was
made under the provision of the Patent Cooperation Treaty, and the Company is in
the process of pursuing international patents pursuant thereto.  

     In October 1996, Cultor acquired 400,000 shares of the Company's Common
Stock at a purchase price of $0.50 pursuant to the Cultor Stock Subscription
Agreement.

     In November 1996, the Company executed a Letter of Intent with C. Brewer
and Company, Limited ("C. Brewer") with respect to the acquisition of between 80
and 90 acres of property in the Ka'u region of the Big Island of Hawaii valued
at between $900,000 and $1,000,000 in exchange for C. Brewer's acquisition of
approximately 6% of the Company's outstanding Common Stock.  In addition,
C. Brewer acquired a three-year warrant (the "C. Brewer Warrant") to purchase up
to 500,000 shares of Aquasearch Common Stock at a purchase price of $1.25 per
share.  In the light of the Company's recent advances in production technology
and yields, the consummation of this transaction will be delayed until the
Company and Cultor determine the best strategy and location for future
development of a natural astaxanthin production facility dedicated solely to
satisfying the requirements of an expanded Aquasearch/Cultor relationship.
 
     In June 1997, Aquasearch was awarded European Patent Number 0494887 for a
"Process and Apparatus for the Production of Photosynthetic Microbes," which not
only claims certain processes, but also certain features of its core technology,
the Aquasearch Growth Module.  The European patent complements, but does not
supplant claims made in the U.S. Patent awarded in 1996.  The Company's European
filing was made under the Patent Cooperation Treaty, and the Company is in the
process of pursuing international patents pursuant thereto.

     In September 1997, Aquasearch executed a Letter of Intent with Inflazyme
Pharmaceuticals, Limited ("Inflazyme") to enter into a ten-year drug development
and manufacturing agreement.  Under the terms of the agreement, Aquasearch would
produce large-scale research quantities of several thousand different microalgae
in its AGM photobioreactors.  Inflazyme would investigate each species for
therapeutic activity in the areas of inflammation, cancer, blood and
cardiovascular diseases.  Aquasearch would receive cost-plus reimbursement of
all its research costs (including dedicated physical facilities); potential
milestone payments 


                                      -30-

<PAGE>

associated with steps in the U.S. Food and Drug Administration drug approval
process; and royalties on future net product sales.  The conversion of this
Letter of Intent into a final Screening and Drug Development Agreement has been
delayed due to management changes within Inflazyme.  Given the extended delay,
there can be no assurances as to when or if a final agreement will be
consummated.

     Aquasearch has an active Scientific Advisory Board consisting of thirteen
Ph.D.s with expertise in the fields of aquaculture; marine biology; fluid
dynamics; and the chemistry, photobiology, physiology, genetics and mass culture
of microalgae.

     INTELLECTUAL PROPERTY AND TECHNOLOGY OPTIMIZATION - 1998
     
     In September 1998, Aquasearch was awarded its first patent in Asia under
Hong Kong Patent Number HK1001232 for a "Process and Apparatus for the
Production of Photosynthetic Microbes," which not only claims certain processes,
but also certain features of its core AGM technology. This patent and the
European patent complement, but does not supplant claims made in the U.S. Patent
awarded in 1996.  The Company is continuing its process of pursuing
international patents pursuant thereto.

     Aquasearch placed great emphasis in the past year on optimizing the AGM and
its performance.  The Company believes that it has made significant advances in
several key areas of its production technology during this period, including: 
(i) biology-based improvements; (ii) advanced production procedures; (iii)
significant increases in AGM size; and (iv) production automation advancements. 
These improvements resulted in a fifteen-fold increase in productivity (weight
of Astaxanthin per unit of production capacity) and sustained operation for a 
nine-month period of the largest photobioreactor the Company has operated to
date, and which the Company believes to be the largest photobioreactor in
existence.

     During the 1998 fiscal year, the Company increased the size of its largest
AGM from 1,000 gallons to 4,000 gallons.  Following the close of the 1998 fiscal
year, the Company further increased the capacity of its AGMs to 7,000 gallons. 
The larger AGM is not only less costly, but requires less labor, operates for a
longer period of time and has significantly greater productivity than the
smaller version.  Management anticipates replacing all production capacity with
the new 7,000 gallon AGMs in 1999, contingent on available capital.  The Company
believes that the use of these very large AGMs will increase total production
capacity by a factor of more than six with no increase in labor costs.

     DEVELOPMENT OF NATURAL ASTAXANTHIN PRODUCTS - 1998

     During the past twelve months, Aquasearch and Cultor have jointly carried
out expensive and essential projects aimed at demonstrating efficacy of the
Company's natural astaxanthin product in salmon and trout feed.  
     
     Two important projects were undertaken in 1997 and 1998.  The first
project, conducted on contract with the Norwegian Fisheries Research Institute,
demonstrated equivalence between Aquasearch's natural astaxanthin product and
Hoffman-LaRoche's synthetic astaxanthin with regard to efficacy of pigmentation
of salmonid fish (salmon and trout).  The second project, still underway, has
demonstrated a shelf life of more than six months for the Company's natural
astaxanthin product.  The shelf life experiments will continue for at least six
months more.

     The results of these product development projects have demonstrated,
largely at Cultor's expense, that Aquasearch's product has viable commercial
applications.  To the knowledge of Aquasearch, no other company has yet
demonstrated equivalent results for any products that might compete with the
synthetic 


                                      -31-

<PAGE>

astaxanthin produced by Hoffman-LaRoche.  Aquasearch believes the results of
these projects provide it with a significant competitive advantage.

     NEW STRATEGIC BUSINESS RELATIONSHIPS - 1998

     In July 1997, Aquasearch agreed to become a charter member of the Marine
Bioproducts Engineering Center (MarBEC) initiative launched by the University of
Hawaii at Manoa.  More than 160 universities -- including University of Hawaii
-- competed nationwide for a total of five Engineering Research Centers to be
awarded by the National Science Foundation.  In November 1998, the award was
officially announced by the National Science Foundation.  MarBEC, with estimated
funding of approximately $40 million for a 10-year period, will focus entirely
on the development of new enzymes and pigments from microalgae.  
     
     Charter industry members of MarBEC (including Aquasearch, Merck, Monsanto,
Hoechst and Eastman Chemical) will have equal preferential rights to new
products from microalgae developed by MarBEC.  Aquasearch believes that it is
the only charter member of MarBEC that has developed photobioreactor technology,
which is likely to be required for the commercial exploitation of any new
product from microalgae.

     In December 1998, shortly after the close of the 1998 fiscal year,
Aquasearch entered into a drug discovery agreement with Enzymed, Inc., a
U.S.-based, privately-held biotechnology company.  Enzymed uses its proprietary
technology, "Combinatorial Biocatalysis," for lead optimization of promising new
drug candidates, under contract to a variety of major pharmaceutical companies,
including Merck, Hoffman LaRoche, and Novartis.  Under the terms of the
agreement with Aquasearch, Enzymed will generate a large number of novel
compounds based upon the starting materials found originally in microalgae and
provided by Aquasearch.  Both companies will share in the potential revenues
from the commercialization of the resulting compound libraries, including access
fees, licensing fees, milestone payments, royalties and commercial sales.

     The Company is currently in preliminary discussions with a major U.S.
chemical company and a major Japanese food/pharmaceutical company with respect
to the development of certain human nutritional supplements or nutraceuticals. 
The Company is also in late-stage discussions with a smaller French
pharmaceutical company with respect to the possible formation of a joint venture
to commercialize microalgae in the nutraceutical and/or pharmaceutical.  There
can be no assurances as to when or if these discussions will lead to the
execution of a letter of intent or final agreement, or whether the terms of such
arrangements will be attractive to the Company.

     RECENT FINANCING ACTIVITY

     During the period from June 1997 to September 1998, the Company raised
$3,305,000 through the sale of Convertible Notes to a total of twelve
"accredited investors".  In connection with the issuance of the convertible
notes, the Company also issued a total of 3,305,000 Warrants to purchase a total
of 3,305,000 shares of Common Stock.  The warrants have an exercise price of
$0.50 per share and have a term of three years.  Between July and September
1998, these convertible notes and accrued interest, were converted into
20,075,648 shares of Common Stock.

     In September and October 1998, the Company issued one-year Convertible 
Notes amounting to $565,000.  The holders of these notes have an option to 
convert to the Company's Common Stock.  The Convertible Notes carry an 
interest rate of 10 percent per annum and warrants to purchase 1,000 shares 
of Common Stock at $0.50 per share for each $1,000 aggregate principal amount 
of Convertible Notes.

                                      -32-

<PAGE>

MANAGEMENT'S PLAN OF OPERATION

     During the next twelve months, Aquasearch intends to focus its efforts on
strengthening its intellectual property position, optimizing the performance of
its proprietary AGM technology, expanding its production capacity, initiating a
business in pharmaceutical drug development, and improving productivity through
employee incentives.

-    INTELLECTUAL PROPERTY:  The Company is maintaining numerous international
     patent applications under the aegis of the Patent Cooperation Treaty, and
     contemplates new filings that will enhance its formal claims to
     intellectual property.  At the same time, Aquasearch continues to develop
     certain trade secrets that management believes will enhance its
     intellectual property position.

-    TECHNOLOGY IMPROVEMENT:  Aquasearch intends to enlarge the size of all its
     proprietary AGMs from 4,000 gallons to 7,000 gallons during 1999. 
     Furthermore, the process control system is slated for hardware and software
     improvements, which the Company believes will reduce capital and labor
     costs and improve productivity.

-    EXPANSION OF PRODUCTION CAPACITY:  Aquasearch began construction in early
     1998 to increase the size of its Keahole Point research and
     development/production facility from one acre to three acres.  Construction
     is expected to be completed in January 1999, and is anticipated to augment
     production capacity to approximately 20 kilograms per month (given existing
     pond finishing constraints).  Pending further discussions with Cultor (or
     other potential partners, provided Aquasearch can be released from its
     exclusivity with Cultor), the Company currently plans to develop a second
     site for large-scale astaxanthin production.  It is currently contemplated
     that this second site would be larger than the ten-acre second site
     initially contemplated in the Cultor Distribution and Development Agreement
     and would have a production capacity significantly greater than 120
     kilograms per month.

-    PHARMACEUTICAL DRUG DEVELOPMENT:  Aquasearch intends to pursue drug
     development agreements with several biotechnology and pharmaceutical
     companies.  The Company believes that the consummation of such agreements
     would cover a significant portion of the Company's pharmaceutical research
     and development costs.  The Company believes that additional personnel will
     need to be hired to perform such projects, but the Company intends to keep
     its current personnel entirely focused on astaxanthin-related science and
     technology.  New personnel hired for drug development work will be
     dedicated entirely to those projects and will function as a separate team,
     which costs will be borne by strategic partners.  The Company believes that
     additional laboratory facilities may also be required for drug development
     activities.  The Company intends that costs for such dedicated facilities
     will be borne by strategic partners.

-    IMPROVEMENTS IN PRODUCTIVITY:  At the outset of fiscal year 1998,
     Aquasearch implemented an incentive compensation program to award
     significant cash bonus incentives to all employees provided that the
     Company met certain quarterly production targets.  Targets were planned
     that management believed would significantly advance the Company's research
     and production efforts.  Under the incentive program, cash bonuses
     represent as much as a 25% increase in salary on a quarterly basis.  The
     Company also awarded stock options to all employees as a further incentive
     to increase productivity.  Aquasearch believes that the implementation of
     its incentive compensation program at the outset of fiscal 1998 was a
     significant factor in the Company's productivity gains in fiscal 1998.


                                      -33-

<PAGE>

     The Company expects to continue producing relatively small amounts of
astaxanthin (less than six kilograms dry weight per month) until February 1999,
when it expects to begin shipping to Cultor.  To date, the Company has satisfied
its requirements for product testing, regulatory approvals and related
developmental activities.  The Company will focus in the next twelve months on
continuing to improve yields and increasing the cost-effectiveness of its
production.

     The Company believes that strategic relationships and collaborations will
continue to be an important part of its business strategy.  There can be no
assurances that the Company will be able to maintain existing corporate partner
relationships, enter into future relationships to develop additional
applications for natural astaxanthin or to develop new microalgae products or
that any such relationships will be successful.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

     Since inception, the Company's primary operating activities have consisted
of basic research and development and production process development; recruiting
personnel; purchasing operating assets; and raising capital.  From inception
through October 31, 1998, the Company had an accumulated deficit of
approximately $7.1 million.  The Company's losses to date have resulted
primarily from costs incurred in research and development and from general and
administrative costs associated with the Company's operations.  The Company
expects to continue to incur operating losses for at least the next two years as
it continues to expand its production facilities and increases its research and
development efforts.  The Company expects to have quarter-to-quarter and
year-to-year fluctuations in revenues, expenses and losses, some of which could
be significant.  Management believes that the forthcoming year will continue to
require significant investment in the Company's strategic development plan;
Aquasearch has already agreed to a commitment from a single investor who plans
to invest a total of $2.0 million during calendar 1999.

     The Company has a limited operating history and any assessment of the
Company's prospects must include the technology risks, market risks, expenses
and other difficulties frequently encountered by development stage companies,
and particularly companies attempting to enter competitive industries with
significant technology risks and barriers to entry.  Although the Company has
attempted to address these risks by, among other things, hiring and retaining
highly qualified persons and forging strategic alliances with companies that
complement the Company's technical strengths, there can be no assurance that the
Company will overcome these risks in a timely manner, if at all.

     The Company is in the process of transition to a full-scale commercial
producer of microalgae products.  These changes in its business have placed and
will continue to place significant demands on the Company's management, working
capital and financial and management control systems.

     RESULTS OF OPERATIONS

     REVENUES.  Since inception, the Company has been primarily engaged in basic
research and development and manufacture process development; recruiting
personnel; purchasing operating assets; and raising capital.  In fiscal 1996,
the Company shipped its natural astaxanthin product to Svenska Foder under the
Svenska Foder Supply Agreement, which resulted in revenues of approximately
$10,000.  Aquasearch's natural astaxanthin product was provided to Cultor under
the Cultor Distribution and Development Agreement, resulting in revenues of
$1,077 in fiscal 1997 and $ -0- in fiscal 1998; the majority of product shipped
or produced was used primarily for product development projects carried out
jointly by Aquasearch and Cultor.


                                      -34-

<PAGE>

     RESEARCH AND DEVELOPMENT COSTS.  Research and development costs include
salaries, consulting fees, development materials, equipment depreciation and
costs associated with operating the Company's one-acre research and
development/production facility. Research and development costs were
approximately $1.2 million for the fiscal year ended October 31, 1998 compared
with $794,000 and $649,000 in 1997 and 1996, respectively.  Substantially all of
these funds were expended to improve the Company's natural astaxanthin
production system, to implement improved computerized process control, and to
reduce capital costs of the AGM technology.  From inception through October 31,
1998, the Company's total research and development costs were approximately $3.1
million.  Aquasearch expects to incur significant additional research and
development expenses in future periods.

     GENERAL AND ADMINISTRATIVE EXPENSES.  General and administrative expenses
consist principally of salaries and fees for professional services.  General and
administrative costs were approximately $964,000, $1.1 million, and $641,000 for
the fiscal years ended October 31, 1998, 1997 and 1996, respectively. The
increase in annual general and administrative expenses since 1996 reflects
additional costs associated with personnel additions, legal fees incurred in
connection with developing and protecting the Company's intellectual property
position and raising capital, as well as other expenses.  Additionally,  in
fiscal 1997, the Company recorded a charge of $275,000 of stock issued as
compensation for the failure by the Company to cause the registration statement
of the shares purchased under a private placement during the period from
October 1996 through April 1997 to be declared effective by the Securities and
Exchange Commission on or before May 29, 1997. From inception through October
31, 1998, the Company's total general and administrative expenses were
approximately $3.7 million.  The Company anticipates that its general and
administrative expenses will increase over time as it expands its production
capacity, expands its intellectual property protection and raises additional
capital.

     LIQUIDITY AND CAPITAL RESOURCES

     The Company has financed its operations to date through public and private
sales of equity securities.  In the fiscal years ended October 31, 1998, 1997
and 1996, Aquasearch raised approximately $3.4 million, $1.3 million and $1.3
million of net proceeds from the sale of shares of Common Stock and/or issuance
of Convertible Notes, respectively, in private placement transactions.  From
inception through October 31, 1998, the Company had raised total net proceeds of
approximately $8.0 million through public and private sales of equity and debt
securities.

     In the fiscal year ended October 31, 1998, operating activities consumed
approximately $1.5 million compared with $2.0 million in 1997 and $470,000 in
1996.  From inception through October 31, 1998, operating activities have
consumed approximately $5.1 million.

     Capital expenditures for the fiscal year ended October 31, 1998, 1997 and
1996 were $1.8 million, $167,000 and $329,000, respectively.  From inception
through October 31, 1998, total capital expenditures have been approximately
$2.6 million.

     As of October 31, 1998, the Company's liquidity was approximately $151,000
in cash and cash equivalents.

     The Company currently estimates that it will require between $2.0 million
and $2.5 million in operating capital over the next twelve months after planned
capital expenditures.  In addition, the Company will require approximately $1.4
million in funding to complete its current expansion.  Aquasearch has already
received a commitment from a single investor who plans to invest a total of $2.0
million during calendar 1999.  


                                      -35-

<PAGE>

     Management plans further expansion of the Company's activities or
facilities provided only that there exist contracts, sales agreements or product
development agreements that are likely to produce revenues to directly justify
the necessary financing.  For example, the Company may require up to an
additional $5.0 million over the next twelve months to fund construction of an
additional production facility if Cultor and Aquasearch were to enter into
either a joint venture or other relationship to produce astaxanthin on a large
scale (assuming that Cultor does not provide any portion of the financing for
this project).  The Company believes that its existing capital resources, funds
to be raised through public and/or private offerings of equity and/or debt
securities and bank financing will be sufficient for continued operations
through the next twelve months.  Aquasearch is presently pursuing additional
sources of capital in order to maintain and expand its operations.  These
capital sources include government contracts and grants, product sales, license
agreements and equity or debt financing.  There can be no assurance that the
Company will be successful in raising the additional capital necessary to
sustain or expand its operations, or that such capital will be available on
terms that would not result in substantial dilution to existing investors. The
Company's inability to raise sufficient capital could cause it to significantly
curtail operations, which would have a material adverse effect on the Company's
business, financial condition, results of operations and relationships with its
corporate partners.  See "Factors That May Affect Future Operating
Results--Substantial Near-Term Capital Needs; Uncertainty of Additional Funding;
Dilution" and "--Substantial Long-Term Capital Needs; Uncertainty of Additional
Funding; Dilution." 


FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS

SUBSTANTIAL NEAR-TERM CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING; DILUTION

     The Company currently estimates that it will require between $2.0 million
and $2.5 million in operating capital over the next twelve months after planned
capital expenditures.  Aquasearch has already received a commitment from a
single investor who plans to invest a total of $2.0 million during calendar
1999; however, there can be no absolute assurance that the promised investment
will be received.  

     Management plans further expansion of the Company's activities or
facilities provided only that there exist contracts, sales agreements or product
development agreements that are likely to produce revenues to directly justify
the necessary financing.  For example, the  Company may require up to an
additional $5.0 million over the next twelve months to fund construction of an
additional production facility if Cultor and Aquasearch enter into either a
joint venture or other relationship to produce astaxanthin on a large scale
(assuming that Cultor does not provide any portion of the financing for this
project).  The Company expects to obtain this funding from sales of equity
and/or convertible debt securities in the private and/or public markets and/or
bank financing.  The Company's capital requirements will depend on many factors
including, but not limited to, the timing of development of the Company's
products, the timing of the scale-up of the existing one-acre research and
development/production facility to a three-acre facility, the timing of the
construction and scale-up of any new natural astaxanthin production facility,
market acceptance of the Company's natural astaxanthin product, and the response
of competitors to the Company's natural astaxanthin product and technology.  If
additional funds are raised through the issuance of equity securities, the
percentage ownership of the current shareholders of the Company will be reduced
and such equity securities may have rights, preferences, and privileges senior
to those of the holders of the Company's Common Stock.  There can be no
assurance that additional capital will be available on terms favorable to the
Company or its shareholders, if at all.  Moreover, the Company's cash
requirements may vary materially due to production yield problems, research and
development results, product testing results, changing relationships with its
corporate partners, changes in the focus and direction of the Company's research
and 


                                      -36-

<PAGE>

development programs, competitive and technological advances, litigation and
other factors. If adequate funds are not available, the Company may be required
to curtail operations significantly or to obtain funds through entering into
collaboration agreements on unattractive terms that may require the Company to
relnquish certain technology or product rights, including patent and other
intellectual property rights.  The Company's inability to raise capital would
have a material adverse effect on the Company's business, financial condition,
results of operations and relationships with its corporate partners.  See  "Item
6.  Management's Plan of Operation--Management's Discussion and Analysis of
Financial Condition and Results of Operations--Overview" and "--Liquidity and
Capital Resources" and "Description of Business--Overview," "--Manufacturing"
and "--Corporate Partner Relationships - Cultor."
     
SUBSTANTIAL LONG-TERM CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING; DILUTION

     Substantial expenditures will be required to enable the Company to continue
its research and development activities and to manufacture and market its
products.  The level of expenditures required for these activities will depend
in part on whether the Company develops, manufactures and markets its products
independently or with other companies through collaborative arrangements.  The
Company's future capital requirements will also depend on one or more of the
following factors: the Company's ability to scale-up and manufacture its natural
astaxanthin product in cost-effective commercial quantities; market acceptance
of the Company's natural astaxanthin product; the extent and progress of its
research and development programs; the time and costs of obtaining regulatory
clearances (for those products subject to such clearance); the progress of
preclinical and clinical studies (where applicable); the costs involved in
filing, protecting and enforcing patent claims; competing technological and
market developments; the cost of developing and/or operating production
facilities for its existing product and potential products (depending on which
products the Company decides to produce itself); and the costs of
commercializing the Company's products.  There can be no assurance that funding
to carry on these activities will be available at all or on favorable terms to
permit successful commercialization of the Company's products.  In addition, the
Company has no credit facility or other committed sources of capital, and there
can be no assurance that it will be able to establish such arrangements on
satisfactory terms, if at all.  To the extent that capital resources are
insufficient to meet future capital requirements, the Company will have to raise
additional funds to continue development of its technologies and products. There
can be no assurance that such funds will be available on favorable terms, or at
all.  To the extent that additional capital is raised through the sale of equity
and/or convertible debt securities,the issuance of such securities could result
in dilution to the Company's shareholders.  If adequate funds are not available,
the Company may be required to curtail operations significantly or to obtain
funds through entering into collaboration agreements on unattractive terms that
may require the Company to relinquish certain technology or product rights,
including patent and other intellectual property rights.  The Company's
inability to raise capital would have a material adverse effect on the Company's
business, financial condition, results of operations and relationships with its
corporate partners.  See "Item 6.  Management's Plan of Operation--Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Overview" and "--Liquidity and Capital Resources," "Description of
Business--Products and Potential Products," "--Manufacturing" and "--Corporate
Partner Relationships."

HISTORY OF LOSSES AND EXPECTATION OF FUTURE LOSSES

     The Company was founded in 1988 and has experienced quarterly and annual
operating losses since its inception.  The Company's net loss in fiscal 1998 was
approximately $2.3 million and the Company's accumulated deficit at October 31,
1998 was approximately $7.1 million.  The Company's losses to date have resulted
primarily from costs incurred in research and development and from general and
administrative costs associated with the Company's operations.  The Company
expects to continue to incur operating losses 


                                      -37-

<PAGE>

for at least the next two years as it expands its production facilities and
increases its research and development efforts.  The Company expects to have
quarter-to-quarter and year-to-year fluctuations in revenues, expenses and
losses, some of which could be significant.  Future financial results will be
affected by, among other things, the following factors: the Company's ability to
successfully manage the transition from a research and development company to a
commercial-scale production enterprise; the Company's ability to complete
successfully the commercialization and cost optimization of its natural
astaxanthin product; production costs and yield issues associated with the
scale-up of production of its natural astaxanthin product; the progress of the
Company's research and development programs with respect to the development of
additional microalgal products; the time and costs of obtaining regulatory
approvals for those products subject to such approval; the Company's ability to
protect its proprietary rights; the costs of filing, protecting and enforcing
the Company's patent claims; competing technological and market developments and
the costs of commercializing and marketing the Company's existing and potential
products.  There can be no assurance that the Company will ever be able to
achieve or sustain profitability in the future.  See "Item 6.  Management's Plan
of Operation--Management's Discussion and Analysis of Financial Condition and
Results of Operations."

RISKS INHERENT IN COMMERCIAL PRODUCTION OF MICROALGAE

     The development of technology to cultivate and harvest a wide variety of
microalgae species is a lengthy and technically challenging process.  The
Company has faced a number of significant technical problems in the development
of its AGM technology and in its initial production of natural astaxanthin
derived from HAEMATOCOCCUS PLUVIALIS, including various forms of microbial
contamination, variability in production cycle times due to technical and
biological factors, and proportional losses of final product due to processing
inefficiencies.  As a result of these factors and, to a lesser extent, ongoing
experimentation with processes and methods and limited capacity, the Company's
production has fluctuated between one and eight kilograms per month during the
past twenty-four months.

     Notwithstanding the Company's significant advances in production capability
in recent quarters, the Company expects to encounter additional technical
problems in connection with the scale-up in production of HAEMATOCOCCUS
PLUVIALIS (and any other potential microalgae products).  Some of these problems
may be presently unknown, may never have been faced, and may have the effect of
lowering production yields.  There can be no assurance that the Company will be
successful in correcting these technical problems.  The Company's failure to
satisfy its obligations to Cultor under the Cultor Distribution and Development
Agreement for an extended period could have a material adverse effect on the
Company's business, financial condition, results of operations and its
relationships with its corporate partners.  See "Item 1. Description of
Description of Business--Overview," "--The Aquasearch Solution," "--Products and
Potential Products," "--Manufacturing" and "--Corporate Partner Relationships."

LIMITED MANUFACTURING EXPERIENCE

     To be successful, the Company must be able to produce its products at
acceptable costs in compliance with contractual requirements, regulatory
requirements and local health, safety and environmental regulations.  The
Company is at an early stage of development and has only limited experience
producing products derived from microalgae.  To date, the Company's only
shipments of its first product, natural astaxanthin derived from microalgae,
have been made to one customer, Cultor, a Finnish multinational corporation,
pursuant to a Supply Agreement (the "Svenska Foder Supply Agreement") entered
into in July 1995 between the Company and Svenska Foder AB ("Svenska Foder"), a
former subsidiary of Cultor, and/or pursuant to the Cultor Distribution and
Development Agreement. In connection with the sale of Svenska Foder to KKR, a
Danish animal feeds company, in December 1996, Cultor acquired all of 


                                      -38-

<PAGE>

Svenska Foder's rights under the Svenska Foder Supply Agreement. The Company has
not been able consistently to meet the five kilograms of natural astaxanthin
production targets initially set forth in the Svenska Foder Supply Agreement at
its existing one-acre research and development/production facility.  Although
the Company believes that its recent advances in production efficiency and
yields are scalable and repeatable at its expanded three-acre site (and any
subsequently developed site), the Company may continue to experience lower than
anticipated production yields or production constraints from time to time that
may adversely affect its ability to satisfy customer orders.  While the
Company's inability to satisfy its production targets to date has not disrupted
relations with its corporate partners, the Company's failure to consistently
demonstrate satisfactory large-scale production economies of scale may have a
material adverse effect on the Company's business, financial condition, results
of operations and its relationships with its corporate partners.  See
"Description of Business--Overview," "--Products and Potential Products,"
"--Manufacturing" and "--Corporate Partner Relationships."

RISKS ASSOCIATED WITH SCALE-UP OF PRODUCTION FACILITIES

     To date, the Company has not produced large quantities of natural
astaxanthin.  The Company has experienced significant delays in product
development and cultivation and harvesting process development from time to time
and its product development and cultivation and harvesting processes may require
additional research and development as well as substantial additional capital
and other resources prior to full scale commercialization. The Company estimates
that it may require approximately $1.4 million in additional financing to
automate, optimize and expand its existing research and development facility
from a one-acre facility to a three-acre facility and an additional $5.0 million
over the subsequent twelve months to complete the construction and commence
operation of an additional production facility dedicated solely to the
production of natural astaxanthin (assuming that Cultor does not finance any
portion of this project).  However, management plans to increase its expansion
activities provided only that it receives reasonable assurance that such
activities may be financed directly from the revenues generated by such
expansion.  Construction and facility scale-up costs as well as research and
development and production costs could substantially exceed budgeted amounts and
estimated time frames may require significant extension.  Any such additional
costs or delays could have a material adverse effect on the Company's business,
financial condition, results of operations and relationships with its corporate
partners.

     The Company expects to complete the expansion of  its facility to three
acres in January 1999.  The expansion began in early 1998.  After completion of
the expansion of the existing one-acre research and development/production
facility to a three-acre facility, the Company believes that it would have
sufficient production capacity, based on existing technology and processes, to
exceed 40 kilograms per month  if sufficient finishing pond space were
available.  Because finishing pond space is constrained at the Keahole Point
site, the Company (with Cultor's approval) plans to limit astaxanthin production
to 20 kilograms per month at the Keahole Point site.

     In view of the advancements in astaxanthin production over the past several
quarters, and pending further discussions with Cultor (and other potential
partners if the Company can be released from its exclusivity with Cultor),
Aquasearch currently plans to develop a second site for large-scale astaxanthin
production that would be larger than the site initially contemplated in the
Cultor Distribution and Development Agreement and would have a production
capacity significantly greater than the September 1999 120 kilograms per month
production target set forth in the Cultor Distribution and Development
Agreement.  There is currently no agreement between Aquasearch and Cultor as to
if, or when, a second site would be constructed, what the size, location or
production capacity of such a site would be, or how the construction or scale-up
of this facility would be financed.  There can be no assurances that Aquasearch
and Cultor will reach an agreement regarding the development, timing, location
or financing of a second site, 


                                      -39-

<PAGE>

whether the Cultor Distribution and Development Agreement would need to be
amended or terminated to accommodate these plans, or whether Cultor would have
any role in connection with this project.

     The scale-up of the Company's production technology, the expansion of the
existing facility and the construction of a new facility pose a number of
significant risks that presently cannot be quantified or fully assessed.  For
example, the Company's production process is critically dependent upon supplies
of freshwater, cold seawater and utilities provided by the Natural Energy
Laboratory of Hawaii Authority, and any interruption in these supplies could
have a material adverse effect on the Company's production capability.
Furthermore, microbial contamination of the Company's water supplies also poses
significant risks to productivity that may override the Company's existing
efforts and capability to maintain the sterility of its water supply.  The
success of the Company's proposed expansion plans will be dependent upon the
timely performance of a large number of contractors, sub-contractors, suppliers
and various agencies of the State of Hawaii that regulate and license
construction, each of which is beyond the control of the Company.  Any failure
by these contractors, suppliers or state agencies to perform in a timely manner
could cause delays, cost overruns or changes in the Company's construction and
expansion plans, which could have a material adverse effect on the Company's
business, financial condition, results of operations and relationships with its
corporate partners.

     The Company has projected a cost of manufacture for natural astaxanthin
that assumes that its current manufacturing processes can be scaled to larger,
more intensively automated AGMs.  To date, the Company has demonstrated that it
can culture and harvest HAEMATOCOCCUS PLUVIALIS using such larger AGMs, but not
ones that are more intensively automated.  If the Company's current AGM design
and processes are not readily able to be more intensively automated, then the
Company may have to expend substantial additional research effort and capital
resources to automate its technology in order to increase yields.  Difficulty in
automating the Company's current processes may translate into higher than
projected product costs or entail significant reengineering efforts in order to
meet commercially viable cost targets, which could have a material adverse
effect on the Company's business, financial condition, results of operations and
relationships with its corporate partners.

     There can be no assurance that the Company will be successful in resolving
known or unknown biological and engineering development problems, that the
Company will be able to develop its products within the estimated time schedule,
or in accordance with present cost projections, or that the products developed
by the Company will be commercially viable or widely accepted.  See "Item 1.
Description of Description of Business--Overview," "--Products and Potential
Products," "--Manufacturing" and "--Corporate Partner Relationships."

CUSTOMER CONCENTRATION

     The Company entered into a three-year exclusive Distribution and
Development Agreement with Cultor (recently extended to four years) with respect
to the production, sale and use of natural astaxanthin in the field of animal
feed and animal nutrition worldwide.  The failure of the Company to gain
additional customers for its natural astaxanthin product in other applications
and customers for its other potential products, the loss of Cultor or any
potential corporate partner as a customer, or a significant reduction in the
level of sales to Cultor or any potential corporate partner could have a
material adverse effect on the Company's business, financial condition, results
of operations and relationships with its corporate partners.  See "Item 1.
Description of Business--Aquasearch's Strategy--Expand Strategic Alliances" and
"--Corporate Partner Relationships."


                                      -40-

<PAGE>

EFFECT OF INCREASED COMPETITION ON MARKET PRICE OF SYNTHETIC AND NATURAL
ASTAXANTHIN

     The Company's natural astaxanthin will compete directly or indirectly with
synthetic astaxanthin and products incorporating the Company's natural
astaxanthin will compete directly with products incorporating the synthetic
astaxanthin product. The synthetic astaxanthin market is currently dominated by
a single producer, Hoffman-LaRoche, which has maintained the market price of its
synthetic astaxanthin (derived from petrochemicals) at approximately $2,500 per
kilogram for more than a decade.  The Company does not know Hoffman-LaRoche's
cost of production for synthetic astaxanthin or its probable response to the
introduction of a competitive product based on natural astaxanthin. 
Hoffman-LaRoche has significantly greater research and development, technical,
financial, sales and marketing resources than the Company and holds a commanding
market share.  There can be no assurance that the market price for synthetic
astaxanthin will remain at $2,500 after commercial introduction of products
incorporating natural astaxanthin.  Any significant decrease in the market price
for synthetic astaxanthin is likely to have an adverse effect on the market
price for products incorporating the Company's natural astaxanthin, which could
have a material adverse effect on the Company's business, financial condition,
results of operations and relationships with its corporate partners.  See "Item
1. Description of Business--Overview," "--Products and Potential
Products--Existing Product: Astaxanthin--Aquaculture" and "Competition."

RISKS ASSOCIATED WITH POTENTIAL JOINT VENTURE

     The Cultor Distribution and Development Agreement currently provides that,
in the event that Cultor exercises its option to create a joint venture company
with Aquasearch to produce natural astaxanthin, Aquasearch would contribute a
natural astaxanthin production facility to be constructed at a later date  in
return for a 50% stake in the new company and Cultor would contribute cash equal
to the appraised value of the Aquasearch's production facility in return for a
50% stake.  In addition, Cultor has the option to increase its stake in the new
company by purchasing from Aquasearch a further 25% of the new company (thus
increasing Cultor's stake to 75%) for cash based on a formula.  In view of the
recent advancements achieved in astaxanthin production, and pending further
discussions with Cultor, Aquasearch currently plans to develop a second site for
large-scale astaxanthin production that would be larger than the initially
contemplated in the Cultor Distribution and Development Agreement and would have
a production capacity significantly greater than the September 1999 production
target of 120 kilograms per month.  There is currently no agreement between
Aquasearch and Cultor as to if, or when, a second site would be constructed,
what the size, location or production capacity of such a site would be, or how
the construction or scale-up of this facility would be financed.  There can be
no assurances that Aquasearch and Cultor will reach an agreement regarding the
development, timing, location or financing of a second site, whether the Cultor
Distribution and Development Agreement would need to be amended or terminated to
accommodate these plans, or whether Cultor would have any role in connection
with this project.

     The decision to form, and the timing of the decision to form, the new joint
venture company is solely within the discretion of Cultor and may occur at any
time prior to September 24, 2000.  However, Cultor and Aquasearch have held
preliminary discussions regarding the need to amend the Cultor Distribution and
Development Agreement in view of the recent improvements in production economics
achieved by Aquasearch.  There can be no assurance as to when or if the Cultor
Distribution and Development Agreement will be amended or whether the terms of
any amendment would be favorable to the Company.  There can be no assurance that
the Company will have developed markets for its natural astaxanthin product
other than animal feed and animal nutrition at the time, if any, that Cultor
exercises its option to form the joint venture company or that the Company and
Cultor determine to amend the Cultor Distribution and Development Agreement. 
Similarly, there can be no assurance that the Company will have developed
microalgae products other than natural astaxanthin at the time, if any, that
Cultor exercises its option to form the joint venture 


                                      -41-

<PAGE>

company or that the Company and Cultor determine to amend the Cultor
Distribution and Development Agreement.  See "Item 1. Description of
Business--Overview" and "--Corporate Partner Relationships--Cultor."

RELIANCE ON CORPORATE PARTNER RELATIONSHIPS

     An important element of the Company's business strategy involves developing
strategic relationships with companies that have established research and
development, sales, marketing and distribution capabilities for the microalgae
products that the Company intends to develop.  In May 1996, the Company executed
the three-year exclusive Cultor Distribution and Development Agreement with
Cultor (recently extended to four years) covering the production and
distribution of the Company's natural astaxanthin product worldwide in the field
of animal feed and animal nutrition.
     
     In December 1998, shortly after the close of the 1998 fiscal year,
Aquasearch entered into a drug discovery agreement with Enzymed, Inc., a
U.S.-based, privately-held biotechnology company.  Under the terms of the
agreement, Enzymed will generate a large number of novel compounds based upon
the starting materials found originally in microalgae and provided by
Aquasearch.  Both companies will share in the potential revenues from the
commercialization of the resulting compound libraries, including access fees,
licensing fees, milestone payments, royalties and commercial sales.

     The Company intends to enter into strategic relationships with other
companies to apply its technology, fund development, commercialize future
products, and assist in obtaining regulatory approvals.  There can be no
assurance that any of the Company's present or future corporate partners will
perform their obligations as expected or devote sufficient resources to the
development, testing or marketing of the Company's potential products developed
under such arrangements.  Any parallel development by a strategic partner of
alternative technologies or products, preclusion of the Company from entering
into competitive arrangements, failure to obtain timely regulatory approvals,
premature termination of an agreement, or failure by a strategic partner to
devote sufficient resources to the development and commercialization of the
Company's products could have a material adverse effect on the Company's
business, financial condition, results of operations and relationships with its
corporate partners.

     The Company's agreements with its consultants and corporate partners are
complex.  There may be provisions within such agreements that give rise to
disputes regarding the rights and obligations of the parties.  These and other
possible disagreements could lead to delays in research, development or
commercialization of certain products, or could result in litigation or
arbitration, which could be time-consuming and expensive, and could have a
material adverse effect on the Company's business, financial condition, results
of operations and relationships with its corporate partners.

     There can be no assurance that the Company will be able to maintain or
expand its relationships with its existing corporate partners or to replace its
existing corporate partners in the event any such relationship were terminated.
In the event of the termination of the Cultor Distribution and Development
Agreement, the Company's ability to distribute its natural astaxanthin product
in the field of animal feed and animal nutrition would be materially adversely
affected, which would have a material adverse effect on the Company's business,
financial condition and results of operations.

     The Company's primary strategy for the development, regulatory approval,
production and commercialization of certain of its products is to enter into
collaborations with various corporate partners, licensors, licensees and others.
There can be no assurance that the Company will be able to negotiate
collaborative arrangements in the future on acceptable terms, if at all, or that
such collaborative arrangements


                                      -42-

<PAGE>

will be beneficial to the Company.  To the extent that the Company is not able
to establish such arrangements, it would face increased capital requirements to
undertake such activities at its own expense and might encounter significant
delays in introducing its products into certain markets or find that the
development, manufacture or sale of its products in such markets is adversely
affected.  See "Description of Business--Aquasearch's Strategy--Expand Strategic
Alliances" and "--Corporate Partner Relationships."

COMPETITION

     Competition in the world market for astaxanthin is intense and is expected
to increase significantly in the near future.  The Company's natural astaxanthin
will compete directly or indirectly with the synthetic astaxanthin product
developed and marketed worldwide by Hoffman La-Roche and products incorporating
the Company's natural astaxanthin will compete directly with products
incorporating the synthetic astaxanthin product as well.  Hoffman-LaRoche has
significantly greater research and development, technical, financial,
management, marketing and sales resources than the Company as well as a
worldwide reputation and dominant market share.  In addition, at least two
companies, Astacarotene and Cyanotech, have either announced plans to produce
natural astaxanthin from microalgae or are producing significant quantities for
test and commercial purposes.  In particular, Cyanotech has announced its
intention to enter into large scale commercial production of natural astaxanthin
and entered into a $1.5 million supply agreement in the fiscal quarter ended
June 30, 1998.

     The Company's natural astaxanthin product is expected to compete with
synthetic astaxanthin (and any other alternative products) primarily on the
basis of product performance, price and proprietary position.  Although
Hoffman-LaRoche has maintained the market price of synthetic astaxanthin at
approximately $2,500 per kilogram for more than a decade, there can be no
assurance that Hoffman-LaRoche will maintain the price of its synthetic
astaxanthin product in response to the introduction of a product incorporating
the Company's natural astaxanthin.  Any such pricing or other competitive
pressure could have a material adverse effect on the Company's business,
financial condition, results of operations and relationships with its corporate
partners.  The existence of products of which the Company is not aware, or
products that may be developed in the future, may also adversely affect the
marketability of the Company's natural astaxanthin product.

     Aquasearch anticipates that competition to develop microalgae products
other than natural astaxanthin will also be intense.  The Company's competitors
for these potential products are expected to include major pharmaceutical, food
processing, chemical and specialized biotechnology companies, many of which will
have financial, technical and marketing resources significantly greater than
those of Aquasearch.  In addition, other emerging marine bioscience companies,
similar to Aquasearch, may form collaborations with large established companies
to support research, development and commercialization of products that may be
competitive with future products of Aquasearch.  Also, academic institutions,
governmental agencies and other public and private research organizations are
conducting research activities and seeking patent protection and may
commercialize products competitive with those of Aquasearch on their own or
through joint ventures.  The existence of products of which Aquasearch is not
aware, or products that may be developed in the future, may adversely affect the
marketability of additional products developed by Aquasearch.

     Aquasearch believes that its AGM and related microalgae cultivation and
harvesting technologies currently offer significant technical and economic
advantages compared with the open pond systems currently used by certain
competitors, including increased yields and the ability to cultivate hundreds of
microalgae species at commercial scale that cannot be produced in open pond
systems due to substantially higher risks of contamination and lack of control.
Aquasearch also believes that its AGM and related 


                                      -43-

<PAGE>

microalgae cultivation and harvesting technologies compare favorably with other
known closed systems with respect to capital and operating costs.  However, the
existence of technology of which Aquasearch is not aware, or technology that may
be developed in the future, may adversely affect the technical and competitive
advantages that Aquasearch currently believes it holds compared with competing
open pond and known closed system microalgae cultivation technologies.

DEPENDENCE ON KEY PERSONNEL

     The Company's prospects depend to a significant extent upon certain members
of senior management, including, in particular, Mark E. Huntley, Ph.D., the
Company's Chairman, President and Chief Executive Officer, Earl S. Fusato, the
Company's Chief Financial Officer and David G. Watumull, the Company's Executive
Vice President of Strategic Development and Corporate Finance.  The loss of any
senior executive or other key employee could have a material adverse effect on
the Company's business, financial condition, results of operations and
relationships with its corporate partners.

     The Company is highly dependent on its ability to attract and retain key
scientific, technical, management and operating personnel, including consultants
and members of its Scientific Advisory Board. As the number of qualified marine
and aquatic microbiologists is limited, competition for such personnel is
intense.  The Company will need to develop expertise and add skilled employees
or retain consultants in such areas as research and development, clinical
testing, government approvals, manufacturing and marketing in the future.  There
can be no assurance that the Company will be able to attract and retain the
qualified personnel or develop the expertise needed in these areas.  The Company
currently has a small research and development and management group with limited
operating experience.  The loss of the services of one or more members of the
research and development or management group or the inability to hire additional
personnel and develop expertise as needed would have a material adverse effect
on the Company's business, financial condition, results of operations and
relationships with its corporate partners.

     Members of the Company's Scientific Advisory Board assist the Company in
optimizing its production and processing methods and formulating research and
development strategy pertaining to both existing and potential microalgae
products.  Most members of the Scientific Advisory Board are not employed by the
Company and each of these members may have commitments to other entities that
could limit their availability to the Company.  There can be no assurance that
the Company will be able to retain its key Scientific Advisory Board members.
See "Description of Business--Scientific Advisory Board."

RISKS ASSOCIATED WITH MANAGEMENT OF GROWTH

     To date, the Company has been engaged almost exclusively in research and
development activities.  The Company is in the process of transitioning to a
full-scale commercial producer of microalgae products. These changes in its
business have placed and will continue to place significant demands on the
Company's management and financial and management control systems.  Failure to
upgrade the Company's operating, management and financial control systems or
difficulties encountered during such upgrades could adversely affect the
Company's business, financial condition, results of operations and relationships
with its corporate partners.  Although the Company believes that its systems and
controls are adequate to address its current needs, there can be no assurance
that such systems will be adequate to address future expansion of the Company's
business.  The Company's results of operations will be adversely affected if
revenues do not increase sufficiently to compensate for the increase in
operating expenses resulting from any expansion and there can be no assurance
that any expansion will be profitable or that it will not adversely affect the
Company's results of operations.  In addition, the success of any future
expansion plans will depend in part upon the Company's ability to continue to
improve and expand its management and financial control 


                                      -44-

<PAGE>

systems, to attract, retain and motivate key personnel, and to raise additional
required capital.  There can be no assurance that the Company will be successful
in these efforts.  See "Item 6.  Management's Plan of Operation--Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Overview" and "--Liquidity and Capital Resources" and "Description
of Business--Aquasearch's Strategy," "--Products and Potential Products" and
"--Manufacturing."
     
RISKS ASSOCIATED WITH EXPANSION INTO ADDITIONAL MARKETS AND PRODUCT DEVELOPMENT

     Other than its natural astaxanthin product, the Company currently has no
products actively under development.  The Company believes that its near-term
prospects are substantially dependent on the expansion of the worldwide market
for natural astaxanthin and the Company's ability to successfully develop and
commercialize new products and penetrate new markets.  There can be no assurance
that the Company can successfully develop its natural astaxanthin or any other
potential microalgae products, that any such products will be capable of being
produced in commercial quantities at reasonable cost, or that any such products
will achieve market acceptance. The Company has no experience marketing its
products directly and is presently entirely dependent on the marketing skills
and efforts of its corporate partners.  There can be no assurance that the
marketing efforts of such corporate partners will be successful or whether such
corporate partners will eventually compete with the Company or assist the
Company's competitors.

     Many other companies have significantly greater marketing and product
development experience and resources to devote to marketing and product
development than the Company.  The Company has entered into, and expects to
enter into additional, selected strategic alliances with third parties for
product development, marketing and sales.  There can be no assurances regarding
the performance of such third parties, or the overall success, if any, of such
strategic alliances.  The inability of the Company to successfully develop or
commercialize its natural astaxanthin or any potential microalgae products would
have a material adverse effect on the Company's business, financial condition,
results of operations and its relationships with its corporate partners.  See
"Description of Business--Aquasearch's Strategy" and "--Products and Potential
Products."

DEPENDENCE ON PROPRIETARY TECHNOLOGY AND UNPREDICTABILITY OF INTELLECTUAL
PROPERTY PROTECTION

     Aquasearch relies upon a combination of patents, copyright protection,
trade secrets, know-how, continuing technological innovation and licensing
opportunities to develop and maintain its competitive position.  The Company's
future prospects depend in part on its ability to obtain patent protection for
its products and processes, to preserve its copyright and trade secrets and to
operate without infringing the proprietary rights of third parties.  Aquasearch
has been awarded one patent in the United States, one patent by the European
Patent Office (which is applicable to all member nations of the European Union),
one patent in Australia and one patent in Hong Kong for its closed system
microalgae cultivation process.  The Company has additional patent applications
pending in the United States and internationally.

     The patent positions of pharmaceutical, biopharmaceutical and biotechnology
companies, including the Company, are generally uncertain and involve complex
legal and factual questions.  There can be no assurance that any of the
Company's pending patent applications will result in issued patents, that the
Company will develop additional proprietary technologies that are patentable,
that any patents issued to the Company or its corporate partners will provide a
basis for commercially viable products or will provide the Company with any
competitive advantages or will not be challenged by third parties, or that the
patents of others will not have a material adverse effect on the ability of the
Company to do business.  In addition, patent law relating to the scope of claims
in the technology fields in which the Company operates is still evolving.  The
degree of future protection for the Company's proprietary rights, therefore, is
uncertain.  


                                      -45-

<PAGE>

Furthermore, there can be no assurance that others will not independently
develop similar or alternative technologies, duplicate any of the Company's
technologies, or, if patents are issued to the Company, design around the
patented technologies developed by the Company.  In addition, the Company could
incur substantial costs in litigation if it is required to defend itself in
patent suits brought by third parties or if it initiates such suits.  

     Others may have filed and in the future are likely to file patent
applications that are similar or identical to those of the Company.  To
determine the priority of inventions, the Company may have to participate in
interference proceedings declared by the United States Patent and Trademark
Office that could result in substantial cost to the Company.  No assurance can
be given that any such patent application will not have priority over patent
applications filed by the Company.  In addition, the laws of certain foreign
countries may not protect the Company's patent and other intellectual property
rights to the same extent as the laws of the United States.

     The Company's future prospects also depend in part on the Company neither
infringing patents or proprietary rights of third parties nor breaching any
licenses that may relate to the Company's technologies and products.  There can
be no assurance that the Company will not infringe the patents, licenses or
other proprietary rights of third parties.  In addition, the Company may in the
future receive notices claiming infringement from third parties as well as
invitations to take licenses under third party patents.  Any legal action
against the Company or its collaborative partners claiming damages and seeking
to enjoin commercial activities relating to the affected products and processes
could, in addition to subjecting the Company to potential liability for damages,
require the Company or its corporate partners to obtain a license in order to
continue to manufacture or market the affected products and processes.  There
can be no assurance that the Company or its corporate partners would prevail in
any such action or that any license (including licenses proposed by third
parties) required under any such patent would be made available on commercially
acceptable terms, if at all.  There may be a significant number of United States
and foreign patents and patent applications in the Company's area of interest,
and the Company believes that there may be significant litigation in the
industry regarding patent and other intellectual property rights.  

    The Company is currently involved in litigation arising out of a 
complaint filed by Cyanotech on July 13, 1998, in the United States District 
Court for the District of Hawaii.  In the complaint, Cyanotech seeks 
declaratory judgment of noninfringement of the Company's U.S. Letters Patent 
No. 5,541,056 (the "5,541,056 Patent"); invalidity of the 5,541,056 Patent; 
and non-misappropriation of the Company's trade secrets relating to closed 
culture production of astaxanthin.  Cyanotech filed the complaint after the 
Company expressed to Cyanotech its concern that Cyanotech infringed the 
5,541,056 patent and misappropriated Aquasearch trade secrets.  On September 
11, 1998, the Company filed (i) an answer denying all of Cyanotech's 
allegations and (ii) a counter claim, alleging infringement of the 5,541,056 
Patent; misappropriation of trade secrets; unfair competition; and breach of 
contract relative to its 1994 Dissolution Agreement with Cyanotech.  On 
December 14, 1998, Cyanotech filed a motion for partial summary judgment of 
noninfringement and invalidity of the 5,541,056 Patent. The summary judgment 
motion is set for a hearing on March 29, 1999. The trial in the lawsuit is 
currently set to begin on September 27, 1999. The Company does not believe 
that Cyanotech's claims are meritorious.  However, the Company may be 
required to dedicate significant management time and incur significant legal 
fees and expenses to pursue this action, which could have a material adverse 
effect on the Company's business, financial condition, results of operations 
and relationships with corporate partners.  In addition, in the event that 
Cyanotech were to prevail in this action, a finding of noninfringement or 
declaration of invalidity of the 5,541,056 Patent could have a material 
adverse effect on the Company's business, financial condition, results of 
operations and relationships with corporate partners.  See "Item 3.  Legal 
Proceedings."

     The enactment of legislation implementing the General Agreement on Trade
and Tariffs has resulted in certain changes in United States patent laws that
became effective on June 8, 1995.  Most notably, the term 


                                      -46-

<PAGE>

of patent protection for patent applications filed on or after June 8, 1995 is
no longer a period of seventeen years from the date of grant.  The new term of
United States patents will commence on the date of issuance and terminate twenty
years after the effective date of filing may result in a substantially shortened
term of the Company's patent protection which may adversely affect the Company's
patent position.

     While the disclosure and use of the Company's proprietary technology,
know-how and trade secrets are generally controlled under agreements with the
parties involved, there can be no assurance that all confidentiality agreements
will be honored, that others will not independently develop similar or superior
technology, that disputes will not arise concerning the ownership of
intellectual property, or that dissemination of the Company's proprietary
technology, know-how and trade secrets will not occur.  See "Description of
Business--Patents, Licenses and Proprietary Technology."

UNCERTAINTY REGARDING OBTAINING AND MAINTAINING GOVERNMENT APPROVALS

     Aquasearch's natural astaxanthin product, potential products and its
research and production activities are or may become subject to varying degrees
of regulation by a number of government authorities in the United States and
other countries, including the United States Food and Drug Administration
("FDA") pursuant to the Federal Food, Drug and Cosmetic Act. Each existing or
potential microalgae product that is developed or marketed by Aquasearch, its
licensees or its corporate partners can present unique regulatory problems and
risks, depending on the product type, uses and method of manufacture.  Any
future products developed by Aquasearch for use in human nutrition,
pharmaceuticals or cosmetics, if any, may require Aquasearch to develop and
adhere to Good Manufacturing Practices ("GMP") as required by the FDA, ISO
standards as required in Europe, and any other applicable standards mandated by
federal, state, local or foreign laws, regulations and policies. Currently, the
Company's production facilities do not comply with GMP or ISO standards and
significant capital expenditures would have to be made and compliance procedures
implemented before the Company's production facilities could meet GMP and ISO
qualifications.

     The Company is also subject to other federal, state and foreign laws,
regulations and policies with respect to labeling of its products, importation
of organisms, and occupational safety, among others.  Federal, state and foreign
laws, regulations and policies are always subject to change and depend heavily
on administrative policies and interpretations.  The Company is working with
Cultor with respect to compliance with foreign laws, regulations and policies
pertaining to use of its natural astaxanthin product in the field of animal feed
and animal nutrition.  There can be no assurance that any changes with respect
to federal, state and foreign laws, regulations and policies, and, particularly
with respect to the FDA or other such regulatory bodies, with possible
retroactive effect, will not have a material adverse effect on the Company's
business, financial condition, results of operations and relationships with its
corporate partners.  There can be no assurance that any of the Company's
potential products will satisfy applicable regulatory requirements.  See
"Description of Business--Government Regulation and Product Testing."

     The Company is subject to numerous environmental and safety laws and
regulations, including those governing the use and disposal of hazardous
materials.  Any violation of, and the cost of compliance with, these regulations
could have a material adverse effect on the Company's business, financial
condition, results of operations and relationships with its corporate partners.
See "Description of Business--Government Regulation and Product Testing."

CONCENTRATION OF PRODUCTION CAPACITY; RELIANCE ON CLIMATIC CONDITIONS

     All of the Company's production capacity is currently located at the Hawaii
Ocean Sciences Technology ("HOST") Business Park at Keahole Point, Kailua-Kona,
Hawaii, on property leased from the 


                                      -47-

<PAGE>

State of Hawaii and situated on a 200-year-old lava flow adjacent to a dormant
volcano.  The Company maintains minimal finished goods inventory.  In the event
that production at, or transportation from, such facility (or any facility that
the Company might construct in the Hawaiian Islands) were interrupted by fire,
volcanic eruption, earthquake, tidal wave, hurricane, or other natural disaster,
work stoppage, termination or suspension of the Company's facility lease by the
State of Hawaii for public use or similar purposes, other regulatory actions or
any other cause, the Company would be unable to continue to produce its products
at such facility.  Such an interruption would have a material adverse effect on
the Company's business, financial condition, results of operations and
relationships with its corporate partners.  See "Description of Business--The
Aquasearch Solution" and "--Properties."

     Due to the importance of sunlight and a consistent warm temperature for
microalgae growth, the Company's production may be significantly affected by
weather patterns and unusual seasonal weather changes.  Any unseasonably cool or
cloudy weather would adversely impact the Company's production and could have a
material adverse effect on the Company's business, financial condition, results
of operations and relationships with its corporate partners.

RISKS ASSOCIATED WITH INTERNATIONAL SALES

     The Company currently has a distribution arrangement with Cultor, a Finnish
company.  The Company expects that international sales will represent a
significant portion of its revenue for the foreseeable future because
aquaculture production, the primary market for natural astaxanthin today, is
more highly developed in Europe and Asia than in the United States.  The
Company's business, financial condition and results of operations may be
materially and adversely affected by any difficulties associated with managing
accounts receivable from international customers, tariff regulations, imposition
of governmental controls, political and economic instability or other trade
restrictions.  Although the Cultor Distribution and Development Agreement
provides that sales will be denominated in United States dollars, fluctuations
in currency exchange rates could cause the Company's products to become
relatively more expensive to customers in the affected country, leading to a
reduction in sales in that country.

PRODUCT LIABILITY

     The Company faces an inherent business risk of exposure to product
liability claims alleging that the use of its technology or products resulted in
adverse effects.  There can be no assurance that the Company's current level of
product liability insurance together with indemnification rights under its
existing license agreements and other collaborative arrangements will be
adequate to protect the Company.  It is uncertain whether the Company will be
able to obtain increased levels of insurance as the Company grows, that any
level of insurance would be economically practical or that it would be able to
renew its current or future policies.  A product liability claim or recall in
excess of insured amounts or amounts recoverable under applicable contractual
arrangements could have a material adverse effect on the Company's business,
financial condition, results of operations and relationships with its corporate
partners.

CONCENTRATION OF STOCK OWNERSHIP

     Based upon an aggregate of 68,564,013 shares of Common Stock outstanding at
October 31, 1998, the Company's directors and executive officers, as a group,
will beneficially own approximately 22.2% of the Company's outstanding Common
Stock.  As a result, these shareholders will have the ability to strongly
influence the actions of the Board of Directors and the outcome of actions that
are brought before the shareholders for approval.  Such a high level of
ownership may have the effect of delaying or preventing a 


                                      -48-

<PAGE>

change in control of the Company and may adversely affect the voting and other
rights of the holders of Common Stock.  See "Item 11.  Security Ownership of
Certain Beneficial Owners and Management."

POSSIBLE VOLATILITY OF STOCK PRICE; LIMITED LIQUIDITY; ABSENCE OF DIVIDENDS

     The market price of the Company's Common Stock has experienced, and may
continue to experience, a high level of volatility, as frequently occurs with
publicly traded life sciences companies and many companies whose securities
trade on the NASD Electronic Bulletin Board.  See " Factors That May Affect
Future Operating Results--Risks Associated with Low-Priced Over-The-Counter"
Securities."  Announcements of technological innovations or new commercial
products by the Company or its competitors, developments or disputes concerning
patent or proprietary rights, publicity regarding actual or potential benefits
relating to products under development by the Company or its competitors,
general regulatory developments affecting the Company's products in both the
United States and foreign countries, market conditions for life sciences
companies in general and economic and other internal and external factors, as
well as period-to-period fluctuations in financial results, may have a
significant impact on the Company's business or the future market price of the
Common Stock.  Since the Company's initial public offering of Common Stock in
January 1989, the average daily trading volume in the Common Stock as reported
on the NASD Electronic Bulletin Board has been relatively low.  See "Price Range
of Common Stock."  There can be no assurance that a more active public trading
market will ever develop for the Common Stock.  The Company has never declared
or paid any cash dividends on its Common Stock and does not intend to do so for
the foreseeable future.  See "Dividend Policy."

RISKS ASSOCIATED WITH LOW-PRICED "OVER-THE-COUNTER" SECURITIES

     The Company's Common Stock is currently traded in the "over-the-counter
market" in the "Electronic Bulletin Board" of the National Association of
Securities Dealers, Inc. (the "NASD").  See "Price Range of Common Stock."
Securities of companies traded on the NASD Electronic Bulletin Board are
generally more difficult to dispose of and to obtain accurate quotations as to
price than securities of companies that are traded on the Nasdaq National
Market, the Nasdaq SmallCap Market or the major stock exchanges.

     The Securities Enforcement and Penny Stock Reform Act of 1990 requires
additional disclosure relating to the market for penny stocks in connection with
trades in any stock defined as a penny stock.  Commission regulations generally
define a penny stock to be an equity security that has a market price of less
than $5.00 per share, subject to certain exceptions.  Such exceptions include
any equity security listed on Nasdaq or a national securities exchange and any
equity security issued by an issuer that has (i) net tangible assets of at least
$2,000,000, if such issuer has been in continuous operation for three years,
(ii) net tangible assets of at least $5,000,000, if such issuer has been in
continuous operation for less than three years, or (iii) average annual revenue
of at least $6,000,000, if such issuer has been in continuous operation for less
than three years.  Unless an exception is available, the regulations require the
delivery, prior to any transaction involving a penny stock, of a disclosure
schedule explaining the penny stock market and the risks associated therewith.

     In addition, trading in the Company's securities is currently subject to
Rule 15g-9 promulgated under the Exchange Act for non-Nasdaq and non-exchange
listed securities.  Pursuant to Rule 15g-9, broker/dealers who recommend the
Company's securities to persons other than established customers and accredited
investors must make a special written suitability determination for the
purchaser and receive the purchaser's written agreement to a transaction prior
to sale.  Securities are exempt from this rule if their market price is at least
$5.00 per share.


                                      -49-

<PAGE>

     The impact of the regulations applicable to penny stocks on the Company's
securities is to reduce the market liquidity of the Company's securities by
limiting the ability of broker/dealers to trade the Company's securities and the
ability of purchasers of the Company's securities to sell their securities in
the secondary market.  The low price of the Company's Common Stock also has a
negative effect on the amount and percentage of transaction costs paid by
individual shareholders and the potential ability of the Company to raise
additional capital by issuing additional shares.  The primary reasons for these
effects include the internal policies of certain institutional investors that
prohibit the purchase of low-priced stocks, the fact that many brokerage houses
do not permit low-priced stocks to be used as collateral for margin accounts or
to be purchased on margin and certain brokerage house policies and practices
that tend to discourage individual brokers from dealing in low-priced stocks. In
addition, since broker's commissions on low-priced stocks represent a higher
percentage of the stock price than commissions on higher priced stocks, the
current low share price of the Common Stock results in individual shareholders
paying transaction costs that are a higher percentage of their total share value
than would be the case if the Company's share price were substantially higher.

     The Company intends to apply for listing on the Nasdaq SmallCap Market as
soon as it meets the eligibility requirements.  Under recently implemented
Nasdaq rules, in order to be eligible for listing on the Nasdaq SmallCap Market:
(i) the Company's Common Stock must have a minimum bid price of $4.00; (ii) the
Company must have minimum tangible net assets (total assets less total
liabilities and goodwill) of $4.0 million or a market capitalization of at least
$50 million or net income of at least $750,000 in two of the three prior years;
(iii) the Company must have a public float of at least one million shares with a
market value of at least $5 million; and (iv) the Common Stock must have at
least three market makers and be held of record by at least 300 shareholders. 
If at any time the Company were to satisfy all listing requirements other than
the minimum bid price of $4.00 per share, then the Board of Directors is likely
to recommend that the Company effect a reverse stock split in order to meet this
minimum trading price listing requirement.  Any such reverse stock split would
require shareholder approval. There can be no assurance that at any time the
Company would be able to satisfy some or all listing requirements or that any
proposed reverse stock split will be approved by the shareholders or
successfully implemented following such approval.

POTENTIAL ADVERSE EFFECT OF EXERCISE OF WARRANTS AND SALES OF WARRANT COMMON
STOCK.  

     As of October 31, 1998, the Company had outstanding 5,347,244 Common 
Stock Purchase Warrants that have an exercise price of $1.00 (the "Warrants") 
per share, 3,418,713 Common Stock Purchase Warrants that have an  exercise 
price of $0.50 per share, and 25,974 Common Stock Purchase Warrants that have 
an exercise price of $0.21 per share. The exercise of the outstanding 
Warrants will dilute the percentage ownership of the holders of the Common 
Stock, and any sales in the public market of Common Stock issuable upon the 
exercise of the Warrants (the "Warrant Common Stock") may adversely affect 
prevailing market prices for the Common Stock.  Moreover, the terms upon 
which the Company will be able to obtain additional equity capital may be 
adversely affected since the holders of such Warrants can be expected to 
exercise them at a time when the Company would, in all likelihood, be able to 
obtain any needed capital on terms more favorable to the Company than those 
provided in the outstanding Warrants.

POTENTIAL ADVERSE EFFECT OF REDEMPTION OF WARRANTS

     The Warrants are subject to redemption by the Company at a price of $.01 
each, commencing on February 1, 1997, on at least 30 days' prior written 
notice, if the average closing bid price of the Common Stock as reported on 
The Nasdaq SmallCap Market, if traded thereon, or, if not traded thereon, the 
average

                                      -50-

<PAGE>

closing sale price if listed on a national securities exchange (or other 
reporting system that provides last sale prices), or, if not traded thereon, 
the average of the closing bid prices on the NASD Electronic Bulletin Board, 
equals or exceeds $1.50 per share (subject to adjustment for stock splits, 
stock dividends and similar events) for a period of 20 trading days during 
any 30 consecutive trading days ending on the third day prior to the date on 
which the Company gives notice of redemption.  Upon the giving of such notice 
of redemption, holders of the Warrants will lose their right to exercise the 
Warrants, except during such 30-day notice of redemption period.  Upon the 
receipt of a notice of redemption of the Warrants, the holders thereof would 
be required to (i) exercise the Warrants and pay the exercise price at a time 
when it may be disadvantageous for them to do so; (ii) sell the Warrants at 
the then market price, if any, when they might otherwise wish to hold the 
Warrants; or (iii) accept the redemption price which is likely to be 
substantially less than the market value of the Warrants at the time of 
redemption.

POTENTIAL ADVERSE EFFECT OF ISSUANCE OF PREFERRED STOCK

     The Company's Articles of Incorporation authorize the issuance of up to
5,000,000 shares of "blank check" Preferred Stock, with such designations,
rights, preferences, privileges and restrictions as determined by the Board of
Directors from time to time.  As a result, the Board of Directors is empowered,
without further shareholder approval, to issue Preferred Stock with dividend,
liquidation, conversion, voting or other rights that could adversely affect the
voting power or other rights of the holders of the Common Stock.  In the event
of issuance, the Preferred Stock could be used, under certain circumstances, as
a method of discouraging, delaying or preventing a change in control of the
Company.  Although the Company has no present plans to issue any shares of
Preferred Stock, there can be no assurance that the Company will not issue
Preferred Stock at some time in the future. 

SHARES ELIGIBLE FOR FUTURE SALE

     As of October 31, 1998, the Company the Company had 68,564,013 shares of
Common Stock outstanding.  Of the shares outstanding, 66,277,279 have either
been registered under the Securities Act or are freely tradable without volume
limitations under Rule 144(k) under the Securities Act.

     No prediction can be made as to the effect, if any, that sales of shares of
Common Stock or the availability of such shares for sale will have on the market
prices prevailing from time to time.  The possibility exists, however, that
substantial amounts of Common Stock may be sold in the public market which may
adversely affect prevailing market prices for the Common Stock and could impair
the Company's ability to raise capital through the sale of its equity
securities.

YEAR 2000 COMPLIANCE 

     The Company believes that its financial, operational and other 
information systems, with limited modifications, will function properly with 
respect to dates in the year 2000 and thereafter.  Many of the Company's 
systems and related software are presently Year 2000 compliant.   The Company 
has plans to upgrade its accounting system and bring its remaining systems 
and software into compliance.  The Company expects to complete this process 
during the 1999 fiscal year.  To date, the Company has not incurred any 
material costs related to the assessment of, and preliminary efforts in 
connection with, its Year 2000 issues and does not anticipate future 
expenditures to have a material impact on its financial position or operating 
results.

     In addition to in-house efforts, the Company is discussing with its 
significant vendors, customers, banks and other third parties whose systems 
failures potentially could have a significant impact on the Company's 
operations to verify their Year 2000 readiness.  The Company expects to 
complete this process during the first half of 1999. The Company will not be 
able to completely assess its Year 2000 readiness until such third parties 
assure the Company of their Year 2000 compliance.  To date, the Company has 
not been notified of any such noncompliance by any material third party.   
However, there can be no assurance that these third parties will not have 
Year 2000 problems that will affect the Company.

     Based on the activities performed to date and subject to verification 
from major vendors, customers, banks and other third parties, the Company 
does not believe that the Year 2000 issue will have a material adverse effect 
on its business or results of operations.  However, the Company's or any 
material third party's failure to identify or correct a Year 2000 problem 
could result in an interruption or failure in the Company's operations.  Such 
interruption or failure could have a material adverse effect on the Company's 
business, financial condition, results of operations and relationships with 
its corporate partners.  

     At this time, the Company does not have a comprehensive contingency plan 
with respect to the Year 2000 issue.  However, if the Company identifies 
significant risks related to Year 2000 noncompliance by the Company or any 
material third parties, the Company will develop contingency plans as deemed 
necessary at that time.

ITEM 7.  FINANCIAL STATEMENTS

     Audited balance sheets as of October 31, 1998, 1997 and 1996 and the
related statements of loss and accumulated deficit, cash flows and stockholders'
equity (deficit) for the years ended October 31, 1998, 1997 and 1996 (and from
inception to October 31, 1998) together with related notes and the reports of
Ernst & Young LLP., independent auditors, appear on pages F-1 through F-20 of 
this Report.


ITEM 8.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

     There were no changes in or disagreements with accountants on accounting
and financial disclosure during fiscal 1998 or fiscal 1997.


                                      -51-

<PAGE>

                                       PART III

ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS AND CONTROL PERSONS; COMPLIANCE WITH
SECTION 16(A) OF THE EXCHANGE ACT.

DIRECTORS AND EXECUTIVE OFFICERS

     The directors and executive officers of Aquasearch and their respective
ages and positions with Aquasearch are set forth in the following table.

<TABLE>
<CAPTION>

NAME                               AGE    POSITION
----                               ---    --------
<S>                                <C>    <C>
Mark E. Huntley, Ph.D. . . . .     48     President, Chief Executive Officer,
                                          and Chairman
Pearn P. Niiler, Ph.D. . . . .     60     Director
Earl S. Fusato . . . . . . . .     51     Chief Financial Officer, Secretary
                                          and Director
Edward E. David, Ph.D. . . . .     73     Director
David G. Watumull. . . . . . .     48     Executive Vice-President, Strategic
                                          Development and Corporate Finance
</TABLE>

     MARK E. HUNTLEY, PH.D., is a co-founder of Aquasearch, a co-inventor of the
Aquasearch Growth Module and has served as the President, Chief Executive
Officer and Chairman of the Board since inception.  Dr. Huntley has served as a
research biologist at Scripps Institution of Oceanography, University of
California, San Diego since 1980.  Dr. Huntley has won numerous awards and
grants in his field, published more than 75 articles and a book, and lectured
throughout the world.  Dr. Huntley serves on the Executive Committee of the
Global Ocean Ecosystem Dynamics program, a component of the United States Global
Change Research Program, and the only element of the International
Geosphere-Biosphere Program that is examining the impact of global climate
change on marine ecosystems.  Dr. Huntley has served as an advisor to numerous
international, national and state agencies, including The United States State
Department, the United States Department of the Interior and the White House
Office of Science and Technology Policy.  Dr. Huntley received a B.Sc. degree
(SUMMA CUM LAUDE) in Biological Oceanography from the University of Victoria,
Canada 1976 and a Ph.D. in Biological Oceanography from Dalhousie University in
Halifax, Canada in 1980.

     PEARN P. NIILER, PH.D., has been a consultant to the Company since 1990 and
has served as a director of the Company since 1991.  Dr. Niiler is an expert in
applied mathematics and fluid dynamics and was a co-inventor of various
processes used in the Aquasearch Growth Module.  Dr. Niiler is a Professor of
Oceanography at Scripps Institution of Oceanography, University of California,
San Diego, where he heads one of the largest oceanographic research programs in
the nation.  Dr. Niiler has taught and conducted research at Harvard College,
Nova University and Oregon State University and has published more than 125
scientific papers.  Dr. Niiler received his B.S. degree from Lehigh University,
earned honors as a Fulbright Scholar at Cambridge University, England, and was
awarded a Ph.D. as a Woodrow Wilson Fellow from Brown University.

     EARL S. FUSATO joined the Company as Chief Financial Officer in April 1997.
Mr. Fusato served as chief financial officer for RESCO, Inc., a Hawaii based
real estate firm from 1992 to 1994, and as a sales representative and consultant
in the real estate industry from 1994 to April 1997.  During the period from
1983 to 1992, Mr. Fusato served in various financial positions with VeriFone,
Inc., including Vice President, 


                                      -52-

<PAGE>

Finance from 1983 to 1987 and Treasurer from 1987 to 1990.  Prior to that, Mr.
Fusato spent 13 years as an auditor at KPMG Peat Marwick, LLP and Ernst & Young,
LLP. Mr. Fusato is a Certified Public Accountant.

     EDWARD E. DAVID, PH.D., has served as a director of the Company since
September 1997.  Dr. David is currently President of EED, Inc., an industrial
and governmental consulting firm, and Vice President and Principal of the
Washington Advisory Group, a science and technology consulting firm.  Dr. David
served as President of Exxon Research and Engineering from 1977 to 1986; as
Executive Vice President of Research and Development of Gould Inc. and as
President of Gould Laboratories from 1973 to 1977; and as Executive Director of
the Communications Systems Division of Bell Laboratories from 1965 to 1970.  Dr.
David served as Science Advisor to the President of the United States and
Director of the White House Office of Science and Technology from 1970 to 1973. 
Dr. David holds 12 honorary degrees, has received numerous national awards and
is a member of the National Academy of Engineering and the National Academy of
Sciences.  Dr. David serves as director  of Intermagnetics General Corp.,
Spacehab Inc., InterVU, Inc., Medjet Inc. and Protein Polymer  Technologies,
Inc.

     DAVID G. WATUMULL joined the Company in 1998 as Executive Vice-President,
Strategic Development and Corporate Finance; he is responsible for new business
development and corporate capital needs.  As a consultant to the Company since
September 1997, Mr. Watumull has been instrumental in securing most of the
additional $5 million raised by Aquasearch in the last eighteen months.  Mr.
Watumull served as Senior Vice-President at First Honolulu Securities, Inc., a
Honolulu based broker-dealer and investment banker, and as its Chief Investment
Officer of its asset management division from 1993 to 1997. At First Honolulu
Securities, Mr. Watumull was responsible for a $1.3 million private placement
financing secured through First Honolulu Securities for Aquasearch.  Mr.
Watumull participated in the negotiations leading to the Letters of Intent with
C. Brewer Ltd. and Inflazyme Pharmaceuticals.   From 1993 to 1997 at First
Honolulu Securities, Mr. Watumull was a biotechnology industry analyst with
clients that included the Wisconsin State Investment Board.  Prior to 1993, Mr.
Watumull owned his own investment management firm specializing in biotechnology.
From 1983 to 1992, he was a money manager and retail broker at Paine Webber. 
Mr. Watumull attended Claremont Men's College (now Claremont McKenna), majoring
in Mathematics.

BOARD OF DIRECTORS COMMITTEES AND OTHER INFORMATION

     All directors hold office until the next annual meeting of shareholders and
until their successors have been duly elected and qualified.  Officers are
elected by and serve at the discretion of the Board of Directors. There are no
family relationships among the directors or officers of the Company.

     The Board of Directors currently has an Audit Committee and a Compensation
Committee.  The Audit Committee oversees the actions taken by the Company's
independent auditors and reviews the Company's internal financial and accounting
controls and policies.  The Compensation Committee is responsible for
determining salaries, incentives and other forms of compensation for officers,
employees and consultants of the Company and administers the Company's incentive
compensation and benefit plans.

DIRECTOR COMPENSATION

     Directors of the Company do not receive cash for services they provide as
directors.  From time to time, certain directors who are not employees of the
Company have served as consultants to the Company for which they have been paid
customary fees based on the value of the services rendered and/or received
grants of options to purchase shares of the Company's Common Stock.  The Company
does not provide additional compensation for committee participation or special
assignments of the Board of Directors.


                                      -53-

<PAGE>

ITEM 10.  EXECUTIVE COMPENSATION

SUMMARY COMPENSATION

     The following table sets forth the information, on an accrual basis, with
respect to the compensation of the Executive Officers of the Company for the
three fiscal years ended October 31, 1998.

<TABLE>
<CAPTION>

 

                          YEAR ENDED       SALARY/OTHER                          NO. OF SECURITIES
   NAME AND POSITION      OCTOBER 31,      COMPENSATION       STOCK AWARDS      UNDERLYING OPTIONS
-----------------------   -----------      ------------       ------------      ------------------
<S>                       <C>              <C>                <C>               <C>
Mark E. Huntley, Ph.D.,      1998          $   67,083(1)         $   0                    0
President and Chief          1997          $        0(1)         $   0                    0
Executive Officer            1996          $        0(1)         $   0                    0

David G. Watumull            1998          $  115,000(2)         $   0                    0
Executive V.P.
 


</TABLE>

(1)  Dr. Huntley has at all times during 1996, 1997, and part of 1997 served as
     a consultant to the Company while continuing his employment as a research
     biologist at Scripps Institute of Oceanography, University of California,
     San Diego.  Pursuant to the rules and regulations of the Commission,
     however, Dr. Huntley's position as President and Chief Executive Officer of
     the Company qualifies him as an employee of the Company. Notwithstanding
     this, all compensation paid to Dr. Huntley through April 1, 1998 has been
     as though he was an independent consultant to the Company.

(2)  Mr. Watumull became an employee and an officer of the Company on July 1,
     1998.  Prior to  that date, Mr. Watumull served as a consultant to the
     Company.  The Compensation amount reflects the total compensation paid to
     him during fiscal 1998.  

OPTION GRANTS IN FISCAL 1998

     There were no grants of stock options made to executive officers and
directors during the fiscal year ended October 31, 1998.

STOCK OPTIONS EXERCISED DURING FISCAL YEAR

     No stock options or stock appreciation rights were exercised by any
executive officers or directors of the Company during the fiscal year ending
October 31, 1998.

OPTION VALUES

     The following table sets forth information with respect to the value of
unexercised options held by executive officers as of October 31, 1998:


                                      -54-

<PAGE>

                            FISCAL YEAR-END OPTION VALUES

 
<TABLE>
<CAPTION>

                                                      NUMBER OF                  VALUE OF UNEXERCISED IN-THE-MONEY
                                           SECURITIES UNDERLYING UNEXERCISED               OPTIONS AT
                                              OPTIONS AT FISCAL YEAR END                FISCAL YEAR END(1)
                                              --------------------------                ------------------
NAME                                        EXERCISABLE       UNEXERCISABLE       EXERCISABLE       UNEXERCISABLE
----                                        -----------       -------------       -----------       -------------
<S>                                         <C>               <C>                 <C>               <C>
Mark E. Huntley, Ph.D.,
President and
Chief Executive Officer...............       1,665,250             -0-             $212,319              -0-

David G. Watumull,
Executive Vice President..............         312,000          760,000               -0-                -0-
</TABLE>

(1)  Value of unexercised options is based on the closing bid price of the
     Company's Common Stock on the Nasdaq Electronic Bulletin Board on October
     30, 1998 ($0.19) minus the exercise price.

LTIP AWARDS DURING FISCAL YEAR

     No long term incentive plan awards were made to any executive officers or
directors of the Company during the fiscal year ending October 31, 1998.

COMPENSATION OF DIRECTORS

     As of October 31, 1998, no director had received any compensation for any
service provided to the Company as a director.

EMPLOYMENT CONTRACTS

     There are currently no employment contracts or change-in-control
arrangements between the Company and any director or executive officer.

EMPLOYEE BENEFIT PLANS

     1997 EMPLOYEE COMPENSATION PACKAGE.  In October 1997, the Board of
Directors adopted the 1997 Employee Compensation Package.  The 1997 Employee
Compensation Package provides for employee compensation to consist of three
components:  (i) base salary; (ii) a cash bonus, equal to 25% of quarterly
salary, payable at the end of each quarter, but only if the Company's
performance equals or exceeds certain cost, revenue and achievement targets
jointly agreed to by management; and (iii) an annual award of stock options to
all employees under the 1996 Stock Option Plan.

     1996 STOCK OPTION PLAN.  In March 1996, the Board of Directors adopted the
1996 Stock Option Plan.  The 1996 Stock Option Plan provides for the grant of
incentive stock options to employees and nonstatutory stock options and stock
purchase rights to employees and consultants.  A total of 5,000,000 shares of
Common Stock have been reserved for issuance under the 1996 Stock Option Plan,
all of which are currently available for grant.  The 1996 Stock Option Plan will
be administered by the Board of Directors, except that with respect to option
grants to executive officers, the 1996 Stock Option Plan is administered by the
Compensation Committee of the Board of Directors.  Options and stock purchase
rights granted under the 1996 Stock Option Plan will vest as determined by the
relevant administrator, and may accelerate and become fully vested in the event
of an acquisition of the Company if so determined by the relevant administrator.
The exercise price of options and stock purchase rights granted under the 1996
Stock 


                                      -55-

<PAGE>

Option Plan will be as determined by the relevant administrator, although the
exercise price of incentive stock options must be at least equal to the fair
market value of the Company's Common Stock on the date of grant.  The Board of
Directors may amend or modify the 1996 Stock Option Plan at any time.  The 1996
Stock Option Plan will terminate in March 2006, unless terminated earlier by the
Board of Directors.

LIMITATIONS ON LIABILITY AND INDEMNIFICATION MATTERS

     The Company has adopted provisions in its Restated Articles of
Incorporation that eliminate the personal liability of its directors for
monetary damages arising from a breach of their fiduciary duties in certain
circumstances to the fullest extent permitted by law and authorize the Company
to indemnify its directors and officers to the fullest extent permitted by law.
Such limitation of liability does not affect the availability of equitable
remedies such as injunctive relief or rescission.

     The Company's Restated Articles of Incorporation provide that the Company
shall indemnify its directors and officers to the fullest extent permitted by
Colorado law, including circumstances in which indemnification is otherwise
discretionary under Colorado  law.  The Company has entered into indemnification
agreements with its officers and directors containing provisions which will in
some respects be broader than the specific indemnification provisions contained
in the Colorado Corporations Code.  The indemnification agreements require the
Company, among other things, to indemnify such officers and directors against
certain liabilities that may arise by reason of their status or service as
directors or officers (other than liabilities arising from willful misconduct of
a culpable nature) and to advance their expenses incurred as a result of any
proceeding against them as to which they could be indemnified.

     At present, there is no pending material litigation or proceeding involving
a director or officer of the Company where indemnification will be required or
permitted.  The Company is not aware of any threatened material litigation or
proceeding which may result in a claim for such indemnification.

ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The following table sets forth certain information with respect to the
beneficial ownership of the Company's Common Stock as of October 31, 1998 for
(i) each entity or group that is known by the Company to beneficially own five
percent or more of the outstanding Common Stock of the Company, (ii) each
director, (iii) each executive officer and (iv) the Company's directors and
officers as a group.  Except pursuant to applicable community property laws or
as indicated in the footnotes to this table, to the Company's knowledge, each
shareholder identified in the table possesses voting and investment power with
respect to all shares of Common Stock shown as beneficially owned by such
shareholder.

<TABLE>
<CAPTION>
 

                                                                                                             PERCENTAGE OF
                                                   NATURE OF                   NUMBER OF SHARES                 SHARES
                                                   BENEFICIAL                   BENEFICIALLY                 BENEFICIALLY
 DIRECTORS AND OFFICERS(1)                         OWNERSHIP                       OWNED                        OWNED(1)
------------------------------------------------   ----------                  ----------------              -------------
<S>                                                <C>                         <C>                           <C>
Mark E. Huntley, Ph.D.(2)
c/o Aquasearch, Inc.
73-4460 Queen Ka'ahumanu Highway, Suite 110
Kailua-Kona, Hawaii 96740......................      Direct                      5,683,186                       8.1%

Earl S. Fusato (3)
c/o Aquasearch, Inc.
73-4460 Queen Ka'ahumanu Highway, Suite 110
Kailua-Kona, Hawaii 96740......................      Direct                      8,454,529                       11.9%


                                      -56-

<PAGE>

Pearn P. Niiler, Ph.D. (4)
c/o Aquasearch, Inc.
73-4460 Queen Ka'ahumanu Highway, Suite 110
Kailua-Kona, Hawaii 96740.......................      Direct                      1,918,402                       2.7%

Edward E. David, Sc.D. (5)
c/o Aquasearch, Inc.
73-4460 Queen Ka'ahumanu Highway, Suite 110
Kailua-Kona, Hawaii 96740.......................      Direct                      150,000                          *

David Watumull (6)
c/o Aquasearch, Inc.
73-4460 Queen Ka'ahumanu Highway, Suite 110
Kailua-Kona, Hawaii 96740.......................      Direct                      312,000                          *

All directors and officers as a group (5 persons)                                 16,518,117                     22.2%

5% SHAREHOLDERS
------------------------------------------------
Jean Sawyer Weaver Trust, Jean S. Weaver, 
Trustee (7)
c/o Aquasearch, Inc.
73-4460 Queen Ka'ahumanu Highway, Suite 110
Kailua-Kona, Hawaii 96740.......................      Direct                      7,541,223                      10.8%

Gregory F. Kowal(8)
900 Fort  Street, #950
Honolulu, Hawaii 96822..........................      Direct                      4,746,735                      6.8%
</TABLE>

---------------------

*    Less than one percent
 

(1)  Applicable percentage of beneficial ownership before the offering made
     hereby is based on 68,564,013 shares outstanding as of October 31, 1998,
     together with applicable options for each shareholder.  Beneficial
     ownership is determined in accordance with the rules and regulations of the
     Commission, and includes voting and investment power with respect to
     shares.  Shares of Common Stock subject to options currently exercisable or
     exercisable within 60 days after October 31, 1998 are deemed outstanding
     for purposes of computing the percentage ownership of the person holding
     such options, but are not deemed outstanding for computing the percentage
     of any other shareholder.
(2)  Includes options to purchase 1,665,250 shares of Common Stock at an
     exercise price of $0.0625 per share, with a term of seven years, payable by
     a promissory note payable over 3 years with interest at 5% per annum.
(3)  Includes options to purchase 500,000 shares and 1,000,000 shares of Common
     Stock at an exercise price of $0.36 and $1.00 per share, respectively, that
     are exercisable within 60 days of October 31, 1998 and warrants to acquire
     115,384 and 873,713 shares of Common Stock at $1.00 and $0.50 per share,
     respectively, that are immediately exercisable.
(4)  Includes options to purchase 1,291,050 shares of Common Stock at an
     exercise price of $0.0625 per share, with a term of seven years, payable by
     a promissory note payable over 3 years with interest at 5% per annum.
(5)  Includes options to purchase 50,000 shares of Common Stock at an exercise
     price of $0.25 that are immediately exercisable.
(6)  Includes options to purchase 312,000 shares at an exercise price of $0.25
     per share that are immediately exercisable.
(7)  Includes warrants to acquire 1,100,000  shares of Common Stock at $0.50 per
     share that are immediately exercisable.
(8)  Includes warrants to acquire 476,190 and 500,000 shares of Common Stock at
     $1.00 and $0.50 per share, respectively, that are immediately exercisable.

ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

     In September and October 1998, the Company issued one-year convertible 
notes amounting to $300,000 to certain of its shareholders. The holders of 
these notes have an option to convert to the Company's Common Stock.  The 
convertible notes carry an interest rate of 10 percent per annum and warrants 
to purchase 1,000 shares of Common Stock at $0.50 per share for each $1,000 
aggregate principal amount of convertible notes. Gregory Kowal, the 
beneficial owner of over 5% of the Company's Common Stock, purchased $150,000 
worth of the notes.

                                      -57-

<PAGE>

     In July 1998, the Company entered into a loan agreement with David
Watumull, its Executive Vice-President of Strategic Development and Corporate
Finance.  Under the terms of the loan agreement and the related promissory note,
the Company loaned Mr. Watumull $50,000, plus $3,500 per month and interest
payments during the life of the loan.  The promissory note has an interest rate
of 9 percent per annum and is secured by Mr. Watumull's common stock options.

     From February to March 1998, the Company sold to Earl Fusato, its Chief
Financial Officer, Secretary, and a member of its Board of Directors, certain
short-term notes in the aggregate principal amount of $250,000 with an interest
rate of 10% per annum.  The notes were payable in full on September 30, 1998. 
In connection with the issuance of the notes, the Company issued to Mr. Fusato
warrants to purchase a total of 113,713 shares of its Common Stock.  The
warrants have an exercise price of $0.50 per share and have a term of three
years.  In October 1998, the principal and accrued interest on this note
amounting to $265,000 was refinanced into a one-year convertible note.  The
convertible note payable carries an interest rate of 10% per annum and warrants
to purchase 100 shares of common stock at $0.50 per share for each $1,000
aggregate principal amount of convertible notes.  At October 31, 1998 none of
the described warrants were issued.

     During the period from June 1997 to September 1998, the Company sold
$3,305,000 aggregate principal amount of Convertible Notes ("1998 Convertible
Notes") to a total of twelve "accredited investors" as defined under Rule 501 of
the Securities Act (the "Selling Security Holders").  In connection with the
issuance of the 1998 Convertible Notes, the Company also issued to the Selling
Security Holders a total of 3,305,000 Warrants (the "1998 Warrants") to purchase
a total of 3,418,713 shares of Common Stock.  The 1998 Warrants have an exercise
price of $0.50 per share and have a term of three years.  As part of this
transaction, the Earl S. Fusato Revocable Trust, Earl S. Fusato, Trustee,
purchased a $760,000 Convertible Note and 760,000 Warrants.  Between July and
September 1998, the Selling Security Holders converted the 1998 Convertible
Notes into 20,075,648 shares of Common Stock.

     In April 1997, the Company sold 1,000,000 shares of Common Stock at $0.21
per share to Mr. Fusato.  The total proceeds to the Company were $210,000.  No
underwriter was used.  This offering was made pursuant to the exemption provided
under Section 4(2) of the Securities Act.

     During the period from October 1996 to April 1997, the Company sold an
aggregate of 5,044,570 Units, consisting of one share of Common Stock and one
Common Stock Purchase Warrant (the "Warrants"), in a private placement under
Section 4(2) of the Securities Act of 1933, as amended.  During the course of
the private placement, the Earl S. Fusato Revocable Living Trust purchased
115,384 Units at $0.26 per Unit.  The Warrants have a term of three years and
are exercisable at $1.00 per share, subject to adjustment.  The Warrants are
redeemable by the Company at $.01 per Warrant during their three-year exercise
period upon 30 days' notice anytime that the closing bid price per share of the
Common Stock exceeds $1.50 per share (subject to adjustment) for 20 trading days
out of 30 consecutive trading days ending on the third day prior to the date of
the notice of redemption. The gross proceeds from this offering were $1,275,980.


                                      -58-

<PAGE>

ITEM 13.  EXHIBITS AND REPORTS ON FORM 8-K

<TABLE>
<CAPTION>
EXHIBITS
<S>         <C>
3.1*        Articles of Incorporation of Registrant

3.2+        Articles of Amendment of Articles of Incorporation, filed
            October 4, 1996

3.3*        By-laws of Registrant

4.1+        Form of 1996 Bridge Loan Note

4.2+        Form of 1997 Private Placement Warrant

4.3++       Form of 1998 Convertible Note

4.4++       Form of 1998 Warrant

4.5++       Form of 1998 Note and Warrant Purchase Agreement 

10.2#       Stock Subscription Agreement between Cultor Ltd. And the Company 
            dated May 14, 1996

10.3+       The Amended Keahole Pointe Facilities Use Agreement dated August
            22, 1996 by and between the National Energy Laboratory of Hawaii
            Authority and the Company

10.4$       Letter of Intent between C. Brewer and Company Limited and the
            Company

27.1        Financial Data Schedule
</TABLE>

*           Incorporated by reference to the exhibit filed with the Company's
            Annual Report on Form 10-KSB for the fiscal year ended October 31,
            1995.

#           Incorporated by reference to the exhibit filed with the Company's
            Current Report on Form 8-K filed September 13, 1996.

+           Incorporated by reference to the exhibit filed with the Company's
            Annual Report on Form 10-KSB for the fiscal year ended October 31,
            1996.

$           Incorporated by reference to the Company's Current Report on Form 
            8-K dated November 13, 1996.

++          Incorporated by reference to the exhibit filed with Amendment No. 1
            to the Company's Registration Statement on Form SB-2 filed October
            28, 1998.


REPORTS ON FORM 8-K

     No reports were filed during the last quarter of year ended October 31,
1998.


                                      -59-

<PAGE>

                                      SIGNATURES

     In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
has duly caused this Annual Report on Form 10KSB to be signed on January 27,
1999, on its behalf by the undersigned, thereunto duly authorized.

                                             AQUASEARCH, INC.


                                             By  /s/ Mark E. Huntley
                                               --------------------------
                                                  Mark E. Huntley
                                                  Chief Executive Officer

     In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the date indicated.

            Signature                                           Date



/s/ Mark E. Huntley                                      January 27, 1999
-------------------------------
Mark E. Huntley
Director, President, CEO & Chairman of the 
Board of Directors



/s/ Pearn P. Niiler                                      January 27, 1999
-------------------------------
Pearn P. Niiler
Director



/s/ Earl S. Fusato                                       January 27, 1999
-------------------------------
Earl S. Fusato
Director, Chief Financial Officer, Principal 
Accounting Officer



/s/ Edward E. David                                      January 27, 1999
-------------------------------
Edward E. David, Ph.D.
Director


                                      -60-

<PAGE>

                              FINANCIAL STATEMENTS

                                AQUASEARCH, INC.

                        (A DEVELOPMENT STAGE ENTERPRISE)


                          INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>

 <S>                                                                               <C>
 Report of Independent Auditors.....................................................F-2

 Audited Financial Statements:

 Balance Sheets as of October 31, 1996, 1997 and 1998...............................F-3

 Statements of Loss and Accumulated Deficit from Inception to October 31, 1998
   and for the Fiscal Years Ended October 31,
   1996, 1997 and 1998..............................................................F-4

 Statements of Cash Flows from Inception to October 31, 1998
   and for the Fiscal Years Ended October 31, 1996, 1997 and 1998...................F-5

 Statements of Stockholders' Equity (Deficit) from Inception to
   October 31, 1998.................................................................F-6

 Notes to Financial Statements.....................................................F-10
</TABLE>

                                      F-1
<PAGE>


                         REPORT OF INDEPENDENT AUDITORS


The Board of Directors
Aquasearch, Inc.

We have audited the accompanying balance sheets of Aquasearch, Inc. (a
development stage enterprise) as of October 31, 1998, 1997 and 1996, and the
related statements of loss and accumulated deficit, cash flows, and
stockholders' equity (deficit) for the years then ended and for the period from
inception to October 31, 1998. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits. The financial statements as of
and for the period from inception to October 31, 1995, were audited by other
auditors whose report dated December 2, 1995 except for Note 5 dated January 26,
1996, and Note 8 dated April 6, 1997, expressed an unqualified opinion on those
statements. The financial statements for the period from inception to October
31, 1995 include no revenues and a net loss of $1,616,518. Our opinion on the
statements of loss and accumulated deficit, cash flows, and stockholders' equity
(deficit) for the period from inception to October 31, 1998, insofar as it
relates to amounts for prior periods through October 31, 1995, is based solely
on the report of the other auditors.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of other auditors provide a reasonable
basis for our opinion.

In our opinion, based on our audits and the report of other auditors, the
financial statements referred to above present fairly, in all material respects,
the financial position of Aquasearch, Inc. (a development stage enterprise) as
of October 31, 1998, 1997 and 1996, and the results of its operations and its
cash flows for the years then ended and the period from inception to October 31,
1998, in conformity with generally accepted accounting principles.

As discussed in Note 1 to the financial statements, the Company's recurring
losses from operations and working capital deficit at October 31, 1998 raise
substantial doubt about its ability to continue as a going concern. The October
31, 1998 financial statements do not include any adjustments that might result
from the outcome of this uncertainty.


                                    /s/ Ernst & Young LLP

January 27, 1999
Honolulu, Hawaii


                                     F-2
<PAGE>

                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)
                                 BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                                   October 31
                                                                     -------------------------------------------
                                                                        1998            1997            1996
                                                                     -----------     -----------     -----------
<S>                                                                  <C>             <C>             <C>
Assets
Current assets:
     Cash .......................................................... $   151,473     $    47,006     $   187,166
     Cash in escrow ................................................           -               -         460,980
     Accounts receivable ...........................................           -           1,219           1,933
     Prepaid expenses ..............................................      48,703          24,439           5,534
     Refundable deposits ...........................................       3,081           4,570           3,145
                                                                     -----------     -----------     -----------
Total current assets ...............................................     203,257          77,234         658,758
                                                                     -----------     -----------     -----------

Note receivable from officer  (Note 4)..............................      50,000               -               -
Notes receivable ...................................................      59,696          30,516               -
Plant and equipment:
     Plant .........................................................   2,519,044         738,889         676,709
     Equipment .....................................................     167,203         173,052          68,349
     Less accumulated depreciation .................................    (201,292)       (104,894)        (35,876)
                                                                     -----------     -----------     -----------
Net plant and equipment ............................................   2,484,955         807,047         709,182
Total assets ....................................................... $ 2,797,908     $   914,797     $ 1,367,940
                                                                     ===========     ===========     ===========

Liabilities and Stockholders' Equity (Deficit)
Current liabilities:
     Accounts payable .............................................. $ 1,084,829     $   446,344     $   466,165
     Deposits held                                                             -               -         460,980
     Notes payable .................................................     315,000         215,000         150,000
     Note payable to officer (Note 2)...............................     265,000         360,000               -
                                                                     -----------     -----------     -----------
 Total current liabilities .........................................   1,664,829       1,021,344       1,077,145
                                                                     -----------     -----------     -----------
Stockholders' Equity (Deficit)
     Preferred stock (5,000,000 shares authorized) (Note 1)                    -               -               -
     Common stock ($0.0001 par value, 100,000,000 shares 
     authorized, 68,564,013, 47,819,881 and 40,829,331
     shares outstanding at October 31, 1998, 1997 and 1996
     respectively) .................................................       7,979           5,904           5,204
     Additional paid-in capital ....................................   8,189,414       4,699,470       3,234,309
     Deficit accumulated during the development stage ..............  (7,064,314)     (4,811,921)     (2,948,718)
                                                                     -----------     -----------     -----------
Total stockholders' equity (deficit) ...............................   1,133,079        (106,547)        290,795
                                                                     -----------     -----------     -----------
Total liabilities and stockholders' equity (deficit) ............... $ 2,797,908     $   914,797     $ 1,367,940
                                                                     ===========     ===========     ===========
</TABLE>

                             SEE ACCOMPANYING NOTES.

                                    F-3
<PAGE>


                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                   STATEMENTS OF LOSS AND ACCUMULATED DEFICIT

<TABLE>
<CAPTION>
                                                                                    For the years ended October 31,
                                                                           -------------------------------------------------
                                                       From inception to
                                                          October 31, 
                                                              1998             1998               1997               1996
                                                       -----------------   --------------    --------------   --------------
<S>                                                    <C>                 <C>               <C>               <C>
Operations
Sales .................................................  $     11,077       $          -      $      1,077      $     10,000
Cost of sales .........................................        23,464                  -             2,238            21,226
                                                       -----------------   --------------    --------------   --------------
Gross loss from operations ............................       (12,387)                 -            (1,161)          (11,226)

Research and development costs ........................     3,053,302          1,166,766           793,770           648,601
General and administrative expenses ...................     3,669,368            964,120         1,072,051           640,702
                                                       -----------------   --------------    --------------   --------------
Loss from operations ..................................    (6,735,057)        (2,130,886)       (1,866,982)       (1,300,529)
Other Income (Expense)
Interest ..............................................      (126,337)          (121,155)            4,465             2,597
Other .................................................        (7,054)              (352)             (686)                -
Investment in joint venture ...........................      (147,096)                 -                 -                 -
                                                       -----------------   --------------    --------------   --------------
Total other income (expense) ..........................      (280,487)          (121,507)            3,779             2,597
                                                       -----------------   --------------    --------------   --------------

Loss before income taxes and extraordinary item .......    (7,015,544)        (2,252,393)       (1,863,203)       (1,297,932)
Extraordinary item - loss on write down of 
assets to liquidation basis ...........................       (14,502)                 -                 -                 -
Loss before income taxes ..............................    (7,030,046)        (2,252,393)       (1,863,203)       (1,297,932)
Federal and State income taxes ........................             -                  -                 -                 -
Net loss ..............................................    (7,030,046)        (2,252,393)       (1,863,203)       (1,297,932)
Accumulated Deficit
Balance, beginning of period ..........................       (34,268)        (4,811,921)       (2,948,718)       (1,650,786)
                                                       -----------------   --------------    --------------   --------------
Balance, end of period ................................  $ (7,064,314)      $ (7,064,314)     $ (4,811,921)     $ (2,948,718)
                                                       =================   ==============    ==============   ==============
Loss per share ........................................  $      (0.27)      $      (0.04)     $      (0.04)     $      (0.03)
                                                       =================   ==============    ==============   ==============
Weighted average shares outstanding ...................    25,701,408         52,697,095        44,646,653        37,679,955
                                                       =================   ==============    ==============   ==============
</TABLE>

                             SEE ACCOMPANYING NOTES.

                                       F-4
<PAGE>


                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                            STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                            For the years ended October 31,
                                                                                  -------------------------------------------------
                                                             From inception to
                                                              October 31, 1998         1998              1997             1996
                                                              -----------------   --------------    --------------   --------------
<S>                                                          <C>                   <C>                <C>                <C>
Cash Flows from Operating Activities
Net loss ..................................................... $(7,030,046)        $(2,252,393)       $(1,863,203)     $(1,297,932)

Adjustments to reconcile net loss to net cash used in
operating activities:
     Amortization ............................................       3,527                   -                  -                -
     Depreciation ............................................     206,999              96,398             69,018           35,556
     Expenses paid with common stock .........................     801,198              45,879            311,154           62,800
     Loss on write down of assets to liquidation basis .......       5,392                   -                  -                -
     Changes in:
         Other current assets ................................     (51,583)            (22,775)           (20,330)           3,033
         Receivables .........................................           -               1,219                714           33,067
         Accounts payable ....................................   1,001,116             638,485            (19,821)         232,968
         Deposits held .......................................           -                   -           (460,980)         460,980
                                                              -----------------   --------------    --------------   --------------
Cash used in operating activities ............................  (5,063,397)         (1,493,187)        (1,983,448)        (469,528)

Cash Flows from Investing Activities
Purchase of fixed assets .....................................  (2,595,831)         (1,774,306)          (166,883)        (329,099)
                                                              -----------------   --------------    --------------   --------------
Cash used in investing activities ............................  (2,595,831)         (1,774,306)          (166,883)        (329,099)

Cash Flows from Financing Activities
Cash (held in) released from escrow ..........................           -                   -            460,980         (460,980)
Increase in notes receivable .................................    (109,696)            (79,180)           (30,516)               -
Issuance of common stock .....................................   7,582,462           3,446,140          1,320,129        1,326,600
Increase in notes payable ....................................     609,800               5,000            425,000          150,000
Offering costs ...............................................    (271,919)                  -           (165,422)         (57,035)
                                                              -----------------   --------------    --------------   --------------
Cash provided by financing activities ........................   7,810,647           3,371,960          2,010,171          958,585
                                                              -----------------   --------------    --------------   --------------

Net increase (decrease) in cash ..............................     151,419             104,467           (140,160)         159,958
Cash, beginning of the period ................................          54              47,006            187,166           27,208
                                                              -----------------   --------------    --------------   --------------

Cash, end of the period ...................................... $   151,473         $   151,473        $    47,006      $   187,166
                                                              =================   ==============    ==============   ==============
</TABLE>

                             SEE ACCOMPANYING NOTES.

                                     F-5
<PAGE>


                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                  STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

                       FROM INCEPTION TO OCTOBER 31, 1998

<TABLE>
<CAPTION>
                                                                                       Common Stock
                                                      -----------------------------------------------------------------------------
                                                                                                                          Total
                                                                                       Additional                      Stockholders'
                                                       Number of                         Paid-in       Accumulated        Equity
                                                        Shares          Amount           Capital         Deficit         (Deficit)
                                                      -----------     -----------      -----------     ------------    ------------
<S>                                                   <C>             <C>              <C>             <C>             <C>
Balance, October 31, 1988 ..........................   20,000,000     $     2,000      $    72,730     $  (101,984)    $   (27,254)

Sale of stock ($0.05 per share) ....................    4,000,000             400          166,291               -         166,691
Treasury shares acquired at no cost ................  (11,198,838)              -                -               -               -
Exercise of A warrants for stock 
     ($0.12 per share) .............................      556,000              56           66,664               -          66,720
Loss for the year ended                             
     October 31, 1989 ..............................            -               -                -        (183,333)       (183,333)
                                                      -----------     -----------      -----------     ------------    ------------
Balance, October 31, 1989 ..........................   13,357,162           2,456          305,685        (285,317)         22,824
Sale of stock ($0.07 per share) ....................      140,000              14            9,786               -           9,800
Stock issued for services ($0.05 per share) ........      300,000              30           13,515               -          13,545
Exercise of A warrants for stock                    
     ($0.12 per share) .............................    2,792,000             279          328,540               -         328,819
Loss for the year ended                             
     October 31, 1990 ..............................            -               -                -        (163,839)       (163,839)
                                                      -----------     -----------      -----------     ------------    ------------
Balance, October 31, 1990 ..........................   16,589,162           2,779          657,526        (449,156)        211,149
Sale of stock ($0.04 per share) ....................      125,000              13            5,987               -           6,000
Stock issued in consideration for loans             
      ($0.04 per share) ............................      290,000              29           11,571               -          11,600
Loss for the year ended October 31, 1991 ...........            -               -                -        (251,401)       (251,401)
                                                      -----------     -----------      -----------     ------------    ------------
</TABLE>

                                      F-6
<PAGE>

                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                  STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
                                   (CONTINUED)

<TABLE>
<CAPTION>
                                                                            Common Stock
                                              ------------------------------------------------------------------------------
                                                                                                                  Total
                                                                               Additional                      Stockholders'
                                               Number of                         Paid-in       Accumulated        Equity
                                                Shares          Amount           Capital          Deficit        (Deficit)
                                              -----------     -----------      -----------     ------------    ------------
<S>                                           <C>             <C>              <C>             <C>             <C>
Balance, October 31, 1991 ...................  17,004,162      $    2,821       $  675,084      $ (700,557)      $  (22,652)
Sale of stock ($0.15 per share) .............      20,000               2            2,998               -            3,000
Stock issued for services ($0.0001 to
      $0.04 per share) ......................     453,500              45            6,134               -            6,179
Loss for the year ended
     October 31, 1992 .......................           -               -                -         (81,128)         (81,128)
                                              -----------     -----------      -----------     ------------    ------------
Balance, October 31, 1992 ...................  17,477,662           2,868          684,216        (781,685)         (94,601)
Sale of stock ($0.08 per share) .............   3,175,000             318          244,071               -          244,389
Stock issued for services
     ($0.08 per share) ......................     673,751              68           54,083               -           54,151
Conversion of notes and advances for
      stock ($0.08 per share) ...............     861,900              87           69,315               -           69,402
Loss for the year ended .....................           -               -                -        (142,198)        (142,198)
     October 31, 1993
                                              -----------     -----------      -----------     ------------    ------------
Balance, October 31, 1993 ...................  22,188,313           3,341        1,051,685        (923,883)         131,143
Sale of stock ($0.03 per share) .............     250,000              25            7,475               -            7,500
Stock issued for services
     ($0.08 per share) ......................   1,025,000             101           81,900               -           82,001
Loss for the year ended
     October 31, 1994 .......................           -               -                -        (240,090)        (240,090)
                                              -----------     -----------      -----------     ------------    ------------
</TABLE>

                                        F-7
<PAGE>

                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                  STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
                                   (CONTINUED)


<TABLE>
<CAPTION>
                                                                                    Common Stock
                                                      ------------------------------------------------------------------------------
                                                                                                                          Total
                                                                                       Additional                      Stockholders'
                                                       Number of                         Paid-in       Accumulated        Equity
                                                        Shares          Amount           Capital          Deficit        (Deficit)
                                                      -----------     -----------      -----------     ------------    ------------
<S>                                                   <C>             <C>              <C>             <C>             <C>
Balance, October 31, 1994 ........................... 23,463,313      $     3,467       $1,141,060      $(1,163,973)    $   (19,446)

Sale of stock ($0.0625 to $0.10 per share) ..........  7,622,500              762          550,883                -         551,645
Stock issued for services ($0.10 per share) .........    177,875               18           12,974                -          12,992
Reissue stock previously canceled
     at no cost .....................................  1,320,000              132             (132)               -               -
Loss for the year ended
     October 31, 1995 ...............................          -                -                -         (288,813)       (288,813)
                                                      -----------     -----------      -----------     ------------    ------------
Balance, October 31, 1995,
     as previously reported ......................... 32,583,688            4,379        1,704,785       (1,452,786)        256,378
Correction of reissuance of stock
      previously canceled (NOTE 8) ..................          -                -          198,000         (198,000)              -
                                                      -----------     -----------      -----------     ------------    ------------
Balance, October 31, 1995, as restated .............. 32,583,688            4,379        1,902,785       (1,650,786)        256,378
Sale of stock ($0.125 to $0.50 per share) . .........  7,901,643              791        1,268,758                -       1,269,549
Stock issued for services ($0.125 to
     $0.62 per share) ...............................    344,000               34           62,766                -          62,800
Loss for the year ended
     October 31, 1996 ...............................          -                -                -       (1,297,932)     (1,297,932)
                                                      -----------     -----------      -----------     ------------    ------------
</TABLE>

                                       F-8
<PAGE>


                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                  STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
                                   (CONTINUED)


<TABLE>
<CAPTION>
                                                                            Common Stock
                                              ------------------------------------------------------------------------------
                                                                                                                  Total
                                                                               Additional                      Stockholders'
                                               Number of                         Paid-in       Accumulated        Equity
                                                Shares          Amount           Capital          Deficit        (Deficit)
                                             -----------     -----------      ------------     ------------    ------------
<S>                                          <C>             <C>              <C>             <C>             <C>
Balance, October 31, 1996 ..................  40,829,331     $     5,204       $ 3,234,309     $(2,948,718)    $   290,795

Sale of stock ($0.21 to $0.44 per
      share) ...............................   5,095,727             510         1,123,681               -       1,124,191
Stock issued for services ($0.17 to
     $0.892 per share) .....................     103,138              11            35,336               -          35,347
Exercise of options for stock
     ($0.625 per share) ....................     488,250              49            30,467               -          30,516
Penalty shares ($0.2116 per share)
       (NOTE 2) ............................   1,303,435             130           275,677               -         275,807
Loss for the year ended October 31,
     1997 ..................................           -               -                 -      (1,863,203)     (1,863,203)
                                             -----------     -----------      ------------     ------------    ------------
Balance, October 31, 1997 ..................  47,819,881     $     5,904       $ 4,699,470     $(4,811,921)    $  (106,547)
Issuance of stock on conversion of
Convertible Note Payable ($0.16 to
$0.19 per Share) ...........................  20,075,648           2,008         3,414,953               -       3,416,961
Stock issued for services ($0.22 to
     $0.25 per share) ......................     201,622              20            45,859               -          45,879
Exercise of options for stock
     ($0.625 per share) ....................     466,862              47            29,132               -          29,179
Loss for the year ended October 31,
     1998 ..................................           -               -                 -      (2,252,393)     (2,252,393)
                                             -----------     -----------      ------------     ------------    ------------
Balance, October 31, 1998 ..................  68,564,013     $     7,979       $ 8,189,414     $(7,064,314)    $ 1,133,079
                                             ===========     ===========      ============     ============    ============
</TABLE>

                             SEE ACCOMPANYING NOTES.

                                     F-9
<PAGE>


                                AQUASEARCH, INC.

                        (A DEVELOPMENT STAGE ENTERPRISE)

                          NOTES TO FINANCIAL STATEMENTS

                         OCTOBER 31, 1998, 1997 AND 1996

1.   BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

     Aquasearch, Inc. (Aquasearch), a Colorado corporation founded in February
1988, is a development stage company that develops and commercializes natural
products from microalgae using its proprietary, large-scale photobioreactor
technology known as the Aquasearch Growth Module. The Company's principal
operations are located in Kailua-Kona, Hawaii.

     Microalgae are a diverse group of over 30,000 species of microscopic plants
that have a wide range of physiological and biochemical characteristics.
Microalgae produce many different and unusual fats, sugars, proteins, amino
acids, vitamins, enzymes, pigments and other bioactive compounds that have
existing and potential commercial applications in such fields as animal and
human nutrition, food colorings, cosmetics, diagnostic products,
pharmaceuticals, research grade chemicals, pigments and dyes. Microalgae grow
ten times faster than the fastest growing land-based crops and represent a
largely unexploited and renewable natural resource with a biodiversity
comparable to that of land-based plants.

     Aquasearch's first commercial product is astaxanthin, a naturally occurring
red pigment derived from a freshwater microalgae. The primary market for
astaxanthin currently is aquaculture. Free swimming salmon and shrimp acquire
pink flesh from natural astaxanthin contained in microalgae and other species
ingested in the wild. Farmed salmon and shrimp, however, currently acquire pink
flesh from the addition of synthetic astaxanthin (or a less effective substitute
product) to their feed.

     Because no significant sales have occurred and because the Company has
devoted most of its efforts since inception to research and development, the
Company is considered to be in the development stage.

BASIS OF PRESENTATION

     The Company's financial statements have been presented on the basis that it
is able to continue as a going concern, which contemplates the realization of
assets and the satisfaction of liabilities in the normal course of business. The
Company has incurred operating losses since inception totaling approximately $7
million. At October 31, 1998, the Company had a working capital deficit of
approximately $1.5 million. During the year ended October 31, 1998, the Company
sold additional shares of stock through a private placement and issued
convertible notes, which were sufficient to fund its immediate operating
financial needs.

     In May 1996, the Company entered into a three-year (recently extended to
four years) Distribution and Development Agreement with Cultor, Ltd. (Cultor).
Aquasearch will act as the exclusive worldwide supplier of natural astaxanthin
derived from microalgae to Cultor in the field of animal feed and animal
nutrition and Cultor will act as the exclusive worldwide distributor of
Aquasearch's natural astaxanthin product in the field of animal feed and animal
nutrition. Cultor is a $2 billion Finnish food conglomerate that is a leading
worldwide producer of animal feed and animal nutrition products.

     The agreement also provides that Cultor and Aquasearch may, at Cultor's
option, mutually develop a joint venture company for the sole purpose of
producing and selling natural astaxanthin in the field of animal feed and animal
nutrition. Pursuant to this arrangement, Aquasearch would contribute a natural
astaxanthin production facility in return for its 50% 

                                    F-10
<PAGE>

stake in the new company and Cultor would contribute cash equal to the 
appraised value of the facility for its 50% stake.

     In connection with the execution of the agreement, Cultor purchased 400,000
shares of the Company's common stock at a purchase price of $0.50 per share.

     The Company has begun its expansion of its present one-acre research and
development facility to a four-acre research and development/production facility
to meet its initial agreed on target production requirement under the Cultor
Agreement.

     The Company currently projects that it will require between $2.0 and $2.5
million in operating capital in 1999, before any planned capital expenditures.
The Company is presently pursuing additional sources of capital in order to
maintain and expand its operations in fiscal 1999. These capital sources include
government contracts and grants, product sales, license agreements and equity
and debt financing.

     The Company's continued existence is dependent upon its ability to obtain
working capital and long-term financing to meet its obligations on a timely
basis and to fund expansion of its production facilities and continued research
and development of new microalgae products. The Company is presently unable to
reasonably determine the likelihood of obtaining such financing. In addition,
the failure of the Company to gain additional customers for its natural
astaxanthin product in other applications and customers for its other potential
products, the loss of Cultor or any potential corporate partner as a customer,
or a significant reduction in the level of sales to Cultor or any potential
corporate partner could have a material adverse effect on the Company's
business, financial condition and results of operations.

     The accompanying financial statements do not include any adjustments,
including those related to the classification of recorded asset amounts or the
amounts or classification of liabilities, that might result from the outcome of
the aforementioned uncertainties.

CASH EQUIVALENTS

     For purposes of the statements of cash flows, the Company considers all
highly liquid investments purchased with an original maturity of three months or
less to be cash equivalents.

CASH IN ESCROW AND DEPOSITS HELD

     Cash in escrow and deposits held represent funds received from prospective
purchasers of the Company's common stock for which written confirmation and
representation letters, as required by the private placement memorandum, were
not received as of the balance sheet date.

PLANT AND EQUIPMENT

     Plant and equipment is stated at cost. Depreciation is provided on the
straight-line method over ten years for plant and five years for equipment.

                                   F-11
<PAGE>

PREFERRED STOCK

     The Company has authorized 5,000,000 shares of "blank check" preferred
stock, with such designations, rights, preferences, privileges and restrictions
to be determined by the Company's Board of Directors. No preferred stock has
been issued as of October 31, 1998.

STOCK ISSUED FOR SERVICES

     Stock issued for services is based on management's estimate of the fair
value of the Company's restricted stock at the date of issue or the fair value
of the services received, whichever is more reliably measurable.

INCOME TAXES

     The Company uses the asset and liability method of accounting for income
taxes as required by Statement of Financial Accounting Standards No. 109 (SFAS
109), ACCOUNTING FOR INCOME TAXES. SFAS 109 requires the recognition of deferred
tax assets and liabilities for the expected future tax consequences of temporary
differences between the carrying amounts and the tax basis of certain assets and
liabilities.

     Since its inception, the Company has incurred net operating losses.
Accordingly, no provision has been made for income taxes.

LOSS PER SHARE

     Loss per share was based on the average common shares outstanding during
the period. Average common share equivalents have not been included in the
computation of loss per share as their effect would be anti-dilutive.

DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

     The carrying amounts of the Company's financial instruments, including
cash, cash in escrow, accounts payable, deposits held and notes payable are
deemed to approximate fair value due to their short-term nature.

USE OF ESTIMATES

     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.

2.   COMMON STOCK AND COMMON STOCK WARRANTS

     On January 12, 1989, the Company sold to the public 4,000,000 shares of its
$0.0001 par value common stock. The shares were sold as part of a unit for $0.05
per unit. Each unit consisted of one share of common stock and one common stock
purchase warrant ("A" warrant). The "A" warrant entitled the holder thereof to
purchase one additional share of common stock and one common stock purchase

                                   F-12
<PAGE>

warrant ("B" warrant) for $0.12 per share. The "B" warrant entitles the holder
to purchase one additional share of common stock for $1.00. The warrants may be
redeemed by the Company at $0.0001 per warrant. The offering netted $165,691 to
the Company on the date of closing.

     During the years ended October 31, 1989 and 1990, 3,348,000 "A" warrants
were exercised at $0.12 per share which netted the Company $393,523 (after issue
costs). All remaining "A" warrants have been canceled. The 3,348,000 "B"
warrants expired on September 15, 1996.

     In August and September 1996, the Company obtained approximately $150,000
of short-term bridge financing from four individual investors pursuant to a note
and warrant purchase agreement dated August 1, 1996. The notes matured on
September 30, 1996.

     In conjunction with the execution of the notes, the investors received a
total of 25,974 warrants entitling the holder to purchase one share of common
stock at an exercise price of $0.21 per share. The warrants expire on December
31, 1999.

     During the period from October 1996 to April 1997, the Company sold an
aggregate of 5,044,570 units, consisting of one share of Common Stock and one
Common Stock Purchase Warrant (the "Warrants"), to accredited investors (the
"Unit Investors") in a private placement (the "Unit Offering"). The purchase
price of the units ranged from $0.21 per unit to $0.44 per unit. The Warrants
have a term of three years and are exercisable at $1.00 per share, subject to
adjustment. The Warrants are redeemable by the Company at $0.01 per Warrant
during their three-year exercise period upon 30 days' notice anytime that the
closing bid price per share of the Common Stock exceeds $1.50 per share (subject
to adjustment) for 20 trading days out of 30 consecutive trading days ending on
the third day prior to the date of the notice of redemption. The gross proceeds
from the Unit Offering were $1,275,980. The placement agent for the Unit
Offering, First Honolulu Securities, Inc., received total commissions of $76,559
(equal to 6% of the gross proceeds from the sale of the units) and 302,674
Common Stock Purchase Warrants (equal to 6% of the number of units sold). The
terms of the Warrants issued are identical to the terms of the Warrants issued
to the Unit Investors in the Unit Offering.

     In October 1997, the Company issued 1,303,000 shares of Common Stock to the
Unit Investors as compensation for the failure by the Company to cause the
registration statement of the shares purchased in the Unit Offering to be
declared effective by the Securities and Exchange Commission on or before May
29, 1997. The registration statement was declared effective on November 12,
1997. The shares have been reflected as issued and outstanding as of October 31,
1997.

     In November 1996, the Company executed a letter of intent with C. Brewer
and Company, Limited (C. Brewer) with respect to the acquisition of between 80
and 90 acres of property on the Big Island of Hawaii valued at between $900,000
and $1,000,000 in exchange for C. Brewer's acquisition of approximately 6% of
the outstanding common stock of the Company. In connection with this
transaction, C. Brewer also acquired a warrant to purchase up to 500,000 shares
of the Company's common stock at an exercise price of $1.25 per share. This
transaction has not been consummated as of October 31, 1998.

     From February to March 1998, the Company sold to an officer/director of the
Company certain short-term notes amounting to $250,000 with an interest rate of
10% per annum. The notes were payable in full on September 30, 1998. In
connection with the issuance of the notes, the Company issued 

                                   F-13
<PAGE>

warrants to purchase a total of 113,713 shares of its common stock. The 
warrants have an exercise price of $0.50 per share and have a term of three 
years. In October 1998, the principal and accrued interest on these notes 
amounting to $265,000 were refinanced into a one-year convertible note. The 
Company issued an additional $300,000 worth of convertible notes during the 
1998 fiscal year.  The $565,000 worth of convertible notes carry an interest 
rate of 10% per annum and warrants to purchase 1,000 shares of common stock at 
$0.50 per share for each $1,000 aggregate principal amount of convertible 
notes. At October 31, 1998 none of the described warrants were issued.

     During the period from June 1997 to September 1998, the Company sold 
$3,305,000 aggregate principal amount of convertible notes to a total of 
twelve "accredited investors". In connection with the issuance of the 
convertible notes, the Company also issued a total of 3,305,000 Warrants to 
purchase a total of 3,305,000 shares of common stock. The warrants have an 
exercise price of $0.50 per share and have a term of three years. As part of 
this transaction, an officer/director, purchased a $760,000 Convertible Note 
and 760,000 Warrants. Between July and September 1998, the $3,305,000 of 
convertible notes were converted into 20,075,648 shares of common stock.

     As of October 31, 1998, there were a total of 8,791,931 common stock
purchase warrants issued and outstanding, of which 5,347,244 warrants had an
exercise price of $1.00 per share, 3,418,713 warrants had an exercise price of
$0.50 per share, and 25,974 warrants had an exercise price of $0.21 per share.
No warrants were exercised during the year ended October 31, 1998. At October
31, 1998, the Company had reserved a sufficient number of shares of its common
stock for issuance pursuant to the exercise of the warrants.

3.   COMMON STOCK OPTIONS

     In August 1995, the Company granted nonstatutory stock options, exercisable
immediately, to seven individuals to purchase a total of 5,777,462 shares of the
Company's common stock at an exercise price of $0.0625 per share. In addition,
the Company also granted stock options to three individuals which became
exercisable in July 1996 to purchase a total of 180,000 shares of the Company's
common stock at an exercise price of $0.61 per share. The options have a term of
seven years.

     In March 1996, the Company's Board of Directors approved a stock option
plan which provides for the granting of nonstatutory stock options to employees
and consultants of the Company. A total of 5,000,000 shares of the Company's
common stock has been reserved for issuance under the plan. Terms of awards
under the plan including vesting requirements, exercise prices and expiration
dates are determined at the discretion of the plan's administrator. The plan
terminates in March 2006.

     In July 1996, the Company granted nonstatutory stock options to a
consultant for a total of 400,000 shares of the Company's common stock at an
exercise price of $0.56 per share. The options were immediately exercisable with
respect to 200,000 shares. The remaining options became exercisable in January
1997 for 100,000 shares and July 1997 for 100,000 shares. The options have a
term of ten years.

     In November 1996, the Company granted nonstatutory stock options to ten
employees for a total of 107,307 shares of the Company's common stock at an
exercise price of $0.34 per share. The options vest over a period of five years
and have a term of ten years.

                                   F-14
<PAGE>

     In January 1997, the Company granted a nonstatutory stock option to an
officer/director of the Company for a total of 1,500,000 shares of the Company's
common stock at an exercise price of $0.36 per share. The option vests over a
period of five years and has a term of ten years.

     In April 1997, the Company sold a total of 1,000,000 shares of its common
stock to an officer/director of the Company at a purchase price of $0.21 per
share. In addition, the Company granted this person a nonstatutory stock option
for a total of 1,000,000 shares of the Company's common stock at an exercise
price of $1.00 per share. The option is fully vested and has a term of ten
years.

     In August 1997, the Company granted a nonstatutory stock option to a
consultant for a total of 1,072,000 shares of the Company's common stock at an
exercise price of $0.25 per share. The option was immediately exercisable with
respect to 112,000 shares. The remainder becomes exercisable on the achievement
of certain agreed on milestones. The option has a term of seven years.

     In September 1997, the Company granted nonstatutory stock options to 14
employees for a total of 474,510 shares of the Company's common stock at an
exercise price of $0.25 per share. The options vest over a period of five years
and have a term of ten years.

     During the year ended October 31, 1997, the Company granted nonstatutory
stock options to four consultants for a total of 145,000 shares of the Company's
common stock at exercise prices ranging from $0.25 to $0.50 per share. The
options are fully vested and have a term of seven years.

     In January 1998, the Company granted nonstatutory stock options to 14
employees for a total of 460,350 shares of the Company's common stock at an
exercise price of $0.25 per share. The options vest over a period of five years
and have a term of ten years.

     The Company has elected to follow Accounting Principles Board Opinion No.
25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES (APB 25), and related
interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided under FASB
Statement No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION (Statement 123),
requires use of option valuation models that were not developed for use in
valuing employee stock options. Under APB 25, because the exercise price of the
Company's employee stock options equals or exceeds the market price of the
underlying stock on the date of grant, no compensation expense is recognized.

     Pro forma information regarding net income and earnings per share is
required by Statement 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of that
statement. The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model with the following weighted-average
assumptions: risk-free interest rate of 6%, expected dividend yield of 0%,
volatility factor of the expected market price of the Company's common stock of
0.58, and an expected life of the option of 5 years.

     The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair 

                                   F-15
<PAGE>

value estimate, in management's opinion, the existing models do not 
necessarily provide a reliable single measure of the fair value of its 
employee stock options.

     For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information follows:

<TABLE>
<CAPTION>
                                                            Year Ended October 31,
                                       ---------------------------------------------------------------
                                            1996                    1997                     1998
                                       ---------------------------------------------------------------
     <S>                               <C>                     <C>                    <C>
     Pro forma net loss                $   1,373,932           $   2,115,244           $   2,359,333

     Pro forma loss per share          $       (0.04)          $       (0.05)          $       (0.04)
</TABLE>

     A summary of the Company's stock option activity, and related information
for the years ended October 31, 1997 and 1998 follows:

<TABLE>
<CAPTION>
                                                            1997                              1998
                                             ----------------------------------------------------------------------
                                                               Weighted-Average                   Weighted-Average
                                                 Options        Exercise Price       Options       Exercise Price
                                             ----------------------------------------------------------------------
     <S>                                     <C>               <C>               <C>              <C>
     Outstanding, beginning of year           6,357,462           $   0.11        9,970,263           $   0.26

     Granted                                  4,298,817               0.47          460,350               0.25

     Exercised                                 (488,250)              0.06         (466,862)              0.06

     Forfeited                                 (197,766)              0.26          (80,000)              0.25
                                              ---------                           ---------

     Outstanding, end of year                 9,970,263           $   0.26        9,883,751           $   0.26
                                              =========                           =========

     Exercisable, end of year                 7,191,000           $   0.20        7,313,000           $   0.22
</TABLE>

     Common stock options of 463,250 and 466,862 exercised during the year ended
October 31, 1997 and 1998, respectively, were in exchange for three-year notes
receivable bearing interest at 5 percent per annum.

                                       F-16
<PAGE>


     Weighted-average exercise prices and fair values of options issued during
the year ended October 31, 1997 and 1998 with exercise prices which equaled or
exceeded the market prices of the Company's stock on the grant date follows:

<TABLE>
<CAPTION>
                                           1997                                  1998
                            ---------------------------------------------------------------------
                                          Weighted-Average                     Weighted-Average
                                          ----------------                     ----------------
                                         Exercise    Fair                     Exercise      Fair
                            Options        Price    Value         Options      Price        Value
                            -------      --------   ------        -------     --------      -----
<S>                        <C>           <C>        <C>           <C>         <C>          <C>
Options whose
exercise price
equaled the market
price of the stock on
the grant date             2,081,817      $0.33      $0.20              -      $  -         $   -

Options whose
exercise price
exceeded the market
price of the stock on
the grant date             2,217,000       0.59       0.07        460,350       0.25         0.12
                           ---------                              -------
Options issued during
the year                   4,298,817                              460,350
                           =========                              =======
</TABLE>


     The following summarizes information about the Company's stock options
outstanding at October 31, 1997 and 1998:

<TABLE>
<CAPTION>
       1997                            Options Outstanding                               Options Exercisable
       ----                            -------------------                               -------------------
                                        Weighted-Average          Weighted-                                Weighted-
     Range of                               Remaining          Average Exercise                        Average Exercise 
 Exercise Prices         Number         Contractual Life           Price               Number               Price
 ---------------        ---------      -------------------     ----------------        ------          ----------------
 <S>                    <C>            <C>                     <C>                    <C>              <C>
       $0.06            5,184,212           8.0 years                $0.06            5,184,000             $0.06

  $0.25 to $0.36        3,256,051              8.9                  0.30                477,000              0.30

  $0.50 to $1.00        1,530,000              9.3                  0.85              1,530,000              0.85
                        ---------                                                     ---------

                        9,970,263                                                     7,191,000
                        =========                                                     =========
</TABLE>

                                       F-17
<PAGE>

<TABLE>
<CAPTION>

       1998                            Options Outstanding                               Options Exercisable
       ----                            -------------------                               -------------------
                                        Weighted-Average          Weighted-                                Weighted-
     Range of                               Remaining          Average Exercise                        Average Exercise 
 Exercise Prices         Number         Contractual Life           Price               Number               Price
 ---------------        ---------      -------------------     ----------------        ------          ----------------
 <S>                    <C>            <C>                     <C>                    <C>              <C>
       $0.06            4,717,350           7.0 years               $0.06             4,717,000             $0.06

  $0.25 to $0.36        3,631,401              8.2                  0.30              1,066,000              0.30

  $0.50 to $1.00        1,535,000              8.3                  0.85              1,530,000              0.85
                        ---------                                                     ---------

                        9,883,751                                                     7,313,000
                        =========                                                     =========
</TABLE>

4.   RELATED PARTY TRANSACTIONS

     During the year ended October 31, 1991, the Company borrowed $29,000 from
stockholders. The four separate notes were unsecured, carried an interest rate
of 12% and were due in August 1992. As an inducement for the loans, the Company
issued a total of 290,000 shares of restricted stock to the lenders. For
purposes of the financial statements, this stock was valued at $0.04 per share
based on recent sales of restricted stock. Loan issue costs of $5,322 were
charged to interest expense in 1991 and unamortized loan issue costs of $6,693
were written off. During the year ended October 31, 1993, these loans were
converted to 430,650 shares of common stock.

     During the year ended October 31, 1995, the Company reissued 1,320,000
shares of common stock to its president and chief executive officer. These were
shares which had been previously returned to the Company (see Note 8).

     The Company has also issued restricted stock for services to various
officers, directors and members of the Scientific Advisory Board as follows:

<TABLE>
<CAPTION>
                     Year            Number of Shares          Value
            ---------------------  --------------------   ----------------
            <S>                    <C>                    <C>
                    1998                 234,000              $58,500
                    1997                 103,138              $39,016
                    1996                  40,000               $5,000
</TABLE>

     In July 1998, the Company entered into a loan agreement with one of its 
officers.  Under the terms of the agreement, the Company loaned the officer 
$50,000 at an interest rate of 9% per annum due in three years.  The loan is 
secured by the officer's common stock options.

5.   INCOME TAXES

     Since its formation the Company has incurred net operating losses. As of
October 31, 1998, the Company had a net operating loss carryforward available to
offset future taxable income for federal and state income tax purposes of
approximately $6.5 million. The net operating loss carryforward for tax

                                    F-18
<PAGE>

reporting purposes expires in the years from 1999 to 2018. The Company also has
a research credit carryover approximating $150,000 which expires between the
years 2003 and 2013.

     No deferred tax benefit or liability has been recorded for temporary
differences between book and tax reporting due to the uncertainty of any
eventual recovery or payment.

6.   INVESTMENT IN OCEANCOLOR, INC.

     In March 1993, the Company invested $50,000 in a joint venture (OceanColor,
Inc.) with Cyanotech Corporation (Cyanotech). The Company and Cyanotech each
owned 50% of OceanColor, Inc. During the year ended October 31, 1994, the
Company invested an additional $97,100 in this joint venture. In November 1994,
the joint venture was dissolved with the licensing rights to its proprietary
technology reverting entirely to the Company. At the time of dissolution, there
was approximately $7,500 of equipment in the joint venture which was distributed
to the Company. (See Note 9)

7.   SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES

     During the year ended October 31, 1995, the Company constructed its plant
facility at a cost of $408,219. At October 31, 1995, there remained in accounts
payable approximately $100,800 of this cost. Accordingly, the amount which
remained in accounts payable was removed from cash paid for the purchase of
fixed assets in the statement of cash flows for the year ended October 31, 1995.

8.   CORRECTION OF ACCOUNTING FOR REISSUANCE OF STOCK PREVIOUSLY CANCELED

     During the year ended October 31, 1995, the Company reissued 1,320,000
shares of restricted stock to its president and chief executive officer. These
were shares which had been previously returned to the Company by the president
and chief executive officer at no cost to the Company. The reissuance was
recorded at par value in the financial statements for the year ended October 31,
1995 with no effect on net loss for that year. The Company has subsequently
valued the reissued stock at $0.15 per share based on the quoted market price of
the restricted stock at the date of reissuance. As a result, the Company's
financial statements for the year ended October 31, 1995 have been restated as
follows:

<TABLE>
<CAPTION>
                                                                            As originally     
                                                                                reported      As restated
                                                                            -------------     ------------
     <S>                                                                    <C>               <C>
     Balance sheet:
          Additional paid-in capital..................................        $1,704,785       $1,902,785
          Deficit accumulated during the development stage............        (1,452,786)      (1,650,786)

     Statement of loss and accumulated deficit:
          General and administrative expenses.........................           195,171          393,171
          Net income (loss)...........................................          (288,813)        (486,813)
          Loss per share..............................................             (0.01)           (0.02)

     Statement of cash flows:
          Expenses paid with common stock.............................            12,998          210,998
</TABLE>

                                 F-19
<PAGE>

9.   CONTINGENT LIABILITIES

     In July 1998, Cyanotech filed a complaint in the United States District
Court for the District of Hawaii against the Company. In the Complaint,
Cyanotech seeks declaratory judgment of noninfringement of the Company's U.S.
Patent No. 5,541,056; invalidity of the Patent; and non-misappropriation of the
Company's trade secrets relating to closed culture production of astaxanthin.
Cyanotech filed the complaint after the Company expressed to Cyanotech its
concern that Cyanotech's use of closed system technology may violate its Patent
and constitute misappropriation of trade secrets. The Company does not believe
that Cyanotech's claims are meritorious.

     In September 1998, the Company filed an answer denying all of Cyanotech's
allegations and a counter claim, alleging infringement of its Patent;
misappropriation of trade secrets; unfair competition; and breach of contract
relative to its 1994 Dissolution Agreement with Cyanotech (See Note 6). The
ultimate outcome of this dispute cannot be presently determined. Accordingly, no
amounts have been accrued or reflected in the accompanying financial statements.

                                 F-20