<PAGE>

                       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, 2000                               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 reported on the NASD Electronic Bulletin
Board, as of January 31, 2001, was $16,889,332.

           The number of shares outstanding of common equity, as of October 31,
2000, was 105,589,076 shares of Common Stock, $0.0001 par value.

           Documents Incorporated by Reference:  None

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

<PAGE>

                                     PART I

THIS ANNUAL REPORT ON FORM 10-KSB CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS
WITHIN THE MEANING OF SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED, INCLUDING STATEMENTS THAT INDICATE WHAT WE "BELIEVE", "EXPECT" AND
"ANTICIPATE" OR SIMILAR EXPRESSIONS. THESE STATEMENTS INVOLVE KNOWN AND UNKNOWN
RISKS, UNCERTAINTIES AND OTHER FACTORS WHICH MAY CAUSE OUR ACTUAL RESULTS,
PERFORMANCE OR ACHIEVEMENTS 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. YOU SHOULD NOT PLACE UNDUE RELIANCE ON THESE FORWARD-LOOKING
STATEMENTS, WHICH REFLECT OUR MANAGEMENT'S ANALYSIS ONLY AS OF THE DATE OF THIS
ANNUAL REPORT. WE UNDERTAKE NO OBLIGATION TO PUBLICLY RELEASE THE RESULTS OF ANY
REVISION OF THESE FORWARD-LOOKING STATEMENTS. YOU ARE 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

We are a development stage company that develops and commercializes natural
products from microalgae using our proprietary photobioreactor technology known
as the Aquasearch Growth Module, or 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 substances and bioactive compounds that have existing and
potential applications in a variety of commercial areas, including human
nutrition, pharmaceuticals, and high value commodities.

Microalgae represent a major fraction of the entire plant kingdom, yet fewer
than 10 species have ever been produced commercially. Microalgae are the fastest
growing plants on earth. Some species can produce 1,000 times their own mass in
a single day. The raw materials required for microalgae production - water,
light and nutrients - are plentiful and cheap. Microalgae are easy to process
using standard manufacturing equipment.

Microalgae production technology has only recently been developed. The first
pure cultures of microalgae were cultivated in the early 1900s, but it was not
until the late 1930s that enough material of a single species was grown in the
laboratory to allow chemical analysis. Attempts at large scale cultivation began
in the 1950s, mostly in open ponds. The first commercial production of
microalgae did not begin until the mid-1970s, and then only for three species
that could be grown in open ponds. No new microalgae species has been grown
commercially in open ponds for the past 25 years. By the 1980s scientists began
to recognize the limitations of open pond technology - lack of control over the
conditions necessary for cultivation and exposure to contamination. New efforts
began to grow microalgae in photobioreactors - closed systems with the ability
to provide controlled conditions.

The major challenge with photobioreactor technology has been to develop
photobioreactors large enough to achieve the economy of scale needed for
commercial application. By the mid-1990s, most photobioreactors were used
exclusively for research, and few exceeded more than 50 gallons (180 liters) in
capacity. The AGM, at more than 6,000 gallons (22,000 liters), is to our
knowledge the largest photobioreactor in existence - and the only
photobioreactor used for commercial production of microalgae.


                                       1

<PAGE>

In addition, the AGM incorporates a very high level of computerized
process-control, allowing reproducible performance. We believe it is the most
advanced technology of its kind.

Our strategy is to build on our leading position in microalgae cultivation
technology to become the world-leading producer of pharmaceuticals,
nutraceuticals and high-value commodities from microalgae. In the short term, we
plan to build market share for microalgae-based nutraceuticals, such as THE
ASTAFACTOR-TM-, to develop a market for our drug discovery products, known as
DRUGS FROM THE SEA-TM-, and to increase market share for AQUAXAN-TM-, our
natural astaxanthin product used in animal feeds. Over the long term, we plan to
develop more products from microalgae, to continuously improve our AGM
technology, and to expand strategic alliances.

We manufacture our products at our five acre, research, development and
production facility in Kailua-Kona, Hawaii. We have enough production capacity
to carry out our strategic plan for the coming year. Our marketing and sales
activities depend to a great degree on distributors, strategic alliance
partners, and on our own personnel. Strategic alliances and partner
relationships with EnzyMed, the Marine Bioproducts Engineering Center, and
various current customers are central to our activities in drug discovery,
product development, regulatory approval processes, sales, marketing and
distribution.

Competition varies according to product area. In the drug-discovery market area,
many biopharmaceutical companies are involved in searching for sources of new
drugs; however, we believe that there are few companies or institutions
currently exploring microalgae as a drug-discovery source. In the nutraceutical
market, we face significant potential competition for THE ASTAFACTOR-TM-, our
first product, astaxanthin-rich microalgae, but we know of no competition for
the second product we plan to launch in 2001. In the market for animal feed
supplements, our natural AQUAXAN-TM- product faces competition from large global
producers of synthetic astaxanthin such as BASF and Hoffman-LaRoche and from
several producers of natural astaxanthin. We believe our product quality
provides the basis to capture adequate market share. As to competition for our
platform technology, the AGM, we do not believe any commercial entity has
developed a photobioreactor that matches the AGM's large size, level of process
control or sustained performance. We believe that competition in each of these
areas is likely to increase significantly over time.

Our patents and intellectual property are key to our business as a marine
biotechnology company. We now have 13 U.S. and international patents relating to
the AGM, general processes for cultivating microalgae in photobioreactors and
specific processes for cultivating HAEMATOCOCCUS. We believe that intellectual
property issues in marine biotechnology will become much more prevalent,
challenging and complex in the future.

Government regulation and product testing are strong factors in the markets for
the products we are developing and producing. Our products face regulation by
the U.S. Food and Drug Administration or similar agencies in foreign countries,
and may require extensive testing for safety and efficacy before being released
for sale.

Legal proceedings have been underway for over a year in a legal dispute with
Cyanotech regarding our intellectual property. On December 30, 1999 the United
States District Court for the District of Hawaii granted summary judgment in our
favor on our claims that Cyanotech infringed our patent, misappropriated our
trade secrets and breached the terms of our 1994 Dissolution Agreement with
Cyanotech. In addition, the Court denied Cyanotech's motion for partial summary
judgment of non-infringement and invalidity of our patent.

Our property at the Hawaii Ocean Science and Technology Business Park provides
an ideal location for the


                                       2

<PAGE>

research and development and the commercial production of microalgae. We have
access to uniquely large volumes of deep ocean water in a stable tropical
climate, conditions that are well-suited for many of the requirements for
microalgae cultivation. Although Hawaii's distance from many markets
increases certain costs of operation, we believe that, on balance, there are
few locations equally favorable to our business.

Our employees, key scientists and our Scientific Advisory Board encompass a
broad array of expertise in critical areas of aquatic microbiology and
bioengineering, and a high degree of competence in operating our research and
commercial production systems. We are strongly dependent on our own personnel
and affiliated scientists for continued growth and development.

MICROALGAE PRODUCTION TECHNOLOGY

MICROALGAE AND OTHER PHOTOSYNTHETIC MICRO-ORGANISMS

BASIC CHARACTERISTICS. Microalgae are single-celled microscopic plants. They
range in size from approximately 1 micron (1/25,000 of an inch) to several
hundred microns. They are "eukaryotic" organisms, meaning that like animals but
unlike bacteria each cell has a nucleus that contains DNA. Like all other
plants, they grow by photosynthesis - the process of using water and carbon
dioxide, combined with light, to produce oxygen and biomass made up primarily of
sugars, fats, and proteins.

DIVERSITY AND HABITAT. There are an estimated 30,000 species of microalgae, and
perhaps a few thousand other species of photosynthetic micro-organisms.
Microalgae live wherever there is water and light. You can find microalgae in
freshwater or seawater, in ice at the North and South Poles, high in the
mountains, in sub-freezing ocean water, in super-heated hot springs, in any body
of water from the surface to depths greater than 600 feet - and everywhere in
between.

REPRODUCTION. The most common way that microalgae reproduce is through division.
When the cell gets large enough it simply divides in two. When the two resulting
cells get large enough, they divide in two, and so on. For most microalgae, cell
division happens at least once a day. However, microalgae also have ways of
reproducing sexually. Typically, two cells fuse together, exchange genetic
material, and then divide into two or more cells.

GROWTH RATES. Microalgae are the fastest growing plants on earth. Since they
divide about once a day, this means they double their mass at the same rate.
Some species of microalgae double about ten times a day, meaning that a single
cell can produce 1,024 cells in a day. No land-based plants are capable of
growing at the rates of microalgae. Sugar-cane, which is the world's fastest
growing crop, doubles its mass about once a week. The fastest growing trees
double their mass about once every few months. On average, microalgae grow about
100 times faster than trees, and ten times faster than any other plant.

UNIQUE CHEMISTRY. Microalgae produce all of the same types of molecules that are
found elsewhere in the plant kingdom - proteins, fats, sugars, and categories of
these, like enzymes, vitamins, and fatty acids. Each species of microalgae is a
unique type of plant. Many species of microalgae produce unique and unusual
molecules that have not been found anywhere else.

The unique molecular makeup of microalgae provides a valuable source of
potential new discoveries in areas such as drugs and nutrition. To date,
researchers at University of Hawaii have found more than 170 bioactive molecules
among microalgae. Of those, only 7 molecules have turned out to be
"rediscoveries," or molecules that are already known to science. In other words,
more than 95% of the bioactive molecules discovered among the microalgae are new
to science. Research performed in the pharmaceutical industry on bacteria and
fungi - major sources of new drugs - has generated a "rediscovery rate" of more
than 99%;


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that is, less than 2% of the bioactive substances discovered in traditional
sources such as terrestrial plants and microbes turn out to be novel.

VALUE OF SUBSTANCES IN MICROALGAE

Here are some representative values of typical biological products, some of
which occur in microalgae:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------
                         PRODUCT                                     PRICE                SOURCE
--------------------------------------------------------------------------------------------------
<S>                                                            <C>                        <C>
           Beta-carotene (chemical, synthetic)                    $600 per kg               1

          Beta-carotene (biological, "natural")                  $1,400 per kg              1

                       Astaxanthin                               $2,500 per kg              2

                         Biotin                                  $7,000 per kg              1

         Royalty fee on the drug "Cryptophycin"                   2% of sales               3

  License fee for a novel compound with bioactivity            $3 to $25 million            2
  demonstrated in pre-clinical trials
--------------------------------------------------------------------------------------------------
</TABLE>
1: Chemical Marketing  Reporter,  Aug. 30, 1993 and Oct. 11, 1993, Schnell
   Publishing Co., Inc., NY.  Prices have not changed significantly since 1993.
2: Internal Company estimate
3: Office of Technology Transfer and Economic Development, University of Hawaii.

BETA-CAROTENE is carotenoid pigment used widely as a food coloring in margarine,
butter, drinks, cakes and candies. It is also sold as a nutritional supplement
or nutraceutical. The total market size is estimated to be in excess of $500
million per year. Beta-carotene is the dominant pigment in microalgae of the
genus DUNALIELLA, where it can account for more than 10% of the total mass.

ASTAXANTHIN is a carotenoid pigment now used primarily as a feed ingredient for
various animals, including salmon and poultry. The 1998 market for astaxanthin
in salmon feed was approximately $185 million. Astaxanthin is the dominant
pigment in microalgae of the genus HAEMATOCOCCUS, where it can account for up to
12% of the total mass.

BIOTIN, or Vitamin H, is widely sold as a nutritional supplement. It is a
bacterial growth factor that is currently produced from yeast. It occurs at
reasonably high levels in some species of microalgae.

CRYPTOPHYCIN is a novel compound with bioactivity that was demonstrated in
pre-clinical trials by its discoverer at the University of Hawaii. Cryptophycin
was isolated from a species of Cyanobacteria, also known as the "blue-green
algae." The compound is in lead development as an anti-cancer drug by a
pharmaceutical company that licensed it from the University of Hawaii.

RATIONALE FOR COMMERCIAL PRODUCTION OF MICROALGAE

Microalgae represent approximately half of all plant species and have been
largely unexploited. Many


                                       4

<PAGE>

characteristics of microalgae make them attractive for commercial production.


           1)   UNTAPPED RESOURCE
                - There are an estimated 30,000 species
                - Fewer than 5,000 species have been cultivated in the
                  laboratory
                - Fewer than 1,000 species have been carefully investigated for
                  new substances
                - Fewer than 10 species have been cultivated at commercial scale

           2)   SOURCE OF NEW SUBSTANCES
                - Several hundred new bioactive substances have been discovered

           3)   SOURCE OF VALUABLE SUBSTANCES
                - Types of molecules already known to be valuable: enzymes,
                  pigments, vitamins
                - Bioactive compounds that could be valuable as pharmaceuticals

           4)   EASE OF PROCESSING
                - Absence of bark, stems or branches makes product extraction
                  easier than other plants
                - Uniform cell structure simplifies mechanical processes
                - Commercial equipment developed for bacteria and fungi can
                  easily be applied

           5)   RAPID GROWTH RATE
                - Growth rate ranges from about 1 to 10 doublings per day
                - Growth rates are faster than any other plants

           6)   LOW COST OF RAW MATERIALS
                - Water, sunlight and carbon dioxide are plentiful and
                  economical
                - By comparison, raw materials for bacteria or fungi include
                  expensive, complex organic substances

           7)   CONTINUOUS GROWTH
                - Unlike land plants, microalgae do not need to complete a "life
                  cycle" to reproduce
                - Growth by cell division makes it possible for microalgae to
                  grow continuously

Although the rationale for commercial production of microalgae is compelling,
certain challenges must be overcome to successfully exploit this resource.

CHALLENGES TO COMMERCIAL MICROALGAE PRODUCTION

Commercial production of microalgae is very similar to large-scale cultivation
of any agricultural crop, with many of the same challenges. The main challenge
is to grow large quantities of a single species sustainably and continuously.

Each species of microalgae is different, just as each species of land plant is
different. Commercial production demands "monoculture" - growing a single
species at a time. No experienced farmer would attempt to grow corn and rice in
the same field. Their water requirements are different, their nutrient
requirements are different, and harvesting techniques are different. The same is
true of microalgae. For example, HAEMATOCOCCUS, which is rich in astaxanthin,
has very different water and nutrient requirements than DUNALIELLA, which is
rich in beta-carotene.

In nature, plants do not live together in large groups of a single species that
are convenient to harvest and produce commercially. Humans have achieved this
level of convenience through control. Corn, for example, does not naturally grow
in rows that cover acre upon acre, uncontaminated by pests or competing


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weeds. After more than 5,000 years of agriculture, humans have devised ways
to accomplish this.

Similarly, single species of microalgae do not naturally fill entire bodies of
water, uncontaminated by pests or competing weeds. For the past 50 years, humans
have attempted to devise ways to accomplish this.

Any method of microalgae cultivation that can solve the following problems will
be successful for commercial production:

           - control of contaminating pests and weeds
           - control of temperature
           - control of nutrients
           - control of light
           - size large enough to achieve economy-of-scale

CONTROL OF CONTAMINATING PESTS AND WEEDS. Any body of water that is rich in
nutrients will eventually be populated by a large variety of micro-organisms,
unless provisions are made to restrict access. Pests that prey on microalgae
include microscopic bacteria and fungi, which can rapidly destroy them, and
animals of all sizes, which can rapidly eat them. The weeds would include any
species of microalgae that the grower did not intend to grow.

CONTROL OF TEMPERATURE. Like any plant, each microalgae species grows best in a
certain temperature range. Just as palm trees grow best in the tropics and
spruce trees grow best in very cold climates, there are some microalgae that
grow best in hot springs while others that grow best in ice water. Within each
temperature range where growth is possible, there is a much smaller range where
growth is fastest. In general, growth rate increases with temperature.

CONTROL OF NUTRIENTS. Each species of microalgae - just like other plant species
- has unique nutrient requirements. All plants need nitrogen to make protein,
and phosphorous to make ATP (adenosine tri-phosphate), which is a main source of
energy. Nitrogen and phosphorous requirements vary from species to species. Then
there are the "micronutrients" - elements like iron, zinc, vitamins, or hormones
- for which species can have very different requirements, also.

CONTROL OF LIGHT. Some plants prefer shade, while others prefer full sunlight.
Microalgae are no different. The intensity of light can dramatically affect
plant biochemistry. For example, moving a houseplant into the full sunlight may
cause the leaves to change color, which is a result of a change in the plant's
chemistry. Each species of microalgae grows best under certain light conditions.

ACHIEVING ECONOMY-OF-SCALE. Most commercial processes are very expensive at
small scale. Economics of the process improve when the scale of the enterprise
is large enough. Large-scale, robotic manufacturing of Ford and Toyota
automobiles is more economical than small-scale, handcrafted manufacturing of
Ferraris and Rolls-Royces. Large-scale agriculture of soybeans by a
highly-mechanized agri-business is more economical than small-scale agriculture
on a family farm.

The essence of a cost-effective commercial process is not dependent on the scale
alone. Success requires the ability to control the process at a large scale.
This principle applies as much to commercial production of microalgae as it does
to the commercial production of automobiles or soybeans.

OVERCOMING CHALLENGES TO COMMERCIAL MICROALGAE PRODUCTION

We believe that the two principal solutions to commercial microalgae production
are to:


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           1)   control the culture system; and
           2)   enlarge the scale.

There have been numerous attempts to develop commercial photobioreactors. To the
best of our knowledge, the Aquasearch Growth Module is the first closed culture,
process-controlled, photobioreactor ever to operate at commercial scale -
greater than 2,750 gallons (10,000 liters).

COMMERCIAL MICROALGAE PRODUCTION - A BRIEF HISTORY

Scientists have conducted laboratory research on the cultivation of microalgae
for more than a hundred years. Attempts at large-scale cultivation, however, are
relatively recent. Here are some of the significant historical events that led
to the development of commercial photobioreactors:

     1871:     NITROGEN AND PHOSPHOROUS RECOGNIZED AS NUTRIENTS FOR MICROALGAE.
               The Russian biologist Famintzin suggests that microalgae use the
               same nutrients as higher plants.

     1890:     MICROALGAE FIRST GROWN IN BACTERIA-FREE CULTURES.
               The freshwater microalgae CHLORELLA and SCENEDESMUS are isolated
               and cultivated by a Dutch bacteriologist, Beyerinck.

     1905:     FIRST CULTURES OF MARINE MICROALGAE. Eighteen species of marine
               microalgae are grown in 60-milliliter culture flasks in Plymouth,
               U.K.  Many of the cultures are contaminated with other species.

     1919:     HIGH GROWTH RATES OF MICROALGAE ARE RECOGNIZED. The microalgae
               CHLORELLA is found to increase its biomass up to 100 times per
               day by the German chemist, Warburg, during his experiments on
               photosynthesis.

     1938:     FIRST "LARGE-SCALE" CULTURE OF MICROALGAE - 7 GALLONS (26
               LITERS). Bostwick Ketchum and A.C. Redfield grow a marine
               species, NITSZCHIA CLOSTERIUM, at Woods Hole Oceanographic
               Institution. They are able to collect enough material every
               day to make chemical measurements.

     1940:     PIGMENTS OF MICROALGAE ARE ISOLATED AND IDENTIFIED. Harold
               Strain and colleagues at the Carnegie Institution are the
               first to extract and identify pigments from blue-green
               algae. This initiates a long-term research program. Over
               the next decade, many species are grown in 2.6 gallon (10
               liter) vessels and their chemical composition is analyzed.

     1944:     FIRST AUTOMATED PHOTOBIOREACTOR - 2.6 GALLONS (10 LITERS).
               Myers and Clark develop and build a laboratory system for
               the continuous culture of CHLORELLA. The automated
               photobioreactor never operates as a fully continuous
               culture.

     1948:     FIRST ECONOMIC ANALYSIS OF LARGE-SCALE CULTURE. The
               Stanford Research Institute, with funding from the Carnegie
               Institution, examines the feasibility of large-scale
               cultivation. In 1950, they conclude that CHLORELLA could be
               grown as a cheap source of protein.

     1949:     CONTINUOUS CULTURE ACHIEVED IN THE LABORATORY. Building on
               their earlier technique using a laboratory photobioreactor,
               Ketchum and Redfield demonstrate how to achieve optimum
               yields of microalgae by continuously adding fresh nutrient
               medium and continuously harvesting.

               MICROALGAE SUGGESTED AS A CHEAP SOURCE OF PROTEIN. H.A.
               Spoehr, Chairman of the Division of Plant Physiology at the
               Carnegie Institution, writes a paper suggesting the
               large-scale cultivation of CHLORELLA as a means of solving
               world hunger. This paper stimulates interest worldwide, and
               leads to numerous pilot plants.


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<PAGE>

     1951:     FIRST LARGE-SCALE, CONTROLLED PHOTOBIOREACTOR - 1,200
               GALLONS (4,500 LITERS). A tubular photobioreactor is built
               and operated in Cambridge, Massachusetts for three months.
               Only temperature is controlled. Average yield is equal to
               three tons per acre per year. Scientists predict yields of
               45 tons per acre per year - ten times more than soybeans.

     1950s:    LARGE-SCALE "OPEN-POND" PRODUCTION SYSTEMS ARE BUILT IN
               GERMANY AND JAPAN . Ponds of various design, all open to
               the atmosphere, are built in Germany (330 gallons (1,200
               liters) in 1951) and Japan (825 gallons (3,000 liters) in
               1953; 4,400 gallons (16,000 liters) in 1957; 16,500 gallons
               (60,000 liters) in 1958). Most systems cannot be maintained
               for more than 30 days.

               FIRST YEAR-ROUND PRODUCTION ACHIEVED AT LARGE SCALE. By
               1958, an open-pond CHLORELLA culture system covering a
               total area of 1,600 square feet (less than 5% of an acre)
               operates for a full year in Japan. The yield is equal to
               12.7 tons per acre per year.

               EXPERIMENTAL PRODUCTION OF MICROALGAE OTHER THAN CHLORELLA.
               In the late 1950s and early 1960s, large-scale open-pond
               cultures are attempted on a handful of other species. Most
               cultures are not controlled, and are overcome by
               contaminants within weeks.

     1960s:    "OPEN-POND" SYSTEMS BECOME WIDESPREAD. Experimental production
               systems are constructed in Czechoslovakia, Romania, Russia,
               Israel, France and the United States.  Species other than
               Chlorella are grown, but no system can be maintained for more
               than three months.

               MICROALGAE CONSIDERED FOR U.S. SPACE PROGRAM, BUT ABANDONED
               AS UNRELIABLE. In the mid-1960s, NASA funds research on the
               use of microalgae cultures to generate oxygen during space
               flight. The scheme proves unreliable, and is replaced by
               more dependable physical-chemical systems.

               FIRST COMMERCIAL PRODUCTION OF CHLORELLA. By the mid-1960s,
               research by the Japan Nutrition Association and the
               Microalgae Research Institute in Tokyo leads to the first
               commercial production of CHLORELLA.

     1970s:    COMMERCIAL OPEN PONDS LARGER THAN 27,500 GALLONS (100,000
               LITERS) are built in Taiwan for CHLORELLA production. By
               the mid-1970s, export to Japan for the food supplement
               market is approximately 800 tons per year.

               COMMERCIAL PRODUCTION OF SPIRULINA begins in Lake Texcoco,
               Mexico. By the late 1970s production reaches 1,000 tons per
               year. The product is initially sold in Japan as an animal
               feed additive and human nutritional supplement. A market
               for SPIRULINA begins to develop in the United States.

               COMMERCIAL OPEN-POND PRODUCTION OF DUNALIELLA, a rich
               source of natural beta-carotene, begins in Israel.
               Hoffman-LaRoche acquires an open-pond facility in Australia
               for the same purpose, but later abandons the project.

     1980s:    COMMERCIAL OPEN PONDS OF 275,000 GALLONS (1,000,000 LITERS)
               are constructed in Southern California for SPIRULINA
               production by Earthrise Farms, which starts operating in
               1982.

               SALES OF MEXICAN SPIRULINA ARE PROHIBITED IN THE UNITED
               STATES DUE TO CONTAMINATION found in studies by the Food
               and Drug Administration in the early 1980s.

               EXPERTS AGREE ON LIMITS OF "OPEN-POND" SYSTEMS, AND SUGGEST
               FOCUS ON PHOTOBIOREACTOR TECHNOLOGY. After three decades of
               research on a wide variety of microalgae, only three have
               been successfully produced: CHLORELLA, SPIRULINA and
               DUNALIELLA. Contamination and control are frequently cited
               in the scientific literature as the main barriers to


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<PAGE>
               commercialization of microalgae.

               AQUASEARCH IS FOUNDED by scientists at Scripps Institution
               of Oceanography. We design concepts for large-scale
               photobioreactors in 1984.

               AQUASEARCH SHOWS THAT LARGE-SCALE PHOTOBIOREACTORS ARE
               COST-EFFECTIVE. The United States Department of Energy
               commissions a confidential study from us in 1985 to
               evaluate the economics of fuel production from microalgae.
               Our analysis shows that large-scale photobioreactors would
               be more cost-effective than open ponds.

               EXPERIMENTAL PHOTOBIOREACTORS UP TO 53 GALLONS (200
               LITERS), with a variety of designs, are developed in
               France, Italy, Israel, Germany, Australia and the U.K. By
               the late 1980s, many microalgae have been cultivated that
               could not be grown in open ponds.

               AQUASEARCH BUILDS THE FIRST CLOSED SYSTEM PHOTOBIOREACTOR
               LARGER THAN 1,100 GALLONS (4,000 liters). In late 1988 we
               build the first Aquasearch Growth Module. Over the next few
               years, we cultivate several species that have not been
               grown in open ponds.

     1990s:    "OPEN-POND" COMMERCIAL PRODUCTION OF HAEMATOCOCCUS IS
               ATTEMPTED AND FAILS. Microbio Resources, a San Diego
               company, devotes 10 acres of open pond facilities to
               HAEMATOCOCCUS production. Repeated problems occur with
               contamination, which destroys cultures within 3 days.
               Microbio ceases operation in the mid-1990s.

               AQUASEARCH GROWTH MODULE REACHES CAPACITY OF 7,000 GALLONS
               (25,000 LITERS). By 1999, we are operating the largest
               known closed-system photobioreactor ever built.

               PATENTS ISSUED ON AQUASEARCH GROWTH MODULE TECHNOLOGY. From
               1996 to 1999, a total of nine patents are issued on
               processes and apparatus related to the Aquasearch Growth
               Module.

               FIRST KNOWN COMMERCIAL PRODUCTION FROM A LARGE-SCALE
               PHOTOBIOREACTOR. Sales of HAEMATOCOCCUS by Aquasearch in
               1999 mark the first known commercial production of any
               microalgae from a closed-system photobioreactor larger than
               27 gallons (100 liters).

THE AQUASEARCH GROWTH MODULE (AGM)

The AGM technology has produced the first new commercial microalgae product
since 1975 that is produced by ANY type of photobioreactor outside the
laboratory. Open-pond technology, on the other hand, has not introduced a single
new species of microalgae to commerce in the past 25 years.

FEATURES OF AGM TECHNOLOGY. The key features of Aquasearch Growth Module
technology are sterility, size, and control. AGM technology has achieved:

           -    control of contaminants and pests;
           -    control of temperature, nutrients and light; and
           -    critical size required for commercial production - more than
                2,750 gallons (10,000 liters).

This level of performance has been the goal of an international research effort
for the past several decades. At 7,000 gallons (25,000 liters), the Ultra-AGM
is, to our knowledge, the largest commercial-scale photobioreactor ever
operated.

Photobioreactor size is an extremely important factor in determining
cost-effectiveness of microalgae production. Most of the capital cost in
controlled, closed-system photobioreactors is not involved in the containment
vessel - rather, it is in the cost of the control system. Thus, any increase in
size results in a
                                       9
<PAGE>

lower cost per unit capacity. For example, a six-fold increase in size of the
AGM - to 7,000 gallons (25,000 liters) - resulted in lowering the cost per
unit capacity by three-fold. Labor costs are related mostly to the number of
photobioreactors being operated, not to their individual size. Thus, a
six-fold increase in size results in about a five-fold decrease in labor
costs.

PROCESS CONTROL - THE KEY TO REPRODUCIBLE PERFORMANCE. We have developed
computerized process control systems for the AGM over the past ten years. Our
current, proprietary process control system makes possible the following
operations:

           -    process monitoring of key production variables at intervals of
                greater than one minute;
           -    data archiving for comprehensive analysis of performance;
           -    automated control of all operations performed more than once a
                day;
           -    immediate alarm system for any system component not operating
                properly; and
           -    automated maintenance for hundreds of system components.

Our process control system has allowed us to rapidly improve performance and
decrease labor requirements.

MICROALGAE AS "SOFTWARE" FOR AGM "HARDWARE." We view the AGM as platform
"hardware" technology. With our current process control system, we can
specify narrow growing conditions of temperature, light, and nutrients in the
AGM. These are the main factors that control the production of microalgae. We
view each species of microalgae as "software," each defined by unique growing
conditions. The AGM "hardware" has the capability to operate many species of
microalgae "software." We believe our production of HAEMATOCOCCUS amply
demonstrates this principle.

COMPETITIVE PRODUCTION SYSTEMS. We are not aware of any closed system
photobioreactor in existence that competes favorably with the AGM. Most of
the comparable technology is:

           -    operated or owned by universities or research laboratories;
           -    less than 55 gallons (200 liters) in capacity (100 times smaller
                than the Ultra-AGM), and
           -    used for research purposes only.

Such experimental photobioreactors are operated in Italy, Israel, Australia,
Germany, U.K., France, Singapore, Netherlands, and the United States.

We are aware of only two closed system photobioreactors other than the AGM
that may potentially be used for commercial production of microalgae. Both
are many times smaller in size than the Ultra-AGM.

           1)   BIOCOIL. The "Biocoil" was developed by Biotechna Ltd. and is
                operated in Australia and the U.K. The Biocoil consists of tubes
                approximately one inch in diameter wrapped around a vertical
                tower. To approach the volume of the Ultra-AGM requires multiple
                Biocoils. We believe the Biocoil has two major disadvantages
                that will make it difficult to attain the same size as the
                Ultra-AGM. First, a Biocoil of comparable size would have more
                than 500 times more surface area than the AGM. This translates
                into 500 times greater capital cost, presuming that the same
                type of material is used for the containment vessel. Second, a
                Biocoil as large as the Ultra-AGM would require a tower capable
                of supporting 25 tons of water. This is an engineering
                requirement not faced by the AGM. We are not aware that Biocoils
                are being used for commercial production. We believe that the
                Biocoil does not include a process-control system that
                approaches the sophistication of ours.


                                      10

<PAGE>


           2)   FLOATING TUBULAR REACTOR. This photobioreactor was developed by
                Heliosynthese of France (now Thallia Pharmaceuticals). Its
                distinguishing feature is the means by which temperature is
                controlled. The entire reactor vessel floats on a body of water.
                The tubular reactor consists of two chambers, one filled with
                microalgae culture medium and the second filled with air.
                Temperature control is accomplished by filling or deflating the
                air chamber, which causes the reactor to float higher or lower
                in the water bath. In our opinion, temperature control in this
                reactor system is very complicated and merely presents the
                possibility of numerous problems that are avoided in the AGM. To
                the best of our knowledge, Thallia is not operating any
                commercial-scale photobioreactors at present.

We believe the AGM offers significant technical and economic advantages
compared with other photobioreactors, including open pond systems. The
advantages of the AGM include size, cost-effectiveness, increased yields, and
the ability to cultivate hundreds of microalgal species at commercial scale
that cannot be produced elsewhere due to higher risks of contamination and
lack of control.

PRODUCTS FROM MICROALGAE

(1)  ASTAXANTHIN - OUR FIRST COMMERCIAL PRODUCT

DESCRIPTION AND PROPERTIES. Astaxanthin is a red-orange, carotenoid pigment.
Astaxanthin is closely related to other well-known carotenoids, such as
beta-carotene, lutein, or zeaxanthin, as shown by the following diagrams of
their molecular structures.


                                  [GRAPHIC]


All of these molecules are antioxidants, but astaxanthin has by far the
strongest antioxidant activity. Some studies indicate that it is ten times
more potent than beta-carotene, and at least 100 times more potent than


                                      11

<PAGE>

vitamin E - another well known antioxidant.

Astaxanthin is one of the main pigments in aquatic animals. But it is not
just a pigment. In animals, astaxanthin performs many essential biological
functions, including:

           -    protecting against the harmful effects of UV light;
           -    enhancing the immune response;
           -    protecting against the oxidation of essential polyunsaturated
                fatty acids;
           -    stimulating pro-vitamin A activity and vision;
           -    improving reproductive capacity; and
           -    assisting in communication.

In species like salmon or shrimp, astaxanthin is essential to normal growth
and survival, and has been attributed vitamin-like properties. Some of these
unique properties are also effective in mammals. We believe astaxanthin has
very promising possibilities for nutraceutical and pharmaceutical
applications in humans. Studies in humans and animal models suggest that
astaxanthin may substantially improve human health, by virtue of its
antioxidant properties, with regard to vision, neurodegenerative diseases,
and certain cancers.

ASTAXANTHIN IN NATURE. You can find astaxanthin in many of your favorite
seafoods, such as salmon, trout, red sea-bream, shrimp, lobster, and caviar,
as well as in many birds. These animals do not naturally produce astaxanthin.
Rather, they ingest astaxanthin as part of their diet. Some species, like
shrimp, can change closely related carotenoids into astaxanthin. However,
astaxanthin provides greater benefits to these species if it appears
naturally in their diet. Other species, like salmon, simply cannot convert
dietary carotenoids into astaxanthin. Similarly, mammals cannot synthesize
astaxanthin.

Where does astaxanthin come from? The richest known sources are
microorganisms, the richest of which are species of HAEMATOCOCCUS, microalgae
that occur throughout the world. The apparent function of astaxanthin in
these microalgae is to protect them from adverse changes in their
environment, such as increased photo-oxidation caused by UV light, which can
occur when water evaporates from the pools in which they live. HAEMATOCOCCUS
can accumulate as much as 100 g of astaxanthin per kg of dry biomass. This
level is 10,000-fold higher than in salmon fillets.

NATURAL VS. SYNTHETIC ASTAXANTHIN. One difference between natural and
synthetic astaxanthin molecules is the spatial orientation of the molecules.
All astaxanthin molecules are made up of the same atoms - carbon, hydrogen
and oxygen - connected in the same sequence. But in some places, these atoms
can be connected to the molecule at a different angle. The position of the
two "OH" groups can actually vary from one astaxanthin molecule to the other,
either rising above the plane level of the molecule, or sinking below that
level. Molecules with these different orientations are called "enantiomers."

In nature there are three main enantiomers of astaxanthin. These are called
3S-3'S, 3R-3'S, and 3R-3'R. To see the difference, imagine that the hydroxyl
(OH) groups are either sticking out of the page ( ) or into the page
(...), as represented here:


                                  [GRAPHIC]


                                      12

<PAGE>


                                  [GRAPHIC]


The orientation of the molecules is significant. When molecules react with
each other, they have to fit together. If the molecules do not fit, they will
not react. Thus, one enantiomer might function in your body while another one
is completely useless.

Differences in spatial configuration are important. A recent study by the
U.S. FDA showed that farmed salmon could be easily distinguished from wild
salmon, because farmed salmon are fed synthetic astaxanthin. Synthetic
astaxanthin contains primarily the 3R-3'S enantiomer. Salmon are unable to
convert this to 3S-3'S - the more common form in nature, and the same form
found in HAEMATOCOCCUS. Thus, salmon fed synthetic astaxanthin can be clearly
distinguished from those fed natural astaxanthin. In shrimp, the main form of
astaxanthin is also the 3S-3'S isomer. A recent study showed that the
astaxanthin from HAEMATOCOCCUS had a superior bio-efficacy over synthetic
astaxanthin, resulting in higher survival of shrimp larvae or juveniles.

Another difference between natural and synthetic astaxanthin is that esters
do not occur in synthetic astaxanthin. The diagrams on the previous page show
molecules of "free" astaxanthin. In nature, however, most astaxanthin occurs
as an "ester." You can make an ester by attaching a fatty acid to either one
or both of the "OH" groups. You have probably heard of "essential" fatty
acids as important components of your diet. Synthetic astaxanthin has no
fatty acids, so it is "free." Scientists believe that one of the main
advantages of astaxanthin esters is that they can be stored in tissues for a
long time without being oxidized.

In salmon, astaxanthin esters predominate in the skin and eggs, while free
astaxanthin is the main form in the flesh and serum (blood). In shrimp,
astaxanthin esters also predominate, except in the ovaries and eggs. In red
sea-bream, most astaxanthin esters are found in the skin. Unlike synthetic
astaxanthin, HAEMATOCOCCUS astaxanthin is extremely rich in esters - the most
common and stable form in nature.

THE ASTAFACTOR-TM- MARKET. We believe that a market is developing for
astaxanthin as a nutritional supplement, or nutraceutical. There is growing
evidence in the scientific and medical literature of the value of astaxanthin
to human wellness. We believe the potential market is in the range of several
hundred million dollars per year. Although we face competition in this
market, we believe that the combination of our product quality and production
capacity will provide us significant competitive advantages. We began sales
of THE ASTAFACTOR-TM-, our nutraceutical astaxanthin product, on March 30,
2000. For more information about THE ASTAFACTOR-TM-, please see "Management's
Plan of Operation - (1) THE ASTAFACTOR-TM- - Nutraceutical Astaxanthin."

THE AQUAXAN-TM- MARKET. We began selling astaxanthin-rich microalgae meal
under the trade name


                                      13

<PAGE>


AQUAXAN-TM- in July 1999. The primary market for astaxanthin in animal feeds
is in salmon feed, although feeds for trout, sea-bream and poultry also
include astaxanthin. The global market for astaxanthin in salmon feeds in
1998 was estimated to be $185 million. The largest competitor in this market
is Hoffman-LaRoche, which is estimated to have more than 95% market share.
However, Hoffman-LaRoche produces synthetic astaxanthin, which is a different
molecule than the natural astaxanthin found in HAEMATOCOCCUS. We believe
there are now niche markets for natural astaxanthin, and that those markets
could grow depending upon consumer preference for a natural alternative. We
would need a large increase in our production capacity to satisfy a
significant demand for AQUAXAN-TM-, and any such increase would require
significant capital and the time to construct expanded production facilities.
We do not intend to seek financing for any such expanded production capacity
unless we receive firm orders for significant additional sales. We cannot
guarantee that such orders will occur. For more information about
AQUAXAN-TM-, please see "Management's Plan of Operation - (3) Aquaxan-TM- -
Natural Astaxanthin for Animal Feed".

(2)  NUTRACEUTICAL PRODUCTS

We are currently planning to launch a second nutraceutical product in the
year 2001. We believe the potential market for this product exceeds $100
million per year. At this time, we are not aware of any competitors that
produce this product. The State of Hawaii Department of Agriculture recently
approved our request to import the relevant species of microalgae that we
will use to produce this product. We began pilot production of this
microalgae in October of 1999. We expect production trials will require at
least six months, and that product formulation and marketing may require an
additional six months. At present, we cannot be certain that we will be
successful in any or all of the many steps required to bring this product to
market. For more information about this product, please see "Management's
Plan of Operation - (2) Our Second Nutraceutical Product."

Currently, several nutraceutical products exist that are derived from
photosynthetic microalgae. These products, discussed below, sell in the range
of $100 to more than $1,000 per kilogram of dried algae.

           1)   CHLORELLA. The primary market for this product is in Japan and
                several other Asian countries. The production process, which
                relies to a great degree on open pond technology, was developed
                in the 1970s. We estimate the market size to be approximately
                $100 million per year.

           2)   SPIRULINA. This product is sold primarily in Europe, Asia and
                North America. The production process, which relies primarily on
                open pond technology, was developed in the 1970s. We believe the
                major producers include Cyanotech, Earthrise Farms of
                California, and recent new enterprises in mainland China. We
                estimate the total market size to be approximately $50 million
                per year.

           3)   DUNALIELLA. This product is a rich source of natural
                beta-carotene. The production process relies primarily on open
                pond technology developed in the 1970s. There are other sources
                of natural beta-carotene, and we have no estimates of the market
                share taken by DUNALIELLA. We believe the total market for
                beta-carotene, including the synthetic compound, is
                approximately $500 million per year.

           4)   "SUPER BLUE-GREEN ALGAE." The primary component of this product
                is the blue-green algae known as APHANIZOMENON FLOS-AQUAE that
                grows wild in Klamath Lake, Oregon. We know of only one supplier
                for this product, Cell Tech, which uses a multi-level marketing
                method. We believe that sales are approximately $100 million per
                year.

           5)   HAEMATOCOCCUS. We believe the largest supplier of this
                astaxanthin-rich microalgae is


                                      14

<PAGE>


                AstaCarotene of Sweden. We estimate the current European market
                to be approximately $15 million per year. We are aware of one
                other company, Cyanotech, that has begun selling this
                nutraceutical.

We believe that many more nutraceutical products could be developed from
microalgae, provided that the microalgae can be produced in commercial
quantities. Known or potential nutritional supplements that have been
identified among the microalgae include omega-3 fatty acids, vitamins and
anti-oxidants.

The production methods for cultivated microalgae nutraceuticals are based
entirely on open-pond technology developed in the 1970s. Despite numerous
attempts, no new microalgae products manufactured in open ponds have come to
market in the past 25 years. The only new microalgae products developed in
this market are either harvested from the wild (Super Blue-Green Algae) or
produced in closed-system photobioreactors (HAEMATOCOCCUS).

Hundreds of microalgae species have been cultivated in laboratory
photobioreactors over the past 50 years. To our knowledge, the AGM has all
the features - and more - of laboratory photobioreactors currently in
operation. We therefore believe that hundreds species of microalgae may be
cultivated for commercial purposes through the use of our AGM technology.

(3)  PHARMACEUTICAL DRUG DEVELOPMENT - DRUGS FROM THE SEA-TM-

Most pharmaceutical products developed to date have been derived from
land-based plants, and the bio-diversity of microalgae is comparable to that
of land-based plants. There is abundant evidence from recent research of the
presence of bioactive substances among the microalgae. Such bioactive
compounds include drug candidates like CRYPTOPHYCIN and LAULIMALIDE, which
are currently in active development or lead optimization.

Our own effort in drug development is aimed at identifying and characterizing
bioactive compounds derived from microalgae that we cultivate. To the extent
we are successful in these efforts, we believe that many pharmaceutical and
biotechnology companies will be interested in collaborating with us. We
believe this interest will exist primarily because of our AGM technology,
which we view as uniquely capable of providing the large quantities of pure
material required for research, development and manufacture of drugs from
microalgae.

We do not currently have the expertise to develop and commercialize
pharmaceutical products on our own. Our general strategy is 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. In June of
2000 we created our first Microalgae Compound Library, in conjunction with
EnzyMed (recently acquired by Albany Molecular Research; NASDAQ:AMRI), for
the purpose of drug discovery via licensing to the biopharmaceutical
industry. Shortly thereafter, we submitted the library to the U.S. National
Cancer Institute for screening against 60 cancer cell lines. The library
continues to be under investigation.

In January 2001 we executed an agreement to develop new pharmaceuticals from
a collection of more than 2,000 strains of microalgae held by University of
Hawaii. The collection has already produced CRYPTOPHYCIN and LAULIMALIDE, two
anti-cancer drug candidates licensed to major pharmaceutical companies and
now in clinical trials. The collection contains 170 other new, bioactive
compounds that have never been tested against other diseases. We plan to
develop compound libraries from these molecules, and will apply our
proprietary cultivation technology to produce quantities sufficient for
pre-clinical trials. Under the agreement, University of Hawaii will receive
approximately $550,000 over the initial two-year term for maintenance and
research work on the collection and royalties from any new drug

                                      15

<PAGE>


candidates discovered by Aquasearch. We are pursuing drug discovery
agreements with research groups at other medical schools in the United
States. Our development of pharmaceutical products from microalgae involves
many significant risks and uncertainties, however, and our efforts in this
area may be unsuccessful. For more information about our pharmaceutical drug
development efforts, please see "Management's Plan of Operation - (4) Drug
Discovery Libraries and - (5) Expanding Our Product Pipeline."

(4)  PIGMENTS FROM MICROALGAE

Using our AGM technology, we have the capability of cultivating additional
microalgae species rich in pigments. Microalgae contain the entire spectrum
of colors found in nature, including more than 1,000 specific pigments. These
pigments may be useful as colorings in foods, cosmetics, textiles, and feeds.
We believe 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. We estimate the
worldwide market for synthetic canthaxanthin is currently in excess of $200
million. We are aware of many 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.

We believe our own expertise is strongly leveraged by our membership in the
Marine Bioproducts Engineering Center (MarBEC) at University of Hawaii and
University of California, Berkeley. One of MarBEC's main goals is to identify
and formulate microalgae-derived pigments for a variety of commercial
applications. MarBEC estimates the potential worldwide market for new
pigments from microalgae to be in excess of $1 billion. As a charter member
of MarBEC, we have preferential intellectual property rights to any new
products or technology developed by MarBEC. We believe we are the only MarBEC
Industry Partner with the capability to produce microalgae in
commercial-scale closed-system photobioreactors. Our development of
additional microalgae pigmentation products involves many significant risks
and uncertainties. For more information about our collaboration with MarBEC,
please see "Management's Plan of Operation - (5) Expanding Our Product
Pipeline."

OUR STRATEGY

Our objective is to be the global leader in microalgae cultivation
technology, as well as the leading producer of pharmaceuticals,
nutraceuticals, and high-value commodities from microalgae. We have several
strategies to achieve these goals.

           1)   BUILD SIGNIFICANT MARKET SHARE IN THE NUTRACEUTICAL ASTAXANTHIN
                MARKET. We intend to build upon our position as the leading
                producer of superior quality natural astaxanthin from
                microalgae. Our marketing strategy includes both direct
                marketing to the consumer as well as through established third
                party distribution channels.

           2)   BUILD A MARKET IN DRUG DISCOVERY. A significant part of our drug
                discovery program plan is our agreement with University of
                Hawaii, which gives Aquasearch exclusive rights to more than 100
                unique, bioactive compounds from microalgae. We plan to
                cultivate the microalgae in this collection, purify the known
                bioactive compounds, and then produce Compound Libraries for
                pre-clinical studies. We expect to further develop new drug
                candidates in collaboration with strategic partners in the
                biopharmaceutical industry.

           3)   BUILD MARKET SHARE IN THE ASTAXANTHIN ANIMAL FEED MARKET. Our
                AQUAXAN-TM- product - superior in astaxanthin content to any
                other natural source - attracted two customers within one week
                of its availability. We believe that this product will help us
                build a reputation for


                                      16

<PAGE>


                quality, which we intend to leverage to build market share.
                Martin Guerin, formerly Cultor's leading manager for development
                of the astaxanthin market, presently serves as our
                Vice-President, Sales and Marketing. We also maintain a strong
                relationship with Cultor as a preferred distributor, through
                which our astaxanthin products will gain faster access to the
                world market than would have been possible if we had attempted
                to build our own marketing and distribution channel first. We
                plan to independently develop and/or collaborate with corporate
                partners to develop additional applications for AQUAXAN-TM-.

           4)   CONTINUALLY IMPROVE AND ENHANCE OUR CORE PLATFORM TECHNOLOGY.
                Our AGM technology has produced the first new commercial product
                in 25 years from the cultivation of photosynthetic microalgae.
                We believe that our proprietary technologies and processes
                provide us with a significant competitive advantage over other
                known microalgae cultivation technologies. We expect that
                further improvements in our automated process control systems
                will lead to even greater product quality, yield, and
                productivity per employee. This year we plan to expand
                applications of AGM and related technologies to other microalgae
                species for new commercial products.

           5)   DEVELOP OTHER COMMERCIAL PIGMENTS. We expect that the award
                of a $2.4 million project from the U.S. Department of Energy
                to develop high value products from microalgae will provide
                the largest springboard for product development. Of the total
                $2.4 million award, we expect to receive $1.2 million over
                three years pursuant to a subcontract with Physical Sciences,
                Inc. We also believe that our partnership in MarBEC will
                leverage the development of commercial pigments from other
                species of microalgae. This is a central goal of MarBEC
                research, and one of the prime reasons we chose to be an
                Industrial Partner.

           6)   EXPAND STRATEGIC ALLIANCES. We intend to strengthen existing
                partnerships and develop new relationships to commercialize
                microalgae products. In particular, we are targeting potential
                partners - like MarBEC, Albany Molecular Research, and
                biopharmaceutical companies in general - that have greater
                research and development, scientific, technical, financial,
                marketing, sales and/or distribution resources than we do. Our
                main objective is to create mutually beneficial alliances that
                create and expand markets for our products.

MANUFACTURING

ASTAXANTHIN. We began cultivating HAEMATOCOCCUS PLUVIALIS at our current
facility in 1995. Our production process employs:

           -    AGM photobioreactors;
           -    "finishing" ponds;
           -    final processing; and
           -    automated process control throughout the production system.

The AGMs are harvested regularly into finishing ponds where we cause the
microalgae to synthesize astaxanthin, i.e. turn red. Once optimal "reddening"
has occurred, the microalgae are de-watered and the ponds emptied. The
resulting product is then further processed and packaged using proprietary
equipment and processes.

OTHER MICROALGAE. All microalgae require controlled temperature, light,
nutrients, pH, and certain other parameters to grow optimally. Our proprietary
AGM process control software allows the operator to set desired limits on most
critical growth parameters within minutes. As a result, the AGM can be used to
cultivate a wide variety of microalgae.

To demonstrate the power of AGM technology, we have cultivated species of
microalgae with widely


                                      17

<PAGE>


different growth requirements, including:

           -    CHLORELLA SOROKINIENSIS;
           -    LYNGBYA LAGERHEIMII; and
           -    HAEMATOCOCCUS LACUSTRIS.

To our knowledge, none of these species have ever been cultivated outside the
laboratory.

We have also cultivated SPIRULINA PLATENSIS in a direct, side-by-side
comparison to open ponds, the standard means of commercial production for
this species. In a four-week experiment, average productivity of the AGM was
double the productivity in open ponds.

For our second nutraceutical product we intend to cultivate another
microalgae species that has never been cultivated outside the laboratory.
Based on past performance of the AGM, we do not anticipate any extraordinary
challenges in producing this microalgae.

PRODUCTION CAPACITY. Astaxanthin production is now utilizing 100% of our
finishing pond production capacity. However, we purposely planned excess
production capacity in AGM photobioreactors and final processing. This
approach allows us several important options.

           1)   ASTAXANTHIN PRODUCTION. We can increase astaxanthin production
                in two ways:

                -    OPTIMIZATION. In 1999 we increased astaxanthin content by
                     50%, and tripled HAEMATOCOCCUS productivity. In late 2000
                     we increased productivity by another 30%. These increases
                     in production were due entirely to optimizing growing
                     conditions through research. We believe more optimization
                     is possible. We have achieved 6% astaxanthin content in the
                     laboratory, which alone would again double our production.
                     We could more than triple production if we attain the
                     greater than 10% content reported in the scientific
                     literature. We are now working on additional methods which,
                     if applied in AGMs and finishing ponds, might independently
                     double production. Based on our operations to date, we
                     believe that optimized production will require no
                     additional capital.

                -    MORE PONDS. We can increase production capacity five-fold
                     by creating additional finishing ponds. We have property
                     available for additional ponds, and pond construction is
                     relatively low in capital cost. We will exercise this
                     option only in response to market demand.

           2)   OTHER MICROALGAE.  We are now focused on microalgae that do not
                require the use of finishing ponds in the production process.
                This approach allows us to use the 80% excess capacity we have
                in AGMs.  We can devote this AGM production capacity to:

                -    OUR SECOND NUTRACEUTICAL PRODUCT. We believe we can produce
                     enough microalgae to sustain our first year's production in
                     this new market, without any increase in production
                     capacity. We base this belief on knowledge - reported in
                     the scientific literature - regarding growth rates and
                     content of the bioactive compound in this species. We
                     intend to optimize yields and processing protocol in pilot
                     production runs over a period of no less than six months.

                -    ADDITIONAL PRODUCTS. Currently, we can simultaneously grow
                     up to five different microalgae species at full production
                     scale. We do not intend any of this production for


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                     immediate sales. However, the rigorous process of pilot
                     production and processing allows us to:

                     1.   optimize productivity;
                     2.   formulate the finished product; and
                     3.   ascertain production economics based on careful
                          measurements rather than assumptions.

MARKETING AND SALES

Our primary business strategy is to establish our reputation as the global
leader in developing and manufacturing high value microalgae products. Our
marketing strategy may vary depending on the product and its market, but is
based on these two fundamental principles:

           1)   CREATE AN ALLIANCE WITH THE CONSUMER. In each of our currently
                chosen markets, the "consumers" are quite different. The
                consumers of AQUAXAN-TM- are animal feed companies. Consumers of
                THE ASTAFACTOR-TM- are individuals. Consumers of DRUGS FROM THE
                SEA-TM- are biopharmaceutical companies. In each of these
                markets, we seek a relationship that allows direct communication
                and mutual benefit. This type of relationship ensures that the
                consumer receives current and accurate information regarding the
                product, and that we receive information enabling us to improve
                the product.

           2)   SELL DIRECTLY TO THE CONSUMER. This approach should always allow
                us to maximize profit. In markets where competitors do not sell
                directly to the consumer, our ability to minimize cost to the
                consumer may offer a competitive edge.

AQUAXAN-TM-. The international nature of the animal feed market requires
reliance on global feed producers or distributors. Our relationship with
Cultor, the world's second largest user of astaxanthin in animal feed, has
allowed us to develop certain strategic research and development, sales and
marketing and distribution arrangements. At the same time our recently
modified agreement, which is in effect for one more year, releases us from
the requirement to sell exclusively to or through Cultor. We are currently
working through Cultor and other companies on product trials in various
countries. These trials are designed to provide data that will fulfill
regulatory requirements, and thus further expand our market. We believe our
strategic relationship with Cultor has reduced the time to market and
increases the likelihood of market acceptance for AQUAXAN-TM-.

Sales of AQUAXAN-TM- began in July 1999 to a European life science company,
and in September 1999 to a Japanese company. Our strategy is to build market
share based on a reputation for quality and dependability. We believe there
is a perception in this market that other producers of natural astaxanthin
have failed to deliver product of consistently high quality. We believe this
market has a significant demand for natural astaxanthin, and that demand will
fall upon the first dependable producer of a high quality product. Based on
our production capability and the quality of our product, we anticipate
receiving more orders for AQUAXAN-TM- in the near future. We will determine
whether to capitalize additional production capacity for AQUAXAN-TM- based on
the demand for the product.

NUTRACEUTICAL ASTAXANTHIN. We began sales of THE ASTAFACTOR-TM-, our
nutraceutical astaxanthin product, on March 30, 2000. We are actively
considering certain proposals that include strategic alliances,
distributorships and direct sales. We prefer a direct sales approach.
However, we would consider entering into a strategic alliance that offered
greater marketing or distribution capability along with significant profit
sharing.


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<PAGE>

DRUGS FROM THE SEA-TM-. The market for our drug discovery products is the
biopharmaceutical industry. We believe that microalgae-derived substances with
demonstrated bioactivity represent a substantially new source of potential
pharmaceuticals. Unlike many biotechnology companies, we do not intend to
develop the expertise necessary to carry any drug candidate through the entire
process of regulatory approval. Instead, we prefer to focus on developing
substances to the pre-clinical stage, and then to rely on strategic alliances to
take drug candidates through the regulatory process. This approach may diminish
our percentage ownership or revenues related to any approved drug. However, this
strategy allows us to focus on our expertise in microalgae cultivation and
biochemistry. We intend to rely on strategic alliances with companies in the
biopharmaceutical industry that have much greater resources than we do in areas
of lead optimization, regulatory approval, sales and marketing.

We produced our first Compound Library in June 2000. It is currently being
tested by the U.S. National Cancer Institute. We believe that a positive result
of these tests would validate our approach, and would facilitate marketing of
this and other Compound Libraries. Our marketing approach is to directly contact
senior managers and scientists in biopharmaceutical companies we have identified
as potential alliance partners. We have already received strong expressions of
interest in our libraries from several companies. For more information on this
market, please see "Management's Plan of Operation - (4) Drug Discovery
Libraries."

STRATEGIC ALLIANCES AND PARTNER RELATIONSHIPS

ENZYMED

In December 1998, we entered into a Compound Library Agreement with EnzyMed to
develop libraries of compounds that would be researched for new drug candidates.
As part of this collaboration, we have agreed to (1) identify and cultivate
bioactive microalgae species, and (2) chemically extract, test, and purify the
bioactive fractions. Our tests rely on cell cultures, human tissue cultures and
genomic screens, conducted in collaboration with certain university research
laboratories. EnzyMed has agreed to apply its proprietary process of
"Combinatorial Biocatalysis" to our unique extracts of microalgae. From each
unique extract, this enzymatic process typically creates multiplecompounds, many
of which may be new to medical science. EnzyMed has demonstrated capability in
Combinatorial Biocatalysis. EnzyMed was recently acquired by Albany Molecular
Research (NASDAQ: AMRI). Aquasearch and Albany completed the first Compound
Librbary in June 2000. Albany's contract customers for this type of "lead
optimization" include Merck, Lilly, Hoffman-LaRoche, Novartis and other
biopharmaceutical companies.

The compounds resulting from Combinatorial Biocatalysis comprise the
"libraries." We believe that Microalgae Compound Libraries will be viewed as
uniquely valuable to the biopharmaceutical industry because they represent a
resource of great diversity that has yet to be explored.

We have agreed with Albany to jointly market these libraries to biotechnology
and pharmaceutical companies that would screen the libraries for new drug
candidates. To the extent we are able to enter into typical industry agreements
in connection with our drug discovery efforts, we anticipate deriving revenues
from the following:

           -    library access fees, with access limited in time and restricted
                to certain disease areas;
           -    license fees for any drug candidate that emerges from
                screening;
           -    milestone payments triggered by generally recognized steps in
                the FDA drug approval process; and
           -    royalties on sales of any approved drug.

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<PAGE>

CULTOR

In May 1996, we entered into a three-year exclusive Distribution and Development
Agreement with Cultor. We agreed to act as the exclusive worldwide supplier of
natural astaxanthin from microalgae to Cultor in the field of animal feed and
animal nutrition and Cultor agreed to act as the exclusive worldwide distributor
of our natural astaxanthin in the field of animal feed and animal nutrition. We
also entered into a Stock Subscription Agreement under which Cultor purchased
400,000 shares of our common stock at a purchase price of $0.50 per share. In
January 1998 we extended the Distribution and Development Agreement to four
years. In June 1999, we modified the agreement and extended it through June
2001.

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 INITIAL AGREEMENT. Key features of the Cultor Distribution and Development
Agreement initially provided for:

           -    PRODUCT DEVELOPMENT. Aquasearch and Cultor would jointly develop
                a natural astaxanthin product for use in animal feeds. Cultor
                would take prime responsibility for conducting product trials,
                establishing a product identity and obtaining regulatory
                approvals.
           -    PRODUCTION.  We would meet certain production targets in
                September 1997 and September 1998.
           -    MARKETING, SALES AND DISTRIBUTION.  Cultor would be responsible
                for selling the product through its
                global distribution network.
           -    PROFIT SHARING. We would share equally in the margin between the
                production cost and the net sales price, less commissions and
                distribution costs.
           -    A JOINT VENTURE OPTION. Cultor could, at its option, form a
                joint venture with us for the exclusive purpose of producing
                astaxanthin for use in animal feeds, in which it would have a
                minimum of 50% ownership.

In 1996 and 1997 Cultor devoted substantial resources to conducting product
trials, market research, and product and trademark registration. By mid-1997, we
were unable to raise enough capital to expand our production capacity to meet
our production targets. We agreed to extend our agreement by one year.

THE 1998 MODIFIED AGREEMENT. We agreed to move production and sales targets up
by one year, to September 1998 and September 1999, and to extend the agreement
through September 2000.

We raised enough capital to begin expanding our production capacity in early
1998. Cultor participated in the expansion by providing to us a senior engineer
with substantial experience in design and construction of bio-product
manufacturing plants, who spent many weeks on site throughout the process of
design and construction. We expected construction to be completed later than our
September target date, but both companies continued to plan a product launch.

In early 1999 Danisco, a Danish food products company, acquired Cultor. New
management has made certain strategic decisions that may ultimately involve the
sale of Cultor companies, including Ewos, that would have an interest in
AQUAXAN-TM-. For the time being, however, Cultor remains intact and maintains
certain marketing and distribution channels pertinent to AQUAXAN-TM-.

THE 1999 MODIFIED AGREEMENT.  In June 1999, we amended our agreement with
Cultor with the following

                                     21

<PAGE>

significant modifications:

           -    TRADEMARK. The AQUAXAN-TM- brand name, with registration
                approved or pending in 16 countries, was transferred to us.
           -    PRODUCT DEVELOPMENT. Cultor will continue to assist us in
                conducting product trials and obtaining regulatory approvals,
                and we will pay associated costs.
           -    MARKETING, SALES AND DISTRIBUTION. Cultor agreed to purchase a
                certain minimum amount of AQUAXAN-TM- through June 2000.
           -    EXCLUSIVITY. We were released from the requirement to sell
                AQUAXAN-TM- exclusively to or through Cultor, but Cultor is
                committed to purchasing AQUAXAN-TM- from us, provided that it
                meets or exceeds mutually agreed specifications.
           -    CULTOR IS A PREFERRED CUSTOMER. Cultor may continue to market
                AQUAXAN-TM- for two years, through June 2001. Cultor has the
                right to pre-empt any purchase of a certain significant amount
                by other customers, provided Cultor meets the terms of such a
                proposed sale.
           -    NO JOINT  VENTURE.  We retain all potential  ownership of
                AQUAXAN-TM-production.  Cultor  relinquishes  its option to form
                a joint venture.

We have developed a strong working relationship with Cultor over the past few
years, and we believe our current agreement supports a continuing alliance of
mutual benefit.

MARBEC

Our Industrial Partnership in MarBEC is key to developing our product pipeline.
MarBEC is a 5-year, $26 million Engineering Research Center, or ERC, funded in
1998 by the U.S. National Science Foundation. There are fewer than two dozen
ERCs in the U.S. In 1998, more than 160 universities competed for only five ERCs
awarded by the National Science Foundation.

MarBEC combines the expertise of world-leading marine science and ocean
engineering programs at the School of Ocean and Earth Sciences and Technology at
University of Hawaii with the nationally-famous chemical engineering program at
the Department of Chemical Engineering at the University of California,
Berkeley.

MarBEC's main research focus is the discovery and development of new products
from microalgae. The Industrial Partnership, for which we have agreed to pay
$20,000 annually, provides the following specific benefits:

           -    new research results prior to public disclosure;
           -    preferential rights to intellectual property;
           -    privilege to sponsor focused research, resulting in exclusive
                intellectual property rights;
           -    preferred access to specialized and unique facilities and
                equipment;
           -    preferred access to microalgae culture collections;
           -    membership on the Industrial Advisory Board along with
                current members Cargill and Cyanotech;
           -    opportunity to influence specific research; and
           -    preferential access to student interns.

On average, ERCs have 35 industry partners. The prime benefits cited by industry
partners in other ERCs include networking with related companies, advance
awareness of new products and technology and the availability of graduates with
superior training and education as future employees.

                                     22


<PAGE>

UNIVERSITY OF HAWAII AT MANOA

In January 2001 we executed an agreement to develop pharmaceuticals from a
unique collection of approximately 2,000 strains of microalgae held by the
University of Hawaii. The agreement gives Aquasearch exclusive rights to more
than 100 unique, bioactive compounds from microalgae contained in the
collection. Two of the compounds are now in Phase II clinical trials for
treatment of cancer. Most importantly, the bioactive compounds have never
been tested in any disease BUT cancer. It is possible that some of these
compounds will also prove active against other diseases. Under the agreement,
the University will receive approximately $550,000 over the initial two-year
term for maintenance and research work on the collection and royalties on any
revenues to Aquasearch that derive from the use of the collection.

COMPETITION

MICROALGAE CULTIVATION TECHNOLOGY

OPEN POND TECHNOLOGY. Open pond technology was developed in the 1950s and 1960s
and formed the basis of many commercial enterprises beginning in the 1970s. Many
companies throughout the world use open ponds to cultivate three species of
microalgae: SPIRULINA, DUNALIELLA and CHLORELLA. Despite numerous attempts to
cultivate other microalgae in open ponds, not a single new product has been
produced using this technology in the past 25 years. Our own research has
demonstrated that SPIRULINA production in AGMs is double that achieved in open
ponds. We do not intend to produce any microalgae in open ponds. We do not
believe this technology represents significant competition.

FERMENTATION. We are aware of two U.S. companies, Martek of Maryland and
Omega-Tech of Colorado, that produce commercial quantities of microalgae using
modified fermentation processes. Fermentation must be carried out in the dark.
Very few species of microalgae can grow in the dark, because most microalgae -
like most other plants - depend upon light to perform photosynthesis.
Furthermore, standard fermentation vessels must be significantly modified for
cultivating marine organisms because the common vessel material, stainless
steel, is rapidly corroded by saltwater. Fermentation may prove effective for
cultivating certain microalgae, but we believe its application is severely
limited.

HARVESTING FROM THE WILD. We are aware of one company, Cell Tech of Oregon,
which harvests natural "blooms" of microalgae. A "bloom" is an unusually high
concentration of microalgae, generally dominated by a single species, which
usually occurs in spring or summer. We do not believe this process is
sufficiently dependable or controllable to represent significant competition.
First, microalgae blooms in nature are generally at least 10 times lower in
concentration than cultivated microalgae. Second, relatively few species of
microalgae actually create blooms. Third, the timing and intensity of blooms is
subject to local climate, water conditions, and other factors that are difficult
if not impossible to control. Finally, many blooms may be dominated by a single
species of microalgae, but often include significant percentages of other
species that may not be desirable.

CLOSED SYSTEM PHOTOBIOREACTORS. We believe that AGM technology is the first
closed-system, process-controlled photobioreactor ever to be operated at
commercial scales larger than 2,750 gallons (10,000 liters). We are aware of
only three companies in the world - Biotechna of Australia, MicroGaia of Hawaii
and Thallia Pharmaceuticals of France - that possess proprietary photobioreactor
technology. Compared to the AGM, we believe that both of these photobioreactors:

           -    are much smaller in scale;
           -    have a more limited operating history; and
           -    are more sensitive to significant cost barriers.

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<PAGE>

Although many other photobioreactors are in operation, to our knowledge all are
operated by universities or research institutes, are 100 times smaller than the
Ultra-AGM, and are not used for commercial purposes. It is possible that
competing photobioreactor technologies already exist, or may emerge in the
future, that could adversely affect our perceived technical and competitive
advantages. However, we believe that AGM technology is now more advanced than
any other photobioreactor technology. For more information on the AGM
technology, please see "Description of Business - Microalgae Production
Technology - The Aquasearch Growth Module (AGM)."

AQUAXAN-TM-

Competitors in the market for astaxanthin used in animal feed include BASF,
Hoffman-LaRoche, Cyanotech, AstaCarotene and Igene. Of these, only Cyanotech and
AstaCarotene produce natural astaxanthin from Haematococcus. Cyanotech's current
product has significantly lower astaxanthin content than AQUAXAN-TM-, which we
believe provides us with a competitive advantage. We believe that AstaCarotene's
production capability in Sweden is much more capital-intensive than ours, and
therefore provides us with a cost advantage. We believe that Igene's yeast
product, the chemical form of which is different from that found in nature,
although possibly successful in the Americas, may face problems with
consumer-acceptance in Europe. Currently, the synthetic astaxanthin manufactured
by BASF and Hoffman-LaRoche dominates the market. Both of these companies have
significantly greater research and development, technical, financial,
management, marketing and sales resources than we do. However, synthetic
astaxanthin can be differentiated from the natural alternative, which we believe
may provide us with certain competitive advantages. Although BASF and
Hoffman-LaRoche may continue to dominate the $185 million market for
astaxanthin, we believe that a significant niche exists for a high quality,
natural source of astaxanthin.

Hoffman-LaRoche has maintained the market price of synthetic astaxanthin at
approximately $2,500 per kilogram for more than a decade, when no viable
competitive product was available. However, Hoffman-LaRoche could reduce 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 our business,
financial condition, results of operations and relationships with corporate
partners. Products of which we are not aware, or products that may be developed
in the future, may also adversely affect the marketability of AQUAXAN-TM-.

THE ASTAFACTOR-TM-

Many of the potential competitors for THE ASTAFACTOR-TM-, our nutraceutical
astaxanthin product, are the same as for Aquaxan-TM-. However, to our knowledge
neither BASF nor Hoffman-LaRoche has indicated an interest in this market.
Furthermore, we believe that consumers of nutraceuticals prefer products from
natural sources to synthetic ones, and will not pay premium prices for
synthetics if they are available. We are aware of many companies interested in
marketing nutraceutical astaxanthin, but of these only Cyanotech and
AstaCarotene produce the product from Haematococcus. We believe our production
process has cost advantages over those of both companies - a lower production
cost than Cyanotech because our product is twice as concentrated, and a lower
capital cost than AstaCarotene because Hawaii's climate requires less costly
modification than Sweden's climate. The remaining known producers of astaxanthin
may face certain challenges that we do not. We believe that the krill extract
sold by Itano of Japan is much more expensive to produce than HAEMATOCOCCUS. We
believe that Igene's yeast product may not be as readily accepted as our natural
astaxanthin product by consumers of nutraceuticals.

                                     24

<PAGE>

DRUGS FROM THE SEA-TM-

The search for new pharmaceuticals is more intensive than it has ever been.
According to a report on the biopharmaceutical industry issued by Andersen
Consulting in November 1997, drug companies will have to expand their product
pipelines by a factor of 10 in the five years ending 2002 in order to maintain
the industry's historic growth rate of 15% per year. The majority of new drugs
originate from natural sources. The pharmaceutical industry must explore
bacteria, fungi, plants and animals for new drugs.

We believe that DRUGS FROM THE SEA-TM- could be a significant source of new
drugs, because it offers the potential to screen almost half the plant kingdom
for the first time. We are not aware of any significant commercial effort to
screen microalgae. Biopharmaceutical companies are reluctant to screen any
natural substance that cannot be "re-grown" in quantities sufficient to supply
the requirements of clinical trials. Laboratory scale photobioreactors cannot
supply enough material for clinical trials. We believe this lack of supply is
the main reason that biopharmaceutical companies have not shown great interest
in screening microalgae.

Competition is not likely to come from companies that provide bacteria or fungi.
Soil bacteria and fungi have been so thoroughly screened for pharmaceuticals
that more than 99% of the so-called "active leads" identified in screening
programs prove to be rediscoveries of known compounds.

We believe that potential competitors in this market must have the demonstrated
ability to cultivate kilogram quantities of raw material under controlled
conditions that assure repeated quality. In our opinion, AGM technology makes
this possible. We are not aware of any competing technology that can meet the
requirements for repeated production of kilogram quantities of microalgae of
stable quality. We are not 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 our
AGM technology.

COMPETITION IN GENERAL

We intend to develop other natural products from microalgae that will compete
with existing natural and synthetic products. We anticipate that competition to
develop additional microalgae products will be intense. Our future competitors
could include major pharmaceutical, food processing, chemical and specialized
biotechnology companies, many of which will have financial, technical and
marketing resources significantly greater than ours. Specialized biotechnology
companies may form collaborations with large established companies to support
research, development and commercialization of products that may compete with
our future products. Academic institutions, governmental agencies and other
public and private research organizations are conducting research activities and
seeking patent protection and may commercialize products that compete with ours.
Any products of which we are not aware, or products that may be developed in the
future, may adversely affect the marketability of new products we develop.

Our competitive position will also depend on our ability to attract and retain
qualified scientific and other personnel, develop effective proprietary
products, successfully perform under any supply agreements, implement research
and development and production plans, obtain patent protection and secure
adequate capital sources.

PATENTS, LICENSES AND PROPRIETARY TECHNOLOGY

We rely upon a combination of patents, copyright protection, trade secrets,
know-how, continuing technological innovation and licensing opportunities to
develop and maintain our competitive position.

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<PAGE>

Our future prospects depend in part on our ability to obtain patent protection
for our products and processes. We need to preserve our copyrights, trademarks
and trade secrets. We also need to operate without infringing the proprietary
rights of third parties.

We have been awarded a total of thirteen patents, relating to three inventions:

           -    the AGM apparatus (Europe, Australia, Norway, Hong Kong, South
                Korea);
           -    general processes for cultivating microalgae in
                photobioreactors (U.S., Europe, Australia); and
           -    processes for cultivating HAEMATOCOCCUS (U.S.).

We have additional patents pending internationally and in the United States.

The patent positions of biopharmaceutical and biotechnology companies, which are
similar to ours, are generally uncertain and involve complex legal and factual
questions. We cannot guarantee that any of our pending patent applications will
result in issued patents, nor can we assure that we will develop more
proprietary technologies that are patentable. Patents issued to our strategic
partners or us may not provide a basis for commercially viable products or may
not provide any competitive advantages. Third parties could challenge our
patents. The patents of others could limit our ability to use certain processes
or technologies. Any of these preceding situations could have a material adverse
effect on our ability to do business. Furthermore, patent law relating to the
scope of claims is still evolving in the technology fields in which we operate.
As a result, the degree of future protection for our proprietary rights is
uncertain. We cannot prevent others from independently developing similar or
alternative technologies, duplicating any of our technologies, or, if patents
are issued to us, designing around our patented technologies. We could incur
substantial costs in litigation if we are required to defend ourselves in patent
suits brought by third parties or if we initiate such suits.

Others may have filed and in the future are likely to file patent applications
that are similar or identical to ours. To determine the priority of inventions,
we may have to participate in interference proceedings declared by the United
States Patent and Trademark Office. Such proceedings could result in substantial
cost to us. We cannot ensure that any such third-party patent application will
not have priority over ours. Additionally, the laws of certain foreign countries
may not protect our patent and other intellectual property rights to the same
extent as the laws of the United States.

Our future prospects also depend in part on our neither infringing patents or
proprietary rights of third parties nor breaching any licenses that may relate
to our technologies and products. We cannot guarantee that we will not infringe
the patents, licenses or other proprietary rights of third parties. We could 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
our strategic partners or us that claim damages and seek to enjoin commercial
activities relating to the affected products and processes could subject us to
potential liability for damages. Such legal actions could also require our
strategic partners or us to obtain a license in order to continue to manufacture
or market the affected products and processes. We cannot ensure that our
strategic partners or we would prevail in any such action. We cannot ensure that
any license, including licenses proposed by third parties, required under any
such a patent would be available on terms that are commercially acceptable, if
at all. We have not conducted an exhaustive patent search and we cannot ensure
that patents do not exist or could not be filed that would have a material
adverse effect on our ability to develop and market our products. There are many
United States and foreign patents and patent applications in our area of
interest. We believe there could be significant litigation in the industry
regarding patent and other intellectual property rights. If we become involved
in such litigation, it could consume a substantial portion of our managerial and
financial resources, which could have a material adverse effect on our business,
financial condition, results of operations, and relationships with corporate

                                     26


<PAGE>

partners. Please see "Legal Proceedings."

The enactment of legislation implementing the General Agreement on Trade and
Tariffs, effective June 8, 1995, has changed certain United States patent laws.
Most notably, the term of patent protection for patent applications filed on or
after that date is no longer a period of seventeen years from the date of grant.
The new term of United States patents begins on the date of issuance and
terminates twenty years after the effective date of filing. This change in the
law could substantially shorten the term of our patent protection, which may
adversely affect our patent position.

We attempt to control the disclosure and use of our proprietary technology,
know-how and trade secrets under agreements with the parties involved. However,
we cannot ensure that others will honor all confidentiality agreements. We
cannot prevent others from independently developing similar or superior
technology, nor can we prevent disputes that could arise concerning the
ownership of intellectual property.

GOVERNMENT REGULATION AND PRODUCT TESTING

Our current and potential products, and our manufacturing and research
activities, are or may become subject to varying degrees of regulation by many
government authorities in the United States and other countries. Such regulatory
authorities could include the State of Hawaii Department of Health, the U.S.
FDA, and comparable authorities in foreign countries. Each existing or potential
microalgae product intended for human use that we develop or market, either
directly or through licensees or strategic partners, may present unique
regulatory problems and risks. Relevant regulations depend on product type, use
and method of manufacture. The FDA regulates, in varying degrees and in
different ways, dietary supplements, other food products, medical devices and
pharmaceutical products. Regulations govern manufacture, testing, exportation,
labeling and advertising.

Prescription pharmaceuticals and certain types of medical devices are regulated
more vigorously than foods, such as dietary supplements. Any products we develop
for use in human nutrition, pharmaceuticals, or cosmetics, could require that we
develop and adhere to GMP as suggested by the FDA, ISO standards as suggested in
Europe, and any other applicable standards mandated by federal, state, local or
foreign laws, regulations and policies. Our current facilities and procedures do
not yet fully comply with GMP or ISO standards, but we have not found it
necessary to implement our plan for compliance. When the necessity arises, we
believe we are ready to respond accordingly. It may be possible in the very near
future to simultaneously qualify for both ISO 9000 and ISO 14000, and we may
prefer to do so because compliance procedures can be expensive.

We are or may become subject to other federal, state and foreign laws,
regulations and policies with respect to labeling of 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. We are working with Cultor,
other distributors and potential customers to achieve compliance with foreign
laws, regulations and policies pertaining to AQUAXAN-TM-. We are also working
with certain consultants regarding compliance with FDA, GMP and ISO policies and
regulations. We cannot ensure that any of our products will satisfy applicable
regulatory requirements. Changes could occur in federal, state and foreign laws,
regulations and policies and, particularly with respect to the FDA or other such
regulatory bodies, such changes could be retroactive. Such changes could have a
material adverse effect on our business, financial condition, results of
operations and relationships with corporate partners.

Regulatory authorities may view AQUAXAN-TM- as a food additive. Nutraceutical
products we develop will be viewed as human dietary supplements. The FDA will
require pre-market clearance for both of these

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<PAGE>

product types if they are intended for ultimate human consumption in the United
States. The process of obtaining FDA clearance for either a food additive or a
human dietary supplement can be expensive and time consuming, although
significantly less expensive than the process for obtaining clearances for a
new pharmaceutical. Extensive information is required on the toxicity of the
additive, including carcinogenicity studies and other animal testing. The FDA
approved the Hoffman-LaRoche synthetic astaxanthin product as a food additive
in 1995, but this does not guarantee that the FDA will grant similar approval
for AQUAXAN-TM-. FDA clearance for dietary supplements can be obtained by
notifying the FDA in writing of our intention to market a certain product and,
if we do not receive any objection within a certain period of time, approval is
implied. Aquasearch received such FDA clearance for THE ASTAFACTOR-TM- in early
2000. We cannot ensure that any of our future potential products will be
cleared by the FDA on a timely basis, if at all.

AQUAXAN-TM- and THE ASTAFACTOR-TM-, our nutraceutical astaxanthin product, are
likely to be distributed in foreign countries, including the European Union,
Japan, Canada and Australia. Regulatory approvals in foreign markets vary by
country. AQUAXAN-TM- 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. We believe the approval process for both AQUAXAN-TM- and THE
ASTAFACTOR-TM- in Australia, Japan and certain other Asian countries will come
under their "natural" status and be approved relatively quickly; however, we can
provide no assurances in this regard. AQUAXAN-TM- has not been submitted to the
European Union for approval, and we cannot guarantee that the determination by
Swedish authorities will have any influence on the determination to be made by
the European Union.

We are 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 our business, financial condition, results of
operations and relationships with corporate partners.

EMPLOYEES

As of October 31, 2000, we had 42 full-time employees, of whom seven have
Ph.D.s. Twenty-one are involved in the production and harvesting process, nine
are involved in research and development and 12 are involved in administration
and support. We consider relations with our employees to be very good. None of
our employees are covered by a collective bargaining agreement.

KEY SCIENTISTS

Our scientists, as a group, lead all aspects of product development, process
optimization and the research upon which our business is based.

DR. MICHAEL CUSHMAN is Vice-President, Research and Development. He received his
Ph.D. in analytical chemistry from Duke University in 1982 and was with Eastman
Chemical Company until October 2000. Dr. Cushman developed more than 20 patents,
yielding multi-million dollar returns for Eastman. Most recently, Dr. Cushman
led a $31 million program that has revolutionized the commercial production of
Vitamin C. The new biotechnology-based process, heralded in 1999 in a joint
announcement by President Clinton and Eastman Chemical, is economically superior
to current petrochemical methods and is now being readied for commercialization.
Dr. Cushman and the team sought and obtained external funding for the project
from the U.S. Department of Commerce. He then provided both technical and
administrative leadership for a team that included two universities and five
industrial partners. In the late 1980s, Dr. Cushman led a technology development
team that significantly improved the economics of Eastman's Coal Gasification
facility. As Laboratory Head for Process Instrumentation in the early 1990s he
directed

                                     28

<PAGE>

process automation, pilot plant support, and the development of novel
process analyzers. As Laboratory Head for Industrial Biochemicals in the
mid-1990's, he was responsible for administration, technology scouting, and
external funding, and led two multi-million dollar research programs.

DR. MAI D. G. LOPEZ received her B.S. (CUM LAUDE) in Biology from University of
the Philippines in 1975, her M.S., also in Biology from University of the
Philippines, in 1981, and earned her Ph.D. in Marine Biology from University of
California, San Diego in 1991. Dr. Lopez has been a leading contributor to
quality control and production practices since joining us in 1999. Her research
career has focused on the feeding ecology of various marine invertebrates, an
area in which she has published 24 scientific papers. She has held an academic
teaching and research position at University of the Philippines (1991-92), and
positions of Visiting Research Scientist at University of Hawaii (1992-94), and
Research Scientist at Scripps Institution of Oceanography (1994-98).

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 our President, Chief Executive Officer and Chairman of the Board, and also
holds a faculty research appointment at the Hawaii Natural Energy Institute,
School of Ocean and Earth Sciences and Technology, University of Hawaii at
Manoa. He was a Research Biologist at Scripps Institution of Oceanography,
University of California, San Diego from 1980 to 1998. 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 served for 10 years on the Executive
Committee of the Global Ocean Ecosystem Dynamics program (1989-1999), 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 Department of State, the United States Department of Interior and the
White House Office of Science and Technology Policy. Dr. Huntley is one of our
co-founders and a co-inventor of the Aquasearch Growth Module.

DR. WALTER NORDHAUSEN received his Diplom in Biology from the University of
Gottingen, Germany in 1986, his M.Sc. in Biological Oceanography from University
of California, San Diego in 1989, and earned his Ph.D. in Marine Biology from
University of California, San Diego in 1993. Dr. Nordhausen is Director of
Operations and Technology Development at our facility at Keahole Point, Hawaii,
and oversees the development and integration of new technology into our
production processes. As a consultant to us in 1998, Dr. Nordhausen coordinated
engineers, contractors, and consultants to design and build a physical plant
entailing $2.5 million in capital improvements. As a Post-Doctoral Researcher at
Scripps Institution of Oceanography (1993-98), he organized and directed
oceanographic field campaigns in oceans of the Arctic, the Antarctic and the
South Pacific. His research career has focused on marine biology and
biochemistry, and involved the design, testing, and use of various
state-of-the-art electronic instruments for remote sensing.

DR. MIGUEL OLAIZOLA received his Ph.D. in Biological Oceanography from the State
University of New York at Stony Brook in 1993. Dr. Olaizola has led research in
pigment biosynthesis, microalgal physiology and productivity since joining us in
1996. He also administers our internship program and manages our quality control
laboratory. Dr. Olaizola devoted his graduate and post-graduate research to the
study of carotenoid biosynthesis in microalgae, primarily diatoms and
cyanobacteria. During 1993 to 1995, Dr. Olaizola was a Post-Doctoral Fellow at
the Joint Research Center of the European Commission in Italy. During 1995 and
1996, Dr. Olaizola was a Post-Doctoral Researcher at Scripps Institution of
Oceanography, University of California, San Diego, where he studied microalgal
growth and physiology. He was recently appointed as an Affiliate Professor of
Aquaculture at the University of Hawaii at Hilo and Adjunct Associate Researcher
at the University of Hawaii at Manoa.

                                     29
<PAGE>

DR. MIA UNSON received her B. S. in Biology from the Ateneo de Manila
University, Philippines (1986), graduating CUM LAUDE. She received her B. S.
in Chemistry (1987) also from the Ateneo de Manila University, and was
awarded the Departmental Award in Chemistry for the most outstanding
graduating student that year. She earned her Ph.D. in Oceanography,
specializing in Marine Chemistry, in 1993 from the Scripps Institution of
Oceanography, University of California, San Diego. Dr. Unson leads Aquasearch
programs in natural products chemistry and drug discovery, directing
collaborative projects with chemists and medical researchers at other
institutions. Her accomplishments include studies of actinomycete thiol
biochemistry, and purification and characterization of marine natural
products from various organisms including cyanobacteria. As a postdoctoral
research chemist in the Department of Chemistry and Biochemistry at the
University of California, San Diego (1995-99) Dr. Unson developed and is the
lead inventor on a pending patent application for a new tuberculosis
immunoassay. Her research career has focused on the development of bioactive
molecules.

DR. MELANIE WEAVER is Director of Clinical Operations. She received her Ph.D.
in experimental psychology from the University of New Mexico in 1988. She
carried out postdoctoral research in psychopharmacology at Rutgers University
(1988-89) and in pharmacology and neuroscience at the University of Texas at
Austin (1989-93). Dr. Weaver has served as Director of Clinical Site
Operations at SCIREX Corporation from 1993 until October 2000, where she
managed and directed more than a hundred clinical studies. SCIREX is a
clinical research organization that provides integrated drug development
services, focusing especially on CNS studies.

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 us with guidance regarding the optimization of our
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. We have largely replaced such
meetings with various forms of electronic communication. We believe that the
individual and collective knowledge and experience of our Scientific Advisory
Board provides us with an important competitive advantage.

Current members of the Aquasearch Scientific Advisory Board are:

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
1980s 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

                                      30

<PAGE>

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. 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. 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 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-Squibb.
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. PEARN 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 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 is a co-inventor of processes used in the Aquasearch Growth Module.

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

                                      31

<PAGE>

and physiology of marine plants. Dr. Redalje is one of our co-founders 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.

JOHN WESTERDAHL holds a B.S. in Foods and Nutritio, a Master's degree in
Public Health in nutrition and health education from Loma Linda University,
and additional degrees and certifications as a Master Herbalist, Registered
Dietitian, and Certified Nutrition Specialist. He is currently the Director
of Health Promotion and Nutritional Services at Castle Medical Center in
Kailua, Hawaii where he is responsible for programs and services in medical
nutrition therapy, preventive medicine and wellness. As Senior Nutritionist
for six years at Shaklee Corporation, a respected manufacturer of nutritional
products, Mr. Westerdahl was actively involved in corporate product
development, research, and technical support, including participation in
human clinical trials. He is a member of the American Dietetic Association,
the American College of Nutrition, the Association of Natural Medicine
Pharmacists, and the American Society of Pharmacognosy. Mr. Westerdahl has
published extensively on the topic of human nutrition, including recent
publications in HANDBOOK OF PEDIATRIC NUTRITION and MEDICINAL HERBS: A VITAL
REFERENCE GUIDE.

We do not employ any members of the Scientific Advisory Board. Each member
may have commitments to other entities that could limit his availability to
us. There can be no assurance that we will be able to retain key Scientific
Advisory Board members.

ITEM 2.  DESCRIPTION OF PROPERTIES

Our research, development and production facilities are located in the Hawaii
Ocean Science and Technology (HOST) Business Park in Kailua-Kona, Hawaii. Our
facility currently consists of approximately five leased acres containing a
number of AGMs, finishing ponds, a processing facility, several laboratories,
administrative offices and additional space for production and research and
development. All our products are currently produced at this facility. We
have no production facilities or offices outside the State of Hawaii.

We believe the location of our business in Hawaii and, in particular, the
location of our facility in the HOST Business Park provide us with important
competitive advantages. A combination of several factors make our facility at
the HOST Business Park a favorable location to produce various species of
microalgae:

           -    consistent warm temperatures;
           -    abundant sunlight;
           -    low rainfall;
           -    access to HOST Business Park scientific equipment, personnel and
                facilities;

                                      32

<PAGE>

           -    tax incentives; and
           -    the provision of cold, clean seawater.

We believe that microalgae production facilities located in areas that lack
these characteristics probably have much higher costs of production and fewer
production days per year than we do at our facility.

At the HOST Business Park, we have 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 temperature of the AGM, and could also be used as a source of
nutrients for cultivating marine microalgae. We have access to a complete
industrial infrastructure in Kailua-Kona. We are located only 30 miles from a
deep water port and are immediately adjacent to an international airport.

We believe the HOST Business Park is an excellent location for our current
facility. The seawater utility at this location is unparalleled for very
large-scale commercial production of marine microalgae. To our knowledge,
nowhere else in the world is there a location with the volume, purity and low
cost of seawater we have available at the HOST Business Park. Large
facilities for producing freshwater microalgae will be more economical at
locations other than the HOST Business Park. The cost of site work in old
lava at Kailua-Kona is more expensive than in many Hawaii locations where
soil prevails. Conditions for very large-scale commercial production of
microalgae are exceptional throughout the Hawaiian Islands. Our location on
the Hawaiian Islands provides us with large tracts of available land with
moderate temperatures, high sunlight, low rainfall, easy access to fresh
water, cooling seawater and power, a favorable business environment and
proximity to the renowned marine biotechnology expertise at MarBEC and the
University of Hawaii. We believe the Hawaiian Islands provide one of the most
advantageous and economical locations in the world to cultivate microalgae on
a commercial scale.

The concentration of our existing and planned research and development
facilities and production facilities in the HOST Business Park or elsewhere
in Hawaii involves various risks and uncertainties from potential natural
disasters such as volcanic eruptions, earthquakes, tidal waves, hurricanes
and related phenomena indigenous to Hawaii.

We are in the process of obtaining a 30-year lease of our current five acre
parcel from the Natural Energy Laboratory of Hawaii Authority, the state
entity which administers the HOST Business Park. More than half of the
800-acre HOST Business Park facility is currently undeveloped and, as one of
the fastest growing and largest employers in HOST Business Park, our lease
application is likely to be considered favorably, although we can provide no
assurances in this regard.

ITEM 3.  LEGAL PROCEEDINGS

On July 13, 1998, Cyanotech filed a complaint against us in the United States
District Court for the District of Hawaii (Case No. CV98-00600ACK). In the
complaint, Cyanotech sought declaratory judgment of non-infringement of our
U.S. Letters Patent No. 5,541,056; invalidity of the 5,541,056 Patent; and
non-misappropriation of our trade secrets relating to closed culture
production of astaxanthin. Cyanotech filed the complaint after we expressed
to Cyanotech our concern that Cyanotech infringed the 5,541,056 Patent and
misappropriated our trade secrets.

On September 11, 1998, we 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 the parties' 1994 Dissolution Agreement.

                                      33

<PAGE>

On December 14, 1998, Cyanotech filed a motion for partial summary judgment
of non-infringement and invalidity of the 5,541,056 Patent.

On March 1, 1999, we filed a motion for partial summary judgment against
Cyanotech for breach of contract and misappropriation of trade secrets. On
March 26, 1999, we filed a cross-motion for summary judgment of patent
infringement. All motions for summary judgment were heard in November 1999.

On December 30, 1999, the United States District Court for the District of
Hawaii granted summary judgment on our motion that Cyanotech infringed our
patent, misappropriated our trade secrets and breached the terms of the
parties' 1994 Dissolution Agreement. In its order, the Court found that the
tube process used by Cyanotech for cultivating microalgae infringed the
5,541,056 Patent. The Court further found that Cyanotech violated the Uniform
Trade Secrets Act and breached the 1994 Dissolution Agreement when it
misappropriated trade secrets relating to our proprietary closed-system
technology for cultivation of microalgae.

In addition, the Court denied Cyanotech's motion for partial summary judgment
of non-infringement and invalidity of our patent. In doing so, the Court
upheld the validity of the 5,541,056 Patent.

On January 14, 2000, Cyanotech filed a motion for reconsideration on the
Court's December 30, 1999 order. We filed our opposition to the motion for
reconsideration on February 1, 2000.

On March 3, 2000, the Court denied Cyanotech's motion for reconsideration.

On May 25, 2000, the Court granted our motion to compel Cyanotech to produce
documents related to its BioDome system, financial information relating to
its astaxanthin production, and communications with third parties concerning
the lawsuit. In its order, the Court determined that the information sought
on the BioDome could be relevant in the litigation and could potentially bear
on the remedies or the extent of the patent infringement and trade secret
misappropriations by Cyanotech.

On August 29, 2000, Cyanotech filed a motion for partial summary judgment of
invalidity of the 5,541,056 Patent.

On December 4, 2000, the Court denied Cyanotech's motion for partial summary
judgment.

We may be required to dedicate significant management time and incur
significant legal fees and expenses to continue our pursuit and settlement of
this action, which could have a material adverse effect on our business,
financial condition, results of operations and relationships with corporate
partners. In addition, in the event that Cyanotech were to prevail, a finding
of non-infringement or declaration of invalidity of our patent could have a
material adverse effect on our business, financial condition, results of
operations and relationships with corporate partners.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

                                      34

<PAGE>

                                     PART II

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

MARKET INFORMATION

Our common stock is traded on the OTC Bulletin Board (Symbol: AQSE:bb). The
following table shows for the periods indicated the high and low bid
quotations for our common stock for the three years ended October 31, 2000.
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 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

FISCAL 1999
     First Quarter...........................                   $0.22                  $0.18
     Second Quarter..........................                   $0.21                  $0.15
     Third Quarter...........................                   $0.52                  $0.14
     Fourth Quarter..........................                   $0.32                  $0.25

FISCAL 2000
     First Quarter...........................                   $0.50                  $0.25
     Second Quarter..........................                   $2.25                  $0.54
     Third Quarter...........................                   $0.88                  $0.51
     Fourth Quarter..........................                   $0.73                  $0.29
</TABLE>

As of the date of October 31, 2000, we had approximately 2,000 record holders of
our 105,589,076 shares of common stock.

DIVIDEND POLICY

We have never paid cash dividends on our capital stock. We currently intend
to retain all available funds to operate and expand our business. We do not
anticipate paying any cash dividends in the foreseeable future.

RECENT SALES OF UNREGISTERED SECURITIES

During the period from June 1997 to October 31, 2000, we sold an aggregate of
$8,303,863 principal amount of convertible notes bearing interest at 10% per
annum. The holders of the convertible notes have an option to convert their
convertible notes into our common stock. The convertible notes provide that
upon conversion, the holders would receive warrants to purchase shares of our
common stock. The warrants have exercise prices ranging from $0.375 to $2.00
per share and a term of three years. As part of

                                      35

<PAGE>

this transaction, Earl S. Fusato, our Chief Financial Officer, Secretary and
a member of our Board of Directors, purchased $2,030,000 of convertible notes.

Through October 31, 2000, some of the holders of the convertibles notes
(amounting to $8,213,863 aggregate principal amount) exercised their option
to convert their convertible notes into shares of common stock. Upon
conversion of the outstanding principal and interest on the convertible
notes, we issued 44,429,284 shares of common stock and also issued 8,000,137
warrants in connection thereto. As part of this transaction, Mr. Fusato
converted $2,030,000 aggregate principal amount of convertible notes and
received 13,286,154 shares of common stock and 1,540,713 warrants.

During the year ended October 31, 2000, we received $263,500 from the
exercise of warrants to purchase 527,000 shares of common stock.

During the period from February 1, 1999 to October 31, 2000, Gregory Kowal
purchased 7,333,334 shares of our common stock at $0.15 per share. In
connection with the purchase, Mr. Kowal received warrants to purchase
1,100,000 shares of our common stock at $0.40 per share with a term of three
years.

In October 2000, Mr. Fusato exercised options to purchase a total of
1,425,000 shares of common stock at an exercise price of $0.36. The shares
were acquired in satisfaction of certain notes payable to officer and accrued
interest.

In July 2000, we issued 50,000 shares of common stock at $0.25 per share to
David Tarnas, for consulting services rendered as a member of our Board of
Directors. In addition, we sold 50,000 shares of common stock at $0.25 per
share to David Tarnas. The total proceeds from this transaction were $12,500.

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

In January and March 1998, we 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 in 1997 and 1998.

In October 1997, we 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
our Board of Directors. In addition, we sold 50,000 shares of common stock
at $0.25 per share to Edward E. David, Sc.D. The total proceeds from this
transaction were $12,500.

In September 1997, Ms. Alcalay exercised an option to purchase 463,250 shares
of common stock at $0.0625 per share under a 3 year, 5 percent note payable,
secured by the underlying shares of common stock.

During the two quarters ended October 31, 1997, we issued one-year
convertible notes payable amounting to $560,000. The holders of these notes
had an option to convert to equity under a planned private placement in early
fiscal 1998. The convertible notes carried 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 were shareholders and an officer/director.

These transactions were exempt from registration under the Securities Act of
1933 pursuant to Section

                                      36

<PAGE>

4(2). No underwriters were involved in these transactions.

ITEM 6.  MANAGEMENT'S PLAN OF OPERATION

THE FOLLOWING DISCUSSION OF OUR MANAGEMENT'S PLAN OF OPERATION CONTAINS
CERTAIN FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 21E OF THE
SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, INCLUDING STATEMENTS, TREND
ANALYSIS AND OTHER INFORMATION RELATIVE TO MARKETS FOR OUR PRODUCTS AND
TRENDS IN REVENUES AND ANTICIPATED EXPENSE LEVELS, AS WELL AS STATEMENTS
INCLUDING WORDS SUCH AS "ANTICIPATE," "EXPECT," "BELIEVE," "PLAN," "ESTIMATE"
AND "INTEND" AND OTHER SIMILAR EXPRESSIONS. THESE STATEMENTS INVOLVE KNOWN
AND UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS THAT MAY CAUSE OUR ACTUAL
RESULTS, PERFORMANCE OR ACHIEVEMENTS TO DIFFER MATERIALLY FROM THOSE
EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS. SUCH FACTORS
INCLUDE, AMONG OTHERS, THE INFORMATION CONTAINED UNDER THE CAPTION "FACTORS
THAT MAY AFFECT FUTURE OPERATING RESULTS" AND OTHER RISKS DETAILED FROM TIME
TO TIME IN OUR PERIODIC REPORTS AND OTHER INFORMATION FILED WITH THE
COMMISSION.

OVERVIEW

We are a development stage company that develops and commercializes natural
products from microalgae using our proprietary photobioreactor technology
known as the Aquasearch Growth Module, or 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.

Although microalgae are believed to be a potential source for many valuable
commercial applications, less than 5,000 species of microalgae have ever been
isolated from nature, and fewer than 10 species of microalgae - less than
one-tenth of one percent of all such species - have ever been cultivated
commercially.

We believe that the development of a large biotechnology industry, based on
thousands of species of microalgae, has been impeded only by a lack of
technology. We anticipate that our commercial production technology will
allow us to create a market for new and valuable substances derived from
microalgae. Our company, since its inception, has been dedicated to this
proposition.

Key achievements in the past year include:

          -   Introduction and sales of our first nutraceutical product, THE
              ASTAFACTOR-TM-
          -   Completion of our first Compound Library in collaboration with
              Albany Molecular Research
          -   Submission of our first library for screening by the U.S. National
              Cancer Institute
          -   Selection to participate in a $2.4 million contract from the U.S.
              Department of Energy, of which we expect to receive $1.2 million
              over three years pursuant to a subcontract with Physical
              Sciences, Inc.
          -   Initiation of two clinical trials on the effects of THE
              ASTAFACTOR-TM- on human health, and
          -   Execution of a strategic drug discovery agreement with the
              University of Hawaii

At the same time, we have strengthened our scientific and managerial
expertise and further optimized our microalgae production process. In October
2000, Aquasearch was honored as "Biotechnology Company

                                      37

<PAGE>

of the Year" by the Hawaii Technology Trade Association.

In 2001, we plan to expand sales of THE ASTAFACTOR-TM-, develop our product
pipepline, and grow our pharmaceutical drug development business.

HISTORY: KEY EVENTS

1984
      AQUASEARCH FOUNDED. Scientists from Scripps Institution of
      Oceanography in La Jolla, California founded Aquasearch, Inc. as a
      California corporation.

1988
      FEB:      We incorporated Aquasearch, Inc. in Colorado.

      MAY:      Aquasearch (Colorado) acquired all the assets of Aquasearch
               (California) in a stock-for-stock exchange.

      JUN:      OPERATIONS BEGIN in Borrego Springs, California.

1988-1993
      RESEARCH AND DEVELOPMENT. We developed our first prototype of the
      AGM. Over the next few years we refined certain details of
      engineering in the AGM. At the same time, we cultivated microalgal
      species of markedly different varieties.

1993
      MAR:      AQUASEARCH-CYANOTECH JOINT VENTURE FORMED. We formed a
                joint venture company with Cyanotech, an unaffiliated
                producer of microalgae. Our goal was to develop commercial
                systems for producing astaxanthin-rich microalgae. We
                contributed approximately $147,000 in capital and licensed
                our AGM technology to the joint venture. Cyanotech
                contributed approximately $15,000 in capital to the joint
                venture and made available its facilities and personnel at
                the HOST Business Park at Keahole Point, Kailua-Kona,
                Hawaii.

1994
      JUN:      CULTOR NEGOTIATION BEGINS. We began discussions with Cultor
                regarding the purchase of astaxanthin-rich microalgae.

      JUL:      FIRST ASTAXANTHIN PRODUCED. We constructed AGMs that
                demonstrated the economics of the production process.  We
                also produced samples of astaxanthin-rich microalgae for
                analysis and trial applications.  Samples were sent to
                Cultor for testing.

      NOV:      AQUASEARCH-CYANOTECH JOINT VENTURE TERMINATED. We decided
                to discontinue the joint venture with Cyanotech.  Under our
                dissolution agreement, all intellectual property rights to
                AGM technology reverted to us.

      DEC:      CULTOR STARTS FEEDING TRIALS on farmed salmon using the
                using astaxanthin-rich microalgae we produced.

1995
      APR:      CONSTRUCTION BEGINS on our own half-acre facility in
                Hawaii, leased from the HOST

                                      38

<PAGE>

                Business Park. We designed the facility for research and
                development, and for production of small amounts of
                astaxanthin-rich microalgae for marketing.

      JUN:      CONSTRUCTION COMPLETED. Our first facility was comprised of
                AGMs and an operating laboratory.

      JUL:      SVENSKA FODER CONTRACT. We entered into a three-year Supply
                Agreement with Svenska Foder, then a subsidiary of Cultor.
                Svenska Foder agreed to act as the exclusive distributor of
                our natural astaxanthin product for animal feed
                applications in Sweden, Norway and Finland. 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 Supply Agreement.

                FACILITY EXPANSION BEGINS. We leased additional space in
                the HOST Business Park to expand our half-acre research and
                development facility to one acre.

      OCT:      ONE-ACRE EXPANSION COMPLETED. We expanded the facility to
                include finishing ponds (the second stage of our production
                process), and additional laboratory space.

1996
      MAY:      CULTOR AGREEMENT. We entered into a three-year Distribution
                and Development Agreement with Cultor (recently extended to
                four years). We agreed to act as the exclusive worldwide
                supplier to Cultor of natural astaxanthin derived from
                microalgae for animal feed applications. Cultor agreed to
                act as the exclusive worldwide distributor of our natural
                astaxanthin product for animal feed applications.

                SCIENTIFIC ADVISORY BOARD FORMED. We created an active
                Scientific Advisory Board consisting of 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.

      JUL:      PROCESS PATENT IN THE U.S.  We were awarded U.S. Patent
                Number 5,541,056 for a "Method of Control of Microorganism
                Growth Process."  This patent claims certain processes that
                operate in our proprietary, closed-system photobioreactor,
                the AGM.  Our U.S. filing was made under the Patent
                Cooperation Treaty.  We began to pursue international
                patents in certain treaty-member nations.

      OCT:      CULTOR ACQUIRES AQUASEARCH STOCK.  Cultor acquired 400,000
                shares of our common stock at a purchase price of $0.50
                per share.

      NOV:      C. BREWER AGREEMENT. We executed a Letter of Intent with C.
                Brewer and Company, Limited ("C. Brewer"). Under the proposed
                agreement we would acquire between 80 and 90 acres of C. Brewer
                property in the Ka'u region of the Big Island of Hawaii, valued
                at between $900,000 and $1,000,000.  In return, C. Brewer would
                acquire approximately 4% of our outstanding common stock and a
                three-year warrant to purchase up to 500,000 shares of
                Aquasearch common stock at $1.25 per share.  To date, we have
                not consummated the transaction with C. Brewer because
                production at our current facility has increased beyond
                expectation.

                                      39

<PAGE>

1997
           APR:      EARL FUSATO NAMED CHIEF FINANCIAL OFFICER, JOINS BOARD. Mr.
                     Fusato brought considerable experience to our management
                     team.  At VeriFone, Inc., a global leader in the
                     transaction automation industry, he served as VP Finance
                     (1983-87), Treasurer (1987-90) and Director of Internal
                     Audit and Manager of Transaction Automation (1990-92). He
                     served as CFO of RESCO Inc., a residential real estate
                     brokerage company (1992-94). He also served in various key
                     positions at Ernst and Young (1978-83) and KPMG Peat
                     Marwick (1971-77).

           JUN:      APPARATUS PATENT IN EUROPE. We were awarded European Patent
                     Number 0494887 for a "Process and Apparatus for the
                     Production of Photosynthetic Microbes." This patent not
                     only claims certain processes, but also certain features of
                     our core technology, the Aquasearch Growth Module. The
                     European patent complements, but does not supplant claims
                     made in the U.S. Patent awarded in 1996. Our European
                     filing was made under the Patent Cooperation Treaty. We are
                     pursuing additional patents in certain treaty-member
                     nations.

           SEP:      DR. EDWARD DAVID JOINS BOARD. Dr. David has a long history
                     of management experience in the fields of science and
                     technology.  During his career he has served as President
                     of Exxon Research and Engineering, Science Advisor to the
                     President of the United States, Executive Director of the
                     Communications Systems Division at Bell Laboratories, and
                     Director of the White House Office of Science and
                     Technology Policy.

1998
           APR:      EXPANSION BEGINS TO TRIPLE OUR PRODUCTION FACILITY. We
                     began construction to expand our production facility in
                     Kona, Hawaii from one acre to three acres.  At the same
                     time, we began upgrading every component of our production
                     system hardware.

           JUN:      WE QUESTION CYANOTECH REGARDING INTELLECTUAL PROPERTY.
                     We formally notified Cyanotech of our concern that their
                     use of photobioreactor technology may violate one of our
                     patents (U.S. patent No. 5,541,056) relating to processes
                     for controlling microalgae growth.  We also expressed
                     concern regarding possible trade secret misappropriation.

           JUL:      DAVID WATUMULL NAMED EXECUTIVE VP, CORPORATE FINANCE AND
                     STRATEGIC DEVELOPMENT. Mr. Watumull brought more strength
                     to our management team.  He has been a respected
                     biotechnology industry analyst, investment banker and money
                     manager for more than 15 years, serving at both Paine
                     Webber and First Honolulu Securities.

                     WE TEST A NEW PHOTOBIOREACTOR - THE ULTRA-AGM. In previous
                     months we designed and engineered the Ultra-AGM. The
                     Ultra-AGM is more than six times larger than any standard
                     production growth module we have used. To our knowledge,
                     the Ultra-AGM is larger than any closed-system
                     photobioreactor ever operated. A six-month testing period
                     begins.

                     CYANOTECH FILES LAWSUIT. Our former joint venture partner
                     filed a complaint in the United States District Court for
                     the District of Hawaii (Case No. CV98-00600ACK) against us.
                     Cyanotech sought a declaratory judgment of:

                          -    invalidity of our U.S. patent for a method to
                               grow microalgae;
                          -    non-infringement by Cyanotech of the U.S. patent;
                               and


                                      40
<PAGE>

                          -    non-misappropriation of our trade secrets
                               regarding the Aquasearch Growth Module.

           SEP:      WE COUNTER-SUE CYANOTECH. We asserted the validity of our
                     U.S. patent.  We also alleged that Cyanotech:

                          - infringed our U.S. patent;,
                          - misappropriated trade secrets related to our AGM
                            technology;
                          - breached our joint venture dissolution
                            agreement; and
                          - engaged in unfair competition.

                     We requested damages, injunctive relief and attorney's fees
                     on each count.

                     APPARATUS PATENT IN HONG KONG. We were awarded patent
                     number HK1001232 for the "Process and Apparatus for the
                     Production of Photosynthetic Microbes." This patent was
                     awarded under the Patent Cooperation Treaty, based on the
                     original filing approved by the European Patent Office in
                     1997.

           NOV:      CHARTER MEMBERSHIP IN MARBEC. MarBEC is a 5-year, $26
                     million Engineering Research Center, funded by the U.S.
                     National Science Foundation. MarBEC is focused on
                     developing new enzymes, pigments and pharmaceuticals,
                     primarily from microalgae. It is based at the University of
                     Hawaii and the University of California, Berkeley. We are
                     among the charter industry members of MarBEC, which also
                     include Monsanto and Eastman Chemical. As a charter member,
                     we have certain preferential rights to new products
                     developed by MarBEC. We are the only member of MarBEC that
                     has developed photobioreactor technology, which we believe
                     is likely to be required for the commercial exploitation of
                     any new product from microalgae.

           DEC:      ENZYMED AGREEMENT. We entered into a Compound Library
                     Agreement with EnzyMed, a privately-held biotechnology
                     company. Under the agreement, we will provide extracts of
                     microalgae that contain unexplored or unexploited
                     substances with biomedical value. EnzyMed will use these
                     extracts to generate compounds using their method of
                     "combinatorial biocatalysis." This method generally
                     produces several hundred compounds from a single extract.
                     We expect some of these compounds to be novel and
                     proprietary. Both companies intend to commercialize the
                     resulting compound "libraries." Compound libraries are
                     typically screened for possible medical applications by the
                     pharmaceutical industry. The pharmaceutical company
                     typically pays an "access fee" for the right to screen the
                     library for a limited time and for limited applications. We
                     will share the revenues generated from the libraries with
                     EnzyMed.

1999
           JAN:      MARTIN GUERIN NAMED VP, SALES AND MARKETING. Mr.
                     Guerin has international experience with world-leading
                     groups in food and feed industries. He held top management
                     positions for marketing and business development with
                     Finfeeds International (1996-98) and EWOS (1994-96), both
                     Cultor companies. His previous experience includes
                     management positions with BP Nutrition (now Nutreco) and
                     Champagnes Cereales.

                     NEW EQUIPMENT INSTALLATION BEGINS. With construction nearly
                     complete on our expanded three-acre facility, we began to
                     install new equipment for process control and for final


                                     41
<PAGE>

                     processing of raw products.

                     THE ULTRA-AGM GOES INTO OPERATION. After a successful
                     six-month testing period, we installed and began to operate
                     the new Ultra-AGM. This new photobioreactor is much larger,
                     more efficient, and less costly than any previous AGM. It
                     also requires 75% less manpower to operate.

           FEB:      CONSTRUCTION COMPLETED ON THREE-ACRE PHYSICAL PLANT. We
                     completed all new structures at our production facility. We
                     tripled the area for both AGMs and finishing ponds. We
                     quadrupled the area under roof to more than 8,000 square
                     feet. We added a multi-purpose building for product
                     processing, packaging and storage that can also accommodate
                     further increases in production at our current site. We
                     laid the foundation for a 10,000 square-foot laboratory
                     that will accommodate expansion of our drug discovery
                     program.

                     NEW PLANT BEGINS PRODUCTION AT FULL CAPACITY. While
                     installing our final processing equipment, we increased our
                     production of raw product to full capacity. We began to
                     store raw product. Final processing of the product will be
                     done once equipment installation is complete.

                     DAVID TARNAS JOINS BOARD. Mr. Tarnas brings political
                     experience to our Board of Directors. As a Hawaii State
                     Representative and Chairman of the House Committee on Ocean
                     Recreation and Marine Resources, he led many important
                     policy initiatives in Hawaii until 1998.

                     PROCESS PATENT IN EUROPE. We were awarded European Patent
                     Number 0772676 for a "Method of Control of Microorganism
                     Growth Process." This patent, originally granted in the
                     U.S., was awarded in Europe under the Patent Cooperation
                     Treaty. It claims certain processes that operate in our
                     Aquasearch Growth Module.

           MAR:      PROCESS PATENT IN U.S. We received U.S. Patent Number
                     5,882,849 for a "Method of Control of HAEMATOCOCCUS Species
                     Growth Process." This patent applies to proprietary
                     techniques we use to grow HAEMATOCOCCUS, our principal
                     source of astaxanthin. We are pursuing international
                     patents in certain member nations that are signatories of
                     the Patent Cooperation Treaty.

           APR:      APPARATUS PATENT IN NORWAY. We were awarded Norwegian
                     Patent Number 304556 for a "Process and Apparatus for the
                     Production of Photosynthetic Microbes." This patent not
                     only claims certain processes, but also certain features of
                     our core technology, the Aquasearch Growth Module.
                     Originally granted in Europe, this patent was awarded in
                     Norway under the Patent Cooperation Treaty.

                     PRODUCT FORMULATION BEGINS ON OUR FIRST NUTRACEUTICAL
                     PRODUCT. A large U.S. chemical company began collaborating
                     with us - under a confidentiality agreement - to formulate
                     an astaxanthin-rich nutraceutical product.

           MAY:      PROCESS PATENT IN AUSTRALIA. We were awarded Australian
                     Patent Number 698772 for a "Method of Control of
                     Microorganism Growth Process." This patent, originally
                     granted in the U.S., was awarded in Australia under the
                     Patent Cooperation Treaty.

                     APPARATUS PATENT IN SOUTH KOREA. We received South Korea
                     Patent Number 700834 for


                                     42
<PAGE>

                     a "Process and Apparatus for the Production of
                     Photosynthetic Microbes." Originally granted in Europe,
                     this patent was awarded in South Korea under the Patent
                     Cooperation Treaty.

                     MICROALGAE FOR OUR SECOND NUTRACEUTICAL PRODUCT APPROVED.
                     The State of Hawaii Department of Agriculture approved our
                     permit application to import a new microalgae species. This
                     species is the basis for our second nutraceutical product,
                     planned for product launch in 2000.

           JUN:      PROCESSING EQUIPMENT INSTALLED. Our manufacturing process
                     became fully operational as final processing equipment came
                     on line.

                     RECORD ASTAXANTHIN LEVELS ACHIEVED. We achieved an
                     astaxanthin content of more than 3% in our final processed
                     product - sustained over the previous three months. This
                     content is at least double the amount claimed by any other
                     known producer of natural astaxanthin. Some of our
                     production runs approached 4% content, and we achieved 6%
                     content at smaller scales.

           JUL:      WE BEGIN SHIPPING NATURAL ASTAXANTHIN to a European life
                     sciences company.

           SEP:      WE BEGIN SHIPPING NATURAL ASTAXANTHIN to a Japanese life
                     sciences company.

           DEC:      THE U.S. DISTRICT COURT FOR THE DISTRICT OF HAWAII GRANTS
                     MOTION FOR SUMMARY JUDGMENT IN OUR FAVOR. The Court rules
                     that Cyanotech infringed our patent, misappropriated our
                     trade secrets, and breached our joint venture dissolution
                     agreement. In addition, the Court denied Cyanotech's motion
                     for partial summary judgment of non-infringement and patent
                     invalidity.

2000
           JAN:      CYANOTECH FILES MOTION FOR RECONSIDERATION on the Court's
                     summary judgment order.

           MAR:      THE U.S. DISTRICT COURT FOR THE DISTRICT OF HAWAII DENIES
                     CYANOTECH'S MOTION FOR RECONSIDERATION. The Court upholds
                     its summary judgment ruling and denies all reconsideration
                     requests made by Cyanotech.

                     WE COMMENCED SALES OF OUR ASTAXANTHIN PRODUCT, THE
                     ASTAFACTOR-TM-.

                     DR. SAMUEL LOCKWOOD APPOINTED AS DIRECTOR OF MEDICAL
                     AFFAIRS. Dr. Lockwood, a research physician and former
                     practicing clinician at the University of Texas Health
                     Science Center, will coordinate clinical trials on our
                     products and serve as the chief medical liaison to the
                     biopharmaceutical industry.

           MAY:      WE ENTERED INTO A MARKETING AGREEMENT WITH PMP PUBLIC
                     AFFAIRS CONSULTING, INC. Under the agreement, PMP will lead
                     a targeted marketing effort for THE ASTAFACTOR-TM-
                     patterned after a patient group strategy well-known and
                     proven in the biotechnology industry.

                     www.astaxanthin.org WEBSITE LAUNCHED. The new website
                     provides comprehensive, up-to-date reviews of the
                     scientific and medical information on astaxanthin, its
                     properties, and possible applications for human health.


                                     43
<PAGE>

           JUN:      $10 MILLION FINANCING COMMITMENT SECURED. An equity line
                     for up to $10 million is secured from Alpha Venture
                     Capital, Inc., a $750 million private equity fund group.
                     The equity line can be drawn against based upon a formula
                     relating to the volume of trading and price of our common
                     stock.

           JUL:      WE RECEIVE AN AWARD FROM THE U.S. DEPARTMENT OF ENERGY.
                     The  project will utilize our AGM technology as the
                     basis of an innovative approach to capture and store
                     gases that cause the "greenhouse effect."  We will team
                     with Physical Sciences, Inc. of Andover, Mass. and the
                     Hawaii Natural Energy Institute at the University of
                     Hawaii on the $2.4 million project. We expect to receive
                     $1.2 million over three years for our work on the
                     project.

           AUG:      OUR FIRST DRUG DISCOVERY LIBRARY IS COMPLETED in
                     collaboration with Albany Molecular Research, Inc. The
                     National Cancer Institute will be screening the library,
                     consisting of a novel set of compounds derived from
                     astaxanthin, for activity in sixty human tumor cell lines,
                     including tests for activity against lung, colon, melanoma,
                     prostate, ovarian, breast, and kidney cancers.

                     WE INITIATE A CLINICAL TRIAL OF ASTAXANTHIN EFFICACY IN
                     CARDIOVASCULAR DISEASE. The trial, conducted at the
                     Thoracic & Cardiovascular Healthcare Foundation in Lansing,
                     Michigan, will evaluate astaxanthin's ability to reduce
                     blood serum levels of C-reactive protein, the single
                     strongest predictor of risk of future cardiovascular events
                     in apparently healthy men and women.

                     WE INITIATE AN IN VITRO STUDY TO INVESTIGATE THE ROLE OF
                     ASTAXATHIN IN EYE HEALTH. The six-month in vitro study will
                     be conducted at the Eye Research Institute at Oakland
                     University in Rochester, Michigan.

                     CYANOTECH FILES A MOTION FOR PARTIAL SUMMARY JUDGMENT of
                     invalidity of the 5,541,056 Patent.

           SEP:      PATENT AWARDED FOR MICROALGAE PRODUCTION PROCESS. The
                     patent, awarded by the Australian Patent Office, applies to
                     a "Method of control of HAEMATOCOCCUS species growth
                     process."

                     DR. MICHAEL CUSHMAN APPOINTED AS VICE-PRESIDENT, RESEARCH
                     AND DEVELOPMENT. Dr. Cushman, previously a Research and
                     Development Leader at Eastman Chemical Company, will lead
                     all product and technology development initiatives,
                     including process optimization, production plant design and
                     expansion, and development of new products.

           OCT:      DR. CLIFFORD DACSO APPOINTED TO CHAIR MEDICAL ADVISORY
                     BOARD. Dr. Dacso, the John S. Dunn, Sr. Research Chair of
                     General Internal Medicine and Professor of Medicine at
                     Baylor College of Medicine, will provide strategic guidance
                     on product development, clinical trial protocols and
                     results, and general oversight of medical affairs.

                     DR. MELANIE WEAVER NAMED DIRECTOR OF CLINICAL OPERATIONS.
                     As Director of Clinical Operations, Dr. Weaver will lead
                     all in-vitro, pre-clinical and clinical trial initiatives
                     to investigate health benefits of nutraceuticals and to
                     support the development of pharmaceutical drugs. Dr. Weaver
                     formerly served as Director of Clinical Site Operations at
                     SCIREX Corporation since 1993.


                                     44
<PAGE>

                     AQUASEARCH HONORED AS BIOTECHNOLOGY COMPANY OF THE YEAR by
                     the Hawaii Technology Trade Association.

           NOV:      WE ENTER INTO AN AGREEMENT TO SPONSOR A CLINICAL TRIAL IN
                     EXERCISE INDUCED ASTHMA. The study, to be conducted at two
                     research centers in Hawaii, will evaluate astaxanthin's
                     ability to decrease the airway obstruction normally seen in
                     patients who experience asthma as a result of exercise.
                     Douglas Hiller, M.D., of Labman Hawaii, Inc. and Jon
                     Ruckle, M.D., of Radiant Research will serve as
                     co-principal investigators.

           DEC:      THE U.S. DISTRICT COURT FOR THE DISTRICT OF HAWAII DENIES
                     CYANOTECH'S AUGUST 2000 MOTION FOR PARTIAL SUMMARY JUDGMENT
                     of invalidity of the 5,541,056 Patent.

2001
           JAN:      WE EXECUTE AN AGREEMENT WITH THE UNIVERSITY OF HAWAII FOR
                     EXCLUSIVE ACCESS TO A COLLECTION OF MORE THAN 2,000 STRAINS
                     OF MICROALGAE. The collection, containing unusual species
                     of microalgae, were collected throughout the world, mostly
                     from the Pacific Ocean basin and screened for bioactive
                     compounds. We intend to develop compound libraries for drug
                     discovery and utilize our AGM technology to produce
                     quantities sufficient for pre-clinical trials.

THE MARINE BIOTECHNOLOGY INDUSTRY

There are 30,000 species of microalgae. Many of these are known to contain
valuable substances, including pharmaceuticals, nutraceuticals, and certain
commodities. Fewer than one-tenth of one percent of these 30,000 species have
been produced commercially.

The total market for only three species of microalgae that are now produced
commercially (SPIRULINA, CHLORELLA and HAEMATOCOCCUS) is estimated to be in the
range of $200-300 million per year. We believe the potential market for products
derived from microalgae could range into the billions of dollars, provided that:
(1) the products are unique, valuable, and numerous; and (2) production
technology is reliable and cost-effective.

Scientific literature demonstrates that:

           -    microalgae contain unique substances;
           -    these unique substances are potentially valuable as
                pharmaceuticals and nutraceuticals; and
           -    these unique substances are numerous among the microalgae.

Until recently, however, there was no technology to provide for the
cost-effective production of microalgae in commercial quantities. We believe
that our AGM provides reliable and cost-effective production technology that
will contribute to the development of a multi-billion dollar marine
biotechnology industry. However, there can be no assurance that such an industry
will develop.

OUR KEY ACHIEVEMENTS

(1)  RELIABLE AND COST EFFECTIVE PRODUCTION TECHNOLOGY

The Aquasearch Growth Module is a novel, reliable and cost-effective production
technology. We have proven the efficacy of the AGM through a 10-year process of
engineering, development, and


                                     45
<PAGE>

demonstration.

We continue to achieve targeted improvements in AGM technology and performance,
as this table shows:

<TABLE>
<CAPTION>
--------------------------------------------------- ---------------------------------------- --------------------------------------
                   IMPROVEMENT                                  PLANNED IN THE                           ACHIEVED IN THE
                                                                   PAST YEAR                                PAST YEAR
--------------------------------------------------- ---------------------------------------- --------------------------------------
<S>                                                 <C>                                      <C>
                Increase AGM size                                     6X                                 Greater than 6X


              Decrease capital cost                                   2X                                       3X
              (per gallon capacity)


           Increase AGM production life                             30 days                                  60 days


          HAEMATOCOCCUS production rate                           Increase 3X                            Greater than 3X


          Astaxanthin content of product                      2.0% of dry weight                 Greater than 3.0% of dry weight
--------------------------------------------------- ---------------------------------------- --------------------------------------
</TABLE>

These improvements to the AGM have reduced costs and increased productivity. We
believe the AGM is the largest commercial photobioreactor in operation. To our
knowledge, our current HAEMATOCOCCUS production rate is higher than any reported
in the scientific literature.

(2)  INTELLECTUAL PROPERTY

We now have 13 U.S. and international patents relating to:

           - the AGM apparatus (Europe, Australia, Norway, Hong Kong, South
             Korea);
           - general processes for cultivating microalgae in photobioreactors
             (U.S., Europe, Australia); and
           - specific processes for cultivating HAEMATOCOCCUS (U.S.).

Additional patents are pending.

We continue to develop trade secrets. We believe that our trade secrets are the
underlying reason for consistent improvements in production and product quality.
We place great value on our intellectual property.

(3)  PRODUCTION CAPACITY

In the past year we expanded our physical plant by a factor of three. We now
have a completely new manufacturing plant. The plant includes new processing
equipment and an upgraded process-control system.

Our HAEMATOCOCCUS cultivation process is done in two steps. We use two types of
large-scale production systems: (1) Aquasearch Growth Modules, and (2)
"finishing" ponds. The following table shows the key features of these two
production systems:


                                     46
<PAGE>

<TABLE>
<CAPTION>
---------------------------- ----------------------------------------------------- -------------------------------------------------
          FEATURE                          AQUASEARCH GROWTH MODULE                                  FINISHING POND
---------------------------- ----------------------------------------------------- -------------------------------------------------
<S>                          <C>                                                   <C>
         Function                       Produce HAEMATOCOCCUS biomass                        Convert biomass to astaxanthin

        Technology                               Proprietary                                          Public domain

     Utilized capacity                               20%                                                  100%
---------------------------- ----------------------------------------------------- -------------------------------------------------
</TABLE>

We have achieved much greater improvements in AGM performance than anticipated.
As a result, we are now using only 20% of our AGM production capacity. If the
market demands, we could increase total production by five times by increasing
our finishing pond capacity. Relative to AGMs, finishing ponds are less costly
to construct.

(4)  SALES

We completed construction of the expanded facility in February 1999. New
processing equipment was installed in June 1999. Sales of AQUAXAN-TM- began
immediately. Sales of THE ASTAFACTOR-TM- began in late March 2000.

(5)  PRODUCT PIPELINE

Prior to this year, our pipeline consisted of a single product: natural
astaxanthin for use in animal nutrition. Our pipeline now includes:

           1)   Nutraceuticals
                -    Natural astaxanthin
                -    A second microalgae-based product

           2)   Drug discovery
                -    Compound libraries

Our nutritional supplement pipeline recently received a boost from the federal
government. In October 2000 Aquasearch began work on a three-year, $2.4 million
project, with funding from the U.S. Department of Energy, to develop proprietary
"high-value products from microalgae." We expect to receive $1.2 million over
three years for our work on the project. To the DOE, these high-value products
would cut the cost of removing carbon dioxide - a greenhouse gas - from Earth's
atmosphere. To Aquasearch, this contract significantly cuts our cost of product
development. We expect our new nutritional supplement products to follow the
process proven by The AstaFactor-TM- - nine to twelve months of product
development, human clinical safety trials, and FDA approval. The State of Hawaii
Department of Agriculture has approved our import permit for a new species of
microalgae that is the basis of our second nutraceutical product.

We completed our first Compound Library in July 2000. Our agreement with
University of Hawaii, signed in January 2001, provides Aquasearch with exclusive
access to a collection of more than 100 new, bioactive compounds from
microalgae. We view this agreement as a cornerstone of our drug development
business. Aquasearch plans to develop many of these molecules into additional
compound libraries.

(6)  OUR TEAM

NEW SCIENTIFIC AND MANAGEMENT EXPERTISE. We have bolstered our team yet again.
Michael Cushman,


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<PAGE>

Ph.D., formerly a senior scientist at Eastman Chemical with years of
experience in managing cost-effective product development, joined us as
Vice-President, Research and Development. Dr. Clifford Dacso, M.D., M.B.A,
Chief of General Internal Medicine and Vice-Chair for Strategic Development
at Baylor College of Medicine, joined us as Chair of our Medical Advisory Board.
Dr. Melanie Weaver, Ph.D., formerly Director of Clinical Site Operations at
Scirex, a national clinical research organization, joined us as Director of
Clinical Operations. These individuals bring Aquasearch a wealth of
management and medical expertise that we believe is critical to advancing our
business.

EMPLOYEES. We believe our employees are strongly motivated for success. In 1998
we introduced a pay-for-performance compensation plan that includes both stock
options and cash bonus programs. We structured the compensation plan to reward
both teamwork and individual excellence. Rewards are generated by performance on
quarterly targets. We believe that our employees are directly responsible for
our recent achievements.

(7)  RECENT FINANCING ACTIVITY

On June 14, 2000, we entered into a common stock purchase agreement with
Alpha Venture Capital, Inc., a Cook Islands corporation, under which we have
agreed to sell and Alpha has agreed to purchase up to $10 million of our
common stock. The agreement requires that we reserve a total of 20 million
shares of our common stock for issuance pursuant to the purchase agreement.
We filed a registration statement on July 13, 2000 with the SEC covering the
resale of the common stock purchased by Alpha Venture Capital. We are under
no obligation to use the equity line. No draws have been made on the equity
line as of October 31, 2000.

In January 2001, the Company entered into an agreement to modify certain terms
of the common stock purchase agreement with Alpha Venture Capital. Subject to
the meeting of certain conditions including the consummation of an initial draw
under the equity line of $560,000 and the delivery of the warrants to purchase
1,500,000 shares of the Company's common stock, the common stock purchase
agreement will be amended to remove the exclusivity and penalty provisions,
release shares presently reserved for future issuance under the equity line, and
adjust the purchase price calculation of future draws.

During the period from June 1997 to October 31, 2000, we sold an aggregate of
$8,303,863 principal amount of convertible notes bearing interest at 10% per
annum. The holders of the convertible notes have an option to convert their
convertible notes into our common stock. The convertible notes provide that upon
conversion, the holders would receive warrants to purchase shares of our common
stock. The warrants have exercise prices ranging from $0.375 to $2.00 per share
and a term of three years. As part of this transaction, an officer/director
purchased $2,030,000 of convertible notes.

Through October 31, 2000, some of the holders of the convertibles notes
(amounting to $8,213,863 aggregate principal amount) exercised their option to
convert their convertible notes into shares of common stock. Upon conversion of
the outstanding principal and interest on the convertible notes, we issued
44,429,284 shares of common stock and also issued 8,000,137 warrants in
connection thereto. As part of this transaction, an officer/director converted
$2,030,000 aggregate principal amount of convertible notes and received
13,286,154 shares of common stock and 1,540,713 warrants.

During the year ended October 31, 2000, we received $263,500 for the exercise of
warrants to purchase 527,000 shares of common stock.

During the period from February 1, 1999 to October 31, 2000, we sold to an
individual 7,333,334 shares of our common stock at $0.15 per share. In
connection with the sale we issued to the individual warrants to purchase
1,100,000 shares of our common stock at $0.40 per share with a term of three
years.

During the year ended October 31, 2000, we issued $250,000 of one-year notes
payable and $370,000 aggregate principal amount of 90-day notes payable. The
notes are unsecured and bear interest at 10% per annum, payable at maturity.

During the year ended October 31, 2000, we issued $450,000 aggregate principal
amount of one-year notes payable to an officer. The notes are unsecured and bear
interest at 10% per annum, payable at maturity.


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<PAGE>

During October 2000, we received a total of $500,000 of short-term advances
from Alpha Venture Capital. The advances are unsecured, bear no interest, and
will be repaid from the initial draw under the equity line.

MANAGEMENT'S PLAN OF OPERATION

PLANNED OPERATIONS

During fiscal 2000, we introduced our first nutraceutical product, initiated a
human clinical trial program for nutraceuticals, further optimized our
production process, and received an award of significant federal funding to
support accelerated product development.

During the next twelve months we will focus on sales and marketing, product
development, and drug discovery, specifically:

           - expanding sales of our first nutraceutical product, THE
             ASTAFACTOR-TM-;
           - formulating more nutraceutical products; and
           - developing compound libraries for drug discovery.

(1)  THE ASTAFACTOR-TM- - NUTRACEUTICAL ASTAXANTHIN

THE PRODUCT. THE ASTAFACTOR-TM-, our first major nutraceutical product, is a
dietary supplement rich in astaxanthin. Astaxanthin is a powerful, bioactive
anti-oxidant (approximately 100 times more potent than Vitamin E), with
anti-inflammatory properties. Astaxanthin has demonstrated efficacy in animal or
human models of:

           -    ALZHEIMER'S AND PARKINSON'S DISEASES: major neurodegenerative
                diseases
           -    MACULAR DEGENERATION: the leading cause of blindness in the U.S.
           -    CHOLESTEROL DISEASE: ameliorates the effects of LDL (the "bad"
                cholesterol)
           -    STROKE: repairs damage caused by lack of oxygen
           -    CANCER: protects against several types of cancer

THE MARKET. We believe a strong market could develop for THE ASTAFACTOR-TM-
among persons afflicted with these ailments because of:

           -    LARGE SIZE OF POTENTIAL MARKET: millions of Americans are
                affected
           -    POOR PROGNOSIS: some of these diseases have ineffective or no
                approved treatments
           -    PROMISING DATA: quality of data in relevant human and animal
                models is promising

Our analysis of reasonable dosage and customary pricing in the nutraceutical
industry suggests that nutraceutical astaxanthin will retail for more than
$50,000 per kilogram. If this estimate proves to be accurate, then we estimate
the potential U.S. market may exceed $500 million per year. This estimate is
based on just one of the six diseases described above, and is derived from the
number of persons affected by the condition, as estimated by physicians who
provide treatment for the disease, and the conventional price of an appropriate
daily dosage. Certain consumers may be highly motivated to use nutraceutical
astaxanthin because:

           -    treatment alternatives do not exist for some ailments; and
           -    sufferers have used nutraceuticals with less demonstrated
                efficacy than astaxanthin.


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<PAGE>

PRODUCTION CAPACITY. Our current production capacity would satisfy approximately
1% of the estimated U.S. market for persons affected by just one of the
illnesses mentioned above. We estimate this would generate retail sales of more
than $5 million per year. We can expand most cost-effectively by adding only
finishing ponds on adjacent property. We do have space available for expansion.
We estimate this space would allow a five-fold expansion of astaxanthin
production at a cost of approximately $1.8 million.

MARKETING STRATEGY. We believe there is a market for our natural astaxanthin at
all levels in the value chain. First, we began selling THE ASTAFACTOR-TM-
directly to consumers. Second, popular demand in Hawaii created the opportunity
to distribute THE ASTAFACTOR-TM- directly to more than 40 retail outlets, and we
are pursuing similar distribution channels elsewhere. Third, we are actively
developing a market for natural astaxanthin as an ingredient. This multi-tiered
strategy is designed to maximize margins at minimal cost.

REGULATORY ISSUES. The U.S. Food and Drug Administration has primary regulatory
responsibility in nutraceutical markets. Many regulations apply. The DSHEA Act
of 1994 governs certain conditions of sale of all nutraceutical products or
dietary supplements in the U.S. We submitted a new dietary supplement
application for THE ASTAFACTOR-TM- to the FDA in December 1999. According to the
DSHEA Act of 1994, the FDA has 75 days from the date of a new dietary supplement
pre-marketing application to object to its sale. If no such objection is made
within that time, the applicant is free to begin marketing. We did not receive
any objection to this application from the FDA.

COMPETITION. AstaCarotene AB of Sweden produces and sells an astaxanthin-rich
nutraceutical product in Europe that, like ours, is based on HAEMATOCOCCUS
microalgae. AstaCarotene must produce their product in a controlled climate,
rather than in Sweden's natural climate. We believe their cost of production is
significantly higher than ours.

Cyanotech recently began sales of a HAEMATOCOCCUS-based nutraceutical. Cyanotech
advertises its natural astaxanthin product to contain 1.5% astaxanthin. Our
product contains 3%. To produce the same amount of astaxanthin, therefore,
Aquasearch requires only half the HAEMATOCOCCUS production capacity. We
therefore believe our cost of production may be less than Cyanotech's. We also
believe that customers may perceive our 3% product as superior to a 1.5%
product, which could confer a competitive advantage over Cyanotech's product.

Igene Biotechnology, Inc. produces astaxanthin from yeast. The chemical form of
astaxanthin in HAEMATOCOCCUS is the one that prevails in nature, and is
different from that in yeast. We believe the nutraceutical market will view the
prevailing natural form of astaxanthin - from HAEMATOCOCCUS - as superior as its
astaxanthin content is 10 times more than that of yeast.

Itano of Japan produces an astaxanthin extract from Antarctic krill, a marine
microcrustacean. The product is distributed in the U.S. in very small amounts
and at very high prices (greater than $650,000 per kilogram). Krill fishing in
Antarctica is very expensive and highly regulated. Krill fishing vessels must
travel for more than two weeks, at a cost of approximately $50,000 per day
simply to complete the voyage between Japan and the Southern Ocean. Suitably
equipped vessels cost approximately $30 million and typically have a lifetime of
only 20 years. The krill fishery is regulated by the Committee for Conservation
of Antarctic Living Resources, an international body comprised of scientists
from Antarctic Treaty member nations. The krill fishery reached its peak in the
mid-1980s and has since declined.

BASF and Hoffman-LaRoche both produce synthetic astaxanthin from petrochemicals.
Their compound is chemically different than natural astaxanthin. The effect of
the difference has not been studied. However, the natural form of a closely
related antioxidant, Vitamin E, was found by its manufacturer (Eastman

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<PAGE>

Chemical) to be four times more potent than the synthetic form. We believe
the nutraceutical market shows less interest in synthetic products than in
natural products, and will pay a premium for a natural product.

TIMING OF PRODUCT RELEASE. We commenced sales of THE ASTAFACTOR-TM- on March 30,
2000.

(2)  OUR SECOND NUTRACEUTICAL PRODUCT

THE PRODUCT. Our second nutraceutical product is a dietary supplement rich in a
certain carotenoid pro-vitamin. The pro-vitamin is known to perform certain
vital functions in human physiology. Like astaxanthin, it is a potent
anti-oxidant. Like astaxanthin, which has very similar molecular properties, it
is present in trace quantities in certain common foods. Also like astaxanthin,
it is overproduced in certain microalgae.

THE MARKET. We believe the market for this product is similar to that for
nutraceutical astaxanthin. Animal and human models have demonstrated the
efficacy of this product in its effect on certain common illnesses. We believe
the potential market for this product will exceed $100 million per year.

PRODUCTION CAPACITY. In mid-1999 we received approval from the State of Hawaii
Department of Agriculture to import the microalgae that is the basis of our
second nutraceutical product. We began cultivation at AGM (commercial) scale in
October of 1999. Our initial tests desmontrated feasibility more rapidly than we
had anticipated. However, the significant federal funding we recently received
for product development provides greater latitude in the choice of additional
products. We now intend to develop several products simultaneously.

PRODUCT FORMULATION. The pro-vitamin in this product has chemical properties
that are similar to astaxanthin, and therefore we believe the product
formulation would also be very similar. We have not yet conducted any studies on
product formulation.

MARKETING STRATEGY. We intend to market this product directly to consumers,
retailers, and product formulators, building on the experience we will have
developed with nutraceutical astaxanthin.

REGULATORY ISSUES. We expect this product to be subject to the same regulatory
issues that govern nutraceutical astaxanthin.

COMPETITION.  We know of no competition for this product.

TIMING OF PRODUCT RELEASE. We plan to release this product within the next 12
months.

(3)  AQUAXAN-TM- - NATURAL ASTAXANTHIN FOR ANIMAL FEED

THE PRODUCT. We have spent several years developing astaxanthin-rich
AQUAXAN-TM-. Astaxanthin is proven to be a vital dietary component in salmon,
trout, red sea bream, and several other species of cultivated seafood products.
In salmon, the primary market, astaxanthin is important as the main source of
their pink flesh color. Recent studies have also demonstrated the importance of
astaxanthin in enhancing the growth rate, vision, and fertility of salmon.
Astaxanthin is routinely used as a feed additive in poultry feeds, for the
purpose of improving the coloration of eggs and reducing the incidence of
infections. Astaxanthin in the diet of swine has been shown to increase
fertility. Several feeding studies with our astaxanthin-rich microalgae in fish
diets have produced the desired results.

THE MARKET. The market for astaxanthin in aquaculture has grown at about 10% per
year over the past 15

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<PAGE>

years. The markets for astaxanthin in feeds for poultry, swine, and other
domestic animals are not yet well developed, and are much smaller. The 1998
global market for astaxanthin was estimated at approximately $185 million.
The sales price for astaxanthin has remained at about $2,500 per kilogram for
the past decade. Consumers in certain niche markets are willing to pay a
premium price. Global annual consumption of astaxanthin is in excess of
65,000 kilograms. Almost all astaxanthin is consumed in five countries which
are, in order of importance, Norway, Chile, Scotland, Canada and Japan.

PRODUCTION CAPACITY. Our current production capacity amounts to less than 1.0%
of the global market. We plan to increase production capacity only in response
to demand. We have the option to increase capacity in two phases. The first
phase would involve constructing more finishing ponds, which would result in an
expansion of our current production capacity by a factor of five. We estimate
this first phase would cost less than $1.8 million, and could generate annual
sales approaching $2.0 million. The second phase would probably require a new
site, because adjacent space is limited at our current site. The modular nature
of the AGM-based production system lends itself well to expansion at any
foreseeable scale. We believe that the experience gained in our recent plant
expansion will make it easier for us to expand our capacity at our existing site
or at adjacent or other sites.

PRODUCT FORMULATION. Any feed ingredient, including astaxanthin-rich microalgae,
requires careful formulation and testing prior to market. Our primary goal has
been to create a product that is at least equal, if not superior to, competitive
feed ingredients. We have focused on creating a product with longer shelf life
that is safer and easier to handle, and produces a better result in the diet. We
believe we have achieved these and other goals to a great degree, some on our
own, and some in collaboration with Cultor. We also believe that further
improvement is possible. If significant changes are made in product formulation,
then new regulatory approvals may have to be obtained. Therefore, we have been
very careful to develop our product to a high standard before placing it on the
market.

MARKETING STRATEGY. We believe that astaxanthin-rich microalgae will account for
a very significant share of the global astaxanthin market. We intend to be a
leader in this market for the following reasons:

           1)   A SUPERIOR PRODUCT. We believe a product that is safer, easier
                to handle, has a longer shelf life, and provides equal or
                greater efficacy per unit cost will eventually take significant
                market share.

           2)   CONSUMER AWARENESS. Farmed salmon now account for almost 40% of
                global salmon production. Consumers are generally not aware that
                the farmed salmon they eat contain a synthetic,
                petrochemical-based coloring. Recent studies by the U.S. FDA
                have shown that farmed salmon are easily distinguished from wild
                salmon because they do not contain the natural form of
                astaxanthin. All other factors being equal, we believe that
                informed consumers will generally prefer a natural astaxanthin
                product over a synthetic one.

The former lead manager of sales and marketing of astaxanthin at Cultor, Martin
Guerin, is now our VP, Sales and Marketing. We recently re-negotiated our
Distribution and Development Agreement with Cultor.

REGULATORY ISSUES. All feed ingredients are regulated in the countries where
they are sold. Regulations differ among astaxanthin-consuming nations. Product
specifications may differ, the stringency of regulations may differ, and the
time required for the application process may differ. In Europe, for example, we
expect regulatory approval could take up to three years, whereas in Chile we
expect such approval should take substantially less time.

COMPETITION. AQUAXAN-TM- competes directly with only one product produced from
HAEMATOCOCCUS

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<PAGE>

microalgae, NATUROSE-TM-, manufactured and sold by Cyanotech. NATUROSE-TM-is
advertised to contain 1.5% astaxanthin. AQUAXAN-TM- contains 3% astaxanthin.

TIMING OF PRODUCT RELEASE.  We began our first sales of AQUAXAN-TM- in July
1999.

(4)  DRUG DEVELOPMENT

THE DRUG DISCOVERY PROCESS. The average cost of discovering one new drug and
bringing it to market now exceeds $320 million. Surprisingly, half those costs
are incurred in "discovery." Pharmaceutical companies may spend more than $150
million before the drug even goes into clinical trials.

THE DISCOVERY PROCESS: Most new drugs are based on substances discovered in
nature. The crude extract of a plant, for example, is shown to have
antibacterial activity. The extract is repeatedly purified and tested until the
antibacterial activity can be attributed to a single molecule. After
pre-clinical testing, this "bioactive" molecule may become a drug candidate for
clinical trials. The cost of discovering and identifying a bioactive molecule
from natural sources is not large, by itself. The real cost of discovery lies
in:

"REDISCOVERY": For every 250 compounds taken to discovery - only 1 is
patentable. The remainder are "rediscoveries" - compounds that are already
known, and therefore not patentable. The cost of rediscovery can be significant.
Rediscoveries are common because biopharmaceutical companies continue to mine
the common natural sources - terrestrial plants and microbes. The rediscovery
rate among the microalgae is very low. Among certain groups of microalgae, MOST
of the bioactive compounds are new, and therefore patentable. Why have
biopharmaceutical companies not exploited this resource? The answer lies in:

CULTIVATION OF SUFFICIENT QUANTITY: Bioactive compounds from natural sources
typically occur in very small amounts. Laboratory cultivation might provide
enough pure compound for identification. But clinical trials must rely on
large-scale cultivation or chemical synthesis. If cultivation cannot supply
enough compound for pre-clinical trials, then the discovery process usually
stops. Synthesis is expensive and, in 1 out of 5 cases, either prohibitively
expensive or impossible.

AQUASEARCH PHOTOBIOREACTOR TECHNOLOGY - ITS ROLE IN DRUG DEVELOPMENT. We believe
that our photobioreactor technology, the Aquasearch Growth Module, (AGM), is a
revolutionary achievement. First, it is 1,000 times larger than the average
laboratory cultivation system. Second, the level of computerized process control
is greater than traditional biotechnology manufacturing processes. These two
achievements allow large quantities of microalgae to be produced under highly
controlled conditions. Solving these problems means that compounds - long
stalled in the discovery process - may now be developed to yield viable drugs.

AQUASEARCH COMPOUND LIBRARIES - MAGNIFYING OPPORTUNITIES FOR DRUG DISCOVERY.
This year we made our first "compound library." We began with pure astaxanthin -
a known bioactive compound - and, in collaboration with Albany Molecular
Research (NASDAQ: AMRI), we created a number of closely related "derivative"
compounds. This collection of compounds is a compound library. Many of our new
compounds are patentable.

Compound libraries like ours are attracting growing interest in the
pharmaceutical industry because they are based on bioactive natural compounds,
modified by a biological (enzymatic) process. Our first compound library has
been under investigation by the U.S. National Cancer Institute (NCI) for the
past six months. Compounds are being screened for activity against approximately
60 types of cancer cells.


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<PAGE>

It is too early report on any results of the NCI investigation, but we believe a
positive result would strongly affirm the value of natural products from
microalgae, AND validate our approach to compound libraries. We expect results
from the NCI in the first few months of 2001.

OUR AGREEMENT WITH UNIVERSITY OF HAWAII - ACCELERATING DRUG DISCOVERY. A
significant part of our drug development program is our agreement with
University of Hawaii (UH), announced in January 2001. This gives Aquasearch
exclusive rights to more than 100 unique, bioactive compounds from microalgae.
These compounds were derived from a remarkable collection of approximately 2,000
strains of microalgae. One of the compounds is now in Phase II clinical trials
for treatment of cancer.

Most importantly, the bioactive compounds have never been tested in any disease
BUT cancer. Other compounds may prove active against other diseases.

We believe our agreement with UH is a significant opportunity. We estimate that
to isolate from nature 100 bioactive compounds from traditional sources, a
biopharmaceutical company would have to isolate and identify approximately
25,000 compounds. We are starting with these compounds and have the technology
to supply sufficient quantities for further testing and pre-clinical trials.

The compounds remaining in the collection may prove active against other
diseases. We plan to increase the probability of success by making compound
libraries from selected bioactive molecules. This approach can create thousands
of lead compounds for pre-clinical screening.

OUR DRUG DEVELOPMENT BUSINESS PLAN. Our business model is designed to reduce the
risks inherent in drug development. Our proprietary cultivation technology -
coupled with exclusive access to dozens of unique molecules in the UH collection
- enables us to proceed rapidly to pre-clinical studies. We expect to offer to
larger biopharmaceutical companies a significant number of new, bioactive
chemical structures for their pipelines.

We plan to develop patentable molecules in the UH collection into compound
libraries over the next several years. The molecules in these libraries would
then be screened against numerous diseases in a variety of pre-clinical trials.
We believe that compounds which survive the pre-clinical study process may have
considerable value.

Our strategy is to focus on strategic partnerships with biopharmaceutical
companies that have an interest in acquiring new drug candidates.

According to a 1997 study by Andersen Consulting, the pharmaceutical industry
must increase its rate of discovery of new drugs by a factor of ten by 2002 in
order to maintain its historic growth rate.

We believe the potential sources of revenue from this approach may include the
following:

           1)   Library Access Fee
                -    access time: limited to 3-12 months
                -    application: limited to certain diseases or disease areas
                -    multiple customers allowed

           2)   Licensing Fee
                -    $3 million to $15 million per compound per indication
                -    activated by decision to begin clinical trials

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<PAGE>

           3)   Milestone Payments
                -    $500,000 to $25 million per event
                -    activated by the results of pre-clinical and clinical
                     trials

           4)   Royalties
                -    activated by FDA approval and full commercialization

(5)  EXPANDING OUR PRODUCT PIPELINE

PRODUCT AREAS.  We have established two areas to expand our product pipeline:

           -    Nutraceuticals
           -    Pharmaceutical drug development

BASIC STRATEGY: NUTRACEUTICALS. We have identified many potential
nutraceutical products among the microalgae, mostly through the published
scientific literature. Our nutritional supplement pipeline has recently
received a major boost from the federal government. In October 2000
Aquasearch began work on a $2.4 million project, with funding from the U.S.
Department of Energy, to develop proprietary "high-value products from
microalgae." We expect to receive $1.2 million over three years for our work
on the project. To the DOE, these high-value products would cut the cost of
removing carbon dioxide - a greenhouse gas - from Earth's atmosphere. To
Aquasearch, this contract dramatically cuts our cost of product development.
We expect our new nutritional supplement products to follow the process
proven by The AstaFactor-TM- - nine to twelve months of product development,
human clinical safety trials, and FDA approval.

We are focused on markets for high-value products that, like those for natural
astaxanthin and our second nutraceutical product, have potential sales of more
than $100 million, and few or no known competitors. At our recently completed
facility, we can directly measure economic feasibility from data gathered during
a six-month production run in our commercial-scale Ultra-AGM.

We are well aware that nutraceutical products, because they are not highly
regulated, have caused concern among some consumers. Our goal is to
self-regulate at a higher standard than required by law. We are implementing a
variety of testing procedures designed to maximize product safety and product
efficacy.

Our marketing approach may determine many aspects of product development. We
would prefer to sell products directly to the consumer. However, if a strategic
partner can contribute significantly to product development or marketing, then
we will consider an alliance that could accelerate or maximize the process.

BASIC STRATEGY: PHARMACEUTICAL DRUG DEVELOPMENT. Our process for expanding the
pipeline in drug development is firmly founded on strategic collaborations and
alliances. We have strongly leveraged our ability to identify, extract, test,
and purify novel bioactive substances from microalgae through our partnership
with University of Hawaii. Additionally, we have enhanced our ability to produce
Microalgae Compound Libraries through our collaboration with Albany Molecular
Research.

We are focused in the next year on developing strategic license agreements with
biopharmaceutical companies. We expect many biopharmaceutical companies will be
interested to access our Compound Libraries for drug discovery. We believe our
management team has well-developed networks and relationships in the
biotechnology industry that bring credibility to our marketing approach.

PRODUCT DEVELOPMENT: MARBEC. MarBEC is a 5-year, $26 million Engineering
Research Center, or ERC, funded in 1998 by the U.S. National Science Foundation.
There are fewer than two dozen ERCs in


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<PAGE>

the U.S. In 1998, more than 160 universities competed for only 5 ERCs awarded
by the National Science Foundation.

MarBEC combines the expertise of world-leading marine science and ocean
engineering programs at the School of Ocean and Earth Sciences and Technology at
University of Hawaii with the nationally-famous chemical engineering program at
the Department of Chemical Engineering at University of California, Berkeley.

           CORE RESEARCH: Discovery and development of new products from
           microalgae

           COST:  Industrial Partnership, $20,000 annually

           BENEFITS TO AQUASEARCH:
              - New research results prior to public disclosure
              - Preferential rights to intellectual property
              - Privilege to sponsor focused research, resulting in exclusive
                intellectual property rights
              - Preferred access to specialized and unique facilities and
                equipment
              - Preferred access to microalgae culture collections
              - Membership on Industrial Advisory Board (current members include
                Aquasearch, Cargill, and Cyanotech)
              - Opportunity to influence specific research
              - Preferential access to student interns

In the first ten years of the ERC program, two dozen centers generated more than
1,000 patents. Industry members in other ERCs have cited the principal benefits
as (1) strategic relationships arising out of the academic/industry network, (2)
access to specialized equipment and facilities, and (3) better educated ERC
graduates.

PRODUCT DEVELOPMENT: UNIVERSITY OF HAWAII. We entered into an agreement in
January 2001 with University of Hawaii that gives Aquasearch exclusive access to
a collection of more than 100 patentable, bioactive compounds from microalgae.
The UH collection has already produced one anti-cancer drug candidate that is
now in clinical trials. Molecules in the UH collection have only been screened
for anti-cancer activity. We believe that some of these molecules will prove
active against other diseases. Key elements of our product development plan
include:

       COMPOUND LIBRARY CREATION AND TESTING
           -  Purification of bioactive molecules from the UH collection
           -  Compound Library creation
           -  Pre-clinical studies

       BENEFITS TO AQUASEARCH:
           -  Five-year license agreement conferring ownership of intellectual
              property to Aquasearch
           -  Increases value of drug candidates

We recognize that pre-clinical screening can be costly. However, we believe it
is a very cost-effective investment. The minimum industry-standard license fee
for one compound alone would substantially repay our anticipated investment.

We have three options for screening and pre-clinical trials. We can do them
ourselves, with a corporate

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<PAGE>

partner, or with a university partner. The cost of facilities, equipment and
expertise dictates that we work with a partner.

TIMING OF PRODUCT RELEASE. Our pipeline expansion is a process designed to yield
many more products at minimal cost. We aim to produce no less than five compound
libraries in the first year of our agreement with University of Hawaii.

GENERAL ASPECTS OF PLANNED OPERATIONS

We expect to increase revenues from sales of AQUAXAN-TM- in 2001. However, we do
not expect this product alone to be profitable, because we intend to reserve
significant production capacity for THE ASTAFACTOR-TM-. Sales of THE
ASTAFACTOR-TM- began on March 30, 2000.

Strategic relationships and collaborations will continue to be an important part
of our business strategy. We now have such relationships with Albany Molecular
Research, University of Hawaii, MarBEC and Cultor. We expect collaborations will
expand to include other corporations and other universities. However, we cannot
be certain to maintain existing partner relationships, nor can we guarantee to
develop other successful relationships.

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

Since inception, our 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, 2000, we had an accumulated deficit of approximately $16.4
million. Our losses to date have resulted primarily from costs incurred in
research and development and from general and administrative expenses associated
with operations. We expect to continue to incur operating losses for at least
the next year as we increase the expansion of our product pipeline. We expect to
have quarter-to-quarter and year-to-year fluctuations in revenues, expenses and
losses, some of which could be significant.

We have a limited operating history. Your assessment of our prospects should
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. We have attempted to address these risks by, among
other things, hiring and retaining highly qualified persons and forging
strategic alliances with companies and universities that complement and leverage
our technical strengths. However, our best efforts cannot guarantee that we will
overcome these risks in a timely manner, if at all.

We are in the process of transition to a full-scale commercial producer of
microalgae products. These changes in our business have placed and will continue
to place significant demands on our management, working capital and financial
and management control systems.

RESULTS OF OPERATIONS

REVENUES. Most of the product we have produced to date has been used for product
development and testing. In July 1999 we began to ship our natural astaxanthin
product, AQUAXAN-TM-. During the years ended October 31, 2000 and 1999, we had
revenues of approximately $158,000 and $52,000, respectively, in connection with
these shipments. We began sales of THE ASTAFACTOR-TM-, our nutraceutical
astaxanthin product, on March 30, 2000 and have recognized approximately $63,000
of initial sales through October 31, 2000. These amounts have been classified as
other income in the accompanying financial statements,


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since they are considered to be incidental to our ongoing research and
development activities.

RESEARCH AND DEVELOPMENT COSTS. Research and development costs include salaries,
development materials, plant and equipment depreciation and costs associated
with operating our three-acre research and development/production facility.
Research and development costs were approximately $2.4 million for the year
ended October 31, 2000 compared with approximately $1.7 million and $1.2 million
for the years ended October 31, 1999 and 1998, respectively. The increases
reflect costs associated with personnel additions, optimizing the very large
Ultra-AGM, expanding production capacity, developing THE ASTAFACTOR-TM- and our
compound drug discovery library. From inception through October 31, 2000,
research and development costs have totaled approximately $7.2 million. We
expect to incur significant additional research and development costs in the
future.

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
consist principally of salaries and fees for professional services. General
and administrative expenses were approximately $1.9 million for the year
ended October 31, 2000 compared with approximately $1.8 million and $1.0
million for the years ended October 31, 1999 and 1998, respectively. The
increase for the year ended October 31, 2000 reflects costs associated with
personnel additions, raising capital, and our initial marketing efforts of
THE ASTAFACTOR-TM- offset by a decrease in legal fees associated with our
ongoing legal dispute with Cyanotech. The increase for the year ended October
31, 1999 reflect additional costs associated with personnel additions, legal
fees incurred in connection with developing and protecting our intellectual
property and raising capital. From inception through October 31, 2000,
general and administrative expenses have totaled approximately $7.4 million.
We anticipate that general and administrative expenses will increase over
time as we expand production capacity, develop more new products, increase
our intellectual property protection, and raise additional capital.

INTEREST EXPENSE. Interest expense for the years ended October 31, 2000, 1999
and 1998 included $381,893, $488,788 and $495,882, respectively, for the
discount resulting from the difference between the conversion price and the fair
value of the common stock underlying the convertible notes issued during those
years. Interest on notes payable were approximately $130,000, $160,000 and
$120,000 for the years ended October 31, 2000, 1999, and 1998, respectively.

LIQUIDITY AND CAPITAL RESOURCES

We have financed our operations until now through public and private sales of
debt and equity securities. During the years ended October 31, 2000, 1999, and
1998, we raised approximately $3.6 million, $4.4 million and $3.3 million,
respectively, of net proceeds from the sale of shares of common stock and/or the
issuance of debt in private placement transactions. From inception through
October 31, 2000, we raised total net proceeds of approximately $15.8 million
through public and private sales of equity and debt securities.

During the year ended October 31, 2000, cash used in operating activities were
approximately $3.3 million compared with $3.2 million and $1.4 million during
the years ended October 31, 1999 and 1998, respectively. From inception through
October 31, 2000, cash used in operating activities have totaled approximately
$11.5 million.

Capital expenditures for the years ended October 31, 2000, 1999, and 1998 were
approximately $254,000, $1.2 million, and $1.8 million, respectively. From
inception through October 31, 2000, capital expenditures have totaled
approximately $4.1 million.

As of October 31, 2000, we had approximately $500,000 in cash.

We estimate a need for approximately $4.0 million in operating capital over the
next twelve months. Projected product sales will begin to pay some operating
costs. In the near term, we believe that existing


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capital resources including the $10 million financing commitment from Alpha
Venture Capital, Inc., funds 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.

We cannot guarantee success in raising the future capital necessary to
sustain or expand our operations, nor are we certain that such capital will
be available on terms that prevent substantial dilution to existing
investors. If we cannot raise sufficient capital, then we might be forced to
significantly curtail operations. Any reduction in operating activity could
have a material adverse effect on our business, financial condition, results
of operations, and relationships with corporate partners.

FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS

RISKS RELATED TO OUR BUSINESS

WE HAVE INCURRED SUBSTANTIAL OPERATING LOSSES AND EXPECT TO INCUR FUTURE LOSSES.
OUR FUTURE FINANCIAL RESULTS ARE UNCERTAIN, AND WE MAY NEVER BECOME A PROFITABLE
COMPANY.

We have had quarterly and annual operating losses since our inception in 1988.
Our net loss in fiscal 2000 was approximately $4.6 million and our accumulated
deficit at October 31, 2000 was approximately $16.4 million. Our losses to date
are primarily due to the costs of research and development, and the general and
administrative costs associated with our operations. Furthermore, we plan to
increase our operating expenses as we continue to expand our product offerings.
As a result, our losses may increase in the future even if we achieve our
revenue goals.

We may be unable to sustain or increase profitability on a quarterly or annual
basis. Many factors could affect our ability to achieve profitability,
including:

        - our ability to successfully manage the transition from a research and
          development company to a commercial-scale production enterprise;

        - our ability to successfully complete the commercialization and cost
          optimization of our products;

        - our ability to manage production costs and yield issues associated
          with increased production of our products;

        - the progress of our research and development programs for developing
          other microalgal products;

        - the time and costs associated with obtaining regulatory approvals for
          our products;

        - our ability to protect our proprietary rights;

        - the costs of filing, protecting and enforcing our patent claims;

        - competing technological and market developments;

        - changes in our pricing policies or the pricing policies of our
          competitors; and

        - the costs of commercializing and marketing our existing and potential
          products.

If our revenues grow more slowly than we anticipate, or if our operating
expenses exceed our expectations and cannot be reduced, our losses could
continue beyond our present expectations and we may never become a profitable
company.

WE MAY BE UNABLE TO RAISE ADDITIONAL CAPITAL OR GENERATE THE CAPITAL NECESSARY
TO SUPPORT OUR PLANNED LEVEL OF RESEARCH AND DEVELOPMENT ACTIVITIES AND
MANUFACTURE AND MARKET OUR PRODUCTS.

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We will require substantial expenditures to support our research and
development activities and to manufacture and market our products. Over the
next twelve months, we project expenditures of $4.0 million in operating
capital, before any planned capital expenditures. Many factors will determine
our future capital requirements, including:

        - our ability to cost-effectively manufacture our products in commercial
          quantities;

        - market acceptance of our products;

        - the extent and progress of our research and development programs;

        - the time and costs of obtaining regulatory clearances for some of our
          products;

        - the progress of pre-clinical and clinical studies, where applicable;

        - the costs of filing, protecting and enforcing patent claims;

        - competing technological and market developments;

        - the cost of developing and/or operating production facilities for our
          existing and potential products; and

        - the costs of commercializing our products.

Product sales have begun to pay some of our operating costs, but we still need
additional funding. We are seeking funds from public or private equity or debt
financing. However, additional financing may not be available on favorable
terms, if at all. If we do not have adequate funds, we may have to curtail
operations significantly. In addition, we may have to enter into unfavorable
agreements that could force us to relinquish certain technology or product
rights, including patent and other intellectual property rights. If we cannot
raise enough capital, then we may have to cut back on production, limit our
product development activities, or delay expansion plans.

WE HAVE LIMITED MANUFACTURING EXPERIENCE, AND IF WE CANNOT OVERCOME THE
CHALLENGES OF PRODUCING MICROALGAE ON A COMMERCIAL SCALE, WE MAY BE UNABLE TO
SATISFY OUR OBLIGATIONS UNDER AGREEMENTS WITH OUR CUSTOMERS.

We have limited experience in manufacturing products derived from microalgae. To
be successful, we must produce products at acceptable costs and ensure that the
quantity and quality of our products comply with contractual requirements,
regulatory requirements and local health, safety and environmental regulations.
Many factors complicate the production of microalgal products and could at any
time limit our monthly production, including:

        - microbial contamination;
        - variability in production cycle times due to technical and biological
          factors; and
        - losses of final product due to inefficient processing.

We currently have sufficient inventory to meet the requirements of our
customers. However, if we cannot increase production of our products, we may be
unable to satisfy our obligations under any future agreements. Our inability to
increase production would limit our revenues, and could cause us to lose
customers that demand more product.

IF WE CHOOSE TO RETAIN SOME OF OUR PRODUCTION CAPACITY OF NATURAL ASTAXANTHIN SO
THAT WE CAN PRODUCE OTHER MICROALGAL PRODUCTS, WE MAY BE UNABLE TO MEET CUSTOMER
DEMAND FOR NATURAL ASTAXANTHIN.

We introduced our first retail nutraceutical product on March 30, 2000. We plan
to retain some of our production capacity of natural astaxanthin in order to
meet anticipated demand for this new product. By limiting the production of
natural astaxanthin for our wholesale customers, we risk being unable to supply
their requirements and we may lose customers. If we fail to establish a market
for our retail product, the


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retention of these wholesale customers would be important to our success in
increasing long-term revenues.

IF THE DEMAND FOR NATURAL ASTAXANTHIN REQUIRES US TO EXPAND OUR CURRENT
PRODUCTION FACILITY, WE MAY EXPERIENCE SIGNIFICANT FINANCIAL, TECHNICAL AND
BIOLOGICAL CHALLENGES.

We believe that we will have to produce natural astaxanthin in ton quantities to
satisfy market demand. In order to meet the anticipated demand for natural
astaxanthin, we will need to expand our production facility. Expanding our
facility will require substantial research and development, additional capital
and significant design and engineering costs.

We currently have only general plans for the size, location and production
capacity of a new or an expanded production facility. We do not have a
commitment to finance the construction of this facility. We plan to rely on a
collaborative arrangement with one or more parties to help us develop and build
a new facility. However, we may be unable to reach an agreement with any other
entity regarding the development, timing, location or financing of a new
facility on favorable terms, if at all. If we fail to either expand our current
production facility or develop a new production facility, then we may lose the
opportunity to increase our revenues. We could also lose wholesale customers,
both current and future, who may rely on increasing product delivery.

OUR CUSTOMER BASE IS CONCENTRATED AMONG SEVERAL CUSTOMERS AND THE LOSS OF ANY OF
THESE CUSTOMERS WOULD MATERIALLY ADVERSELY AFFECT OUR REVENUES.

Our business currently depends on several customers: a European-based
distributor, a U.S. life sciences company, a U.S. nutraceutical company and a
Japanese life sciences company. These companies currently purchase approximately
75% of the natural astaxanthin products we produce. If we lose one or more of
these customers, or if they do not continue buying our products at the current
and anticipated purchase levels, then our revenues could decrease. In addition,
the loss of one or more of these customers may adversely affect our reputation
and we could have difficulty attracting new customers.

IF WE FAIL TO MAINTAIN CURRENT OR FUTURE STRATEGIC RELATIONSHIPS, OUR BUSINESS
WOULD SUFFER.

An important component of our business strategy is to develop strategic
relationships with companies that have established research and development,
sales, marketing and distribution capabilities for the microalgal products that
we intend to develop. For example, we entered into a strategic relationship with
Cultor in 1996 relating to the production and worldwide distribution of our
natural astaxanthin product for animal feed and animal nutrition. In December
1998, we entered into a Compound Library Agreement with EnzyMed to develop
libraries of compounds to be jointly marketed to biotechnology and
pharmaceutical companies to screen the libraries for new drug candidates.

We intend to enter into strategic relationships with other companies to develop
additional applications for our technology, commercialize our future products,
assist us in obtaining regulatory approvals and provide sources of funding. We
cannot guarantee that any of our present or future corporate partners will
perform their obligations to us, or that we will be able to perform our
obligations to them. Additionally, our strategic relationships could be
adversely affected by many additional factors, including:

        - the development of competing technologies or products by a
          strategic partner;
        - the failure of strategic partners to devote sufficient resources to
          developing and commercializing our products;
        - our inability to enter into competitive arrangements;


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        - our failure to obtain timely regulatory approvals; or
        - the premature termination of an agreement with a strategic partner.

We have complex agreements with our consultants and corporate partners that may
give rise to disputes regarding the rights and obligations of the parties. Any
dispute or disagreement could lead to delays in research, development or
commercialization of our products. Disputes could result in litigation or
arbitration, which could be time consuming and expensive. Any dispute could
limit our ability to generate revenue, and could also damage our relationships
with customers and other corporate partners.

We may be unable to maintain or expand our relationships with existing corporate
partners, or to replace existing corporate partners if our relationships with
existing partners terminate. If we are unable to establish appropriate strategic
relationships, we may need to raise additional capital to undertake these
activities at our own expense. If we cannot rely on corporate partners for
strategic assistance in their areas of expertise and instead have to develop our
own expertise in these areas, then we may experience delays in launching,
marketing, selling and distributing new products. Any delay could create
additional costs, and limit our ability to expand our business.

IF WE FAIL TO ATTRACT AND RETAIN KEY PERSONNEL WE WILL BE UNABLE TO EXECUTE OUR
BUSINESS PLAN AND OUR BUSINESS WILL SUFFER.

Our success depends on the continued efforts of the principal members of our
management team, specifically:

        - Mark E. Huntley, Ph.D., our Chairman, President and Chief Executive
          Officer;

        - Earl S. Fusato, our Chief Financial Officer;

        - Michael Cushman, Ph.D., our Vice-President of Research and
          Development, and

        - Martin Guerin, our Vice-President of Sales and Marketing.

We are also highly dependent on our ability to attract and retain key
scientific, technical, management and operating personnel, including consultants
and members of our Scientific Advisory Board. The number of qualified aquatic
microbiologists and bioengineers is limited, so competition for their services
is intense. In order to execute our business plan, we need to develop expertise
and add skilled employees or retain consultants in areas such as research and
development, clinical testing, government approvals, manufacturing and
marketing. We may be unable to attract and retain qualified personnel or develop
the expertise needed in these areas. We currently have a small research and
development and management group with limited operating experience. If we lose
or fail to attract key personnel, we may be unable to execute our business plan.

IF THE MEMBERS OF OUR SCIENTIFIC ADVISORY BOARD ARE UNABLE TO COMMIT SUFFICIENT
TIME TO OUR BUSINESS, WE MAY NOT BE ABLE TO DEVELOP NEW MICROALGAL PRODUCTS.

The members of the Scientific Advisory Board are not our employees and each
member has commitments to other entities that could limit their availability to
us. We depend on members of our Scientific Advisory Board to assist us in
optimizing production and processing methods. We also rely on them to formulate
research and development strategy for both existing and potential microalgal
products. Due to their limited availability, we cannot be sure that they will be
able to commit the time necessary to provide us with the guidance we need, nor
can we be certain that we will be able to retain key Scientific Advisory Board
members.

OUR BUSINESS WILL NOT OPERATE EFFICIENTLY AND OUR RESULTS OF OPERATIONS WILL BE
NEGATIVELY AFFECTED IF WE ARE


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UNABLE TO EFFECTIVELY MANAGE OUR GROWTH.

Until last year, we focused almost exclusively on product research and
technology development. As we began full-scale commercial production of
microalgal products, we have had to create or expand many activities, including
outsourcing, customer relations, engineering, construction, recruiting, and
training. During this transition, we have experienced rapid growth, and we
expect this growth to continue. Over the past year, the number of our employees
has nearly doubled. We expect that number to double again next year to reach a
total of approximately 80 employees. We have had to dramatically improve our
management systems in order to deal with the increase in the number of
employees. In addition, our growth will require significant improvement in our
organization, planning and management and we expect that we will need to expand
our production capabilities. We are in the early stages of designing and
planning an expanded production facility at another location.

We expect significant demands on our financial and management control systems to
increase this year. We believe our systems and controls will address current
needs, but they may be inadequate to address future business expansion. If we
fail to upgrade our financial and management control systems, or if we encounter
difficulties during these upgrades, then we may not be able to effectively
manage our human and financial resources. Such inefficiencies could make it
difficult to retain or attract employees, and could directly or indirectly
create unnecessary expenses.

AS WE EXPAND OUR PRODUCT LINE AND ATTEMPT TO PENETRATE ADDITIONAL MARKETS, WE
MAY FACE SIGNIFICANT CHALLENGES.

We are actively developing three product lines, nutraceuticals, compound
libraries for drug discovery and natural astaxanthin for animal feed. We believe
the success of our nutraceutical product line will depend on our ability to
implement our marketing strategy and comply with the standards of Good
Manufacturing Practice, or GMP. We expect the success of our compound library
products will depend primarily on our ability to attract corporate customers in
the biopharmaceutical industry and, ultimately, on their discovery of new drug
candidates. We believe the prospects for both natural astaxanthin for animal
feed and nutraceutical astaxanthin will depend, in the short term, on product
quality and competitive pricing. Our ability to penetrate new markets for
natural astaxanthin products will, we believe, depend strongly on regulatory
approval in several major markets.

We cannot assure successful development of any existing or potential
microalgae-based product line, nor can we guarantee market acceptance of any of
our products. We have marketing experience in animal feed markets, however, we
do not have experience in nutraceutical or pharmaceutical markets. We have no
experience in electronic marketing or in direct retail sales. We are strongly
dependent on the marketing skills and efforts of our corporate partners,
consultants and contractors. We cannot assure you that our partners, consultants
or contractors will be successful in their marketing efforts, nor can we prevent
them from competing with us or assisting our competitors. If we are unable to
successfully develop or commercialize any of our product lines, then our
revenues will fail to grow.

WE MAY BE UNABLE TO ADEQUATELY PROTECT OR ENFORCE OUR INTELLECTUAL PROPERTY
RIGHTS, AND OUR EFFORTS TO DO SO COULD BE TIME CONSUMING AND EXPENSIVE AND COULD
DIVERT MANAGEMENT ATTENTION FROM EXECUTING OUR BUSINESS STRATEGY.

We regard the protection of our patents, copyrights, trade secrets and know-how
as critical to our success. We rely on a combination of patent, copyright and
trade secret laws and contractual restrictions to protect our proprietary rights
and maintain our competitive position. Our future prospects depend in part on
our


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ability to protect our intellectual property while operating without
infringing the proprietary rights of third parties.

We have been awarded two patents in the United States, two patents by the
European Patent Office, three patents in Australia, and one patent each in Hong
Kong, Norway and South Korea for our closed system microalgae cultivation
process. We have additional patent applications pending in the United States and
internationally. We cannot guarantee that any of our pending patent applications
will result in issued patents. We may be unable to develop any additional
patentable proprietary technologies. We cannot be certain that any patents
issued to us or to our corporate partners will provide a basis for commercially
viable products or provide us with any competitive advantage. Third parties
could challenge our patents, or could obtain patents that have a material
adverse effect on our ability to do business.

The patent positions of pharmaceutical, biopharmaceutical and biotechnology
companies, including ours, are generally uncertain and involve complex legal and
factual questions. Patent law is still evolving in the scope of claims in the
technology area in which we operate. The degree of future protection for our
proprietary rights, therefore, is uncertain. We cannot guarantee that others
will not independently develop similar or alternative technologies. Other
parties may duplicate our technologies, or, if patents are issued to us, they
may design around the patented technologies we developed. Other parties may have
filed or could file patent applications that are similar or identical to some of
ours. These patent applications could have priority over ours. To determine the
priority of inventions, we may have to participate in interference proceedings
declared by the United States Patent and Trademark Office, which could be very
costly. In addition, the laws of some foreign countries may not protect our
patents and other intellectual property rights to the same extent as the laws of
the United States.

We could incur substantial costs in litigation if we need to defend ourselves
against patent infringement claims brought by third parties, or if we choose to
initiate claims. We are currently involved in an intellectual property lawsuit
with Cyanotech, one of our competitors. The lawsuit concerns one of our U.S.
patents as well as trade secrets related to the Aquasearch Growth Module. We
have in the past, and we may in the future, be required to dedicate significant
management time and incur significant legal fees and expenses to continue
pursuit and settlement of this action. In addition, a finding of noninfringement
or declaration of invalidity of our patent could hurt the exclusivity of our
proprietary technology. Present and potential future corporate partners may not
collaborate with us if our intellectual property position is weakened. In
addition, a finding of noninfringement or declaration of invalidity of our
patent could lead to difficulties in obtaining future financing.

We believe there could be significant litigation in our industry regarding
patent and other intellectual property rights. For example, third parties may
bring infringement or other claims against us for using intellectual property
that we internally developed or license from third parties. In addition,
although nondisclosure agreements generally control the disclosure and use of
our proprietary technology, know-how and trade secrets, we cannot guarantee that
all confidentiality agreements will be honored or that our proprietary
technology, know-how and trade secrets will not be disseminated.

Any future claims against third parties or patent prosecutions could be time
consuming, result in costly litigation and divert our technical and management
personnel. We may not prevail in the action, nor can we predict whether third
parties will license necessary intellectual property rights to us on
commercially acceptable terms, if at all. Any of these outcomes could be very
costly and could hurt our ability to develop future products.

IF WE ARE UNABLE TO COMPLY WITH ENVIRONMENTAL LAWS AND REGULATIONS, OUR BUSINESS
MAY BE HARMED.


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We are subject to federal, state and local laws and regulations governing the
use, manufacture, storage, handling and disposal of hazardous materials and
waste products. We currently maintain a supply of several hazardous materials at
our facilities. In the event of an accident, we could be held liable for any
damages that result, and the liability could exceed our resources.

OUR PRODUCTION CAPABILITY IS HIGHLY DEPENDENT ON ENVIRONMENTAL AND CLIMATIC
FACTORS BEYOND OUR CONTROL.

All of our production capacity is now located on property that is situated on a
200-year-old lava flow adjacent to a dormant volcano. Since we maintain minimal
finished goods inventory, any future event that caused a disruption in
production at our facility would significantly impair our ability to meet
customer demand. These events could include fire, volcanic eruption, earthquake,
tidal wave, hurricane, or other natural disaster. In addition, conditions such
as consistent sunlight, high temperatures and the provision of uncontaminated
seawater are necessary for microalgal growth. If we experience any significant
or unusual change in climate or should our water supplies be threatened by
microbial contamination, there could be an adverse impact on our production. If
we cease production for any significant period, the success of our business
would be threatened from a resulting loss of customers, revenues, and valuable
employees.

CURRENCY FLUCTUATIONS AND DIFFERENT STANDARDS, REGULATIONS AND LAWS RELATING TO
INTERNATIONAL OPERATIONS MAY ADVERSELY AFFECT OUR RESULTS OF OPERATIONS.

We expect to sell many of our products on a global scale, because their use is
more highly developed in Europe and Asia than in the United States. We also
expect that our compound libraries will be marketed internationally.
International business is generally more difficult, and can create costs and
delays. For example, tariff regulations, governmental controls and regulations,
political and economic instability or other trade restrictions can all lead to
increased costs of operation and possible loss of revenues.

We currently distribute a substantial amount of our products to companies in
Europe and Japan. Our supply agreements provide for sales in United States
dollars. Fluctuations in currency exchange rates could make our products more
expensive in some countries, resulting in the loss of customers in foreign
markets.

WE MAY BE SUBJECT TO PRODUCT LIABILITY LAWSUITS AND OUR INSURANCE MAY BE
INADEQUATE TO COVER DAMAGES.

Clinical trials or marketing of any of our current or potential products may
expose us to liability claims arising from the use of these products. We cannot
ensure that our current product liability insurance, together with
indemnification rights under our existing license agreements and other
collaborative arrangements, will be adequate to protect us against any claims
and resulting liabilities. As we expand our business, we may be unable to obtain
additional insurance on commercially reasonable terms. We could suffer harm to
our financial condition and our reputation if a product liability claim or
recall exceeds insured amounts.

BECAUSE OUR PRINCIPAL SHAREHOLDERS HAVE SIGNIFICANT CONTROL OF OUR MANAGEMENT
AND AFFAIRS, THESE STOCKHOLDERS MAY BE ABLE TO CONTROL US AND ALSO PREVENT
POTENTIALLY BENEFICIAL ACQUISITIONS OF OUR COMPANY BY OTHERS.

As of October 31, 2000, our directors and executive officers, as a group,
beneficially own approximately 26% of the 105,589,076 outstanding shares of our
common stock. As a result, our officers and directors may be able to strongly
influence the actions of the Board of Directors and other matters requiring
approval of our shareholders. This concentration of ownership could delay or
prevent a change in control and may adversely affect the voting and other rights
of our shareholders. Our principal shareholders may

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have interests that differ from our other shareholders, particularly in the
context of potentially beneficial acquisitions of our company by others. For
example, to the extent that these shareholders are our employees, they may be
less inclined to vote for acquisition of our company by others if that
acquisition would terminate their employment, diminish their
responsibilities, or reduce their compensation.

RISKS RELATED TO OUR INDUSTRY

IF WE FAIL TO COMPETE EFFECTIVELY AGAINST LARGER, MORE ESTABLISHED COMPANIES
WITH GREATER RESOURCES, OUR BUSINESS WOULD SUFFER.

Competition in the market for nutraceutical products is intense. Factors
affecting competition include financial resources, research and development
capabilities, and manufacturing and market experience and resources.

Our nutraceutical astaxanthin product will compete directly with the products of
at least three companies that sell a similar nutraceutical product. Itano of
Japan, currently produces an extract from Antarctic krill that is rich in
astaxanthin. This product is distributed in the United States. The other two
companies have a product that, like ours, is based on HAEMATOCOCCUS PLUVIALIS.
AstaCarotene of Sweden has produced and sold its nutraceutical astaxanthin for
several years, and has established a market in Europe. Cyanotech Corporation,
based in Hawaii, sells a competing nutraceutical astaxanthin product. Each of
these three companies may have technical, financial, management, marketing, and
sales resources and experience that are greater than ours. We expect our
nutraceutical astaxanthin product will compete on the basis of product quality,
price, proprietary position, and marketing strategy. However, if our competitors
develop a proprietary position that inhibits our ability to compete, or if our
marketing strategy is not successful, then our revenues may not increase.

Competition in the world market for animal feed applications of astaxanthin is
strong and is expected to increase significantly in the near future. Our natural
astaxanthin product will compete directly or indirectly with the synthetic
astaxanthin product developed and marketed worldwide by Hoffman-LaRoche.
Additional competition will likely come from BASF, a large German chemical
company that recently started producing synthetic astaxanthin. Likewise,
products incorporating our natural astaxanthin will compete directly with
products incorporating the synthetic astaxanthin product. Both Hoffman-LaRoche
and BASF have a worldwide reputation and significantly greater research and
development, technical, financial, management, marketing and sales resources
than we do. Additionally, Hoffman-LaRoche has a dominant market share.

We anticipate that competition to develop microalgal products other than natural
astaxanthin will be intense. We expect competitors to include major
pharmaceutical, food processing, chemical and specialized biotechnology
companies. Many of these companies will have financial, technical and marketing
resources significantly greater than ours. There are also other emerging marine
biotechnology companies that could form collaborations with large established
companies to support research, development and commercialization of products
that may compete with our current and future products. Also, academic
institutions, governmental agencies and other public and private research
organizations are conducting research activities and seeking patent protection
for microalgal products and may commercialize products that compete with ours on
their own or through joint ventures. In addition, there may be technologies we
are unaware of, or technologies that may be developed in the future, that could
adversely affect our perceived technical and competitive advantage.

INCREASED COMPETITION MAY SIGNIFICANTLY REDUCE THE MARKET PRICE OF SYNTHETIC AND
NATURAL ASTAXANTHIN.


                                    66
<PAGE>

Our natural astaxanthin product competes directly or indirectly with synthetic
astaxanthin products, at least in markets for animal feed applications.
Similarly, products incorporating our natural astaxanthin will compete directly
with products incorporating the synthetic astaxanthin product. A single
producer, Hoffman-LaRoche, Inc., currently dominates the synthetic astaxanthin
market. Hoffman-LaRoche has maintained the market price of its synthetic
astaxanthin, which is derived from petrochemicals, at approximately $2,500 per
kilogram for more than a decade.

We do not know Hoffman-LaRoche's cost of production for synthetic astaxanthin or
how Hoffman-LaRoche will respond 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 we do,
and it holds a commanding market share. We cannot guarantee that the market
price for synthetic astaxanthin will remain at $2,500 after the commercial
introduction of products that incorporate natural astaxanthin. Any significant
decrease in the market price for synthetic astaxanthin will likely have an
adverse effect on the market price for products incorporating our natural
astaxanthin. A substantial decrease in market price could limit or eliminate our
profitability, and could effectively remove us from the market.

IF WE ARE UNABLE TO COMPLY WITH GOVERNMENT REGULATION OF OUR PRODUCTS AND
PRODUCTION ACTIVITIES, WE MAY BE FORCED TO DISCONTINUE PRODUCTION OF CURRENT OR
FUTURE PRODUCTS.

We are subject to federal, state, local and foreign laws and regulations
governing our products and production activities. Each existing or potential
microalgal product that we develop, produce, market or license presents unique
regulatory problems and risks. The problems and risks depend on product type,
its uses, and method of manufacture. For products used in human nutrition,
pharmaceuticals, or cosmetics, we may be required to develop and adhere to Good
Manufacturing Practices as required by the FDA, ISO standards as required in
Europe, and any other applicable standards. We began in early 1999 to develop a
program that will assure compliance with both GMP and ISO standards. Our goal is
to be certified fully compliant within one year. However, we cannot guarantee
that we will meet GMP and ISO qualifications. If we are unable to comply with
these practices and procedures, we may be unable to produce our current or
future products.

We are also subject to other federal, state and foreign laws, regulations and
policies, including those concerning labeling products, importing organisms, and
occupational safety. We have worked with Cultor on compliance with foreign laws,
regulations and policies pertaining to our natural astaxanthin product for use
in animal feed. We have also been working with various consultants on compliance
with FDA regulations regarding our nutraceutical product line. Federal, state
and foreign laws, regulations and policies are always subject to change and
depend heavily on administrative policies and interpretations. Some of these
changes, particularly with respect to the FDA or other regulatory bodies, could
be retroactive. Changes like these could impact our ability to continue
producing current or future products. We cannot guarantee that any of our
potential products will satisfy applicable regulatory requirements.

BECAUSE WE ARE A LIFE SCIENCES COMPANY, THE PRICE OF OUR COMMON STOCK MAY BE
HIGHLY VOLATILE.

The trading price of our common stock has been and is likely to continue to be
highly volatile. We could be subject to wide fluctuations in price in response
to various factors, many of which are beyond our control, including:

        - announcements of technological innovations or new commercial
          products by us or our competitors;
        - developments concerning proprietary rights, including patent, by us
          or our competitors;


                                    67
<PAGE>

        - publicity regarding actual or potential benefits relating to
          products under development by us or our competitors;
        - conditions or trends in the life sciences or nutraceutical market;
        - changes in the market valuations of other biotechnology and life
          sciences companies;
        - general regulatory developments affecting our products in both the
          United States and foreign countries; and
        - developments concerning our collaborations with corporate partners.

In addition, technology companies have experienced extreme price and volume
fluctuations that have often been unrelated or disproportionate to the operating
performance of those companies. There has been particular volatility in the
market prices of securities of life science companies. These broad market and
industry factors may seriously harm the market price of our common stock,
regardless of operating performance.

RISKS RELATED TO THE SECURITIES MARKETS AND OUR COMMON STOCK

OUR COMMON STOCK IS TRADED IN THE OVER-THE-COUNTER MARKET, WHICH MAY MAKE THE
STOCK MORE DIFFICULT TO TRADE ON THE OPEN MARKET.

Our common stock is currently traded in the over-the-counter market on the NASD
Electronic Bulletin Board. Securities on the NASD Electronic Bulletin Board are
generally more difficult to trade than those on the Nasdaq National Market, the
Nasdaq SmallCap Market or the major stock exchanges. Since the initial public
offering of our common stock in January 1989, the average daily trading volume
of our common stock has been relatively low. We cannot ensure that a more active
public trading market will ever develop for our common stock. In addition,
accurate price quotations are difficult to obtain and price volatility is common
for companies whose securities trade on the NASD Electronic Bulletin Board.

SHAREHOLDERS MAY EXPERIENCE SIGNIFICANT DILUTION FROM OUR SALE OF SHARES TO
ALPHA VENTURE CAPITAL, INC. UNDER THE COMMON STOCK PURCHASE AGREEMENT AND
WARRANTS. IN ADDITION, THE RESALE BY ALPHA VENTURE CAPITAL, INC. OF OUR COMMON
STOCK MAY LOWER ITS MARKET PRICE.

On June 14, 2000, we entered into a common stock purchase agreement with Alpha
Venture Capital, Inc. Under this agreement, we have agreed to sell and Alpha
Venture Capital has agreed to purchase up to $10 million of our common stock.
The sale of our common stock to Alpha Venture Capital will have a dilutive
effect on our stockholders. Alpha Venture Capital's resale of our common stock
will also significantly increase the number of publicly traded shares, which
could also lower the market price of our common stock.

THE SALE OF A SUBSTANTIAL NUMBER OF SHARES OF OUR COMMON STOCK BY SHAREHOLDERS
OTHER THAN ALPHA VENTURE CAPITAL, INC. COULD CAUSE THE MARKET PRICE OF OUR
COMMON STOCK TO DECLINE.

As of October 31, 2000, we had 105,589,076 shares of common stock outstanding.
Of these shares 61,415,751 have either been registered under the Securities Act
or are freely tradable without volume limitations under Rule 144(k) of the
Securities Act.

We cannot predict the effect, if any, that sales of shares of our common stock
or the availability of these shares for sale will have on prevailing market
prices. However, if substantial amounts of our common stock were sold in the
public market, then market prices for our common stock could decrease so much
that we may not be able to raise additional capital through the sale of equity
securities.


                                    68
<PAGE>

If we raise additional funds by selling equity securities, the share ownership
of our existing investors could be diluted or the new equity purchasers may
obtain terms that are better than those of our current investors. We expect to
need additional funding for capital expenditures. If we raise additional funds
by selling equity securities, the share ownership of our existing investors
could be diluted. In addition, new equity purchasers may obtain rights,
preferences or privileges that are superior to those of our existing
shareholders.

THE ABILITY OF OUR BOARD OF DIRECTORS TO ISSUE PREFERRED STOCK COULD ADVERSELY
AFFECT THE INTERESTS OF OUR SHAREHOLDERS.

Our Articles of Incorporation authorize the issuance of up to 5,000,000 shares
of "blank check" preferred stock. Our Board of Directors has the power to
determine all designations, rights, preferences, privileges and restrictions of
this preferred stock. In addition, our Board of Directors is not required to
obtain 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 our common stock. The Board of Directors could
issue the preferred stock to discourage, delay or prevent a change in control of
our company, even if a change of control would be beneficial to our
shareholders. We have no present plans to issue any shares of preferred stock,
but those plans could change.


ITEM 7.  FINANCIAL STATEMENTS

Audited balance sheets as of October 31, 2000, 1999, and 1998 and the related
statements of loss and accumulated deficit, cash flows and stockholders' equity
(deficit) for the years ended October 31, 2000, 1999, and 1998 (and from
inception to October 31, 2000) together with related notes and the report of
Ernst & Young LLP, independent auditors, appear on pages F-1 through F-25 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 2000 or 1999.


                                    69
<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 following table sets forth certain information regarding our directors
and executive officers as of October 31, 2000.

<TABLE>
<CAPTION>
------------------------------------------------- ----------------- -----------------------------------------------
NAME                                                    AGE         POSITION
------------------------------------------------- ----------------- -----------------------------------------------
<S>                                                     <C>         <C>
Mark E. Huntley, Ph.D.......................             50         President, Chief Executive Officer
                                                                    and Chairman of the Board

Earl S. Fusato..............................             53         Chief Financial Officer, Secretary and Director

Michael Cushman, Ph.D.......................             52         Vice-President, Research and Development

Martin Guerin...............................             39         Vice-President, Sales and Marketing

David G. Watumull...........................             50         Executive Vice-President, Strategic Development
                                                                    and Corporate Finance

Edward E. David, Ph.D.......................             75         Director

Pearn P. Niiler, Ph.D.......................             62         Director

David Tarnas................................             40         Director

</TABLE>

MARK E. HUNTLEY, PH.D., is one of our co-founders, a co-inventor of the
Aquasearch Growth Module and has served as our President, Chief Executive
Officer and Chairman of the Board since 1992. He also currently holds a
faculty research appointment at the School of Ocean and Earth Sciences,
University of Hawaii at Manoa. Dr. Huntley was a Research Biologist at
Scripps Institution of Oceanography, University of California, San Diego from
1980 to 1998. He has won numerous awards and grants in his field, published
more than 75 articles and a book, and lectured throughout the world. He
served for 10 years on the Executive Committee of the Global Ocean Ecosystem
Dynamics program (1989-1999), 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
Department of State, 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.

EARL S. FUSATO has served as our Chief Financial Officer since 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, 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.


                                      70

<PAGE>

MICHAEL CUSHMAN, PH.D. was appointed our Vice-President, Research and
Development in September 2000. Dr. Cushman leads all product and technology
development initiatives at Aquasearch, including process optimization and
production plant design and expansion. Dr. Cushman was previously with
Eastman Chemical Company since 1982, one of the top ten global suppliers of
custom-manufactured fine chemicals for pharmaceuticals, agricultural
chemicals, and other markets. Dr. Cushman developed more than 20 patents,
yielding multi-million dollar returns for Eastman. At Eastman, Dr. Cushman
led a $31 million program that has revolutionized the commercial production
of Vitamin C. The new biotechnology-based process, heralded last year in a
joint announcement by President Clinton and Eastman Chemical, is economically
superior to current petrochemical methods and is now being readied for
commercialization. Dr. Cushman and the team sought and obtained external
funding for the project from the U.S. Department of Commerce. He then
provided both technical and administrative leadership for a team that
included two universities and five industrial partners. One of the industrial
partners, Genencor (NASDAQ:GCOR), is a Silicon Valley-based biotechnology
company, partly owned by Eastman, that went public earlier this year. Dr.
Cushman received his Ph.D. in analytical chemistry from Duke University in
1982 and has been with Eastman Chemical Company since then. In the late
1980s, Dr. Cushman led a technology development team that significantly
improved the economics of Eastman's Coal Gasification facility.

MARTIN GUERIN became our Vice-President, Sales and Marketing in January 1999.
He has international management experience with world leading groups in feed
production, feed and food ingredients, and aquaculture, with responsibilities
in R&D, marketing and sales, business development and profit center
management. He led the development of Aquastar Ltd. to become the second
largest supplier of shrimp feeds in Thailand, growing in three years to more
than 200 employees and $20 million in sales before being acquired by BP
Nutrition in 1992. As Senior Sales Manager for Champagnes Cereales, France,
he built sales of starch derivatives, sweeteners and other food ingredients
(1992-94). For EWOS, the world's second largest manufacturer of fish feeds,
he devised and implemented business development strategy in the Asia-Pacific
region (1994-96). As Marketing and Development Manager for Finnfeeds
International, a Cultor company, he developed a new business area in
aquaculture feed ingredients (1996-99). Mr. Guerin received his Baccalaureat
from the Ecole Saint-Louis Gonzague in Paris, France in 1981, his M.Sc. in
Agricultural Science from the Institut National Agronomique in Paris in1984,
his M.Sc. in Aquaculture from Auburn University in 1986, and his M.B.A. from
the University of Paris in 1988.

DAVID G. WATUMULL served as our Executive Vice-President, Strategic
Development and Corporate Finance from July 1998 to December 2000. He was
responsible for new business development and corporate capital needs. As a
consultant to us from September 1997 to mid-1998, Mr. Watumull was
instrumental in securing most of the additional $5 million in financing we
raised in that period. He served as Senior Vice-President at First Honolulu
Securities, Inc. ("First Honolulu"), a Honolulu based broker-dealer and
investment banker, and as Chief Investment Officer of First Honolulu's asset
management division, First Honolulu Securities Asset Management, from 1993 to
1997. At First Honolulu, Mr. Watumull was responsible for a $1.3 million
private placement financing secured for us. Mr. Watumull was directly
involved in negotiations that led to agreements with C. Brewer and EnzyMed.
From 1993 to 1997 at First Honolulu, Mr. Watumull was a biotechnology
industry analyst with clients that included the Wisconsin State Investment
Board. Prior to his duties with First Honolulu, Mr. Watumull owned his own
investment management firm specializing in biotechnology. From 1983 to 1992,
he worked as a money manager and retail broker at Paine Webber in Honolulu.
Mr. Watumull majored in Mathematics at Claremont Men's College (now Claremont
McKenna).

EDWARD E. DAVID, PH.D., has served as a director since September 1997. Dr.
David is currently President of EED, Inc., an industrial and governmental
consulting firm, and Vice President, Treasurer, 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

                                      71

<PAGE>

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 1950 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 also serves on the board of directors of the following companies:
Spacehab, Inc., Medjet, Inc. and Protein Polymer Technologies.

PEARN P. NIILER, PH.D., has served as a consultant for us since 1990 and has
served as a director 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.

DAVID TARNAS has served as a director since January 1999. He has devoted his
career to creating and advising on public policy in relation to marine
resources. As elected State Representative for the district of North
Kona-South Kohala, Mr. Tarnas was Chairman of the House Committee on Ocean
Recreation and Marine Resources (1994-98). His knowledge and leadership are
respected throughout the State of Hawaii. Mr. Tarnas has served as a policy
advisor to Malaysia, Thailand, Morocco, the Federated States of Micronesia,
and countries in East Africa, East Asia and the Middle East on matters of
marine resource development. He is currently advising the Government of
Madagascar on the development of a national system of marine protected areas.
In 1998 Mr. Tarnas became Project Development Leader for the Earl and Doris
Bakken Foundation, where he is responsible for developing and leading
projects on community health. Mr. Tarnas received his Diplome, 2eme degre in
Etudes francaises (French Studies) from the University of Strasbourg, France
in 1981, his B.A. in Political Science from Kalamazoo College in 1982, and
earned his M.A. in Marine Affairs at the Institute for Marine Studies,
University of Washington in 1985.

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 our directors or officers.

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

DIRECTOR COMPENSATION

Our directors do not receive cash for services they provide as directors.
From time to time, certain directors who are not our employees have served as
consultants to us 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 our common stock. We do not provide additional compensation for
committee participation or


                                      72

<PAGE>

special assignments of the Board of Directors.


ITEM 10.  EXECUTIVE COMPENSATION

SUMMARY COMPENSATION

The following table sets forth the information, on an accrual basis, with
respect to the compensation of our executive officers for the three fiscal
years ended October 31, 2000.

<TABLE>
<CAPTION>

                                                                                                NO. OF
                                                                                              SECURITIES
                                 YEAR ENDED           SALARY/OTHER                            UNDERLYING
  NAME AND POSITION              OCTOBER 31,          COMPENSATION        STOCK AWARDS         OPTIONS
------------------------         -----------          ------------        ------------        ----------
<S>                              <C>                  <C>                 <C>                 <C>
Mark E. Huntley, Ph.D.,             2000               $  115,000            $  0                  0
President and Chief                 1999               $  115,000            $  0              2,000,000
Executive Officer                   1998               $   67,083(1)         $  0                  0

Earl S. Fusato,                     2000               $  110,000            $  0                  0
Chief Financial Officer             1999               $  110,000            $  0                  0

David G. Watumull,                  2000               $  105,000            $  0                  0
Executive Vice President            1999               $  105,000            $  0                  0
                                    1998               $  115,000(2)         $  0                  0
</TABLE>

(1)        Dr. Huntley during part of 1998 served as a consultant to us while
           continuing his employment as a Research Biologist at Scripps
           Institution of Oceanography, University of California, San Diego.
           Pursuant to the rules and regulations of the Securities and Exchange
           Commission, however, Dr. Huntley's position as our President and
           Chief Executive Officer qualifies him as one of our employees.
           Notwithstanding this, all compensation paid to Dr. Huntley through
           April 1, 1998 has been as though he was an independent consultant to
           us.
(2)        Mr. Watumull became an employee and an officer on July 1, 1998.
           Prior to that date, Mr. Watumull served as a consultant to us.
           The 1998 compensation amount reflects the total compensation paid to
           him during fiscal 1998.  Mr. Watumull resigned from the Company in
           December 2000.

OPTION GRANTS IN FISCAL 2000

No stock options were granted to our executive officers during the fiscal
year ended October 31, 2000.


                                      73

<PAGE>

STOCK OPTIONS EXERCISED DURING FISCAL 2000

<TABLE>
<CAPTION>
                                      SHARES
                                    ACQUIRED ON                                   EXERCISE       DATE
   NAME AND POSITION                  EXERCISE           VALUE REALIZED            PRICE       EXERCISED
-----------------------             ------------         --------------           --------     ---------
<S>                                 <C>                  <C>                      <C>          <C>
Earl S. Fusato,
Chief Financial Officer             1,425,000(1)            $513,000               $0.36        10/23/00
</TABLE>

(1)        Shares were acquired in satisfaction of certain notes payable to
           officer and accrued interest.

FISCAL YEAR-END OPTION VALUES

The following table shows information regarding the value of unexercised options
held by executive officers as of October 31, 2000:

<TABLE>
<CAPTION>

                                         NUMBER OF SECURITIES UNDERLYING                        VALUE OF UNEXERCISED
                                               UNEXERCISED OPTIONS                             IN-THE-MONEY OPTIONS(1)
                                 ------------------------------------------------- ---------------------------------------------
     NAME AND POSITION                 EXERCISABLE             UNEXERCISABLE           EXERCISABLE             UNEXERCISABLE
-------------------------------- ------------------------ ------------------------ ------------------------ --------------------
<S>                                    <C>                     <C>                     <C>                     <C>
Mark E. Huntley, Ph.D.,
President and Chief
Executive Officer                       2,998,590                 666,660                $387,171                   $ 0

Earl S. Fusato,
Chief Financial Officer                 1,000,000                  75,000                   $ 0                      $ 0

David G. Watumull,
Executive Vice President(2)               612,000                 460,000                 $27,540                  $20,700
</TABLE>

(1)        Value of unexercised options is based on the closing bid price of our
           common stock on the Nasdaq Electronic Bulletin Board on October 31,
           2000 ($0.295) minus the exercise price.
(2)        Mr. Watumull resigned from the Company in December 2000.

LTIP AWARDS DURING FISCAL YEAR

We did not make any long term incentive plan awards to any executive officers
or directors during the fiscal year ended October 31, 2000.

EMPLOYMENT CONTRACTS

We do not currently have any employment contracts or change-in-control
arrangements with 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:


                                      74

<PAGE>

           1)   base salary;

           2)   a cash bonus equal to 25% of quarterly salary, payable at the
                end of each quarter, but only if our performance equals or
                exceeds certain cost, revenue and achievement targets jointly
                agreed to by management; and

           3)   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 for nonstatutory stock options and
stock purchase rights to employees and consultants. The 1996 Stock Option
Plan is 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 we are acquired if so determined by the relevant
administrator. The exercise price of options and stock purchase rights
granted under the 1996 Stock Option Plan will be as determined by the
relevant administrator, provided the exercise price of incentive stock
options is at least equal to the fair market value of our 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

We have adopted provisions in our Restated Articles of Incorporation that
eliminate the personal liability of our directors for monetary damages
arising from a breach of their fiduciary duties in certain circumstances, to
the fullest extent permitted by law. These provisions authorize us to
indemnify 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.

Our Restated Articles of Incorporation provide that we shall indemnify our
directors and officers to the fullest extent permitted by Colorado law,
including circumstances in which indemnification is otherwise discretionary
under Colorado law. We have entered into indemnification agreements with our
officers and directors that contain provisions which may be broader than the
specific indemnification provisions contained in the Colorado Corporations
Code. These indemnification agreements require us, among other things, to
indemnify 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. These same
agreements require us 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
any of our directors or officers where indemnification will be required or
permitted. We are 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 provides information known to us about the beneficial
ownership of our common stock as of October 31, 2000 for: (1) each entity or
group that is known by us to beneficially own five percent or more of our
common stock; (2) each of our executive officers; (3) each of our directors;
and (4)


                                      75

<PAGE>

our directors and executive officers as a group. To the best of our
knowledge, each shareholder identified below has voting and investment power
with respect to all shares of common stock shown, unless community property
laws or footnotes to this table are applicable.

<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              7,066,519                 6.5%

Earl S. Fusato(3)
c/o Aquasearch, Inc.
73-4460 Queen Ka'ahumanu Highway, Suite 110
Kailua-Kona, Hawaii 96740......................................        Direct             18,445,959                17.1%

Pearn P. Niiler, Ph.D.(4)
c/o Aquasearch, Inc.
73-4460 Queen Ka'ahumanu Highway, Suite 110
Kailua-Kona, Hawaii 96740......................................        Direct              2,966,402                 2.8%

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                612,000                  *

Martin Guerin(7)
c/o Aquasearch, Inc.
73-4460 Queen Ka'ahumanu Highway, Suite 110
Kailua-Kona, Hawaii 96740......................................        Direct                251,363                  *

David Tarnas(8)
c/o Aquasearch, Inc.
73-4460 Queen Ka'ahumanu Highway, Suite 110
Kailua-Kona, Hawaii 96740......................................        Direct                150,000                  *

All directors and executive officers as a group
    (7 persons)(9).............................................                           29,642,244                25.9%

5% SHAREHOLDERS
---------------------------------------------------------------

Jean Sawyer Weaver Trust, Jean S. Weaver, Trustee (10)
c/o Aquasearch, Inc.
73-4460 Queen Ka'ahumanu Highway, Suite 110
Kailua-Kona, Hawaii 96740......................................        Direct              6,916,223                 6.5%

Gregory F. Kowal (11)
900 Fort  Street, #950
Honolulu, Hawaii 96822.........................................        Direct             12,113,343                11.3%

Lance S. & Elaine Nakamura (12)
c/o Aquasearch, Inc.
73-4460 Queen Ka'ahumanu Highway, Suite 110
Kailua-Kona, Hawaii 96740......................................        Direct              6,208,866                 5.8%
</TABLE>

*          Less than one percent


                                      76

<PAGE>

(1)        Applicable percentage of beneficial ownership is based on 105,589,076
           shares outstanding as of October 31, 2000. Beneficial ownership is
           determined in accordance with rules and regulations of the Securities
           and Exchange Commission. In computing the number of shares
           beneficially owned by a person and the percentage ownership of that
           person, shares of common stock subject to options or warrants held by
           that person that are currently exercisable or exercisable within 60
           days after October 31, 2000 are deemed outstanding, but are not
           deemed outstanding for computing the percentage of any other person.
(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 that are exercisable within 60 days of October 31, 2000.
           Also includes options to purchase 1,383,333 shares at an exercise
           price of $0.50 per share that are exercisable within 60 days of
           October 31, 2000.
(3)        Includes options to purchase 1,000,000 shares of common stock at an
           exercise price of $1.00 per share that are exercisable within 60 days
           of October 31, 2000 and warrants to acquire 1,540,713 shares of
           common stock at $0.50 per share 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 that are exercisable within 60 days of October 31, 2000.
           Also includes options to purchase 940,000 shares at an exercise price
           of $0.50 per share that are exercisable within 60 days of October 31,
           2000.
(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 612,000 shares at an exercise price of
           $0.25 per share that are immediately exercisable. Mr. Watumull
           resigned from the Company in December 2000.
(7)        Includes warrants to acquire 15,000 shares of common stock at $0.50
           per share that are immediately exercisable.  Also includes options to
           purchase 100,000 and 25,425  shares at an exercise price of $0.22 and
           $0.33 per share, respectively, that are exercisable within 60 days of
           October 31, 2000.
(8)        Includes options to purchase 50,000 shares of common stock at an
           exercise price of $0.25 that are immediately exercisable.
(9)        See notes 2-8 above.
(10)       Includes warrants to acquire 1,100,000 shares of common stock at
           $0.50 per share that are immediately exercisable.
(11)       Includes warrants to acquire 650,000 and 1,100,000 shares of common
           stock at $0.50 and $0.40 per share, respectively, that are
           immediately exercisable.
(12)       Includes warrants to acquire 798,000 shares of common stock at $0.50
           per share that are immediately exercisable.


ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

During the period from June 1997 to October 31, 2000, we sold an aggregate of
$8,303,863 principal amount of convertible notes bearing interest at 10% per
annum. The holders of the convertible notes have an option to convert their
convertible notes into our common stock. The convertible notes provide that
upon conversion, the holders would receive warrants to purchase shares of our
common stock. Earl S. Fusato, our Chief Financial Officer, Secretary and a
member of our Board of Directors, participated in the private placement and
purchased $2,030,000 worth of the notes. In addition, Lance S. and Elaine
Nakamura, the beneficial owner of over 5% of our common stock, and Gregory
Kowal purchased $790,000 and $650,000 worth of notes, respectively.

Through October 31, 2000, some of the holders of the convertibles notes
(amounting to $8,213,863 aggregate principal amount) exercised their option
to convert their convertible notes into shares of common stock. Upon
conversion of the outstanding principal and interest on the convertible
notes, we issued 44,429,284 shares of common stock and also issued 8,000,137
warrants in connection thereto. As part of this transaction, Mr. Fusato
converted $2,030,000 aggregate principal amount of convertible notes and
received 13,286,154 shares of common stock and 1,540,713 warrants. In
addition, Lance S. and Elaine Nakamura received 4,863,694 shares and 798,000
warrants upon conversion of their notes. Mr. Kowal received 3,415,008 shares
and 650,000 warrants upon conversion of his notes.

During the two years ended October 31, 2000, Mr. Kowal, the beneficial owner
of over 5% of our common stock purchased 7,333,334 shares of our common stock
at $0.15 per share. In connection with the

                                      77

<PAGE>

purchase, Mr. Kowal received 1,100,000 warrants with an exercise price of
$0.40 per share.

In October 2000, Mr. Fusato exercised options to purchase a total of
1,425,000 shares of common stock at an exercise price of $0.36. The shares
were acquired in satisfaction of certain notes payable to officer and accrued
interest.

In July 1998, we entered into a three year loan agreement with David
Watumull, our Executive Vice-President of Strategic Development and Corporate
Finance. Under the terms of the loan agreement and the related promissory
note, we loaned Mr. Watumull $50,000, plus $3,500 per month for the life of
the loan. The promissory note has an interest rate of nine percent per annum
and is secured by Mr. Watumull's common stock options. Mr. Watumull resigned
from the Company in December 2000. In accordance with the terms of the
promissory note, upon Mr. Watumull's resignation the loan and accrued
interest became due and payable within 30 days.


ITEM 13.  EXHIBITS AND REPORTS ON FORM 8-K

<TABLE>
<CAPTION>

EXHIBITS
<S>               <C>
  3.1*            Articles of Incorporation
  3.2+            Articles of Amendment to Articles of Incorporation dated October 4, 1996
  3.3***          Articles of Amendment to Articles of Incorporation filed March 30, 2000
  3.4*            By-laws
  4.1+            Form of 1996 Bridge Loan Note
  4.2+            Form of 1997 Warrant
  4.3++           Form of Convertible Note
  4.4++           Form of Warrant
  4.5++           Form of Note and Warrant Purchase Agreement
  10.1#           Distribution and Development Agreement between Cultor, Ltd. and Aquasearch, Inc. dated May 14, 1996
  10.2#           Stock Subscription Agreement between Cultor, Ltd. and Aquasearch, Inc. dated May 14, 1996
  10.3+           The Amended Keahole Point  Facilities Use Agreement dated August 22, 1996 by and between The Natural Energy
                  Laboratory of Hawaii Authority and Aquasearch, Inc.
  10.4$           Letter of Intent between C. Brewer and Company Limited and Aquasearch, Inc.
  10.5##          Amendment to Distribution and Development Agreement between Cultor, Ltd. and Aquasearch, Inc. dated June 14, 1999
  10.6$$          Common Stock Purchase Agreement (including Form of Warrant) between Alpha Venture Capital, Inc. and Aquasearch,
                  Inc. dated June 14, 2000
  10.7$$          Registration Rights Agreement between Alpha Venture Capital, Inc. and Aquasearch, Inc. dated June 14, 2000
</TABLE>

*          Incorporated by reference to the exhibit filed with our Annual Report
           on Form 10-KSB for the fiscal year ended October 31, 1995.
#          Incorporated by reference to the exhibit filed with our Current
           Report on Form 8-K filed September 13, 1996.
+          Incorporated by reference to the exhibit filed with our Annual Report
           on Form 10-KSB for the fiscal year ended October 31, 1996.


                                      78

<PAGE>

++         Incorporated by reference to the exhibit filed with Amendment No. 1
           to our Registration Statement on Form SB-2 filed October 28, 1998.
$          Incorporated by reference to our Current Report on Form 8-K dated
           November 13, 1996.
$$         Incorporated by reference to the exhibit filed with our Registration
           Statement on Form SB-2 filed July 13, 2000.
##         Incorporated by reference to the exhibit filed with Amendment No. 1
           to our Registration Statement on Form SB-2 filed November 9, 1999.
***        Incorporated by reference to the exhibit filed with Post-Effective
           Amendment No. 1 to our Registration Statement on Form SB-2 filed
           April 28, 2000.


                                      79

<PAGE>

REPORTS ON FORM 8-K

No reports were filed during the last quarter of the year ended October 31,
2000.


                                  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 February 2,
2001, on its behalf by the undersigned, thereunto duly authorized.

                                           AQUASEARCH, INC.


                                           By  /s/ Mark E. Huntley
                                               ---------------------------------
                                               Mark E. Huntley, Ph.D.
                                               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.

<TABLE>
<CAPTION>

                  Signature                                      Date
<S>                                                        <C>
/s/ Mark E. Huntley                                        February 2, 2001
------------------------------------------
Mark E. Huntley, Ph.D.
Director, President, CEO & Chairman of
the Board of Directors

/s/ Pearn P. Niiler                                        February 2, 2001
------------------------------------------
Pearn P. Niiler, Ph.D.
Director

/s/ Earl S. Fusato                                         February 2, 2001
------------------------------------------
Earl S. Fusato
Director, Chief Financial Officer

/s/ Edward E. David                                        February 2, 2001
------------------------------------------
Edward E. David, Ph.D.
Director


/s/ David Tarnas                                           February 2, 2001
------------------------------------------
David Tarnas
Director
</TABLE>


                                      80
<PAGE>

                              FINANCIAL STATEMENTS

                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)


                                    Contents


Report of Independent Auditors...........................................F-2

Audited Financial Statements:

Balance Sheets as of October 31, 2000, 1999 and 1998.....................F-3

Statements of Loss and Accumulated Deficit from Inception to
  October 31, 2000 and for the Years Ended October 31, 2000,
  1999 and 1998.........................................................F-4

Statements of Cash Flows from Inception to October 31, 2000
   and for the Years Ended October 31, 2000, 1999 and 1998...............F-5

Statements of Stockholders' Equity (Deficit) from Inception to
   October 31, 2000......................................................F-6

Notes to Financial Statements...........................................F-11

                                    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, 2000, 1999 and 1998, 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, 2000. 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.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. 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 provide a reasonable basis for our opinion.

In our opinion, 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, 2000, 1999 and 1998, and the
results of its operations and its cash flows for the years then ended and the
period from inception to October 31, 2000, in conformity with accounting
principles generally accepted in the United States.

As discussed in Note 1 to the financial statements, the Company's recurring
losses from operations and working capital deficit at October 31, 2000 raise
substantial doubt about its ability to continue as a going concern. The October
31, 2000 financial statements do not include any adjustments that might result
from the outcome of this uncertainty.
                                            /s/ Ernst & Young LLP

Honolulu, Hawaii
February 2, 2001

                                    F-2
<PAGE>




                                  AQUASEARCH, INC.
                          (A DEVELOPMENT STAGE ENTERPRISE)

                                  BALANCE SHEETS
<TABLE>
<CAPTION>

                                                                                          October 31
                                                              -------------------------------------------------------------------
                                                                       2000                  1999                  1998
                                                              -------------------------------------------------------------------
<S>                                                             <C>                   <C>                   <C>
Assets
Current assets:
   Cash                                                         $          509,492    $           90,522    $          151,473
   Accounts receivable                                                      12,356                24,300                     -
   Prepaid expenses                                                          6,212                11,507                48,703
   Refundable deposits                                                       8,724                 3,053                 3,081
                                                              -------------------------------------------------------------------
Total current assets                                                       536,784               129,382               203,257

Note receivable from officer, net (NOTE 5)                                  50,000                50,000                50,000
Plant and equipment:
   Plant                                                                 3,015,319             2,795,258             2,519,044
   Equipment                                                             1,093,952             1,060,348               167,203
   Less accumulated depreciation                                          (662,002)             (413,244)             (201,292)
                                                              -------------------------------------------------------------------
Net plant and equipment                                                  3,447,269             3,442,362             2,484,955
                                                              -------------------------------------------------------------------
Total assets                                                    $        4,034,053    $        3,621,744    $        2,738,212
                                                              ===================================================================

Liabilities and stockholders' equity
Current liabilities:
   Accounts payable                                             $        1,171,965    $          894,995    $          968,429
   Due to officer                                                          297,000               241,800               131,400
   Short-term advances (NOTE 2)                                            500,000                     -                     -
   Notes payable (NOTE 4)                                                  710,000               170,000               300,000
   Notes payable to officer (NOTE 4)                                       757,419             1,830,000               265,000
                                                              -------------------------------------------------------------------
Total current liabilities                                                3,436,384             3,136,795             1,664,829

Stockholders' equity:
   Preferred stock (5,000,000 shares authorized) (NOTE 1)                        -                     -                     -
   Common stock ($0.0001 par value, 150,000,000 shares
     authorized, 105,589,076, 87,060,501 and 68,564,013
     shares issued and outstanding at October 31, 2000,
     1999 and 1998, respectively)                                          11,679                 9,829                 7,979
   Additional paid-in capital                                           16,970,990            12,262,839             8,784,120
   Notes receivable (NOTE 3)                                               (29,179)              (58,133)              (59,696)
   Deficit accumulated during the development stage                    (16,355,821)          (11,729,586)           (7,659,020)
                                                              -------------------------------------------------------------------
Total stockholders' equity                                                 597,669               484,949             1,073,383
                                                              -------------------------------------------------------------------
Total liabilities and stockholders' equity                      $        4,034,053    $        3,621,744    $        2,738,212
                                                              ===================================================================
</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,
                                                   2000                  2000                 1999                  1998
                                          ----------------------------------------------------------------------------------------
 Operations
<S>                                         <C>                   <C>                   <C>                  <C>
 Sales                                      $           11,077    $                -    $                -   $                -
 Cost of sales                                          23,464                     -                     -                    -
                                          ----------------------------------------------------------------------------------------
 Gross loss from operations                            (12,387)                    -                     -                    -
 Research and development costs                      7,223,649             2,440,631             1,695,448            1,166,766
 General and administrative expenses                 7,359,595             1,917,600             1,772,627              964,120
                                          ----------------------------------------------------------------------------------------
 Loss from operations                              (14,595,631)           (4,358,231)           (3,468,075)          (2,130,886)

 Other income (expense)
 Interest (NOTE 4)                                  (1,866,447)             (492,232)             (653,172)            (617,037)
 Other                                                 267,855               224,228                50,681                 (352)
 Investment in joint venture                          (147,096)                    -                     -                    -
                                          ----------------------------------------------------------------------------------------
 Total other income (expense)                       (1,745,688)             (268,004)             (602,491)            (617,389)
                                          ----------------------------------------------------------------------------------------
 Loss before extraordinary item
                                                   (16,341,319)           (4,626,235)           (4,070,566)          (2,748,275)
 Extraordinary item - loss on write down
    of assets to liquidation basis                     (14,502)                    -                     -                    -
                                          ----------------------------------------------------------------------------------------
 Net loss                                   $      (16,355,821)   $       (4,626,235)   $       (4,070,566)  $       (2,748,275)
                                          ========================================================================================

 Net loss per share                         $           (0.40)    $           (0.05)    $           (0.05)   $           (0.05)
                                          ========================================================================================
 Weighted average shares outstanding                41,043,855           100,662,175            76,375,752           52,697,095
</TABLE>
SEE ACCOMPANYING NOTES.

                                    F-4

<PAGE>



                                  AQUASEARCH, INC.
                          (A DEVELOPMENT STAGE ENTERPRISE)

                              STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>

                                                        From inception to              For the years ended October 31,
                                                           October 31,      -------------------------------------------------------
                                                               2000                2000                  1999                  1998
                                                -----------------------------------------------------------------------------------
<S>                                               <C>                   <C>                  <C>                   <C>
Cash flows used in operating activities:
Net loss                                          $      (16,355,821)   $    (4,626,235)   $       (4,070,566)   $    (2,748,275)
Adjustments to reconcile net loss to net cash
used in operating activities:
     Depreciation                                            662,002            248,758               241,881              96,398
     Allowance on note receivable from officer                98,000             42,000                42,000              14,000
     Expenses paid with common stock                       1,222,460            267,321                41,981             157,839
     Discount on convertible notes payable                 1,465,387            381,893               488,788             495,882
     Changes in:
        Other current assets                                 (14,936)              (376)               37,224             (22,775)
        Receivables                                          (12,356)            11,944               (24,300)              1,219
        Accounts payable                                   1,171,966            276,971               (73,434)            552,085
        Due to officer                                       297,000             55,200               110,400              86,400
                                                -----------------------------------------------------------------------------------
Cash used in operating activities                        (11,466,298)        (3,342,524)           (3,206,026)         (1,367,227)

Cash flows used in investing activities:
Purchases of fixed assets                                 (4,109,271)          (253,665)           (1,199,288)         (1,774,306)
                                                -----------------------------------------------------------------------------------
Cash used in investing activities                         (4,109,271)          (253,665)           (1,199,288)         (1,774,306)

Cash flows from financing activities:
Decrease (increase) in notes receivable                     (117,483)           (13,046)              (40,437)            (64,000)
Proceeds from issuance of common stock                     6,076,033            634,575               750,000             500,000
Proceeds from short-term advances                            500,000            500,000                     -                   -
Proceeds from notes payable                               10,198,863          3,194,063             3,634,800           2,810,000
Repayment of notes payable                                  (105,285)          (105,285)
Offering costs                                              (467,067)          (195,148)                    -                   -
                                                -----------------------------------------------------------------------------------
Cash provided by financing activities                     16,085,061          4,015,159             4,344,363           3,246,000
                                                -----------------------------------------------------------------------------------

Net increase (decrease) in cash                              509,492            418,970               (60,951)            104,467
Cash, beginning of the period                                      -             90,522               151,473              47,006
                                                 ----------------------------------------------------------------------------------
Cash, end of the period                           $          509,492    $       509,492    $           90,522    $        151,473
                                                 ==================================================================================

Supplemental non-cash information:
      Conversion of convertible notes payable to
        common stock                              $       8,213,863    $      3,209,063    $        2,199,800    $      2,805,000
      Reduction in notes payable to officer
        and related interest for exercise of
        stock options                                       513,000             513,000                     -                   -
</TABLE>
SEE ACCOMPANYING NOTES.


                                    F-5
<PAGE>

                                  AQUASEARCH, INC.
                          (A DEVELOPMENT STAGE ENTERPRISE)

                    STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

                         FROM INCEPTION TO OCTOBER 31, 2000

<TABLE>
<CAPTION>
                                                                                  Common Stock
                                          -----------------------------------------------------------------------------------------

                                                                                                                         Total
                                                                          Additional                                  Stockholders'
                                           Number of                       Paid-in         Notes      Accumulated       Equity
                                            Shares              Amount     Capital       Receivable     Deficit        (Deficit)
                                          -----------------------------------------------------------------------------------------
<S>                                       <C>              <C>         <C>             <C>           <C>         <C>
Issue of stock                             20,000,000      $    2,000  $    72,730     $          -  $         - $      74,730
Loss from inception to October 31, 1988             -              -            -                 -      (101,984)    (101,984)
                                          -----------------------------------------------------------------------------------------

Balance, October 31, 1988                  20,000,000           2,000       72,730                -      (101,984)     (27,254)
Sale of stock and A Warrants ($0.05 per     4,000,000             400      166,291                -             -       166,691
    unit)
Shares reacquired at no cost              (11,198,838)              -            -                -             -             -
Exercise of A warrants ($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 ($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)
                                          -----------------------------------------------------------------------------------------

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
</TABLE>

SEE ACCOMPANYING NOTES.

                                    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         Notes      Accumulated       Equity
                                            Shares              Amount     Capital        Receivable    Deficit        (Deficit)
                                          -----------------------------------------------------------------------------------------
<S>                                        <C>             <C>         <C>             <C>           <C>          <C>
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    861,900              87       69,315                -             -        69,402
    ($0.08 per share)
Loss for the year ended October 31, 1993            -               -            -                -      (142,198)     (142,198)
                                          -----------------------------------------------------------------------------------------

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)
                                          -----------------------------------------------------------------------------------------

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
    ($0.0625 to $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
</TABLE>
SEE ACCOMPANYING NOTES.

                                    F-7

<PAGE>


<TABLE>
<CAPTION>
                                                                                Common Stock
                                          -----------------------------------------------------------------------------------------

                                                                                                                         Total
                                                                          Additional                                  Stockholders'
                                           Number of Shares                Paid-in         Notes      Accumulated       Equity
                                                                Amount     Capital        Receivable    Deficit        (Deficit)
                                          -----------------------------------------------------------------------------------------
<S>                                        <C>             <C>         <C>             <C>           <C>          <C>
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)
                                          -----------------------------------------------------------------------------------------

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
    ($0.0625 per share) (NOTE 3)              488,250              49       30,467          (30,516)            -            -
Penalty shares
    ($0.2116 per share) (NOTE 2)            1,303,435             130      275,677                -             -      275,807
Discount on convertible notes payable               -               -       98,824                -             -       98,824
Loss for the year ended October 31, 1997            -               -            -                -    (1,962,027)  (1,962,027)
                                          -----------------------------------------------------------------------------------------

Balance, October 31, 1997                  47,819,881           5,904    4,798,294          (30,516)   (4,910,745)    (137,063)
Sale of stock
   ($0.156 per share)                       3,205,128             321      499,679                -             -      500,000
Issuance of stock on conversion of
   convertible notes payable
   ($0.16 to $0.19 per share)              16,870,520           1,687    2,915,274                -             -    2,916,961
</TABLE>
SEE ACCOMPANYING NOTES.

                                    F-8

<PAGE>

<TABLE>
<CAPTION>
                                                                                Common Stock
                                       --------------------------------------------------------------------------------------------

                                                                                                                         Total
                                                                          Additional                                  Stockholders'
                                         Number of Shares                  Paid-in         Notes      Accumulated        Equity
                                                                 Amount    Capital        Receivable    Deficit        (Deficit)
                                        -------------------------------------------------------------------------------------------
<S>                                        <C>             <C>         <C>             <C>           <C>          <C>
Stock issued for services ($0.22 to
   $0.25 per share)                           201,622      $       20  $    45,858     $          -  $         -  $       45,878
Exercise of options for stock
   ($0.0625 per share)
   (NOTE 3)                                   466,862              47       29,133          (29,180)            -              -
Discount on convertible notes payable
   (NOTE 4)                                         -               -      495,882                -             -        495,882
Loss for the year ended October 31,
   1998                                             -               -            -                -    (2,748,275)    (2,748,275)
                                        -------------------------------------------------------------------------------------------

Balance, October 31, 1998                  68,564,013           7,979    8,784,120          (59,696)   (7,659,020)    1,073,383
Issuance of stock on conversion of
   convertible notes payable ($0.14
   to $0.26 per share)                     13,496,488           1,350    2,240,431                -             -     2,241,781
Sale of stock
   ($0.15 per share)                        5,000,000             500      749,500                -             -       750,000
Payment on notes receivable issued
   upon exercise of common stock
   options                                          -               -            -            1,563             -         1,563
Discount on convertible notes payable
   (NOTE 4)                                         -               -      488,788                -             -       488,788
Loss for the year ended October 31,
   1999                                             -               -            -                -    (4,070,566)   (4,070,566)
                                        ===========================================================================================
Balance, October 31, 1999                  87,060,501   $       9,829  $12,262,839     $    (58,133) $(11,729,586)  $   484,949
Issuance of stock on conversion of
   convertible notes payable ($0.13
   to $1.26 per share)                     14,062,275           1,403    3,149,291                -             -     3,150,694
</TABLE>
SEE ACCOMPANYING NOTES.

                                    F-9

<PAGE>

<TABLE>
<CAPTION>
                                                                                   Common Stock
                                       --------------------------------------------------------------------------------------------

                                                                                                                          Total
                                                                          Additional                                  Stockholders'
                                           Number of Shares                Paid-in         Notes      Accumulated         Equity
                                                                 Amount    Capital        Receivable    Deficit         (Deficit)
                                        -------------------------------------------------------------------------------------------
<S>                                        <C>             <C>          <C>               <C>        <C>            <C>
Sales, grants, and issuance of stock
   upon exercise of stock options
   ($0.15 to $0.58 per share)               3,939,300             394      913,520                -             -       913,914
Issuance of stock upon exercise of
   warrants ($0.50 per share)                 527,000              53      263,447                -             -       263,500
Payment on notes receivable issued
   upon exercise of common stock
   options                                          -               -            -           28,954             -        28,954
Discount on convertible notes payable
   (NOTE 4)                                         -               -      381,893                -             -       381,893
Loss for the year ended October 31,
   2000                                             -               -                  -          -    (4,626,235)  (4,626,235)
                                        -------------------------------------------------------------------------------------------

Balance, October 31, 2000                 105,589,076      $   11,679   $     16,970,990  $ (29,179) $(16,355,821)  $   597,669
                                        ===========================================================================================
</TABLE>
SEE ACCOMPANYING NOTES.

                                    F-10
<PAGE>

                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                          NOTES TO FINANCIAL STATEMENTS

                        OCTOBER 31, 2000, 1999, AND 1998

1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

Aquasearch, Inc., 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 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. Many of
these are known to contain valuable substances 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.

In June 1999, the Company completed the expansion of its research and
development facility to include a three-acre production and processing plant.
Aquasearch's first commercial product is astaxanthin, a naturally occurring red
pigment derived from a freshwater microalgae.

The Company has devoted most of its efforts since inception to research and
development, and accordingly, is considered to be in the development stage. For
the years ended October 31, 2000, 1999, and 1998, sales of astaxanthin were
approximately $220,000, $52,000, and 0, respectively, and are included in other
income in the accompanying financial statements.

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 $16
million. At October 31, 2000, the Company had a working capital deficit of
approximately $3 million. During the year ended October 31, 2000, the Company
sold additional shares of stock through the issuance of convertible notes and
received other debt financing which were sufficient to fund its immediate
operating financial needs.

                                       F-11

<PAGE>

1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

BASIS OF PRESENTATION (CONTINUED)

The Company currently projects that it will require approximately $4 million in
operating capital in fiscal 2001, before any planned capital expenditures. The
Company is presently pursuing additional sources of capital in order to finance
its operations in fiscal 2001. These capital sources include equity and debt
financing, license agreements, and government contracts and grants.

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 successfully produce microalgae on a commercial
scale, the inability to protect or enforce its intellectual property rights, or
the loss of any existing or 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.

PLANT AND EQUIPMENT

Plant and equipment are stated at cost. Depreciation is provided on the
straight-line method over the estimated useful lives of the assets.

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, 2000.

STOCK ISSUED FOR SERVICES

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

                                       F-12

<PAGE>

1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

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.

NET LOSS PER SHARE

Net loss per share was based on the weighted average common shares outstanding
during the period. Common shares issuable upon exercise of outstanding warrants,
options and convertible notes payable have not been included in the computation
of net 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,
accounts receivable, notes receivable, accounts payable 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.

RECLASSIFICATION

Certain prior year amounts have been reclassified to conform with the 2000
presentation.

2. COMMON STOCK AND COMMON STOCK WARRANTS

On June 14, 2000, the Company entered into a common stock purchase agreement
with Alpha Venture Capital, Inc., a Cook Islands corporation, under which the
Company agreed to sell and Alpha Venture Capital agreed to purchase up to $10
million of the Company's common stock. The agreement requires the Company to
reserve a total of 20 million shares of common stock for issuance pursuant to
the purchase agreement. The Company filed a registration statement on July 13,
2000 with the SEC covering the resale of the common stock purchased by Alpha
Venture Capital. The agreement expires 18 months after the initial draw or
the date at which an aggregate of $10 million of common stock has been sold
to Alpha Venture Capital.

The minimum amount of each draw under the equity line is $100,000. The maximum
amount that can be drawn is the lesser of 200% of the average trading volume of
the 20 consecutive trading days ending on the day before the closing date of the
draw or $1 million. The share purchase price for each draw is equal to

                                       F-13

<PAGE>

2. COMMON STOCK AND COMMON STOCK WARRANTS (CONTINUED)

80% of the lowest closing bid price during any of the five business days
immediately following the draw notification to Alpha Venture Capital.

In connection with the agreement, the Company is to issue warrants to Alpha
Venture Capital for the purchase of 150,000 shares of common stock at $0.48
per share and warrants to purchase 1,350,000 shares of common stock at $0.54
per share. In addition, the Company agreed to issue warrants to purchase up
to a maximum of 950,000 shares of common stock on a pro rata basis in
conjunction with each draw, exercisable at the closing bid price at the date
of each draw. The warrants have a term of five years.

A commitment fee, in the amount of 5% of the draws on the first $5 million and
3% of the draws on the remaining $5 million, will be paid to Alpha Venture
Capital.

The Company is under no obligation to use the equity line. No draws have been
made on the equity line as of October 31, 2000.

During October 2000, the Company received a total of $500,000 of short-term
advances from Alpha Venture Capital. The advances are unsecured, bear no
interest, and will be repaid from the initial draw under the equity line.

In January 2001, the Company entered into an agreement to modify certain terms
of the common stock purchase agreement with Alpha Venture Capital. Subject to
the meeting of certain conditions including the consummation of an initial draw
under the equity line of $560,000 and the delivery of the warrants to purchase
1,500,000 shares of the Company's common stock, the common stock purchase
agreement will be amended to remove the exclusivity and penalty provisions,
release shares presently reserved for future issuance under the equity line, and
adjust the purchase price calculation of future draws.

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
warrant ("B" warrant) for $0.12 per share. Each "B" warrant entitled the holder
to purchase one additional share of common stock for $1.00. The offering netted
$166,691 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 $395,539. All remaining
"A" warrants have been canceled. The 3,348,000 "B" warrants expired on September
15, 1996.

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 had a term
of three years and were exercisable at $1.00 per share, subject to adjustment.
The Warrants have expired as of October 31, 2000. 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).

                                       F-14

<PAGE>

2. COMMON STOCK AND COMMON STOCK WARRANTS (CONTINUED)

In October 1997, the Company issued 1,303,435 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 and the related expense of $275,807 was reflected in general and
administrative expenses for the year ended October 31, 1997.

Shares of common stock issuable upon exercise of outstanding warrants, options
and convertible notes payable as of October 31, 2000 are as follows:

<TABLE>

       <S>                                                                               <C>
       Stock options granted to current and former directors, executive officers,
         employees and consultants (NOTE 3)                                               14,092,418
       Warrants outstanding:
          @ $0.375                                                                            45,000
          @ $0.40                                                                          1,100,000
          @ $0.50                                                                          6,778,425
          @ $0.75                                                                            568,086
          @ $1.00                                                                            489,249
          @ $1.50                                                                            154,599
          @ $2.00                                                                             79,491
       Shares issuable upon conversion of outstanding convertible notes
          payable                                                                            181,338
       Warrants (@ $0.75) issuable upon conversion of outstanding convertible
         notes payable                                                                        90,000
                                                                                          ----------
                                                                                          23,578,606
                                                                                          ==========
</TABLE>

3. COMMON STOCK OPTIONS

In August 1995, the Company granted nonstatutory stock options, exercisable
immediately, to five individuals to purchase a total of 150,000 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 four individuals to purchase a total
of 5,627,462 shares at an exercise price of $0.0625 per share. The Company also
granted stock options to three individuals which became exercisable in July 1996
to purchase a total of 180,000 shares at an exercise price of $0.62 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. Terms of awards under the plan including vesting
requirements, exercise prices and expiration dates are determined at the
discretion of the Board of Directors. The plan terminates in March 2006.

                                       F-15

<PAGE>

3. COMMON STOCK OPTIONS (CONTINUED)

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.

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,
who subsequently became an officer, 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 in 2002 through 2004 or upon the achievement of certain agreed on
milestones, if earlier. 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.

In November 1998, the Company granted nonstatutory stock options to 15 employees
for a total of 663,716 shares of the Company's common stock at an exercise price
of $0.20 per share. The options vest over a period of five years and have a term
of ten years.

                                       F-16

<PAGE>

3. COMMON STOCK OPTIONS (CONTINUED)

During the year ended October 31, 1999, the Company granted nonstatutory
stock options to an officer and director for a total of 3,200,000 shares of
the Company's common stock at an exercise price of $0.50 per share. The
options vest over periods of three and five years and have a term of seven
years. In addition, the Company granted nonstatutory stock options to an
officer and employee for a total of 350,000 shares of the Company's common
stock at exercise prices of $0.22 and $0.28 per share. The options vest over
a period of five years and have a term of nine years.

In January 1999, the Company granted a nonstatutory stock option to a member of
its Board of Directors for 50,000 shares of the Company's common stock at an
exercise price of $0.25 per share. The option vested immediately and has a term
of seven years.

In November 1999, the Company granted nonstatutory stock options to 18 employees
for a total of 779,772 shares of the Company's common stock at an exercise price
of $0.33 per share. The options vest over a period of five years and have a term
of ten years.

In October 2000, the Company granted a nonstatutory stock option to one of its
officers for 500,000 shares of the Company's common stock at an exercise price
of $0.34 per share. The option vests over a period of five years and has a term
of ten years.

In October 2000, an officer/director of the Company exercised options for a
total of 1,425,000 shares of common stock at an exercise price of $0.36. The
shares were acquired in satisfaction of certain notes payable to officer and
accrued interest.

During the year ended October 31, 2000, the Company granted nonstatutory stock
options to four employees and two non-employees for a total of 575,000 shares of
the Company's common stock with exercise prices ranging from $0.25 to $0.83 per
share. The options vest over three to five years and have a term of seven 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.

Stock options issued to non-employees for services were at exercise prices at or
above market at the dates of grant and the Company believes the fair value of
these options were not material to the financial statements.

                                       F-17

<PAGE>

3. COMMON STOCK OPTIONS (CONTINUED)

Pro forma information regarding net loss and net loss 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 Statement 123. 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:

<TABLE>
<CAPTION>
                                           2000         1999        1998
                                        ---------     --------   ---------
    <S>                                 <C>          <C>         <C>
    Risk-free interest rate                    6%          6%          6%
    Expected dividend yield                    0%          0%          0%
    Expected life                         5 years     5 years     5 years
    Expected volatility                      0.98        0.47        0.58
</TABLE>

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 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 effect of applying
Statement 123 on pro forma net loss for the years ended October 31, 2000, 1999,
and 1998 are not likely to be representative of the effects for future years
since the 2000, 1999, and 1998 pro forma net loss amounts reflect expense for
only one year of vesting. The Company's pro forma information follows:

<TABLE>
<CAPTION>
                                      2000          1999          1998
                                  -----------   -----------   -----------
<S>                               <C>           <C>           <C>
    Net loss:
       As reported                $ 4,626,235   $ 4,070,566   $ 2,748,275
       Pro forma                  $ 4,929,396   $ 4,217,830   $ 2,855,215
    Loss per share:
       As reported                $      0.05   $      0.05   $     0.05
       Pro forma                  $      0.05   $      0.06   $     0.05
</TABLE>

                                       F-18

<PAGE>

3. COMMON STOCK OPTIONS (CONTINUED)

A summary of the Company's stock option activity, and related information for
the years ended October 31, 2000, 1999, and 1998 follows:

<TABLE>
<CAPTION>

                                                   2000                           1999                         1998
                                       ------------------------------  ---------------------------  --------------------------
                                                         Wtd-Avg Ex                    Wtd-Avg Ex                   Wtd-Avg Ex
                                           Options         Price           Options       Price          Options       Price
                                       ---------------  -------------  --------------  -----------  --------------  ----------
<S>                                    <C>              <C>            <C>             <C>          <C>             <C>
Outstanding, beginning of year          13,776,238      $   0.32         9,883,751     $   0.27     9,970,263       $  0.26
Granted                                  1,904,772          0.43         4,213,716         0.43       460,350          0.25
Exercised                               (1,457,342)         0.36                 -            -      (466,862)         0.06
Forfeited                                 (131,250)         0.52          (321,229)        0.24       (80,000)         0.25
                                       ------------                    -----------                  ----------
Outstanding, end of year                14,092,418      $   0.33        13,776,238     $   0.32     9,883,751       $  0.27
                                       ============                    ===========                  ==========
Exercisable, end of year                10,199,435      $   0.31         9,849,858     $   0.31     7,313,000       $  0.22
</TABLE>

Common stock options of 466,862 exercised during the year ended October 31, 1998
were in exchange for a three-year note receivable bearing interest at 5 percent
per annum. The note balance of $29,179 at October 31, 2000 is presented in
stockholders' equity.

Weighted-average exercise prices and fair values of options issued during the
years ended October 31, 2000, 1999, and 1998 with exercise prices which equaled
or exceeded the market prices of the Company's stock on the grant date follows:

<TABLE>
<CAPTION>

                                         2000                                 1999                                  1998
                           ---------------------------------  -----------------------------------  --------------------------------
                                           Weighted-Ave.                        Weighted-Ave.                      Weighted-Ave.
                                       ---------------------               ----------------------               -------------------
                                           Ex.       Fair                      Ex.         Fair                    Ex.      Fair
                             Options      Price      Value      Options       Price        Value     Options      Price     Value
                           ----------  ----------  ---------  -----------  ------------  --------  -----------  ---------  --------
<S>                        <C>         <C>         <C>        <C>          <C>           <C>         <C>          <C>        <C>
Options whose exercise
  price equaled the
  market price of the
  stock on the grant date   1,829,772    $  0.43   $  0.32        250,000    $  0.28      $ 0.25             -    $    -     $   -
Options whose exercise
  price exceeded the
  market price of the
  stock on the grant date      75,000       0.25      0.09      3,963,716       0.44        0.05       460,350      0.25      0.12
                            ---------                           ---------                              -------
Options issued during
  the year                  1,904,772                           4,213,716                              460,350
                            =========                           =========                              =======
</TABLE>

                                       F-19

<PAGE>

3. COMMON STOCK OPTIONS (CONTINUED)

The following summarizes information about the Company's stock options
outstanding at October 31, 2000:

<TABLE>
<CAPTION>

                                            Options Outstanding                              Options Exercisable
                               ------------------------------------------------         ------------------------------
                                                 Wtd-Ave
                                                Remaining             Wtd-Ave                                Wtd-Ave
 Range of Exercise                             Contractual           Excercise                              Exercise
      Prices                     Number            Life                Price               Number             Price
------------------             ----------    ---------------       ------------         ------------       -----------
<S>                            <C>           <C>                   <C>                  <C>                <C>
 $0.06 to $0.22                 5,334,478        2.5 years           $   0.08             5,024,201         $   0.07
 $0.25 to $0.40                 3,572,940           6.9                  0.29             1,438,015             0.26
 $0.50 to $1.00                 5,185,000           5.6                  0.62             3,737,219             0.64
                               ----------                                                ----------
                               14,092,418                                                10,199,435
                               ==========                                                ==========
</TABLE>

4. NOTES PAYABLE

Notes payable consisted of the following as of October 31:

<TABLE>
<CAPTION>
                                                                      2000           1999          1998
                                                                   ----------    ------------    ----------
<S>                                                                <C>           <C>             <C>
      One-year convertible notes, unsecured, bearing interest at
        10% per annum payable at the earlier of conversion or
        maturity                                                   $   90,000     $   130,000     $ 300,000

      60 day short-term bridge financing note, unsecured,
        bearing interest at 10% per annum                                   -          40,000             -

      90 day short-term bridge financing notes, unsecured,
        bearing interest at 10% per annum                             370,000               -             -

      One-year promissory note, unsecured, bearing interest at
        10% per annum                                                 250,000               -             -
                                                                   ----------     -----------     ---------
      Total notes payable                                          $  710,000     $   170,000     $ 300,000
                                                                   ==========     ===========     =========
      One-year convertible notes payable to an officer of the
        Company, unsecured, bearing interest at 10% per annum
        payable at the earlier ofconversion or maturity            $        -     $ 1,005,000     $ 265,000

</TABLE>

                                       F-20
<PAGE>

4. NOTES PAYABLE (CONTINUED)
<TABLE>
<CAPTION>
<S>                                                             <C>                    <C>                    <C>
      Six-month note payable to an officer of the Company,
        unsecured, bearing interest at 10% per annum                     100,000                      -                      -

      One-year notes payable to an officer of the Company,
        unsecured, bearing interest at 10% per annum                     657,419                825,000                      -
                                                              ---------------------- ---------------------  ---------------------
      Total notes payable to officer                            $        757,419       $      1,830,000       $        265,000
                                                              ====================== =====================  =====================
</TABLE>

Interest expense incurred on the above notes totaled approximately $130,000,
$160,000, and $120,000 for the years ended October 31, 2000, 1999, and 1998,
respectively. Since inception, interest incurred has been settled through the
issuance of common stock.

During the period from June 1997 to October 31, 2000, the Company issued a total
of approximately $8.3 million in principal amount of convertible notes to
"accredited investors" in private placements. The principal and any accrued
interest are convertible for a period of six months from the date of the note
into shares of the Company's common stock at a 15% discount to the market price
of the stock on the issuance date of the note. The convertible notes also
provide for the holders to receive warrants to purchase shares of common stock
ranging from $0.375 to $2.00 per share in a total amount equal to the dollar
amount of the note upon conversion or 40% of the dollar amount of the note if
not converted. The warrants have a term of three years.

The following summarizes convertible notes payable transactions during the three
years ended October 31, 2000:

<TABLE>
<CAPTION>
                                                                                                    Upon Conversion
                                                                      Principal        --------------------------------------------
                                                                   Amount of Notes       Number of Shares          Number of
                                                                                              Issued               Warrants
                                                                ---------------------- --------------------- ----------------------
<S>                                                               <C>                          <C>                    <C>
    Balance at October 31, 1997                                   $        200,000
    Convertible notes sold                                               2,145,000
    Notes converted                                                     (2,045,000)            12,049,180             2,045,000
                                                                ----------------------
    Balance at October 31, 1998                                            300,000
    Convertible notes sold                                               1,764,800
    Notes converted                                                     (1,934,800)            11,859,290             1,934,800
                                                                ----------------------
    Balance at October 31, 1999                                            130,000
    Convertible notes sold                                               2,164,063
    Notes converted                                                     (2,204,063)             7,234,660             2,593,337
                                                                ----------------------
    Balance at October 31, 2000                                   $         90,000
                                                                ======================
</TABLE>

                                   F-21

<PAGE>

4. NOTES PAYABLE (CONTINUED)

The following summarizes convertible notes payable to officer transactions
during the three years ended October 31, 2000:
<TABLE>
<CAPTION>
                                                                                                    Upon Conversion
                                                                      Principal         --------------------------------------------
                                                                   Amount of Notes        Number of Shares          Number of
                                                                                               Issued               Warrants
                                                                 ---------------------  --------------------- ----------------------
<S>                                                                <C>                           <C>                     <C>
     Balance at October 31, 1997                                   $         360,000
     Convertible notes sold                                                  665,000
     Notes converted                                                        (760,000)            4,821,340               760,000
                                                                 ---------------------
     Balance at October 31, 1998                                             265,000
     Convertible notes sold                                                1,005,000
     Notes converted                                                        (265,000)            1,637,198               265,000
                                                                 ---------------------
     Balance at October 31, 1999                                           1,005,000
     Convertible notes sold                                                        -
     Notes converted                                                      (1,005,000)            6,827,616               402,000
                                                                 ---------------------
     Balance at October 31, 2000                                   $               -
                                                                 =====================

</TABLE>

Interest expense for the years ended October 31, 2000, 1999, and 1998 includes
approximately $380,000, $490,000 and $500,000, respectively, of discount on
convertible notes payable resulting from the difference between the conversion
price and the fair value of the common stock underlying the convertible notes on
their respective issuance dates.

5. 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).

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 plus $3,500 per month for the life of the loan. The loan has an interest
rate of 9% per annum and a term of three years. The loan is secured by the
officer's common stock options. The officer resigned from the Company in
December 2000. In accordance with the

                                   F-22
<PAGE>

5. RELATED PARTY TRANSACTIONS (CONTINUED)

terms of the promissory note, upon the officer's resignation the loan and
accrued interest became due and payable within 30 days.

Due to officer represents unpaid compensation owed to the Company's chief
financial officer.

6. INCOME TAXES

Since its formation the Company has incurred net operating losses. As of October
31, 2000, the Company had a net operating loss carryforward available to offset
future taxable income for federal and state income tax purposes of approximately
$13.5 million. The net operating loss carryforward for tax reporting purposes
expires in the years from 2001 to 2020. The Company also has a research credit
carryover approximating $300,000 which expires between the years 2003 and 2020.

Deferred income taxes are the result of provisions of the tax laws that either
require or permit certain items of income or expense to be reported for tax
purposes in different periods than they are reported for financial reporting
purposes. The primary component of the Company's deferred income taxes relate to
its net operating loss carryforward of approximately $13.5 million.

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.

7. 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.

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:

                                   F-23
<PAGE>

8. CORRECTION OF ACCOUNTING FOR REISSUANCE OF STOCK PREVIOUSLY CANCELED
   (CONTINUED)

<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>

9. DISPUTE WITH CYANOTECH

On July 13, 1998, Cyanotech filed a complaint against the Company in the United
States District Court for the District of Hawaii (Case No. CV98-00600ACK). In
the complaint, Cyanotech sought declaratory judgment of non-infringement of the
Company's U.S. Letters Patent No. 5,541,056; 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 the Company's trade secrets.

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 the parties' 1994 Dissolution Agreement.

On December 14, 1998, Cyanotech filed a motion for partial summary judgment of
non-infringement and invalidity of the 5,541,056 Patent.

On March 1, 1999, the Company filed a motion for partial summary judgment
against Cyanotech for breach of contract and misappropriation of trade secrets.
On March 26, 1999, the Company filed a cross-motion for summary judgment of
patent infringement. All motions for summary judgment were heard in November
1999.

On December 30, 1999, the United States District Court for the District of
Hawaii granted summary judgment on the Company's motion that Cyanotech infringed
the Company's patent, misappropriated the Company's trade secrets and breached
the terms of the parties' 1994 Dissolution Agreement. In its order, the Court
found that the tube process used by Cyanotech for cultivating microalgae
infringed the 5,541,056 Patent. The Court further found that Cyanotech violated
the Uniform Trade Secrets Act and breached the 1994 Dissolution Agreement when
it misappropriated trade secrets relating to the Company's proprietary
closed-system technology for cultivation of microalgae.

                                   F-24

<PAGE>

9. DISPUTE WITH CYANOTECH (CONTINUED)

In addition, the Court denied Cyanotech's motion for partial summary judgment of
non-infringement and invalidity of the Company's patent. In doing so, the Court
upheld the validity of the 5,541,056 Patent.

On January 14, 2000, Cyanotech filed a motion for reconsideration on the Court's
December 30, 1999 order. The Company filed its opposition to the motion for
reconsideration on February 1, 2000.

On March 3, 2000, the Court denied Cyanotech's motion for reconsideration.

On May 25, 2000, the Court granted the Company's motion to compel Cyanotech to
produce documents related to its BioDome system, financial information relating
to its astaxanthin production, and communications with third parties concerning
the lawsuit. In its order, the Court determined that the information sought on
the BioDome could be relevant in the litigation and could potentially bear on
the remedies or the extent of the patent infringement and trade secret
misappropriations by Cyanotech.

On August 29, 2000, Cyanotech filed a motion for partial summary judgment of
invalidity of the 5,541,056 Patent.

On December 4, 2000, the Court denied Cyanotech's motion for partial summary
judgment.

The Company has not accrued or reflected any amounts related to the dispute
in the accompanying financial statements. Legal costs are expensed as
incurred.

10. COMMITMENTS

In January 2001, the Company entered into a research and license agreement with
a major university to access, manufacture, use and sell products from a
microalgal collection. Under terms of the research agreement, the university is
to receive approximately $550,000 over the initial two-year term for maintenance
and research work on the collection. The license agreement provides for
royalties to be paid to the university on income from commercialization of
products developed from the collection.



                                   F-25