<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, 1999                                   NUMBER 33-23460-LA


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

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


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

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

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

         Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]

         Check if there is no disclosure of delinquent filers pursuant to Item
405 of Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [ X ]

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

         The aggregate market value of the voting stock held by non-affiliates
computed by reference to the price at which the stock was sold, or the average
bid and asked prices of such stock, as of December 31, 1999, was $26,988,755.

         The number of shares outstanding of each of issuer's classes of common
equity, as of October 31, 1999, was 87,060,501 shares of Common Stock, $0.0001
par value.

         Documents Incorporated by Reference:  None

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


                                        1
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                                     PART I

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

ITEM 1.  DESCRIPTION OF BUSINESS

OVERVIEW

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


                                       2
<PAGE>

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. 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, 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 is insignificant competition from
companies or institutions exploring microalgae as a drug-discovery source. In
the nutraceutical market, we may face some significant potential competition for
our first product, astaxanthin-rich microalgae, but we know of no competition
for the second product we plan to launch in 2000. 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. In the first six months of 1999 we were issued five new
patents related to our core technology, the AGM. 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 (FDA) or similar agencies in foreign
countries, and may require extensive testing for safety and efficacy before
being released for sale.


                                       3
<PAGE>

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 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 or 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 10 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 10 times faster than any other plant.


                                       4
<PAGE>

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 about
98%; that is, only about 2% of the "new" bioactive substances discovered in
bacteria and fungi turn out to be new after all.

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           $3 to $15 million         2
      bioactivity 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.


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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 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.


                                      6
<PAGE>

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 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


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<PAGE>

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:

         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.


                                      8
<PAGE>

                  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.

         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


                                      9
<PAGE>

                  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
                  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).

                                      10
<PAGE>

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 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. We now employ only six persons who are exclusively
involved with production. Our productivity per employee has increased more than
ten-fold in the past year. We attribute this increase in productivity largely to
the use of process control.

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


                                      11
<PAGE>

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.

         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]


                                      12
<PAGE>


                                  [GRAPHIC]

                                  [GRAPHIC]

All of these molecules are antioxidants, but astaxanthin has by far the
strongest antioxidant activity. Some studies indicate that it is 10 times
more potent than beta-carotene, and at least 100 times more potent than
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


                                      13
<PAGE>

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
(A), as represented here:


                                  [GRAPHIC]

                                  [GRAPHIC]

                                  [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.


                                      14
<PAGE>

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 NUTRACEUTICAL ASTAXANTHIN 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 plan to launch our
nutraceutical product in the first quarter of 2000. Based on our available
production capacity, we believe that we can be profitable within one year as
a result of sales of this product, provided that we meet our marketing goals.
However, we cannot ensure that our marketing campaign will occur in the way
we have planned or that it will be successful. For more information about our
nutraceutical astaxanthin product, please see "Management's Plan of
Operation -- (1) Nutraceutical Astaxanthin."

THE AQUAXAN-TM- MARKET. We began selling astaxanthin-rich microalgae meal
under the trade name AQUAXAN-TM- to a European company in July 1999 and to a
Japanese company in September 1999. Through October 1999 these sales,
amounting to $52,000, have been included in other income in the Company's
financial statements. 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
2000. 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

                                      15

<PAGE>

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 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-


                                       16
<PAGE>

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. We are currently
creating our first Microalgae Compound Library, in conjunction with EnzyMed, for
the purpose of drug discovery via licensing to the biopharmaceutical industry.
We project our compound library will be available to the market in early 2000.
We are also negotiating drug discovery agreements with research groups at four
different 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."


                                       17
<PAGE>

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. If we are able to obtain a one percent share of the
              estimated market for nutraceutical astaxanthin, we believe that we
              may be profitable within one year of our initial sales of this
              product.

         2)   BUILD A MARKET IN DRUG DISCOVERY. We intend to offer access to
              unique Microalgae Compound Libraries beginning in early 2000. We
              plan to cultivate and screen new microalgae through our
              collaborations with MarBEC and several medical schools. Proven
              bioactive substances will be developed into Compound Libraries
              through our collaboration with EnzyMed. 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 quality, which we intend to leverage to build
              market share. During the past year, we hired Cultor's leading
              manager for development of the astaxanthin market, Martin Guerin,
              as 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 believe that
              the combination of our microalgae cultivation technology and
              expertise with Cultor's animal feed and animal nutrition research
              and development capabilities and worldwide sales, marketing and
              distribution network provides us with an important competitive
              advantage. We plan to independently develop and/or collaborate
              with Cultor and other corporate partners with respect to the
              development of 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 our partnership
              in MarBEC will lead to 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, EnzyMed and Cultor - that have greater
              research and development,


                                       18
<PAGE>

              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 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 the past year we increased astaxanthin
                  content by 50% (from 2% to


                                       19
<PAGE>

                  3%), and tripled HAEMATOCOCCUS productivity. This 4.5X
                  increase in production was due entirely to optimizing
                  growing conditions through research. We believe more
                  optimization is possible. We have recently achieved 6%
                  astaxanthin content in the laboratory, which alone would
                  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 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. The consumers of
              nutraceutical astaxanthin are individuals. The 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


                                       20
<PAGE>

              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 two more years, 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 strong pent-up 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 plan a product launch in early 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.

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 expect our first Microalgae Compound Library to be available in early 2000.
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


                                      21
<PAGE>

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 creates scores of compounds, many of
which may be new to medical science. EnzyMed has demonstrated capability in
Combinatorial Biocatalysis. EnzyMed'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 EnzyMed 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.

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.


                                      22
<PAGE>

                  -   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 significant modifications:

                  -   TRADEMARK. The AQUAXAN-TM- brand name, with
                      registration approved or pending in 16 countries, is
                      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 agrees to
                      purchase a certain minimum amount of AQUAXAN-TM-
                      through June 2000.

                  -   EXCLUSIVITY. We are 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. We expect sales through Cultor to begin shortly.


                                      23
<PAGE>

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 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 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 Monsanto, Cargill, Inc. 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.

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.


                                      24
<PAGE>

HARVESTING FROM THE WILD. We are aware of one company, Cell Tech of Oregon, that
harvests natural "blooms" of microalgae. A "bloom" is an unusually high
concentration of microalgae, generally dominated by a single species, that
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 two companies in the world - Biotechna of Australia 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.

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. In June 1999
Cyanotech announced an agreement with Norsk-Hydro, the world's largest salmon
producer. Under the agreement, the parties would form a joint venture
majority-owned by Norsk-Hydro if Cyanotech completes certain activities to
optimize production. 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 serious 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-


                                      25
<PAGE>

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-.

NUTRACEUTICAL ASTAXANTHIN

Many of the potential competitors for nutraceutical astaxanthin 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 genetically-modified yeast product may
not be as readily accepted as our natural astaxanthin product by consumers of
nutraceuticals.

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 95% of 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.

                                   26

<PAGE>

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. 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 nine 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.).

Five of these patents were issued in the first six months of 1999 alone. 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. Our patents could be
challenged by third parties. 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

                                     27

<PAGE>

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 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

                                  28

<PAGE>

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. However, we have initiated a plan aimed at becoming
GMP-compliant in 2000, and ISO-compliant shortly thereafter. 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. Any
nutraceutical product we develop will be viewed as a human dietary
supplement. The FDA will require pre-market clearance for both of these
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. Itano and Cyanotech are already selling
an astaxanthin-rich dietary supplement in the United States, but we cannot
assume this precedent will assure the approval of our own nutraceutical
astaxanthin product. As of the date of this report, neither we nor any of our
corporate partners have applied for FDA clearance for any of our products. We
cannot ensure that any of our potential products will be cleared by the FDA
on a timely basis, if at all.

AQUAXAN-TM- and 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 our
nutraceutical astaxanthin product 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

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<PAGE>

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, 1999, we had 26 full-time employees, of whom six have
Ph.D.s. Twelve are involved in the production and harvesting process, eight
are involved in research and development and six 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. JOHN DORE received his B.Sc. in Bioengineering from University of
California, Berkeley in 1987, and earned his Ph.D. in Biological Oceanography
from the University of Hawaii in 1995. Dr. Dore conducts research in many
areas of microbiology, and has been a significant contributor to various
aspects of process engineering at our company since 1996. Dr. Dore conducted
his Ph.D. research on the microbially-mediated chemical processes of nitrogen
cycling. As a Post-Doctoral Researcher at the University of Hawaii, Dr. Dore
studied growth and carbon isotope chemistry of microalgae in continuous
cultures (1995-96). As a graduate student, he received fellowships from the
Research Corporation of the University of Hawaii (1991-1992) and Achievement
Rewards for College Scientists (1989-1990). Dr. Dore has published at least
20 scientific articles.

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 leads the research effort on
protozoans, and has been a leading contributor to quality control and
production practices since joining us in 1999. Her research career has
focused on the role of microalgae in the nutrition of numerous species of
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

                                      30
<PAGE>

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 has been 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.

DR. MIA UNSON received her B.S. in Biology from Ateneo de Manila University,
Philippines in 1986, her B.S. in Chemistry from Ateneo de Manila University,
Philippines in 1987, and earned her Ph.D. in Marine Chemistry from University
of California, San Diego in 1993. Dr. Unson joined our company in 1999, where
she leads programs in natural product chemistry and drug discovery. She is
also responsible for directing collaborative projects with chemists and
medical researchers in academia. Her accomplishments include development of
genomic screens, and fractionation, purification and characterization of a
variety of novel compounds from mycobacteria and numerous marine organisms,
including cyanobacteria. As a research scientist in the Department of
Chemistry and Biochemistry at 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.

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

                                   31

<PAGE>

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 Advisory
Council. Three of his books, HARVEST OF THE SEA, AQUACULTURE (now in its 25th
printing) and SUSTAINABLE AQUACULTURE (published in 1997), establish him as
one of the fathers of modern aquaculture.

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

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

DR. 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

                                      32

<PAGE>

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 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.

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.

                                      33

<PAGE>

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;
                  -        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 sea water 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.

                                     34

<PAGE>

We have started the application process for 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. Leases of 30 years
have historically been awarded to companies once they have completed their
research and development stage, which we have completed. The
government-administered process to award a thirty-year lease has usually
taken less than two years. More than half of the 800-acre HOST Business Park
facility is currently undeveloped. We believe that, 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.

On November 14, 1996, we executed a Letter of Intent with C. Brewer to
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. C.
Brewer agreed to accept between 2,570,000 and 2,850,000 shares of our common
stock at a purchase price of $0.35 per share and acquire a three-year warrant
to purchase up to 500,000 shares of common stock at a purchase price of $1.25
per share. We have not consummated the transaction with C. Brewer. We decided
we do not yet need 80 to 90 acres of land, because production at our current
facility has increased beyond expectation.

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 seeks declaratory judgment of non-infringement of our
U.S. Letters Patent No. 5,541,056 (the "5,541,056 Patent"); 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 our 1994 Dissolution Agreement with Cyanotech.

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 judgement 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 our 1994
Dissolution Agreement with Cyanotech. 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. The Company's opposition brief is due on
February 1, 2000.

                                    35
<PAGE>

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 in an
appeal of the Court's ruling, a finding of noninfringement 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.

                                   36

<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 as reported by M.H. Myerson & Company, one of
the Company's market makers. These quotations are believed to represent
inter-dealer quotations without adjustment for retail mark-up, mark-down or
commissions, and may not represent actual transactions.

<TABLE>
<CAPTION>
                                                              HIGH BID        LOW BID
<S>                                                           <C>             <C>
FISCAL 1997
    First Quarter...........................................   $0.63           $0.33
    Second Quarter..........................................   $0.39           $0.20
    Third Quarter...........................................   $0.53           $0.28
    Fourth Quarter..........................................   $0.36           $0.19

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

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
</TABLE>

As of the date of October 31, 1999, the Company had approximately 2,000
record holders of its 87,060,501 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. As of October
31, 1999, we had an accumulated deficit of approximately $11.7 million, and
until this deficit is eliminated we can pay dividends only out of net profits.

RECENT SALES OF UNREGISTERED SECURITIES

During the period from June 1997 to October 31, 1999, we sold an aggregate of
$6,139,800 aggregate 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

                                    37

<PAGE>

provide that upon conversion, the holders would receive warrants to purchase
shares of our common stock. The warrants have an exercise price of $0.50 per
share and a term of three years. As part of this transaction, an
officer/director purchased $2,030,000 of convertible notes.

As of October 31, 1999, some of the holders of the convertibles notes
(amounting to $5,004,800 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 30,367,008 shares of common stock and also issued 5,004,800
warrants in connection thereto. As part of this transaction, an
officer/director converted $1,025,000 aggregate principal amount of
convertible notes and received 6,458,538 shares of common stock and 1,025,000
warrants.

These transactions were exempt from registration under the Securities Act of
1933 pursuant to Section 4(2). No underwriters were involved in these
transactions.

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

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

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

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

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

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

In April 1997, the Company sold 1,000,000 shares of its Common Stock to an
officer of the Company at a purchase price of $0.21 per share. In addition,
the Company granted this person a non-statutory stock option to purchase
1,000,000 shares of Common Stock at an exercise price of $1.00 per share. The

                                     38

<PAGE>

option has a term of ten years. These transactions were exempt from
registration under the Securities Act of 1933 pursuant to Section 4(2). No
underwriters were involved in these transactions.

During the period from October 1996 to April 1997, the Company sold an
aggregate of 5,044,570 Units, consisting of one share of Common Stock and one
Common Stock Purchase Warrant (the "Warrants"), to 42 accredited investors
(the "Unit Investors") in a private placement (the "Unit Offering") under
Section 4(2) of the Securities Act of 1933, as amended. The purchase price of
the Units ranged from $0.21 per Unit to $0.44 per Unit. The Warrants have a
term of three years and are exercisable at $1.00 per share, subject to
adjustment. The Warrants are redeemable by the Company at $0.01 per Warrant
during their three-year exercise period upon 30 days' notice anytime that the
closing bid price per share of the Common Stock exceeds $1.50 per share
(subject to adjustment) for 20 trading days out of 30 consecutive trading
days ending on the third day prior to the date of the notice of redemption.
The gross proceeds from the Unit Offering were $1,275,980. The Placement
Agent for the Unit Offering, First Honolulu Securities, Inc., received total
commissions of $76,558.80 (equal to 6% of the gross proceeds from the sale of
the Units) and 302,674 Common Stock Purchase Warrants (equal to 6% of the
number of Units sold). The terms of the Warrants issued to First Honolulu
Securities, Inc. are identical to the terms of the Warrants issued to the
Unit Investors in the Unit Offering.

In October 1997, the Company issued 1,303,435 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 (the
"Commission") on or before May 29, 1997. The registration statement was
declared effective on November 12, 1997. These have been reflected in the
shares issued and outstanding as of October 31, 1997.

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

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

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

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

                                   39

<PAGE>

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

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

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

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

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

In September 1995, the Company sold 2,712,500 shares of Common Stock at $0.08
per share to 16 accredited investors in a private placement under Section
4(2) of the Securities Act. No underwriters were used.

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

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

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

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

ITEM 6.  MANAGEMENT'S PLAN OF OPERATION

                                      40
<PAGE>

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

OVERVIEW

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.

Our key achievements in the past year include major advances in our platform
technology, the AGM. In the past 12 months, we have:

                  -        created the new "Ultra-AGM," which has six-fold
                           greater capacity than the previous AGM model - an
                           increase from 1,060 to 6,600 gallons;

                  -        tripled the capacity-per-unit-cost of the AGM;

                  -        tripled the productivity-per-unit-capacity of
                           HAEMATOCOCCUS - our astaxanthin-rich microalgae; and

                  -        doubled the astaxanthin content of HAEMATOCOCCUS -
                           from 1.5% to 3.0%.

                                       41

<PAGE>

During the same time period, we have:

                  -        tripled the size of our production facility;

                  -        tripled our patents - from three to nine;

                  -        tripled our total production capacity;

                  -        initiated sales of our products;

                  -        expanded our product pipeline to include
                           nutraceuticals and pharmaceuticals;

                  -        strengthened our management team in areas of
                           strategic development and marketing; and

                  -        augmented our research team in natural products
                           chemistry and drug development.

In the past year we focused primarily on technology and infrastructure. This
year we are focused on marketing, sales, and further expanding our product
pipeline.

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.

                                           42

<PAGE>


         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 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.

                                           43

<PAGE>

         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.

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

                                           44

<PAGE>

                  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

                  -        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

                                         45

<PAGE>

                  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
                  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

                                            46

<PAGE>

                  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 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.

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,

                                     47

<PAGE>

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 demonstration.

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

<TABLE>
<CAPTION>

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

                IMPROVEMENT                           PLANNED IN 1998                   ACHIEVED IN 1999

--------------------------------------------------------------------------------------------------------------------
      <S>                                           <C>                          <C>
             Increase AGM size                              6X                           Greater than 6X

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

       Increase AGM production cycle                      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 patents relating to:


                                       48
<PAGE>

         -        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.).

Five of these patents were issued in the first five months of 1999 alone.
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:

<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 5X by
increasing our finishing pond capacity. Relative to AGMs, finishing ponds are
less costly to construct.

(4)  SALES

In 1998 we projected sales to begin as soon as our expanded facility was
constructed, and our new processing equipment was installed.

We completed construction of the expanded facility in February 1999. New
processing equipment was installed in June 1999. Sales began immediately.

(5)  PRODUCT PIPELINE

In 1998 our pipeline consisted of a single product: natural astaxanthin for
use in animal nutrition. We have now expanded our pipeline to include:

         1)   Nutraceuticals
              -    Natural astaxanthin

                                        49

<PAGE>

              -    A second microalgae-based product

         2)   Drug discovery
              -    Compound libraries

These products are all in active development. A large U.S. chemical company
is collaborating with us - under a confidentiality agreement - to formulate
our natural astaxanthin nutraceutical. However, we cannot guarantee that the
collaboration will extend beyond product formulation. The State of Hawaii
Department of Agriculture has just approved our import permit for a new
species of microalgae that is the basis of our second nutraceutical product.
EnzyMed has received our first microalgae extracts, and has begun work to
produce our first compound library.

(6)  OUR TEAM

NEW MANAGEMENT. We believe our team is stronger than ever - at all levels.
Within the last year we added important experience and expertise at the
management level, including David Watumull, Martin Guerin and David Tarnas.
Together, these individuals bring us new experience and expertise in:

         -        international marketing and sales in food and feed industries;

         -        strategic development in biotechnology and pharmaceutical
                  industries;

         -        public/private sector collaboration; and

         -        fund raising.

NEW RESEARCH SCIENTISTS. Dr. Walter Nordhausen, Dr. Mai Lopez, and Dr. Mia
Unson have joined our research team in the past year. Together, they more
than double our research effort, and bring us proven experience in:

         -        biopharmaceutical product development;

         -        marine biology and biochemistry;

         -        natural products chemistry; and

         -        research program management.

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

During the period from June 1997 to October 31, 1999, we sold an aggregate of
$6,139,800 aggregate 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 an exercise price of $0.50 per
share and a term of three years. As part of this transaction, an
officer/director purchased $2,030,000 of convertible notes.

As of October 31, 1999, some of the holders of the convertibles notes
(amounting to $5,004,800 aggregate principal amount) exercised their option
to convert their convertible notes into shares of

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common stock. Upon conversion of the outstanding principal and interest on
the convertible notes, we issued 30,367,008 shares of common stock and also
issued 5,004,800 warrants in connection thereto. As part of this transaction,
an officer/director converted $1,025,000 aggregate principal amount of
convertible notes and received 6,458,538 shares of common stock and 1,025,000
warrants.

MANAGEMENT'S PLAN OF OPERATION

PLANNED OPERATIONS

Last year we focused on technology and infrastructure. We strengthened our
intellectual property, expanded our physical plant, and augmented production
capacity.

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

         - initiating sales of our first nutraceutical product, natural
           astaxanthin;
         - formulating our second nutraceutical product;
         - growing sales of AQUAXAN-TM-;
         - marketing and selling compound libraries for drug discovery; and
         - expanding our product pipeline.

(1)  NUTRACEUTICAL ASTAXANTHIN

THE PRODUCT. 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). 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 our nutraceutical
astaxanthin product 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


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         -  sufferers have used nutraceuticals with less demonstrated efficacy
            than astaxanthin.

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 would allow a 5-fold expansion at a cost of approximately $1.8
million.

PRODUCT FORMULATION. We are collaborating in product formulation with a large
U.S. chemical company that has significant experience in nutraceutical products.
Our collaboration is being carried out under a confidentiality agreement.
However, we cannot guarantee that our collaboration will extend beyond product
formulation.

MARKETING STRATEGY. We intend to sell this product directly to consumers.
Several wholesale purchasers of nutraceutical products have also contacted us
regarding our product. We may or may not enter into supply agreements with one
or more wholesalers.

REGULATORY ISSUES. The U.S. FDA 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. The FDA details certain procedures that comprise "Good Manufacturing
Practice" (GMP) with which we will have to comply. The State of Hawaii
Department of Health imposes certain regulations on the preparation of
substances for human consumption. We are taking action to comply with all
relevant regulations and recommended procedures. We plan to achieve compliance
in 2000.

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 announced its intention to launch 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


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<PAGE>

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 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. Subject to obtaining the necessary regulatory
approvals, we plan to release our nutraceutical astaxanthin product in the first
quarter of 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. We intend to devote approximately six months to optimizing
production in AGMs. Based on our knowledge and observations of this microalgae,
we believe we have enough production capacity to sustain product introduction.
After approximately one year of production, we project that initial sales would
support the cost of expanding our physical plant.

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,
building on the experience we will have developed with nutraceutical
astaxanthin. We may also sell limited amounts to wholesalers.

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, nor for the pro-vitamin
it contains.

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

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

THE PRODUCT. We have spent several years developing astaxanthin-rich
AQUAXAN-TM- in conjunction with


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Cultor. 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 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,


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<PAGE>

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 microalgae, NATUROSE-TM-, manufactured and sold by Cyanotech.
NATUROSE-TM- is advertised to contain 1.5% astaxanthin. AQUAXAN-TM- contains 3%
astaxanthin. Cyanotech recently announced a possible joint venture to produce
NATUROSE-TM- with Norsk-Hydro, the world's dominant salmon farming company. The
Cyanotech/Norsk-Hydro joint venture appears to be contingent on the results of
"production optimization" that has yet to take place. We believe such a joint
venture, if it occurs, could substantially contribute to developing the market
for AQUAXAN-TM-.

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

(4)  DRUG DISCOVERY LIBRARIES

THE DRUG DISCOVERY PROCESS. A large number of modern medicines were originally
discovered in plants. The drug discovery process generally starts by identifying
a plant that has "bioactive" properties. The compound responsible for
bioactivity is identified through a sequence of chemical extraction, testing,
and purification. The pure compound is tested, first in animal models and then
in human clinical trials. If the entire process is completed, the result is a
new drug.

In conjunction with EnzyMed, we have developed a drug discovery process adapted
to microalgae. Our role in this process is 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. Bioactive fractions are then subjected to Combinatorial
Biocatalysis, a process which creates, on average, hundreds of derivative
compounds from each pure bioactive compound using EnzyMed's proprietary
enzymatic methods. The resulting Microalgae Compound Libraries are then ready to
market.

THE PRODUCT. Compound libraries are a major source of drug discovery in today's
pharmaceutical industry. The "library" consists of pure compounds, commonly in
sets of 96, packaged in special containers designed for "High-Throughput
Screening." The screening process identifies new drug candidates by testing for
bioactivity, often targeted at certain diseases. Tests might be based on the
ability to kill certain types of cells (e.g. bacteria, cancer), or they might be
based on genetic pathways involved in specific diseases. Any positive result
from a screening test could eventually lead to a new medicine.

We believe the Aquasearch/EnzyMed Microalgae Compound Library is unique because
it has these features:

         1)   Unexplored resource

                  -  Few microalgae have been screened by the pharmaceutical
                     industry


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<PAGE>

         2)   Quantity
              -    Species: 30,000
              -    Bioactive compounds: thousands
              -    Average derivatives of each bioactive compound:
                   hundreds via Combinatorial Biocatalysis

         3)   Possible Patentability
              -    Bioactive compounds in microalgae may be new to science
              -    Bioactive derivatives from Combinatorial Biocatalysis may be
                   new to science

THE MARKET. Consumers of compound libraries are biopharmaceutical companies.
These companies are strongly motivated to find new sources of drugs. According
to a 1997 study by Andersen Consulting, the pharmaceutical industry must
increase its rate of discovery of new drugs by a factor of 10 in five years in
order to maintain its historic growth rate.

Compound libraries are typically marketed as a package that includes the
following terms and conditions:

         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
              -    activated by decision to begin trials

         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

PRODUCTION CAPACITY. We are producing our first compound library in
collaboration with EnzyMed. We have provided EnzyMed with a purified extract of
a known bioactive compound, and they are now producing derivatives using
Combinatorial Biocatalysis.

We have demonstrated capability in identification, microalgae cultivation,
extraction, purification, and testing of bioactivity. Our research team includes
professional scientists with expertise in all these areas. However, we have only
limited facilities and equipment for chemistry (extraction, purification) and
biochemistry (testing). In these areas, we now rely on collaborations with
several universities and members of our Scientific Advisory Board. We plan to
expand capacity with a 6,000 sq. ft. laboratory dedicated to drug discovery and
appropriate equipment, at an estimated cost of $2.0 million. Our ability to
finance this expansion depends on funds we would have to raise through revenues,
debt or equity.

EnzyMed has demonstrated capability in Combinatorial Biocatalysis. Its contract
customers for this type of "lead optimization" currently include leading
pharmaceutical and biopharmaceutical companies.


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<PAGE>

MARKETING STRATEGY. Both Aquasearch and EnzyMed have considerable marketing
know-how in the drug discovery market. A number of major pharmaceutical and
biotech companies have already expressed an interest in our first compound
library. Senior officers of both companies are responsible for marketing the
compound libraries.

TIMING OF PRODUCT RELEASE. We plan to release our first library for access
within six months.

(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 plan to expand our nutraceutical product
pipeline using a common process. A fundamental principle of this process is that
we rely on strategic collaborations and alliances whenever special Aquasearch
expertise and technology is not required. We have already identified many
potential nutraceutical products among the microalgae, mostly through the
published scientific literature.

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 partnerships with
major universities. Additionally, we have enhanced our ability to produce
Microalgae Compound Libraries through our collaboration with EnzyMed.

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 ("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 5 ERCs awarded by the National Science
Foundation.


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<PAGE>

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:
                   Aquasearch, Monsanto, 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: OTHER UNIVERSITIES. We are currently negotiating research
agreements with medical schools at four universities. If consummated, these
agreements will strongly leverage our own product development efforts.

         CORE RESEARCH:  Pre-clinical screening for drug candidates
              -    Purification of extracts from approximately 1,200 species of
                   microalgae in 3 years
              -    Tissue culture screening
              -    Genomic screening: allows extracts to be tested for effects
                   on specific diseases
              -    Genetic control of microalgae biochemistry
              -    Targets: skin cancer, breast cancer, antivirals, antifungals

         COST:    Approximately $500,000 per year. Projects range from 1 to 3
                  years. One project requires no funds.

         BENEFITS TO AQUASEARCH:
              -    Ownership of intellectual property
              -    Increases value of drug candidates to $3 to $15 million PER
                   COMPOUND

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

If we are able to enter into agreements with all four universities, we expect to
generate and screen approximately 10,000 extracts over 3 years at a cost of $1.5
million. If our pre-clinical trials yield only


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one bioactive compound, the minimum license fee we expect would be $3 million.

We have three options for screening and pre-clinical trials. We can do them
ourselves, with a corporate partner, or with a university partner. The cost of
facilities, equipment and expertise dictates that we work with a partner. The
advantage of the university partners we have chosen is significant, because the
universities perform contract research and we retain ownership of the compounds.

TIMING OF PRODUCT RELEASE. Our pipeline expansion is a process designed to yield
many more products at minimal cost. Our goal is two products per year. The
result could be less, or it could be far greater.

GENERAL ASPECTS OF PLANNED OPERATIONS

We expect to steadily increase revenues from sales of AQUAXAN-TM-. However, we
do not expect this product alone to be profitable, because we intend to reserve
significant production capacity for nutraceutical astaxanthin.

Subject to obtaining the necessary regulatory approvals, we intend to launch our
nutraceutical astaxanthin product in early 2000. We anticipate that we will
become profitable within one year of the launch if we hit our sales targets -
with no increase in production capacity. However, there can be no assurance that
this will occur.

Strategic relationships and collaborations will continue to be an important part
of our business strategy. We now have such relationships with EnzyMed, 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, 1999, we had an accumulated deficit of approximately $11.7
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 do 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.


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<PAGE>

RESULTS OF OPERATIONS

REVENUES. Since inception, our main activities have been basic research and
development and manufacture process development; recruiting personnel;
purchasing operating assets; and raising capital. During the four months ended
October 31, 1999, we started to ship our natural astaxanthin product. This
revenue amounting to approximately $52,000 has been classified as other income.
Most of the product we produced in 1997 and 1998 was used for product
development and testing. Most of the product we have produced in 1999 is in
inventory, and awaits final formulation before it can be sold.

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 $1.7 million for the year
ended October 31, 1999 compared with approximately $1.2 million and $800,000 for
the years ended October 31, 1998 and 1997, respectively. Most of these funds
were expended to develop the very large Ultra-AGM, to expand production
capacity, to implement improved computerized process control, and to reduce
capital costs of the AGM technology. From inception through October 31, 1999,
research and development costs totaled approximately $4.8 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 $1.8 million for the year ended
October 31, 1999 compared with approximately $1.0 million and $1.1 million for
the years ended October 31, 1998 and 1997, respectively. The increase reflects
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, 1999, general and administrative
expenses totaled approximately $5.4 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.

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, 1999, 1998 and
1997, we raised approximately $4.4 million, $3.3 million and $1.7 million of net
proceeds from the sale of shares of common stock and/or the issuance of debt,
respectively, in private placement transactions. From inception through October
31, 1999, we raised total net proceeds of approximately $12.4 million through
public and private sales of equity and debt securities.

During the year ended October 31, 1999, operating activities consumed
approximately $3.2 million compared with $1.4 million and $2.0 million during
the years ended October 31, 1998 and 1997, respectively. From inception through
October 31, 1999, operating activities have consumed approximately $8.1 million.

Capital expenditures for the years ended October 31, 1999, 1998 and 1997 were
approximately $1.2 million, $1.8 million and $200,000, respectively. From
inception through October 31, 1999, capital expenditures have totaled
approximately $3.9 million.

As of October 31, 1999, our liquidity was approximately $90,000 in cash and cash
equivalents.


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We estimate a need for approximately $3.0 million in operating capital over the
next twelve months. We need an additional $0.5 million to consummate strategic
research agreements with four university medical schools. Projected product
sales will begin to pay some operating costs. We now believe that product sales
could lead to profitability within twelve months after the start of sales of
nutraceutical astaxanthin, and that some future expansion could be financed out
of profits. In the near term, we believe that existing capital resources, funds
to be raised through public and/or private offerings of equity and/or debt
securities and bank financing will be sufficient for continued operations
through the next twelve months. We are now pursuing more sources of capital to
maintain operations and, more importantly, to expand our product pipeline. These
capital sources include government contracts and grants, product sales, license
agreements and equity or debt financing. We cannot guarantee success in raising
the additional capital necessary to sustain or expand 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

WE HAVE SIGNIFICANT SHORT-TERM AND LONG-TERM CAPITAL NEEDS AND ARE UNCERTAIN OF
OBTAINING FUTURE FINANCING.

We project expenditures of $3.0 million in operating capital over the next
twelve months after planned capital expenditures, plus an additional $0.5
million to consummate strategic research agreements with four university medical
schools. Over the long-term, we will require substantial expenditures to support
our research and development activities and to manufacture and market our
products. The level of expenditures depends in part on whether we develop,
manufacture and market our products independently or through collaborations with
other companies. Our future capital requirements will depend on many additional
factors, including:

      -  our ability to manufacture our products in cost-effective commercial
         quantities;
      -  market acceptance our products;
      -  the extent and progress of our research and development programs;
      -  the time and costs of obtaining regulatory clearances for certain
         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.

Moreover, our cash requirements may vary materially due to problems of
production, results of research and development, results of product testing,
changes in relationships with corporate partners, changes in the focus and
direction of our research and development programs, competitive and
technological advances, litigation and other factors.

Projected product sales will begin to pay some of our operating costs. However,
we expect that we will need additional funding from public or private equity or
debt financing to address our capital needs. Additional financing may not be
available on favorable terms, if at all. Furthermore, we have no credit


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facility or other committed sources of capital, and we cannot assure
satisfactory terms for such arrangements, if at all. 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. If we do not have adequate
funds, we might curtail operations significantly or we might enter into
collaboration agreements on unattractive terms that could require us to
relinquish certain technology or product rights, including patent and other
intellectual property rights. Our inability to raise capital would have a
material adverse effect on our business, financial condition, results of
operations, and relationships with corporate partners.

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.

Since our inception in 1988, we have experienced quarterly and annual operating
losses. Our net loss in fiscal 1999 was approximately $4.1 million and our
accumulated deficit at October 31, 1999 was approximately $11.7 million. Our
losses to date have resulted primarily from the costs of research and
development, and from general and administrative costs associated with
operations. We expect to continue incurring operating losses for at least the
next year as we expand our product pipeline. We expect that quarter-to-quarter
and year-to-year revenues, expenses and losses will fluctuate, at times
materially. Many factors could affect our future financial results, 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;
      -  production costs and yield issues associated with the scale-up of
         production of our products;
      -  the progress of our research and development programs for developing
         other microalgal products;
      -  the time and costs of obtaining regulatory approvals for products
         subject to such approval;
      -  our ability to protect our proprietary rights;
      -  costs of filing, protecting and enforcing our patent claims;
      -  competing technological and market developments; and
      -  the costs of commercializing and marketing our existing and potential
         products.

We cannot guarantee that we will ever be able to achieve or sustain
profitability in the future.

WE MUST OVERCOME NUMEROUS CHALLENGES TO SUCCESSFULLY PRODUCE MICROALGAE ON A
COMMERCIAL SCALE.

We have faced many significant technical problems developing our Aquasearch
Growth Module, or AGM, technology. Our initial production of natural astaxanthin
from HAEMATOCOCCUS PLUVIALIS was complicated by many factors, including various
forms of microbial contamination, variability in production cycle times due to
technical and biological factors and losses of final product due to processing
inefficiencies. As a result of these factors, our monthly production of
astaxanthin varied considerably until 1998. During most of 1998 and into early
1999, we expanded and completely transformed our facility. This expansion and
related technical advances have allowed us to increase our monthly production of
astaxanthin since early 1999.

We expect to once again scale up production of HAEMATOCOCCUS PLUVIALIS as well
as other potential microalgae products. We believe that scaling up HAEMATOCOCCUS
PLUVIALIS production is likely to be less


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challenging than scaling up other microalgae products that we have not yet
cultivated on a large scale. We believe the most challenging aspect of
scaling up production of these products is likely to involve problems of
biology rather than engineering. However, we believe that scaling up
production of our current and potential products will always present
additional technical problems. Some of these problems may be unknown, may
never have been faced and could result in lowered production. We may not be
successful in addressing any or all of these technical problems. If we are
unsuccessful in our efforts to scale up production of these products, we may
be unable to satisfy our obligations under any agreements we may enter into,
including agreements with any customers for our products. As a result, our
business, financial condition, results of operations, and relationships with
corporate partners could be materially adversely affected.

WE HAVE LIMITED MANUFACTURING EXPERIENCE.

We are at an early stage of development and we have limited experience in
manufacturing products derived from microalgae. To be successful, we must
produce products at acceptable costs. The quantity and quality of our products
must also comply with contractual requirements, regulatory requirements and
local health, safety and environmental regulations.

We first shipped our natural astaxanthin product to Cultor Ltd., a Finnish-based
multinational food conglomerate ("Cultor"), under a Supply Agreement that began
in July 1995. We began shipping our natural astaxanthin product to a second
European company in July 1999, and to a Japanese company in September 1999. We
currently have enough inventory to supply the immediate requirements of our
current customers. However, we may have insufficient production capacity to
satisfy future orders, if any. Furthermore, we may choose to retain our entire
production capacity of natural astaxanthin in late 1999 to satisfy possible
demand for our first nutraceutical product. This decision could affect the
potential for sales to our current customers.

The markets for our natural astaxanthin product may change, and our customers
may also change. We may experience unanticipated constraints on production at
various times, and such constraints could adversely affect our ability to
satisfy customer orders. Our inability to satisfy production targets to date has
not disrupted relations with corporate partners, but our failure to consistently
demonstrate satisfactory large-scale production economies of scale could have a
material and adverse effect on our business, financial condition, results of
operations, and relationships with corporate partners.

WE MAY NEED TO EXPAND OUR CURRENT PRODUCTION FACILITY TO MEET ANTICIPATED MARKET
DEMAND FOR OUR PRODUCTS. SUCH AN EXPANSION WOULD POSE SIGNIFICANT FINANCIAL,
TECHNICAL AND BIOLOGICAL CHALLENGES.

To date, we have not produced ton quantities of natural astaxanthin. At various
times we have experienced significant delays in developing products, and also in
developing processes of cultivation and harvesting. These development activities
may require additional research and development as well as substantial
additional capital and other resources prior to greater commercialization. We
believe that market demand for our natural astaxanthin products may require
additional expansion and scale-up. We expect the design and engineering we have
done to date can be readily scaled, but the amount of additional design and
engineering costs will depend on how large the scale-up is. Construction and
facility scale-up costs, as well as research and development and production
costs, could substantially exceed budgeted amounts and estimated time frames may
need to be extended. Any such additional costs or delays could have a material
adverse effect on our business, financial condition, results of operations, and
relationships with corporate partners.


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Our previous one-acre research and development/production facility was not
adequate to meet the initial production target of 40 kilograms per month under a
Distribution and Development Agreement entered into with Cultor in 1996. To
address this need, we budgeted $2.5 million for the expansion of our facility
from one to three acres. The expansion, which began in early 1998, was
substantially completed in January 1999. We now believe it possible to exceed
production of 40 kilograms per month at the new facility if sufficient
finishing-pond space is available. However, because finishing pond space is
limited at our site, we plan to limit astaxanthin production to no more than 10
kilograms per month.

We anticipate that we may develop an additional site for large-scale astaxanthin
production. The production capacity of any new site we develop will be entirely
dependent on market demand, which we anticipate may exceed 120 kilograms per
month. We currently have no specific plans as to what the size, location or
production capacity of such a site would be, or how the construction or scale-up
of this facility would be financed. We anticipate that we will need to enter
into a collaborative arrangement with one or more parties to assist us in the
development and construction of a new facility. However, we may not be able to
reach an agreement with any other entity regarding the development, timing,
location, or financing of a second site on favorable terms, if at all.

We cannot quantify or fully assess the many significant risks involved in
scaling up our production technology, further expanding our existing facility,
or constructing a new facility. For example, our production process critically
depends upon supplies of freshwater, cold seawater and utilities provided by the
Natural Energy Laboratory of Hawaii Authority, and any interruption in these
supplies could have a material adverse effect on our production capability. We
also face the risk that our water supplies could be threatened by microbial
contamination that overrides our existing efforts and capability to maintain
sterility. The success of our expansion plans will depend upon timely
performance of many contractors, sub-contractors, suppliers and various agencies
of the State of Hawaii that regulate and license construction, each of which is
beyond our control. We could experience delays, cost overruns or changes in our
construction and expansion plans if these contractors, suppliers or state
agencies fail to perform in a timely manner. Such events could have a material
adverse effect on our business, financial condition, results of operations, and
relationships with corporate partners.

We cannot assure success in resolving known or unknown biological and
engineering development problems that may accompany any scale-up efforts. We
cannot be certain that we will be able to develop new products within estimated
time schedules, in accordance with present cost projections, or that the
products we develop will be commercially viable or widely accepted.

OUR CUSTOMER BASE IS CONCENTRATED.

Our business currently depends on several customers: Cultor; EnzyMed, Inc., a
division of Albany Molecular Research, Inc. ("EnzyMed"); a European life
sciences company; and a Japanese life sciences company. We depend on EnzyMed for
developing libraries of compounds that can be marketed to screen for bioactivity
and subsequent drug development. We currently depend on the other three
companies for sales of our natural astaxanthin products.

If our astaxanthin customers do not continue buying our products at the current
and anticipated purchase levels, then our business, financial condition, results
of operations, and relationships with corporate partners could be materially
adversely affected. Likewise, the failure of EnzyMed to produce compound
libraries, our failure to adequately fund the collaborative project with
EnzyMed, or the lack of interest by potential customers in the library compounds
could have a material adverse effect on our business, financial condition,
results of operations, and relationships with corporate partners. Moreover, our
failure


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to gain additional customers for other applications of our natural
astaxanthin product or for other new products could have a material adverse
effect on our business, financial condition, results of operations, and
relationships with corporate partners.

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

Our natural astaxanthin product will compete directly or indirectly with
synthetic astaxanthin products, at least in markets for animal feed
applications. Likewise, products incorporating our natural astaxanthin will
compete directly with products incorporating the synthetic astaxanthin product.
The synthetic astaxanthin market is currently dominated by a single producer,
Hoffman-LaRoche, Inc. ("Hoffman LaRoche"). 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, which could have a material adverse effect on our business,
financial condition, results of operations, and relationships with corporate
partners.

WE RELY HEAVILY ON RELATIONSHIPS WITH CORPORATE PARTNERS.

Our business strategy is strongly focused on developing strategic relationships
with companies that have established research and development, sales, marketing
and distribution capabilities for the microalgae products that we intend to
develop. In May 1996, we entered into a three-year Distribution and Development
Agreement with Cultor (recently extended to four years) for 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 that we would jointly market 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 as expected, or that we will be able to perform our
obligations to them. We cannot be certain that any of our current or future
partners will devote enough resources to developing, testing or marketing
potential products developed under such arrangements. Our business, financial
condition, results of operations, and relationships with corporate partners
could be materially adversely affected by a number of factors including:

        - the development of competing technologies or products by a strategic
          partner;
        - our preclusion from entering into competitive arrangements;
        - our failure to obtain timely regulatory approvals;
        - the premature termination of an agreement with a strategic partner;
          or
        - the failure of a strategic partner to devote sufficient resources to
          developing and commercializing our products.


                                      65
<PAGE>

We have complex agreements with our consultants and corporate partners. Such
agreements have provisions that might give rise to disputes regarding the rights
and obligations of the parties. Such disputes and disagreements 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, and could have a material adverse effect on our business, financial
condition, results of operations, and relationships with 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. Such changes in our corporate partnerships could
have a material adverse effect on our business, financial condition, and results
of operations.

Our primary strategy for the development, regulatory approval, production and
commercialization of certain products is to enter into collaborations with
various corporate partners, licensors, licensees and others. We may not be able
to negotiate collaborative arrangements with these parties on acceptable terms,
if at all, or that such collaborative arrangements will be beneficial to us. If
we are unable to establish appropriate strategic relationships, we may need to
raise more capital to undertake such 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 such expertise ourselves, then we might expect
delays in launching, marketing, selling and distributing new products. Such
delays could have a material adverse effect on our business, financial condition
and results of operations.

WE FACE COMPETITION FROM A NUMBER OF COMPANIES THAT MAY BE IN A BETTER POSITION
TO COMPETE IN OUR INDUSTRY.

Competition in the market for nutraceutical products is intense. Our
nutraceutical astaxanthin product will compete directly with the products of at
least three companies that either sell, or have announced the intention to sell,
a similar nutraceutical product. One of these, 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 ("Cyanotech"),
based in Hawaii, recently began sales of a similar 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. We believe
AstaCarotene will have an advantage in European markets, which they essentially
established. We believe Cyanotech may have an advantage in United States markets
by virtue of their experience with SPIRULINA, another microalgae-based
nutraceutical product. We are aware of proprietary positions held by other
potential competitors, that do not produce the product, that could inhibit our
ability to compete purely on other grounds. We believe our marketing strategy
for nutraceutical astaxanthin is unique, but we cannot guarantee it to be
successful. If competitors develop a proprietary position that inhibits our
ability to compete, or if our marketing strategy is not successful, then our
business, financial condition, results of operations, and relationships with
corporate partners could be materially and adversely affected.

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

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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 dominant market share. Two other companies,
AstaCarotene and Cyanotech, claim to produce natural astaxanthin from
microalgae or are producing significant quantities for test and commercial
purposes.

Our natural astaxanthin product for feed applications is expected to compete
with synthetic astaxanthin, and any other alternative products, primarily on the
basis of product performance, price and proprietary position. Hoffman-LaRoche
has maintained the market price of synthetic astaxanthin at approximately $2,500
per kilogram for more than a decade, but we cannot be sure that it will maintain
that price in response to any new product introductions, including our own. 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. There could also be products we are unaware of, or
products developed in the future, that could adversely affect the marketability
of our natural astaxanthin product.

We anticipate that competition to develop microalgae 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 microalgae products and may commercialize products that compete with ours on
their own or through joint ventures.

We believe that our Aquasearch Growth Module and related microalgae cultivation
and harvesting technologies offer significant technical and economic advantages
compared to technologies used by certain competitors. Compared to open pond
systems, for example, the AGM provides greater productivity, greater process
control, and a substantial reduction in the potential hazards of contamination.
We also believe that our AGM and related microalgae cultivation and harvesting
technologies are more economical to construct and operate than any existing
comparable technology. However, 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.

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

Our success will depend on the continued services of certain members of senior
management, particularly Mark E. Huntley, Ph.D., our Chairman, President and
Chief Executive Officer; Earl S. Fusato, our Chief Financial Officer; David G.
Watumull, our Executive Vice President of Strategic Development and Corporate
Finance; and Martin Guerin, our Vice-President, Sales and Marketing. The loss of
any senior executive or other key employee could have a material adverse effect
on our business, financial condition, results of operations, and relationships
with corporate partners.

We are 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

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of qualified aquatic microbiologists and bioengineers is limited, so
competition for such personnel is intense. 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. However, 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 were to lose one or more key personnel, or if we were
unable to hire additional personnel and develop expertise as needed, our
business, financial condition, results of operations, and relationships with
corporate partners could be materially adversely affected.

Members of our Scientific Advisory Board assist us in optimizing production and
processing methods and formulating research and development strategy for both
existing and potential microalgae products. Most members of the Scientific
Advisory Board are not our employees. Each member may have commitments to other
entities that could limit their availability to us. We cannot be sure that we
will be able to retain our key Scientific Advisory Board members.

OUR BUSINESS WILL NOT OPERATE EFFICIENTLY AND OUR RESULTS OF OPERATIONS WILL BE
NEGATIVELY AFFECTED IF WE ARE UNABLE TO EFFECTIVELY MANAGE OUR GROWTH.

To date, we have focused almost exclusively on product research and technology
development. We are now making the transition to full-scale commercial
production of microalgae products. This major change in our business has placed,
and will continue to place, significant demands on our financial and management
control systems. If we fail to upgrade our operating, management and financial
control systems, or if we encounter difficulties during such upgrades, then our
business, financial condition, results of operations, and relationships with
corporate partners could be materially adversely affected. We believe our
systems and controls will address current needs, but they may be inadequate to
address future business expansion. Our results of operations will be adversely
affected if revenues do not increase enough to compensate for the increased
operating expenses that result from any expansion. Expansion may not be
profitable, and could adversely affect our results of operations. Success of any
future expansion plans will depend partly upon our ability to continue to
improve and expand our management and financial control systems, to attract,
retain and motivate key personnel, and to raise additional required capital. We
may not be successful in these efforts.

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

We are actively developing three product lines:

        1)  nutraceuticals;
        2)  compound libraries for drug discovery; and
        3)  natural astaxanthin for animal feed.

In the coming year we intend to launch our own nutraceutical product, based on
natural astaxanthin. We believe the success of our nutraceutical product line
will depend strongly on marketing strategy. Success of the nutraceutical product
line also depends on our ability to comply with 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

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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 do have marketing experience in animal feed markets, but we
have no such 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 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.

Many companies have much greater marketing and product development experience
and significantly greater resources to devote to marketing and product
development than we do. We have entered into, and expect to enter into
additional, selected strategic alliances with third parties for product
development, marketing and sales. We cannot guarantee the performance of such
third parties, or the overall success of such strategic alliances. If we are
unable to successfully develop or commercialize any product line -
nutraceuticals, drug discovery, natural astaxanthin or any potential microalgae
products - then our business, financial condition, results of operations and
relationships with corporate partners could be adversely affected.

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 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, two 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. The patent positions of pharmaceutical, biopharmaceutical and
biotechnology companies, including 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. 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. We cannot be sure that such patents will 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. In addition, 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 might duplicate our technologies, or, if patents are issued to us, they
might 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. Such 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 certain foreign countries may not
protect our patents and other intellectual property rights to the same extent as
the laws of the United States.

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We could incur substantial costs in litigation if we need to defend ourselves in
patent suits brought by third parties, or if we initiate such suits. We are
currently involved in an intellectual property lawsuit with Cyanotech, one of
our competitors. In July 1998, Cyanotech filed a complaint for declaratory
judgment of patent non-infringement, patent invalidity, and non-misappropriation
of trade secrets in Federal District Court in Hawaii. Cyanotech's complaint
concerned one of our U.S. patents as well as trade secrets related to the
Aquasearch Growth Module. In September 1998, we filed a counterclaim asserting
patent infringement, misappropriation of trade secrets, unfair competition and
breach of contract. In December 1998, Cyanotech filed a motion for partial
summary judgment of non-infringement and invalidity of our patent. In March
1999, we filed a motion for summary judgement against Cyanotech for breach of
contract, misappropriation of trade secrets and patent infringement. All motions
for summary judgment were heard in November 1999. On December 30, 1999, the
Court granted summary judgment on our motion 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.

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 in an appeal of the Court's ruling, a
finding of noninfringement 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.

We believe there could be significant litigation in our industry regarding
patent and other intellectual property rights. We cannot guarantee that
infringement or other claims will not be asserted or prosecuted against us in
the future whether resulting from our internally developed intellectual property
or licenses from third parties If third parties bring any legal action against
us or our partners, they could:

    -  claim damages and seek to enjoin commercial activities relating to the
       affected products and processes;
    -  subject us to potential liability for damages; or
    -  require us or our corporate partners to obtain a license in order
       to continue to manufacture or market the affected products and
       processes.

Any future assertions or prosecutions could be time-consuming, result in costly
litigation and divert our technical and management personnel. We may not prevail
in any such action, nor can we predict that any license, including licenses
proposed by third parties, would be made available on commercially acceptable
terms, if at all. Any of these outcomes could have a material adverse effect on
our business, financial condition, results of operations, and relationships with
corporate partners.

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

The disclosure and use of our proprietary technology, know-how and trade secrets
are generally controlled under agreements with the parties involved. However, we
cannot guarantee that all

                                70

<PAGE>

confidentiality agreements will be honored or that our proprietary
technology, know-how and trade secrets will not be disseminated. Such illicit
disclosures or uses of our intellectual property could materially and
adversely affect our business, financial condition, and relationships with
corporate partners.

WE ARE SUBJECT TO EXTENSIVE GOVERNMENT REGULATION.

Our products and production activities are, or may be, subject to regulation by
government authorities. Such regulatory authorities include the U.S. FDA, the
United States Federal Trade Commission, the State of Hawaii Department of
Agriculture and comparable authorities in foreign countries.

Each existing or potential microalgae product that we develop, produce, market
or license to our corporate partners can present 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 mandated by federal, state, local or foreign laws,
regulations and policies.

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 in 2000.
We expect to dedicate significant resources so that our production facilities
can meet GMP and ISO qualifications.

We are also subject to other federal, state and foreign laws, regulations and
policies with respect to labeling products, importing organisms, and
occupational safety, among others. We have been working 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 such regulatory bodies, could be retroactive. Changes like
these could have a material adverse effect on our business, financial condition,
results of operations, and relationships with corporate partners. We cannot
guarantee that any of our potential products will satisfy applicable regulatory
requirements.

We are subject to many 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.

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

All of our production capacity is now located at the HOST Business Park at
Keahole Point, Kailua-Kona, Hawaii, on property leased from the State of Hawaii
and situated on a 200-year-old lava flow adjacent to a dormant volcano. We
maintain minimal finished goods inventory. If any event were to disrupt
production at our facility, then we might be unable to continue production. Such
events could include fire, volcanic eruption, earthquake, tidal wave, hurricane,
or other natural disaster, work stoppage, termination or suspension of our lease
by the State of Hawaii, other regulatory actions or any other cause. Such an
interruption could materially and adversely affect our business, financial
condition, results of operations, and relationships with corporate partners.

                               71

<PAGE>

The consistent sunlight and high temperatures of Hawaii are beneficial to
microalgal growth. Thus, any significant or unusual change in climate could
adversely affect our production. Unseasonably cool or cloudy weather would
adversely impact our production and could adversely affect our business,
financial condition, results of operations, and relationships with corporate
partners.

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

We expect to sell many of our products on a global scale. We have a distribution
arrangement with Cultor for our natural astaxanthin product in animal feeds. We
have also shipped our natural astaxanthin product to life sciences companies in
Europe and Japan. We expect international sales will represent a significant
portion of our revenue for these products, 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.

Our business, financial condition, and results of operations may be materially
and adversely affected by any difficulties associated with managing accounts
receivable from international customers, tariff regulations, imposition of
governmental controls and regulations, political and economic instability or
other trade restrictions. Our supply agreements provide that sales will be
denominated in United States dollars, but fluctuations in currency exchange
rates could cause our products to become more expensive to customers in the
affected country, leading to a reduction in sales in that country.

WE MAY BE EXPOSED TO PRODUCT LIABILITY CLAIMS.

We face an inherent business risk of exposure to product liability claims
alleging that the use of our technology or products resulted in adverse effects.
This risk applies to all of our current products - nutraceuticals, compound
libraries, and astaxanthin for animal feed. We cannot ensure that our current
level of 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, if at all. Any product liability claim or recall
that exceeds insured amounts, or amounts recoverable under applicable
contractual arrangements, could materially and adversely effect our business,
financial condition, results of operations, and relationships with corporate
partners.

OUR PRINCIPAL SHAREHOLDERS HAVE SIGNIFICANT CONTROL OF OUR MANAGEMENT AND
AFFAIRS, WHICH THEY COULD EXERCISE AGAINST YOUR BEST INTEREST.

Based on the 87,060,501 shares of common stock outstanding at October 31, 1999,
our directors and executive officers, as a group, beneficially own approximately
22% of our outstanding common stock. As a result, our officers and directors
might be able to strongly influence the actions of the Board of Directors and
the outcome of actions brought to our shareholders for approval. Such a high
level of ownership may have the effect of delaying or preventing a change in
control and may adversely affect the voting and other rights of our
shareholders.

THE PRICE OF OUR COMMON STOCK HAS BEEN AND MAY CONTINUE TO BE VOLATILE.

The market price of our common stock has been, and may continue to be highly
volatile. Price volatility

                              72

<PAGE>

is common with publicly traded life sciences companies and companies whose
securities trade on the NASD Electronic Bulletin Board. Many events could
have a significant impact on our business and the future market price of our
common stock, including:

     -  announcements of technological innovations or new commercial products
        by us or our competitors;

     -  developments or disputes concerning patent or proprietary rights;

     -  publicity regarding actual or potential benefits relating to products
        under development by us or our competitors;

     -  general regulatory developments affecting our products in both the
        United States and foreign countries;

     -  market conditions for life sciences companies in general; and

     -  economic and other internal and external factors, including
        period-to-period fluctuations in our financial results.

Since the initial public offering of our common stock in January 1989, the
average daily trading volume in the common stock as reported on the NASD
Electronic Bulletin Board has been relatively low. We cannot ensure that a more
active public trading market will ever develop for our common stock. We have
never declared or paid any cash dividends on our common stock and we do not
intend to do so in the foreseeable future.

OUR COMMON STOCK IS CONSIDERED A PENNY STOCK AND 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
Electronic Bulletin Board of the National Association of Securities Dealers,
Inc. (the "NASD"). 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. In addition, accurate price
quotations are also more difficult to obtain.

Our common stock is considered a "penny stock," which is defined by regulations
of the Securities and Exchange Commission as an equity security with a market
price of less than $5.00 per share. However, an equity security with a market
price under $5.00 will not be considered a penny stock if it fits within any of
the following exceptions:

     1)  the equity security is listed on Nasdaq or a national securities
         exchange;

     2)  the issuer of the equity security has been in continuous operation for
         LESS than three years, and either has (a) net tangible assets of at
         least $5,000,000, or (b) average annual revenue of at least $6,000,000;
         or
     3)  the issuer of the equity security has been in continuous operation for
         MORE than three years, and has net tangible assets of at least
         $2,000,000.

OUR TANGIBLE NET ASSETS ARE LESS THAN $4,000,000, THE MINIMUM AMOUNT REQUIRED
FOR LISTING ON THE NASDAQ SMALLCAP MARKET.

If you buy or sell a penny stock, SEC regulations require that you receive,
prior to the transaction, a disclosure explaining the penny stock market and
associated risks. Furthermore, trading in our common stock is currently subject
to Rule 15g-9 of the Exchange Act, which relates to non-Nasdaq and non-exchange
listed securities. Under this rule, broker/dealers who recommend our securities
to persons other

                           73

<PAGE>

than established customers and accredited investors must make a special
written suitability determination for the purchaser and receive the
purchaser's written agreement to a transaction prior to sale. Securities are
exempt from this rule if their market price is at least $5.00 per share.

Penny stock regulations will tend to reduce market liquidity of our common
stock, because they limit the broker/dealers' ability to trade, and a
purchaser's ability to sell, the stock in the secondary market. The low price of
our common stock has a negative effect on the amount and percentage of
transaction costs paid by individual shareholders. The low price of our common
stock also limits our ability to raise additional capital by issuing additional
shares. There are several reasons for these effects. First, the internal
policies of certain institutional investors prohibit the purchase of low-priced
stocks. Second, many brokerage houses do not permit low-priced stocks to be used
as collateral for margin accounts or to be purchased on margin. Third, some
brokerage house policies and practices tend to discourage individual brokers
from dealing in low-priced stocks. Finally, broker's commissions on low-priced
stocks usually represent a higher percentage of the stock price than commissions
on higher priced stocks. As a result, our shareholders pay transaction costs
that are a higher percentage of their total share value than if our share price
were substantially higher.

We intend to apply for listing on the Nasdaq SmallCap Market as soon as we meet
their eligibility requirements. This table compares our current status to the
Nasdaq eligibility requirements:

<TABLE>
<S>                              <C>                              <C>
-------------------------------- -------------------------------- -------------------------
          ELIGIBILITY              NASDAQ SMALL CAP ELIGIBILITY          AQUASEARCH
           CRITERION                        REQUIREMENT                CURRENT STATUS
-------------------------------- -------------------------------- -------------------------
       Minimum bid price                       $4.00                      $0.32 (1)
        of common stock
-------------------------------- -------------------------------- -------------------------
      Tangible net assets                   $4.0 million                $484,949 (1)
              OR
     Market capitalization                  $50 million                $28 million (1)
              OR
   Net income in 2 of 3 years                 $750,000                       N/A
-------------------------------- -------------------------------- -------------------------
          Public float                    1,000,000 shares              45,412,217 (1)
              with
        Market value of:                     $5 million                $15 million (1)
-------------------------------- -------------------------------- -------------------------
     Market makers of record                     3                        2 active
-------------------------------- -------------------------------- -------------------------
     Shareholders of record                     300                         >300
-------------------------------- -------------------------------- -------------------------
</TABLE>

 (1) As of October 31, 1999.

If our tangible net assets and our market capitalization meet the minimum Nasdaq
eligibility criteria, our Board of Directors is likely to recommend that we
effect a reverse stock split to meet this listing requirement. Any such reverse
stock split would require shareholder approval. We cannot be certain to satisfy
all listing requirements, nor can we ensure that any proposed reverse stock
split will be approved by the shareholders or successfully implemented following
such approval.

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

                              74

<PAGE>

Our Articles of Incorporation authorize the issuance of up to 5,000,000 shares
of "blank check" preferred stock, with designations, rights, preferences,
privileges and restrictions determined by our Board of Directors. As a result,
our board of directors may, without further shareholder approval, issue
preferred stock with dividend, liquidation, conversion, voting or other rights
that could adversely affect the voting power or other rights of the holders of
the common stock. The Board of Directors could issue the preferred stock to
discourage, delay or prevent a change in control of Aquasearch, 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.

THE SALE OF A SUBSTANTIAL NUMBER OF SHARES OF OUR COMMON STOCK COULD CAUSE THE
MARKET PRICE OF OUR COMMON STOCK TO DECLINE.

As of October 31, 1999, we had 87,060,501 shares of common stock outstanding. Of
the shares outstanding, 45,412,217 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 such shares for sale will have on prevailing market
prices. However, substantial amounts of our common stock could be sold in the
public market, which may adversely affect prevailing market prices for the
common stock and could impair our ability to raise additional capital through
the sale of equity securities.

YEAR 2000 COMPLIANCE

We believe that our financial, operational and other information systems, with
limited modifications, will function properly with respect to dates in the year
2000 and thereafter. The Company has upgraded its accounting system and brought
its remaining systems and software into compliance. To date, the Company has not
incurred any material costs related to the assessment of, and efforts in
connection with, its Year 2000 issues and does not anticipate future
expenditures to have a material impact on its financial position or operating
results.

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

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

ITEM 7.  FINANCIAL STATEMENTS

                                75
<PAGE>

Audited balance sheets as of October 31, 1999, 1998, and 1997 and the related
statements of loss and accumulated deficit, cash flows and stockholders' equity
(deficit) for the years ended October 31, 1999, 1998 and 1997 (and from
inception to October 31, 1999) together with related notes and the report of
Ernst & Young LLP, independent auditors, appear on pages F-1 through F-23 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 1999 or 1998.

                              76

<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, 1999.
<TABLE>
<CAPTION>
------------------------------------------------- --------- -------------------------------------------------------
NAME                                                 AGE    POSITION
------------------------------------------------- --------- ----------------------------------------------------------
<S>                                                  <C>    <C>
Mark E. Huntley, Ph.D............................    49     President, Chief Executive Officer
                                                            and Chairman of the Board

Earl S. Fusato...................................    52     Chief Financial Officer, Secretary and Director

Martin Guerin....................................    38     Vice-President, Sales and Marketing

David G. Watumull................................    49     Executive Vice-President, Strategic
                                                            Development and Corporate Finance

Edward E. David, Ph.D............................    74     Director

Pearn P. Niiler, Ph.D............................    61     Director

David Tarnas.....................................    39     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.

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

                                77

<PAGE>

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 has served as our Executive Vice-President, Strategic
Development and Corporate Finance since July 1998. He is 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 and Principal of the Washington Advisory Group, a
science and technology consulting firm. Dr. David served as President of Exxon
Research and Engineering from 1977 to 1986; as Executive Vice President of
Research and Development of Gould Inc. and as President of Gould Laboratories
from 1973 to 1977; and as Executive Director of the Communications Systems
Division of Bell Laboratories from 1965 to 1970. Dr. David served as Science
Advisor to the President of the United States and Director of the White House
Office of Science and Technology from 1970 to 1973. Dr. David holds 12 honorary
degrees, has received numerous national awards and is a member of the National
Academy of Engineering and the National Academy of Sciences. Dr. David also
serves on the board of directors of the following companies: Spacehab, Inc.,
Intermagnetics General Corporation, InterVU, 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.

                                 78
<PAGE>

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. 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 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, 1999.

                                 79

<PAGE>

<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.,       1999          $  115,000           $  0         2,000,000
President and Chief           1998          $   67,083(1)        $  0             0
Executive Officer             1997          $        0(1)        $  0             0


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

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

(1)   Dr. Huntley has at all times during 1997, and 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.

OPTION GRANTS IN FISCAL 1999

The following table shows information regarding stock options granted to our
executive officers during the fiscal year ended October 31, 1999:

<TABLE>
<CAPTION>
                              NO. OF
                            SECURITIES   % OF TOTAL OPTIONS
                            UNDERLYING       GRANTED TO
                             OPTIONS     EMPLOYEES IN FISCAL    EXERCISE      EXPIRATION
  NAME AND POSITION          GRANTED            YEAR              PRICE          DATE
------------------------ --------------- ------------------- -------------- --------------
<S>                         <C>                  <C>              <C>          <C>

Mark E. Huntley, Ph.D.,     2,000,000            66%              $0.50        1/21/2006
President and Chief
Executive Officer

</TABLE>

STOCK OPTIONS EXERCISED DURING FISCAL YEAR

None of our executive officers or directors exercised stock options or stock
appreciation rights during the fiscal year ended October 31, 1999.

                                80

<PAGE>

FISCAL YEAR-END OPTION VALUES

The following table shows information regarding the value of unexercised options
held by executive officers as of October 31, 1999:

<TABLE>
<CAPTION>
                                    NUMBER OF SECURITIES UNDERLYING              VALUE OF UNEXERCISED IN-THE-MONEY
                                          UNEXERCISED OPTIONS                               OPTIONS (1)
                                -----------------------------------------     -----------------------------------------
      NAME AND POSITION             EXERCISABLE         UNEXERCISABLE             EXERCISABLE         UNEXERCISABLE
------------------------------- -------------------- --------------------     -------------------   -------------------
<S>                             <C>                  <C>                      <C>                   <C>
Mark E. Huntley, Ph.D.,              2,815,253             849,997                 $428,802                -0-
President and Chief
Executive Officer

David G. Watumull,                     312,000             760,000                  $21,840              $53,200
Executive Vice President
</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 30,
         1999 ($0.32) minus the exercise price.

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, 1999.

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:

     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. A total of 5,000,000 shares
of common stock have been reserved for issuance under the 1996 Stock Option
Plan, all of which are currently available for grant. The 1996 Stock Option Plan
is administered


                                      81
<PAGE>

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, 1999 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)
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                                SHARES
                                                              BENEFICIAL      NUMBER OF SHARES       BENEFICIALLY
DIRECTORS AND OFFICERS (1)                                     OWNERSHIP     BENEFICIALLY 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             6,866,519             7.6%


                                      82
<PAGE>

<CAPTION>                                                                                           PERCENTAGE OF
                                                               NATURE OF                                SHARES
                                                              BENEFICIAL      NUMBER OF SHARES       BENEFICIALLY
DIRECTORS AND OFFICERS (1)                                     OWNERSHIP     BENEFICIALLY OWNED       OWNED (1)
-----------------------------------------------------       --------------   ------------------   -------------------
<S>                                                         <C>              <C>                  <C>
Earl S. Fusato (3)
c/o Aquasearch, Inc.
73-4460 Queen Ka'ahumanu Highway, Suite 110
Kailua-Kona, Hawaii 96740.............................          Direct            10,731,727            11.9%

Pearn P. Niiler, Ph.D. (4)
c/o Aquasearch, Inc.
73-4460 Queen Ka'ahumanu Highway, Suite 110
Kailua-Kona, Hawaii 96740.............................          Direct             2,654,735             3.0%

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               147,605              *

David Tarnas
c/o Aquasearch, Inc.
73-4460 Queen Ka'ahumanu Highway, Suite 110
Kailua-Kona, Hawaii 96740.............................             --                     --              --

All directors and executive officers as a group
   (7 persons) (8)....................................                            21,162,586            22.1%


<CAPTION>

5% SHAREHOLDERS
-----------------------------------------------------------
<S>                                                         <C>              <C>                  <C>
Jean Sawyer Weaver Trust, Jean S. Weaver, Trustee (9)
c/o Aquasearch, Inc.
73-4460 Queen Ka'ahumanu Highway, Suite 110
Kailua-Kona, Hawaii 96740.............................          Direct             7,541,223             8.6%

Gregory F. Kowal (10)
900 Fort  Street, #950
Honolulu, Hawaii 96822................................          Direct            10,291,199            11.6%

Lance S. & Elaine Nakamura (11)
c/o Aquasearch, Inc.
73-4460 Queen Ka'ahumanu Highway, Suite 110
Kailua-Kona, Hawaii 96740.............................          Direct             6,074,384             6.5%
</TABLE>

*        Less than one percent

(1)      Applicable percentage of beneficial ownership is based on 87,060,501
         shares outstanding as of October 31, 1999. 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, 1999 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


                                      83
<PAGE>

         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, 1999. Also includes options to purchase 1,183,333 shares at an
         exercise price of $0.50 per share that are exercisable within 60 days
         of October 31, 1999.
(3)      Includes options to purchase 875,000 shares and 1,000,000 shares of
         common stock at an exercise price of $0.36 and $1.00 per share,
         respectively, that are exercisable within 60 days of October 31, 1999
         and warrants to acquire 115,384 and 1,138,713 shares of common stock at
         $1.00 and $0.50 per share, respectively, that are immediately
         exercisable.
(4)      Includes options to purchase 1,291,050 shares of common stock at an
         exercise price of $0.0625 per share, with a term of seven years,
         payable by a promissory note payable over 3 years with interest at 5%
         per annum that are exercisable within 60 days of October 31, 1999. Also
         includes options to purchase 628,333 shares at an exercise price of
         $0.50 per share that are exercisable within 60 days of October 31,
         1999.
(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.
(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 21,667 shares at an exercise price of $0.25 per share that
         are exercisable within 60 days of October 31, 1999.
(8)      See notes 2-7 above.
(9)      Includes warrants to acquire 1,100,000 shares of common stock at
         $0.50 per share that are immediately exercisable.
(10)     Includes warrants to acquire 476,190, 650,000 and 750,000 shares of
         common stock at $1.00, $0.50 and $0.40 per share, respectively, that
         are immediately exercisable.
(11)     Includes warrants to acquire 261,363 and 750,000 shares of common stock
         at $1.00 and $0.50 per share, respectively, that are immediately
         exercisable.


ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

During the period from June 1997 to October 31, 1999, we raised $6,139,800
through the private placement of convertible notes. These convertible notes bear
interest at 10 percent per annum, have a term of one year and are convertible
into shares of common stock. Upon conversion of the notes, each note holder will
receive warrants to purchase 1,000 shares of common stock for each $1,000
aggregate principal amount of convertible notes purchased. Earl S. Fusato, our
Chief Financial Officer, Secretary and a member of our Board of Directors, and
his wife, Mae Fusato, as Trustee of the Mae H. Fusato Revocable Trust,
participated in the private placement and purchased $2,030,000 worth of the
notes. In addition, Lance S. and Elaine Nakamura, and Gregory Kowal, the
beneficial owners of over 5% of our common stock, purchased $750,000 and
$150,000 worth of notes, respectively.

During the year ended October 31, 1999, Gregory Kowal purchased 5,000,000 shares
of our common stock at $0.15 per share. In connection with the purchase Mr.
Kowal received 750,000 warrants with an exercise price of $0.40 per share.

In July 1998, we entered into a 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 and interest payments during the life of
the loan. The promissory note has an interest rate of 9 percent per annum and is
secured by Mr. Watumull's common stock options.

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

During the period from October 1996 to April 1997, the Company sold an aggregate
of 5,044,570 Units, consisting of one share of Common Stock and one Common Stock
Purchase Warrant (the "Warrants"), in a private placement under Section 4(2) of
the Securities Act of 1933, as amended. During the course of


                                      84
<PAGE>

the private placement, the Earl S. Fusato Revocable Living Trust purchased
115,384 Units at $0.26 per Unit. The Warrants have a term of three years and
are exercisable at $1.00 per share, subject to adjustment. The Warrants are
redeemable by the Company at $0.01 per Warrant during their three-year
exercise period upon 30 days' notice anytime that the closing bid price per
share of the Common Stock exceeds $1.50 per share (subject to adjustment) for
20 trading days out of 30 consecutive trading days ending on the third day
prior to the date of the notice of redemption. The gross proceeds from this
offering were $1,275,980.

ITEM 13.  EXHIBITS AND REPORTS ON FORM 8-K

EXHIBITS

3.1*     Articles of Incorporation of Registrant

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

3.3*     By-laws of Registrant


4.1+     Form of 1996 Bridge Loan Note


4.2+     Form of 1997 Private Placement Warrant


4.3++    Form of 1998 Convertible Note


4.4++    Form of 1998 Warrant


4.5++    Form of 1998 Note and Warrant Purchase Agreement


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

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

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

10.5##   Amendment to Distribution and Development Agreement between Cultor Ltd.
         and Aquasearch, dated June 14, 1999

27.1     Financial Data Schedule


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

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

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

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


                                      85
<PAGE>

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

##       Incorporated by reference to the exhibit filed with Amendment No. 1 to
         the Company's Registration Statement on Form SB-2 filed November 9,
         1999.

REPORTS ON FORM 8-K

No reports were filed during the last quarter of the year ended October 31,
1999.


                                   SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has
duly caused this Annual Report on Form 10KSB to be signed on January 28, 2000,
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                                            January 28, 2000
--------------------------------------------
Mark E. Huntley, Ph.D.
Director, President, CEO & Chairman of the Board of Directors


/s/ PEARN P. NIILER                                            January 28, 2000
--------------------------------------------
Pearn P. Niiler, Ph.D.
Director


/s/ EARL S. FUSATO                                            January 28, 2000
--------------------------------------------
Earl S. Fusato
Director, Chief Financial Officer


/s/ EDWARD E. DAVID                                            January 28, 2000
--------------------------------------------
Edward E. David, Ph.D.
Director


/s/ DAVID TARNAS                                               January 28, 2000
--------------------------------------------
David Tarnas
Director
</TABLE>
                                          86

<PAGE>

                              FINANCIAL STATEMENTS

                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                                    Contents

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

Audited Financial Statements:

Balance Sheets as of October 31, 1999, 1998 and 1997...........................................F-3

Statements of Loss and Accumulated Deficit from Inception to October 31, 1999
   and for the Years Ended October 31, 1999,
   1998 and 1997...............................................................................F-4

Statements of Cash Flows from Inception to October 31, 1999
   and for the Years Ended October 31, 1999, 1998 and 1997.....................................F-5

Statements of Stockholders' Equity (Deficit) from Inception to
   October 31, 1999............................................................................F-6

Notes to Financial Statements.................................................................F-10
</TABLE>
                                       F-1

<PAGE>

                         REPORT OF INDEPENDENT AUDITORS

The Board of Directors
Aquasearch, Inc.

We have audited the accompanying balance sheets of Aquasearch, Inc. (a
development stage enterprise) as of October 31, 1999, 1998 and 1997, 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, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits. The financial
statements as of and for the period from inception to October 31, 1995, were
audited by other auditors whose report dated December 2, 1995 except for Note
5 dated January 26, 1996, and Note 8 dated April 6, 1997, expressed an
unqualified opinion on those statements. The financial statements for the
period from inception to October 31, 1995 include no revenues and a net loss
of $1,650,786. Our opinion on the statements of loss and accumulated deficit,
cash flows, and stockholders' equity (deficit) for the period from inception
to October 31, 1999, insofar as it relates to amounts for prior periods
through October 31, 1995, is based solely on the report of the other auditors.

We conducted our audits in accordance with 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 and the report of other auditors provide a reasonable basis for our
opinion.

In our opinion, based on our audits and the report of other auditors, the
financial statements referred to above present fairly, in all material
respects, the financial position of Aquasearch, Inc. (a development stage
enterprise) as of October 31, 1999, 1998 and 1997, and the results of its
operations and its cash flows for the years then ended and the period from
inception to October 31, 1999, in conformity with accounting principles
generally accepted in the United States.

As disclosed in Note 4 to the financial statements, the Company has restated
its 1998 and 1997 financial statements to recognize the discount associated
with the issuance of notes convertible to common stock at a discount to the
market price of the stocks.

As discussed in Note 1 to the financial statements, the Company's recurring
losses from operations and working capital deficit at October 31, 1999 raise
substantial doubt about its ability to continue as a going concern. The
October 31, 1999 financial statements do not include any adjustments that
might result from the outcome of this uncertainty.

                                                  /s/ Ernst & Young LLP

Honolulu, Hawaii
January 27, 2000

                                       F-2

<PAGE>

                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                                 BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                           October 31
                                                    ---------------------------------------------------------
                                                                              1998              1997
                                                                         (as restated)      (as restated)
                                                           1999             (NOTE 4)          (NOTE 4)
                                                    ---------------------------------------------------------
<S>                                                   <C>                <C>               <C>
Assets
Current assets:

   Cash                                               $         90,522   $        151,473  $         47,006
   Accounts receivable                                          24,300                  -             1,219
   Prepaid expenses                                             11,507             48,703            24,439
   Refundable deposits                                           3,053              3,081             4,570
                                                    ---------------------------------------------------------
Total current assets                                           129,382            203,257            77,234

Note receivable from officer (NOTE 5 )                          50,000             50,000                 -
Plant and equipment:
   Plant                                                     2,795,258          2,519,044           738,889
   Equipment                                                 1,060,348            167,203           173,052
   Less accumulated depreciation                              (413,244)          (201,292)         (104,894)
                                                    ---------------------------------------------------------
Net plant and equipment                                      3,442,362          2,484,955           807,047
                                                    ---------------------------------------------------------
Total assets                                          $      3,621,744   $      2,738,212  $        884,281
                                                    =========================================================

Liabilities and stockholders' equity (deficit)
Current liabilities:
   Accounts payable                                   $      1,136,795   $      1,099,829  $        461,344
   Notes payable (NOTE 4)                                      170,000            300,000           200,000
   Notes payable to officer (NOTE 4 )                        1,830,000            265,000           360,000
                                                    ---------------------------------------------------------
Total current liabilities                                    3,136,795          1,664,829         1,021,344

Stockholders' equity (deficit):
   Preferred stock (5,000,000 shares authorized)
     (NOTE 1)                                                        -                  -                 -
   Common stock ($0.0001 par value, 100,000,000
     shares authorized, 87,060,501, 68,564,013 and
     47,819,881 shares outstanding at October 31,
     1999, 1998 and 1997, respectively) (NOTE 10 )               9,829              7,979             5,904
   Additional paid-in capital                               12,262,839          8,784,120         4,798,294
   Notes receivable (NOTE 3)                                   (58,133)           (59,696)          (30,516)
   Deficit accumulated during the development stage        (11,729,586)        (7,659,020)       (4,910,745)
                                                    ---------------------------------------------------------
Total stockholders' equity (deficit)                           484,949          1,073,383          (137,063)
                                                    ---------------------------------------------------------

Total liabilities and stockholders' equity (deficit)  $      3,621,744`  $      2,738,212  $        884,281
                                                    =========================================================
</TABLE>
SEE ACCOMPANYING NOTES.

                                       F-3

<PAGE>

                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                   STATEMENTS OF LOSS AND ACCUMULATED DEFICIT

<TABLE>
<CAPTION>
                                              From inception               For the years ended October 31,
                                              to October 31,   ---------------------------------------------------------
                                                   1999               1999               1998              1997
                                                                                    (as restated)      (as restated)
                                                                                       (NOTE 4)           (NOTE 4)
                                           ----------------------------------------------------------------------------
<S>                                          <C>                <C>                <C>               <C>
Operations

Sales                                        $        11,077    $             -    $             -   $         1,077
Cost of sales                                         23,464                  -                  -             2,238
                                           ----------------------------------------------------------------------------
Gross loss from operations                           (12,387)                 -                  -            (1,161)
Research and development costs                     4,783,018          1,695,448          1,166,766           793,770
General and administrative expenses                5,441,995          1,772,627            964,120         1,072,051
                                           ----------------------------------------------------------------------------
Loss from operations                             (10,237,400)        (3,468,075)        (2,130,886)       (1,866,982)

Other income (expense)

Interest                                          (1,374,215)          (653,172)          (617,037)          (94,359)
Other                                                 43,627             50,681               (352)             (686)
Investment in joint venture                         (147,096)                 -                  -                 -
                                           ----------------------------------------------------------------------------
Total other income (expense)                      (1,477,684)          (602,491)          (617,389)          (95,045)
                                           ----------------------------------------------------------------------------
Loss before income taxes and extraordinary
  item                                           (11,715,084)        (4,070,566)        (2,748,275)       (1,962,027)
Extraordinary item - loss on write down of
  assets to liquidation basis                        (14,502)                 -                  -                 -
                                           ----------------------------------------------------------------------------
Net loss                                     $   (11,729,586)   $    (4,070,566)   $    (2,748,275)  $    (1,962,027)
                                           ============================================================================

Loss per share                               $         (0.39)   $         (0.05)   $         (0.05)  $         (0.04)
                                           ----------------------------------------------------------------------------
Weighted average shares outstanding               29,987,669         76,375,752         52,697,095        44,646,653
                                           ============================================================================
</TABLE>
SEE ACCOMPANYING NOTES.

                                                   F-4
<PAGE>


                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                            STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                              From inception
                                              to October 31,                For the years ended October 31,
                                                    1999               1999              1998              1997
                                                                                    (as restated)      (as restated)
                                                                                       (NOTE 4)          (NOTE 4)
                                            ----------------------------------------------------------------------------
<S>                                         <C>                  <C>                <C>               <C>
Cash flows from operating activities:
Net loss                                      $   (11,729,586)   $    (4,070,566)   $    (2,748,275)  $    (1,962,027)
Adjustments to reconcile net loss to net
   cash used in operating activities:
    Depreciation                                      413,244            241,881             96,398            69,018
    Expenses paid with common stock                   955,139             41,981            157,839           311,154
    Discount on convertible notes payable
       (NOTE 4)                                     1,083,494            488,788            495,882            98,824
    Changes in:
       Other current assets                           (14,560)            37,224            (22,775)          (20,330)
       Receivables                                    (24,300)           (24,300)             1,219               714
       Accounts payable                             1,136,795             36,966            638,485           (19,821)
       Deposits held                                        -                  -                  -          (460,980)
                                            ----------------------------------------------------------------------------
Cash used in operating activities                  (8,179,774)        (3,248,026)        (1,381,227)       (1,983,448)

Cash flows used in investing activities:
Purchases of fixed assets                          (3,855,606)        (1,199,288)        (1,774,306)         (166,883)
                                            ----------------------------------------------------------------------------
Cash used in investing activities                  (3,855,606)        (1,199,288)        (1,774,306)         (166,883)

Cash flows from financing activities:
Cash released from escrow                                   -                  -                  -           460,980
Decrease (increase) in notes receivable               (48,437)             1,563            (50,000)                -
Proceeds from issuance of common stock              5,441,458            750,000            500,000         1,289,613
Proceeds from notes payable                         7,004,800          3,634,800          2,810,000           425,000
Offering costs                                       (271,919)                 -                  -          (165,422)
                                            ----------------------------------------------------------------------------
Cash provided by financing activities              12,125,902          4,386,363          3,260,000         2,010,171
                                            ----------------------------------------------------------------------------

Net increase (decrease) in cash                        90,522            (60,951)           104,467          (140,160)
Cash, beginning of the period                               -            151,473             47,006           187,166
                                            ----------------------------------------------------------------------------
Cash, end of the period                       $        90,522    $        90,522    $       151,473   $        47,006
                                            ============================================================================

Supplemental disclosure of cash
   flow information:

       Non-cash financing transactions:

          Conversion of convertible notes
               payable to common stock        $     5,004,800    $     2,199,800    $     2,805,000   $             -
</TABLE>

SEE ACCOMPANYING NOTES.


                                     F-5
<PAGE>


                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                  STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

                       FROM INCEPTION TO OCTOBER 31, 1999

<TABLE>
<CAPTION>
                                                                              Common Stock
                                    ---------------------------------------------------------------------------------------------
                                                                     Additional                                       Total
                                                                      Paid-in           Notes     Accumulated   Stockholders'
                                    Number of Shares   Amount         Capital         Receivable    Deficit   Equity (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 unit)                        4,000,000       400         166,291               -                -         166,691
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
                                    ---------------------------------------------------------------------------------------------
                                                                     Additional                                       Total
                                                                      Paid-in           Notes     Accumulated   Stockholders'
                                    Number of Shares   Amount         Capital         Receivable    Deficit   Equity (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
   ($0.08 per share)                         861,900         87          69,315               -               -          69,402
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>


                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

            STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (CONTINUED)

<TABLE>
<CAPTION>
                                                                              Common Stock
                                    ---------------------------------------------------------------------------------------------
                                                                       Additional                                      Total
                                                                        Paid-in          Notes        Accumulated  Stockholders'
                                    Number of Shares     Amount         Capital        Receivable       Deficit   Equity (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 (NOTE 4)                                -          -          98,824               -               -          98,824
Loss for the year ended October 31,
   1997                                            -          -               -               -      (1,962,027)     (1,962,027)
                                    ---------------------------------------------------------------------------------------------
Balance, October 31, 1997
   (as restated) (NOTE 4)                 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>


                                AQUASEARCH, INC.

                        (A DEVELOPMENT STAGE ENTERPRISE)

            STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (CONTINUED)

<TABLE>
<CAPTION>
                                                                              Common Stock
                                    ---------------------------------------------------------------------------------------------
                                                                       Additional                                     Total
                                                                        Paid-in          Notes        Accumulated  Stockholders'
                                    Number of Shares     Amount         Capital        Receivable       Deficit  Equity (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
   (as restated) (NOTE 4)               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
                                    ---------------------------------------------------------------------------------------------
                                    ---------------------------------------------------------------------------------------------
</TABLE>

SEE ACCOMPANYING NOTES.

                                     F-9
<PAGE>


                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                          NOTES TO FINANCIAL STATEMENTS

                         OCTOBER 31, 1999, 1998 AND 1997

1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

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

Aquasearch's first commercial product is astaxanthin, a naturally occurring red
pigment derived from a freshwater microalgae. Currently, the primary market for
astaxanthin is in animal feeds. During the next year, the Company plans on
initiating sales of astaxanthin as a human dietary supplement or nutraceutical.
In June 1999 the Company completed the expansion of its research and development
facility to include a three-acre production and processing plant. During the
four months ended October 31, 1999 the Company began selling small amounts of
astaxanthin in the animal feeds market.

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

BASIS OF PRESENTATION

The Company's financial statements have been presented on the basis that it is
able to continue as a going concern, which contemplates the realization of
assets and the satisfaction of liabilities in the normal course of business. The
Company has incurred operating losses since inception totaling approximately
$11.7 million. At October 31, 1999, the Company had a working capital deficit of
approximately $3 million. During the year ended October 31, 1999, the Company
sold additional shares of stock through the issuance of convertible notes, which
were sufficient to fund its immediate operating financial needs.

The Company currently projects that it will require approximately $3 million in
operating capital in fiscal 2000, before any planned capital expenditures. The
Company is presently pursuing additional sources of capital in order to finance
its operations in fiscal 2000. These capital sources include equity and debt
financing, product sales, license agreements, and government contracts and
grants.

                                F-10

<PAGE>


                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)

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

BASIS OF PRESENTATION (CONTINUED)

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.

CASH EQUIVALENTS

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

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, 1999.

STOCK ISSUED FOR SERVICES

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-11

<PAGE>

                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)


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.

LOSS PER SHARE

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 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 and accounts payable, are deemed to
approximate fair value due to their short-term nature. The carrying amounts
of the Company's notes payable approximate their 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 1999
presentation.

2. COMMON STOCK AND COMMON STOCK WARRANTS

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

                             F-12

<PAGE>

                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)


2. COMMON STOCK AND COMMON STOCK WARRANTS (CONTINUED)

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

In October 1997, the Company issued 1,303,435 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 is reflected in general and
administrative expenses for the year ended October 31, 1997.

In November 1996, the Company executed a letter of intent with C. Brewer and
Company, Limited (C. Brewer) with respect to the acquisition of between 80 and
90 acres of property on the Big Island of Hawaii valued at between $900,000 and
$1,000,000 in exchange for C. Brewer's acquisition of approximately 6% of the
outstanding common stock of the Company. In connection with this transaction, C.
Brewer would acquire a warrant to purchase up to 500,000 shares of the Company's
common stock at an exercise price of $1.25 per share. This transaction has not
been consummated as of October 31, 1999.

                            F-13

<PAGE>

                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)


2. COMMON STOCK AND COMMON STOCK WARRANTS (CONTINUED)

Shares of common stock issuable upon exercise of outstanding warrants, options
and convertible notes payable as of October 31, 1999 are as follows:
<TABLE>
<S>                                                                        <C>
      Stock options granted to current and former directors, executive
        officers, employees and consultants (Note 3)                         13,776,238
      Warrants outstanding:
        @ $0.21                                                                  25,974
        @ $0.40                                                                 750,000
        @ $0.50                                                               5,646,513
        @ $1.00                                                               5,347,244
      Shares issuable upon conversion of outstanding convertible notes
        payable                                                               7,046,689
      Warrants (@ $0.50) issuable upon conversion of outstanding
        convertible notes payable (Note 4)                                    1,135,000
                                                                           -------------
                                                                             33,727,658
                                                                           =============
</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. A total of 5,000,000 shares of the Company's common
stock has been reserved for issuance under the plan. Terms of awards under the
plan including vesting requirements, exercise prices and expiration dates are
determined at the discretion of the Board of Directors. The plan terminates in
March 2006.

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

                                F-14

<PAGE>

                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)


3. COMMON STOCK OPTIONS (CONTINUED)

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.

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

                             F-15

<PAGE>

                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                     NOTES TO FINANCIAL STATEMENTS (CONTINUED)


3. COMMON STOCK OPTIONS (CONTINUED)

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.

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.

Pro forma information regarding net income and earnings per share is required by
Statement 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of that statement. The fair
value for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions:

<TABLE>
<CAPTION>
                                                  1999         1998        1997
                                            --------------------------------------
      <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                         0.47         0.58         0.63

</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.

                             F-16

<PAGE>

                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                     NOTES TO FINANCIAL STATEMENTS (CONTINUED)


3. COMMON STOCK OPTIONS (CONTINUED)

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

<TABLE>
<CAPTION>
                                               1999           1998           1997
                                          ---------------------------------------------
       <S>                                <C>              <C>            <C>
       Net loss:
          As reported                       $  4,070,566   $  2,748,275   $  1,962,027
          Pro forma                         $  4,217,830   $  2,855,215   $  2,214,068
       Loss per share:
          As reported                       $       0.05   $       0.05   $       0.04
          Pro forma                         $       0.06   $       0.05   $       0.05
</TABLE>

A summary of the Company's stock option activity, and related information for
the years ended October 31, 1999, 1998 and 1997 follows:
<TABLE>
<CAPTION>
                                           1999                       1998                     1997
                                 --------------------------  ------------------------ -----------------------
                                               Wtd-Avg                    Wtd-Avg                  Wtd-Avg
                                               Ex Price                   Ex Price                 Ex Price
                                    Options                     Options                  Options
                                 --------------------------  ------------------------ -----------------------
<S>                              <C>           <C>            <C>          <C>        <C>           <C>
Outstanding, beginning of year     9,883,751   $  0.27         9,970,263   $ 0.26       6,357,462   $ 0.11
Granted                            4,213,716      0.43           460,350     0.25       4,298,817     0.47
Exercised                                  -         -          (466,862)    0.06        (488,250)    0.06
Forfeited                           (321,229)     0.24           (80,000)    0.25        (197,766)    0.26
                                 -------------                ------------            -------------
Outstanding, end of year          13,776,238   $  0.32         9,883,751   $ 0.27       9,970,263   $ 0.26
                                 ==============               ============            =============

Exercisable, end of year           9,849,858   $  0.31         7,313,000   $ 0.22       7,191,000   $ 0.20

</TABLE>

Common stock options of 466,862 and 463,250 exercised during the years ended
October 31, 1998 and 1997, respectively, were in exchange for three-year notes
receivable bearing interest at 5 percent per annum. The note balances of
$58,133, $59,696 and $30,516 at October 31, 1999, 1998 and 1997, respectively,
are presented in stockholders' equity (deficit).

                              F-17

<PAGE>

                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                     NOTES TO FINANCIAL STATEMENTS (CONTINUED)


3. COMMON STOCK OPTIONS (CONTINUED)

Weighted-average exercise prices and fair values of options issued during the
years ended October 31, 1999, 1998 and 1997 with exercise prices which equaled
or exceeded the market prices of the Company's stock on the grant date follows:
<TABLE>
<CAPTION>
                                   1999                        1998                        1997
                       ---------------------------  --------------------------- ----------------------------
                                   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            250,000   $ 0.28  $ 0.25          -     $  -     $  -    2,081,817   $  0.33  $ 0.20
Options whose
  exercise price
  exceeded the
  market price of
  the stock on the
  grant date            3,963,716   0.44    0.05      460,350    0.25    0.12    2,217,000      0.59    0.07
                        ---------                     -------                    ---------
Options issued
  during the year       4,213,716                     460,350                    4,298,817
                        =========                     =======                    =========
</TABLE>

The following summarizes information about the Company's stock options
outstanding at October 31, 1999:

<TABLE>
<CAPTION>
                                    Options Outstanding                          Options Exercisable
                      -------------------------------------------------  -------------------------------------
                                           Wtd-Ave
                                          Remaining        Wtd-Ave                                Wtd-Ave
  Range of Exercise                      Contractual       Exercise                               Exercise
        Prices             Number           Life            Price         Number                   Price
 ----------------------------------------------------------------------  -------------------------------------
 <S>                  <C>                 <C>              <C>           <C>                   <C>
 $0.06 to $0.22           5,365,728       3.7 years        $  0.08        4,927,026             $   0.07
 $0.25 to $0.36           3,675,510          6.7              0.30        1,557,829                 0.31
 $0.50 to $1.00           4,735,000          6.2              0.61        3,365,003                 0.66
                      -----------------                                  ------------------
                         13,776,238                                       9,849,858
                      =================                                  ==================
</TABLE>

                                  F-18

<PAGE>

                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                     NOTES TO FINANCIAL STATEMENTS (CONTINUED)


4. NOTES PAYABLE

Notes payable consisted of the following as of October 31:
<TABLE>
<CAPTION>
                                                              1999                1998               1997
                                                        ------------------ ------------------- ------------------
     <S>                                                  <C>                <C>                <C>
     One-year convertible notes, unsecured, bearing
       interest at 10% per annum payable at the earlier
       of conversion or maturity                          $     130,000      $     300,000      $     200,000

     60 day short-term bridge financing note,
       unsecured, bearing interest at 10% per annum
       payable at maturity                                       40,000                  -                  -
                                                        ------------------ ------------------- ------------------
     Total notes payable                                  $     170,000      $     300,000      $     200,000
                                                        ================== =================== ==================

     One-year convertible notes payable to an officer
       of the Company, unsecured, bearing interest at
       10% per annum payable at the earlier of
       conversion or maturity                             $   1,005,000      $     265,000      $     360,000

     One-year notes payable to an officer of the
       Company, unsecured, bearing interest at 10% per
       annum payable at maturity                                825,000                  -                  -
                                                        ------------------ ------------------- ------------------
     Total notes payable to officer                       $   1,830,000      $     265,000      $     360,000
                                                        ================== =================== ==================

</TABLE>

Interest expense incurred on the above notes totaled approximately $160,000,
$120,000 and $12,000 for the years ended October 31, 1999, 1998 and 1997,
respectively.

During the period from June 1997 to October 31, 1999 the Company issued a
total of approximately $6.1 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 at $0.50 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.

                              F-19
<PAGE>

                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                     NOTES TO FINANCIAL STATEMENTS (CONTINUED)



4. NOTES PAYABLE (CONTINUED)

The following summarizes convertible notes payable transactions during the three
years ended October 31, 1999:

<TABLE>
<CAPTION>
                                                                                       Upon Conversion
                                                           Principal      --------------------------------------
                                                           Amount of            Number of         Number of
                                                             Notes            Shares Issued       Warrants
                                                       ------------------ --------------------------------------
    <S>                                                <C>                      <C>                 <C>
    Balance at October 31, 1996                          $           -
    Convertible notes sold                                     200,000
                                                       ------------------
    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
                                                       ==================
</TABLE>

The following summarizes convertible notes payable to officer transactions
during the three years ended October 31, 1999:
<TABLE>
<CAPTION>
                                                                                       Upon Conversion
                                                           Principal      --------------------------------------
                                                           Amount of            Number of         Number of
                                                             Notes            Shares Issued       Warrants
                                                       ------------------ --------------------------------------
    <S>                                                <C>                      <C>               <C>
     Balance at October 31, 1996                         $             -
     Convertible notes sold                                      360,000
                                                       -------------------
     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
                                                       ===================
</TABLE>

                             F-20

<PAGE>

                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                     NOTES TO FINANCIAL STATEMENTS (CONTINUED)


4. NOTES PAYABLE (CONTINUED)

The Company has restated its financial statements for the years ended October
31, 1998 and 1997 to recognize the discount and related expense 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 for convertible notes issued during those years. The impact of the
aforementioned on the Company's financial statements for the years ended
October 31, 1998 and 1997 was as follows:

<TABLE>
<CAPTION>
                                                  October 31, 1998                    October 31, 1997
                                         ----------------------------------- -----------------------------------
                                          As originally                       As originally
                                            reported         As restated        reported         As restated
                                         ----------------- ----------------- ----------------- -----------------
   <S>                                     <C>               <C>               <C>               <C>
   Balance sheet:

     Additional paid-in capital            $   8,189,414     $  8,784,120      $   4,699,470     $  4,798,294
     Deficit accumulated during the
      development stage                       (7,064,314)      (7,659,020)        (4,811,921)      (4,910,745)
   Statement of loss and accumulated
     deficit:
     Interest income (expense)                  (121,155)        (617,037)             4,465          (94,359)
     Net loss                                 (2,252,393)      (2,748,275)        (1,863,203)      (1,962,027)
     Loss per share                                (0.04)           (0.05)             (0.04)           (0.04)
</TABLE>

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).

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

                             F-21

<PAGE>

                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                     NOTES TO FINANCIAL STATEMENTS (CONTINUED)


5. RELATED PARTY TRANSACTIONS (CONTINUED)

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

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

6. INCOME TAXES

Since its formation the Company has incurred net operating losses. As of October
31, 1999, the Company had a net operating loss carryforward available to offset
future taxable income for federal and state income tax purposes of approximately
$9.5 million. The net operating loss carryforward for tax reporting purposes
expires in the years from 1999 to 2019. The Company also has a research credit
carryover approximating $200,000 which expires between the years 2003 and 2019.

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. (See Note 9)

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-22

<PAGE>

                                AQUASEARCH, INC.
                        (A DEVELOPMENT STAGE ENTERPRISE)

                     NOTES TO FINANCIAL STATEMENTS (CONTINUED)


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

In July 1998, Cyanotech filed a complaint in the United States District Court
for the District of Hawaii against the Company. In the complaint, Cyanotech
sought declaratory judgment of noninfringement of the Company's U.S. Patent No.
5,541,056; invalidity of the patent; and non-misappropriation of the Company's
trade secrets relating to closed culture production of astaxanthin. Cyanotech
filed the complaint after the Company expressed to Cyanotech its concern that
Cyanotech's use of closed system technology may violate its patent and
constitute misappropriation of trade secrets.

In September 1998, the Company filed an answer denying all of Cyanotech's
allegations and a counter claim, alleging infringement of its patent;
misappropriation of trade secrets; unfair competition; and breach of contract
relative to its 1994 Dissolution Agreement with Cyanotech (See Note 7).

On December 30, 1999, the United States District Court for the District of
Hawaii granted summary judgment in favor of the Company on its claims that
Cyanotech infringed its patent, misappropriated the Company's trade secrets, and
breached the terms of the 1994 Dissolution Agreement. Additionally, the Court
denied Cyanotech's motion for partial summary judgment of noninfringement and
patent invalidity.

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

The Company has not accrued or reflected any amounts related to the dispute in
the accompanying financial statements.

10. SUBSEQUENT EVENT

On December 27, 1999 the shareholders of the Company approved an amendment to
the Company's Articles of Incorporation to increase the number of shares of
authorized common stock of the Company from 100,000,000 shares to 150,000,000
shares.

                                F-23