<PAGE>

                                                                    EXHIBIT 13.1

                                  GALAGEN INC.
                         INDEX TO FINANCIAL INFORMATION
                                      1999

<TABLE>
<CAPTION>
                                                                                                                     PAGE
                                                                                                                     ----
<S>                                                                                                                <C>
Management's Discussion and Analysis of Financial Condition and Results of Operations..............................     1
Quantitative and Qualitative Disclosures About Market Risk.........................................................     5
Balance Sheets.....................................................................................................     6
Statements of Operations...........................................................................................     7
Statements of Changes in Stockholders' Equity......................................................................     8
Statements of Cash Flows...........................................................................................     9
Notes to Financial Statements......................................................................................    10
Report of Independent Auditors.....................................................................................    20
Selected Financial Data............................................................................................    22
Market for Registrant's Common Equity and Related Stockholder Matters..............................................    23
</TABLE>

<PAGE>

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

FORWARD-LOOKING STATEMENTS

         The information presented in this Annual Report to Stockholders for
the year ended December 31, 1999 (the "Annual Report") contains
forward-looking statements within the meaning of the safe harbor provisions
of Section 21E of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). Such statements are subject to risks and uncertainties,
including those discussed below under "Disclosure Regarding Forward-Looking
Statements" and in the Company's Annual Report on Form 10-K for the year
ended December 31, 1999 ("Form 10-K") under "Risk Factors", that could cause
actual results to differ materially from those projected. Because actual
results may differ, readers are cautioned not to place undue reliance on
these forward-looking statements.

GENERAL

         GalaGen's mission is to become the leading presence in foods,
beverages and dietary supplements that help enhance the immune system and to
take advantage of all of colostrum's benefits. A critical factor for success
of the Company is its immune-enhancing ingredient which has been branded
Proventra-TM- Brand Natural Immune Components ("Proventra"). Proventra is
derived from colostrum, the highly nutritious first milk from a dairy cow
after its calf is born. The primary components found in Proventra are
naturally occurring broad spectrum antibodies or specialized proteins that
enhance the body's own immune system to provide protection against harmful
micro-organisms. Additional immune-enhancing components found in Proventra
include lactoperoxidase, lactoferrin, growth factors and other substances to
bolster the body's resistance.

         The Company, in conjunction with strategic partners, continues to
expand applications for its technology and is developing a portfolio of
Proventra-based products that target the needs of consumers and the
healthcare market.

         The Company, in conjunction with Land O' Lakes, has worked with a
marketing testing firm to develop a yogurt containing Proventra. The Company
believes that the future success of a Proventra yogurt product will be
enhanced by continuing to follow its strategy of introduction of products
through large market leaders. Accordingly, the Company has obtained rights
from Land O'Lakes to pursue an alliance with major yogurt manufacturers. The
Company is currently exploring alliance relationships with these major
companies and any yogurt product introductions will be dependent upon
successful completion of a yogurt license agreement.

         In 1998, the Company entered into a collaboration and license
agreement and a manufacturing and supply agreement with Wyeth-Ayerst
Laboratories ("Wyeth-Ayerst"), a division of American Home Products
Corporation. The two companies will develop and commercialize a proprietary
ingredient with unique antibacterial properties for use in pediatric formula
and other nutritional products. The collaboration, during the research and
development phase of the product, will be funded by Wyeth-Ayerst through
payments to the Company.

         In January 1999, the Company entered into a collaboration agreement
with General Nutrition Corporation, Inc. for product development,
manufacturing, supply and retail marketing of its Proventra. The agreement
calls for the two companies to develop and market a range of immune-enhancing
dietary supplements and nutrition formulas.


                                       1
<PAGE>

         In March 1999, the Company entered into an agreement with Tropicana
Products, Inc., a division of PepsiCo Inc. Under this agreement, the two
companies will explore development of nutritious beverages for the
health-conscious consumer. See Note 5 to the Financial Statements.

         In March 1999, the Company also entered into a licensing and
distribution agreement with Hormel Health Labs ("HHL"), a wholly-owned
subsidiary of Hormel Foods Corporation. HHL licensed the manufacturing and
distribution rights for a new, clinically tested, cultured dairy beverage the
Company developed to improve the gastrointestinal health of patients in
hospitals and nursing homes. The product includes a patented ingredient
combination and will also incorporate the Company's Proventra.

         In July 1999, the Company licensed its line of critical care
nutrition products, previously acquired from NM Holdings, Inc. ("NMI"), to
HHL. The licensing agreement granted HHL worldwide rights to manufacture,
distribute, market and sell the Company's critical care products. Under the
terms of the agreement HHL will pay royalties, subject to an annual minimum
royalty, to the Company based upon net sales of the specified products. HHL
commenced selling the Company's critical care products on a limited basis in
September 1999, and on an exclusive basis effective October 1999.

         In October 1999, the Company entered into a collaborative licensing
agreement with Novartis Consumer Health Inc. ("Novartis") whereby the Company
granted Novartis certain rights to defined Proventra technology. Also in
October, the Company and Novartis entered into a supply agreement for which
the Company will supply the Proventra ingredients (see Note 5 of Notes to
Financial Statements).

         In December 1999, the Company entered into a product development
agreement with Novartis.

RESULTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997

         GENERAL. The net loss decreased by $1,924,026, or 43%, in 1999 to
$2,596,203 from $4,520,229 in 1998 and decreased $1,114,905, or 20%, in 1998
from $5,635,134 in 1997. The decrease in 1999 was due primarily to increased
product sales, increased licensing and product development revenue, decreased
interest expense and decreased product development expense offset by
increased selling, marketing, general and administrative expense. The
decrease in 1998 was primarily due to increased revenue from the Company's
critical care product line, increased product development and licensing
revenue and decreased product development expense offset by increased
selling, marketing and general and administrative expense in support of the
consumer and clinical nutrition product development programs described above.

         REVENUES. Revenues increased $2,305,199, or 263%, in 1999 to
$3,181,278 from $876,079 in 1998. The increase in 1999 was due to increased
sales of the critical care products of approximately $776,000, increased
licensing revenues of approximately $500,000 relating to the Company's
license agreements (see Note 2 of Notes to Financial Statements), increased
product development revenue of approximately $614,000 related to the
Company's separate research agreements, increased sales of the Company's
Proventra product of approximately $327,000 and increased royalty revenue of
approximately $88,000 (see Note 5 of Notes to Financial Statements). In 1998
revenues of $876,079 consisted of approximately $584,000 in sales of the
Company's critical care products, approximately $250,000 of licensing
revenue, approximately $32,000 in Proventra product sales and approximately
$10,000 of product development revenue.

         COST OF GOODS SOLD. Cost of goods sold increased $459,465, or 188%,
in 1999 to $703,606 from $244,141 in 1998. The increase in 1999 was due to
increased cost of goods sold due to increased sales from the critical care
products of approximately $294,000 and increased cost of goods sold related
to increased product sales of the Proventra products of approximately
$165,000. For 1998 the cost of goods sold was $244,141, which consisted of
approximately $228,000 from the critical care product sales and approximately
$16,000 related to the Proventra product sales.


                                       2
<PAGE>

         SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased $706,449, or 32%, in 1999 to $2,941,811
from $2,235,362 in 1998 and increased $694,519, or 45%, in 1998 from
$1,540,843 in 1997. The increase in 1999 was due to increased sales,
marketing and personnel expense for the Company's critical care nutrition
products of approximately $531,000, increased marketing and personnel expense
for the Company's consumer products of approximately $199,000 and increased
legal expense of approximately $66,000 offset by decreased shareholders
relation expense of approximately $90,000. The increase in 1998 was due to
increased sales, marketing and personnel expense for the Company's consumer
and critical care products of approximately $739,000 and increased
shareholder relations expense of approximately $42,000 offset by decreased
insurance costs of approximately $40,000, decreased financing expenses of
approximately $24,000, and decreased legal expenses of approximately $22,000.

         PRODUCT DEVELOPMENT EXPENSES. Expenses for product development
decreased $295,777, or 15%, in 1999 to $1,618,518 from $1,914,295 in 1998 and
decreased $1,845,791, or 49%, in 1998 from $3,760,086 in 1997. In 1999,
approximately $312,000 of the decrease was from decreased personnel expense
and approximately $305,000 of the decrease was from decreased expenses
related to the pharmaceutical program terminated during 1998. These decreases
were offset by increased consumer research and development expense of
approximately $71,000 and the receipt of $250,000, for return of license
rights, which reduced 1998 product development expense. Approximately
$852,000 of the decrease in 1998 was due to the decreased development
expenses related to the terminated pharmaceutical programs, approximately
$684,000 of the decrease was due to decreased associated personnel and
consulting expense, approximately $250,000 of the decrease was related to the
fee received from the re-licensing of previously licensed technology, which
was offset against product development expense, and approximately $60,000 of
the decrease was from reductions in other program expenses.

         DEPRECIATION AND AMORTIZATION. Depreciation and amortization
decreased $88,353, or 12%, in 1999 to $679,121 from $767,474 and increased
$166,585, or 28%, in 1998 from $600,889 in 1997. The decrease in 1999 was due
to decreased deferred compensation expense of approximately $125,000,
decreased depreciation expense of approximately $109,000 related to the
Company's note payable conversion (see Note 6 of Notes to Financial
Statements) and decreased deferred expense amortization of approximately
$89,000 offset by increased intangible asset amortization of approximately
$234,000 related to the Company's asset acquisitions. The increase in 1998
was due primarily to increased amortization of warrants issued for services
of approximately $168,000 and increased deferred expense amortization of
approximately $113,000 offset by decreased deferred compensation amortization
of approximately $88,000 and decreased depreciation expense of approximately
$26,000.

         INTEREST INCOME. Interest income for 1999 decreased $161,705, or
48%, to $176,302 from $338,007 in 1998 and decreased $110,315, or 25%, from
$448,322 in 1997. The decreases were primarily attributable to the decreased
levels of investable funds.

         INTEREST EXPENSE. Interest expense decreased $562,316, or 98%, in
1999 to $10,727 from $573,043 in 1998 and increased $391,405, or 215%, from
$181,638 in 1997. The decrease in interest expense in 1999 is due to the
conversion of the Company's convertible debt (see Note 4 of Notes to
Financial Statements) as well as the conversion of the Company's note payable
into an operating lease (see Note 6 of Notes to Financial Statements). In
1998, approximately $465,000 of the interest expense was the amortization of
the value of warrants plus the value of the discount in connection with the
convertible debentures the Company issued in November 1997 and approximately
$108,000 was line of credit interest expense. Interest expense for 1997
consisted primarily of line of credit interest expense of approximately
$92,000 and amortization of the value of warrants plus the value of the
discount in connection with convertible debentures of approximately $82,000.

LIQUIDITY AND CAPITAL RESOURCES; CASH FLOW ANALYSIS

                  Cash used in operating activities decreased by $1,180,173,
or 33%, in 1999 to $2,360,681 from $3,540,854 in 1998 and decreased
$2,511,294, or 41%, in 1998 from $6,052,148 in 1997. Cash used in


                                       3
<PAGE>

operations during 1999 was used primarily to fund operating losses as well as
repayment of current obligations. Cash used in operations for 1998 was used
primarily to fund operating losses and was offset slightly by changes in
operating assets and liabilities.

         The Company invested $2,782,790 in 1999, and $13,276 in 1997, in the
purchase of available for sale securities. In 1998, the Company redeemed
$7,511,619 of its available-for-sale securities. In 1999, the Company
invested $227,802 in purchased product development technology. The Company
invested $2,093 in 1999, $39,365 in 1998 and $215,320 in 1997 in equipment
and tenant improvements related to the Company's pilot plant manufacturing
facility. The Company invested $13,857 in 1999, $50,475 in 1998 and $63,685
in 1997 in lab equipment, computer equipment and software and furniture used
primarily to support the Company's operations. In 1998, the Company invested
$141,363 in fixed assets and inventory received relating to the asset
purchase agreement with NMI (see Note 5 in Notes to Financial Statements).

       In 1999, the Company received net private placement funding proceeds
of $1,903,000. Also in 1999, the Company repurchased warrants for $375,000.

       The Company's operating lease for select pilot plant, manufacturing
equipment and office equipment calls for future annual payments of
approximately $410,000 through May 2001 with a final payment of $165,000 in
June 2001. The Company's seven-year operating lease for additional select
manufacturing equipment requires annual payments of approximately $131,000
through 2003. Additionally, the Company's five-year lease agreement for
specified manufacturing space requires future annual payments of
approximately $87,000 through June 2001 (see Note 8 in Notes to Financial
Statements).

       The Company anticipates that its existing resources and interest
thereon will be sufficient to satisfy its anticipated cash requirements
through approximately the first quarter of 2001. The Company's working
capital and capital requirements will depend upon numerous factors, including
revenue from product sales and collaboration arrangements, the progress of
the Company's market research, product development and ability to obtain
partners with the appropriate manufacturing, sales, distribution and
marketing capabilities. The Company's capital requirements also will depend
on the levels of resources devoted to the development of manufacturing
capabilities, technological advances, the status of competitive products and
the ability of the Company to establish partners or strategic alliances to
provide funding to the Company for certain manufacturing, sales, product
development and marketing activities.

         The Company expects to incur substantial additional marketing
expense and product development expense. Capital expenditures may be
necessary to establish additional commercial scale manufacturing facilities.
The Company will need to raise substantial additional funds for longer-term
product development, manufacturing and marketing activities that may be
required in the future. The Company's ability to continue funding its planned
operations beyond the first quarter of 2001 is dependent upon its ability to
generate product revenues or to obtain additional funds through equity or
debt financing, strategic alliances, license agreements or from other
financing sources. A lack of adequate revenues or funding could eventually
result in the insolvency or bankruptcy of the Company. At a minimum, if
adequate funds are not available, the Company may be required to delay or to
eliminate expenditures for certain of its product development efforts or to
license to third parties the rights to commercialize products or technologies
that the Company would otherwise seek to develop itself. Because of the
Company's significant long-term capital requirements, it may seek to raise
funds when conditions are favorable, even if the Company does not have an
immediate need for such additional capital at such time. If the Company has
not raised funds prior to when its needs for funding become immediate, the
Company may be forced to raise funds when conditions are unfavorable, which
could result in significant dilution for current stockholders.

YEAR 2000 ISSUES

         The Company began the process of assessing its risks associated with
Year 2000 date conversion in 1998. This assessment included the business
hardware and software applications, manufacturing facilities and


                                       4
<PAGE>

external third party business partners or suppliers. In late 1999, the
Company completed its remediation and testing. The process was completed with
total costs of approximately $60,000. As a result of those planning and
implementation efforts the Company experienced no significant business
disruptions and believes its systems successfully responded to the Year 2000
date change. The Company is not aware of any material problems resulting from
Year 2000 issues either with its products, its internal business systems or
its external business partners or suppliers. The Company will continue to
monitor its operations throughout the year 2000 to ensure that any latent
Year 2000 matters that may arise are addressed promptly.

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

         This Annual Report to Stockholders contains certain forward looking
statements within the meaning of Section 21E of the Exchange Act. Such
forward-looking statements are based on the beliefs of the Company's
management as well as on assumptions made by and information currently
available to the Company at the time such statements were made. When used in
this Annual Report, the words "anticipate", "believe", "estimate", "expect",
"intend" and similar expressions, as they relate to the Company, are intended
to identify such forward-looking statements. Although the Company believes
these statements are reasonable, readers of this Annual Report should be
aware that actual results could differ materially from those projected by
such forward-looking statements as a result of the risk factors listed below
and set forth in the Company's Form 10-K under the caption "Risk Factors."
Readers of this Annual Report should consider carefully the factors listed
below and under the caption "Risk Factors" in the Company's Form 10-K, as
well as the other information and data contained in this Annual Report. The
Company cautions the reader, however, that such list of factors under the
caption "Risk Factors" in the Company's Form 10-K and listed below may not be
exhaustive and that those or other factors, many of which are outside of the
Company's control, could have a material adverse effect on the Company and
its results of operations. Factors that could cause actual results to differ
include, without limitation, the Company's ability to generate sufficient
working capital and obtain necessary financing to meet capital requirements,
loss of Nasdaq Market National listing, the Company's ability to form
strategic alliances with marketing and distribution partners, the Company's
exposure to product liability claims, consumers' perception of product safety
and quality, the Company's reliance on flawed market research, potential
competitors that are larger and financially stronger, the Company's ability
to receive regulatory approval for its products and the Company's ability to
manufacture an acceptable product on a commercial scale. All forward-looking
statements attributable to the Company or persons acting on its behalf are
expressly qualified in their entirety by the cautionary statements set forth
hereunder and under the caption "Risk Factors" in the Company's Form 10-K.

           QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         The Company's market risk is unlikely to have a material adverse
effect on the Company's business, results of operations or financial
condition.


                                       5

<PAGE>

                                  GALAGEN INC.

                                 BALANCE SHEETS
<TABLE>
<CAPTION>

ASSETS

                                                                                                          DECEMBER 31
                                                                                             -------------------------------------
                                                                                                     1999             1998
                                                                                             -------------------------------------
<S>                                                                                       <C>                <C>
     Current assets:
       Cash and cash equivalents ........................................................     $    204,817         $  4,081,733
       Available-for-sale securities ....................................................        2,782,790                    -
       Accounts receivable, net of allowance of $18,951 in 1999 and $14,020 in 1998 .....          499,606              314,579
       Inventory ........................................................................           56,372              303,150
       Prepaid expenses .................................................................          146,023              197,994
                                                                                             ------------------  -----------------
     Total current assets ...............................................................        3,689,608            4,897,456

     Property and equipment .............................................................          687,746              671,796
       Less accumulated depreciation ....................................................         (400,301)            (270,418)
                                                                                             ------------------  -----------------
                                                                                                   287,445              401,378

     Customer list ......................................................................          360,000              450,000
     Other intangible assets ............................................................          300,872              219,847
     Deferred expenses ..................................................................           93,750              324,659
                                                                                             ------------------  -----------------
                                                                                                   754,622              994,506

     Total assets .......................................................................     $  4,731,675         $  6,293,340
                                                                                             ==================  =================

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:

  Accounts payable ......................................................................     $    273,717         $    641,922
  Development contract advance ..........................................................          125,850              290,089
  Accrued expenses ......................................................................           19,036               46,903
  Convertible notes, net of discount of $6,667 in 1998 ..................................                -              193,333
                                                                                             ------------------  -----------------
Total current liabilities ...............................................................          418,603            1,172,247

Commitments

Other long-term liabilities .............................................................           45,000               45,000

Stockholders' equity:
  Preferred stock, $.01 par value:
     Authorized shares - 15,000,000
     Issued and outstanding shares - none in 1999 and 1998 ..............................                -                    -
  Common stock, $.01 par value:
     Authorized shares - 40,000,000
     Issued and outstanding shares - 10,416,462 in 1999; 8,948,446 in 1998 ..............          104,165               89,484
  Additional paid-in capital ............................................................       64,099,393           62,386,292
  Accumulated deficit ...................................................................      (59,935,486)         (57,339,283)
  Deferred compensation .................................................................                -              (60,400)
                                                                                             ------------------  -----------------
  Total stockholders' equity ............................................................        4,268,072            5,076,093
                                                                                             ------------------  -----------------

Total liabilities and stockholders' equity ..............................................     $  4,731,675         $  6,293,340
                                                                                             ==================  =================
</TABLE>

                             See accompanying notes.


                                       6
<PAGE>

                                  GALAGEN INC.

                            STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
                                                                         YEAR ENDED DECEMBER 31
                                                           -------------------------------------------------------
                                                               1999              1998               1997
                                                           -------------------------------------------------------
<S>                                                    <C>                <C>                <C>
Revenues:
 Product sales .....................................        $ 1,718,781        $   616,168         $        -
 Product licensing revenue .........................            750,000            250,000                  -
 Product development revenue .......................            624,238              9,911                  -
 Other revenue .....................................             88,259                  -                  -
                                                           -----------------  ----------------  ----------------
                                                              3,181,278            876,079                  -

Operating expenses:
 Cost of goods sold ................................            703,606            244,141                  -
 Selling, general and administrative ...............          2,941,811          2,235,362          1,540,843
 Product development ...............................          1,618,518          1,914,295          3,760,086
 Depreciation and amortization .....................            679,121            767,474            600,889
                                                           -----------------  ----------------  ----------------
                                                              5,943,056          5,161,272          5,901,818
                                                           -----------------  ----------------  ----------------
Operating loss .....................................         (2,761,778)        (4,285,193)        (5,901,818)

Interest income ....................................            176,302            338,007            448,322
Interest expense ...................................            (10,727)          (573,043)          (181,638)
                                                           -----------------  ----------------  ----------------

Net loss ...........................................        $(2,596,203)       $(4,520,229)       $(5,635,134)
                                                           =================  ================  ================

Net loss per share
  Basic and diluted ................................        $      (.26)       $      (.56)       $      (.78)


Weighted average number of common shares outstanding
  Basic and diluted ................................          9,957,306          8,067,564          7,184,722
</TABLE>

                             See accompanying notes.


                                       7

<PAGE>

                                  GALAGEN INC.

                  STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>

                                                        COMMON STOCK        ADDITIONAL     DEFERRED
                                                    --------------------     PAID-IN        COMPEN-      ACCUMULATED
                                                      SHARES    AMOUNT       CAPITAL        SATION         DEFICIT         TOTAL
                                                    ------------------------------------------------------------------------------
<S>                                               <C>         <C>        <C>            <C>         <C>            <C>
Balance at December 31, 1996.....................    7,163,769  $71,638    $58,926,654    $(579,468)  $(47,183,920)   $11,234,904
    Amortization of deferred compensation........                                           273,864                       273,864
    Deferred compensation adjustment, canceled
    options......................................                              (35,800)      35,800                             -
    Exercise of stock options....................       64,703      647         79,004                                     79,651
    Common stock issued for services.............        1,493       15         14,376                                     14,391
    Discount valuation for convertible debentures                              318,182                                    318,182
    Valuation of issued options and warrants.....                              280,450                                    280,450
    Warrant valuation for note payable...........                               78,800                                     78,800
    Stock issued through employee stock purchase
    plan.........................................        5,009       50          7,920                                      7,970
    Net loss for the year........................                                                       (5,635,134)    (5,635,134)
                                                   -------------------------------------------------------------------------------
Balance at December 31, 1997.....................    7,234,974   72,350     59,669,586     (269,804)   (52,819,054)     6,653,078
    Amortization of deferred compensation........                                           185,404                       185,404
    Deferred compensation adjustment, canceled
    options......................................                              (24,000)      24,000                             -
    Exercise of stock options and warrants.......      111,325    1,113        261,097                                    262,210
    Conversion of convertible debentures.........    1,260,073   12,601      1,330,882                                  1,343,483
    Valuation of issued warrants.................                              488,750                                    488,750
    Common stock issued for asset purchase.......      318,800    3,188        621,812                                    625,000
    Stock issued through employee stock purchase
    plan.........................................       23,274      232         38,165                                     38,397
    Net loss for the year........................                                                       (4,520,229)    (4,520,229)
                                                   -------------------------------------------------------------------------------
Balance at December 31, 1998.....................    8,948,446   89,484     62,386,292      (60,400)   (57,339,283)     5,076,093
    Amortization of deferred compensation........                                            60,400                        60,400
    Issuance of common stock, net of fees .......    1,315,000   13,150      1,889,850                                  1,903,000
    Warrant repurchase...........................                             (375,000)                                  (375,000)
    Conversion of convertible debentures.........      139,927    1,400        176,981                                    178,381
    Stock issued through employee stock purchase
    plan.........................................       13,089      131         21,270                                     21,401
    Net loss for the year........................                                                       (2,596,203)    (2,596,203)
                                                   -------------------------------------------------------------------------------
Balance at December 31, 1999.....................   10,416,462 $104,165    $64,099,393       $-       $(59,935,486)    $4,268,072
                                                   ===============================================================================
</TABLE>




                             See accompanying notes.


                                       8
<PAGE>

                                  GALAGEN INC.

                            STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
                                                                                  YEAR ENDED DECEMBER 31
                                                                ---------------------------------------------------------
                                                                        1999                1998                1997
                                                                ---------------------------------------------------------
<S>                                                            <C>                  <C>                  <C>
OPERATING ACTIVITIES:
Net loss ...................................................        $(2,596,203)        $(4,520,229)        $(5,635,134)
Adjustments to reconcile net loss to cash used in
  operating activities:
   Depreciation expense ....................................            129,884             238,918             264,741
   Deferred expense amortization ...........................                  -             112,893                   -
   Amortization of warrants issued for services ............            253,105             230,259              62,284
   Amortization of intangible assets .......................            235,732                   -                   -
   Noncash interest cost of convertible debentures .........             10,727             464,998              81,378
   Deferred compensation amortization ......................             60,400             185,404             273,864
Stock issued for services and license agreement ............                  -                   -              14,391
Changes in operating assets and liabilities:
     Inventory .............................................            270,418            (237,634)                  -
     Accounts receivable ...................................           (207,623)           (314,579)                  -
     Prepaid expenses ......................................             29,775             (82,171)            (31,738)
     Other assets ..........................................                  -                   -                   -
     Accounts payable and accrued expenses .................           (546,896)            381,287          (1,081,934)
                                                                  -----------------   ------------------  ----------------
Net cash used in operating activities ......................         (2,360,681)         (3,540,854)         (6,052,148)
                                                                  -----------------   ------------------  ----------------

INVESTING ACTIVITIES:
Purchase of property and equipment .........................            (15,950)            (89,840)           (279,005)
Payment for asset purchase .................................           (227,802)           (141,363)                  -
Sale(purchase) of available-for-sale securities, net .......         (2,782,790)          7,511,619             (13,276)
                                                                  -----------------   ------------------  ----------------
Net cash provided by(used in) investing activities .........         (3,026,542)          7,280,416            (292,281)
                                                                  -----------------   ------------------  ----------------

FINANCING ACTIVITIES:
Proceeds from issuance of common  stock, net of costs ......          1,903,000                   -                   -
Proceeds from common  stock options exercised ..............                  -             262,210              79,651
Proceeds from convertible notes, net of issuance costs .....            (39,094)                  -           1,380,919
Payment for warrant repurchase .............................           (375,000)                  -                   -
Net proceeds(payment) from(on) note payable ................                  -            (114,344)          1,162,248
Proceeds from Employee Stock Purchase Plan .................             21,401              38,397               7,970
                                                                  -----------------   ------------------  ----------------
Net cash provided by financing activities ..................          1,510,307             186,263           2,630,788
                                                                  -----------------   ------------------  ----------------

Increase (decrease) in cash ................................         (3,876,916)          3,925,825          (3,713,641)
Cash and cash equivalents at beginning of year .............          4,081,733             155,908           3,869,549
                                                                  -----------------   ------------------  ----------------
Cash and cash equivalents at end of year ...................        $   204,817         $ 4,081,733         $   155,908
                                                                  =================   ==================  ================

SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Discount valuation for convertible debentures ..............        $         -         $         -         $   318,182
Valuation of issued options and warrants ...................                  -             488,750             359,250
Stock issued for asset purchase ............................                  -             625,000                   -
Conversion of note payable to operating lease ..............                  -           1,047,904                   -
Deferred compensation adjustment, canceled options .........                  -              24,000              35,800
Conversion of convertible debentures plus related
 accrued interest, to common stock .........................            178,381           1,343,483                   -
</TABLE>

                             See accompanying notes.


                                       9

<PAGE>

                                  GALAGEN INC.

                          NOTES TO FINANCIAL STATEMENTS

1.       DESCRIPTION OF BUSINESS

         GalaGen Inc. is a nutritional products company that is utilizing its
proprietary immune-enhancing ingredients and patented manufacturing processes
to commercialize health-promoting foods and beverages. These immune-enhancing
ingredients, including Proventra-TM- Brand Natural Immune Components
("Proventra"), are comprised of antibodies and other proteins that are
derived from the milk collected in the first few milkings of a dairy cow
after its calf is born. The Company continues to expand applications for its
technology and is developing a portfolio of immune-enhancing products that
target the needs of consumers and the healthcare market. The Company operates
in a single business segment.

2.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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.

REVENUE RECOGNITION

         Revenue from product sales is recognized at the time of shipment.
Fee revenue is recognized upon exchange for services performed or products
delivered that represent the culmination of a separate earnings process. If
there are continuing performance obligations related to the services to be
provided, or products to be delivered, then the revenue is deferred and
recognized as the services and/or products are performed and/or delivered
over the term of the arrangement.

ADOPTION OF RECENT STAFF ACCOUNTING BULLETIN

         In December 1999 the Securities & Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101") "REVENUE RECOGNITION IN FINANCIAL
STATEMENTS", summarizing certain of the SEC staff's views in applying
generally accepted accounting principles to revenue recognition. SAB 101
requires that nonrefundable, up-front license fees be deferred and recognized
generally over the term of the license agreement, unless the agreements and
facts and circumstances of the transaction clearly reflect the completion of
the earnings process as defined, regardless of the fact they are
nonrefundable. The Company's policy historically has been to recognize such
nonrefundable, up-front license fees as revenue upon receipt and the signing
of the agreement.

         In accordance with SAB 101, the Company will apply the accounting
described in SAB 101 as required, beginning in the first quarter of 2000, and
will record a cumulative effect adjustment for the change in accounting,
expected to be a one-time charge to earnings of approximately $730,000.

PRODUCT DEVELOPMENT COSTS

         All product development costs are charged to operations as incurred.

NET LOSS PER SHARE

         Basic loss per share is computed by dividing the net loss by the
weighted average number of common shares outstanding for the year. Diluted
loss per share reflects the potential dilution that could


                                       10
<PAGE>

occur if securities or other contracts to issue common stock were exercised
or converted into common stock and resulted in the issuance of common stock.
Basic and diluted loss per share are the same in all years presented as all
potential common shares were antidilutive.

INCOME TAXES

         Income taxes are accounted for using the liability method. Deferred
income taxes are provided for temporary differences between financial
reporting and tax bases of assets and liabilities.

CASH EQUIVALENTS

         Cash equivalents are available-for-sale and are carried at cost
which approximates fair market value.

INVESTMENTS

         Investments in corporate debt securities with a remaining maturity
of more than three months at the date of purchase were classified as
available-for-sale as of December 31, 1999. The book value of the investments
approximated their estimated market value. All investments have a contractual
maturity of less than one year.

INVENTORY

         Inventories are stated at the lower of cost or market using the
first-in, first-out method. The Company evaluates the need for reserves
associated with obsolete inventory as needed. Inventory at December 31
consisted of the following:

<TABLE>
<CAPTION>
                                                        1999             1998
                                                  ---------------   --------------
<S>                                              <C>               <C>
                          Raw materials ........      $ 46,660        $ 67,995
                          Finished goods .......         9,712         235,155
                                                  ---------------   --------------
                                                      $ 56,372        $303,150
                                                  ===============   ==============
</TABLE>

PROPERTY AND EQUIPMENT

         Property and equipment are recorded at cost and depreciated on a
straight-line basis over their estimated useful lives of three to seven years.

IMPAIRMENT

         The Company evaluates its long-lived assets for impairment losses
when indicators of impairment are present by comparing the non-discounted
cash flows to the asset's carrying amount. An impairment loss is recorded if
necessary.

CUSTOMER LIST AND OTHER INTANGIBLE ASSETS

         Customer list represents the value of an acquired customer database.
The customer list is amortized over the useful life of the asset of five
years. The accumulated amortization at December 31,1999 and 1998 was $90,000
and $0, respectively. Other intangible assets consist of purchased technology
and goodwill. Purchased technology represents the value of an acquired food
product and is being amortized over three years. Goodwill represents the
excess of purchase price and related costs over the value assigned to net
assets acquired. Goodwill is amortized on a straight-line basis over
two-years. The accumulated amortization at December 31, 1999 and 1998 was
$146,777 and $0, respectively.


                                       11
<PAGE>

STOCK BASED COMPENSATION

         The Company has adopted the disclosure-only provisions of Statement
of Financial Accounting Standards No. 123, ACCOUNTING FOR STOCK BASED
COMPENSATION ("Statement 123"), but applies Accounting Principles Board
Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES ("APB 25"), and
related interpretations in accounting for its stock plans. Under APB 25, when
the exercise price of stock options equals the market price of the underlying
stock on the date of grant, no compensation expense is recognized.

MAJOR CUSTOMERS

         In 1999, sales to two major customers were $750,000 and $324,238
respectively, or 23.6% and 10.2% of total revenues.

3.       RELATED PARTY TRANSACTIONS

         The Company entered into the following agreements with Land O'Lakes:

ROYALTY AGREEMENT

         The Company will pay to Land O'Lakes a royalty on net receipts from
any product, other than infant formula, which is based on existing technology
or technology improvements, as defined by the agreement. The Company will pay
an additional royalty on net receipts from infant formula based on existing
or improved technology and an additional royalty on net receipts from infant
formula based on new technology, as defined by the agreement. This agreement
will continue until terminated by both parties. Royalty payments range from
one to two percent of net receipts. Royalty expense recognized based on the
royalty agreement was not significant.

LICENSE AGREEMENT

         The Company has licensed to Land O'Lakes the rights to use the
Company's existing technologies and technology improvements, as defined by
the agreement, for Land O'Lakes' use in animal products, functional foods and
infant formula. The Company received a lump sum license fee of $10,000. The
Company has agreed not to compete for fifteen years in the area of animal
products and functional foods based on milk and colostrum based
immunoglobulin technology. Land O'Lakes has agreed not to compete for fifteen
years in the areas of prescription drugs and over-the-counter drugs regulated
by the Food and Drug Administration. The term of this agreement is perpetual.

         In 1997, Land O'Lakes granted a five-year license, an amendment to
the license above, in the area of functional foods to use existing technology
and future technology improvements in the development, formulation,
manufacture, marketing, distribution and sale of kefir-based products, as
defined in the granted license. In consideration of granting the Company this
license, Land O'Lakes will receive a royalty of five percent from food
components or ingredients sold by the Company to be included in a kefir-based
product and one percent of net receipts from a kefir-based finished product
sold by the Company.

         In 1998, the Company and Land O'Lakes signed an amended and restated
license agreement in which the Company has significantly broadened its rights
to develop and market functional foods. Under the restated license agreement,
the Company can use, improve, exploit, license or share existing technology,
technology improvements and new technologies, as defined, in all areas except
under certain "reserved food" and "first refusal food product" categories.

SUPPLY AGREEMENT

         The Company entered into an agreement with Land O'Lakes in 1992
whereby the Company was to purchase and Land O'Lakes was to supply, at their
option, all of the Company's commercial requirements


                                       12
<PAGE>

for colostrum and milk. As part of the agreement, Land O'Lakes was to provide
expertise in dairy herd selection, on-farm management, membership relations
and procurement to the Company for the manufacture of antibody material. In
August 1999, the Company and Land O'Lakes terminated the supply agreement.

MASTER SERVICES AGREEMENT

         In 1992, the Company entered into an agreement with Land O'Lakes
whereby the Company may purchase services from Land O'Lakes for certain
administrative and research and development activities. The agreement is
currently extended through December 31, 2000. The Company was charged
approximately $377,000, $375,000 and $442,000 in 1999, 1998 and 1997,
respectively, in accordance with the Master Services Agreement.

LEASE AGREEMENTS

         In 1996, the Company entered into a five-year lease agreement with
Land O'Lakes for specified space within the Land O'Lakes facility in
connection with the Company's manufacturing facility. Also in 1996, the
Company entered into an equipment operating lease which was guaranteed by
Land O'Lakes. See Note 8.

4.       CAPITAL STOCK

FINANCINGS

         In April 1999, the Company raised $1,972,500 through the private
placement of 1,315,000 shares of common stock. The shares sold in the private
placement were at an 8% discount to the closing price of the common stock on
the Nasdaq Stock Market on the closing date. Costs associated with the
private placement were $69,500.

         In November 1997, the Company raised $1,500,000 through the private
placement sale of 6% convertible debentures (the "Debentures") to three
institutional investors. In 1999 and 1998, $200,000 and $1,300,000 of
Debenture principal plus accrued interest were converted into the aggregate
maximum of 139,927 and 1,260,073 shares of common stock, respectively. Under
the terms of the Debentures, there was a limitation on the maximum number of
shares of common stock that could be issued upon conversion of the
Debentures. That maximum was reached through the conversions in 1999 and as a
result the Company repaid remaining Debenture principal plus accrued interest
of approximately $39,000 in 1999.

EMPLOYEE STOCK PURCHASE PLAN

         The Company has an Employee Stock Purchase Plan for which 270,833
shares of common stock have been reserved. All employees who have met the
service eligibility requirements may contribute from one to ten percent of
their compensation during a purchase period for the purchase of shares under
the plan. Purchases are made at the lower of 85% of the fair market value of
the Company's common stock on the first day, or the last day, of the
applicable purchase period. In 1999 and 1998, 13,089 shares and 20,004 shares
of common stock, respectively, were purchased and issued to employees and in
1997, 8,279 shares of common stock were purchased of which 3,270 and 5,009
were issued to employees in 1998 and 1997, respectively.

5.       PRODUCT AND LICENSING AGREEMENTS

         CRITICAL CARE PRODUCT AGREEMENTS

         In 1998, GalaGen purchased substantially all of Nutrition Medical
Inc.'s ("NMI") critical care enteral nutrition products and formulas, all
related inventory valued at $65,516, certain other fixed assets valued at
$31,000 and the existing customer base of over 500 hospitals and home
healthcare facilities


                                       13
<PAGE>

valued at $450,000. Total consideration for the transaction was $696,516,
exclusive of closing costs of $69,847, comprised of $71,516 cash and 318,800
shares of the Company's common stock which was valued at $625,000. Goodwill
of $219,847 was recorded. The Company will pay to NMI a royalty of nine
percent of net U.S. sales, as defined, of the critical care products in
excess of (i) $5,000,000 during the year ending December 31, 2000, (ii)
$6,000,000 during the year ending December 31, 2001, and (iii) $7,500,000
during the year ending December 31, 2002. Additionally, the Company will pay
to NMI a royalty on certain international sales of the critical care products
of (i) five percent of net international sales in excess of $200,000 through
December 1999, and (ii) two and one half percent of net international sales
in excess of $200,000 during the year ending in December 2000. No royalties
were due in 1999.

         Subsequently, in 1999, the Company entered into a licensing and
distribution agreement with a subsidiary of Hormel Foods Corporation. The
licensing agreement granted worldwide rights to manufacture, distribute,
market and sell the Company's previously acquired line of critical care
enteral nutrition products and formulas. Under the terms of the agreement
Hormel Health Labs ("HHL") will pay monthly royalties subject to an annual
minimum royalty to the Company based upon net sales of the specified
products. HHL commenced selling the critical care products on a limited basis
in September 1999, and on an exclusive basis effective October 1999.

         AMERICAN HOME PRODUCTS CORPORATION AGREEMENT

         In 1998, the Company entered into a collaboration and license
agreement and a manufacturing and supply agreement with Wyeth-Ayerst
Laboratories, a division of American Home Products Corporation ("AHP"). The
companies will develop and commercialize a proprietary ingredient with unique
antibacterial properties for use in pediatric formula and other nutritional
products. The companies will collaborate during the research and development
phase of the product, which will be funded by Wyeth-Ayerst through payments
to the Company. Additionally, Wyeth-Ayerst will have financial and oversight
responsibilities for all clinical trials and regulatory compliance related to
the use of the ingredient in pediatric formula products. Wyeth-Ayerst will
have worldwide rights to the use of the ingredient in its pediatric formula
and other nutritional products. The Company will retain its right to
manufacture the ingredient and has the right to request a sublicense from
Wyeth-Ayerst to develop and commercialize non-pediatric formula nutritional
products. In 1998, the Company received a non-refundable licensing fee and a
research and development advance from AHP. In 1998, the Company recorded the
licensing fee as revenue. In 1999, the Company received an additional advance
from AHP for research and development. The entire research and development
advance was recorded as a contract payable which will be recognized as
research and development revenue when the Company incurs the associated
expenses. In 1999 and 1998, respectively, $324,238 and $9,911 was amortized
and recorded as research and development revenue. Warrants were issued to AHP
to purchase 200,000 shares of common stock at $2.45 per share. The warrant
expire 2005. The fair value of the warrant was $250,000, which the Company is
amortizing over the 2-year term of the research and development program. In
1999 and 1998, respectively, $125,000 and $31,250 was amortized.

         TROPICANA PRODUCTS, INC.

         In February 1999, the Company entered into an agreement with
Tropicana Products Inc. to explore product development opportunities. The
agreement expired in December 1999. The nonrefundable fee received was
recorded as development revenue in 1999.

         NOVARTIS CONSUMER HEALTH, SA AGREEMENTS

         In October 1999, the Company entered into a license agreement with
Novartis Consumer Health, SA ("Novartis"). In return for granting Novartis
exclusive rights to certain products and proprietary technology the Company
received a nonrefundable license fee which was recorded as revenue in 1999
(see Note 2 regarding Adoption of Recent Staff Accounting Bulletin). The
agreement specifies an additional payment to the Company upon the date of
first sale, and milestone payments based on


                                       14

<PAGE>

aggregate sales levels. As further consideration for the license, Novartis
shall pay specified royalties, during the royalty period, on annual net sales.

         Also in October 1999, the Company entered into a supply agreement
with Novartis to manufacture and supply Proventra to Novartis on a cost-plus
basis. The Company has the responsibility to ensure continuity of supply.

         In December 1999, the Company and Novartis entered into a
development agreement for various product development and research projects.
Novartis shall pay for pre-approved activities related to the research
projects. The Company will initially record payments received as an advance,
and recognize revenue as the Company incurs the associated expense. The
Company also shall receive a four and one half percent royalty from future
Novartis sales as additional compensation.

6.       OPERATING LEASE

         In 1997, the Company established a note payable for approximately
$1,319,000 for fixed assets with Transamerica Business Credit Corporation
("Transamerica"). In 1998, the Company converted the note payable into an
operating lease. At the time of the conversion the net book value of the
associated assets approximated the note payable balance. Terms of the
operating lease include monthly payments through May 2001 of approximately
$36,000 with a final payment of $165,000 in June 2001. The Company's property
and equipment secure the operating lease. Transamerica received warrants to
purchase 40,000 shares of common stock exercisable at $2.50 per share. The
warrants expire June 2002. The warrants were valued at approximately $79,000
which was amortized to interest expense over the term of the note payable.

7.       OPTIONS AND WARRANTS

STOCK OPTION PLAN

         The Company has a 1992 Stock Plan (the "1992 Plan") and a 1997
Incentive Plan (the "1997 Plan"), under which incentive and non-qualified
options may be granted, and has reserved 880,210 and 1,250,000 shares of
common stock, respectively, for issuance. The Company uses these plans as an
incentive for employees, directors and technical advisors. Stock awards of up
to 100,000 shares of common stock may also be granted under the 1997 Plan.
Options are granted at fair market value as determined on the date of grant
and normally vest over three to five years.

         The following plan and non-plan options are outstanding at December 31,
1999:

<TABLE>
<CAPTION>
                                                                                            NON             WEIGHTED
                                                    1992 PLAN          1997 PLAN            PLAN             AVERAGE
                                                     OPTIONS            OPTIONS           OPTIONS            OPTION
                                                   OUTSTANDING        OUTSTANDING       OUTSTANDING           PRICE
                                             --------------------------------------------------------------------------
<S>                                        <C>                <C>                <C>                <C>
          Balance at December 31, 1996 ...           670,228            185,644                            $   4.74
           Granted .......................                 -            379,300                  -             3.96
           Exercised .....................           (51,162)                 -            (13,541)            1.23
           Canceled ......................           (69,335)           (60,000)            (4,334)            4.51
                                             ---------------     --------------       ------------      -----------
          Balance at December 31, 1997 ...           549,731            319,300            167,769             4.96
           Granted .......................           475,088            798,962            166,687             2.70
           Exercised .....................           (27,248)           (10,000)            (1,082)            2.37
           Canceled ......................          (682,533)          (355,540)          (208,524)            4.54
                                             ---------------     --------------       ------------      -----------
          Balance at December 31, 1998 ...           315,038            752,722            124,850             2.79
            Granted                                  349,083            482,500                  -             2.00
             Exercised                                     -                  -                  -             2.69
             Cancelled                               (48,231)          (186,003)           (16,249)            2.71
                                             ---------------     --------------       ------------      -----------
          Balance at December 31, 1999               615,890          1,049,219            108,601         $   2.43
                                             ===============     ==============       ============
</TABLE>


                                       15
<PAGE>

         The following table summarizes information about the stock options
outstanding at December 31, 1999:

<TABLE>
<CAPTION>
                                     OPTIONS OUTSTANDING                          OPTIONS EXERCISABLE
                        ------------------------------------------------  ----------------------------------------
                                      WEIGHTED-AVERAGE       WEIGHTED                          WEIGHTED
      RANGE OF             NUMBER         REMAINING           AVERAGE          NUMBER      AVERAGE EXERCISE
   EXERCISE PRICE       OUTSTANDING   CONTRACTUAL LIFE    EXERCISE PRICE    EXERCISABLE          PRICE
 -----------------------------------------------------------------------------------------------------------------
<S>                  <C>             <C>              <C>                <C>             <C>
     $        1.50         31,000         9 years           $   1.50          6,000         $   1.50
              1.56         30,000         9 years               1.56              -                -
              1.66          5,500         10 years              1.66              -                -
              1.72         25,000         9 years               1.72              -                -
              1.88        349,083         10 years              1.88              -                -
              1.94         30,000         9 years               1.94              -                -
              1.97          7,500         9 years               1.97              -                -
              2.10        252,500         9 years               2.10         52,500             2.10
              2.19         25,000         9 years               2.19          8,333             2.19
              2.38         41,500         9 years               2.38         23,800             2.38
              2.53        100,000         10 years              2.53              -                -
              2.56        538,567         6 years               2.56        418,838             2.56
              3.13        309,519         9 years               3.13         65,943             3.13
              3.25         15,000         7 years               3.25         15,000             3.25
              7.39         13,541         4 years               7.39         13,541             7.39
                      --------------                                       ----------
      $1.50 - 7.39      1,773,710                           $   2.43        603,955         $   2.69
</TABLE>

         Options expire in five years and three months to ten years from the
original grant date. Fully vested and exercisable options were 603,955,
437,686 and 355,349 as of December 31, 1999, 1998 and 1997, respectively. The
weighted average exercise prices for the fully vested and exercisable options
as of December 31, 1999, 1998 and 1997 were $2.69, $2.72 and $4.86,
respectively.

         In 1997, the Company granted options for 20,000 shares of common
stock to two consultants for services provided, of which 15,000 are fully
vested and 5,000 were cancelled in 1999. In 1997, a consultant was granted a
stock award from the 1997 Plan of 1,493 shares of common stock in exchange
for services provided. In 1998, a consultant was granted ten-year options
from the 1997 Plan for 35,000 shares of common stock at fair market value of
the date of grant for services to be provided, of which 18,333 are fully
vested. Consulting expense recognized based on the fair values of the
instruments granted were not significant.

WARRANTS

A summary of the warrants outstanding at December 31, 1999:

<TABLE>
<CAPTION>

                                                    WARRANTS
GRANTED TO:                                        OUTSTANDING          EXPIRATION DATE          EXERCISE PRICE
------------------------------------------------------------------------------------------------------------------
<S>                                               <C>          <C>                        <C>
 Former Convertible Promissory Note Holders           46,479               October 2000               $11.07
 Line of Credit Guarantors                           192,012              February 2001                $7.00
 Consultants                                          10,000                 March 2002                $2.13
 TransAmerica                                         40,000                  June 2002                $2.50
 Former Debenture Holders                            127,000              November 2002                $2.34
 Financial Consultants                                65,000              December 2002        $2.50 - $3.00
 Officer and Director                                137,500       April-September 2003        $1.38 - $3.00
 Investor Relations                                   50,000               August  2003                $3.13
 Licensee                                            200,000               October 2005                $2.45
                                                  ----------
                                                     867,991
                                                  ==========
</TABLE>

         In connection with the June 1994 to October 1995 Convertible
Promissory Notes (the "Notes") issuance of $8,275,000, the note holders
received warrants, exercisable at $11.07 per share, to purchase 149,384
shares of the Company's common stock. These warrants expire five years from
the date of grant,

                                       16
<PAGE>

through October 2000. As of December 31, 1999, warrants to purchase 46,479
shares were still outstanding.

         In 1995, Chiron Corporation was issued warrants to purchase 200,000
shares of the Company's Series F preferred stock for $150,000. Chiron
exercised some of the warrants in March 1996. In May of 1999, the Company
repurchased the remaining warrants from Chiron for $375,000.

         In 1996, the Company granted warrants to purchase 162,011 shares of
common stock at $7.00 per share to six parties, one of which is a company
which has a representative on the Company's Board. The Company also granted
warrants to purchase 7,500 and 22,501 shares of the Company's common stock at
$7.00 per share to certain investment funds associated with a representative
on the Company's Board in return for their issuance of two convertible
promissory notes. These warrants expire February 2001.

         In 1997, the Company issued warrants to purchase 10,000 shares of
common stock, granted at $2.13, which was the fair market value on the date
of grants, for certain services to be rendered. The warrants expire in March
2002. The fair value of the warrant, approximately $5,000, was amortized and
expensed in 1997.

         In 1997, the Company issued warrants to financial consultants to
purchase 25,000 and 40,000 shares of common stock at $2.50 and $3.00,
respectively, which was greater than the market value of the common stock at
the date of grant. The warrants expire in December 2002. These warrants have
a fair value of $50,450 which was amortized over the term of the consulting
relationship.

         In 1998, the Company issued warrants to purchase 75,000, 25,000,
25,000 and 12,500 shares of common stock at $1.38, $2.63, $3.00 and $1.81 per
share, respectively, to an officer and director of the Company for services
performed while under a consulting agreement. The warrants expire from April
through September 2003. The fair value of the warrants was $68,750, which was
amortized over the term of the consulting agreement.

         In 1998, warrants were issued to individuals of an investor
relations firm to purchase 50,000 shares of common stock at $3.125 per share.
The warrants expire in August 2003. The fair value of the warrants was
$100,000, which was amortized over the term of the investor relations
agreement.

STOCK OPTION REVISIONS

         In 1998, the Company canceled all directors and employees common
stock option agreements, totaling 941,075 shares of common stock under the
1992 Plan, the 1997 Plan and nonplan options, that were issued with a grant
price greater than the fair market value at the date of re-grant. New stock
option agreements were issued with an exercise price of $2.56 per share and a
ten year term.

STOCK-BASED COMPENSATION

         Pro forma information regarding net loss and loss per share is
required as if the Company had accounted for its employee stock options under
the fair value method of Statement 123. The fair value for these options was
estimated at the date of grant using the Black-Scholes option pricing model
with the following weighted-average assumptions for 1999, 1998 and 1997:
risk-free interest rates approximating 5.5%, 5.0% and 6.2%, respectively;
volatility factor of the expected market price of the Company's common stock
of .894, 1.08 and .527, respectively; expected dividend yield of 0%; and a
weighted-average expected life of the option of two to seven years. The
weighted average fair value of the options granted in 1999, 1998 and 1997 is
$1.61, $2.36 and $2.16 per share, respectively, as computed as described
above.

         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. Because the Company's
employee stock


                                       17
<PAGE>

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 may not necessarily provide a reliable single measure of the
fair value of its employee stock options.

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

<TABLE>
<CAPTION>

                                                               1999             1998              1997
                                                          --------------    -------------     -------------
<S>                                                        <C>               <C>               <C>
          Pro forma amortized expense ................     $   745,354       $   566,859       $   435,589
          Pro forma net loss .........................     $(3,341,557)      $(5,087,088)      $(6,070,723)
          Pro forma net loss per share, basic and
            diluted ..................................     $     (0.34)      $     (0.63)      $      (.84)
</TABLE>

         The pro forma effect on net loss for 1999, 1998 and 1997 is not
representative of the pro forma effect on net loss in future years because it
does not take into consideration pro forma compensation expense related to
grants made prior to 1995.

DEFERRED COMPENSATION

         In 1995, the Company canceled certain stock option agreements within
the Plans and certain stock options that were outside of the Plans that had
grant prices ranging from $7.38 per share to $11.07 per share and issued new
stock option agreements with the same terms and conditions except that the
grant prices were $3.69 per share. The Company recorded $1,657,000 as
deferred compensation for the difference between the new grant price per
share of common stock and the fair market value of the common stock per share
on the date of grant, as determined by the board of directors, multiplied by
the total number of options affected. In December 1998 and 1997, the Company
adjusted the deferred compensation balance by $24,000 and $35,800 to account
for terminated employee options that were not vested. The deferred
compensation is amortized ratably over the vesting period of the options and
was fully amortized in 1999. In 1999, 1998 and 1997, $60,400, $185,404 and
$273,864 was amortized.

8.       COMMITMENTS

         In addition to royalty commitments disclosed elsewhere, the Company
has commitments under the following agreements:

LICENSE AGREEMENTS

         In 1998, the Company received a $250,000 fee from a company for the
re-licensing of previously licensed technology. Pursuant to this agreement,
the Company is entitled to receive royalties on the net sales of certain
GalaGen ingredients and certain GalaGen nutritional products that incorporate
their technology.

         In 1995, the Company entered into a License and Collaboration
Agreement with Chiron Corporation involving the licensing of Chiron adjuvant
technology for certain products. Pursuant to this agreement, Chiron has
granted an exclusive worldwide license for certain of Chiron's proprietary
adjuvant technology to the Company for which the Company issued 17,143 shares
of its Series F-1 preferred stock to Chiron.

         The royalties on the above agreements range from one-half to five
percent, depending on the volume, of certain net sales.


                                       18


<PAGE>

LEASE COMMITMENTS

         The Company leases certain office equipment under a one year
operating lease.

         In 1996, the Company entered into a five-year lease agreement with
Land O'Lakes for specified space within the Land O'Lakes facility in
connection with the Company's manufacturing facility. The lease calls for
annual payments of approximately $87,000 and can be extended for additional
one-year periods at the option of the Company. See Note 3.

         In 1996, the Company entered into an equipment operating lease.
Lease payments of approximately $11,000 per month will continue through 2003
with the Company's option to extend for an additional 12 months. The lease is
guaranteed by Land O'Lakes.

         In June 1998 the Company entered into an operating lease with
monthly payments of approximately $36,000 until May 2001 and a final payment
of $165,000 due June 2001. See Note 8.

         The total lease expense was $648,343, $441,972 and $199,808,
respectively, for the years ended December 31, 1999, 1998, and 1997. The
future minimum annual lease payments are as follows:

<TABLE>
<CAPTION>

<S>                                  <C>
                        2000........    $  630,000
                        2001........       511,000
                        2002........       131,000
                        2003........       131,000
                                        ----------
                                        $1,403,000
                                        ==========
</TABLE>

9.       INCOME TAXES

         As of December 31, 1999, GalaGen has operating loss carryforwards to
offset future taxable income of approximately $39,400,000 which begin to expire
in 2007. No benefit has been recorded for such loss carryforwards, and
utilization in future years may be limited, if significant ownership changes
have occurred.

         Components of deferred tax assets are as follows:

<TABLE>
<CAPTION>

                                                                        December 31
                                                     ----------------------------------------------------
                                                          1999               1998              1997
                                                          ----               ----              ----
<S>                                                 <C>                <C>                 <C>
          Loss carryforwards ....................      $ 14,579,000       $ 13,445,000       $ 12,000,000
          Research and development tax credit
             carryforwards ......................           888,000            894,000            791,000
          Deferred compensation .................           494,000            472,000            403,000
          Amortization of intangibles ...........            66,000                  -                  -
                                                      -------------      -------------      -------------
                                                       $ 16,027,000       $ 14,811,000       $ 13,194,000
          Less valuation allowance ..............       (16,027,000)       (14,811,000)       (13,194,000)
                                                      -------------      -------------      -------------
          Net deferred tax assets ...............      $          -       $          -       $          -
                                                      =============      =============      =============
</TABLE>


                                       19
<PAGE>

                         REPORT OF INDEPENDENT AUDITORS

Board of Directors
GalaGen Inc.

         We have audited the accompanying balance sheets of GalaGen Inc. as
of December 31, 1999 and 1998, and the related statements of operations,
changes in stockholders' equity and cash flows for each of the three years in
the period ended December 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.

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

         In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of GalaGen Inc. at
December 31, 1999 and 1998 and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1999 in
conformity with accounting principles generally accepted in the United States.

                                                   Ernst & Young LLP

Minneapolis, Minnesota
February 25, 2000


                                       20
<PAGE>

                             SELECTED FINANCIAL DATA

       The selected financial data set forth below as of December 31, 1999
and 1998 and for each of the three years in the period ended December 31,
1999 are derived from the financial statements of the Company which have been
audited by Ernst & Young LLP, independent auditors, and are included herein.
The selected financial data as of December 31, 1997, 1996 and 1995 and for
each of the two years in the period ended December 31, 1996 are derived from
audited financial statements which are not included herein. The data set
forth below should be read in conjunction with the financial statements and
notes thereto included in the appendix and with "Management's Discussion and
Analysis of Financial Condition and Results of Operations," included above.

<TABLE>
<CAPTION>

                                                                              YEAR ENDED DECEMBER 31
                                                     -----------------------------------------------------------------------------
                                                            1999            1998            1997           1996             1995
                                                     -----------------------------------------------------------------------------
                                                               (IN THOUSANDS, EXCEPT SHARE NUMBERS AND PER SHARE DATA)
<S>                                                   <C>             <C>             <C>             <C>             <C>
STATEMENTS OF OPERATIONS:
   Revenues ......................................    $     3,181     $       876     $         -     $         -     $       150
   Operating costs and expenses:
     Cost of goods sold ..........................            704             244               -               -               -
     Selling, general and administrative .........          2,942           2,235           1,541           1,480           1,417
     Product development .........................          1,619           1,914           3,760           5,258           3,731
     Depreciation and amortization ...............            679             768             601             409             605
   Operating loss ................................         (2,762)         (4,285)         (5,902)         (7,147)         (5,603)
   Interest income ...............................            176             338             448             605              31
   Interest expense ..............................            (11)           (573)           (181)           (945)           (507)
   Net loss before extraordinary gain ............         (2,596)         (4,520)         (5,635)         (7,487)         (6,079)
   Extraordinary gain on extinguishment of
     debt ........................................              -               -               -               -             605
   Net loss for the period .......................         (2,596)         (4,520)         (5,635)         (7,487)         (5,474)
   Preferred stock dividend ......................              -               -               -          (7,297)              -
   Net loss applicable to common stockholders ....    $    (2,596)    $    (4,520)    $    (5,635)    $   (14,784)         (5,474)
   Net loss per share applicable to common
     stockholders
     Basic and diluted ...........................    $      (.26)    $      (.56)    $      (.78)    $     (2.24)    $     (2.87)

   Weighted average number of common shares
      outstanding
     Basic and diluted ...........................      9,957,306       8,067,564       7,184,722       6,604,902       1,904,059

</TABLE>

<TABLE>
<CAPTION>
                                                                           DECEMBER 31
                                                    ------------------------------------------------------------
                                                    1999          1998          1997          1996          1995
                                                    ----          ----          ----          ----          ----
                                                                          (IN THOUSANDS)
<S>                                              <C>           <C>           <C>           <C>           <C>
BALANCE SHEET DATA:
    Cash and cash equivalents .............      $    205      $  4,082      $    156      $  3,870      $    509
    Available-for-sale securities .........         2,783             -         7,512         7,498             -
    Working capital (deficiency) ..........         3,271         3,725         7,028         9,776        (1,033)
    Total assets ..........................         4,732         6,293         9,530        12,959           818
    Note payable ..........................             -             -         1,162             -             -
    Convertible notes .....................             -           193         1,072             -         8,199
    Total liabilities .....................           464         1,217         2,877         1,724        10,521
    Stockholders' equity (deficiency) .....         4,268         5,076         6,653        11,235        (9,703)

</TABLE>

                                       21
<PAGE>

                      MARKET FOR REGISTRANT'S COMMON EQUITY
                         AND RELATED STOCKHOLDER MATTERS

         The Company's common stock, par value $.01 per share, has been
publicly traded since the closing of the Company's initial public offering on
April 1, 1996. The common stock trades on the Nasdaq National Market tier of
The Nasdaq Stock Market under the symbol GGEN. At March 27, 2000, the number
of holders of the common stock was approximately 2,550, consisting of 150
record holders and 2,400 stockholders whose stock is being held by a bank,
broker or other nominee. On March 27, 2000, the closing sale price of a share
of the common stock was $2.875.

         The high and low sale prices per share of the common stock for the
four quarters during the years ended December 31, 1999 and 1998 were as
follows:

<TABLE>

                                     1999                           1998
                            ----------------------         ----------------------
                              HIGH          LOW             HIGH           LOW
                            ----------------------         ----------------------
<S>                          <C>          <C>              <C>           <C>
   First Quarter             $2.625       $1.750           $2.250        $0.844
   Second Quarter            $2.406       $1.438           $3.313        $1.563
   Third Quarter             $2.750       $1.625           $4.000        $1.625
   Fourth Quarter            $2.125       $1.375           $3.000        $1.375
</TABLE>

         The Company has never paid cash dividends on the common stock. The
Board of Directors does not anticipate paying cash dividends in the foreseeable
future.


                                       22
<PAGE>

                 SCHEDULE II: VALUATION AND QUALIFYING ACCOUNTS

                                  GALAGEN INC.

                                DECEMBER 31, 1999

<TABLE>
<CAPTION>

                                                     Balance at           Charged to Costs                        Balance at
                Description                     Beginning of Period         and Expenses        Deductions      End of Period
                -----------                     -------------------         ------------        ----------      -------------
<S>                                             <C>                         <C>                 <C>             <C>
Year Ended December 31, 1999:
    Allowance for returns and doubtful
       accounts                                        $14,020                 $ 4,931                   -          $18,951
                                                       -------                 -------             -------          -------
                                    Total              $14,020                 $ 4,931                   -          $18,951
                                                       =======                 =======             =======          =======
Year Ended December 31, 1998:
    Allowance for returns and doubtful
       accounts                                              -                 $14,020                   -          $14,020
                                                       -------                 -------             -------          -------
                                    Total                    -                 $14,020                   -          $14,020
                                                       =======                 =======             =======          =======
Year Ended December 31, 1997:
                                    Total                    -                       -                   -                -
                                                       =======                 =======             =======          =======
</TABLE>


                                       23