<PAGE>   1
                       SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549


                                  FORM 10-KSB

[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
      ACT OF 1934 FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2000

                         COMMISSION FILE NUMBER 0-25353

                                  DEMEGEN, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)


          COLORADO                                         84-1065575
(State or Other Jurisdiction of                          (IRS Employer
 Incorporation or Organization)                        Identification No.)

  1051 BRINTON ROAD, PITTSBURGH, PA                          15221
(Address of Principal Executive Office)                    (Zip Code)

                                 (412) 241-2150
                          (Issuer's Telephone Number)

          Securities to be Registered under Section 12 (b) of the Act:

                                      NONE

          Securities to be Registered under Section 12 (g) of the Act:

                         Common Stock, $0.001 par value
                                (Title of Class)


Indicate by check mark whether the registrant (1) has filed all reports to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.

                             Yes   X    No
                                 -----     -----

The aggregate market value of the voting stock held by non-affiliates of the
registrant was $25,843,822 as of December 5, 2000, computed on the basis of the
average of the bid and asked prices on such date.

As of December 5, 2000 there were 32,304,778 shares of the registrant's Common
Stock outstanding.

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

                       DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 2001 Annual Meeting of Stockholders are
incorporated by reference into Part III.
<PAGE>   2



                                     PART I

ITEM 1 - BUSINESS

THE COMPANY

The Company was formed after the July 27, 1992 acquisition of the assets of The
Demeter Corporation by Excelsior Capital Corporation ("Excelsior"). Excelsior
was incorporated in Colorado on September 16, 1987. Excelsior acquired all of
the assets of The Demeter Corporation in exchange for 6,625,821 shares of
Excelsior's $0.001 par value common stock. The Demeter Corporation's assets
consisted of intangible assets related to various biotechnology applications in
the fields of human and animal health care, agricultural and commercial
chemicals. Subsequent to the acquisition, Excelsior changed its name to Demeter
BioTechnologies, Ltd. On September 18, 1998, shareholders approved the proposal
of the Company's Board of Directors to change the Company's name to Demegen,
Inc. The Company is currently incorporated in the State of Colorado.

For accounting purposes, the acquisition was treated as a reverse acquisition
whereby The Demeter Corporation acquired Excelsior Capital Corporation. The
historical financial statements prior to the acquisition are those of The
Demeter Corporation utilizing the capital structure of Excelsior. However, The
Demeter Corporation had no operating activities from the date of inception,
December 6, 1991, through July 27, 1992. Likewise, Excelsior had no operating
activities prior to December 6, 1991.

The Company discovers, designs and develops novel peptides, proteins and genes
for the treatment of solid tumors, cystic fibrosis, multi-drug resistant
bacteria and fungi. Applications also include genetically enhanced agricultural
products. The Company expects human clinical trials for a number of
pharmaceutical applications in calendar 2001.

The Company has assembled a skilled and experienced management team, backed up
by a knowledgeable and active board of directors and scientific collaborators.
Within the past two years, the Company has significantly restructured its people
resources. Five outside directors with significant industry experience have
been elected to the Board. Six employees have been hired in the past two years,
four of which enhance the Company's research capabilities or drug development.
The Company's business strategy is structured to efficiently leverage in-house
core strengths with in-depth disease and product knowledge of its scientific and
commercial partners. This strategy permits simultaneous development of multiple
products, thereby reducing risk and expanding opportunities.

The Company has nine issued United States patents and has in-licensed three
additional related U.S. patents. Additional U.S. patents are pending along with
comparable international filings. These technologies are a platform for a number
of product applications. Dr. Jaynes, the Company's Vice President of Research,
has been at the forefront of research into the use of anti-microbial peptides
for the treatment of diseases for over fifteen years and many of the patents
carry very early filing dates and provide broad coverage.

In 1999, peptide drugs accounted for worldwide sales of some $3.4 billion, which
represents only about 4% of the overall pharmaceutical market, and are estimated
to be growing at the rate of 10-15% per year. Examples include Copaxone,
Zoladex, Vancomycin, and Bacitracin. Over three hundred naturally occurring
peptides have been identified. Demegen peptides, however, are all novel products
not found in nature, and include a variety of structural forms. Simply stating
that the peptide form is a-helical, B-sheet or cyclic, however, does not reflect
some of the unique design characteristics used by Dr. Jaynes. The development
and expansion of proteomic and genomic tools will expand the market
opportunities for new peptide and protein products.

Although peptides compose only a small portion of the therapeutic drug market,
there are considerable efforts underway by numerous companies. It is estimated
that over $3 billion has been invested in those companies thus far. The Company
believes this is an indication of the strong belief in the potential for new
peptide therapeutics. The Company has compared its compounds to a number of
other peptide compounds in development by others and believes its technology is
soundly positioned to produce successful products.

The market opportunities for each of the Company's target products are
substantial and in most cases address unmet medical needs. The emergence of
multi-drug resistant bacteria is a major problem, especially for hospitalized
patients. Sexually transmitted infections - HIV, Chlamydia, and Gonorrhea - also
continue to be major public heath problems. B. cepacia is, too often, a deadly
problem for Cystic Fibrosis patients. And, despite a forty-year war on cancer,
much still needs to be done. The Company's pipeline of molecules contains
potential solutions for each of these problems. The Company's technologies can
be delivered by a variety of routes of administration depending on the disease
target, including topical, injection, inhalation, and genetic.

The Company has licensed two agricultural applications to Dow AgroSciences,
formerly Mycogen Corporation which was acquired by Dow AgroSciences. The
first application is for genetically enhanced plants with increased bacterial
and fungal resistance. The second is for genetically enhanced crops with
improved nutrition. Genetically enhanced plants have achieved significant market
penetration in the United States, and, except for Europe, the international
markets are growing rapidly. Most of the new traits to date are insect
resistance and herbicide tolerance. The Company's two licenses are for new
traits that address two additional major markets. The Company has, thus far,
received over two million dollars in payments from Dow AgroSciences.

The Company expects to market and sell products that address niche markets and
license applications that require extensive Phase III clinical trials and
commercialization capabilities. Large pharmaceutical companies look to
biotechnology companies as sources of new products. The biotechnology companies
are usually able to discover and complete early clinical trials much more
efficiently than the large pharmaceutical companies. For a small biotech beyond
the discovery phase, two elements are critical for success. One is having the
right people skills to solve technical issues and the second is having
sufficient technology diversity to overcome application failures that may occur
and to discontinue low probability opportunities. To address these issues, the
Company believes that technology acquisitions or mergers are an important and
inevitable


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component of long term success. Consequently, the Company will actively seek
strategic alliances with other biotechnology companies where there are
opportunities to enhance shareholder value, reduce risks and expand its
technology platforms. The Company has already entered into research
collaborations with two other biotechnology companies.

In June 1998, the Company received a $2 million equity investment from the CEO
Venture Fund of Pittsburgh, PA. Another round with private investors raised $2.8
million in March 2000. Since 1992, the Company has raised over $14 million in
equity.

             OVERVIEW - TECHNOLOGY, APPLICATIONS, PARTNERS & STATUS

<TABLE>
<S>               <C>               <C>      <C>               <C>                        <C>
CORE                                         DISCOVERY, DESIGN AND DEVELOPMENT OF NOVEL
TECHNOLOGY:                                  PEPTIDES, PROTEINS AND GENES


MECHANISMS:                MEMBRANE DISRUPTION                          HOST MODULATION

APPLICATIONS:     DERMAL            RESPIRATORY DISEASES,      SOLID TUMORS               ENHANCED
                  INFECTIONS        CYSTIC FIBROSIS                                       AGRICULTURAL
                                                                                          PRODUCTS

STRATEGIC         S. IL UNIV,       UNIV OF NC                 PITTS CANCER INST          DOW AGROSCIENCES,
PARTNERS:         NIH                                          DUKE UNIV                  AVIGENICS

MOLECULES:        D2A21             12A21,                     D21-10N                    D4E1, D5C, ASP1,
                                    D2A21                                                 D1A21

STATUS:           PHASE I           IN VIVO                    IN VIVO                    IN PLANTA
</TABLE>



                                                                          Page 3

<PAGE>   4
OPERATIONS

The Company's headquarters and laboratory are located in Pittsburgh,
Pennsylvania and it comprises approximately 2,400 square feet with about
one-third devoted to laboratory space. For development of pharmaceutical
products, the Company has developed close working relationships with several
universities. This strategy has enabled the Company to accomplish more with
less. Significant major laboratory infrastructure has been avoided and
development programs can be easily accelerated or slowed to adjust for
scientific or technical challenges that inevitably arise during drug
development, but without the inefficiencies that may occur when all research,
clerical, investigation and new drug development activities are performed
in-house. During the course of a typical year, some 20 researchers, experts in
their disease field, are working on the development of the Company's products at
academic and other research institutions.

The majority of the Company's agricultural technologies are licensed to the
Company's agricultural partner, Dow AgroSciences. Dow AgroSciences is
responsible for all of the development, patent and regulatory costs for the
individual crops, and is also responsible for developing sublicense relationship
for crops that it is not developing on its own. As part of the Company's
agreement with Dow AgroSciences, Dow AgroSciences is funding research at the
Company to expand and broaden the intellectual property estate. The Company
believes its research into gene function, combined with Dr. Jaynes' design
methodologies, will produce additional agricultural license opportunities.

It is worth noting that since the Company's inception, many millions of dollars,
in addition to the use of sophisticated laboratories, have been expended by
universities, government agencies, and private foundations developing products
using the Company's technologies, but with the Company maintaining commercial
rights and control. These expenditures (not reflected in the Company's financial
statements), as well as the number of different organizations participating,
confirm the broad acceptability and confidence in the Company's technology.

PHARMACEUTICAL PRODUCTS

BACTERIA

A major problem, which strongly encourages the development of a new class of
antibiotics agents, is that many common pathogens are becoming resistant to the
therapeutics that have treated patients for the last forty years. Each year in
the United States, about two million cases of infection are contracted by people
while they are in the hospital. Infection remains the principal cause of death
of hospitalized patients in the United States, and one of the leading causes of
all deaths throughout the world. Treatment of infection is a rapidly increasing
concern because of the exponential rate of emergence of antibiotic-resistant
bacteria, compounded by the lack of new antibiotic options effective against
these organisms. The total worldwide anti-infective market is estimated to be
over $25 billion. The topical anti-infective market is estimated to be $2
billion worldwide.

The Company currently has four anti-bacterial applications in pre-clinical
development. Three would be topically delivered and the fourth would be inhaled.

The lead compound for the topical applications is D2A21. It has demonstrated
antimicrobial activity against a broad spectrum of bacterial pathogens. D2A21
has potent in vitro activity against pathogens from species of: Staphylococcus,
Pseudomonas, Enterococcus, Streptococcus, E. coli, Gonococcus, and Chlamydia, as
well as against numerous strains of methicillin-resistant Staphylococcus aureus
("MRSA") and vancomycin-resistant Enterococcus ("VRE"). D2A21 in vivo results
have been demonstrated against Trichomonas, Burkholderia Cepacia and
Porphyromonas gingivalis. The Company has demonstrated that its compounds are
effective in increasing survival when injected sub-eschar into a Pseudomonas
infected mouse model. In summary, D2A21 and other of the Company's compounds
have demonstrated both broad and selective effects against a wide range of
bacterial pathogens, thereby indicating the potential for a number of product
applications.

INFECTED BURNS AND INFECTED WOUNDS: The application in development is for
prevention and treatment of severely burned or surgical patients at risk for
bacterial infections. The use of topical antimicrobial agents has been an
important adjunct to the prevention and treatment of wound infections, yet burn
wound sepsis remains the most common and serious complication of major burn
injury, accounting for over 60% of deaths in burn patients. Also, there are
several disadvantages associated with the use of the most common agents, silver
sulfadiazine and mafenide acetate, including their substantial ability to
inhibit wound healing at clinically effective antimicrobial dosages. Many
topical antimicrobial agents used following burn injury are toxic to
keratinocytes and fibroblasts. The Company's compounds, however, do not retard
cellular growth and wound healing. Furthermore, the development of multi-drug
resistant organisms has become an increasingly important problem in the
management of major surgical infections, in addition to those involving burn
wounds.

The Company's research has been conducted with scientists at the University of
North Carolina, Loyola University and Southern Illinois University. A Phase I
clinical trial for infected burns and a second Phase I for infected wounds is
expected to begin in the next few months. Upon successful completion of the
Phase I trials, Phase II clinical trials will begin later in 2001. The Company's
initial market will be hospitalized burn patients. This hospital burn market is
about 50,000 patients and is a $50 million opportunity. It is the Company's plan
to market this product through a contract sales force. The market for infected
surgical wounds is some 2 million patients and is a $200 million opportunity.
The Company plans to license this opportunity.


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<PAGE>   5


DEMEGEN'S VAGINAL MICROBICIDE: Another application is an intravaginal gel that
prevents the transmission of Chlamydia and other sexually transmitted infections
("STIs"). Speaking about the need for a vaginal microbicide, Penelope Hitchcock,
director of the Sexually Transmitted Diseases Branch at the National Institute
of Allergy and Infectious Diseases stated "The real urgency here is that the
epidemic of HIV, the epidemic of STIs, is upon us, and we need this product
right now." According to a report by Family Health International, approximately
333 million new cases of the five most common curable STIs occurred globally in
1995 in women and men of reproductive age, and heterosexual transmission
accounts for about 75% of all HIV-1 infections. Further, according to survey
results 12.6 million women in the United States are worried about getting HIV or
an STI and are interested in using a microbicide. The Company plans to license
this application. In the U.S., ten million sexually active women would be the
primary market. A similar market exists in other developed countries. In the
developing world, one hundred million women need this kind of product. It is
anticipated there will be substantial government subsidies for the developing
world market.

Prevention of sexually transmitted infections is currently an unmet medical need
and represents an additional $1 Billion market in developed countries. In 1999
over two million women were newly infected with HIV. Chlamydia, caused by the
bacteria Chlamydia trachomatis, is the most common sexually transmitted disease
in the United States. It affects 2-4% of the sexually active population, but up
to 75% of those who have it do not notice symptoms and may carry the disease for
many years. If untreated, the result could be chronic infection or scarring of
the reproductive system with increased risk of infertility and tubal
pregnancies. A survey conducted by the Alan Guttmacher Institute found that some
eight million women in the United States would be very interested in using a
microbicidal product, even at a cost roughly twice that of a male condom. Other
studies have found similar strong interest in Brazil, Egypt, France, India and
other countries.

The Company's efforts to develop this application are being supported by the
Sexually Transmitted Diseases Branch at the National Institutes of Health
("NIH"), the Division of AIDS at the NIH, in addition to scientists at
Magee-Womens Research Institute at the University of Pittsburgh and the
University of Washington. The Company is using its D2A21 compound for this
application also, but with a slightly different formulation, thereby taking
advantage of common toxicology and pharmacology data requirements. Primate
efficacy experiments are underway. With successful results, Phase I clinical
trials for this application could begin in 2001, with the majority of funding
from NIH.

CYSTIC FIBROSIS/PULMONARY INFECTIONS: The Company anticipates that a second
synthetic protein product to be developed will be an inhaled drug to treat
Burkholderia cepacia. This bacteria can de deadly to Cystic Fibrosis patients
and there is currently no effective treatment. Approximately 35% of B. cepacia
infected patients contract accelerated pulmonary deterioration or fulminant,
necrotizing pneumonia with rapidly fatal bacteremia. B. cepacia is also a
causative agent for endocarditis, catheter-associated urinary tract infections,
and wound infections. B. cepacia is rarely found in non-CF patients, but
transmission can occur between CF and non-CF patients and can result in serious
illness and death. It is believed that B. cepacia is underreported because
normally only specimens from CF patients are analyzed for this disease. The
product is also effective against Pseudomonas aeruginosa. The Company plans to
seek Orphan Drug status for this indication and expects to begin clinical trials
in 2001. The lead molecule for this product is 12A21. A companion protein
modulates host response, such that in Cystic Fibrosis patients there would be
reduced lung fibrosis. A clinical trial for this indication may begin in late
2001. The Cystic Fibrosis patient population is about 70,000 worldwide, sadly
because most patients die at a young age. The product under development would be
a maintenance medication and would extend lives, and thereby create an expanding
market. It is likely this product would also function against other respiratory
diseases.

In an animal model, the Company's compound has demonstrated the ability to
control the diseases and the fibrotic growth. This application is being
developed in conjunction with researchers at the University of North Carolina.
Thus far, the Company has received a $100,000 SBIR grant from the NIH for this
pulmonary infection pre-clinical program.

CANCER

Evaluations by the National Cancer Institute (NCI) and private laboratories
indicate that the Company's compounds may have broad applicability against many
solid tumors including prostate, lung, breast, head and neck, ovarian, bladder,
and melanoma. Most of the Company's initial in vivo experiments were against
prostate cancer. While compelling animal results were achieved, the data
indicated that a multi-functional activity was occurring, different than the
traditional cell lysis theory ascribed to anti-microbial peptides. Based on
subsequent analysis, the Company believes the most probable target applications
for this compound are solid tumors such as head and neck, brain glioblastoma,
and prostate.

Within the next 12 months, over 100,000 people in the U.S. will be diagnosed
with a primary or metastatic brain tumor. Glioblastomas represent 23% of all
primary brain tumors. Brain tumors are the second leading cause of cancer death
in children under age 15 and in young adults up to age 34. Brain tumors are the
second fastest growing cause of cancer death among those over age 65, and unlike
the first and third fastest growing causes (lung cancer and melanoma), no
behavioral change has been shown to reduce the risk. Approximately 44 percent of
all primary brain tumors are benign. Unlike most benign tumors found elsewhere
in the body, benign brain tumors may recur and may result in death. Because of
their location at the control center for thought, emotion and physical function,
brain tumors are difficult to treat. The cure rate for most brain tumors is
significantly lower than that for most other types of cancer. Children who are
cured of leukemia are shown to be at greater risk of developing a brain tumor.
Brain tumor research is underfunded and the public, in general, is unaware of
the magnitude of the problem.



                                                                          Page 5
<PAGE>   6

Prostate cancer, the second leading cause of cancer deaths in men in the United
States, affects 9.7 million Americans. Over 200,000 new cases are diagnosed each
year and more than 40,000 American men die of this disease annually. Carcinoma
of the prostate is the most commonly diagnosed cancer in men and the second most
common cause of cancer death in western civilization. It is predominantly a
tumor of older men, which frequently responds to treatment when widespread and
may be cured when localized.

Current therapeutic options include surgery, radiation therapy, hormonal therapy
and chemotherapy. The approach to treatment is influenced by stage of disease,
age, and coexisting medical conditions. Surgery (radical prostatectomy) and
radiation are options for early stage cancer that has not spread outside the
prostate. Hormone therapy and chemotherapy are considered for metastatic or
recurring disease.

A significant number of patients, especially when diagnosed at a more advanced
stage, relapse and develop incurable disseminated metastatic disease. None of
the treatments for advanced disease provide significant benefit to survival.
Effective treatment modalities for patients with residual or non-localized
disease are clearly needed. According to IMS (a market research firm), the U.S.
market for cancer therapeutics in 1996 was almost $3 billion dollars. These IMS
figures do not include drugs like Neupogen, a billion dollar drug, which is only
a cancer adjunct. The prostate cancer drugs Lupron, Zoladex, Eulexin, and
Casodex have worldwide sales of $1.7 billion, and are only palliative for
metastatic prostate disease.

EFFICACY IN ANIMAL MODELS: Evaluation of the Company compounds have occurred in
several animal models for cancer, with the objective of optimizing dose and
schedule. Significant findings to date include:

o        Significant anti-cancer activity against prostate, lung, ovarian,
         breast, CNS and melanoma tumor cell lines

o        Selective cytotoxicity for tumor tissue vs. normal tissue

o        Cytotoxicity for prostate cancer cell lines, 4-8 fold greater than
         conventional chemotherapy agents

o        Low dose (< 1mg/kg) anti-cancer activity in an aggressive model of
         prostate cancer in vivo. Data indicate a benefit to survival, growth
         retardation and/or regression of primary tumor and reduction in
         metastases

o        Equivalent activity when given by intratumoral, intraperitoneal,
         intravenous or subcutaneous route of administration

Rats treated with D2A21 achieved a 60% reduction in the growth of primary tumors
and a significant reduction in the number of lung metastases. D2A21 was
administered intravenously at a low dose, (just 0.179 mg. per injection), that
was effective without causing toxicity to the animals. Importantly, the survival
rate increased from 25% for controls to 75% for D2A21 treated animals.

An important outcome of these studies was the evidence of the multi-function
activity of the D2A21 molecule. Additional animal studies are continuing to
confirm the mechanism of action and to determine the correct dosage amount and
form. Considerable toxicology and pharmacology tests have already been
satisfactorily completed. Assuming continued progress, the Company anticipates
initiating a Phase I clinical trial by the end of 2001.

SUPPORT FOR THE DEMEGEN CANCER PROGRAM: The Company has received considerable
outside support for its cancer program. Researchers and clinicians at the
University of Pittsburgh Cancer Institute, Duke University Medical Center, and
the National Cancer Institute have given time, research, and counsel to help the
Company develop this cancer therapeutic. Also, the Company has received over
$1.5 million dollars in research grants from non-profit cancer foundations and
institutes.


OTHER RESEARCH PROGRAMS

The bulk of the Company's research and development activities, as described
above, are focused on products for topical infections, respiratory diseases, and
solid cancer. Other research accomplishments indicate there are a number of
logical extensions to these applications that will join the product pipeline.
For example, another of the Company's compounds had demonstrated significant
anti-fungal properties. This would be a natural extension of the topical gel
product. Currently, there is an unmet medical need for neo-natal conjunctivitis
which is caused by Chlamydia infections passed on by the mother. With a
different formulation, this product application could be available for clinical
trials by 2002. The respiratory results achieved thus far also indicate the
Chronic Obstructive Pulmonary Disease (COPD), a $1 billion market, is a
potential extension.

PHARMACEUTICAL DEVELOPMENT SCHEDULE

Human clinical trials are typically conducted in three sequential phases which
may overlap. Phase I involves the initial introduction of the drug into human
subjects or patients where the product is tested for safety, dosage, tolerance,
absorption, metabolism, distribution and excretion. Phase II involves studies in
a limited patient population to (i) identify possible adverse effects and safety
risks, (ii) determine the efficiency of the product for specific, targeted
indications, and (iii) determine dosage tolerance and optimal dosage. When Phase
II evaluation demonstrates that the product may be effective and has an
acceptable safety profile, Phase III trials are undertaken to further evaluate
dosage and clinical efficacy and to further test for safety in an expanded
patient population at multiple clinical study sites. A pivotal Phase III trial
is an adequate and well-controlled study which provides the primary basis for
determining whether there is "substantial evidence" to support the claims of
effectiveness for new drugs and forms the basis for a New Drug Application
("NDA"). The regulatory authority or the sponsor may suspend clinical trials at
any point in this process if either entity concludes that clinical subjects are
being




                                                                          Page 6
<PAGE>   7

exposed to an unacceptable health risk, that the trials are not being conducted
in compliance with applicable regulatory requirements, or for other reasons.


AGRICULTURAL PRODUCTS

The application of biotechnology to agricultural crops is directed to the
creation of differentiated, value-added plants and products that improve
production, extend shelf life, prevent pathogenic disease, enhance nutritional
value, and reduce the negative environmental impact of potentially hazardous
chemicals. Genetically engineering crops accelerates the traditional, time
consuming process of cross breeding of crops. In addition to speed, genetic
engineering enables the designer to introduce characteristics that would most
likely not be feasible with traditional techniques.

Perhaps the most fundamental driving force for these new crops is the basic
recognition that the world's population is growing by over 50,000,000 people per
year. At the same time, as economies improve in developing countries, the demand
for food increases faster than the population, or its ability to produce it. The
president of a large agricultural biotechnology company has stated that the
output per acre will need to double in the next 30 years, just to maintain the
current levels of hunger and malnutrition.

DISEASE RESISTANT CROPS

In November 1997, the Company concluded its first licensing agreement with Dow
AgroSciences to utilize the Company's antimicrobial plant genes in developing
disease resistant agricultural crops. The Company and Dow AgroSciences will also
seek third party licensees in order to expand the use of the technology into a
broad range of crops and geographic regions. The Company will receive royalty
and milestone payments as well as sublicense fees.

The importance of the Company's technology is illustrated in the examples that
follow. For many fungal diseases, chemical fungicides are the only treatment
alternative and can add five to ten percent to the cost of the crop and pose
serious environmental concerns. For other diseases, there are no treatments
available and genetic engineering may be the only alternative.

One example is the recent outbreak of citrus canker in South Florida. Citrus
canker is a highly contagious disease caused by the bacterium Xanthomonas
axonopodis pathovar citri. It can destroy entire orchards; however, the disease
poses no health risk to humans or animals. Canker manifests itself on the fruit
as raised, brown, corky lesions, surrounded by yellow rings. Hundreds of
thousands of citrus trees in South Florida have already been removed to stop the
spread of canker. The state of Florida offers $100 to homeowners to help offset
the cost of planting new trees. Producing trees that are genetically resistant
to canker would take some time, but the long term benefits could be enormous.

Another example is Pierce's disease caused by Xylella fastidiosa. This bacterium
kills grapevines by blocking their water transport system. An infected vine
produces no crop and usually dies within two years. The disease ranges from
North America through Central America and parts of South America. Pierce's
disease has cost the California wine and grape industries millions of dollars in
lost revenues (up to $20,000 per acre) since it began destroying grapevines in
Napa and Sonoma counties several years ago. During severe outbreaks, losses to
this disease may require major replanting. If it remains unchecked, the disease
could also spread to citrus, almonds and ornamentals. In Florida and other
southeastern states, the disease is considered to be the single most formidable
obstacle to the growing of European grape varieties. Other strains of Xylella
fastidiosa have been discovered, and almost all of these can cause leaf
scorching of woody perennials such as American elm, maple, mulberry, or plum. In
other plants, such as peach and alfalfa, the bacterium stunts the plant's
growth.

An important fungal disease in the U.S. is late blight of potatoes caused by the
fungus, Phytophthora infestans. The U.S. strain is a virulent "cousin" of the
fungus that caused the Irish potato famine. It was first reported in the U.S. in
the late 1980's and has spread up the East Coast from Florida to Maine, and as
far west as Idaho and Oregon. The disease causes discoloration of the leaves
accompanied by a secondary disease, downy mildew. The tubers may also be
infected in the field or in storage, causing discoloration of the skin and a
reddish brown dry rot extending into the tuber. Later, a slimy, foul smelling
rot may destroy the tuber. The US-8 strain is now the most widely distributed
form of late blight in the U.S. It is also the most problematic because of its
resistance to metalaxyl, a fungicide commonly used to combat the fungus. Two
additional factors compound the problem posed by the fungus. First, it is
difficult to detect low levels of late blight in the field and unless it is
detected early, the fungus does not respond to antifungal treatments. The second
problem involves the lifecycle of the fungus. The late blight disease cycle of
penetration, colonization, sporulation and dispersal can occur in less than five
days.

One example of the effectiveness of the Company's technology was demonstrated by
the USDA against Erwinia carotvora, commonly known as potato "soft rot". Soft
rot affects tubers while in storage or in the soil prior to harvest and can
decay the seed tubers or seed pieces after planting. Soft rots also cause the
decay of numerous other fleshy fruits and vegetables, such as cucumbers, onions,
tomatoes, and lettuce, and some ornamental plants, such as iris. Soft rot can
cause extensive damage to potatoes in storage within a few hours.



                                                                          Page 7
<PAGE>   8

The USDA's Agricultural Research Service in Albany, CA, conducted the field
tests in the Ranger Russet potato using one of the Company's disease resistant
plant genes. (The Company and the USDA have had five Cooperative Research and
Development Agreements (CRADA), under which a number of projects have been
conducted.)

The experiments conducted to test efficacy of soft rot protection indicated that
those tubers which contain and express the Company genes almost totally resist
rotting. After a five day incubation period, compared to the control, the amount
of soft rot reduction ranged from 85% to 96%. This is a highly significant
result that has not been achieved before in potatoes. Losses caused by soft rot
diseases are estimated at 10% in the United States or about $300 million, and
often much higher in other countries.

Most transgenic development for crop protection is targeted at replacing
insecticides or increasing herbicide resistance. The Company's gene products
primarily target bactericides and fungicides. The Company believes its success
and patent position in controlling bacterial and fungal diseases is unique.
Fungicide expenditures in the United States and the world are $550 million and
$4.1 billion respectively. United States farmers purchase about $4 billion of
seeds each year.

NUTRITION ENHANCED CROPS

Developing new engineered crops is a lengthy process. Development schedules are
limited by their natural cycle time to produce crops. This can range from 4-6
months for vegetables to several years for tree crops. While one gene may work
in many crops, the transformation process has to be done species by species,
and, as with pharmaceuticals, a number of regulatory hurtles need to be
satisfied.

While Dow AgroSciences is developing specific crops, it is expected that
numerous partners for other crops will need to be engaged in order to realize
the full potential of this technology. Efforts to date have focused on
identification and selection of the most promising gene candidates. Some in
plant successes have been reported by collaborators in such crops as apple,
pear, potato and ornamentals.

The Company expects income from this technology will be derived from license
fees and royalties, but material payments are not expected for several years.

In addition to disease resistance traits, the Company has invented "storage
protein" or nutrition genes, which contain all the essential amino acids for
healthy animal or human growth. The first field proof of concept was in sweet
potatoes, under the direction of Dr. C.S. Prakash, Professor and Director of the
Center for Plant Biotechnology at Tuskegee University. Sweet potatoes grown with
the Company's nutrition genes produce all of the essential amino acids required
for daily consumption. Remarkably, the overall protein levels in the sweet
potatoes averaged over three times the normal levels.

One of the crops which historically valued additional protein is wheat for food
uses. Standard wheat flour contains about 11% protein. Commercial users of flour
often add wheat gluten to achieve a higher protein content. Wheat with a higher
protein content, in the 14% to 17% range, can command premiums ranging from $.20
to $1.25 per bushel. Accordingly, a higher protein wheat offers a market
opportunity of several hundred million dollars annually. The Company hopes to
capitalize on this market opportunity.

The Company's nutrition technology will also be very important for U.S. and
world animal feed producers. In the future, animal feed producers may be able to
obtain the essential amino acids they require, in constructing their feed
rations for poultry and swine, directly from corn, sorghum or even soybeans. The
savings on their feed bill could be substantial, in addition to avoiding some of
the problems that occur occasionally from the use of animal-based ingredients in
feed rations.

Plants are generally deficient in the essential amino acids that all animals,
including humans, need to grow and sustain health. Of the twenty essential amino
acids humans need, our bodies can only synthesize about twelve. The other eight
must be ingested regularly to sustain health. Infants and young children whose
diets largely consist of plant-based foods, such as in many developing
countries, are particularly at risk. Millions of young people die or suffer
permanent mental and physical damage yearly as a result of insufficient
essential amino acid intake. In developed countries, such crops could have
considerable appeal to vegetarians.

Worldwide, the market for the Company's nutrition genes could easily be $1
billion in ten years. This technology, another example of Dr. Jaynes' design
methodology, is also supported with an allowed United States patent and a number
of additional filings.

The nutrition technology faces similar technological and regulatory hurtles as
the disease resistance technology. In addition, the number of candidate crops in
which the nutrition technology would apply is much smaller than that for disease
resistance. On the other hand, higher protein crops should capture value later
in the value chain, and, therefore, success in just a few crops offers
significant potential.

The Company's main efforts, in conjunction with Dow AgroSciences, is focused on
the identification and selection of lead genes, developing of analytical
methods, and evaluation of regulatory factors. In 2000, the Company received
$570,000 from Dow AgroSciences for research support and fees. In 2001, the
Company expects to receive $640,000 for research support and fees. Significant
milestone payments or royalties are not expected for several years.



                                                                          Page 8
<PAGE>   9

GOVERNMENT REGULATION

Drug Approval Process

Regulation by governmental authorities in the United States and other countries
is a significant factor in the development, production and marketing of the
Company's proposed products. All of the Company's products will require
regulatory approval by governmental agencies prior to commercialization. In
particular, human therapeutic products are subject to rigorous preclinical and
clinical testing and other approval procedures in the United States by the FDA
and similar health authorities in foreign countries. Various federal statutes
and regulations also govern or influence the testing, manufacturing, quality
control, safety, labeling, storage, record-keeping and marketing of such
products. The process of obtaining these approvals and the subsequent compliance
with appropriate federal and foreign statutes and regulations require the
expenditure of substantial resources. Any failure by the Company or its
collaborators or licensees to obtain, or any delay in obtaining, regulatory
approval could adversely affect the marketing of any of the Company's products
and its ability to receive revenues therefrom. The Company has neither applied
for nor received regulatory approval to market any products.

The steps required before a pharmaceutical agent may be marketed in the United
States include (i) preclinical laboratory, in vivo and formulation studies, (ii)
the submission to the FDA of an IND, which must become effective before human
clinical trials may commence, (iii) adequate and well controlled human clinical
trials to establish safety and efficiency of the proposed drug in its intended
indication, (iv) the submission of a New Drug Application ("NDA") to the FDA,
and (v) the FDA approval of the NDA.

In order to clinically test, produce and market products for diagnostic or
therapeutic use, a company must comply with mandatory procedures and safety
standards established by the FDA and comparable agencies in foreign countries.
Before beginning human clinical testing of a potential new drug, a company must
file an IND and receive clearance from the FDA. The IND is a summary of the
preclinical studies which were carried out to characterize the drug, including
toxicity and safety studies, as well as an in-depth discussion of the human
clinical studies which are being proposed. Approval of a local institution
review board ("IRB") and informed consent of trial subjects is also required.

Human clinical trials are typically conducted in three sequential phases which
may overlap. Phase I involves the initial introduction of the drug into human
subjects or patients where the product is tested for safety, dosage, tolerance,
absorption, metabolism, distribution and excretion. Phase II involves studies in
a limited patient population to (i) identify possible adverse effects and safety
risks, (ii) determine the efficiency of the product for specific, targeted
indications, and (iii) determine dosage tolerance and optimal dosage. When Phase
II evaluation demonstrates that the product may be effective and has an
acceptable safety profile, Phase III trials are undertaken to further evaluate
dosage and clinical efficacy and to further test for safety in an expanded
patient population at multiple clinical study sites. A pivotal Phase III trial
is an adequate and well-controlled study which provides the primary basis for
determining whether there is "substantial evidence" to support the claims of
effectiveness for new drugs and forms the basis for an NDA. The regulatory
authority or the sponsor may suspend clinical trials at any point in this
process if either entity concludes that clinical subjects are being exposed to
an unacceptable health risk, that the trials are not being conducted in
compliance with applicable regulatory requirements, or for other reasons.

The results of product development, preclinical studies and clinical studies are
submitted to the FDA as part of an NDA for approval of the marketing and
commercial shipment of the product. The FDA may deny approval of an NDA if
applicable regulatory criteria are not satisfied, or may require additional
data. Even if such data is submitted, the FDA may ultimately decide that the NDA
does not satisfy its criteria for approval. Once issued, a product approval may
be withdrawn if compliance with regulatory standards is not maintained or if
problems occur after the product reaches the market. In addition, the FDA may
require testing and surveillance programs to monitor the effect of approved
products which have been commercialized, and it has the power to prevent or
limit further marketing of a product based upon the results of these
post-marketing programs.

Satisfaction of these FDA requirements, or similar requirements by foreign
regulatory agencies, typically takes several years and the time needed to
satisfy them may vary substantially, based upon the type, complexity and novelty
of the drug product. The effect of government regulation may be to delay or to
prevent marketing of potential products for a considerable period of time and to
impose costly procedures upon the Company's activities. There can be no
assurance that the FDA or any other regulatory agency will grant approval for
any products being developed by the Company on a timely basis, or at all.
Success in preclinical or early stage clinical trials does not assure success in
later stage clinical trials. Data obtained from preclinical and clinical
activities are susceptible to varying interpretations which could delay, limit
or prevent regulatory approval. If regulatory approval of a product is granted,
such approval may impose limitations on the indicated uses for which a product
may be marketed. Further, even if regulatory approval is obtained, later
discovery of previously unknown problems with a product may result in
restrictions on the product, including withdrawal of the product from the
market. Delay in obtaining or failure to obtain regulatory approvals would have
a material adverse affect on the Company's business. Marketing the Company's
products abroad will require similar regulatory approvals and is subject to
similar risks. In addition, the Company is unable to predict the extent of
adverse government regulation that might arise from future United States or
foreign governmental action.



                                                                          Page 9
<PAGE>   10

Before the Company's products can be marketed outside of the United States, they
are subject to regulatory approval similar to that required in the United
States, although the requirements governing the conduct of clinical trials,
product licensing, pricing and reimbursement vary widely from country to
country. No action can be taken to market any product in a country until an
appropriate application has been approved by the regulatory authorities in that
country. The current approval process varies from country to country, and the
time spent in gaining approval varies from that required for FDA approval. In
certain countries, the sales price of a product must also be approved. The
pricing review period often begins after market approval is granted. No
assurance can be given that, even if a product is approved by a regulatory
authority, satisfactory prices will be approved for the Company's products.

No assurance can be provided that the Company's INDs or NDAs will be
successfully reviewed by the FDA, or that similar applications will be
successfully reviewed by foreign regulatory authorities. Further, the FDA and
foreign authorities may at any time take legal or regulatory action against a
product or the Company if it concludes that a product has not complied with
applicable laws and regulations or that earlier evaluations of a product's
safety or effectiveness may not have been adequate or appropriate. Such action
may include, but is not limited to, restrictions on manufacture and shipment of
products, seizure of products, injunctions and civil and criminal penalties. The
FDA's policies may change and additional government regulations may be
promulgated which could prevent or delay regulatory approval of the Company's
potential products. Moreover, increased attention to the containment of health
care costs in the United States and in foreign markets could result in new
government regulations which could have a material adverse effect on the
Company's business. The Company is unable to predict the likelihood of adverse
governmental regulation which might arise from future legislative or
administrative action, either in the United States or abroad.

New genetically enhanced crops are subject to extensive regulatory approval
process that could include the FDA, the USDA, and the EPA and similar
governmental agencies in other countries, not dissimilar to that faced by the
pharmaceutical process.

There has been an increased resistance in Europe to genetically modified
organisms ("GMO"). Some foreign governments have or are expected to mandate the
disclosure on consumer products of the inclusion of GMOs. This has resulted in
certain food processors requesting that their suppliers only provide them with
non-genetically modified agricultural products. While there is an awareness of
GMOs in the United States, it has not progressed to the point of other
countries. In November 1999, a Bipartisan bill was introduced in Congress that
would require labels identifying whether fresh produce or any ingredient in
packaged foods was grown from genetically modified seed. Additionally, the FDA
has signaled it is considering changes in genetically modified crops.

In 1999, there were some forty million hectares globally planted with transgenic
crops, 43% more than in 1998. 72% of those crops were planted in the United
States, with 84% of the total made up of soybean and corn. Despite this wide
acceptance of these products, there is much negative emotion, especially in
Europe. However, offsetting this emotion, the developing countries are starting
to speak in favor of such crops because they see such crops as absolutely
necessary methods to produce enough food to feed their people. Further, the
Company believes that when crops that directly benefit people are demonstrated,
such as the Company's high nutrition sweet potato, there will be more acceptance
compared to crops that permit greater use of chemical herbicides. None the less,
there is no assurance that the Company, its licensee, or any other partners will
be successful in achieving regulatory approval.


ENVIRONMENTAL REGULATION

The Company does not incur significant costs in complying with federal or state
environmental regulations due to the nature of its activities.


TECHNOLOGY BASE

The Company's technology was designed by Jesse M. Jaynes, Ph.D. Dr. Jaynes has
over 15 years of peptide design experience and is a biochemist by training. Dr.
Jaynes was the first to demonstrate and publish results showing that
antimicrobial peptides had antifungal, anticancer and antiprotozoal activity and
could also be used for enhanced plant disease resistance and enhanced animal
disease resistance.

Dr. Jaynes is a Co-Founder of the Company and serves as Vice President of
Research. The Company believes having a molecular architect as part of the
management team distinguishes the Company from its peptide biotech competitors
which have typically in-licensed their lead molecules. As a result, the Company
has a structure and process in place for creating a pipeline of new molecular
product applications.

Peptides with lytic properties occur in nature and are part of the natural
immune systems of many animals, insects and plants. Over 300 natural peptides
have been identified. The Company's core science is the ability to design
molecules which are many times more powerful than those occurring in nature,
with minimal toxicity. The Company's compounds range in length from 17 to 40
amino acids and they have no sequence homology to the peptides found in nature.
In its discovery process, the Company has identified a number of
characteristics, which, when incorporated into the design of a molecule, create
compounds with unique properties. These design "rules" include parameters for
charge density, length, amphipathy,



                                                                         Page 10
<PAGE>   11

hydrophobicity and spatial orientation. When optimized, these characteristics
permit the ability to design molecules with increased specificity and activity,
which means some are more effective against cancer than bacteria, for example.

Understanding the rules for creating the desired properties is an important
aspect of the Company's core technology. The Company has identified several
thousand different molecules which comprise several classes of molecules. This
relatively small number represents the spectrum of molecules with the most
desirable features and benefits compared to the hundreds of millions of
potential combinations and permutations that could theoretically be created. The
Company has created a large library of molecules from which new lead compounds
can be selected as potential new drug candidates.


MECHANISM OF ACTION

In general, these kind of compounds are believed to act by disrupting the
membrane or cell wall, thereby allowing fluids to enter the cell and cause the
cell to be destroyed or lysed. Because healthy human cells have a more complex
cytoskeletal structure, which a pathogenic cell does not possess, the healthy
cell has the ability to repair any damage. In the case of bacteria, this method
of action effectively precludes bacteria from mutating to avoid destruction,
thereby giving the Company's compounds a competitive advantage over most other
antibiotics where drug resistance is becoming a major problem. The Company's
compounds are also effective directly against cancer cells. Cancer cells are, in
effect, unhealthy cells, and therefore have weakened cytoskeletal structures.


ENGINEERED CROPS

The Company has designed plant genes that destroy many agricultural fungal and
bacterial pathogens once inserted transgenically into the genome of crops. The
crops then take on the disease resistant trait and are able to express the
peptide into future generations of the plant. The Company has constructed an
inventory of genes which are being used to incorporate disease resistance into
plants, securing good yields while reducing the use and cost of environmentally
undesirable chemicals.

Genetically engineering crops accelerates the traditional, time consuming cross
breeding of crops. In addition to speed, genetic engineering enables the
designer to introduce characteristics, in particular, pest and disease
resistance, which would most likely not be feasible with traditional techniques.
Although plant genetic engineering still faces regulatory hurdles, there have
been significant recent breakthroughs in acceptability of biologically enhanced
crops. Bt genes, which protect plants from harmful insects (Monsanto, Dow
AgroSciences and others), highlight the major efforts underway to genetically
modify plants.

The Company has also designed another type of plant gene, a custom designed
storage protein which has significant potential for improving animal feeds as
well as human nutrition, by improving the amino acid profile of various food and
feed crops. Recent independent results indicate that the total protein content,
not just the deficient amino acids, could be increased four fold.

The principal goal in plant protein design has historically been to increase one
or two individual amino acids. These approaches have generally not been
successful because they were unable to stabilize sufficient quantities of the
target proteins. Dr. Jaynes took a broader approach and built upon the
structural requisites he used to design proteins with anti-bacterial traits.

Dr. Jaynes designed a protein molecule which, when produced by the plant, would
produce the eight most essential amino acids needed by humans, and offsetting
those in which the crops, on average, were most deficient. A key step was to
create a molecular structure that mimics a natural plant storage protein's
ability to form stable aggregates and accumulate within the plant cell. This
design concept, ASP ("Artificial Storage Protein") achieved the goal of a
qualitative improvement in protein content. The structural arrangement also
facilitates the bioavailability of the essential amino acids by setting up
targets for the main digestive enzymes of the mammalian gut, and thereby
breaking down the protein into its constituent amino acids.

The design concept developed by Dr. Jaynes also accomplished a quantitative
increase in total protein content. Normally a plant produces a variety of
proteins. Many of these are broken down to accomplish various plant tasks and
the plant produces new proteins. The ASP gene reduces this "turnover" (loss of
protein) of the natural proteins within the plant, thereby allowing for greatly
increased protein content. The reasons for the turnover reduction are not yet
understood, but the result of inserting an ASP gene yields significant
qualitative and quantitative improvement in protein content without degradation
of other important characteristics.

Building on the ASP success, Dr. Jaynes has established a design methodology for
optimizing a given crop for a given application, e.g. corn that satisfies the
specific feeding requirements of hogs.

In 1999, there were some forty million hectares globally planted with transgenic
crops, 43% more than in 1998. 72% of those crops were planted in the United
States, with 84% of the total made up of soybean and corn. Despite this wide
acceptance of these products, there is much negative emotion, especially in
Europe. However, offsetting this emotion, the developing countries are starting
to speak in favor of such crops because they see such crops as absolutely
necessary methods to produce enough food to feed their people. An article
headline in the October 2000 New York Times illustrates this point: "China
Rushes to Adopt Genetically Modified Crops". China has approved the release of
more than 100 genetically engineered



                                                                         Page 11
<PAGE>   12

crops, double the number released in the United States. Further, the Company
believes that when crops that directly benefit people are demonstrated, such as
the Company's high nutrition sweet potato, there will be more acceptance
compared to crops that permit greater use of chemical herbicides.

PRODUCTION

One of the impediments for peptide therapeutics has been cost of goods. One
estimate for synthesizing 20kg was $350 per gram, with the expectation of
achieving $250 per gram. A recent article by one producer predicted $40-$120 per
gram. For some diseases, such as for treating cancer, these levels may be
satisfactory. Other products may require much lower cost. Because of the
increased interest in protein therapeutics, the number of alternate production
methods has exploded. The production systems include bacterial, fungal, yeast,
milk, eggs, algae, and plants. Although the Company has not selected a
production method yet, discussions with some of the providers of alternate
methods indicate that costs could eventually be less than $10 per gram.

Compared to many peptides, D2A21, the Company's lead compound is relatively easy
to make. Because it is active at very low concentrations, the Company believes
it would be competitive in the marketplace for treating cancers and severe
infections. For an application that would require larger quantities, such as a
vaginal gel, the cost would need to be substantially even lower. The Company
expects to enter into a relationship with a company that has the capability to
produce the Company's compounds at very low cost.

The peptides for preclinical and initial clinical development activities have
been manufactured by Multiple Peptide Systems ("MPS") of San Diego, California,
using a manufacturing method based on currently available solid phase peptide
synthesis technology. The development of specifications and establishment of
analytical methods is being carried out jointly by MPS and the Company. The
Company is currently negotiating with a contract manufacturer to produce the
Company's clinical supplies.


PATENTS

The Company has been awarded twelve (12) United States patents. The Company has
also filed a number of United States patent applications, as well as
corresponding applications in the PCT and foreign countries. The Company's
patent strategy is to strive for broad coverage for a class of molecules for a
wide range of diseases in humans, animals, and plants.

For its agricultural applications, the Company has acquired the right to three
(3) U.S. and three (3) international patents from Louisiana State University
("LSU"). These patents include broad claims for conferring bacterial and fungal
resistance in plants. Dr. Jesse M. Jaynes, the Company's Vice President of
Research, was the principal inventor on these patents when he was a professor
and researcher at LSU. These patents also carry early filing dates, thereby
giving the Company a very strong patent position in the disease resistant plant
area. One of the patents also licensed to the Company provides broad coverage
for nutrition enhancement technology issued in September 1998. The Company has
also been assigned Dr. Jaynes' rights to patents related to earlier work at LSU.





                                 DEMEGEN PATENTS

<TABLE>
<CAPTION>
--------------------- ----------------- -----------------------------------------------------------------------
                           ISSUE                                     PATENT TITLE
     PATENT NO.            DATE
--------------------- ----------------- -----------------------------------------------------------------------

<S>                        <C>          <C>
    US 6,084,156           7-4-00       Plants Producing Lytic Peptides (expires June 17, 2011)
--------------------- ----------------- -----------------------------------------------------------------------

    US 6,018,102          1-25-00       Ubiquitin-Lytic Peptide Fusion Gene Constructs, Protein Products
                                        Deriving Therefrom, and Methods of Making and Using Same (expires
                                        October 8, 2013)
--------------------- ----------------- -----------------------------------------------------------------------

    US 6,001,805          12-14-99      Method of Enhancing Wound Healing by Stimulating Fibroblast and
                                        Keratinocyte Growth in Vivo Utilizing Amphipathic Peptides (expires
                                        March 17, 2015)
--------------------- ----------------- -----------------------------------------------------------------------

    US 5,968,904          10-19-99      Modified Arginine containing Lytic Peptides and Method of Making the
                                        Same by Glycoxylation (expires November 8, 2013)
--------------------- ----------------- -----------------------------------------------------------------------

    US 5,955,573          9-21-99       Ubiquitin-Lytic Peptide Fusion Gene Constructs, Protein Products
                                        Deriving Therefrom, and Methods of Making and Using Same (expires
                                        July 22, 2014)
--------------------- ----------------- -----------------------------------------------------------------------
</TABLE>



                                                                         Page 12
<PAGE>   13

<TABLE>
<CAPTION>
--------------------- ----------------- -----------------------------------------------------------------------
                           ISSUE                                     PATENT TITLE
     PATENT NO.            DATE
--------------------- ----------------- -----------------------------------------------------------------------

<S>                        <C>          <C>
   US 5,811,654*          9-22-98       Plants Genetically Enhanced for Nutritional Quality (expires July 25,
                                        2006)
--------------------- ----------------- -----------------------------------------------------------------------

    US 5,773,413          6-30-98       Method of combating Mammalian Neoplasias, and Lytic Peptides Therefor
                                        (expires February 10, 2015)
--------------------- ----------------- -----------------------------------------------------------------------

    US 5,744,445          4-28-98       Method of Treating Pulmonary Disease States with Non-Naturally
                                        Occurring Amphipathic Peptides (expires April 28, 2015)
--------------------- ----------------- -----------------------------------------------------------------------

    US 5,717,064          2-10-98       Methylated Lysine-Rich Lytic Peptides and Method of Making Same by
                                        Reductive Alkylation (expires February 10, 2015)
--------------------- ----------------- -----------------------------------------------------------------------

   US 5,597,946*          1-28-97       Method for Introduction of Disease and Pest Resistance Into Plants
                                        and Novel Genes Incorporated Into Plants Which Code Therefor (expires
                                        January 28, 2014)
--------------------- ----------------- -----------------------------------------------------------------------

   US 5,597,945*          1-28-97       Plants Genetically Enhanced for Disease Resistance (expires January
                                        28, 2014)
--------------------- ----------------- -----------------------------------------------------------------------

    US 5,561,107          10-1-96       Method of Enhancing Wound Healing by Stimulating Fibroblast and
                                        Keratinocyte Growth in Vivo Utilizing Amphipathic Peptides (expires
                                        October 1, 2013)
--------------------- ----------------- -----------------------------------------------------------------------
</TABLE>

* Patents in-licensed from Louisiana State University




COMPETITION

There are at least forty other biotechnology companies who are developing
peptide compounds for antimicrobial or anti-cancer applications. Through the
Internet, the Company regularly monitors patents, press announcement, and
publications in order to be informed about the Company's fields of technology
and the actions of competitors. These companies include: Applied Microbiology,
Cubist Pharmaceuticals, Intrabiotics, Magainin Pharmaceuticals, Micrologix
Biotech, Microcide Pharmaceutical, Inc., Periodontix and Xoma Corporation. The
market capitalization of these companies ranges from $30 million to $1.4
billion. While not every competitor has been evaluated, based on the reviews
that have been conducted thus far, the Company believes it has a solid position
and a number of unique characteristics, and has achieved its current level of
accomplishment with relatively modest spending. In comparing the Company to
other peptide companies, the following are general observations:

There are two broad classes of competitors - other companies using a peptide
technology platform, and companies using other technology platforms to address
the same diseases. To our knowledge, there are at least 40 peptide companies
focused on at least some twenty disease indications. For each disease
indication, there can be dozens of non-peptide companies with other
technologies.

Defining peptide competitors is not obvious. The types of peptides in the
Company's portfolio are often referred to as lytic or antimicrobial peptides
("AMP"). Many peptide companies have their own name for compounds that
purportedly perform similar functions to the Company's. Heretofore, there have
not yet been any approved AMP peptide products. Other companies do not consider
their peptides in this class at all, yet a review of their documents show
examples of pore-forming mechanisms that are typically ascribed to AMPs. The
Company's recent work indicates that at least some of these molecules or their
fragments perform in a way that is very different than is viewed as typical of
AMPs. (This suggests that the Company's next generation of molecules may be more
related to a different set of peptide competitors than has been traditionally
thought.)



                                                                         Page 13
<PAGE>   14

Among the peptide companies, several are working on a number of different
disease areas, making summarization difficult, but in general the efforts are
directed as follows:

         Cancers                    26%
         Bacteria                   18%
         Viral                      14%
         Autoimmune                 11%
         Wound care                  8%
         Cardiovascular              8%
         Inflammation                8%
         Diabetics                   8%


In general, most peptide companies, unlike the Company, have in licensed their
initial lead compounds and few have in-house capability to generate new leads.


EMPLOYEES

The Company currently has nine employees but also supports, directly or
indirectly, some twenty researchers at academic and other research institutions.
These academic and other research institutions are the recipients of SBIR grants
requested by the Company, are performing pre-clinical research and/or assisting
the Company with its study of its peptides.


COMPANY HISTORY AND GENERAL INFORMATION

The Company was formed after the July 27, 1992 acquisition of the assets of The
Demeter Corporation by Excelsior Capital Corporation ("Excelsior"). Excelsior
was incorporated in Colorado on September 16, 1987. Excelsior acquired all of
the assets of The Demeter Corporation in exchange for 6,625,821 shares of
Excelsior's $0.001 par value common stock. The Demeter Corporation's assets
consisted of intangible assets related to various biotechnology applications in
the fields of human and animal health care, agricultural and commercial
chemicals. Subsequent to the acquisition, Excelsior changed its name to Demeter
BioTechnologies, Ltd. On September 18, 1998, the shareholders approved the
recommendation of the Company's Board of Directors to change the Company's name
to Demegen, Inc.

The Company is a "Development Stage Company" that designs synthetic
peptide/protein compounds and genes for pharmaceutical and agricultural
applications. Current development programs include a new treatment for prostate
cancer and sexually transmitted diseases, and two transgenic agricultural
applications - one to prevent plant diseases, the other to increase the
nutritional value of food and feed crops.

The Company has two licenses in place for its agricultural technology, disease
resistance and nutritional enhancement, to Dow AgroSciences which has produced
historic revenue streams and will continue to produce revenue as Mycogen
proceeds towards commercialization of these technologies. The Company is
focusing its pharmaceutical efforts upon therapies to prevent or treat bacterial
diseases and cancer which it expects to license to a major pharmaceutical firm,
when the therapeutic will be either in Phase II or entering Phase III clinical
trials. The Company does not have any formal agreements with pharmaceutical
firms at this time.

ITEM 2 - DESCRIPTION OF PROPERTY

The Company's office and lab are located at 1051 Brinton Road, Pittsburgh, PA
15221. The Company occupies 3,000 square feet of leased space. The lease is for
a three year term, expiring September 2001 at a gross monthly rental, including
utilities, of $3,948. Prior to the Company's move to Pittsburgh in September
1998, the Company was located in Durham, North Carolina.

The Company fully utilizes its office space and laboratory.

The majority of the Company's application research is conducted by independent
labs, academic and research institutions and commercial partners. The Company's
laboratory focuses primarily on research related to the Company's core
technologies in assisting Dow AgroSciences in an ancillary capacity with the
development and commercialization of the agricultural technologies.

The Company believes that these facilities are adequate for its current needs.


ITEM 3 - LEGAL PROCEEDINGS

None



                                                                         Page 14
<PAGE>   15

ITEM 4 - SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS

None

ITEM 5 - MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The Company's Common Stock has been quoted on the Over-the-Counter Bulletin
Board since 1994 under the symbol "DBOT". The following table sets forth, based
upon information received from the National Quotation Bureau, the high and low
bid/ask prices for the Common Stock for the quarters indicated. The quotations
represent bid between dealers and do not include retail mark-up, mark-down or
commissions, and do not represent actual transactions.




<TABLE>
<CAPTION>
Fiscal            December 31               March 31           June 30           September 30
------            -----------               --------           -------           ------------

<S>               <C>                       <C>                <C>               <C>
2000

High                  $0.33                   $1.53             $1.00               $0.65
Low                   $0.19                   $0.29             $0.53               $0.46


1999

High                  $0.51                   $0.51             $0.63               $0.44
Low                   $0.21                   $0.32             $0.29               $0.24
</TABLE>




At December 2, 2000, there were 503 holders of record of 32,304,778 shares of
Common Stock, exclusive of holders which maintain their ownership in
"Street-Name" at brokerage houses, and one holder of record of 4,444,444 shares
of Preferred Stock. There are approximately 1,526 stockholders which hold their
ownership in street name.


                                    PART II

ITEM 6 - SELECTED FINANCIAL DATA

The following table sets forth certain financial data for, and as of the end of,
the years ended September 30, 2000, 1999, 1998, 1997, and 1996 and for the
period December 6, 1991 (inception) to September 30, 2000:




<TABLE>
<CAPTION>
                                                                                                                    December 6
                                                               Year Ended September 30,                          1991 (Inception)
                                   ----------------------------------------------------------------------------  to September 30,
                                       2000            1999            1998            1997             1996           2000
                                       ----            ----            ----            ----             ----     ----------------

<S>                                <C>             <C>             <C>             <C>             <C>             <C>
STATEMENT OF OPERATIONS DATA:

Grant and Other Income             $    763,765    $  1,118,576    $  1,376,918    $    764,834    $    271,777    $  4,580,262

Total Expenses                        2,419,247       2,456,318       3,370,671       1,708,607       2,841,255      19,011,011

Net Loss                             (1,655,482)     (1,337,742)     (1,993,753)       (943,773)     (2,569,478)    (14,430,749)

Net Loss per Share (dilutive)                      $      (0.06)   $      (0.06)   $      (0.13)   $      (0.05)   $      (0.17)

Dividends per Share                                $       0.00    $       0.00    $       0.00    $       0.00    $       0.00

Weighted Average Number
   of Common Shares
   Outstanding                       29,759,153      26,255,104      23,867,091      19,537,047      15,479,889

BALANCE SHEET DATA:


Cash & Cash Equivalents            $  1,825,352    $    583,585    $  1,686,658    $    310,252    $     19,266

Working Capital (deficiency)          1,413,408           6,849       1,329,541      (1,498,477)     (2,754,591)

Total Assets                          2,311,592       1,084,505       2,114,750         651,963         156,147

Long-term obligations                   360,180         203,147                             -0-             -0-             -0-
Deficit accumulated during
   development stage                (16,039,877)    (14,119,462)    (12,523,358)     (9,443,772)     (8,499,999)

Redeemable convertible preferred
   Stock                              2,033,787       1,768,846       1,510,484                             -0-             -0-
Shareholders' Equity
   (Deficit)                           (633,989)     (1,555,934)       (122,130)     (1,158,216)     (2,642,523)
</TABLE>




                                                                         Page 15
<PAGE>   16

ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION & RESULTS
OF OPERATIONS

GENERAL

Since commencement of operations in 1992, the Company has been engaged in
research and development activities, including conducting preclinical studies
and clinical trials, and recruiting its scientific and management personnel,
establishing laboratory facilities and raising capital. The Company has not
received any revenue from the direct sale of its products to the general public
but has received grant monies and license payments from other corporations from
the license of the Company's technology.

The Company is a "Development Stage Company" that designs synthetic
peptide/protein compounds and genes for pharmaceutical and agricultural
applications. Current development programs include a new treatment for prostate
cancer, severely burned patients, a vaginal microbicide, and pulmonary
infections, and two transgenic agricultural applications - one to prevent plant
diseases, the other to increase the nutritional value of food and feed crops.

The Company has two licenses in place for its agricultural technology, disease
resistance and nutritional enhancement, to Dow Agro Sciences which has produced
historic revenue streams and will continue to produce revenue as Dow Agro
Sciences proceeds towards commercialization of these technologies.


RESULTS OF OPERATION

SEPTEMBER 30, 2000 VS 1999

In the year ended September 30, 2000 (Fiscal 2000), grants and other income
decreased to $0.8 million from $1.1 million in the year ended September 30, 1999
(Fiscal 1999). This decrease was due to the absence in the current year of
grants as compared to the prior year. In Fiscal 2000, the Company received a
$150,000 program related loan from a local charity. Had this been a grant,
revenues between the two years would have been more comparable. The Fiscal 2000
revenue was from licensing fee and research funding received from Dow Agro
Sciences as part of a license entered into during Fiscal 1998.

Total expenses decreased by $0.35 million in the current year, exclusive of the
$0.31 million non-cash charge in the Fiscal 2000 period for the compensation
package to retain the new Chief Operating Officer - Pharmaceutical Products.

Research and development expenses decreased by $0.26 million, excluding the
aforementioned non-cash charge, as the Company pursued starting Phase I clinical
trials early in Fiscal 2001 for its infected burn and infected wound
therapeutic.

General and administrative expenses decreased slightly to $0.7 million in Fiscal
2000 from $0.8 million in Fiscal 1999. Depreciation and amortization remained
relatively constant in the two fiscal years as both periods included the costs
associated with the new laboratory at the Company's new Pittsburgh office.

The Company did not have a federal or state income tax provision in either
Fiscal 2000 or 1999 due to the loss recorded in each period.

The amounts described above resulted in a net loss of $1.66 million for Fiscal
2000. The net loss would have been $1.25 million if the aforementioned non-cash
charge was excluded. The net loss for Fiscal 1999 was $1.34 million.


SEPTEMBER 30, 1999 VS 1998

In the year ended September 30, 1999 (Fiscal 1999), grants, license fees and
other income was $1.1 million compared to $1.4 million in the year ended
September 30, 1998 (Fiscal 1998). The Fiscal 1999 revenue was primarily due to a
$0.5 million licensing fee and research funding received from Dow AgroSciences
as part of the modification of its license agreement providing Dow Agro Sciences
with an additional license for the Company's agricultural nutrition
technologies. Additionally, a cancer charity made a grant of $0.375 million
during the Fiscal 1999 period as part of an ongoing program to fund the
Company's development of cancer fighting drugs. During the Fiscal 1998 period,
revenue of $0.9 million was received from Dow AgroSciences relative to the
initial license for the Company's agricultural disease resistance technologies.
Additionally a grant of $0.25 million was received from the aforementioned
cancer charity.

Total expenses increased in the current year exclusive of the $1.7 million
non-cash charge in the Fiscal 1998 period for the issuance of stock options to
employees and directors. The increase was due to a higher employee headcount in
the current fiscal period and increased expenditures supporting the Company's
research activity.



                                                                         Page 16
<PAGE>   17

Research and development expenditures increased to $1.5 million in Fiscal 1999
from $0.9 million in Fiscal 1998 due to increased funding relative to its cancer
drug research. The focus of this research was upon the method of action and
other areas in preparation for the submission of an IND to the FDA.

General and administrative expenses increased by $0.1 million to $0.78 million
in the current fiscal year as compared to the prior fiscal year when the $1.7
million non-cash charge for compensation expense is excluded from the prior
fiscal year. Depreciation and amortization increased to $0.15 million from $0.12
million in Fiscal 1998 due to capitalization of additional patent costs and the
construction of a new laboratory at the Company's new Pittsburgh office.

The Company did not have a federal or state income tax provision in either
Fiscal 1999 or 1998 due to the loss recorded in each year. An allowance was
recognized to offset the tax benefit until such time that the Company generates
taxable income.

The amounts described above resulted in a net loss of $1.3 million in the Fiscal
1999 period as compared to a net loss of $2.0 million for the Fiscal 1998
period.


LIQUIDITY AND CAPITAL RESOURCES

FISCAL 2000

During the year ended September 30, 2000, the Company's cash increased by $1.2
million. Net cash provided by financing activities of $2.5 million was partially
offset by a $1.1 million of net cash utilized by operating activities and $0.1
million of net cash utilized by investing activities.

Cash from financing activities was generated from $2.4 million of net proceeds
from the private placement of securities and $0.15 million received from a local
foundation in the form of a note payable. The loan matures on February 28, 2005
with interest at 5%. The loan is to fund program related research.

Cash utilized in operating activities was caused by the net loss of $1.66
million and a $0.09 million decrease in unearned revenue. This was partially
offset by $0.13 million of depreciation and amortization, $0.16 million of stock
issued for services, $0.04 million for the amortization of the deferred
compensation component of shareholders' equity, the $0.26 million non-cash
charge for the compensation package to retain the new Chief Operating Officer -
Pharmaceutical Products and a $0.04 million of stock issued for compensation.

Cash utilized by investing activities was primarily due to a $0.11 million
increase in intangible assets due to the capitalization of patent related
expenses.


FISCAL 1999

During the year ended September 30, 1999, the Company's cash and cash
equivalents decreased by $1.1 million to $0.6 million. Net cash provided by
financing activities of $0.1 million was offset by $0.27 million of net cash
utilized by investing activities and net cash used by operating activities of
$0.93 million.

Specifically, cash inflows from financing activities included $0.02 million
realized from the exercise of stock options, $0.02 million from an equipment
financing and a $0.07 million increase in payables to related parties.

The $0.93 million of cash utilized by operating activities consisted of the net
loss of $1.3 million, and a decrease of $0.09 million in unearned revenue,
partially offset by $0.15 million of depreciation and amortization, a $0.04
million decrease in accounts receivable, and a $0.23 million increase in
accounts payable and other liabilities.

The $0.27 million of cash utilized by investing activities relates to $0.21
million for the purchase of property, plant and equipment and $0.06 million of
patent costs capitalized as intangible costs in the current year.

FISCAL 1998

During the year ended September 30, 1998, the Company's cash and cash
equivalents increased by $1.4 million to $1.7 million. Net cash provided by
financing activities of $1.6 million was partially offset by a $0.01 million of
net cash utilized by operating activities and $0.14 million of net cash utilized
by investing activities.

Specifically, cash inflows from financing activities included the $1.9 million
net proceeds from the issuance of preferred stock and warrant to the CEO Venture
fund in June 1998. Additionally, $0.09 million was realized from the exercise of
stock options. These sources of funds were partially offset by a $0.41 million
decrease in payables to related parties.

The $0.1 million of cash utilized by operating activities consisted of the net
loss of $2.0 million and a decrease of $0.21 million in accounts payable and
other liabilities offset by the $1.7 million of non-cash compensation related to
the issuance of below market stock options issued to employees and directors
that vested during the year, $0.12 million of depreciation and



                                                                         Page 17
<PAGE>   18

amortization, $0.09 million of stock issued for services and a $0.18 million
increase in unearned revenue relating to the $0.3 million three year
administration fee paid to the Company in October 1997 by Mycogen.

The $0.14 million of cash utilized by investing activities relates to $0.05
million for the purchases of property, plant and equipment and $0.08 million of
patent costs capitalized as intangible assets in the current year.

Prospective Information

The Company believes that it has adequate liquidity to fund its operations in
Fiscal 2001 if the expected milestones, research support, license, sub-license
and equity financing payments are received as expected. Should the expected
payments either be delayed or not forth coming, the Company would take the
necessary actions to scale back its level of expenditures, primarily research
expenditures associated with new projects, to maintain sufficient cash flow to
fund basic operations. On a long term basis, it will be necessary for the
Company to access additional funding so that it can continue to fund the Phase I
and Phase II testing of its therapeutic agents. This funding may be in the form
of a private placement of equity securities or a secondary issuance of
securities into the market.

The Company intends to pursue the acquisition/merger of biotechnology companies
with similar technologies to increase the range of potential product offerings
that the Company will have to push through the clinical trial pipeline and to
broaden its exposure to potential partners.


ITEM 7a - QUANTITATIVE AND QUALITATIVE MARKET RISK

None


ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements of the registrant and the report of Ernst & Young LLP
are submitted under Item 14 of this report beginning on page F-1.


ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL MATTERS

Not applicable









                                                                         Page 18
<PAGE>   19




                                    PART III

The information called for by Part III (Items #10, 11, 12 and 13) is
incorporated herein by reference to the registrant's definitive Proxy Statement
for the 2001 Annual Meeting of Stockholders to be filed with the Securities and
Exchange Commission pursuant to Regulation 14A of the Securities Exchange Act of
1934.


ITEM 14 - FINANCIAL STATEMENTS, EXHIBITS AND REPORTS ON FORM 8-K

a. Each of the following items are contained in the Company's financial
statements and are set forth herein beginning on page F-1.

         (i)      Report of Ernst & Young LLP, Independent Auditors

         (ii)     Balance Sheets as of September 30, 2000 and 1999

         (iii)    Statements of Operations for the Years Ended September 30,
                  2000, 1999 and 1998 and for the period December 6, 1991
                  (inception) to September 30, 2000

         (iv)     Statements of Shareholders' Deficit for the Years Ended
                  September 30, 2000, 1999 and 1998 and for the period December
                  6, 1991 (inception) to September 30, 2000

         (v)      Statements of Cash Flows for the Years Ended September 30,
                  2000, 1999 and 1998 and for the period December 6, 1991
                  (inception) to September 30, 2000

         (vi)     Notes to Financial Statements

                  No schedules for Demegen, Inc. for which provision is made in
                  the applicable accounting regulations of the Securities and
                  Exchange Commission are required under the related
                  instructions, not applicable, or the required information is
                  shown in the financial statements or notes thereto


b.  Exhibits


3.1      Articles of Incorporation of the Company, as amended filed as Exhibit
         to the registrant's Form 10, is incorporated herein by reference

3.2      Amended and Restated By-laws of the Company filed as Exhibit
         to the registrant's Form 10, is incorporated herein by reference

4.1      Specimen of Common Stock Certificate filed as Exhibit
         to the registrant's Form 10, is incorporated herein by reference

4.2      Stock Purchase Agreement, dated June 15, 1998, between the Registrant
         and the Principal Shareholders of the Registrant and the CEO Venture
         Fund III filed as Exhibit to the registrant's Form 10, is incorporated
         herein by reference

4.2.1    Terms of Convertible Preferred Stock filed as Exhibit to the
         registrant's Form 10, is incorporated herein by reference

4.3      Warrant to Purchase Common Stock, dated June 15, 1998, between the
         Registrant and the Registrant and the CEO Venture Fund III filed as
         Exhibit to the registrant's Form 10, is incorporated herein by
         reference

4.4      Shareholders' Agreement, dated June 15, 1998, by and among the Company,
         Richard Ekstrom, Jesse Jaynes and the CEO Venture Fund III filed as
         Exhibit to the registrant's Form 10, is incorporated herein by
         Reference



                                                                         Page 19
<PAGE>   20

4.5      Supplemental Agreement between Demegen, Inc. and CEO Venture Fund III,
         dated February 8, 2000 concerning Warrant No. 1 held by CEO Venture
         Fund, filed as Exhibit 4 to the registrant's Quarterly Report on Form
         10-QSB, for the quarter ended Mnarch 31, 2000 is incorporated herein by
         reference

4.6      Supplemental Agreement to Purchase Units of Demegen, Inc. filed as
         Exhibit 4 a. to the registrant's Current Report on Form 8-K, dated
         April 5, 2000,, is incorporated herein by reference

4.7      Supplemental Agreement to Purchase Common Shares of Demegen, Inc. filed
         as Exhibit 4 b. to the registrant's Current Report on Form 8-K, dated
         April 5, 2000,, is incorporated herein by reference

10.1     License and Royalty Agreement, effective May 1, 1997, between the
         Registrant and Louisiana State University filed as Exhibit to the
         registrant's Form 10, is incorporated herein by reference*

10.2     Restated Demeter-Mycogen License and Royalty Agreement, effective
         September 23, 1997, between the Registrant and Mycogen Corporation
         filed as Exhibit to the registrant's Form 10, is incorporated herein by
         reference*

10.3     Addendum to Restated Demeter-Mycogen License and Royalty Agreement,
         effective November 13, 1998, between the Registrant and Mycogen
         Corporation filed as Exhibit to the registrant's Form 10, is
         incorporated herein by reference*

10.4     Employment Agreement, dated June 15, 1998, between the Registrant and
         Richard D. Ekstrom filed as Exhibit to the registrant's Form 10, is
         incorporated herein by reference

10.4-1   Employment Agreement, dated November 1, 1995, between the Registrant
         and Richard D. Ekstrom filed as Exhibit to the registrant's Form 10, is
         incorporated herein by reference

10.5     Employment Agreement, dated June 15, 1998, between the Registrant and
         Jesse M. Jaynes filed as Exhibit to the registrant's Form 10, is
         incorporated herein by reference

10.6     Employment Agreement, dated June 15, 1998, between the Registrant and
         James E. Thornton filed as Exhibit to the registrant's Form 10, is
         incorporated herein by reference

10.7     Compensation Release Agreements dated September 19, 1997 filed as
         Exhibit to the registrant's Form 10, is incorporated herein by
         reference:

         a)       Richard D. Ekstrom
         b)       Bruce A. Guthrie
         c)       Donald A. Guthrie
         d)       Jesse M. Jaynes
         e)       D. Thomas Roane
         f)       A. Lee Caldwell
         g)       James E. Thornton

10.8     Consulting Agreement between the Company and Progressive Media Group,
         Inc., dated February 12, 1998 filed as Exhibit to the registrant's
         Form 10, is incorporated herein by reference

10.9     Settlement Agreement between the Company and Philip Sears dated
         January, 1998 filed as Exhibit to the registrant's Form 10, is
         incorporated herein by reference

10.10    Settlement Agreement dated September 11, 1996, among the Company and
         Gordon Julian and Sirius Enterprises, Inc. filed as Exhibit to the
         registrant's Form 10, is incorporated herein by reference



                                                                         Page 20
<PAGE>   21

10.11    Technology Transfer, Support and Royalty Assignment Agreement dated
         February 19, 1992, between the Company and Dr. Jesse M. Jaynes filed
         as Exhibit to the registrant's Form 10, is incorporated herein by
         reference

10.12    Letter of Understanding dated November 13, 1996 between the Company and
         Pacific West Cancer Fund filed as Exhibit to the registrant's Form 10,
         is incorporated herein by reference

10.13    Stock Option Agreements dated March 6, 1998 filed as Exhibit to the
         registrant's Form 10, is incorporated herein by reference

         a)       Richard D. Ekstrom
         b)       Bruce A. Guthrie
         c)       Donald A. Guthrie
         d)       Jesse M. Jaynes
         e)       D. Thomas Roane
         f)       A. Lee Caldwell
         g)       Alfonso Lovo-Cordero
         h)       Antonio Maggioni
         i)       George N. Keeney
         j)       James E. Thornton
         k)       Ute Schweb

10.14    Stock Option Agreements dated November 2, 1996 filed as Exhibit to the
         registrant's Form 10, is incorporated herein by reference

         a)       Bruce A. Guthrie
         b)       Thomas Roane
         c)       Alfonso Lovo-Cordero
         d)       Antonio Maggioni
         e)       George N. Keeney
         f)       James E. Thornton

10.15    Stock Option Agreements dated September 1, 1997 filed as Exhibit to the
         registrant's Form 10, is incorporated herein by reference

         a)       Donald A. Guthrie
         b)       Alfonso Lovo-Cordero
         c)       Antonio Maggioni
         d)       George N. Keeney

10.16    Stock Option Agreements dated September 18, 1998 filed as Exhibit to
         the registrant's Form 10, is incorporated herein by reference

         a)       Roger A. Laine, Ph.D.
         b)       Wayne F. Topkins, Ph.D.
         c)       Paul L. Kornblith, M.D.

10.17    Settlement Agreement dated, September 25, 1996 between the Company and
         The Peregrine Group filed as Exhibit to the registrant's Form 10, is
         incorporated herein by reference

10.18    Compensation Release Agreement dated September 19, 1997 between the
         Company and Richard D. Ekstrom relative to the cancellation of the
         Share Repurchase Agreement and the issuance of 145,000 shares of the
         Company's Restricted Stock filed as Exhibit to the registrant's Form
         10, is incorporated herein by reference

10.19    Settlement Agreement and Mutual Release between the Company and James
         Ladd dated December 31, 1996 with subsequent Letter Agreement of
         December 31, 1997 between the Company and James Ladd filed as Exhibit
         to the registrant's Form 10, is incorporated herein by reference

10.20    1998 Stock Option Plan filed as Exhibit to the registrant's Form 10,
         is incorporated herein by reference



                                                                         Page 21
<PAGE>   22

10.21    Sample Employee Nondisclosure, Noncompete and Developments Agreement
         filed as Exhibit to the registrant's Form 10, is incorporated by
         reference

10.22    Settlement Agreement, dated September 17, 1996, between the Company and
         John Bridwell filed as Exhibit to the registrant's Form 10, is
         incorporated herein by reference

10.23    Stock Option Agreement dated February 19, 1999 filed as Exhibit to the
         registrant's Form 10, is incorporated herein by reference

         a)  Konrad M. Weis, Ph.D.

         b)  John Bridwell

         c)  James Colker

10.24    Assignment of Option dated May 1, 1999 by and among James Colker, CEO
         Venture Fund III and Demegen, Inc. filed as Exhibit to the registrant's
         Form 10, is incorporated herein by reference

10.25    Stock Option Agreement dated May 24, 1999 with Robert E. Hannan filed
         as Exhibit to the registrant's Form 10-KSB for the year ended September
         30, 1999, is incorporated herein by reference

10.26    James E. Thornton Termination Agreement dated August 23, 1999 filed as
         Exhibit to the registrant's Form 10-KSB for the year ended September
         30, 1999, is incorporated herein by reference

10.27    Stock Option Agreement dated November 19, 1999 with Jerry B. Hook filed
         as Exhibit to the registrant's Form 10-KSB for the year ended September
         30, 1999, is incorporated herein by reference

10.28    Employment Agreement, dated March 6, 2000, between the Registrant and
         S. Robert Fatora filed as Exhibit to the registrant's Quarterly Report
         on Form 10-QSB, for the quarter ended March 31, 2000 is incorporated
         herein by reference

24.      Power of Attorney

27.      Financial Statement Schedules

* Certain portions of this exhibit have been omitted based upon a request for
  Confidential Treatment. The non-public information has been filed with the
  Commission.


c.  Reports on Form 8-K

   The registrant did not file any Current Reports on Form 8-K during the three
   months ended September 30, 2000.











                                                                         Page 22
<PAGE>   23



                                   SIGNATURES


Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.


                                     Demegen, Inc.

Date: December 14, 2000

                                     By: /s/ Richard D. Ekstrom
                                         ---------------------------------
                                     Richard D. Ekstrom
                                     Chairman of the Board of Directors,
                                     President and Chief Executive Officer
                                     (Principal Executive Officer)


Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the followings persons on behalf of the registrant and
in the capacities and on the dates indicated.


Date: December 14, 2000            By: /s/ Richard D. Ekstrom
                                       -----------------------
                                   Richard D. Ekstrom
                                   Chairman of the Board of Directors,
                                   President and Chief Executive Officer
                                   (Principal Executive Officer)

Date: December 14, 2000            By: /s/ Jesse M. Jaynes, Ph.D.
                                       ---------------------------
                                   Jesse M. Jaynes, Ph.D.
                                   Vice President and Director

Date: December 14, 2000             By: /s/ James Colker
                                       -----------------
                                   James Colker
                                   Director

Date: December 14, 2000            By: /s/ John Bridwell
                                       ------------------
                                   John Bridwell
                                   Director

Date: December 14, 2000            By: /s/ Konrad M. Weis, Ph.D.
                                       --------------------------
                                   Konrad M. Weis. Ph.D.
                                   Director

Date: December 14, 2000            By: /s/ Robert E. Hannan
                                       --------------------------
                                   Robert E. Hannan
                                   Director

Date: December 14, 2000            By: /s/ Jerry B. Hook, Ph.D.
                                       ---------------------------
                                   Jerry B. Hook, Ph.D.
                                   Director



                                                                         Page 23
<PAGE>   24
[ERNST & YOUNG LLP LETTERHEAD]



                         Report of Independent Auditors

Board of Directors
Demegen, Inc.

We have audited the accompanying balance sheets of Demegen, Inc. (a development
stage company) as of September 30, 2000 and 1999, and the related statements of
operations, shareholders' deficit, and cash flows for the years ended September
30, 2000, 1999 and 1998 and for the period from December 6, 1991 (inception)
through September 30, 2000. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits. The financial statements for the
period from December 6, 1991 (inception) through September 30, 1994, were
audited by other auditors whose report dated November 10, 1994, expressed an
unqualified opinion on those statements and included an explanatory paragraph
regarding the entity's ability to continue as a going concern, that is not
included in our current report as the result of additional financing obtained by
the Company. The financial statements for the period December 6, 1991
(inception) through September 30, 1994, include total revenues and net loss of
$1,116,800 and $3,056,682, respectively. Our opinion on the statements of
operations, shareholders' deficit, and cash flows for the period December 6,
1991 (inception) through September 30, 2000, insofar as it relates to amounts
for prior periods through September 30, 1994, is based solely on the report of
other auditors.

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

In our opinion, based on our audits and the report of other auditors, the
financial statements referred to above present fairly, in all material respects,
the financial position of Demegen, Inc. (a development stage company) at
September 30, 2000 and 1999, and the results of its operations and its cash
flows for the years ended September 30, 2000, 1999, and 1998, and for the period
from December 6, 1991 (inception) through September 30, 2000, in conformity with
generally accepted accounting principles.


                              /s/ ERNST & YOUNG LLP


Pittsburgh, PA
November 17, 2000










                                      F-1


<PAGE>   25

                                  Demegen, Inc.
                          (A Development Stage Company)

                                 Balance Sheets

<TABLE>
<CAPTION>
                                                                          SEPTEMBER 30
                                                                   2000                  1999
                                                         --------------------------------------------

<S>                                                             <C>                   <C>
ASSETS
Current assets:
   Cash and cash equivalents                                    $1,825,352            $  583,585
   Accounts receivable                                              22,409                22,546
   Prepaid expenses and other current assets                            --                 2,057
                                                         --------------------------------------------
Total current assets                                             1,847,761               608,188

Property and equipment:
   Furniture and equipment                                         201,389               195,786
   Computer hardware and software                                  164,412               165,758
                                                         --------------------------------------------
                                                                   365,801               361,544
   Less accumulated depreciation and amortization                 (208,971)             (151,219)
                                                         --------------------------------------------
                                                                   156,830               210,325
Intangible assets:
   Licenses                                                        245,000               245,000
   Patents                                                         359,837               248,436
                                                         --------------------------------------------
                                                                   604,837               493,436
Less accumulated amortization                                     (297,836)             (227,444)
                                                         --------------------------------------------
                                                                   307,001               265,992

                                                         --------------------------------------------
Total assets                                                    $2,311,592            $1,084,505
                                                         ============================================
</TABLE>



<TABLE>
<CAPTION>
                                                                          SEPTEMBER 30
                                                                   2000                  1999
                                                         --------------------------------------------


<S>                                                        <C>                      <C>
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
   Accounts Payable                                        $    263,303             $    354,988
   Accrued payroll                                               97,261                   28,442
   Unearned revenue                                                  --                   91,667
   Current portion of notes payable                              42,000                   63,558
   Other liabilities                                             31,789                   62,684
                                                         --------------------------------------------
Total current liabilities                                       434,353                  601,339

Notes payable                                                   360,180                  203,147
Other                                                           117,261                   67,107
                                                         --------------------------------------------
Total liabilities                                               911,794                  871,593

Commitments and contingency

Redeemable convertible preferred stock, $.001 par value--
   40,000,000 shares authorized; 4,444,444 shares issued
   and outstanding                                            2,033,787                1,768,846

Shareholders' deficit:
   Common stock, $.001 par value--100,000,000 shares
     authorized; 32,304,778 and 26,361,899 shares
     issued and outstanding at September 30, 2000 and
     September 30, 1999, respectively                            32,305                   26,362
   Warrants                                                   1,287,004                  497,000
   Deferred Compensation                                       (343,999)                      --
   Subscription receivable                                     (188,511)                      --
   Additional paid-in capital                                14,619,089               12,040,166
   Deficit accumulated during the development stage         (16,039,877)             (14,119,462)
                                                         --------------------------------------------
Total shareholders' deficit                                    (633,989)              (1,555,934)
                                                         --------------------------------------------
Total liabilities and shareholders' deficit                $  2,311,592             $  1,084,505
                                                         ============================================
</TABLE>


See accompanying notes.

                                       F-2


<PAGE>   26

                                  Demegen, Inc.
                          (A Development Stage Company)

                            Statements of Operations



<TABLE>
<CAPTION>
                                                                                                    PERIOD FROM
                                                                                                  DECEMBER 6, 1991
                                                                                                   (INCEPTION) TO
                                                         YEAR ENDED SEPTEMBER 30                    SEPTEMBER 30,
                                                2000               1999                1998             2000
                                        ----------------------------------------------------------------------------

<S>                                         <C>                <C>                <C>                 <C>
Income:
   License                                  $   220,000        $   350,000        $   906,651         $  1,576,651
   Grant and other                              472,432            708,475            425,398            2,827,308
   Interest                                      71,333             60,101             44,869              176,303
                                        ----------------------------------------------------------------------------
Total income                                    763,765          1,118,576          1,376,918            4,580,262

Expenses:
   Research and development                   1,560,981          1,513,680            880,965            7,053,866
   General and administrative                   709,533            784,891          2,338,817           10,382,152
   Interest                                      14,207              3,140             28,295              996,931
   Depreciation and amortization                134,526            154,607            122,594              578,062
                                        ----------------------------------------------------------------------------
Total expenses                                2,419,247          2,456,318          3,370,671           19,011,011
                                        ----------------------------------------------------------------------------
Net loss                                     (1,655,482)        (1,337,742)        (1,993,753)         (14,430,749)

Preferred dividend and accretion
    amounts                                    (264,933)          (258,362)        (1,085,833)          (1,609,128)
                                        ----------------------------------------------------------------------------

Net loss applicable to common stock         $(1,920,415)       $(1,596,104)       $(3,079,586)        $(16,039,877)
                                        ============================================================================

Net loss per common share, basic and
   diluted                                  $    ($0.06)       $     (0.06)       $     (0.13)
                                        ============================================================================

Weighted average common stock
   outstanding                               29.759,153         26,255,104         23,867,091
                                        ============================================================================
</TABLE>


See accompanying notes.


                                       F-3




<PAGE>   27


                                  Demegen, Inc.
                          (A Development Stage Company)

                       Statements of Shareholders' Deficit

<TABLE>
<CAPTION>
                                                                                                 COMMON STOCK
                                                                           AVERAGE     ----------------------------------
                                                                            PRICE
                                                                          PER SHARE        SHARES            AMOUNT
                                                                        -------------------------------------------------
<S>                                                                       <C>           <C>               <C>
   Acquired in merger with Excelsior Capital Corporation                                 10,743,571       $    10,744
   Loss from inception (December 6, 1991) to September 30, 1992                                  --                --
   Capital contributed by a shareholder                                                          --                --
   Proceeds from the sale of unrestricted shares contributed by
     shareholders in exchange for restricted shares                       $   .62           439,045               439
   Payment of debt with stock warrants                                                           --                --
   Payment of interest with stock warrants                                                       --                --
   Issuance of receivable from officer                                                           --                --
   Net loss for the year                                                                         --                --
                                                                                       ------------------------------
Balance at September 30, 1993                                                            11,182,616            11,183
   Proceeds from the sale of unrestricted shares by shareholders
     in exchange for restricted shares                                        .75           691,738               692
   Issuance of stock for consulting services                                 1.54            58,336                58
   Issuance of stock subscriptions for loan origination fee                  1.14           131,250               131
   Payment of interest with stock warrants                                                       --                --
   Net loss for the year                                                                         --                --
                                                                                       ------------------------------
Balance at September 30, 1994                                                            12,063,940            12,064
   Proceeds from the sale of restricted common shares                        1.06           193,133               193
   Issuance of restricted shares in exchange for unrestricted
     shares contributed by shareholders                                                     171,694               172
   Proceeds from the sale of unrestricted shares contributed by
     shareholders in exchange for restricted shares                          2.18                --                --
   Issuance of restricted shares for payment of services/compensation         .89           402,251               402
   Issuance of warrants                                                                          --                --
   Payment of interest with stock warrants                                                       --                --
   Net loss for the year                                                                         --                --
                                                                                       ------------------------------
Balance September 30, 1995                                                               12,831,018            12,831
   Proceeds from the sale of common shares                                    .70           683,250               683
   Issuance of shares for payment of services/compensation                    .60           890,868               891
   Issuance of shares in settlement of outstanding debt
     and other obligations                                                    .47         4,468,285             4,468
   Payment of interest with warrants                                                             --                --
   Net loss for the year                                                                         --                --
                                                                                       ------------------------------
Balance at September 30, 1996                                                            18,873,421            18,873
   Proceeds from the sale of restricted and unrestricted common shares        .36           340,000               340
   Issuance of shares for payment of services/compensation                    .41         1,178,258             1,178
   Issuance of shares in exchange for patent and technology license           .35           700,000               700
   Issuance of restricted shares in exchange for unrestricted
     shares contributed by shareholders                                                     162,720               163
   Exchange of amounts due to related parties for restricted shares           .33           450,000               450
   Exchange of redemption right of related party for additional
     restricted shares                                                        .33           145,000               145
   Settlement of amounts due to related parties through debt
     forgiveness and issuance of shares                                                          --                --
   Net loss for the year                                                                         --                --
                                                                                       ------------------------------
Balance at September 30, 1997                                                            21,849,399            21,849
   Proceeds from exercise of stock options                                $   .05         1,750,000             1,750
   Compensation expense from Stock option activity                                               --                --
   Issuance of warrants                                                                          --                --
   Allocation of conversion feature of redeemable convertible
     preferred stock                                                                             --                --
   Accretion of conversion feature of redeemable convertible
     preferred stock                                                                             --                --
   Dividends on redeemable convertible preferred stock                                           --                --
   Accretion of redeemable convertible preferred stock                                           --                --
   Issuance of shares for payment of collaborators                        $   .47            20,000                20
   Settlement of employee litigation                                      $   .36         1,975,000             1,975
   Issuance of shares for services                                        $   .47           187,500               188
   Issuance of additional shares to venture capital funds and
     individual investors                                                                    85,000                85
   Net loss for the year                                                                         --                --
                                                                                       ------------------------------
Balance at September 30, 1998                                                            25,866,899            25,867


   Dividends on redeemable convertible preferred stock                                           --                --
   Accretion of redeemable convertible preferred stock                                           --                --
   Proceeds from exercise of Stock options                                $   .05           350,000               350
   Issuance of shares for services                                        $  0.46           145,000               145
   Extension of expiration date of stock option                                                  --                --
   Net loss for the year                                                                         --                --
                                                                                       ------------------------------
Balance at September 30, 1999                                                            26,361,899            26,362


   Dividends on redeemable convertible preferred stock                                           --                --
   Accretion of redeemable convertible preferred stock                                           --                --
   Proceeds from sale of common stock and warrants, net of
      Issuance costs of $126,783                                          $  0.50         5,566,004             5,566
   Issuance of shares and options for services/compensation               $  0.88           376,875               377
   Amortization of stock based compensation                                                      --                --
   Net loss for the year                                                                         --                --
                                                                                       ------------------------------
Balance at September 30, 2000                                                            32,304,778       $    32,305
                                                                                       ==============================
</TABLE>


<TABLE>
<CAPTION>
                                                                                                     DEFERRED
                                                                                 WARRANTS          COMPENSATION
                                                                             ----------------------------------
<S>                                                                             <C>                <C>
   Acquired in merger with Excelsior Capital Corporation                        $        --        $        --
   Loss from inception (December 6, 1991) to September 30, 1992                          --                 --
   Capital contributed by a shareholder                                                  --                 --
   Proceeds from the sale of unrestricted shares contributed by
     shareholders in exchange for restricted shares                                      --                 --
   Payment of debt with stock warrants                                                   --                 --
   Payment of interest with stock warrants                                               --                 --
   Issuance of receivable from officer                                                   --                 --
   Net loss for the year                                                                 --                 --
                                                                                ------------------------------
Balance at September 30, 1993                                                            --                 --
   Proceeds from the sale of unrestricted shares by shareholders
     in exchange for restricted shares                                                   --                 --
   Issuance of stock for consulting services                                             --                 --
   Issuance of stock subscriptions for loan origination fee                              --                 --
   Payment of interest with stock warrants                                               --                 --
   Net loss for the year                                                                 --                 --
                                                                                ------------------------------
Balance at September 30, 1994                                                            --                 --
   Proceeds from the sale of restricted common shares                                    --                 --
   Issuance of restricted shares in exchange for unrestricted
     shares contributed by shareholders                                                  --                 --
   Proceeds from the sale of unrestricted shares contributed by
     shareholders in exchange for restricted shares                                      --                 --
   Issuance of restricted shares for payment of services/compensation                    --                 --
   Issuance of warrants                                                                  --                 --
   Payment of interest with stock warrants                                               --                 --
   Net loss for the year                                                                 --                 --
                                                                                ------------------------------
Balance September 30, 1995                                                               --                 --
   Proceeds from the sale of common shares                                               --                 --
   Issuance of shares for payment of services/compensation                               --                 --
   Issuance of shares in settlement of outstanding debt
     and other obligations                                                               --                 --
   Payment of interest with warrants                                                     --                 --
   Net loss for the year                                                                 --                 --
                                                                                ------------------------------
Balance at September 30, 1996                                                            --                 --
   Proceeds from the sale of restricted and unrestricted common shares                   --                 --
   Issuance of shares for payment of services/compensation                               --                 --
   Issuance of shares in exchange for patent and technology license                      --                 --
   Issuance of restricted shares in exchange for unrestricted
     shares contributed by shareholders                                                  --                 --
   Exchange of amounts due to related parties for restricted shares                      --                 --
   Exchange of redemption right of related party for additional
     restricted shares                                                                   --                 --
   Settlement of amounts due to related parties through debt
     forgiveness and issuance of shares                                                  --                 --
   Net loss for the year                                                                 --                 --
                                                                                ------------------------------
Balance at September 30, 1997                                                            --                 --
   Proceeds from exercise of stock options                                               --                 --
   Compensation expense from Stock option activity                                       --                 --
   Issuance of warrants                                                             497,000                 --
   Allocation of conversion feature of redeemable convertible
     preferred stock                                                                     --                 --
   Accretion of conversion feature of redeemable convertible
     preferred stock                                                                     --                 --
   Dividends on redeemable convertible preferred stock                                   --                 --
   Accretion of redeemable convertible preferred stock                                   --                 --
   Issuance of shares for payment of collaborators                                       --                 --
   Settlement of employee litigation                                                     --                 --
   Issuance of shares for services                                                       --                 --
   Issuance of additional shares to venture capital funds and
     individual investors                                                                --                 --
   Net loss for the year                                                                 --                 --
                                                                                ------------------------------
Balance at September 30, 1998                                                       497,000


   Dividends on redeemable convertible preferred stock                                   --                 --
   Accretion of redeemable convertible preferred stock                                   --                 --
   Proceeds from exercise of Stock options                                               --                 --
   Issuance of shares for services
   Extension of expiration date of stock option                                          --                 --
   Net loss for the year                                                                 --                 --
                                                                                ------------------------------
Balance at September 30, 1999                                                       497,000


   Dividends on redeemable convertible preferred stock                                   --                 --
   Accretion of redeemable convertible preferred stock                                   --                 --
   Proceeds from sale of common stock and warrants, net of
      Issuance costs of $126,783                                                    779,241                 --
   Issuance of shares and options for services/compensation                          10,763           (387,000)
   Amortization of stock based compensation                                              --             43,001
   Net loss for the year                                                                 --                 --
                                                                                ------------------------------
Balance at September 30, 2000                                                   $ 1,287,004        $  (343,999)
                                                                                ==============================
</TABLE>

See accompanying notes

                                       F-4
<PAGE>   28

<TABLE>
<CAPTION>
                                                                                   ADDITIONAL               RECEIVABLE
                                                                                     PAID-IN                  FROM
                                                                                     CAPITAL               SHAREHOLDERS
                                                                        ------------------------------------------------
<S>                                                                               <C>                      <C>
   Acquired in merger with Excelsior Capital Corporation                          $    312,681             $         --
   Loss from inception (December 6, 1991) to September 30, 1992                             --                       --
   Capital contributed by a shareholder                                                123,700                       --
   Proceeds from the sale of unrestricted shares contributed by
     shareholders in exchange for restricted shares                                    272,461                       --
   Payment of debt with stock warrants                                                  33,333                       --
   Payment of interest with stock warrants                                              17,774                       --
   Issuance of receivable from officer                                                      --                  (65,117)
   Net loss for the year                                                                    --                       --
                                                                                  -------------------------------------
   Balance at September 30, 1993                                                       759,949                  (65,117)
   Proceeds from the sale of unrestricted shares by shareholders
     in exchange for restricted shares                                                 517,708                       --
   Issuance of stock for consulting services                                            89,942                       --
   Issuance of stock subscriptions for loan origination fee                            149,869                       --
   Payment of interest with stock warrants                                              56,164                       --
   Net loss for the year                                                                    --                       --
                                                                                  -------------------------------------
   Balance at September 30, 1994                                                     1,573,632                  (65,117)
   Proceeds from the sale of restricted common shares                                  204,807                       --
   Issuance of restricted shares in exchange for unrestricted
     shares contributed by shareholders                                                   (172)                      --
   Proceeds from the sale of unrestricted shares contributed by
     shareholders in exchange for restricted shares                                    349,304                   65,117
   Issuance of restricted shares for payment of services/compensation                  357,681                       --
   Issuance of warrants                                                                 11,625                       --
   Payment of interest with stock warrants                                             127,500                       --
   Net loss for the year                                                                    --                       --
                                                                                  -------------------------------------
Balance September 30, 1995                                                           2,624,377                       --
   Proceeds from the sale of common shares                                             479,817                       --
   Issuance of shares for payment of services/compensation                             536,359                       --
   Issuance of shares in settlement of outstanding debt
     and other obligations                                                           2,113,054                       --
   Payment of interest with warrants                                                    84,996                       --
   Net loss for the year                                                                    --                       --
                                                                                  -------------------------------------
Balance at September 30, 1996                                                        5,838,603                       --
   Proceeds from the sale of restricted and unrestricted common shares                 104,660                       --
   Issuance of shares for payment of services/compensation                             477,629                       --
   Issuance of shares in exchange for patent and technology license                    244,300                       --
   Issuance of restricted shares in exchange for unrestricted
     shares contributed by shareholders                                                   (163)                      --
   Exchange of amounts due to related parties for restricted shares                    149,550                       --
   Exchange of redemption right of related party for additional
     restricted shares                                                                    (145)                      --
   Settlement of amounts due to related parties through debt
     forgiveness and issuance of shares                                              1,449,273                       --
   Net loss for the year                                                                    --                       --
                                                                                  -------------------------------------
Balance at September 30, 1997                                                        8,263,707                       --
   Proceeds from exercise of stock options                                              85,750                       --
   Compensation expense from stock option activity                                   1,699,440                       --
   Issuance of warrants                                                                     --                       --
   Allocation of conversion feature of redeemable
     convertible preferred stock                                                     1,022,222                       --
   Accretion of conversion feature of redeemable
     convertible preferred stock                                                            --                       --
   Dividends on redeemable convertible preferred stock                                      --                       --
   Accretion of redeemable convertible preferred stock                                      --                       --
   Issuance of shares for payment of collaborators                                       9,360                       --
   Settlement of employee litigation                                                   710,217                       --
   Issuance of shares for services                                                      87,750                       --
   Issuance of additional shares to venture capital funds and
     individual investors                                                                  (85)                      --
   Net loss for the year                                                                    --                       --
                                                                                  -------------------------------------
Balance at September 30, 1998                                                       11,878,361                       --


   Dividends on redeemable convertible preferred stock                                      --                       --
   Accretion of redeemable convertible preferred stock                                      --                       --
   Proceeds from exercise of Stock options                                              17,150                       --
   Issuance of shares for services                                                      66,655                       --
   Extension of expiration date of stock option                                         78,000                       --
   Net loss for the year                                                                    --                       --
                                                                                  -------------------------------------
Balance at September 30, 1999                                                       12,040,166                       --

   Dividends on redeemable convertible preferred stock                                      --                       --
   Accretion of redeemable convertible preferred stock                                      --                       --
   Proceeds from sale of common stock and warrants                                   1,871,412                 (282,002)
   Issuance of shares and options for services/compensation                            707,511                   93,491
   Amortization of stock based compensation                                                 --                       --
   Net loss for the year                                                                    --                       --
                                                                                  -------------------------------------
Balance at September 30, 2000                                                     $ 14,619,089             $   (188,511)
</TABLE>

<TABLE>
<CAPTION>
                                                                                     DEFICIT
                                                                                   ACCUMULATED
                                                                                   DURING THE
                                                                                   DEVELOPMENT
                                                                                      STAGE                    TOTAL
                                                                                  -------------------------------------
<S>                                                                               <C>                      <C>
   Acquired in merger with Excelsior Capital Corporation                          $         --             $    323,425
   Loss from inception (December 6, 1991) to September 30, 1992                       (244,100)                (244,100)
   Capital contributed by a shareholder                                                     --                  123,700
   Proceeds from the sale of unrestricted shares contributed by
     shareholders in exchange for restricted shares                                         --                  272,900
   Payment of debt with stock warrants                                                      --                   33,333
   Payment of interest with stock warrants                                                  --                   17,774
   Issuance of receivable from officer                                                      --                  (65,117)
   Net loss for the year                                                            (1,044,154)              (1,044,154)
                                                                                  -------------------------------------
   Balance at September 30, 1993                                                    (1,288,254)                (582,239)
   Proceeds from the sale of unrestricted shares by shareholders
     in exchange for restricted shares                                                      --                  518,400
   Issuance of stock for consulting services                                                --                   90,000
   Issuance of stock subscriptions for loan origination fee                                 --                  150,000
   Payment of interest with stock warrants                                                  --                   56,164
   Net loss for the year                                                            (1,768,428)              (1,768,428)
                                                                                  -------------------------------------
   Balance at September 30, 1994                                                    (3,056,682)              (1,536,103)
   Proceeds from the sale of restricted common shares                                       --                  205,000
   Issuance of restricted shares in exchange for unrestricted
     shares contributed by shareholders                                                     --                       --
   Proceeds from the sale of unrestricted shares contributed by
     shareholders in exchange for restricted shares                                         --                  414,421
   Issuance of restricted shares for payment of services/compensation                       --                  358,083
   Issuance of warrants                                                                     --                   11,625
   Payment of interest with stock warrants                                                  --                  127,500
   Net loss for the year                                                            (2,873,839)              (2,873,839)
                                                                                  -------------------------------------
Balance September 30, 1995                                                          (5,930,521)              (3,293,313)
   Proceeds from the sale of common shares                                                  --                  480,500
   Issuance of shares for payment of services/compensation                                  --                  537,250
   Issuance of shares in settlement of outstanding debt
     and other obligations                                                                  --                2,117,522
   Payment of interest with warrants                                                        --                   84,996
   Net loss for the year                                                            (2,569,478)              (2,569,478)
                                                                                  -------------------------------------
Balance at September 30, 1996                                                       (8,499,999)              (2,642,523)
   Proceeds from the sale of restricted and unrestricted common shares                      --                  105,000
   Issuance of shares for payment of services/compensation                                  --                  478,807
   Issuance of shares in exchange for patent and technology license                         --                  245,000
   Issuance of restricted shares in exchange for unrestricted
     shares contributed by shareholders                                                     --                       --
   Exchange of amounts due to related parties for restricted shares                         --                  150,000
   Exchange of redemption right of related party for additional
     restricted shares                                                                      --                       --
   Settlement of amounts due to related parties through debt
     forgiveness and issuance of shares                                                     --                1,449,273
   Net loss for the year                                                              (943,773)                (943,773)
                                                                                  -------------------------------------
Balance at September 30, 1997                                                       (9,443,772)              (1,158,216)
   Proceeds from exercise of stock options                                                  --                   87,500
   Compensation expense from stock option activity                                          --                1,699,440
   Issuance of warrants                                                                     --                  497,000
   Allocation of conversion feature of redeemable
     convertible preferred stock                                                            --                1,022,222
   Accretion of conversion feature of redeemable
     convertible preferred stock                                                    (1,022,222)              (1,022,222)
   Dividends on redeemable convertible preferred stock                                 (40,000)                 (40,000)
   Accretion of redeemable convertible preferred stock                                 (23,611)                 (23,611)
   Issuance of shares for payment of collaborators                                          --                    9,380
   Settlement of employee litigation                                                        --                  712,192
   Issuance of shares for services                                                          --                   87,938
   Issuance of additional shares to venture capital funds and
     individual investors                                                                   --                       --
   Net loss for the year                                                            (1,993,753)              (1,993,753)
                                                                                  -------------------------------------
Balance at September 30, 1998                                                      (12,523,358)                (122,130)


   Dividends on redeemable convertible preferred stock                                (160,000)                (160,000)
   Accretion of redeemable convertible preferred stock                                 (98,362)                 (98,362)
   Proceeds from exercise of Stock options                                                  --                   17,500
   Issuance of shares for services                                                          --                   66,800
   Extension of expiration date of stock option                                             --                   78,000
   Net loss for the year                                                            (1,337,742)              (1,337,742)
                                                                                  -------------------------------------
Balance at September 30, 1999                                                      (14,119,462)              (1,555,934)

   Dividends on redeemable convertible preferred stock                                (160,000)                (160,000)
   Accretion of redeemable convertible preferred stock                                (104,933)                (104,933)
   Proceeds from sale of common stock and warrants                                          --                2,374,217
   Issuance of shares and options for services/compensation                                 --                  425,142
   Amortization of stock based compensation                                                 --                   43,001
   Net loss for the year                                                            (1,655,482)              (1,655,482)
                                                                                  -------------------------------------
Balance at September 30, 2000                                                     $(16,039,877)            $   (633,989)
                                                                                  =====================================
</TABLE>


                                       F-5
<PAGE>   29

                                  Demegen, Inc.
                          (A Development Stage Company)

                            Statements of Cash Flows

<TABLE>
<CAPTION>
                                                                                                                      PERIOD FROM
                                                                                                                    DECEMBER 6, 1991
                                                                                                                      (INCEPTION)
                                                                       YEAR ENDED SEPTEMBER 30                      TO SEPTEMBER 30
                                                           2000                 1999                1998                  2000
                                                   ---------------------------------------------------------------------------------
<S>                                                   <C>                  <C>                  <C>                  <C>
CASH FLOW FROM OPERATING ACTIVITIES
Net income (loss)                                     $ (1,655,482)        $ (1,337,742)        $ (1,993,753)        $(14,430,749)
Adjustments to reconcile net loss to net cash
    used in operating activities:
Depreciation and amortization                              134,526              154,607              122,594              578,062
Stock issued for services                                  161,142                   --               97,318            1,890,200
Stock based compensation                                    43,001                   --                   --               43,001
Issuance of stock options to employees and
   directors                                               264,000               78,000            1,699,440            2,041,440
Warrants issued for interest                                    --                   --                   --              286,434
Notes payable issued for services                               --                   --                   --               58,194
Other                                                        2,134                   --                   --               26,482
Changes in operating assets and liabilities:
Accounts receivable                                            137               37,383              (59,929)             (22,409)
Prepaid expenses and other current assets                    2,057                9,802              (10,409)                  --
Unearned revenue                                           (91,667)             (91,666)             183,333                   --
Accounts payable and other liabilities                      (3,607)             217,335             (141,186)           1,422,438
                                                   ---------------------------------------------------------------------------------
Net cash used in operating activities                   (1,143,759)            (932,281)            (102,592)          (8,106,907)

CASH FLOW FROM INVESTING ACTIVITIES
Purchase of property and equipment                         (12,765)            (210,157)             (54,027)            (396,140)
Cash received on equipment disposals                            --                   --                   --                9,643
Intangible assets                                         (111,401)             (64,463)             (84,610)            (359,368)
                                                   ---------------------------------------------------------------------------------
Net cash used in investing activities                     (124,166)            (274,620)            (138,637)            (745,865)

CASH FLOW FROM FINANCING ACTIVITIES
Net proceeds from issuance of equity
   Instruments, net of transaction costs                 2,374,217                   --            1,943,873            6,683,717
Proceeds from exercise of stock options                         --               17,500               87,500              105,000
Proceeds from notes payable                                150,000               21,109                   --            1,298,609
(Decrease) increase in payable to employees
   and directors                                            14,550               72,614             (413,738)           2,687,962
Payments on notes payable                                  (29,075)              (7,395)                  --              (97,164)
                                                   ---------------------------------------------------------------------------------
Net cash provided by financing activities                2,509,692              103,828            1,617,635           10,678,124
                                                   ---------------------------------------------------------------------------------

Net increase (decrease) in cash and cash
   equivalents                                           1,241,767           (1,103,073)           1,376,406            1,825,352
Cash and cash equivalents at beginning of
   period                                                  583,585            1,686,658              310,252                   --
                                                   ---------------------------------------------------------------------------------
Cash and cash equivalents at end of period            $  1,825,352         $    583,585         $  1,686,658         $  1,825,352
                                                   =================================================================================

SUPPLEMENTAL DISCLOSURES OF CASH FLOW
   INFORMATION
Cash paid for interest                                $      8,582         $      3,140         $     14,080         $     30,224
                                                   =================================================================================

NONCASH ACTIVITIES
Common stock issued in satisfaction of related
   party payable                                      $         --         $     66,800         $    712,192         $    778,992
                                                   =================================================================================
Dividends on redeemable convertible preferred
   stock                                              $    160,000         $    160,000         $     40,000         $    360,000
                                                   =================================================================================
Accretion of redeemable convertible preferred
   stock                                              $    104,947         $     98,362         $  1,045,833         $  1,249,142
                                                   =================================================================================
Receivable due from stockholders                      $    282,002         $         --         $         --         $    282,002
                                                   =================================================================================
Common stock issued for issuance costs                $    100,000         $         --         $         --         $    100,000
                                                   =================================================================================
</TABLE>


See accompanying notes.

                                       F-6
<PAGE>   30



                                  Demegen, Inc.
                          (A Development Stage Company)

                          Notes to Financial Statements

                               September 30, 2000


1. HISTORY AND NATURE OF THE BUSINESS

Demeter BioTechnologies, Ltd. was formed after the July 27, 1992 acquisition of
the assets of The Demeter Corporation by Excelsior Capital Corporation
("Excelsior"). Excelsior was incorporated in Colorado on September 16, 1987.
Excelsior acquired all the assets of The Demeter Corporation in exchange for
6,625,821 shares of Excelsior's $.001 par value common stock. The Demeter
Corporation's assets consisted of intangible assets related to various
biotechnology applications in the fields of human and animal health care,
agriculture, and commercial chemicals.

For accounting purposes, the acquisition was treated as a reverse acquisition
whereby The Demeter Corporation acquired Excelsior Capital Corporation. The
historical financial statements prior to the acquisition are those of The
Demeter Corporation utilizing the capital structure of Excelsior. However, The
Demeter Corporation had no operating activities from the date of inception,
December 6, 1991 through July 27, 1992. Likewise, Excelsior had no operating
activities prior to December 6, 1991.

On September 18, 1998, the Board of Directors of the Company ratified the
shareholder vote changing the Company's name from Demeter BioTechnologies, Ltd.
to Demegen, Inc. (the "Company").

The Company designs unique molecules which have antimicrobial characteristics,
but with low toxicity and benign environmental impact. The Company's products,
are peptides (small proteins) or peptide-like molecules. Their primary feature
is their ability to destroy a wide range of bacteria, viruses, fungi, protozoa,
and cancer cells at low concentrations without harming healthy cells. The
Company also designs genes which, when incorporated into a plant, have the
ability to confer disease resistance or improve nutritional value. The Company
uses university, corporate, and governmental strategic alliance partners to
determine efficacy in treating a specific pathogen and then licenses the use of
the compounds for that application. If successful, the Company's primary source
of revenues will be from supplying the compounds to licensees and receiving
related license fees, royalties, and research grants. The Company has licensed
substantially all of its plant agricultural technologies to Dow Agro Sciences
LLC.

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.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents consists principally of currency on hand, demand
deposits at commercial banks, and liquid investment funds having a maturity of
three months or less at the time of purchase.


PREOPERATING COSTS

Costs incurred during the developmental stage, such as expenses associated with
research and development, raising capital, establishing markets, and developing
sources of supply, are expensed as incurred.

                                       F-7

<PAGE>   31

                                  Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)


2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

COMMON STOCK ISSUED FOR OTHER THAN CASH

Services purchased and other transactions settled in the Company's common stock
are recorded at the estimated fair value of the stock issued if that value is
more readily determinable than the fair value of the consideration received.

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost. Depreciation is computed using the
straight-line method over the estimated useful lives (generally three to five
years) of the individual assets. Depreciation expense amounted to $64,134,
$56,948 and $30,824, during 2000, 1999 and 1998, respectively.

INTANGIBLE ASSETS

Intangible assets include patent costs and purchased license agreements and are
stated at cost, net of accumulated amortization. Amortization is calculated
using the straight-line method over estimated useful lives ranging from 3 to 17
years. The Company assesses on an ongoing basis the recoverability of the cost
of its patents and licenses by determining its ability to generate future cash
flows sufficient to recover the recorded amounts over the remaining useful lives
of the assets. This process necessarily involves significant management
judgment. The Company currently anticipates fully recovering the recorded cost
of these assets and, accordingly, no valuation adjustment has been recognized to
date. Because of the development stage nature of the Company, significant
uncertainty exists as to whether revenue expectations will be met. Should the
Company determine in the future that permanent diminution in value of the
intangibles has occurred, a charge against operating results would be recorded.

GRANT AND OTHER INCOME

Grant income is not recognized until received.

During fiscal years 1999 and 1998, the Company received grant proceeds of
$375,000 and $250,000, respectively, from the Pacific West Cancer Fund in
support of the Company's cancer research efforts. The funds were recognized as
revenue upon receipt as the contracts did not contain any penalties, successful
outcomes clauses or refunding provisions.

The Company received $27,882, $91,808 and $79,000 in fiscal 2000, 1999 and 1998,
respectively, under research agreements with the National Institute of Health
and the National Science Foundation. Revenue was recognized as the research
funds were expended.

LICENSE AND SUPPORT

License fees are recognized at the time that the agreement is entered into as
the earning process is complete and the Company has no future performance
obligations. Support fees are recognized ratably over the contract period as the
related costs are incurred.

Milestone payments will be recognized upon the achievement of the related
criteria by the respective license subject to a reasonable assurance that the
milestone payment will be forthcoming.



                                       F-8

<PAGE>   32

                                  Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)


2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)


STOCK-BASED COMPENSATION

The Company has adopted the disclosure provisions of Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation ("SFAS No.
123"). SFAS No. 123 permits the Company to continue accounting for stock-based
compensation as set forth in Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees ("APB Opinion No. 25"), provided the
Company discloses the pro forma effect on net income and earnings per share of
adopting the full provisions of SFAS No. 123. Accordingly, the Company continues
to account for stock-based compensation under APB Opinion No. 25 and has
provided the required pro forma disclosures.


3. INCOME TAXES

The Company accounts for income taxes using the liability method.

Significant components of the Company's deferred tax asset at September 30, 2000
and 1999, are as follows:



                                            2000                1999
                                         -----------        -----------

*  Compensation expense on unexercised
     stock options                           498,030        $   481,690
*  NOL carryforwards                       4,268,605          2,683,828
*  Excess book amortization                   71,894             59,998
*  Other                                      (7,387)                --
                                         -----------        -----------
        Total deferred tax asset           4,831,142          3,225,516

   Valuation allowance                    (4,831,142)        (3,225,516)
                                         -----------        -----------
   Net deferred tax assets               $         0        $         0
                                         ===========        ===========


Net operating losses totaling approximately $11,233,000 are currently available
and begin to expire in 2007. Deferred tax liabilities relate to differences in
the financial and tax carrying amounts of fixed assets.

A valuation allowance has been provided for the entire deferred tax asset amount
until such time that the Company demonstrates the ability to produce taxable
income.

4. PRIVATE PLACEMENT OF SECURITIES

During the second quarter of Fiscal 2000, the Company closed on a private
placement of its securities to institutional and other accredited investors
raising $2.65 million of which $0.28 million was in the form of prepaid
services, which are presented in equity as "Subscription Receivable" and are
being amortized over the life of the respective agreements, with the remainder
of $2.4 million in cash. The private placement resulted in the sale of 5.56
million restricted shares of common stock and warrants to purchase an additional
5.56 million shares of the Company's common stock.


                                       F-9

<PAGE>   33

                                  Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)


4. PRIVATE PLACEMENT OF SECURITIES (CONTINUED)

The investors were offered one unit at $0.50 per unit. Each unit consisted of
one share of restricted common stock and a warrant to purchase one share of the
Company's common stock for $0.75 per share. The warrant expires the earlier of
March 31, 2005 or 60 days after a call by the Company. The Company may call the
warrants at any time after March 31, 2001, provided that the price of the
Company's common stock has been in excess of $1.50 per share for each of the
forty consecutive trading days immediately preceding the date of the call. Upon
receipt of the call, warrant holders shall have sixty days to elect to exercise
all or a portion of the warrants.

The Company has agreed to file a registration statement with the Securities &
Exchange Commission to register all common stock which comprise the unit and the
common stock issuable from the exercise of the warrant on or before March 31,
2001.

Pricing of the securities was determined based on several factors, including
reference to market price of the Company's common stock, the holding period
requirement of restricted stock, and the Company's need for additional funding
for development of pharmaceutical products.

Funds raised will be utilized to fund the Company's product development efforts.

5. REDEEMABLE CONVERTIBLE PREFERRED STOCK

In June 1998, the Company issued 4,444,444 shares of redeemable convertible
preferred stock ("preferred stock") and warrants for net proceeds of $1,943,873
(net of $56,127 of expenses incurred in connection with the issuance). Of the
total proceeds $497,000 was allocated to warrants as the estimated fair value
and $1,022,222 was allocated to the conversion feature associated with the
preferred stock and classified as additional paid-in capital. In June 1998, the
entire discount was immediately accreted back to the preferred stock and treated
as a dividend as the preferred shares are immediately convertible into common
stock at the option of the preferred shareholder.

The holders of the preferred stock are entitled to receive, when, as and if
declared by the Board of Directors, out of funds legally available therefore,
dividends at the rate of $0.036 per share, semiannually, on each outstanding
share of convertible preferred stock. Such dividends have a priority over any
dividends paid on the common stock. Dividends on the preferred stock are
cumulative and the right to such dividends shall accrue to holders of
convertible preferred stock until declared by the Board of Directors. The
Company has accounted for the cumulative semiannual dividends through periodic
accretion to the preferred stock.

In the event of any liquidation, dissolution, or winding up of the Company, the
holders of preferred stock shall be entitled to receive the greater of $0.45 per
share, plus all unpaid and accrued dividends thereon, or the amount the holder
of the shares of the preferred stock would otherwise be entitled to receive had
each such share been converted into common stock immediately prior to such
liquidation, dissolution or wind-up.

Each share of preferred stock is convertible at any time, at the option of the
holder thereof, into an equal number of fully paid and nonassessable shares of
common stock. In addition, if at any time the Company shall effect a firm
commitment underwritten public offering of shares of common stock in which the
aggregate price paid for such shares by the public shall be at least $8,000,000,
then effective


                                      F-10
<PAGE>   34

                                  Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)

5. REDEEMABLE CONVERTIBLE PREFERRED STOCK (CONTINUED)

immediately before the closing of the sale of such shares by the Company
pursuant to such public offering, all outstanding shares of preferred stock
shall automatically convert to common stock.

The shares of preferred stock shall be redeemable at the election of the holder
upon at least ninety days notice to the Company. The Company shall redeem from
the holder on or at any time after May 31, 2003, 2004, and 2005, up to one-third
of the shares of preferred stock held by the holder, with the intent that,
should the holder elect, at any time after May 31, 2005, the total number of
shares held by the holder would be subject to redemption. The preferred stock to
be redeemed shall be paid for in cash at an amount equal to the greater of (i)
$0.45 per share plus, in the case of each share, an amount equal to all accruing
unpaid dividends (whether or not declared), or (ii) such amount per share as
would have been payable had each such share been converted to common stock
immediately prior to the actual date of redemption.

The shares of preferred stock vote on matters on an as-converted basis; i.e.,
each share of preferred stock has one vote, as do each owner of a share of
common stock.

The holder of the preferred stock has a warrant to purchase 4,965,556 shares of
common stock of the Company at $0.45 per share. The warrant shall be
exercisable, in whole or in part, through June 14, 2008. The Company may call
the warrant at any time after December 31, 1998, provided the Company's common
stock has been in excess of $1.50 per share for each of the forty consecutive
trading days immediately preceding the date of the call.

Upon receipt of the call, the call holder shall have sixty days to elect to
exercise all or a portion of this warrant and up to two years to pay for such
shares. Upon such exercise, in addition to receiving the number of shares of
common stock to which the holder shall be entitled, the holder of the warrant
also shall receive a new warrant ("replacement warrant"). The replacement
warrant shall be exercisable for one share of common stock for every two shares
of common stock purchased in response to the aforementioned call. The exercise
price of the replacement warrant is $1.50 per share, and the term of the
replacement warrant shall be the longer of two years from the date of the
issuance or the balance of the original term of the warrant.


6. STOCK OPTIONS AND WARRANTS

The Company granted stock options to certain employees and directors during the
years ended September 30, 2000 and 1999 at exercise prices which approximated or
exceeded fair value at the date of grant. The majority of the stock options
issued in the year ended September 30, 2000 were issued in connection with the
retention of the Chief Operating Officer-Pharmaceutical Products (See Note 11
for further discussion of this employment agreement). Exclusive of the
aforementioned stock options, the majority of the stock options issued in the
year ending September 30, 2000 vest over time (up to 3 years). All of the
options issued in the year ending September 30, 1999 vested immediately.

The Company granted stock options to certain employees and directors during the
year ended September 30, 1998 at a $0.05 per share exercise price, which was
below the fair value based upon management's estimate of the fair value of the
stock issued at the date of grant. The shares were fully vested at September 30,
1998, and a $1,699,440 noncash charge was recognized to reflect the compensation
value of the options issued. All of these options expire in 2008.

                                      F-11

<PAGE>   35

                                  Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)


6. STOCK OPTIONS AND WARRANTS (CONTINUED)

A summary of the Company's stock option activity is as follows:



<TABLE>
<CAPTION>
                                                                            OPTIONS OUTSTANDING
                                                      ----------------------------------------------------------------
                                                                                   WEIGHTED
                                                                                   AVERAGE          WEIGHTED AVERAGE
                                                        NUMBER OF SHARES        EXERCISE PRICE         FAIR VALUE
                                                      ----------------------------------------------------------------

<S>                                                     <C>                     <C>                 <C>
Balance at September 30, 1997                                1,025,000              $0.41                 $0.09
Options granted during year                                  5,820,000              $0.05                 $0.27
Options exercised for common stock during year              (1,750,000)             $0.05                 $0.27
                                                      ----------------------------------------------------------------
Balance at September 30, 1998                                5,095,000              $0.12                 $0.23
                                                      ================================================================

Granted                                                        380,000              $0.45                 $0.41
Options exercised for common stock                            (350,000)             $0.05                 $0.37
                                                      ----------------------------------------------------------------
Balance at September 30, 1999                                5,125,000              $0.15                 $0.46
                                                      ===============================================================

Options granted during year                                  2,275,000              $0.63                 $0.79
                                                      ----------------------------------------------------------------
Balance at September 30, 2000                                7,400,000              $0.30                 $0.56
                                                      ================================================================
</TABLE>


As of September 30, 2000 and 1999, 5,503,333 and 5,055,000, respectively, of the
options were vested and exercisable.

Pro forma information regarding net income and earnings per share is required by
SFAS No. 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of that Statement. The fair
value for these options was estimated at the date of grant using a Black-Scholes
options pricing model with the following weighted average assumptions for fiscal
2000, 1999 and 1998: risk-free interest rate of 6%; dividend yield of 0%;
volatility factors of the expected market price of the Company's common stock of
1.49, 1.41 and 0.97, respectively, and a weighted average expected option life
of five years.

The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.

Changes in the subjective input assumptions can materially affect the fair value
estimate, and therefore, the existing models do not necessarily provide a
reliable single measure of the fair value of employee stock options. Had the
compensation cost of the Company's stock option plans been determined based on
the fair value at the date of grant for awards in 2000, 1999 and 1998 consistent
with the provisions of SFAS No. 123, the Company's net loss would have been
increased to the pro forma amounts indicated below:


                                      F-12


<PAGE>   36
                                  Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)

6. STOCK OPTIONS AND WARRANTS (CONTINUED)


<TABLE>
<CAPTION>
                                                           YEAR ENDED SEPTEMBER 30
                                                 2000               1999                1998
                                             ----------------------------------------------------

<S>                                          <C>                 <C>                 <C>
Net loss available to common stock:
   As reported                               $(1,920,415)        $(1,596,104)        $(3,079,586)
   Pro forma                                 $(2,058,313)        $(1,746,117)        $(4,615,720)

Basic and diluted earnings per share:
   As reported                               $     (0.06)        $     (0.06)        $     (0.13)
   Pro forma                                 $     (0.07)        $     (0.07)        $     (0.19)
</TABLE>


The maturity date of an option held by an officer of the Company to purchase up
to 600,000 shares of common stock at an exercise price of $0.15 per share was
extended from October 31, 2000 to October 31, 2010 at the September 17, 1999
meeting of the Compensation Committee. The Company recorded a $78,000 non-cash
charge in fiscal 1999 to reflect the aforementioned extension.

At September 30, 2000, there were outstanding warrants to purchase 5,642,879
shares of the Company's common stock at an exercise price of $0.75 per warrant
(refer to Note 4 for additional information). Those warrants which were sold
with the common shares were valued at $790,004 ($0.14 per warrant).
Additionally, the holder of the preferred stock holds a warrant to purchase
common stock (refer to Note 5 for additional information).

7. NOTE PAYABLE

In December 1999, the Company received $150,000 from a local foundation to fund
program related research. The loan matures on February 28, 2005 with a balloon
payment due at that time. The loan is at an interest rate of 5% with interest
due February 28 of each year. The loan contains call provisions which could
result in the loan becoming due before its planned maturity. The Company does
not foresee, at this time, the call provisions becoming effective.

The Company has a note payable totaling $252,180 as of September 30, 2000 which
is payable at $3,500 monthly at an interest rate of 6%. Payments under this
agreement began in March 2000 and will extend until August 2007.

8. COMMITMENTS

The Company leases its office and laboratory facilities under a three-year lease
expiring September 30, 2001 at a monthly rental of $3,948. During 2000, 1999 and
1998, the Company incurred rent expense totaling $56,830, $45,830 and $34,105,
respectively.

During 1997, the Company entered into a license agreement with a university to
obtain certain patent rights. In exchange for the license of the patents, the
Company issued common stock. The value assigned to the patents was based upon
management's estimate of the fair value of the stock issued. In addition, the
Company is obligated to pay certain royalties under the terms of the agreement
for each licensed product. The agreement requires minimum royalty payments to
maintain the license of the patents. The Company paid $45,000 in royalty
payments pursuant to this agreement in 1998.

9. MARKETING

In December 1997, the Company entered into a license agreement with Mycogen
Corporation, which was subsequently acquired by Dow AgroSciences whereby the
Company licensed substantially all rights for disease prevention and treatment
for

                                      F-13

<PAGE>   37

                                  Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)

9. MARKETING (CONTINUED)

agricultural applications. The Company received a license issue fee of $950,000,
consisting of $700,000 for the rights to licensed patents and the Company's
technology in the field of activity, $200,000 for the rights to the Company's
patents and technology for use in formulated licensed products and $50,000 for
the right of first refusal through September 30, 1998 to obtain an exclusive
license to the Company's Nutrition Patents and Technology. These payments were
recognized as revenue in fiscal 1998, as the earnings process was complete
according to the terms of the contract.

The agreement also provided that the Company receive $300,000 to provide Dow
AgroSciences with support services of personnel for a joint research effort for
a three year period. This was classified as unearned revenue on the balance
sheet and is being amortized into revenue, on a straight-line basis, over the
three year life of the support services commitment.

The agreement also provides for milestone payments (amounts based upon Dow
AgroSciences' attainment of certain contract defined outputs measures) to be
made to the Company by Dow AgroSciences upon 1) regulatory approval or first
sale of any type of product by Dow AgroSciences, 2) additional payment for first
commercial sale of certain crops by Dow AgroSciences and 3) additional payment
for first commercial sale of any other crop within the field of activity by Dow
AgroSciences. The Company will also receive royalties on all sales by Dow
AgroSciences and all sublicenses entered into by Dow AgroSciences. Minimum
annual royalties are due beginning January 1, 2003 through 2014 and are
recoupable against the aforementioned royalties due from Dow AgroSciences.

Dow AgroSciences will undertake management of future development, regulatory
approvals, seed production and marketing. The companies will also undertake a
joint agricultural research effort, as discussed above, to identify new
molecular designs. Dow AgroSciences may unilaterally terminate this agreement
without cause.

The Dow AgroSciences Agreement was amended on October 11, 1998 to provide Dow
Agro Science with an additional license for the Company's agricultural nutrition
technologies. The Company received a minimum annual royalty of $200,000 at the
execution of the contract. Additionally, in 1999, the Company received an
initial payment of $150,000 and an additional $150,000 which was due six months
after the contract execution. The research funding is to increase by $50,000
annually over the remaining four years of the funding term. These payments were
currently recognized as revenue as the earnings process was complete according
to the terms of the contract and the payments are not subject to recoupment by
Dow AgroSciences.

The agreement also provides for milestone payments (amounts based upon Dow
AgroSciences' attainment of certain contract defined output measures) to be made
to the Company by Dow Agro Science upon 1) technical feasibility benchmark
payments for certain products developed by Dow AgroSciences, 2) animal feeding
benchmark in certain animal studies by Dow AgroSciences 3) additional payment
for first commercial sale of certain crops by Dow AgroSciences, 4) additional
payment for first commercial sale of any other crop within a contractually
defined field of activity by Dow AgroSciences and 5) additional payments for
achievement of cumulative gross margin benchmark for sale of certain crops by
Dow AgroSciences. The Company will also receive royalties on all sales by Dow
AgroSciences and all sublicenses entered into by Dow AgroSciences. Minimum
annual royalties cease upon the achievement of certain of the aforementioned
benchmarks.

In addition, Dow AgroSciences will be responsible for all development and
commercialization costs. Dow AgroSciences is now owned by the Dow Chemical
Company.

                                      F-14

<PAGE>   38

                                  Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)


10. NET LOSS PER COMMON SHARE

The following table sets forth the computation of basic and diluted earnings per
share:


<TABLE>
<CAPTION>
                                                                   YEAR ENDED SEPTEMBER 30
                                                              2000           1999          1998
                                                     -------------------------------------------------
<S>                                                       <C>            <C>            <C>
Numerator:
   Net loss                                               $(1,655,482)   $(1,337,742)   $(1,993,753)
   Preferred stock dividends and accretion
     amounts                                                 (264,933)      (258,362)    (1,085,833)
                                                     -------------------------------------------------
   Numerator for basic loss per share--income
     available to common stockholders                      (1,920,415)    (1,596,104)    (3,079,586)

Denominator:
   Denominator for basic and loss per
     share--weighted average shares                        29,759,153     26,255,104     23,867,091
                                                     -------------------------------------------------
Basic and diluted loss per share                          $     (0.06)   $     (0.06)   $     (0.13)
                                                     =================================================
</TABLE>


At September 30, 2000, the Company had 5,503,333 vested options (7,400,000
outstanding) for the purchase of the Company's Common Stock at exercise prices
ranging from $0.05 per share to $0.875 per share. Additionally, the 4,444,444
shares of Redeemable Convertible Preferred Stock are convertible into the
Company's Common Stock on a 1 for 1 basis. Furthermore, the holder of the
Redeemable Convertible Preferred Stock holds a warrant for 4,965,556 shares of
the Company's Common Stock at an exercise price of $0.45 per share. The
purchasers of Common Stock in the March 2000 Private Placement received warrants
for 5,566,004 shares of the Company's common Stock at an exercise price of $0.75
per share. These potentially dilutive securities were not included in the
calculation of dilutive earnings per share because the effect would be
anti-dilutive.


11. EMPLOYMENT AGREEMENT

Effective April 1, 2000, the Company hired a Chief Operating Officer -
Pharmaceutical Products. His employment agreement is for an initial term of
three years and provides for the issuance of 300,000 shares of restricted common
stock upon joining the Company and options to purchase, subject to achievement
of certain funding, investigative new drug ("IND") approval and
commercialization objectives, up to 1,400,000 shares of the Company's common
stock at exercise prices of $0.45 and $0.90 per share. The valuation of the
restricted stock and stock options resulted in a non-cash charge of $264,000 in
the quarter ending June 30, 2000 which was included in research and development
expense. The related Deferred Compensation component of Stockholders' Equity
($387,000) will be amortized against income over the terms of the various option
agreements. At September 30, 2000, the balance in the Deferred Compensation
account was $343,999 with $43,001 charged against operations in the year ending
September 30, 2000.





                                      F-15