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                      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, 2001

                        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 $14,527,517 as of December 6, 2001, computed on the basis of the
average of the bid and asked prices on such date.

As of December 6, 2001 there were 44,022,778 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. [ ]

The Registrant's total revenue for the fiscal year ended September 30, 2001 was
$1,111,004.

                     DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 2002 Annual Meeting of Stockholders are
incorporated by reference into Part III.




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                                                                          Page 1



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                                     PART I

ITEM 1 - BUSINESS

THE COMPANY

The Company is a clinical stage biopharmaceutical company, which discovers
designs and develops natural and novel peptides for the treatment of infectious
diseases and cancer. The primary drugs under development target significant
markets for which there are few, if any, satisfactory alternatives. These
include treatment for oral candidiasis, a disease prevalent in HIV patients, a
treatment for Pseudomonas in Cystic Fibrosis ("CF") patients, a disease that can
be fatal to children, and a treatment for glioblastoma, a form of head and neck
cancer that has a very low survival rate. During Fiscal 2001 the Company
acquired most of the assets of Periodontix, Inc., another peptide therapeutic
company, thereby nearly doubling its technology assets and product pipeline.
Synergies between the two companies will enhance and accelerate the development
of products built on complementary peptide platforms. A number of additional
applications for preventing or treating infectious disease are also in the
development pipeline. In addition to pharmaceutical products, the Company's
technology is being applied to the development of enhanced agricultural products
and a number of development partners are already in place.

The Company has assembled a skilled and experienced management team, backed up
by a knowledgeable and active board of directors and scientific collaborators.
The Company's business strategy is structured to efficiently leverage in-house
core strengths with the 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 licensed or been assigned twenty issued United States patent and
eight international patents. These include composition of matter claims for over
sixty new molecules. These technologies covered by these patents are a platform
for a number of product applications.

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.

In 2000, 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. The Company's peptides, however, are all novel
products not found in nature, and include a variety of structural forms
incorporating unique design characteristics of the co-founder and Chief
Scientist of the Company. 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
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.


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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.

While the Company is primarily focused on developing new pharmaceuticals, it
also holds unique patents related to the use of its technologies in agricultural
applications and has attracted a number of partners. The partnerships are
essentially self-funded and do not consume equity investments. The partners
perform and pay for nearly all the cost of developing a crop incorporating the
Company's technology. As individual crops are commercialized, milestone payments
and/or royalties will be paid to the Company. Independent consultants have
validated the market potential for these applications and researchers at
universities and the United States Department of Agriculture have been advocates
for the Company's technology. The Company had an agreement covering
substantially all agricultural applications with Dow AgroSciences. On October
31, 2001 Dow AgroSciences notified the Company that it was exercising its right
to terminate the agreement.

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 new technologies and complete early clinical trials
much more efficiently than the large pharmaceutical companies. For a small
biotech company 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 efficiently discontinue low probability
opportunities. To address these issues, the Company believes that technology
acquisitions or mergers are an important and inevitable component of its
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.

In June 1998, the Company received a $2 million equity investment from the CEO
Venture Fund of Pittsburgh, PA. Other rounds with private investors raised $2.8
million and $1.3 million in March 2000 and May 2001, respectively. Since 1992,
the Company has raised over $16 million in equity.

OPERATIONS

The Company's corporate headquarters is located in Pittsburgh, Pennsylvania and
it comprises approximately 2,400 square feet with about one-third devoted to
laboratory space. The Watertown site (formerly Periodontix) comprises
approximately 6,200 square feet of leased space with over one-third devoted to
laboratory space for development of pharmaceutical products. The Company has
also 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 people
inefficiencies that occur when everything is performed in-house.

It is worth noting that since the Company's inception, many millions of dollars,
in addition to the use of sophisticated laboratories, has 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.

PERIODONTIX ASSET ACQUISITION

As part of the Company's continuing effort to build shareholder value, the
Company acquired substantially all the assets of Periodontix, Inc.
("Periodontix") in July 2001. In seeking an acquisition candidate, the Company's
goal was to broaden the Company's peptide technology platform, increase the
value of the Company to attract




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institutional investors, strengthen the depth of people skills, expand
laboratory capability, and defuse risk.

In evaluating Periodontix a number of attractive attributes were identified that
were not generally visible. Because of its name, Periodontix appeared to be
focused just on dental applications - gingivitis and periodontitis. These are
important opportunities, but with a difficult commercialization path. Dentists
are not prolific drug prescribers; therefore the ultimate market is the
over-the-counter market which requires a very low cost active ingredient.
Additionally, a large pharmaceutical partner would require much more proof
before they would be interested; finally the next clinical trials would be long,
large, and with difficult end points.

However, the initial Periodontix patents and all the preliminary work in the
development of the P113 molecules was against fungal pathogens and subsequent
research showed efficacy against important Cystic Fibrosis pathogens. There was
already an approved Investigator New Drug Application ("IND") for oral
candidiasis and the Cystic Fibrosis Foundation had already funded an initial
evaluation against Pseudomonas. Although the research yielded positive results,
prior ownership had made no request for additional funding. The Company saw the
opportunity to shift focus to medical diseases - ones that addressed unmet
medical needs, were much higher profile in terms of attracting investor
interest, where additional funding support appeared to be relatively easy to
obtain, and where the next clinical trials were smaller, with clearer endpoints,
and more likely to attract larger partners.

In addition to the technology, the Company saw the opportunity to retain a core
team of excellent peptide scientists whose skill base complimented those at the
Company. In addition, a well-equipped excellent microbiology and development
laboratory was acquired along with substantial GMP clinical materials.

Negotiations began in late 2000 and the transaction was completed in a series of
steps by July 2001. The total payments for the asset acquisition were nine
million shares of the Company's common stock and warrants to purchase nine
million shares of the Company's common stock with a $1.25 exercise price, plus
$350,000 in cash payable over time for Periodontix' fee to their investment
banker. The warrants are callable if the Company share price exceeds $2.50 per
share for twenty days. In order to satisfy the needs of both parties, the
transaction involved two major steps. About half the payment was made in return
for a license to the technology. For accounting purposes, this was written off
over the seven-month term of the license because it provided the Company with
the opportunity to further evaluate Periodontix without committing to an
acquisition. The balance of the payment, made in July 2001, was treated as
acquisition consideration

Assessing the transaction, the Company acquired two well-developed molecules
that were further along the clinical trial path than the molecules at the
Company, along with people and facilities capable of advancing both the
Periodontix molecules as well as the Company's. In effect, the transaction
substantially increased the Company's technology platform and capabilities with
moderate dilution.


PHARMACEUTICAL PRODUCTS

A major problem, which strongly encourages the development of a new class of
antibiotic 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 hospitalized. 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 annual market is estimated
to be over $25 billion. The topical anti-infective annual market is estimated to
be $2 billion worldwide.


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The Company is developing products for treating or preventing bacterial and
fungal diseases. In addition, certain cancer tumors are also suitable targets
for the Company's peptide-based therapeutics.

ORAL RINSE FOR CANDIDIASIS

Candida species are fungi, which are part of the normal flora of humans and the
environment. C. albicans, the most commonly identified human pathogen, usually
lives in balance with the other microorganisms in the body. When this balance is
disturbed by immune system changes (AIDS, immunosuppressants), broad-spectrum
antibiotics, or mucous barrier disrupters, endogenous C. albicans can become
pathogenic and cause disease. Candidiasis has emerged as the most common
opportunistic fungal disease.

The Company is developing a novel, synthetic antimicrobial peptide in a rinse
formulation for the treatment and prevention of oral candidiasis. This
condition, also known as thrush, is an AIDS-related opportunistic illness that
is highly prevalent in HIV-infected individuals. Up to 40% of AID patients'
experience symptoms of oral candidiasis. Other immunocompromised individuals,
including cancer patients receiving chemotherapy, are also susceptible to oral
fungal infections. The disease causes pain, inability to eat, and increases the
risk of additional infection. If the infection becomes systemic, it can be life
threatening. Resistance to current therapies is increasing. Oral candidiasis
outbreaks often recur and maintenance therapy may be needed.

The product under development by the Company is an alcohol-free mouthrinse that
can be swallowed to help protect the esophagus from infection. The rinse
contains a novel active ingredient, P113L, which is a 12 amino-acid
antimicrobial peptide that has demonstrated a high level of in vitro activity
against Candida albicans, including drug-resistant HIV patient isolates. The
benefits of this product over current treatments are its demonstrated safety in
humans, which is related to its natural origin, and the reduced risk of drug
resistance due to P113L's unique mechanism of action. P113L is based on
naturally occurring antimicrobial proteins found in human saliva called
"histatins," which play an important role in the body's natural defense against
disease.

An active IND for this product is in place, with a Phase 1/2 clinical trial
expected to be initiated in 2002 in HIV patients with oral candidiasis. P113L is
protected with composition of matter and use patents in the USA and abroad. The
Company intends to add value to this opportunity while seeking a pharmaceutical
partner to complete its development plan, obtain regulatory approval, market and
distribute the product. However, we cannot be certain after further study that
this oral rinse for candidiasis will prove to be safe and effective in reducing
the severity of candidiasis in cancer patients receiving chemotheropy or in AIDS
patients, will obtain regulatory approval or will be successfully
commercialized.

SAFETY
The amino acid sequence of P113L is derived from histatins, which are compounds
found naturally in human saliva. Toxicology studies performed to date as well as
experience in the clinic with a P113L mouthrinse being developed for the
treatment of gingivitis have shown P113L to be safe and well tolerated. The
gingivitis product has progressed through Phase 2 clinical studies and has been
tested in over 300 subjects.

EFFICACY
The antimicrobial activity of histatins was initially established using Candida
albicans. Activity against this organism was used in a screen of histatin
peptide fragments which lead to the discovery of P113L as being the smallest
histatin fragment which retained antimicrobial activity equivalent to that of
the parent compound. Additional in vitro testing has shown that P113L has very
potent activity against a variety of isolates of C. albicans, C. glabrata, C.
parapsilosis and C. tropicalis, all with MIC values of 3.1 (mu)g/mL or less.
Resistance to fluconazole had no bearing on the sensitivity of these organisms
to P113L.

P113L has also been shown to have very potent antibacterial activity against a
variety of organisms. In vitro testing has shown P113L to be effective against
both Gram (-) and (+) species including E. coli, H. influenzae, P. aeruginosa,
S.


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typhimurium, S. aureus, S. epidermidis, S. mutans and S. sobrinus. In the case
of P aeruginosa and S. aureus, antibacterial activity has been demonstrated
against a variety of clinical isolates, many of which were resistant to
traditional antibiotics. For both bacteria and fungi, P113L has been shown to
kill cells as opposed to simply inhibiting their growth. Experiments conducted
using P. aeruginosa have shown that P113L acts by binding to the cell surface,
kills very quickly (within minutes), and acts by permeablizing both the outer
and inner membranes of the cell.

P113L has been shown to bind to tissues in the oral cavity. In a clinical study,
it was shown that approximately 30% of the peptide administered in a mouthrinse
was retained in the oral cavity following rinsing.

MARKET OPPORTUNITY
Up to 40% of AIDS patients' experience symptoms of oral candidiasis. The disease
causes pain, inability to eat, and increases the risk of additional infection.
Resistance to current therapies is increasing. Oral candidiasis outbreaks often
recur and maintenance therapy may be needed. It has been recommended that all
AIDS patients receive prophylactic treatment for oral candidiasis.


ORAL RINSE FOR MUCOSITIS ASSOCIATED INFECTIONS

The Company is developing a novel, synthetic antimicrobial peptide in a rinse
formulation for the treatment and prevention of infections associated with oral
mucositis. This condition is a common side effect of chemotherapy and radiation
therapy in patients with head and neck cancer as well as patients undergoing
bone marrow transplantation. These treatments can cause lesions to form in the
oral cavity as a result of damage to the oral mucosa, which can then become
infected. Oral mucositis is often mentioned as one of the single worst side
effects of chemotherapy and radiation therapy due to the severe pain and
difficulty in eating that result from this condition. The symptoms can become so
severe that they can interfere with the completion of cancer treatments. There
is currently no efficacious standard of care for this debilitating condition.

The oral rinse being developed by the Company contains a novel active
ingredient, P113L, which is a 12 amino-acid antimicrobial peptide. P113L is
active against a broad spectrum of infectious agents, including the Gram (-)
bacteria Pseudomonas aeruginosa, Streptococcus mutans and Streptococcus
sobrinus. Also, potent antifungal activity has been demonstrated against Candida
albicans and related Candida species, including isolates resistant to
fluconazole.

A Phase 2 IND for this product is expected to be submitted early in fiscal 2002
for a clinical trial in cancer patients receiving radiation therapy. P113L is
protected with composition of matter and use patents in the USA and abroad. The
Company intends to add value to this opportunity while seeking a pharmaceutical
partner to complete its development plan, obtain regulatory approval, market and
distribute the product. However, we cannot be certain after further study that
this oral rinse for mucositis associated infections will prove to be safe or
effective in reducing the severity of oral mucositis in-patients, will receive
regulatory approval or will be successfully commercialized.

SAFETY
The amino acid sequence of P113L is derived from histatins, which are compounds
found naturally in human saliva. Toxicology studies performed to date, as well
as experience in the clinic with a P113L mouthrinse being developed for the
treatment of gingivitis, have shown P113L to be safe and well tolerated. The
gingivitis product has progressed through Phase 2 clinical studies and has been
tested in over 300 subjects.

EFFICACY
The antimicrobial activity of histatins was initially established using Candida
albicans. Activity against this organism was used in a screen of histatin
peptide fragments which led to the discovery of P113L as being the smallest
histatin fragment which retained antimicrobial activity equivalent to that of
the parent compound. Additional in vitro testing has shown that P113L has very
potent activity against a variety of isolates of C. albicans, C. glabrata, C.
parapsilosis and C.


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tropicalis, all with MIC values of 3.1 (mu)g/mL or less. Resistance to
fluconazole had no bearing on the sensitivity of these organisms to P113L.

P113L has also been shown to have very potent antibacterial activity against a
variety of organisms. In vitro testing has shown P113L to be effective against
both Gram (-) and (+) species including E. coli, H. influenzae, P. aeruginosa,
S. typhimurium, S. aureus, S. epidermidis, S. mutans and S. sobrinus. In the
case of P aeruginosa and S. aureus, antibacterial activity has been demonstrated
against a variety of clinical isolates, many of which were resistant to
traditional antibiotics. For both bacteria and fungi, P113L has been shown to
kill cells as opposed to simply inhibiting their growth. Experiments conducted
using P. aeruginosa have shown that P113L acts by binding to the cell surface,
kills very quickly (within minutes), and acts by permeablizing both the outer
and inner membranes of the cell.

In addition to their antimicrobial activity, histatins, including P113L, exhibit
other biological activities that could have an impact on oral mucositis. For
example, P113L has been shown to inhibit bacterial hemagglutination, which could
interfere with bacterial colonization of sites where blood is present, and to
neutralize lipopolysaccharide (LPS), a potent stimulator of the immune system.
P113L also binds to tissues in the oral cavity. In a clinical study, it was
shown that approximately 30% of the peptide administered in a mouthrinse was
retained in the oral cavity following rinsing.

MARKET OPPORTUNITY
Oral mucositis occurs in 15- 40% of patients receiving standard chemotherapy and
70% to 100% of patients receiving chemotherapy for bone marrow transplant.
Furthermore, 100% of patients receiving radiation therapy for head and neck
cancers are afflicted with oral mucositis. These cancer treatments damage the
oral mucosa, which then becomes infected. The resulting ulceration of the mouth
and tongue is extremely painful, in many cases preventing the patient from
eating, drinking or sleeping and requiring morphine to relieve the pain. Oral
mucositis is often identified by cancer patients as the single worst side effect
of chemotherapy and radiation therapy. In addition, the oral lesions can allow
bacteria to enter the blood stream causing life-threatening systemic infections.

Currently, the worldwide population of patients with mucositis is estimated at
400,000 to 600,000 patients receiving chemotherapy or radiation, with an
additional 48,000 experiencing severe mucositis associated with hematopoietic
stem cell transplantation. Approximately 350,000 to 400,000 patients in the USA
experience mucositis resulting from these conditions. Mucositis is expected to
increase in frequency and severity as oncologists utilize increasingly
aggressive cancer treatments in hope of achieving cure.

Severe mucositis necessitates a delay in the chemotherapy schedule or a
reduction of the dose, as well as treatment of complications such as pain,
dehydration, malnutrition, and infection. There are currently no pharmaceutical
agents on the market to effectively prevent or treat oral mucositis.


INHALED P113D FOR LUNG INFECTIONS IN CYSTIC FIBROSIS


CF is a genetic disease, which affects approximately 30,000 individuals in the
United States. The gene defect in CF results in altered secretions in a number
of organs, including the lung. The thickened mucous in the lungs creates an
ideal environment for bacterial infections, particularly of Pseudomonas
aeruginosa, to take hold. It is these lung infections which lead to mortality in
CF patients.

The Company is developing a novel, synthetic antimicrobial peptide for delivery
via inhalation for the treatment and prevention of lung infections in CF
patients. Currently, there are a limited number of products approved for the
treatment of lung infections in CF patients. Pulmozyme(R) was approved in 1993
to help reduce the viscosity of the mucous in the lungs of CF patients. In 1997,
TOBI(TM), tobramycin for inhalation, was approved in the US as the first inhaled
antibiotic to treat CF lung infections. TOBI(TM) is given on a one month on/one
month off cycle, primarily to


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minimize the development of resistant organisms. This dosing regimen and the
development of strains resistant to tobramycin presents a clear need for
additional inhaled antimicrobials to treat the lung infections associated with
CF.

The product under development by the Company is a novel 12 amino-acid
antimicrobial peptide, P113D, which can be delivered directly to the lung by
aerosolization, using a standard nebulizer. P113D is based on naturally
occurring antimicrobial proteins found in human saliva called "histatins," which
play an important role in the body's natural defense against disease in the oral
cavity. This peptide has demonstrated a high level of in vitro activity against
P. aeruginosa, including drug-resistant patient isolates. Because of its unique
mechanism of action, this product is not expected to contribute to drug
resistance to classical antibiotics.

The Cystic Fibrosis Foundation (CFF), which provided a $200,000 grant for
preclinical studies, is supporting efforts through Phase 2 clinical trials with
a grant for $1.5 million. The $1.5 million grant was received by the Company in
August 2001. The Company has a clear picture of the path forward to take this
product into the clinic, based on the feedback from the FDA to a pre-IND
submission. P113D is protected with composition of matter and use patents in the
USA and abroad. The Company intends to add value to this opportunity while
seeking a pharmaceutical partner to complete its development plan, obtain
regulatory approval, and market and distribute the product. However, we can not
be certain after further study that P113D solutions for inhalation will prove to
be safe and effective in treating and preventing lung infections in CF patients,
will receive regulatory approvals or will be successfully commercialized.

SAFETY
The amino acid sequence of P113D is derived from histatins, which are compounds
found naturally in human saliva. This peptide has been modified by the
incorporation of amino acids in the "D" configuration. Toxicology studies
performed to date as well as experience in the clinic with P113L, which is
composed of amino acids in the natural "L" configuration, have shown P113L to be
safe and well tolerated. Toxicology testing on P113D is in progress.

EFFICACY
P113 was determined to be the smallest histatin fragment which retained
antimicrobial activity equivalent to that of the parent compound. Interestingly,
synthesizing P113 with D-amino acids gave rise to P113D, a compound that was
impervious to enzymatic degradation and maintained the antimicrobial activity of
the parent compound. P113D also has very potent in vitro activity against a
variety of Gram (-) and (+) bacteria including P. aeruginosa, S. aureus, H.
influenzae, S. typhimurium, E. coli, S. epidermidis, S. mutans and S. sobrinus.
In the case of P. aeruginosa and S. aureus, antibacterial activity has been
demonstrated against a variety of CF patient clinical isolates which are
resistant to traditional antibiotics. P. aeruginosa isolates that produce thick
alginate secretions (mucoid phenotype) are also susceptible to killing by P113D.
For both bacteria and fungi such as Candida albicans, P113D has been shown to
kill cells as opposed to simply inhibiting their growth. It has been
demonstrated that P113D acts by binding to the cell surface and increasing the
permeability of both the outer and inner membranes of the cells of Gram (-)
bacteria, killing them within seconds.

For a compound to be effective in treating lung infections associated with CF,
it must be stable and maintain activity in the altered mucous environment of the
CF lung. P113D has been shown to be stable for days in sputum from CF patients
and is able to significantly reduce the number of bacteria in sputum from CF
patients. P113D has been shown to work in concert with Pulmozyme(R), an approved
drug used by approximately 70% of CF patients, which helps reduce the viscosity
of the mucous .

MARKET OPPORTUNITY
CF is a genetic disease that affects approximately 70,000 children and young
adults worldwide, with about 30,000 in the United States and another 30,000 in
Europe. It is estimated that 60% of these individuals are infected with P.
aeruginosa.


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DEMEGEL(TM): INFECTED BURN/WOUND PRODUCT

The Company is developing a novel synthetic antimicrobial peptide, in a gel
formulation, as a wound-healing product to treat infected burns and wounds.
These wounds are typically colonized with highly infectious pathogens that are
often resistant to antibiotics. DEMEGEL(TM) is a better treatment for these
wounds, or at least as good as the current standards of care, as indicated by in
vitro and in vivo results obtained by the Company and its collaborators.
DEMEGEL(TM) contains a very low concentration of the active ingredient, D2A21,
which is a 23 amino-acid amphipathic peptide. D2A21 is active against many
infectious agents, including multidrug-resistant strains of Pseudomonas
aeruginosa and Staphylococcus aureus. Also, anti-fungal activity has been
demonstrated against Candida albicans, Aspergillus niger, Mucor sp, and
Trichophyton mentagrophytes.

D2A21 is protected with composition and use patents in the USA and abroad. The
Company intends to add value to this opportunity while seeking a pharmaceutical
partner to complete its development plan, obtain regulatory approval, market and
distribute the product. However, we cannot be certain after further study that
DEMEGEL(TM) will prove to be safe and effective in treating infected burns and
wounds, will receive regulatory approval or will be successfully commercialized.

SAFETY
The initial safety profile of D2A21 has been established. The peptide does not
inhibit wound healing and is not cytotoxic to cultured keratinocyte skin cells.
It is not a dermal irritant, nor does it induce contact sensitization. The
peptide is not a mammalian or bacterial mutagen. Acute and chronic systemic
toxicity studies have established a safe dose, which is a multiple of the
efficacious dose for DEMEGEL(TM).

EFFICACY
In vitro data have shown that Pseudomonas aeruginosa cells are killed within 30
minutes by low dosages of D2A21, and Staphylococcus aureus cells are killed
within 2 hours by low dosages of D2A21. Furthermore, no growth of either
species was detected at 24 hours after incubation with the peptides. These
results have been confirmed in two animal infectivity models. In a standard
infected in vivo rodent burn model, D2A21 demonstrated significant
antibacterial activity against Pseudomonas aeruginosa, sterilizing burn eschar
and decreasing sub-eschar bacterial load, allowing for a markedly significant
improvement in survival in this infected burn wound model. The model was
employed to evaluate the effects of D2A21 on eschar and subeschar muscle
quantitative cultures against Pseudomonas aeruginosa. By day 3 (three) there
was a four-fold decrease in subeschar bacterial growth and zero eschar
bacterial growth in the D2A21 treated group versus the control group, which had
9.5 x 10(7) eschar colony forming units. In this same model, D2A21 demonstrated
significant improvement in percent survival (85% versus 0% in the control
group, p < 0.001).

A second model was employed to demonstrate the in vivo efficacy of DEMEGEL(TM)
in a standard infected wound model. In this study DEMEGEL(TM) was compared to
the standards of care; silver sulfadiazine (SSD) and Sulfamylon. Forty-eight
(48) rodents with full thickness dorsum defects were treated with either
DEMEGEL(TM), SSD, Sulfamylon, or control gel daily for 20 days. Survival was
100% for the DEMEGEL(TM) group, 83% for the Sulfamylon group, 50% for control
and 33% for SSD treated animals. These results initially demonstrate that
DEMEGEL(TM) is better than or at least equal to the current standards of care
for the treatment of infected wounds.


MARKET OPPORTUNITY
The use of topical antimicrobial agents has been an important adjunct in the
prevention and treatment of burn/wound infections. However, there are several
disadvantages to the use of the most common agents, silver sulfadiazine and
mafenide acetate (the active ingredient in Sulfamylon), including their
substantial ability to inhibit wound healing when applied at clinically
effective antimicrobial dosages. In addition, both of these agents are
particularly cytotoxic to cultured keratinocyte skin grafts, a procedure used
commonly in severely burned patients. Furthermore, the development of multi-drug
resistant pathogens in the hospital setting has become an increasingly important
problem in the management of major

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                                                                          Page 9
<PAGE>

surgical infections, including those due to burn wounds. Burn wound sepsis
remains the most common and serious complication of major burn injury,
accounting for over 60% of deaths in burn patients today. Therefore, there is an
unmet medical need for novel agents to provide local control of infection, in
particular for drug resistant organisms, without inhibiting the normal tissue
repair processes. Such agents could have widespread applicability in the
management of burn and wound patients in both hospital and out-patient settings.
Hospital-related infected burns and wounds affect over 2 million people per year
in the USA alone.


PROVENA(TM) VAGINAL MICROBICIDE

The Company is developing a novel, synthetic antimicrobial peptide in a gel
formulation for the prevention of sexually transmitted infections (STIs). In
both developed and developing countries, there is a compelling need for a
female-controlled, over-the-counter method for the prevention of STIs. Condoms
are currently the only proven method available to prevent the spread of STIs,
but people are either unwilling to use them or unable to negotiate their use.
Almost all funding for this project has been supplied either directly or
indirectly by the National Institutes of Health ("NIH"). The Company believes
that funding will continue to be available for clinical trials, clinical
materials and project management support.

ProVena(TM) contains a very low concentration of the active ingredient, D2A21,
which is a 23 amino-acid amphipathic peptide. D2A21 is active against many
infectious agents, and kills Chlamydia, Gonorrhea, herpes, and HIV. Furthermore,
D2A21 spares beneficial lactobacillus organisms and is safe and nonirritating to
vaginal tissue. The gel is water-soluble, odorless and colorless. These
characteristics make the Company's gel an ideal vaginal microbicide for the
prevention of STIs.

D2A21 is protected with composition and use patents in the USA and abroad. The
Company intends to add value to this opportunity while seeking a pharmaceutical
partner to complete its development plan, obtain regulatory approval, market and
distribute the product. However, we cannot be certain after further study
ProVena(TM) will prove to be safe and effective in preventing STIs, will receive
regulatory approvals or will be successfully commercialized.

SAFETY
The initial safety profile of D2A21 has been established. It is not a dermal
irritant, nor does it induce contact sensitization at the recommended dose. The
peptide is not a mammalian or bacterial mutagen. Acute and chronic systemic
toxicity studies have established a safe dose, which is a multiple of the
efficacious dose for ProVena(TM). D2A21 does not harm the natural lactobacillus
flora found in the vaginal mucosa, and the gel formulation has been proven safe
and non-irritating in rabbits and primates.

EFFICACY
D2A21 is effective in killing Chlamydia, Gonorrhea, Trichomonas, herpes virus
strains, and HIV. The microbicidal activity in a gel formulation is maintained
at varying pH and in the presence of human blood, two conditions expected to be
found in the urogenital tracts of humans.

At this time, primate efficacy studies using the gel in the prevention of
Chlamydia and HIV are in progress at NIH sponsored sites.

MARKET OPPORTUNITY
One out of every five Americans carries a sexually transmitted disease.
Americans spend approximately $8.4 billion each year to treat STIs,
approximately $4.5 billion of that on HIV/AIDS. Today, an estimated
800,000-900,000 people in the United States are living with HIV, the virus that
causes AIDS, and about one-third are unaware of their infections. AIDS is
currently the leading cause of death in men between the ages of 25 and 44 in the
United States and fourth leading cause of death in women in this age group.

Each year in the United States, 4 million cases of Chlamydia infection are
reported. However, 75% of women and 50% of men are asymptomatic and unwitting
carriers of the disease. If left untreated, Chlamydia infection in women leads
to pelvic


--------------------------------------------------------------------------------
                                                                         Page 10
<PAGE>

inflammatory disease, which in turn leads to infertility, ectopic pregnancies,
and a 3-5 times greater risk of acquiring HIV. There are about 1 million cases
of Gonorrhea infections in the USA each year, and approximately half of those
infected have no symptoms. A woman infected with Gonorrhea is at increased risk
of acquiring HIV. Diagnosed Chlamydia and Gonorrhea infections are treated with
antibiotics at an annual health care cost of over $2 billion.

Trrichomonas is a common STI, attacking 2 to 3 million Americans every year.
There are 1 million new cases each year of genital warts caused by HPV, another
sexually transmitted infection. And genital herpes is a chronic, lifelong viral
infection, spreading at a rate of 500,000 new cases per year. There are even
more people infected who have no symptoms and remain undiagnosed.

Women worldwide have asserted their willingness to buy and use a vaginal
microbicide. There is currently no safe and effective product on the market to
prevent STIs, other than condoms.

D2A21: GLIOBLASTOMA TREATMENT

The Company is developing a novel synthetic peptide, D2A21, for direct injection
into head and neck tumors, and as a possible treatment for neoplastic
meningitis. D2A21 is a 23 amino-acid amphipathic peptide, with activity
demonstrated in vitro against prostate, breast, and melanoma tumor cells. The
program is in late stage pre-IND development, with safety and efficacy in vivo
studies underway in rodent glioblastoma.

D2A21 is protected with composition and use patents in the USA and abroad. The
Company intends to add value to this opportunity while seeking a pharmaceutical
partner to complete its development plan, obtain regulatory approval, market and
distribute the product. However, we cannot be certain after further study that
D2A21 will prove to be safe and effective in inhibiting the growth of human
glioblastoma or be a treatment for neoplastic meningitis, will receive
regulatory approvals or will be successfully commercialized.

SAFETY
The initial safety profile of D2A21 has been established. The peptide is not
cytotoxic to cultured keratinocyte skin cells and does not inhibit wound
healing. It is not a dermal irritant, nor does it induce contact sensitization.
The peptide is not a mammalian or bacterial mutagen. Acute and chronic systemic
toxicity studies have established a safe dose, which is a multiple of the
efficacious dose used of D2A21.

EFFICACY
In vitro data have shown that D2A21 inhibits the growth of human glioblastoma
cell line approximately 70% of the cases at low dosages of concentration of
peptides and 90% of the cases at moderate dosages of concentration of peptide.
Experiments are underway to test the Maximally Tolerated Dose ("MTD"), the dose
limiting toxicity and potential efficacy of D2A21 when delivered intratumorally
into the intracerebral compartment of the rodent model. The model is an athymic
rat with a malignant glioma xenograft. Also, experiments are underway to
determine the MTD, dose limiting toxicity and potential efficacy of D2A21
delivered intrathecally in a carcinomatous neoplastic meningitis rodent model.

MARKET OPPORTUNITY
Eight thousand people in the United States each year are diagnosed with a brain
cancer called malignant glioma. Glioblastoma multiforme, which occurs primarily
in adults, is an especially aggressive type of malignant glioma. It has proved
extremely difficult to treat effectively using conventional cancer therapies
such as surgery and radiation, with or without chemotherapy. Because malignant
gliomas rarely metastasize to other parts of the body, systemic drug delivery is
unnecessary. Furthermore, due to the blood-brain barrier, many chemotherapeutic
agents are ineffective in the brain. 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. Unlike most benign tumors
found elsewhere in the


--------------------------------------------------------------------------------
                                                                         Page 11
<PAGE>

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 relative to other cancer treatments and the
public, in general, is unaware of the magnitude of this cancer.

In many cases, neoplastic meningitis can result from a glioma or other tumor
that has "spread." The intrathecal compartment is an ideal reservoir for tumor
growth, resulting in the development of neoplastic meningitis. Most systemically
administered chemotherapeutic agents are ineffective in this cerebrospinal
fluid. Ironically, because of the improved treatment of systemic solid tumors,
neoplastic meningitis is becoming an increasing complication of breast and lung
adenocarcinomas and melanomas. When central nervous system relapse of solid
tumors results in the development of neoplastic meningitis, it most likely
because of a failure of tumoricidal agents, administered systemically, to
achieve a therapeutic level in the intrathecal space. Patients with neoplastic
meningitis have a median survival of only 2-3 months. To overcome the
limitations of systemic delivery of chemotherapeutic agents, direct delivery
into the intrathecal compartment is actively being investigated.


AGRICULTURAL PRODUCTS

Through extensive collaborations with universities and the United States
Department of Agriculture, the Company's peptides have been shown to be a
platform from which to derive genes to confer important new plant
characteristics. This business opportunity has been able to attract sufficient
funding such that it is essentially self-sufficient.

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

The importance of the Company's technology is illustrated in the examples that
follow. For many diseases, chemical fungicides are the only alternative and can
add five to ten percent to the cost of a crop. For other crops, there are no
sprayable treatments available and genetic engineering may be the only
alternative. Current efforts are underway with licensees or collaborators
include cotton, grapes, apples, pears, and potatoes.

One such example is Pierce's disease. Pierce's disease is caused by Xylella
fastidiosa, a bacterium that kills grapevines by blocking their water transport
tissue. A vine infected with Pierce's disease usually dies within two years and
produces no crop. Pierce's disease ranges from North America through Central
America and parts of South America. It is present in some California vineyards
every year. Pierce's disease has cost the California wine and grape industries
millions of dollars in lost revenues since it began destroying grapevines in
Napa and Sonoma counties several years ago, at a cost of some $20,000 per acre.
During severe epidemics, losses due to Pierce's disease may require major
replanting. In


--------------------------------------------------------------------------------
                                                                         Page 12
<PAGE>

Florida and other southeastern states, the disease is considered to be the
single most formidable obstacle to the growing of European varieties. Other
strains of Xylella fastidiosa have been discovered, and almost all of these
cause leaf scorching of woody perennials such as American elm, maple, mulberry,
or plum. In some plants, such as peach and alfalfa, the bacterium slows and
stunts plant's growth.

An important fungal disease example is "late blight", caused by the fungus,
Phytophthora infestans. This disease is a virulent cousin of the disease that
caused the Irish potato famine. The disease was first reported in the late
1980's and has spread up the East Coast from Florida to Maine, and has reached
west to Idaho and Oregon. The disease causes discoloration of the leaves
accompanied by downy mildew, which is the first sign of infection. 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 it is resistant to metalaxyl, a generic, commonly used (on late blight)
fungicide. This resistance makes suppressing the fungal epidemic more difficult.
Two factors compound the problem posed by the fungus. First of all, it is
difficult to detect low levels of late blight in the field. 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

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. The
market for these disease resistant technologies is estimated to exceed $6
billion.

The Company plans to capitalize on this technology through research
collaborations with private companies, universities and government agencies. The
Company expects nearly all of the development costs to be borne by collaborators
or licensees. Commercially approved products are not expected for a number of
years. If approvals are achieved, the Company expects to receive royalties on a
crop by crop basis.


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 United States Food and Drug Administration ("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.



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                                                                         Page 13
<PAGE>

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.

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


--------------------------------------------------------------------------------
                                                                         Page 14
<PAGE>

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. Nonetheless,
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

Except for the technology acquired as part of the Periodontix acquisition, the
Company's technology was designed by Jesse M. Jaynes, Ph.D., the Company's Chief
Scientist. 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



--------------------------------------------------------------------------------
                                                                         Page 15
<PAGE>

activity that could also be used for enhanced plant disease resistance and
enhanced animal disease resistance.

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 10 to 40
amino acids and they have no sequence homology to the peptides found in nature.
In its discovery process, the Company has identified and filed patents on 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, 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 that 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.

Through the acquisition of Periodontix, the Company acquired a number of
Histatin based molecules. Histatins are small, cationic, histidine-rich peptides
secreted by humanpartoid and submandibular-sublingual glands. These histatins
are part of the defense system for controlling the growth of pathogenic bacteria
and fungi in the oral cavity. P113 is a 12 amino acid peptide whose sequence is
derived from histatin 5. The Company's patents include composition of matter
protection for P113 and other molecules.

PRODUCTION

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.

Based on discussions with suppliers, the Company anticipates that adequate
supplies of clinical materials will be available from suppliers at acceptable
costs using solid or solution phase synthesis. The Company has also examined the
longer range cost and supply issues. Substantial progress has been made in
recent years in driving peptide costs to low levels and the Company anticipates
it will be able to contract for manufacturing the active compounds at price
levels that would produce excellent profit margins.

COMPETITION

There are some forty other biotechnology companies who are developing peptide
compounds for antimicrobial or anti-cancer applications. Through the Internet
and other sourcing, the Company regularly monitors patents, press announcements,
and publications in order to be informed about the Company's fields of
technology and the actions of competitors. In addition to companies developing
antimicrobial peptides, other non-peptide companies are developing products to
treat the same diseases that the Company is targeting, and in some cases there
are already products on the market to treat the Company's target diseases. Many
of the existing anti-infective drugs, however, are either losing effectiveness
because of the increase in resistance, or have safety profiles that are not
ideal. As a result, the Company believes its products offer competitive
advantages to these anti-bacterial and anti-fungal products.

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



--------------------------------------------------------------------------------
                                                                         Page 16
<PAGE>

Major competitive peptide companies include Cubist Pharmaceuticals,
Intrabiotics, Micrologix, and Xoma Corporation. The market capitalization of
these companies ranges from $40 million to $1 billion. Some of these companies
have products based on technologies other than peptides, and in general, most
are much better funded than the Company.

Other current or potential competitors in the Company's therapeutic target areas
include: Bristol-Myers Squibb and Alza (Candidiasis), Access Pharmaceuticals
(Mucositis), Chiron (CF) Bertek Pharmaceuticals (Infected Burn/Wound), and
Guilford Pharmaceuticals (Glioblastoma).

The Company believes it has accomplished much with its modest funding. There are
three molecules that have demonstrated excellent potential for treating sizable
markets with unmet medical needs. There are several additional molecules in the
pipeline, along with the technical skills to refine and develop these molecules
and create new ones. The Company has established validation of its technology
platform with collaboration and licenses in a number of non-pharmaceutical
applications. The Company is actively involved in developing partners for
pharmaceutical products and expects to be successful as products move through
"proof of concept" clinical trials and product value is enhanced.

PATENTS

The Company has licenses or been assigned twenty (20) United States patents. The
Company has also filed a number of United States patent applications, as well as
corresponding applications in the patent convention treaty countries and other
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 Chief Scientist, 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 and was issued in September 1998. The Company has also
been assigned Dr. Jaynes' rights to patents related to earlier work at LSU.
<TABLE>
<CAPTION>

                                                    DEMEGEN PATENTS

------------------------- ------------- -----------------------------------------------------------------------
       PATENT NO.          ISSUE DATE                                PATENT TITLE
------------------------- ------------- -----------------------------------------------------------------------

<S>                         <C>         <C>
      US 6,191,110          2-20-01     Method of Enhancing Wound Healing by Stimulating Fibroblast and
                                        Keratinocyte Growth in vivo, Utilizing Amphipatic Peptides (expires
                                        April 20, 2014)
------------------------- ------------- -----------------------------------------------------------------------

      US 6,153,210         11-28-00     Use of Locally Delivered Metal Ions for Treatment of Periodontal
                                        Disease (expires November 28, 2017)
------------------------- ------------- -----------------------------------------------------------------------

      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
------------------------- ------------- -----------------------------------------------------------------------
</TABLE>



--------------------------------------------------------------------------------
                                                                         Page 17
<PAGE>
<TABLE>
<CAPTION>
------------------------- ------------- -----------------------------------------------------------------------
       PATENT NO.          ISSUE DATE                                PATENT TITLE
------------------------- ------------- -----------------------------------------------------------------------
<S>                        <C>          <C>
                                        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)
------------------------- ------------- -----------------------------------------------------------------------

     US 5,912,230**         6-15-99     Anti-fungal and Anti-bacterial Histatin-based Peptides (expires March
                                        11, 2018)
------------------------- ------------- -----------------------------------------------------------------------

     US 5,885,965**         3/23/99     Anti-fungal D-amino Acid Histatin-based Peptides (expires December 5,
                                        2017)
------------------------- ------------- -----------------------------------------------------------------------

     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     Method of Treating Pulmonary Disease States with Non-Naturally
                                        Occurring Amphipathic Peptides (expires April 28, 2015)
------------------------- ------------- -----------------------------------------------------------------------

     US 5,696,078**         12-9-97     Method for Treating Fungal Infections Using Histatin-Based Peptides
                                        (expires December 9, 2014)
------------------------- ------------- -----------------------------------------------------------------------

     US 5,646,119**          7-8-97     D-amino Acid Histatin-based Peptides as Anti-fungal and
                                        Anti-bacterial agents (expires July 8, 2014)
------------------------- ------------- -----------------------------------------------------------------------

     US 5,631,228**         5-20-97     Anti-fungal and Anti-bacterial Histatin-based Peptides (expires May
                                        20, 2014)
------------------------- ------------- -----------------------------------------------------------------------

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

      US 5,486,503          1-23-96     Anti-Fungal Histatin Based Peptides (expires January 23, 2013)
------------------------- ------------- -----------------------------------------------------------------------
</TABLE>

* Patents in-licensed from Louisiana State University
** Patents in-licensed from Boston University


--------------------------------------------------------------------------------
                                                                         Page 18
<PAGE>

EMPLOYEES

The Company currently has nine employees but also supports, directly or
indirectly, researchers at academic and other research institutions. These
academic and other research institutions 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" in the clinical trial stage. The
primary drugs under development target significant markets for which there are
few, if any, satisfactory alternatives. These include treatment for oral
candidiasis, a disease prevalent in HIV patients, a treatment for Pseudomonas in
CF patients, a disease that can be fatal to children, and a treatment for
glioblastoma, a form of head and neck cancer that has a very low survival rate.
During Fiscal 2001 the Company acquired Periodontix, Inc., another peptide
therapeutic company, thereby nearly doubling its technology assets and product
pipeline. Synergies between the two companies will enhance and accelerate the
development of products built on complementary peptide platforms. A number of
additional applications for preventing or treating infectious disease are also
in the development pipeline. In addition to pharmaceutical products, the
Company's technology is being applied to the development of enhanced
agricultural products.

ITEM 2 - DESCRIPTION OF PROPERTY

The Company's Pittsburgh office and laboratory are located at 1051 Brinton Road,
Pittsburgh, PA 15221. The Company occupies 2,400 square feet of leased space.
The lease is for a six month term, expiring March 2002 at a gross monthly
rental, including utilities, of $3,948. The Watertown site comprises
approximately 6200 square feet of leased space. The lease is for a four year
term at a gross monthly rental, including utilities, of $11,093 and expires in
June 2003.

The Company fully utilizes its office space and is sub-leasing its laboratory
space in Pittsburgh and is attempting to locate sub-tenants to occupy
approximately one-third of the Watertown facility.

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


ITEM 3 - LEGAL PROCEEDINGS

In December 2001, the Company commenced arbitration proceeding against Dow
AgroSciences LLC for damages the Company's management believes it has sustained
as a result of Dow AgroSciences' failure to perform certain contractual
obligations under the agreement that was terminated by Dow AgroSciences on
October 31, 2001. The Company is asserting a claim for substantial damages. The
Company can not predict the outcome of the arbitration. Also, in December 2001,
Dow AgroSciences asserted a claim for the Company to return the most recent
minimum royalty payment. The Company does not believe that the now terminated
agreement requires it to do so. The agreement calls for mediation and
arbitration of disputes.

ITEM 4 - SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS

None



--------------------------------------------------------------------------------
                                                                         Page 19
<PAGE>

                                     PART II


ITEM 5 - MARKET FOR 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 QUARTERSS ENDED
                         --------------------------------------------------------------------

Fiscal            December 31               March 31           June 30           September 30
------            -----------               --------           -------           ------------

2001

<S>                   <C>                     <C>               <C>                 <C>
High                  $1.01                   $1.00             $0.67               $0.52
Low                   $0.42                   $0.56             $0.47               $0.34


2000

High                  $0.33                   $1.53             $1.00               $0.65
Low                   $0.19                   $0.29             $0.53               $0.46
</TABLE>




At December 2, 2001, there were 503 holders of record of 44,022,778 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 2,050 stockholders which hold their
ownership in street name.

The Company has not paid any cash dividends in respect to its Common Stock and
has no present intention to pay any such dividends in the foreseeable future.
The Company intends to retain any earnings for use in the business operations.
In addition, in the Shareholders' Agreement, dated June 15, 1998, by and among
the Company and the persons named therein, the Company agreed, with certain
limited exceptions, not to pay any dividend on its shares without the written
consent of the holders of at least a majority of the then outstanding shares of
preferred stock of the Company.

On February 16, 2001, the Company issued options to purchase 25,000 shares of
Common Stock to each of John Bridwell, Konrad Weis and James Colker and 35,000
shares of Common Stock to each of Robert Hannan and Jerry Hook and on August 16,
2001, the Company issued options to purchase 25,000 shares of Common Stock to
Joseph Lovett, non-employee directors of the Company, as compensation for their
respective service to the Company's Board. The options were issued pursuant to
the terms of the Company's 1998 Stock Option Plan and the issuances were exempt
from registration under the Securities Act of 1933, as amended (the "Securities
Act"), as transactions not involving a public offering under Section 4(2). The
options were for a five-year term at an exercise price of $0.75 per share and
were immediately vested.

During the third quarter of Fiscal 2001, the Company made a private placement
pursuant to Section 4(2) of the Securities Act of its securities to
institutional and other accredited investors raising $1.28 million of which
$0.181 million was in the form of future services with the remainder of $1.09
million in cash. The private placement resulted in 2.543 million restricted
shares of Common Stock and

--------------------------------------------------------------------------------
                                                                         Page 20
<PAGE>

warrants to purchase and additional 2.543 million shares of the Company's Common
Stock.

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
May 31, 2006 or 60 days after a call by the Company. The Company may call the
warrants at any time, provided that the price of the Company's common stock has
been in excess of $1.50 per share for each of the twenty 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.


SELECTED FINANCIAL DATA

The following table sets forth certain financial data for, and as of the end of,
the years ended September 30, 2001, 2000, 1999, 1998 and 1997 and for the period
December 6, 1991 (inception) to September 30, 2001:

<TABLE>
<CAPTION>
                                                                                                                      December 6
                                                                Year Ended September 30,                           1991 (Inception)
                                     ---------------------------------------------------------------------------   to September 30,
                                          2001              2000            1999            1998            1997          2001
                                          ----              ----            ----            ----            ----          ----



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

Grant and Other Income                 $  1,111,004    $    763,765    $  1,118,576    $  1,376,918    $    764,834    $  5,691,266

License amortization and purchased
   research & development related
   to Periodontix acquisition             7,667,739            --              --              --              --         7,667,739

Total Expenses                           11,614,079       2,419,247       2,456,318       3,370,671       1,708,607      30,625,090

Net Loss                                (10,503,075)     (1,655,482)     (1,337,742)     (1,993,753)       (943,773)    (24,933,824)

Net Loss per Share (dilutive)          $      (0.29)   $      (0.06)   $      (0.06)   $      (0.13)   $      (0.05)

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

Weighted Average Number
   of Common Shares
   Outstanding                           37,163,279      29,759,153      26,255,104      23,867,091      19,537,047

BALANCE SHEET DATA:


Cash & Cash Equivalents                $    537,478    $  1,825,352    $    583,585    $  1,686,658    $    310,252

Working Capital (deficiency)               (304,245)      1,413,408           6,849       1,329,541      (1,498,477)

Total Assets                                837,500       2,311,592       1,084,505       2,114,750         651,963

Long-term obligations                       354,286         360,180         203,147           -0-             -0-

Deficit accumulated during
   development stage                    (26,814,911)    (16,039,877)    (14,119,462)    (12,523,358)     (9,443,772)

Redeemable convertible preferred
   Stock                                  2,305,748       2,033,787       1,768,846       1,510,487           -0-
Shareholders' Equity
   (Deficit)                             (2,717,067)       (633,989)     (1,555,934)       (122,130)     (1,158,216)
</TABLE>


ITEM 6 - 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" in the clinical trial stage. The
primary drugs under development target significant markets for which there are
few, if any, satisfactory alternatives. These include treatment for oral
candidiasis, a disease prevalent in HIV patients, a treatment for Pseudomonas in
CF patients, a disease that can be fatal to children, and a treatment for
glioblastoma, a form of head and neck cancer that has a very low survival rate.
During Fiscal 2001, the Company acquired most of the assets of Periodontix,
Inc., another peptide




--------------------------------------------------------------------------------
                                                                         Page 21
<PAGE>

therapeutic company, thereby nearly doubling its technology assets and product
pipeline. Synergies between the two companies will enhance and accelerate the
development of products built on complementary peptide platforms. A number of
additional applications for preventing or treating infectious disease are also
in the development pipeline.


RESULTS OF OPERATION

SEPTEMBER 30, 2001 VS 2000

In the year ended September 30, 2001 (Fiscal 2001), grants and other income
increased to $1.1 million from $0.8 million in the year ended September 30, 2000
(Fiscal 2000). In Fiscal 2001 this amount included a $0.4 million grant from a
foundation. In Fiscal 2000, the Company received a $0.15 million program related
loan from a local charity. Had this been a grant, revenues between the two years
would have been more comparable. The most significant component of revenue in
both fiscal years was from licensing fees and research funding received from Dow
AgroSciences as part of a license entered into during Fiscal 1998. After months
of negotiations, on October 31, 2001 the Company received notice of termination
from Dow AgroSciences of this agreement. As a result of the termination, the
Company took a $0.18 million charge for patent costs that had been capitalized
with respect to the agreement.

Total expenses increased to $11.6 million in the current fiscal year from $2.4
million in the prior fiscal year. Current fiscal year expenses included $7.7
million of non-cash expenses consisting of the aforementioned $0.18 million
charge related to the termination of the Dow AgroSciences agreement, $4.85
million of amortization of the Periodontix license and $2.64 million for the
write off of purchased research associated with the Periodontix acquisition. In
evaluating Periodontix a number of attractive attributes were identified that
were not generally visible. Because of its name, Periodontix appeared to be
focused just on dental applications - gingivitis and periodontitis. These are
important opportunities, but with a difficult commercialization path. Dentists
are not prolific drug prescribers; therefore the ultimate market was the
over-the-counter market which requires a very low cost active ingredient.
Additionally, a large pharmaceutical partner would require much more proof
before they would be interested; finally the next clinical trials would be long,
large, and with difficult end points.

Assessing the transaction, the Company acquired two well-developed molecules
that were further along the clinical trial path than the molecules at the
Company, along with people and facilities capable of advancing both the
Periodontix molecules as well as the Company's.

Exclusive of the aforementioned non-cash expenses, expenses would have been
$3.95 million as compared with $2.4 million for the prior fiscal year. The $1.55
million increase was due to the expenses associated with the Watertown office
which the Company began operating on January 1, 2001 under the license agreement
with Periodontix prior to the acquisition of the majority of the Periodontix
assets in July 2001.

Research and development expenses increased by $1.0 million due to the
aforementioned addition of the Watertown office on January 1, 2001.

General and administrative expenses increased to $1.2 million in Fiscal 2001
from $0.7 million in Fiscal 2000 due to the aforementioned addition of the
Watertown office on January 1, 2001. Depreciation and amortization remained
relatively constant in the two fiscal years.

The Company did not have a federal or state income tax provision in either
Fiscal 2001 or 2000 due to the loss recorded in each period and cumulative from
inception.

The amounts described above resulted in a net loss of $10.5 million for Fiscal
2001. The net loss would have been $2.8 million if the aforementioned non-cash
charges were excluded. The net loss for Fiscal 2000 was $1.7 million.

--------------------------------------------------------------------------------
                                                                         Page 22
<PAGE>

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
AgroSciences as part of a license entered into during Fiscal 1998.

Total expenses increased 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.


LIQUIDITY AND CAPITAL RESOURCES

FISCAL 2001

During the year ended September 30, 2001, the Company's cash and cash
equivalents decreased by $1.3 million to $0.5 million. Net cash utilized by
operating activities of $1.95 million and $0.3 million of net cash utilized by
investing activities was partially offset by net cash provided by financing
activities of $0.96 million.

Specifically, the $1.95 million of cash utilized by operating activities
consisted of the net loss of $10.5 million which was partially offset by $0.16
million of depreciation and amortization, $7.7 million of amortization of the
Periodontix license, purchased research and development that was written-off
and intangibles written off due to the termination of the Dow AgroSciences
agreement, an increase of $0.22 million in accounts payable and other
liabilities, $0.05 million increase in unearned revenue $0.39 million of stock
issued for services and $0.09 million of stock based compensation.

The Company expected that the Periodontix acquisition would provide access to
new and additional future funding opportunities. However, the significant
adverse changes in the capital markets combined with the termination of the Dow
AgroSciences agreement has resulted in the Company not being able to access
significant funding which has resulted in the aforementioned intangible asset
realization writedowns.

The $0.31 million of cash utilized by investing activities relates to $0.23
million expended for the Periodontix license and acquisition, $0.03 million for
the purchases of property, plant and equipment and $0.05 million of patent costs
capitalized as intangible assets in the current year.

Cash inflows from financing activities included the $1.0 million net proceeds
from the private placement of securities. This source of funds was partially
offset by $0.08 million of payments on notes payable.



--------------------------------------------------------------------------------
                                                                         Page 23
<PAGE>

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 Company's 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.


PROSPECTIVE/FORWARD-LOOKING INFORMATION
---------------------------------------

This Annual Report on Form 10-KSB contains forward-looking statements within the
meaning of The Private Securities Litigation Reform Act of 1995 (the "Act"). In
particular, when use herein, the words "plan," "estimates," "confident that,"
"believe," "expect," or "intend to," and similar expressions are intended to
identify forward-looking statements within the meaning of the Act and are
subject to the safe harbor created by the Act. Such statements are subject to
certain risks and uncertainties and actual results could differ materially from
those expressed in any of the forward-looking statements. Such risks and
uncertainties include, but are not limited to, market conditions, general
acceptance of the Company's products and technologies, possible delays or
failures to develop and/or commercialize any technology, possible risks related
to adverse clinical results, impact of alternative technology advances, inherent
risks in early stage development of such technology, competitive factors, the
ability to successfully complete additional financings and other risks described
in the Company's reports and filings with the Securities and Exchange
Commission.

In addition, information regarding market and industry statistics and other
numbers contained in this Annual Report are included based upon information
available to us that we believe is accurate. It is generally based on academic
and other



--------------------------------------------------------------------------------
                                                                         Page 24
<PAGE>


publications. We have not independently verified all data and cannot assure you
of the accuracy of the data we have included.

The Company is subject to the risks associated with emerging technology-oriented
companies. Primary among these risks are the ability to obtain sufficient
financing, competition from substitute products and the ability to successfully
develop and market its products. As of September 30, 2001, the Company has an
accumulated deficit of $26,815,000. In addition, the Company has a working
capital deficiency of approximately $305,000 as of September 30, 2001.

For the year ended on September 30, 2001, the Company incurred a loss of
$10,503,000 and used $1,945,000 of cash for operations during fiscal 2001.

The Company historically has obtained its working capital requirements through
equity issuances to shareholders, royalty payments and from certain borrowing
arrangements. Management has plans in Fiscal 2002 to issue additional equity to
shareholders and to obtain additional funding support from grants and product
development partners. Should these plans not be successful, there is uncertainty
as to the Company's ability to continue as a going concern through the year
ending September 30, 2002. The Company's current cash resources are close to
being exhausted and it is extremely uncertain that new sources of cash will be
identified and will be received during Fiscal 2002.

The financial statements do not include any adjustments relating to the
recoverability and classification of assets or the amount and classification of
liabilities that might be necessary should the Company be unable to continue as
a going concern. The Company's continued existence is dependent upon its ability
to generate sufficient cash flows from equity financing and successfully
concluding additional license agreements.

ITEM 7 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements of the registrant and the report of Ernst & Young LLP
are submitted under Item 13 of this report beginning on page F-1.


ITEM 8 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL MATTERS

Not applicable




--------------------------------------------------------------------------------
                                                                         Page 25
<PAGE>





                                    PART III

The information called for by Part III (Items #9, 10, 11 and 12) is incorporated
herein by reference to the registrant's definitive Proxy Statement for the 2002
Annual Meeting of Stockholders to be filed with the Securities and Exchange
Commission pursuant to Regulation 14A of the Securities Exchange Act of 1934, as
amended.


ITEM 13 - 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, 2001 and 2000

         (iii)    Statements of Operations for the Years Ended September 30,
                  2001, 2000 and 1999 and for the period December 6, 1991
                  (inception) to September 30, 2001

         (iv)     Statements of Shareholders' Deficit for the Years Ended
                  September 30, 2001, 2000 and 1999 and for the period December
                  6, 1991 (inception) to September 30, 2001

         (v)      Statements of Cash Flows for the Years Ended September 30,
                  2001, 2000 and 1999 and for the period December 6, 1991
                  (inception) to September 30, 2001

         (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

2.1      Asset Purchase Agreement, dated as of July 16, 2001 between Demegen,
         Inc. and Periodontix, Inc. filed as Exhibit to the registrant's Form
         8-K dated July 31, 2001, is incorporated herein by reference

2.1.1    Option Agreement between Demegen, Inc. and Periodontix, Inc., dated
         February 16, 2001 filed as Exhibit to the registrant's Form 8-K dated
         February 20, 2001, is incorporated herein by reference

2.1.2    License Agreement between Demegen, Inc. and Periodontix, Inc., dated
         February 8, 2001 filed as Exhibit to the registrant's Form 8-K dated
         February 20, 2001, is incorporated herein by reference

2.1.3    Form of Demegen Warrant filed as Exhibit to the registrant's Form 8-K
         dated February 20, 2001, is incorporated herein by reference

2.1.4    Escrow Agreement between Demegen, Inc. and Periodontix, Inc., dated
         February 16, 2001 filed as Exhibit to the registrant's Form 8-K dated
         February 20, 2001, is incorporated herein by reference

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 tothe
         registrant's Form 10-QSB for the quarter ending June 30, 2001 dated
         August 13, 2001, is incorporated herein by reference


--------------------------------------------------------------------------------
                                                                         Page 26
<PAGE>

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

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 March 31, 2000 is incorporated herein by
         reference

4.6      Subscription 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      Warrant for the Purchase of Shares 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

4.8      Letter dated June 28, 2001 from CEO Venture Fund III to Consent to
         increase the number of directors and amend the Amended and Restated
         By-Laws of the Company filed as an Exhibit to the registrant's Quarter
         Report on Form 10-QSB for the quarter ended June 30, 2001 dated August
         13, 2001, is incorporated herein by reference

4.9      Subscription Agreement to Purchase Units of Demegen, Inc. filed as
         Exhibit 4 a. to the registrant's Current Report on Form 8-K, dated July
         18, 2001,, is incorporated herein by reference

4.10     Warrant for the Purchase of Shares Common Shares of Demegen, Inc. filed
         as Exhibit 4 b. to the registrant's Current Report on Form 8-K, dated
         July 18, 2001,, 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



--------------------------------------------------------------------------------
                                                                         Page 27
<PAGE>

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     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

10.7     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

10.8     1998 Stock Option Plan filed as Exhibit to the registrant's Form 10,
         is incorporated herein by reference

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

10.10    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

10.11    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

10.12    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

10.13    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

10.14    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

10.15    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

10.16    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

99       Letter dated June 28, 2001 from CEO Venture Fund III to consent to the
         increase in the number of Directors and Amend the Amended and Restated
         By-Laws of the Company filed as Exhibit 99 to the registrant's
         Quarterly Report on Form 10-QSB for the quarter ended June 30, 2001 is
         incorporated herein by reference

--------------------------------------------------------------------------------
                                                                         Page 28
<PAGE>

* 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 filed the following Current Reports on Form 8-K during the
   three months ended September 30, 2001:


-        Form 8-K dated July 31, 2001 reporting the acquisition of all of
         Periodontix, Inc.'s technologies and rights to clinical trials, except
         to Periodontix' photodynamic technology

-        Form 8-K/A dated September 28, 2001 with the audited December 31, 2000
         and 1999 financial statements of Periodontix, Inc. and related pro
         formas









--------------------------------------------------------------------------------
                                                                         Page 29
<PAGE>




                                   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: January 2, 2002

                                     By: /s/ Richard D. Ekstrom
                                         ---------------------------------
                                     Richard D. Ekstrom
                                     Chairman of the Board of Directors,
                                     President and Chief 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: January 2, 2002                By: /s/ Richard D. Ekstrom
                                         -----------------------
                                     Richard D. Ekstrom
                                     Chairman of the Board of Directors,
                                     President and Chief Executive Officer
                                     (Principal Executive Officer,
                                     Principal Financial Officer and Principal
                                     Accounting Officer)

Date: December 14, 2001              By: /s/ Jesse M. Jaynes, Ph.D.
                                         ---------------------------
                                     Jesse M. Jaynes, Ph.D.
                                     Chief Scientist and Director

Date: December 14, 2001              By: /s/ James Colker
                                        -----------------
                                     James Colker
                                     Director

Date: December 14, 2001              By:
                                       ------------------
                                     John Bridwell
                                     Director

Date: December 14, 2001              By: /s/ Konrad M. Weis, Ph.D.
                                         --------------------------
                                     Konrad M. Weis. Ph.D.
                                     Director

Date: December 14, 2001              By: /s/ Robert E. Hannan
                                         --------------------------
                                     Robert E. Hannan
                                     Director

Date: December 14, 2001              By: /s/ Jerry B. Hook, Ph.D.
                                         ---------------------------
                                     Jerry B. Hook, Ph.D.
                                     Director

Date: December 14, 2001              By: /s/ Joseph P. Lovett
                                         ---------------------------
                                     Joseph P. Lovett
                                     Director



--------------------------------------------------------------------------------
                                                                         Page 30
<PAGE>




[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, 2001 and 2000, and the related statements of
operations, shareholders' deficit, and cash flows for each of the three years in
the period ended September 30, 2001 and for the period from December 6, 1991
(inception) through September 30, 2001. 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 audit.

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

In our opinion the financial statements referred to above present fairly, in all
material respects, the financial position of Demegen, Inc. (a development stage
company) at September 30, 2001 and 2000, and the results of its operations and
its cash flows for each of the three years in the period ended September 30,
2001 and for the period from December 6, 1991 (inception) through September 30,
2001, in conformity with accounting principles generally accepted in the United
States.

The accompanying financial statements have been prepared assuming that Demegen,
Inc. will continue as a going concern. As more fully described in Note 1, the
Company has experienced significant losses and has an accumulated deficit of
$26.8 million and a working capital deficiency of $305,000. These conditions
raise substantial doubt about the Company's ability to continue as a going
concern. The financial statements do not include any adjustments to reflect the
possible future effects on the recoverability and classification of assets, or
the amounts and classification of liabilities, that may result from the outcome
of this uncertainty.


                              /s/ ERNST & YOUNG LLP


Pittsburgh, PA
November 30, 2001

                                      F-1


--------------------------------------------------------------------------------
                                                                         Page 31
<PAGE>



<TABLE>
<CAPTION>
                                  Demegen, Inc.
                          (A Development Stage Company)
                                 Balance Sheets

                                                                          SEPTEMBER 30
                                                                   2001                  2000
                                                         --------------------------------------------
<S>                                                       <C>                      <C>
ASSETS
Current assets:
   Cash and cash equivalents                              $      537,478            $    1,825,352
   Accounts receivable                                            46,310                    22,409
   Prepaid expenses and other current assets                       6,500                      --
                                                         --------------------------------------------
Total current assets                                             590,288                 1,847,761

Property and equipment:
   Furniture and equipment                                       339,843                   231,175
   Computer hardware and software                                135,906                   134,626
                                                         --------------------------------------------
                                                                 475,749                   365,801
   Less accumulated depreciation and amortization               (280,116)                 (208,971)
                                                         --------------------------------------------
                                                                 195,633                   156,830
Intangible assets:
   Licenses                                                         --                     245,000
   Patents                                                        31,162                   357,918
                                                         --------------------------------------------
                                                                  31,162                   602,918
Less accumulated amortization                                       --                    (297,836)
                                                         --------------------------------------------
                                                                  31,162                   305,082
Other assets                                                      20,417                     1,919
                                                         --------------------------------------------
Total assets                                              $      837,500            $    2,311,592
                                                         ============================================
<CAPTION>

                                                                            SEPTEMBER 30
                                                                     2001                  2000
                                                          --------------------------------------------

<S>                                                       <C>                      <C>
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
   Accounts Payable                                       $      725,552            $      263,303
   Accrued payroll                                                  --                      97,261
   Unearned revenue                                               50,000                      --
   Current portion of notes payable                               97,130                    42,000
   Other liabilities                                              21,851                    31,789
                                                         --------------------------------------------
Total current liabilities                                        894,533                   434,353

Notes payable                                                    354,286                   360,180
Other                                                               --                     117,261
                                                         --------------------------------------------
Total liabilities                                              1,248,819                   911,794

Commitments and contingency

Redeemable convertible preferred stock, $.001 par value--
   40,000,000 shares authorized; 4,444,444 shares issued
   and outstanding                                             2,305,748                 2,033,787

Shareholders' deficit:
   Common stock, $.001 par value--100,000,000 shares
     authorized; 44,022,778 and 32,304,778 shares
     issued and outstanding at September 30, 2001 and
     September 30, 2000, respectively                             44,023                    32,305
   Warrants                                                    4,362,301                 1,287,004
   Deferred Compensation                                        (332,344)                 (343,999)
   Subscription receivable                                      (291,150)                 (188,511)
   Additional paid-in capital                                 20,315,014                14,619,089
   Deficit accumulated during the development stage          (26,814,911)              (16,039,877)
                                                         --------------------------------------------
Total shareholders' deficit                                   (2,717,067)                 (633,989)
                                                         --------------------------------------------
Total liabilities and shareholders' deficit               $      837,500            $    2,311,592
                                                         ============================================
See accompanying notes
</TABLE>
                                       F-2

--------------------------------------------------------------------------------
                                                                         Page 32
<PAGE>


                                  Demegen, Inc.
                          (A Development Stage Company)

                            Statements of Operations

<TABLE>
<CAPTION>


                                                                                                          PERIOD FROM
                                                                                                       DECEMBER 6, 1991
                                                                                                        (INCEPTION) TO
                                                              YEAR ENDED SEPTEMBER 30                    SEPTEMBER 30,
                                                    2001               2000                1999               2001
                                           ----------------------------------------------------------------------------

<S>                                          <C>                 <C>                 <C>                 <C>
Income:
   License                                   $    190,000        $    220,000        $    350,000        $  1,766,651
   Grant and other                                860,033             472,432             708,475           3,687,341
   Interest                                        60,971              71,333              60,101             237,274
                                           ----------------------------------------------------------------------------
Total income                                    1,111,004             763,765           1,118,576           5,691,266

Expenses:
   Research and development                     2,551,968           1,560,981           1,513,680           9,605,834
   General and administrative                   1,211,160             709,533             784,891          11,593,312
   Interest                                        20,034              14,207               3,140           1,016,965
   License amortization and purchased
      research & development related
      to the Periodontix acquisition            7,667,739                --                  --             7,667,739
   Depreciation and amortization                  163,178             134,526             154,607             741.240
                                           ----------------------------------------------------------------------------
Total expenses                                 11,614,079           2,419,247           2,456,318          30,625,090
                                           ----------------------------------------------------------------------------
Net loss                                      (10,503,075)         (1,655,482)         (1,337,742)        (24,933,824)

Preferred dividend and accretion
    amounts                                      (271,959)           (264,933)           (258,362)         (1,881,087)
                                           ----------------------------------------------------------------------------

Net loss applicable to common stock          $(10,775,034)       $ (1,920,415)       $ (1,596,104)       $(26,814,911)
                                           ============================================================================

Net loss per common share, basic and
   diluted                                   $     ($0.29)       $      (0.06)       $      (0.06)
                                           ============================================================================
Weighted average common stock
   outstanding                                 37,163,279          29,759,153          26,255,104
                                           ============================================================================
</TABLE>



See accompanying notes.


                                      F-3



--------------------------------------------------------------------------------
                                                                         Page 33
<PAGE>
                                  Demegen, Inc.
                          (A Development Stage Company)

                       Statements of Shareholders' Deficit
<TABLE>
<CAPTION>



                                                                                      COMMON  STOCK
                                                                    AVERAGE   -------------------------
                                                                     PRICE                                               DEFERRED
                                                                   PER SHARE     SHARES       AMOUNT        WARRANTS   COMPENSATION
                                                                  ----------  -----------   -----------   -----------  ------------

<S>                                                                  <C>     <C>           <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                                                             --            --         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                    $.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       497,000           --


   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       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                                     $0.50     5,566,004         5,566       779,241           --
   Issuance of shares and options for services/compensation          $0.88       376,875           377        10,763       (387,000)
   Amortization of stock based compensation                                         --            --            --           43,001
   Net loss for the year                                                            --            --            --             --
                                                                             -----------   -----------   -----------    -----------
Balance at September 30, 2000                                                 32,304,778        32,305     1,287,004       (343,999)


   Proceeds from exercise of Stock options                            $.05       125,000           125          --             --
   Dividends on redeemable convertible preferred stock                              --            --            --             --
   Accretion of redeemable convertible preferred stock                              --            --            --             --
   Issuance of a warrant for services                                               --            --          56,000           --
   Proceeds from sale of common stock and warrants, net of
      Issuance costs of $85,968                                      $0.50     2,543,000         2,543       890,050           --
   Issuance of shares and options for services/compensation          $0.38        50,000            50          --          (74,349)
   Amortization of stock based compensation                                         --            --            --           86,004
   License Agreement and Acquisition of Periodontix                  $0.55     9,000,000         9,000     2,129,247           --
   Net loss for the year                                                            --            --            --             --
                                                                             -----------   -----------   -----------    -----------
Balance at September 30, 2001                                                 44,022,778       $44,023    $4,362,301      $(332,344)
                                                                             ===========   ===========   ===========    ===========
</TABLE>

See accompanying notes                                   F-4

--------------------------------------------------------------------------------
                                                                         Page 34
<PAGE>
<TABLE>
<CAPTION>



                                                                                                           DEFICIT
                                                                                                         ACCUMULATED
                                                                         ADDITIONAL     RECEIVABLE        DURING THE
                                                                          PAID-IN           FROM         DEVELOPMENT
                                                                          CAPITAL       SHAREHOLDERS        STAGE           TOTAL
                                                                       ------------------------------------------------------------

<S>                                                                       <C>         <C>             <C>                 <C>
   Acquired in merger with Excelsior Capital Corporation                  $312,681    $       --      $       --          $323,425
   Loss from inception (December 6, 1991) to September 30, 1992               --              --          (244,100)       (244,100)
   Capital contributed by a shareholder                                    123,700            --              --           123,700
   Proceeds from the sale of unrestricted shares contributed by
     shareholders in exchange for restricted shares                        272,461            --              --           272,900
   Payment of debt with stock warrants                                      33,333            --              --            33,333
   Payment of interest with stock warrants                                  17,774            --              --            17,774
   Issuance of receivable from officer                                        --           (65,117)           --           (65,117)
   Net loss for the year                                                      --              --        (1,044,154)     (1,044,154)
                                                                       ------------------------------------------------------------
   Balance at September 30, 1993                                           759,949         (65,117)     (1,288,254)       (582,239)
   Proceeds from the sale of unrestricted shares by shareholders
     in exchange for restricted shares                                     517,708            --              --           518,400
   Issuance of stock for consulting services                                89,942            --              --            90,000
   Issuance of stock subscriptions for loan origination fee                149,869            --              --           150,000
   Payment of interest with stock warrants                                  56,164            --              --            56,164
   Net loss for the year                                                      --              --        (1,768,428)     (1,768,428)
                                                                       ------------------------------------------------------------
   Balance at September 30, 1994                                         1,573,632         (65,117)     (3,056,682)     (1,536,103)
   Proceeds from the sale of restricted common shares                      204,807            --              --           205,000
   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            --           414,421
   Issuance of restricted shares for payment of services/compensation      357,681            --              --           358,083
   Issuance of warrants                                                     11,625            --              --            11,625
   Payment of interest with stock warrants                                 127,500            --              --           127,500
   Net loss for the year                                                      --              --        (2,873,839)     (2,873,839)
                                                                       ------------------------------------------------------------
Balance September 30, 1995                                               2,624,377            --        (5,930,521)     (3,293,313)
   Proceeds from the sale of common shares                                 479,817            --              --           480,500
   Issuance of shares for payment of services/compensation                 536,359            --              --           537,250
   Issuance of shares in settlement of outstanding debt
     and other obligations                                               2,113,054            --              --         2,117,522
   Payment of interest with warrants                                        84,996            --              --            84,996
   Net loss for the year                                                      --              --        (2,569,478)     (2,569,478)
                                                                       ------------------------------------------------------------
Balance at September 30, 1996                                            5,838,603            --        (8,499,999)     (2,642,523)
   Proceeds from the sale of restricted and unrestricted common shares     104,660            --              --           105,000
   Issuance of shares for payment of services/compensation                 477,629            --              --           478,807
   Issuance of shares in exchange for patent and technology license        244,300            --              --           245,000
   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            --              --           150,000
   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            --              --         1,449,273
   Net loss for the year                                                      --              --          (943,773)       (943,773)
                                                                       ------------------------------------------------------------
Balance at September 30, 1997                                            8,263,707            --        (9,443,772)     (1,158,216)
   Proceeds from exercise of stock options                                  85,750            --              --            87,500
   Compensation expense from stock option activity                       1,699,440            --              --         1,699,440
   Issuance of warrants                                                       --              --              --           497,000
   Allocation of conversion feature of redeemable
     convertible preferred stock                                         1,022,222            --              --         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                           9,360            --              --             9,380
   Settlement of employee litigation                                       710,217            --              --           712,192
   Issuance of shares for services                                          87,750            --              --            87,938
   Issuance of additional shares to venture capital funds and
     individual investors                                                      (85)           --              --              --
   Net loss for the year                                                      --              --        (1,993,753)     (1,993,753)
                                                                       ------------------------------------------------------------
Balance at September 30, 1998                                           11,878,361            --       (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                                  17,150            --              --            17,500
   Issuance of shares for services                                          66,655            --              --            66,800
   Extension of expiration date of stock option                             78,000            --              --            78,000
   Net loss for the year                                                      --              --        (1,337,742)     (1,337,742)
                                                                       ------------------------------------------------------------
Balance at September 30, 1999                                           12,040,166            --       (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                       1,871,412        (282,002)           --         2,374,217
   Issuance of shares and options for services/compensation                707,511          93,491            --           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                                           14,619,089        (188,511)    (16,039,877)       (633,989)

   Proceeds from exercise of Stock options                                   6,125            --              --             6,250
   Dividends on redeemable convertible preferred stock                        --              --          (160,000)       (160,000)
   Accretion of redeemable convertible preferred stock                        --              --          (111,959)       (111,959)
   Issuance of a warrant for services                                         --              --              --            56,000
   Proceeds from sale of common stock and warrants, net of
      Issuance costs of $85,968                                            472,425        (360,486)           --         1,004,532
   Issuance of shares and options for services/compensation                249,875         257,847            --           433,423
   Amortization of stock based compensation                                   --              --              --            86,004
   License Agreement and Acquisition of Periodontix                      4,967,500            --              --         7,105,747
   Net loss for the year                                                      --              --       (10,503,075)    (10,503,075)
                                                                       ------------------------------------------------------------
Balance at September 30, 2001                                          $20,315,014       ($291,150)   $(26,814,911)    $(2,717,067)
                                                                       ============================================================
</TABLE>



                                       F-5


--------------------------------------------------------------------------------
                                                                         Page 35
<PAGE>


                                  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
                                                                     2001             2000             1999             2001
                                                               ------------------------------------------------------------------
<S>                                                             <C>               <C>              <C>             <C>
CASH FLOW FROM OPERATING ACTIVITIES
Net income (loss)                                               $(10,503,075)     $(1,655,482)     $(1,337,742)    $(24,933,824)
Adjustments to reconcile net loss to net cash
 used in operating activities:
Depreciation and amortization                                        163,178          134,526          154,607          741,240
License amortization and purchased research &
 development related to the Periodontix acquisition                7,667,739             --               --          7,667,739
Stock issued for services                                            388,390          161,142             --          2,278,590
Stock based compensation                                              86,004           43,001             --            129,005
Issuance of stock options to employees and
   directors                                                          45,033          264,000           78,000        2,086,473
Warrants issued for interest                                            --               --               --            286,434
Notes payable issued for services                                       --               --               --             58,194
Other                                                                (31,379)           2,134             --             (4,897)

Changes in operating assets and liabilities:

Accounts receivable                                                  (23,901)             137           37,383          (46,310)
Prepaid expenses and other current assets                             (6,500)           2,057            9,802           (6,500)
Unearned revenue                                                      50,000          (91,667)         (91,666)          50,000
Accounts payable and other liabilities                               219,162           (3,607)         217,335        1,641,600
                                                               ------------------------------------------------------------------
Net cash used in operating activities                             (1,945,349)      (1,143,759)        (932,281)     (10,052,256)

CASH FLOW FROM INVESTING ACTIVITIES
Purchase of property and equipment                                   (27,613)         (12,765)        (210,157)        (423,753)
Cash received on equipment disposals                                    --               --               --              9,643
License with & acquisition of Periodontix                           (230,000)            --               --           (230,000)
Intangible assets                                                    (48,912)        (111,401)         (64,463)        (408,280)
                                                               ------------------------------------------------------------------
Net cash used in investing activities                               (306,525)        (124,166)        (274,620)      (1,052,390)

CASH FLOW FROM FINANCING ACTIVITIES
Net proceeds from issuance of equity
   Instruments, net of transaction costs                           1,017,415        2,374,217             --          7,701,132
Proceeds from exercise of stock options                                6,250             --             17,500          111,250
Proceeds from notes payable & capital leases                          18,673          150,000           21,109        1,317,282
(Decrease) increase in payable to employees
   and directors                                                        --             14,550           72,614        2,687,962
Payments on notes payable                                            (78,338)         (29,075)          (7,395)        (175,502)
                                                               ------------------------------------------------------------------
Net cash provided by financing activities                            964,000        2,509,692          103,828       11,642,124
                                                               ------------------------------------------------------------------

Net increase (decrease) in cash and cash
   equivalents                                                    (1,287,874)       1,241,767       (1,103,073)         537,478
Cash and cash equivalents at beginning of
   period                                                          1,825,352          583,585        1,686,658             --
                                                               ------------------------------------------------------------------
Cash and cash equivalents at end of period                      $    537,478      $ 1,825,352      $   583,585     $    537,478
                                                               ==================================================================

SUPPLEMENTAL DISCLOSURES OF CASH FLOW
   INFORMATION
Cash paid for interest                                          $     20,034      $     8,582      $     3,140     $     50,258
                                                               ==================================================================

NONCASH ACTIVITIES
Common stock issued in satisfaction of related
   party payable                                                $       --        $      --        $    66,800     $    778,992
                                                               ==================================================================
Dividends on redeemable convertible preferred
   stock                                                            $160,000      $   160,000      $   160,000     $    520,000
                                                               ==================================================================
Accretion of redeemable convertible preferred
   stock                                                            $111,959      $   104,947      $    98,362     $  1,361,101
                                                               ==================================================================
Receivable due from stockholders                                    $181,000      $   282,002      $      --       $    463,002
                                                               ==================================================================
Common stock issued for issuance costs                          $       --        $   100,000      $      --       $    100,000
                                                               ==================================================================
Common stock and warrants issued as part
of the Periodontix transaction                                  $  7,145,747      $      --        $      --       $  7,145,747
                                                               ==================================================================
See accompanying notes.
</TABLE>
                                      F-6




--------------------------------------------------------------------------------
                                                                         Page 36
<PAGE>

                                  Demegen, Inc.
                          (A Development Stage Company)

                          Notes to Financial Statements

                               September 30, 2001


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 is considered a development stage company for financial statement
disclosure purposes because the Company is devoting substantially all of its
efforts to establishing new products.

The Company is a biopharmaceutical company, with has compounds in clinical
trials, which discovers, designs and develops natural and novel peptides for the
treatment of infectious diseases and cancer. The primary drugs under development
target significant markets for which there are few, if any, satisfactory
alternatives. These include treatment for oral candidiasis, a disease prevalent
in HIV patients, a treatment for Pseudomonas in CF Patients, a disease that can
be fatal to children, and a treatment for glioblastoma, a form of head and neck
cancer that has a very low survival rate. During Fiscal 2001 the Company
acquired substantially all the assets of Periodontix, Inc., another peptide
therapeutic company. For accounting purposes the acquisition was accounted under
the "purchase method" of accounting.

The Company is subject to the risks associated with emerging technology-oriented
companies. Primary among these risks are the ability to obtain sufficient
financing, competition from substitute products and the ability to successfully
develop and market its products. As of September 30, 2001, the Company has an
accumulated deficit of $26,815,000. In addition, the Company has a working
capital deficiency of $304,000 as of September 30, 2001 and has used $1,945,000
of cash for operations during fiscal 2001.

For the year ended September 30, 2001, the Company incurred a loss of
$10,503,000.

The Company historically has obtained its working capital through equity
issuances to shareholders, royalty payments and from certain borrowing
arrangements. Management has plans in Fiscal 2002 to issue additional equity to
shareholders and to obtain additional funding support from grants and product
development partners. Should these plans not be successful, there is uncertainty
as to the Company's ability to continue as a going concern through the year
ending September 30, 2002.



                                      F-7


--------------------------------------------------------------------------------
                                                                         Page 37
<PAGE>

                                  Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)


1. HISTORY AND NATURE OF BUSINESS (CONTINUED)


The financial statements do not include any adjustments relating to the
recoverability and classification of assets or the amount and classification of
liabilities that might be necessary should the Company be unable to continue as
a going concern. The Company's continued existence is dependent upon its ability
to generate sufficient cash flows from equity financing and successfully
concluding additional license agreements.


2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

USE OF ESTIMATES

The preparation of financial statements in conformity with accounting principles
generally accepted in the United States 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.

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 $71,178,
$64,134 and $56,948, during 2001, 2000 and 1999, respectively.

INTANGIBLE ASSETS

In fiscal 2000 Intangible assets include patent costs and purchased license
agreements and were stated at cost, net of accumulated amortization. With the
unanticipated termination of the Dow AgroSciences agreement all Intangible
assets that were originally being recovered through the cash flow associated
with the agreement were adjusted to net realizable value with a $177,785 charge
against income for the year ended September 30, 2001. Prior to the impairment
charge amortization was calculated using the straight-line method over estimated
useful lives ranging from 3 to 17 years.

GRANT AND OTHER INCOME

Grant income is not recognized until received as the grants did not include any
penalties, successful outcomes clauses or refunding provisions.

During fiscal years 2001 and 1999, the Company received grant proceeds of
$400,000 and $375,000, respectively to expand efforts to develop therapeutics to
treat cancer. The funds were recognized as revenue upon receipt as the contracts
do not contain any penalties, successful outcomes clauses or refunding
provisions. License revenue is recognized as revenue upon receipt, except for
those that contain




                                       F-8


--------------------------------------------------------------------------------
                                                                         Page 38



<PAGE>

                                  Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

contractual provisions that require the Company to provide services or the
attainment of certain goals, in those cases, the revenues is deferred as
unearned revenue until these penalties, clauses or provisions expire.

The Company received $27,882 and $91,808 in fiscal 2000 and 1999, 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.

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. NEW ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No.
141, "Business Combinations," which eliminated the pooling of interest method of
accounting for all business combinations initialed after June 30, 2001 and
addresses the initial recognition and measurement of goodwill and other
intangible assets acquired in a business combination. The Company adopted this
accounting standard for business combinations initiated after June 30, 2001.

The Company adopted SFAS 142, "Goodwill and Other Intangible Assets," effective
July 1, 2001 and the Periodontix transaction was accounted for under SFAS 141
and 142. SFAS 142 addresses the financial and accounting and reporting standards
for the acquisition of intangible assets outside of a business combination and
for goodwill and other intangible assets subsequent to their acquisition. This
accounting standard requires that goodwill be separately disclosed from other
intangible assets in the statement of financial position, and no longer be
amortized but tested for impairment on a periodic basis. The provisions of this
accounting standard also require the completion of a transitional impairment
test within six months of adoption, with any impairments identified treated as a
cumulative effect of a change in accounting principle.

4. INCOME TAXES

The Company accounts for income taxes using the liability method.

Significant components of the Company's deferred tax asset at September 30, 2001
and 2000, are as follows:




                                       F-9




--------------------------------------------------------------------------------
                                                                         Page 39
<PAGE>

                                  Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)

4. INCOME TAXES (CONTINUED)

                                            2001                2000
                                         -----------        -----------

*  Compensation expense on unexercised
     stock options                       $   567,980        $   498,030
*  NOL carryforwards                       5,370,798          4,268,605
*  Excess book amortization                2,802,828             71,894
*  Other                                       7,813             (7,387)
                                         -----------        -----------
        Total deferred tax asset           8,749,420          4,831,142

   Valuation allowance                    (8,749,420)        (4,831,142)
                                         -----------        -----------
   Net deferred tax assets               $         0        $         0
                                         ===========        ===========


Net operating losses totaling approximately $14,100,000 are currently available
and begin to expire in 2007.

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.

5. PRIVATE PLACEMENT OF SECURITIES

During the third quarter of Fiscal 2001, the Company made a private placement of
its securities to institutional and other accredited investors raising $1.28
million of which $0.181 million was in the form of future services recognized in
equity as subscription receivable, as services are prepaid, with the remainder
of $1.09 million in cash. The private placement resulted in the sale of 2.543
million restricted shares of Common Stock and warrants to purchase an additional
2.543 million shares of the Company's Common Stock.

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
May 31, 2006 or 60 days after a call by the Company. The Company may call the
warrants at any time, provided that the price of the Company's common stock has
been in excess of $1.50 per share for each of the twenty 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.

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 working capital and product
development efforts.

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 future services,
which are presented in equity as "Subscription Receivable" as services are
prepaid and are recognized 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-10

--------------------------------------------------------------------------------
                                                                         Page 40
<PAGE>


                                  Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)

5. PRIVATE PLACEMENT (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.

6. 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 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.

                                      F-11


--------------------------------------------------------------------------------
                                                                         Page 41
<PAGE>


                                  Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)


6. REDEEMABLE CONVERTIBLE PREFERRED STOCK (CONTINUED)


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.


7. STOCK OPTIONS AND WARRANTS

The Company granted stock options to certain employees and directors during the
years ended September 30, 2001 and 2000 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 12
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.

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, 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
                                                     ========================================================

Granted                                                   992,500                $0.75               $0.83
Options exercised for common stock                       (125,000)               $0.05               $0.75
                                                     --------------------------------------------------------
Balance at September 30, 2001                           8,267,500                $0.36               $0.59
                                                     ========================================================
</TABLE>

                                      F-12




--------------------------------------------------------------------------------
                                                                         Page 42
<PAGE>

                                  Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)


7. STOCK OPTIONS AND WARRANTS (CONTINUED)

As of September 30, 2001 and 2000, 5,996,687 and 5,503,333, 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
2001, 2000 and 1999: risk-free interest rate of 6%; dividend yield of 0%;
volatility factors of the expected market price of the Company's common stock of
1.43, 1.49 and 1.41 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 2001, 2000 and 1999 consistent
with the provisions of SFAS No. 123, the Company's net loss would have been
increased to the pro forma amounts indicated below:
<TABLE>
<CAPTION>


                                                                YEAR ENDED SEPTEMBER 30
                                                     2001               2000           1999
                                                 --------------------------------------------------

<S>                                              <C>               <C>              <C>
Net loss available to common stock:
   As reported                                   $(10,775,034)     $(1,920,415)     $(1,596,104)
   Pro forma                                     $(11,340,598)     $(2,058,313)     $(1,746,117)

Basic and diluted earnings per share:
   As reported                                         $(0.29)          $(0.06)          $(0.06)
   Pro forma                                           $(0.31)          $(0.07)          $(0.07)
</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, 2001, there were outstanding warrants to purchase 8,185,879
shares of the Company's common stock at an exercise price of $0.75 per warrant
(refer to Note 5 for additional information). Those warrants which were sold
with the common shares in the private placements in fiscal 2001 and 2000 and
were valued at $890,050 ($0.35 per warrant) and $790,004 ($0.14 per warrant),
respectively. Additionally, the holder of the preferred stock holds a warrant to
purchase common stock (refer to Note 5 for additional information), Periodontix
holds a warrant to purchase common stock at $1.25 per share. (refer to Note 13
for additional information) and an unrelated party holds a warrant to purchase
200,000 shares of the Company's common stock at an exercise price of $1.00 per
warrant.

                                      F-13




--------------------------------------------------------------------------------
                                                                         Page 43
<PAGE>

                                  Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)

8. 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 $216,820 as of September 30, 2001 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.

9. COMMITMENTS

The Company leases its office and laboratory facilities in Pittsburgh under a
six month lease expiring March 31, 2002 at a monthly rental of $3,948.
Additionally, the Company leases its office and laboratory facilities in
Watertown site under a lease expiring June 2003 at a gross monthly rental of
$11,093.

During 2001, 2000 and 1999, the Company incurred rent expense totaling $153,124,
$56,830 and $45,830, 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 $25,000 in royalty
payments pursuant to this agreement in 2001.

10. 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 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 Dow AgroSciences Agreement was amended on October 11, 1998 to provide Dow
AgroSciences 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 research funding payment of $150,000 and an additional $150,000 which
was due six months after the contract execution. The research funding was 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.


                                      F-14



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                                                                         Page 44
<PAGE>

                                    Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)

10. MARKETING (CONTINUED)

On October 31, 2001 Dow AgroSciences notified the Company that it was exercising
its right to terminate the agreement. The termination of the agreement resulted
in certain impairment charges as discussed in Note 2.


11. 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
                                                              2001             2000            1999
                                                     ---------------------------------------------------

<S>                                                     <C>                <C>              <C>
Numerator:
   Net loss                                             $(10,503,075)      $(1,655,482)     $(1,337,742)
   Preferred stock dividends and accretion
     amounts                                                (271,959)         (264,933)        (258,362)
                                                     ---------------------------------------------------
   Numerator for basic loss per
     share--income available to common
     stockholders                                        (10,775,034)       (1,920,415)      (1,596,104)

Denominator:
   Denominator for basic and loss per
     share--weighted average shares                       37,163,279        29,759,153       26,255,104
                                                     ---------------------------------------------------
Basic and diluted loss per share                              $(0.29)           $(0.06)          $(0.06)
                                                     ===================================================
</TABLE>


At September 30, 2001, the Company had 5,996,667 vested options (8,267,500
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 2001 and 2000 Private Placements received
aggregate warrants for 8,185,879 shares of the Company's common Stock at an
exercise price of $0.75 per share. Periodontix received warrants for 9,000,000
shares of the Company's common Stock at an exercise price of $1.25 per share and
an unrelated third party holds a warrant for 200,000 shares of the Company's
common Stock at an exercise price of $1.00 per share These potentially dilutive
securities were not included in the calculation of dilutive earnings per share
because the effect would be anti-dilutive.

12. 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





                                            F-15




--------------------------------------------------------------------------------
                                                                         Page 45
<PAGE>

                                    Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)


12. EMPLOYMENT AGREEMENT(CONTINUED)


($387,000) is being amortized against income over the terms of the various
option agreements. At September 30, 2001, the balance in the Deferred
Compensation account was $257,995 with $86,004 and $43,001 charged against
operations in the years ending September 30, 2001 and 2000, respectively.


13. ACQUISITION

Effective January 1, 2001 the Company entered into a definitive license
agreement with an option to purchase with Periodontix, Inc for all of their
technologies and rights in related clinical trials, except for Periodontix'
photodynamic technology. In evaluating Periodontix a number of attractive
attributes were identified that were not generally visible. Because of its name,
Periodontix appeared to be focused just on dental applications - gingivitis and
periodontitis.

The transaction was structured under a short-term license agreement to permit
the Company a period of time to evaluate Periodontix's technology and obtain the
necessary funds to support the additional research, prior to exercising the
purchase option. The terms of the agreement were as follows:

-        On December 15, 2000, the Company made a $50,000 good faith
         non-refundable payment to Periodontix.

-        During February 2001, the Company issued Periodontix 2.3 million
         restricted shares of the Company's Common Stock and warrants to
         purchase up to 2.3 million Common Shares of the Company's Common Stock
         at an exercise price of $1.25 per share. The Warrants have a five-year
         term and are callable by the Company if the price of the Company's
         Common Stock trades above $2.50 per share for twenty consecutive
         trading days.

-        On April 2, 2001, Periodontix received the second issuance under the
         license agreement of 2 million restricted shares of the Company's
         Common Stock and warrants to purchase up to 2 million Common Shares of
         the Company's Common Stock at an exercise price of $1.25 per share. The
         Warrants have a five year term and are callable by the Company if the
         price of the Company's Common Stock trades above $2.50 per share for
         twenty consecutive trading days.

-        On July 16, 2001, under the license agreement, the Company exercised
         its option to purchase the aforementioned technologies, free and clear
         of all liens and to terminate the license by the issuance of 4.7
         million restricted shares of the Company's Common Stock and warrants to
         purchase up to 4.7 million Common Shares of the Company's Common Stock
         at an exercise price of $1.25 per share. The Warrants have a five year
         term and are callable by the Company if the price of the Company's
         Common Stock trades above $2.50 per share for twenty consecutive
         trading days.

-        On January 1, 2001 the Company hired selected Periodontix employees to
         facilitate the clinical trials and other tasks related to the license
         period.

-        Beginning January 1, 2001 the Company agreed to pay Periodontix for
         rent and utilities at their office and other operating costs.

-        As part of the license fee, the Company paid $175,000 to Periodontix on
         April 2, 2001 and is obligated to make a second $175,000 payment to
         Periodontix on December 1, 2001.



                                      F-16

--------------------------------------------------------------------------------
                                                                         Page 46
<PAGE>

                                    Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)

13. ACQUISITION (CONTINUED)

The initial (February 2001) license payment of restricted common stock and
warrants issued to Periodontix was valued at $2.7 million and along with the
$0.05 million deposit made in December 2000 were classified as Deferred
Licensing Fees and were amortized over the seven month term of the license.

The second (April 2001) license payment of restricted common stock and warrants
issued to Periodontix was valued at $1.78 million and along with the two $0.175
million payments that the Company is obligated to make were classified as
Deferred Licensing Fees and were amortized over the remaining four month term of
the license.

The final (July 2001) license payment of restricted common stock and warrants
issued to Periodontix was valued at $2.66 million. Additionally, $0.09 million
of capital leases were assumed.

For accounting purposes the acquisition was accounted under the "purchase
method" of accounting. The purchase price was allocated as follows, based upon
an independent valuation:

Fixed Assets                                $   82,386
In-Process Research and Development          2,641,953
Patents                                         31,162

The In-Process research and development was written-off in the year ended
September 30, 2001 as technological feasibility of the in-process technologies
so acquired had not been achieved and no alternative future use had been
established.

The following unaudited pro forma condensed operating statements for the years
ended September 30, 2001 and 2000 assume that the acquisitions were consummated
on October 1, 2000 and 1999, respectively. There results are not necessarily
indicative of those results that would have occurred had the acquisition
actually been made on October 1, 2000 or of the future operations of the
combined companies.
<TABLE>
<CAPTION>

                                                      Years ended September 30,
                                                 2001                           2000
                                             -----------                   -----------

<S>                                            <C>                             <C>
Income                                         $1,156,004                      $948,765
Expenses                                       12,163,578                    12,944,915
                                             ------------                  ------------
Net Loss                                      (11,007,574)                  (11,996,150)

Preferred Dividend & Accretion Amount            (271,959)                     (264,933)
                                             ------------                  ------------
Net loss applicable to common shares         $(11,279,533)                 $(12,261,083)
                                             ============                  ============

Net loss per common shares                         $(0.27)                       $(0.32)
                                             ============                  ============
Weighted average shares outstanding            42,454,245                    38,759,153
                                             ============                  ============
</TABLE>

The pro forma results for the year ended September 30, 2001 and 2000 included
$4,848,000 of amortization of the license with Periodontix and $2,642,000 for
the write-off of acquired in process research and development.


                                      F-17



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