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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, 1999

                         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        No   X
    -----     -----

The aggregate market value of the voting stock held by non-affiliates of the
registrant was $6,854,094 as of December 6, 1999, computed on the basis of the
average of the bid and asked prices on such date.

As of December 6, 1999 there were 26,361,899 shares of the registrant's Common
Stock outstanding.

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

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 2000 Annual Meeting of Stockholders
are incorporated by reference into Part III.


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                                     PART I

ITEM 1 - BUSINESS

THE COMPANY

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

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

The Company is a life science company located in Pittsburgh, Pennsylvania. The
Company is developing two types of proprietary products. These products include
peptide (small protein) therapeutics for pharmaceutical applications and
plant genes for agricultural applications.

The Company's business strategy is to focus its resources on the design and
development of its core technology, while licensing to larger partners its many
potential applications for commercialization. The Company has a platform
technology which can be commercialized by using specific compounds as the active
ingredient for many different potential products. The compounds have
demonstrated activity against many different types of infectious diseases and
cancer. The Company is targeting specific peptides or plant genes, disease
targets and commercial partners with whom products will be fully developed and
commercialized.

The Company has discovered key structural design parameters to construct
proprietary synthetic compounds with potent anti-cancer and anti-bacterial
performance characteristics. In the peptide form, the Company's compounds are
stable and soluble and have demonstrated efficacy in treating certain diseases
in animals. The anti-cancer and anti-bacterial performance represent significant
market opportunities - both in terms of the size of the market and also because
there are no cures or effective treatments for the important diseases being
targeted. In the plant gene form, the Company's compounds have been transformed
successfully in crops. In vivo disease resistant results have been obtained in
both potatoes and tobacco, both important demonstration crops. Significant
nutrition enhancement in sweet potatoes has also been obtained including both
qualitative and quantitative increases in overall plant protein content.

The Company has assembled an experienced team that will further develop, enhance
and protect its core technology, as well as aggressively develop product
applications from the technology. In general, the Company's primary sources of
revenue will be license fees, milestone payments, royalties, research grants and
revenues from supplying materials to licensees. The Company's November 1997
license agreement with Mycogen Corporation, a large agricultural biotechnology
company owned by Dow AgroSciences LLC, a wholly owned entity of The Dow Chemical


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Company, was the Company's first major success at licensing technology which the
Company has developed.

The Company received an initial payment for licensing its disease resistant
agricultural technology. Additionally, the Company will receive future milestone
payments, as Dow Agro Sciences commercializes the agricultural technology, and
royalties for licensing its disease resistant agricultural technology. The Dow
Agro Sciences Agreement includes the exclusive license of certain technologies
for genetic disease prevention and spray-on treatment. The Dow Agro Sciences
partnership is poised to become a major revenue stream for the Company as Dow
Agro Sciences pursues the commercial application of the process. In November
1998, the Company expanded the agreement with Dow Agro Sciences to include its
agricultural nutrition technology. The Company could receive up to $20 million,
exclusive of royalties, over the next four to six years in the form of license
fees, research support and milestone payments as Dow Agro Sciences
commercializes these agricultural technologies. The Dow Agro Sciences milestone
payments under the initial agreement (disease resistance) are expected to begin
upon regulatory approval or first sale. Additional milestone payments will be
received for the first commercial sale of certain crops and for the first
commercial sale of other crops not specified in the agreement. The term of the
initial agreement is the later of the expiration of the last patent or the
cessation of sales of products covered by the license.

The Dow Agro Sciences milestone payments under the addendum (nutrition
enhancement) are expected to begin in 2000 for the achievement of certain
technical feasibility benchmarks. Additional milestone payments are expected to
be received in 2000 - 2008 for animal feeding benchmarks, the first commercial
sale of certain crops, for the first commercial sale of other crops not
specified in the agreement and the achievement of cumulative gross margin
benchmark sale of certain crops. The term of the addendum is the later of the
expiration of the last nutrition patent or the cessation of sales of products
covered by the license.

Dow Agro Sciences will be responsible for all development and commercialization
costs. By licensing agricultural applications, the Company will be able to focus
upon pharmaceutical applications and will have a revenue source to help fund the
pharmaceutical research and development.

In June 1998, the Company received a $2 million equity investment from the CEO
Venture Fund of Pittsburgh, PA. The financial commitment marked the largest
investment in the Company since the Company's inception. Since 1992, the Company
has raised in excess of $12 million of capital since inception.

OPERATIONS

The Company's primary focus is the development of human therapeutics. The
Company accomplishes this by developing and refining its core technology and
intellectual property, and secondly, by using its drug development team to bring
individual applications from the pre-clinical stage to human clinical studies.
The Company plans to out-license its pharmaceutical products, after completing
Phase I or Phase II human clinical trials for that application. The majority of
the Company's agricultural technologies are being developed and will be
commercialized by the Company's agricultural partner. In this role, Dow Agro
Sciences is spending significant funds to develop enhanced crops using the
Company's plant gene technology. Dow Agro Sciences is providing all of the
development, patent and regulatory costs and clearances for the individual
crops.

During the past few years, the Company has explored the breadth of its
technology in order to determine the best targets for initial commercialization.
In order to attain proof of concept for an application, the Company has
collaborated with many renowned scientists with U.S. medical centers and
research universities, as well as in the laboratories of the NIH and USDA. In
doing so, the Company was able to develop numerous pharmaceutical and
agricultural applications with limited personnel and without large
infrastructure resources.

Since the Company's inception, an estimated $5 million and the use of
sophisticated laboratories have been expended by universities, governmental
agencies and private foundations developing products using the Company's
technologies, while the Company maintains commercial rights and control.

The Company has not sought to build all of the pre-clinical facilities required
for drug development. However, the Company has established a core laboratory in
Pittsburgh to be able to perform microbiology, tissue screening, quality control
and chemistry necessary to develop the utility and potential of its compounds as
well as testing the design theories of


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Dr. Jesse M. Jaynes, inventor of the Company's core technologies. The Company
expects to continue to out-source toxicology and animal efficacy studies
required in development of therapeutic applications. This minimizes
infrastructure cost.


PHARMACEUTICAL APPLICATIONS

The Company has selected a lead compound, for development as a cancer
therapeutic. The majority of the Company's cancer results to date have been
directed towards prostate cancer. However, a number of evaluations by the
National Cancer Institute ("NCI") and private laboratories have indicated that
this compound may have broad applicability against many types of cancers. In
addition to its cancer program, the Company has pre-clinical research programs
to prevent and treat bacterial and viral infections.

The Company hopes to work with a strategic partner for late stage development
and commercialization of its cancer application. However, the Company will seek
to accomplish Phase I human clinical studies before licensing this application.
The Company's strategy is to advance the Company's applications as far as
possible so that they are much more valuable before licensing them to a large
commercial partner.

During the next twelve months, the Company expects to complete all of the
efficacy, toxicology, pharmcokinetic and chemistry and manufacturing tests
necessary for a new drug substance to get investigative new drug ("IND")
approval from the Federal Drug Agency ("FDA").

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

Currently, therapeutic options include surgery, radiation therapy, hormonal
therapy and chemotherapy. The approach to treatment is influenced by the stage
of the disease, age and coexisting medical conditions. Surgery (radical
prostatectomy) and radiation are options for early stage cancer that has not
spread outside the prostate. Hormone therapy and chemotherapy are considered for
metastatic or recurring disease. The median age at diagnosis is 72 years. A
significant number of patients, especially when diagnosed at a more advanced
stage, relapse and develop incurable disseminated metastatic disease. None of
the current treatments for advanced disease provide significant benefit to
survival. Effective treatment modalities for patients with residual or
non-localized disease are clearly needed.

D2A21 has also demonstrated anti-tumor activity or solid tumors cell lines,
including lung, breast, ovarian, bladder, central nervous system and melanoma.
Additional studies in two laboratories indicate that prostate cancer cell lines
appear to be more susceptible to D2A21 than other solid tumor cell lines.
Therefore, the initial indication for this development plan is the treatment of
prostate cancer.


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Rats treated with D2A21 achieved a 60% reduction in the growth of primary tumors
and a significant reduction in the number of lung metastases. The survival
rate increased from 25% for controls to 75% for D2A21 treated animals.

D2A21 has been effective in reducing tumors when administered by the following
systemic routes, which include: sub-coetaneous, intra-parentinal ("IP") and
intravenous ("IV"). The Company is in the process of selecting the final dosage
schedule for D2A21 to complete the pre-clinical efficacy and toxicology tests.


HUMAN CLINICAL TRIALS

It is the Company's goal to begin Phase I human clinical trials within the next
twelve months. The major purpose of a Phase I study is to define a safe dose and
schedule of administration of D2A21. Generally, cancer patients eligible for
Phase I have confirmed malignancy for which no effective therapeutic options are
known. Although the emphasis of the study is safety rather than efficacy, it
would be of use to maximize the opportunity for recognizing therapeutic benefit.

The specific Phase I protocols are being developed with the Prostate and
Urologic Cancer Center at the University of Pittsburgh Cancer Institute. It is
anticipated that the University of Pittsburgh Cancer Institute will conduct the
Phase I clinical trials.

Phase II studies will be designed to assess the anti-tumor efficacy of D2A21.
Using the dose and schedule found to be safe in Phase I studies, D2A21 will be
given to groups of patients with prostate cancer. The selection of cancers to
study in Phase II is usually based upon preclinical efficacy studies and any
promising results in Phase I studies.

Once D2A21 has demonstrated adequate efficacy and safety in Phase II studies, it
will enter Phase III testing where it will be compared to generally accepted
therapies for efficacy and toxicity. Demegen anticipates licensing during or
after Phase II clinical trials.


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SUPPORT FOR THE DEMEGEN CANCER PROGRAM

The Company has received considerable outside support for its cancer program.
Researchers and clinicians at the University of Pittsburgh Cancer Institute,
Duke University Medical Center and the National Cancer Institute have given
time, research and counsel to help the Company develop this cancer therapeutic.

The Company has also received over $1.5 million in research grants from
non-profit cancer foundations and institutes from early 1993 to date. In
addition to direct financial support, numerous university and governmental labs
have conducted research with D2A21, at no charge to the Company, to confirm the
anti-tumor effectiveness of this compound in animal models.


ANTI-BACTERIAL APPLICATIONS

In addition to its cancer program, the Company is conducting pre-clinical
experiments to assess using D2A21 and its compound for anti-bacterial
therapeutics. These include an intravaginal gel that prevents the transmission
of Chlamydia, a sexually transmitted disease ("STD") which affects the
reproductive health of 4 to 8 million U.S. women each year. The Company's
efforts to develop this application have been extensively supported by
institutions, which include: the Sexually Transmitted Diseases Branch at the
National Institutes of Health ("NIH"), the Division of AIDS at the NIH. In
addition to the Company's $100,000 Small Business Innovation Research Program
("SBIR") grant from the NIH for STD prevention, the NIH has also been indirectly
funding the Company's related research at a number of universities. The Company
hopes to begin Phase I clinical trials of a typical gel to prevent Chlamydia
in 2000.

The Company is also pursuing the effectiveness of its compounds in treating
infected burns and burn wounds at the University of Southern Illinois. The
Company hopes to begin Phase I clinical trials of a polymer gel to prevent
infections of burn wounds also in 2000.

The Company is also conducting tests to determine the effectiveness of its
compounds in treating pulmonary multi-drug resistant bacterial infections,
in appropriate animal models. The Company has received an additional $100,000
SBIR grant from the NIH for its pulmonary infection pre-clinical program, which
is being researched at the University of North Carolina - Chapel Hill.

The Company has demonstrated antimicrobial activity against a broad spectrum of
bacterial pathogen. Its compounds have potent in vitro activity against
pathogens from species of: Staphylococcus, Pseudomonas, Enterococcus,
Streptococcus, E. coli, Gonococcus and Chlamydia. The Company's compounds have
shown in vitro efficacy against all of these dangerous pathogens, as well as
methicillin-resistant Staphylococcus aureus ("MRSA") and vancomycin-resistant
enterococcus ("VRE"). The Company has demonstrated that its Peptidyl mimes are
effective in increasing survival when injected sub-eschar into Pseudomonas
infected mouse model. In another animal model, the Company compound successfully
eliminated a protozoal infection (Chagas disease), when administered
intravenously in mice.

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


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organisms. The Company is optimistic that their compound's will be an effective
alternative to antibiotics in treating infection. If the compound is effective,
the evolution of antibiotic-resistant bacteria will also become a moot issue.


PHARMACEUTICAL DEVELOPMENT SCHEDULE


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


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AGRICULTURAL PLANT GENES


The Company's platform technologies can be applied to a variety of disease
problems not only for mammals but plants as well. The Company's agricultural
genes have been well received by the agribusiness community. So much so that
business opportunities developed rapidly and a substantial value has already
been achieved. The proceeds from the license of its agricultural application
help the Company fund pharmaceutical product development.

The application of biotechnology to agricultural crops is directed to the
creations of differentiated, value-added plants and products which improve
production, extend shelf life, prevent pathogenic disease, enhance nutritional
value and reduce the negative environmental impact of potentially hazardous
chemicals. Genetically engineering crops reduces the time to develop new crops
through accelerated cross breeding of crops. In addition to speed, genetic
engineering enables the designer to introduce characteristics, in particular
pest and disease resistance, which would most likely not be feasible with
traditional techniques.

Perhaps the most fundamental driving force for these new crops is the basic
recognition that the world's population is growing by over 50 million people per
year. At the same time, as economies improve in developing countries, the demand
for food increases faster than the population, or their 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 thirty years, just to maintain
the current levels of hunger and malnutrition.


DISEASE RESISTANT CROPS

In November 1997, the Company concluded a significant exclusive licensing
agreement with Mycogen Corporation to utilize the Company's antimicrobial plant
genes in developing disease resistant agricultural crops. Mycogen is a large
agricultural biotechnology company based in San Diego, California. In October
1998, The Dow Chemical Co. purchased the remaining share of Mycogen that it did
not already own. Dow Agro Sciences, LLC is a wholly owned subsidiary of The Dow
Chemical Company, a $20 billion conglomerate with significant business interests
in the agricultural business sector.

Under the agreement, Dow Agro Sciences is responsible for all subsequent
development and commercialization costs to fully develop, protect and
commercialize this unique technology. Dow Agro Sciences will also seek third
parties for commercialization in order to accelerate development and to expand
the number of different crops being commercialized.

In November 1998, the Company amended the aforementioned agreement with Dow Agro
Sciences adjusting the milestone and related payments and minimum royalties. The
modification provided an additional exclusive license for the Company's
agricultural nutrition technologies.

The Dow Agro Sciences Agreement conveys to Dow Agro Sciences all rights with
regard to the development and use of the technology for plant related
applications. Dow Agro Sciences has a period of time from the date of the
Agreement to pursue the commercialization of the technology covered by the
Agreement. After that time, the Company has the right to bring possible
interested parties to Dow Agro Sciences and certain rights may be returned.

Including disease resistance and nutrition, the revised agreement calls for over
$20 million in payments to the Company, as Dow Agro Sciences commercializes the
agricultural technology, exclusive of royalties, for license fees, research
support and milestone payments.

Minimum royalties begin in 2003 for the disease resistance agreement. Prior to
that, other milestone payments or license fees may be forthcoming depending upon
the development of those products. Relative to the nutrition addendum, minimum
royalties and research support funding are received annually. Milestone payments
and sub-license fees are expected to begin in fiscal 2000.

The structure of the Dow Agro Sciences partnership is such that Dow Agro
Sciences assumes nearly all responsibilities and costs for product development,
regulatory approval and marketing. The Company will need relatively few
resources to support this licensee of its technology.


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The Company's Chief Scientist, and two to four full time equivalent employees
will provide technical assistance and research support.

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

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

Most transgenic development for crop protection is targeted at replacing
insecticides or increasing herbicide resistance. The Company believes its
success and patent position in controlling bacterial and fungal diseases is
unique. Fungicide expenditures in the United States and the world are $550
million and $4.1 billion, respectively.







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NUTRITIONAL ENHANCED CROPS


In addition to disease resistance traits, the Company has invented "storage
protein" or nutrition genes, DNP, which contain all the essential amino acids
for healthy animal or human growth. The first field proof of this concept has
been obtained in sweet potatoes, in testing conducted under the direction of Dr.
C.S. Prakash, Professor and Director of the Center for Plant Biotechnology at
Tuskegee University. Sweet potatoes grown with the Company's nutrition genes
produce all of the essential amino acids required for daily consumption. The
overall protein levels in the sweet potatoes averaged over 16% compared to the
normal levels of less than 5%.

One of the crops which historically valued additional protein is wheat for food
uses. Standard wheat flour contains about 11% protein. Commercial users of flour
often add wheat gluten to achieve a higher protein content. Wheat with a higher
protein content, in the 14% to 17% range, can command premiums ranging from
$0.20 to $1.25 per bushel. Accordingly, a higher protein wheat offers a market
opportunity of several hundred million annually.

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

Plants are generally deficient in the essential amino acids that all animals
including humans need to grow and sustain health. Of the twenty essential amino
acids humans need, only about twelve are synthesized naturally, the other eight
must be ingested regularly to sustain health. Infants and young children are
particularly at risk. Millions of young people die or suffer permanent mental
and physical damage yearly as a result of insufficient essential amino acid
intake. In developed countries, such crops could have considerable appeal to
vegetarians.

The use of this technology would produce a new class of products worldwide, the
market for these kinds of products could be $1 billion per year within ten
years. This technology, is supported with a United States patent.



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GOVERNMENT REGULATION


Drug Approval Process

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

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

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


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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 or 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 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.

There has been an increased awareness in Europe and Asia as 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.


ENVIRONMENTAL REGULATIONS

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


                                       11

<PAGE>   13

COMPETITIVE CONDITIONS


There exists intense competition in the pharmaceutical and biotechnology
industries. The Company faced competition from a variety of sources, both direct
an indirect. There are several other biotechnology companies that are developing
peptide compounds for antimicrobial or anti-cancer applications. These companies
include: Applied Microbiology, Cubist Pharmaceuticals, Magainin Pharmaceuticals,
Micrologix Biotech, Microcide Pharmaceutical, Inc. and Xoma Corporation.

While there are a number of applications in clinical trials, the Company is not
aware of any products which have yet been approved for sale.

Based on the potency of its compound as reported to the Company by independent
medical collaborators, the Company believes that its compound can successfully
compete.

The Company's competition appears to be focusing primarily on anti-bacterial
applications, and unlike the Company, has not reported similar successes in the
cancer area. Nor do these competitors have any agricultural products in their
pipeline. Given the Company's patent position in the agricultural area, the
Company feels it is in a strong position to dominate this area as compared to
the aforementioned competitors. To the best of the Company's knowledge, there
are few, if any, peptide biotechnology companies in the plant genetic arena.

In addition to peptide competitors, there are, of course, many companies working
to develop new antibiotics and cures for infectious diseases and cancers. This
bodes well for the Company since large pharmaceutical companies are actively
seeking new compounds. As the Company's product development progresses, the
Company believes its technology becomes more appealing to a wider selection of
potential partners.

TECHNOLOGY BASE

The Company's technology was designed by Dr. Jaynes, who has over fifteen years
of peptide design experience and is a biochemist by training. He is a Co-Founder
of the Company and serves as Vice President of Research. The Company believes
having a molecular architect as part of the management team distinguishes the
Company from its peptide biotech competitors which have typically in-licensed
their lead molecules. As a result, the Company has a structure and process in
place for creating a pipeline of new molecular product applications.

Peptides with lytic properties occur in nature and are part of the natural
immune systems of many plants, animals and insects. The Company's core science
is the ability to design synthetic molecules which are many times more powerful
than those occurring in nature, with minimal toxicity. The Company's molecules
range in length from 17 to 40 amino acids and they have no sequence homology to
the peptides found in nature. In its discovery process, the Company has
identified and filed patents on a number of characteristics, which, when
incorporated into the design of the molecule, create compounds with unique
properties. These design "rules" include parameters for charge density, length,
amphipathy, hydrophobicity and spatial orientation. When organized, these
characteristics permit the ability to design molecules with increased
specificity and activity, which means some compounds are more effective against
cancer than bacteria, for example.

The nutritional technology is a significant innovation without a naturally
occurring antecedent. As a result this technology has the potential to create a
whole new industry.


                                       12
<PAGE>   14

Understanding the rules for creating the desired properties is an important
aspect of the Company's core technology. The Company has designed several
thousand different 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 which could
theoretically be created.

The understanding of these core discoveries are currently being significantly
expanded. In a partnership with Mycogen, an extensive evaluation process is now
underway. Should this process yield new breakthroughs or discoveries, the
Company will retain all rights to non-agricultural applications.


SCIENTIFIC ADVISORY BOARD

The Company's Scientific Advisory Board comprises leading scientists from
several disciplines. The Company frequently consults with its Scientific
Advisory Board on research and development and strategies and techniques. The
members of the Company's Scientific Advisory Board are as follows:

Paul L. Kornblith, M.D., is President and Founder of Precision Therapeutics. Dr.
Kornblith serves as an Adjunct Professor in the School of Health and
Rehabilitation Sciences at the University of Pittsburgh. Dr. Kornblith also
serves as Vice Chairman and Professor of Neurosurgery and Co-Director of the
University of Pittsburgh's Brain Tumor Center. He also serves on the editorial
boards of five other cancer and neurosurgical journals. Previously, Dr.
Kornblith served as Chief of the Surgical Neurology Branch, NINCDA, and the
National Institute of Health ("NIH").

Roger A. Laine, Ph.D., is a Professor of BioChemistry and Molecular Biology and
Director of the LSU Mass Spectrometry Facility at Louisiana State University.
Dr. Laine serves as President and Founder of Anomeric, Inc. He was previously
the Scientific Founder of Glycomed, now part of Ligand Pharmaceuticals.

Wayne F. Tompkins, Ph.D., is Professor in the Department of Microbiology,
Pathology and Parasitology at North Carolina State University. Dr. Tompkins also
serves as the Immunology Programs Coordinator at North Carolina State. He
received his Ph.D. in Virology and Immunology from the University of Wisconsin.
Dr. Tompkins is the co-developer of the Feline Immunodeficiency Virus ("FIV")
cat model, an accepted animal model for testing potential HIV therapeutics.

Paul Zorner, Ph.D., is senior scientist of the Global Industrial Biochemistry
Platform at the Dow Chemical Co. and was formerly vice president of product
development at Mycogen. Dr. Zorner has had over 20 U.S. patents issues. He is
also Chairman of the strategic planning committee, member of the publication
board and member of the sustainable agricultural committee of the Weed Science
Society of America.


PRINCIPAL SCIENTIFIC COLLABORATORS

The Company's primary scientific collaborators are as follows:

Cancer Therapeutics

         Robert H. Getzenberg, Ph.D. Co-Director, Prostate & Urologic Cancer
         Center, University of Pittsburgh Center Institute, Pittsburgh, PA

Bacterial Preventatives & Therapeutics

         Sharon Hillier, Ph.D., Associate Professor of Obstetrics, Gynecology &
         Reproduction, Magee-Womens Research Institute at the University of
         Pittsburgh Medical Center, Pittsburgh, PA

         Roland R. Arnold, Ph.D., Professor Diagnostic Sciences and
         Periodontology, University of North Carolina at Chapel Hill, NC

         David C. Henke, M.D., Assistant Professor, Department of Medicine,
         Director, Outpatient Clinical Services, Division of Pulmonary Diseases,
         University of North Carolina at Chapel Hill, NC

         Michael W. Neumeister, M.D., F.R.C.S.C., Assistant Professor, Program
         Director, Plastic Surgery Residency Program, Institute for Plastic and
         Reconstructive Surgery, Southern Illinois University, Springfield, IL

Crop Disease Resistance and Nutrition Enhancement

         C.S. Prakash, Ph.D., Professor and Director of the Center of
         Plant Biotechnology at Tuskegee University in Alabama

         Arthur K. Weissinger, Ph.D., Associate Professor of Crop Science, North
         Carolina State University, Raleigh, NC


MECHANISM OF ACTION

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

For cancer, the general theory for mechanism of action of the Peptidyl MIMs has
been that of initial membrane disruption with subsequent cell lysis and death of
the patient or the cell. However, research results suggest that additional
factors come into play in the in vivo situation. The Company is accumulating
evidence which indicates that D2A21 may have anti-angiogenic properties in
addition to its lytic function. The anti-angiogenic property interferes with
tumor blood supply, and reduces the growth rate for the primary tumor.


GENETIC ENGINEERING


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

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


                                       13
<PAGE>   15

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

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

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

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


PRODUCTION


Peptides are currently produced using a chemical synthesis process. Using
synthesis, the Company's compounds typically cost $1,200 to $5,000 per gram,
depending upon the volume and other characteristics. Large scale production will
lower this cost significantly. For most pharmaceutical application, because
the compounds are active in very low concentrations, cost of the compound is not
a significant issue. The Company expects that its compounds can be produced at a
satisfactory cost level. For applications which may require a very low cost, the
Company is currently developing a source of supply that is expected to meet the
necessary cost targets.

The peptide for nonclinical and initial clinical development activities have
been manufactured by a third party vendor, using a manufacturing method based
upon currently available solid phase peptide synthesis technology. The
development of specifications and establishment of analytical methods is being
carried out jointly with a number of entities and the Company. The manufacturer
selected by the Company will perform quality control and stability testing of
the drug substance. For commercial quantities there are a number of companies
with capabilities to produce peptides on a large scale. The Company anticipates
it, or its licenses, will be able to contract for suitable large scale peptide
production. Implementation of all of the methods is the responsibility of the
manufacturer. The


                                       14
<PAGE>   16

Company has established a standard commercial relationship with a manufacturer
to produce the clinical supplies that the Company currently requires.


PATENTS, LICENSES AND PROPRIETARY RIGHTS


The Company has filed a number of United States patent applications, as well as
corresponding applications in the PCT and foreign countries.. The Company's
patent strategy is to strive for broad coverage for a class of molecules for a
wide range of diseases in humans, animals and plants. The Company's lead
molecule, D2A21 is patented as a composition of matter. Additionally, the
Company has in excess of 40 molecules patented as compositions of matter.

For its agricultural applications, the Company has acquired the exclusive rights
to three U.S. and five international patents from Louisiana State University
("LSU"). The license from LSU expires in 2014. These patents include broad
claims for plants with bacterial and fungal resistance or enhanced nutrition.
Dr. Jaynes, the Company's Vice President of Research, was the principal
investigator 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 and nutrition enhanced plant
area. The Company has also been assigned Dr. Jaynes' exclusive rights to patents
related to has earlier work at LSU.


STATUS OF DEMEGEN PATENTS

<TABLE>
<CAPTION>
Patent #                                    Title
--------                                    -----

<S>                 <C>
5,561,107           Method of Enhancing Wound Healing by Stimulating Fibroblast
                    and Keratinocyte Growth in Vito, Utilizing Amphipathic Peptides
                    (expires October 1, 2013)

5,597,945*          Plants Generically Enhanced for Disease Resistance (expires
                    January 28, 2014)

5,597,946*          Method for Introduction of Disease and Pest Resistance into Plants
                    and Novel Genes Incorporated into Plants Which Code Therefore
                    (expires January 28, 2014)

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

5,744,445           Method of Treating Pulmonary Diseases with Non-Naturally
                    Occurring Amphipathic Peptides (expires April 28, 2015)

5,773,413           Method of Combating Mammalian Neoplasias and Lytic Peptides
                    Therefor (expires February 10, 2015)

5,811,654*          Plants genetically enhanced for nutritional quality (expires
                    July 25, 2006)

5,955,573           Ubiquitin-lytic peptide fusion gene constructs, protein
                    products deriving therefrom, and methods of making and using
                    same (expires July 22, 2014)

5,968,904           Modified Arginine containing Lytic Peptides and Method of
                    Making the same by Glyoxylation (expires November 8, 2013)

Pending             Numerous other applications have been submitted
</TABLE>

* Patents in-licensed from Louisiana State University

EMPLOYEES

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


                                       15
<PAGE>   17


COMPANY HISTORY AND GENERAL INFORMATION

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

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

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

The Company's offices and laboratory are located at 1051 Brinton Road,
Pittsburgh, PA 15221 and its telephone number is 412-241-2150. The Company
occupies 3,000 square feet of leased space. The lease is for a three year term,
expiring September 2001, at a monthly rental of $3,948. Prior to the Company's
move to Pittsburgh in September 1998, the Company was located in Durham, North
Carolina.

ITEM 2 - DESCRIPTION OF PROPERTY

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

The Company fully utilizes its office space and laboratory.

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

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


ITEM 3 - LEGAL PROCEEDINGS

None

ITEM 4 - SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS

None

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

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

<TABLE>
<CAPTION>
Fiscal            December 31               March 31           June 30           September 30
------            -----------               --------           -------           ------------
<S>                   <C>                     <C>               <C>                 <C>
1999

High                  $0.51                   $0.51             $0.63               $0.44
Low                   $0.21                   $0.32             $0.29               $0.24

1998

High                  $0.88                   $0.66             $0.75               $0.53
Low                   $0.42                   $0.32             $0.30               $0.24
</TABLE>

At December 2, 1999, there were 503 holders of record of 26,361,899 shares of
Common Stock, exclusive of holders which maintain their ownership in
"Street-Name" at brokerage houses, and one holder of record of 4,444,444 shares
of Preferred Stock. There are approximately 1,230 stockholders which hold their
ownership in street name.


                                    PART II

ITEM 6 - SELECTED FINANCIAL DATA

The following table sets forth certain financial data for, and as of the end of,
the years ended September 30, 1999, 1998, 1997, 1996 and 1995 and for the period
December 6, 1991 (inception) to September 30, 1999:

<TABLE>
<CAPTION>
                                                                                                                      December 6
                                                                 Year Ended September 30,                          1991 (Inception)
                                        -------------------------------------------------------------------------  to September 30,
                                            1999           1998           1997           1996           1995             1999
                                            ----           ----           ----           ----           ----       ----------------

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

Grant and Other Income                  $  1,118,576    $  1,376,918   $    764,834   $    271,777   $    167,592    $  3,816,497

Total Expenses                             2,456,318       3,370,671      1,708,607      2,841,255      3,041,431      16,591,764
</TABLE>


                                       16
<PAGE>   18
<TABLE>
<S>                                     <C>            <C>            <C>            <C>             <C>            <C>

Net Loss                                  (1,337,742)    (1,993,753)      (943,773)    (2,569,478)     (2,873,839)   (12,775,267)

Net Loss per Share (dilutive)           $      (0.06)  $      (0.13)  $      (0.05)  $      (0.17)   $      (0.35)

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

Weighted Average Number
   of Common Shares
   Outstanding                            26,255,104     23,867,091     19,537,047     15,479,889      12,529,314

BALANCE SHEET DATA:


Cash & Cash Equivalents                 $    583,585   $  1,686,658   $    310,252   $     19,266    $      1,004

Working Capital (deficiency)                   6,849      1,329,541     (1,498,477)    (2,754,591)     (3,382,190)

Total Assets                               1,084,505      2,114,750        651,963        156,147         106,746

Long-term obligations                         -0-            -0-            -0-             -0-            13,899

Deficit accumulated during
   development stage                     (14,119,462)   (12,523,358)    (9,443,772)    (8,499,999)     (5,930,521)

Redeemable convertible preferred
   Stock                                   1,768,846      1,510,484         -0-            -0-             -0-

Shareholders' Equity
   (Deficit)                              (1,555,934)      (122,130)    (1,158,216)    (2,642,523)     (3,293,313)
</TABLE>


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

GENERAL

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

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

The Company has two licenses in place for its agricultural technology, disease
resistance and nutritional enhancement, to Dow Agro Sciences which has produced
historic revenue streams and will continue to produce revenue as Dow Agro
Sciences proceeds towards commercialization of these technologies. The Company
is focusing its pharmaceutical efforts upon the commercialization of its cancer
therapeutic which it expects to license to a large pharmaceutical producer.


                                       17
<PAGE>   19


RESULTS OF OPERATION:

SEPTEMBER 30, 1999 VS 1998

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

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

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

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

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

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


SEPTEMBER 30, 1998 VS 1997

In the year ended September 30, 1998 (Fiscal 1998) grants and other income
increased significantly to $1.4 million from $0.8 million in the year ended
September 30, 1997 (Fiscal 1997). This increase was due to a $0.9 million
licensing fee received from Dow Agro Sciences as part of the license entered
into during Fiscal 1998. Additionally, a cancer charity made a grant of $0.25
million during Fiscal 1998 as part of an ongoing program to fund the Company's
development of cancer fighting drugs. During Fiscal 1997, a grant of $0.5
million was received from this fund. Additionally, the Company recognized $0.1
million of revenue related to research expenses funded by Dow Agro Sciences and
received $0.04 million of interest on its cash balances.

Research and development expenses increased to $0.9 million in Fiscal 1998 from
$0.6 million in Fiscal 1997 due to the Company's increased funding relative to
its cancer and sexually transmitted disease drug research.

General and administrative expenses increased to $2.3 million in Fiscal 1998
from $0.9 million in Fiscal 1997. Included in general and administrative
expenses was a non-cash charge of $1.7 million for the issuance of below market
stock options issued to employees and directors during Fiscal 1998 that vested
during the year. Exclusive of the non-cash charge, general and administrative
expenses decreased by $0.25 million to $0.62 million due to decreased legal
costs and overall cost containment.

Interest expense decreased to $0.03 million in Fiscal 1998 from $0.17 million in
Fiscal 1997 due to the $1.6 million decrease in amounts payable to related
parties through the conversion of certain amounts to restricted stock and
forgiveness of certain amounts payable late in Fiscal 1997. The receipt of the
license fee from Mycogen in March 1998 put the Company in a cash positive
position and was used to eliminate the majority of interest bearing payables to
employees and directors. Additionally, the conversion and forgiveness of
employee debt in Fiscal 1997 eliminated a significant amount of liabilities
which were interest bearing.

Depreciation and amortization increased to $0.12 million in Fiscal 1998 from
$0.07 million in Fiscal 1997. The increase was primarily due to increased
amortization of the License Agreement with LSU which required an initial payment
of 700,000 shares (valued at $245,000) of the Company's common stock in May 1997
and the increase in amortization of capitalized patent costs associated with the
Company's product processes.

The Company did not have a federal or state income tax provision in either
Fiscal 1998 or 1997 due to the loss recorded in each period.

The amounts described above resulted in a net loss of $2 million for Fiscal
1998. The net loss would have been $0.3 million if the aforementioned non-cash
charge was excluded.


                                       18
<PAGE>   20


LIQUIDITY AND CAPITAL RESOURCES

FISCAL 1999

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

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

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

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

FISCAL 1998

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

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

The $0.1 million of cash utilized by operating activities consisted of the net
loss of $2 million and a decrease of $0.21 million decrease in accounts payable
and other liabilities offset by the $1.7 million of non-cash compensation
related to the issuance of below market stock options issued to employees and
directors that vested during the year, $0.12 million of depreciation and
amortization, $0.09 million of stock issued for services and a $0.18 million
increase in unearned revenue relating to the $0.3 million three year
administration fee paid to the Company in October 1997 by Mycogen.

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


FISCAL 1997

During the year ended September 30, 1997, the Company's cash increased by $0.3
million. Net cash provided by financing activities of $0.9 million was partially
offset by a $0.6


                                       19
<PAGE>   21

million of net cash utilized by operating activities and $0.07 million of net
cash utilized by investing activities.

Cash from financing activities was generated from $0.1 million net proceeds from
the issuance of the Company's Common Stock and $0.82 million increase in
payables to related parties due to services provided to the Company.

Cash utilized in operating activities was caused by the net loss of $0.94
million and a $0.5 million decrease in accounts payable and accrued expenses.
This was partially offset by $0.07 million of depreciation and amortization and
$0.48 million of stock issued for services rendered to the Company.

Cash utilized by investing activities was primarily due to a $0.08 million
increase in intangible assets due to the capitalization of patent related
expenses.


Year 2000

The Year 2000 issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any computer program
that is not Year 2000 compliant and has date sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000.

The Company processes its financial information on a commercially sold
accounting package. This package has been modified by the developer such that
they have represented to the Company that it is Year 2000 compliant. The
Company's payroll is processed by a third party processor who has notified the
Company that they are Year 2000 compliant. The remaining computer applications
at the Company are not date sensitive and are primarily of a word processing,
data base or scientific research nature.

The Company has not and does not expect to perform an assessment of the Year
2000 preparedness of all of its third party relationships. In making this
decision, the Company has considered that there are many vendors for the
products that they purchase should they have to change suppliers due to a Year
2000 problem. The Company has not selected an institution to perform its Phase I
clinical tests. The issue of Year 2000 preparedness will be part of the
selection process at the time that the institution to handle the clinical trials
is selected.

In the worst case, a Year 2000 failure at one of the Company's vendors could
result in a delay in the availability of an item on order. Except for the
purchase of peptides from vendors, of which the Company keeps a sufficient
inventory to manage short-term requirements, all other items purchased from
third party vendors are of the nature of office supplies and miscellaneous
items. The unavailability of any of the aforementioned would result in the
purchase of the affected items from another vendor as none of these items are
vendor specific.


                                       20
<PAGE>   22

Prospective Information

The Company believes that it has adequate liquidity to fund its operations in
Fiscal 2000 if the expected milestone, research support, license and sub-license
payments are received from Dow Agro Sciences as expected. Should the expected
payments either be delayed or not forth coming the Company would scale back its
level of expenditures to maintain sufficient cash flow to fund basic operations.
On a long term basis, it will be necessary for the Company to access additional
funding so that it can continue to fund the Phase I and Phase II testing of its
therapeutic agents. This funding may be in the form of a private placement of
equity securities or a secondary issuance of securities into the market.


ITEM 7a - QUANTITATIVE AND QUALITATIVE MARKET RISK

None


ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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


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

Not applicable


                                    PART III

The information called for by Part III (Items #10, 11, 12 and 13) is
incorporated herein by reference to the registrant's definitive Proxy
Statement for the 2000 Annual Meeting of Stockholders to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A of the Securities
Exchange Act of 1934.


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

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

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



                                       21
<PAGE>   23

         (ii)     Balance Sheets as of September 30, 1999 and 1998

         (iii)    Statements of Operations for the Years Ended September 30,
                  1999, 1998 and 1997 and for the period December 6, 1991
                  (inception) to September 30, 1999

         (iv)     Statement of Shareholders' Deficit for the Years Ended
                  September 30, 1999, 1998 and 1997 and for the period December
                  6, 1991 (inception) to September 30, 1999

         (v)      Statements of Cash Flows for the Years Ended September 30,
                  1999, 1998 and 1997 and for the period December 6, 1991
                  (inception) to September 30, 1999

         (vi)     Notes to Financial Statements

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


b.  Exhibits


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

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

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

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

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

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

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

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

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

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

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

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

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


                                       22
<PAGE>   24

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

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

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

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

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

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

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

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

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

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

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

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

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

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


                                       23
<PAGE>   25

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

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

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

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

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

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

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

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

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

     a)  Konrad M. Weis, Ph.D.

     b)  John Bridwell

     c)  James Colker

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

10.25    Stock Option Agreement dated May 24, 1999 with Robert E. Hannan

10.26    James E. Thornton Termination Agreement dated August 23, 1999

10.27    Stock Option Agreement dated November 19, 1999 with Jerry B. Hook

24       Power of Attorney

27.      Financial Statement Schedules


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


c.  Reports on Form 8-K

   The registrant did not file any Current Reports on Form 8-K during the three
   months ended September 30, 1999.

d.  Directors and Officers of Registrant did not timely file required Forms 3
    and 4. Aforementioned individuals are now in full compliance.



                                       24
<PAGE>   26

                                   SIGNATURES


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


                                     Demegen, Inc.

Date: December 21, 1999

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


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


Date: December 21, 1999            By: /s/ Richard D. Ekstrom
                                       -----------------------
                                   Richard D. Ekstrom
                                   Chairman of the Board of Directors,
                                   President and Chief Executive Officer
                                   (Principal Executive Officer)

Date: December 21, 1999            By: /s/ Jesse M. Jaynes, Ph.D.
                                       ---------------------------
                                   Jesse M. Jaynes, Ph.D.
                                   Vice President and Director

Date: December 21, 1999             By: /s/ James Colker
                                       -----------------
                                   James Colker
                                   Director

Date: December 21, 1999            By: /s/ John Bridwell
                                       ------------------
                                   John Bridwell
                                   Director

Date: December 21, 1999            By: /s/ Konrad M. Weis, Ph.D.
                                       --------------------------
                                   Konrad M. Weis. Ph.D.
                                   Director

Date: December 21, 1999            By: /s/ Robert E. Hannan
                                       --------------------------
                                   Robert E. Hannan
                                   Director

Date: December 21, 1999            By: /s/ Jerry B. Hook, Ph.D.
                                       ---------------------------
                                   Jerry B. Hook, Ph.D.
                                   Director



                                       25
<PAGE>   27
[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, 1999 and 1998, and the related statements of
operations, shareholders' deficit, and cash flows for the years ended September
30, 1999, 1998, and 1997, and for the period from December 6, 1991 (inception)
through September 30, 1999. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits. The financial statements for the
period from December 6, 1991 (inception) through September 30, 1994, were
audited by other auditors whose report dated November 10, 1994, expressed an
unqualified opinion on those statements and included an explanatory paragraph
regarding the entity's ability to continue as a going concern, that is not
included in our current report as the result of additional financing obtained by
the Company. The financial statements for the period December 6, 1991
(inception) through September 30, 1994, include total revenues and net loss of
$1,116,800 and $3,056,682, respectively. Our opinion on the statements of
operations, shareholders' deficit, and cash flows for the period December 6,
1991 (inception) through September 30, 1999, insofar as it relates to amounts
for prior periods through September 30, 1994, is based solely on the report of
other auditors.

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

In our opinion, based on our audits and the report of other auditors, the
financial statements referred to above present fairly, in all material respects,
the financial position of Demegen, Inc. (a development stage company) at
September 30, 1999 and 1998, and the results of its operations and its cash
flows for the years ended September 30, 1999, 1998, and 1997, and for the period
from December 6, 1991 (inception) through September 30, 1999, in conformity with
generally accepted accounting principles.


                                             /s/ ERNST & YOUNG LLP


Pittsburgh, PA
November 12, 1999





                                      F-1
<PAGE>   28



                                  Demegen, Inc.
                          (A Development Stage Company)

                                 Balance Sheets


<TABLE>
<CAPTION>
                                                                          SEPTEMBER 30
                                                                   1999                  1998
                                                         --------------------------------------------

<S>                                                             <C>                     <C>
ASSETS
Current assets:
   Cash and cash equivalents                                    $  583,585            $1,686,658
   Accounts receivable                                              22,546                59,929
   Prepaid expenses and other current assets                         2,057                11,859
                                                         --------------------------------------------
Total current assets                                               608,188             1,758,446

Property and equipment:
   Furniture and equipment                                         195,786                38,440
   Computer hardware and software                                  165,758               113,416
                                                         --------------------------------------------
                                                                   361,544               151,856
   Less accumulated depreciation and amortization                 (151,219)              (94,271)
                                                         --------------------------------------------
                                                                   210,325                57,585
Intangible assets:
   Licenses                                                        245,000               245,000
   Patents                                                         248,436               183,504
                                                         --------------------------------------------
                                                                   493,436               428,504
Less accumulated amortization                                     (227,444)             (129,785)
                                                         --------------------------------------------
                                                                   265,992               298,719







                                                         --------------------------------------------
Total assets                                                    $1,084,505            $2,114,750
                                                         ============================================
</TABLE>



                                      F-2
<PAGE>   29



<TABLE>
<CAPTION>
                                                                                    SEPTEMBER 30
                                                                             1999                  1998
                                                                   --------------------------------------------

<S>                                                                     <C>                     <C>
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
   Payable to employees and directors                                   $     92,000          $    110,933
   Accounts payable                                                          354,988               178,232
   Unearned revenue                                                           91,667                91,668
   Other liabilities                                                          62,684                48,072
                                                                   --------------------------------------------
Total current liabilities                                                    601,339               428,905

Payable to employees and directors                                           203,147               178,400
Unearned revenue                                                                  --                91,665
Other                                                                         67,107                27,426
                                                                   --------------------------------------------
Total liabilities                                                            871,593               726,396

Commitments and contingency

Redeemable convertible preferred stock, $.001 par value--
   40,000,000 shares authorized; 4,444,444 shares issued
   and outstanding                                                         1,768,846             1,510,484

Shareholders' deficit:
   Common stock, $.001 par value--100,000,000 shares
     authorized; 26,361,899 and 25,866,899 shares
     issued and outstanding at September 30, 1999 and
     September 30, 1998, respectively                                         26,362                25,867
   Warrants                                                                  497,000               497,000
   Additional paid-in capital                                             12,040,166            11,878,361
   Deficit accumulated during the development stage                      (14,119,462)          (12,523,358)
                                                                   --------------------------------------------
Total shareholders' deficit                                               (1,555,934)             (122,130)
                                                                   --------------------------------------------
Total liabilities and shareholders' deficit                             $  1,084,505          $  2,114,750
                                                                   ============================================
</TABLE>


See accompanying notes.



                                      F-3
<PAGE>   30
                                  Demegen, Inc.
                          (A Development Stage Company)

                            Statements of Operations

<TABLE>
<CAPTION>
                                                                                                    PERIOD FROM
                                                                                                  DECEMBER 6, 1991
                                                                                                   (INCEPTION) TO
                                                         YEAR ENDED SEPTEMBER 30                    SEPTEMBER 30,
                                                1999               1998                1997             1999
                                       ----------------------------------------------------------------------------
<S>                                         <C>                <C>                 <C>
Income:
   License                                  $   350,000        $   906,651         $   100,000        $  1,356,651
   Grant and other                              708,475            425,398             664,834           2,354,876
   Interest                                      60,101             44,869                  --             104,970
                                       ----------------------------------------------------------------------------
Total income                                  1,118,576          1,376,918             764,834           3,816,497

Expenses:
   Research and development                   1,513,680            880,965             596,772           5,492,885
   General and administrative                   784,891          2,338,817             866,910           9,672,619
   Interest                                       3,140             28,295             172,356             982,724
   Depreciation and amortization                154,607            122,594              72,569             443,536
                                       ----------------------------------------------------------------------------
Total expenses                                2,456,318          3,370,671           1,708,607          16,591,764
                                       ----------------------------------------------------------------------------

Net loss                                     (1,337,742)        (1,993,753)           (943,773)        (12,775,267)

Preferred dividend and accretion
    amounts                                    (258,362)        (1,085,833)                 --          (1,344,195)
                                       ----------------------------------------------------------------------------
Net loss applicable to common stock
                                            $(1,596,104)       $(3,079,586)        $  (943,773)       $(14,119,462)
                                       ============================================================================

Net loss per common share, basic and
   diluted                                  $     (0.06)       $     (0.13)        $     (0.05)
                                       ============================================================================

Weighted average common stock
   outstanding                               26,255,104         23,867,091          19,537,047
                                       ============================================================================
</TABLE>

See accompanying notes.


                                      F-4
<PAGE>   31
                                  Demegen, Inc.
                          (A Development Stage Company)

                       Statements of Shareholders' Deficit

<TABLE>
<CAPTION>
                                                                                                 COMMON STOCK
                                                                           AVERAGE     ---------------------------------
                                                                            PRICE
                                                                          PER SHARE        SHARES              AMOUNT      WARRANTS
                                                                        -------------- ---------------- ----------------  --------
<S>                                                                     <C>            <C>              <C>               <C>
   Acquired in merger with Excelsion 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
                                                                                       ================ ================  ========
</TABLE>

See accompanying notes.



                                      F-5
<PAGE>   32

<TABLE>
<CAPTION>
                                                                                                          DEFICIT
                                                                                                        ACCUMULATED
                                                                       ADDITIONAL                        DURING THE
                                                                        PAID-IN        RECEIVABLE       DEVELOPMENT
                                                                        CAPITAL       FROM OFFICER         STAGE          TOTAL
                                                                      --------------------------------------------------------------
<S>                                                                   <C>            <C>            <C>               <C>
   Acquired in merger with Excelsion 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)
                                                                      ==============================================================
</TABLE>





                                      F-6
<PAGE>   33
                                  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
                                                         1999                1998                1997                1999
                                                 -------------------------------------------------------------------------------
<S>                                                   <C>                  <C>               <C>                <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)                                     $(1,337,742)       $(1,993,753)          $(943,773)       $(12,775,267)
Adjustments to reconcile net loss to net cash
   used in operating activities:
Depreciation and amortization                             154,607            122,594              72,569             443,536
Stock issued for services                                      --             97,318             478,807           1,729,058
Loss on disposals of equipment                                 --                 --              17,722              17,722
Issuance of stock options to employees and
   directors                                               78,000          1,699,440                  --           1,777,440
Warrants issued for interest                                   --                 --                  --             286,434
Notes payable issued for services                              --                 --                  --              58,194
Write-off of intangible assets                                 --                 --                  --               6,626
Changes in operating assets and liabilities:
Accounts receivable                                        37,383            (59,929)                --              (22,546)
Prepaid expenses and other current assets                   9,802            (10,409)             23,363              (2,057)
Unearned revenue                                          (91,666)           183,333                 --               91,667
Accounts payable and other liabilities                    217,335           (141,186)           (206,861)          1,426,045
                                                 -------------------------------------------------------------------------------
Net cash used in operating activities                    (932,281)          (102,592)           (558,173)         (6,963,148)

CASH FLOW FROM INVESTING ACTIVITIES
Purchase of property and equipment                       (210,157)           (54,027)             (3,595)           (383,375)
Cash received on equipment disposals                           --                 --               9,643               9,643
Intangible assets                                         (64,463)           (84,610)            (79,532)           (247,967)
                                                 -------------------------------------------------------------------------------
Net cash used in investing activities                    (274,620)          (138,637)            (73,484)           (621,699)

CASH FLOW FROM FINANCING ACTIVITIES
Net proceeds from issuance of equity
   instruments                                                 --          1,943,873             105,000           4,309,500
Proceeds from exercise of stock options                    17,500             87,500                  --             105,000
Proceeds from notes payable                                21,109                 --                  --           1,148,609
(Decrease) increase in payable to employees
   and directors                                           72,614           (413,738)            817,643           2,673,412
Payments on notes payable                                  (7,395)                --                  --             (68,089)
                                                 -------------------------------------------------------------------------------
Net cash provided by financing activities                 103,828          1,617,635             922,643           8,168,432
                                                 -------------------------------------------------------------------------------

Net increase (decrease) in cash and cash
   equivalents                                         (1,103,073)         1,376,406             290,986             583,585
Cash and cash equivalents at beginning of
   period                                               1,686,658            310,252              19,266                  --
                                                 -------------------------------------------------------------------------------
Cash and cash equivalents at end of period            $   583,585        $ 1,686,658           $ 310,252        $    583,585
                                                 ===============================================================================

SUPPLEMENTAL DISCLOSURES OF CASH FLOW
   INFORMATION
Cash paid for interest                                $     3,140        $    14,080           $      --        $     21,642
                                                 ===============================================================================

NONCASH ACTIVITIES
Common stock issued in satisfaction of related
   party payable                                      $    66,800        $   712,192           $      --        $    778,992
                                                 ===============================================================================
Dividends on redeemable convertible preferred
   stock                                              $   160,000        $    40,000           $      --        $    160,000
                                                 ===============================================================================
Accretion of redeemable convertible preferred
   stock                                              $    98,362        $  1,045,833          $      --        $  1,144,195
                                                 ===============================================================================
</TABLE>

See accompanying notes.

                                      F-7
<PAGE>   34





                                  Demegen, Inc.
                          (A Development Stage Company)

                          Notes to Financial Statements

                               September 30, 1999


1. HISTORY AND NATURE OF THE BUSINESS

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

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

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

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


                                      F-8
<PAGE>   35

                                  Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)



2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

USE OF ESTIMATES

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.

CASH AND CASH EQUIVALENTS

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


PREOPERATING COSTS

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

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 $56,948,
$30,824, and $34,554 during 1999, 1998, and 1997, respectively. Accelerated
depreciation methods are used for income tax purposes.




                                      F-9
<PAGE>   36

                                  Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)



2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

INTANGIBLE ASSETS

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

GRANT AND OTHER INCOME

Grant income is not recognized until received.

During fiscal years 1999, 1998 and 1997, the Company received grant proceeds of
$375,000, $250,000 and $500,000, respectively, from the Pacific West Cancer Fund
in support of the Company's cancer research efforts. The funds were recognized
as revenue upon receipt as the contracts did not contain any penalties,
successful outcomes clauses or refunding provisions.

The Company received approximately $91,808, $79,000 and $85,000 in fiscal 1999,
1998 and 1997 under research agreements with the National Institute of Health
and the National Science Foundation. Revenue was recognized as the research
funds were expended.

LICENSE AND SUPPORT

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

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

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.



                                      F-10
<PAGE>   37


                                  Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)


3. INCOME TAXES

The Company accounts for income taxes using the liability method. Under the
liability method, deferred tax assets and liabilities are determined based on
differences between the financial reporting and tax bases of assets and
liabilities.

Significant components of the Company's deferred tax asset at September 30,
1999 and 1998, are as follows:

<TABLE>
<CAPTION>
                                            1999               1998
                                         -----------        -----------
<S>                                      <C>                <C>
*  Compensation expense on unexercised
     stock options                           481,690        $   454,000
*  NOL carryforwards                       2,683,828          2,251,000
*  Excess book amortization                   59,998             35,000
                                         -----------        -----------
        Total deferred tax asset           3,225,516          2,740,000

   Valuation allowance                    (3,225,516)        (2,740,000)
                                         -----------        -----------
   Net deferred tax assets               $         0        $         0
                                         ===========        ===========
</TABLE>

Net operating losses totaling approximately $7,100,000 are currently available
and begin to expire in 2007. Deferred tax liabilities relate to differences in
the financial and tax carrying amounts of fixed assets.

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

4. RELATED PARTY TRANSACTIONS

During 1997, the Company reached agreements with certain current and former
employees related to amounts payable to these individuals for primarily wages.
The amounts payable to these individuals at August 31, 1997 of approximately
$2,200,000 were reduced to approximately $646,000 at September 30, 1997
primarily through the exchange of amounts accrued and payable for shares of the
Company's common stock. The Company has recorded the issuance of shares as a
contribution of capital from certain of its officers, management, and key
employees at the value per share as negotiated in the agreements. Accordingly,
common stock and additional paid-in capital increased by approximately
$1,600,000 related to the agreement. The agreements also provide for either the
payment of bonuses totaling $185,000 or the issuance of 185,000 shares of the
Company's common stock at $1.00 per share to the employees in future years
should target levels of license and/or royalty revenues be achieved.

During 1996, the Company converted the majority of its notes payable to
shareholders through the issuance of common stock. Pursuant to the terms of
these settlements, notes payable of $1,091,667, accrued interest of $361,094,
and outstanding warrants covering 1,832,194 shares of common stock, valued at
$319,767 were satisfied through the issuance of 3,755,285 shares of the
Company's restricted common stock. The value assigned to the common stock issued
was based upon the amounts contained in the respective debt agreements relative
to the forgone debt and related accrued interest and the value of the warrants
were based upon debt and interest payments exchanged for warrants in prior
years.

In December 1996, a former employee filed a claim against the Company for
payment of back compensation, payment of outstanding promissory notes, and for
termination provisions of his employment contract. The Company filed for
arbitration, as called for in the employment contract. In October 1997, the
Court stayed the litigation and ordered the parties to proceed with




                                      F-11
<PAGE>   38


                                  Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)


4. RELATED PARTY TRANSACTIONS (CONTINUED)

arbitration. In January 1998, the matter was settled with the issuance of
1,975,000 shares of the Company's common stock and a cash payment of $30,000.
The expenses related to this settlement were recorded in fiscal 1997 and prior
years.

5. COMMON STOCK

Included in the common stock account balance at September 30, 1998 is 425,000
restricted shares for which the Company has received consideration, either in
cash or services provided, but has not yet issued the restricted share
certificates to the shareholders.

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.



                                      F-12
<PAGE>   39

                                  Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)



6. REDEEMABLE CONVERTIBLE PREFERRED STOCK (CONTINUED)

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

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

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

Upon receipt of the call, the call holder shall have sixty days to elect to
exercise all or a portion of this warrant. 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
year ended September 30, 1998 at a $0.05 per share exercise price, which was
below the fair value based upon management's estimate of the fair value of the
stock issued at the date of grant. The shares were fully vested at September 30,
1998, and a $1,699,440 noncash charge was recognized to reflect the compensation
value of the options issued. All of these options expire in 2008.



                                      F-13
<PAGE>   40


                                  Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)


7. STOCK OPTIONS AND WARRANTS (CONTINUED)

The Company granted stock options to certain employees and directors during the
years ended September 30, 1999 and 1997 at exercise prices which approximated
fair value at the date of grant. Options granted to an officer in 1996 vested
200,000 shares each at the date of issuance and November 1, 1996, with the
remaining options vesting on November 1, 1997. Options granted during the years
ended September 30, 1998 and 1997 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, 1996                                  600,000              $0.15                 $0.03
Options granted during year                                    425,000              $0.77                 $0.17
                                                      ----------------------------------------------------------------
Balance at September 30, 1997                                1,025,000              $0.41                 $0.09
Options granted during year                                  5,820,000              $0.05                 $0.27
Options exercised for common stock during year
                                                            (1,750,000)             $0.05                 $0.27
                                                      ----------------------------------------------------------------
Balance at September 30, 1998                                5,095,000              $0.12                 $0.23
                                                      ================================================================

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

As of September 30, 1999 and 1998, 5,055,000 and 5,095,000, respectively, of
the options were vested and exercisable.

Pro forma information regarding net income and earnings per share is required by
SFAS No. 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of that Statement. The fair
value for these options was estimated at the date of grant using a Black-Scholes
options pricing model with the following weighted average assumptions for fiscal
1999, 1998 and 1997: risk-free interest rate of 6%; dividend yield of 0%;
volatility factors of the expected market price of the Company's common stock of
1.41, 0.97 and 1.24, 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



                                      F-14
<PAGE>   41


                                  Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)


7. STOCK OPTIONS AND WARRANTS (CONTINUED)

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 1999, 1998, and 1997
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
                                                     1999            1998             1997
                                              --------------------------------------------------
<S>                                              <C>              <C>             <C>
Net loss available to common stock:
   As reported                                   $(1,596,104)     $(3,079,586)    $  (943,773)
   Pro forma                                     $(1,746,117)     $(4,615,720)    $(1,370,617)

Basic and diluted earnings per share:
   As reported                                        $(0.06)          $(0.13)         $(0.05)
   Pro forma                                          $(0.07)          $(0.19)         $(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, 1999, there were outstanding warrants to purchase 4,000 shares
of the Company's common stock at an exercise price of $2.50 per warrant. The
warrants expire December 31, 1999. Additionally, the holder of the preferred
stock holds a warrant to purchase common stock (refer to Note 6 for additional
information).

8. COMMITMENTS

The Company leases its office and laboratory facilities under a three-year lease
expiring September 30, 2001 at a monthly rental of $3,948. During 1999, 1998,
and 1997, the Company incurred rent expense totaling $45,830, $34,105, and
$45,100, respectively.


                                      F-15
<PAGE>   42

                                  Demegen, Inc.
                          (A Development Stage Company)

                    Notes to Financial Statements (continued)


8. COMMITMENTS (CONTINUED)

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

9. MARKETING

In December 1997, the Company entered into a license agreement with Mycogen
Corporation, which was subsequently acquired by Dow Agro Science 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
Agro Science with support services of personnel for a joint research effort for
a three year period. This was classified as unearned revenue on the balance
sheet and is being amortized into revenue, on a straight-line basis, over the
three year life of the support services commitment.

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

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

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

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

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

10. NET LOSS PER COMMON SHARE

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

<TABLE>
<CAPTION>
                                                                 YEAR ENDED SEPTEMBER 30
                                                              1999          1998            1997
                                                     -------------------------------------------------
<S>                                                       <C>              <C>          <C>
Numerator:
   Net loss                                               $(1,337,742)   $(1,993,753)   $  (943,773)
   Preferred stock dividends and accretion
     amounts                                                 (258,362)    (1,085,833)            --
                                                     -------------------------------------------------
   Numerator for basic earnings per
     share--income available to common
     stockholders                                          (1,596,104)    (3,079,586)      (943,773)

Denominator:
   Denominator for basic and earnings per
     share--weighted average shares                        26,255,104     23,867,091     19,537,047
                                                     -------------------------------------------------
Basic and diluted loss per share                          $     (0.06)   $     (0.13)   $     (0.05)
                                                     =================================================
</TABLE>

At September 30, 1999, the Company had 5,125,000 options 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. These potentially dilutive securities were
not included in the calculation of dilutive earnings per share because the
effect would be anti-dilutive.

11. LIQUIDITY

The Company believes that it has adequate liquidity to fund its operations in
Fiscal 2000 if the expected milestone, research support, license and
sub-license payments are received from Dow Agro Science as expected. Should the
expected payments either be delayed or not forthcoming, the Company would scale
back its level of expenditures to maintain sufficient cash flow to fund basic
operations.

                                      F-16