SCHEDULE 14A
PROXY STATEMENT PURSUANT TO SECTION 14(a) OF THE
SECURITIES EXCHANGE ACT OF 1934

Filed by the Registrant [ X ]
Filed by a Party other than the Registrant [ ]

Check the appropriate box:

[ ] Preliminary Proxy Statement
[ X ] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to 240.14a-11(c) or 240.14a-12
[ ] Confidential, for use of the Commission Only (as permitted by Rule
14a-6(e)(2))

DEMEGEN, INC.
- --------------------------------------------------------------------------------
(Name of Registrant as Specified In Its Charter)

- --------------------------------------------------------------------------------
(Name of Person(s) Filing Proxy Statement, If Other Than The Registrant)

Payment of Filing Fee (Check the appropriate box):

[ X ] No fee required.
[ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and
0-11.

1) Title of each class of securities to which transaction applies:

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2) Aggregate number of securities to which transaction applies:

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3) Per unit price or other underlying value of transaction
computed pursuant to Exchange Act Rule 0-11: (set forth the
amount on which the fee is calculated and state how it was
determined).

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4) Proposed maximum aggregate value of transaction:

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5) Total fee paid:

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[ ] Check box if any part of the fee is offset as provided by Exchange Act
Rule 0-11(a)(2) and identify the filing for which the offsetting fee
was paid previously. Identify the previous filing by registration
statement number, or the Form or Schedule and the date of its filing.

1) Amount Previously Paid:

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2) Form, Schedule or Registration Statement No.:

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3) Filing Party:

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4) Date Filed:

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DEMEGEN, INC.

NOTICE OF ANNUAL MEETING OF STOCKHOLDERS

Notice is hereby given that the Annual Meeting of Stockholders of Demegen, Inc.,
(the "Corporation") will be held at the Company's office at, 1051 Brinton Road
Pittsburgh, Pennsylvania 15221, on Thursday, September 12, 2002 at 11:00 a.m.
local time for the following purposes:

1. To elect six directors to serve for a one year period.

2. To ratify the appointment by the Board of Directors of Ernst & Young LLP
as independent auditors for the fiscal year ending September 30, 2002.

3. To transact such other business as may properly come before the meeting
or any adjournment thereof.

Required Vote. The presence, in person or by proxy, of the holders of a majority
of all Common Stock and Preferred Stock is necessary for a quorum at the Annual
Meeting. In all matters other than the election of Directors, the affirmative
vote of the majority of shares present in person or represented by proxy shall
decide any question before such meeting. Directors will be elected by a
plurality of the votes cast, either in person or by proxy, at the Annual
Meeting.

YOUR VOTE IS IMPORTANT. If you are unable to attend the Annual Meeting, please
mark, date, sign and return the accompanying proxy in the enclosed return
envelope by September 5, 2002. A Stockholder executing and returning a proxy has
the power to revoke it at any time before it is voted (i) by giving written
notice of such revocation to the Corporation, (ii) by submission of another
proxy bearing a later date or (iii) by attending the meeting and requesting to
vote in person.

By Order of the Board of Directors

Richard D. Ekstrom,
Chairman

DEMEGEN, INC.

PROXY STATEMENT
FOR ANNUAL MEETING OF STOCKHOLDERS
TO BE HELD ON
SEPTEMBER 12, 2002

PROXIES

The Board of Directors is soliciting proxies from Stockholders to permit
Stockholders who are unable to attend the Annual Meeting to cast their vote.

A proxy form is included with this Proxy Statement. This proxy permits the
Stockholder to direct the proxy holders to vote in accordance with any
specification made thereon and, if no specification is made, will be voted for
the election as directors of the nominees named herein and in favor of ratifying
the appointment of Ernst & Young LLP as independent auditors for the fiscal year
ending September 30, 2002.

A Stockholder executing and returning a proxy has the power to revoke it at any
time before it is voted (i) by giving written notice of such revocation to the
Secretary of the Company, or (ii) by submission of another proxy bearing a later
date or (iii) by attending the meeting and requesting to vote in person.

The enclosed proxy should be signed in the name of the Stockholder listed
thereon.

QUORUM AND VOTE REQUIRED FOR APPROVAL

The presence, in person or by proxy, of the holders of a majority of all Common
Stock and Preferred Stock is necessary for a quorum at the Annual Meeting. The
favorable vote of a majority of the votes represented at the meeting is required
for the approval of each proposal brought before the Meeting, except for the
election of Directors, which will be determined by a plurality of the votes
cast.

IF YOU ARE UNABLE TO ATTEND THE MEETING, PLEASE SIGN AND DATE THE ENCLOSED PROXY
FORM AND RETURN IT IN THE ENCLOSED RETURN ENVELOPE BY SEPTEMBER 5, 2002.

The Board of Directors
Demegen, Inc.

July 26, 2002

GENERAL INFORMATION

This Proxy Statement is furnished beginning August 1, 2002 to all stockholders
in connection with the solicitation on behalf of the Board of Directors of
Demegen, Inc. (the "Corporation") of proxies to be voted at the Annual Meeting
of the Stockholders of the Corporation on Thursday, September 12, 2002.

The Record Date for determining those stockholders entitled to notice of, and
those stockholders entitled to vote at, the Annual Meeting is July 19, 2002 and
any adjournment thereof. As of that date, 47,017,778 shares of the Corporation's
common stock, par value $0.001 per share (the "Common Stock") and 4,444,444
shares of its convertible preferred stock, par value $0.001 per share (the
"Preferred Stock") were issued and outstanding. Each holder of shares of Common
Stock and each holder of shares of Preferred Stock shall have one vote for each
share held of record on each matter which is being submitted for stockholder
approval except in connection with the election of directors. In accordance with
the provisions of the Corporation's Articles of Incorporation, as amended (the
"Articles"), (i) three directors are to be elected solely by the holders of
Common Stock, (ii) two directors are to be elected solely by the holders of
Preferred Stock, and (iii) one director is to be elected by all stockholders.

ELECTION OF DIRECTORS

The size of the Board of Directors is currently six members. At the Special
Meeting of Stockholders held on September 19, 1998, amendments to the
Corporation's Articles were approved which created a classified Board of
Directors of six members, three of whom are to be elected solely by the vote of
holders of Common Stock and one of whom is elected by the holders of the Common
Stock and Preferred Stock. The remaining two members are elected by the holders
of the Preferred Stock. Accordingly, holders of Common Stock are entitled to
vote their shares for four of the six directors to be elected at the Annual
Meeting.

The proxies given by holders of Common Stock will be voted for the election as
directors of four nominees to hold office for a period of one year or until
election of their successors. All nominees are current members of the Board.
Should any nominee become unable to accept election, the proxies will be voted
for the election of such person, if any, as shall be recommended by the Board of
Directors, or for holding a vacancy to be filled by the Board. The Board of
Directors has no reason to believe that the persons listed as nominees will be
unable to serve.

The following table lists, as of July 15, 2002 the following information
concerning each nominee for director: his principal occupation or employment;
age; the year in which he first became a director of the Corporation; and any
directorships in public companies.

<Table>
<Caption>
DIRECTOR
NAME, PRINCIPAL OCCUPATION, AND AGE SINCE
----------------------------------- --------

NOMINEES TO BE ELECTED BY COMMON STOCKHOLDERS

RICHARD D. EKSTROM 1996
Richard D. Ekstrom has served as Chairman of the Board of
Directors and President of the Company since January 1996.
Mr. Ekstrom has also served as the Company's Chief Financial
Officer and Secretary since December 1994 and December 2001,
respectively. Mr. Ekstrom holds a B.A. from Cornell
University and an M.B.A. from Boston University. From 1990
through 1991, Mr. Ekstrom was President of Cost Containment
Corporation and from 1993 through 1994, he was Chief
Operating Officer of Preferred Solutions Inc., both of which
were start-up pharmacy benefit management companies. Age,
58.

ROBERT E. HANNAN 1999
Robert E. Hannan was the Principal and Chief Executive
Officer of the Genesis Group, a consulting group that has
focused its activities since 1981 on the evaluation and
commercialization of new technology for the Pharmaceutical,
Biotechnology and Diagnostic Medicine industry. Mr. Hannan
is also Founder/CEO of POV Incorporated, a strategic report
publishing firm and four health care newsletters under the
"Genesis Report" brand name. These publishing assets were
sold to Wolters Kluwer in 1999 and Mr. Hannan remains as a
consultant to that organization. He also serves as a member
of the Board of Directors of three other privately held
Healthcare and Biotechnology companies. Age, 55.
</Table>

<Table>
<Caption>
DIRECTOR
NAME, PRINCIPAL OCCUPATION, AND AGE SINCE
----------------------------------- --------

JOSEPH LOVETT 2001
Joseph Lovett is a managing director of Saturn Life
Sciences, a Boston and Pittsburgh based venture capital fund
focusing on investing in new science companies. He was
formerly President of Beacon Life Sciences, a Boston area
venture capital development corporation. Mr. Lovett is also
a General Partner of Medical Science Partners, a venture
capital fund. Mr. Lovett previously was a member of the
Board of Directors of Periodontix, Inc. which was acquired
by the Company in July 2001. Mr. Lovett previously held
senior management positions with MDS Capital, Damon Biotech,
Inc., C.R. Bard and Mallinckrodt, Inc. Age, 53.

NOMINEE TO BE ELECTED BY ALL STOCKHOLDERS

JERRY B. HOOK 1999
Jerry B. Hook, Ph.D., is the former Chairman of the Board
and CEO of Sparta Pharmaceuticals, Inc., which was recently
sold to Supergen, Inc. Dr. Hook was previously President and
CEO of Lexin Pharmaceutical, which was acquired by Sparta in
1996. Prior to Lexin, he was Senior Vice President and
Director, Research and Development SmithKline Beecham
Pharmaceuticals. Currently, Dr. Hook is on the Board of
Directors of two privately held biotechnology firms. Dr.
Hook was Professor of Pharmacology and Toxicology at
Michigan State University and Director, Center for
Environmental Toxicology. Age, 64.

NOMINEES TO BE ELECTED BY PREFERRED STOCKHOLDERS

KONRAD WEIS 1998
Konrad M. Weis, Ph.D., is the former President and Chief
Executive Officer of Bayer USA, the American subsidiary of
Bayer AG, a chemical, pharmaceutical and information
company. Dr. Weis is currently on the boards of PNC Equity
Management Corporation, Titan Pharmaceuticals and Visible
Genetics, Inc. In addition, he is a trustee of Carnegie
Mellon University and the Heinz Endowments. Age, 73.

JAMES COLKER 1998
James Colker is the Managing General Partner of Colker and
Newlin Management Associates III ("CNMA"), and managing
partner of the CEO Venture Fund III ("CEO"). He is also a
director of the Pittsburgh Technology Council, the
Pennsylvania Technology Council and trustee of Penn
Southwest Association, as well as a board member of a number
of small advanced technology companies. Previously, Mr.
Colker was Chairman and Chief Executive Officer of Contraves
Goerz Corporation. Age, 73.
</Table>

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the
Company's directors, executive officers and persons who beneficially own more
than ten percent of a class of the Company's registered equity securities to
file with the Securities and Exchange Commission and deliver to the Company
initial reports of ownership and reports of changes in ownership of such
registered equity securities.

To the Company's knowledge, based solely on a review of the copies of such
reports furnished to the Company or written representations that no other
reports were required, the Company's directors, executive officers and more than
ten percent stockholders filed on a timely basis all reports due under Section
16(a) for the year ended September 30, 2001, and for previous fiscal years,
except as described below.

With respect to the year ended September 30, 1999, CEO Venture Fund III ("CEO")
and the following individuals, all of whom are affiliated with CEO, failed to
file a Form 3 with respect to the Company: its general partner (Colker and
Newlin Management Associates III "CNMA III"), Eugene R. Yost, Gary G. Glausser,
Ned Renzi and Glen Chatfield (collectively, the "Partners"). With respect to the
year ended September 30, 2000, CEO and its Partners failed to file Forms 4 with
respect to two transactions by CEO. With respect to the year ended September 30,
2001, CEO and its Partners failed to timely file Forms 4 with respect to one
transaction by CEO during the year. For each of the above transactions, CEO and
its Partners have filed the required forms.

Periodontix, Inc. ("Periodontix") did not timely file Forms 3 and 4 for the
Common Stock and warrants to purchase Common Stock issued by the Company to
Periodontix in January, April and July of 2001 in connection with the Company's
three-stage acquisition of certain assets of Periodontix. The required Form 3
has been filed.

THE BOARD OF DIRECTORS RECOMMENDS THAT STOCKHOLDERS' VOTE "FOR" THE ELECTION OF
EACH OF THE NOMINEES.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth information regarding beneficial ownership of the
Company's Common Stock by (i) all persons (including any "group as that term is
defined in Section 13 (d)(3) of the Securities Exchange Act of 1934, as
amended), who were known by the Company to be the beneficial owners of more that
5% of the outstanding Common Stock (ii) each director of the Company, (iii) each
executive officer of the Company named in the Summary Compensation Table set
forth above under "Executive Compensation" and (iv) all directors and executive
officers of the Company as a group. Except as otherwise indicated in the
footnotes to the table, all beneficial ownership information set forth below is
as of July 15, 2002.

<Table>
<Caption>
BENEFICIAL OWNERSHIP
--------------------
TITLE OF NUMBER OF
NAME AND ADDRESS CLASS SHARES (1) % (1)
---------------- -------- ----------- ------

Richard D. Ekstrom (2) Common 2,988,250 5.76%
1051 Brinton Road
Pittsburgh, PA 15221
Robert E. Hannan (3) Common 160,000 *
1051 Brinton Road
Pittsburgh, PA 15221
Konrad Weis Ph.D. (4) Common 1,009,616 1.95%
1051 Brinton Road
Pittsburgh, PA 15221
James Colker (5) Common 10,785,000 18.87%
One North Shore Center
Suite 201
12 Federal Street
Pittsburgh, PA 15212
Jerry B. Hook Ph.D. (6) Common 160,000 *
1051 Brinton Road
Pittsburgh, PA 15221
Joseph P. Lovett. (7) Common 25,000 *
1051 Brinton Road
Pittsburgh, PA 15221
All Directors and Officers Common 15,127,866 25.94%
as a group (6 persons)
Periodontix, Inc. (8) Common 17,685,000 29.25%
29 Babe Ruth Drive
Sudbury, MA 01406
CEO Venture Fund III (9) Common 10,685,000 18.71%
One North Shore Center
Suite 201
12 Federal Street
Pittsburgh, PA 15212
</Table>

- ---------------
* Less than 1%

(1) Beneficial ownership is determined in accordance with the rules of the
Securities & Exchange Commission and generally includes voting or investment
power with respect to securities. Shares of Common Stock subject to options
or warrants
4

currently exercisable or convertible, or exercisable or convertible within
60 days of July 15, 2002, are deemed outstanding for computing the
percentage of the person holding such option or warrant but are not deemed
outstanding for computing the percentage of any other person. Except as
indicated in the footnotes to this table and pursuant to applicable
community property laws, the persons named in the table have sole voting and
investment power with respect to all shares of Common Stock beneficially
owned.

(2) Includes 450,000 shares of Common Stock issuable upon the exercise of
options that are currently exercisable.

(3) Represents 160,000 shares of Common Stock issuable upon the exercise of
options that are currently exercisable.

(4) Includes 75,000 shares of Common Stock issuable upon the exercise of options
that are currently exercisable. Additionally, Mr. Weis has a warrant to
purchase 200,000 shares of the Company's Common Stock at an exercise price
of $0.75 per share. The Warrant expires on March 31, 2005. Mr. Weis is the
managing partner of Weis Capital Fund LP ("Fund") and, thus, may be deemed
to have beneficial ownership over the Fund's 234,000 shares of the Company's
Common Stock and 100,000 Warrants held by the Fund. The Warrant is at an
exercise price of $0.75 per share. The Warrant expires on March 31, 2005

(5) As managing general partner of CNMA III, the managing general partner of
CEO, Mr. Colker may be deemed to have beneficial ownership of the Company's
securities owned by CEO. On June 15, 1998, CEO purchased from the Company
4,444,444 shares of Preferred Stock which are convertible into 4,444,444
shares of the Company's Common Stock and a warrant to purchase 4,965,556
shares of the Company's Common Stock at an exercise price of $0.45 per
share. The warrant expires on June 14, 2008. On April 5, 2000, CEO purchased
400,000 units from the Company. Each unit consisted of one (1) share of
Common Stock and a warrant to purchase one (1) share of the Company's Common
Stock at $0.75 per share. That warrant expires on March 31, 2005. On
September 26, 2001, CEO purchased 200,000 units from the Company. Each unit
consisted of one (1) share of Common Stock and a warrant to purchase one (1)
share of the Company's Common Stock at $0.75 per share. That warrant expires
on May 31, 2006.

Additionally, Mr. Colker has assigned to CEO options to purchase, in the
aggregate, 75,000 shares of the Company's Common Stock that were granted to
him as a director of the Company which are: (i) options to purchase 25,000
shares of Common Stock at an exercise price of $0.45 per share, (ii) options
to purchase 25,000 shares of Common Stock at an exercise price of $0.50 per
share, and (iii) options to purchase 25,000 shares of Common Stock at an
exercise price of $0.75 per share. The options are all currently exercisable.

During fiscal 2001, Mr. Colker purchased 50,000 units from the Company. Each
unit consisted of one (1) share of Common Stock and a warrant to purchase one
(1) share of the Company's Common Stock at $0.75 per share. That warrant
expires on May 31, 2006.

(6) Represents 160,000 shares of Common Stock issuable upon the exercise of
options that are currently exercisable.

(7) Represents 25,000 shares of Common Stock issuable upon the exercise of
options that are currently exercisable.

(8) Includes warrants to purchase 9,000,000 shares of the Company's Common Stock
at an exercise price of $1.25 per share. The warrants expire in 2006.

(9) On June 15, 1998, CEO purchased from the Company 4,444,444 shares of
Preferred Stock which are convertible into 4,444,444 shares of the Company's
Common Stock and a warrant to purchase 4,965,556 shares of the Company's
Common Stock at an exercise price of $0.45 per share. The warrant expires on
June 14, 2008. On April 5, 2000, CEO purchased 400,000 units from the
Company. Each unit consisted of one (1) shares of Common Stock and a warrant
to purchase one (1) share of the Company's Common Stock at $0.75 per share.
That warrant expires on March 31, 2005. On September 26, 2001, CEO purchased
200,000 units from the Company. Each unit consisted of one (1) shares f
Common Stock and a warrant to purchase one (1) share of the Company's Common
Stock at $0.75 per share. That warrant expires on May 31, 2006.

During the fiscal year ended September 30, 2001, there were ten regular meetings
of the Board of Directors, and each of the incumbent directors attended at least
75% of the total number of meetings of the Board of Directors during their
tenure as a

director except for Mr. Hannan who attended 60% of the meetings. Each of the
incumbent directors attended at least 75% of the meetings of the committees of
the Board of Directors on which they served during the fiscal year during their
tenure as a director.

The Board of Directors has several committees which perform various functions.
The Audit Committee reviews the work of the Corporation's independent auditors
and management to ensure that each is properly discharging its responsibilities
in the area of financial control and reporting. The committee presently consists
of Messrs. Colker, Weis, Lovett, Hannan and Hook. The Audit Committee held one
meeting in the fiscal year ended September 30, 2001, however telephonic
discussions were held on a quarterly basis with the independent auditors.

The Nominating Committee recommends prospective nominees for election to the
Board of Directors. The committee presently consists of Messrs. Colker, Weis,
Lovett, Hook, Hannan and Ekstrom. The Nominating Committee held one meeting in
the fiscal year ended September 30, 2001. The Nominating Committee will consider
recommendations by stockholders in accordance with the Corporation's By-Laws.
Any such recommendations are to be submitted to the Secretary of the Corporation
in accordance with the By-Laws.

The Compensation Committee is responsible for administering the Corporation's
Stock Option Plan, designating employees eligible to participate in such plan,
the number of options to be granted and the terms and conditions of each option.
The Compensation also reviews the performance of the Corporation's management
and makes recommendations with respect to the compensation of management. The
committee presently consists of Messrs. Colker, Weis, Lovett, Hook and Hannan.
The Compensation Committee held one meeting in the fiscal year ended September
30, 2001.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

The Compensation Committee consists of Messrs. Colker, Weis, Lovett, Hook and
Hannan.

EXECUTIVE OFFICERS; COMPENSATION

EXECUTIVE OFFICERS

Executive officers of the Company as of July 31, 2002 are as follows:

<Table>
<Caption>
NAME AGE POSITION HELD
- ---- --- -------------

Richard D. Ekstrom 58 Chairman, President and Secretary
</Table>

SUMMARY COMPENSATION TABLE

The following table sets forth information with respect to the named executives
concerning their respective annual and long term compensation for the last three
years.

SUMMARY COMPENSATION TABLE

<Table>
<Caption>
ANNUAL COMPENSATION AWARDS PAYOUTS
-------------------------------------- -----------------------------------
(E) (F) (G) (H) (I)
(A) (B) (C) (D) OTHER ANNUAL RESTRICTED OPTIONS/ LTIP ALL OTHER
NAME AND YEAR SALARY BONUS COMPENSATION STOCK SARS PAYOUTS COMPENSATION
PRINCIPAL POSITION (A) ($) ($) ($) AWARDS($)(C) (#) ($) ($)(E)
------------------ --- --------- ------- ---------------- -------------- -------- ------- ------------

Richard D. Ekstrom 2001 $180,000 $40,000 -- -- -- -- --
President 2000(B) $140,000 $25,000 -- -- 600,000 -- --
1999 $120,000 -- -- -- -- -- --
S. Robert Fatora 2001 $211,666 -- -- -- -- -- --
COO 2000(D) $102,500 -- -- $264,000 1,400,000 -- --
1999 $ -- -- -- -- -- -- --
Jesse M. Jaynes 2001 $136,700 $12,500 -- -- -- -- $2,338
Chief Scientist 2000 $120,000 $10,000 -- -- -- -- $2,048
1999 $120,000 -- -- -- -- -- $1,648
</Table>

- ---------------
(A) Represents fiscal years ended September 30.

(B) Of the 600,000 option grant to Mr. Ekstrom in Fiscal 2000, 450,000 have
vested with the remaining shares vesting on May 1, 2003. The exercise price
of these options is $0.75 per share and the options expire in Fiscal 2010.

(C) Dr. Fatora received 300,000 restricted Common Shares upon his employment
with the Company, such shares are still held by Dr. Fatora. They were valued
at $0.88 per share (the closing share price on the day he commenced his
employment with the company (April 1, 2000)).

(D) Upon his employment with the Company, Dr. Fatora received options to
purchase up to 1,200,000 shares of the Corporation's common stock at
exercise prices of $0.45 and $0.90 per share. The options vest the earlier
of seven years from issue or the achievement of certain performance
objectives. The options expire in Fiscal 2010. He also received options for
200,000 shares of which 100,000 are vested and 100,000 vest on April 1, 2002
at an exercise price of $0.45 per share and expire in fiscal 2010. All of
Dr. Fatora's options expired with his termination in January 2002.

(E) Represents premiums on $1 million life insurance policy on the life of Dr.
Jaynes whose beneficiary Dr. Jaynes' family. The policy lapsed in fiscal
2002 due to Dr. Jaynes termination.

Messrs. Ekstrom, Fatora and Jaynes have signed employment agreements with the
Company.

Mr. Ekstrom's agreement, dated June 15, 1998, is for one year and automatically
renews each June 1 unless either Mr. Ekstrom or the Company elects not to renew.

On January 4, 2001, Dr. Fatora resigned his employment with the Company. Dr.
Fatora's employment agreement was for a three year term commencing on April 1,
2000.

On January 16, 2001, Dr. Jaynes' employment was terminated with the Company and
he resigned as a member of the Company's Board of Directors.

COMPENSATION OF DIRECTORS

The non-employee directors of the Company are reimbursed for expenses that they
incur in performing Board duties.

During Fiscal 2001, the members of the Company's Board of Directors received the
following options to purchase shares of the Company's Common Stock. All of these
options expire in Fiscal 2006.

<Table>
<Caption>
DIRECTOR OPTIONS TO PURCHASE EXERCISE PRICE
-------- ------------------- --------------

Konrad Weis 25,000 shares $0.75
James Colker (A) 25,000 shares $0.75
Robert Hannan 35,000 shares $0.75
Jerry Hook 35,000 shares $0.75
Joseph Lovett (B) 25,000 shares $0.75
</Table>

- ---------------
(A) Mr. Colker assigned his options to CEO.

(B) Mr. Lovett received 25,000 options upon his appointment to the Board of
Directors in August 2001.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Mr. Colker is an affiliate of CEO Venture Fund, which beneficially owns
approximately 18.71% of the Company's capital stock and has the right to elect
two of the Company's Directors.

Before joining the Company's Board of Directors, Mr. Lovett previously served as
a director of Periodontix, Inc. which sold substantially all of its assets to
the Company in a series of transactions which were completed on July 16, 2001.
As a result of such transactions, Periodontix beneficially owns approximately
29.25% of the Company's capital stock.

During March 2002, in conjunction with the exercise of options, the Company sold
1,700,000 shares of common stock to an Mr. Ekstrom at purchase prices of $.05 to
$.15 per share. Recourse (to the general assets of the borrowers) promissory
notes

in the amount of $145,000 are to be issued in conjunction with this sale. The
notes are due one year after the sale of the related shares. If the shares are
donated to charity, the Company will waive repayment of that portion of the
notes which relate to the donated shares.

RATIFICATION OF INDEPENDENT AUDITORS

The Board of Directors of the Company, acting upon the recommendation of its
Audit Committee, has appointed Ernst & Young LLP, independent auditors, to
examine the financial statements of the Company for the fiscal year ending
September 30, 2002. Ernst & Young LLP has conducted the annual audit of the
Company's financial statements since 1995. Although stockholder approval of this
appointment is not required by law or binding on the Board, the Board believes
that stockholders should be given this opportunity to express their views. If
the stockholders do not ratify the appointment of Ernst & Young LLP as the
Company's independent auditors, the Board will consider this vote in determining
whether or not to continue the engagement of Ernst & Young LLP.

A representative of Ernst & Young LLP is expected to be present at the meeting
with an opportunity to make a statement if such representative desires to do so
and to respond to appropriate questions.

Fees paid to Ernst & Young LLP for the last fiscal year were: Annual Audit -
$38,500 (including reviews of quarterly filings) and Audit Related Service
$10,663 (including $7,163 of procedures relative to a Registration Statement on
Form SB-2 to register stock related to warrants issued as part of private
placement and $3,500 of services related to a Current Report on Form 8-K/A
filing in connection with its acquisition of Periodontix).

The Audit Committee believes that the above services are compatible with
maintaining Ernst & Young LLP's independence.

THE BOARD OF DIRECTORS RECOMMENDS RATIFICATION OF THE APPOINTMENT OF ERNST &
YOUNG LLP.

OTHER BUSINESS

The Board of Directors is not aware of any other matter to be voted upon at the
meeting. However, stockholders unable to attend the Annual Meeting of
Stockholders may permit the person or persons designated in the proxy form
submitted by them to vote their shares in their discretion upon any other
business which may properly come before the meeting.

AUDIT COMMITTEE MATTERS

Securities & Exchange Commission rules now require that every year the report of
the Audit Committee be included.

DEMEGEN, INC.

REPORT OF AUDIT COMMITTEE

The Audit Committee oversees the Company's financial reporting process on behalf
of the Board of Directors. Management has the primary responsibility for the
financial statements and the reporting process including the systems of internal
controls. In fulfilling its oversight responsibilities, the Audit Committee
reviewed the audited financial statements of the Annual Report on Form 10-KSB
with management including a discussion of the quality, not just the
acceptability, of the accounting principles, the reasonableness of significant
judgements, and clarity of disclosures of the financial statements.

The Audit Committee reviewed with the independent auditors, who are responsible
for expressing an opinion on the conformity of those financial statements with
generally accepted accounting principles, their judgements as to the quality,
not just the acceptability, of the Company's accounting principles and such
other matters as are required to be discussed with the Audit Committee under
generally accepted auditing standards. In addition, the Audit Committee has
discussed with the independent auditors, the auditors' independence from
management and the Company including the matters in the written disclosures
required by the Independence Standards Board.

The Audit Committee discussed with the Company's independent auditors the
overall scope and plans for their audit. The Audit Committee meets with the
independent auditors, with and without management present, to discuss the
results of their examinations, their evaluations of the Company's internal
controls, and the overall quality of the Company's financial

reporting. The Audit Committee held one meeting during Fiscal 2001, however
telephonic discussions were held on a quarterly basis with the independent
auditors..

In reliance on the reviews and discussions referred to above, the Audit
Committee recommended to the Board of Directors, and the Board of Directors
approved, that the audited financial statements be included in the Annual Report
on Form 10-KSB for the year ended September 30, 2001 for filing with the
Securities and Exchange Commission. The Audit Committee and the Board of
Directors have also recommended, subject to shareholder ratification, the
selection of the Company's independent auditors.

The Audit Committee has adopted a written charter which was included in the
Company's proxy statement for its annual meeting held on February 16, 2001.

Respectfully submitted,

James Colker, Chairman
Robert E. Hannan
Jerry B. Hook, Ph.D.
Joseph Lovett
Konrad M. Weis, Ph.D

STOCKHOLDERS' PROPOSALS FOR 2002 ANNUAL MEETING

Pursuant to Rule 14a-8 under the Securities and Exchange Act of 1934, as amended
(the "Exchange Act"), stockholders may present proper proposals for inclusion in
the Company's proxy statement and for consideration at the next Annual Meeting
of Stockholders by submitting such proposals to the Company in a timely manner.
In order to be so included for the 2003 Annual Meeting, stockholder proposals
must be received by the Company no later than November 1, 2002 and must
otherwise comply with the requirements of Rule 14a-8. Stockholder proposals
submitted outside the processes of Rule 14a-8 must be received by the Company no
later than December 1, 2002 and must otherwise comply with the requirements of
Rule 14a-4(c) under the Exchange Act; in accordance with Rule 14a-4(c), proxy
holders will have discretionary authority to vote in accordance with their
judgement upon any such proposal which is not timely received by the Company or
which does not otherwise comply with Rule 14a-4(c).

PART II
ITEM 5 -- MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

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

<Table>
<Caption>
FISCAL QUARTERS ENDED
-----------------------------------------------
FISCAL DECEMBER 31 MARCH 31 JUNE 30 SEPTEMBER 30
- ------ ----------- -------- ------- ------------

2001
High............................................... $1.01 $1.00 $0.67 $0.52
Low................................................ $0.42 $0.56 $0.47 $0.34
2000
High............................................... $0.33 $1.53 $1.00 $0.65
Low................................................ $0.19 $0.29 $0.53 $0.46
</Table>

At December 2, 2001, there were 503 holders of record of 44,022,778 shares of
Common Stock, exclusive of holders which maintain their ownership in
"Street-Name" at brokerage houses, and one holder of record of 4,444,444 shares
of Preferred Stock. There are approximately 2,050 stockholders which hold their
ownership in street name.

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

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

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

The investors were offered one unit at $0.50 per unit. Each unit consisted of
one share of restricted common stock and a warrant to purchase one share of the
Company's Common Stock for $0.75 per share. The warrant expires the earlier of
May 31, 2006 or 60 days after a call by the Company. The Company may call the
warrants at any time, provided that the price of the Company's common stock has
been in excess of $1.50 per share for each of the twenty consecutive trading
days immediately preceding the date of the call. Upon receipt of the call,
warrant holders shall have sixty days to elect to exercise all or a portion of
the warrants.

SELECTED FINANCIAL DATA

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

<Table>
<Caption>
DECEMBER 6,
1991
(INCEPTION)
YEAR ENDED SEPTEMBER 30, TO
----------------------------------------------------------------------- SEPTEMBER 30,
2001 2000 1999 1998 1997 2001
------------ ------------ ------------ ------------ ----------- ----------------

STATEMENT OF OPERATIONS
DATA:
Grant and Other Income... $ 1,111,004 $ 763,765 $ 1,118,576 $ 1,376,918 $ 764,834 $ 5,691,266
License amortization and
purchased research &
development related to
Periodontix
acquisition............ 7,667,739 -- -- -- -- 7,667,739
Total Expenses........... 11,614,079 2,419,247 2,456,318 3,370,671 1,708,607 30,625,090
Net Loss................. (10,503,075) (1,655,482) (1,337,742) (1,993,753) (943,773) (24,933,824)
Net Loss per Share
(dilutive)............. $ (0.29) $ (0.06) $ (0.06) $ (0.13) $ (0.05)
Dividends per Share...... $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ 0.00
Weighted Average Number
of Common Shares
Outstanding............ 37,163,279 29,759,153 26,255,104 23,867,091 19,537,047
BALANCE SHEET DATA:
Cash & Cash
Equivalents............ $ 537,478 $ 1,825,352 $ 583,585 $ 1,686,658 $ 310,252
Working Capital
(deficiency)........... (304,245) 1,413,408 6,849 1,329,541 (1,498,477)
Total Assets............. 837,500 2,311,592 1,084,505 2,114,750 651,963
Long-term obligations.... 354,286 360,180 203,147 -0- -0-
Deficit accumulated
during development
stage.................. (26,814,911) (16,039,877) (14,119,462) (12,523,358) (9,443,772)
Redeemable convertible
preferred Stock........ 2,305,748 2,033,787 1,768,846 1,510,487 -0-
Shareholders' Equity
(Deficit).............. (2,717,067) (633,989) (1,555,934) (122,130) (1,158,216)
</Table>

ITEM 6 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION & RESULTS
OF OPERATIONS

GENERAL

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

The Company is a "Development Stage Company" in the clinical trial stage. The
primary drugs under development target significant markets for which there are
few, if any, satisfactory alternatives. These include treatment for oral
candidiasis, a disease prevalent in HIV patients, a treatment for Pseudomonas in
CF patients, a disease that can be fatal to children, and a treatment for
glioblastoma, a form of head and neck cancer that has a very low survival rate.
During Fiscal 2001, the Company acquired most of the assets of Periodontix,
Inc., another peptide therapeutic company, thereby nearly doubling its
technology assets and product pipeline. Synergies between the two companies will
enhance and accelerate the development of products built on complementary
peptide platforms. A number of additional applications for preventing or
treating infectious disease are also in the development pipeline.

RESULTS OF OPERATION

SEPTEMBER 30, 2001 VS 2000

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

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

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

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

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

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

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

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

SEPTEMBER 30, 2000 VS 1999

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

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

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

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

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

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

LIQUIDITY AND CAPITAL RESOURCES

FISCAL 2001

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

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

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

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

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

FISCAL 2000

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

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

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

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

FISCAL 1999

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

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

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

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

PROSPECTIVE/FORWARD-LOOKING INFORMATION

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

In addition, information regarding market and industry statistics and other
numbers contained in this Annual Report are included based upon information
available to us that we believe is accurate. It is generally based on academic
and other publications. We have not independently verified all data and cannot
assure you of the accuracy of the data we have included.

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

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

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

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

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

Not applicable

REPORT OF INDEPENDENT AUDITORS

Board of Directors
Demegen, Inc.

We have audited the accompanying balance sheets of Demegen, Inc. (a development
stage company) as of September 30, 2001 and 2000, and the related statements of
operations, shareholders' deficit, and cash flows for each of the three years in
the period ended September 30, 2001 and for the period from December 6, 1991
(inception) through September 30, 2001. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.

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

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

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

/s/ ERNST & YOUNG LLP

Pittsburgh, PA
November 30, 2001

DEMEGEN, INC.
(A DEVELOPMENT STAGE COMPANY)

BALANCE SHEETS

<Table>
<Caption>
SEPTEMBER 30,
----------------------------
2001 2000
------------ ------------

ASSETS
Current assets:
Cash and cash equivalents................................. $ 537,478 $ 1,825,352
Accounts receivable....................................... 46,310 22,409
Prepaid expenses and other current assets................. 6,500 --
------------ ------------
Total current assets.................................... 590,288 1,847,761
Property and equipment:
Furniture and equipment................................... 339,843 231,175
Computer hardware and software............................ 135,906 134,626
------------ ------------
475,749 365,801
Less accumulated depreciation and amortization............ (280,116) (208,971)
------------ ------------
195,633 156,830
Intangible assets:
Licenses.................................................. -- 245,000
Patents................................................... 31,162 357,918
------------ ------------
31,162 602,918
Less accumulated amortization............................... -- (297,836)
------------ ------------
31,162 305,082
Other assets................................................ 20,417 1,919
------------ ------------
Total assets............................................ $ 837,500 $ 2,311,592
============ ============
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts Payable.......................................... $ 725,552 $ 263,303
Accrued payroll........................................... -- 97,261
Unearned revenue.......................................... 50,000 --
Current portion of notes payable.......................... 97,130 42,000
Other liabilities......................................... 21,851 31,789
------------ ------------
Total current liabilities............................... 894,533 434,353
Notes payable............................................... 354,286 360,180
Other....................................................... -- 117,261
------------ ------------
Total liabilities....................................... 1,248,819 911,794
Commitments and contingency
Redeemable convertible preferred stock, $.001 par value --
40,000,000 shares authorized; 4,444,444 shares issued and
outstanding............................................... 2,305,748 2,033,787
Shareholders' deficit:
Common stock, $.001 par value -- 100,000,000 shares
authorized; 44,022,778 and 32,304,778 shares issued and
outstanding at September 30, 2001 and September 30,
2000, respectively...................................... 44,023 32,305
Warrants.................................................. 4,362,301 1,287,004
Deferred Compensation..................................... (332,344) (343,999)
Subscription receivable................................... (291,150) (188,511)
Additional paid-in capital................................ 20,315,014 14,619,089
Deficit accumulated during the development stage.......... (26,814,911) (16,039,877)
------------ ------------
Total shareholders' deficit............................. (2,717,067) (633,989)
------------ ------------
Total liabilities and shareholders' deficit............. $ 837,500 $ 2,311,592
============ ============
</Table>

See accompanying notes.
16

DEMEGEN, INC.
(A DEVELOPMENT STAGE COMPANY)

STATEMENTS OF OPERATIONS

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

Income:
License.................................... $ 190,000 $ 220,000 $ 350,000 $ 1,766,651
Grant and other............................ 860,033 472,432 708,475 3,687,341
Interest................................... 60,971 71,333 60,101 237,274
------------ ----------- ----------- ------------
Total income............................ 1,111,004 763,765 1,118,576 5,691,266
Expenses:
Research and development................... 2,551,968 1,560,981 1,513,680 9,605,834
General and administrative................. 1,211,160 709,533 784,891 11,593,312
Interest................................... 20,034 14,207 3,140 1,016,965
License amortization and purchased research
& development related to the Periodontix
acquisition............................. 7,667,739 -- -- 7,667,739
Depreciation and amortization.............. 163,178 134,526 154,607 741.240
------------ ----------- ----------- ------------
Total expenses.......................... 11,614,079 2,419,247 2,456,318 30,625,090
------------ ----------- ----------- ------------
Net loss..................................... (10,503,075) (1,655,482) (1,337,742) (24,933,824)
Preferred dividend and accretion amounts..... (271,959) (264,933) (258,362) (1,881,087)
------------ ----------- ----------- ------------
Net loss applicable to common stock.......... $(10,775,034) $(1,920,415) $(1,596,104) $(26,814,911)
============ =========== =========== ============
Net loss per common share, basic and
diluted.................................... $ (0.29) $ (0.06) $ (0.06)
============ =========== ===========
Weighted average common stock outstanding.... 37,163,279 29,759,153 26,255,104
============ =========== ===========
</Table>

See accompanying notes.

DEMEGEN, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF SHAREHOLDERS' DEFICIT
<Table>
<Caption>

AVERAGE COMMON STOCK ADDITIONAL RECEIVABLE
PRICE -------------------- DEFERRED PAID-IN FROM
PER SHARE SHARES AMOUNT WARRANTS COMPENSATION CAPITAL SHAREHOLDERS
--------- ---------- ------- ---------- ------------ ----------- ------------

Acquired in merger with Excelsior
Capital Corporation............... 10,743,571 $10,744 $ -- $ -- $ 312,681 $ --
Loss from inception (December 6,
1991) to September 30, 1992....... -- -- -- -- -- --
Capital contributed by a
shareholder....................... -- -- -- -- 123,700 --
Proceeds from the sale of
unrestricted shares contributed by
shareholders in exchange for
restricted shares................. $ .62 439,045 439 -- -- 272,461 --
Payment of debt with stock
warrants.......................... -- -- -- -- 33,333 --
Payment of interest with stock
warrants.......................... -- -- -- -- 17,774 --
Issuance of receivable from
officer........................... -- -- -- -- -- (65,117)
Net loss for the year............... -- -- -- -- -- --
---------- ------- ---------- --------- ----------- ---------
Balance at September 30, 1993........ 11,182,616 11,183 -- -- 759,949 (65,117)
Proceeds from the sale of
unrestricted shares by
shareholders in exchange for
restricted shares................. .75 691,738 692 -- -- 517,708 --
Issuance of stock for consulting
services.......................... 1.54 58,336 58 -- -- 89,942 --
Issuance of stock subscriptions for
loan origination fee.............. 1.14 131,250 131 -- -- 149,869 --
Payment of interest with stock
warrants.......................... -- -- -- -- 56,164 --
Net loss for the year............... -- -- -- -- -- --
---------- ------- ---------- --------- ----------- ---------
Balance at September 30, 1994........ 12,063,940 12,064 -- -- 1,573,632 (65,117)
Proceeds from the sale of restricted
common shares..................... 1.06 193,133 193 -- -- 204,807 --
Issuance of restricted shares in
exchange for unrestricted shares
contributed by shareholders....... 171,694 172 -- -- (172) --
Proceeds from the sale of
unrestricted shares contributed by
shareholders in exchange for
restricted shares................. 2.18 -- -- -- -- 349,304 65,117
Issuance of restricted shares for
payment of
services/compensation............. .89 402,251 402 -- -- 357,681 --
Issuance of warrants................ -- -- -- -- 11,625 --
Payment of interest with stock
warrants.......................... -- -- -- -- 127,500 --
Net loss for the year............... -- -- -- -- -- --
---------- ------- ---------- --------- ----------- ---------
Balance September 30, 1995........... 12,831,018 12,831 -- -- 2,624,377 --
Proceeds from the sale of common
shares............................ .70 683,250 683 -- -- 479,817 --
Issuance of shares for payment of
services/compensation............. .60 890,868 891 -- -- 536,359 --
Issuance of shares in settlement of
outstanding debt and other
obligations....................... .47 4,468,285 4,468 -- -- 2,113,054 --
Payment of interest with warrants... -- -- -- -- 84,996 --
Net loss for the year............... -- -- -- -- -- --
---------- ------- ---------- --------- ----------- ---------
Balance at September 30, 1996........ 18,873,421 18,873 -- -- 5,838,603 --
Proceeds from the sale of restricted
and unrestricted common shares.... .36 340,000 340 -- -- 104,660 --
Issuance of shares for payment of
services/compensation............. .41 1,178,258 1,178 -- -- 477,629 --
Issuance of shares in exchange for
patent and technology license..... .35 700,000 700 -- -- 244,300 --
Issuance of restricted shares in
exchange for unrestricted shares
contributed by shareholders....... 162,720 163 -- -- (163) --
Exchange of amounts due to related
parties for restricted shares..... .33 450,000 450 -- -- 149,550 --
Exchange of redemption right of
related party for additional
restricted shares................. .33 145,000 145 -- -- (145) --
Settlement of amounts due to related
parties through debt forgiveness
and issuance of shares............ -- -- -- -- 1,449,273 --
Net loss for the year............... -- -- -- -- -- --
---------- ------- ---------- --------- ----------- ---------

<Caption>
DEFICIT
ACCUMULATED
DURING THE
DEVELOPMENT
STAGE TOTAL
------------ -----------

Acquired in merger with Excelsior
Capital Corporation............... $ -- $ 323,425
Loss from inception (December 6,
1991) to September 30, 1992....... (244,100) (244,100)
Capital contributed by a
shareholder....................... -- 123,700
Proceeds from the sale of
unrestricted shares contributed by
shareholders in exchange for
restricted shares................. -- 272,900
Payment of debt with stock
warrants.......................... -- 33,333
Payment of interest with stock
warrants.......................... -- 17,774
Issuance of receivable from
officer........................... -- (65,117)
Net loss for the year............... (1,044,154) (1,044,154)
------------ -----------
Balance at September 30, 1993........ (1,288,254) (582,239)
Proceeds from the sale of
unrestricted shares by
shareholders in exchange for
restricted shares................. -- 518,400
Issuance of stock for consulting
services.......................... -- 90,000
Issuance of stock subscriptions for
loan origination fee.............. -- 150,000
Payment of interest with stock
warrants.......................... -- 56,164
Net loss for the year............... (1,768,428) (1,768,428)
------------ -----------
Balance at September 30, 1994........ (3,056,682) (1,536,103)
Proceeds from the sale of restricted
common shares..................... -- 205,000
Issuance of restricted shares in
exchange for unrestricted shares
contributed by shareholders....... -- --
Proceeds from the sale of
unrestricted shares contributed by
shareholders in exchange for
restricted shares................. -- 414,421
Issuance of restricted shares for
payment of
services/compensation............. -- 358,083
Issuance of warrants................ -- 11,625
Payment of interest with stock
warrants.......................... -- 127,500
Net loss for the year............... (2,873,839) (2,873,839)
------------ -----------
Balance September 30, 1995........... (5,930,521) (3,293,313)
Proceeds from the sale of common
shares............................ -- 480,500
Issuance of shares for payment of
services/compensation............. -- 537,250
Issuance of shares in settlement of
outstanding debt and other
obligations....................... -- 2,117,522
Payment of interest with warrants... -- 84,996
Net loss for the year............... (2,569,478) (2,569,478)
------------ -----------
Balance at September 30, 1996........ (8,499,999) (2,642,523)
Proceeds from the sale of restricted
and unrestricted common shares.... -- 105,000
Issuance of shares for payment of
services/compensation............. -- 478,807
Issuance of shares in exchange for
patent and technology license..... -- 245,000
Issuance of restricted shares in
exchange for unrestricted shares
contributed by shareholders....... -- --
Exchange of amounts due to related
parties for restricted shares..... -- 150,000
Exchange of redemption right of
related party for additional
restricted shares................. -- --
Settlement of amounts due to related
parties through debt forgiveness
and issuance of shares............ -- 1,449,273
Net loss for the year............... (943,773) (943,773)
------------ -----------
</Table>

DEMEGEN, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF SHAREHOLDERS' DEFICIT (CONTINUED)
<Table>
<Caption>

Balance at September 30, 1997........ 21,849,399 $21,849 $ -- $ -- $ 8,263,707 $ --
Proceeds from exercise of stock
options........................... $ .05 1,750,000 1,750 -- -- 85,750 --
Compensation expense from Stock
option activity................... -- -- -- -- 1,699,440 --
Issuance of warrants................ -- -- 497,000 -- -- --
Allocation of conversion feature of
redeemable convertible preferred
stock............................. -- -- -- -- 1,022,222 --
Accretion of conversion feature of
redeemable convertible preferred
stock............................. -- -- -- -- -- --
Dividends on redeemable convertible
preferred stock................... -- -- -- -- -- --
Accretion of redeemable convertible
preferred stock................... -- -- -- -- -- --
Issuance of shares for payment of
collaborators..................... .47 20,000 20 -- -- 9,360 --
Settlement of employee litigation... .36 1,975,000 1,975 -- -- 710,217 --
Issuance of shares for services..... .47 187,500 188 -- -- 87,750 --
Issuance of additional shares to
venture capital funds and
individual investors.............. 85,000 85 -- -- (85) --
Net loss for the year............... -- -- -- -- -- --
---------- ------- ---------- --------- ----------- ---------
Balance at September 30, 1998........ 25,866,899 25,867 497,000 -- 11,878,361 --
Dividends on redeemable convertible
preferred stock................... -- -- -- -- -- --
Accretion of redeemable convertible
preferred stock................... -- -- -- -- -- --
Proceeds from exercise of Stock
options........................... .05 350,000 350 -- -- 17,150 --
Issuance of shares for services..... 0.46 145,000 145 -- -- 66,655 --
Extension of expiration date of
stock option...................... -- -- -- -- 78,000 --
Net loss for the year............... -- -- -- -- -- --
---------- ------- ---------- --------- ----------- ---------
Balance at September 30, 1999........ 26,361,899 26,362 497,000 -- 12,040,166 --
Dividends on redeemable convertible
preferred stock................... -- -- -- -- -- --
Accretion of redeemable convertible
preferred stock................... -- -- -- -- -- --
Proceeds from sale of common stock
and warrants, net of Issuance
costs of $126,783................. 0.50 5,566,004 5,566 779,241 -- 1,871,412 (282,002)
Issuance of shares and options for
services/compensation............. 0.88 376,875 377 10,763 (387,000) 707,511 93,491
Amortization of stock based
compensation...................... -- -- -- 43,001 -- --
Net loss for the year............... -- -- -- -- -- --
---------- ------- ---------- --------- ----------- ---------
Balance at September 30, 2000........ 32,304,778 32,305 1,287,004 (343,999) 14,619,089 (188,511)
Proceeds from exercise of Stock
options........................... .05 125,000 125 -- -- 6,125 --
Dividends on redeemable convertible
preferred stock................... -- -- -- -- -- --
Accretion of redeemable convertible
preferred stock................... -- -- -- -- -- --
Issuance of a warrant for
services.......................... -- -- 56,000 -- -- --
Proceeds from sale of common stock
and warrants, net of Issuance
costs of $85,968.................. 0.50 2,543,000 2,543 890,050 -- 472,425 (360,486)
Issuance of shares and options for
services/compensation............. 0.38 50,000 50 -- (74,349) 249,875 257,847
Amortization of stock based
compensation...................... -- -- -- 86,004 -- --
License Agreement and Acquisition of
Periodontix....................... 0.55 9,000,000 9,000 2,129,247 -- 4,967,500 --
Net loss for the year............... -- -- -- -- -- --
---------- ------- ---------- --------- ----------- ---------
Balance at September 30, 2001........ 44,022,778 $44,023 $4,362,301 $(332,344) $20,315,014 ($291,150)
========== ======= ========== ========= =========== =========

<Caption>
DEFICIT
ACCUMULATED
DURING THE
DEVELOPMENT
STAGE TOTAL
------------ -----------

Balance at September 30, 1997........ $ (9,443,772) $(1,158,216)
Proceeds from exercise of stock
options........................... -- 87,500
Compensation expense from Stock
option activity................... -- 1,699,440
Issuance of warrants................ -- 497,000
Allocation of conversion feature of
redeemable convertible preferred
stock............................. -- 1,022,222
Accretion of conversion feature of
redeemable convertible preferred
stock............................. (1,022,222) (1,022,222)
Dividends on redeemable convertible
preferred stock................... (40,000) (40,000)
Accretion of redeemable convertible
preferred stock................... (23,611) (23,611)
Issuance of shares for payment of
collaborators..................... -- 9,380
Settlement of employee litigation... -- 712,192
Issuance of shares for services..... -- 87,938
Issuance of additional shares to
venture capital funds and
individual investors.............. -- --
Net loss for the year............... (1,993,753) (1,993,753)
------------ -----------
Balance at September 30, 1998........ (12,523,358) (122,130)
Dividends on redeemable convertible
preferred stock................... (160,000) (160,000)
Accretion of redeemable convertible
preferred stock................... (98,362) (98,362)
Proceeds from exercise of Stock
options........................... -- 17,500
Issuance of shares for services..... -- 66,800
Extension of expiration date of
stock option...................... -- 78,000
Net loss for the year............... (1,337,742) (1,337,742)
------------ -----------
Balance at September 30, 1999........ (14,119,462) (1,555,934)
Dividends on redeemable convertible
preferred stock................... (160,000) (160,000)
Accretion of redeemable convertible
preferred stock................... (104,933) (104,933)
Proceeds from sale of common stock
and warrants, net of Issuance
costs of $126,783................. -- 2,374,217
Issuance of shares and options for
services/compensation............. -- 425,142
Amortization of stock based
compensation...................... -- 43,001
Net loss for the year............... (1,655,482) (1,655,482)
------------ -----------
Balance at September 30, 2000........ (16,039,877) (633,989)
Proceeds from exercise of Stock
options........................... -- 6,250
Dividends on redeemable convertible
preferred stock................... (160,000) (160,000)
Accretion of redeemable convertible
preferred stock................... (111,959) (111,959)
Issuance of a warrant for
services.......................... -- 56,000
Proceeds from sale of common stock
and warrants, net of Issuance
costs of $85,968.................. -- 1,004,532
Issuance of shares and options for
services/compensation............. -- 433,423
Amortization of stock based
compensation...................... -- 86,004
License Agreement and Acquisition of
Periodontix....................... -- 7,105,747
Net loss for the year............... (10,503,075) (10,503,075)
------------ -----------
Balance at September 30, 2001........ $(26,814,911) $(2,717,067)
============ ===========
</Table>

See accompanying notes.

DEMEGEN, INC.
(A DEVELOPMENT STAGE COMPANY)

STATEMENTS OF CASH FLOWS

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

CASH FLOW FROM OPERATING ACTIVITIES
Net income (loss)............................... $(10,503,075) $(1,655,482) $(1,337,742) $(24,933,824)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization................... 163,178 134,526 154,607 741,240
License amortization and purchased research &
development related to the Periodontix
acquisition................................... 7,667,739 -- -- 7,667,739
Stock issued for services....................... 388,390 161,142 -- 2,278,590
Stock based compensation........................ 86,004 43,001 -- 129,005
Issuance of stock options to employees and
directors..................................... 45,033 264,000 78,000 2,086,473
Warrants issued for interest.................... -- -- -- 286,434
Notes payable issued for services............... -- -- -- 58,194
Other........................................... (31,379) 2,134 -- (4,897)
Changes in operating assets and liabilities:
Accounts receivable............................. (23,901) 137 37,383 (46,310)
Prepaid expenses and other current assets....... (6,500) 2,057 9,802 (6,500)
Unearned revenue................................ 50,000 (91,667) (91,666) 50,000
Accounts payable and other liabilities.......... 219,162 (3,607) 217,335 1,641,600
------------ ----------- ----------- ------------
Net cash used in operating activities........... (1,945,349) (1,143,759) (932,281) (10,052,256)
CASH FLOW FROM INVESTING ACTIVITIES
Purchase of property and equipment.............. (27,613) (12,765) (210,157) (423,753)
Cash received on equipment disposals............ -- -- -- 9,643
License with & acquisition of Periodontix....... (230,000) -- -- (230,000)
Intangible assets............................... (48,912) (111,401) (64,463) (408,280)
------------ ----------- ----------- ------------
Net cash used in investing activities........... (306,525) (124,166) (274,620) (1,052,390)
CASH FLOW FROM FINANCING ACTIVITIES
Net proceeds from issuance of equity
Instruments, net of transaction costs......... 1,017,415 2,374,217 -- 7,701,132
Proceeds from exercise of stock options......... 6,250 -- 17,500 111,250
Proceeds from notes payable & capital leases.... 18,673 150,000 21,109 1,317,282
(Decrease) increase in payable to employees and
directors..................................... -- 14,550 72,614 2,687,962
Payments on notes payable....................... (78,338) (29,075) (7,395) (175,502)
------------ ----------- ----------- ------------
Net cash provided by financing activities....... 964,000 2,509,692 103,828 11,642,124
------------ ----------- ----------- ------------
Net increase (decrease) in cash and cash
equivalents................................... (1,287,874) 1,241,767 (1,103,073) 537,478
Cash and cash equivalents at beginning of
period........................................ 1,825,352 583,585 1,686,658 --
------------ ----------- ----------- ------------
Cash and cash equivalents at end of period...... $ 537,478 $ 1,825,352 $ 583,585 $ 537,478
============ =========== =========== ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION
Cash paid for interest.......................... $ 20,034 $ 8,582 $ 3,140 $ 50,258
============ =========== =========== ============
</Table>

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

See accompanying notes.

DEMEGEN, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS

SEPTEMBER 30, 2001

1. HISTORY AND NATURE OF THE BUSINESS

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

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

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

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

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

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

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

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

CASH AN CASH EQUIVALENTS

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

COMMON STOCK ISSUED FOR OTHER THAN CASH

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

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost. Depreciation is computed using the
straight-line method over the estimated useful lives (generally three to five
years) of the individual assets. Depreciation expense amounted to $71,178,
$64,134 and $56,948, during 2001, 2000 and 1999, respectively.

INTANGIBLE ASSETS

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

GRANT AND OTHER INCOME

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

During fiscal years 2001 and 1999, the Company received grant proceeds of
$400,000 and $375,000, respectively to expand efforts to develop therapeutics to
treat cancer. The funds were recognized as revenue upon receipt as the contracts
do not contain any penalties, successful outcomes clauses or refunding
provisions. License revenue is recognized as revenue upon receipt, except for
those that contain contractual provisions that require the Company to provide
services or the attainment of certain goals, in those cases, the revenues is
deferred as unearned revenue until these penalties, clauses or provisions
expire.

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

LICENSE AND SUPPORT

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

DEMEGEN, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

STOCK-BASED COMPENSATION

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

3. NEW ACCOUNTING PRONOUNCEMENTS

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

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

4. INCOME TAXES

The Company accounts for income taxes using the liability method.

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

<Table>
<Caption>
2001 2000
----------- -----------

* Compensation expense on unexercised stock options......... $ 567,980 $ 498,030
* NOL carryforwards......................................... 5,370,798 4,268,605
* Excess book amortization.................................. 2,802,828 71,894
* Other..................................................... 7,813 (7,387)
----------- -----------
Total deferred tax asset............................... 8,749,420 4,831,142
Valuation allowance....................................... (8,749,420) (4,831,142)
----------- -----------
Net deferred tax assets................................... $ 0 $ 0
=========== ===========
</Table>

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

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

5. PRIVATE PLACEMENT OF SECURITIES

During the third quarter of Fiscal 2001, the Company made a private placement of
its securities to institutional and other accredited investors raising $1.28
million of which $0.181 million was in the form of future services recognized in
equity as subscription receivable, as services are prepaid, with the remainder
of $1.09 million in cash. The private placement resulted in

DEMEGEN, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

5. PRIVATE PLACEMENT OF SECURITIES (CONTINUED)

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

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

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

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

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

6. REDEEMABLE CONVERTIBLE PREFERRED STOCK

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

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

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

DEMEGEN, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

6. REDEEMABLE CONVERTIBLE PREFERRED STOCK (CONTINUED)

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

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

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

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

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

7. STOCK OPTIONS AND WARRANTS

The Company granted stock options to certain employees and directors during the
years ended September 30, 2001 and 2000 at exercise prices which approximated or
exceeded fair value at the date of grant. The majority of the stock options
issued in the year ended September 30, 2000 were issued in connection with the
retention of the Chief Operating Officer-Pharmaceutical Products (See Note 12
for further discussion of this employment agreement). Exclusive of the
aforementioned stock options, the majority of the stock options issued in the
year ending September 30, 2000 vest over time (up to 3 years). All of the
options issued in the year ending September 30, 1999 vested immediately.

DEMEGEN, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

7. STOCK OPTIONS AND WARRANTS (CONTINUED)

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

<Table>
<Caption>
OPTIONS OUTSTANDING
------------------------------------------
WEIGHTED WEIGHTED
NUMBER AVERAGE AVERAGE
OF SHARES EXERCISE PRICE FAIR VALUE
---------- -------------- ----------

Balance at September 30, 1998.......................... 5,095,000 $0.12 $0.23
Granted................................................ 380,000 $0.45 $0.41
Options exercised for common stock..................... (350,000) $0.05 $0.37
---------- ----- -----
Balance at September 30, 1999.......................... 5,125,000 $0.15 $0.46
========== ===== =====
Options granted during year............................ 2,275,000 $0.63 $0.79
---------- ----- -----
Balance at September 30, 2000.......................... 7,400,000 $0.30 $0.56
========== ===== =====
Granted................................................ 992,500 $0.75 $0.83
Options exercised for common stock..................... (125,000) $0.05 $0.75
---------- ----- -----
Balance at September 30, 2001.......................... 8,267,500 $0.36 $0.59
========== ===== =====
</Table>

As of September 30, 2001 and 2000, 5,996,687 and 5,503,333, respectively, of the
options were vested and exercisable.

Pro forma information regarding net income and earnings per share is required by
SFAS No. 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of that Statement. The fair
value for these options was estimated at the date of grant using a Black-Scholes
options pricing model with the following weighted average assumptions for fiscal
2001, 2000 and 1999: risk-free interest rate of 6%; dividend yield of 0%;
volatility factors of the expected market price of the Company's common stock of
1.43, 1.49 and 1.41 respectively, and a weighted average expected option life of
five years.

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

Changes in the subjective input assumptions can materially affect the fair value
estimate, and therefore, the existing models do not necessarily provide a
reliable single measure of the fair value of employee stock options. Had the
compensation cost of the Company's stock option plans been determined based on
the fair value at the date of grant for awards in 2001, 2000 and 1999 consistent
with the provisions of SFAS No. 123, the Company's net loss would have been
increased to the pro forma amounts indicated below:

<Table>
<Caption>
YEAR ENDED SEPTEMBER 30,
------------------------------------------
2001 2000 1999
------------ ----------- -----------

Net loss available to common stock:
As reported....................................... $(10,775,034) $(1,920,415) $(1,596,104)
Pro forma......................................... $(11,340,598) $(2,058,313) $(1,746,117)
Basic and diluted earnings per share:
As reported....................................... $ (0.29) $ (0.06) $ (0.06)
Pro forma......................................... $ (0.31) $ (0.07) $ (0.07)
</Table>

DEMEGEN, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

7. STOCK OPTIONS AND WARRANTS (CONTINUED)

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

At September 30, 2001, there were outstanding warrants to purchase 8,185,879
shares of the Company's common stock at an exercise price of $0.75 per warrant
(refer to Note 5 for additional information). Those warrants which were sold
with the common shares in the private placements in fiscal 2001 and 2000 and
were valued at $890,050 ($0.35 per warrant) and $790,004 ($0.14 per warrant),
respectively. Additionally, the holder of the preferred stock holds a warrant to
purchase common stock (refer to Note 5 for additional information), Periodontix
holds a warrant to purchase common stock at $1.25 per share. (refer to Note 13
for additional information) and an unrelated party holds a warrant to purchase
200,000 shares of the Company's common stock at an exercise price of $1.00 per
warrant.

8. NOTE PAYABLE

In December 1999, the Company received $150,000 from a local foundation to fund
program related research. The loan matures on February 28, 2005 with a balloon
payment due at that time. The loan is at an interest rate of 5% with interest
due February 28 of each year. The loan contains call provisions which could
result in the loan becoming due before its planned maturity.

The Company does not foresee, at this time, the call provisions becoming
effective. The Company has a note payable totaling $216,820 as of September 30,
2001 which is payable at $3,500 monthly at an interest rate of 6%. Payments
under this agreement began in March 2000 and will extend until August 2007.

9. COMMITMENTS

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

During 2001, 2000 and 1999, the Company incurred rent expense totaling $153,124,
$56,830 and $45,830, respectively.

During 1997, the Company entered into a license agreement with a university to
obtain certain patent rights. In exchange for the license of the patents, the
Company issued common stock. The value assigned to the patents was based upon
management's estimate of the fair value of the stock issued. In addition, the
Company is obligated to pay certain royalties under the terms of the agreement
for each licensed product. The agreement requires minimum royalty payments to
maintain the license of the patents. The Company paid $25,000 in royalty
payments pursuant to this agreement in 2001.

10. MARKETING

In December 1997, the Company entered into a license agreement with Mycogen
Corporation, which was subsequently acquired by Dow AgroSciences whereby the
Company licensed substantially all rights for disease prevention and treatment
for agricultural applications. The Company received a license issue fee of
$950,000, consisting of $700,000 for the rights to licensed patents and the
Company's technology in the field of activity, $200,000 for the rights to the
Company's patents and technology for use in formulated licensed products and
$50,000 for the right of first refusal through September 30, 1998 to obtain an
exclusive license to the Company's Nutrition Patents and Technology. These
payments were recognized as revenue in fiscal 1998, as the earnings process was
complete according to the terms of the contract.

The agreement also provided that the Company receive $300,000 to provide Dow
AgroSciences with support services of personnel for a joint research effort for
a three year period. This was classified as unearned revenue on the balance
sheet and is being amortized into revenue, on a straight-line basis, over the
three year life of the support services commitment.
28

DEMEGEN, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

10. MARKETING (CONTINUED)

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

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

11. NET LOSS PER COMMON SHARE

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

<Table>
<Caption>
YEAR ENDED SEPTEMBER 30,
------------------------------------------
2001 2000 1999
------------ ----------- -----------

Numerator:
Net loss.......................................... $(10,503,075) $(1,655,482) $(1,337,742)
Preferred stock dividends and accretion amounts... (271,959) (264,933) (258,362)
------------ ----------- -----------
Numerator for basic loss per share -- income
available to common stockholders............... (10,775,034) (1,920,415) (1,596,104)
Denominator:
Denominator for basic and loss per
share -- weighted average shares............... 37,163,279 29,759,153 26,255,104
------------ ----------- -----------
Basic and diluted loss per share.................... $ (0.29) $ (0.06) $ (0.06)
============ =========== ===========
</Table>

At September 30, 2001, the Company had 5,996,667 vested options (8,267,500
outstanding) for the purchase of the Company's Common Stock at exercise prices
ranging from $0.05 per share to $0.875 per share. Additionally, the 4,444,444
shares of Redeemable Convertible Preferred Stock are convertible into the
Company's Common Stock on a 1 for 1 basis. Furthermore, the holder of the
Redeemable Convertible Preferred Stock holds a warrant for 4,965,556 shares of
the Company's Common Stock at an exercise price of $0.45 per share. The
purchasers of Common Stock in the 2001 and 2000 Private Placements received
aggregate warrants for 8,185,879 shares of the Company's common Stock at an
exercise price of $0.75 per share. Periodontix received warrants for 9,000,000
shares of the Company's common Stock at an exercise price of $1.25 per share and
an unrelated third party holds a warrant for 200,000 shares of the Company's
common Stock at an exercise price of $1.00 per share These potentially dilutive
securities were not included in the calculation of dilutive earnings per share
because the effect would be anti-dilutive.

12. EMPLOYMENT AGREEMENT

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

DEMEGEN, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

12. EMPLOYMENT AGREEMENT (CONTINUED)

various option agreements. At September 30, 2001, the balance in the Deferred
Compensation account was $257,995 with $86,004 and $43,001 charged against
operations in the years ending September 30, 2001 and 2000, respectively.

13. ACQUISITION

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

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

- -- On December 15, 2000, the Company made a $50,000 good faith non-refundable
payment to Periodontix. -- During February 2001, the Company issued
Periodontix 2.3 million restricted shares of the Company's Common Stock and
warrants to purchase up to 2.3 million Common Shares of the Company's Common
Stock at an exercise price of $1.25 per share. The Warrants have a five-year
term and are callable by the Company if the price of the Company's Common
Stock trades above $2.50 per share for twenty consecutive trading days.

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

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

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

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

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

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

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

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

DEMEGEN, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

13. ACQUISITION (CONTINUED)

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

<Table>

Fixed Assets................................................ $ 82,386
In-Process Research and Development......................... 2,641,953
Patents..................................................... 31,162
</Table>

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

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

<Table>
<Caption>
YEARS ENDED SEPTEMBER 30,
----------------------------
2001 2000
------------ ------------

Income...................................................... $ 1,156,004 $ 948,765
Expenses.................................................... 12,163,578 12,944,915
------------ ------------
Net Loss.................................................... (11,007,574) (11,996,150)
Preferred Dividend & Accretion Amount....................... (271,959) (264,933)
------------ ------------
Net loss applicable to common shares........................ $(11,279,533) $(12,261,083)
============ ============
Net loss per common shares.................................. $ (0.27) $ (0.32)
============ ============
Weighted average shares outstanding......................... 42,454,245 38,759,153
============ ============
</Table>

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

DEMEGEN, INC.
PROXY FOR ANNUAL MEETING OF STOCKHOLDERS
SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS

The undersigned hereby appoints Richard D. Ekstrom with full power to
act, as proxy, with the power to appoint his substitute, and hereby
authorizes him to represent and vote, as designated below, the shares
of Common Stock of Demegen, Inc. held of record by the undersigned at
the Annual Meeting of Stockholders to be held on September 12, 2002
and any adjournments thereof.

<Table>

A. Ratification of Ernst & Young LLP as independent [ ] FOR [ ] AGAINST [ ] ABSTAIN
auditors.
B. Nominees for Director
Richard D. Ekstrom [ ] FOR [ ] AGAINST [ ] ABSTAIN
Joseph Lovett [ ] FOR [ ] AGAINST [ ] ABSTAIN
Robert E. Hannan [ ] FOR [ ] AGAINST [ ] ABSTAIN
Jerry B. Hook [ ] FOR [ ] AGAINST [ ] ABSTAIN
</Table>

THIS PROXY WILL BE VOTED IN THE MANNER SPECIFIED ABOVE. IF NO
SPECIFICATION IS MADE,

THE PROXY SHALL BE VOTED "FOR" EACH OF THE PROPOSALS LISTED ABOVE AND
"FOR"

EACH OF THE NOMINEES. SUBMITTING THIS PROXY IN ADVANCE OF THE MEETING.

(Continued and to be signed on the other side)

As to any other matter, said attorneys shall vote in accordance with
the recommendation of the Board of Directors.

Please mark: I do [ ] do not [ ] plan to attend the meeting.

DATED:

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

(Signature of Stockholder)

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

(Signature if held jointly)

IMPORTANT: PLEASE DATE AND SIGN EXACTLY AS NAME APPEARS HEREON. IF SHARES
ARE HELD JOINTLY, EACH
STOCKHOLDER NAMED SHOULD SIGN.
EXECUTORS, ADMINISTRATORS,
TRUSTEES, ETC. SHOULD SO
INDICATE WHEN SIGNING. IF THE
SIGNER IS A CORPORATION, PLEASE
SIGN FULL CORPORATE NAME BY
DULY AUTHORIZE OFFICER.