Results of Operations

Fiscal 2007 Compared to Fiscal 2006

Product Sales

Product sales for the year ended December 31, 2007 increased by $466,000 (11%) to $4,772,000 from $4,306,000 in 2006, primarily due to growth in sales of First Defense®. We believe that sales of our products may be influenced by the price of milk, heifers and calves. A common index used in the industry to measure the price of milk is known as the Class III milk price, which indicates the value of 100 pounds of milk sold into the cheese market. The average Class III milk price for 2007 was $18.04 per 100 pounds, which represents a 52% increase over the 2006 average of $11.89. The average for 2006 decreased by 15% from the 2005 average of $14.05. For a point of reference, this price level was $10.42 in 2002, which approximates the price level experienced during the 1970's. While an increase in the sales value of milk is good for our customers, some of this benefit has been offset by an increase in the cost to produce milk. One measure of this relationship is known as the milk-to-feed ratio. The milk-to-feed ratio measures the amount of feed that can be purchased with one pound of milk. In December 2007, this ratio dropped below the 3.0 level for the first time since June 2007, but this level is still above levels experienced in 2006. Another indication of the economic condition of the dairy industry is the price received by producers for heifers (cows that have not given birth to a first calf). In 2007, this price is estimated to have increased by approximately 6% to $1,840 in comparison to $1,735 per cow in 2006. This 2006 price is estimated to have held relatively flat in comparison to $1,773 in 2005.

Sales of First Defense®increased by 16% during the year ended December 31, 2007 in comparison to the same period in 2006. This increase was principally driven by higher sales volume rather than higher selling prices. Sales of First Defense ® are normally seasonal, with higher sales expected during the first and fourth quarters and lower sales expected during the second and third quarters. First Defense ® continues to benefit from wide acceptance by dairy and beef producers as an effective tool to prevent calf scours. During the second quarter of 2006, certain regional organic certifying agencies determined that the ingredients in First Defense® are in compliance with the National Organic Program (NOP) and may be considered for use on organic farms. First Defense® should be considered a preventative vaccine as described in USDA-NOP regulations for organic producer consideration when establishing management plans.

Sales of Wipe Out® Dairy Wipesdecreased by 24% during the year ended December 31, 2007 in comparison to the same period in 2006. Domestic sales were essentially unchanged in 2007, and sales of this product into South Korea of approximately $90,000 during the year ended December 31, 2006 were not repeated in 2007. We believe that domestic sales growth potential is limited because most of our sales of this product tend to be to smaller farms that are under continued financial pressures that are forcing many small dairy producers out of business.

The other products we sell primarily into the dairy industry increased to $108,000 during the year ended December 31, 2007 compared to $88,000 during the same period in 2006. The other products we sell outside of dairy and beef industries, principally Isolate™ (formerly known as Crypto-Scan®), decreased to $116,000 during the year ended December 31, 2007 compared to $121,000 during the same period in 2006.

We have generally held our product selling prices without increase for the past seven years. During the first quarter of 2008, we implemented a modest increase to the selling price of First Defense®.

Other Revenues

Due primarily to the recognition of all remaining non-cash deferred technology licensing revenue during the third quarter of 2007, other revenues increased by 162%, or $801,000, to $1,297,000 during the year ended

December 31, 2007 in comparison to the same period in 2006. Technology licensing revenue increased by 170%, or $786,000 to $1,248,000 during the year ended December 31, 2007 in comparison to the same period in 2006, due to the recognition during the third quarter of 2007 of all remaining deferred revenue from milestone payments under a product development and marketing agreement with Pfizer, which terminated during the third quarter of 2007. Royalty income increased by $28,000 during the year ended December 31, 2007 in comparison to the same period in 2006, as the result of higher sales reported by the firm that has licensed our milk protein purification technology. No product development grants or contracts have been applied-for or awarded since the first quarter of 2006.

Gross Margin

Changes in the gross margin on product sales are summarized in the following
table for the respective periods (in thousands, except for percentages):



                                       Twelve Month Periods           Increase
                                        Ended December 31,           (Decrease)
                                        2007            2006       Amount       %
          Gross margin               $     2,504       $ 2,424     $    80       3 %
          Percent of product sales            52 %          56 %        (4 %)   (7 %)

Product costs amounted to 48% of product sales in 2007 as compared to 44% in 2006. Driven primarily by increased sales of First Defense®, the gross margin on product sales increased by $80,000 (3%) to $2,504,000 from $2,424,000 in 2006. Internally developed products such as First Defense® tend to have higher gross margin percentages than acquired products. We anticipate a moderately lower gross margin percentage initially as new products are developed and acquired. Our gross margin percentage during 2007 was somewhat lower than normally expected during the nine month period ended September 30, 2007. We experienced some temporary inefficiencies during the renovation of our facility, which generally resulted in decreased output with no decline in labor and overhead costs. During the nine month period ended September 30, 2007, the gross margin on First Defense ® also was adversely affected by biological yields from our raw material, which do fluctuate over time. Product mix also affects gross margin in that we earn a higher gross margin on First Defense® and a lower gross margin on Wipe Out® Dairy Wipes. More generally, we are beginning to experience higher costs for production of First Defense® and Wipe Out® Dairy Wipes due to increased labor costs and expenses associated with our efforts to implement compliance with cGMP regulations in our production processes.

Because First Defense® customers are price sensitive, we have held its selling price without significant increase for about seven years, believing that we can benefit more from higher unit sales volume than through a higher average selling price per unit. During the first quarter of 2008, we implemented a modest increase to the selling price of First Defense ® reflecting a part of the increase we have experienced in our labor and raw material costs.

Product Development and Licensing

Product development expenses increased by 64%, or $613,000, to $1,579,000 during the year ended December 31, 2007, as compared to $966,000 during the same period in 2006. Product development expenses aggregated 26% and 20% of total revenues in 2007 and 2006, respectively. During the years ended December 31, 2007 and 2006, product development expenses included $439,000 and $220,000, respectively, in amortization of the intangible asset pertaining to our November 2004 buy-out of certain future milestone and royalty payment obligations under our license to the animal health applications of Nisin. Net of these amortization expenses, product development expenses of $1,140,000 and $746,000, amounted to 24% and 17% of product sales during the years ended December 31, 2007 and 2006, respectively. The majority of our product development budget from 2000 through 2007 has been focused on the development of Mast Out®. Going forward, we expect to focus our internally-funded product development expenses on Mast Out® and other improvements, extensions or additions to our current product line and an effort to achieve cGMP compliance in our manufacturing operations.

In addition to the development efforts on Mast Out®, we are actively exploring further improvements, extensions, or additions to our current product line. We are investigating the potential to prevent scours in calves caused by pathogens other than those within the current First Defense® disease claims (E. coli K99 and coronavirus). We also remain interested in acquiring other new products and technologies that fit with our sales focus on the dairy and beef industries.

General and Administrative Expenses

General and administrative expenses increased by approximately $132,000 (18%) to $843,000 in 2007 as compared to $712,000 in 2006. These increases result, in large part, from increased stock-based compensation expense (approximately $44,000 during 2007 compared to $18,000 during 2006), costs associated with complying with the Sarbanes-Oxley Act of 2002 and other costs associated with being a publicly-held company.

Product Selling Expenses

Product selling expenses increased by approximately $35,000 (7%) to $506,000 in 2007, aggregating 11% of product sales in 2007 and 2006. We continue to leverage the efforts of our small sales force through veterinary distributors. Our objective is to maintain the ratio of product selling expenses to product sales below 15% on an annual basis.

Interest Income

Interest income increased by approximately $8,000 (3%) to $276,000 in 2007 in comparison to 2006 due principally to an increase in interest rates in 2007 that was offset, in part, by a reduction in funds invested during 2007. We have not incurred interest expense since we repaid our outstanding bank debt in May 2002.

Income Before Income Taxes and Net Income

Upon termination of the product development and marketing agreement with Pfizer, we recognized $931,000 in related deferred revenue and amortized $329,000 of an associated intangible technology asset, resulting in a $602,000 net increase to income before income taxes during the third quarter of 2007. During the year ended December 31, 2007, we recognized $1,248,000 in deferred revenue related to the product development and marketing agreement, and we recorded $439,000 in amortization expense pertaining to the associated intangible technology asset, resulting in a net increase to income before income taxes of $808,000.

Income before income taxes of $1,144,000 for the year ended December 31, 2007 compares to $1,034,000 for the year ended December 31, 2006. We recorded income tax expense at an effective tax rate of 42% and 37% in 2007 and 2006, respectively, resulting in net income of $662,000 and $647,000 for the years ended December 31, 2007 and 2006, respectively. Income tax expense included a deferred tax expense (benefit) of $435,000 and ($101,000) for the years ended December 31, 2007 and 2006, respectively. The increase in the effective tax rate was largely due to an increase in non tax deductible stock-based compensation expense. Our net income during the years ended December 31, 2007 and 2006 was $662,000 ($0.22 per diluted share) and $647,000 ($0.21 per diluted share), respectively.

Fiscal 2006 Compared to Fiscal 2005

Product Sales

Product sales for the year ended December 31, 2006 increased by $73,000 (2%) to $4,306,000 from $4,233,000 in 2005, primarily due to growth in sales of First Defense®. We believe that sales of our products are influenced by the price of milk sold by our primary customers. After declining in 2002 to price levels common in the 1970's, the price of milk increased to a recent high in 2004 before decreasing in 2005 and further decreasing

in 2006. A common index used in the industry to measure this trend is known as the Class III milk price, which indicates the value of 100 pounds of milk sold into the cheese market. The average Class III milk price for 2006 was $11.89 per 100 pounds, which represents a 15% decrease from the 2005 average of $14.05, but is still 14% higher than the 2002 price level of $10.42. The average Class III milk price for 2004 and 2003 was $15.39 and $11.42, respectively. The declines reflected in this price index over the past two years may have limited the rate of increase of our product sales.

Sales of First Defense®increased by 6% during the year ended December 31, 2006 in comparison to the same period in 2005. This increase was principally driven by higher sales volume rather than higher selling prices. Sales of First Defense ® are normally seasonal with highest sales expected in the first quarter and lower sales expected during the summer months.

Sales of Wipe Out® Dairy Wipesincreased by 9% during the year ended December 31, 2006 in comparison to the same period in 2005. During 2006, domestic sales increased 5% and foreign sales increased 20%. We believe that domestic sales growth potential is limited because most of our sales of this product tend to be to smaller farms that are under continued financial pressures that are forcing many small dairy producers out of business. Sales of this product into South Korea of approximately $90,000 and $100,000 during the years ended December 31, 2006 and 2005, respectively, were not repeated in 2007.

The other products we sell primarily into the dairy industry decreased to $88,000 during the year ended December 31, 2006 compared to $153,000 during the same period in 2005. The other products we sell outside of dairy and beef industries, principally Isolate™ (formerly known as Crypto-Scan®), decreased to $121,000 during the year ended December 31, 2006 compared to $214,000 during the same period in 2005.

We generally held our product selling prices without increase during 2006 and 2005.

Other Revenues

Other revenues for the year ended December 31, 2006 decreased by $254,000 (34%) to $495,000 from $750,000 in 2005. Technology licensing revenue included approximately $444,000 and $455,000 during the years ended December 31, 2006 and 2005, respectively, in revenue recognized from the $2,150,000 in milestone payments received from Pfizer. The remaining balance of $1,230,000 was recorded as deferred revenue at December 31, 2006 and is expected to be recognized over the period ending December 31, 2008. Effective October 1, 2005, this revenue recognition period was extended by one year from December 31, 2007. Technology licensing revenue also included approximately $18,000 and $190,000 during the years ended December 31, 2006 and 2005, respectively, under a $225,000 supplemental contract to supply and test additional Mast Out® clinical material for Pfizer. Grant income was $12,000 and $66,000 for the years ended December 31, 2006 and 2005, respectively, comprising approximately 1% of total revenues in 2006 and 2005. Most of the grant income supported work on the development of TravelGAM™. Royalty income decreased by $18,000 (46%) to $21,000 in 2006 due to lower sales of whey protein isolate by our licensee.

Gross Margin

Changes in the gross margin on product sales are summarized in the following
table for the respective periods (in thousands, except for percentages):



                                       Twelve Month Periods
                                        Ended December 31,           (Decrease)
                                        2006            2005       Amount       %
          Gross margin               $     2,424       $ 2,599     $  (176 )    (7 %)
          Percent of product sales            56 %          61 %        (5 %)   (8 %)

Product costs amounted to 44% of product sales in 2006 as compared to 39% in 2005. The gross margin on product sales decreased by $176,000 (7%) to $2,424,000 from $2,599,000 in 2005, primarily due to a higher

per unit cost of production of First Defense® and increased sales of Wipe Out ® Dairy Wipes which product has a lower gross margin. Internally developed products such as First Defense® tend to have higher gross margin percentages than acquired products. We anticipate a moderately lower gross margin percentage initially as new products are developed and acquired.

Product Development and Licensing

We decreased our product development expenditures by approximately $304,000 (24%) to $966,000 in 2006 as compared to $1,270,000 in 2005. Work under a supplemental agreement worth $225,000 to supply and test additional clinical trial material for Pfizer was 92% and 84% completed as of December 31, 2006 and 2005, respectively. Amortization expense of the intangible asset pertaining to the November 2004 buy out of our Mast Out ® royalty obligation from Nutrition 21, Inc. decreased to $220,000 during the year ended December 31, 2006 from $293,000 during the year ended December 31, 2005. The remaining asset balance of $439,000 as of December 31, 2006 is expected to be amortized to product development expense over the period ending December 31, 2008. Effective October 1, 2005, this expense amortization period was extended by one year from December 31, 2007. Product development expenses aggregated 20% and 25% of total revenues in 2006 and 2005, respectively. Product development expenses exceeded grant income by approximately $954,000 in 2006 and by $1,204,000 in 2005. These "net" product development expenses decreased to 22% of product sales in 2006 from 28% of product sales in 2005. Excluding the non-cash amortization expense, the "net" product development expenses were $734,000 and $912,000 during the years ended December 31, 2006 and 2005, respectively, amounting to 17% and 22% of product sales, respectively. The majority of our product development budget from 2000 through 2006 has been focused on the development of Mast Out ®. During this period, Pfizer was responsible for most of the Mast Out® product development expenses.

General and Administrative Expenses

General and administrative expenses decreased by approximately $3,000 (less than 1%) to $712,000 in 2006 as compared to $715,000 in 2005. Increases in salaries and other costs were offset by decreases in payments to outside advisors and consultants.

Product Selling Expenses

Product selling expenses increased by approximately $44,000 (10%) to $471,000 in 2006, aggregating 11% of product sales in 2006, compared to 10% in 2005. We expect to invest less than 15% of product sales in selling expenses. We continue to leverage the efforts of our small sales force through veterinary distributors.

Interest Income

Interest income increased by approximately $140,000 (110%) to $268,000 in 2006 in comparison to 2005 due principally to the increased amount of invested funds and an increase in interest rates in 2006. We have not incurred interest expense since we repaid our outstanding bank debt in May 2002.

Income Before Income Taxes; Net Income

Income before income taxes of $1,034,000 for the year ended December 31, 2006 compares to $1,071,000 for the year ended December 31, 2005. We recorded income tax expense at an effective tax rate of 37% and 34% in 2006 and 2005, respectively, resulting in net income of $647,000 and $708,000 for the years ended December 31, 2006 and 2005, respectively. The 2005 income tax expense included a tax benefit of approximately $62,000 due to the elimination of a valuation allowance pertaining to certain deferred tax assets. Income tax expense included a deferred tax (benefit) expense of ($101,000) and $140,000 for the years ended December 31, 2006 and 2005, respectively.