Results of Operations

Fiscal Year 2008 Compared to Fiscal Year 2007

Product Sales

Product sales for the year ended December 31, 2008 decreased by $144,000 (3%) to $4,628,000 from $4,772,000 in 2007. Domestic product sales increased by 3% during the year ended December 31, 2008, while foreign sales decreased by 26%, in comparison to 2007. As we introduce our products (principally First Defense®) to markets outside of the United States, we expect some sales volatility in those territories. Despite the decline in 2008 in comparison to 2007, foreign sales in 2008 were 18% greater than foreign sales in 2006. We

believe that sales of our products may be influenced by the price of milk, cows 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 2008 was $17.44 per 100 pounds, which represents a 3% decrease from the 2007 average of $18.04. However, this price has declined in 2009. The average for the months of January and February 2009 was $10.05 in comparison to $18.18 for the same period in 2008. For a point of reference, the average for all of 2002 was $10.42, which approximates the price levels experienced during the 1970's. While any decrease in the sales value of milk is not good for our customers, dairy producers are also facing increases in the costs 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 January 2009, the milk-to-feed ratio of 1.69 was the worst it has ever been since the USDA began using the profitability measure in 1985. A ratio of 1.69 means that a dairy producer can buy 1.69 pounds of feed for every pound of milk sold. Whenever the ratio meets or exceeds 3.0, it is considered profitable to buy feed and produce milk. Another indication of the economic condition of the dairy industry is the price received by producers for milk cows. In 2008, this price is estimated to have increased by approximately 6% to $1,953 in comparison to $1,840 per cow in 2007, but this value is declining in 2009. During 2008, the value of bull calves in the dairy industry declined materially making it less economical to treat bull calves with First Defense®. The size of the U.S. dairy herd has remained consistently in the range of approximately 9,000,000 to 9,300,000 cows over the last ten years, but a significant decrease in the herd size is expected in 2009.

Sales of First Defense®decreased by 3% during the year ended December 31, 2008 in comparison to the same period in 2007. A 2% increase in our average selling price was more than offset by a 6% decrease in unit sales volume. 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 preventive vaccine as described in USDA-NOP regulations for organic producer consideration when establishing management plans.

Sales of Wipe Out® Dairy Wipesdecreased by 2% during the year ended December 31, 2008 in comparison to the same period in 2007. Domestic sales were essentially unchanged in 2008. We believe that domestic sales growth potential is limited because most of our sales of this product tend to be to smaller dairies 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 $116,000 during the year ended December 31, 2008 compared to $108,000 during the same period in 2007. The other products we sell outside of dairy and beef industries, principally Isolate™ (formerly known as Crypto-Scan ®), increased slightly to $119,000 during the year ended December 31, 2008 compared to $116,000 during the same period in 2007.

We generally held our product selling prices without increase during the seven year period ended December 31, 2007. During the first quarter of 2008, we implemented a modest increase to the selling price of First Defense®.

Other Revenues

Technology licensing revenue decreased by 100%, or $1,248,000, during the year ended December 31, 2008 in comparison to the same period in 2007, 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 decreased by $44,000 to just $5,000 during the year ended December 31, 2008 in comparison to the same period in 2007, as the result of less 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
                                       Ended December 31,            (Decrease)
                                       2008            2007       Amount        %
         Gross margin               $     2,069       $ 2,504     $  (435 )    (17 %)
         Percent of product sales            45 %          52 %        (7 %)   (13 %)

We now experience lower gross margin percentages in comparison to those achieved in the past. The gross margin as a percentage of product sales was 45% and 52% during the years ended December 30, 2008 and 2007, respectively. This compares to gross margin percentages of 56% and 61% for the years ended December 31, 2006 and 2005, respectively. The gross margin percentage was unusually low during 2008. Our current annual target is to improve the gross margin percentage from 45% to closer to 50%. A number of factors account for the relative increase in costs and for their variability. We expect some fluctuations in gross margin percentages from quarter to quarter. The gross margin on First Defense® was adversely affected by biological yields from our raw material, which do fluctuate over time. 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. Like most manufacturers in the U.S., we have been experiencing increases in the cost of raw materials that we purchase. 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. Because First Defense ® customers are price sensitive, we had held its selling price without significant increase for about seven years, believing that we could benefit more from higher unit sales volume than through a higher average selling price per unit. However, 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 11%, or $167,000, to $1,746,000 during the year ended December 31, 2008, as compared to $1,579,000 during the same period in 2007. Product development expenses aggregated 38% and 26% of total revenues in 2008 and 2007, respectively. During the year ended December 31, 2007, product development expenses included $439,000, 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 in 2007, product development expenses of $1,746,000 and $1,140,000, amounted to 38% and 24% of product sales during the years ended December 31, 2008 and 2007, respectively. The majority of our product development budget from 2000 through 2008 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. The other improvements, extensions, or additions to our current product line include 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) such as rotavirus. 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 $83,000 (10%) to $926,000 in 2008 as compared to $843,000 in 2007. These increases result, in large part, from 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 $64,000 (13%) to $570,000 in 2008, increasing to 12% of product sales in 2008 from 11% in 2007. 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 decreased by approximately $72,000 (26%) to $204,000 in 2008 in comparison to 2007 due principally to a decrease in interest rates and a reduction in funds invested during 2008. We have not incurred interest expense since we repaid our outstanding bank debt in May 2002.

Loss Before Income Taxes and Net Loss

Our loss before income taxes of $961,000 during the year ended December 31, 2008 is in contrast to income before income taxes of $1,144,000 during the year ended December 31, 2007. We recorded a 51% income tax benefit during the year ended December 31, 2008 and income tax expense at an effective tax rate of 42% during the year ended December 31, 2007. Our income tax (benefit) expense included a deferred tax (benefit) expense of ($108,000) and $435,000 during the years ended December 31, 2008 and 2007, respectively. Our net loss of $469,000 ($0.16 per share) during the year ended December 31, 2008 is in contrast to net income of $662,000 ($0.22 per diluted share) during the year ended December 31, 2007.

Fiscal Year 2007 Compared to Fiscal Year 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 milk cows. 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 preventive vaccine as described in USDA-NOP regulations for organic producer consideration when establishing management plans.

Sales of Wipe Out ® Dairy Wipes decreased 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 tend to be price sensitive, we have held its selling price without significant increase for approximately the past 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.

Selected Financial Data

The selected financial data set forth below has been derived from our audited
financial statements. The information should be read in conjunction with the
audited financial statements and related notes appearing elsewhere in this Form
10-K and in earlier reports filed on Form 10-KSB or 10-K.



                                                                 Year Ended December 31,
                                                 2004         2005         2006         2007        2008
                                                      (In thousands, except for per share amounts)
Statement of Operations Data:
Product sales                                  $   3,524    $   4,233    $   4,306    $  4,772    $  4,628
Total revenues                                     3,696        4,983        4,801       6,069       4,634
Gross margin from product sales                    2,075        2,599        2,424       2,504       2,069
Product development expenses                       1,092        1,270          966       1,579       1,746
Selling and administrative expenses                1,035        1,141        1,182       1,349       1,496
Net interest and other income                         56          133          263         272         207
Income (loss) before income taxes                    177        1,071        1,034       1,144        (961 )
Net income (loss)                                    144          708          647         662        (469 )

Statement of Cash Flows Data:
Net cash provided by operating activities      $   1,358    $     765    $   1,583    $    350    $     53

Per Common Share:
Basic net income (loss)                        $    0.05    $    0.25    $    0.22    $   0.23    $  (0.16 )
Diluted net income (loss)                      $    0.05    $    0.24    $    0.21    $   0.22    $  (0.16 )
Cash dividend                                         --           --           --          --          --

                                                                   As of December 31,
                                                 2004         2005         2006         2007        2008
                                                      (In thousands, except for per share amounts)
Balance Sheet Data:
Cash, cash equivalents and short-term
investments                                    $   4,450    $   5,150    $   6,614    $  5,412    $  5,054
Total assets                                       9,530        9,955       11,364      10,412      10,128
Current liabilities                                  814          697        1,417         356         484
Net working capital                                4,998        6,091        6,934       6,710       6,245
Long-term liabilities                                986          700          615          --          --
Stockholders' equity                           $   7,729    $   8,558    $   9,332    $ 10,057    $  9,644

Per Outstanding Common share:
Cash, cash equivalents and short-term
investments                                    $    1.59    $    1.81    $    2.28    $   1.87    $   1.75
Stockholders' equity                           $    2.77    $    3.00    $    3.22    $   3.48    $   3.33

Financial Condition, Liquidity and Capital Resources

We had approximately $5,054,000 in available cash and short-term investments as of December 31, 2008. We are using some of this cash to fund product development, principally Mast Out®, and to invest in our efforts to become compliant with cGMP regulations in our manufacturing operations. We continue to look for new product acquisition opportunities that would have a strategic fit with the products that we currently sell.

The table below summarizes the changes in selected, key balance sheet items:

                                            Balance at December 31,                 (Decrease)
                                              2007                 2008            $           %
                                                   (In thousands, except for percentages)
Cash, cash equivalents and short-term
investments                                 $        5,412     $       5,054     $ (358 )      (7 %)
Total assets                                        10,412            10,128       (284 )      (3 %)
Net working capital                                  6,710             6,245       (465 )      (7 %)
Stockholders' equity                        $       10,057     $       9,644     $ (413 )      (4 %)

Cash, cash equivalents and short-term investments decreased by 7%, or $358,000, . . .