SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Quarterly Period Ended September 30, 2001.

Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Transition Period from _____________________ to _____________________.

Commission file number 0-27976.

GalaGen Inc

(Exact name of registrant as specified in its charter)

Delaware		41-1719104
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

301 Carlson Parkway, Suite 301 Minnetonka, Minnesota		55305
(Address of principal executive offices)		(Zip Code)

(952) 258-5500
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ý No o

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. Common Stock, $.01 par value – 12,275,448 shares as of October 31, 2001.

INDEX

GALAGEN INC.

PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)

	Balance Sheets - September 30, 2001 and December 31, 2000

	Statements of Operations - Three and Nine months ended September 30, 2001 and September 30, 2000

	Statements of Cash Flows - Nine months ended September 30, 2001 and September 30, 2 000

	Notes to Financial Statements

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 3.	Quantitative and Qualitative Disclosures About Market Risk

PART II.	OTHER INFORMATION

Item 6.	Exhibits and Reports on Form 8-K

SIGNATURES

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

GALAGEN INC.

BALANCE SHEETS

ASSETS	September 30, 2001			December 31, 2000
	(Unaudited)
Current assets:
Cash and cash equivalents	$	256,799		$	826,943
Accounts receivable, net of allowance of $13,136 in 2001 and 2000	17,566			554,760
Prepaid expenses	116,868			206,886
Inventory	107,080			224,746
Total current assets	498,313			1,813,335

Property and equipment	860,864			860,864
Less accumulated depreciation	(651,532		)	(536,262		)
	209,332			324,602

Customer list, net	-			270,000
Other intangible assets, net	-			106,373
Restricted cash	-			77,679
Deferred expenses	159,919			18,000
	159,919			472,052

Total assets	$	867,564		$	2,609,989

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Accounts payable	$	892,301		$	949,872
Development contract advance	84,275			89,275
Current portion of deferred revenue	107,140			107,140
Current portion of capital lease obligation	39,705			34,584
Notes payable	208,906			-
Other current liabilities	12,454			32,364
Total current liabilities	1,344,781			1,213,235

Commitments

Capital lease obligations	3,650			34,104
Deferred revenue	437,361			517,716
Other long-term liabilities	45,000			45,000
Total Long-term liabilities	486,011			596,820

Stockholders’ equity (deficit):
Preferred stock, $.01 par value:
Authorized shares – 15,000,000
Issued and outstanding shares – none in 2001 and 2000	-			-
Common stock, $.01 par value:
Authorized shares – 40,000,000
Issued and outstanding shares – 12,275,448 in 2001 and 2000	122,754			122,754
Additional paid–in capital	65,532,809			65,532,809
Accumulated deficit	(66,618,791		)	(64,855,629		)
Total stockholders’ equity (deficit)	(963,228		)	799,934

Total liabilities and stockholders’ equity	$	867,564		$	2,609,989

See accompanying notes.

Note: The balance sheet at December 31, 2000 has been derived from audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

GALAGEN INC.

STATEMENTS OF OPERATIONS

(Unaudited)

	Three Months Ended September 30						Nine Months Ended September 30
	2001			2000			2001			2000
Revenues:
Product sales	$	-		$	2,853		$	-		$	9,312
Product licensing revenue	26,786			26,786			80,358			80,358
Product development revenue	-			66,397			5,000			230,403
Royalty revenue	13,163			35,579			84,792			136,030
	39,949			131,615			170,150			456,103
Operating expenses:
Cost of goods sold	-			1,976			-			4,782
Selling, general and administrative	217,925			614,231			1,064,861			1,763,292
Product development	496,608			627,936			1,415,360			1,742,329
Depreciation and amortization	66,229			135,075			231,593			405,225
	780,762			1,379,218			2,711,814			3,915,628
Operating loss	(740,813		)	(1,247,603		)	(2,541,664		)	(3,459,525		)

Interest income	110			17,569			12,842			86,806
Gain on sale of critical care enteral nutrition products business	779,252			-			779,252			-
Interest expense	(7,092		)	-			(13,592		)	-

Net income (loss) before accounting change	31,457			(1,230,034		)	(1,763,162		)	(3,372,719		)

Cumulative effect of change in accounting principle	-			-			-			(732,000		)

Net income (loss)	$	31,457		$	(1,230,034	)	$	(1,763,162	)	$	(4,104,719	)

Net income (loss) per share – basic and diluted
Net income (loss) before accounting change	$	-		$	(.12	)	$	(.14	)	$	(.32	)
Cumulative effect of change in accounting principle	$	-		$	-		$	-		$	(.07	)

Net income (loss) per share	$	-		$	(.12	)	$	(.14	)	$	(.39	)

Weighted average number of common shares outstanding basic and diluted	12,275,448			10,518,371			12,275,448			10,493,086

See accompanying notes.

GALAGEN INC.

STATEMENTS OF CASH FLOWS

(Unaudited)

	Nine Months Ended September 30
	2001			2000
Operating activities:
Net loss	$	(1,763,162	)	$	(4,104,719	)
Adjustments to reconcile net loss to cash used in operating activities:
Depreciation and amortization	231,593			405,223
Gain on sale of critical care enteral nutrition products business	(779,252		)	-
Write-down of inventory	147,516			-
Loss from permanent impairment of purchased technology	42,549			-
Cumulative effect of accounting change	-			732,000
Changes in operating assets and liabilities	498,266			557,373
Net cash used in operating activities	(1,622,490		)	(2,410,123		)

Investing activities:
Purchase of property, plant and equipment	-			(14,541		)
Proceeds from sale of critical care enteral nutrition products business	1,000,000			-
Decrease in restricted cash	77,679			-
Change in available-for-sale securities, net	-			2,782,790
Net cash provided by investing activities	1,077,679			2,768,249

Financing activities:
Proceeds from issuance of common stock	-			237,248
Payments on capital lease	(25,333		)	-
Net cash (used in) provided by financing activities	(25,333		)	237,248
Decrease in cash	(570,144		)	595,374
Cash and cash equivalents at beginning of period	826,943			204,817
Cash and cash equivalents at end of period	$	256,799		$	800,191

See accompanying notes.

GALAGEN INC.

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

The accompanying unaudited financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information, pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, all adjustments (consisting of normal, recurring accruals) considered necessary for fair presentation have been included. Operating results for the nine months ended September 30, 2001, are not necessarily indicative of the results that may be expected for the year ended December 31, 2001. These financial statements should be read in conjunction with the audited financial statements and accompanying notes contained in the Annual Report of GalaGen Inc. (the “Company”) on Form 10-K, as amended, for the fiscal year ended December 31, 2000.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. The Company has had recurring losses and has negative stockholders equity as of September 30, 2001. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include adjustments to the carrying value of assets and liabilities, which may be necessary should the Company not continue in operation.

2. Summary of Significant Accounting Policies

Use of Estimates

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

Revenue Recognition

Revenues from product sales are recognized at the time of shipment and transfer of title. Revenues from product development fees are recognized as services are rendered and as milestones are achieved. Revenues from non-refundable up-front license fees are recognized over the term of the development agreement unless the fee is in exchange for products delivered or services performed that represent the culmination of a separate earnings process.

In the fourth quarter of 2000 and retroactive to January 1, 2000, the Company changed its method of accounting for revenue recognition in accordance with Staff Accounting Bulletin (SAB) No. 101, “Revenue Recognition in Financial Statements.” Previously, the Company had recognized revenue for nonrefundable, up-front license fees as revenue upon receipt and signing of the agreement. Under the new accounting method adopted retroactive to January 1, 2000, the Company recognizes revenue from nonrefundable up-front license fees over the term of the agreement unless the fee is in exchange for products delivered or services performed that represent the culmination of a separate earnings process. The cumulative effect of the change on prior years resulted in a charge to income of $732,000, which is included in the loss for the first quarter of 2000. The effect of the change on the nine months ended September 30, 2001 was to decrease the loss before the cumulative effect of the accounting change by $80,358.

For each of the quarters ended March 31, June 30, September 30, and December 31, 2000, and the quarters ended March 31, June 30, and September 30, 2001 the Company recognized $26,786 in revenue that was included in the cumulative effect adjustment as of January 1, 2000. Additionally, the Company will recognize in revenue $107,144 annually for the years ending December 31, 2001 through 2006 for amounts included in the cumulative effect adjustment.

Adoption of Recent FASB Statements of Financial Accounting Standards No. 141 and No. 142

In June 2001 the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets, drastically changing the accounting for business combinations, goodwill and intangible assets. The FASB requires companies to adopt Statement No. 141 and No. 142 beginning January 1,2002. The Company continues to analyze the effects of Statement No. 141 and No. 142 but does not expect the adoption of the Statements to have an impact on future results.

Basic net income (loss) per share is computed by dividing the net loss by the weighted average number of common shares outstanding for the year. Diluted net income (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock and resulted in the issuance of common stock. Basic and diluted net income (loss) per share are the same in all periods presented as all common share equivalents were antidilutive.

Inventory

Inventories are stated at the lower of cost or market using the first-in, first-out method. The Company periodically evaluates the need for reserves associated with obsolete inventory. As of September 30, 2001, the Company determined the realizable value of both the raw material and finished goods inventory was below cost. As a result the Company reduced the net carrying cost of both raw materials and finished goods inventory by a total of $147,516 to more accurately represent current fair market value. Inventory at September 30, 2001 and December 31, 2000 consisted of the following (net of reserve):

	September 30,		December 31,
	2001		2000
Raw materials	$	16,024	$	46,674
Finished goods	91,056		178,072
	$	107,080	$	224,746

Reclassifications

Certain items in these financial statements have been reclassified to conform to the current period presentation.

3. Financing of Annual Directors and Officers and Product Liability Insurance Premiums

In April 2001, the Company financed the annual premium of $73,633 for directors and officers and product liability insurance. Terms of the financing included a down payment of $22,154 and monthly payments of $5,984 through January 2002. The remaining payments totaling $23,492 are included in short-term notes payable as of September 30, 2001.

4. Sale of Critical Care Enteral Nutrition Products Business to Hormel HealthLabs

In July 1999, the Company entered into a licensing and distribution agreement with Hormel HealthLabs (“HHL”), a subsidiary of Hormel Foods Corporation. The licensing agreement granted worldwide rights to manufacture, distribute, market and sell the Company’s previously acquired line of critical care enteral nutrition products and formulas. Under the terms of the agreement HHL paid monthly royalties subject to an annual minimum royalty to the Company based upon net sales of the specified products and reimbursed the Company for expenses incurred in supporting the specified products. HHL commenced selling the critical care products on a limited basis in September 1999, and on an exclusive basis effective October 1999.

In August 2001, the Company sold all of the assets related to its critical care enteral nutrition products business to HHL. As consideration for the assets, HHL paid the Company $1,000,000 less unearned amounts from an advance on royalties and expenses given to the Company in June 2001. As a result of the transaction the Company recognized a gain of $779,252 in the third quarter of 2001 consisting of proceeds of $1,000,000 less unamortized customer list costs of $217,500 and transaction costs of $3,248.

5. Note Payable

In August 2001, the Company converted the outstanding accounts payable balance relating to three vendors to separate notes payable. The notes totaling $184,459 carry an interest rate of 6.0% per annum. The unpaid principle and accrued interest are payable upon demand of the respective note holder. As of September 30, 2001, the Company has not made any payments of principle or interest.

6. Impairment of Purchased Technology

The Company evaluates its long-lived assets for impairment losses when indications of impairment are present by comparing the non-discounted cash flows to the asset’s carrying amount. An impairment loss is recorded if necessary. In the third quarter of 2001, the Company determined the asset Purchased Technology, which represents the value of a food product acquired in 1998 and is being amortized over three years, had been impaired. The Company recorded a charge of $42,549 to reduce the carrying value of the asset to $0 as of September 30, 2001.

PART I - FINANCIAL INFORMATION

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

The information presented in this item contains forward-looking statements within the meaning of the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Such statements are subject to risks and uncertainties, including those discussed below under “Risk Factors” and in the Company’s Annual Report on Form 10-K, as amended, for the year ended December 31, 2000 (“Form 10-K”) under “Risk Factors”, that could cause actual results to differ materially from those projected. Because actual results may differ, readers are cautioned not to place undue reliance on these forward-looking statements.

General

GalaGen’s mission is to become the leading presence in foods, beverages and dietary supplements that help enhance the immune system and to take advantage of all of colostrum’s benefits. A critical factor for success of the Company is its immune-enhancing ingredient, which has been branded Proventraä Brand Natural Immune Components (“Proventra”). Proventra is derived from colostrum; the highly nutritious first milk from a dairy cow after its calf is born. The primary components found in Proventra are naturally occurring broad-spectrum antibodies or specialized proteins that enhance the body’s own immune system to provide protection against harmful micro-organisms. Additional immune-enhancing components found in Proventra include lactoperoxidase, lactoferrin, growth factors and other substances to bolster the body’s resistance.

The Company, in conjunction with strategic partners, seeks to expand applications for its technology and develop a portfolio of Proventra-based products that target the needs of consumers and the healthcare market.

In 1998, the Company entered into a collaboration and license agreement and a manufacturing and supply agreement with Wyeth-Ayerst Laboratories (“Wyeth-Ayerst”), a division of American Home Products Corporation. The two companies will develop and commercialize a proprietary ingredient with unique antibacterial properties for use in pediatric formula and other nutritional products. The collaboration, during the research and development phase of the product, will be funded by Wyeth-Ayerst through payments to the Company.

In January 1999, the Company entered into a collaboration agreement with General Nutrition Corporation, Inc. for product development, manufacturing, supply and retail marketing of its Proventra. The agreement calls for the two companies to develop and market a range of immune-enhancing dietary supplements and nutrition formulas.

In March 1999, the Company also entered into a licensing and distribution agreement with Hormel HealthLabs (“HHL”), a wholly owned subsidiary of Hormel Foods Corporation. HHL licensed the manufacturing and distribution rights for a new, clinically tested, cultured dairy beverage the Company developed to improve the gastrointestinal health of patients in hospitals and nursing homes. The product includes a patented ingredient combination and will also incorporate the Company’s Proventra.

In July 1999, the Company licensed its line of critical care nutrition products, to HHL. The licensing agreement granted HHL worldwide rights to manufacture, distribute, market and sell the Company’s critical care products. Under the terms of the agreement HHL paid royalties, subject to an annual minimum royalty, to the Company based upon net sales of the specified products. HHL commenced selling the Company’s critical care products on a limited basis in September 1999, and on an exclusive basis effective October 1999. In August 2001, the Company sold all of the assets related to its critical care enteral nutrition products business to HHL. See Note 4.

In October 1999, the Company entered into a collaborative licensing agreement with Novartis Consumer Health Inc. (“Novartis”) whereby the Company granted Novartis certain rights to defined Proventra technology. Also in October, the Company and Novartis entered into a supply agreement for which the Company will supply the Proventra ingredients.

In December 1999, the Company and Novartis entered into a development agreement for various product development and research projects. Novartis will pay for pre-approved activities related to the research projects. The Company will initially record payments received as an advance, and recognize revenue as the Company incurs the associated expense. The Company also will receive a royalty from future Novartis sales as additional compensation. No royalties were due in 2001 or 2000.

In July 2000, the Company entered into a supply agreement with Estee Lauder Inc., to supply its colostrum-based ingredient for use in cosmetic skin care products.

The Company, in conjunction with Land O’ Lakes, has worked with a marketing/testing firm to develop a yogurt containing Proventra. The Company believes that the future success of a Proventra yogurt product will be enhanced by continuing to follow its strategy of introduction of products through large market leaders. Accordingly, the Company has obtained rights from Land O’Lakes to pursue an alliance with major yogurt manufacturers. The Company is currently exploring alliance relationships with these major companies and any yogurt product introductions will be dependent upon successful completion of a yogurt license agreement.

Results of Operations

For the Three Months ended September 30, 2001 and 2000

General. The Company reported net income of $31,457 for the three months ended September 30, 2001 compared to a loss of $1,230,034 for the same period in 2000. The change was due primarily to reduced marketing and research activities in the third quarter of calendar year 2001, the gain of $779,252 from the sale of the critical care enteral nutrition products business partially offset by the $147,516 inventory write-down and by decreased product development and royalty revenue.

Revenues. For the three months ended September 30, 2001 revenues of $39,949 comprised of royalty revenue of $13,163, and $26,786 of licensing revenue recognized in the third quarter due to the amortization of the SAB 101 cumulative effect adjustment. For the same period in 2000, revenues of $131,615 consisted of $66,397 in product development revenue, $35,579 in royalty revenue, product sales of $2,853 and the amortization of the cumulative effect adjustment totaling $26,786.

Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased $396,306, or 64.5%, for the three months ended September 30, 2001 to $217,925 from $614,231 for the same period in 2000. The decrease is due primarily to decreased marketing expenses of in addition to a decrease in administrative personnel expenses.

Product Development Expenses. Expenses for product development decreased $131,328, or 20.9%, for the three months ended September 30, 2001 to $496,608 from $627,936 for the three months ended September 30, 2000. The decrease was primarily due to decreased expenses in support of the Company’s clinical product efforts and decreased expenses related to the Wyeth contract offset by a charge of $42,549 to recognize the permanent impairment of purchased technology.

Depreciation and Amortization. Depreciation and amortization for the three months ended September 30, 2001 decreased $68,846, or 51.0%, to $66,229 from $135,075 for the same period in 2000. The decrease was primarily due to decreased amortization of warrants and options issued for services and decreased amortization of goodwill, which was fully amortized as of December 31, 2000 and decreased amortization of the customer list which was eliminated in August as part of the sale of the critical care enteral nutrition products business.

Other Income (Expense). Interest income for the three months ended September 30, 2001 decreased $17,459, or 99.4%, to $110 from $17,569 for the same period in 2000. The decrease is primarily attributable to the decreased level of invested funds. Interest expense of $7,092 for the three months ended September 30, 2001 related to a capital lease entered into in October 2000, interest related to the financing of the directors and officers and product liability insurance annual insurance premiums and accrued interest on the notes payable.

For the Nine Months ended September 30, 2001 and 2000

General. The net loss decreased by $2,341,557, or 57.0%, for the nine months ended September 30, 2001 to $1,763,162 from $4,104,719 for the same period in 2000. The decrease in the loss was due primarily to the cumulative effect adjustment of $732,000 recorded in the first quarter of 2000, the gain recognized in August 2001 related to the sale of the critical care enteral nutrition products business, see note 4 to the financial statements, and partially offset by the $147,516 inventory write-down and decreased product development and royalty revenue. In addition, product development and selling and general expenses were reduced due to decreased marketing and research activities occurring in the first nine months of calendar year 2001.

Revenues. For the nine months ended September 30, 2001 revenues of $170,150 included product development and royalty revenue of $5,000 and $84,792, respectively. In addition, $80,358 of licensing revenue was recognized during the period due to the amortization of the SAB 101 cumulative effect adjustment. For the same period in 2000, revenues of $456,103 consisted of $230,403 in product development revenue, $136,030 in royalty revenue, an amortization of the cumulative effect adjustment totaling $80,358 and product sales of $9,312.

Cost of Goods Sold. For the nine months ended September 30, 2001 and 2000, the cost of goods sold of $0 and $4,782, respectively, related to the product sales.

Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased $698,431, or 39.6%, for the nine months ended September 30, 2001 to $1,064,861 from $1,763,292 for the first nine months of 2000. The decrease is due primarily to decreased marketing expenses in addition to a decrease in administrative personnel expenses.

Product Development Expenses. Expenses for product development decreased $326,969, or 18.8%, for the nine months ended September 30, 2001 to $1,415,360 from $1,742,329 for the same period in 2000. The decrease was primarily due to decreased expenses in support of the Company’s clinical product efforts and decreased expenses related to the Wyeth contract offset by a charge of $42,549 to recognize the permanent impairment of purchased technology.

Depreciation and Amortization. Depreciation and amortization for the nine months ended September 30, 2001 decreased $173,632, or 42.8%, to $231,593 from $405,225 for the same period in 2000. The decrease was primarily due to decreased amortization of warrants and options issued for services and decreased amortization of goodwill, which was fully amortized as of December 31, 2000 and decreased amortization of the customer list which was eliminated in August as part of the sale of the critical care enteral nutrition products business.

Other Income (Expense). Interest income for the nine months ended September 30, 2001 decreased $73,964, or 85.2%, to $12,842 from $86,806 for the same period in 2000. The decrease is primarily attributable to the decreased level of invested funds. Interest expense of $13,592 for the nine months ended September 30, 2001 related to a capital lease entered into in October 2000 and interest related to the financing of the directors and officers and product liability insurance annual insurance premiums and accrued interest on the notes payable.

Liquidity and Capital Resources

Cash used in operating activities decreased by $787,633, or 32.7%, for the nine months ended September 30, 2001 to $1,622,490 from $2,410,123 for the same period in 2000. Cash used in operations for the nine months ended September 30, 2001 went primarily to fund operating losses offset by accounts receivable collections of $537,194 and increases in accounts payable and accrued expenses of $126,425. For the same period in 2000, cash used in operations went primarily to fund operating losses.

For the nine months ended September 30, 2001 and 2000, the Company invested $0 and $14,541, respectively, in computer and manufacturing equipment to support its operations. The Company sold $2,782,790 of its available-for-sale securities for the nine months ended September 30, 2000. Proceeds from the sale of the critical care enteral nutrition products business were $1,000,000 for the nine months ended September 30, 2001.

Proceeds from the exercise of common stock options and warrants for the nine months ended September 30, 2000 were $237,248.

The Company anticipates that its existing resources and interest thereon will not be sufficient to satisfy its anticipated cash requirements through the year ending December 31, 2001. The Company’s working capital and capital requirements will depend upon numerous factors, including revenue from product sales and collaboration arrangements, the progress of the Company’s market research, product development and ability to obtain partners with the appropriate manufacturing, sales, distribution and marketing capabilities. The Company’s capital requirements also will depend on the levels of resources devoted to the development of manufacturing capabilities, technological advances, the status of competitive products and the ability of the Company to establish partners or strategic alliances to provide funding to the Company for certain manufacturing, sales, product development and marketing activities.

The Company needs to raise substantial additional funds for current operations, product development, manufacturing and marketing activities. The Company’s ability to continue funding its planned operations is dependent upon its ability to generate product revenues or to obtain additional funds through equity or debt financing, strategic alliances, license agreements or from other financing sources. A lack of adequate revenues or funding could result in the insolvency or bankruptcy of the Company. At a minimum, if adequate funds are not available, the Company may be required to delay or to eliminate expenditures for certain of its product development efforts or to license to third parties the rights to commercialize products or technologies that the Company would otherwise seek to develop itself. Because of the Company's significant long–term capital requirements, it may seek to raise funds at any time, even when conditions are unfavorable, which could result in significant dilution for current stockholders.

Pursuant to a Master Lease Agreement dated as of June 30, 1998 (the “Lease Agreement”), the Company leases certain laboratory equipment, computer equipment and tenant improvements from Transamerica Business Credit Corporation (“Transamerica”). Under a Security Agreement with Transamerica dated as of June 30, 1998 (the “Security Agreement”), the Company’s obligations under the Lease Agreement are secured by a first priority lien on substantially all of the Company’s equipment, fixtures and improvements and personal property. The Lease Agreement requires the Company to make certain monthly lease payments. The lease expired in June 2001 and requires the Company to purchase the laboratory equipment, computer equipment and tenant improvements through the payment of $164,900 representing the fair market value as of June 30, 2001 or elect to renew the lease for an additional twelve months. As of September 30, 2001, the Company has not made the full amount of the June lease payment and has not exercised the option to purchase the equipment and improvements for fair market value. The Company has received notice that Transamerica considers the Company to be in default under the Lease Agreement and the Security Agreement and that Transamerica reserves all of its rights and remedies under such agreements. The Company currently is in negotiations with Transamerica regarding payments to be made under the Lease Agreement.

The Company has had recurring losses and negative cash flows from operations, including a net loss of $1,763,162 and negative cash flow from operations of $1,622,490 in the first nine months of calendar year 2001. These conditions raise substantial doubt about the Company’s ability to continue as a going concern.

The Company has hired an investment bank to assist management in seeking additional investors or in selling certain of the Company’s assets.

In August 2001, the Company sold all of the assets related to its critical care enternal nutrition products business to Hormel HealthLabs (“HHL”), a subsidiary of Hormel Foods Corporation. As consideration for the assets, HHL paid the Company $1,000,000 less unearned amounts from the advance.

The Company’s common stock, par value $.01 per share, has been publicly traded since the closing of the Company’s initial public offering on April 1, 1996. During 2000 the common stock traded on the Nasdaq National Market tier of The Nasdaq Stock Market under the symbol GGEN through October 1, 2000 and then was traded on the Nasdaq SmallCap tier through December 31, 2000. The common stock was delisted in early January 2001 and now trades on the Over-the-Counter Bulletin Board under the symbol GGEN.

Risk Factors

Certain statements made in this Quarterly Report on Form 10-Q are forward–looking statements based on our current expectations, assumptions, estimates and projections about our business and our industry. These forward–looking statements involve risks and uncertainties. Our business, financial condition and results of operations could differ materially from those anticipated in these forward–looking statements as a result of certain factors, as more fully described below and elsewhere in this Form 10-Q. You should consider carefully the risks and uncertainties described below, which are not the only ones facing our Company. Additional risks and uncertainties also may impair our business operations. We undertake no obligation to update publicly any forward–looking statements for any reason, even if new information becomes available or other events occur in the future.

General

We may not ever achieve a profitable level of operations.

Our ability to achieve profitable operations depends in large part on:

• entering into agreements to develop products and establish markets for those products; and

• making the transition from a research company to an operating and marketing company.

We cannot be sure we will be successful in ever achieving either result. We have experienced significant operating losses in each year since our inception in 1987. We have an accumulated deficit of approximately $67 million as of September 30, 2001. We may continue to lose money in the future.

If we cannot obtain continuing funding, we may be unable to implement our business plans.

If we cannot find adequate funding, we may have to delay or eliminate some of our product development plans. We may be required to grant licenses to others to establish markets for products or technologies that we would otherwise seek to market ourselves.

Our cash requirements for working capital depend on numerous factors. These factors include:

• our spending on marketing activities, including clinical marketing trials;

• our progress in finding partners to help us develop products and market those products;

• the willingness and ability of our partners to provide funding for our activities;

• our spending on product development programs;

• the rate of technological advances in the production of our products;

• our spending on facilities, equipment and personnel to make our products; and

• the status of competitive products.

Our long-term ability to continue funding our planned operations depends on our ability to obtain additional funds through:

• product revenues;

• equity or debt financing;

• partners to help us develop products and market those products;

• license agreements; or

• other financing sources.

Because of our significant long–term capital requirements, we may seek to raise funds at any time. We may do so even when conditions are unfavorable. This could result in significant dilution of our current stockholders.

If we do not achieve a profitable level of operations and cannot find funding in the future, we could become insolvent or bankrupt.

If we do not achieve a profitable level of operations and we do not obtain funding necessary from some source other than operations, we could deplete our cash reserves and become insolvent or bankrupt.

The relatively low level of trading in our common stock may make it highly volatile.

Our Common Stock is traded on the Over-the-Counter Bulletin Board, or OTCBB and the volume of shares of Common Stock traded on that market has been relatively small. Given the small volume of shares traded, market fluctuations may have a particularly adverse effect on the market price of our Common Stock. We cannot be sure of the liquidity of the market for the Common Stock or the price at which any sales may occur. The volume of trading in our Common Stock in the future will depend upon the number of holders of the Common Stock, the interest of securities dealers in maintaining a market in the Common Stock and other factors beyond our control. The market price of our Common Stock could be subject to significant fluctuations in response to:

• our operating results;

• the operating results of our competitors or other biotechnology companies;

• technological developments;

• government regulations;

• the status of our proprietary rights to potential products;

• litigation;

• public safety concerns; and

• other factors.

Some of these factors are unrelated to our operating performance and beyond our control.

GalaGen and our stockholders may have difficulty in selling shares of our Common Stock.

The OTCBB is not a listing service, market or exchange. Instead, it is a regulated quotation service that displays real-time quotes, last-sale prices and volume information for securities traded on it. In order for a security to trade on the OTCBB, market makers must be willing to make a market in the security. We cannot be sure that market makers will continue to make a market in shares of our Common Stock. Even if market makers do continue to make a market in our Common Stock, we cannot be sure that they will be successful in executing trades placed with them. The lack of a liquid market for our Common Stock, may make it difficult for us to raise funds through the sale of our Common Stock or securities convertible into Common Stock.

We may be subject to product liability claims that exceed our insurance coverage.

Our business involves exposure to potential product liability risks that are inherent in the production, manufacture and distribution of consumer and clinical food products that are designed to be ingested. The successful assertion or settlement of any uninsured claim, a significant number of insured claims or a claim exceeding our insurance coverage could have a material adverse effect on our business and financial condition. We cannot be sure that we will be able to obtain product liability insurance on acceptable terms or that provides adequate protection. Furthermore, we cannot be sure that we will be able to secure increased insurance coverage as the markets for our products increase.

If we rely on inaccurate market information, we could make a decision that has a material adverse effect on our business and financial condition.

Because we are currently developing our products and markets for those products, we are particularly reliant on market data. If that data is inaccurate, we may commit resources to product development and marketing efforts that do not become profitable. Product development and marketing efforts that do not become profitable may have a material adverse effect on our business and financial condition. We have obtained market and related data from a competitive-market analysis firm. We have not independently verified the accuracy of that information. In any event, the methodology typically used in compiling market and related data makes it subject to inherent uncertainties and estimations. As a result, we cannot be sure as to the accuracy or completeness of our market information.

Inadequate Proventra production could have a material adverse effect on our business and financial condition.

Given our limited experience in manufacturing Proventra, we cannot be sure that we will be successful in producing Proventra of acceptable quality on a commercial scale and at acceptable costs in our manufacturing facility. If we cannot, our business and financial condition could be materially adversely affected. Our production of Proventra will be regulated by the Minnesota Department of Agriculture. We believe that our current manufacturing facility will meet the anticipated requirements for the production of Proventra for use in consumer and clinical nutritional products through the year 2001. Further, we believe that contract manufacturers would be available to increase our Proventra production capacity quickly, if required. However, until we begin producing Proventra on a commercial scale, we cannot be sure that our production capabilities will be adequate.

Failure of our collaborations to develop and market products containing Proventra could have a material adverse effect on our business and financial condition.

We are relying on collaborations with larger more established companies to develop and market products containing Proventra. Our collaborators’ inability to bring products to market could have a material adverse effect on our business and financial condition. Introduction of new products depends on our ability and our collaborators’ ability to accomplish the following:

• complete market research;

• complete product development;

• establish product manufacturing;

• initiate marketing, sales and distribution activities related to such products; and

• provide the funding necessary to accomplish such activities.

Delays or high costs in product development could have a material adverse effect on our business and financial condition.

If we, or our strategic partners, cannot obtain accurate marketing data, or develop a product responsive to the needs identified by that data, our business and financial condition could be materially adversely affected. The amount of time it will take us, together with our strategic partners, to develop consumer and clinical nutrition products and the associated costs of developing those products depends on, among other things, the results of our market research for consumer and clinical products. It also depends on our discussions with certain end users or purchasers of the potential products. Market research and discussions may give us indications of potential customers, what types of products they may desire and what clinical information is necessary for effective marketing and sales.

Risks Specific to Functional Food and Nutraceutical Products

Consumer fear of Bovine Songiform Encephalopahy, or BSE, may impair our ability to commercialize products containing bovine colostrum.

Occurrences of BSE, or “mad cow disease,” in certain parts of the world may lead to consumer resistance to product containing bovine derived ingredients. Such consumer resistance, or concerns on the part of consumer product developers and manufacturers about such consumer resistance, may impair our ability to commercialize products containing our proprietary bovine colostrum ingredients.

Public misperception of the safety of our product could have a material adverse effect on our business and financial condition.

We are highly dependent upon consumers’ perception of the safety and quality of our products as well as of similar products distributed by other companies. Thus, for example, the publication of reports asserting that such products may be harmful could have a material adverse effect on our business and financial condition, regardless of whether such reports are scientifically supported and regardless of whether the alleged harmful effects would be present at the dosages recommended for such products.

Innovative ingredients may produce unwanted effects and expose us to product liability claims or loss of consumer confidence.

If we develop products with innovative ingredients that over time are shown to produce unwanted effects, we could be exposed to product liability claims and lose consumer confidence, which could have a material adverse effect on our business and financial condition. Some of our future products may contain innovative ingredients or combinations of ingredients that do not have a long history of human consumption. While we believe all of our products will be safe when taken as we direct, there is little long-term experience with human consumption of certain of these innovative product ingredients or combinations thereof in concentrated form. Although we perform research and/or test the formulation and production of our products, we will sponsor only limited clinical studies or rely on other outside published data.

If larger companies with greater access to capital and product markets enter our segment of the nutritional products market, we may be materially adversely affected.

Because the nutritional products industry generally has low barriers to entry, additional competitors could enter the market at any time. Potential competitors could be larger than we are, have greater access to capital than we do and may be better able to withstand volatile market conditions than we are. Although the nutritional products industry to date has been characterized by many relatively small participants, national or international companies (which may include pharmaceutical companies or other suppliers to mass merchandisers) may seek to enter or to increase their presence in this industry or to consolidate it. Increased competition in the industry could have a material adverse effect on our business and financial condition.

Our failure to obtain necessary approvals or otherwise comply with government regulations could have a material adverse effect on our business and financial condition.

Our current and potential functional foods and nutraceutical products may become subject to governmental regulation in the future. The burden of such regulation could add materially to the costs and risks of our development and marketing efforts. There can be no assurance that we could obtain the required approvals or comply with new regulations if our products are subject to additional governmental regulation in the future.

Some of our products in development may be subject to regulation by one or more federal agencies, principally the Food and Drug Administration and the Federal Trade Commission, and to a lesser extent the Consumer Product Safety Commission and the United States Department of Agriculture regarding the formulation, manufacturing, processing, packaging, labeling, advertising, distribution and sale of nutritional supplements. These activities are also regulated by various governmental agencies for the states and localities in which the Company's products are sold, as well as by governmental agencies in certain foreign countries in which the Company's products are sold. Among other matters, regulation of the Company by the FDA and FTC is concerned with claims made with respect to a product which refer to the value of the product in treating or preventing disease or other adverse health conditions.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The Company’s market risk is unlikely to have a material adverse effect on the Company’s business, results of operations or financial condition.

PART II. OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K.

(a.) Exhibits

Exhibit No.	Description	Method of Filing
3.1	Second Restated Bylaws of the Company.(10)	Incorporation By Reference

3.2	Restated Certificate of Incorporation of the Company.(3)	Incorporated By Reference

4.1	Specimen Common Stock Certificate.(1)	Incorporated By Reference

4.2-4.18	Intentionally left blank.

4.19	Form of Subscription Agreement and Investment Letter (8)	Incorporated By Reference

4.20-4.23	Intentionally left blank.

4.24	Stock Purchase Warrant issued to CPR (USA) Inc. dated November 18, 1997.(13)	Incorporated By Reference

4.25	Stock Purchase Warrant issued to Libertyview Plus Fund dated November 18, 1997.(14)	Incorporated By Reference

4.26	Stock Purchase Warrant issued to Libertyview Fund, LLC dated November 18, 1997.(15)	Incorporated By Reference

4.27	Warrant issued to CLARCO Holdings dated as of December 1,1997.(16)	Incorporated By Reference

4.28	Warrant issued to CLARCO Holdings dated as of December 1,1997.(17)	Incorporated By Reference

4.29	Intentionally left blank.

4.30	Warrant issued to Henry J. Cardello dated as of April 13, 1998. (20)	Incorporated By Reference

4.31	Warrant issued to Henry J. Cardello dated as of April 30, 1998. (20)	Incorporated By Reference

4.32	Warrant issued to Henry J. Cardello dated as of June 19, 1998. (20)	Incorporated By Reference

4.33	Warrant issued to William Young and Rebecca Young dated as of August 12, 1998.(24)	Incorporated By Reference

4.34	Warrant issued to Henry J. Cardello dated as of September 30, 1998.(24)	Incorporated By Reference

4.35	Warrant issued to American Home Products Corporation dated as of October 15, 1998.(24)	Incorporated By Reference

4.36	Form of Registration Rights Agreement dated April 20, 1999.(25)	Incorporated By Reference

4.37	Subscription Agreement and Investment Letter dated April 20, 1999 (Lombard Odier & Cie).(26)	Incorporated By Reference

4.38	Subscription Agreement and Investment Letter dated April 20, 1999 (H. Leigh Severance).(27)	Incorporated By Reference

4.39	Subscription Agreement and Investment Letter dated April 20, 1999 (H. L. Severance, Inc. Profit Sharing Plan and Trust).(28)	Incorporated By Reference

4.40	Subscription Agreement and Investment Letter dated April 20, 1999 (H. L. Severance, Inc. Pension Plan and Trust).(29)	Incorporated By Reference

4.41	Subscription Agreement and Investment Letter dated April 20, 1999 (Winston R. Wallin).(30)	Incorporated By Reference

4.42	Warrant issued to Carlson Real Estate Company, Inc. dated June 12, 2000 (34)	Incorporated By Reference

#10.1	License Agreement between the Company and Land O’Lakes dated May 7, 1992.(1)	Incorporated By Reference

#10.2	Royalty Agreement between the Company and Land O’Lakes dated May 7, 1992.(1)	Incorporated By Reference

10.3	Intentionally left blank.

10.4	Master Services Agreement between the Company and Land O’Lakes dated May 7, 1992.(1)	Incorporated By Reference

*10.5	GalaGen Inc. 1992 Stock Plan, as amended. (5)	Incorporated By Reference

10.6-10.7	Intentionally left blank.

#10.8	License and Collaboration Agreement between the Company and Chiron Corporation dated March 20, 1995.(1)	Incorporated By Reference

*10.9	GalaGen Inc. Employee Stock Purchase Plan, as amended. (2)	Incorporated By Reference

10.10-10.11	Intentionally left blank.

10.12	Master Equipment Lease between the Company and Cargill Leasing Corporation, dated June 6, 1996. (2)	Incorporated By Reference

10.13	Agreement for Progress Payments between the Company and Cargill Leasing Corporation, dated June 6, 1996. (2)	Incorporated By Reference

10.14	Agreement for Lease between the Company and Land O’Lakes, dated June 3, 1996. (2)	Incorporated By Reference

10.15-10.18	Intentionally left blank.

*10.19	GalaGen Inc. Annual Short Term Incentive Cash Compensation Plan. (4)	Incorporated By Reference

*10.20	GalaGen Inc. Annual Long Term Incentive Stock Option Compensation Plan. (4)	Incorporated By Reference

*10.21	GalaGen Inc. 1997 Incentive Plan. (6)	Incorporated By Reference

10.22	Master Loan and Security Agreement with TransAmerica Business Credit Corporation dated June 8, 1997. (7)	Incorporated By Reference

10.23	Amended and Restated License Agreement between the Company and Land O' Lakes dated March 11, 1998. (19)	Incorporated By Reference

#10.24	License Agreement between the Company and Metagenics, Inc. dated April 7, 1998. (20)	Incorporated By Reference

10.25-10.29	Intentionally left blank.

#10.30	Collaboration and License Agreement between the Company and American Home Products Corporation acting through its Wyeth-Ayerst Laboratories Division, dated October 15, 1998. (24)	Incorporated By Reference

#10.31	Manufacturing and Supply Agreement between the Company and American Home Products Corporation acting through its Wyeth-Ayerst Laboratories Division dated October 15, 1998.(24)	Incorporated By Reference

#10.32	Product Development Collaboration, Manufacturing and Supply, and Retail Marketing Agreement between the Company and General Nutrition Corporation, dated December 22, 1998.(24)	Incorporated By Reference

10.33	Intentionally left blank

10.34	Repurchase Agreement by and between GalaGen Inc. and Chiron Corporation, dated April 1, 1999. (31)	Incorporated By Reference

#10.35	Licensing and Distribution Agreement by and between GalaGen Inc. and American Institutional Products, Inc., dated March 15, 1999.(31)	Incorporated By Reference

10.36	Intentionally left blank

10.37	Licensing and distribution agreement between GalaGen Inc. and American Institutional Products, Inc., dated July 15, 1999. (32)	Incorporated By Reference

#10.38	Licensing Agreement by and between GalaGen Inc. and Novartis Consumer Health, Inc., dated October 25, 1999. (33)	Incorporated By Reference

#10.39	Supply Agreement by and between GalaGen Inc. and Novartis Consumer Health, Inc., dated October 25, 1999. (33)	Incorporated By Reference

#10.40	Development Agreement by and between GalaGen Inc. and Novartis Consumer Health, Inc., dated December 17, 1999. (33)	Incorporated By Reference

10.41	301 Carlson Parkway Lease between Carlson Real Estate Company and Galagen, Inc. dated June, 2000. (34)	Incorporated By Reference

#10.42	Supply Agreement between Estee Lauder, Inc. and Galagen, Inc. (34)	Incorporated By Reference

*10.43	Employment Agreement with Robert Hoerr, M.D., dated December 6, 2000. (35)	Incorporated By Reference

*10.44	Employment Agreement with Henry J. Cardello, dated December 6, 2000. (35)	Incorporated By Reference

(1)		Incorporated herein by reference to the same numbered Exhibit to the Company’s Registration Statement on Form S-1 (Registration No. 333-1032).
(2)		Incorporated herein by reference to the same numbered Exhibit to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1996 (File No. 0-27976).
(3)		Incorporated herein by reference to the same numbered Exhibit to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1996 (File No. 0-27976).
(4)		Incorporated herein by reference to the same numbered Exhibit to the Company’s Annual Report on Form 10-K for the period ended December 31, 1996 (File No. 0-27976).
(5)		Incorporated herein by reference to the same numbered Exhibit to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1997 (File No. 0-27976).
(6)		Incorporated herein by reference to Appendix A to the Company’s 1997 Definitive Proxy Statement on Schedule 14A (File No. 0-27976).
(7)		Incorporated herein by reference to the same numbered Exhibit to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1997 (File No. 0-27976).
(8)		Incorporated herein by reference to Exhibit No. 99 to the Company’s Report on Form 8-K, dated October 13, 2000 (File No. 0-27976).
(9)		Intentionally not used.
(10)		Incorporated by reference to the same numbered exhibit to the Company’s Current Report on Form 8-K dated December 6, 2000 (File No. 0-27976).
(11)		Intentionally not used.
(12)		Intentionally not used.
(13)		Incorporated herein by reference to Exhibit No. 4.9 to the Company’s Registration Statement on Form S-3 (Registration No. 333-41151).
(14)		Incorporated herein by reference to Exhibit No. 4.10 to the Company’s Registration Statement on Form S–3(Registration No. 333-41151).
(15)		Incorporated herein by reference to Exhibit No. 4.11 to the Company’s Registration Statement on Form S–3 (Registration No. 333-41151).
(16)		Incorporated herein by reference to Exhibit No. 4.12 to Amendment No. 1 to the Company’s Registration Statement on Form S-3 (Registration No. 333-41151).
(17)		Incorporated herein by reference to Exhibit No. 4.13 to Amendment No. 1 to the Company’s Registration Statement on Form S-3 (Registration No. 333-41151).
(18)		Intentionally not used.
(19)		Incorporated herein by reference to the same numbered Exhibit to the Company’s Annual Report on Form 10-K for the period ended December 31, 1997 (File No. 0-27976).
(20)	- (23)	Intentionally left blank.
(24)		Incorporated herein by reference to the same numbered Exhibit to the Company’s Annual Report on Form 10-K for the period ended December 31, 1998 (File No. 0-27976).
(25)		Incorporated herein by reference to Exhibit No. 4.5 to Amendment No. 2 to the Company’s Registration Statement on Form S-3/A (Registration No. 333-71883).
(26)		Incorporated herein by reference to Exhibit No. 4.6 to Amendment No. 2 to the Company’s Registration Statement on Form S-3/A (Registration No. 333-71883).
(27)		Incorporated herein by reference to Exhibit No. 4.7 to Amendment No. 2 to the Company’s Registration Statement on Form S-3/A (Registration No. 333-71883).
(28)		Incorporated herein by reference to Exhibit No. 4.8 to Amendment No. 2 to the Company’s Registration Statement on Form S-3/A (Registration No. 333-71883).
(29)		Incorporated herein by reference to Exhibit No. 4.9 to Amendment No. 2 to the Company’s Registration Statement on Form S-3/A (Registration No. 333-71883).
(30)		Incorporated herein by reference to Exhibit No. 4.10 to Amendment No. 2 to the Company’s Registration Statement on Form S-3/A (Registration No. 333-71883).
(31)		Intentionally not used
(32)		Intentionally not used
(33)		Incorporated herein by reference to the same numbered Exhibit to the Company’s Annual Report on Form 10-K for the Year Ended December 31, 1999. (File No. 0-27976)

(34)		Incorporated herein by reference to the same numbered Exhibit to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2000. (File No. 0-27976)

(35)		Incorporated herein by reference to the same numbered Exhibit to the Company’s Annual Report on Form 10K, as amended, for the year ended December 31, 2000. (File No. 0-27976)

*		Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K.
#		Contains portions for which confidential treatment has been granted to the Company.

(b) Reports on Form 8-K

A Current Report on Form 8K was filed on August 17, 2001 related to the sale of the Company’s critical care enteral nutrition products business and amendment to such Current Report Form 8K was filed on October 16, 2001 filing the required pro forma financial statements related to the transaction.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	GalaGen Inc.
	(Registrant)

Date: November 14^th, 2001	By:	/s/ Henry J. Cardello
		Henry J. Cardello,
		Chief Executive Officer
		(Acting Principal Financial Officer and Principal Accounting Officer)

Use of Estimates

Revenue Recognition

Adoption of Recent FASB Statements of Financial Accounting Standards No. 141 and No. 142

Net Income (Loss) Per Share

Results of Operations

For the Three Months ended September 30, 2001 and 2000

For the Nine Months ended September 30, 2001 and 2000

Item 3. Quantitative and Qualitative Disclosures About Market Risk

GALAGEN INC 10-Q