GENERAL

ZymeTx, Inc. is engaged in the discovery, development and commercialization of unique products used to diagnose and treat viruses. The scientific foundation for our business is based upon the role of enzymes in the process of viral infection. Our strategy is to:

o develop products that may be used to diagnose and treat a range of viral diseases; o earn revenues from marketing ZstatFlu, our first diagnostic product; o continue our diagnostic research and development program into other platform technologies; and o sustain an anti-viral therapeutic research and development program.

ViraZyme(R), our core technology, exploits the subtle structural differences and characteristics of enzymes to create products to diagnose and treat viruses. Our diagnostic technology is a platform for proprietary two-part compounds that will split when the compound contacts a specific enzyme which is the viral target site. As a result of this split, one part of the compound reveals itself in formats easily detected by the naked eye, permitting the user to determine whether the virus is present. For therapeutic products, the technology platform uses modified versions of the diagnostic compounds that bind to specific viral enzymes to interrupt the replication cycle, and a proprietary Inverted Drug Screening System (IDS).

The initial viral targets of our diagnostic products are respiratory infections including influenza A and influenza B, respiratory syncytial virus, parainfluenza and adenovirus. There are three genera of influenza virus, A, B, and C; A and B are most common to humans, while C rarely causes significant infection. Respiratory syncital virus infects humans, usually children, which is an important cause of acute respiratory disease. Adenovirus can cause respiratory disease, keratoconjunctivitis, diarrhea, cystitis and other diseases.

For fiscal 2000 and fiscal 2001, we incurred net losses of $6.8 million and $7.0 million respectively. As of June 30, 2001, our working capital was a deficit of $1.7 million. Our plan for fiscal 2002 can only be achieved if we can obtain new financing, aggregating $3.5 million during the second quarter of fiscal 2002. We cannot assure that financing will be available on terms satisfactory to us, or that such financing will be available at all. Additionally, our ability to conduct research and development beyond that planned for fiscal 2002 will be dependent on our ability to generate cash flow from operations adequate to finance these activities. The lack of adequate capital resources to conduct research and development could limit our ability to introduce new products or make improvements in our existing product line.

As an alternative to financing, we are considering all other options, including the sale of the company, the sale of significant assets of the company or dissolution of the company. See Liquidity and Capital Resources.

ZymeTx was incorporated under the laws of the State of Delaware in 1994. ViraZyme(R), ViraSTAT(R) and ZstatFlu(TM) are trademarks owned or licensed by ZymeTx.

ZYMETX TECHNOLOGY

SCIENTIFIC BACKGROUND. Our ViraZyme(R) technology focuses on the development of highly specific/selective molecules that will interact only with an enzyme of specific origin such as viral, mammalian or bacterial origin. This permits interaction with one enzyme while preventing activity with a similar enzyme of different origin. We can identify the fingerprint of critical enzymes and then build molecules having great preference for only the targeted form of the enzyme. We build these molecules using proprietary assays supported by X-ray crystallography. The enzyme structure is analyzed with 3-dimensional computer aided designs, and by "rational design" which is a method of designing a molecule based upon knowledge of the desired structural characteristics.

The core of the ViraZyme(R) approach is to identify essential target sites of viral enzymes and synthetically produce molecules that act selectively upon an identified target site. This approach has now been shown to develop both diagnostic and therapeutic programs.

We select viral diseases other than influenza to be targeted for commercialization of our products based on the following criteria:

o potential market size;

o the viral disease's incidence, morbidity/mortality;

o the availability of diagnostics and therapeutics for the viral disease; and

o the existence of possible corporate partners.

During fiscal 2000 and fiscal 2001, we incurred research and development expenses of approximately $1.6 million and $1.2 million, respectively. Developing any additional products will require significant ongoing research and development and capital resources not currently available to us.

ZSTATFLU(TM)

BACKGROUND. Our flagship product, ZstatFlu(TM), permits physicians to detect both influenza types A and B virus directly from a patient specimen while in the physician's office. The unique patented technology of ZstatFlu(R) targets the influenza neuraminidase enzyme. The ViraZyme(R) technology incorporates patented substrate molecules which react with the influenza neuraminidase enzyme to generate a visible color exposing the presence of the virus.

PRODUCT STATUS. The FDA cleared the original ZstatFlu(TM) test in September 1997. In August 1998 and August 1999 we introduced FDA cleared improvements to this product. These improvements have made the test easier to use and have improved the test's performance.

One such improvement made the test "portable." A specimen may be transported from the collection point such as a patient's room in a nursing home to a remote regional testing site such as a centralized reference laboratory or hospital laboratory without the use of special packaging. In early fiscal 2000 we reduced the test time from 30 minutes to 20 minutes, making it more convenient for results to be obtained while patients wait in a doctor's office.

In December 2000 the ZstatFlu(TM) test was granted waived status by the United States Food and Drug Administration (FDA). The waived status under the Clinical Laboratory Improvements Amendment (CLIA) means the test procedure can be performed properly and safely without the usual regulatory requirements that govern most other laboratory tests because of the test's simplicity of use and performance features.

OTHER CURRENT PRODUCTS CLEARED BY THE FDA

We have a history of successfully gaining FDA 510(k) clearances; however, we have chosen not to expend resources to market the products described below, and we cannot assure you we will ever market these products or that marketing such products would generate significant income.

VIRAZYME(R) CULTURE SCREEN. ViraZyme(R) Culture Screen, cleared by the FDA in June 1996, detects influenza and parainfluenza viruses and is a product available to clinical labs, in contrast to the use of ZstatFlu(R), which is used both in physician office laboratories and clinical labs. We believe the Culture Screen product reduces labor-intensive procedures in the clinical laboratory and reduces costs.

VIRASTAT(R) PARAINFLUENZA 1, 2 AND 3 FITC-LABELED MONOCLONAL ANTIBODIES. ViraSTAT(R) Parainfluenza 1, 2 and 3, cleared by the FDA in 1995, is the first of a series of clinical lab products we developed using monoclonal antibody technology. Monoclonal antibodies are highly specific for a particular part of an organism and are homogeneous in that they all arise from a single cell clone. This directly labeled product has several distinct advantages over time and labor-intensive tests of other clinical lab products currently available. We intend to

develop other monoclonal antibody-based products for the detection of adenovirus and RSV, and the influenza type A and B products which comprise a panel test detecting multiple viruses.

VIRASTAT(R) INFLUENZA TYPES A AND B FITC-LABELED MONOCLONAL ANTIBODIES. ViraSTAT(R) Influenza types A and B were produced and cleared by the FDA in 1999, and are the follow-on products developed toward completion of a respiratory virus panel of monoclonal antibodies.

OTHER DIAGNOSTIC PRODUCTS IN DEVELOPMENT

ADVANCED VIRAL TESTING PLATFORM TECHNOLOGY. In fiscal 2000, we were awarded a $213,000, three-year grant from Oklahoma Center for the Advancement of Science & Technology for the commercial development and clinical testing of a chemiluminescence-based advanced viral testing platform technology. This technology, which has completed laboratory testing, is being developed as a highly sensitive and highly specific platform with broad application to detect multiple viral disease organisms.

In fiscal 2001, we signed a definitive agreement with Polaroid Corporation to govern the continued development and commercial marketing of a new film and chemiluminescence-based rapid disease detection platform using this light-emitting technology. This new system will initially target the rapid diagnosis of influenza and will be followed by applications to other viral diseases.

ADDITIONAL VIRASTAT(R) FITC-LABELED MONOCLONAL ANTIBODIES. We have developed an improved proprietary method for directly labeling monoclonal antibodies with a commonly used fluorescent dye. This method represents the currently accepted method employed by clinical laboratories to culture and identify viruses. These antibodies may be marketed separately or in a panel with other monoclonal antibodies for detection of respiratory viruses. ViraSTAT(R) monoclonal antibodies have been found superior to commercially available antibodies in our tests.

THERAPEUTIC RESEARCH PROGRAM

During fiscal 2000 and 2001 we reallocated our financial resources to focus on the further development and enhancement of our ZstatFlu(TM) diagnostic product. We expect to devote greater resources to therapeutic development in fiscal 2003, provided that we have the financial ability to do so. Despite this reallocation, we continue to conduct pre-clinical research in the following areas through funding by National Institutes of Health (NIH) grants, and are seeking additional grants from other agencies. For fiscal 2000 and 2001, funded grants to the Company aggregated $120,000 and $135,000, respectively.

INFLUENZA THERAPEUTIC DEVELOPMENT. We currently have an antiviral compound, ZX-2401 and are completing in-vitro studies comparing its efficacy to reference antiviral compounds. We are expanding the in-vitro testing for confirmation at outside laboratories and to have this compound included in testing against other viruses.

RESPIRATORY SYNCYTIAL VIRUS THERAPEUTIC DEVELOPMENT. We have been awarded a $100,000 S Innovative Research Phase 1 grant by the National Institutes of Health to continue studies toward the development of several compounds that show potential antiviral activity against RSV. Currently these compounds are in preclinical studies. RSV is a major, highly infectious pediatric respiratory tract disease occurring worldwide. RSV infects children by 2 years of age and is the leading cause of bronchiolitis and pneumonia in infants, and can be a significant cause of disease in immunocompromised adults and the elderly.

IMMUNE MODULATORY THERAPEUTIC DEVELOPMENT. In addition to its Respiratory Syncytial Virus Therapeutic Development program, the Company has identified a series of compounds through its Inverted Drug Screening Program (IDS) that has the effect of stimulating T-cells, B-cells and macrophages. These preparations are currently in pre-clinical studies and the Company has applied for federal grants to continue development of this program. Immune modulators may be important in the treatment of immunodeficiencies of the body caused by viral infection or by chemotherapy for malignant diseases.

SALES AND MARKETING

INFLUENZA MARKET. Our primary market is the seasonal disease influenza. Influenza is caused by a virus spread from person to person generally through physical contact or contact with respiratory fluids. According to the Center for Disease Control in Atlanta, Georgia, each year the disease affects 30 million to 60 million people in the United States depending on the length and severity of the season. In a typical year, the disease results in approximately 130,000 hospitalizations and 30,000 to 40,000 deaths.

Historically, the use of diagnostic testing follows the availability of therapeutic products. During the 1999-2000 influenza season a new family of antiviral therapeutic products became available to treat influenza. GlaxoWellcome's influenza therapeutic Relenza(TM) and Roche Laboratories influenza therapeutic TamiFlu(TM) were introduced during the 1999/2000 influenza season. We believe that the presence of these therapeutics has enhanced the marketability of all influenza diagnostic products, including ZstatFlu(TM).

MARKET STRATEGY. To maximize the market opportunity created by the introduction of influenza therapeutics, we have implemented an influenza comprehensive disease management program. This program includes informing physicians and consumers about the importance of vaccination, disease surveillance, rapid diagnosis and treatment. Our marketing program involves several distinct components:

o National Flu Surveillance Network. The cornerstone of our total disease management program is the National Flu Surveillance Network, which is the first real time influenza reporting service. This service operates as an influenza surveillance and diagnosis network through the use of ZstatFlu and reporting of results by participating physicians. During the 2000-2001 influenza season our National Flu Surveillance Network at www.fluwatch.com included over 1,100 sites that had in excess of 6,000 reporting physicians. We believe that our disease surveillance coverage is the most comprehensive in the United States and that real time reporting of influenza outbreaks through our National Flu Surveillance Network improves the use of diagnostics as a complement to the growing use of influenza therapeutics.

o Hospital Market. In the hospital market we are sponsoring direct comparisons of our product with our competitors' products and have contracted with distribution companies that target this market segment.

o Physician Office Laboratories. For physician office laboratories and commercial/reference laboratories we continue to enlist product users through our National Flu Surveillance Network in addition to traditional distribution channels. We believe that managed care has not adopted influenza testing due to the lack of definitive information on cost savings and outcome improvements. We have developed a proprietary economic model based on third party validation that depicts potential cost savings through the use of a comprehensive disease management protocol featuring our rapid diagnostic. This model is being presented to managed care companies in anticipation of adoption.

MANUFACTURING ARRANGEMENTS; SOURCES OF RAW MATERIAL

We have sufficient finished goods in inventory currently undergoing rework in house (at a cost of approximately $100,000) to generate sales and cash in excess of $4.0 million in fiscal 2002. Should sales exceed this amount, we have manufacturing arrangements with two producers of chemicals, a supplier of heaters, and two assembly and packaging suppliers to support another $2.0 million in sales, at a cost of approximately $1.0 million.

JAPANESE AND OTHER FOREIGN MARKETS

In March 2001, the Japan Ministry of Health, Labor and Welfare approved ZstatFlu(TM) for sale in Japan. Nichirei Corporation (Tokyo, Japan) managed the ZstatFlu(TM) approval process in Japan for ZymeTx and ordered an additional 100,000 units for delivery between July and November 2001.

Requirements for marketing a diagnostic product in Europe are generally less stringent than in the United States. Once an application for marketing clearance is submitted to the FDA, the product covered by such application may be marketed in some European countries. Without specific registration we can market our diagnostic in the European Union, Hong Kong, Singapore, Mexico, Spain and Middle Eastern countries. Although a large majority of

our product is allocated to the growing United States and Japanese market, we are evaluating opportunities for foreign sales in European countries.

COMPETITION

Competition in our markets is intense. We compete with a large number of companies ranging from very ses to large diagnostic, healthcare, pharmaceutical, biomedical and chemical companies, many of which have substantially greater financial, manufacturing, marketing and product research resources than we have. Academic institutions, governmental agencies and other public and private research organizations are also conducting research activities and may commercialize products on their own or through joint ventures. We intend to compete primarily on the basis of preferred regulatory categorization (CLIA waiver), the clinical utility, accuracy, speed, ease of use and other performance characteristics of our products and, to a lesser degree, on the price of our products.

DIAGNOSTICS. Other companies have developed influenza diagnostics which may compete with our products. The existence of these and other competing products or procedures that may be developed in the future may adversely affect the marketability of products which we develop.

Although our existing licensed patent rights cover a broad field of enzyme based viral diagnostics, others have developed traditional antibody based diagnostics for viral disease. Two other companies, Quidel and Biostar, are marketing influenza diagnostic tests for both types A and B viruses. Becton Dickinson markets a test for influenza type A and recently has added a second companion test for influenza type B. We believe the methods used by these competitors are substantially different than our methods and do not offer the anticipated market advantages of the ViraZyme(R) system. We cannot assure that we will be successful in developing our products to realize the expected marketing advantages or that the advantages of our competitors' products will not exceed those of our products.

THERAPEUTICS. During the 1999-2000 influenza season GlaxoWellcome and Roche introduced their influenza therapeutics. These new drugs are neuraminidase inhibitors, which inhibit viral replication (thus slowing the disease process). They are considered more effective against the flu, exhibit fewer side effects, and are less subject to resistance development, than previously available drugs. Other major pharmaceutical companies have announced clinical trials for their newly developed compounds as well. These competitors are further advanced in the development of influenza therapeutics than we are, which could be a barrier to market acceptance of our therapeutic products, if developed. In addition these companies have substantially greater financial resources and marketing capabilities than we do. In the event we develop a therapeutic product, we plan to contract with large pharmaceutical companies. We cannot assure that such a contract can be secured on terms satisfactory to us, or at all.

Our competitive position will also depend on our ability to:

o obtain adequate capital resources,

o attract and retain qualified scientific and other personnel,

o develop effective proprietary products,

o implement production and marketing plans, and

o obtain patent protection.

INTELLECTUAL PROPERTY

LICENSES FROM OMRF. In 1997, Oklahoma Medical Research Foundation granted us an exclusive, perpetual, worldwide license covering all of the patents which comprise the ViraZyme(R) technology and all foreign patents and patent applications corresponding to those patent applications. The licensed United States patents expire in the United States from 2010 to 2013 and relate to methods for using naturally occurring viral enzymes to detect the presence of a specific virus by a visible reaction, and patents on specific novel compounds, synthesis pathways and

composition of matter. The license grants us the perpetual, exclusive worldwide right to manufacture, use or sell products made under those patent rights. In consideration for the OMRF license, we:

o paid OMRF a license fee of $825,000,

o executed a note in the principal amount of $425,000,

o granted OMRF a 2.0% royalty on net sales of products derived from patents held by OMRF and covered by the license,

o granted to OMRF a warrant to purchase 5,667 shares of our common stock initially at $3.20 per share (reduced to $0.70 per share on April 13, 2001, and $0.38 per share on July 13, 2001) and

o issued OMRF 165,130 shares of common stock.

OTHER PROPRIETARY RIGHTS. In addition to patent rights, we rely on trade secrets, trademarks and nondisclosure agreements to establish and protect our proprietary rights. Despite these precautions, it may be possible for unauthorized third parties to utilize our technology or to obtain and use information that we regard as proprietary. The laws of some foreign countries do not protect our proprietary rights in our processes and products to the same extent as United States laws.

We rely substantially on technologies which are not patentable or proprietary and therefore may be available to our competitors. In addition, many of the processes and much of the know-how of importance to our technology are dependent upon the skills, knowledge and experience of our scientific and technical personnel, which are not patentable. To protect our rights in these areas, we require all employees, significant consultants and advisors, and collaborators to enter into confidentiality agreements. We cannot assure that these agreements will provide meaningful protection for our trade secrets, know-how or other proprietary information if there is unauthorized use or disclosure. We may have competitors who independently develop substantially equivalent technology or who gain access to our trade secrets, knowledge or other proprietary information. ViraZyme(R) and ViraSTAT(R) are trademarks registered to OMRF and licensed to us under the terms of the OMRF license.

GOVERNMENT REGULATION

The following summarizes principal areas of governmental regulation which affect our operations. Any change in governmental regulations or their interpretation could have a material adverse effect on us.

REGULATION OF DIAGNOSTIC PRODUCTS. The manufacture, distribution and sale of our diagnostic products in the U.S require prior authorization by the FDA. The FDA and similar agencies in foreign countries, especially Japan, have promulgated substantial regulations which apply to the testing, marketing, export and manufacturing of diagnostic products. We will usually be required to submit proof of the safety and efficacy of a new diagnostic product to obtain FDA clearance. This proof typically requires clinical and laboratory tests. The testing, preparation of necessary applications and processing of those applications by the FDA is expensive and time consuming.

The clinical testing required by our diagnostic products is expected to be significantly less extensive than that required for the development of a drug or therapeutic product or for an invasive procedure. Clinical testing may take several months or even years to complete, depending on the nature of the filing. We cannot assure that the FDA will act favorably or quickly in making its review, and we may encounter significant difficulties and costs in obtaining FDA clearances. The FDA may request the development of additional data after the original submission. The FDA may also limit the scope of the labeling or permitted use of the product or deny the application altogether. Delays imposed by the patent approval process may materially reduce the period during which we will have the exclusive right to exploit those products or technologies.

The marketability of our diagnostic products may also be affected by state and Federal legislation covering the use of diagnostic tests in physician offices. CLIA-88, the Clinical Laboratory Improvement Act of 1988, established quality standards for all laboratory testing regardless of where the tests are performed. This act also requires

physicians' offices conducting tests with sophisticated instruments or specially trained personnel to be certified or licensed.

Our currently contemplated diagnostic products are regulated as medical devices. All medical devices must undergo FDA review under either a Section 510(k) pre-market notification or a pre-market approval application prior to commercial distribution. A 510(k) is submitted to demonstrate that the product in question is "substantially equivalent" to another legally marketed device. If our diagnostic products do not qualify for clearance under the 510(k) procedure, we may be required to file a pre-market approval application which shows:

o the product is safe and effective based on extensive clinical testing among several diverse testing sites and population groups; and

o the product has acceptable sensitivity and specificity.

Sensitivity is the measure of actual positives versus the sum of false positives and false negatives in a diagnostic test. A high value indicates that the test detects even low levels of the desired target. A low value indicates that detection occurs at higher levels of infection. Specificity is the measure of actual negatives versus the sum of actual negatives and false positives in a diagnostic test. A high value indicates that the test detects only the desired target. A low value is indicative of detection of similar but not targeted entities.

A pre-market approval application requires much more extensive testing than the 510(k) procedure and has a longer filing review period. In response to a pre-market approval application, the FDA may:

o grant marketing clearance,

o request additional information,

o set restrictive limits on claims for use, or

o deny the application all together.

Product clearance may be withdrawn after it is received if regulatory standards are not maintained or if problems occur after the product reaches the market. The FDA may require surveillance programs to monitor the effect of products which have been commercialized. It can prevent or limit further marketing of products based on the results of these post-marketing programs. The FDA must also, under the pre-market approval application guidelines, approve the manufacturing facilities and procedures for the product. The FDA inspects diagnostic companies on a routine basis for regulatory compliance with quality system requirements, which is a set of standards required by the FDA for an organization to sell its products to consumers. We believe that the use of our diagnostic products will not be restricted in physician office laboratories located within our target markets.

REGULATION BY FOREIGN GOVERNMENTS. Sales of our products outside the United States are also subject to regulatory requirements imposed by foreign governments. Regulatory requirements for diagnostic products vary significantly from country to country. Regulations in Western Europe, Canada, Australia, Japan and other developed countries are often less stringent than are the regulatory requirements in the United States The time to meet such regulatory requirements outside the United States may be longer or shorter than that required to achieve United States clearance.

OTHER GOVERNMENT REGULATION. In addition to regulations enforced by the FDA, we also are or will be subject to regulation under the Clinical Laboratory Improvement Act of 1988, the Occupational Safety and Health Act, the Environmental Protection Act, the Resource Conservation and Recovery Act and other present and future Federal, state or local regulations. Our research and development activities involve the controlled use of hazardous materials, chemicals and viruses. Although we believe that our safety procedures for handling and disposing of such materials comply with the standard prescribed by state and Federal regulations, the risk of accidental contamination or injury from these materials cannot be completely eliminated. We could be held liable for any damages that result from an accident, and the liability could exceed our resources.

EMPLOYEES

We had 20 full time employees as of October 14, 2001, comprising seven laboratory/laboratory support personnel, three manufacturing employees, four marketing employees and six employees in administration and finance. Six employees have doctorate degrees, one with a M.D. We believe that our relations with our personnel are excellent. Our future success will depend in large part upon our continued ability to attract and retain highly skilled and qualified personnel. Competition for such personnel is intense.