**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-QSB**

** **
| **ý** | **QUARTERLY  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|----------------------------------------------------------------------------------------|

 

**FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30,2003**

 

**OR**

** **
| **o** | **TRANSITION  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|-----------------------------------------------------------------------------------------|

** **

**FOR THE TRANSITION PERIOD FROM           TO          **

** **

**Commission File Number 0-23553**

** **

**PHOTOGEN TECHNOLOGIES, INC.**

(Exact name of small business issuer asspecified in its charter)

 

| **NEVADA**                                                      |   | **62-1742885**                       |
|-----------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer Identification No.) |

 

**6175 Lusk BoulevardSan Diego, CA 92121**

(Address ofprincipal executive offices) (Zip Code)

 

**858/410-5601**

(Issuer’s telephone number, including areacode)

 

State the number of shares outstanding of each of the issuer’s classesof common equity, as of the latest practicable date: 19,433,298 shares ofcommon stock, $.001 par value per share, issued and outstanding at November 12,2003.

 

Transitional Small Business Disclosure Format(check one):

 

Yes  o     No  ý

 

 

----

 

**INDEX**

 
| PART I.  | FINANCIAL INFORMATION                                           |   |
|----------|-----------------------------------------------------------------|--------|
| ITEM 1.  | FINANCIAL STATEMENTS                                            |   |
|     |                                                            |   |
| ITEM 2.  | MANAGEMENT’S  DISCUSSION AND ANALYSIS OR PLAN OF OPERATION |   |
|     |                                                            |   |
| ITEM 3.  | CONTROLS  AND PROCEDURES                                        |   |
|     |                                                            |   |
| PART II. | OTHER INFORMATION                                               |   |
| ITEM 1.  | LEGAL PROCEEDINGS                                               |   |
|     |                                                            |   |
| ITEM 2.  | CHANGES IN SECURITIES                                           |   |
|     |                                                            |   |
| ITEM 3.  | DEFAULTS UPON SENIOR SECURITIES                                 |   |
|     |                                                            |   |
| ITEM 5.  | OTHER INFORMATION                                               |   |
|     |                                                            |   |
| ITEM 6.  | EXHIBITS  AND REPORTS ON FORM 8-K                               |   |

 

----

 

**PART I. FINANCIAL INFORMATION**

** **

## **ITEM 1.**     FINANCIALSTATEMENTS

 

Photogen Technologies, Inc.

(A Development Stage Company)

Consolidated Condensed Balance Sheets

All amounts in $

 
|                                                                                                                                             |   | **September  30,  2003** |       | **December 31,  2002** |       |
|--------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|------------|------------------------|------------|
|                                                                                                                                             |   | **(Unaudited)**          |       | **(Audited)**          |       |
| **Assets**                                                                                                                                       |   |                     | ** ** |                   | ** ** |
| **Current Assets**                                                                                                                               |   |                     | ** ** |                   | ** ** |
| Cash and cash equivalents                                                                                                                        |   | $                        | 227,970    |                   | $          | 6,090,904 |   |
| Deposits                                                                                                                                         |   | 108,721                  |       | 98,721                 |       |
| Prepaid expenses                                                                                                                                 |   | 582,592                  |       | 693,313                |       |
| **Total Current Assets**                                                                                                                         |   | **919,283**              | ** ** | **6,882,938**          | ** ** |
|                                                                                                                                             |   |                     | ** ** |                   | ** ** |
| **Property, Plant and Equipment,**  less accumulated depreciation of $552,916 and $14,651, respectively                                          |   | 6,737,735                |       | 36,000                 |       |
|                                                                                                                                             |   |                     | ** ** |                   | ** ** |
| **Patent Costs,** net  of amortization of $173,437 and $142,359, respectively                                                                    |   | 326,562                  |       | 357,641                |       |
|                                                                                                                                             |   |                     | ** ** |                   | ** ** |
| **Deposits**                                                                                                                                     |   | 14,383                   |       | 14,383                 |       |
|                                                                                                                                             |   |                     | ** ** |                   | ** ** |
| **Investment in  Alliance**                                                                                                                      |   | —                   |       | 1,255,000              |       |
|                                                                                                                                             |   |                     | ** ** |                   | ** ** |
| **Purchased  Technology, net of amortization of $322,237 and $0, respectively**                                                                  |   | 15,469,750               |       | —                 |       |
|                                                                                                                                             |   |                     | ** ** |                   | ** ** |
| **Investment in and  Advances to Affiliate**                                                                                                     |   | 2,999,011                |       | 8,192,452              |       |
| Total Assets                                                                                                                                     |   | $                        | 26,466,724 |                   | $          | 16,738,414 |   |
|                                                                                                                                             |   |                     | ** ** |                   | ** ** |
| **Liabilities and  Shareholders’ Equity**                                                                                                   |   |                     | ** ** |                   | ** ** |
|                                                                                                                                             |   |                     | ** ** |                   | ** ** |
| **Current Liabilities**                                                                                                                          |   |                     | ** ** |                   | ** ** |
| Accounts payable                                                                                                                                 |   | $                        | 2,510,355  |                   | $          | 835,003 |   |
| Accrued expenses                                                                                                                                 |   | 3,285,375                |       | 34,132                 |       |
| Notes payable                                                                                                                                    |   | 1,250,000                | ** ** | **—**             | ** ** |
| Lines of Credit                                                                                                                                  |   | 8,293,810                | ** ** | **—**             | ** ** |
| Accrued equipment lease                                                                                                                          |   | 334,720                  |       | 401,664                |       |
| **Total Current Liabilities**                                                                                                                    |   | **15,674,260**           | ** ** | **1,270,799**          | ** ** |
|                                                                                                                                             |   |                     | ** ** |                   | ** ** |
| **Accrued Equipment  Lease**                                                                                                                     |   | 234,304                  |       | 401,664                |       |
|                                                                                                                                             |   |                     | ** ** |                   | ** ** |
| **Shares Subject to Rescission**                                                                                                                 |   | —                   |       | 650,000                |       |
|                                                                                                                                             |   |                     | ** ** |                   | ** ** |
| **Puttable Shares**                                                                                                                              |   | 1,946,508                |       | —                 |       |
|                                                                                                                                             |   |                     | ** ** |                   | ** ** |
| **Shareholders’ Equity**                                                                                                                    |   |                     | ** ** |                   | ** ** |
| Preferred stock; par value $.01 per share;  5,000,000 shares authorized including:                                                               |   |                     | ** ** |                   | ** ** |
| Series A Preferred Stock; 12,856 shares  authorized, issued and outstanding, liquidation preference $1,000 per share  (in aggregate $12,856,000) |   | 128                      |       | 128                    |       |
| Common stock; par value $.001 per share;  150,000,000 shares authorized; 19,433,298 and 16,137,465 shares issued and  outstanding, respectively  |   | 19,433                   |       | 16,137                 |       |
| Additional paid-in capital                                                                                                                       |   | 49,849,384               |       | 43,144,880             |       |
| Common stock to be issued upon shareholder  approval                                                                                             |   | 5,080,082                | ** ** |                   | ** ** |
| Deficit accumulated during the development  stage                                                                                                |   | (46,337,375              | )          | (28,745,194            | )          |
| **Total Shareholders’  Equity**                                                                                                             |   | 8,611,652                |       | 14,415,951             |       |
|                                                                                                                                             |   | $                        | 26,466,724 |                   | $          | 16,738,414 | ** ** |

 

1

----

 

Photogen Technologies, Inc.

(A Development Stage Company)

Consolidated Condensed Statements of Operations

(Unaudited)

All amounts in $

 
|                                                                               |   | **Three  Months  Ended  September 30,  2003** |       | **Three  Months  Ended  September 30,  2002** |       | **Nine  Months  Ended  September 30,  2003** |       | **Nine  Months  Ended  September 30,  2002** |        | **Cumulative  Amounts  From  November 3,  1996  (inception) to  September 30,  2003** |       |
|------------------------------------------------------------------------------------|--------|-----------------------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|-------------|---------------------------------------------------------------------------------------|------------|
|                                                                               |   |                                          |       |                                          |       |                                         |       |                                         |        | **(Unaudited)**                                                                       |       |
|                                                                               |   |                                          | ** ** |                                          | ** ** |                                         | ** ** |                                         | ** **  |                                                                                  | ** ** |
| **Operating Expenses**                                                             |   |                                          |       |                                          |       |                                         |       |                                         |        |                                                                                  |       |
| Research and development                                                           |   | $                                             | 562,703    |                                          | $          | 376,279                                      |       | $                                            | 1,383,145   |                                                                                  | $          | 715,816 |   | $ | 5,739,782 |   |
| Sales, general and administrative                                                  |   | 4,306,244                                     |       | 841,804                                       |       | 10,771,833                                   |       | 2,166,441                                    |        | 27,419,355                                                                            |       |
| Restructuring charges                                                              |   | —                                        |       | —                                        |       | —                                       |       | 451,068                                      |        | 1,404,508                                                                             |       |
| Provision for future lease payments                                                |   | —                                        |       | —                                        |       | —                                       |       | —                                       |        | 1,264,208                                                                             |       |
|                                                                               |   |                                          |       |                                          |       |                                         |       |                                         |        |                                                                                  |       |
| **Total Operating  Expenses**                                                      |   | 4,868,947                                     |       | 1,218,083                                     |       | 12,154,978                                   |       | 3,333,325                                    |        | 35,827,853                                                                            |       |
|                                                                               |   |                                          |       |                                          |       |                                         |       |                                         |        |                                                                                  |       |
| **Loss from Joint  Venture**                                                       |   | (195,896                                      | )          | (305,400                                      | )          | (5,193,441                                   | )          | (1,245,845                                   | )           | (12,108,457                                                                           | )          |
|                                                                               |   |                                          |       |                                          |       |                                         |       |                                         |        |                                                                                  |       |
| **Investment Income**                                                              |   | 581                                           |       | 30                                            |       | 7,394                                        |       | 1,532                                        |        | 1,216,335                                                                             |       |
|                                                                               |   |                                          |       |                                          |       |                                         |       |                                         |        |                                                                                  |       |
| **Interest Expense**                                                               |   | (197,169                                      | )          | (71,444                                       | )          | (251,157                                     | )          | (172,157                                     | )           | (718,052                                                                              | )          |
|                                                                               |   |                                          |       |                                          |       |                                         |       |                                         |        |                                                                                  |       |
| Loss from continuing operations                                                    |   | (5,261,431                                    | )          | (1,594,897                                    | )          | (17,592,182                                  | )          | (4,749,795                                   | )           | (47,438,027                                                                           | )          |
|                                                                               |   |                                          |       |                                          |       |                                         |       |                                         |        |                                                                                  |       |
| Discontinued Operations                                                            |   |                                          |       |                                          |       |                                         |       |                                         |        |                                                                                  |       |
| Loss from operations of discontinued  therapeutic business                         |   | —                                        |       | (244,719                                      | )          | —                                       |       | (1,291,825                                   | )           | (10,679,101                                                                           | )          |
| Gain from split-off of therapeutic business                                        |   | —                                        |       | —                                        |       | —                                       |       | —                                       |        | 11,779,752                                                                            |       |
|                                                                               |   |                                          |       |                                          |       |                                         |       |                                         |        |                                                                                  |       |
| Income (loss) from discontinued operations                                         |   | —                                        |       | (244,719                                      | )          | —                                       |       | (1,291,825                                   | )           | 1,100,651                                                                             |       |
|                                                                               |   |                                          |       |                                          |       |                                         |       |                                         |        |                                                                                  |       |
| **Net Loss**                                                                       |   | $                                             | (5,261,431 | )                                             | $          | (1,839,616                                   | )          | $                                            | (17,592,182 | )                                                                                     | $          | (6,041,620 | ) | $ | (46,337,376 | ) |
|                                                                               |   |                                          |       |                                          |       |                                         |       |                                         |        |                                                                                  |       |
| **Dividends on  Preferred Stock**                                                  |   | (267,510                                      | )          | (345,622                                      | )          | (791,480                                     | )          | (1,024,300                                   | )           |                                                                                  |       |
|                                                                               |   |                                          |       |                                          |       |                                         |       |                                         |        |                                                                                  |       |
| **Net Loss Applicable  to Common Shareholders**                                    |   | $                                             | (5,528,941 | )                                             | $          | (2,185,238                                   | )          | $                                            | (18,383,662 | )                                                                                     | $          | (7,065,920 | ) |   |   |
|                                                                               |   |                                          |       |                                          |       |                                         |       |                                         |        |                                                                                  |       |
| **Basic and Diluted  Loss per Common Share**                                       |   | $                                             | (.26       | )                                             | $          | (.23                                         | )          | $                                            | (0.99       | )                                                                                     | $          | (.73 | ) |   |   |
|                                                                               |   |                                          | ** ** |                                          | ** ** |                                         | ** ** |                                         | ** **  |                                                                                  | ** ** |
| **Weighted Average  Number of Common Shares Outstanding – Basic and Diluted** |   | 21,361,817                                    |       | 9,710,575                                     |       | 18,562,221                                   |       | 9,710,575                                    |        |                                                                                  |       |

 

2

----

 

Photogen Technologies, Inc.

(A Development Stage Company)

Consolidated Condensed Statements of Shareholders’ Equity

(Unaudited)

 
|                                                                |   | **Preferred Stock** |   | **Common  Stock** |   | **Members’  Capital** |   | **Common  Stock  To be  Issued** |   | **Additional  Paid-in  Capital** |   | **Deficit  Accumulated  Development  Stage** |   | **Total** |   |
|---------------------------------------------------------------------|--------|---------------------|--------|-------------------|--------|----------------------------|--------|----------------------------------|--------|----------------------------------|--------|----------------------------------------------|--------|-----------|--------|
| **Series A**                                                        |   | **Series B**        |
| **Shares**                                                          |   | **Amount**          |   | **Shares**        |   | **Amount**                 |   | **Shares**                       |   | **Amount**                       |
|                                                                |   |                |   |              |   |                       |   |                             |   |                             |   |                                         |   |      |   |   |   |   |   |   |   |   |   |
| Contribution of capital                                             |   | —              |   | $                 | — |                       | — |                             | $      | —                           |   | —                                       |   | $         | — |   | $ | 7,268 |   | — |   | $ | — |   | $ | — |   | $ | 7,268 |   |
| Net loss for the period ended December 31, 1996                     |   | —              |   | —            |   | —                     |   | —                           |   | —                           |   | —                                       |   | (1,779    | )      | — |   | — |   | — |   | (1,779 | ) |
|                                                                |   |                |   |              |   |                       |   |                             |   |                             |   |                                         |   |      |   |   |   |   |   |   |   |   |   |
| **Balance,** at May 15,  1997                                       |   | —              |   | $                 | — |                       | — |                             | $      | —                           |   | —                                       |   | $         | — |   | $ | 9,000 |   | — |   | $ | — |   | $ | (3,511 | ) | $ | 5,489 |   |
|                                                                |   |                |   |              |   |                       |   |                             |   |                             |   |                                         |   |      |   |   |   |   |   |   |   |   |   |
| Issuance of common stock                                            |   | —              |   | —            |   | —                     |   | —                           |   | 1,578,208                        |   | 1,578                                        |   | —    |   | — |   | 1,801,872 |   | — |   | 1,803,450 |   |
| Effect of recapitalization and merger                               |   | —              |   | —            |   | —                     |   | —                           |   | 7,421,792                        |   | 7,422                                        |   | (9,000    | )      | — |   | 1,203,765 |   | 1,732 |   | 1,203,919 |   |
| Cost associated with recapitalization and merger                    |   | —              |   | —            |   | —                     |   | —                           |   | —                           |   | —                                       |   | —    |   | — |   | (371,111 | ) | — |   | (371,111 | ) |
| Net loss for the period May 16, 1997 to December 31, 1997           |   | —              |   | —            |   | —                     |   | —                           |   | —                           |   | —                                       |   | —    |   | — |   | — |   | (554,702 | ) | (554,702 | ) |
|                                                                |   |                |   |              |   |                       |   |                             |   |                             |   |                                         |   |      |   |   |   |   |   |   |   |   |   |
| **Balance,** at December  31, 1997                                  |   | —              |   | —            |   | —                     |   | —                           |   | 9,000,000                        |   | 9,000                                        |   | —    |   | — |   | 2,634,526 |   | (556,481 | ) | 2,087,045 |   |
|                                                                |   |                |   |              |   |                       |   |                             |   |                             |   |                                         |   |      |   |   |   |   |   |   |   |   |   |
| Issuance of common stock                                            |   | —              |   | —            |   | —                     |   | —                           |   | 218,755                          |   | 219                                          |   | —    |   | — |   | 6,999,781 |   | — |   | 7,000,000 |   |
| Costs associated with common stock issuance                         |   | —              |   | —            |   | —                     |   | —                           |   | —                           |   | —                                       |   | —    |   | — |   | (50,000 | ) | — |   | (50,000 | ) |
| Options issued to consultants                                       |   | —              |   | —            |   | —                     |   | —                           |   | —                           |   | —                                       |   | —    |   | — |   | 45,446 |   | — |   | 45,446 |   |
| Net loss for the year ended December 31, 1998                       |   | —              |   | —            |   | —                     |   | —                           |   | —                           |   | —                                       |   | —    |   | — |   | — |   | (1,973,913 | ) | (1,973,913 | ) |
|                                                                |   |                |   |              |   |                       |   |                             |   |                             |   |                                         |   |      |   |   |   |   |   |   |   |   |   |
| **Balance,** at December  31, 1998                                  |   | —              |   | —            |   | —                     |   | —                           |   | 9,218,755                        |   | 9,219                                        |   | —    |   | — |   | 9,629,753 |   | (2,530,394 | ) | 7,108,578 |   |
|                                                                |   |                |   |              |   |                       |   |                             |   |                             |   |                                         |   |      |   |   |   |   |   |   |   |   |   |
| Exercise of stock options                                           |   | —              |   | —            |   | —                     |   | —                           |   | 1,125                            |   | 1                                            |   | —    |   | — |   | 50,062 |   | — |   | 50,063 |   |
| Issuance of warrants and options                                    |   | —              |   | —            |   | —                     |   | —                           |   | —                           |   | —                                       |   | —    |   | — |   | 3,664,749 |   | — |   | 3,664,749 |   |
| Issuance of common stock                                            |   | —              |   | —            |   | —                     |   | —                           |   | 125,967                          |   | 126                                          |   | —    |   | — |   | 6,082,528 |   | — |   | 6,082,654 |   |
| Issuance of preferred stock                                         |   | 12,015              |   | 120               |   | —                     |   | —                           |   | —                           |   | —                                       |   | —    |   | — |   | 11,578,839 |   | — |   | 11,578,959 |   |
| Net loss for the year ended December 31, 1999                       |   | —              |   | —            |   | —                     |   | —                           |   | —                           |   | —                                       |   | —    |   | — |   | — |   | (6,052,841 | ) | (6,052,841 | ) |
|                                                                |   |                |   |              |   |                       |   |                             |   |                             |   |                                         |   |      |   |   |   |   |   |   |   |   |   |
| **Balance,** at December  31, 1999                                  |   | 12,015              |   | 120               |   | —                     |   | —                           |   | 9,345,847                        |   | 9,346                                        |   | —    |   | — |   | 31,005,931 |   | (8,583,235 | ) | 22,432,162 |   |
|                                                                |   |                |   |              |   |                       |   |                             |   |                             |   |                                         |   |      |   |   |   |   |   |   |   |   |   |
| Stock option compensation                                           |   | —              |   | —            |   | —                     |   | —                           |   | —                           |   | —                                       |   | —    |   | — |   | 125,020 |   | — |   | 125,020 |   |
| Issuance of warrants and options                                    |   | —              |   | —            |   | —                     |   | —                           |   | —                           |   | —                                       |   | —    |   | — |   | 1,366,050 |   | — |   | 1,366,050 |   |
| Issuance of preferred stock dividend                                |   | 841                 |   | 8                 |   | —                     |   | —                           |   | —                           |   | —                                       |   | —    |   | — |   | (8 | ) | — |   | — |   |
| Issuance of preferred stock                                         |   | —              |   | —            |   | 337,056                    |   | 3,370                            |   | —                           |   | —                                       |   | —    |   | — |   | 5,272,970 |   | — |   | 5,276,340 |   |
| Net loss for the year ended December 31, 2000                       |   | —              |   | —            |   | —                     |   | —                           |   | —                           |   | —                                       |   | —    |   | — |   | — |   | (10,787,062 | ) | (10,787,062 | ) |
|                                                                |   |                |   |              |   |                       |   |                             |   |                             |   |                                         |   |      |   |   |   |   |   |   |   |   |   |
| **Balance,** at December  31, 2000                                  |   | 12,856              |   | 128               |   | 337,056                    |   | 3,370                            |   | 9,345,847                        |   | 9,346                                        |   | —    |   | — |   | 37,769,963 |   | (19,370,297 | ) | 18,412,510 |   |
|                                                                |   |                |   |              |   |                       |   |                             |   |                             |   |                                         |   |      |   |   |   |   |   |   |   |   |   |
| Stock option compensation                                           |   | —              |   | —            |   | —                     |   | —                           |   | —                           |   | —                                       |   | —    |   | — |   | 64,729 |   | — |   | 64,729 |   |
| Issuance of common stock for cash                                   |   | —              |   | —            |   | —                     |   | —                           |   | 49,245                           |   | 49                                           |   | —    |   | — |   | 418,674 |   | — |   | 418,723 |   |
| Issuance of common stock in satisfaction Of anti-dilution provision |   | —              |   | —            |   | —                     |   | —                           |   | 190,856                          |   | 191                                          |   | —    |   | — |   | (191 | ) | — |   | — |   |
| Issuance of preferred stock dividend                                |   | —              |   | —            |   | 20,224                     |   | 202                              |   | —                           |   | —                                       |   | —    |   | — |   | (202 | ) | — |   | — |   |
| Net loss for the year ended December 31, 2001                       |   | —              |   | —            |   | —                     |   | —                           |   | —                           |   | —                                       |   | —    |   | — |   | — |   | (9,723,016 | ) | (9,723,016 | ) |
|                                                                |   |                |   |              |   |                       |   |                             |   |                             |   |                                         |   |      |   |   |   |   |   |   |   |   |   |
| **Balance,** at December  31, 2001                                  |   | 12,856              |   | 128               |   | 357,280                    |   | 3,572                            |   | 9,585,948                        |   | 9,586                                        |   | —    |   | — |   | 38,252,973 |   | (29,093,313 | ) | 9,172,946 |   |

 

3

----

 
|                                                                                        |   | **Preferred Stock** |       | **Common Stock** |       | **Members’  Capital** |       | **Common  Stock  To be  Issued** |       | **Additional  Paid-in  Capital** |       | **Deficit  Accumulated  Development  Stage** |       | **Total** |       |
|---------------------------------------------------------------------------------------------|--------|---------------------|------------|------------------|------------|----------------------------|------------|----------------------------------|------------|----------------------------------|------------|----------------------------------------------|------------|-----------|------------|
| **Series A**                                                                                |   | **Series B**        |
| **Shares**                                                                                  |   | **Amount**          |       | **Shares**       |       | **Amount**                 |       | **Shares**                       |       | **Amount**                       |
|                                                                                        |   |                |       |             |       |                       |       |                             |       |                             |       |                                         |       |      |       |   |   |   |   |   |   |   |   |
| **Balance,** at December  31, 2001                                                          |   | 12,856              |       | $                | 128        |                       | 357,280    |                             | $          | 3,572                            |       | 9,585,948                                    |       | $         | 9,586      |   | $ | — |   | $ | — |   | $ | 38,252,973 |   | $ | (29,093,313 | ) | $ | 9,172,946 |   |
|                                                                                        |   |                |       |             |       |                       |       |                             |       |                             |       |                                         |       |      |       |   |   |   |   |   |   |   |   |
| Stock option compensation                                                                   |   | —              |       | —           |       | —                     |       | —                           |       | —                           |       | —                                       |       | —    |       | — |   | 73,870 |   | — |   | 73,870 |   |
| Issuance of warrants for service                                                            |   | —              |       | —           |       | —                     |       | —                           |       | —                           |       | —                                       |       | —    |       | — |   | 322,000 |   | — |   | 322,000 |   |
| Issuance of options in settlement of lawsuit                                                |   | —              |       | —           |       | —                     |       | —                           |       | —                           |       | —                                       |       | —    |       | — |   | 806,415 |   | — |   | 806,415 |   |
| Employee compensation from stock options                                                    |   | —              |       | —           |       | —                     |       | —                           |       | —                           |       | —                                       |       | —    |       | — |   | 988,184 |   | — |   | 988,184 |   |
| Issuance of preferred stock dividends                                                       |   | —              |       | —           |       | 40,194                     |       | 402                              |       | —                           |       | —                                       |       | —    |       | — |   | (402 | ) | — |   | — |   |
| Conversion of Series B to common stock                                                      |   | —              |       | —           |       | (397,474                   | )          | (3,974                           | )          | 422,316                          |       | 422                                          |       | —    |       | — |   | 3,552 |   | — |   | — |   |
| Beneficial inducement costs for convertible debt converted                                  |   | —              |       | —           |       | —                     |       | —                           |       | —                           |       | —                                       |       | —    |       | — |   | 206,348 |   | — |   | 206,348 |   |
| Conversion of line of credit with Élan to common stock                                 |   | —              |       | —           |       | —                     |       | —                           |       | 128,437                          |       | 128                                          |       | —    |       | — |   | 3,082,359 |   | — |   | 3,082,487 |   |
| Conversion of line of credit with entity controlled by director of  company to common stock |   | —              |       | —           |       | —                     |       | —                           |       | 2,314,815                        |       | 2,315                                        |       | —    |       | — |   |  2,497,685 |   | — |   | 2,500,000 |   |
| Retirement of common stock returned in shareholder transaction (Note  6(f))                 |   | —              |       | —           |       | —                     |       | —                           |       | (5,137,109                       | )          | (5,137                                       | )          | —    |       | — |   | (12,221,182 | ) | — |   | (12,226,319 | ) |
| Issuance of common stock for cash                                                           |   | —              |       | —           |       | —                     |       | —                           |       | 8,823,058                        |       | 8,823                                        |       | —    |       | — |   | 9,133,078 |   | — |   | 9,141,901 |   |
| Net loss for the year ended December 31, 2002                                               |   | —              |       | —           |       | —                     |       | —                           |       | —                           |       | —                                       |       | —    |       | — |   | — |   | 348,119 |   | 348,119 |   |
|                                                                                        |   |                |       |             |       |                       |       |                             |       |                             |       |                                         |       |      |       |   |   |   |   |   |   |   |   |
| **Balance,** at December  31, 2002                                                          |   | 12,856              |       | $                | 128        |                       | —     |                             | $          | —                           |       | 16,137,465                                   |       | $         | 16,137     |   | $ | — |   | $ | — |   | $ | 43,144,880 |   | $ | (28,745,194 | ) | $ | 14,415,951 |   |
|                                                                                        |   |                | ** ** |             | ** ** |                       | ** ** |                             | ** ** |                             | ** ** |                                         | ** ** |      | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Issuance of common stock for cash                                                           |   | —              |       | —           |       | —                     |       | —                           |       | 27,778                           |       | 28                                           |       | —    |       | — |   | 29,972 |   | — |   | 30,000 |   |
| Issuance of common stock for standstill agreement                                           |   | —              |       | —           |       | —                     |       | —                           |       | 750,000                          |       | 750                                          |       | —    |       | — |   | 1,173,000 |   | — |   | 1,173,750 |   |
| Conversion of Series B to common stock                                                      |   | —              |       | —           |       | —                     |       | —                           |       | 100                              |       | —                                       |       | —    |       | — |   | — |   | — |   | — |   |
| Options issued to consultants for services                                                  |   | —              |       | —           |       | —                     |       | —                           |       | —                           |       | —                                       |       | —    |       | — |   | 9,200 |   | — |   | 9,200 |   |
| Shares issued to consultant for services                                                    |   | —              |       | —           |       | —                     |       | —                           |       | 37,500                           |       | 37                                           |       | —    |       | — |   | 99,788 |   | — |   | 99,825 |   |
| Employee compensation from stock options                                                    |   | —              |       | —           |       | —                     |       | —                           |       | —                           |       | —                                       |       | —    |       | — |   | 895,992 |   | — |   | 1,105,992 |   |
| Shares issued in Technology Purchase                                                        |   | —              |       | —           |       | —                     |       | —                           |       | 2,198,137                        |       | 2,198                                        |       | —    |       | — |   | 5,581,070 |   | — |   | 5,583,268 |   |
| Shares to be issued in Technology Purchase                                                  |   | —              |       | —           |       | —                     |       | —                           |       | —                           |       | —                                       |       | —    |       | 5,043,226 |   |   |   | — |   | 5,043,226 | ** ** |
| Shares previously subject to rescission                                                     |   | —              |       | —           |       | —                     |       | —                           |       | 124,627                          |       | 125                                          |       | —    |       | — |   | 649,875 |   | — |   | 650,000 |   |
| Shares issued to Xmark for penalties                                                        |   | —              |       | —           |       | —                     |       | —                           |       | 98,826                           |       | 99                                           |       | —    |       | — |   | 163,577 |   | — |   | 163,676 |   |
| Shares issued to Xmark for interest                                                         |   | —              |       | —           |       | —                     |       | —                           |       | 21,649                           |       | 22                                           |       | —    |       | — |   | 48,575 |   | — |   | 48,597 |   |
| Shares to be issued to Xmark for interest                                                   |   | —              |       | —           |       | —                     |       | —                           |       | —                           |       | —                                       |       | —    |       | 36,856 |   | — |   | — |   | 36,856 |   |
| Options exercised through cashless exercise                                                 |   | —              |       | —           |       | —                     |       | —                           |       | 37,216                           |       | 37                                           |       | —    |       | — |   | (37 | ) | — |   | — |   |
| Xmark puttable shares classified as mezzanine equity                                        |   | —              |       | —           |       | —                     |       | —                           |       | —                           |       | —                                       |       | —    |       | — |   | (1,946,508 | ) | — |   | (1,946,508 | ) |
| Net loss for the nine months ended September 30, 2003                                       |   | —              |       | —           |       | —                     |       | —                           |       | —                           |       | —                                       |       | —    |       | — |   | — |   | (17,592,182 | ) | (17,592,182 | ) |
|                                                                                        |   |                |       |             |       |                       |       |                             |       |                             |       |                                         |       |      |       |   |   |   |   |   |   |   |   |
| **Balance,** at September  30, 2003                                                         |   | 12,856              |       | $                | 128        |                       | —     |                             | $          | —                           |       | 19,433,298                                   |       | $         | 19,433     |   | $ | — |   | $ | 5,080,082 |   | $ | 49,849,384 |   | $ | (46,337,375 | ) | $ | 8,611,652 |   |

 

4

----

 

Photogen Technologies, Inc.

(A Development Stage Company)

Consolidated Condensed Statements of Cash Flows

(Unaudited)

All amounts in $

 
|                                                                                                   |   | **Nine  Months  Ended  September 30,  2003** |        | **Nine  Months  Ended  September 30,  2002** |   | **Cumulative  Amounts  From  November 3,  1996  (Inception)** |   |
|--------------------------------------------------------------------------------------------------------|--------|----------------------------------------------|-------------|----------------------------------------------|--------|---------------------------------------------------------------|--------|
|                                                                                                   |   |                                         |        |                                         |   | **(Unaudited)**                                               |   |
| **Cash Flows From  Operating Activities**                                                              |   |                                         |        |                                         |   |                                                          |   |
| Net loss                                                                                               |   | $                                            | (17,592,182 | )                                            | $      | (6,041,620                                                    | )      | $ | (46,337,376 | ) |
| Loss from discontinued operations                                                                      |   | —                                       |        | 1,291,825                                    |   | 10,679,101                                                    |   |
| Depreciation and amortization                                                                          |   | 569,489                                      |        | 317,525                                      |   | 2,247,393                                                     |   |
| Loss on disposal of fixed assets                                                                       |   | —                                       |        | —                                       |   | 38,424                                                        |   |
| Gain on sale of marketable securities                                                                  |   | —                                       |        | —                                       |   | (18,503                                                       | )      |
| United States Treasury Notes Amortization                                                              |   | —                                       |        | —                                       |   | 12,586                                                        |   |
| Gain on sale of therapeutic business                                                                   |   | —                                       |        | —                                       |   | (11,779,752                                                   | )      |
| Allowance for notes receivable                                                                         |   | 1,491,500                                    |        | —                                       |   | 1,491,500                                                     |   |
| Stock option compensation                                                                              |   | 905,191                                      |        | 43,701                                       |   | 2,583,761                                                     |   |
| Issuance of stock for standstill agreement                                                             |   | 1,337,426                                    |        | —                                       |   | 1,337,426                                                     |   |
| Beneficial inducement costs for convertible  notes                                                     |   | —                                       |        | —                                       |   | 206,348                                                       |   |
| Issuance of warrants in exchange for  services rendered                                                |   | —                                       |        | —                                       |   | 4,317,091                                                     |   |
| Issuance of stock options in settlement of  lawsuit                                                    |   | —                                       |        | —                                       |   | 806,415                                                       |   |
| Issuance of stock for services rendered                                                                |   | 99,825                                       |        | —                                       |   | 99,825                                                        |   |
| Loss from investment in affiliate                                                                      |   | 5,193,441                                    |        | 1,245,845                                    |   | 12,108,457                                                    |   |
| Issuance of stock for interest payments                                                                |   | 85,455                                       |        | —                                       |   | 85,455                                                        |   |
| Changes in operating assets and liabilities  (net of acquisition of *Imagent*assets  and liabilities): |   |                                         |        |                                         |   |                                                          |   |
| Prepaid expenses                                                                                       |   | 110,723                                      |        | (252,683                                     | )      | (582,590                                                      | )      |
| Accounts payable                                                                                       |   | 1,675,350                                    |        | 904,572                                      |   | 2,580,353                                                     |   |
| Accrued expenses                                                                                       |   | 80,260                                       |        | 656,453                                      |   | 349,969                                                       |   |
| Accrued equipment lease                                                                                |   | (234,304                                     | )           | 91,131                                       |   | 899,673                                                       |   |
| Accrued restructuring                                                                                  |   | —                                       |        | 276,068                                      |   | —                                                        |   |
| Net cash used in operating activities  (continuing operations)                                         |   | (6,227,828                                   | )           | (1,467,183                                   | )      | (18,874,444                                                   | )      |
| Net cash used in discontinued operations                                                               |   | —                                       |        | (1,291,825                                   | )      | (10,679,101                                                   | )      |
| **Cash Flows From  Investing Activities**                                                              |   |                                         |        |                                         |   |                                                          |   |
| Sale of marketable securities                                                                          |   | —                                       |        | —                                       |   | 2,164,464                                                     |   |
| Purchases of marketable securities                                                                     |   | —                                       |        | —                                       |   | (2,182,967                                                    | )      |
| Purchases of United States Treasury Notes                                                              |   | —                                       |        | —                                       |   | (38,656,973                                                   | )      |
| Sales of United States Treasury Notes                                                                  |   | —                                       |        | —                                       |   | 39,778,548                                                    |   |
| Purchase of capital assets                                                                             |   | —                                       |        | —                                       |   | (636,877                                                      | )      |
| Proceeds from sale of equipment                                                                        |   | —                                       |        | —                                       |   | 145,551                                                       |   |
| Costs to acquire patent                                                                                |   | —                                       |        | —                                       |   | (237,335                                                      | )      |
| Investment in and advances to affiliate                                                                |   | —                                       |        | (639,971                                     | )      | (15,107,468                                                   | )      |
| Decrease (increase) in deposit                                                                         |   | (10,000                                      | )           | 100,000                                      |   | (453,753                                                      | )      |
| Investment in Alliance Pharmaceutical Corp.                                                            |   | —                                       |        | —                                       |   | (1,255,000                                                    | )      |
| Purchase of *Imagent* business                                                                         |   | (6,515,108                                   | )           | —                                       |   | (6,515,108                                                    | )      |
| Principal payment on acquisition debt                                                                  |   | (1,250,000                                   | )           | —                                       |   | (1,250,000                                                    | )      |
| Net cash used in investing activities                                                                  |   | (7,775,108                                   | )           | (539,971                                     | )      | (24,206,918                                                   | )      |
| Net cash used in investing activities of  discontinued operations                                      |   | —                                       |        | —                                       |   | (1,306,676                                                    | )      |
| **Cash Flows From  Financing Activities**                                                              |   |                                         |        |                                         |   |                                                          |   |
| Principal payments on capital leases                                                                   |   | —                                       |        | —                                       |   | (291,704                                                      | )      |
| Net proceeds from issuance of equity                                                                   |   | 30,000                                       |        | —                                       |   | 40,539,340                                                    |   |
| Proceeds from capital contributions by  shareholders                                                   |   | —                                       |        | —                                       |   | 1,911,674                                                     |   |
| Proceeds from issuance of debt                                                                         |   | 8,160,000                                    |        | 2,057,905                                    |   | 13,506,910                                                    |   |
| Cost of recapitalization                                                                               |   | —                                       |        | —                                       |   | (371,111                                                      | )      |
| Net cash provided by financing activities                                                              |   | 8,190,000                                    |        | 2,057,905                                    |   | 55,295,109                                                    |   |
| *Increase  (decrease) in Cash and Cash Equivalents*                                                    |   | (5,862,934                                   | )           | (1,241,074                                   | )      | 227,970                                                       |   |
| **Cash and Cash Equivalents,**  at beginning of period                                                 |   | 6,090,904                                    |        | 1,352,904                                    |   | —                                                        |   |
| **Cash and Cash Equivalents,**  at end of period                                                       |   | $                                            | 227,970     |                                         | $      | 111,830                                                       |   | $ | 227,970 |   |

 

5

----

 
| **Supplemental Schedule of Noncash Investing  and Financing Activities 2003**     |   |       |       |
|-----------------------------------------------------------------------------------|--------|------------|------------|
| **Acquisition of the medical imaging business  of Alliance Pharmaceutical Corp.** |   |       |       |
| **Summary of Purchase Transaction**                                               |   |       |       |
| Issuance  of common stock                                                         |   | $          | 5,583,268  |   |
| Common  stock to be issued                                                        |   | 5,043,226  |       |
| Cash  advances in prior year                                                      |   | 1,255,000  |       |
| Net  current cash advances prior to acquisition                                   |   | 2,584,383  |       |
| Cash paid  at closing                                                             |   | 669,117    |       |
| Direct  payments to vendors on behalf of Alliance                                 |   | 182,435    |       |
| Acquisition Costs                                                                 |   | 1,254,205  |       |
| Purchase  Price                                                                   |   | $          | 16,571,634 |   |
| **Fair Value of Assets Acquired and Liabilities  Assumed**                        |   |       |       |
| Property, Plant and Equipment                                                     |   | $          | 7,240,145  |   |
| Purchased  Technology                                                             |   | 15,136,282 |       |
| Assumption  of debt to Xmark                                                      |   | (2,500,000 | )          |
| Assumption  of Alliance liabilities                                               |   | (3,304,793 | )          |
| Fair Value  of Assets Acquired                                                    |   | $          | 16,571,634 |   |
| **Reclassification of common stock subject to  rescission to equity of $650,000** |   |       |       |

 

6

----

 

**1.****                                      Basisof Presentation**

 

The accompanying unaudited financial statements have been prepared inaccordance with generally accepted accounting principles for interim financialinformation pursuant to Regulation S-B. Accordingly, they do not include all of the information and footnotesrequired by generally accepted accounting principles for complete financialstatements.  In the opinion ofmanagement, all adjustments (consisting of normal recurring accruals as well asadjustments related to the acquisition of the medical imaging business (“*Imagent*Business,*”* “Purchased Technology” or “TechnologyPurchase”) of Alliance Pharmaceutical Corp. (“Alliance”) considered necessaryfor a fair presentation have been included. Operating results for the nine months ended September 30, 2003are not necessarily indicative of the results that may be expected for the yearending December 31, 2003.

 

**2.****                                      GoingConcern**

 

Management believes it lacks sufficientworking capital to fund operations****forthe entire fiscal year ending December 31, 2003.  Therefore, substantial additional capital resources will berequired to fund the ongoing operations related to our marketing andmanufacturing of *Imagent* and ourresearch and business development activities. Our financial condition raises substantial doubt about our ability tocontinue as a going concern.  We believethere are a number of potential alternatives available to meet the continuingcapital requirements such as public or private financings or collaborativeagreements.  We are taking continuingactions to reduce our ongoing expenses. If adequate funds are not available, we will be required to significantlycurtail our operating plans and may have to sell or license out significantportions of our technology or potential products.  The 2002 and 2003 financial statements, including those containedin this Form 10-QSB, do not include any adjustment to reflect the possiblefuture effects on the recoverability and classification of assets or the amountand classification of liabilities that may result from the outcome of thisuncertainty.

 

During the next twelve months we will focus ourefforts primarily on exploring various options concerning our businesses,including securing additional financing, joint ventures, licensing or sellingall or a portion of our technology and other possible strategictransactions.  Our ability tocommercialize *Imagent* and developPH-50 and N1177 depends on the successful implementation of one or more ofthese transactions.

 

Depending on the availability of capital and whetheror not we pursue a sale or licensing strategy for *Imagent*, we will focus our operating efforts on thesales and marketing of *Imagent*.  If additional capital becomes available, wealso expect to conduct preclinical and human clinical studies of our productsin development.  Subject to theavailability of sufficient capital, we expect to continue to incur increasinglosses for at least the next three years as we intensify research anddevelopment, preclinical and clinical testing and associated regulatoryapproval activities and engage in or provide for the manufacture and/or sale ofany products that we may develop.

 

7

----

 

Greater capital resources would enable us toquicken and expand our marketing and research and development activities, andour failure to raise additional capital will (absent a suitable collaborativeagreement providing for a third party to take over these functions)significantly impair or curtail our ability to conduct further activities.  In any event, complete development andcommercialization of our technology will require substantial additionalfunds.  We are seeking to raise capitalthrough the sale of our common stock or other securities in a private placementto fund our immediate and longer-term capital needs.

 

The financial statements do not include anyadjustment to reflect the possible future effects on the recoverability andclassification of assets or the amount and classification of liabilities thatmay result from the outcome of this uncertainty.

 

**3.****                                      Basicand Diluted Loss Per Common Share**

 

Basic and diluted loss per common share is computed based on theweighted average number of common shares outstanding.  Basic and diluted loss per share excludes the impact ofoutstanding options, warrants and convertible preferred stock, as they areantidilutive.  Potential common sharesexcluded from the calculation at September 30, 2003 are 7,223,553 options,377,431 warrants and 186,136 shares issuable upon the conversion of Series AConvertible Preferred Stock.  Basic anddiluted loss per common share includes 1,985,522 shares to be issued followingshareholder approval.

 

**4.****                                      PurchasedTechnology**

 

On June 18, 2003, the Company closed on theacquisition of the medical imaging business including *Imagent*â(perflexane lipid microspheres), an FDA-approved product, of AlliancePharmaceutical Corp.  Photogen’sfinancial statements include the results of operations for the PurchasedTechnology from the closing date of the transaction, June 18, 2003, through theend of the reporting period.

 

Included in the purchase were an FDA-approved manufacturing facility,the marketing, manufacturing and supporting infrastructure for the product, andan intellectual property portfolio of approximately thirty patents in the areaof ultrasound imaging.  *Imagent*has been approved for marketing by the FDA for use in patients with sub optimalechocardiograms to opacify the left ventricle and thereby improve visualizationof the main pumping chamber of the heart, and to improve delineation of theendocardial borders of the heart.  As aresult, ultrasound with *Imagent* may better distinguish normal andabnormal heart structure and function - two critical indicators of cardiachealth.  Echocardiography is the mostwidely used imaging modality for the diagnosis of heart disease, the leadingcause of death in the U.S.  The attractivenessof the ultrasound imaging market potential together with the acquisition of anapproved product and an extensive intellectual property portfolio werefundamental reasons for the acquisition and primary determinants of thepurchase price.

 

A summary of the preliminary Purchased Technology acquisition costs andallocation to the assets acquired and liabilities assumed is as follows:

 

8

----

 
| Summary of Purchase Transaction                        |   |       |       |
|--------------------------------------------------------|--------|------------|------------|
| Issuance of common stock                               |   | $          | 5,583,268  |   |
| Common stock to be issued                              |   | 5,043,226  |       |
| Cash advances in prior year                            |   | 1,255,000  |       |
| Net current cash advances prior to  acquisition        |   | 2,584,383  |       |
| Cash paid at closing                                   |   | 669,117    |       |
| Direct payments to vendors on behalf of  Alliance      |   | 182,435    |       |
| Acquisition costs                                      |   | 1,254,205  |       |
| Purchase  Price                                        |   | $          | 16,571,634 |   |
|                                                   |   |       |       |
| Fair Value of Assets Acquired and  Liabilities Assumed |   |       |       |
| Property, plant & equipment                        |   | $          | 7,240,145  |   |
| Purchased technology                                   |   | 15,136,282 |       |
| Assumption of debt to Xmark                            |   | (2,500,000 | )          |
| Assumption of certain Alliance liabilities             |   | (3,304,793 | )          |
| Fair Value  of Assets Acquired                         |   | $          | 16,571,634 |   |

** **

At the closing, Photogen paid approximately$669,000 in cash and delivered 2,198,137 shares of its common stock.  In addition to bridge financing Photogenprovided to Alliance before the closing, its purchase of a $1,250,000 interestin Alliance’s obligations to two of its creditors, Xmark Fund, Ltd. and XmarkFund, L.P. (collectively “Xmark”), and its assumption of specified Allianceoperating liabilities related to *Imagent*,Photogen is obligated to pay, at various times between 90 and 365 days afterthe closing, (i) an aggregate of $2,500,000 to Xmark, (ii) subject to reachingsatisfactory agreements with certain Alliance secured and unsecured creditors,an aggregate amount of up to approximately $3,000,000 to creditors other thanXmark and (iii) subject to stockholder approval, deliver an aggregate ofapproximately 1,985,522 shares of its common stock.

 

In addition, after the closing and throughJune 2010, Photogen must pay Alliance further consideration in the form of anearn out based on *Imagent*revenue, subject to certain reductions. This earn out equals, for each year of the earn out:  7.5% of *Imagent*revenue up to $20,000,000; 10% of *Imagent*revenue between $20,000,000 and $30,000,000; 15% of *Imagent* revenue between $30,000,000 and $40,000,000; and 20%of *Imagent* revenue above$40,000,000.  The earn out will bereduced by amounts Photogen pays pursuant to a license agreement with ScheringAktiengesellschaft (“Schering”), net of payments received from Schering underthe license, and amounts of any indemnification claims Photogen has againstAlliance.  The earn out is subject tothree additional offsets (which are to be applied in the manner described inthe Asset Purchase Agreement dated as of June 10, 2003 with Alliance) thatentitle Photogen to retain portions of the earn out otherwise payable toAlliance.

 

Intangible assets resulting from the acquisition of the *Imagent* business are estimated bymanagement based on the fair value of the assets received.  These intangible assets consist entirely ofpurchased technology.  PurchasedTechnology related to the *Imagent*business is amortized on a straight-line basis over twelve years.  Purchased Technology is stated at cost, lessaccumulated amortization.

 

9

----

 

Following is summarized statements of revenues and direct expenses forthe Purchased Technology for the year ended December 31, 2002 and theapproximate six-month period ended June 18, 2003 (date of purchase):

** **
|                              |   | **Year ended  12/31/02** |       | **Six-  Month  period  ended  6/18/03** |       | **Total for  Periods** |       |
|-----------------------------------|--------|--------------------------|------------|-----------------------------------------|------------|------------------------|------------|
| Expenses:                         |   |                     | ** ** |                                    | ** ** |                   | ** ** |
|                              |   |                     |       |                                    |       |                   |       |
| Research & development        |   | $                        | 12,775,041 |                                    | $          | 4,501,299              |       | $ | 17,276,341 |   |
| Sales, general and administrative |   | 5,080,021                |       | 1,363,973                               |       | 6,443,995              |       |
| Total Expenses                    |   | $                        | 17,855,062 |                                    | $          | 5,865,272              |       | $ | 23,720,336 |   |

 

10

----

 

Below is supplemental pro forma information that discloses the resultsof operations for the technology purchase for the current three and nine monthperiods ending September 30, 2003, as well as the corresponding periodsfor the preceding year ending September 30, 2002.  The pro forma information is as if theacquisition had been completed as of the beginning of the periodspresented.  The pro forma data giveeffect to actual operating results prior to the acquisition, adjusted toinclude the pro forma effect of amortization of intangibles and weighted sharesoutstanding.

 
|                                                                           |   | **Actual**                                    |       | **Pro Forma**                                 |       |
|--------------------------------------------------------------------------------|--------|-----------------------------------------------|------------|-----------------------------------------------|------------|
|                                                                           |   | **Three  Months  ended  September  30, 2003** |       | **Three  Months  ended  September  30, 2002** |       | **Nine Months  ended  September  30, 2003** |   | **Nine Months  ended  September  30, 2002** |   |
| Expenses:                                                                      |   |                                          | ** ** |                                          | ** ** |   | ** ** |   | ** ** |
| Research & development                                                     |   | $                                             | 562,703    |                                          | $          | 3,721,279 |   | $ | 5,884,444 |   | $ | 10,389,903 |   |
| Sales, general and administrative                                              |   | 4,306,244                                     |       | 2,736,090                                     |       | 12,780,379 |   | 6,828,230 |   |
| Restructuring charge                                                           |   | —                                        |       | —                                        |       | — |   | 451,068 |   |
| Total Expenses                                                                 |   | 4,868,947                                     |       | 6,457,369                                     |       | 18,664,823 |   | 17,669,201 |   |
| Loss from joint venture                                                        |   | (195,896                                      | )          | (305,400                                      | )          | (5,193,441 | ) | (1,245,845 | ) |
| Investment income                                                              |   | 581                                           |       | 30                                            |       | 7,394 |   | 1,532 |   |
| Interest expense                                                               |   | (197,169                                      | )          | (71,444                                       | )          | (251,157 | ) | (172,157 | ) |
| Loss from continuing operations                                                |   | (5,261,431                                    | )          | (6,834,183                                    | )          | (24,102,027 | ) | (19,085,671 | ) |
| Discontinued operations – net                                             |   | —                                        |       | (244,719                                      | )          | — |   | (1,291,825 | ) |
| Net income (Loss)                                                              |   | $                                             | (5,261,431 | )                                             | $          | (7,078,902 | ) | $ | (24,102,027 | ) | $ | (20,377,496 | ) |
| Dividends on Preferred Stock                                                   |   | (267,510                                      | )          | (345,622                                      | )          | (791,480 | ) | (1,024,300 | ) |
| Net loss applicable to common shareholder                                      |   | $                                             | (5,528,941 | )                                             | (7,424,524 | ) | (24,893,507 | ) | (21,401,796 | ) |
| Pro forma net loss per share                                                   |   | $                                             | (0.26      | )                                             | $          | (.54 | ) | $ | (1.18 | ) | $ | (1.55 | ) |
| Weighted average number of common shares  outstanding – basic and diluted |   | 21,361,817                                    |       | 13,769,607                                    |       | 21,134,297 |   | 13,769,607 |   |

 

This pro forma information is not necessarilyindicative of the actual results that would have been achieved had thePurchased Technology been acquired the first day of the Company’s three- ornine-month periods, nor is it necessarily indicative of future results.

 

11

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**5.****                                       ****JointVenture/Investment in Affiliate**

 

Following is summarized financial information for Sentigen Ltd. at andas of the nine months ended September 30, 2003 and 2002:

 
| **September 30,**                                                                                                 |   | **2003**  |       | **2002**   |       |
|-------------------------------------------------------------------------------------------------------------------|--------|-----------|------------|------------|------------|
|                                                                                                              |   |      | ** ** |       | ** ** |
| Cash                                                                                                              |   | $         | 410        |       | $          | **—** |   |
| License purchased from Élan, net of  amortization and impairment of $11,184,791 and $1,956,527, respectively |   | 3,815,209 |       | 13,043,473 |       |
|                                                                                                              |   |      | ** ** |       | ** ** |
| Total assets                                                                                                      |   | $         | 3,815,619  |       | $          | 13,043,473 |   |
|                                                                                                              |   |      | ** ** |       | ** ** |
| Due to affiliates                                                                                                 |   | $         | 378,099    |       | $          | 366,961 |   |
|                                                                                                              |   |      | ** ** |       | ** ** |
| Total shareholders’ equity                                                                                   |   | 3,437,520 |       | 12,676,512 |       |
|                                                                                                              |   |      | ** ** |       | ** ** |
| Total liabilities and equity                                                                                      |   | $         | 3,815,619  |       | $          | 13,043,473 |   |
|                                                                                                              |   |      | ** ** |       | ** ** |
| Research and development Expense                                                                                  |   | $         | —     |       | $          | 802,926 |   |
| General and administrative expense                                                                                |   | —    |       | 18,739     |       |
| Amortization of license                                                                                           |   | 733,698   |       | 733,698    |       |
| Impairment of license                                                                                             |   | 5,750,000 |       | —     |       |
|                                                                                                              |   |      | ** ** |       | ** ** |
| Net loss                                                                                                          |   | $         | 6,483,698  |       | $          | 1,555,363 |   |

 

**6.****                                      EquityTransactions**

 

Pursuant to a Standstill and Make Whole Agreement dated as of December30, 2002 with Xmark, secured creditors of Alliance, the Company issued a totalof 750,000 shares to Xmark.  Xmarkagreed to not exercise any rights against Alliance as a creditor.  The value of these shares was treated as anexpense.

 

On May 2, 2003, the Company executed a Going Forward Agreement withXmark that provided, among other things, for the issuance of shares of theCompany’s common stock upon the acquisition of the Purchased Technology aspayment for interest owed by Alliance to Xmark.  On June 18, 2003, the Company issued 2,198,137 shares of itscommon stock to certain creditors of Alliance, including 1,056,144 shares toXmark pursuant to the Going Forward Agreement, as partial consideration for theTechnology Purchase.  Following approvalby shareholders, the Company will issue an additional 1,985,522 shares tocertain other creditors as part of the Purchased Technology.  Shareholders representing 61.1% of theoutstanding stock of the Company have indicated

 

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their commitment to vote in favor of the issuing of the additionalshares in connection with the acquisition.

 

On May 27, 2003 the Company issued 11,250 shares of its Common Stock toXmark as a penalty for failure to timely register certain shares held by Xmark.

 

On July 31, 2003 the Company issued 82,977 shares of its Common Stockto Xmark for interest and penalties, including the failure to timely registercertain shares of its Common Stock held by Xmark as of that date.

 

On September 2, 2003, pursuant to a Letter Agreement dated as of August18, 2003 with Xmark, the Company issued 26,248 shares of its Common Stock toXmark for the failure to timely register certain shares of its Common Stockheld by Xmark as of that date.

 

Total shares issued to Xmark as a result of the agreements noted aboveare 1,926,619.  In addition, anaggregate of 19,888 shares of the Company’s Common Stock are issuable to Xmarkfor payment of accrued interest.  Xmarkhas a put right for all these shares that would, under certain circumstances,require the Company to purchase the shares from Xmark at a price of $1.00 pershare.  As a result, $1,946,508 has beenclassified as mezzanine equity at September 30, 2003.

 

In the second quarter, the Company recognized the issuance of 124,627shares of common stock that previously had been subject to rescission.

 

During the first nine months of 2003, the Company issued an aggregateof 102,594 shares pursuant to several factors including cash, compensation forservice and cashless exercise of stock options in addition to the aboveissuances.

 

**7.****                                      StockOptions**

 

The Company has adopted the disclosure-only provisions of Statement ofFinancial Accounting Standards No. 123, “Accounting for Stock BasedCompensation” (SFAS No. 123), but applies the intrinsic value method set forthin Accounting Principles Board Opinion No. 25 for stock options granted toemployees and directors.  The Companyexpenses the fair value of stock options granted to nonemployees.  In 2002, the Company issued stock options toemployees with an exercise price less than the market price on the date ofgrant, which vest over four years.  In2003, the Company issued stock options in connection with the TechnologyPurchase with an exercise price less than the market price on the date of grant,which vest over four years.  The Companyalso issued to an employee stock options with an exercise price less than themarket price on the date of grant that vest over eight months. Accordingly,compensation expense of $366,723 and $895,993 has been recorded in the thirdquarter and nine months of 2003, respectively.

 

For stock options granted to employees and directors during the firstnine months of 2003, the Company has estimated the fair value of each optiongranted using the Black-Scholes option-pricing model with the followingassumptions:

 

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|                                             |   | **2003** |   |
|--------------------------------------------------|--------|----------|--------|
|                                             |   |     |   |
| Weighted average fair value per options  granted |   | $        | 2.05   |   |
|                                             |   |     |   |
| Significant assumptions (weighted average)       |   |     |   |
| Risk-free interest rate at grant date            |   | 3.0      | %      |
| Expected stock price volatility                  |   | 99       | %      |
| Expected option life (years)                     |   | 5        |   |
|                                                  |        |          |        |  |

** **

If the Company had elected to recognize compensation expense based onthe fair value at the grant dates, consistent with the method prescribed bySFAS No. 123, net loss per share would have been changed to the pro formaamounts indicated below:

** **
|                                                                                                               |   | **Three  Months  Ended  September 30,  2003** |       | **Nine  Months  Ended  September 30,  2003** |   |
|--------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------|------------|----------------------------------------------|--------|
|                                                                                                               |   |                                          |       |                                         |   |
| Net Loss Applicable to Common Shareholders,  as reported                                                           |   | $                                             | (5,528,941 | )                                            | $      | (18,383,662 | ) |
|                                                                                                               |   |                                          |       |                                         |   |
| Add stock based employee compensation  expense included in reported net income                                     |   | 366,723                                       |       | 895,993                                      |   |
|                                                                                                               |   |                                          |       |                                         |   |
| Less total stock-based employee  compensation expense determined under the fair value based method for all  awards |   | (1,139,987                                    | )          | (3,419,962                                   | )      |
| Pro forma net loss                                                                                                 |   | $                                             | (6,302,205 | )                                            | $      | (20,907,631 | ) |
|                                                                                                               |   |                                          |       |                                         |   |
| Basic and diluted loss per common share, as  reported                                                              |   | $                                             | (0.26      | )                                            | $      | (0.99 | ) |
|                                                                                                               |   |                                          |       |                                         |   |
| Basis and diluted loss per common share,  pro forma                                                                |   | $                                             | (0.30      | )                                            | $      | (1.13 | ) |

** **

**8.****                                      SecuredDebt**

 

Notes payable – Atthe closing of the Technology Purchase, the Company issued to Xmark promissorynotes in the total principal amount of $2,500,000.  The notes were payable in two equal installments on August 5 andNovember 3, 2003 or (if sooner) at the time the Company completes a financingof at least $18,000,000 of gross proceeds and bear interest at 3% over theprime rate.  Interest is payable inshares of common stock.

 

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Obligations to Xmark (including obligations under the put right) aresecured by a first priority security interest on the *Imagent* related tangible and intangible assets.

 

The Company defaulted on the principal payment due to Xmark on August5, 2003 and Xmark delivered a notice stating that it was accelerating allamounts due under the notes.  On August18, 2003, the Company and Xmark executed a Letter Agreement pursuant to whichthe Company made an immediate payment of $1,250,000 and Xmark rescinded thedefault notice.  In addition, as part ofthe Letter Agreement:

 

•                  The Company hasthe right to extend the November 3, 2003 payment due date monthly until April3, 2004 for a fee (and not as a reduction of any amounts due and owing underthe promissory notes) ranging from $50,000 to $100,000 per month.  The Company exercised its right to extend theNovember 3, 2003 payment for one month.

 

•                  The demandregistration rights held by Xmark became piggyback registration rights.

 

•                  Thedefinition of “Event of Default” was amended. The provision that an Event of Default included any default by the Companyin the payment of borrowed money indebtedness was eliminated.  Instead, the Company agreed that it would bean Event of Default if it made any repaymentsof borrowed money indebtedness.

 

•                  If the Companymakes payments to certain institutions, it will make a pro-rata payment toXmark.

 

Lines of Credit – Toobtain funds for operations and certain cash payments related to the TechnologyPurchase, the Company issued $8,160,000 in notes, of which $4,160,000 areRevolving Convertible Senior Secured Promissory Notes (“Revolving Notes”) andthe balance are non-convertible (“Demand Notes”) (collectively, the “PromissoryNotes”) to three institutional investors (“Investors”).  The Promissory Notes are secured by a firstpriority security interest on all the Company’s assets (but as to the lien on *Imagent* related assets, the lien issubordinate to the security interest held by Xmark), bear interest at 7.25% perannum, compounded monthly, and were due on the earlier of August 5, 2003 (inthe case of the Revolving Notes) or are due upon demand (in the case of theDemand Notes) or upon the occurrence of an “acceleration event” (in the case ofall Promissory Notes).  All principaland interest under the Revolving Notes will convert into the Company’s commonstock upon completion of a qualified financing that closes before August 5,2003 at the same price and on the same terms as are in effect for the otherinvestors in the qualified financing; and the Investors will have the samerights, benefits and obligations as other investors in that financing.  No such financing had occurred as of August5, 2003.  The acceleration eventsinclude a breach of the Company’s obligations or representations under asecurity agreement in favor of the Investors; if the Company files for bankruptcyprotection or similar events occur indicating insolvency; if the Companyliquidates, or if the Company incurs any debt senior or pari passu to the debtof the Investors.

 

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The Company defaulted on $4,160,000 of its Revolving Notes due to theInvestors.  The Investors have notasserted any of their rights under the default provisions of the RevolvingNotes and (although no obligation to do so) have continued to advance capital,pursuant to the Demand Notes, to the Company. All other terms and conditions of these Revolving Notes remainunchanged.

 

**9.****                                      AccruedExpenses**

 

Accrued expenses consist of the following at September 30, 2003and December 31, 2002:

 
|                                           |   | **September  30, 2003** |      | **December  31, 2002** |   |
|------------------------------------------------|--------|-------------------------|-----------|------------------------|--------|
| Alliance liabilities assumed from  acquisition |   | $                       | 2,929,676 |                   | $      | — |   |
| Payroll liabilities                            |   | 150,090                 |      | 34,132                 |   |
| New Hope office abandonment provision          |   | 205,609                 |      | —                 |   |
| Total accrued expenses                         |   | $                       | 3,285,375 |                   | $      | 34,132 |   |

 

**10.****                               Propertyand Equipment**

 

Property and equipment is stated at cost and depreciated over theestimated useful lives of the assets (three to seven years) using thestraight-line method.  Amortization ofleasehold improvements is computed on the straight-line method over the shorterof the lease term or the estimated useful lives of the assets.  Maintenance and repairs are charged tooperations as incurred.  When assets aresold, or otherwise disposed of, the cost and related accumulated depreciationare removed from the accounts and any gain or loss is included in operations.

 

Property and equipment consist of the following at September 30,2003 and December 31, 2002:

 
|                                      |   | **September 30,  2003** |      | **December  31, 2002** |   |
|-------------------------------------------|--------|------------------------------|-----------|------------------------|--------|
| Leasehold improvements                    |   | $                            | 5,560,869 |                   | $      | 33,131 |   |
| Furniture, fixtures and equipment         |   | 1,729,782                    |      | 17,520                 |   |
| Total                                     |   | 7,290,651                    |      | 50,651                 |   |
| Accumulated depreciation and amortization |   | (552,916                     | )         | (14,651                | )      |
| Property, plant and equipment, net        |   | $                            | 6,737,735 |                   | $      | 36,000 |   |

 

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**11.****                               Commitments**

 

***Leases***

 

The Company has leased its facilities andcertain equipment under non-cancelable operating leases, which expire atvarious times through 2008.  The leasesrequire the Company to pay for all maintenance, insurance and property taxes.

 

On August 31, 2003, the Company closed its Pennsylvania corporateheadquarters and transferred its headquarters to its *Imagent* facility in San Diego, California.  The Company recorded a charge of $244,459 inthe third quarter ($199,529 for remaining lease payments for the office and $12,103for certain remaining equipment leases and $32,827 to write off certainleasehold improvements) related to the closing of the office.

 

The Company also has an operating lease forlaboratory equipment expiring in 2004. During 2001, the Company determined that equipment leased by the Companyunder this operating lease would no longer be used by the Company in itsresearch.  As a result, in 2001, theCompany recorded a provision for all future lease payments of $1,264,208.  At September 30, 2003, $569,024 remainsto be paid.  Minimum future rentalpayments under these leases are as follows:

 
| **Period ending December 31,**         |   | **Operating  Leases** |          |
|----------------------------------------|--------|-----------------------|---------------|
| Three months ending December 31, 2003  |   | $                     | 324,175       |   |
| Twelve months ending December 31, 2004 |   | 1,319,131             |          |
| Twelve months ending December 31, 2005 |   | 945,168               |          |
| Twelve months ending December 31, 2006 |   | 900,339               |          |
| Twelve months ending December 31, 2007 |   | 877,514               |          |
| Twelve months ending December 31, 2008 |   | 147,081               |          |
| **Total minimum lease payments**       |   | **$**                 | **4,513,408** | ** ** |

 

***License Agreements***

 

In September 1997, Alliance entered into theSchering License Agreement, which provided Schering with worldwide exclusivemarketing and manufacturing rights, drug compositions, and medical devices andsystems related to perfluorocarbon ultrasound imaging products, including *Imagent*. In February 2002, the agreement with Schering was modified to giveAlliance exclusive rights to market the product in the U.S. for cardiologyindications for a five-year period, with Schering to be paid a nominal royaltyon such sales.  At the expiration of thefive-year period, Alliance had the option to acquire all of Schering’s rightsto the product on a worldwide basis or, alternatively, to allow Schering theopportunity to obtain co-promotion rights along with Alliance.  The rights Alliance had under the ScheringLicense Agreement were transferred to Photogen at the consummation of itsacquisition of the *Imagent*Business.

 

Concurrent with the restructuring of the Schering agreement in 2002,Alliance entered into a five-year exclusive agreement with Cardinal Health,Inc. (“Cardinal”) to assist the marketing of *Imagent*.  Under the agreement, Cardinal will performcertain packaging, distribution, and sales services for Alliance under afee-for-service arrangement.  Photogenassumed the Cardinal agreement from Alliance at the consummation of the *Imagent* acquisition.

 

17

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**ITEM 2****.  MANAGEMENT’SDISCUSSION AND ANALYSIS OR PLAN OF OPERATION**

** **

Portions of the discussionin this Form 10-QSB contain forward-looking statements and are subject to theRisk Factors described below. References to the “Company,” “Photogen,” “we” or “our” are to PhotogenTechnologies, Inc. and its consolidated subsidiaries.  References to the “*Imagent*Business,” “Technology Purchase” or “Purchased Technology” are to the medicalimaging business of Alliance Pharmaceutical Corp. (“Alliance”) acquired by uson June 18, 2003.  *Imagent*® is a registered trademark ownedby Photogen.

 

Theaccompanying financial statements have been prepared assuming we are a goingconcern.  The Company lacks sufficientworking capital to fund operations for the remainder of the fiscal year endingDecember 31, 2003 without additional debt or equity financing.  The financial statements for the nine monthsended September 30, 2003 do not include any adjustment to reflect thepossible future effects on the recoverability and classification of assets orthe amount and classification of liabilities that may result from thisuncertainty.

 

OnNovember 12, 2002, we split off our therapeutic business to certain foundingshareholders in exchange for all of their 52.9% ownership interest in Photogenand recognized a gain on the disposition of approximately $ 11,780,000.  Our therapeutic business had been focused onthe development of certain photodynamic therapy products.  Our remaining diagnostic business has beenfocused on the development of products for medical imaging, with particularemphasis on cardiovascular imaging.

 

On June 18, 2003, we closed on the acquisition of assets related to thediagnostic imaging business, including *Imagent*(perflexane lipid microspheres), an FDA-approved product, of Alliance.  We also entered into a number of agreementsrelated to that acquisition.  Includedin the purchase were an FDA-approved manufacturing facility, the marketing,manufacturing and supporting infrastructure for the product and an intellectualproperty portfolio of approximately thirty patents in the area of ultrasoundimaging.  The financial statementsinclude the operating impact of this acquisition from June 18, 2003 through theend of the reporting period.  We arecurrently seeking additional capital to operate the *Imagent* business and to continue our development programs.

 

At the closing of the *Imagent*acquisition, we paid approximately $669,000 in cash and delivered 2,198,137shares of our common stock.  At thedirection of Alliance, we delivered the cash and stock to creditors, employeesand vendors of Alliance.  In addition tobridge financing we provided to Alliance before the closing, our purchase of a$1,250,000 interest in Alliance’s obligations to two of its creditors, XmarkFund, Ltd. and Xmark Fund, L.P. (collectively “Xmark”), and our assumption ofspecified Alliance operating liabilities related to *Imagent*, we are obligated to pay additional amounts toAlliance secured and unsecured creditors after the closing (including Xmark,discussed below, and others).  Atvarious times between 90 and 365 days after the closing, we must pay, subjectto reaching satisfactory agreements with certain Alliance secured and unsecuredcreditors, an aggregate amount of up to approximately $3,000,000 to creditorsother than Xmark and (subject to stockholder approval, discussed below) deliverup to an aggregate of approximately 1,985,522 shares of our common stock.  The amount of consideration was determinedthrough arms-length negotiations.

 

18

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In addition, after the closing and through 2010, we must pay Alliance furtherconsideration in the form of an earn out based on *Imagent* revenue we invoice (subject to certainreductions).  This earn out equals, foreach year of the earn out:  7.5% of *Imagent* revenue up to $20,000,000; 10% of *Imagent* revenue between $20,000,000 and$30,000,000; 15% of *Imagent*revenue between $30,000,000 and $40,000,000; and 20% of *Imagent* revenue above $40,000,000.  The earn out will be reduced by amounts wepay pursuant to a license agreement with Schering Aktiengesellschaft(“Schering”), net of payments we receive from Schering under the license, andamounts of any indemnification claims we have against Alliance.  The earn out is subject to three additionaloffsets (which are to be applied in the manner described in the Asset PurchaseAgreement dated as of June 10, 2003 with Alliance) that entitle us to retainportions of the earn out otherwise payable to Alliance:

 

•                  Up to approximately $1,600,000 for a fixedprice offset, depending on the satisfaction of certain conditions;

 

•                  The amount of any payments not committed toat closing that we make after the closing to Alliance’s creditors plus up to$1,000,000 of litigation expenses for certain patent and other litigation; and

 

•                  Between $4,000,000 and $5,000,000, which isthe principal and accrued interest under our bridge loans to Alliance,depending on the satisfaction of certain conditions.

 

We also entered into a series of agreements with Xmark.  Pursuant to a Standstill and Make WholeAgreement dated as of December 30, 2002, we issued 750,000 shares of our commonstock in the first quarter 2003 to Xmark, who agreed to not exercise any rightsagainst Alliance as a creditor for the period of the standstill.  On May 2, 2003, we entered into a GoingForward Agreement pursuant to which Xmark agreed to extend the period duringwhich Xmark had refrained from exercising its rights as a creditor againstAlliance to permit us to complete the acquisition.  On that date, we also purchased a $1,250,000 interest in Alliance’sobligations to Xmark.

 

At the closing of our acquisition of the *Imagent* assets, pursuant to the Going Forward Agreement, wedelivered to Xmark our promissory notes in the total principal amount of$2,500,000.  These notes are payable intwo equal installments on August 5, 2003 and November 3, 2003 or (if sooner) atthe time we complete a financing resulting in at least $18,000,000 of grossproceeds to us and bear interest at 3% over the prime rate (payable in sharesof our common stock).  At the closing ofthe *Imagent* acquisition, we alsoissued Xmark an additional 1,056,144 shares that represented payment ofinterest that was due to Xmark by Alliance through the closing date of theacquisition.  The value of theseadditional 1,056,144 shares has been treated as part of the purchase price ofthe *Imagent* business.

 

Our obligations to Xmark are secured by a first priority securityinterest on the *Imagent* relatedtangible and intangible assets.  Xmarkwould be entitled to foreclose on its lien covering these assets if we defaulton our obligations to Xmark, if we lose FDA approval for *Imagent*, if we fail to pay other debts, orif we file for bankruptcy protection or similar matters.

 

19

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We defaulted on the principal payment due on August 5, 2003 and Xmarkdelivered a notice to us stating that it was accelerating all amounts due underthe notes.  We negotiated a newagreement with Xmark dated August 18, 2003 (the “Letter Agreement”) pursuant towhich we agreed to make an immediate payment of $1,250,000 and Xmark agreed torescind the default notice.  The otherkey terms of the Letter Agreement are as follows:

 

•                  We remainobligated to make a second principal payment of $1,250,000 on the earlier tooccur of (i) November 3, 2003 or (ii) the consummation of one or moreinstitutional financings resulting in aggregate gross proceeds to us of atleast $18,000,000.  We will have theright to extend the November 3rd due date monthly until April 3,2004 for a fee (and not as a reduction of any amounts due and owing under thepromissory notes) ranging from $50,000 to $100,000 per month.  We have paid $50,000 and exercised our rightto extend the November 3, 2003 due date by one month.

 

•                  Within twentydays of the execution of the Letter Agreement we will pay to Xmark, in cash orin shares of our common stock (valued at $1.00 per share, subject to certainadjustments), $26,248 for failure to timely register the shares of our commonstock issued to Xmark for resale, which payment has been made with shares of ourcommon stock.

 

•                  Our obligationto register the shares of common stock issued to Xmark for resale under theterms of the Going Forward Agreement was terminated and no further penaltypayments or shares will be due to Xmark as a result of our failure to registerthe shares of our common stock held by Xmark. In lieu of the demand registration rights Xmark previously had, theLetter Agreement provides that Xmark will have piggyback registration rights.

 

•                  The definitionof “Event of Default” in the security agreements securing our obligations toXmark was amended.  The provision thatan Event of Default included any default by us in the payment of borrowed moneyindebtedness was eliminated.  Instead,we agreed that it would be an Event of Default if we made repayments ofborrowed money indebtedness.

 

•                  With regard topayments to certain specified institutions, we agreed that, when paid, we wouldalso make a pro rata payment to Xmark.

 

Except as specifically amended by the Letter Agreement, the terms ofthe Going Forward Agreement and the other agreements governing our obligationsto Xmark remain in effect, including Xmark’s put right with respect to ourcommon stock that Xmark owns.

 

Xmark’s put right, as set forth in the Going Forward Agreement,requires us to repurchase at $1.00 per share up to 750,000 shares of commonstock we issued under the Standstill and Make Whole Agreement and alladditional shares we issue to Xmark under the Going Forward Agreement.  The put right is fully exercisable beginningon the earlier of 13 months after the closing of the acquisition of the *Imagent* assets or the date on which weclose a financing for $20,000,000 or more. Before that time, Xmark can exercise the put right in

 

20

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quarterly installments beginning 90 days after the closing of ouracquisition of the *Imagent*assets.  In connection with thesequarterly installments, we can elect to defer repurchasing the shares if welack adequate cash to satisfy our operating and working capital requirementsfor the subsequent 18-month period based on an operating plan approved by ourBoard.  We agreed to use our reasonableefforts to have sufficient cash to meet our operating plan.  If we do not repurchase these shares, Xmarkis entitled to a payment of 1.5% of the value of the shares not repurchased forany 30-day period or pro rata portion thereof during which such failure iscontinuing.

 

We issued 82,977 shares of our common stock to Xmark on July 31, 2003for interest and various penalties, including the failure to register theshares of our common stock held by Xmark by that date.  We issued 26,248 shares of our common stockto Xmark on September 2, 2003, pursuant to the Letter Agreement, for failure toregister shares of our common stock held by Xmark as of August 18, 2003.  An additional 19,888 shares of our commonstock are issuable to Xmark in payment of interest.

 

In connection with the closing of the acquisition of the *Imagent* assets, we issued approximately18% of our outstanding common stock. Nasdaq rules applicable under these circumstances require us to obtainprior stockholder approval before issuing more than 20% of our stock.  We intend to hold a meeting of stockholdersin the near future.  At the stockholdermeeting, we will ask stockholders to consider approving our issuing additionalshares of common stock that may exceed 20% of the outstanding common stock,which will be utilized in connection with the acquisition.  Additional details about these matters willbe provided in our proxy materials to be filed with the Securities and ExchangeCommission.

 

We expect that our quarterly and annual results of operations willfluctuate based on several factors including, the timing and amount of expensesinvolved in marketing and manufacturing *Imagent*,conducting our research programs, particularly the conduct of clinical trials,the cost of clinical material used in those trials and required for compliancewith FDA regulations and the amount, if any, of fees, milestone payments andresearch support payments received from potential strategic partners.

 

We consider the valuation of our investment in the purchased technologyof *Imagent* to be a significantestimate.  The carrying value of thistechnology at September 30, 2003 is $15,469,750.  The assumptions underlying the financial forecast have been basedon currently available information including estimates of market size andpenetration, pricing, competitive threats and general operating expenses.  These estimates may change and such changesmay impact future estimates of carrying value.

 

We also consider our investment in the joint venture with affiliates ofÉlan Corporation, plc (“Élan”) to be subject to a significant estimate.  The carrying value of our 80.1% equityinterest in Sentigen, Ltd., the joint venture entity, plus advances toSentigen, Ltd., at December 31, 2002 and September 30, 2003totaled $8,192,452 and $2,999,011, respectively.  Members of Sentigen’s management reviewed its financialprojections and have concluded that given delays in the development of

 

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N1177, resulting from capital constraints, the carrying value of theintangible assets in the joint venture should be reduced by $2,500,000 in2002.  In addition, in the secondquarter of 2003, based on the re-prioritization of the development of N1177 andas the development plans are being further delayed pending the acquisition ofsufficient capital to allocate to the development of N1177, Sentigen recordedan additional impairment provision of $5,750,000.  The assumptions underlying the financial forecasts were based oncurrently available information, including estimates of development costs,pricing, operating expenses and market sizes and penetration.  These estimates may change and any suchchanges may impact future estimates of appropriate carrying values.

 

**Results of Operations**

 

Prior to our acquisition of the *Imagent*assets in June, 2003, our efforts were focused on the development and clinicaltesting of diagnostic products, specifically PH-50, being developed as acardiovascular imaging agent, and N1177, being developed for lymphography, thediagnosis of cancer metastasizing to lymph nodes.  To date, we have not generated revenues from the sale of any proposeddiagnostic products or other operations. Net loss applicable to common shareholders (after preferred dividends)was $7,065,920 and $18,383,662 for the nine months ended September 30,2002 and 2003, respectively.  Ourcumulative losses since inception, including “in-kind” preferred stock andbeneficial conversion dividends totaling $8,437,709, are approximately$54,775,085.

 

With the acquisition of the *Imagent*business, we hired approximately 35 employees related to this business.  These employees were formerly associatedwith Alliance and bring capabilities in manufacturing, marketing and additionalcapabilities in research and related administrative infrastructure.  We also continue to contract with third partyconsultants having expertise in clinical development and regulatory matters tosupplement our internal capabilities. In addition, we contract with third party research laboratories,contract research organizations and manufacturers for clinical materialsupplies and the management of clinical trials, and with academic and otherinstitutions to conduct specified research projects.

 

Research and development expenses for the nine months endedSeptember 30, 2002 and 2003 were $715,816 and $1,383,145,respectively.  These expenses includepersonnel costs, fees and other compensation paid to outside consultants, andcosts associated with conducting preclinical and clinical studies andmanufacturing product to be used in these studies.

 

Substantially all of the research expenses in the first nine months of2003 were oriented to the preclinical development of PH-50, a product havinggreater market potential than N1177, and, since the acquisition of the *Imagent* Business, expenses anddepreciation associated with continued development of *Imagent* for new indications.  Expenses associated with the development ofPH-50 are borne completely by us, whereas expenses associated with thedevelopment of N1177 are charged to Sentigen, our joint venture.  Due to capital constraints, we incurredminimal expenses in the joint venture, other than amortization of ourinvestment in the joint venture, during the nine months of 2003.

 

Selling, general and administrative expenses from continuing operationswere $2,166,441 and $10,771,833 for the nine months ended September 30,2002 and 2003, respectively.  Theseexpenses include costs associated with our acquisition of the *Imagent* business prior to firmlycommitting to the acquisition, obtaining patent protection for our intellectualproperty, costs associated with administrative personnel and corporatemanagement, the amortization of certain

 

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options granted to our employees, the amortization of purchasedtechnology, legal and related expenses and facilities expenses.

 

In the first nine months of 2003, selling, general and administrativeexpenses increased by $8,605,392 to $10,771,833.  The primary reasons for the increase were related to ouracquisition of the *Imagent*business from Alliance including, (i) provisions we have taken againstadvances we had made to Alliance and shares of our common stock we had issuedto Xmark pursuant to a standstill agreement with Xmark, (ii) costs ofconducting due diligence and other activities related to the acquisition of the*Imagent* business,(iii) costs incurred by us to operate the *Imagent*business following its acquisition, (iv) depreciation, and (v) amortization ofthe purchased technology.

 

As part of the November, 2002 restructuring and financing, stockoptions were granted to our remaining employees with an exercise price equal tothe price at which common stock was sold to the new institutionalinvestors.  As part of the acquisitionof the *Imagent* business and therelated hiring of employees from Alliance, we granted these new employees anaggregate of 1,865,750 stock options with an exercise price of $1.25 pershare.  Pursuant to an agreement withDr. Taffy Williams, our Chief Executive Officer, an aggregate of 1,050,000stock options were granted to Dr. Williams, subject to shareholderapproval (shareholders representing an excess of 50% of our outstanding commonstock have indicated their commitment to vote in favor of approving theseoptions).  As the exercise prices werebelow the closing price of our common stock at the dates of grant, we recordedan expense of approximately $895,933 in the first nine months of 2003reflecting the differentials between those respective two prices.

 

In the fourth quarter of 1999, we entered into a joint venture withaffiliates of Élan for the development of N1177, a potential product toidentify and diagnose lymph nodes for the presence of cancer.  We own 80.1% of the joint venture entity,Sentigen, Ltd., with the balance owned by Élan.  During the first nine months of 2002 and 2003, we recorded lossesfrom the joint venture of $1,245,845 and $5,193,441, respectively.  In 2002, these losses resulted from ourshare of development expenses incurred in the joint venture by the twoparticipants, including personnel expenses and costs associated with developinga manufacturing process, and the purchase of drug substance and othermaterials.  In 2003, these losses weresubstantially the result of the amortization of the license purchased from Élanand a $4,605,000 charge for further impairment of the license value as, due tothe lower priority of the development of N1177 and capital constraints, limiteddevelopment work was being conducted.

 

Investment income for the nine months ended September 30, 2002 and2003 was $1,532 and $7,394, respectively. Investment income is generated by the amount of capital in ourinvestment portfolio prior to it being used to fund our operations and the rateof interest earned on that capital.  Weinvest funds in the investment portfolio in U.S. government obligations.  We expect investment income to continue tofluctuate both as the size of the investment portfolio decreases or increasesand as the rate of interest earned by the portfolio varies due to shifts inshort term interest rates.

 

Since inception, we had been developing products for both therapeuticand medical imaging applications.  Asone of a series of transactions on November 12, 2002, we split off ourtherapeutic business to certain founding shareholders in exchange for all oftheir 52.9% ownership interest in Photogen. Accordingly, the expenses associated with that business have

 

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been reclassified as discontinued operations.  Our therapeutic business had been focused on the development ofcertain photodynamic therapy products, in particular a compound we calledPH-10.  In the nine months of 2002, weincurred losses related to these operations of $1,291,825.

 

For the nine months ended September 30, 2002 and 2003 we had nopurchases of equipment and leasehold improvements other than the acquisition ofthe****assets related to the *Imagent* business, including the lease of amanufacturing facility located in San Diego. During the next twelve months we expect capital expenditures forequipment to be less than $500,000.

 

**Liquidity; CapitalResources**

 

Without additional financing we may not have sufficient cash resourcesfor our entire fiscal year ending December 31, 2003.  We are currently funding our operations through borrowings,evidenced by secured promissory notes, payable upon demand, from our principalinstitutional investors.  We will needsubstantial additional financing for our research, clinical testing, productdevelopment and marketing programs.  Wecannot accurately estimate the amount of additional financing required;however, the amount could be an additional****$30 millionor more over the next several years. See “Risk Factors—We must raise additional financing in the future andour inability to do so will prevent us from implementing our business plan,”below.

 

At September 30, 2003, we had cash and cash equivalents totalingapproximately $227,970**. **Since that date, we have expendedall those funds and, as described above, are currently funding our operationsthrough borrowings from our principal institutional investor, as cash isrequired for operations.  This investorhas continued to provide funding to us, but there can be no assurance that theinvestor will continue to provide funding to us.

 

OnJune 18, 2003, we closed the acquisition of the *Imagent* business from Alliance.  At the closing, we paid approximately $669,000 in cash anddelivered 2,198,137 shares of our common stock.  At the direction of Alliance, we delivered the cash and stock tocreditors, employees and vendors of Alliance. In addition to bridge financing we provided to Alliance before theclosing, our purchase of a $1,250,000 interest in Alliance’s obligations toXmark and our assumption of specified Alliance operating liabilities related to*Imagent*, we are obligated to payadditional amounts to Alliance secured and unsecured creditors at various timesbetween 90 and 365 days after the closing, (i) an aggregate of $2,500,000 toXmark, (ii) subject to reaching satisfactory agreements with certain Alliancesecured and unsecured creditors, an aggregate amount of up to approximately$3,000,000 to creditors other than Xmark, (iii) pay certain royalties basedupon sales of *Imagent*throughJune 2010, subject to certain offsets, and (iv) subject to stockholder approvaldeliver up to an aggregate of approximately 1,985,522 shares of our commonstock.

 

We also entered into a series of agreements with Xmark.  Prior to our acquisition of the *Imagent* Business, pursuant to a Standstilland Make Whole Agreement with Xmark, we issued a total of 761,250 shares (including11,250 shares as a penalty for the failure to register those shares by April,2003) of our common stock to Xmark and Xmark agreed to not exercise any rightsagainst Alliance as a creditor.  On May2, 2003, we entered into a Going Forward Agreement pursuant to which Xmarkagreed to extend the period during which Xmark had

 

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refrained from exercising its rights as a creditor against Alliance topermit us to complete the acquisition.

 

At the closing of the *Imagent*acquisition, we issued Xmark an additional 1,056,144 shares that representedpayment of interest that was due to Xmark by Alliance through the closing dateof the acquisition.  The value of theseadditional 1,056,144 shares has been treated as part of the purchase price ofthe *Imagent* business.

 

Also at the closing of our acquisition of the *Imagent* assets, pursuant to the GoingForward Agreement, we delivered to Xmark our promissory notes in the totalprincipal amount of $2,500,000.  Thesenotes are payable in two equal installments on August 5, 2003 and November 3,2003 or (if sooner) at the time we complete a financing resulting in at least$18,000,000 of gross proceeds to us and bear interest at 3% over the primerate.  The interest on the notes ispayable in shares of our common stock. Our obligations to Xmark are secured bya first priority security interest on the *Imagent*related tangible and intangible assets. Xmark would be entitled to foreclose on its lien covering these assetsif we default on our obligations to Xmark, if we lose FDA approval for *Imagent*, if we fail to pay other debts, orif we file for bankruptcy protection or similar matters.

 

We defaulted on the principal payment due on August 5, 2003 and Xmarkdelivered a notice to us stating that it was accelerating all amounts due underthe notes.  We negotiated a newagreement with Xmark dated August 18, 2003 (the “Letter Agreement”) pursuant towhich we agreed to make an immediate payment of $1,250,000 and Xmark agreed torescind the default notice.  The otherkey terms of the Letter Agreement are as follows:

 

•                  We remainobligated to make a second principal payment of $1,250,000 on the earlier tooccur of (i) November 3, 2003 or (ii) the consummation of one or moreinstitutional financings resulting in aggregate gross proceeds to us of atleast $18,000,000.  We will have theright to extend the November 3rd due date monthly until April 3,2004 for a fee (and not as a reduction of any amounts due and owing under thepromissory notes) ranging from $50,000 to $100,000 per month.  We have exercised our right to extend theNovember 3, 2003 due date by one month.

 

•                  Within twentydays of the execution of the Letter Agreement we will pay to Xmark, in cash orin shares of our common stock (valued at $1.00 per share, subject to certainadjustments), $26,248 for failure to timely register the shares of our commonstock issued to Xmark for resale, which payment has been made with shares ofour common stock.

 

•                  Our obligationto register the shares of common stock issued to Xmark for resale under theterms of the Going Forward Agreement was terminated and no further penaltypayments or shares will be due to Xmark as a result of our failure to registerthe shares of our common stock held by Xmark. In lieu of the demand registration rights Xmark previously had, theLetter Agreement provides that Xmark will have piggyback registration rights.

 

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•                  The definitionof “Event of Default” in the security agreements securing our obligations toXmark was amended.  The provision thatan Event of Default included any default by us in the payment of borrowed moneyindebtedness was eliminated.  Instead,we agreed that it would be an Event of Default if we made repayments ofborrowed money indebtedness.

 

•                  With regard topayments to certain specified institutions, we agreed that, when paid, we wouldalso make a pro rata payment to Xmark.

 

Except as specifically amended by the Letter Agreement, the terms ofthe Going Forward Agreement and the other agreements governing our obligationsto Xmark remain in effect, including Xmark’s put right with respect to ourcommon stock that Xmark owns.

 

Xmark’s put right, as set forth in the Going Forward Agreement,requires us to repurchase at $1.00 per share up to 750,000 shares of commonstock we issued under the Standstill and Make Whole Agreement and alladditional shares we issue to Xmark under the Going Forward Agreement.  The put right is fully exercisable beginningon the earlier of 13 months after the closing of the acquisition of the *Imagent* assets or the date on which weclose a financing for $20,000,000 or more. Before that time, Xmark can exercise the put right in quarterlyinstallments beginning 90 days after the closing of our acquisition of the *Imagent* assets.  In connection with these quarterly installments, we can elect todefer repurchasing the shares if we lack adequate cash to satisfy our operatingand working capital requirements for the subsequent 18-month period based on anoperating plan approved by our Board. We agreed to use our reasonable efforts to have sufficient cash to meetour operating plan.  If we do notrepurchase these shares, Xmark is entitled to a payment of 1.5% of the value ofthe shares not repurchased for any 30-day period or pro rata portion thereofduring which such failure is continuing.

** **

Three of our existing institutional investors have provided capital tous in exchange for our convertible Promissory Notes in an aggregate principalamount of up to $8,160,000 (at September 30, 2003).  The notes bear interest at a rate of 7.25%per annum, compounded monthly.  A totalof $4,160,000 of these notes are convertible into our common stock.  Unless converted into common stock, amountsdue under the notes were payable on the earlier of August 5, 2003 or thedate that we commit various defaults or become subject to bankruptcy or similarproceedings.  We defaulted on thepayment of $4,160,000 of these notes on August 5, 2003; however, these investorscontinue to loan us capital under demand notes which bear interest at the rateof 7.25% per annum, compounded monthly.

 

The entire principal and interest outstanding under our convertiblenotes to these investors automatically converts into shares of our common stockon the same terms and at the same price as the shares issued in a financing foradditional long-term capital.  In noevent, however, may these be converted into shares of our common stock prior tostockholder approval if and to the extent that conversion would violate Nasdaqrules applicable to us.  To secure theobligations under our notes to these investors, we granted them a securityinterest in all of our tangible and intangible assets, including intellectualproperty.  This lien covers our *Imagent*-related assets, but as to theseassets the investors’ lien is subordinate to the security interest held byXmark.

 

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In the first nine months of 2003, excluding the 1,926,619 shares of ourcommon stock issued to Xmark and the 1,141,993 shares issued to other creditorsof Alliance pursuant to the *Imagent*Business acquisition, we issued an aggregate of 102,594 shares of our commonstock pursuant to several factors including cash, compensation for services andthe cashless exercise of stock options.

 

In the second quarter, we recognized the issuance of 124,627 shares ofour common stock that previously had been subject to rescission.

 

Wehave been financing our operations with the proceeds of the financing we closedin November and December 2002 and January 2003 and, currently, throughborrowings under our promissory notes from certain of our existinginstitutional investors.  Our ability toconduct operations is entirely dependent on our ability to obtain additionalcapital from these and potentially other investors.  If we raiseadditional funds by issuing equity securities, substantial dilution to existingstockholders may result.  However, therecan be no assurance that such capital will be available under acceptable terms,if at all.  See “RiskFactors — We must raise additional financing in the future and ourinability to do so will prevent us from implementing our business developmentplan,” below.

 

Wehave used, and expect over the next 12 months to use the capital available fromsales of common stock and debt, for general corporate purposes, includingactivities related to the marketing and manufacture of *Imagent*, preparing for and conductingclinical trials, purchase and preparation of clinical material, conduct ofpreclinical studies, administrative expenses to support our research anddevelopment activities, capital expenditures and to meet working capital needs.

 

We are currently seeking to raise capital in one or more transactionsto fund our immediate and longer-term capital needs through the privateplacement of securities to accredited investors.  Inaddition, we expect to evaluate from time to time the acquisition or license ofbusinesses, technologies or products. The purchase of any such licenses or technologies would be funded by aportion of any net proceeds of future offerings or the issuance of debt orequity securities specifically for that purpose.  We expect our use ofcapital to increase as we build the commercial presence of *Imagent* and conduct further clinicaltrials of our products in development.

 

Atthe time of the acquisition of the *Imagent*business, we entered into a lease agreement with a unit of Baxter Internationalfor certain equipment used for the manufacture of *Imagent*.  Our annualcost for this lease is approximately $126,000. Our other long-term commitments that are not recorded on our financialstatements are for our office space in San Diego, California.  Annual rent for the California lease, whichexpires in 2008, is approximately $792,000. In addition, we have provided for the remaining lease payments ofcertain laboratory equipment that is no longer useful to our operations.  The lease expires in 2004, and the remainingpayments total approximately $569,024.

 

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**Plan of Operation**

 

Management believes it lacks sufficient working capital to fundoperations****for the entire fiscalyear ending December 31, 2003. Therefore, substantial additional capital resources will be required tofund the ongoing operations related to our marketing and manufacturing of *Imagent* and our research and businessdevelopment activities.  Our financialcondition raises substantial doubt about our ability to continue as a goingconcern.  We believe there are a numberof potential alternatives available to meet the continuing capital requirementssuch as public or private financings or collaborative agreements.  We are taking continuing actions to reduceour ongoing expenses.  If adequate fundsare not available, we will be required to significantly curtail our operatingplans and may have to sell or license out significant portions of ourtechnology or potential products.  The2002 and 2003 financial statements, including those contained in this Form10-QSB, do not include any adjustment to reflect the possible future effects onthe recoverability and classification of assets or the amount andclassification of liabilities that may result from the outcome of thisuncertainty.

 

Duringthe next twelve months we will focus our efforts primarily on exploring variousoptions concerning our businesses, including securing additional financing,joint ventures, licensing or selling all or a portion of our technology andother possible strategic transactions. Our ability to commercialize *Imagent*and develop PH-50 and N1177 depends on the successful implementation of one ormore of these transactions.  In July2003, given our change into an operating company with the acquisition of *Imagent*, we entered into an agreement withTaffy Williams, our Chief Executive Officer. Our agreement with Dr. Williams provided, among other things, that wewould begin a search for a chief executive officer with greater experience inmanaging operating companies.  Since thattime, we have also been working with consultants who have advised us onoperational and management issues.  Inlight of the various options for the future of our business currently underconsideration - including that if we sell *Imagent*we would return to being focused on development rather than operations - theCompany is reevaluating its agreement with Dr. Williams and may seek to extendDr. Williams’ tenure with the Company and amend other provisions of thatagreement.  We have not selected a newChief Executive Officer at this time and Dr. Williams will continue in thatrole until we do.

 

Dependingon the availability of capital and whether or not we pursue a sale or licensingstrategy for *Imagent*, wewill focus our operating efforts on the sales and marketing of *Imagent*. If additional capital becomes available, we also expect to conductpreclinical and human clinical studies of our products in development.  Subject to the availability of sufficientcapital, we expect to continue to incur increasing losses for at least the nextthree years as we intensify research and development, preclinical and clinicaltesting and associated regulatory approval activities and engage in or providefor the manufacture and/or sale of any products that we may develop.

 

Greater capital resources would enable us to quicken and expand ourmarketing and research and development activities, and our failure to raiseadditional capital will (absent a suitable collaborative agreement providingfor a third party to take over these functions) significantly impair or curtailour ability to conduct further activities. In any event, complete development and commercialization of ourtechnology will require substantial additional funds.  See “Risk Factors—We must raise additional financing in thefuture and our inability to do so

 

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will prevent us from implementing our business plan,” below.  We are seeking to raise capital through thesale of our common stock or other securities in a private placement to fund ourimmediate and longer-term capital needs.

 

**ITEM 3****.  CONTROLS AND PROCEDURES**

 

Wemaintain a set of disclosure controls and procedures and internal controlsdesigned to ensure that information required to be disclosed in filings madepursuant to the Securities Exchange Act of 1934 is recorded, processed,summarized and reported within the time periods specified in the SEC’s rulesand forms. Our principal executive and financial officers have evaluated ourdisclosure controls and procedures as of the end of the period covered by thisQuarterly Report on Form 10-QSB and have determined that such disclosurecontrols and procedures are effective.

 

Our recent acquisition of the *Imagent*business from Alliance presents new challenges to our ability to maintaininternal controls and procedures.  Wehave completed the certification of the Company’s internal controls andprocedures in this Form 10-QSB on the basis that the financial informationrelating to the *Imagent* businesswas provided by Alliance’s financing organization, part of the other financialinformation was compiled by our employees who are experienced from theirprevious work for Alliance in performing such tasks for public companies, andother information was prepared in accordance with our normal disclosureprocedures and controls.  As we continueto integrate the *Imagent* businessinto the Company and consolidate the financial function of this business withour previous operations, we intend to reevaluate the effectiveness of ourinternal controls so that they are appropriate to our new business.

 

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**PART II. OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

On June 18, 2003, we filed a complaintagainst Amersham Health, Inc. and two other Amersham affiliates alleging thatcertain Amersham products infringe on claims in our patents covering *Imagent*.  The case is captioned as PhotogenTechnologies, Inc. and Alliance Pharmaceutical Corp. v. Amersham Health Inc.et. al., Civil Action No. 03CV2853(SRC), in the United States DistrictCourt for the District of New Jersey. Our complaint alleges that principally through their Optison® product,Amersham Health Inc. and related Amersham entities infringe on seven patentsowned by us.  We are also seeking adeclaration that the claims of fourteen Amersham patents are invalid and arenot infringed by our *Imagent*product.  Alliance, the party from whomwe recently acquired the *Imagent*product, is also a plaintiff in the suit. We are seeking damages, an injunction against Amersham, a declaratoryjudgment and other relief.

 

Amersham filed an answer dated July 18, 2003 denying the materialallegations of our claims and asserting certain affirmative defenses andcounterclaims.  Amersham’s counterclaimsagainst us include claims of patent infringement, breach of contract, breach ofgood faith and fair dealing, and tortuous interference with contract.  We are studying Amersham’s answer, defensesand counterclaims in consultation with our counsel.

 

On July 29, 2003, the European Patent Office revoked Amersham’sEuropean Patent (EP) No. 620744 with claims directed to contrastagents.  We had brought the oppositionproceeding against the EP ‘744 patent in the European Patent Office.  The EP ‘744 is a counterpart to the patentsthat are the subject of our suit against Amersham in the United Statesdescribed above.

 

**ITEM 2. CHANGES IN SECURITIES**

 

During the nine-month period ending September 30, 2003, we haveissued securities in the transactions described below without registrationunder the Securities Act.  Thesesecurities were offered and sold by us in reliance upon exemptions from theregistration requirements provided by Section 4(2) of the Securities Actand Regulation D under the Securities Act relating to sales not involvingany public offering, and/or Rule 701 under the Securities Act relating totransactions occurring under compensatory benefit plans.  We relied on representations and warrantiesfrom the purchasers of the securities that they were acquiring the securitiesfor their own account and not with a view to, or for sale in connection with,any distribution of the securities in violation of the Securities Act.

 

•                  Pursuant to the terms of the Standstill andMake Whole Agreement dated as of December 30, 2002, in each of January,February and March 2003, we issued 250,000 shares (an aggregate of 750,000shares) to Xmark in exchange for Xmark’s agreement to forbear from exercisingits remedies as a creditor against Alliance.

 

•                  Pursuant to the terms of a ConsultingAgreement dated as of January 30, 2003, we issued up to 75,000 shares ofour common stock to a consultant, subject to certain forfeiture provisions, inexchange for consulting services.  Forfeitureprovisions for 37,500 of these shares have expired through September 30,2003.

 

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•                  During January and February 2003, we awarded40,000 options to acquire common stock pursuant to our 2000 Long Term IncentiveCompensation Plan (the “2000 Plan”).

 

•                  In January 2003 we issued 27,778 shares ofour common stock for cash.

 

•                  On May 27, 2003, we issued an aggregate of11,250 shares to Xmark as a penalty for failing to register for resale theshares of common stock issued to Xmark.

 

•                  In June 2003, we issued an aggregate of10,000 shares of our common stock pursuant to cashless exercise of options.

 

•                  In May and June, 2003, we issued revolvingconvertible senior secured promissory notes to certain of our investors in anaggregate principal amount of $4,160,000 bearing interest at 7.25% annually,compounded monthly.

 

•                  In connection with the acquisition of the *Imagent* assets, we issued an aggregate of2,198,137 shares of our common stock to various creditors of Alliance on June18, 2003.

 

•                  In June 2003, we awarded options to acquire1,865,750 shares of our common stock at an exercise price of $1.25 per share tonew employees under our 2000 Plan.

** **

•                  In July 2003, we granted our Chief ExecutiveOfficer options to acquire 1,050,000 shares of our common stock at an exerciseprice of $1.08 per share, subject to shareholder approval.

** **

•                  In July 2003 we issued 27,216 shares of ourcommon stock as a cashless exercise of certain warrants.

** **

•                  In July 2003 we issued 82,977 shares of ourcommon stock to Xmark for interest and penalty for failing to timely registershares of common stock issued to Xmark.

** **

•                  In September 2003 we issued 26,248 shares ofour common stock to Xmark as a penalty for failing to timely register shares ofcommon stock issued to Xmark.

** **

•                  In the second and third quarter 2003 weissued senior secured promissory notes, payable upon demand, to three of ourinvestors in an aggregate amount of $4,000,000 bearing interest at 7.25%annually, compounded monthly.

** **

Inaddition, in June 2003 we recorded the issuance of 124,627 shares of our commonstock that had previously been subject to rescission.

** **

**ITEM 3. DEFAULTS UPON SENIOR SECURITIES**

 

Under the terms of that certain Going Forward Agreement we entered intowith Xmark dated as of May 2, 2003, we had an obligation to pay Xmark$1,250,000 on August 5, 2003 and an additional $1,250,000 on November 3, 2003or (if sooner) at the time we complete a financing resulting in at least$18,000,000 of gross proceeds to us.  OnAugust 5, 2003, we were unable to make our $1,250,000 payment to Xmark.  On August 6, 2003, we received a defaultnotice from Xmark regarding our failure to make the $1,250,000 payment.  On August 18, 2003, we entered into a LetterAgreement with Xmark pursuant to which we agreed to make an immediate paymentof $1,250,000 and Xmark agreed to rescind the default notice.  The other key terms of the Letter Agreementare as follows:

 

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•                  We remainobligated to make a second principal payment of $1,250,000 on the earlier tooccur of (i) November 3, 2003 or (ii) the consummation of one or moreinstitutional financings resulting in aggregate gross proceeds to us of atleast $18,000,000.  We will have theright to extend the November 3rd due date monthly until April 3,2004 for a fee (and not as a reduction of any amounts due and owing under thepromissory notes) ranging from $50,000 to $100,000 per month.  We have extended the November 3rddue date to December 3rd for a fee of $50,000.

 

•                  Within twentydays of the execution of the Agreement we will pay to Xmark, in cash or inshares of our common stock (valued at $1.00 per share, subject to certainadjustments), $26,248 for failure to timely register the shares of our commonstock issued to Xmark for resale, which payment has been made with shares ofour common stock.

 

•                  Our obligationto register the shares of common stock issued to Xmark for resale under theterms of the Going Forward Agreement was terminated and no further penaltypayments or shares will be due to Xmark as a result of our failure to registerthe shares of our common stock held by Xmark. In lieu of the demand registration rights Xmark previously had, theLetter Agreement provides that Xmark will have piggyback registration rights.

 

•                  The definitionof “Event of Default” in the security agreements securing our obligations toXmark was amended.  The provision thatan Event of Default included any default by us in the payment of borrowed moneyindebtedness was eliminated.  Instead,we agreed that it would be an Event of Default if we made repayments ofborrowed money indebtedness; and with regard to payments to certain specifiedinstitutions, we agreed that we would also make a pro rata payment to Xmark.

 

Except as specifically amended by the Agreement, the terms of the GoingForward Agreement and the other agreements governing our obligations to Xmarkremain in effect, including, but not limited to, Xmark’s put right with respectto our common stock that Xmark owns.

 

We were also obligated to repay our convertible promissory notes infavor of three of our investors for an aggregate principal amount of $4,160,000as of August 5, 2003.  We were unable tomeet our obligation under the terms of these notes at that time; however, thesenote holders continue to loan us capital, as evidenced by secured promissorynotes bearing interest at 7.25% per annum, compounded monthly and payable upondemand.  Our obligations to these noteholders are secured by a second priority lien in favor of the note holders onour *Imagent*-related assets and afirst priority lien in favor of the note holders on all of our other assets.

 

**ITEM 5. OTHER INFORMATION**

 

**RISK FACTORS**

 

This Form 10-QSB contains (and press releases and other publicstatements we may issue from time to time may contain) a number offorward-looking statements regarding our business and operations.  Statements in this document that are nothistorical facts are forward-looking statements.  Such forward-looking statements include those relating to:

 

•                  our currentbusiness and product development plans,

 

•                  our futurebusiness and product development plans,

 

•                  the timing andresults of regulatory approval for proposed products, and

 

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•                  projectedcapital needs, working capital, liquidity, revenues, interest costs and income.

 

Examples of forward-looking statements include predictive statements,statements that depend on or refer to future events or conditions, andstatements that may include words such as “expects,” “anticipates,” “intends,”“plans,” “believes,” “estimates,” “should,” “may,” or similar expressions, orstatements that imply uncertainty or involve hypothetical events.

 

Forward-looking statements involve known and unknown risks anduncertainties that may cause our actual results in future periods to differmaterially from what is currently anticipated. We make cautionary statements in certain sections of this Form 10-QSB,including under “Risk Factors.”  Youshould read these cautionary statements as being applicable to all relatedforward-looking statements wherever they appear in this Form 10-QSB, in thematerials referred to in this Form 10-QSB, in the materials incorporated byreference into this Form 10-QSB, or in our press releases or other publicstatements.  In light of these risks,uncertainties and assumptions, the forward-looking events discussed in thisForm 10-QSB or other documents incorporated by reference might not occur.  No forward-looking statement is a guaranteeof future performance and you should not place undue reliance on anyforward-looking statement.

 

The following are the key risk factors that may affect our futureresults:

 

**We must raiseadditional financing in the future and our inability to do so will prevent usfrom continuing as a going concern and implementing our business developmentplan.**

 

During 2002, we sold $12,028,902 of our common stock to certaininstitutional investors and a group of individual accredited investors at aprice per share of $1.08 ($2,500,000 of which was from the conversion of ouroutstanding note payable to Tannebaum, LLC). Our cash and securities on hand at September 30, 2003, followingexpenditures incurred by our operations and the acquisition of the *Imagent* Business including the financingof that business pending its acquisition, was approximately $227,970.  We have expended all these funds and arecurrently funding our operations through the issuance of secured promissorynotes to one or more of our principal institutional investors.  We will need substantial additionalfinancing for our marketing and product development programs.

 

We cannot accurately estimate the amount of additional financingrequired to develop our products.  Inparticular, we are currently seeking capital in one or more transactions tofund our immediate and longer-term capital needs through a private placement toaccredited investors.  Additional fundsmay not be available on acceptable terms, if at all, and existing stockholders maybe diluted as a result of those offerings. The pricing of our common stock, or other securities convertible intocommon stock, in any such transaction may also result in an increase in thenumber of shares of common stock issuable upon exercise of warrants inaccordance with the anti-dilution provisions in the instruments governing thosesecurities.

 

**Prior to ouracquisition of the *Imagent*assets, we were a development stage company, we have conducted only limitedstudies on our products in development and we do not have any revenues from sales.**

 

Our company and our technologies, other than our recently acquired *Imagent* product, are in early stages ofdevelopment. We began our business as a biopharmaceutical company in 1997.  To date, we have not generated revenues fromsales or operations.  We expect togenerate revenue from sales of our newly acquired product, *Imagent*, but there can be no assurancethat we will be able to generate enough revenue from such sales to beprofitable for at least several years, if at all.

 

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The drug products we currently contemplate developing will requirecostly and time-consuming research and development, preclinical and clinicaltesting and regulatory approval before they can be commercially sold.  We may not be able to develop our technologyinto marketable products or develop our technology so it is effective fordiagnosis or treatment of human diseases. As a result of changing economic considerations, market, clinical orregulatory conditions, or clinical trial results, we may shift our focus ordetermine not to continue one or more of the projects we are currentlypursuing.

 

**We have a history of losses and we may notachieve or maintain profitability in the future or pay cash dividends.**

 

We have incurred losses since the beginning of our operations.  As of September 30, 2003, we haveincurred cumulative net losses (before dividends on preferred stock) ofapproximately $46,337,376.  We expectour losses to increase in the future as our financial resources are used forresearch and development, preclinical and clinical testing, regulatoryactivities, manufacturing, marketing and other related expenses.  We may not be able to achieve or maintainprofitability in the future.  We havenever declared or paid any cash dividends to stockholders and do not expect todo so in the foreseeable future.

 

**The market forimaging products is extremely competitive, and many of our competitors havegreater resources and have products that are in more advanced stages ofdevelopment than we do, which may give them a competitive advantage over us.**

 

In addition to the *Imagent*product*,* there are currently twoFDA approved ultrasound contrast agents being marketed in the U.S. for certaincardiology applications by Amersham Health, Inc. and Bristol-Myers Squibb.  In addition, Bracco International has fileda New Drug Application with the FDA seeking approval to market itsproduct.  Two other companies (POINT Biomedicaland Acusphere) are in advanced clinical trials for the use of ultrasoundcontrast agents for assessing certain organs and vascular structures.  We expect that competition in the ultrasoundcontrast imaging field will be based primarily on each product’s safetyprofile, efficacy, stability, ease of administration, breadth of approvedindications, and physician, healthcare payer and patient acceptance.  We are at the very early stages of launchingthe *Imagent* product, and wecannot predict whether it will compete successfully with these other products.

 

**We filed a suit against Amersham for patent infringementwhich, if resolved unfavorably, could impede our ability to utilize our patentsfor *Imagent*.**

 

We filed acomplaint against Amersham Health, Inc. and two other Amersham affiliatesalleging that certain Amersham products infringe on claims in our patentscovering *Imagent*.  We also seek a declaration that our patentsdo not infringe on Amersham’s in this area, and other relief.  Alliance joined us as a plaintiff in thissuit.  Amersham filed an answer denyingthe material allegations of our claims and asserting certaincounterclaims.  If the suit is resolvedunfavorably to us, we may have difficulty utilizing the protections of ourpatents for *Imagent* and there maybe other complications that may make it difficult to implement ourcommercialization strategy for *Imagent*.

 

**Our common stock could be delisted from the NASDAQ SmallCapMarket, which would make trading in our common stock more difficult.**

 

Since November1999, our common stock has been quoted in the Nasdaq SmallCap Market.  Our shares could be delisted if we fail tomeet the listing requirements of the Nasdaq SmallCap Market, which would forceus to list our shares on the OTC Bulletin Board or some other quotation medium,such as pink sheets, depending upon our ability to meet the specific listingrequirements of those quotation systems. As a result, an investor might find it more difficult to dispose of, orto obtain accurate price

 

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quotations for, ourshares.  Delisting might also reduce thevisibility, liquidity and price of our common stock.

 

On August 26, 2003 andSeptember 8, 2003, we received notices from Nasdaq that we did not meetspecified listing criteria.  Wecorrected the identified deficiencies to Nasdaq’s satisfaction and Nasdaqnotified us that it had withdrawn its delisting notice.

 

If our commonstock were delisted from the Nasdaq SmallCap Market and were not traded onanother national securities exchange, we could become subject to penny stockregulations that impose additional sales practice disclosure and market makingrequirements on broker/dealers who sell or make a market in our stock.  The rules of the SEC generally define “pennystock” to be common stock that has a market price of less than $5.00 per shareand is not traded on a national exchange. If our stock became subject to penny stock regulations, it couldadversely affect the ability and willingness of broker/dealers who sell or makea market in our common stock and of investors to purchase or sell our stock inthe secondary market.

 

**Our proposed products are subject to extensive testing andgovernment approval, and we may not obtain or maintain the approvals necessaryto sell our proposed products.**

 

Other than *Imagent*, none of our proposed imagingproducts has received the FDA’s approval. An extensive series of clinical trials and other associated requirementsmust be completed before our proposed products can be approved and sold in theU.S. or other countries.  Requirementsfor FDA approval of a product include preclinical and clinical testing foreffective use and safety in animals and humans, which can be extremelycostly.  The time frame necessary toperform these tasks for any individual product is long and uncertain, and wemay encounter problems or delays that we cannot predict at this time.  Even if testing is successful, our proposedproducts may not demonstrate sufficient effectiveness or safety to warrantapproval by the FDA or other regulatory authorities.  Any regulatory approval may not cover the clinical symptoms orindications that we may seek.  We mustalso obtain regulatory approvals comparable to those required in the U.S. tomarket our products in other countries.

 

Other than *Imagent*, our proposed technologies andproducts generally must complete preclinical tests in animals and three phasesof tests (also called clinical trials) in humans before we can market them foruse.  Use of our technology has beenlimited primarily to laboratory experiments and animal testing; only N1177 hascompleted Phase 1 human clinical trials. We have not yet conducted substantive studies on the effectiveness ofour compounds on human subjects.

 

Our resultsfrom early clinical trials may not predict results that we will obtain inlarge-scale clinical trials, as a number of companies have suffered significantsetbacks in advanced clinical trials, even after promising results in earlytrials.

 

We may notconduct additional Phase 2 or Phase 3 clinical trials for our products and suchtrials, if begun, may not demonstrate any efficacy or may not be completedsuccessfully in a timely manner, if at all.

 

The rate ofcompletion of our clinical trials depends upon, among other things, the rate ofpatient enrollment.  Patient enrollmentis a function of many factors, including the size of the patient population fora particular indication, the nature of the clinical protocol under which ourproducts will be studied, the proximity of the patient to a clinical site andthe eligibility criteria for the study. Delays in planned patient enrollment may result in increased costs,regulatory filing delays, or both.

 

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Furthermore,we, the FDA or other regulatory authorities may alter, suspend or terminateclinical trials at any time.  If we donot successfully complete clinical trials and obtain regulatory approval for aproduct, we will not be able to market that product.

 

**Any products approved by the FDA are subject to postmarketrequirements of the FDA.**

 

Our FDA approvedproduct, *Imagent*, is subject tonumerous postmarket requirements by regulatory authorities.  We will be subject to inspection andmarketing surveillance by the FDA to determine our compliance with regulatoryrequirements with respect to any approved products.  If the FDA finds that we have failed to comply, it can institutea wide variety of enforcement actions, ranging from a public warning letter tomore severe sanctions such as:

 

•                  fines, injunctions and civil penalties;

 

•                  recall or seizure of our products;

 

•                  operating restrictions, partial suspension ortotal shutdown of production; and

 

•                  criminal prosecution.

 

Anyenforcement action by the FDA may also affect our ability to commerciallydistribute our products in the U.S.

 

**Product liability claims could increase our costs andadversely affect our results of operations.**

 

The clinicaltesting, manufacturing and marketing of our product candidates may expose us toproduct liability claims, and we may experience material product liabilitylosses in the future.  We maintaincertain levels of product liability insurance for the use of our products, butour coverage may not continue to be available on terms acceptable to us oradequate for liabilities we actually incur. A successful claim brought against us in excess of available insurancecoverage, or any claim or product recall that results in significant adversepublicity against us, may have a material adverse effect on our business andresults of operations.

** **

**If we do not obtain and maintain patent or other protectionof our core technologies, we may have difficulty commercializing products usingthese technologies.**

 

Our successdepends in part on our ability to obtain, assert and defend our patents,protect trade secrets and operate without infringing the intellectual propertyof others.  Among the important risks inthis area are that:

 

•                  Our patent applications may not result inissued patents.  Moreover, any issuedpatents may not provide us with adequate protection of our intellectualproperty or competitive advantages, and the law on the scope of patent coverageis continually changing.

 

•                  Various countries limit the subject matterthat can be patented and limit the ability of a patent owner to enforce patentsin the medical field.  This may limitour ability to obtain or utilize those patents internationally.

 

•                  Existing or future patents or patentapplications (and the products or methods they cover) of our competitors (orothers, such as research institutions or universities) may interfere, invalidate,conflict with or infringe our patents or patent applications.  Similarly, the use

 

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ofthe methods or technologies contained in our patents, patent applications andother intellectual property may conflict with or infringe the rights of others.

 

•                  If an advance is made that qualifies as ajoint invention, the joint inventor or his or her employer may have rights inthe invention.

 

We will beable to protect our proprietary rights from unauthorized use by third partiesonly to the extent that these rights are covered by valid and enforceablepatents or effectively maintained as trade secrets.  We own two patents in the U.S., and certain other patents in foreigncountries including Australia, Canada, Japan and Germany that relate to methodsfor performing lymphography.  We alsoacquired an extensive patent portfolio related to *Imagent* as part of the acquisition of the *Imagent* business.

 

Other than thepatents and patent applications we acquired through the purchase of the *Imagent* Business, we have filed patentapplications in the U.S. and under the Patent Cooperation Treaty covering anumber of foreign countries.  Thesepatent applications relate to the use of nanoparticulates, including PH-50, ascardiovascular imaging agents and to deliver pharmacologically activesubstances for treatment of various diseases. We are also the exclusive licensee of a group of patented proprietarycompounds known as “nanoparticulates,” including N1177 and PH-50 from NycomedImaging AS.  We are the exclusivelicensee of U.S. and foreign patent applications from Massachusetts GeneralHospital which relate to diagnostic imaging agents and methods for using thediagnostic imaging agents for medical location, treatment and diagnosis oftumors and other diseased tissues.

 

Additionalpatents may never be issued on any of the patent applications we own or licensefrom third parties.  Furthermore, evenif such patents are issued, the validity of the patents might successfully bechallenged by a third party.  Thepatents might not provide protection against competitive products or otherwisebe commercially valuable, or the applications filed by others might result inpatents that would be infringed by the manufacture, use or sale of ourproducts.

 

The patentposition of biopharmaceutical companies involves complex legal and factualquestions and therefore we cannot assure the enforceability of thesepatents.  Litigation over patents andother intellectual property rights occurs frequently in our industry and thereis a risk that we may not prevail in disputes over the ownership ofintellectual property.  Further, aninterference proceeding with the Patent and Trademark Office may be institutedover the rights to certain inventions and there is a risk that we may notprevail in such an interference proceeding. Those disputes can be expensive and time consuming, even if weprevail.  Intellectual property disputesare often settled through licensing arrangements that could be costly tous.  In any intellectual propertylitigation, it is possible that licenses necessary to settle the dispute wouldnot be available on commercially reasonable terms or that we would not be ableto redesign our technologies to avoid any claimed infringement.

 

Confidentialityagreements covering our intellectual property may be violated and we may nothave adequate remedies for any violation. Third parties may challenge our existing patents and seek to hold theminvalid or unenforceable.  Also, ourintellectual property may in other ways become known or be independentlydiscovered by competitors.

 

To the extentwe use intellectual property through licenses or sub-licenses (as is the casefor some of our lymphography technology), our rights are subject to us performingthe terms of the license or sub-license agreement with third parties.  Our rights are also subject to the actionsof third parties we may not be able to control, such as our sub-licensorcomplying with the terms of its license with the patent owner and the patentowner maintaining the patent.

 

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Whereintellectual property results from a research project supported by governmentfunding, the government has limited rights to use the intellectual propertywithout paying us a royalty.

 

**We are highly dependent upon a small number of employees andconsultants who provide management expertise, and it may be difficult toimplement our business operations and development plans without this expertise.**

 

Theseindividuals have entered into employment or consulting agreements,confidentiality and/or non-competition agreements with us.  We could suffer competitive disadvantage,loss of intellectual property or other material adverse effects on our businessand results of operations if any employee or consultant violates or terminatesthese agreements or terminates his or her association with us.  Our growth and future success also dependsupon the continued involvement and contribution from these individuals, as wellas our ability to attract and retain highly qualified personnel now and in thefuture.

 

We currentlyemploy two senior executive officers, including Dr. Williams (our ChiefExecutive Officer) and Mr. Boveroux (our Chief Financial Officer).  We also have retained consultants to adviseus in regulatory affairs and product development matters.  If we lost the services of our executiveofficers or outside consultants, we could experience a delay in theimplementation of our business plan until we arranged for another individual orfirm to fulfill the role.

 

**The raw materials necessary for themanufacture of PH-50 and N1177 are supplied by one supplier.  The raw materials for *Imagent* are subject to a long-term supplycontract with one supplier.  Aninterruption in availability of those materials may impair our ability to testand market those products.**

 

We haveassumed the rights and obligations of Alliance under the terms of the long-termsupply agreement that Alliance has entered for the principal raw material for *Imagent. *Althoughsome raw materials for the *Imagent*product are currently qualified from only one source and we have someinventory, we will attempt to acquire additional inventory of these materialsand to negotiate long-term supply arrangements.  Raw materials used in *Imagent*cannotbe changed without equivalency testing of any new material by us and approvalof the FDA.

 

We currentlyrely on Nanosystems, a division of Élan, as the sole supplier of the rawnanoparticulates used to manufacture PH-50 and N1177.  There can be no assurance that Nanosystems will continue tosupply us with the raw materials that we need in a timely manner on conditionsthat are acceptable to us.

** **

**We may encounter difficulties starting orexpanding our manufacturing operations.**

 

We are leasinga single manufacturing facility located in San Diego, California.  This facility is subject to a variety ofquality systems regulations, international quality standards and otherregulatory requirements, including requirements for good manufacturingpractices, or current good manufacturing procedures.  We may encounter difficulties expanding our manufacturingoperations in compliance with these regulations and standards, which also couldresult in a delay or termination of manufacturing or an inability to meetproduct demand.

 

We will facerisks inherent in operating a single facility for the manufacture of *Imagent.* At this time, we do not have alternative production plans in place oralternative facilities available should the San Diego manufacturing facilitycease to function.  These risks includeunforeseen plant shutdowns due to personnel, equipment or other factors, andthe resulting inability to meet customer orders on a timely basis.

 

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**We have to rely on third parties and collaborativerelationships for the manufacture, clinical testing and marketing of *Imagent* and our proposed products, and itmay be difficult to implement our business development plans without thesecollaborations.**

 

We currentlyhave an agreement for sales and marketing of *Imagent*by Cardinal Health, Inc. that is under reevaluation to be more consistent withour current needs and resources.  Wehave had and expect to continue in the future to have a variety of researchagreements with universities and other research institutions to investigatespecific protocols.  We also contractand expect to continue to contract with research organizations and other thirdparties to manage clinical trials of our proposed products in development.  We must obtain and maintain collaborativerelationships with third parties for research and development, preclinical andclinical testing, marketing and distribution of our proposed products.

 

We arecurrently involved in a joint venture with affiliates of Élan, calledSentigen, Ltd., to develop and commercialize materials in the field oflymphography.  Collaborativerelationships may limit or restrict our operations or may not result in anadequate supply of necessary resources. Our collaborative partner could also pursue alternative technologies asa means of developing or marketing products for the diseases targeted by ourcollaborative program.  If a third partywe are collaborating with fails to perform under its agreement or fails to meetregulatory standards, this could delay or prematurely terminate clinicaltesting of our proposed products.

** **

**Our products may not be fully accepted by physicians,laboratories and health insurance providers, which would reduce our revenue andlimit our ability to raise capital.**

 

Our growth andsuccess will depend upon market acceptance by physicians, laboratories andhealth insurance providers of our products. This requires acceptance of our products as clinically useful andcost-effective alternatives to other medical imaging methods.  In addition, physicians may utilize imagingtechniques other than those for which our products are being developed (such asmagnetic resonance imaging (MRI)) to image internal vasculature and organs andtherefore, our products may not be utilized.

** **

**Changes in health care reimbursement policies or legislationmay make it difficult for patients to use or receive reimbursement for usingour products, which could reduce our revenues.**

 

Our successwill depend, in part, on the extent to which health insurers, managed careentities and similar organizations provide coverage or reimbursement for usingthe medical procedures and devices we plan to develop.  These third-party payers are increasinglychallenging the price of medical procedures and services and establishingguidelines that may limit physicians’ selections of innovative products andprocedures.  We also cannot predict theeffect of any current or future legislation or regulations relating tothird-party coverage or reimbursement on our business.  We may not be able to achieve marketacceptance of our proposed products or maintain price levels sufficient toachieve or maintain any profits on our proposed products if adequate reimbursementcoverage is not available.  Failure byphysicians, hospitals and other users of our products to obtain sufficientreimbursement from third-party payers for the procedures in which our productswould be used or adverse changes in governmental and private third-partypayers’ policies toward reimbursement for such procedures would have a materialadverse effect on our business.

** **

**A small group of stockholders control Photogen, which maymake it difficult for stockholders who are not in that group to influencemanagement.**

 

As ofSeptember 30, 2003, a small group of stockholders control approximately64.7% of our outstanding common stock. Several of our principal stockholders are also parties to a Voting,Drag-Along

 

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and Right of First RefusalAgreement (the “Voting Agreement”) concerning the election of certain designeesto the Board of Directors.  The VotingAgreement requires these stockholders to vote their shares for the election ofcertain individuals nominated by parties to the Voting Agreement.  This concentration of ownership and controlmay delay or prevent a change in control of Photogen, and may also result in asmall supply of shares available for purchase in the public securities markets.These factors may affect the market and the market price for our common stockin ways that do not reflect the intrinsic value of our common stock.

 

**The price and trading volume of our common stock fluctuatessignificantly, like that of many biopharmaceutical companies, which may make itdifficult for us or a stockholder to sell our common stock at a suitable priceand may cause dilution for existing stockholders when we issue additionalshares.**

 

During theperiod from January 1, 2003 through September 30, 2003 the closingtrade price of our common stock ranged from $2.73 to $0.90****per share.  Daily trading volume ranged from zero shares to approximately42,900 shares during that period.

 

The marketprices for securities of biopharmaceutical companies in general have beenhighly volatile and may continue to be highly volatile in the future.  The following factors may have an impact onthe price of our common stock:

 

•                  Announcements by us or others regardingscientific discoveries, technological innovations, commercial products, patentsor proprietary rights;

 

•                  Announcements by us concerning the licensingor other transactions of our products or technologies;

 

•                  Private sale of a significant block of ourcommon stock at a price below the then current market price of our common stockand the subsequent registration and sale of those shares;

 

•                  The progress of preclinical or clinicaltesting;

 

•                  Developments or outcome of litigationconcerning proprietary rights, including patents;

 

•                  Changes in government regulation;

 

•                  Public concern about the safety of devices ordrugs;

 

•                  Limited coverage by securities analysts;

 

•                  The occurrence of any of the risk factorsdescribed in this section;

 

•                  Sales of large blocks of stock by anindividual or institution;

 

•                  Changes in our financial performance fromperiod to period, securities analysts’ reports, and general market conditions;and

 

•                  Economic and other external factors or adisaster or crisis.

 

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**If stockholders holding substantial amounts of our common stockshould sell their stock in the public market, the price of our stock could falland it may be more costly for us to raise capital.**

 

Wehave reserved shares of common stock for future issuance upon grants ofoptions, or exercise or conversion of outstanding options and warrants andconvertible securities.  In addition,some of our shares are eligible for sale in the public market free ofrestriction under Rule 144 of the Securities Act.  Others shares of our common stock aresubject to agreements requiring us to permit the holders of the shares, undercertain circumstances, to join in a public offering of our stock or to demandthat we register their shares for resale.

 

Ifour options and warrants are all issued and exercised, investors may experiencesignificant dilution in the voting power of their common stock.  The sale of these shares could placedownward pressure on the overall market price of our common stock.

 

**ITEM 6****.****                                                     EXHIBITSAND REPORTS ON FORM 8-K**

 

(a)                                  Exhibits.

 

The followingis a list of exhibits filed as part of this Form 10-QSB.  Exhibits that were previously filed areincorporated by reference.  For exhibitsincorporated by reference, the location of the exhibit in the previous filingis indicated in parenthesis.

 
| **EXHIBIT NO.** |   | **DESCRIPTION**                                                                                                                                                                                                                                    |
|-----------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                                                                                                                                                               |
| 10.1            |   | Agreement dated as of  August 14, 2003 by and between Photogen Technologies, Inc., Xmark Fund, Ltd.  and Xmark Fund, L.P. (Filed as Exhibit 10.1 to the Company’s 8-K filed on  August 15, 2003 and incorporated herein by reference.)        |
|            |   |                                                                                                                                                                                                                                               |
| 10.2            |   | Letter Agreement dated  as of August 18, 2003 by and between Photogen Technologies, Inc., Xmark Fund,  Ltd. and Xmark Fund, L.P. (Filed as Exhibit 10.1 to the Company’s 8-K filed  on August 20, 2003 and incorporated herein by reference.) |
|            |   |                                                                                                                                                                                                                                               |
| 10.3            |   | Agreement dated as of  February 28, 2002 by and between RedKey, Inc. and Alliance Pharmaceutical  Corp. Confidential portions of this exhibit were redacted.                                                                                       |
|            |   |                                                                                                                                                                                                                                               |
| 10.4            |   | Agreement and Assignment  dated as of June 11, 2003 by and among Photogen Technologies, Inc., Cardinal  Health 411, Inc., Cardinal Health 105, Inc. and Alliance Pharmaceutical Corp.  Confidential portions of this exhibit were redacted.        |
|            |   |                                                                                                                                                                                                                                               |
| 10.5            |   | Agreement dated as of July 23, 2003  between Taffy J. Williams, Ph.D. and Photogen Technologies, Inc.                                                                                                                                              |
|            |   |                                                                                                                                                                                                                                               |
| 31.1            |   | Certification  of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002.                                                                                                                                          |
|            |   |                                                                                                                                                                                                                                               |
| 31.2            |   | Certification  of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002.                                                                                                                                          |

 

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| 32.1   |   | Certification  of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                     |
| 32.2   |   | Certification  of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

(b)                                 Reportson Form 8-K.

 

The followingreports on Form 8-K were filed during the three-month period endingSeptember 30, 2003:

 

1.                                       On July 28, 2003, the Company filed a CurrentReport on Form 8-K disclosing under Item 5 the filing of an answer to ourcomplaint against Amersham Health, Inc. and two other Amersham affiliatesdenying the material allegations of our claims and asserting certainaffirmative defenses and counterclaims.

 

2.                                       On August 6, 2003, the Company filed aCurrent Report on Form 8-K disclosing under Item 5 our inability to meet ourobligations to Xmark under the terms of the Going Forward Agreement and tothree of our investors under the terms of various promissory notes.

 

3.                                       On August 7, 2003, the Company filed aCurrent Report on Form 8-K disclosing under Item 5 that we were not indiscussions with Xmark concerning restructuring of the Xmark indebtedness.

 

4.                                       On August 15, 2003,the Company filed a Current Report on Form 8-K disclosing under Items 5, 6 and7 our borrowings from two of our investors, the Agreement with Xmark datedAugust 14, 2003, the appointment of Jonathan Fleming to our Board and theresignations of various directors of the Company.

 

5.                                       On August 20, 2003, the Company filed aCurrent Report on Form 8-K disclosing under Item 5 our letter agreement withXmark dated August 18, 2003.

 

6.                                       On August 29, 2003, the Company filed aCurrent Report on Form 8-K disclosing under Item 5 Nasdaq’s notification on August26, 2003 of our failure to comply with the requirements for continued listing.

 

7.                                       On September 11, 2003, the Company filed aCurrent Report on Form 8-K disclosing under Item 5 Nasdaq’s notification ofadditional deficiencies on September 8, 2003.

 

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**Signatures**

 

In accordance with the requirements of the Exchange Act, the registranthas caused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 
| Date:  November 19, 2003 | Photogen Technologies, Inc.                                                                                                           |
|------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------|
|                               |                                                                                                                                  |
|                               |                                                                                                                                  |
|                               | /s/ Taffy J. Williams                                                                                                                 |
|                               | Taffy J. Williams, Ph.D., President  and Chief Executive Officer                                                                      |
|                               |                                                                                                                                  |
|                               |                                                                                                                                  |
|                               | /s/ Brooks Boveroux                                                                                                                   |
|                               | Brooks Boveroux, Senior Vice President – Finance and Chief Financial  Officer (Principal Financial and Chief Accounting Officer) |

 

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**ExhibitIndex**

 
| **EXHIBIT NO.** |   | **DESCRIPTION**                                                                                                                                                                                                                                       |
|-----------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                                                                                                                                                                  |
| +10.1           |   | Agreement dated as of August 14, 2003 by  and between Photogen Technologies, Inc., Xmark Fund, Ltd., and Xmark Fund L.  P. (Filed as Exhibit 10.1 to the Company’s 8-K filed on August 15, 2003 and  incorporated herein by reference.)          |
|            |   |                                                                                                                                                                                                                                                  |
| +10.2           |   | Letter Agreement dated  as of August 18, 2003 by and between Photogen Technologies, Inc., Xmark Fund,  Ltd., and Xmark Fund L.P. (Filed as Exhibit 10.1 to the Company’s 8-K filed  on August 20, 2003 and incorporated herein by reference.)    |
|            |   |                                                                                                                                                                                                                                                  |
| *10.3           |   | Agreement dated as of February 28, 2002  by and between RedKey, Inc. and Alliance Pharmaceutical Corp. Confidential portions of this  exhibit were redacted.                                                                                          |
|            |   |                                                                                                                                                                                                                                                  |
| *10.4           |   | Amendment and Assignment Agreement dated  as of June 11, 2003 by and among Photogen Technologies, Inc., Cardinal Health  411, Inc., Cardinal Health 105, Inc. and Alliance Pharmaceutical Corp. Confidential portions of this  exhibit were redacted. |
|            |   |                                                                                                                                                                                                                                                  |
| *10.5           |   | Agreement dated as of July 23, 2003  between Taffy J. Williams, Ph.D. and Photogen Technologies, Inc.                                                                                                                                                 |
|            |   |                                                                                                                                                                                                                                                  |
|  *31.1     |   | Certification of Principal Executive  Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                              |
|            |   |                                                                                                                                                                                                                                                  |
| *31.2           |   | Certification of Principal Financial  Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                              |
|            |   |                                                                                                                                                                                                                                                  |
| *32.1           |   | Certification of Principal Executive  Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section  906 of the Sarbanes-Oxley Act of 2002.                                                                                              |
|            |   |                                                                                                                                                                                                                                                  |
| *32.2           |   | Certification of Principal Financial  Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section  906 of the Sarbanes-Oxley Act of 2002.                                                                                              |

 

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*Filedherewith

+Incorporatedherein by reference

 

44

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